Please wait
UNITED
STATES SECURITIES AND EXCHANGE COMMISSION
Washington,
D.C. 20549
FORM
10-Q
|
þ
|
QUARTERLY
REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF
1934
|
For
the quarterly period ended: September 30, 2008
|
¨
|
TRANSITION
REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF
1934
|
for
the transition period from
to
Commission
File Number: 000-22752
PROGRESSIVE
GAMING INTERNATIONAL CORPORATION
(Exact
Name of Registrant as Specified in Its Charter)
|
|
|
|
|
Nevada
|
|
88-0218876
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|
(State
or Other Jurisdiction of
Incorporation
or Organization)
|
|
(IRS
Employer
Identification
Number)
|
920
Pilot Road, Las Vegas, NV 89119
(Address
of Principal Executive Office and Zip Code)
(702) 896-3890
(Registrant’s
Telephone Number, Including Area Code)
(Former
Name, Former Address and Former Fiscal Year, if Changed Since Last
Report)
Indicate
by a 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. Yes R
No
Indicate
by check mark whether the registrant is a large accelerated filer, an
accelerated filer, a non-accelerated filer, or a smaller reporting company. See
definition of “accelerated filer and large accelerated filer” in Rule 12b-2
of the Exchange Act. (Check one):
Large
Accelerated Filer Accelerated
Filer R Non-Accelerated
Filer (Do not check if a smaller reporting company) Smaller
Reporting Company
Indicate
by check mark whether the registrant is a shell company (as defined in
Rule 12b-2 of the Exchange
Act). Yes No R
APPLICABLE
ONLY TO CORPORATE ISSUERS:
Indicate
the number of shares outstanding of each of the issuer’s classes of common stock
as of the latest practicable date:
|
|
|
|
|
|
|
7,895,331
|
|
as of
|
|
November
11, 2008
|
|
(Amount Outstanding)
|
|
|
|
(Date)
|
PROGRESSIVE
GAMING INTERNATIONAL CORPORATION
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|
Page
|
|
|
|
|
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3
|
|
|
|
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|
4
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5
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6
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8
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|
30
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39
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|
39
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|
40
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|
40
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41
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54
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55
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|
56
|
PROGRESSIVE
GAMING INTERNATIONAL CORPORATION
|
|
|
September
30,
|
|
|
December 31,
|
|
|
(Amounts
in thousands, except share data)
|
|
2008
|
|
|
2007
|
|
|
ASSETS
|
|
(Unaudited)
|
|
|
|
|
|
Current
assets:
|
|
|
|
|
|
|
|
Cash
and cash equivalents
|
|
$ |
3,592 |
|
|
$ |
19,063 |
|
|
Restricted
cash
|
|
|
475 |
|
|
|
— |
|
|
Accounts
receivable, net of allowance for doubtful accounts of $3,465 and
$942
|
|
|
11,557 |
|
|
|
21,360 |
|
|
Current
portion of contract sales and notes receivable, net of allowance for
doubtful accounts of $383 and $472
|
|
|
1,899 |
|
|
|
829 |
|
|
Inventories,
net of reserves of $1,252 and $768
|
|
|
7,178 |
|
|
|
6,576 |
|
|
Prepaid
expenses
|
|
|
4,268 |
|
|
|
1,643 |
|
|
Current
assets of discontinued operations
|
|
|
— |
|
|
|
680 |
|
|
Total
current assets
|
|
|
28,969 |
|
|
|
50,151 |
|
|
Contract
sales and notes receivable
|
|
|
1,758 |
|
|
|
— |
|
|
Property
and equipment, net
|
|
|
4,099 |
|
|
|
3,893 |
|
|
Intangible
assets, net
|
|
|
7,120 |
|
|
|
25,646 |
|
|
Goodwill
|
|
|
14,698 |
|
|
|
42,373 |
|
|
Noncurrent
assets of discontinued operations
|
|
|
— |
|
|
|
2,131 |
|
|
Other
assets
|
|
|
7,170 |
|
|
|
9,715 |
|
|
Total
assets
|
|
$ |
63,814 |
|
|
$ |
133,909 |
|
|
LIABILITIES
AND STOCKHOLDERS’ EQUITY
|
|
|
|
|
|
|
|
|
|
Current
liabilities:
|
|
|
|
|
|
|
|
|
|
Trade
accounts payable
|
|
$ |
7,546 |
|
|
$ |
6,234 |
|
|
Customer
deposits
|
|
|
939 |
|
|
|
1,403 |
|
|
Current
portion of long-term debt and other liabilities, net of unamortized
discount of $3,212 and $148
|
|
|
28,576 |
|
|
|
29,852 |
|
|
Accrued
liabilities
|
|
|
8,425 |
|
|
|
11,305 |
|
|
Deferred
revenues and license fees
|
|
|
2,620 |
|
|
|
2,416 |
|
|
Current
liabilities of discontinued operations
|
|
|
3,314 |
|
|
|
3,695 |
|
|
Total
current liabilities
|
|
|
51,420 |
|
|
|
54,905 |
|
|
Other
long-term liabilities
|
|
|
8,806 |
|
|
|
6,290 |
|
|
Noncurrent
liabilities of discontinued operations
|
|
|
996 |
|
|
|
1,175 |
|
|
Deferred
tax liability
|
|
|
— |
|
|
|
588 |
|
|
Total
liabilities
|
|
|
61,222 |
|
|
|
62,958 |
|
|
Commitments
and contingencies
|
|
|
|
|
|
|
|
|
|
Stockholders’
equity:
|
|
|
|
|
|
|
|
|
|
Preferred
stock, $0.10 par value, 5,000,000 shares authorized, none issued and
outstanding
|
|
|
— |
|
|
|
— |
|
|
Common
stock, $0.10 par value, 12,500,000 and 100,000,000 shares authorized and
7,895,331 and 61,993,509 shares issued and outstanding
|
|
|
790 |
|
|
|
6,199 |
|
|
Additional
paid-in capital
|
|
|
323,399 |
|
|
|
306,879 |
|
|
Other
comprehensive income
|
|
|
1,658 |
|
|
|
4,734 |
|
|
Accumulated
deficit
|
|
|
(321,309 |
) |
|
|
(245,038 |
) |
|
Subtotal
|
|
|
4,538 |
|
|
|
72,774 |
|
|
Less
treasury stock, 59,203 and 317,174 shares, at cost
|
|
|
(1,946 |
) |
|
|
(1,823 |
) |
|
Total
stockholders’ equity
|
|
|
2,592 |
|
|
|
70,951 |
|
|
Total
liabilities and stockholders’ equity
|
|
$ |
63,814 |
|
|
$ |
133,909 |
|
See notes
to unaudited consolidated financial statements.
PROGRESSIVE
GAMING INTERNATIONAL CORPORATION
|
|
|
Three
Months Ended
|
|
|
Nine
Months Ended
|
|
|
|
|
September
30,
|
|
|
September
30,
|
|
|
(Amounts
in thousands, except per share amounts)
|
|
2008
|
|
|
2007
|
|
|
2008
|
|
|
2007
|
|
|
Revenues
|
|
$ |
13,684 |
|
|
$ |
18,324 |
|
|
$ |
46,962 |
|
|
$ |
51,874 |
|
|
Cost
of revenues
|
|
|
7,608 |
|
|
|
8,190 |
|
|
|
23,501 |
|
|
|
23,841 |
|
|
Gross
profit
|
|
|
6,076 |
|
|
|
10,134 |
|
|
|
23,461 |
|
|
|
28,033 |
|
|
Selling,
general and administrative expense
|
|
|
10,577 |
|
|
|
7,276 |
|
|
|
27,032 |
|
|
|
22,860 |
|
|
Research
and development
|
|
|
1,828 |
|
|
|
2,441 |
|
|
|
8,083 |
|
|
|
7,028 |
|
|
Depreciation
and amortization
|
|
|
1,876 |
|
|
|
1,942 |
|
|
|
5,623 |
|
|
|
5,481 |
|
|
Restructuring
charges
|
|
|
3,465 |
|
|
|
— |
|
|
|
3,901 |
|
|
|
— |
|
|
Asset
impairment charges
|
|
|
43,755 |
|
|
|
— |
|
|
|
43,755 |
|
|
|
— |
|
|
Total
operating expenses
|
|
|
61,501 |
|
|
|
11,659 |
|
|
|
88,394 |
|
|
|
35,369 |
|
|
Operating
loss
|
|
|
(55,425 |
) |
|
|
(1,525 |
) |
|
|
(64,933 |
) |
|
|
(7,336 |
) |
|
Interest
expense, net
|
|
|
(1,389 |
) |
|
|
(2,431 |
) |
|
|
(3,420 |
) |
|
|
(8,978 |
) |
|
Mark-
to- market (losses)/gains
|
|
|
(1,011 |
) |
|
|
— |
|
|
|
(1,011 |
) |
|
|
— |
|
|
Fair
value of debt issued in excess of proceeds
|
|
|
(5,731 |
) |
|
|
— |
|
|
|
(5,731 |
) |
|
|
— |
|
|
Loss
on early retirement of debt
|
|
|
— |
|
|
|
(783 |
) |
|
|
— |
|
|
|
(783 |
) |
|
Loss
from continuing operations before income taxes
|
|
|
(63,556 |
) |
|
|
(4,739 |
) |
|
|
(75,095 |
) |
|
|
(17,097 |
) |
|
Income
tax (provision) benefit
|
|
|
(35 |
) |
|
|
— |
|
|
|
462 |
|
|
|
— |
|
|
Loss
from continuing operations
|
|
|
(63,591 |
) |
|
|
(4,739 |
) |
|
|
(74,633 |
) |
|
|
(17,097 |
) |
|
Loss
from discontinued operations, net of tax of $0.0 for the three and nine
months of 2008 and $0.0 and $11.2 million for the three and nine
months of 2007
|
|
|
— |
|
|
|
(34,998 |
) |
|
|
(1,638 |
) |
|
|
(65,602 |
) |
|
Net
loss
|
|
$ |
(63,591 |
) |
|
$ |
(39,737 |
) |
|
$ |
(76,271 |
) |
|
$ |
(82,699 |
) |
|
Weighted
average common shares:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Basic
|
|
|
7,830 |
|
|
|
4,792 |
|
|
|
7,779 |
|
|
|
4,502 |
|
|
Diluted
|
|
|
7,830 |
|
|
|
4,792 |
|
|
|
7,779 |
|
|
|
4,502 |
|
|
Basic
and diluted loss per share:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Loss
from continuing operations
|
|
$ |
(8.12 |
) |
|
$ |
(0.99 |
) |
|
$ |
(9.59 |
) |
|
$ |
(3.80 |
) |
|
Loss
from discontinued operations
|
|
|
— |
|
|
|
(7.30 |
) |
|
|
(0.21 |
) |
|
|
(14.57 |
) |
|
Net
loss
|
|
$ |
(8.12 |
) |
|
$ |
(8.29 |
) |
|
$ |
(9.80 |
) |
|
$ |
(18.37 |
) |
See notes
to unaudited consolidated financial statements.
PROGRESSIVE
GAMING INTERNATIONAL CORPORATION
(UNAUDITED)
|
|
|
Three
Months Ended
|
|
|
Nine
Months Ended
|
|
|
|
|
September
30,
|
|
|
September
30,
|
|
|
(Amounts
in thousands)
|
|
2008
|
|
|
2007
|
|
|
2008
|
|
|
2007
|
|
|
Net
loss
|
|
$ |
(63,591 |
) |
|
$ |
(39,737 |
) |
|
$ |
(76,271 |
) |
|
$ |
(82,699 |
) |
|
Other
comprehensive income, net of tax:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Foreign
currency translation (loss) gain
|
|
|
(3,489 |
) |
|
|
894 |
|
|
|
(3,076 |
) |
|
|
1,919 |
|
|
Comprehensive
loss
|
|
$ |
(67,080 |
) |
|
$ |
(38,843 |
) |
|
$ |
(79,347 |
) |
|
$ |
(80,780 |
) |
See notes
to unaudited consolidated financial statements.
PROGRESSIVE
GAMING INTERNATIONAL CORPORATION
|
|
|
Nine
Months Ended
|
|
|
|
|
September 30,
|
|
|
(Amounts
in thousands)
|
|
2008
|
|
|
2007
|
|
|
Cash
flows from operating activities:
|
|
|
|
|
|
|
|
Net
loss
|
|
$ |
(76,271 |
) |
|
$ |
(82,699 |
) |
|
Adjustments
to reconcile net loss to net cash used in continuing operating
activities:
|
|
|
|
|
|
|
|
|
|
Loss
from discontinued operations, net of tax
|
|
|
1,638 |
|
|
|
65,602 |
|
|
Depreciation
|
|
|
1,080 |
|
|
|
1,147 |
|
|
Amortization
|
|
|
4,543 |
|
|
|
4,335 |
|
|
Provision
for bad debts
|
|
|
2,917 |
|
|
|
4 |
|
|
Provision
for obsolete and excess inventory
|
|
|
578 |
|
|
|
— |
|
|
Amortization
of debt discount and debt issue costs
|
|
|
749 |
|
|
|
2,344 |
|
|
Net
loss on disposition of property and equipment
|
|
|
(3 |
) |
|
|
— |
|
|
Impairment
of goodwill and long lived assets
|
|
|
43,756 |
|
|
|
— |
|
|
Stock-based
compensation
|
|
|
2,826 |
|
|
|
2,658 |
|
|
Mark
- to - market losses
|
|
|
1,011 |
|
|
|
— |
|
|
Fair
value of debt issued in excess of proceeds
|
|
|
5,731 |
|
|
|
— |
|
|
Changes
in operating assets and liabilities:
|
|
|
|
|
|
|
|
|
|
Accounts
receivable
|
|
|
6,556 |
|
|
|
(2,818 |
) |
|
Contract
sales and notes receivable
|
|
|
(23 |
) |
|
|
3,824 |
|
|
Inventories
|
|
|
(1,240 |
) |
|
|
457 |
|
|
Prepaid
expenses and other assets
|
|
|
(756 |
) |
|
|
(556 |
) |
|
Trade
accounts payable
|
|
|
1,253 |
|
|
|
(4,149 |
) |
|
Accrued
expenses and other current liabilities
|
|
|
(3,415 |
) |
|
|
565 |
|
|
Customer
deposits, deferred revenue and other liabilities
|
|
|
232 |
|
|
|
(5,880 |
) |
|
Accrued
restructuring expenses
|
|
|
897 |
|
|
|
— |
|
|
Deferred
taxes
|
|
|
(582 |
) |
|
|
— |
|
|
Net
cash used in continuing operating activities
|
|
|
(8,523 |
) |
|
|
(15,166 |
) |
|
Net
cash used in discontinued operating activities
|
|
|
(2,167 |
) |
|
|
(1,491 |
) |
|
Net
cash used in operating activities
|
|
|
(10,690 |
) |
|
|
(16,657 |
) |
|
Cash
flows from investing activities:
|
|
|
|
|
|
|
|
|
|
Purchases
of property and equipment
|
|
|
(1,362 |
) |
|
|
(1,177 |
) |
|
Proceeds
from sales of property and equipment
|
|
|
4 |
|
|
|
9 |
|
|
Purchases
of intangible assets
|
|
|
(714 |
) |
|
|
(1,032 |
) |
|
Net
cash used in continuing investing activities
|
|
|
(2,072 |
) |
|
|
(2,200 |
) |
|
Proceeds
from sale of slot and table games segment
|
|
|
— |
|
|
|
19,756 |
|
|
Net
cash used in other discontinued investing activities
|
|
|
— |
|
|
|
(142 |
) |
|
Net
cash provided by discontinued investing activities
|
|
|
— |
|
|
|
19,614 |
|
|
Net
cash (used in) provided by investing activities
|
|
|
(2,072 |
) |
|
|
17,414 |
|
|
Cash
flows from financing activities:
|
|
|
|
|
|
|
|
|
|
Principal
payments on notes payable and long-term debt
|
|
|
(30,000 |
) |
|
|
(10,950 |
) |
|
Principal
payments on capital leases
|
|
|
— |
|
|
|
(5 |
) |
|
Proceeds
from long-term debt and notes payable net of discount of $833 and
$0
|
|
|
29,167 |
|
|
|
3,200 |
|
|
Increase
in restricted cash
|
|
|
(475 |
) |
|
|
— |
|
|
Debt
issuance costs
|
|
|
(3,278 |
) |
|
|
— |
|
|
Residual
costs of equity offering
|
|
|
(13 |
) |
|
|
— |
|
|
Purchase
of treasury stock
|
|
|
(121 |
) |
|
|
(134 |
) |
|
Proceeds
from issuance of common stock
|
|
|
302 |
|
|
|
30,127 |
|
|
Proceeds
from short term borrowings
|
|
|
1,789 |
|
|
|
— |
|
|
Net
cash (used in) provided by continuing financing activities
|
|
|
(2,629 |
) |
|
|
22,238 |
|
|
Effect
of exchange rate changes on cash and cash equivalents
|
|
|
(80 |
) |
|
|
100 |
|
|
Increase
(decrease) in cash and cash equivalents
|
|
|
(15,471 |
) |
|
|
23,095 |
|
|
Cash
and cash equivalents, beginning of period
|
|
|
19,063 |
|
|
|
7,183 |
|
|
Cash
and cash equivalents, end of period
|
|
$ |
3,592 |
|
|
$ |
30,278 |
|
CONSOLIDATED
STATEMENTS OF CASH FLOWS (UNAUDITED) (Continued)
|
|
|
Nine Months Ended
|
|
|
|
|
September 30,
|
|
|
(Amounts
in thousands)
|
|
2008
|
|
|
2007
|
|
|
Supplemental
disclosure of cash flows information:
|
|
|
|
|
|
|
|
Cash
paid for interest
|
|
$ |
3,415 |
|
|
$ |
6,205 |
|
|
Cash
paid for state and federal taxes
|
|
$ |
41 |
|
|
$ |
14 |
|
|
Intellectual
property acquired through financing
|
|
$ |
— |
|
|
$ |
6,878 |
|
|
Present
value of guaranteed minimum future payments from sale of table games
division
|
|
$ |
— |
|
|
$ |
2,811 |
|
See notes
to unaudited consolidated financial statements.
PROGRESSIVE
GAMING INTERNATIONAL CORPORATION
Amounts
disclosed in the accompanying footnote tables are shown in thousands while
amounts included in text are disclosed in actual amounts.
1.
GENERAL
These
unaudited consolidated financial statements have been prepared in accordance
with accounting principles generally accepted in the United States of America
for interim financial information and with the instructions to Form 10-Q and
Rule 10-01 of Regulation S-X. Accordingly, they do not include all of
the information and notes required by accounting principles generally accepted
in the United States of America for complete audited financial statements. These
statements should be read in conjunction with the audited consolidated financial
statements and notes thereto included in the Company’s Annual Report on Form
10-K for the year ended December 31, 2007. In the opinion of the
Company, the accompanying unaudited consolidated financial statements contain
all adjustments (consisting of normal accruals and charges) necessary to present
fairly the financial position of the Company at September 30, 2008, and the
results of its operations for the three and nine months ended September 30, 2008
and 2007, and cash flows for the nine months ended September 30, 2008
and 2007. The results of operations for the three and nine months ended
September 30, 2008 are not necessarily indicative of the results to be
expected for the entire year.
2.
BASIS OF PRESENTATION, LIQUIDITY AND CAPITAL RESOURCES
The
consolidated financial statements have been prepared on the basis of a going
concern which contemplates the realization of assets and the satisfaction of
liabilities in the normal course of business. At September 30, 2008,
the Company had total cash and cash equivalents of $3.6 million and a net
working capital deficit of $22.5 million. The Company generated net losses
from operations of $76.3 million during the nine months ended September 30,
2008, and the Company has an accumulated deficit of $321.3 million at September
30, 2008. The Company’s net cash and cash equivalents balance of $3.6 million at
September 30, 2008 reflects a decrease of $15.5 million compared to December 31,
2007. This change resulted from net cash used in continuing operating activities
of $8.5 million, net cash used in continuing investing activities of $2.1
million related to ongoing investments in intellectual property and property and
equipment used in operations, net cash used in financing activities of $2.6
million, and net cash used in discontinued operations of $2.2 million for
payments of certain liabilities related to the disposed slot and table games
divisions.
On August
4, 2008, the Company entered into two financing transactions with potential
borrowings of $42.5 million. These transactions include (i) a Senior
Secured Credit Facility of up to $27.5 million with Private Equity Management
Group Financial Corporation (“PEM”), and (ii) a $15 million Senior Secured
Convertible Note offering with International Game Technology (“IGT”). The credit
facility with PEM consists of a revolving loan of up to $12.5 million and a term
loan of $15 million. Collectively, these arrangements are referred to
as the “Credit Facilities”.
The
Senior Secured Credit Facility and the Senior Secured Convertible Note include
among other requirements, quarterly financial covenants for Adjusted Minimum
EBITDA, debt service coverage ratios, tangible net worth and liquidity
requirements, as well as restrictions on additional indebtedness and the ability
to issue dividends.
In
connection with the closing of the Senior Secured Credit Facility, the Company
issued to PEM warrants to purchase 125,000 shares of the Company’s
common stock with an exercise price of $8.40 per share. In connection
with the closing of the Senior Secured Convertible Note offering, the Company
issued IGT warrants to purchase 68,750 shares of its common stock with
an exercise price of $8.40 per share and warrants to purchase 111,487
shares of its common stock with an exercise price of $7.12 per
share. On November 15, 2008 PEM received 112,500 additional
shares of the Company’s common stock. On November 15, 2008
IGT received an additional 225,000 warrants with an exercise price of
$0.69. The warrants and shares were issued pursuant to
Section 4(2) and Regulation D of the Securities Act of 1933, as
amended.
On August
15, 2008, the Company closed and funded the Credit Facilities with PEM and
IGT. The Company borrowed approximately $16.8 million from PEM,
including $15 million from the PEM term loan and $1.8 million under the
revolving credit facility. The Company also closed and funded the
Senior Secured Convertible Note in the amount of $15 million. The
Company used the proceeds along with $2.6 of cash on hand to repay the $30
million of Senior Secured Notes, accrued interest of $1.1 million and
transaction costs of $3.2 million. Subsequent to the closing of these
transactions, the Company incurred additional post closing costs related to
legal and other fees of approximately $1 million.
On
September 29, 2008, the Company announced that it had taken action to reduce
annual aggregate selling, general and administrative, research and development
and operating expenses by approximately $13 - $15 million, or approximately 25%
- - 29% of overall expenses. These actions are expected to be
completed in the 4th quarter
of 2008 and significantly reduce the Company’s cash
expenditures. Additionally, Company management have identified
certain non-strategic and non-operating assets that could potenially be
sold to interested parties and result in cash proceeds sufficient to
cover all or a portion of the working capital deficit and other payments such as
the settlement due Hasbro. These potential asset sales will require
the consent of PEM and IGT under their respective financing
arrangements. There can be no assurances that PEM or IGT will consent
to the sale of these assets.
As of
September 30, 2008, the Company’s cash and cash equivalents were less than
anticipated due to (i) unanticipated transaction costs related to the
complexities and legal requirements under the IGT and PEM Credit Facilities for
which the Company paid the majority of these costs from existing cash on hand
(ii) the Company’s inability to collect under certain customer arrangements,
including a large customer located in Asia for approximately $2.5 million and
(iii) a decline in the Company’s revenues and cash flows primarily as a result
of gaming market conditions resulting in slower capital
spending by customers. Based on these factors, the Company believes
it will need additional liquidity to fund its working capital deficit and pay
for obligations as they become due in the normal course of
business.
Recent
macro-economic events, slowness in capital spending, customer credit issues and
higher than expected financing transaction costs has left the Company in default
with certain covenants under the Senior Secured Credit Facility with PEM and the
Senior Secured Convertible Note with IGT. On October 7, 2008, the
Company notified IGT and PEM that it believed it was in default with the
financial covenants contained within their respective
agreements. Also, the Company failed to make a payment due Hasbro in
the amount of $1.0 million in September 2008. Hasbro has petitioned the court
and the court has granted a writ of execution requiring that the consent
judgment be enforced in the amount of $1.7 million, representing all remaining
amounts due under the settlement agreement. The Company is attempting to
restructure the payment terms with Hasbro, although there can be no assurance
that the parties will come to an agreement regarding such revised
terms.
As a
result of the aforementioned events of default, the Company is unable to borrow
additional amounts under its Senior Credit Facility. As a result, the
Company received a Notice of Acceleration and Demand for Payment under Credit
Agreement from PEM. The Notice demands payment of all obligations in
the amount of $16,788,598 including accrued and unpaid interest and fees, by
November 14, 2008.
On November
17, 2008, the Company and PEM executed a letter whereby PEM has agreed to
forbear from exercising any of PEM’s rights and remedies under the Credit
Agreement in regards to the Notice, from day to day, until November 21, 2008
while the Company works on strategic alternatives, including a potential sale of
the Company. The letter also indicates that PEM may also terminate the
forbearance at their sole discretion at any time upon written notice to the
Company.
In
addition to the proposed asset divestitures, the Board of Directors of the
Company engaged a investment banker on October 13, 2008 to assist the Company in
reviewing strategic alternatives intended to enhance shareholder value. The
Company expects to consider and evaluate available alternatives during the
strategic review process including, but not limited to, the sale of the
Company.
If the
Company is unable to secure additional liquidity from operations or from the
sale of non-strategic assets or other strategic alternatives including
additional financing or a sale of the entity, the Company will be unable to pay
for obligations arising in its business and would not be able to continue
as a going concern.
3.
SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Principles of
Consolidation. The consolidated financial statements include the accounts
for the Company and all of its majority-owned subsidiaries and are maintained in
accordance with accounting principles generally accepted in the United States of
America. All significant intercompany balances and transactions have been
eliminated.
Cash and Cash
Equivalents. Cash and cash
equivalents include cash on hand, demand deposits, and short-term investments
with original maturities of less than ninety (90) days. The Company places
its cash and temporary investments with financial institutions. At
September 30, 2008, the Company had deposits with financial institutions in
excess of FDIC insured limits by $4.0 million.
Restricted
Cash.
Restricted cash consists of cash and cash equivalents pledged to secure
the Company’s revolving line of credit for employee travel and similar
expenses.
Receivables and
Allowance for Doubtful Accounts. The Company regularly evaluates the
collectibility of its trade receivable balances based on a combination of
factors. When a customer’s account becomes past due, dialogue is initiated with
the customer to determine the cause. If it is determined that the customer will
be unable to meet its financial obligation to the Company, such as in the case
of a bankruptcy filing, deterioration in the customer’s operating results or
financial position or other material events impacting their business, a specific
reserve is recorded for bad debt to reduce the related receivable to the amount
the Company expects to recover given all information available. The Company also
records reserves for bad debt for all other customers based on certain other
factors including the length of time the receivables are past due and historical
collection experience with individual customers. If circumstances related to
specific customers change, the Company’s estimates of the recoverability of
receivables could materially change.
Inventories.
Inventories are stated at the lower of cost (determined using the first-in,
first-out method) or market.
Long-Lived
Assets. Property and equipment are stated at cost and are depreciated
using the straight-line method over the useful lives of the assets, which range
from 3 to 10 years. Costs of major improvements are capitalized; costs of
normal repairs and maintenance are charged to expense as incurred. Management
requires long-lived assets that are held and used by the Company to be reviewed
for impairment annually or whenever events or changes in circumstances indicate
that the carrying amount of an asset may not be recoverable from related future
undiscounted cash flows. During the quarter ended September 30, 2008 economic
circumstances indicated that the carrying amount of its long-lived assets may
not be recoverable. In response to the noted economic impairment
indicators the Company performed interim impairment testing.
Assets Held for
Sale. Assets classified as held for sale are stated at the lower of cost
or fair value less cost to sell.
Patents and
Trademarks. The Company capitalizes the cost of registering and
successful defense of patents and trademarks. These costs are amortized over the
useful life of the patent or trademark.
Intangible
Assets. Intangible assets consist of patent and trademark rights,
goodwill, intellectual property rights, covenants not to compete, software costs
and license fees. Intangible assets are recorded at cost and are amortized
(except goodwill and perpetual licenses) on a straight-line basis over 5 to 20
years based on the period of time the asset is expected to contribute directly
or indirectly to future cash flows.
The
Company adopted Statement of Financial Accounting Standards (“SFAS”)
No. 142, “Goodwill and Other Intangible Assets” effective January 1,
2002. Under SFAS No. 142, goodwill and indefinite life intangible assets
are no longer amortized but are subject to periodic impairment tests. Other
intangible assets with finite lives, such as patents, software development
costs, trademark and proprietary property rights, and license and non-compete
agreements will continue to be amortized over their useful lives. Management
performs impairment reviews annually or whenever events or circumstances occur
that would indicate the assets may be impaired. During the quarter ended
September 30, 2008 a combination of factors, including the current economic
environment, the Company's operating results, and a sustained decline in the
Company's market valuation, the Company has concluded that the carrying amount
of its intangible assets may not be recoverable. In
response to the noted economic impairment indicators the Company performed
interim impairment testing.
Deferred
Revenues. Deferred revenues consist primarily of arrangements for which
revenues will be recognized in future periods.
Customer
Deposits. Customer deposit liabilities represent payments and payment
obligations collected in advance from customers pursuant to agreements under
which the related sale of inventory has not been completed.
Other
Assets. Other long-term assets primarily represent advance royalty
payments, minority investments, unamortized loan fees and security deposits for
building and equipment leases and other services. The Company’s minority
investments in non-public companies are accounted for using the cost method, and
are regularly reviewed for impairment. When facts and circumstances indicate
that an impairment has occurred that is other-than-temporary, the Company
records an impairment charge and reduces the carrying value of the
investment.
Litigation and
Other Contingencies. The Company is involved in various legal matters,
litigation and claims of various types in the ordinary course of its business
operations. The Company has regular litigation reviews, including updates from
corporate and outside counsel, to assess the need for accounting recognition or
disclosure of these contingencies. The status of significant claims is
summarized in Note 12.
Generally
accepted accounting principles require that liabilities for contingencies be
recorded when it is probable that a liability has been incurred and the amount
can be reasonably estimated. Significant management judgment is required related
to contingent liabilities and the outcome of litigation because both are
difficult to predict. For contingencies where an unfavorable outcome is
reasonably possible and which are significant, the Company discloses the nature
of the contingency and, where feasible, an estimate of the possible
loss.
Foreign Currency
Translation. The Company accounts for currency translation in accordance
with SFAS No. 52, “Foreign Currency Translation.” Balance sheet accounts
are translated at the exchange rate in effect at each balance sheet date. Income
statement accounts are translated at the average rate of exchange prevailing
during the period. Translation adjustments resulting from this process are
charged or credited to other comprehensive loss.
Non-monetary
Exchanges. The Company adopted SFAS No. 153 “Exchanges of
Non-Monetary Assets” for the quarter ended September 30, 2005. SFAS
No. 153 addresses the measurement for the exchange of non-monetary assets.
SFAS No. 153 requires that exchanges be recorded at fair value provided
that fair value is determinable and other qualifying criteria are met as
described in the standard. If fair value is not determinable or if the other
qualifying criteria are not met, the exchange is recorded at cost.
Revenue
Recognition. The Company recognizes revenue depending on the line of
business as follows:
Systems. The Company’s systems
segment offers a suite of products that when combined, supports many facets of a
gaming operation, and consolidates the management of slot machines, table games,
server-based gaming, account wagering, marketing and cage into one fully
integrated system. There are proprietary hardware and software components to the
systems. The Company accounts for system sales in accordance with Statement of
Position “SOP” 97- 2, “Software Revenue Recognition.” System sales are evidenced
by a signed contract. Follow-up spare parts and hardware-only sales are
evidenced by a purchase order or other approved form. Revenue for system sales
is recognized when: (i) there is an arrangement with a fixed or
determinable price; (ii) collectibility of the sale is probable; and
(iii) the hardware and software have been delivered and installed, training
has been completed, and acceptance has occurred.
Not all
systems contracts require installation. Examples include sales of hardware only
to (i) previous customers that are expanding their systems,
(ii) customers that have multiple locations and do the installation
themselves and require additional software licenses and hardware and
(iii) customers purchasing spare parts.
Postcontract Customer
Support.
Maintenance and support for substantially all of the Company’s products are sold
under agreements with established vendor-specific objective evidence of fair
value in accordance with the applicable accounting literature. These contracts
are generally for a period of three years and revenue is recognized ratably over
the contract service period. Training is also sold under agreements with
established vendor-specific objective evidence of fair value, which is based on
daily rates and is recognized as the services are provided.
License Arrangements. A significant portion of
the Company’s revenues are generated from the license of intellectual property,
software and game content. These licenses are sold on a stand-alone basis or in
multiple element arrangements. Revenue is recognized from these transactions in
accordance with the applicable accounting literature. Revenues under perpetual
license arrangements are generally recognized when the license is delivered.
Revenues under fixed term arrangements are generally recognized over the term of
the arrangement or in a manner consistent with the earnings process. For
arrangements with multiple deliverables, revenue is generally recognized as the
elements are delivered so long as the undelivered elements have established fair
values as required in the applicable accounting literature.
Slot and Table Games. Prior to the Company’s
disposal of the slot and table games segment in 2007, the Company’s revenue
recognition policies for these operations were as follows: The
Company leased and sold proprietary slot and table games to casino customers.
Table game lease contracts were typically for a 36-month period with a 30-day
cancellation clause. The lease revenue was recognized on a monthly basis. Slot
machine lease contracts were either on revenue participation or a fixed-rental
basis. Slot machine lease contracts were typically for a month-to-month period
with a 30-day cancellation clause. On a participation basis, the Company earned
a share of the revenue that the casino earned from these slot machines. On a
fixed-rental basis, the Company charged a fixed amount per slot machine per day.
Revenues from both types of lease arrangements were recognized on the accrual
basis. The sales agreements for proprietary table games and slot games consisted
of the sale of hardware and a perpetual license for the proprietary intellectual
property. Slot and table game sales were executed by a signed contract or a
customer purchase order. Revenues for these sales agreements were generally
recognized when the hardware and intellectual property were delivered to the
customer.
Stock-Based
Compensation. Beginning January 2006, the Company adopted the modified
prospective application method contained in SFAS No. 123 (revised December
2004), “Share-Based Payment” (“SFAS No. 123(R)”), to account for
share-based payments. As a result, the Company applies this pronouncement to new
awards or modifications of existing awards in 2006 and thereafter. Prior to the
adoption of SFAS No. 123(R), the Company accounted for share-based payments
under the recognition and measurement provisions of Accounting Principles Board
(“APB”) Opinion No. 25, “Accounting for Stock Issued to Employees,” and
related Interpretations, as permitted by SFAS No. 123, “Accounting for Stock-Based
Compensation.” Under APB No. 25, no compensation cost was required to be
recognized for options granted that had an exercise price equal to the market
value of the underlying common stock on the date of grant.
Equity
Instruments Issued to Outside Parties. The
Company’s accounting policy for equity instruments issued to outside parties in
exchange for goods and services follows the provisions of Emerging Issues Task
Force (“EITF”) 96-18, “Accounting for Equity Instruments That are Issued to
Other Than Employees for Acquiring, or in Conjunction with Selling, Goods or
Services” and EITF 00-18, “Accounting Recognition for Certain Transactions
Involving Equity Instruments Granted to Other Than Employees.” The measurement
date for the fair value of the equity instruments issued is determined at the
earlier of (i) the date at which a commitment for performance by the
consultant or vendor is reached or (ii) the date at which the consultant or
vendor’s performance is complete. In the case of equity instruments issued to
consultants, the fair value of the equity instrument is recognized as a charge
to the statement of operations over the term of the consulting agreement. The
number of outstanding options issued to consultants at September 30, 2008 was
3,125, with a range of exercise prices from $36.40 to $55.04 per share. The fair
values of these option awards have been fully amortized to expense.
During
the year ended December 31, 2006, the Company issued warrants to purchase
an aggregate of 43,750 shares of the Company’s common stock to Ableco Holding
LLC (“Ableco”) representing a portion of the debt issue costs related to the
Company’s long-term debt arrangements. At the date of issuance, these warrants
had a term of seven years. The fair value of these warrants was recorded as a
prepaid loan fee, and recognized as a charge to the statement of operations
using the straight-line method over the term of the debt facility. Due to the
termination of this debt facility, the unamortized fair value of these warrants
was written off during the fourth quarter of 2007. These warrants contain
anti-dilution provisions requiring certain adjustments when dilutive equity
transactions occur. At September 30, 2008, the number of shares issuable under
outstanding warrants held by Ableco was 75,308, with exercise prices ranging
from $29.17 to $38.46.
From time
to time, the Company issues stock purchase warrants to third parties in
consideration for intellectual property licensing arrangements. During the year
ended December 31, 2006, the Company issued warrants to purchase 40,625
shares of the Company’s common stock, all of which are outstanding at
September 30, 2008, at an exercise price of $60.00 per share in exchange
for certain intellectual property rights licensed from Harrah’s. The outstanding
warrants issued have a weighted average exercise price of $60.00 per
share. These warrants were valued using the Black-Scholes-Merton
option-pricing model using a volatility of 60%, an expected life of six years, a
risk free rate of 4.79%, and expected dividends of zero.
In
connection with the closing of the Senior Credit Facility as more fully
described in Note 11, the Company issued warrants to purchase 1 million
shares of the Company’s common stock to an affiliate of PEM, pursuant to a
Common Stock and Warrant Purchase Agreement dated August 15, 2008 by and
among the Company, Private Equity Management Group Inc. (“PEM Inc.”) and Private
Equity Management Group LLC (“PEM LLC”), both of which are PEM affiliates. The
warrants are exercisable for five years at an exercise price of $8.40 per share
subject to certain anti-dilution provisions. PEM Inc. also received 125,000
shares of the Company’s common stock at closing. On November 15, 2008 PEM
received 112,500 additional shares of the Company’s common stock as
rerquired inder the terms of the Senior Credit Facility agreement. The warrants
and shares were issued pursuant to Section 4(2) and Regulation D of the
Securities Act of 1933, as amended.
In
connection with the closing of the Convertible Note Offering as more fully
described in Note 11, the Company issued to IGT warrants to purchase
(i) 68,750 shares of the Company’s common stock with an exercise price
equal to $8.40 per share and (ii) 111,487 shares of the Company’s common
stock with an exercise price equal to $7.12 per share (the “Initial IGT
Warrants”). On November 15, 2008 IGT received an additional 225,000
warrants with an exercise price of $0.69. The warrants were
issued pursuant to Section 4(2) and Regulation D of the Securities Act of
1933, as amended.
Software
Development Capitalization. The Company capitalizes external direct costs
related to the development of certain software products that meet the criteria
under SFAS No. 86, “Accounting for the Costs of Computer Software to Be
Sold, Leased, or Otherwise Marketed.”
Income
Taxes. Effective January 1, 2007, the Company adopted FIN No.
48,”Accounting for Uncertainty in Income Taxes—an interpretation of FASB
Statement No. 109.” FIN 48 prescribes a recognition threshold and a measurement
attribute for the financial statement recognition and measurement of tax
positions taken or expected to be taken in a tax return. For those benefits to
be recognized, a tax position must be more likely than not to be sustained upon
examination by taxing authorities.
The
Company has assessed all material positions taken in any income tax return,
including all significant uncertain positions, in all tax years that are still
subject to assessment or challenge by relevant taxing authorities. Assessing an
uncertain tax position begins with the initial determination of the position's
sustainability and is measured at the largest amount of benefit that is greater
than 50 percent likely of being realized upon ultimate settlement. As of each
balance sheet date, unresolved uncertain tax positions must be reassessed, and
we will determine whether (i) the factors underlying the sustainability
assertion have changed and (ii) the amount of recognized tax benefit is still
appropriate. The recognition and measurement of tax benefits requires
significant judgment. Judgments concerning the recognition and measurement of a
tax benefit are subject to change as new information becomes
available.
Guarantees.
In November 2002, the FASB issued FASB Interpretation No. 45,
“Guarantor’s Accounting and Disclosure Requirements for Guarantees, including
Indirect Guarantees of Indebtedness of Others, an interpretation of FASB
Statements No. 5, 57 and 107 and rescission of FIN 34.” The disclosure
requirements are effective for financial statements issued after
December 15, 2002. While the Company has various guarantees included in
contracts in the normal course of business, primarily in the form of
indemnities, the Company believes these guarantees would only result in
immaterial increases in future costs, and do not represent significant or
contingent liabilities of the indebtedness of others.
Use of Estimates
and Assumptions. The Company’s consolidated financial statements are
prepared in conformity with accounting principles generally accepted in the
United States. Certain of the Company’s accounting policies require that
management apply significant estimates, judgments and assumptions, that it
believes are reasonable, in calculating the reported amounts of certain assets,
level 3 fair value estimates, liabilities, revenues and expenses and related
disclosure of contingent assets and liabilities. By their nature, these
estimates are subject to an inherent degree of uncertainty. Management’s
judgments are based on historical experience, terms of existing contracts,
observance of known industry trends, and information available from outside
sources, as appropriate. On a regular basis, management evaluates its estimates
including those related to lives assigned to the Company’s assets, the
determination of bad debt, inventory valuation reserves, asset impairment, tax
positions, and self-insurance reserves. There can be no assurance that actual
results will not differ from those estimates.
Reclassifications.
Certain balance sheet and operating statement amounts reported in the prior
period have been reclassified to conform to the current period
presentation.
Obligations to
issue Additional Shares and Warrants. As further described in
Note 11, the Company is obligated under certain circumstances to issue
additional shares and warrants in connection with transactions that closed on
August 15, 2008. The Company initially recorded these obligations at
fair value and recognized subsequent changes in fair value in other income
(expense) in the consolidated statement of operations.
Derivatives
Embedded in Certain Debt Securities. The Company evaluates
instruments for embedded derivatives in accordance with SFAS No. 133,
“Accounting for Derivative Instruments and Hedging Activities”, and related
guidance. If the Company is required to account for an embedded
derivative separately, it initially records the derivative instrument at its
fair value. The Company recognizes changes in the fair value of
derivatives that do not qualify for hedge accounting in other income (expense)
in the consolidated statement of operations.
Recently Issued
Accounting Standards.
In December 2007, the Financial Accounting Standards Board (“FASB”)
issued SFAS No. 141(R), "Business Combinations." SFAS No. 141(R) replaces SFAS
No. 141, "Business Combinations", but retains the requirement that the purchase
method of accounting for acquisitions be used for all business combinations.
SFAS No. 141(R) expands on the disclosures previously required by SFAS No. 141,
better defines the acquirer and the acquisition date in a business combination,
and establishes principles for recognizing and measuring the assets acquired
(including goodwill), the liabilities assumed and any noncontrolling interests
in the acquired business. SFAS No. 141(R) also requires an acquirer to record an
adjustment to income tax expense for changes in valuation allowances or
uncertain tax positions related to acquired businesses. SFAS No. 141(R) is
effective for all business combinations with an acquisition date in the first
annual period following December 15, 2008; early adoption is not permitted. The
Company will adopt this statement as of January 1, 2009. The Company is
currently evaluating the impact SFAS No. 141(R) will have on our
consolidated financial statements.
In
December 2007, the FASB issued SFAS No. 160, “Noncontrolling Interest in
Consolidated Financial Statements, an amendment of ARB No. 51.” This
statement establishes accounting and reporting standards for ownership interest
in subsidiaries held by parties other than the parent and for the
deconsolidation of a subsidiary. It also clarifies that a
noncontrolling interest in a subsidiary is an ownership interest in the
consolidated entity that should be reported as equity in the consolidated
financial statements. SFAS No. 160 changes the way the consolidated
income statement is presented by requiring consolidated net income to be
reported at amounts that include the amount attributable to both the parent and
the noncontrolling interests. The statement also establishes
reporting requirements that provide sufficient disclosure that clearly identify
and distinguish between the interest of the parent and those of the
noncontrolling owners. This statement is effective for fiscal years
beginning on or after December 15, 2008. The adoption of SFAS No. 160
is not expected to have a material impact on the Company’s financial position,
results of operations or cash flows.
In March
2008, the FASB issued SFAS No. 161, “Disclosures about Derivative Instruments
and Hedging Activities—an amendment of FASB Statement No. 133.” SFAS No.
161 requires entities that utilize derivative instruments to provide qualitative
disclosures about their objectives and strategies for using such instruments, as
well as any details of credit-risk-related contingent features contained within
derivatives. Statement 161 also requires entities to disclose
additional information about the amounts and location of derivatives located
within the financial statements, how the provisions of SFAS 133 have been
applied, and the impact that hedges have on an entity’s financial position,
financial performance, and cash flows. Statement 161 is effective for
fiscal years and interim periods beginning after November 15, 2008, with early
application encouraged. The Company is currently evaluating the
impact SFAS No. 161 will have on its consolidated financial
statements.
In
April 2008, the FASB issued FSP No. FAS 142-3, “Determination of the
Useful Life of Intangible Assets.” This FSP amends the factors that should be
considered in developing renewal or extension assumptions used to determine the
useful life of a recognized intangible asset under Statement of Financial
Accounting Standards (“SFAS”) No. 142, “Goodwill and Other Intangible
Assets.” The intent of this FSP is to improve the consistency between the useful
life of a recognized intangible asset under Statement 142 and the period of
expected cash flows used to measure the fair value of the asset under SFAS 141
(revised 2007), “Business Combinations,” and other U.S. generally accepted
accounting principles (“GAAP”). This FSP is effective for financial statements
issued for fiscal years beginning after December 15, 2008. The adoption of
FAS 142-3 is not expected to have a material impact on the Company’s financial
position, results of operations or cash flows.
In May
2008, the FASB issued FSP No. APB 14-1 “Accounting for Convertible Debt
Instruments That May Be Settled in Cash upon Conversion (Including Partial Cash
Settlement).” This FSP specifies that issuers of such instruments should
separately account for the liability and equity components in a manner that will
reflect the entity's nonconvertible debt borrowing rate when interest cost is
recognized in subsequent periods. This FSP is effective for financial statements
issued for fiscal years beginning after December 15, 2008 and interim
periods within those fiscal years and will be applied retrospectively to all
periods presented. The Company is currently evaluating the impact this
pronouncement will have on its consolidated financial statements.
In May
2008, FASB issued SFAS No.162, “The Hierarchy of Generally Accepted Accounting
Principles.” The pronouncement mandates the GAAP hierarchy reside in the
accounting literature as opposed to the audit literature. This has the practical
impact of elevating FASB Statements of Financial Accounting Concepts in the GAAP
hierarchy. This pronouncement will become effective 60 days following SEC
approval. The Company does not believe this pronouncement will have a material
impact on its consolidated financial statements.
In May
2008, FASB issued SFAS No. 163, “Accounting for Financial Guarantee Insurance
Contracts-an interpretation of FASB Statement No. 60.” The scope of the
statement is limited to financial guarantee insurance (and reinsurance)
contracts. The pronouncement is effective for fiscal years beginning after
December 31, 2008. The Company does not believe this pronouncement will have a
material impact on its consolidated financial statements.
In
June 2008, the FASB issued FSP EITF 03-6-1, “Determining Whether
Instruments Granted in Share-Based Payment Transactions are Participating
Securities” (“FSP EITF 03-6-1”), which addresses whether instruments granted in
share-based payment transactions are participating securities prior to vesting
and, therefore, need to be included in earnings allocation in computing earnings
per share under the two-class method as described in SFAS No. 128,
“Earnings Per Share.” Under the guidance in FSP EITF 03-6-1, unvested
share-based payment awards that contain non-forfeitable rights to dividends or
dividend equivalents (whether paid or unpaid) are participating securities and
shall be included in the computation of earnings per share pursuant to the two
class method. FSP EITF 03-6-1 is effective for fiscal periods beginning after
December 15, 2008. All prior-period earnings per share data presented shall
be adjusted retrospectively. Early application is not permitted. The
Company is currently evaluating the impact this pronouncement will have on
its consolidated financial statements.
4.
DISCONTINUED OPERATIONS
On
September 28, 2007, the Company completed the sale of its table games
division to Shuffle Master, Inc. Upon closing, the Company received $19.8
million in cash. The Purchase Agreement also provides for earn-out payments
based on the installed base growth of the table game division assets through
2016, subject to certain conditions, including $3.5 million in guaranteed
minimum payments expected to be realized over the next four years. The table
games division consisted of casino table games with proprietary intellectual
property, including patents, trademarks, copyrights, etc. that had been
developed, acquired or licensed from third parties.
During
June 2007, the Company entered into two arrangements to sell its remaining slot
route and slot inventory to Reel Games, Inc., and the disposal of the slot
operations was completed during the third quarter of 2007.
The
Company has no continuing involvement in the disposed businesses, and continuing
direct cash flows from the slot and table businesses ceased within one year
from the date of sale.
The
assets and liabilities associated with discontinued operations are presented in
separate line items in the Consolidated Balance Sheets. The components of the
assets and liabilities of discontinued operations at September 30, 2008 are
presented below, along with comparable carrying values of the assets and
liabilities at December 31, 2007.
|
|
|
September
30,
|
|
|
December 31,
|
|
|
|
|
2008
|
|
|
2007
|
|
|
(Amounts
in thousands)
|
|
(Unaudited)
|
|
|
|
|
|
Current
assets of discontinued operations (1)
|
|
$ |
— |
|
|
$ |
680 |
|
|
Noncurrent
assets of discontinued operations (present value of minimum future
payments due from purchaser) (2)
|
|
|
— |
|
|
|
2,131 |
|
|
Current
liabilities of discontinued operations
|
|
|
3,314 |
|
|
|
3,695 |
|
|
Noncurrent
liabilities of discontinued operations
|
|
|
996 |
|
|
|
1,175 |
|
|
Net
liabilities of discontinued operations (3)
|
|
$ |
4,310 |
|
|
$ |
2,059 |
|
(1)
Current assets of discontinued operations consisting of contracts receivable of
$0.7 million were reclassified to contracts receivable of continuing operations
as of June 30, 2008.
(2)
Noncurrent assets of discontinued operations consisting of long term contracts
receivable of $2 million were reclassified to contracts receivable of continuing
operations as of June 30, 2008.
(3)
Liabilities of discontinued operations consist of settlement charges payable of
$1.9 million, future royalties payable of $2 million, and other payables of $0.4
million.
The
changes in the liabilities of discontinued operations during the nine months
ended September 30, 2008, are identified below:
|
|
|
September 30,
|
|
|
|
|
2008
|
|
|
(Amounts
in thousands)
|
|
(Unaudited)
|
|
|
Liabilities
of discontinued operations as of December 31, 2007
|
|
$ |
4,870 |
|
|
Payment
of accrued liabilities charged to expense
|
|
|
(1,607 |
) |
|
Additional
royalty liability accrual
|
|
|
794 |
|
|
Additional
legal liability accrual
|
|
|
253 |
|
|
|
|
|
|
|
|
Liabilities
of discontinued operations as of September 30, 2008
|
|
$ |
4,310 |
|
The
components of the loss from discontinued operations (unaudited) are presented
below.
|
|
|
Three
Months Ended
|
|
|
Nine
Months Ended
|
|
|
|
|
September
30,
|
|
|
September
30,
|
|
|
(Amounts
in thousands)
|
|
2008
|
|
|
2007
|
|
|
2008
|
|
|
2007
|
|
|
Loss
from discontinued operations before income tax benefit
|
|
$ |
— |
|
|
$ |
(625 |
) |
|
$ |
(1,638 |
) |
|
$ |
(2,608 |
) |
|
Accrued
charge for settlement of litigation
|
|
|
— |
|
|
|
(24,677 |
) |
|
|
— |
|
|
|
(24,677 |
) |
|
Income
tax provision (benefit)
|
|
|
— |
|
|
|
— |
|
|
|
— |
|
|
|
— |
|
|
Loss
on disposal
|
|
|
— |
|
|
|
(9,696 |
) |
|
|
— |
|
|
|
(49,507 |
) |
|
Income
tax benefit on disposal
|
|
|
— |
|
|
|
— |
|
|
|
— |
|
|
|
11,190 |
|
|
Total
|
|
$ |
— |
|
|
$ |
(34,998 |
) |
|
$ |
(1,638 |
) |
|
$ |
(65,602 |
) |
5. FAIR
VALUE MEASUREMENTS
The
Company adopted SFAS No. 157, “Fair Value Measurements” on January 1, 2008. SFAS
No. 157, among other things, defines fair value, establishes a consistent
framework for measuring fair value and expands disclosure for each major asset
and liability category measured at fair value on either a recurring or none
recurring basis. SFAS No. 157 clarifies that fair value is an exit price,
representing the amount that would be received to sell an asset or paid to
transfer a liability in an orderly transaction between market participants. As
such, fair value is a market-based measurement that should be determined based
on assumptions that market participants would use in pricing an asset or
liability. As a basis for considering such assumptions, SFAS No. 157 establishes
a three-tier fair value hierarchy, which prioritizes the inputs used in
measuring fair value as follows:
Level
1. Observable
inputs such as quoted prices in active markets;
Level
2. Inputs,
other than the quoted prices in active markets, that are observable either
directly or indirectly; and
Level
3. Unobservable
inputs in which there is little or no market data, which require the reporting
entity to develop its own
assumptions.
Assets
measured at fair value on a recurring and nonrecurring basis are as follows
(unaudited):
|
(Amounts
in thousands)
|
|
Fair
Value at September 30, 2008
|
|
|
Quoted
prices in active markets for identical assets (Level 1)
|
|
|
Significant
other observable inputs (Level 2)
|
|
|
Significant
unobservable inputs
(Level
3)
|
|
|
Assets
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Cash,
restricted cash and cash equivalents (level 1, recurring)
|
|
$ |
4,067 |
|
|
$ |
4,067 |
|
|
$ |
— |
|
|
$ |
— |
|
|
Investment
in Magellan Technology Pty Ltd.(level 3, nonrecurring)
|
|
|
2,888 |
|
|
|
— |
|
|
|
— |
|
|
|
2,888 |
|
|
Total
assets measured at fair value
|
|
$ |
6,955 |
|
|
$ |
4,067 |
|
|
$ |
— |
|
|
$ |
2,888 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Liabilities
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
PEM
term loan (level 3, nonrecurring)
|
|
$ |
12,553 |
|
|
$ |
— |
|
|
|
— |
|
|
$ |
12,553 |
|
|
Convertible
note (level 3, nonrecurring)
|
|
|
14,235 |
|
|
|
— |
|
|
|
— |
|
|
|
14,235 |
|
|
Senior
secured credit facility embedded derivatives (level 3, non
recurring)
|
|
|
552 |
|
|
|
— |
|
|
|
— |
|
|
|
552 |
|
|
Convertible
notes embedded derivatives (level3, non recurring)
|
|
|
1,607 |
|
|
|
— |
|
|
|
— |
|
|
|
1,607 |
|
|
Total
liabilities measured at fair value
|
|
$ |
28,947 |
|
|
$ |
— |
|
|
$ |
— |
|
|
$ |
28,947 |
|
During
the period the Company recorded an impairment charge of $2.3 million related to
the Company’s investment in Magellan Technology Pty Ltd. Magellan
Technology is measured at fair value on a nonrecurring basis, and was measured
at September 30, 2008. The Company also recorded adjustment to fair
value charges of $0.4 million and $1.3 million to the embedded derivatives
related to the Senior Secured Credit facility and Convertible Notes
respectively. The $2.3 million impairment charge is reported on the
asset impairment line of the statement of operations, and the $1.7
million in fair value charges related to the embedded derivatives is reported on
the mark- to- market gains and losses line of the statement of
operations.
6.
RECEIVABLES
Accounts
receivable at September 30, 2008 and December 31, 2007 consist of the
following:
|
|
|
September 30,
|
|
|
December 31,
|
|
|
|
|
2008
|
|
|
2007
|
|
|
(Amounts
in thousands)
|
|
(Unaudited)
|
|
|
|
|
|
Trade
accounts
|
|
$ |
14,576 |
|
|
$ |
21,566 |
|
|
Other
|
|
|
446 |
|
|
|
736 |
|
|
Subtotal
|
|
|
15,022 |
|
|
|
22,302 |
|
|
Less:
allowance for doubtful accounts
|
|
|
(3,465 |
) |
|
|
(942 |
) |
|
Net
|
|
$ |
11,557 |
|
|
$ |
21,360 |
|
Contract
sales and notes receivable at September 30, 2008 and December 31, 2007
consist of the following:
|
|
|
September 30,
|
|
|
December 31,
|
|
|
|
|
2008
|
|
|
2007
|
|
|
(Amounts
in thousands)
|
|
(Unaudited)
|
|
|
|
|
|
Contract
sales and notes receivable
|
|
$ |
4,040 |
|
|
$ |
1,301 |
|
|
Less:
allowance for doubtful accounts
|
|
|
(383 |
) |
|
|
(472 |
) |
|
Net
|
|
|
3,657 |
|
|
|
829 |
|
|
Current
portion
|
|
$ |
1,899 |
|
|
$ |
829 |
|
7. INVENTORIES
Inventories
at September 30, 2008 and December 31, 2007 consist of the
following:
|
|
|
September 30,
|
|
|
December 31,
|
|
|
|
|
2008
|
|
|
2007
|
|
|
(Amounts
in thousands)
|
|
(Unaudited)
|
|
|
|
|
|
Raw
materials
|
|
$ |
5,848 |
|
|
$ |
5,013 |
|
|
Finished
goods
|
|
|
2,472 |
|
|
|
2,315 |
|
|
Work
in progress
|
|
|
110 |
|
|
|
16 |
|
|
Subtotal
|
|
|
8,430 |
|
|
|
7,344 |
|
|
Less:
reserve for obsolete inventory
|
|
|
(1,252 |
) |
|
|
(768 |
) |
|
Net
|
|
$ |
7,178 |
|
|
$ |
6,576 |
|
8. GOODWILL
AND OTHER INTANGIBLE ASSETS
In
accordance with SFAS No. 142 (“Goodwill and Other Intangible Assets”) and
SFAS No. 144 (“Accounting for the Impairment or Disposal of Long-Lived
Assets”), the Company performs an impairment analysis on all of its long-lived
and intangible assets on an annual basis or whenever events or changes in
circumstances indicate that the carrying amount of an asset may not be
recoverable. For assets with indefinite lives such as goodwill, management
performs an annual valuation to determine if any impairment has
occurred. During the quarter ended September 30, 2008 economic
circumstances indicated that the carrying amount of the Company’s long-lived and
intangible assets may not be recoverable. In response to the noted
economic impairment indicators, the Company performed interim impairment
testing.
Goodwill.
For purposes of testing goodwill, the Company performed Step One of the SFAS No.
142 test by estimating the fair value of the Company’s single reporting unit (to
which all goodwill is allocated) utilizing both market and income approach fair
value measurement techniques, including using relevant data available through
and as of September 30, 2008. The market approach is a valuation technique in
which fair value is estimated based on observed prices in actual transactions
and on asking prices for similar assets. The valuation process is essentially
that of comparison and correlation between the subject asset and other similar
assets. The income approach is a technique in which fair value is estimated
based on the discounted cash flows that an asset could be expected to generate
over its useful life, including residual value cash flows. These cash flows are
discounted to their present value equivalents using a rate of return that
accounts for the relative risk of not realizing the estimated annual cash flows
and for the time value of money.
Under the
market approach, the fair value of the Company’s single reporting unit was
estimated based upon the fair value of invested capital of the Company as well
as a separate comparison to revenue and EBITDA multiples for similar publicly
traded companies in the casino management system industry.
Under the
income approach, the fair value of the Company’s single reporting unit was
estimated based on the present value of estimated future cash flows for the
reporting unit. The assumptions supporting the discounted cash flow method,
including the discount rate, were determined using the Company's best estimates
as of the date of the impairment review. Impairment assessment inherently
involves judgment as to assumptions about expected future cash flows and the
impact of market conditions on those assumptions. Future events and changing
market conditions may impact the Company’s assumptions as to prices, costs,
growth rates or other factors that may result in changes in the Company’s
estimates of future cash flows. Although the Company believes the assumptions it
used in testing for impairment are reasonable, significant changes in any one of
the Company’s assumptions could produce a significantly different result. Taking
into consideration both market and income approach estimates, the indicated fair
value of the Company’s single reporting unit was less than its carrying value,
and therefore, the Company was required to perform Step Two of the SFAS 142
goodwill impairment test.
In Step
Two of the impairment test, the Company determined the implied fair value of
goodwill for the single reporting unit by allocating the fair value of the
reporting unit determined in Step One to all the assets and liabilities of the
single reporting unit, including any recognized and unrecognized intangible
assets, as if the reporting unit had been acquired in a business combination and
the fair value of the reporting unit was the acquisition price. As a result of
the Step Two testing, the Company determined that goodwill was impaired and
therefore, recorded an impairment charge of $25 million as of September 30, 2008
to write-down the carrying value of goodwill.
Definite Life
Intangible Assets. Each of
the Company’s intangible assets, excluding goodwill, is amortized over its
appropriate estimated useful life on a straight-line basis. The Company grouped
the intangible assets, which include patents, trademarks, customer lists,
software development, and core technology, by product (or in one case, on a
stand alone basis) to perform this evaluation and used data and assumptions
through September 30, 2008. The Company utilized appropriate valuation
techniques, as described above, to separately estimate the fair values of all of
its definite life intangible assets by group as of September 30, 2008, and
compared those estimates to related carrying values. The estimated future cash
flows were dependent on a number of critical management assumptions including
estimates of revenue growth, changes in technology and competition, operating
costs and other relevant assumptions. For certain intangible assets for
which market information was available, fair value was estimated using the
market approach. As of September 30, 2008, based on the results of these tests,
the Company determined that an impairment of $14 million existed which was
attributable to the Company’s definite life intangible assets. This
estimate was recorded during the quarter ended September 30, 2008 and will be
reevaluated and updated in the fourth quarter.
The net
carrying value of goodwill and other intangible assets at September 30,
2008 is comprised of the following (unaudited):
|
(Amounts
in thousands)
|
|
|
|
|
Goodwill
|
|
$ |
14,698 |
|
|
Definite
life intangible assets (detail below)
|
|
|
7,120 |
|
|
Total
|
|
$ |
21,818 |
|
Definite
life intangible assets as of September 30, 2008, subject to amortization,
are comprised of the following (unaudited):
|
|
|
|
|
|
|
|
|
|
|
Weighted-Average
|
|
|
|
Gross Carrying
|
|
|
Accumulated
|
|
|
|
|
Amortization
|
|
(Amounts
in thousands)
|
|
Amount
|
|
|
Amortization
|
|
|
Net
|
|
Period
|
|
Patent
and trademark rights
|
|
$ |
3,982 |
|
|
$ |
— |
|
|
$ |
3,982 |
|
9
years
|
|
Software
development costs
|
|
|
358 |
|
|
|
(311 |
) |
|
|
47 |
|
2
years
|
|
Licensed
technology
|
|
|
1,283 |
|
|
|
— |
|
|
|
1,283 |
|
5
years
|
|
Core
technology and other proprietary rights
|
|
|
2,679 |
|
|
|
(871 |
) |
|
|
1,808 |
|
5
years
|
|
Total
|
|
$ |
8,302 |
|
|
$ |
(1,182 |
) |
|
$ |
7,120 |
|
7
years
|
The
reduction in the gross carrying amount of definite life intangible assests as of
September 30, 2008 includes an impairment charge of $14.3 million and the
impairment charge is presented in the continuing operations of the Company’s
consolidated statements of operations. Amortization expense for definite life
intangible assets of $1.5 million and $4.5 million compared to
$1.5 million and $4.3 million was included in loss from continuing operations
for the three and nine months ended September 30, 2008 and 2007,
respectively. Prior to the disposal of the slot and table games segment,
amortization expense for definite life intangible assets of $0.0 million and
$0.6 million was included in loss from discontinued operations for the three
and nine months ended September 30, 2007.
The net
carrying value of goodwill as of September 30, 2008, is included in the
Company’s geographic operations as follows (unaudited):
|
(Amounts
in thousands)
|
|
|
|
|
North
America
|
|
$ |
— |
|
|
Europe
|
|
|
13,077 |
|
|
Australia
/ Asia
|
|
|
1,621 |
|
|
Total
goodwill
|
|
$ |
14,698 |
|
During
the nine months ended September 30, 2008, the net carrying value of
goodwill decreased by $25.3 million as a result of the impairment charge and by
$2.4 million as a result of changes in the foreign currency rates used to
translate the balance sheet of the Company’s international operations., for a
total decrease in goodwill of $27.7 million.
9. OTHER
ASSETS
Other
assets at September 30, 2008 and December 31, 2007 consist of the
following:
|
|
|
September 30,
|
|
|
December 31,
|
|
|
|
|
2008
|
|
|
2007
|
|
|
(Amounts
in thousands)
|
|
(Unaudited)
|
|
|
|
|
|
Deposits
|
|
$ |
276 |
|
|
$ |
241 |
|
|
Minority
investments
|
|
|
2,887 |
|
|
|
5,178 |
|
|
Royalties
|
|
|
2,099 |
|
|
|
4,262 |
|
|
Prepaid
loan fees and other
|
|
|
1,908 |
|
|
|
34 |
|
|
Total
|
|
$ |
7,170 |
|
|
$ |
9,715 |
|
10.
ACCRUED LIABILITIES
Accrued
liabilities at September 30, 2008 and December 31, 2007 consist of the
following:
|
|
|
September
30,
|
|
|
December 31,
|
|
|
|
|
2008
|
|
|
2007
|
|
|
(Amounts
in thousands)
|
|
(Unaudited)
|
|
|
|
|
|
Payroll
and related costs
|
|
$ |
2,773 |
|
|
$ |
5,601 |
|
|
Interest
|
|
|
420 |
|
|
|
863 |
|
|
Restructuring
and severance expense
|
|
|
1,561 |
|
|
|
197 |
|
|
Legal
and tax
|
|
|
1,112 |
|
|
|
1,330 |
|
|
Patent
liability
|
|
|
1,471 |
|
|
|
2,800 |
|
|
Other
|
|
|
1,088 |
|
|
|
514 |
|
|
Total
|
|
$ |
8,425 |
|
|
$ |
11,305 |
|
11.
LONG-TERM DEBT AND SHORT-TERM BORROWINGS
The
Company had the following long term obligations as of September 30, 2008 and
December 31, 2007(amounts in thousands):
|
|
|
2008 (unaudited)
|
|
|
2007
|
|
|
11.875%
Senior Secured Notes due August 15, 2008,
net
of unamortized discount of $148
|
|
$ |
— |
|
|
$ |
29,852 |
|
|
Senior
Secured Credit Facility
$15.0
million Term Loan, bearing interest payable
monthly
at 10% per annum, due August 15, 2010,
net
of unamortized discount of $2.4 million and
$0,
for 2008 and 2007 respectively, subject to one one-year extension
option,
monthly payments
of principal in the amount of
$312,500
due beginning August 15, 2009
|
|
|
12,553 |
|
|
|
— |
|
|
|
|
|
|
|
|
|
|
|
|
$12.5
million Revolving Loan, bearing interest
payable
monthly at the Reference (“prime”) Rate
plus
4.5% (9.5% at September 30, 2008) per
annum,
due August 15, 2011
|
|
|
1,789 |
|
|
|
— |
|
|
Convertible
Note, bearing interest payable semi-annually at 7%, due August 15, 2014,
net of unamortized discount of $0.8 million and $0, subject to redemption
at the option of the holder, at par, anytime on or after February 15,
2012
|
|
|
14,234 |
|
|
|
— |
|
|
Total
|
|
$ |
28,576 |
|
|
$ |
29,852 |
|
|
Less:
current portion
|
|
$ |
(28,576 |
) |
|
$ |
(29,852 |
) |
|
Long-term
portion
|
|
|
— |
|
|
|
— |
|
During
November 2007, the Company redeemed $15 million of its 11.875% Senior Secured
Notes (the “Notes”) at a redemption price of 100% of the principal amount of the
Notes, plus accrued and unpaid interest to the redemption date. The
Company repaid the remaining $30 million of aggregate outstanding principal of
the Notes on August 15, 2008 using the proceeds of the transactions described
further below.
Senior
Secured Credit Facility
On
August 15, 2008 (the “Closing Date”), the Company entered into a senior
secured credit facility (the “Senior Credit Facility”) with PEM. The Senior
Credit Facility consists of (i) a revolving loan of up to $12.5 million
(the “Revolving Loan”) and (ii) a term loan of $15.0 million (the “Term
Loan”). The Term Loan is subject to prepayment penalties of 4% and 1%
of the outstanding principal amount in the first and second year,
respectively.
In
connection with the closing of the Senior Credit Facility, the Company issued to
warrants to purchase 125,000 shares of the Company’s common stock to a PEM
affiliate (the “PEM Warrants”), The PEM Warrants are exercisable at
$8.40 per share for five years, subject to adjustment for certain anti-dilution
provisions. PEM also received 125,000 shares of the Company’s common
stock at the closing (the “Initial Shares”). On November 15,
2008, PEM received an additional 112,500 shares of the Company’s common
stock.
On the
Closing Date, the Company allocated the proceeds it received between the Term
Loan, the PEM Warrants, the Initial Shares, the obligation to issue Additional
Shares, and certain embedded derivative financial instruments that the Company
was required to recognize separately. The amounts recorded and the
methodologies employed in determining fair value for each of these instruments
are as follows:
|
Instrument
|
|
Value
recorded at closing
|
|
Method used to determine fair
value
|
|
Term
Loan, net of discount of $1.8 million
|
|
$ |
13,240 |
|
Present
value at market participant rate (15%)
|
|
PEM
Warrants
|
|
|
426 |
|
Binomial
American call option model, term 5 years,
volatility 60% and risk free interest rate 3.11%
|
|
Initial
Shares
|
|
|
870 |
|
NASDAQ
market quote multiplied by number of shares
|
|
Obligation
to issue Additional Shares
|
|
|
630 |
|
Total
obligation to PEM less initial shares value and Black Scholes put
model
|
|
Embedded
Derivatives, net
|
|
|
118 |
|
Discounted
cash flow model
|
The
Company recorded the proceeds allocated to the PEM Warrants and Initial Shares
as components of equity. The Company recorded the proceeds allocated
to the obligation to issue Additional Shares and the embedded derivatives as
liabilities. The process of allocating the proceeds received between
the various instruments resulted in the Company recording the Term Loan at a
discount from the principal amount. The Company will accrete the
discount over the initial term using the effective interest method, which will
result in it recognizing additional interest expense.
As of
September 30, 2008, the fair value of the obligation to issue Additional Shares
was $160,875. Based upon the price of the Company’s common stock at
September 30, 2008, the Company would issue the maximum number of shares
issuable under the terms of the agreement.
Certain
provisions of the Senior Credit Facility represent embedded derivatives that
must be separated from the host contract. These provisions include
the option to extend the maturity date of the Term Loan for a fee of 1%,
mandatory redemption under specified circumstances (primarily upon receipt of
cash proceeds from an offering of securities or disposition of assets), and
redemption upon a change in control of the Company. The combined
value of these features was $0.1 million at the Closing Date and $0.6 million at
September 30, 2008 primarily as a result of the decline in the Company's stock
price. Changes in fair value are recognized as other income (expense)
in the accompanying consolidated statements of operations.
Pursuant
to a Security Agreement dated August 15, 2008 (the “PEM Security
Agreement”), by and between the Company and PEM, the Company’s obligations under
the Senior Credit Facility are secured by first priority security interests in
all the Company’s current and future assets, including without limitation, all
personal, real, mixed and intellectual property of the Company, as well as a
first priority security interest in the stock of the Company’s subsidiaries.
Pursuant to a Guarantor Security Agreement dated August 15, 2008 (the “PEM
Guarantor Security Agreement”), by and between each of the Guarantors (all of
which are consolidated subsidiaries of the Company) and PEM, the Company’s
obligations under the Senior Credit Facility are also secured by first priority
security interests in all the Guarantors’ current and future assets. The
Company’s and the Guarantors’ accounts are and will be subject to cash control
agreements in favor of PEM.
The
Senior Credit Facility has certain restrictive covenants including, but not
limited to, limitations on additional indebtedness and securities offerings,
dividends, dispositions of assets and payments of dividends.
As of
September 30, 2008, the Company was in default on certain covenants of the
Senior Credit Facility, as a result the Company received a Notice of
Acceleration and Demand for Payment under Credit Agreement (the “Notice”) from
PEM. The Notice demands payment of all obligations in the amount of
$16.8 million including accrued and unpaid interest and fees, by November
14, 2008. As a result of the default and acceleration, the Company has
classified the entire outstanding amount due under the Senior Credit Facility as
a current liability.
On November
17, 2008, the Company and PEM executed a letter whereby PEM has agreed to
forbear from exercising any of PEM’s rights and remedies under the Credit
Agreement in regards to the Notice, from day to day, until November 21, 2008
while the Company works on strategic alternatives, including a potential sale of
the Company. The letter also indicates that PEM may also terminate the
forbearance at their sole discretion at any time upon written notice to the
Company.
Convertible
Note Offering and Related Asset Purchase and License Agreement
On
August 15, 2008, the Company also completed a convertible note offering
(the “Convertible Note Offering”) with International Game Technology (“IGT”),
pursuant to which the Company issued $15 million in principal amount of Senior
Secured Convertible Notes (the “Convertible Notes”). The Convertible
Notes are convertible into 2,106,742 shares of common stock of the Company at a
price of $7.12 per share.
In
connection with the closing of the Convertible Note Offering, the Company issued
to IGT warrants to purchase (i) 68,750 shares of the Company’s common stock
with an exercise price equal to $8.40 per share and (ii) 111,487 shares of
the Company’s common stock with an exercise price equal to $7.12 per share (the
“Initial IGT Warrants”). On November 15, 2008 IGT received an
additional 225,000 warrants with an exercise price of $0.69.
As a
condition to the closing of the Convertible Note Offering, the Company also
entered into an Asset Purchase and License Agreement (the “APL”) with
IGT. Pursuant to the APL, the Company assigned its worldwide
intellectual property rights relating to the Company’s Casinolink® Jackpot
System to IGT (the “Assigned Intellectual Property”). The Company
also granted IGT a license to the Company’s present and future patents required
to exercise full use of the Casinolink® Jackpot
System. In return, IGT agreed to pay the Company certain future
royalty payments and granted the Company a license to the Assigned Intellectual
Property for use with the Company’s current Casinolink® Jackpot
System customers, subject to certain restrictions. The Company will
pay IGT certain royalties for each IGT sb™ device incorporating the
Casinolink® Jackpot
System. In connection with the APL, the Company entered into a software
customization and integration agreement pursuant to which the Company will
provide services and support to IGT in order to integrate the Casinolink® Jackpot
System into IGT’s sb™
systems. The Company will receive certain payments for providing
these integration services based on completion of agreed-upon project
milestones. The Company also entered into a separate software
maintenance agreement with IGT pursuant to which the Company will provide IGT
maintenance and support services relating to the Casinolink® Jackpot
System.
Because
of the concurrent negotiation and execution of the APL and Convertible Note
Offering, the Company has accounted for the arrangement with IGT in accordance
with Emerging Issues Task Force (EITF) Issue No. 01-1, Accounting for a Convertible
Instrument Granted or Issued to a Nonemployee for Goods or Services or a
Combination of Goods or Services and Cash. Accordingly, the
Company recorded the Convertible Notes, the Initial IGT Warrants, the obligation
to issue Additional Warrants, the APL, and certain embedded derivative financial
instruments required to be recognized separately at their respective fair values
at the Closing Date. The values recorded and the methodologies
employed in determining fair value for each of these instruments are as
follows:
|
Instrument
|
|
Value
recorded at closing
|
|
Method used to determine fair
value
|
|
Convertible
Notes, net of discount of $0.8 million
|
|
$ |
14,210 |
|
Convertible bond
model
|
|
Initial
IGT Warrants
|
|
|
646 |
|
Black Scholes option
pricing method, term 5 years, volatility 60% and risk free interest rate
3.11%
|
|
Additional
Warrants
|
|
|
240 |
|
Binomial Lattice Model
and Monte Carlo simulation method
|
|
Asset
Purchase and License Agreement
|
|
|
— |
|
Discounted Cash Flow
method
|
|
Embedded
Derivatives
|
|
|
352 |
|
Convertible Bond Model;
including callable and redeemable
methods
|
The fair
value of the Convertible Notes represented a substantial premium to their face
amount. Pursuant to Accounting Principles Board Opinion No. 14, Accounting for Convertible Debt and
Debt Issued with Stock Purchase Warrants, the Company recorded the excess
of the fair value of the Convertible Notes over their face amount as additional
paid in capital. The Company recorded the fair value of the Initial
IGT Warrants in equity and the obligation to issue Additional Warrants as a
liability. The Company determined that the fair value of the APL was
not material. The Company recognized a charge to earnings of $5.7
million, representing the excess of the fair value of the rights and instruments
granted to IGT over the consideration received by the Company. The
Company recorded the Convertible Notes at a discount from their face amount
because it is required to separately account for certain derivatives embedded in
the Convertible Notes. The Company will accrete the discount as
additional interest expense, using the effective interest method, over the
period ending February 15, 2012 when the Convertible Notes will be subject to
redemption at par plus accrued interest, at the option of the
holder.
As of
September 30, 2008, the fair value of the obligation to issue Additional
Warrants was $31,000. Based upon the price of the Company’s common
stock at September 30, 2008, the Company would issue the maximum number of
warrants issuable under the terms of the agreement.
Certain
provisions of the Convertible Notes represent embedded derivatives that must be
separated from the host contract. These provisions include a change
in the base interest rate from 7% to 12% per annum upon the occurrence of
certain events (principally the sale of securities for a price below the strike
price of the Convertible Notes), the right of IGT to redeem the Convertible
Notes upon a change in control of the Company at a price of 101% of the face
amount of the Convertible Notes, and a cash penalty of 0.5% per day
should the Company fail to timely deliver common shares upon notice of
conversion. The combined value of these features was $0.4 million at
the Closing Date and $1.6 million at September 30, 2008 as a result of the
decline in the Company's stock price. Changes in the fair are
recognized as other income (expense) in the accompanying consolidated statements
of operations.
Pursuant
to a Security Agreement dated August 15, 2008 (the “IGT Security
Agreement”), by and between the Company and IGT, the Company’s obligations under
the Note Purchase Agreement and the Convertible Notes are secured by a lien,
subject to the liens in favor of the Senior Credit Facility with PEM, on all of
the Company’s current and future assets, including without limitation, all
personal, real, mixed and intellectual property of the Company, as well as a
security interest in the stock of the Company’s subsidiaries. Pursuant to the
Guarantor Security Agreement dated August 15, 2008 (the “IGT Guarantor
Security Agreement”), by and between each of the Guarantors (all of which are
consolidated subsidiaries of the Company) and IGT, the Company’s obligations
under the Convertible Notes and the related Note Purchase Agreement are also
secured by a lien, subject to the liens in favor of the Senior Credit Facility
with PEM, in all the Guarantors’ current and future assets. The collateral and
right to payment on the Convertible Notes is subordinated only to the Senior
Credit Facility pursuant to the terms of an intercreditor agreement between IGT
and PEM.
The
Convertible Notes have certain restrictive covenants including, but not limited
to, limitations on additional indebtedness and securities offerings, dividends,
dispositions of assets and payments of dividends.
As of
September 30, 2008, the Company was in default on certain covenants of the
Convertible Notes. As a result, the current interest rate on all
outstanding principal has increased by 5% per annum, until the Company cures the
default. The Company has classified the entire outstanding note amount as a
current liability as a result of the default.
Registration
Rights Agreement
The
Company entered into a Registration Rights Agreement dated August 15, 2008
(“Registration Rights Agreement”) with PEM Inc., PEM LLC and IGT. The
Company is required to file a registration statement (the “Registration
Statement”) to register the Common Shares, the shares of the Company’s common
stock issuable upon conversion of the Convertible Notes (the “Conversion
Shares”), and the shares issuable upon exercise of the PEM Warrants and IGT
Warrants, as well as certain additional shares of the Company’s common stock
(collectively, the “Registrable Shares”). The Company is required to
file the Registration Statement within 120 days of August 15, 2008 (the
“Initial Filing Date”) and have the Registration Statement declared effective
within 150 days from August 15, 2008 (the “Initial Effectiveness
Date”). The Company is subject to liquidated damages in certain
circumstances, including if it does not file the Registration Statement by the
Initial Filing Date or if it has not had the Registration Statement declared
effective by the Initial Effectiveness Date. The liquidated damages
are equal to 2.0% per month of $1.50 multiplied by the total number of
Registrable Shares, subject to a cap equal to 10.0% of the product of $1.50
times the number of Registrable Shares for each month or portion
thereof. In the opinion of management, it is not probable that the
Company will fail to obtain an effective Registration
Statement. Therefore, no accrual for liquidated damages under the
terms of the Registration Rights Agreement has been included in the cost of the
transaction or at September 30, 2008.
Future
Principal Payments
The
aggregate principal payments under the terms of the Senior Credit Facility,
Revolving Loan and the Convertible Notes are as follows as of September 30, 2008
(unaudited):
|
Remainder
of 2008
|
|
$ |
31,788,597 |
|
|
2009
|
|
|
— |
|
|
2010
|
|
|
— |
|
|
2011
|
|
|
— |
|
|
2012
|
|
|
— |
|
|
2013
|
|
|
— |
|
|
Thereafter
|
|
$ |
— |
|
The
preceding table assumes that the extension option on the Term Loan is not
exercised and that the early redemption option, effective February 15, 2012 is
also not exercised.
12.
COMMITMENTS AND CONTINGENCIES
Legal
proceedings. The Company is involved in routine litigation,
including bankruptcies, collection efforts, disputes with former employees and
other matters in the ordinary course of its business operations. Management is
not aware of any matter, pending or threatened, that in its judgment would
reasonably be expected to have a material adverse effect on the Company or its
operations.
The
Company had a dispute with Hasbro, Inc. that was filed in the U.S. District
Court in Rhode Island relating to the calculation of royalty payments from 1999
through 2002 on the sale and license of certain of Progressive’s branded slot
machines. Hasbro was seeking monetary damages in excess of $8 million. On
October 25, 2007 the parties entered into a settlement agreement and mutual
release of all claims whereby the parties agreed to release all claims between
them and settle all disputes with no admission of wrongdoing, and for the
Company to pay Hasbro the sum of $2.7 million, with payment as follows: $1
million within five days of the execution of the settlement agreement, $1
million no later than September 15, 2008, and $0.7 million no later than March
15, 2009; provided, however that such payment obligation may be reduced by $0.1
million if the last payment is made December 15, 2008, and may be reduced by an
additional $0.1 million in the event the final amount is paid no later than
September 15, 2008.
The
Company did not make the $1.0 million payment due in September 2008 under the
terms of the settlement agreement. As a result, Hasbro petitioned the United
States District Court, District of Rhode Island and the court subsequently
granted a writ of execution requiring that the consent judgment be enforced in
the amount of $1.7 million, representing the remaining amount due under the
settlement agreement. Although, the Company is attempting to restructure the
payment terms with Hasbro, there can be no assurance that the parties will come
to an agreement regarding such revised terms.
On or
about May 8, 2006, the Company was served with a First Amended Complaint by
Gregory F. Mullally in regards to a case pending in the United States District
Court for the District of Nevada. Mr. Mullally’s First Amended Complaint added
the Company and over ten other defendants in a case that has been pending since
2005. The case makes various legal claims relating to an allegation that Mr.
Mullally owns the Internet rights to the proprietary table games known as
Caribbean Stud ® and 21 Superbucks. The Company intends to defend this claim
vigorously. The Company is currently awaiting a ruling on its Motion
for a Summary Judgment.
On or
about August 1, 2006, the Company was served with a Complaint by DTK, LLC
in regards to a case pending in the Circuit Court of Harrison County,
Mississippi, First Judicial District. The Complaint makes various legal claims
surrounding allegations that the Company is responsible for damages caused by
Hurricane Katrina to DTK’s former facility in Gulfport. Trial on this case was
set to occur within a three week period starting in January 2008.The trial was
then postponed and the parties agreed to participate in mediation in April
2008. Plaintiffs were seeking losses of approximately $0.5 million.
In April 2008, the parties agreed to settle the case for a sum of $0.3 million
paid over three installments, with the final payment due in November
2008.
In
addition to the items listed above, from time to time the Company is also
involved in other legal matters, litigation, claims and proceedings in the
ordinary course of its business operations, including matters involving
bankruptcies of debtors, collection efforts, disputes with former employees, and
other matters. The Company has established loss provisions only for matters
in which losses are probable and can be reasonably estimated. At this time,
management has not reached a determination that any of the matters listed above
or if any of the Company’s other litigation matters are expected to result in
liabilities that will have a material adverse effect on the Company’s financial
position or results of operations.
13.
EQUITY TRANSACTIONS
One-for-Eight
Reverse Stock Split. A
one-for-eight reverse stock split (the “Reverse Split”) of the authorized
and issued and outstanding common stock, par value $0.10 per share was duly
approved by the Board of Directors of the Company without shareholder approval,
in accordance with the authority conferred by Section 78.207 of the Nevada
Revised Statutes. The Reverse Split was effected by filing a Certificate of
Change pursuant to Section 78.209 of the Nevada Revised Statutes (the
“Certificate of Change”) with the Nevada Secretary of State. The
Certificate of Change effected the Reverse Split at 5:00 p.m., Pacific time, on
September 15, 2008 (the “Record Date”) and amended the Registrant’s
Articles of Incorporation to decrease the authorized number of shares of the
Registrant’s Common Stock from one hundred million (100,000,000) shares to
twelve million five hundred thousand (12,500,000) shares.
Pursuant
to the Reverse Split, holders of the Company’s common stock were deemed to hold
one (1) whole post-split share of the Company’s common stock for every
eight (8) whole shares of the Company’s issued and outstanding common stock
held immediately prior to 5:00 p.m., Pacific time, on the Record Date. No
fractional shares of the Registrant’s Common Stock were issued in connection
with the Reverse Split. Shareholders who are entitled to a fractional
post-split share will receive in lieu thereof one (1) whole post-split
share.
Stock
Repurchase. As
previously announced in 2002, the Company’s Board of Directors authorized the
Company to purchase up to $2.0 million worth of the Company’s common stock (the
“Authorization”). During the quarter ended September 30, 2008,
it repurchased 17,413 shares of its common stock for total consideration of
approximately $100,000 in open market transactions. In view of the recent market
performance of its common stock, the Company may resume purchases under the
Authorization, in an aggregate amount up to approximately the $1.4 million
remaining under the Authorization. Purchases maybe made from time to time, as
and when permissible under applicable securities law, in the open market at
prevailing market prices, through 10b-5-1 programs or in privately negotiated
transactions. The timing and actual number of shares to be purchased will depend
on market conditions and other factors. Purchases may be discontinued at any
time.
Equity Issued.
In connection with the closing of the Senior Credit Facility, the Company
issued warrants to purchase 125,000 shares of the Company’s common stock to a
PEM affiliate (the “PEM Warrants”), The PEM Warrants are exercisable
at $8.40 per share for five years, subject to adjustment for certain
anti-dilution provisions. PEM also received 125,000 shares of the
Company’s common stock at the closing (the “Initial Shares”). On
November 15, 2008 PEM received 112,500 additional shares of the Company’s
common stock. The warrants and shares were issued pursuant to Section 4(2)
and Regulation D of the Securities Act of 1933, as amended.
In
connection with the closing of the Convertible Note Offering, the Company issued
to IGT warrants to purchase (i) 68,750 shares of the Company’s common stock
with an exercise price equal to $8.40 per share and (ii) 111,487 shares of
the Company’s common stock with an exercise price equal to $7.12 per share (the
“Initial IGT Warrants”). On November 15, 2008 IGT received an
additional 225,000 warrants with an exercise price of $0.69.
14.
INCOME TAXES
For the
three months and nine months ended September 30, 2008, the Company recognized a
tax provision of $0.04 million and a tax benefit $0.5 million, respectively,
related to its foreign operations. The Company will continue to
review the tax losses and income generated in the future by the foreign
subsidiaries to evaluate whether they should be reflected as a benefit or
provision in the Company’s consolidated financial statements. For the
three months and nine months ended September 30, 2007, the Company did not
recognize a tax benefit or provision due to its net operating loss
position.
15.
NET LOSS PER SHARE
Effective
September 15, 2008, the Board of Directors of the Company, without shareholder
approval in accordance with the authority conferred by Section 78.207 of
the Nevada Revised Statutes, approved a one-for-eight reverse stock split (the
“Reverse Split”). Pursuant to the Reverse Split, holders of the
Company’s common stock are deemed to hold one (1) whole post-split share of
the Company’s common stock for every eight (8) whole shares of the
Company’s issued and outstanding common stock held immediately prior to 5:00
p.m., Pacific time, on the Record Date. No fractional shares of the
Registrant’s Common Stock were issued in connection with the Reverse
Split. Shareholders who are entitled to a fractional post-split share will
receive in lieu thereof one (1) whole post-split share. Earnings per share
computations, balance sheets, and footnote presentation of shares and share
equivalents for the three and nine months ended September 30, 2008 have been
restated to reflect the Reverse Split. The Reverse Split resulted in a reduction
in the number of the authorized shares from 100,000,000 to
12,500,000.
The
following table presents a reconciliation of the basic and diluted loss per
share (unaudited) for the three and nine months ended September 30, 2008 and
2007:
|
(Amounts
in thousands except per share amounts)
|
|
Basic
|
|
|
Diluted
|
|
|
For the three months ended
September 30, 2008:
|
|
|
|
|
|
|
|
Loss
from continuing operations
|
|
$ |
(63,591 |
) |
|
$ |
(63,591 |
) |
|
Loss
from discontinued operations
|
|
|
— |
|
|
|
— |
|
|
Net
loss
|
|
$ |
(63,591 |
) |
|
$ |
(63,591 |
) |
|
|
|
|
|
|
|
|
|
|
|
Weighted
average common shares
|
|
|
7,830 |
|
|
|
7,830 |
|
|
Per
share amount
|
|
|
|
|
|
|
|
|
|
Loss
from continuing operations
|
|
$ |
(8.12 |
) |
|
$ |
(8.12 |
) |
|
Loss
from discontinued operations
|
|
|
— |
|
|
|
— |
|
|
Net
loss
|
|
$ |
(8.12 |
) |
|
$ |
(8.12 |
) |
|
|
|
|
|
|
|
|
|
|
|
For the three months ended
September 30, 2007:
|
|
|
|
|
|
|
|
|
|
Loss
from continuing operations
|
|
$ |
(4,739 |
) |
|
$ |
(4,739 |
) |
|
Loss
from discontinued operations
|
|
|
(34,998 |
) |
|
|
(34,998 |
) |
|
Net
loss
|
|
$ |
(39,737 |
) |
|
$ |
(39,737 |
) |
|
|
|
|
|
|
|
|
|
|
|
Weighted
average common shares
|
|
|
4,792 |
|
|
|
4,792 |
|
|
Per
share amount
|
|
|
|
|
|
|
|
|
|
Loss
from continuing operations
|
|
$ |
(0.99 |
) |
|
$ |
(0.99 |
) |
|
Loss
from discontinued operations
|
|
|
(7.30 |
) |
|
|
(7.30 |
) |
|
Net
loss
|
|
$ |
(8.29 |
) |
|
$ |
(8.29 |
) |
|
|
|
|
|
|
|
|
|
|
|
For the nine months ended September 30, 2008:
|
|
|
|
|
|
|
|
|
|
Loss
from continuing operations
|
|
$ |
(74,633 |
) |
|
$ |
(74,633 |
) |
|
Loss
from discontinued operations
|
|
|
(1,638 |
) |
|
|
(1,638 |
) |
|
Net
loss
|
|
$ |
(76,271 |
) |
|
$ |
(76,271 |
) |
|
|
|
|
|
|
|
|
|
|
|
Weighted
average common shares
|
|
|
7,779 |
|
|
|
7,779 |
|
|
Per
share amount
|
|
|
|
|
|
|
|
|
|
Loss
from continuing operations
|
|
$ |
(9.59 |
) |
|
$ |
(9.59 |
) |
|
Loss
from discontinued operations
|
|
|
(0.21 |
) |
|
|
(0.21 |
) |
|
Net
loss
|
|
$ |
(9.80 |
) |
|
$ |
(9.80 |
) |
|
|
|
|
|
|
|
|
|
|
|
For the nine months ended September 30, 2007:
|
|
|
|
|
|
|
|
|
|
Loss
from continuing operations
|
|
$ |
(17,097 |
) |
|
$ |
(17,097 |
) |
|
Loss
from discontinued operations
|
|
|
(65,602 |
) |
|
|
(65,602 |
) |
|
Net
loss
|
|
$ |
(82,699 |
) |
|
$ |
(82,699 |
) |
|
|
|
|
|
|
|
|
|
|
|
Weighted
average common shares
|
|
|
4,502 |
|
|
|
4,502 |
|
|
Per
share amount
|
|
|
|
|
|
|
|
|
|
Loss
from continuing operations
|
|
$ |
(3.80 |
) |
|
$ |
(3.80 |
) |
|
Loss
from discontinued operations
|
|
|
(14.57 |
) |
|
|
(14.57 |
) |
|
Net
loss
|
|
$ |
(18.37 |
) |
|
$ |
(18.37 |
) |
16.
RELATED PARTY TRANSACTIONS
During
2005, the Company sold substantially all the assets of its sign and graphics
manufacturing business to a third party, retaining less than 1% equity interest.
The Company and Mikohn Signs and Graphics, LLC (“MSG”) signed a Transition
Services Agreement and a Manufacturer’s Supply Agreement upon completion of the
transaction. The Transition Services Agreement had a term of six months ending
in November 2005.
Both
parties entered into a three year Manufacturer’s Supply Agreement at the close
of the transaction, whereby MSG would purchase electronics from the Company at
its standard OEM pricing. MSG purchased $0.0 million and $0.3 million in
electronic displays and related products from the Company during the nine months
ended September 30, 2008 and 2007, respectively.
From time
to time, the Company purchases signage and sign related products from MSG in
conjunction with its progressive jackpot systems. The Company purchased $0.0
million and $0.4 million in inventory from MSG during the nine months ended
September 30, 2008 and 2007, respectively.
In 2005,
the Company entered into a worldwide exclusive license with Magellan Technology
Pty Limited (“Magellan”). The Company licensed, on an exclusive basis,
Magellan’s rights to its RFID reader, tag and related intellectual property for
any gaming applications for $3.1 million. The Company also completed the
purchase of a minority interest in Magellan in 2006. From time to time, the
Company purchases inventory from Magellan in connection with the Company’s
exclusive global master license to use Magellan’s RFID technology in gaming
worldwide. The Company purchased $0.8 million and $0.1 million in inventory
from Magellan during the nine months ended September 30, 2008 and 2007,
respectively.
17.
SEGMENT REPORTING
The
Company’s business historically consisted of two reportable segments:
(i) slot and table games, and (ii) systems. The slot and table games
business segment, which was reclassified to discontinued operations as of
June 30, 2007, included the development, licensing and distribution of
proprietary slot and table games. Revenues were derived from leases, revenue
sharing arrangements, royalty and license fee arrangements with casinos and
gaming suppliers. The Company’s systems segment offers a suite of products that
when combined, supports every facet of a gaming operation, and consolidates the
management of slot machines, table games, server-based gaming, account wagering,
marketing and cage into one fully integrated system.
The
accounting policies of the segments are the same as those described in
Note 3.
The
Company evaluates performance and allocates resources based upon profit or loss
from operations before income taxes. Certain operating expenses, which are
separately managed at the corporate level, are not allocated to the business
segments. These unallocated costs include primarily the costs associated with
executive administration, finance, human resources, legal, general marketing and
information systems. The depreciation and amortization expense of identifiable
assets not allocated to the business segments are also included in these
costs.
As a
result of the reclassification of the slot and table games segment to
discontinued operations as of June 30, 2007, all of the Company’s
continuing operations are now included in the systems segment.
The
Company attributes revenue and expenses to a geographic area based on the
location from which the product was shipped or the service was performed.
Geographic segment information for the three months and nine months ended
September 30, 2008 and 2007 consists of (unaudited):
|
|
|
Three
Months Ended
|
|
|
Nine
Months Ended
|
|
|
(Amounts
in thousands)
|
|
September
30,
|
|
|
September
30,
|
|
|
Geographic
Operations
|
|
2008
|
|
|
2007
|
|
|
2008
|
|
|
2007
|
|
|
Revenues:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
North
America
|
|
$ |
8,523 |
|
|
$ |
11,879 |
|
|
$ |
26,450 |
|
|
$ |
33,239 |
|
|
Australia
/ Asia
|
|
|
1,632 |
|
|
|
2,107 |
|
|
|
8,371 |
|
|
|
7,052 |
|
|
Europe
|
|
|
3,529 |
|
|
|
4,338 |
|
|
|
12,141 |
|
|
|
11,583 |
|
|
Total
|
|
$ |
13,684 |
|
|
$ |
18,324 |
|
|
$ |
46,962 |
|
|
$ |
51,874 |
|
|
(Loss)
income from continuing operations before income taxes:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
North
America
|
|
$ |
(45,426 |
) |
|
$ |
(4,897 |
) |
|
$ |
(
58,074 |
) |
|
$ |
(16,540 |
) |
|
Australia
/ Asia
|
|
|
(4,307 |
) |
|
|
(136 |
) |
|
|
(1,821 |
) |
|
|
(16 |
) |
|
Europe
|
|
|
(13,823 |
) |
|
|
294 |
|
|
|
(15,200 |
) |
|
|
(541 |
) |
|
Total
|
|
$ |
(63,556 |
) |
|
$ |
(4,739 |
) |
|
$ |
(75,095 |
) |
|
$ |
(17,097 |
) |
|
Depreciation
and amortization:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
North
America
|
|
$ |
1,224 |
|
|
$ |
1,119 |
|
|
$ |
3,602 |
|
|
$ |
3,356 |
|
|
Australia
/ Asia
|
|
|
46 |
|
|
|
186 |
|
|
|
156 |
|
|
|
262 |
|
|
Europe
|
|
|
606 |
|
|
|
637 |
|
|
|
1,865 |
|
|
|
1,863 |
|
|
Total
|
|
$ |
1,876 |
|
|
$ |
1,942 |
|
|
$ |
5,623 |
|
|
$ |
5,481 |
|
18.
STOCK-BASED COMPENSATION
The
Company adopted SFAS No. 123R, “Share Based Payment” effective January 1, 2006.
The total compensation expense relating to stock-based compensation follows
(amount in thousands):
|
|
|
Three
Months Ended
|
|
|
Nine
Months Ended
|
|
|
(Amounts
in thousands)
|
|
September
30,
|
|
|
September
30,
|
|
|
|
|
(Unaudited)
|
|
|
(Unaudited)
|
|
|
|
|
2008
|
|
|
2007
|
|
|
2008
|
|
|
2007
|
|
|
Selling,
general and administrative
|
|
$ |
967 |
|
|
$ |
648 |
|
|
$ |
2,267 |
|
|
$ |
1,900 |
|
|
Research
and development
|
|
|
(144 |
) |
|
|
193 |
|
|
|
262 |
|
|
|
501 |
|
|
Cost
of revenues
|
|
|
99 |
|
|
|
99 |
|
|
|
297 |
|
|
|
257 |
|
|
Stock-based
compensation expense charged to continuing operations
|
|
|
922 |
|
|
|
940 |
|
|
|
2,826 |
|
|
|
2,658 |
|
|
Stock-based
compensation expense charged to discontinued operations
|
|
|
— |
|
|
|
(4 |
) |
|
|
— |
|
|
|
150 |
|
|
Total
stock-based compensation expense
|
|
$ |
922 |
|
|
$ |
936 |
|
|
$ |
2,826 |
|
|
$ |
2,808 |
|
19.
SUBSEQUENT EVENTS
Strategic
Alternatives. On October 13, 2008, the Company engaged Roth Capital
Partners, LLC to assist the Company in a comprehensive review of strategic
alternatives intended to enhance shareholder value. The Company expects to
consider and evaluate available alternatives during the strategic review process
including, but not limited to, the sale of the Company. The Company has not
set any timetable for the conclusion of this strategic review and does not
intend to comment with respect to this process unless or until a specific
alternative is approved by its Board of Directors. During the process, there may
be risks that certain customers, employees, and business partners may react
negatively to the uncertainty of the process or in the event the process does
not result in any transaction. The pursuit of strategic alternatives may also
involve significant expenses and management time and attention, and otherwise
disrupt our business. There can be no assurance that the review process will
result in the consummation of any sale or other transaction.
Debt Covenant
Default. Recent
macro-economic events, slowness in capital spending, customer credit issues and
higher than expected financing transaction costs have left the Company in
default with certain covenants under the Senior Credit Facility with PEM and the
Convertible Note with IGT. On October 7, 2008, the Company notified PEM and IGT
that it believed it was in default with the financial covenants contained within
their respective agreements. As a result, the Company received a Notice of
Acceleration and
Demand for Payment under Credit Agreement from PEM. The Notice
demands payment of all obligations in the amount of $16,788,597.97 including
accrued and unpaid interest and fees, by November 14, 2008.
On November
17, 2008, the Company and PEM executed a letter whereby PEM has agreed to
forbear from exercising any of PEM’s rights and remedies under the Credit
Agreement in regards to the Notice, from day to day, until November 21, 2008
while the Company works on strategic alternatives, including a potential sale of
the Company. The letter also indicates that PEM may also terminate the
forbearance at their sole discretion at any time upon written notice to the
Company.
Non-Payment of
Legal
Settlement. On
October 25, 2007 the Company and Hasbro entered into a settlement agreement and
mutual release of all claims related to a dispute between the parties. The
settlement agreement included a consent judgment and the parties agreed to
release all claims between them and settle all disputes with no admission of
wrongdoing. The Company agreed to pay Hasbro certain sums as part of the
settlement. The Company did not make the $1.0 million payment due in September
2008 under the terms of the settlement agreement. As a result, Hasbro petitioned
the United States District Court, District of Rhode Island and the
court subsequently granted a writ of execution requiring that the consent
judgment be enforced in the amount of $1.7 million, representing the remaining
amount due under the settlement agreement. Although the Company is attempting to
restructure the payment terms with Hasbro, there can be no assurance that the
parties will come to an agreement regarding such revised
terms.
PROGRESSIVE
GAMING INTERNATIONAL CORPORATION
CAUTIONARY
NOTICE
This
Quarterly Report on Form 10-Q contains “forward-looking statements” within the
meaning of Section 27A of the Securities Act of 1933, as amended, and
Section 21E of the Securities Exchange Act of 1934, as amended.
Forward-looking statements sometimes include the words “may,” “will,”
“estimate,” “intend,” “continue,” “expect,” or “anticipate,” and other similar
words. Statements expressing expectations regarding our future (including
pending gaming and patent approvals) and projections relating to products,
sales, revenues and earnings are typical of such statements.
All
forward-looking statements, although reasonable and made in good faith, are
subject to the risks and uncertainties inherent in predicting the future. Our
actual results may differ materially from those projected, stated or implied in
these forward-looking statements as a result of many factors, including, but not
limited to, overall industry environment, customer acceptance of our new
products, delay in the introduction of new products, the further approvals of
regulatory authorities, adverse court rulings, production and/or quality control
problems, the denial, suspension or revocation of privileged operating licenses
by governmental authorities, competitive pressures and general economic
conditions, our financial condition, our debt service obligations, and our
ability to secure future financing. These and other factors that may affect our
results are discussed more fully in “Risk Factors” and elsewhere in this
Quarterly Report on Form 10-Q.
Forward-looking
statements speak only as of the date they are made. Readers are warned that we
undertake no obligation to update or revise such statements to reflect new
circumstances or unanticipated events as they occur, and are urged to review and
consider disclosures we make in this and other reports that discuss factors
germane to our business. See particularly our reports on Forms 10-K, 10-K/A,
10-Q, 10-Q/A, 8-K and 8-K/A filed from time to time with the Securities and
Exchange Commission.
General
Information
We are a
global supplier of integrated casino and jackpot management solutions for the
gaming industry. This technology is widely used to enhance casino operations and
help drive greater revenues for existing products. Our products include multiple
forms of regulated wagering solutions in wired, wireless and mobile
formats.
We offer
a suite of products that when combined, supports every facet of a gaming
operation, and consolidates the management of slot machines, table games,
server-based gaming, account wagering, marketing and cage into one fully
integrated system. The system can support from one venue to several hundred
venues in a multi-site configuration. Our current revenues are primarily
comprised of software, hardware, installation and support services, which
comprise both upfront payments as well as recurring fees.
Previously,
we developed, acquired and distributed table and slot game content as well as
technologies to meet the needs of gaming operators worldwide. In 2004, we began
repositioning our business to focus solely on technology and completed a series
of acquisitions and divestitures to reposition our company. During 2005
and 2006 we completed a number of strategic transactions. We
strengthened our portfolio of intellectual property through the acquisitions of
EndX, VirtGame and PitTrak, and through a technology licensing agreement and
minority investment in Magellan. We also entered into strategic agreements with
IGT and Shuffle Master for the table management business, Cantor Gaming for the
sports and poker business and Elixir Gaming for the growing Asian casino
management business, and disposed of our interior signage division.
Prior to
June 30, 2007, our company included both our systems segment and the table and
slot games segment pursuant to which we developed, acquired, licensed and
distributed proprietary and non-proprietary branded and non-branded table and
slot games. During the third quarter of 2007, we disposed of our slot and table
businesses, and we have classified the slot and table games segment as a
discontinued operation in accordance with Statement of Financial Accounting
Standards No. 144 “Accounting for the Impairment or Disposal of Long Lived
Assets” — see Note 3 in the Notes to Consolidated Financial
Statements.
Amounts
disclosed in the accompanying tables are shown in thousands except per share
amounts, while amounts included in text are disclosed in actual amounts. All
percentages reported are based on those rounded numbers.
RESULTS
OF OPERATIONS
Three
Months Ended September 30, 2008 and 2007
Revenues
and cost of revenues:
|
(Amounts
in thousands, except installation base amounts)
|
|
2008
|
|
|
2007
|
|
|
Systems
revenues and gross profit
|
|
|
|
|
|
|
|
Revenues
|
|
$ |
13,684 |
|
|
$ |
18,324 |
|
|
Cost
of revenues
|
|
|
7,608 |
|
|
|
8,190 |
|
|
Gross
profit
|
|
$ |
6,076 |
|
|
$ |
10,134 |
|
|
Gross
profit percentage
|
|
|
44.4 |
% |
|
|
55.3 |
% |
|
|
|
|
|
|
|
|
|
|
|
Systems
installation base
|
|
|
|
|
|
|
|
|
|
Slot management
|
|
|
|
|
|
|
|
|
|
Beginning
of period
|
|
|
84,797 |
|
|
|
66,218 |
|
|
Increase
during the period
|
|
|
626 |
|
|
|
5,504 |
|
|
End
of period
|
|
|
85,423 |
|
|
|
71,722 |
|
|
Percentage
increase
|
|
|
0.7 |
% |
|
|
8.3 |
% |
|
Table management
|
|
|
|
|
|
|
|
|
|
Beginning
of period
|
|
|
6,879 |
|
|
|
3,426 |
|
|
Increase
during the period
|
|
|
90 |
|
|
|
1,448 |
|
|
End
of period
|
|
|
6,969 |
|
|
|
4,874 |
|
|
Percentage
increase
|
|
|
1.3 |
% |
|
|
42.3 |
% |
Overview.
In December 2004, we announced our intent to focus our business on
systems and technology, and we have completed a number of strategic
transactions, acquisitions and divestitures since this decision. With the
completion of the table and slot games divestitures during 2007, we have now
completed this repositioning of our business. The operations of the disposed
slot and table games businesses have been accounted for as discontinued
operations for all period presented, in accordance with Statement of Financial
Accounting Standards No. 144 “Accounting for the Impairment or Disposal of
Long Lived Assets” (“SFAS No. 144”). The sole component of our revenues
from continuing operations is now systems revenue, which is generated primarily
from the sale and maintenance of modular and integrated casino management
systems.
The key
business metrics used by management are slot and table management system
installed base, representing the number of slot machines or table games that are
connected to our systems, and daily fees which represent the recurring payments
made by the customer for software maintenance or other ongoing services and
products.
Systems revenues
and gross profit. Our systems revenues for the quarter ended September
30, 2008 were $13.7 million, or $4.6 million lower than the prior year quarter.
The 25.3% decline in systems revenues was primarily a result of decreased
capital spending by our customers and a general decline in economic conditions
in the regions where we operate. Our gross profit margin for the
third quarter of 2008 of 44.4% reflects a decrease of 10.9% compared to our
gross profit margin of 55.3% during the third quarter of 2007, reflecting the
impact of lower levels of revenues during the 2008 period, and the impact of a
$0.5 million write-down of inventory related to products no longer being offered
by the Company.
For the
quarter ended September 30, 2008, our slot management revenues were $12.8
million compared to $16.2 million for the third quarter of 2007, a net decrease
of $3.4 million. Our slot management installed base was 85,423 at
September 30, 2008, compared to 71,722 at September 30, 2008, reflecting year
over year growth of 13,701 or 19.1%. Our installed base of slot
management systems grew by 626 during the third quarter of 2008, compared to
growth of 5,504 during the third quarter of 2007. The decrease in slot
management revenue and slot management installed base growth is primarily a
result of lower levels of capital expenditures by our customers. In addition,
the higher growth rate in the prior year quarter was driven by initial sales of
our CJS system following the approval for commercialization of the system in
Nevada during the second quarter of 2007.
Table
management systems revenues decreased by $1.3 million year over year, from $2.1
million for the quarter ended September 30, 2007 to $0.8 million for the quarter
ended September 20, 2008. Our table management installed base was
6,969 at September 30, 2008, compared to 4,874 at September 30, 2008, reflecting
year over year growth of 2,095 or 43%.Our installed base of table management
systems grew by 90 during the quarter ended September 30, 2008, compared to
growth of 1,448 for the quarter ended September 30, 2007. The decline in the
growth rate of our table management installed base was primarily due to the
previously mentioned slowdown in capital expenditures by our
customers.
Three
Months Ended September 30, 2008 and 2007
Condensed
Statement of Operations
|
(Amounts
in thousands, except per share amounts)
|
|
2008
|
|
|
2007
|
|
|
Revenues
|
|
$ |
13,684 |
|
|
$ |
18,324 |
|
|
Cost
of revenues
|
|
|
7,608 |
|
|
|
8,190 |
|
|
Gross
profit
|
|
|
6,076 |
|
|
|
10,134 |
|
|
Selling,
general and administrative expense
|
|
|
10,577 |
|
|
|
7,276 |
|
|
Research
and development expense
|
|
|
1,828 |
|
|
|
2,441 |
|
|
Depreciation
and amortization
|
|
|
1,876 |
|
|
|
1,942 |
|
|
Restructuring
charges
|
|
|
3,465 |
|
|
|
— |
|
|
Asset
impairment charges
|
|
|
43,755 |
|
|
|
— |
|
|
Total
operating expenses
|
|
|
61,501 |
|
|
|
11,659 |
|
|
Operating
loss
|
|
|
(55,425 |
) |
|
|
(1,525 |
) |
|
Interest
expense, net
|
|
|
(1,389 |
) |
|
|
(2,431 |
) |
|
Mark-to-market
(losses)/gains
|
|
|
(1,011 |
) |
|
|
— |
|
|
Fair
value of debt issued in excess of proceeds
|
|
|
(5,731 |
) |
|
|
— |
|
|
Loss
on early retirement of debt
|
|
|
— |
|
|
|
(783 |
) |
|
Loss
from continuing operations before income tax
provision
|
|
|
(63,556 |
) |
|
|
(4,739 |
) |
|
Income
tax provision
|
|
|
(35 |
) |
|
|
— |
|
|
Loss
from continuing operations
|
|
|
(63,591 |
) |
|
|
(4,739 |
) |
|
Loss
from discontinued operations, net of taxes
|
|
|
— |
|
|
|
(34,998 |
) |
|
Net
loss
|
|
$ |
(63,591 |
) |
|
$ |
(39,737 |
) |
|
|
|
|
|
|
|
|
|
|
|
Basic
and diluted weighted average common shares
|
|
|
7,830 |
|
|
|
4,792 |
|
|
Basic
and diluted loss per share:
|
|
|
|
|
|
|
|
|
|
Loss
from continuing operations
|
|
$ |
(8.12 |
) |
|
$ |
(0.99 |
) |
|
Loss
from discontinued operations
|
|
|
— |
|
|
|
(7.30 |
) |
|
Net
loss
|
|
$ |
(8.12 |
) |
|
$ |
(8.29 |
) |
Selling, general
and administrative expense (“SG&A”). SG&A expenses increased by
$3.3 million during the quarter ended September 30, 2008 compared to the same
period in 2008. During the third quarter of 2008, we recognized a
$2.7 million charge for bad debt expense. These increases were partially offset
by a release of $1.2 million in year-to-date accruals for trade show and
management bonus expenses. Included in selling, general and administrative
expense is non-cash stock-based compensation expense of $1.0 million and $0.7
million for the three months ended September 30, 2008 and 2007, respectively.
SG&A expense for the third quarter of 2008 includes a year-to-date
reclassification of $0.6 million in cash and non-cash personnel costs related to
transfers of personnel from the research and development line.
Research
and development expense (“R&D”). R&D expense consists primarily
of personnel and related costs for design and development of our product lines.
During the third quarter of 2008, research and development expenses decreased by
$0.6 million compared to the same period in 2007. The decrease was
primarily a result of lower compensation and benefits costs along with a
year-to-date adjustment to reclassify $0.6 million of personnel-related expense
from R&D to SG&A. Excluding the effect of a the personnel
reclassification, non-cash stock-based compensation expense of $0.3 million and
$0.2 million was included in R&D expense for the third quarter of 2008 and
2007, respectively.
Depreciation and
amortization. Depreciation and amortization expense for the third quarter
of 2008 was $1.9 million compared to $1.9 million during the third quarter of
2007.
Restructuring
charges. During the third quarter of 2008, we recognized
restructuring charges of $3.5 million, primarily representing employee severance
costs related to our recently announced plan to reduce selling, general and
administrative, research and development and operating expenses.
Asset impairment
charges. During the quarter ended September 30, 2008, we
recognized asset impairment charges of $43.8 million to reduce the carrying
values of certain assets to their fair values, and to charge off certain assets
that are no longer expected to benefit our ongoing business. These
charges included $25 million for goodwill, $14 million for definite life
intangible assets, and $2.8 million for other assets.
Interest expense,
net. Our interest expense primarily includes interest costs and
amortization of debt issuance costs from our Convertible Note, our Senior
Secured Credit Facility, our former 11.875% Senior Secured Notes due 2008, and
our former senior secured term credit facility. Net interest expense for the
third quarter of 2008 was $1.4 million, representing a decrease of 42.9%
compared to net interest expense of $2.4 million for the same period in
2007. The decrease is attributable primarily to a net decrease of
$23.2 million in outstanding borrowings under our current and former debt
facilities compared to September 30, 2007 balances.
Mark-to-market
(losses)/gains. During the third quarter of 2008, we recorded
mark-to-market losses of $1.8 million, partially offset by mark-to-market gains
of $0.8 million, related to changes in the market values of certain bifurcated
embedded derivative features of our Convertible Note and our Senior Secured
Credit Facility.
Fair value of
debt issued in excess of proceeds. During the quarter ended
September 30, 2008, we recorded a one-time charge of $5.7 million representing
the excess in fair value granted over the proceeds received from the Convertible
Note arrangement.
Income
taxes. For the quarter ended September 30, 2008, we recorded a
small net income tax provision related to our European operations. For the
quarter ended September 30, 2007, we did not recognize a tax benefit or
provision due to our net operating loss position.
Discontinued
operations, net of taxes. Discontinued operations includes the
earnings and losses, net of taxes, of the slot and table games operations, which
were disposed of during the second half of 2007. As of June 30, 2008,
substantially all charges related to the disposal of the slot and table
operations had been recognized, and no charges for these discontinued operations
were recorded during the quarter ended September 30,
2008. During the quarter ended September 30, 2007, we recorded
a charge of $35 million related to the slot and table operations disposal,
which included a $24.7 million charge for the Webb vs. Mikohn legal settlement,
a loss on disposal of $9.7 million, and a loss from operations of the
discontinued segment of $0.6 million.
Loss per share.
For the quarter ended September 30, 2008, we incurred a loss from
continuing operations per fully-diluted share of $8.12 compared to a loss of
$0.99 from continuing operations per fully diluted share for the third quarter
of 2007, based on weighted average shares of 7.8 million and 4.8 million,
respectively. Significant factors contributing to the increase in loss per share
from continuing operations were a decline in gross margins of $4.1 million,
impairment charges of $43.8 million, restructuring charges of $3.5 million, an
increase of $2.7 million in bad debt charges, and charges of $6.7 million
related to our Convertible Note and Senior Secured Credit Facility and related
derivative features, partially offset by a $1 million improvement in net
interest expense, and a 63.4% increase in the number of weighted average shares
outstanding.
Nine
Months Ended September 30, 2008 and 2007
Revenues
and cost of revenues:
|
(Amounts
in thousands, except installation base amounts)
|
|
2008
|
|
|
2007
|
|
|
Systems
revenues and gross profit
|
|
|
|
|
|
|
|
Revenues
|
|
$ |
46,962 |
|
|
$ |
51,874 |
|
|
Cost
of revenues
|
|
|
23,501 |
|
|
|
23,841 |
|
|
Gross
profit
|
|
$ |
23,461 |
|
|
$ |
28,033 |
|
|
Gross
profit percentage
|
|
|
50.0 |
% |
|
|
54.0 |
% |
|
|
|
|
|
|
|
|
|
|
|
Systems
installation base
|
|
|
|
|
|
|
|
|
|
Slot management
|
|
|
|
|
|
|
|
|
|
Beginning
of period
|
|
|
76,339 |
|
|
|
59,000 |
|
|
Increase
during the period
|
|
|
9,084 |
|
|
|
12,722 |
|
|
End
of period
|
|
|
85,423 |
|
|
|
71,722 |
|
|
Percentage
increase
|
|
|
11.9 |
% |
|
|
21.6 |
% |
|
Table management
|
|
|
|
|
|
|
|
|
|
Beginning
of period
|
|
|
5,740 |
|
|
|
2,947 |
|
|
Increase
during the period
|
|
|
1,229 |
|
|
|
1,927 |
|
|
End
of period
|
|
|
6,969 |
|
|
|
4,874 |
|
|
Percentage
increase
|
|
|
21.4 |
% |
|
|
65.4 |
% |
Systems revenues
and gross profit. Our systems revenues for the nine months ended
September 30, 2008 were $47 million, or $4.9 million lower than the prior year
period, primarily as a result of a decline in capital expenditures by our
customers. Our gross profit margin for the nine months ended
September 30, 2008 of 50% reflects a decrease of 4% compared to our gross profit
margin of 54% for the same period in 2007, primarily as a result of the decrease
in total revenues, and the previously mentioned write-off of obsolete inventory
during the 2008 period.
For the
nine months ended September 30, 2008, our slot management revenues were $41.6
million compared to $47.7 million for the nine months ended September 30,
2007. The decrease of $6.1 million is primarily a result of the
previously mentioned slowdown in capital expenditures by our customers. Our
installed base of slot management systems grew by 9,084 during the first nine
months of 2008, compared to growth of 12,722 during the same period in
2007.
Table
management systems revenues increased by 27.6% year over year, growing from $4.2
million for the nine months ended September 30, 2007 to $5.3 million for the
nine months ended September 30, 2008. This $1.1 million growth in
table management revenues year over year was primarily driven by installations
of systems with large corporate customers during the first half of
2008. Our installed base of table management systems grew by 1,229
during the first nine months of 2008, compared to growth of 1,927 for the
comparable period in 2007.
Nine
Months Ended September 30, 2008 and 2007
Condensed
Statement of Operations
|
(Amounts
in thousands, except per share amounts)
|
|
2008
|
|
|
2007
|
|
|
Revenues
|
|
$ |
46,962 |
|
|
$ |
51,874 |
|
|
Cost
of revenues
|
|
|
23,501 |
|
|
|
23,841 |
|
|
Gross
profit
|
|
|
23,461 |
|
|
|
28,033 |
|
|
Selling,
general and administrative expense
|
|
|
27,032 |
|
|
|
22,860 |
|
|
Research
and development expense
|
|
|
8,083 |
|
|
|
7,028 |
|
|
Depreciation
and amortization
|
|
|
5,623 |
|
|
|
5,481 |
|
|
Restructuring
charges
|
|
|
3,901 |
|
|
|
— |
|
|
Asset
impairment charges
|
|
|
43,755 |
|
|
|
— |
|
|
Total
operating expenses
|
|
|
88,394 |
|
|
|
35,369 |
|
|
Operating
loss
|
|
|
(64,933 |
) |
|
|
(7,336 |
) |
|
Interest
expense, net
|
|
|
(3,420 |
) |
|
|
(8,978 |
) |
|
Mark
to market gains and losses
|
|
|
(1,011 |
) |
|
|
— |
|
|
Fair
value of debt issued in excess of proceeds
|
|
|
(5,731 |
) |
|
|
— |
|
|
Loss
on early retirement of debt
|
|
|
— |
|
|
|
(783 |
) |
|
Loss
from continuing operations before income tax
provision
|
|
|
(75,095 |
) |
|
|
(17,097 |
) |
|
Income
tax provision
|
|
|
462 |
|
|
|
— |
|
|
Loss
from continuing operations
|
|
|
(74,633 |
) |
|
|
(17,097 |
) |
|
Loss
from discontinued operations, net of taxes
|
|
|
(1,638 |
) |
|
|
(65,602 |
) |
|
Net
loss
|
|
$ |
(76,271 |
) |
|
$ |
(82,699 |
) |
|
|
|
|
|
|
|
|
|
|
|
Basic
and diluted weighted average common shares
|
|
|
7,779 |
|
|
|
4,502 |
|
|
Basic
and diluted loss per share:
|
|
|
|
|
|
|
|
|
|
Loss
from continuing operations
|
|
$ |
(9.59 |
) |
|
$ |
(3.80 |
) |
|
Loss
from discontinued operations
|
|
|
(0.21 |
) |
|
|
(14.57 |
) |
|
Net
loss
|
|
$ |
(9.80 |
) |
|
$ |
(18.37 |
) |
Selling, general
and administrative expense (“SG&A”). SG&A expenses increased by
$4.2 million during the nine months ended September 30, 2008 compared to the
same period in 2007. This increase was primarily attributable to a $2.9 million
increase in bad debt expense as well as increased operating expenses of our
foreign operations. Included in selling, general and administrative
expense is non-cash stock-based compensation expense of $2.3 million and $2.0
million for the nine months ended September 30, 2008 and 2007,
respectively.
Research and
development expense (“R&D”). During the first nine months of 2008,
research and development expenses increased by $1.1 million to $8.1 million
compared to $7 million for the same period in 2007. The increase was
primarily a result of increased travel, as well as higher compensation and
benefits costs. Included in research and development expense is non-cash
stock-based compensation expense of $0.3 million and $0.2 million for the nine
months ended September 30, 2008 and 2007, respectively.
Depreciation and
amortization. Depreciation and amortization expense for the nine months
ended September 30, 2008 was $5.6 million compared to $5.5 million during the
comparable period in 2007. The slight increase resulted from higher
amortization expense related to additions to our intellectual property
portfolio, partially offset by a decrease in depreciation expense as a result of
certain fixed assets becoming fully depreciated.
Restructuring
charges. During the first three quarters of 2008, we
recognized restructuring charges of $3.5 million, primarily representing
employee severance costs related to our recently announced plan to reduce
selling, general and administrative, research and development and operating
expenses.
Asset impairment
charges. During the three quarters ended September 30, 2008,
we recognized asset impairment charges of $43.8 million to reduce the carrying
values of certain assets to their fair values, and to charge off certain assets
that are no longer expected to benefit our ongoing business. These
charges included $25 million for goodwill, $14 million for definite life
intangible assets, and $2.8 million for other assets.
Interest expense,
net. Our interest expense primarily includes interest costs and
amortization of debt issuance costs from our Convertible Note, our Senior
Secured Credit Facility, our former 11.875% Senior Secured Notes due 2008, and
our former senior secured term credit facility. Net interest expense for the
first three quarters of 2008 was $3.4 million compared to $9.0 million for the
prior year period. The 62.2% decrease year over year is attributable
primarily to a decrease in our outstanding borrowings, as well as a $1.2 million
waiver fee recorded in the second quarter of 2007.
Mark-to-market
(losses)/gains. During the nine months ended September 30,
2008, we recorded mark-to-market losses of $1.8 million, partially offset by
mark-to-market gains of $0.8 million, related to changes in the market values of
certain bifurcated embedded derivative features of our Convertible Note and our
Senior Secured Credit Facility.
Fair value of
debt issued in excess of proceeds. During the nine months
ended September 30, 2008, we recorded a one-time charge of $5.7 million
representing the excess in fair value granted over the proceeds received from
the Convertible Note
Income
taxes. For the nine months ended September 30, 2008, we
recognized a net tax benefit of $0.5 million related to our foreign
operations. For the nine months ended September 30, 2007, we did not
recognize a tax benefit or provision due to our net operating loss
position.
Discontinued
operations, net of taxes. For the nine months ended September
30, 2008, we recorded residual charges totaling $1.6 million related to the
disposed slot and table operations. These residual charges represent
additional provisions for doubtful receivables of the disposed units, and
additional accruals for table-games related royalties, settlements and legal
fees. During the nine months ended September 30, 2007, discontinued
operations charges totaled $65.6 million, including a $38.3 million loss on
disposal, net of tax, a $24.7 million charge related to the Webb vs. Mikohn
legal settlement, and loss from operations of the discontinued segment of $2.6
million.
Loss per
share. For the nine months ended September 30, 2008, we
incurred a loss from continuing operations per fully-diluted share of $9.59
compared to a loss from continuing operations per fully-diluted share of $3.80
for the nine months ended September 30, 2007, based on weighted average shares
of 7.8 million and 4.5 million, respectively. Significant factors
contributing to the increase in loss per share from continuing operations were a
decline in gross margins of $4.6 million, impairment charges of $43.8 million,
restructuring charges of $3.9 million, an increase of $2.7 million in bad debt
charges, and charges of $6.7 million related to our Convertible Note and Senior
Secured Credit Facility and related derivative features, partially offset by a
$5.6 million improvement in net interest expense, and a 73.3% increase in the
number of weighted average shares outstanding.
Liquidity
and Capital Resources
The
consolidated financial statements have been prepared on the basis of a going
concern which contemplates the realization of assets and the satisfaction of
liabilities in the normal course of business. At September 30, 2008,
the Company had total cash and cash equivalents of $3.6 million and a net
working capital deficit of $22.5 million. The Company generated net losses
from operations of $76.3 million during the nine months ended September 30,
2008, and the Company has an accumulated deficit of $321.3 million at September
30, 2008. The Company’s net cash and cash equivalents balance of $3.6 million at
September 30, 2008 reflects a decrease of $15.5 million compared to December 31,
2007. This change resulted from net cash used in continuing operating activities
of $8.5 million, net cash used in continuing investing activities of $2.1
million related to ongoing investments in intellectual property and property and
equipment used in operations, net cash used in financing activities of $2.6
million, including $3.3 million in cash payments for legal, accounting and other
advisors related to the Company’s August 15, 2008 debt refinancing, and net cash
used in discontinued operations of $2.2 million for payments of certain
liabilities related to the disposed slot and table games divisions.
On August
4, 2008, the Company entered into two financing transactions with potential
borrowings of $42.5 million. These transactions include (i) a senior
secured credit facility (the “Senior Credit Facility”) of up to $27.5 million
with Private Equity Management Group Financial Corporation (“PEM”), and (ii) a
$15 million senior secured convertible note offering (the “Convertible Notes”)
with International Game Technology (“IGT”). The Senior Credit Facility with PEM
consists of a revolving loan of up to $12.5 million and a term loan of $15
million.
The
Senior Credit Facility and the Convertible Note include among other
requirements, quarterly financial covenants for Adjusted Minimum EBITDA, debt
service coverage ratios, tangible net worth and liquidity requirements, as well
as restrictions on additional indebtedness and the ability to issue
dividends.
In
connection with the closing of the Senior Credit Facility, the Company issued to
PEM 1 million shares of the Company’ warrants to purchase shares of the
Company’s common stock with an exercise price of $8.40 per share. PEM
also received 125,000 shares of the Company’s common stock at the closing (the
“Initial Shares”). In connection with the closing of the Convertible Note
offering, the Company issued IGT warrants to purchase 68,750 warrants with an
exercise price of $8.40 per share and 111,487 warrants with an exercise price of
$7.12 per share (the “Initial IGT Warrants”). On November 15,
2008 IGT received an additional 225,000 warrants with an exercise price of $0.69
and PEM received 112,500 additional shares of the Company’s common
stock.
On August
15, 2008, the Company closed and funded the Senior Credit Facility and
Convertible Note with PEM and IGT, respectively. The Company borrowed
approximately $16.8 million from PEM, including $15 million from the PEM term
loan and $1.8 million under the revolving credit facility. The Company also
closed and funded the Convertible Note in the amount of $15 million. The Company
used the proceeds along with $2.6 million of cash on hand to repay the $30
million of its 11.875% Senior Secured Notes, accrued interest of $1.1 million
and transaction costs of $3.2 million. Subsequent to the closing of these
transactions, the Company incurred additional post closing costs related to
legal and other fees in excess of $1 million.
On
September 29, 2008, the Company announced that it had taken action to reduce
annual aggregate selling, general and administrative, research and development
and operating expenses by approximately $13 to $15 million, or approximately 25%
to 29% of overall expenses. These actions are expected to be completed in the
fourth quarter of 2008 and significantly reduce the Company’s cash expenditures.
Additionally, Company management has identified certain non-strategic and
non-operating assets that could be sold to interested parties and result in cash
proceeds sufficient to cover all or a portion of the working capital
deficit and other payments such as the settlement due Hasbro. These potential
asset sales will require the consent of PEM and IGT under their respective
financing arrangements. There can be no assurances that PEM or IGT will consent
to the sale of these assets.
As of
September 30, 2008, the Company’s cash and cash equivalents were less than
anticipated due to (i) unexpected transaction costs related to the complexities
and legal requirements under the PEM Senior Credit Facility and IGT Convertible
Note offering, the majority of costs of which the Company paid from existing
cash on hand (ii) the Company’s inability to collect under certain customer
arrangements, including a large customer located in Asia for approximately $2.5
million and (iii) a decline in the Company’s revenues and cash flows primarily
as a result of economic conditions and slower capital spending by customers.
Based on these factors, the Company believes it will need additional liquidity
to fund its working capital deficit and pay for obligations as they become due
in the normal course of business.
Recent
macro-economic events, slowness in capital spending, customer credit issues and
higher than expected financing transaction costs have left the Company in
default with certain covenants under the Senior Credit Facility with PEM and the
Convertible Note with IGT. On October 7, 2008, the Company notified PEM and IGT
that it believed it was in default with the financial covenants contained within
their respective agreements. Also, the Company failed to make a payment due
Hasbro in the amount of $1.0 million in September 2008. Hasbro petitioned the
court and the court granted a writ of execution requiring that the consent
judgment be enforced in the amount of $1.7 million, representing all remaining
amounts due under the settlement agreement. The Company is attempting to
restructure the payment terms with Hasbro, although there can be no assurance
that the parties will come to an agreement regarding such revised
terms.
As a
result of the aforementioned events of default, the Company is unable to borrow
additional amounts under its Senior Credit Facility. As a result, the
Company received a Notice of Acceleration and Demand for Payment under Credit
Agreement from PEM. The Notice demands payment of all obligations in
the amount of $16,788,597.97 including accrued and unpaid interest and fees, by
November 14, 2008.
On November
17, 2008, the Company and PEM executed a letter whereby PEM has agreed to
forbear from exercising any of PEM’s rights and remedies under the Credit
Agreement in regards to the Notice, from day to day, until November 21, 2008
while the Company works on strategic alternatives, including a potential sale of
the Company. The letter also indicates that PEM may also terminate the
forbearance at their sole discretion at any time upon written notice to the
Company.
In addition to the proposed
asset divestitures, the Board of Directors of the Company engaged an investment
bank on October 13, 2008 to assist the Company in reviewing strategic
alternatives intended to enhance shareholder value. The Company expects to
consider and evaluate available alternatives during the strategic review process
including, but not limited to, the sale of the Company.
If the
Company is unable to secure additional liquidity from operations or from the
sale of non-strategic assets or other strategic alternatives including
additional financing or a sale of the entity, the Company will be unable to pay
for obligations arising in its business and may not be able to continue as a
going concern.
Significant
components of cash flows from continuing operating activities for the nine
months ended September 30, 2008 are as follows:
|
(Amounts
in millions)
|
|
|
|
|
Net
loss from continuing operations
|
|
$ |
(74.7 |
) |
|
Impairment
of goodwill and long lived assets
|
|
|
43.8 |
|
|
Fair
value of debt issued in excess of proceeds
|
|
|
5.7 |
|
|
Depreciation
and amortization
|
|
|
5.6 |
|
|
Provision
for bad debts
|
|
|
2.9 |
|
|
Stock
based compensation
|
|
|
2.8 |
|
|
Mark-to-market
losses
|
|
|
1.0 |
|
|
Amortization
of debt discount and issue costs
|
|
|
0.7 |
|
|
Provision
for obsolete inventory
|
|
|
0.6 |
|
|
Other,
primarily changes in assets and liabilities
|
|
|
3.1 |
|
|
Net
cash used in continuing operating activities
|
|
$ |
(8.5 |
) |
Other
significant investing and financing sources (uses) of cash during the nine
months ended September 30, 2008 were:
|
Proceeds
from long-term debt and notes payable, net of discount
|
|
|
29.2 |
|
|
Proceeds
from short-term borrowings
|
|
|
1.8 |
|
|
Proceeds
from issuance of common stock
|
|
|
0.3 |
|
|
Principal
payments on notes payable and long-term debt
|
|
|
(30.0 |
) |
|
Debt
issuance costs
|
|
|
(3.3 |
) |
|
Investments
in property and equipment used in operations
|
|
|
(1.4 |
) |
|
Investments
in intangible assets
|
|
|
(0.7 |
) |
|
Cash
used to secure corporate credit card account
|
|
|
(0.5 |
) |
Strategic
Alternatives. On October 13, 2008, the Company issued a press release
announcing that the Board of Directors engaged Roth Capital Partners, LLC to
assist the Company in a comprehensive review of strategic alternatives
intended to enhance shareholder value. The Company expects to consider and
evaluate available alternatives during the strategic review process including,
but not limited to, the sale of the Company. The Company has not set any
timetable for the conclusion of this strategic review and does not intend to
comment further publicly with respect to this process unless or until a specific
alternative is approved by its Board of Directors. During the process, there may
be risks that certain customers, employees, and business partners may react
negatively to the uncertainty of the process or in the event the process does
not result in any transaction. The pursuit of strategic alternatives may also
involve significant expenses and management time and attention, and otherwise
disrupt our business. There can be no assurance that the review process will
result in the announcement or consummation of any sale or other
transaction.
Off-Balance
Sheet Arrangements
We have
no off-balance sheet arrangements with unconsolidated entities or other
persons.
Capital
Expenditures and Other
During
the nine months ended September 30, 2008, we invested approximately $1.4 million
in property and equipment, primarily for additions to office and computer
equipment used in our domestic operations, and expansion of our facilities in
Macau.
Critical
Accounting Policies
A
description of our critical accounting policies can be found in “Item 7.
Management’s Discussion and Analysis of Financial Condition and Results of
Operations” of our Annual Report on Form 10-K for the year ended December 31,
2007.
Recently
Issued Accounting Standards
In
December 2007, the Financial Accounting Standards Board (“FASB”) issued SFAS No.
141(R), "Business Combinations." SFAS No. 141(R) replaces SFAS No. 141,
"Business Combinations", but retains the requirement that the purchase method of
accounting for acquisitions be used for all business combinations. SFAS No.
141(R) expands on the disclosures previously required by SFAS No. 141, better
defines the acquirer and the acquisition date in a business combination, and
establishes principles for recognizing and measuring the assets acquired
(including goodwill), the liabilities assumed and any noncontrolling interests
in the acquired business. SFAS No. 141(R) also requires an acquirer to record an
adjustment to income tax expense for changes in valuation allowances or
uncertain tax positions related to acquired businesses. SFAS No. 141(R) is
effective for all business combinations with an acquisition date in the first
annual period following December 15, 2008; early adoption is not permitted. The
Company will adopt this statement as of January 1, 2009. We are currently
evaluating the impact SFAS No. 141(R) will have on our consolidated
financial statements.
In
December 2007, the FASB issued SFAS No. 160, “Noncontrolling Interest in
Consolidated Financial Statements, an amendment of ARB No. 51.” This
statement establishes accounting and reporting standards for ownership interest
in subsidiaries held by parties other than the parent and for the
deconsolidation of a subsidiary. It also clarifies that a
noncontrolling interest in a subsidiary is an ownership interest in the
consolidated entity that should be reported as equity in the consolidated
financial statements. SFAS No. 160 changes the way the consolidated
income statement is presented by requiring consolidated net income to be
reported at amounts that include the amount attributable to both the parent and
the noncontrolling interests. The statement also establishes
reporting requirements that provide sufficient disclosure that clearly identify
and distinguish between the interest of the parent and those of the
noncontrolling owners. This statement is effective for fiscal years
beginning on or after December 15, 2008. The adoption of SFAS No. 160
is not expected to have a material impact on the Company’s financial position,
results of operations or cash flows.
In March
2008, the FASB issued SFAS No. 161, “Disclosures about Derivative Instruments
and Hedging Activities—an amendment of FASB Statement No. 133.” SFAS No.
161 requires entities that utilize derivative instruments to provide qualitative
disclosures about their objectives and strategies for using such instruments, as
well as any details of credit-risk-related contingent features contained within
derivatives. Statement 161 also requires entities to disclose
additional information about the amounts and location of derivatives located
within the financial statements, how the provisions of SFAS 133 have been
applied, and the impact that hedges have on an entity’s financial position,
financial performance, and cash flows. Statement 161 is effective for
fiscal years and interim periods beginning after November 15, 2008, with early
application encouraged. The Company is currently evaluating the
impact SFAS No. 161 will have on its consolidated financial
statements.
In
April 2008, the FASB issued FSP No. FAS 142-3, “Determination of the
Useful Life of Intangible Assets.” This FSP amends the factors that should be
considered in developing renewal or extension assumptions used to determine the
useful life of a recognized intangible asset under Statement of Financial
Accounting Standards (“SFAS”) No. 142, “Goodwill and Other Intangible
Assets.” The intent of this FSP is to improve the consistency between the useful
life of a recognized intangible asset under Statement 142 and the period of
expected cash flows used to measure the fair value of the asset under SFAS 141
(revised 2007), “Business Combinations,” and other U.S. generally accepted
accounting principles (“GAAP”). This FSP is effective for financial statements
issued for fiscal years beginning after December 15, 2008. The adoption of
FAS 142-3 is not expected to have a material impact on the Company’s financial
position, results of operations or cash flows.
In May
2008, the FASB issued FSP No. APB 14-1 “Accounting for Convertible Debt
Instruments That May Be Settled in Cash upon Conversion (Including Partial Cash
Settlement).” This FSP specifies that issuers of such instruments should
separately account for the liability and equity components in a manner that will
reflect the entity's nonconvertible debt borrowing rate when interest cost is
recognized in subsequent periods. This FSP is effective for financial statements
issued for fiscal years beginning after December 15, 2008 and interim
periods within those fiscal years and will be applied retrospectively to all
periods presented. The Company is currently evaluating the impact this
pronouncement will have on its consolidated financial statements.
In May
2008, FASB issued SFAS No.162, “The Hierarchy of Generally Accepted Accounting
Principles.” The pronouncement mandates the GAAP hierarchy reside in the
accounting literature as opposed to the audit literature. This has the practical
impact of elevating FASB Statements of Financial Accounting Concepts in the GAAP
hierarchy. This pronouncement will become effective 60 days following SEC
approval. The Company does not believe this pronouncement will have a material
impact on its consolidated financial statements.
In May
2008, FASB issued SFAS No. 163, “Accounting for Financial Guarantee Insurance
Contracts-an interpretation of FASB Statement No. 60.” The scope of the
statement is limited to financial guarantee insurance (and reinsurance)
contracts. The pronouncement is effective for fiscal years beginning after
December 31, 2008. The Company does not believe this pronouncement will have a
material impact on its consolidated financial statements.
In
June 2008, the Financial Accounting Standards Board (“FASB”) issued FASB
Staff Position (“FSP”) EITF 03-6-1, “Determining Whether Instruments Granted in
Share-Based Payment Transactions are Participating Securities” (“FSP EITF
03-6-1”), which addresses whether instruments granted in share-based payment
transactions are participating securities prior to vesting and, therefore, need
to be included in earnings allocation in computing earnings per share under the
two-class method as described in SFAS No. 128, “Earnings Per Share.” Under
the guidance in FSP EITF 03-6-1, unvested share-based payment awards that
contain non-forfeitable rights to dividends or dividend equivalents (whether
paid or unpaid) are participating securities and shall be included in the
computation of earnings per share pursuant to the two class method. FSP EITF
03-6-1 is effective for fiscal periods beginning after December 15, 2008.
All prior-period earnings per share data presented shall be adjusted
retrospectively. Early application is not permitted. The Company is
currently evaluating the impact this pronouncement will have on its consolidated
financial statements.
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Item 3.
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QUANTITATIVE
AND QUALITATIVE DISCLOSURES ABOUT MARKET
RISK
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Refer to Part I, Item 7A, of the Company’s annual
report on Form 10-K for the fiscal year ended December 31, 2007. There have
been no material changes in market risks since the fiscal year end.
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Item 4.
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CONTROLS
AND PROCEDURES
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The Company maintains disclosure controls and procedures (as
defined in Exchange Act Rules 13a-15(e) and 15(d)-15(e)) designed to ensure that
it is able to record the information it is required to disclose in the reports
it files with the SEC, and to process, summarize and report this information
within the time periods specified in the rules and forms of the SEC, and that
such information is accumulated and communicated to the Company’s management,
including its Chief Executive Officer and Chief Financial Officer, as
appropriate, to allow for timely decisions regarding required disclosure. These
disclosure controls and procedures are designed and maintained by or under the
supervision of the Company’s Chief Executive Officer and Chief Financial
Officer, as required by the rules of the SEC. The Company’s Chief Executive
Officer and Chief Financial Officer are responsible for evaluating the
effectiveness of the disclosure controls and procedures. Based on their
evaluation of the Company’s disclosure controls and procedures as of the end of
the period covered by this report, the Chief Executive and Chief Financial
Officers believe that the Company’s disclosure controls and procedures were
effective.
No
changes in the Company’s internal control over financial reporting have occurred
during the Company’s fiscal quarter ended September 30, 2008, that have
materially affected, or are reasonably likely to materially affect, the
Company’s internal control over financial reporting.
PROGRESSIVE
GAMING INTERNATIONAL CORPORATION
The legal
proceedings described in Item 3 of the Company’s annual report on Form 10-K
for the year ended December 31, 2007, should be read in conjunction with
this disclosure. No material developments related to these various litigation
matters have occurred, except as disclosed herein.
The
Company had a dispute with Hasbro, Inc. that was filed in the U.S. District
Court in Rhode Island relating to the calculation of royalty payments from 1999
through 2002 on the sale and license of certain of Progressive’s branded slot
machines. Hasbro was seeking monetary damages in excess of $8 million. On
October 25, 2007 the parties entered into a settlement agreement and mutual
release of all claims whereby the parties agreed to release all claims between
them and settle all disputes with no admission of wrongdoing, and for the
Company to pay Hasbro the sum of $2.7 million, with payment as follows: $1
million within five days of the execution of the settlement agreement, $1
million no later than September 15, 2008, and $0.7 million no later than March
15, 2009; provided, however that such payment obligation may be reduced by $0.1
million if the last payment is made December 15, 2008, and may be reduced by an
additional $0.1 million in the event the final amount is paid no later than
September 15, 2008.
The
Company did not make the $1.0 million payment due in September 2008 under the
terms of the settlement agreement. As a result, Hasbro petitioned the United
States District Court, District of Rhode Island and the court subsequently
granted a writ of execution requiring that the consent judgment be enforced in
the amount of $1.7 million, representing the remaining amount due under the
settlement agreement. Although, the Company is attempting to restructure the
payment terms with Hasbro, there can be no assurance that the parties will come
to an agreement regarding such revised terms.
On or
about August 1, 2006, we were served with a Complaint by DTK, LLC in
regards to a case pending in the Circuit Court of Harrison County, Mississippi,
First Judicial District. The Complaint makes various legal claims surrounding
allegations that Progressive is responsible for damages caused by Hurricane
Katrina to DTK’s former facility in Gulfport. Trial on this case was set to
occur within a three week period starting in January, 2008. The trial was
then postponed and the parties agreed to participate in mediation in April
2008. Plaintiffs were seeking losses of approximately $0.5 million.
In April 2008, the parties agreed to settle the case for a sum of $0.3 million
paid over three installments, with the final payment due in November
2008.
From time
to time we are also involved in other legal matters, litigation and claims of
various types in the ordinary course of our business operations, including
matters involving bankruptcies of debtors, collection efforts, disputes with
former employees and other matters. We intend to defend all of these matters
vigorously. However, we cannot assure you that we will be successful in
defending any of the matters described above or any other legal matters,
litigation or claims in which we may become involved from time to time. If we
are not successful in defending these matters, we may be required to pay
substantial license fees, royalties or damages, including statutory or other
damages, post significant bonds and/or discontinue a portion of our operations.
Furthermore, our insurance coverage and other capital resources may be
inadequate to cover anticipated costs of these lawsuits or any possible
settlements, damage awards, bonds or license fees. Even if unsuccessful, these
claims still can harm our business severely by damaging our reputation,
requiring us to incur legal costs, lowering our stock price and public demand
for our stock, and diverting management’s attention away from our primary
business activities in general.
You
should consider carefully the following risk factors, together with all of the
other information included in this Quarterly Report on Form 10-Q. Each of these
risk factors could adversely affect our business, operating results and
financial condition, as well as adversely affect the value of an investment in
our common stock. In these circumstances, the market price of our common stock
could decline, and you may lose all or part of your investment in our
securities. An investment in our securities is speculative and involves a high
degree of risk. You should not invest in our securities if you cannot bear the
economic risk of your investment for an indefinite period of time and cannot
afford to lose your entire investment.
We
have marked with an asterisk those risk factors that reflect changes from the
risk factors included in our Annual Report on Form 10-K for the year ended
December 31, 2007, filed with the SEC on March 17, 2008.
Risks
Relating to Our Business
*We
have substantial short-term debt and related debt service obligations, and the
failure to satisfy these obligations could materially and adversely impact our
financial viability or ultimately result in our inability to continue as a going
concern.
On
September 30, 2008, our total outstanding debt was approximately $31.8 million
which consisted primarily of the outstanding $15 million pursuant to the terms
of the Credit Agreement between the Company and PEM, $12.5 million of a
revolving loan under the Credit Agreement with PEM, and $15 million pursuant to
the terms of the Note and Warrant Purchase Agreement between the Company and IGT
(collectively, the “Loans”). We are currently in default on the Loans and do not
have sufficient cash to satisfy the obligations therein.
Failure
to satisfy the conditions contained in the Loans may result in PEM and/or IGT
having the right to foreclose upon the collateral securing that debt. If a
foreclosure is effected upon the collateral securing the Loans, our financial
viability would be materially and adversely impacted, and we may be forced
to negotiate with our lenders regarding a restructuring of the Loans, sell some
or all of our assets to satisfy our obligations under the Loans or pursue other
alternatives available through formal proceedings, up to and including
bankruptcy, any of which would cause our business to suffer, may force us to
curtail our operations and may ultimately result in our inability to continue as
a going concern.
*Our cash flow
from operations and available credit are not sufficient to meet our short-term
capital requirements and, as a result, we are dependent upon additional and/or
restructured financing, which may not be available.
Historically,
we have not generated sufficient cash flow from operations to satisfy our
capital requirements and have relied upon debt and equity financing arrangements
to satisfy such requirements. Our current cash flows and capital resources are
insufficient to meet our short-term debt obligations and commitments, and we may
be forced to reduce or delay activities and capital expenditures if we are
unable to obtain additional debt or restructure or refinance our current debt.
In the event that we are unable to obtain additional debt or restructure or
refinance our current debt, we will be left without sufficient liquidity and we
will not be able to meet our debt service requirements and repayment
obligations. There can be no assurance that future financing arrangements will
be available on acceptable terms, or at all. If we are unable to obtain future
financing on terms acceptable to us, this will pose a significant risk to our
liquidity and our ability to meet operational and other cash
requirements.
Additionally,
substantially all of our assets are pledged as security to the holders of our
outstanding Loans. The ability of our stockholders to participate in the
distribution of our assets upon our liquidation or recapitalization will be
subject to the prior claims of our secured and unsecured creditors. Any
foreclosure of our assets by such creditors will materially reduce the assets
available for distribution to our stockholders.
*We have and
expect to continue to have substantial debt and debt service requirements, which
could have an adverse impact on our business and the value of our common
stock.
Our
substantial debt may make it more difficult for us to operate and effectively
compete in the gaming industry. The degree to which we and/or one or more of our
subsidiaries are leveraged could have important adverse consequences on our
value as follows:
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it
may be difficult for us to make payments on our outstanding
indebtedness;
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•
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a
significant portion of our cash flows from operations must be dedicated to
debt service and will not be available for other purposes that would
otherwise be operationally value-enhancing uses of such
funds;
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•
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our
ability to borrow additional amounts for working capital, capital
expenditures, potential acquisition opportunities and other purposes may
be limited;
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•
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we
may be limited in our ability to withstand competitive pressures and may
have reduced financial flexibility in responding to changing business,
regulatory and economic conditions in the gaming
industry;
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•
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we
may be at a competitive disadvantage because we may be more highly
leveraged than our competitors and, as a result, more restricted in our
ability to invest in our growth and
expansion;
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•
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failure
to comply with applicable debt covenants that result in an event of
default could result in all of our indebtedness being immediately due and
payable; and
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•
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if
new debt is added to our and our subsidiaries’ current debt levels, the
related risks that we and they now face could
intensify.
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Realization
of any of these factors could adversely affect our financial condition and
results of operations.
Our
lenders have imposed numerous debt covenants that include financial and
operating restrictions that may adversely affect how we conduct our business and
potentially reduce our revenues and affect the value of our common
stock.
We are
subject to numerous covenants in our debt agreements that impose financial
and operating restrictions on our business. These restrictions may affect our
ability to operate our business, may limit our ability to take advantage of
potential business opportunities as they arise, and may adversely affect the
conduct and competitiveness of our current business, which could in turn reduce
our revenues and thus affect the value of our common stock. Specifically, these
covenants may place restrictions on our ability to, among other
things:
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pay
dividends, redeem or repurchase our stock or make other
distributions;
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•
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make
acquisitions or investments;
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use
assets as security in other
transactions;
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enter
into transactions with affiliates;
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•
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merge
or consolidate with others;
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dispose
of assets or use asset sale
proceeds;
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create
liens on our assets;
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amend
agreements related to existing indebtedness;
or
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amend
our material contracts.
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Our
failure to comply with our debt-related obligations and the related event of
default has resulted in an acceleration of our indebtedness with PEM. This in
turn could have a material adverse effect on our operations, our revenues and
thus our common stock value.
On November
17, 2008, the Company and PEM executed a letter whereby PEM has agreed to
forbear from exercising any of PEM’s rights and remedies under the Credit
Agreement in regards to the Notice, from day to day, until November 21, 2008
while the Company works on strategic alternatives, including a potential sale of
the Company. The letter also indicates that PEM may also terminate the
forbearance at their sole discretion at any time upon written notice to the
Company.
Additionally,
the covenants governing our indebtedness restrict the operations of our
subsidiaries, including, in some cases, limiting the ability of our subsidiaries
to make distributions to us, and these limitations could impair or adversely
affect the conduct and competitiveness of our current business.
Lastly,
we are required by the Loans to offer to repurchase or make certain payments on
our debt at times when we may lack the financial resources to do so, such as
upon a change of control. These expenditures may materially and adversely affect
our liquidity and our ability to maintain or grow our business as payments to
satisfy the debt will be diverted away from any investment in the growth of our
business, thus potentially affecting the value of our common stock.
If
we are unable to develop or introduce innovative products and technologies that
gain market acceptance and satisfy consumer preferences, our current and future
revenues will be adversely affected.
Our
current and future performance is dependent upon the continued popularity of our
existing products and technologies and our ability to develop and introduce new
products and technologies that gain market acceptance and satisfy consumer
preferences. The popularity of any of our gaming products and technologies may
decline over time as consumer preferences change or as new, competing products
or new technologies are introduced by our competitors. If we are unable to
develop or market innovative products or technologies in the future, or if our
current products or technologies become obsolete or otherwise noncompetitive,
our ability to sustain current revenues from our existing customers or to
generate additional revenues from existing or new customers would be adversely
affected, which, in turn, could materially reduce our profitability and growth
potential. In addition, the introduction of new and innovative products and
technologies by our competitors that are successful in meeting consumer
preferences also could materially reduce our competitiveness and adversely
affect our revenues and our business.
The
development of new products and technologies requires a significant investment
by us prior to any of the products or technologies becoming available for the
market. New products, such as new gaming technologies, may not gain popularity
with gaming patrons and casinos, or may not maintain any popularity achieved. In
the event any new products or technologies fail to gain market acceptance or
appeal to consumer preferences, we may be unable to recover the cost of
developing these products or technologies.
We
may not realize expected benefits from the sale of our table game assets to
Shuffle Master.
In
connection with the sale of our table game division, or TGD, assets to Shuffle
Master Inc., or Shuffle Master, the purchase agreement for that sale and a
related 5-year technology license to integrate our Casinolink Jackpot System, or
CJS, progressive jackpot system module for use with Shuffle Master’s progressive
specialty table games, we received $3 million for the initial integration of our
CJS system with Shuffle Master’s tables, which was completed in the fourth
quarter of 2007. The purchase agreement also provides for earn-out payments
based on the installed base growth of the TGD assets through 2016 (subject to
certain conditions), including $3.5 million in guaranteed minimum payments. We
also expect to receive recurring monthly royalty payments for the placement of
our CJS on Shuffle Master’s specialty table games. The timing and amounts of any
earn-out or royalty payments related to the sale of the TGD assets and the
related license are subject to Shuffle Master’s ownership and operation of those
assets, and the actual earn-out and royalty payments could be substantially
lower than we expect, which could adversely affect our anticipated revenues and
our business.
If
we are unable to develop new technologies, our products and technologies may
become obsolete or noncompetitive.
The
gaming sector is characterized by the development of new technologies and
continuous introduction of new products. Our success is dependent upon new
product development and technological advancements, including the continued
development and commercialization of the Table iD™ system, our cashless
technology, table player tracking technologies, central server-based products
and technologies, progressive jackpot systems, integrated management systems and
sports and poker management systems. The markets in which we compete are subject
to frequent technological changes, and one or more of our competitors may
develop alternative technologies or products for bonusing, progressive jackpots,
slot accounting, cashless technology, player tracking or game promotions, or a
superior game platform which may not be made available to us. While we expend a
significant amount of resources on research and development and product
enhancement, we may not be able to continue to improve and market our existing
products or technologies or develop and market new products at a rapid enough
pace. Further technological developments may cause our products or technologies
to become obsolete or noncompetitive.
If
our current or proposed products or technologies do not receive regulatory
approval, our revenue and business prospects will be adversely
affected.
Our
products and technologies are in various stages of development. Our development
efforts are dependent on factors such as obtaining requisite governmental
approvals. Each of these products and technologies requires separate regulatory
approval in each market in which we do business, and this regulatory approval
may either not be granted at all or not be granted in a timely manner, for
reasons primarily outside of our control. In addition, we cannot predict with
any accuracy which jurisdictions or markets, if any, will accept, and which
authorities will approve, the operation of our gaming products and technologies,
or the timing of any such approvals. A lack of regulatory approval for our
products and technologies, or delays in obtaining necessary regulatory
approvals, will adversely affect our revenues and business
prospects.
For
example, new features for RFID (Radio Frequency Identification) and table
management systems, central server based gaming and sports and poker management
systems represent key strategic initiatives for the Company. We are at various
stages in the approval and development process for each initiative and are
moving forward with the regulators in various jurisdictions to obtain required
approvals. We cannot assure you that we will receive the necessary approvals in
all of the jurisdictions we have sought approval nor can we assure you that
there will not be any production delays in developing and distributing these
products and technologies. Any delay in production or in the regulatory process,
or a denial of regulatory approval altogether, for any one of these initiatives
will adversely impact our revenues and business.
If
our products or technologies currently in development do not achieve commercial
success, our future revenue and business prospects could be adversely
affected.
While we
are pursuing and will continue to pursue product and technological development
opportunities, there can be no assurance that such products or technologies will
come to fruition or become successful. Furthermore, while a number of those
products and technologies are being tested, we cannot provide any definite date
by which they will be commercially viable and available, if at all. We may
experience operational problems with such products after commercial introduction
that could delay or prevent us from generating 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 or technologies currently in development will meet
evolving industry standards and consumer demands. We cannot assure you that we
will be able to adapt to technological changes or offer products on a timely
basis or establish or maintain a competitive position.
We
may not be successful in forming or maintaining strategic alliances with other
companies, which could negatively affect our product offerings and
sales.
Our
business is becoming increasingly dependent on forming or maintaining strategic
alliances with other companies, and we may not be able to form or maintain
alliances that are important to ensure that our products and technologies are
compatible with third-party products and technologies, to enable us to license
our products and technologies to potential new customers and into potential new
markets, and to enable us to continue to enter into new agreements with our
existing customers. There can be no assurance that we will identify the best
alliances for our business or that we will be able to maintain existing
relationships with other companies or enter into new alliances with other
companies on acceptable terms or at all. The failure to maintain or establish
successful strategic alliances could have a material adverse effect on our
business or financial results. If we cannot form and maintain significant
strategic alliances with other companies as our target markets and technology
evolve, the sales opportunities for our products and technologies could
deteriorate.
If
any conflicts arise between us and any of our alliance partners, our reputation,
revenues and cash position could be significantly harmed.
Conflicts
may arise between us and our alliance partners, such as conflicts concerning
licensing and royalty fees, development or distribution obligations, the
achievement of milestones or the ownership or protection of intellectual
property developed by the alliance or otherwise. Any such disagreement between
us and an alliance partner could result in one or more of the following, each of
which could harm our reputation, result in a loss of revenues and a reduction in
our cash position:
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unwillingness
on the part of an alliance partner to pay us license fees or royalties we
believe are due to us under the strategic
alliance;
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uncertainty
regarding ownership of intellectual property rights arising from our
strategic alliance activities, which could result in litigation, permit
third parties to use certain of our intellectual property or prevent us
from utilizing such intellectual property rights and from entering into
additional strategic alliances;
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unwillingness
on the part of an alliance partner to keep us informed regarding the
progress of its development and commercialization activities, or to permit
public disclosure of the results of those
activities;
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slowing
or cessation of an alliance partner’s development or commercialization
efforts with respect to our products or
technologies;
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delays
in the introduction or commercialization of products or technologies;
or
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termination
or non-renewal of the strategic
alliance.
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In
addition, certain of our current or future alliance partners may have the right
to terminate the strategic alliance on short notice. Accordingly, in the event
of any conflict between the parties, our alliance partners may elect to
terminate the agreement or alliance prior to completion of its original term. If
a strategic alliance is terminated prematurely, we would not realize the
anticipated benefits of the strategic alliance, our reputation in the industry
and in the investment community may be harmed and our stock price may
decline.
In
addition, in certain of our current or future strategic alliances, we may agree
not to develop products independently, or with any third party, directly
competitive with the subject matter of our strategic alliances. Our strategic
alliances may have the effect of limiting the areas of research, development
and/or commercialization that we may pursue, either alone or with others, which,
in turn, may cause us to forego potentially profitable business
opportunities. For example, as part of our joint development
arrangement with IGT and Shuffle Master, we agreed not to manufacture or sell
our intelligent shoe products for a three-year period. Under certain
circumstances, however, our alliance partners may research, develop, or
commercialize, either alone or with others, products in related fields that are
competitive with the products or potential products that are the subject of such
strategic alliances.
Our
failure to protect, maintain and enforce our existing intellectual property or
secure, maintain and enforce such rights for new proprietary technology could
adversely affect our future growth and success.
Our
ability to successfully protect our intellectual property is essential to our
success. We protect our intellectual property through a combination of patent,
trademark, copyright and trade secret laws, as well as licensing agreements and
third-party nondisclosure and assignment agreements. Certain of our existing and
proposed products are covered by patents issued in the United States, which may
differ from patent protection in foreign jurisdictions, where our intellectual
property may not receive the same degree of protection as it would in the United
States. In addition, in many countries intellectual property rights are
conditioned upon obtaining registrations for trademarks, patents and other
rights, and we have not obtained such registrations in all relevant
jurisdictions. Failure to effectively protect our intellectual property could
significantly impair our competitive advantage and adversely affect our revenues
and the value of our common stock.
Our
future success is also dependent upon our ability to secure our rights in any
new proprietary technology that we develop. We file trademark, copyright and
patent applications to protect intellectual property rights for many of our
trademarks, proprietary gaming products and improvements to these products. Our
failure to obtain protection for our patents and trademarks could cause us to
become subject to additional competition and could have a material adverse
effect on our future revenues and operations. In addition, any of the patents
that we own, acquire or license may be determined to be invalid or otherwise
unenforceable and would, in such case, not provide any protection with respect
to the associated intellectual property rights.
Our
competitors may develop non-infringing products or technologies that adversely
affect our future growth and revenues.
It is
possible that our competitors will produce proprietary gaming products similar
to ours without infringing on our intellectual property rights. We also rely on
unpatented proprietary technologies. It is possible that others will
independently develop the same or similar technologies or otherwise obtain
access to the unpatented technologies upon which we rely for future growth and
revenues. In addition, to protect our trade secrets and other proprietary
information, we generally require employees, consultants, advisors and strategic
partners to enter into confidentiality agreements or agreements containing
confidentiality provisions. We cannot assure you that these agreements will
provide meaningful protection for our trade secrets, know-how or other
proprietary information in the event of any unauthorized use, misappropriation
or disclosure of such trade secrets, know-how or other proprietary information.
Failure to meaningfully protect our trade secrets, know-how or other proprietary
information could adversely affect our future growth and revenues.
We
may incur significant litigation expenses protecting our intellectual property
or defending our use of intellectual property, which may have a material adverse
effect on our cash flow.
Significant
litigation regarding intellectual property exists in our industry. Competitors
and other third parties may infringe our intellectual property rights.
Alternatively, competitors may allege that we have infringed their intellectual
property rights. Any claims, even those made by third parties which are without
merit, could:
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be
expensive and time consuming to defend resulting in the diversion of
management’s attention and
resources;
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•
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cause
one or more of our patents to be ruled or rendered unenforceable or
invalid, or require us to cease making, licensing or using products or
systems that incorporate the challenged intellectual property;
or
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•
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require
us to spend significant time and money to redesign, reengineer or rebrand
our products or systems if
feasible.
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See “Part
I, Item 3. Legal Proceedings” in our Annual Report on Form 10-K for the year
ended December 31, 2007, filed with the SEC on March 17, 2008, “Part
II, Item 1. Legal Proceedings” in our Quarterly Report on Form 10-Q for the
quarterly period ended June 30, 2008 and “Part II, Item 1. Legal Proceedings” in
this Quarterly Report on Form 10-Q for a description of various legal
proceedings in which we are or have been involved and developments related to
those proceedings.
If
we are found to have infringed or to be infringing on a third-party’s
intellectual property rights, we may be forced to discontinue certain products
or technologies, pay damages or obtain a license to use the intellectual
property, any of which may adversely affect our future growth and
revenues.
If we are
found to have infringed or to be infringing on a third party’s intellectual
property rights, we may be forced to discontinue certain products or the use of
certain competitive technologies or features, which may have a material adverse
effect on our future growth and revenues. Alternatively, if the company holding
the applicable patent is willing to give us a license that allows us to develop,
manufacture or market our products or technologies, we may be required to obtain
a license from them. Such a license may require the payment of a license,
royalty or similar fee or payment and may limit our ability to market new
products or technologies, which would adversely affect our future growth and
revenues. In addition, if we are found to have committed patent infringement we
may be obligated to pay damages or be subject to other remedies, which could
adversely affect the value of our common stock.
Some
of our products may contain open source software which may be subject to
restrictive open source licenses requiring us to make our source code available
to third parties and potentially granting third parties certain rights to the
software.
Some of
our products may contain open source software which may be subject to
restrictive open source licenses. Some of these licenses may require that we
make our source code related to the licensed open source software available to
third parties and/or license such software under the terms of a particular open
source license potentially granting third parties certain rights to the
software. We may incur legal expenses in defending against claims that we did
not abide by such licenses. If our defenses are unsuccessful we may be enjoined
from distributing products containing such open source software, be required to
make the relevant source code available to third parties, be required to grant
third parties certain rights to the software, be subject to potential damages or
be required to remove the open source software from our products. Any of these
outcomes could disrupt our distribution and sale of related products, put us at
a competitive disadvantage relative to third parties and adversely affect our
revenues and the value of our common stock.
We
operate in a highly competitive market and may be unable to successfully compete
which may harm our operating results.
We
compete with a number of developers, manufacturers and distributors of similar
products and technologies. Many of our competitors are large companies that have
greater access to capital, marketing and development resources than we have.
Larger competitors may have more resources to devote to research and development
and may be able to more efficiently and effectively obtain regulatory approval.
Pricing, product features and functionality, accuracy and reliability are key
factors in determining a provider’s success in selling its system. Because of
the high initial costs of installing a computerized monitoring system, customers
for such systems generally do not change suppliers once they have installed a
system. This may make it difficult for us to attract customers who have existing
computerized monitoring systems.
Our
business and revenues will be negatively affected if we are unable to compete
effectively in the markets for our products and technologies. New competitors
also may enter our key markets. Numerous factors may affect our ability to
successfully compete and thus affect our future performance,
including:
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the
relative popularity of our existing products and our ability to develop
and introduce appealing new
products;
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•
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our
ability to maintain existing regulatory approvals and to obtain further
regulatory approvals as needed; and
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our
ability to enforce our existing intellectual property rights and to
adequately secure, maintain and protect rights for new
products.
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The
gaming industry is highly regulated, and we must adhere to various regulations
and maintain our licenses to continue our operations.
The
distribution of gaming products and conduct of gaming operations are extensively
regulated by various domestic and foreign gaming authorities. Although the laws
of different jurisdictions vary in their technical requirements and are amended
from time-to-time, virtually all jurisdictions in which we operate require
registrations, licenses, findings of suitability, permits and other approvals,
as well as documentation of qualifications, including evidence of the integrity,
financial stability and responsibility of our officers, directors, major
stockholders and key personnel. If we fail to comply with the laws and
regulations to which we are subject, the applicable domestic or foreign gaming
authority may impose significant penalties and restrictions on our operations,
resulting in a material adverse effect on our revenues and future business. See
“Item 1. Business—Government Regulation” in our Annual Report on Form 10-K for
the year ended December 31, 2007, filed with the SEC on June 30, 2008, for a
description of the regulations that apply to our business.
Future
authorizations or regulatory approvals may not be granted in a timely manner or
at all which would adversely affect our results of operations.
We will
be subject to regulation in any other jurisdiction where our customers may
operate in the future. Future authorizations or approvals required by domestic
and foreign gaming authorities may not be granted at all or as timely as we
would like, and current or future authorizations may not be renewed. In
addition, we may be unable to obtain the authorizations necessary to operate new
products or new technologies or to operate our current products or technologies
in new markets. In either case, our results of operations would likely be
adversely affected. Gaming authorities can also place burdensome conditions and
limits on future authorizations and approvals. If we fail to maintain or obtain
a necessary registration, license, approval or finding of suitability, we may be
prohibited from selling our products or technologies for use in the
jurisdiction, or we may be required to sell them through other licensed entities
at a reduced profit. The continued growth of markets for our products and
technologies is contingent upon regulatory approvals by various federal, state,
local and foreign gaming authorities. We cannot predict which new jurisdictions
or markets, if any, will accept and which authorities will approve the operation
of our gaming products and technologies, the timing of any such approvals or the
level of our penetration in any such markets.
Enforcement
of remedies or contracts against Native American tribes could be
difficult.
Many of
our contracts with Native American tribes are subject to sovereign immunity and
tribal jurisdiction. If a dispute arises with respect to any of those
agreements, it could be difficult for us to protect our rights. Native American
tribes generally enjoy sovereign immunity from suit similar to that enjoyed by
individual states and the United States. In order to sue a Native American tribe
(or an agency or instrumentality of a Native American tribe), the tribe must
have effectively waived its sovereign immunity with respect to the matter in
dispute. Moreover, even if a Native American tribe were to waive sovereign
immunity, such waiver may not be valid and in the absence of an effective waiver
of sovereign immunity by a Native American tribe, we could be precluded from
judicially enforcing any rights or remedies against that tribe.
Our
business is closely tied to the casino industry and factors that negatively
impact the casino industry may also negatively affect our ability to generate
revenues.
Casinos
and other gaming operators represent a significant portion of our customers.
Therefore, factors that may negatively impact the casino industry may also
negatively impact our future revenues. If casinos experience reduced patronage,
revenues may be reduced as our systems may not perform well and may be taken off
of the casino floor altogether.
The level
of casino patronage, and therefore our revenues, are affected by a number of
factors beyond our control, including:
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general
economic conditions;
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levels
of disposable income of casino
patrons;
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•
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downturn
or loss in popularity of the gaming
industry;
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•
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the
relative popularity of entertainment alternatives to casino
gaming;
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•
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the
growth and number of legalized gaming
jurisdictions;
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local
conditions in key gaming markets, including seasonal and weather-related
factors;
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increased
transportation costs;
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acts
of terrorism and anti-terrorism
efforts;
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changes
or proposed changes to tax laws;
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increases
in gaming taxes or fees;
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•
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legal
and regulatory issues affecting the development, operation and licensing
of casinos;
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•
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the
availability and cost of capital to construct, expand or renovate new and
existing casinos;
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•
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the
level of new casino construction and renovation schedules of existing
casinos; and
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competitive
conditions in the gaming industry and in particular gaming markets,
including the effect of such conditions on the pricing of our games and
products.
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These
factors significantly impact the demand for our products and
technologies.
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In the
event that there is a decline in public acceptance of gaming, this may affect
our ability to do business in some markets, either through unfavorable
legislation affecting the introduction of gaming into emerging markets, or
through resulting reduced casino patronage. We cannot assure you that the level
of support for legalized gaming or the public use of leisure money in gaming
activities will not decline.
Economic,
political and other risks associated with our international sales and operations
could adversely affect our operating results.
Since we
sell our products worldwide, our business is subject to risks associated with
doing business internationally. Our sales to customers outside
the Americas, primarily Europe, and Asia, accounted for over half
of our consolidated revenue for the quarter ended September 30, 2008. We expect
the percentage of our international sales to continue to increase during the
remainder of 2008. Accordingly, our future results could be harmed by a variety
of factors, including:
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changes
in foreign currency exchange rates;
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changes
in regulatory requirements;
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costs
to comply with applicable laws;
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changes
in a specific country’s or region’s political or economic
conditions;
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•
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tariffs
and other trade protection
measures;
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•
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import
or export licensing requirements;
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•
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potentially
negative consequences from changes in tax
laws;
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•
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different
regimes controlling the protection of our intellectual
property;
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•
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difficulty
in staffing and managing widespread
operations;
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•
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changing
labor regulations;
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•
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requirements
relating to withholding taxes on remittances and other payments by
subsidiaries;
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restrictions
on our ability to own or operate subsidiaries, make investments or acquire
new businesses in these
jurisdictions;
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•
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restrictions
on our ability to repatriate dividends from our subsidiaries;
and
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violations
under the Foreign Corrupt Practices
Act.
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Holders
of our common stock are subject to the requirements of the gaming laws of all
jurisdictions in which we are licensed.
Pursuant
to applicable laws, gaming regulatory authorities in any jurisdiction in which
we are subject to regulation may, in their discretion, require a holder of any
of our securities to provide information, respond to questions, make filings, be
investigated, licensed, qualified or found suitable to own our securities.
Moreover, the holder of the securities making any such required application is
generally required to pay all costs of the investigation, licensure,
qualification or finding of suitability.
If any
holder of our securities fails to comply with the requirements of any gaming
authority, we have the right, at our option, to require such holder to dispose
of such holder’s securities within the period specified by the applicable gaming
law or to redeem the securities to the extent required to comply with the
requirements of the applicable gaming law.
Additionally,
if a gaming authority determines that a holder is unsuitable to own our
securities, such holder will have no further right to exercise any voting or
other rights conferred by the securities, to receive any dividends,
distributions or other economic benefit or payments with respect to the
securities or to continue its ownership or economic interest in our securities.
We can be sanctioned if we permit any of the foregoing to occur, which may
include the loss of our licenses.
Future
acquisitions could prove difficult to integrate, disrupt our business, dilute
stockholder value and strain our resources.
As part
of our business strategy, we intend to continue to 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 complete, our business, operating results, financial condition
and prospects may be impaired. Acquisitions and investments involve numerous
risks, including:
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difficulties
in integrating operations, technologies, services, accounting and
personnel;
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difficulties
in supporting and transitioning customers of our acquired companies to our
technology platforms and business
processes;
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diversion
of financial and management resources from existing
operations;
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difficulties
in obtaining regulatory approval for technologies and products of acquired
companies;
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potential
loss of key employees;
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dilution
of our existing stockholders if we finance acquisitions by issuing
convertible debt or equity securities, which dilution could adversely
affect the market price of our
stock;
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•
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inability
to generate sufficient revenues to offset acquisition or investment costs;
and
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potential
write-offs of acquired assets.
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Acquisitions
also frequently result in recording of goodwill and other intangible assets,
which are subject to potential impairments in the future that could harm our
operating results. 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
business will be seriously jeopardized if we are unable to attract and retain
key employees.
Our
success depends on the continued contributions of our principal management,
development and scientific personnel, and the ability to hire and retain key
personnel, particularly in the technology area and continue to grow our existing
businesses. We face intense competition for such personnel. The loss of services
of any principal member of our management team could adversely impact our
operations and ability to raise additional capital.
If
our products or technologies contain defects, our reputation could be harmed and
our results of operations adversely affected.
Some of
our products and technologies are complex and may contain undetected defects.
The occurrence of defects or malfunctions could result in financial losses for
our customers and in turn termination of leases, licenses, cancellation of
orders, product returns and diversion of our resources. Any of these occurrences
could also result in the loss of or delay in market acceptance of our products
or technologies and loss of sales.
As
our business is subject to quarterly fluctuation, our operating results and
stock price could be volatile, particularly on a quarterly basis.
Our
quarterly revenue and net income may vary based on the timing of the opening of
new gaming jurisdictions, the opening or closing of casinos or the expansion or
contraction of existing casinos, gaming regulatory approval or denial of our
products and corporate licenses, the introduction of new products or the
seasonality of customer capital budgets, and our operating results have
historically been lower in quarters with lower sales. In addition, prior to the
year ended December 31, 2007, up to approximately 40% of our revenues
were based on cash-based licensing transactions, the majority of which were
generated from intellectual property, content and technology licensing
activities. Most of these non-recurring transactional revenues were from gaming
supplier original equipment manufacturers, or OEMs, and service providers. Each
such transaction has been unique, depending on the nature, size, scope and
breadth of the intellectual property, content, or technology that was being
licensed and/or the rights the licensee or the buyer wishes to
obtain.
Risks
Relating to Our Securities
The
share price of our common stock may be volatile and could decline
substantially.
The
trading price of our common stock has been volatile and is likely to continue to
be volatile. Our stock price could be subject to wide fluctuations in response
to a variety of issues including broad market factors that may have a material
adverse impact on our stock price, regardless of actual performance. These
factors include:
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periodic
variations in the actual or anticipated financial results of our business
or of our competitors;
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downward
revisions in securities analysts’ estimates of our future operating
results or of the future operating results of our
competitors;
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material
announcements by us or our
competitors;
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quarterly
fluctuations in non-recurring revenues from cash-based licensing
transactions;
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public
sales of a substantial number of shares of our common stock;
and
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adverse
changes in general market conditions or economic trends or in conditions
or trends in the markets in which we
operate.
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If
our quarterly or annual results are below the expectations of securities market
analysts and investors, the price of our common stock may decline.
Many
factors, including those described in this “Risk Factors” section, can affect
our business, financial condition and results of operations, which makes the
prediction of our financial results difficult. These factors
include:
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changes
in market conditions that can affect the demand for the products we
sell;
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quarterly
fluctuations in non-recurring revenues from cash-based licensing
transactions;
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general
economic conditions that affect the availability of disposable income
among consumers; and
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the
actions of our competitors.
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If our
quarterly or annual operating results fall below the expectations of securities
market analysts and investors due to these or other risks, securities analysts
may downgrade our common stock and some of our stockholders may sell their
shares, which could adversely affect the trading prices of our common stock.
Additionally, in the past, companies that have experienced declines in the
trading price of their shares due to events of this nature have been the subject
of securities class action litigation. If we become involved in a securities
class action litigation in the future, it could result in substantial costs and
diversion of our management’s attention and resources, thus harming our
business.
*Future
sales of our common stock may depress our stock price.
The
market price for our common stock could decline as a result of sales by existing
stockholders of large numbers of shares of our common stock or the perception
that such sales may occur. Such sales of our common stock also might make it
more difficult for us to sell equity or equity-related securities in the future
at a time and at the prices that we deem appropriate. Of the estimated
approximately 8 million shares outstanding on September 30,
2008:
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approximately
7.9 million shares generally are freely tradable in the public market;
and
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•
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approximately
0.1 million additional shares may be sold by our executive officers and
directors subject to compliance with the volume limitations and other
restrictions of rule 144.
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Additionally,
as of September 30, 2008, there were outstanding options, restricted share
grants, and warrants to purchase an aggregate of approximately 1.1 million of
our shares and we may grant options to purchase up to approximately 290,000
additional shares under our stock option plans. Shares issued on exercise of
those instruments would be freely tradable in the public market, except for any
that might be acquired by our officers or directors. However, any of those
shares that might be acquired by any of our officers and directors could be
sold, subject to compliance with the volume limitations and other restrictions
of Rule 144.
On August
4, 2008, we entered into definitive agreements for refinancing transactions with
PEM and IGT described elsewhere in this quarterly report on Form 10-Q. Upon the
closing of the refinancing transactions on August 15, 2008, the $15 million in
principal amount of the IGT convertible promissory note was initially be
convertible into approximately 2,106,742 shares of our common
stock. We also issued 125,000 new shares of common stock to PEM and
warrants to PEM to purchase 125,000 shares of common stock. We also issued
warrants to IGT to purchase 180,237 shares of common stock. On
November 15, 2008 we were required to issue an additional 112,500 shares of
common stock to PEM and warrants for an additional 225,000 shares of our common
stock to IGT in certain circumstances . Based upon the approximately 8 million
shares of common stock outstanding on September 30, 2008, if the maximum amount
of the IGT convertible promissory note is converted, the maximum amount of our
common stock issuable pursuant to the refinancing transactions is issued and the
maximum amount of all the warrants to be issued pursuant to the refinancing
transactions are exercised (subject to the assumptions indicated above), we will
have up to approximately 10.6 million shares outstanding, representing a
potential increase of approximately 33.0% in the number of shares outstanding on
September 30, 2008.
We
have the ability to issue additional equity securities, which would lead to
dilution of our issued and outstanding common stock.
The
issuance of additional equity securities or securities convertible into equity
securities would result in dilution of then-existing stockholders’ equity
interests in us. Our board of directors has the authority to issue, without vote
or action of stockholders, up to 625,000 shares of preferred stock in one or
more series, and has the ability to fix the rights, preferences, privileges and
restrictions of any such series. Any such series of preferred stock could
contain dividend rights, conversion rights, voting rights, terms of redemption,
redemption prices, liquidation preferences or other rights superior to the
rights of holders of our common stock. If we issue convertible preferred stock,
a subsequent conversion may dilute the current common stockholders’ interest.
Our board of directors has no present intention of issuing any such preferred
stock, but reserves the right to do so in the future.
We
do not intend to pay cash dividends. As a result, stockholders will benefit from
an investment in our common stock only if it appreciates in value.
We do not
plan to pay any cash dividends on our common stock in the foreseeable future,
since we currently intend to retain any future earnings to finance our
operations and further expansion and growth of our business, including
acquisitions. Moreover, the covenants governing our indebtedness restrict our
ability to pay and declare dividends without the consent of the applicable
lenders. As a result, the success of an investment in our common stock will
depend upon any future appreciation in its value. We cannot guarantee that our
common stock will appreciate in value or even maintain the price at which
stockholders have purchased their shares.
Anti-takeover
provisions in our organizational documents, our stockholder rights plan and
Nevada law could make a third-party acquisition of us difficult and therefore
could affect the price investors may be willing to pay for our common
stock.
The
anti-takeover provisions in our articles of incorporation, our bylaws, our
stockholder rights plan and Nevada law could make it more difficult for a third
party to acquire us without the approval of our board of directors. Under these
provisions, we could delay, deter or prevent a takeover attempt or third-party
acquisition that certain of our stockholders may consider to be in their best
interests, including a takeover attempt that may result in a premium over the
market price of our common stock. In addition, these provisions may prevent the
market price of our common stock from increasing substantially in response to
actual or rumored takeover attempts and also may prevent changes in our
management. Because these anti-takeover provisions may result in our being
perceived as a potentially more difficult takeover target, this may affect the
price investors are willing to pay for shares of our common
stock.
Item 2. Unregistered Sales of Equity Securities and Use of
Proceeds
None.
Issuer
Repurchases of Equity Securities
The
following table summarizes purchases of equity securities by the issuer and
affiliated purchasers for the three months ended September 30,
2008:
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(d) Maximum Number (or
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(c)
Total Number of
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approximate
Dollar
|
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|
|
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Shares
(or Units)
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Value)
of Shares (or
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Purchased as Part of
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Units)
that May Yet
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(a) Total Number
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(b) Average Price
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Publicly
Announced
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Be
Purchased Under
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of Shares (or Units
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Paid
per Share
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Plans
or
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the
Plans for
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Period
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Purchased)(1)
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(or
Unit)
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Programs(2)
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Programs
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Beginning
balance
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|
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21,975 |
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$ |
2,000,000 |
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July
2008
|
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|
— |
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|
— |
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|
— |
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August
2008
|
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|
17,571 |
|
|
$ |
5.75 |
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17,413 |
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|
|
|
|
|
September
2008
|
|
|
1,609 |
|
|
$ |
5.75 |
|
|
|
— |
|
|
|
|
|
|
Ending
balance
|
|
|
|
|
|
|
|
|
|
|
39,388 |
|
|
$ |
2,000,000 |
|
|
(1)
|
Represents
1,767 shares withheld for income tax purposes at the time of issuance of
vested restricted stock awards, and 17,413 shares purchased on the open
market as part of the publicly announced stock repurchase
program.
|
(2) On
August 13, 2002 our Board of Directors authorized the purchase of up to $2
million of our common stock. Since the authorization of the plan, we have
purchased approximately 39,388 shares of our common stock for an
approximate aggregate of $584,000.
|
|
|
|
|
|
Exhibits.
|
|
|
|
|
|
|
|
|
|
Exhibit
|
|
Document
Description
|
|
3.1
|
|
Amended
and Restated Articles of Incorporation, incorporated by reference to
Exhibit 3.1 to Amendment No. 1 to the Company’s Registration
Statement on Form S-1 (No. 33-69076).
|
|
|
|
|
3.2
|
|
Amendment
to Amended and Restated Articles of Incorporation incorporated by
reference to Exhibit 3.1 to the Company’s Current Report on 8-K filed
on March 28, 2006.
|
|
|
|
|
3.3
|
|
Amended
and Restated Bylaws, incorporated by reference to Exhibit 3.1 to the
Company’s Current Report on Form 8-K filed on November 20,
2007.
|
|
|
|
|
3.4
|
|
Certificate
of Designation, Rights, Preferences, and Rights of Series A Junior
Participating Preferred Stock of the Company, incorporated by reference to
Exhibit A of Exhibit 3 to the Registration Statement on
Form 8-A filed on August 2, 2000.
|
|
|
|
|
4.1
|
|
Specimen
Certificate of common stock of the Company, incorporated by reference to
the Company’s Registration Statement on Form S-8 filed on June 11,
2007.
|
|
|
|
|
4.2
|
|
Rights
Agreement, dated June 14, 1999, by and between the Company and U.S.
Stock Transfer Corporation, as the Rights Agent, incorporated by reference
to Exhibit 3 to the Company’s Registration Statement on Form 8-A
filed on August 2, 2000.
|
|
|
|
|
4.3
|
|
Form
of Warrant, dated October 22, 2003, incorporated by reference to
Exhibit 4.2 to the Company’s Registration Statement on Form S-3
filed on November 20, 2003.
|
|
|
|
|
4.4
|
|
Warrant
Agreement, dated August 22, 2001, by and among the Company and
Firstar Bank, N.A., incorporated by reference to Exhibit 4.6 to the
Company’s Registration Statement on Form S-3 filed on
September 14, 2001.
|
|
|
|
|
4.5
|
|
Indenture,
dated August 22, 2001, by and among the Company, Firstar Bank, N.A.
and the Guarantors, incorporated by reference to Exhibit 4.8 of the
Company’s Registration Statement on Form S-3 filed on
September 14, 2001.
|
|
|
|
|
4.6
|
|
Guarantee,
dated August 22, 2001, by and among the Guarantors named therein,
incorporated by reference to Exhibit 4.9 of the Company’s
Registration Statement on Form S-3 filed on September 14,
2001.
|
|
|
|
|
4.7
|
|
Pledge
and Security Agreement, dated August 22, 2001, by and among the
Company, Firstar Bank, N.A. and the Guarantors named therein, incorporated
by reference to Exhibit 4.10 of the Company’s Registration Statement
on Form S-3 filed on September 14, 2001.
|
|
|
|
|
4.8
|
|
Deed
of Trust, Security Agreement and Fixture Filing with Assignment of Rents,
dated August 22, 2001, by and among the Company, Stewart Title of
Nevada and Firstar Bank, N.A., incorporated by reference to
Exhibit 4.11 of the Company’s Registration Statement on Form S-3
filed on September 14, 2001.
|
|
|
|
|
4.9
|
|
Trademark
Security Agreement, dated August 22, 2001, by and between the Company
and Firstar Bank, N.A., incorporated by reference to Exhibit 4.12 of
the Company’s Registration Statement on Form S-3 filed on
September 14, 2001.
|
|
|
|
|
4.10
|
|
Patent
Security Agreement, dated August 22, 2001, by and between the Company
and Firstar Bank, N.A., incorporated by reference to Exhibit 4.13 of
the Company’s Registration Statement on Form S-3 filed on
September 14, 2001.
|
|
|
|
|
4.11
|
|
Copyright
Security Agreement, dated August 22, 2001, by and between the Company
and Firstar Bank, N.A., incorporated by reference to Exhibit 4.14 of
the Company’s Registration Statement on Form S-3 filed on
September 14, 2001.
|
|
|
|
|
|
31.1
|
|
Certification
of Chief Executive Officer Pursuant to Rule 13a-14(a) or
Rule 15d-14(a) of the Securities Exchange Act of 1934, as adopted
pursuant to Section 302 of the Sarbanes-Oxley Act of
2002.
|
|
|
|
|
|
|
31.2
|
|
Certification
of Chief Financial Officer Pursuant to Rule 13a-14(a) or
Rule 15d-14(a) of the Securities Exchange Act of 1934, as adopted
pursuant to Section 302 of the Sarbanes-Oxley Act of
2002.
|
|
|
|
|
|
|
32.1
|
|
Certification
of Chief Executive Officer Pursuant to 18 U.S.C. Section 1350, as
adopted Pursuant to Section 906 of the Sarbanes-Oxley Act of
2002.
|
|
|
|
|
|
|
32.2
|
|
Certification
of Chief Financial Officer Pursuant to 18 U.S.C. Section 1350, as
adopted Pursuant to Section 906 of the Sarbanes-Oxley Act of
2002.
|
|
Pursuant
to the requirements of the Securities Exchange Act of 1934, the Registrant has
duly caused this report to be signed on its behalf by the undersigned thereunto
authorized.
|
|
PROGRESSIVE
GAMING
|
|
|
INTERNATIONAL
CORPORATION,
|
|
|
Registrant
|
|
|
|
|
|
By:
/s/ HEATHER A. ROLLO
|
|
|
Heather
A. Rollo
|
|
|
Executive
Vice President, Chief Financial
|
|
|
Officer
and Treasurer
|
|
|
(on
behalf of the Registrant and as principal
|
|
|
financial
officer)
|
|
|
November
17, 2008
|