(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)
(Zip
Code)
Registrant’s
telephone number, including area code: (702)
796-9090
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
o No
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
x No
As
of
June 30, 2006, there were 11,341,612 shares of the Registrant’s common stock,
$0.001 par value, issued and outstanding.
Accounts
Receivable, net of allowance for doubtful accounts
1,227,211
1,311,849
Inventories
1,332,901
1,270,445
Prepaid
Expenses
984,278
957,889
Income
tax refund
159,490
-
Deferred
tax asset
137,110
82,604
Total
current assets
28,744,978
4,134,304
Property
and Equipment, net of accumulated depreciation
6,085,877
5,016,573
Other
assets, net of accumulated amortization
266,845
1,176,671
Deferred
tax asset
756,357
720,955
Total
assets
$
35,854,057
$
11,048,503
Liabilities
and stockholders' equity:
Current
liabilities:
Accounts
Payable
$
474,517
$
330,564
Commissions
Payable
282,271
184,863
Accrued
Expenses
252,867
184,496
Income
Taxes Payable
0
158,446
Notes
payable, current portion
246,905
536,495
Total
current liabilities
1,256,560
1,394,864
Notes
payable, net of current portion
—
—
Stockholders'
equity:
Common
stock (0.001 par value, 150,000,000 shares authorized, 8,350,000
for
December 31, 2005 and 11,341,612 for June 30, 2006 of shares issued
and
outstanding)
11,342
8,350
Additional
paid in capital
29,435,095
4,702,039
Retained
earnings
5,151,060
4,943,250
Total
stockholders’ equity
34,597,497
9,653,639
Total
liabilities and stockholders’ equity
$
35,854,057
$
11,048,503
See
notes
to condensed consolidated financial statements.
Adjustments
to reconcile net income to net cash provided by operating
activities:
Depreciation
888,421
1,012,287
Amortization
227,071
227,069
Stock
for services
983,774
Change
in operating assets and liabilities:
Accounts
receivable
84,638
145,679
Inventories
(62,456
)
274,137
Prepaid
expenses
(26,389
)
(596,241
)
Deferred
Tax
(89,908
)
(189,644
)
Income
tax receivable
(159,490
)
136,525
Other
assets
(2,967
)
(10,931
)
Accounts
payable
143,953
24,461
Accrued
expenses
68,371
53,230
Commissions
payable
97,409
90,952
Income
tax payable
(158,446
)
9,036
Net
cash provided by operating activities
2,201,791
2,327,989
Cash
flows from investing activities:
Purchase
of assets
(1,934,447
)
(960,443
)
Proceeds
on disposal of assets
Net
cash used in investing activities
(1,934,447
)
(960,443
)
Cash
flows from financing activities
Dividends
—
(90,000
)
Sale
of Stock
24,414,717
—
Payments
on note payable
(289,590
)
(275,494
)
Net
cash used in financing activities
24,125,127
(365,494
)
Net
increase (decrease) in cash and cash equivalents
24,392,471
1,002,052
Cash
and cash equivalents, beginning
511,517
1,379,925
Cash
and cash equivalents, ending
$
24,903,988
$
2,381,977
Supplemental
disclosure of cash flow information:
Interest
$
10,268
$
19,873
Cash
paid for income taxes
$
547,337
$
783,863
See
notes
to condensed consolidated financial statements.
6
FORTUNET,
INC.
NOTES
TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
1.
Nature
of Business and Interim Basis of Presentation:
Nature
of business:
FortuNet,
Inc. (We, FortuNet or the Company) was incorporated in 1989 in Nevada. FortuNet
is engaged primarily in the business of designing, manufacturing and leasing
electronic bingo and entertainment systems throughout North America.
FortuNet
derives 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.
Interim
Basis of Presentation:
The
accounting policies followed in the preparation of the financial information
herein are the same as those summarized in the Company’s 2005 Annual Report on
Form 10-K, except for the Company’s adoption of Statement of Financial
Accounting Standards (“SFAS”) No. 123R on January 1, 2006 (see Notes 3
and 4). The condensed consolidated balance sheet at December 31, 2005 was
derived from audited consolidated financial statements at that date. The interim
condensed consolidated financial information is unaudited and should be read
in
conjunction with the Company’s 2005 Annual Report on Form 10-K. In the opinion
of management, all adjustments, consisting of normal and recurring adjustments
that are necessary to fairly present the financial condition of the Company
as
of June 30, 2006 and the results of its operations and its cash flows for the
three and six months ended June 30, 2006 and 2005 have been included. Interim
results of operations are not necessarily indicative of the results of
operations for the full year due to seasonality and other factors.
2.
Earnings
Per Share:
In
accordance with the provisions of SFAS No. 128, Earnings
Per Share, basic
net
income is computed by dividing net income by the weighted average number of
common shares outstanding during the period. Diluted earnings per common share
is calculated by dividing the amount of income available to common shareholders
by the number of diluted weighted average shares of common stock outstanding
during each period. Potentially dilutive securities include common shares
purchasable upon exercise of stock options and any non-vested
stock.
The
following table sets forth the computations for basic and dilutive earnings
per
common share:
Diluted
weighted average number of shares outstanding
10,787,641
8,350,000
10,787,641
8,350,000
Basic
Earnings Per Share
$
0.00
$
0.06
$
0.02
$
0.14
Diluted
Earnings Per Share
$
0.00
$
0.06
$
0.02
$
0.14
7
3.
Adoption
of Recently Issued Accounting Pronouncements:
On
January 1, 2006, we were required to apply the provisions of Financial
Accounting Standards Board (“FASB”) Statement of Financial Accounting Standard
No. 123 (revised 2004) (“SFAS 123R”), “Share-Based Payment”, and SEC Staff
Accounting Bulletin No. 107 (“SAB 107”), “Share-Based Payment”, requiring
the measurement and recognition of all share-based compensation under the fair
value method. Under the fair value recognition provisions of this statement,
share-based compensation cost is estimated at the grant date based on the value
of the award and is recognized as expense over the vesting period. Option
valuation models require the input of highly subjective assumptions, and changes
in the assumptions used can materially affect the fair value estimate.
Additionally, judgment is required in estimating stock price volatility,
expected dividends, and expected term for options that remain outstanding.
Actual results, and future estimates, may differ substantially from our current
estimates.
In
November 2004, FASB issued SFAS No. 151 “Inventory
Costs,”
which
amends the guidance in ARB No. 43, Chapter 4 “Inventory
Pricing,”
to
clarify the accounting for abnormal amounts of idle facility expense, freight,
handling costs, and wasted material (spoilage). Paragraph 5 of ARB 43,
Chapter 4, previously stated that under some circumstances, items such as
idle facility expense, excessive spoilage, double freight, and rehandling costs
may be so abnormal as to require treatment as current period charges. SFAS
No.
151 requires that those items be recognized as current-period charges regardless
of whether they meet the criterion of “so abnormal.” In addition, SFAS No. 151
requires that allocation of fixed production overheads to the costs of
conversion be based on the normal capacity of the production facilities. SFAS
No. 151 became effective for our inventory costs incurred since January 1,2006.
The application of SFAS No. 151 has not had a material effect on our
consolidated financial statements.
On
January 1, 2006, the Company adopted SFAS No. 123R, “Share-Based
Payments” (“SFAS No. 123R”), which requires companies to measure the cost
of employee services received in exchange for an award of equity instruments
based on the grant date fair value of the award. The Company has equity
incentive plans that provide for the issuance of stock options, restricted
stock
and other equity incentives.
On
January 30, 2006, the Company issued 61,112 shares of restricted stock to two
of
its officers. One-sixth of these shares have vested in January 2006 and upon
completion of each month thereafter. On January 30, 2006, the Company
issued 5,500 shares of restricted stock to independent members of the board
of
directors. Upon completion of each fiscal quarter of the current fiscal year,
25% of these shares will vest.
On
April1, 2006, the Company issued options to purchase 67,000 shares of common stock
to
some of its employees with a three year vesting period and a life of 5
years.
On
May15, 2006, the Company issued options to purchase 9,000 shares of common stock
to
some of its employees with a three year vesting period and a life of 5
years.
The
Company recognizes stock-based compensation expense over the requisite service
period of the individual grants.
Compensation
cost related to vested restricted stock for the three and six months ended
June30, 2006, including costs referred to in Note 5, was $512,379 and $949,758,
respectfully. Costs associated with these expenses are included in general
and
administrative expenses. A total of $99,750 of unrecognized compensation costs
related to nonvested restricted stock is expected to be recognized over future
periods.
8
5.
Commitments
and contingencies:
At
June30, 2006, the Company has entered into non-cancelable purchase commitments
for
certain inventory components used in its normal operations. The purchase
commitments covered by these agreements are for less than one year and in the
aggregate amount to approximately $1,730,000.
The
Company engaged the services of Spiegel Partners, LLC to provide advisory
services associated with the Company’s initial public offering. In consideration
of these services, the Company paid approximately $182,000 in cash, at the
close
of the initial public offering, less any prior payments made in monthly
installments of $10,000 - $30,000 per month.
The
Company has engaged future services of Spiegel Partners, LLC to provide advisory
services following the completion of the offering. In consideration of these
services, the Company issued 50,000 shares of common stock, which will vest
monthly per the provision of such continued service agreement for a six month
period following the initial public offering. In addition, we expect to pay
approximately $130,000 to Spiegel Partners, LLC in cash in equal monthly
installments over such six month period with an ending date of July 31,2006.
6.
Research
and development:
Research
and development costs are primarily for costs of software and hardware
development and continued enhancements for the electronic bingo systems that
the
Company leases to customers. The total amount of research and development was
$231,323 and $459,972 during the three and six months ended June 30, 2005 and
$110,015 and $368,224 during the three and six months ended June 30, 2006.
In
compliance with the provisions of FASB SFAS No. 86, because we achieved
technological feasibility in the development of our mobile gaming system in
the
beginning of the second quarter of 2006, we capitalized $283,326 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.
7.
Legal
proceedings:
The
Company is pursuing a patent infringement lawsuit against two of its
competitors, Planet Bingo, LLC and its alleged subsidiary Melange Computer
Services, Inc. The lawsuit involves two of the Company’s patents. The Company
alleges that one of its patents is being infringed by both defendants and the
other patent is being infringed by Planet Bingo, LLC only. The Company filed
this action in May 2004 in the United States Federal Court, District of Nevada.
The Company is 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 claimed that our operations infringe one
of
its own patents. The patent that Planet Bingo, LLC claims that we have infringed
has been invalidated in a separate lawsuit. This decision is on appeal.
The
Company recently filed a lawsuit against GameTech International Incorporated
and
its subsidiary, GameTech Arizona Corporation. The amended complaint alleges
that
GameTech International and GameTech Arizona have violated the Racketeering
and
Corrupt Organizations Act (“RICO), Nevada deceptive trade practices act and the
Lanham Act by manufacturing, distributing, selling and advertising gaming
devices without first complying with Nevada gaming laws. We are seeking both
injunctive relief and monetary damages in the lawsuit.
The
Company believes that the final resolution of any such threatened or pending
litigation, individually or in the aggregate, is not likely to have a material
adverse effect on the Company’s business, cash flow, results of operations or
financial position.
8.
Initial
Public Offering:
In
January 2006 the Company sold 2,500,000 shares of its’ common stock in an
underwritten initial public offering raising proceeds of approximately $21.5
million, net of underwriters commission. In February 2006, the underwriter
exercised its right to purchase 475,000 shares pursuant to an over allotment
option resulting in proceeds of approximately $3.2 million, net of underwriters
commission. The Company incurred costs of $981,630 in connection with the
initial public offering.
9
9.
Subsequent
events:
In
June
2006 the Company entered into an agreement with a Nevada casino group including
a provision for the lease of, with the option to buy the Company’s mobile gaming
products incorporating traditional casino games, subject to obtaining prior
approval of the Nevada Gaming Commission for the sale of such mobile gaming
systems in Nevada.
In
response to the publication of Nevada’s technical Policies applicable to the
mobile gaming systems in late June 2006, the Company modified its mobile gaming
platform to fully comply, in the Company’s belief, with the newest Policies and
submitted in August, 2006, an updated documentation package covering the
Company’s modified mobile gaming platform for review by Nevada Gaming Control
Board. The Company expects that the hardware testing phase of the review process will commence in the
near future. The Company expects the process of reviewing and testing of
its
mobile gaming platform by Nevada Gaming Control Board to be very rigorous and
of
unknown duration.
ITEM
2. MANAGEMENT’S
DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF
OPERATION
This
Quarterly Report on Form 10-Q contains forward-looking statements within
the “safe harbor” provisions of the Private Securities Litigation Reform Act of
1995. All statements included in this Quarterly Report, other than statements
that are purely historical, are forward-looking statements. Words such as
“anticipate,”“contemplate,”“expect,”“intend,”“plan,”“believe,”“seek,”“estimate,”“will,”“will continue to be,” or the negative of foregoing and
similar expressions regarding beliefs, plans expectations or intentions
regarding the future also identify forward-looking statements. Forward-looking
statements in this Quarterly Report include, without limitation: (1) our belief
that the disclosures contained within the unaudited condensed consolidated
financial statements are adequate to make the information presented not
misleading; (2) our belief that, upon approval of our wireless gaming devices
by
the Nevada gaming authorities, Nevada casino patrons will be able to play
traditional casino games using our wireless player terminals; (3) our
expectation that we will continue to introduce other new products for the
conventional bingo market segment; (4) our anticipation that our existing lease
contracts will include an option to purchase our gaming platforms for use in
conducting traditional casino games; (5) our expectation that we will incur
significant additional expenses in connection with the procurement of equipment
and components and the manufacture of additional stationary and wireless player
terminals and our expectation that we will continue to record costs of revenue
that include materials, labor, and direct and indirect manufacturing costs
and
associated warranty costs; (6) our belief that we will experience similar or
increasing levels of litigation and other legal expenses in the future; (7)
our
belief that we will not generate any revenue from the sale or lease of mobile
gaming platforms to play traditional casino games, such as keno, poker and
slots, during the remainder of 2006; (8) our expectation that, in the future,
we
will experience similar changes in sales and marketing expenses in correlation
with changes in lease revenue generated through our distributors; (9) our
ability to capitalize the additional cost of developing our gaming platform
until the deployment of our mobile gaming system is achieved; (10) our estimate
that we will have a similar effective tax rate in the coming quarters; (11)
our
anticipation that our current leasing revenue will be sufficient to fund our
operating expenses in the short term and that we will not need additional
financing; (12) our belief that long term cash will be generated from existing
operations and also through selling or leasing of our products in new markets;
(13) our opinion that the final resolution of any threatened or pending
litigation will not have a material adverse effect on our business, cash flow,
results of operations or financial position; (14) our plan, if necessary, to
seek additional financing through bank borrowings or public or private debt
or
equity financings; (15) our ability to obtain an injunction against future
patent infringement and recovery of damages as a result of past patent
infringement, and (16) our expectation that a portion of our future growth
will
result from the general expansion of the gaming industry.
Our
expectations, beliefs, objectives, anticipations, intentions and strategies
regarding the future, including, without limitation, those concerning expected
operating results, revenues and earnings are not guarantees of future
performance and are subject to risks and uncertainties that could cause actual
results to differ materially from results contemplated by the forward-looking
statements including, but not limited to: (1) unanticipated changes in standards
and reporting requirements; (2) an unanticipated delay in the Nevada Gaming
Control Board’s review of our mobile gaming platform or its rejection of our
product; (3) our inability to create or introduce new products for the
conventional bingo market; (4) our loss of existing customers or our failure
to
gain approval for our gaming platforms to play traditional casino games; (5)
unanticipated decreases in our manufacturing; (6) unanticipated final resolution
of our litigation matters; (7) unexpected early approval of our gaming platform;
(8) our loss of existing distributors or our failure to further broaden our
distribution channel; (9) a decrease in our research and development expenses;
(10) unanticipated changes to applicable tax rates or laws or changes in our
tax
position; (11) an unanticipated need for additional funds for operating
expenses, new business opportunities or other unforeseen events; (12) our
inability to successfully enter new markets as a result of regulatory,
competitive or other reasons; (13) the uncertainty of the outcome of any pending
or threatened litigation; (14) our inability to obtain additional financings
through bank borrowings or debt or equity financing at all or on terms that
are
favorable to us; (15) our inability to protect our intellectual property rights;
and (16) the failure of the gaming industry to expand at the rate we
expect.
10
We
assume
no obligation to update any forward-looking statements. Readers are cautioned
not to place undue reliance on forward-looking statements, which speak only
as
of the date of this Quarterly Report on Form 10-Q. Readers should also
review the cautionary statements and discussion of the risks of our business
set
forth elsewhere herein under the heading “Risk Factors” under Part II,
Item 1A and our other filings with the Securities and Exchange Commission
(“SEC”), including our Annual Report on Form 10-K (No. 000-51703)
filed on March 31, 2006 and our Current Reports on Form 8-K.
Overview
We
are an
established and profitable manufacturer of multi-game and multi-player
server-based gaming platforms. Our gaming platforms include networks of both
wireless and stationary player terminals, cashier-based point-of-sale terminals,
self-service point-of-sale kiosks and game file servers that conduct and control
bingo games. Our gaming platforms are also capable of conducting traditional
casino games, such as keno, poker and slots, in addition to, and concurrently
with, bingo.
We
believe that our field-proven mobile gaming platform has been adapted to comply
with the regulations promulgated by the Nevada Gaming Commission on
March 23, 2006 and Mobile Gaming System Policies published by Nevada Gaming
Commission on July 21, 2006. Our gaming platforms currently enable patrons
to
play bingo using either our wireless or our stationary player terminals. Our
gaming platforms also enable patrons to play traditional casino games using
our
stationary player terminals. We have 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. Upon anticipated approval of our
wireless gaming devices by the Nevada gaming authorities, Nevada casino patrons
will be able to play traditional casino games using our wireless player
terminals. There is no assurance however as to the timing of the review process
or that our mobile gaming platform will be approved by the Nevada Gaming Control
Board or NGCB.
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 upgraded our fourth generation wireless player
terminal to serve as a multi-game platform that enables patrons to play
traditional casino games in casino public areas in addition to playing bingo.
We
also recently introduced a new advanced bingo flashboard that utilizes long-life
color light emitting diodes instead of conventional incandescent lamps. We
have
sold our first set of the new flashboards to a customer in Nevada. We intend
to
continue to introduce other new products for the conventional bingo market
segment.
Almost
all of our revenues are currently generated by placing electronic bingo systems
in bingo halls under contracts based on (a) a fixed fee per use per session,
(b)
a fixed weekly fee per terminal or (c) a percentage of the revenue generated
by
each terminal. Revenue growth is affected by player acceptance of electronic
bingo as an addition or an alternative to paper bingo in our existing customer
establishments, our ability to expand operations into new markets and our
ability to increase our market share in the existing market. 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 rental revenue due to the addition of customers and
a
decrease in rental revenue due to the loss of customers. Our rental revenue
is
also affected from period to period as a result of changes in operations at
our
existing customer locations, which result from numerous factors over which
we
have little or no control.
11
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 we may be selling our gaming platforms for use
in
conducting traditional casino games, as an option included into lease contracts.
At that time, our revenue may include product revenue from sales of equipment,
in addition to our leasing revenue. At such time, our product revenue will
be
determined by the then current price for our products and our unit-volume
sales.
We
envision that if we develop product sales revenue, we will also see a recurring
revenue component generated from software upgrades and/or maintenance of the
software components of our sold products.
Our
expenses currently consist of:
(a)
cost
of revenue, depreciation of bingo terminals and other capitalized equipment
under lease to customers, maintenance, repair and refurbishment of bingo
terminals and related support equipment, and cost of shipping. Installation
costs and initial shipment expenses associated with new customer lease contracts
are expensed as cost of revenue in the period in which the equipment is
deployed. Expenses related to maintenance, repair and refurbishment of our
existing equipment that has been deployed at customer locations are expensed
as
cost of revenue in the period in which the maintenance, repair or refurbishment
is performed. These expenses are incurred to, among other things, maintain
our
existing equipment in working order, provide our customers with updated
equipment, fix software bugs, if any, provide new functionality and minimize
the
number of different installation configurations that we must support. We are
not
obligated to perform maintenance, repair or refurbishment under the terms of
our
rental agreements with our customers, but we do so in order to improve the
quality and reliability of our products;
(b)
general and administrative expenses, including the costs of activities
associated with the management of our company and related support, including
the
costs of payroll and benefits, amortization of our noncompete agreement with
a
former executive of our wholly-owned subsidiary, Millennium Games, Inc.
(“Millennium”), travel costs, professional fees, facility lease expenses and bad
debt expense reserves;
(c)
sales
and marketing expenses, consisting predominately of commissions paid to
distributors for promoting and supporting our products and related marketing
costs; and
(d)
costs
of research and development activities geared to the further development of
our
gaming platform, including labor costs and costs of hardware and software
testing, prototyping and development tools.
We
envision that the development of our product revenue will require us to record
costs of revenue that include materials, labor, and direct and indirect
manufacturing costs and associated warranty costs.
Millennium,
our wholly-owned subsidiary, holds equipment placement contracts for our bingo
products in selected territories in the United States. All of our other
operations, including the operation and maintenance of our bingo products in
all
territories and the exclusive distribution of our bingo products in Nevada,
Texas and Washington, are conducted by FortuNet.
During
the three months ended June 30, 2006, we incurred $458,079 in legal expenses
primarily due to ongoing patent infringement litigation against defendants
Planet Bingo, LLC and Melange Computer Services, Inc., and additional costs
associated with being a public company. Our legal expenses increased
substantially when compared with the $87,793 in legal expenses for the three
months ended June 30, 2005. We expect similar or increasing levels of litigation
and other legal expenses in the future.
Sales
revenue.
Rental
revenue was $3,994,553 during the three months ended June 30, 2006, compared
to
$3,581,524 during the three months ended June 30, 2005, an increase of $413,029,
or 11.5%. Rental revenue was $7,973,336 during the six months ended June 30,2006, compared to $7,471,736 during the six months ended June 30, 2005, an
increase of $501,600, or 6.7%. This increase in sales revenue was due primarily
to the deployment of additional bingo player units.
For
the
three months ended June 30, 2006, the net change in our revenue as a result
of
changes in our customer base was an increase in revenue of $80,025 and the
net
change in revenue as a result of changes in operations at our existing customer
locations was an increase of revenue of $333,104.
Our
revenue during the quarter ended June 30, 2006 was derived solely from our
bingo
business. During the second quarter we did not realize any revenue from the
sale
or lease of mobile gaming platforms to play traditional casino games, such
as
keno, poker and slots. We do not expect to generate any such revenue during
the
remainder of 2006. We cannot sell or lease mobile gaming platforms in Nevada
to
play traditional casino games until we receive all necessary regulatory
approvals to do so.
Costs
and Expenses
Cost
of revenue.
Cost of
revenue was $544,627 during the three months ended June 30, 2006, compared
to
$615,727 during the three months ended June 30, 2005, a decrease of $71,100,
or
11.5%. Cost of revenue was $1,042,183 during the six months ended June 30,2006,
compared to $1,218,850 during the six months ended June 30, 2005, a decrease
of
$176,667, or 14.5%. The decrease in cost of revenue was attributable primarily
to the decrease in depreciation, installation and maintenance expenses.
Specifically, the depreciation cost for the three months ended June 30, 2006
was
$435,482 as compared to $502,909 for the three months ended June 30, 2005.
Our
installation, maintenance and shipping expense also decreased from $112,817
for
the three months ended June 30, 2005 to $109,144 for the three months ended
June30, 2006. This decrease was partially attributable to a decrease in the rate
of
new installations of player units in the six months ending June 30, 2006 as
compared to the six months ending June 30, 2005. As a result of this overall
decrease in costs, our gross margin increased from 82.8% for the three months
ended June 30, 2005 to 86.4% for the three months ended June 30,2006.
13
General
and administrative.
General
and administrative expenses were $2,262,862, or 56.6% of revenue, for the three
months ended June 30, 2006 compared to $909,286, or 25.4% of revenue, for the
three months ended June 30, 2005, an increase of $1,353,576, or 148.9%. General
and administrative expenses were $3,948,040, or 49.5% of revenue, for the six
months ended June 30, 2006 compared to $1,873,076, or 25.1% of revenue, for
the
six months ended June 30, 2005, an increase of $2,074,964, or 110.8%. This
cost
increase was associated with our transition from being a private company to
being a public company and was primarily attributable to (a) consulting services
provided by Spiegel Partners LLC with a second quarter cost of $289,904, (b)
second quarter costs associated with the stock grants to certain of our
executives in the amount of $402,877 and (c) second quarter costs associated
with our payments to our outside directors in the amount of $24,375. We expect
to have costs similar to the costs incurred with respect to Spiegel Partners
LLC
in the first month of the third quarter, but not thereafter. We
will
have costs similar to the costs associated with the stock grants and payments
to
our directors in each of the remaining quarters of 2006.
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 $145,140 in the second quarter. These additional costs included the cost
of
director and officer’s insurance, securities filings and additional audit costs.
Our litigation and other legal expenses increased from $87,793 during the three
months ended June 30, 2005 to $458,079 during the three months ended June 30,2006 an increase of $370,286 or 421.8%.
Sales
and marketing.
Sales
and marketing expenses were $1,269,928, or 31.8% of revenue, for the three
months ended June 30, 2006, compared to $1,030,296, or 28.8% of revenue, for
the
three months ended June 30, 2005, an increase of $239,632, or 23.3%. Sales
and
marketing expenses were $2,567,853, or 32.2% of revenue, for the six months
ended June 30, 2006, compared to $2,170,270 or 29.0% of revenue, for the six
months ended June 30, 2005, an increase of $397,583, or 18.3%. This increase
was
attributable primarily to the expansion of our existing distributors. In the
future, we expect to have similar changes in sales and marketing expenses in
correlation with changes in lease revenue generated through our
distributors.
Research
and development.
Research and development expenses were $110,015, or 2.8% of revenue, for the
three months ended June 30, 2006, compared to $231,323, or 6.5% of revenue,
for
the three months ended June 30, 2005, a decrease of $121,308, or 52.4%. Research
and development expenses were $368,224, or 4.6% of revenue, for the six months
ended June 30, 2006, compared to $459,972, or 6.2% of revenue, for the six
months ended June 30, 2005, a decrease of $91,748, or 19.9%. In compliance
with
the provisions of FASB SFAS No. 86, because we achieved technological
feasibility in the development of our mobile gaming system in the beginning
of
the second quarter of 2006, we capitalized $283,326 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.
Provision
for income taxes.
An
income tax provision of $10,634 with an effective tax rate of 38.2% was recorded
for the three months ended June 30, 2006, compared to $305,035 with an effective
tax rate of 37.6% for the three months ended June 30, 2005, a decrease of
$294,401, or 96.5%. An income tax provision of $141,450 with an effective tax
rate of 40.5% was recorded for the six months ended June 30, 2006, compared
to
$631,480 with an effective tax rate of 35.4% for the six months ended June30,2005, a decrease of $490,030, or 77.6%. This decrease was primarily due to
a
decrease in taxable income during the three and six months ended June 30, 2006.
The temporary increase in the effective tax rate reflects the effect of
executive bonuses granted in connection with our initial public offering and
certain permanent differences between financial accounting principles and tax
accounting principles related to depreciation and state tax liabilities. In
the
next two quarters, we anticipate having a similar effective tax rate for the
reasons discussed above.
Liquidity
and Capital Resources
Since
inception, we have financed our operations primarily with revenue generated
from
the leasing of our bingo products. In January 2006 we successfully completed
our
initial public offering of our common stock. As of June 30, 2006, our principal
sources of liquidity were cash and cash equivalents of $24,903,988 and accounts
receivable net of allowance for doubtful accounts of $1,227,211. 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.
14
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 and the remaining
payments incurred in connection with becoming the 100% owner of Millennium
($246,905 in the aggregate). Payments to Spiegel Partners, LLC for advisory
services ended in July 2006, and the remaining balance of the long term debt
associated with an acquisition of Millennium is expected to be fully repaid
by
December of 2006.
We
believe that our cash flow from operations will be adequate to meet our
anticipated requirements for working capital and capital expenditures for the
next 12 months and for the foreseeable future. However, we may need to raise
additional funds if our estimates of anticipated liquidity needs are inaccurate
or if we need additional cash for new business development opportunities or
other unforeseen events. Although no additional financing is currently
contemplated, we may seek, if necessary or otherwise advisable, additional
financing through bank borrowings or public or private debt or equity
financings. Such additional financing, if necessary, may not be available to
us,
or, if available, may not be on terms favorable to us. The terms of any
financing that we obtain in the future may impose limitations on our operations
and management structure.
Summary
of Condensed Consolidated Statements of Cash Flow
Net
increase (decrease) in cash and cash equivalents
24,392,471
1,002,050
Cash
and cash equivalents, beginning
511,517
1,379,925
Cash
and cash equivalents, ending
24,903,988
2,381,975
Operating
Activities
For
the
six months ended June 30, 2006, net cash provided by operating activities was
$2,201,791, resulting from net income of $207,810, a depreciation and
amortization non-cash contribution of $1,115,492, a non-cash contribution of
stock for services in the amount of $983,774 and a change in operating assets
and liabilities of $(105,285). For the six months ended June 30, 2005, net
cash
provided by operating activities was $2,327,989, resulting from net income
of
$1,151,429, depreciation and amortization of $1,239,356 and change in operating
assets and liabilities of $(62,796). The increase in net cash provided by
operating activities during the six months ended June 30, 2006 as compared
to
the six months ended June 30, 2005 was primarily due to stock issued for
services.
Investing
Activities
For
the
six months ended June 30, 2006, $1,934,447 of net cash was used for investing
activities, with $716,446 being used to fund the manufacture of additional
equipment for lease to our customers and the balance spent on other capital
expenditures, including $884,701 for the expansion of our manufacturing base.
For
the
six months ended June 30, 2005, $960,445 of net cash was used for investing
activities, with $854,875 being used to fund the manufacture of additional
equipment for lease to our customers and the balance spent on other capital
expenditures primarily attributable to an expansion of our manufacturing
base.
15
Financing
Activities
Net
cash
raised through financing activities consisting of the $24,414,717 raised as
a
result of the sale of our stock in our initial public offering.
For
the
six months ended June 30, 2005, $365,494 of net cash was used for financing
activities, with $275,494 used for payments on a non-compete
agreement.
The
increase in our financing activities between the period ended June 30, 2006
and
the period ended June 30, 2005 is due to the initial public offering completed
in January 2006.
Off-Balance
Sheet Arrangements
As
of
June 30, 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.
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 negative 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.
Application
of Critical Accounting Policies and Estimates
Our
condensed consolidated financial statements have been prepared in accordance
with United States generally accepted accounting principles. The preparation
of
these financial statements requires us to make estimates and assumptions that
affect the reported amounts of assets and liabilities and the disclosure of
contingent assets and liabilities at the reporting date and reported amounts
of
revenue and expenses during the reporting period. On an ongoing basis, we
evaluate our estimates and judgments, including those related to revenue
recognition, bad debts, 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.
There
has
been no material change in the critical accounting policies that affect our
more
significant judgments and estimates used in the preparation of our condensed
consolidated financial statements described in our Annual Report on Form 10-K
for fiscal year ended December 31, 2005, except for the changes required with
respect to share-based compensation. See Footnote 4 to our condensed
consolidated financial statements for more information.
ITEM
3. 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 diluted protection of intellectual
property. We are most affected by fluctuations in the value of currencies in
southeast Asia.
16
We
are
also subject to significant credit risk resulting from the fact that a
significant portion of our accounts receivable are owed to us by relatively
few
of our customers. One customer made up 21.6% and 35.7% of rental revenues for
the six months ended June 30, 2005 and 2006, respectively. Furthermore, one
other customer made up 10.6% and 9.3% of the accounts receivable balance for
the
six months ended June 30, 2005 and 2006, respectively. If these few customers
fail to perform their obligations to us, we may lose a significant portion
of
our revenue.
We
do not
require collateral to extend credit to our customers but we do perform ongoing
credit evaluations of our customers’ financial condition.
At
present, we do not believe we are subject to any material variable interest
risk
or similar market risks.
ITEM
4. CONTROLS
AND PROCEDURES
Evaluation
of Disclosure Controls and Procedures
We
are
required to maintain disclosure controls and procedures that are designed to
provide reasonable assurance that information required to be disclosed in our
reports under the Securities Exchange Act is recorded, processed, summarized
and
reported within the time period specified in the Securities and Exchange
Commission’s rules and forms and that such information is accumulated and
communicated to our management, including our Chief Executive Officer and Chief
Financial Officer, as appropriate, to allow timely decisions regarding required
disclosure.
As
required by Rule 13a-15(b) promulgated under the Securities Exchange Act, our
management, with the participation of our Chief Executive Officer and Chief
Financial Officer, evaluated the design and operating effectiveness as of June30, 2006 of our disclosure controls and procedures, as defined in Rule 13a-15(e)
promulgated under the Securities Exchange Act. Based on this evaluation our
Chief Executive Officer and Chief Financial Officer concluded that, as of June30, 2006 our disclosure controls and procedures were effective to enable the
company to record, process, summarize and report information required under
the
Securities and Exchange Commission’s rules in a timely fashion.
Changes
in Internal Control Over Financial Reporting
There
were no significant changes in the Company’s internal control over financial
reporting identified in management’s evaluation during the three months ended
June 30, 2006 that have materially affected, or are reasonably likely to
materially affect, the Company’s internal control over financial
reporting.
PART
II OTHER INFORMATION
ITEM
1. LEGAL
PROCEEDINGS
We
continue to pursue a patent infringement lawsuit against two of our competitors,
Planet Bingo, LLC and its alleged subsidiary Melange Computer Services, Inc.
The
lawsuit involves two of our patents. We allege that one of our patents is being
infringed by both defendants and the other patent is being infringed by Planet
Bingo, LLC only. 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 own 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 some of our operations
or
pay substantial damages.
In
late
March 2006 we filed a lawsuit in the United States District Court of Nevada
against GameTech International Incorporated and its subsidiary, GameTech Arizona
Corporation. The amended complaint alleges that GameTech has violated the
Racketeering Influenced and Corrupt Organization Act (“RICO”), the Nevada
deceptive trade practices act and the Lanham Act by manufacturing, distributing,
selling and advertising gaming devices without first complying with Nevada
gaming laws. We are seeking injunctive relief and monetary damages in the
lawsuit.
17
We
believe that the final resolution of any such threatened or pending litigation,
individually or in the aggregate, is not likely to have a material adverse
effect on our business, cash flow, results of operations or financial
position.
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. We also prosecute various collection claims against
delinquent customers.
ITEM
1A. RISK
FACTORS
The
risk
factors set forth below captioned “If
our existing product does not comply fully, or at all, with the mobile gaming
regulations…”,
“Our
failure to obtain approvals for our mobile gaming platform under the regulations
promulgated under the Nevada Mobile Gaming Law…”,
“Changes
in technology or our inability to introduce new, commercially viable
products…”,
“Economic
downturns or a decline in the popularity of gaming…”,
“A
governmental shutdown of a gaming regulatory body…”,
“Casinos
draw a significant percentage of their customers
from…”,
“Our
common stock has only been publicly traded since…”
and
“We
do not intend to pay dividends in the future.”
are new
or have been modified from prior versions of these risk factors set forth in
our
Annual Report on Form 10-K for the period ended December 31, 2005.
Risks
Relating to Our Business
If
our existing product does not comply fully, or at all, with the mobile gaming
regulations, we may incur substantial additional research and development
expenses or fail to execute our growth strategy.
The
regulations require that our mobile gaming systems be approved by the Nevada
Gaming Commission before we may distribute these systems to Nevada casinos.
The
Nevada Gaming Commission may impose significant requirements on the
functionality or design of mobile gaming systems that may be manufactured,
distributed or operated in Nevada. To the extent that our existing mobile gaming
platform may not comply with such requirements, we would need to undertake
additional research and development activities that may be costly, time
consuming or require the procurement of components that are scarce in supply.
Despite undertaking additional research and development activities, we may
not
be able to design or develop a mobile gaming platform that complies with the
standards and Policies adopted by the Nevada Gaming Commission, in which case
we
would be unable to manufacture, distribute or operate wireless player terminals
that enable casino players to play traditional casino games in the public areas
of gaming establishments permitted under the Nevada Mobile Gaming Law, and
therefore be unable to fully execute our growth strategy.
Our
failure to obtain approvals for our mobile gaming platform under the regulations
promulgated under the Nevada Mobile Gaming Law will negatively impact our growth
strategy.
The
regulations promulgated under the Nevada Mobile Gaming Law require us to obtain
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.
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.
18
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 2005 we derived
99.93% 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.
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.
19
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.
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.
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.
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 years ended
December 31, 2004 and 2005, approximately 56.4% and 55.4%, respectively, of
our revenues were derived through nine distributors. During the same periods,
we
derived approximately 29.0% and 29.7%, respectively, 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.
20
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 touchscreens 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 touchscreen
monitors from a new supplier. In addition, the supplies of the central
processing units, memory and peripheral drives for our mobile gaming platforms
are often uncertain and subject to significant backlogs from time to time due
to
spikes in general demand for such products. We compete with other companies
for
the production capacity of third party manufacturers and suppliers of these
and
other components. Certain of these competing companies have substantially
greater financial and other resources than we have and thus we may be at a
competitive disadvantage in seeking to procure production capacity.
To
procure certain parts, components and subassemblies, we sometimes commit to
supply contracts in which we commit to purchase large quantities over extended
periods of time. By doing so, we are exposed to a number of risks. If the market
prices of these components drop below the prices at which we are committed
to
purchase them, our purchase commitments may preclude us from taking advantage
of
reductions in market prices. If the components are surpassed by superior
technology that becomes available after we make our purchase commitments, our
purchase commitments may preclude us from taking advantage of technological
advancements. If a change in the design or specifications of our products
results in a substitution or elimination of a component, we may be forced to
write off a substantial quantity of obsolete inventory of components or to
sell
such components in the open market at a loss.
Our
inability to contract with third-party manufacturers and suppliers to provide
a
sufficient supply of our components on acceptable terms and on a timely basis
could negatively impact our relationships with customers and materially and
adversely harm our business. For those components that we procure under supply
contracts, if any of such supply contracts were to be terminated or breached,
we
may not be able to procure an alternate supply on terms as favorable to us
in
time, or at all. We may suffer lengthy delays in our manufacturing process
while
we seek to procure an alternate supply. A delay in our ability to manufacture
products may adversely affect our goodwill with customers, expose us to
liability to customers and result in the loss of business opportunities. Any
alternate supply of parts, components or subassemblies may be more expensive
to
us or may require us to undertake additional engineering activities to integrate
the alternate supply into our products or manufacturing process.
Certain
parts, components and subassemblies for our products are manufactured outside
of
the United States, which exposes us to the risks of foreign currency
fluctuations, political and economic instability and limited protection of
intellectual property.
If
our wireless gaming terminals do not achieve and maintain widespread acceptance
by gaming establishments and casino game players as a means to play traditional
casino games, our business operations will not grow as anticipated.
Our
current business depends on the preferences of gaming establishment players
that
play bingo games, and our growth strategy depends on the preferences of gaming
establishment players that play traditional casino games, such as poker, keno
and slots. The tastes and preferences of players of bingo and traditional casino
games are known to change over time. If the bingo games or traditional casino
games that we enable gaming establishment players to play using our wireless
gaming terminals do not appeal to players to the degree anticipated, our mobile
gaming platforms will not be fully utilized and our business will suffer.
The
success of our growth strategy will depend to a large extent on broad market
acceptance of our wireless gaming terminals among casinos and their players
who
play traditional casino games. The only market acceptance that our wireless
gaming terminals currently enjoy is as a means to play bingo games
electronically. Even if we are successful in deploying mobile gaming platforms
that enable casino players to play traditional casino games, gaming
establishments and their players may still not use our wireless gaming terminals
for a number of reasons, including preference for live dealers, preference
to
play casino games in a traditional environment using traditional equipment,
mistrust of technology and perceived lack of reliability. We believe that the
acceptance of our wireless gaming terminals by gaming establishments and their
players will depend on our ability to demonstrate the economic and other
benefits of our products to gaming establishments, casino players becoming
comfortable with using our wireless gaming terminals, the attractiveness of
the
casino games that players can play using our wireless gaming terminals, ease
of
use, and the reliability of the hardware and software that comprise our mobile
gaming platforms.
21
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 expected
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.
We
expect to spend substantial amounts on research and development, but these
efforts may fail or lead to operational problems that could negatively impact
our operations.
In
order
to compete effectively in an era of technological changes, we must continuously
enhance our existing products and develop, introduce and market new products
and
services. As a result, we expect, as needed, to continue to make a significant
investment in product development. Our development of products is dependent
on
factors such as assessing market trends and demands and obtaining requisite
governmental approvals. Although we are pursuing and will continue to pursue
product development opportunities, we may fail to develop any new products
or
services or enhancements to existing products. Even if new products or services
are developed, these products or services may not prove to be commercially
viable, or we may not be able to obtain the various gaming licenses and
approvals necessary to manufacture and distribute these products or provide
these services to our customers. We may experience operational problems with
such products after commercial introduction that could delay or defeat the
ability of such products to generate revenue or operating profits. Future
operational problems could increase our costs, delay our plans or adversely
affect our reputation or our sales of other products, which, in turn, could
materially adversely affect our success. We cannot predict which of the many
possible future products will meet evolving industry standards and casino or
player demands.
Changes
in technology or our inability to introduce new, commercially viable products
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.
22
If
we are
successful in adapting and improving our products, our new products may not
achieve market acceptance. Our ability to introduce new products may require
regulatory approvals, which may significantly increase the costs associated
with
developing a new product and the time required to introduce a new product into
the marketplace. In order to obtain these regulatory approvals we may need
to
further modify our products which would increase our costs of development and
may make our products likely to achieve market acceptance.
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.
Defects
in, and fraudulent manipulation of, our gaming platforms could reduce our
revenue, increase our costs, burden our engineering and marketing resources,
involve us in litigation and adversely affect our gaming licenses.
The
real
and perceived integrity and security of mobile gaming is critical to its ability
to attract players. We strive to set exacting standards of system security
for
the systems that we provide to gaming establishments, and our reputation in
this
regard is an important factor in our business dealings with our customers and
regulators, such as the Nevada Gaming Commission and other governmental
agencies. For this reason, an actual or alleged system security defect or
failure attributable to us could have a material adverse effect upon our
business, financial condition, results and prospects, including our ability
to
retain existing contracts or obtain new contracts.
Our
success will depend on our ability to avoid, detect and correct software and
hardware defects and prevent fraudulent manipulation of our mobile gaming
platforms. Although our mobile gaming platforms are subject to rigorous internal
testing and will be subject to additional testing by regulators in certain
gaming jurisdictions, we may not be able to build and maintain products that
are
free from defects or manipulations and that satisfy these tests. Although we
have taken rigorous steps to prevent defects and manipulations, our gaming
platforms could suffer from such defects and manipulation after they are put
into operation.
Although
we do not believe it is likely, it is possible that an individual could breach
the security systems of a casino or bingo hall, gain access to the central
game
file server on which our server-based mobile gaming platform operates and
fraudulently manipulate its operations. The occurrence of such fraudulent
manipulation or of defects or malfunctions could result in financial losses
for
our customers and, in turn, termination of leases, cancellation of orders,
product returns and diversion of our resources. Even if our customers do not
suffer financial losses, casinos and bingo halls may replace our gaming
platforms if they do not perform according to expectations. Any of these
occurrences could also result in the loss of or delay in market acceptance
of
our server-based gaming platform and loss of licenses, leases and sales.
In
addition, the occurrence of defects in, or fraudulent manipulation of, our
gaming platforms may give rise to claims for lost revenue and related litigation
by our gaming establishment customers and may subject us to investigation or
other disciplinary action by regulatory authorities that could include
suspension or revocation of our regulatory approvals.
23
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.
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 Director 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.
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. 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.
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.
Future
acquisitions could prove expensive, 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:
24
·
Difficulties
in integrating operations, technologies, services, accounting and
personnel;
·
Difficulties
in supporting and transitioning customers of our acquired companies
to our
technology 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 four United States patents relating to our products
and
corresponding patents in certain foreign countries. Of the four patents, one
expires in August, 2006, two expire in 2010 and one expires in 2012. The patents
that we own now or in the future may not provide us with significant competitive
advantages or may be impaired by challenges to the validity or enforceability
of
such patents. For example, in the past the validity of one of our patents has
been repeatedly challenged, and is currently being challenged in court along
with another patent we recently acquired. Others may independently develop
similar or more advanced technologies or products or design around aspects
of
our technology that may be patented.
It
is
possible that third parties may copy or otherwise obtain and use our information
and proprietary technology without our authorization or otherwise infringe
on
our intellectual property rights. We may have to rely on litigation to enforce
our intellectual property rights and contractual rights. For example, we are
pursuing a patent infringement action against Planet Bingo, LLC and Melange
Computer Services, Inc. to discontinue what we believe to be their infringement
of our rights arising under our patents. Both defendants have counterclaimed
that our patents are invalid and Planet Bingo, LLC has alleged that our
operations infringe one of its patents. See “Item 3. Legal Proceedings” for
a more detailed discussion of this litigation. If these counterclaims are
successful, our patents may be invalidated or limited in scope or we may be
forced to modify or discontinue our operations or pay substantial damages.
If
litigation that we initiate is unsuccessful, including the litigation described
above, we may not be able to protect the value of our intellectual property
and
our business could be adversely affected.
We
have
patent applications that are currently pending before the United States Patent
and Trademark Office. These patent applications may not result in any patents
being issued. If these patent applications do not become issued patents, our
competitors would not be prevented from using these inventions described in
the
applications.
In
addition, we may face claims of infringement that could interfere with our
ability to use technology or other intellectual property rights that are
material to our business operations. If a claim of infringement against us
is
successful, we may be required to pay royalties to use technology or other
intellectual property rights that we had been using or we may be required to
enter into a license agreement and pay license fees, or we may be required
to
stop using the technology or other intellectual property rights that we had
been
using. We may be unable to obtain necessary licenses from third parties at
a
reasonable cost or within a reasonable time. Any litigation of this type,
whether successful or unsuccessful, could result in substantial costs to us
and
diversions of our resources.
25
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 fund the planned expansion of our inventory.
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 required, our continued operations may have to be scaled down
or
even ceased and our ability to generate revenues would be materially impaired.
Our
inability to lease suitable facilities may harm, delay or prevent our
operations.
The
long
term lease for our Las Vegas, Nevada facility, which is our only facility,
expires in December 2010. This facility provides us with a convenient
central location from which to service our customers. We may not be able to
extend the lease on its current terms or, if required, locate new adequate
manufacturing facilities on commercially reasonable terms or at all.
Risks
Relating to Our Industry
Economic
downturns or 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.
26
We
operate in a highly competitive industry, 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., Planet Bingo, LLC, 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, we may face competition from these providers
in
the market for mobile gaming devices in the future. Given the market
penetration, name recognition, marketing resources and familiarity with the
gaming device industry generally, traditional casino game device manufacturers
could be a significant competitive threat to us. We expect fierce competition
from multiple large competitors dominating their respective markets in our
expansion efforts, such as Aristocrat Leisure, Ltd., International Game
Technology, Alliance Gaming Corporation, WMS Gaming Inc. and Shuffle Master,
Inc., that may enter the market for mobile gaming devices. In addition, we
may
in the future face potential competition from new entrants into the gaming
device market, such as Cantor Fitzgerald LP, a large financial services company
that already offers wireless sports betting in the United Kingdom, and at least
two other gaming technology companies, Chimera Technology Corp. and Diamond
I,
Inc. Finally, traditional casino operators, most of whom are much larger than
us, may attempt to enter the emerging mobile gaming market. Some of our
competitors and potential competitors have significant advantages over us,
including greater name recognition, longer operating histories, pre-existing
relationships with current or potential customers, proprietary technology,
significantly greater financial, marketing and other resources and more readily
available access to capital that could allow them to respond more quickly to
new
or changing opportunities.
Other
providers of electronic bingo products have in the past reduced, and may in
the
future continue to reduce, the prices of their products to gaming establishments
in order to win those gaming establishments as customers and to gain market
share. To the extent that competitive pressures force us to reduce our prices
or
provide other incentives to establish or maintain relationships with gaming
establishments, our business and operating results could be adversely affected.
Expansion
of the gaming industry faces opposition that could limit our access to some
markets and impair our growth.
We
expect
a substantial portion of our future growth to result from the general expansion
of the gaming industry. The expansion of gaming activities in new markets can
be
very controversial and may depend heavily on the support of national, local
and
tribal governments. Changes in government leadership, failure to obtain
requisite voter support in referenda, failure of legislators to enact enabling
legislation and limitations on the volume of gaming activity that is permitted
in particular jurisdictions may prevent us from expanding our operations into
new markets. A failure by the gaming industry to expand at the rate that we
expect could have a material adverse effect on our business, growth rates,
financial condition and operating results.
Gaming
opponents continue to persist in efforts to curtail the expansion of legalized
gaming. Unfavorable public referendums, anti-gaming legislation or unfavorable
legislation affecting or directed at manufacturers or operators of gaming
products may materially and adversely impair our business and growth prospects.
Gaming opponents may be successful in preventing the legalization of mobile
gaming in jurisdictions where mobile gaming may be presently prohibited or
in
limiting the expansion of mobile gaming where it is currently permitted, in
either case to the detriment of our business, financial condition, results
and
prospects.
A
governmental shutdown of a gaming regulatory body in a jurisdiction where we
operate may cause a disruption in our business and harm our operating results.
On
July5, 2006, Atlantic City casinos were forced to close down due to the shutdown
of
the New Jersey gaming regulatory body. The New Jersey State government closed
all of its non-essential governmental agencies because the legislature had
not
adopted a new budget by the constitutional deadline. One such non-essential
governmental agency was the Casino Control Commission, which regulates gambling
in Atlantic City’s casinos. New Jersey State law prohibits the operation of
casinos without the supervision of Casino Control Commission employees, so
the
casinos were forced to close down. A similar shutdown of a regulatory gaming
body in a jurisdiction where we do business may disrupt our ability to do
business and adversely affect our revenue and results of
operations.
27
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 Hurricane Katrina, and any disruption to our business resulting from
Hurricane Katrina 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. Accordingly, we anticipate that our
revenue and results of operations in Louisiana will decline in 2006 as a result
of Hurricane Katrina. During the hurricane season of 2005, we had a decrease
in
revenues from operations in Louisiana of approximately $132,000 and anticipate
that 2006 revenues will be negatively affected by approximately $155,000.
Although we cannot predict the extent of any such decline, any interruption
to
our business resulting from Hurricane Katrina, or other natural disaster, will
adversely affect our revenue and results of operations.
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. Although we are still assessing the full extent of the
losses, we may suffer a loss of equipment as a result of Hurricane Katrina.
Our
insurance may not be adequate to recover our losses from Hurricane Katrina
or
any other natural disaster. More 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. 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.
Casinos
draw a significant percentage of their customers from limited geographic
regions. Events adversely impacting the economy or these regions may also impact
our business.
Casinos
where we operate draw a substantial portion of their customers from specific
geographic areas. An increase in fuel costs or transportation prices, a decrease
in airplane seat availability, or a deterioration of relations of the casinos
with tour and travel agents could adversely affect our business. The outbreak
of
public health threats at any of the casinos where we operate or in the areas
in
which they are located, or the perception that such threats exist, as well
as
adverse economic conditions that affect the national or regional economies,
whether resulting from war, terrorist activities or other geopolitical conflict,
weather or other factors, could have a significant adverse effect on our
business, financial condition and results of operations.
28
Risks
related to our capital structure
Beneficial
holders of our securities will be 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.
Our
common stock has only been publicly traded since January 31, 2006 and we expect
that the price of our common stock will fluctuate
substantially.
There
has
only been a public market for our common stock since January 31, 2006. The
market price of our common stock may fluctuate significantly in response to
a
number of factors, some of which are beyond our control, including those
described above under “Risks Related to Our Business,”“Risks Related to Our
Industry” and the following:
·
our
failure to maintain our current customers, including because of
consolidation in the gaming
industry;
·
actual
or anticipated fluctuations in our or our competitors’ revenue, operating
results or growth rate;
·
any
adverse results in litigation initiated by us or by other against
us;
·
the
loss of a significant supplier, or the failure of a significant supplier
to provide the goods that we rely on them
for;
29
·
our
inability to introduce successful, new products and services in a
timely
manner or the introduction of new products or services by our competitors
that reduce the demand for our products and
services;
·
our
failure to successfully enter new markets or the failure or new markets
to
develop in the time and manner that we
anticipate;
·
announcements
by our competitors of significant new contracts or contract renewals
or of
new products or services;
·
changes
in general economic conditions or the gaming
industry;
·
the
trading volume of our common stock;
·
sales
of common stock or other actions by our current officers, directors
and
stockholders;
·
acquisitions,
strategic alliances or joint ventures involving us or our
competitors;
·
future
sales of our common stock or other securities;
·
the
failure of securities analysts to cover our common stock or changes
in
financial estimates or recommendations by
analysts;
·
our
failure to meet the revenue, net income or earnings per share estimates
of
securities analysts or investors;
·
additions
or departures of key personnel;
·
terrorist
acts, theft, vandalism, fires, floods or other natural
disasters; and
·
rumors
or speculation as to any of the above which we may be unable to confirm
or
deny due to disclosure restrictions imposed on us by law or which
we
otherwise deem imprudent to comment
upon.
In
addition, the stock market in general has experienced price and volume
fluctuations that have often been unrelated or disproportionate to the operating
performance of particular businesses. These broad market and industry factors
may materially reduce the market price of our common stock, regardless of our
operating performance.
Securities
class action litigation is often brought against a company following a decline
in the market price of its securities. We may in the future be a target of
similar litigation. Securities litigation could result in substantial costs
defending the lawsuit and divert management’s attention and resources, and could
seriously harm our business and negatively impact our stock price.
We
do not intend to pay dividends in the future.
We
currently intend to retain all available funds and any future earnings for
use
in the operation and expansion of our business and do not anticipate paying
any
cash dividends in the foreseeable future. As a result, capital appreciation,
if
any, of our common stock will be the sole source of potential gain for our
stockholders for the foreseeable future.
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.
Form
of Certificate Representing Common Stock, $.001 Par Value Per Share,
of
FortuNet, Inc.(2)
10.1
Amendment
No. 2 to FortuNet Inc. Exempt Employment Agreement by and between
FortuNet
Inc. and Jack B. Coronel, dated as of July 6, 2006(1)
10.2
Amendment
No. 1 to FortuNet Inc. Exempt Employment Agreement by and between
FortuNet
Inc. and William R. Jacques, Jr., dated as of July 6, 2006(1)
10.3
Summary
of Amendments to Unwritten Employment Arrangements with Yuri Itkis
and
Boris Itkis(1)
31.1*
Certificate
of Yuri Itkis, Chief Executive Officer of FortuNet, Inc. dated August14,2006 in accordance with Rules 13a-14(a) and 15d-14(a) of the
Securities Exchange Act, as amended, as adopted pursuant to
Section 302 of the Sarbanes-Oxley Act of 2002
31.2*
Certificate
of William R. Jacques, Jr., Chief Financial Officer of FortuNet,
Inc.
dated August 14, 2006 in accordance with Rules 13a-14(a) and
15d-14(a) of the Securities Exchange Act, as amended, as adopted
pursuant
to Section 302 of the Sarbanes-Oxley Act of 2002
32.1*
Certificate
of Yuri Itkis, Chief Executive Officer of FortuNet, Inc. and William
R.
Jacques, Jr., Chief Financial Officer of FortuNet, Inc. dated August14,2006 in accordance with 18 U.S.C. 1350, as adopted pursuant to
Section 906 of the Sarbanes-Oxley Act of
2002
(1)
Incorporated
by reference to our Current Report on Form 8-K (File No. 000-51703)
filed
with the SEC on July 7, 2006.
(2)
Incorporated
by reference to Amendment No. 1 of our Registration Statement filed
on
Form S-1 (File No. 333-128391) filed with the Commission on October27,2005.
(3)
Incorporated
by reference to Amendment No. 3 of our Registration Statement filed
on
Form S-1 (File No. 333-128391) filed with the Commission on November21,2005.
* Filed
herewith.
32
SIGNATURES
Pursuant
to the requirements of Section 13 or 15(d) of the Securities Exchange Act of
1934, the registrant has duly caused this report to be signed on its behalf
by
the undersigned, thereunto duly authorized.
