<PAGE>
++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++
+INFORMATION CONTAINED HEREIN IS SUBJECT TO COMPLETION OR AMENDMENT. A +
+REGISTRATION STATEMENT RELATING TO THESE SECURITIES HAS BEEN FILED WITH THE +
+SECURITIES AND EXCHANGE COMMISSION. THESE SECURITIES MAY NOT BE SOLD NOR MAY +
+OFFERS TO BUY BE ACCEPTED PRIOR TO THE TIME THE REGISTRATION STATEMENT +
+BECOMES EFFECTIVE. THIS PROSPECTUS SHALL NOT CONSTITUTE AN OFFER TO SELL OR +
+THE SOLICITATION OF AN OFFER TO BUY NOR SHALL THERE BE ANY SALE OF THESE +
+SECURITIES IN ANY STATE IN WHICH SUCH OFFER, SOLICITATION OR SALE WOULD BE +
+UNLAWFUL PRIOR TO REGISTRATION OR QUALIFICATION UNDER THE SECURITIES LAWS OF +
+ANY SUCH STATE. +
++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++
SUBJECT TO COMPLETION, DATED JULY 8, 1996
[LOGO APPEARS HERE]
- --------------------------------------------------------------------------------
3,500,000 SHARES
COMMON STOCK
- --------------------------------------------------------------------------------
All of the 3,500,000 shares of Common Stock, par value $0.001 per share
("Common Stock"), are being sold by Silicon Gaming, Inc. ("SGI" or the
"Company"). Prior to this offering, there has been no public market for the
Common Stock. It is currently estimated that the initial public offering
price will be between $10.00 and $12.00 per share. See "Underwriting" for a
discussion of the factors to be considered in determining the initial public
offering price. The Company has applied to have the Common Stock approved for
listing on the Nasdaq National Market under the symbol "SGIC."
AN INVESTMENT IN THE SHARES OF COMMON STOCK OFFERED HEREBY INVOLVES A HIGH
DEGREE OF RISK. SEE "RISK FACTORS" COMMENCING ON PAGE 7.
THESE SECURITIES HAVE NOT BEEN APPROVED OR DISAPPROVED BY THE SECURITIES AND
EXCHANGE COMMISSION OR ANY STATE SECURITIES COMMISSION NOR HAS THE SECURITIES
AND EXCHANGE COMMISSION OR ANY STATE SECURITIES COMMISSION PASSED UPON THE
ACCURACY OR ADEQUACY OF THIS PROSPECTUS. ANY REPRESENTATION TO THE CONTRARY
IS A CRIMINAL OFFENSE.
NEITHER THE NEVADA GAMING COMMISSION, THE NEVADA STATE GAMING CONTROL BOARD,
THE MISSISSIPPI GAMING COMMISSION NOR ANY OTHER GAMING AUTHORITY HAS PASSED
UPON THE ACCURACY OR ADEQUACY OF THIS PROSPECTUS OR THE INVESTMENT MERITS OF
THE COMMON STOCK OFFERED HEREBY. ANY REPRESENTATION TO THE CONTRARY IS
UNLAWFUL.
<TABLE>
<CAPTION>
PRICE UNDERWRITING PROCEEDS TO
TO PUBLIC DISCOUNT(1) COMPANY(2)
<S> <C> <C> <C>
Per Share $ $ $
Total(3) $ $ $
</TABLE>
(1) The Company has also agreed (i) to issue to Deutsche Morgan Grenfell/C.
J. Lawrence Inc., Bear, Stearns & Co. Inc., Montgomery Securities and
Oppenheimer & Co., Inc. warrants (the "Representatives' Warrants") to
purchase up to an aggregate of 177,777 shares of Common Stock for $
per share (120% of the initial public offering price of the Common Stock
offered hereby) and (ii) to grant certain registration rights with
respect to such shares. See "Underwriting."
(2) Before deducting expenses of this offering of approximately $1,250,000
payable by the Company.
(3) The Company has granted to the Underwriters an option to purchase up to
525,000 additional shares of Common Stock to cover over-allotments. If
all such shares are purchased, the total Price to Public, Underwriting
Discount and Proceeds to Company will be $ , $ and $ ,
respectively. See "Underwriting."
The shares of Common Stock are offered by the Underwriters, subject to prior
sale, when and as if delivered to and accepted by them, and subject to
approval of certain legal matters by counsel and certain other conditions.
The Underwriters reserve the right to withdraw, cancel or modify such offer
and to reject orders in whole or in part. Delivery of shares of Common Stock
offered hereby to the Underwriters is expected to be made in New York, New
York, on or about , 1996.
DEUTSCHE MORGAN GRENFELL
BEAR, STEARNS & CO. INC.
MONTGOMERY SECURITIES
OPPENHEIMER & CO., INC.
The date of this Prospectus is , 1996.
<PAGE>
[Graphic Appears Here]
Photograph of the Company's slot machine with logos for Phantom Belle, Krazy
Keno, Buccaneer Gold, Fort Knox, Meteors! and Win-O-Matic, a suite of games
that are currently in production or under development, depicted on the device's
touch screen display.
----------------
A NEW GENERATION OF
INTERACTIVE WAGERING ENTERTAINMENT
IN CONNECTION WITH THIS OFFERING, THE UNDERWRITERS MAY OVER-ALLOT OR EFFECT
TRANSACTIONS WHICH STABILIZE OR MAINTAIN THE MARKET PRICE OF THE COMMON STOCK
OF THE COMPANY AT A LEVEL ABOVE THAT WHICH MIGHT OTHERWISE PREVAIL IN THE OPEN
MARKET. SUCH TRANSACTIONS MAY BE EFFECTED ON THE NASDAQ STOCK MARKET OR
OTHERWISE. SUCH STABILIZING, IF COMMENCED, MAY BE DISCONTINUED AT ANY TIME.
2
<PAGE>
Depictions of sample game screens for Fort Knox, Win-O-Matic, Buccaneer
Gold and Phantom Belle with the following accompanying description alongside
each depiction: Fort Knox - Silicon Gaming merges PC technology with casino
---------
entertainment to create a new generation of innovative wagering products,
Win-O-Matic - An old-fashioned slot machine with a 50's flair, the Win-O-Matic
- -----------
is simple to play and features traditional reel symbols like cherries, lemons
and plums, Buccaneer Gold - Buccaneer Gold is a pirate-themed version of a
--------------
traditional reel slot that features lively, animated jackpot celebrations and a
swashbuckling bonus feature and Phantom Belle - Draw poker on a 19th century
-------------
river boat, Phantom Belle pits players against a ghostly dealer and a host of
other haunted characters. All such games are footnoted with the following
text: "The images shown reflect games that are currently in production or under
development."
Graphic showing overlapping circles which represent the Company's focus on
gaming entertainment, customer needs and technology with the accompanying text,
"Our understanding of casino gaming, entertainment, and multimedia technology
results in a fresh, innovative approach to creating wagering products that we
believe offer higher revenue potential to casino operators."
Bar graph depicting the revenue spent or estimated to be spent on casino
gaming in the United States from 1990 through 1997 with the following
accompanying text, "Casino gaming is a significant component of the
entertainment economy. In the U.S. last year, more money was spent in casinos
than on movies and video rentals combined."
Additional text reads as follows: "Silicon Gaming intends to become the
gaming industry's leading provider of innovative wagering games and related
products. Our strategy is to focus on: Enhancing Entertainment Value. We believe
that the next generation of slot machines must offer players a richer, more
interactive, more entertaining experience than what is currently available. Our
games are wrapped in engaging stories and feature a combination of computer
animation, live-action video, and digital audio. As a result, we feel these
products will attract both new and existing slot players and will hold their
interest for longer periods of time. Developing Customer Intimacy-Understanding
both the casino operator and the slot" (text continued on next page).
<PAGE>
Depictions of sample game screens for Fort Knox (carryover picture and
text from previous page), Krazy Keno, Roulette Royale and Meteors! with the
following accompanying descriptions alongside each depiction: Krazy Keno-The
----------
balls shoot through the air to hit or miss the player's spots. Krazy Keno uses
dazzling animation to add color and heighten anticipation in this old-time
favorite, Roulette Royale-The wheel spins and spins as players adjust their bets
---------------
in Roulette Royale, a faithful representation of the classic table game and
Meteors!-Three-reel gaming launches into outer space in Meteors, a Magic Windows
- --------
game where bonus rounds warp trigger-happy players into double-jackpot
hyperspace. All such games are footnoted (from the previous page) with the
following text: "The images shown reflect games that are currently in production
or under development."
Pictures showing the Company's slot machine platform with the accompanying
text, "The Silicon Gaming platform is designed to resemble a traditional slot
machine in terms of its footprint, size, shape, and features-such as the
side-mounted handle."
A depiction of the Company's Machine Management System, the slot machine's
on-line help and information system with the accompanying text, "To make our
machines even easier to use our on-line help and information system offers
players step-by-step instructions."
Additional text (continued from the previous page) reads as follows:
"player allows us to develop a range of products that are responsive to their
needs. We believe our wagering experiences reflect the more sophisticated tastes
of today's entertainment consumer. And our proprietary Machine Management System
gives casino personnel a powerful, yet easy-to-use set of diagnostic and
auditing tools. INTEGRATING PC TECHNOLOGY -- In order for us to build a machine
that is flexible enough to meet the anticipation demands of a changing industry,
we leverage computer technology. Our Pentium-based multimedia platform can
support a wide range of game production styles and techniques. And by
integrating off-the-shelf components into the modular design of our platform,
the machine is easy to service, configure, and upgrade."
<PAGE>
PROSPECTUS SUMMARY
The following summary is qualified in its entirety by the information,
including financial information, appearing elsewhere in this Prospectus. Except
as otherwise noted, all information in this Prospectus, including financial
information, shares and per share data: (i) gives effect to a 2-for-3 reverse
stock split to be effected prior to or concurrently with this offering; (ii)
reflects the automatic conversion of the Company's outstanding Redeemable
Preferred Stock (other than the Series A1 and Series B1 Redeemable Preferred
Stock) into an aggregate of 3,528,349 shares of Common Stock upon the
completion of this offering; and (iii) assumes that the Underwriters' over-
allotment option is not exercised. See "Underwriting."
THE COMPANY
Silicon Gaming, Inc. ("SGI" or the "Company") is engaged in the design and
development of what it believes will be the next generation of interactive slot
machines for use in casinos and other gaming establishments. The Company's
product combines an advanced multimedia gaming platform with software-based
games that the Company believes will be more engaging and entertaining than
other gaming devices currently available and will, as a result, generate
increased gaming revenue per device ("win per machine") for the casino
operator. The Company has manufactured several fully functioning prototypes and
has applied for product approval in Nevada, and, if approved, expects to be
able to ship its first product for commercial trial in late 1996. As of July 3,
1996, the Company had received nonbinding commitments to install and evaluate
its gaming platform from Bally's Las Vegas, Boulder Station Hotel & Casino,
Caesars Palace Las Vegas, Circus Circus Hotel & Casino, Excalibur Hotel Casino,
the Flamingo Hilton, Grand Casino Biloxi, Grand Casino Gulfport, Grand Casino
Tunica, Hard Rock Hotel & Casino, Harrah's Las Vegas, ITT Sheraton Desert Inn,
Sheraton Tunica, Luxor Hotel Casino, MGM Grand Hotel/Casino, New York-New York
Hotel/Casino, Palace Station Hotel & Casino, Station Casino Kansas City, St.
Charles Riverfront Station, Stratosphere Hotel & Casino and Texas Station, each
of which has agreed to install and evaluate from eight to 30 of the Company's
machines. Collectively, these casinos have agreed to install approximately 400
units.
The Company's gaming platform features high resolution video presented across
the full surface of a large touchscreen display. The games feature high quality
animation, video clips, digital sound and a level of visual appeal and
interactivity that the Company believes is unattainable by the current
generation of slot machines. The Company is attempting to maximize the
entertainment value offered by the two-dimensional surface of the video screen
by providing multiple levels of achievement within the same game, so that,
through successful play over a period of time, a player may advance to a
bonusing sequence and win additional jackpots. Utilizing these features, SGI
believes that its products will encourage longer and more frequent periods of
play by existing slot machine customers and attract new gaming customers who
are seeking greater entertainment value than that offered by the current
generation of slot machines. In addition, the Company has designed its machines
with a number of features, such as play stoppage entertainment, modular
components, and the Company's Machine Management System software, which
provides easy-to-use diagnostics designed to minimize player inconvenience and
machine down-time.
HISTORY
The Company was founded in 1993 by executives in the high technology and
multimedia entertainment industries who believed that existing "hardware
dominant" slot machines were not fully utilizing available technology and
entertainment capabilities. These founders believed that the slot machine
experience, enhanced by the application of multimedia technology and production
practices, would be more entertaining to slot players, resulting in longer and
more frequent periods of play and thus greater win per machine for casino
operators. In October 1994, the Company hired Andrew S. Pascal from The Mirage
Hotel and Casino, where he served as Director of Slot Operations and Marketing.
Based on his experience, Mr. Pascal agreed that SGI had identified a
significant market
3
<PAGE>
opportunity that was not being addressed by existing slot machine vendors.
Since joining the Company, Mr. Pascal has had principal responsibility for the
design specifications of the Company's game platform and has supervised
development of the various games that will be offered on the Company's
machines. In June 1995, the Company hired its first full-time Chief Executive
Officer, Donald J. Massaro, a founder and Chief Executive Officer of several
technology companies.
In the course of its development, SGI has built relationships with a number
of influential organizations and individuals in the high technology and gaming
industries. In addition, the Company has attracted investment capital from
venture capital firms and institutional investors including Kleiner Perkins
Caufield & Byers, Technology Partners, Benchmark Capital Management and Capital
Research and Management Company. Investors from relevant industries include
Station Casinos, Inc. and International Game Technology, Inc. ("IGT") from the
gaming industry, The Interpublic Group of Companies, Inc. from the advertising
industry and RSA Data Security, Inc. from the data security industry.
STRATEGY
Although the gaming industry has enjoyed significant growth over the past
five years, the Company believes that most of the investment over this period
has been made in physical assets such as large hotels and themed attractions,
and that comparatively little has been invested in further developing the
actual casino games which, in the aggregate, account for a majority of the
average casino's revenue. In contrast, the Company has focused its resources
primarily on developing what it believes will be the next generation of
interactive slot machines and on implementing its strategy of providing a
gaming platform that offers slot machine players a more entertaining and
engaging experience than is available from current gaming machines. The Company
believes that its machines will encourage casino patrons to play more
frequently and for longer periods of time and will also attract new gaming
customers, particularly younger patrons who typically are not attracted to
current generation slot machines. The Company believes that, as a result, its
machines will outperform most existing machines in win per machine and thus
motivate casino operators to supplement or replace existing slot machines with
SGI products.
SGI intends initially to sell its hardware platform bundled with a suite of
six gaming options, play stoppage entertainment and the Company's Machine
Management System. The Company believes that over time, as casino operators
reach the target mix of SGI machines within their slot portfolios, software
sales and upgrades will constitute an increasing percentage of its overall
sales. If this occurs, the Company believes that its corporate and financial
profile will resemble that of a software developer more than that of a hardware
manufacturer.
THE SGI PRODUCT
The majority of today's slot machines are "hardware dominant," consisting of
a fixed and unvarying game played out on spinning reels or a small video screen
mounted within a large metal box. By contrast, the Company's products are
"software dominant," in that the attraction and entertainment value of its
machines is created by software programs that run SGI's games. SGI's platform
is expected to offer the player a selection of different games on a single
machine. Furthermore, the Company's 26-inch-diagonal touchscreen display serves
both as the play field when the machine is in use and as a source of attraction
by displaying sample game highlights and information, when the machine is not
in use. Another benefit of a "software dominant" machine is that casino
operators can quickly and easily change or upgrade games. The Company expects
that casino operators will be able to upgrade SGI's machines simply by
installing new software, rather than by replacing an entire slot machine.
The SGI machine features a number of sophisticated technology components,
including a 133-mhz Pentium processor, a 4-gigabyte hard disk drive, state-of-
the-art video processing devices and a high speed PCI bus. The software
powering the Company's machines is significantly more complex and flexible than
the software driving the current generation of slot machines and video
4
<PAGE>
gaming devices. The Company believes that the programs driving current
generation gaming devices utilize approximately 0.1 megabytes of information.
By contrast, each of the Company's games utilizes several hundred megabytes of
information, requiring storage on a high capacity hard drive. The Company has
completed development of one game, Fort Knox, and expects that, by the time it
is approved to ship product in late 1996, it will have completed a suite of six
gaming options that are currently in various stages of development, play
stoppage entertainment and its Machine Management System.
The Company's product strategy is initially to develop sophisticated and
entertaining highly-themed versions of traditional reel-based slot and video
poker machines and SGI versions of other traditional casino games, such as
blackjack, craps, roulette and keno, in order to minimize intimidation or
confusion of players due to an unfamiliar game format. The Company believes
that products currently offered (or, to its knowledge, under development) by
other vendors offer few of the multimedia features or game complexity that the
Company's games will offer. The Company also intends, over the longer term, to
offer sports games such as golf and horse racing and to develop new games that
have not previously been presented in a gaming environment. In addition to the
six gaming options it expects to have completed by late 1996, the Company
currently intends to develop at least six new games per year, beginning in
1997.
The Company has developed a number of proprietary product attributes and is
seeking patent protection for some of them. Although licensing such
technologies is not an integral part of the Company's business plan, the
Company believes that it may be able to enter into business relationships with
other organizations that might want to use these technologies. The Company
believes that the proprietary nature of certain of these attributes,
particularly its game authentication method, may provide some protection from
competitors seeking to use software-based games to replicate the gaming
experience offered by the Company's machine.
THREE-PHASE PRODUCT INTRODUCTION
The Company intends to introduce its product and begin its marketing and
sales efforts in a controlled and deliberate manner, following a three-phase
program through 1998:
1996: The Company's first objective will be to complete development of the
product and have it licensed and available for sale in one or more
jurisdictions before year-end. The Company has received nonbinding
commitments to install and evaluate its gaming platform from several
leading Las Vegas casinos, subject to prior receipt of regulatory
approval.
1997: The Company intends to sell a limited number of machines in 1997 so
that it can carefully monitor the reactions of casino patrons and
operators to the Company's platform, game software and product support
features, while building a sales and support infrastructure in gaming
markets nationwide in preparation for a full roll-out in 1998. During this
year, the Company also intends to seek licensing in additional
jurisdictions.
1998: The Company intends to broaden the marketing and distribution of its
platform and software games in 1998. Because of the restraints imposed by
its product introduction program, the Company currently believes that 1998
will be the first year in which a reasonable assessment of the commercial
potential of its products can be made.
SGI was incorporated in California on July 27, 1993. Its principal offices
are located at 2800 W. Bayshore Road, Palo Alto, California 94303. The
Company's telephone number is (415) 842-9000.
----------------
The Silicon Gaming logo and name are trademarks of the Company. This
Prospectus also includes trade names, trademarks and service marks of other
companies.
5
<PAGE>
THE OFFERING
<TABLE>
<S> <C>
Common Stock offered by the Company...... 3,500,000 shares
Common Stock to be outstanding after this
offering................................ 10,619,638 shares(1)(2)
Common Stock to be outstanding after this
offering, assuming conversion of Series
A1 and Series B1 Redeemable
Preferred Stock......................... 14,875,953 shares(2)
Use of proceeds.......................... Continued development, marketing, in-
troduction and roll-out of the
Company's products and general corpo-
rate purposes. See "Use of Proceeds."
Proposed Nasdaq National Market Symbol... SGIC
</TABLE>
SUMMARY CONSOLIDATED FINANCIAL DATA
(In thousands, except per share data)
<TABLE>
<CAPTION>
PERIOD FROM THREE CUMULATIVE
INCEPTION YEAR NINE MONTHS MONTHS ENDED(3) FROM INCEPTION
(JULY 27, 1993) ENDED ENDED ------------------ (JULY 27, 1993)
THROUGH MARCH 31, DECEMBER 31, JUNE 30, MARCH 31, THROUGH
MARCH 31, 1994 1995 1995(3) 1995 1996 MARCH 31, 1996
--------------- --------- ------------ -------- --------- ---------------
<S> <C> <C> <C> <C> <C> <C>
STATEMENT OF OPERATIONS
DATA:
Operating Expenses:
Research and
development............ $ 79 $ 1,539 $ 3,137 $ 584 $ 1,595 $ 6,350
Selling, general and
administrative......... 61 312 922 168 742 2,037
----- ------- ------- ------ ------- -------
Loss from operations.... (140) (1,851) (4,059) (752) (2,337) (8,387)
Interest income
(expense).............. -- (15) 85 17 1 71
----- ------- ------- ------ ------- -------
Net loss................ $(140) $(1,866) $(3,974) $ (735) $(2,336) $(8,316)
===== ======= ======= ====== ======= =======
Pro forma net loss per
share.................. $ (0.50) $(0.10) $ (0.27)
======= ====== =======
Shares used in
computation(4)......... 8,023 7,667 8,803
======= ====== =======
</TABLE>
<TABLE>
<CAPTION>
MARCH 31, 1996
------------------------------------
PRO FORMA
ACTUAL PRO FORMA(5) AS ADJUSTED(6)
------- ------------ --------------
<S> <C> <C> <C>
BALANCE SHEET DATA:
Cash and equivalents..................... $ 7,657 $14,866 $49,421
Working capital.......................... 7,154 14,363 48,918
Total assets............................. 9,130 16,339 50,894
Long-term debt........................... 706 706 706
Redeemable convertible preferred stock... 15,996 6,455 6,455
Deficit accumulated during the
development stage....................... (8,316) (8,316) (8,316)
Total shareholders' equity (deficiency).. (8,277) 8,473 43,028
</TABLE>
- --------
(1) Assumes no conversion of the outstanding Series A1 and Series B1 Redeemable
Preferred Stock, which may be converted into an aggregate of 4,256,315
shares of Common Stock at the option of the holders with 75 days' notice to
the Company.
(2) Assumes no exercise of options or warrants after March 31, 1996. As of May
31, 1996, there were outstanding options and warrants to purchase 607,270
shares of Common Stock at a weighted average exercise price of $3.22 per
share. The Company has also agreed to issue the Representatives' Warrants.
(3) Effective April 1, 1995, the Company changed its fiscal year end from March
31 to December 31.
(4) See Note 1 of Notes to Consolidated Financial Statements for an explanation
of the method used to determine the number of shares used in the
computation of pro forma net loss per share.
(5) The pro forma balance sheet data gives effect to the April and May 1996
sales of 1,542,000 shares of Series C Redeemable Preferred Stock, the
subsequent conversion of 1,998,332 shares of Series A and 4,386,141 shares
of Series B Redeemable Preferred Stock on a one-for-one basis into shares
of Series A1 and Series B1 Redeemable Preferred Stock, respectively, and
the automatic conversion upon the closing of this offering of all
outstanding shares of Redeemable Preferred Stock, other than Series A1 and
Series B1 Redeemable Preferred Stock, into 3,528,349 shares of Common
Stock.
(6) The pro forma as adjusted balance sheet takes into account the pro forma
adjustments described in footnote 5 above as adjusted to reflect the sale
of 3,500,000 shares of Common Stock at an assumed offering price of $11.00
per share, less estimated underwriting discount and offering expenses.
6
<PAGE>
RISK FACTORS
This Prospectus contains forward-looking statements within the meaning of
Section 27A of the Securities Act of 1933. Such forward-looking statements may
be found in this section and under "Prospectus Summary," "Management's
Discussion and Analysis of Financial Condition and Results of Operation,"
"Business--Industry Background," "--Strategy," "--SGI Paradigm," "--Product
Development," "--Sales and Marketing," and "--Gaming Regulation and
Licensing." Actual events or results could differ materially from those
discussed in the forward-looking statements as a result of various factors,
including, without limitation, the risk factors set forth below and elsewhere
in this Prospectus. The following risk factors should be considered carefully
before purchasing the Common Stock offered hereby.
SINGLE PRODUCT; RISK OF TECHNICAL ERRORS; UNCERTAIN MARKET ACCEPTANCE. The
Company's success will depend on the success of a single product. The
Company's gaming platform is in the final stages of development and has not
been licensed for manufacture, distribution or sale in any jurisdiction, sold
to any gaming operator or installed in any casino or other gaming
establishment. The Company's gaming platform has not been beta tested because
such testing requires prior regulatory approval of the platform in the test
jurisdiction. Therefore, there can be no assurance that a substantial
technical difficulty with, or an undetected error in, the Company's software
or hardware will not arise, possibly resulting in unanticipated costs,
production delays or delays in product licensing.
To achieve commercial success, the Company's gaming platform must be
accepted both by casino operators and by gaming patrons. Because acceptance of
the platform by casino operators will ultimately depend on win per machine,
the Company believes that its ultimate success will depend on player
acceptance. The Company has performed only limited market studies to support
its belief that its platform design will be perceived by slot players as an
improvement in slot machine design, and there can be no assurance that its
gaming platform will be accepted by casino patrons. Player preferences are
highly subjective, vary substantially among geographic and demographic markets
and are subject to unpredictable change. Because the Company's gaming platform
contains features not found on traditional slot machines, it may not appeal to
the player for whom familiarity and predictability are an important
consideration. As a new and relatively small entrant in a market dominated by
larger companies, the Company believes that its success will require that its
gaming platform demonstrate superior, as opposed to merely comparable, win per
machine when compared to traditional slot machines and other gaming platforms
offered by more established competitors. Although several casinos have agreed
to install and evaluate the Company's gaming platform, any purchases of gaming
platforms by such casinos, or others that may conduct similar evaluations in
the future, will be subject to the superior performance of the platform on the
casino floor. If the Company's gaming platform does not perform well in its
initial evaluations, the Company's business, financial condition and results
of operation would be materially and adversely affected, and investors would
be exposed to the loss of their entire investment.
REGULATORY APPROVAL. The Company will be required to obtain the necessary
licenses, approvals, findings of suitability, and product approvals in all
jurisdictions in which it intends to distribute its products. The licensing
and approval processes can involve extensive investigation into the Company
and its officers, directors, employees, principal shareholders, and product,
and can require significant expenditures of time and resources by the Company.
The Company and certain of its subsidiaries have been approved to manufacture
and distribute gaming devices in Nevada and Mississippi. The Company has also
applied for the requisite corporate and individual approvals in Missouri and
Colorado and intends to file for the requisite approvals in New Jersey and in
other jurisdictions wherein its products can be legally sold. To date, the
Company has submitted its product for approval in Nevada. The Company has not
yet obtained licensing approval with respect to any of its products and there
can be no assurance that the Company will receive such approvals. The
regulations relating to company and product licensing are subject to change,
and other jurisdictions, including the federal government, may elect to
regulate or tax gaming activities. The Company cannot predict the nature of
any such changes or their impact on the Company.
7
<PAGE>
The Company intends to store its game software and Machine Management System
on a writeable internal hard disk drive that will enhance data storage and
facilitate upgrades to game software. Current technical standards in Nevada
prohibit the storage of software affecting game outcome in a medium that can
be altered through the circuitry or programming of the gaming device.
Accordingly, implementation of the Company's current platform design will
require a modification to the applicable technical standard or any similar
regulations of any other jurisdictions where the Company intends to sell its
machine. Although the Company believes that the Nevada gaming authorities may
modify the technical standard in the near future in a manner that will permit
the implementation of the Company's current design, there can be no assurance
that such modification will occur in the near future or at all, or that a
similar modification will be made to the regulations of any other
jurisdiction. Moreover, any such modification will be subject to
administrative procedures in Nevada that allow for comment by certain parties
currently licensed under Nevada gaming regulations. Thus, certain existing or
potential competitors of the Company could object to modifications to the
technical standard that may be necessary to permit the Company to implement
its current design. There can be no assurance that such objection will not
affect the outcome of this administrative procedure in a manner that would
prevent the Company's implementation of its current platform design. The
Company believes that it can alter its product to comply with existing
regulations by disabling the write feature of its hard drive in a manner that
could not be changed without violating the integrity of the machine. Although
this alternative would limit the machine's ability to store substantial
quantities of game history data during play and the ease of software upgrades,
the Company does not believe that this alternative would affect actual play
characteristics of the Company's games or the operation of the Machine
Management System. Notwithstanding the foregoing, there can be no assurance
that the existing technical standard in Nevada would be interpreted in a
manner that would permit the Company to comply by making such modification.
Any beneficial holder of the Company's Common Stock may be subject to
investigation by any gaming authority in any jurisdiction in which the Company
does business if such authorities have reason to believe that such ownership
may be inconsistent with the gaming policies of that jurisdiction. Persons who
acquire beneficial ownership of more than certain designated percentages of
the Common Stock may be subject to certain reporting and qualification
procedures. In addition, changes in control of the Company and certain other
corporate transactions may not be effected without the prior approval of
gaming authorities in other jurisdictions in which the Company plans to do
business. Such provisions could adversely affect the marketability of the
Common Stock or prevent certain corporate transactions, including mergers or
other business combinations. See "Business--Gaming Regulation and Licensing."
DEVELOPMENT STAGE COMPANY; EXPECTATION OF LOSSES; NEGATIVE CASH FLOWS. The
Company was founded in July 1993 and, as a development stage company, has not
yet generated revenues from the sale of its products. The Company does not
expect to generate revenues in 1996. As of March 31, 1996, the Company had
cumulative net losses since inception of $8.3 million, and the Company expects
to continue to incur substantial losses and negative cash flow at least
through mid-1998. There can be no assurance that the Company will become
profitable or cash flow positive at any time in the future. The likelihood of
the success of the Company must be considered in light of the expenses,
difficulties, complications and delays frequently encountered in connection
with the formation of a new business and the competitive and regulatory
environment in which the Company must operate. In particular, the Company's
operations to date have focused primarily on product development, and the
Company has little or no experience in the areas of manufacturing, sales,
product distribution or customer support. It is not possible to estimate
future operating expenses and revenues based upon historical operating
performance. Operating results will depend, in part, on
8
<PAGE>
matters over which the Company has no control, including, without limitation,
general economic conditions, gaming regulations and taxes, the ability of the
Company to obtain the licenses necessary to conduct its business, competition,
the actual number of orders for its products and the availability of talented
personnel.
COMPETITION. The gaming machine industry is characterized by intense
competition, which is based on, among other things, a device's ability to
generate win per machine through product appeal to players, knowledge of
customer requirements such as ease of use, ease of service, support and
training, distribution, name recognition and price. In recent years, the
gaming machine market has been dominated by IGT which, according to industry
sources, captured approximately 70% of the market in 1995. Because of its
extensive market presence, distribution capacity, player acceptance and
financial, technological and other resources, IGT represents formidable
competition. Several other companies, including Bally Gaming International,
Inc., are established in or seeking to enter the gaming machine business.
Companies in historically unrelated industries, such as Sega Enterprises Ltd.
("Sega"), have technological resources that could offer them a competitive
advantage in developing multimedia-based gaming machines. Sega currently
offers gaming machines to a limited number of markets and has announced plans
to apply for manufacturing and distribution licenses in Nevada. In general,
the Company's existing competitors, as well as many potential new competitors,
have significantly greater financial and technical resources than the Company,
as well as more established customer bases and distribution channels, which
may allow them to move rapidly into the Company's market and acquire
significant market share. Increased competition is likely to result in price
reductions, reduced operating margins and loss of market share, any of which
could materially and adversely affect the Company's business, operating
results or financial condition. Furthermore, any success the Company might
have may benefit existing competitors and induce new competitors to enter the
market. There can be no assurance that the Company will be a successful
competitor in the gaming machine industry. See "Business--Competition."
MANAGEMENT OF GROWTH. Execution of the Company's plan of operation will
require significant growth. The Company's current plans for growth will place
a significant strain on the Company's financial, managerial and other
resources. The Company's ability to manage its growth effectively will require
it to continue to improve its operational, financial and management
information systems and to attract, motivate and train key employees. If the
Company's executives are unable to manage growth effectively, the Company's
business, operating results and financial condition would be materially and
adversely affected.
DEPENDENCE ON KEY PERSONNEL. The operations of the Company depend to a great
extent on the management efforts of its officers and other key personnel and
on the ability to attract new key personnel and retain existing key personnel
in the future. Competition is intense for highly skilled product development
employees in particular, and there can be no assurance that the Company will
be successful in attracting and retaining such personnel, or that it can avoid
increased costs in order to do so. In addition, the Company's officers and key
employees are not bound by noncompetition agreements that extend beyond their
employment at the Company, and there can be no assurance that employees will
not leave the Company or compete against the Company. The Company's failure to
attract additional qualified employees or to retain the services of key
personnel could have a material adverse effect on the Company's operating
results and financial condition. The Company currently maintains a "key-man"
life insurance policy in the amount of $3 million on the life of Andrew S.
Pascal, the Company's Executive Vice President--Marketing and Game
Development. See "Management."
Limited Protection of Intellectual Property Rights; Risk of Litigation. The
Company regards its products as proprietary and relies primarily on a
combination of trademark, copyright and trade secret laws and employee and
third-party nondisclosure agreements to protect its proprietary rights.
Defense of intellectual property rights can be difficult and costly, and there
can be no assurance that the Company will be able effectively to protect its
technology from misappropriation by competitors. In
9
<PAGE>
addition, the protections offered by trademark, copyright and trade secret
laws would not prevent a competitor from designing games having appearance and
functionality that closely resembles the Company's games. At present, the
Company's principal proprietary technology consists of its game authentication
algorithm, which inhibits the ability of any person to tamper with the game
software resident in its products, and its random number generator algorithm,
which determines the outcome of each gaming proposition. While the Company
believes that these algorithms are unique at present, the algorithms are not
patented, and there can be no assurance that a competitor of the Company will
not succeed in developing an authentication algorithm or a random number
generator algorithm that performs as well as or better than the Company's.
Although the Company has applied for a U.S. patent with respect to its
authentication algorithm, there can be no assurance that such patent will be
issued, or, if issued, that such patent will not be successfully challenged in
subsequent litigation.
As the number of software products in the industry increases and the
functionality of these products further overlaps, software developers and
publishers may increasingly become subject to infringement claims. The Company
may also become subject to infringement claims, with or without merit, that
are brought by competitors who are motivated by a desire to disrupt the
Company's business. Although the Company is not currently aware of any claim
that it is infringing any intellectual property rights, there can be no
assurance that the Company will not face claims, with or without merit, in the
future. Any such claims or litigation could be costly and could result in a
diversion of management's attention, which could have a material adverse
effect on the Company's business and financial condition. Any settlement of
such claims or adverse determinations in such litigation could also have a
material adverse effect on the Company's business and financial condition.
RAPIDLY CHANGING TECHNOLOGY. The Company's products utilize hardware
components that have been developed primarily for the personal computer and
multimedia industries. These industries are characterized by rapid
technological change and product enhancements. The Company's ability to remain
competitive and retain any technological lead may depend in part upon its
ability to continually develop new slot machine games that take full advantage
of the technological possibilities of state-of-the-art hardware. Should any
current or potential competitor of the Company succeed in developing a
competing software-based gaming platform, such competitor could be in a
position to outperform the Company in its ability to exploit developments in
microprocessor, video technology or other multimedia technology. The emergence
of a suite of slot machine games that is superior to the Company's in any
respect could substantially diminish the Company's product sales and thereby
have a material adverse effect on the Company's operating results.
CAPITAL REQUIREMENTS. The Company believes that the net proceeds of this
offering, combined with cash on hand, will be sufficient to fund its capital
and operating requirements until the Company is capable of generating positive
cash flow from operations. No assurance can be given, however, that the
Company will not be required to seek additional financing to fund its
operations prior to such time. In that event, there can be no assurance that
the Company will be able to obtain such financing, or that, if it is able to
obtain such financing, it will be able to do so on satisfactory terms or on a
timely basis. If additional funds are raised through the issuance of equity,
convertible debt or similar securities, the percentage of ownership of the
Company's shareholders will be reduced, shareholders may experience additional
dilution, and such securities may have rights or preferences senior to those
of the Common Stock. Moreover, if adequate funds were not available to satisfy
the Company's short-term or long-term capital requirements, the Company would
be required to limit its operations significantly. The Company's capital
requirements will depend on many factors, including, but not limited to, the
rate at which the Company can introduce its products, the market acceptance
and competitive position of such products, the response of competitors to the
products and the ability of the Company, its management and its products to
satisfy the licensing requirements in various jurisdictions. See "Management's
Discussion and Analysis of Financial Condition and Results of Operation--
Liquidity and Capital Resources."
10
<PAGE>
LIMITED MANUFACTURING EXPERIENCE. In order for the Company to be successful,
its products must be manufactured to meet high quality standards in commercial
quantities at competitive prices. Although the Company has produced small
quantities of prototype devices for testing, design and licensing purposes, it
has never attempted to manufacture its product in commercial quantities. The
transition to commercial manufacturing of the Company's product, either by the
Company or by a contract manufacturer, will involve various risks and
uncertainties including unforeseen costs or assembly difficulties and the
possibility that anticipated efficiencies or economies of scale will fail to
materialize. A failure by the Company to successfully manage this transition
would have a material adverse affect on the Company's business, operating
results or financial condition. See "Business--Manufacturing."
DEPENDENCE ON SINGLE-SOURCE SUPPLIERS. The Company currently obtains a
number of its system's components from single-source suppliers. There can be
no assurance that the Company would be able to procure, substitute or produce
such components in the event that these single sources were unable to supply
these components. The failure or delay by any supplier to furnish the Company
with any such components would have a material adverse effect on the Company's
business, financial condition and results of operation. See "Business--Product
Development."
SHARES ELIGIBLE FOR FUTURE SALE. Sales of substantial amounts of Common
Stock in the public market after this offering could adversely affect
prevailing market prices for the Common Stock. The 3,500,000 shares offered
hereby (other than shares purchased by "affiliates" of the Company) will be
freely tradable without restriction in the public market as of the date of
this Prospectus. Certain shareholders, including affiliates of the Company,
who together will own 7,119,638 shares of Common Stock after this offering
(representing all of the shares of Common Stock outstanding immediately prior
to this offering), have agreed not to offer or sell any Common Stock until the
expiration of 180 days following the date of this Prospectus without the prior
consent of the Company, Deutsche Morgan Grenfell/C. J. Lawrence Inc. or both.
Of these shares, approximately 3,620,524 shares will be available for
immediate sale in the public market beginning 180 days after the date of this
Prospectus, subject in some cases to the volume and other restrictions of Rule
144 or Rule 701 under the Securities Act. Shareholders of the Company also
together own 6,384,473 shares of the Company's Series A1 and Series B1
Redeemable Preferred Stock ("Nonvoting Preferred"), which is convertible into
shares of the Company's Common Stock at the rate of two shares of Common Stock
for every three shares of Nonvoting Preferred upon 75 days' prior notice and
therefore is not counted in the calculation of beneficial ownership of Common
Stock under the rules of the Securities and Exchange Commission. These shares
of Nonvoting Preferred are convertible into a total of 4,256,315 shares of
Common Stock, of which 221,110 shares would be available for immediate sale
beginning 180 days after the date of this Prospectus if such shares of
Nonvoting Preferred were converted as described above. Approximately 3,499,114
additional shares of outstanding Common Stock and 4,035,205 shares that are
issuable upon conversion of Nonvoting Preferred will become eligible for sale
following expiration of their two-year holding periods under Rule 144 or
vesting periods that may apply to restricted shares, which will expire from
January 1997 to May 2000. The holders of approximately 3,528,349 shares of
outstanding Common Stock and 4,035,205 shares that are issuable upon
conversion of Nonvoting Preferred are entitled to certain rights with respect
to the registration of such shares under the Securities Act. In addition, the
Company intends to file a registration statement under the Securities Act
approximately 90 days after the date of this Prospectus to register
approximately 1,805,278 shares of Common Stock issued or reserved for issuance
under the Company's 1994 Stock Option Plan, Employee Stock Purchase Plan and
Outside Directors Stock Purchase Plan (collectively, the "Stock Plans"). As of
May 31, 1996, there were outstanding options for the purchase of 449,667
shares, of which options for 13,542 shares were vested. All options are
immediately exercisable, but all shares issued upon exercise of unvested
options are subject to repurchase by the Company until such shares become
vested. See "Description of Capital Stock--Registration Rights" and "Shares
Eligible for Future Sale."
11
<PAGE>
NO MARKET FOR COMMON STOCK; POSSIBLE VOLATILITY OF STOCK. There has been no
public market for the Company's Common Stock prior to this offering, and there
can be no assurance that an active public market will develop or be sustained.
The initial public offering price of the Common Stock has been determined by
negotiations between the Company and the Underwriters. See "Underwriting" for
a discussion of the factors considered in determining the initial public
offering price. The public offering price of the Common Stock, however, may
not be indicative of prices that may prevail at any future time. Furthermore,
stock prices for many technology companies fluctuate widely for reasons that
may be unrelated to operating results. These fluctuations, as well as general
economic, political and market conditions, may adversely affect the market
price of the Common Stock.
CONTROL BY EXISTING SHAREHOLDERS. The Company's officers and directors and
their affiliates will, in the aggregate, beneficially own approximately 35.0%
of the Company's outstanding shares of Common Stock after this offering (33.4%
if the Underwriters' overallotment option is exercised). Certain of these
shareholders also hold shares of Nonvoting Preferred, which is convertible
into shares of Common Stock upon 75 days' notice and therefore is not included
in beneficial ownership calculations under the rules of the Securities and
Exchange Commission. Assuming conversion of all outstanding shares of such
Nonvoting Preferred, the Company's officers and directors and their affiliates
would, in the aggregate, beneficially own approximately 45.9% of the Company's
outstanding shares of Common Stock after this offering (44.3% if the
Underwriters' overallotment option is exercised). Each group will have the
ability to exert significant influence over and control the election of the
Company's Board of Directors and determine corporate actions requiring
shareholder approval. See "Principal Shareholders" and "Description of Capital
Stock."
DILUTION. Purchasers of the Common Stock offered hereby will suffer
immediate and substantial dilution in the net tangible book value of the
Common Stock from the initial public offering price. To the extent outstanding
options to purchase the Company's Common Stock are exercised, there will be
further dilution. See "Dilution."
NO DIVIDENDS. The Company has not paid any cash dividends in the past and
does not expect to do so in the foreseeable future.
12
<PAGE>
USE OF PROCEEDS
The net proceeds to the Company from this offering are estimated to be
approximately $34.6 million ($39.9 million if the Underwriters' over-allotment
option is exercised in full), assuming the shares offered hereby are sold at
an initial public offering price of $11.00 per share. The Company expects the
net proceeds of this offering to be used for the continued development,
marketing, introduction and roll-out of its gaming machine and for general
corporate purposes. A portion of the proceeds may also be used to acquire or
invest in complementary businesses or products or to obtain the right to use
complementary technologies. While from time to time the Company evaluates
potential acquisitions of such businesses, products or technologies, there are
no present understandings, commitments or agreements with respect to any
acquisition of other businesses, products or technologies. Pending such uses,
the proceeds will be invested in short-term, investment grade, interest-
bearing securities.
DIVIDEND POLICY
The Company has never paid or declared any cash dividends. It is the present
policy of the Company to retain earnings to finance the growth and development
of the business and, therefore, the Company does not anticipate paying cash
dividends on its Common Stock in the foreseeable future. The Company's Amended
and Restated Articles of Incorporation prohibit the Company from paying
dividends on the Common Stock in any fiscal year unless the holders of
Nonvoting Preferred have been paid preferential dividends in specified amounts
during such fiscal year. See "Description of Capital Stock."
13
<PAGE>
CAPITALIZATION
The following table sets forth (i) the capitalization of the Company as of
March 31, 1996, (ii) the pro forma capitalization after giving effect to the
sale of 1,542,000 shares of Series C Redeemable Preferred Stock in April and
May 1996, the subsequent conversion of 1,998,332 shares of Series A and
4,386,141 shares of Series B Redeemable Preferred Stock on a one-for-one basis
into Series A1 and Series B1 Redeemable Preferred Stock, respectively, and the
conversion upon the closing of this offering of all outstanding shares of
Redeemable Preferred Stock (other than Nonvoting Preferred) into 3,528,349
shares of Common Stock, and (iii) pro forma capitalization as adjusted to
reflect the sale of 3,500,000 shares of Common Stock offered hereby at an
assumed initial public offering price of $11.00 per share and the application
of the estimated net proceeds therefrom. The information set forth below
should be read in conjunction with the consolidated financial statements and
notes thereto and "Management's Discussion and Analysis of Financial Condition
and Results of Operations" contained elsewhere in this Prospectus.
<TABLE>
<CAPTION>
MARCH 31, 1996
------------------------------
PRO FORMA
ACTUAL PRO FORMA AS ADJUSTED
------- --------- -----------
(IN THOUSANDS)
<S> <C> <C> <C>
Cash and equivalents............................ $ 7,657 $14,866 $49,421
======= ======= =======
Current portion of capital lease
obligations(1)................................. $ 141 $ 141 $ 141
======= ======= =======
Long-term obligations less current portion(1)... $ 706 $ 706 $ 706
------- ------- -------
Redeemable convertible preferred stock, $0.001
par value, shares authorized: 20,192,802
actual; 20,417,802 pro forma; 6,884,473 pro
forma as adjusted; shares issued and
outstanding: actual, 10,134,997; pro forma and
pro forma as adjusted, 6,384,473(2)............. 15,996. 6,455 6,455
------- ------- -------
Shareholders' equity (deficiency):
Common stock, $0.001 par value, 16,666,667
shares authorized, shares issued and
outstanding: actual, 3,591,289; pro forma,
7,119,638; pro forma as adjusted,
10,619,638(3)................................ 233 16,983 51,538
Notes receivable from shareholders.............. (194) (194) (194)
Deficit accumulated during the development
stage.......................................... (8,316) (8,316) (8,316)
------- ------- -------
Total shareholders' equity (deficiency)..... (8,277) 8,473 43,028
------- ------- -------
Total capitalization...................... $ 8,425 $15,634 $50,189
======= ======= =======
</TABLE>
- --------
(1) See Note 5 of Notes to Consolidated Financial Statements.
(2) See Note 6 of Notes to Consolidated Financial Statements. Each share of
Nonvoting Preferred remaining outstanding after the closing of the
offering is convertible into 0.6667 shares of Common Stock at the option
of the holder upon 75 days' notice to the Company.
(3) Excludes 1,805,278 shares of Common Stock reserved for future issuance
under the Stock Plans, of which at May 31, 1996 there were outstanding
options to purchase 449,667 shares of Common Stock as well as warrants to
purchase 157,602 shares of Common Stock, at a combined weighted average
exercise price per share of $3.22. The Company has also agreed to issue
the Representatives' Warrants. See "Management--Executive Compensation--
Stock Plans," "Description of Capital Stock--Warrants," "Underwriting" and
Notes 5, 7 and 10 of Notes to Consolidated Financial Statements.
14
<PAGE>
DILUTION
The pro forma net tangible book value of the Company as of March 31, 1996
was $8,473,000, or $1.19 per share of Common Stock. Pro forma net tangible
book value per share represents the amount of total assets of the Company
reduced by the amount of its total liabilities and Redeemable Preferred Stock
and divided by the total number of shares of Common Stock outstanding after
giving effect to the sale of 1,542,000 shares of Series C Redeemable Preferred
Stock in April and May 1996, the subsequent conversion of 1,998,332 shares of
Series A and 4,386,141 shares of Series B Redeemable Preferred Stock on a one-
for-one basis into shares of Series A1 and Series B1 Redeemable Preferred
Stock, respectively, and the conversion of all outstanding shares of
Redeemable Preferred Stock (other than Nonvoting Preferred) into 3,528,349
shares of Common Stock upon closing of this offering. Without taking into
account any other change in such net tangible book value after March 31, 1996,
other than to give effect to the sale by the Company of 3,500,000 shares
offered hereby at an assumed initial public offering price of $11.00 per share
and receipt of the estimated net proceeds therefrom, the net tangible book
value of the Company as of March 31, 1996 would have been approximately
$43,028,000, or $4.05 per share. This represents an immediate increase in such
net tangible book value of $2.86 per share to existing shareholders and an
immediate dilution of $6.95 per share to new investors. The following table
illustrates this per share dilution:
<TABLE>
<S> <C> <C>
Assumed initial public offering price per share................... $11.00
Pro forma net tangible book value per share as of March 31,
1996........................................................... $1.19
Increase per share attributable to new investors................ 2.86
-----
Pro forma net tangible book value per share after the offering.... $ 4.05
------
Net tangible book value dilution per share to new investors....... $ 6.95
======
</TABLE>
The following table sets forth as of March 31, 1996, on a pro forma basis,
the differences between the existing shareholders and the new investors with
respect to the number of shares of Common Stock purchased from the Company,
the total consideration paid to the Company (assuming the initial public
offering price of the Common Stock offered hereby of $11.00) and the average
price per share paid:
<TABLE>
<CAPTION>
SHARES PURCHASED TOTAL CONSIDERATION AVERAGE
------------------ ------------------- PRICE PER
NUMBER PERCENT AMOUNT PERCENT SHARE
---------- ------- ----------- ------- ---------
<S> <C> <C> <C> <C> <C>
Existing shareholders.......... 7,119,638 67.0% $18,034,000 31.9% $ 2.53
New investors.................. 3,500,000 33.0% 38,500,000 68.1% $11.00
---------- ----- ----------- -----
Total........................ 10,619,638 100.0% $56,534,000 100.0%
========== ===== =========== =====
</TABLE>
The above computations assume no conversion of the outstanding Nonvoting
Preferred, which may be converted into an aggregate of 4,256,315 shares of
Common Stock at the option of the holders with 75 days' notice to the Company.
If all shares of Nonvoting Preferred outstanding as of March 31, 1996 are
converted, the net tangible book value per share immediately after completion
of the offering would be $3.33. This represents an immediate dilution in net
tangible book value of $7.67 per share to purchasers of Common Stock in this
offering. In addition, the above computations assume no exercise of options or
warrants after March 31, 1996. As of May 31, 1996, there were outstanding
options and warrants to purchase 607,270 shares of Common Stock at a weighted
average exercise price of $3.22 per share. The Company has also agreed to
issue the Representatives' Warrants. To the extent outstanding options and
warrants are exercised, there will be further dilution to new investors. See
"Capitalization," "Management--Director Compensation," "Management--Executive
Compensation--Stock Plans," "Description of Capital Stock-Warrants,"
"Underwriting" and Notes 5, 7 and 10 of Notes to Consolidated Financial
Statements.
15
<PAGE>
SELECTED CONSOLIDATED FINANCIAL DATA
(In thousands, except per share amounts)
The selected consolidated financial data presented below as of March 31,
1995, and December 31, 1995, and for the period from inception (July 27, 1993)
through March 31, 1994, the year ended March 31, 1995, and the nine-month
period ended December 31, 1995, are derived from the audited consolidated
financial statements of the Company included elsewhere in this Prospectus. The
selected consolidated financial data as of March 31, 1994, has been derived
from audited consolidated financial statements that are not included herein.
The selected consolidated financial data as of March 31, 1996, and for the
three-month periods ended June 30, 1995, and March 31, 1996, and cumulative,
are unaudited but have been prepared on the same basis as the audited
financial data and in the opinion of management, contain all adjustments,
consisting only of normal recurring accruals, necessary for a fair
presentation of the results of operations for such periods. The results of
operations for the three months ended March 31, 1996, are not necessarily
indicative of results to be expected for the full fiscal year. The data should
be read in conjunction with management's discussion and analysis of financial
condition and statements of operations, the consolidated financial statements,
related notes and other financial information included elsewhere in this
Prospectus.
<TABLE>
<CAPTION>
PERIOD FROM CUMULATIVE
INCEPTION YEAR NINE MONTHS THREE MONTHS ENDED FROM INCEPTION
(JULY 27, 1993) ENDED ENDED ------------------ (JULY 27, 1993)
THROUGH MARCH 31, DECEMBER 31, JUNE 30, MARCH 31, THROUGH
MARCH 31, 1994 1995 1995(1) 1995 1996 MARCH 31, 1996
--------------- --------- ------------ -------- --------- ---------------
<S> <C> <C> <C> <C> <C> <C>
STATEMENT OF OPERATIONS
DATA:
Operating Expenses:
Research and
development............ $ 79 $ 1,539 $ 3,137 $ 584 $ 1,595 $ 6,350
Selling, general and
administrative......... 61 312 922 168 742 2,037
----- ------- ------- ------ ------- -------
Loss from operations.... (140) (1,851) (4,059) (752) (2,337) (8,387)
Interest income
(expense).............. -- (15) 85 17 1 71
----- ------- ------- ------ ------- -------
Net loss................ $(140) $(1,866) $(3,974) $ (735) $(2,336) $(8,316)
===== ======= ======= ====== ======= =======
Pro forma net loss per
share(2)............... $ (0.50) $(0.10) $ (0.27)
======= ====== =======
Shares used in
computation............ 8,023 7,667 8,803
======= ====== =======
</TABLE>
<TABLE>
<CAPTION>
MARCH 31, 1996
------------------------------
PRO FORMA
MARCH 31, MARCH 31, DECEMBER 31, PRO AS
1994 1995 1995(1) ACTUAL FORMA(3) ADJUSTED(4)
--------- --------- ------------ ------- -------- -----------
<S> <C> <C> <C> <C> <C> <C>
BALANCE SHEET DATA:
Cash and equivalents.... $ 36 $ 241 $ 2,399 $ 7,657 $14,866 $49,421
Working capital
(deficiency)........... (169) (1,253) 2,027 7,154 14,363 48,918
Total assets............ 67 486 3,486 9,130 16,339 50,894
Long-term debt.......... -- -- 272 706 706 706
Redeemable convertible
preferred stock........ -- 967 8,496 15,996 6,455 6,455
Deficit accumulated
during the development
stage.................. (140) (2,006) (5,980) (8,316) (8,316) (8,316)
Total shareholders'
equity (deficiency).... (138) (2,003) (5,946) (8,277) 8,473 43,028
</TABLE>
- -------
(1) Effective April 1, 1995, the Company changed its fiscal year end from
March 31 to December 31.
(2) See Note 1 of Notes to Consolidated Financial Statements for an
explanation of the method used to determine the number of shares used in
the computation of pro forma net loss per share.
(3) The pro forma balance sheet data gives effect to the April and May 1996
sales of 1,542,000 shares of Series C Redeemable Preferred Stock, the
subsequent conversion of 1,998,332 shares of Series A and 4,386,141 shares
of Series B Redeemable Preferred Stock on a one-for-one basis into Series
A1 and Series B1 Redeemable Preferred Stock, respectively, and the
conversion upon completion of the offering of all outstanding shares of
Redeemable Preferred Stock, other than Nonvoting Preferred, into 3,528,349
shares of Common Stock.
(4) The pro forma as adjusted balance sheet takes into account the pro forma
adjustments described in footnote 3 above as adjusted to reflect the sale
of 3,500,000 shares of Common Stock at an assumed offering price of $11.00
per share, less estimated underwriting discount and offering expenses.
16
<PAGE>
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF
OPERATIONS
OVERVIEW
The Company was incorporated on July 27, 1993 to design, develop,
manufacture, distribute, and market interactive gaming devices that implement
advanced multimedia technologies using state-of-the art off-the-shelf
components. Since its formation, the Company has been in the development
stage, and its principal activities have consisted of assembling a technical,
marketing and executive staff, developing its gaming platform, raising
capital, and initiating applications for regulatory approvals in Nevada and
other jurisdictions to manufacture, distribute and sell its gaming devices. To
date, the Company has generated no revenue and has had negative cash flow.
Effective April 1, 1995, the Company changed its fiscal year end from March
31 to December 31. Accordingly, the period ended December 31, 1995 is a nine-
month period.
The Company expects its first commercial product to be submitted for
licensing approval and approved for shipment in one or more jurisdictions in
late 1996. Subject to such approval, the Company expects to commence
production of commercial products and customer product evaluations in the
fourth quarter of 1996, although the Company does not expect to generate
revenue from such activities in 1996. As is industry practice, gaming devices
are typically installed on a trial basis on casino floors for a period of 30
to 90 days before a sales decision by the customer. In 1997, the Company
intends to transition from the development stage. Future revenue, profits, and
cash flows will depend on market acceptance of the Company's products, the
ability of such products to generate higher revenues for casinos as compared
to competitive products, and the technical performance of the Company's
products. Additionally, among other things, the Company must continue to
attract, retain and motivate qualified personnel and meet all the initial and
ongoing licensing requirements in key jurisdictions. See "Risk Factors."
RESULTS OF OPERATIONS
The Company is in the development stage and has not generated any revenue to
date. As of March 31, 1996, the Company had net losses since inception of
$8,316,000. To date, the Company has focused its resources on product
development, including system hardware and software, and game concept
development and software coding. The Company expects to complete development
of the initial version of its gaming device and begin production in the third
quarter of 1996. In addition to continuing and increasing expenditures in
research and development, the Company will need to incur significant expenses
and other costs associated with manufacturing. In 1996, units will be
manufactured solely for testing and engineering, continued game development,
licensing approval, regulatory field trials and customer evaluations. The
Company does not expect any product sales in 1996 and therefore expects to
generate no revenue in 1996.
Amounts from inception (July 27, 1993) through March 31, 1994, the year
ended March 31, 1995, the nine month period ended December 31, 1995, and the
three month periods ended June 30, 1995 and March 31, 1996 may not be
comparable due to the different duration of the periods and the Company's
change in fiscal year. The Company believes that operating expenses will
increase in the future as the Company continues to develop its product and
emerges from the development stage to begin commercial operations, including
manufacturing, marketing and sales.
RESEARCH AND DEVELOPMENT
Research and development ("R&D") expenses include payroll and related costs
of employees engaged in ongoing design and development activities, fees to
outside contractors, prototype development expenses, overhead costs, equipment
depreciation and supplies. To date, the Company
17
<PAGE>
has expensed all costs associated with the research, design and development of
its products. See Note 1 of Notes to Consolidated Financial Statements. R&D
expenses were $79,000, $1,539,000, $3,137,000 and $1,595,000 for the period
from inception through March 31, 1994, the year ended March 31, 1995, the nine
month period ended December 31, 1995, and the three month period ended March
31, 1996, respectively. Increases over the periods have resulted from the
incremental hiring of personnel, increased usage of engineering consultants
and fees to acquire outside technologies. The Company believes that a
significant level of R&D expenses is required due to the technical nature of
the product and the elaborate requirements of the game development process.
Accordingly, the Company anticipates devoting substantial resources, including
additional personnel, to R&D and that these costs will continue to increase in
absolute dollars in future periods.
SELLING, GENERAL AND ADMINISTRATIVE
Selling, general and administrative ("SG&A") expenses include payroll and
related costs for administrative and executive personnel, overhead costs,
legal and associated costs, corporate and product licensing costs in various
jurisdictions and fees for professional services. SG&A expenses were $61,000,
$312,000, $922,000 and $742,000 for the period from inception through March
31, 1994, the year ended March 31, 1995, the nine month period ended December
31, 1995, and the three month period ended March 31, 1996, respectively.
Increases over the periods result from the incremental hiring of personnel and
expenses associated with applying for corporate and product licensing in
various jurisdictions. SG&A expenses are expected to increase substantially in
absolute dollars as the Company invests in sales and marketing activities to
launch its products and in administrative personnel to support its growing
infrastructure and comply with regulatory requirements.
INCOME TAXES
As of March 31, 1996, the Company had net operating loss carryforwards of
approximately $8,100,000 for federal purposes and $1,700,000 for state
purposes. These loss carryforwards will expire beginning in 2000, if not
utilized. The Company also has R&D credit carryforwards of approximately
$100,000 for federal purposes and $50,000 for state purposes as of March 31,
1996, which expire beginning in 2000. A valuation allowance has been recorded
for these deferred tax assets as a result of uncertainties regarding the
realization of these assets due to the lack of earnings history of the
Company. Due to changes in ownership, as defined by Section 382 of the
Internal Revenue Code, resulting from the sale of Series B and Series C
Redeemable Preferred Stock and the Common Stock offered hereby, the annual
deductibility of a substantial portion of the federal net operating loss and
tax carryforwards will be limited. See Note 8 of Notes to Consolidated
Financial Statements.
LIQUIDITY AND CAPITAL RESOURCES
To date, the Company has financed its operations primarily through the
private placements of Redeemable Preferred Stock and loans from shareholders
which were subsequently converted to Redeemable Preferred Stock. As of March
31, 1996, the amounts raised in the private placements of Redeemable Preferred
Stock, net of issuance costs, totaled approximately $16.0 million. As of
March 31, 1996, the Company had $7.7 million of cash on hand to fund
operations. In addition, the Company raised $7.2 million, net of issuance
costs, through additional sales of Redeemable Preferred Stock in April and May
1996. See Note 10 of Notes to Consolidated Financial Statements. Adjusted for
these sales as of March 31, 1996, the Company's pro forma cash on hand would
have been $14.9 million.
The Company's operating activities used cash of $75,000, $1,696,000,
$3,731,000 and $2,145,000 for the period from inception through March 31,
1994, the year ended March 31, 1995, the nine-month period ended December 31,
1995 and the three-month period ended March 31, 1996, respectively. Cash used
in operating activities primarily reflected net losses, partially offset by
depreciation and amortization and changes to working capital.
18
<PAGE>
From inception through March 31, 1996, the Company has acquired a total of
approximately $1.5 million in fixed assets, primarily computer equipment. The
Company has a $1.0 million lease line to finance the acquisition of fixed
assets, which has been fully drawn upon as of the date of this offering.
The Company believes that its cash on hand, together with the net proceeds
from this offering will be sufficient to meet its anticipated cash needs for
working capital, capital expenditures and business expansion through the
middle of 1998. However, the Company may need to raise additional funds to
finance more rapid expansion, to develop its products, to respond to
competitive pressures or to acquire complementary products, businesses or
technologies. No assurance can be given that additional financing will be
available or that, if available, it will be available on terms acceptable to
the Company or its shareholders. If adequate funds are not available to
satisfy either the short-term or long-term capital requirements, the Company
may be required to limit its operations significantly. The Company's capital
requirements will depend on many factors, including, but not limited to, the
rate at which the Company can introduce its products, the market acceptance
and competitive position of such products, the response of competitors to the
Company's products, and the ability of the Company to satisfy the
jurisdictional licensing requirements for its officers, directors and
products. See "Risk Factors."
19
<PAGE>
BUSINESS
The Company is engaged in the design and development of what it believes
will be the next generation of interactive slot machines for use in casinos
and other gaming establishments. The Company's product combines an advanced
multimedia gaming platform with software-based games that the Company believes
will be more engaging and entertaining than other gaming devices currently
available and will, as a result, generate increased win per machine for the
casino operator. The Company has manufactured several fully functioning
prototypes and has applied for licensing in Nevada and other jurisdictions,
and, if approved, expects to be able to ship its first product for commercial
trial in late 1996. As of July 3, 1996 the Company has received nonbinding
commitments to install and evaluate its gaming platform from Bally's Las
Vegas, Boulder Station Hotel and Casino, Caesars Palace Las Vegas, Circus
Circus Hotel & Casino, Excalibur Hotel Casino, the Flamingo Hilton, Grand
Casino Biloxi, Grand Casino Gulfport, Grand Casino Tunica, Hard Rock Hotel &
Casino, Harrah's Las Vegas, ITT Sheraton Desert Inn, ITT Sheraton Tunica,
Luxor Hotel Casino, MGM Grand Hotel/Casino, New York-New York Hotel/Casino,
Palace Station Hotel & Casino, Station Casino Kansas City, St. Charles
Riverfront Station, Stratosphere Hotel & Casino and Texas Station, each of
which has agreed to install and evaluate from eight to 30 of the Company's
machines. Collectively, these casinos have agreed to install approximately 400
units.
The Company's gaming platform features high resolution video presented
across the full surface of a large touchscreen display. The games feature high
quality animation, video clips, digital sound and a level of visual appeal and
interactivity that the Company believes is unattainable by the current
generation of slot machines. The Company is attempting to maximize the
entertainment value offered by the two-dimensional surface of the video screen
by providing multiple levels of achievement within the same game, so that,
through successful play over a period of time, a player may advance to a
bonusing sequence and win additional jackpots. Utilizing these features, SGI
believes that its products will encourage longer and more frequent periods of
play by existing slot machine customers and attract new gaming customers who
are seeking greater entertainment value than that offered by the current
generation of slot machines. In addition, the Company has designed its
machines with a number of features, such as play stoppage entertainment,
modular components and the Company's Machine Management System software, which
provides easy-to-use diagnostics designed to minimize player inconvenience and
machine down-time.
INDUSTRY BACKGROUND
The U.S. gaming machine market is currently dominated by reel-based slot
machines, which were broadly introduced in the 1960s, when the free-spinning
reel was made possible by advances in electro-mechanical circuitry. The free-
spinning reel enabled manufacturers to create different versions of the same
product by varying such things as the number of reels, the number of stops on
each reel and the number and variety of payoff combinations. The 1980s saw the
introduction of "stepper" technology which allowed for a greater number of
physical stops, or outcomes, on a reel, enabling casino operators to offer
larger jackpots due to the lower likelihood of their being hit. Another
significant development was the installation of electronic memory in machines,
allowing players to keep an "account" of credits on the machine consisting of
initial money inserted plus winnings minus losses. Since the player did not
have to reinsert coins for every pull of the handle, the number of pulls per
hour was increased significantly, and players tended to rewager much of the
amounts won, raising the total win per machine. Except for the addition of
features such as bill acceptors and player tracking systems, the technology
employed by slot machines in the 1970s and 1980s still predominates in
current-generation machines.
In the 1980s, hardware and software advances allowed for application of
video graphics to gaming devices. Using these techniques, IGT was the first
company to introduce video poker. Video poker offers slot players two
important advantages. First, the game is interactive, since the player has to
decide which cards to hold or discard during the hand. This feature allows the
outcome to be influenced somewhat by the player, an attribute unavailable on
reel-based machines. Second, the use
20
<PAGE>
of a video screen allows machine manufacturers to develop more interesting and
attractive graphics than are available on reel-based slot machines. Recently,
Bally Gaming International, Inc. ("Bally Gaming") expanded the capabilities of
video-based devices when it introduced Game Maker, a popular video-based
machine which offers the player a choice of up to ten different games on a
single machine. The Company believes that the popularity of video poker and
multi-game machines suggests that customers may be receptive to a more complex
and interactive slot experience.
In the late 1980s, a category of slot machine games called "progressives"
was introduced and became very popular. The progressive configuration
generally consists of traditional reel-based machines linked together by a
computer network that allows them to share a common jackpot which is usually
much larger than the jackpot that a single, unlinked machine could support.
Progressive jackpots are usually several million dollars, and have
occasionally exceeded $10 million. Progressives may be linked locally within a
bank of a few machines, across an entire casino, or, across an entire state.
IGT is the dominant competitor in the progressives market. In Nevada, as of
September 30, 1995, IGT's eight progressive systems collectively linked
approximately 4,700 gaming machines through wide area networks.
Slot machines, video gaming machines and similar devices are the dominant
source of gaming revenue for casino operators in most U.S. gaming markets.
Slot revenue as a percentage of total gaming revenue in 1995 was 56.3% in
Nevada and 70.6% in Atlantic City. Jurisdictions where gaming has recently
been legalized have reported similar statistics. For example, in 1995, slot
machines accounted for 72.7% of casino revenue in Illinois, 66.4% in Louisiana
and 77.2% in Iowa. In addition to constituting the largest portion of gaming
revenue, slot revenue is more profitable for casino operators, since slot
machines require much lower labor costs than table games.
All casino games offer the same underlying proposition: the opportunity to
win money in varying amounts and with varying frequency, but with the
statistical certainty of losing money to the casino operator over an extended
period of time. With slot machines, the prospect of winning can be varied
across the spectrum from many small jackpots won frequently to one very large
jackpot won very rarely. Players' risk/reward appetites will determine what
type of machine they will want to play, and the nature of the payoffs can be
deduced from the "pay table," a chart which graphically shows how much can be
won based on various outcomes and various amounts of money wagered.
Notwithstanding the differences in jackpot frequency and size, however, all
slot machines retain a net amount of the money wagered through them over time.
This amount is referred to as the "hold" and is generally expressed as a
percentage of the amount of money inserted into the machine, which is called
the "handle." The hold percentage in any given machine is preset by the
manufacturer based on specifications from the casino, and subject to legal
parameters in some jurisdictions, and may differ from machine to machine on a
casino floor.
The return on an investment in slot machines is relatively high. In January
1996, the average win per machine per day on the Las Vegas Strip was $101. A
new slot machine from a major manufacturer, equipped with player tracking and
slot accounting software, costs approximately $8,000 and generally has a
useful life exceeding five years. At this price, a new slot machine earning
the Las Vegas Strip average would recoup its purchase price in 80 days. While
certain markets have lower average wins per day than the Las Vegas Strip, many
other markets have win per day figures that are significantly higher. For
example, in January 1996, the Trump Taj Mahal casino in Atlantic City reported
win per machine per day of $151, Foxwoods Hotel and Casino in Ledyard,
Connecticut reported win per machine per day of $359, and Harrah's riverboat
casino in Joliet, Illinois reported win per machine per day of $411.
Because of the importance of slot win to casino operators and the high
returns available from an investment in slot machines, the Company believes
that casino operators are willing to try new slot machine products that offer
the prospect of higher win per machine per day. At the same time, operators
are motivated to remove any machines that are performing significantly below
expectations.
21
<PAGE>
SGI believes that its machines will generate win per machine per day that will
exceed that of the average installed machine, and therefore believes that it
will be able to penetrate the market, generate orders for its machines and
maintain a share of casino floor space. However, there can be no assurance
that SGI's machines will generate such additional win per machine per day.
Growth in demand for slot machines has historically been driven by the
opening of new casinos, including casinos in jurisdictions where gaming has
recently been legalized. Since the prospect of new jurisdictions legalizing
gaming has been significantly reduced, demand based on new openings will be
largely limited to new projects in existing markets. Several new projects are
under construction or have been announced in Las Vegas, Atlantic City, on the
Gulf Coast and in the Midwest.
While the physical useful life of a slot machine can be up to a decade or
more, casino operators have tended to replace machines on a cycle closer to
every five years. Also, the development of certain new features which offer
the prospect of significantly increased slot earnings, such as the advent of
bill acceptors in the 1990s, can encourage operators to replace machines even
more rapidly.
Because of the slowing in demand from new casino projects, and because the
large number of machines installed during the high growth period will be soon
reaching their normal replacement time, the Company believes that the new slot
machine sales in the replacement category will surpass gaming machine sales
for new installations in the near future. The Company believes that it will
more easily penetrate the replacement segment of the slot machine market,
since the operators of a newly-opening casino may be less likely to risk
overall success on the trial of a relatively unproven product.
The market for slot machines outside of North America is relatively small,
with the exception of Australia, and is generally difficult to forecast. In
addition, international markets have often served as an outlet for used
machines. While SGI intends to take advantage of certain opportunities in
international markets, the Company intends to pursue these markets only after
successfully establishing itself in North America.
STRATEGY
Although the gaming industry has enjoyed significant growth over the past
five years, the Company believes that most of the investment over this period
has been made in physical assets such as large hotels and themed attractions,
and that comparatively little has been invested in further developing the
actual casino games which, in the aggregate, account for a majority of the
average casino's revenue. In contrast, the Company has focused its resources
primarily on developing what it believes will be the next generation of
interactive slot machines and on implementing its strategy of providing a
gaming platform that offers slot machine players a more entertaining and
engaging experience than is available from current gaming machines. The
Company believes that its machines will encourage casino patrons to play more
frequently and for longer periods of time and will also attract new gaming
customers, particularly younger patrons who typically are not attracted to
current generation slot machines. The Company believes that, as a result, its
machines will outperform most existing machines in win per machine and thus
motivate casino operators to supplement or replace existing slot machines with
SGI products.
SGI PARADIGM
The Company believes it has identified an underlying structure to the
typical slot play session, consisting of four distinct phases: initial
attraction; initial play; extended play; and completion. During each of these
phases, certain factors determine whether the player advances from one phase
to the next. SGI has sought to understand these four phases so that (1) it can
maximize the likelihood that a slot customer will play its machine, (2) once
playing, the player will stay at the machine for a long period of time, and
(3) the player will return frequently to play the same or similar SGI
machines.
Initial Attraction. The Company believes that the factors that determine
whether a customer will initiate play include the machine's visual appeal,
the payout structure, promotional graphics and other external attributes
that convey the impression that the machine would be entertaining to play.
22
<PAGE>
Initial Play. Once play commences, the customer makes an initial decision
about whether to continue. The Company believes that the factors that
affect this decision include whether the game meets the customer's
entertainment expectations, conforms to his or her payout expectations, is
easy to understand and play, and is relatively trouble-free.
Extended Play. Extended play occurs when the player has become fully
engaged in the entertainment experience provided by the game. Because
extended play eliminates idle machine time, extended play is strongly
desired by casino operators. Once the player commits to extended play, any
interruption in play, such as a fill, malfunction or reset for change
service, becomes an excuse to end the session.
Completion. Completion is the final phase of the play session and can
occur, for example, when the customer runs out of money, runs out of time,
or achieves a targeted jackpot level. As part of the completion phase, a
customer may also form the desire to play the same machine at a later time
based on a number of factors, including winnings and entertainment value.
PRODUCTS
The Company has developed a product that it believes represents the next
generation of interactive gaming devices for use in casinos and other gaming
establishments in the United States and worldwide. The Company has built
several prototypes of its product, which utilizes multimedia technologies to
present casino games that the Company believes will be more engaging and
entertaining than other gaming devices currently available. The Company's
games feature high-resolution video presented across the full surface of a
large touchscreen display. The games feature high quality animation, video
clips, digital sound and a level of game attractiveness and interaction that
the Company believes is unavailable from and unachievable by current
generation slot machines. Unlike traditional "hardware dominant" slot
machines, the principal features of each of SGI's proprietary games are
software based, allowing SGI and its customers to adapt their game offerings
to evolving technologies and changing consumer tastes without structural
change to, or replacement of, the gaming platform.
PLATFORM, HARDWARE AND OTHER PHYSICAL ATTRIBUTES
SGI's gaming platform is designed to resemble a traditional slot machine in
many respects. The machine occupies the same footprint as a traditional slot
machine and is of roughly the same general size and shape, enabling casino
operators to replace traditional slot machines with SGI's machines without any
reconfiguration of the casino floor. The most distinctive attribute of the
product is its vertically oriented 26-inch-diagonal touchscreen video monitor.
A player's sense of interactivity is heightened by the ability to make all the
required decisions on the screen, within the game itself. For players who are
uncomfortable or unfamiliar with touchscreen devices, all of the traditional
slot machine controls have been included as well. Thus, a player can control
the game by using the touchscreen, by pushing a series of buttons similar to
those found on current slot or video poker machines, or by pulling a handle as
on traditional slot machines. Coin handling mechanisms, bill acceptors, card
readers and other devices related to cash deposit, credit and win payout are
similar to those used in current gaming machines. The music, voice and other
audible features of the Company's games are played on a digital sound system.
The principal electronic hardware used in SGI's gaming platform consists of
high-end multimedia and PC components. The central processing unit is an Intel
133-mhz Pentium chip. This processor is accompanied by a variety of video and
auxiliary controllers, some of which have been developed exclusively for use
with the Company's products. In order to enhance the speed and quality of
real-time activities, the Company's machine uses 32 megabytes of random access
memory. The density and complexity of the software controlling the machine
requires a high capacity 4-gigabyte hard disk drive. These components are
connected internally by a high speed PCI bus. SGI's reliance on sophisticated
23
<PAGE>
full motion video and high quality audio presentations requires the use of
state-of-the-art technology, and SGI expects to upgrade the performance of its
platform periodically as higher performance components become available. SGI
machines are intended to be easily reconfigurable in the field through the
replacement of hardware components such as microprocessors and video and
auxiliary controllers, allowing casino operators to upgrade hardware in a cost
effective manner.
The Company's gaming platform is assembled almost entirely from off-the-
shelf hardware, which the Company anticipates will reduce the chance of a
parts shortage and will enable the Company to continue to manufacture its
devices using state-of-the-art components as PC and multimedia technology
advance. There can be no assurance, however, that the Company will continue to
enjoy a reliable supply of hardware components. Moreover, certain components
such as the touchscreen display are manufactured by a single source and may be
particularly susceptible to interruptions in supply. See "Risk Factors--
Dependence on Single-Source Suppliers." Although SGI has developed two
proprietary application-specific integrated circuits in order to meet certain
specialized requirements of its platform, the Company does not expect to
develop computer hardware components as a regular part of its product
development process.
SGI's machines have been designed to accept future hardware upgrades that
will take advantage of networking capabilities. When networked, two or more
machines can be linked, facilitating activities such as group play,
tournaments and progressives. For example, a particular group of platforms can
be configured to announce to players that a tournament will begin at a
particular time and allow each player to opt in. Similarly, platforms can be
configured so that when one machine hits a jackpot, a player at another
machine can win a bonus award; the two affected platforms then display a
coordinated audio/video simulation of a coin flying out of one tray and into
the other. The Company believes that features of this kind will promote
interaction among players at adjacent platforms and thereby maintain player
interest for longer periods of time.
SGI has incorporated numerous features into its gaming platform that are
designed both to attract the player and to maintain his or her interest over
an extended period of time. For example, SGI's gaming platform can be
programmed to allow for a free spin following a specified number of
unsuccessful attempts in order to ensure a minimum level of reward to the
player. Similarly, SGI's machines are capable of running promotional or
entertainment video programs during play stoppages such as those caused by a
hopper refill, malfunction or request for change. These features have been
designed to reduce the likelihood that a player will leave the machine during
a play stoppage event. This feature may also provide an additional revenue or
promotional source to the operator by providing a medium for commercial
messages.
SGI's gaming platform employs modular construction at almost every level,
facilitating upgrades and minimizing machine down-time. Such modularity
permits the rapid exchange of components as a part of a regular maintenance
program, to upgrade integrated circuit components, or to replace defective
parts. Using SGI's proprietary Machine Management System, casino personnel can
run a variety of diagnostic programs or review detailed performance data
directly from the gaming platform itself. In the case of a malfunctioning
component, a casino technician can quickly restore play simply by swapping out
the failed component with a new one. The modularity of SGI's platform will
also facilitate upgrades of hardware components such as card readers and bill
validators as new components become available. The Company believes that these
features may allow casino operators to reduce platform down-time and shorten
the time required to fix any malfunction, thereby increasing the time the
platform is available for play and reducing the risk that a player will elect
to terminate a gaming session as a result of play stoppage.
To address the desire of slot machine operators to respond efficiently to
service calls that cause stoppages in play, SGI's slot machine incorporates
what SGI believes to be a significant improvement
24
<PAGE>
over the traditional "candle" (the light on the top of a slot machine). SGI's
multi-state candle uses variable color and strobe rate displays to convey more
information than a simple call for help. Different colors signify different
repair stages, and changes in strobe rate signify how long the customer has
been waiting, features that the Company believes will assist the casino floor
staff in prioritizing response to customer needs.
GAMES AND OTHER SOFTWARE
While SGI believes that the design of its machine and its hardware
components are important to its operation and its ability to foster initial
and extended play, it believes that the most important factor affecting the
success of its platform will be the games themselves and the software that
controls those games. The majority of the Company's development efforts to
date have been devoted to hardware, system software and game development, and
the Company expects that, in the future, game development will be its
principal development activity.
The SGI machine will be a multi-game platform. The Company expects that the
initial release of its product will include: six gaming options consisting of
four separate game themes and two percentaging-based variations of such
themes; play stoppage entertainment; and the Machine Management System. The
Company intends to develop at least six new games per year beginning in 1997.
See "Product Development."
The Company's games have been designed to present traditional casino games
with the benefit of video and audio enhancements that are afforded by the
Company's use of high-end multimedia hardware. While the underlying game may
consist of a traditional casino game such as roulette, poker, blackjack, keno
or a reel-based slot machine, the game itself is only one aspect of the
entertainment experience. SGI's product embeds such games in an engaging and
entertaining story. For example, Fort Knox, SGI's basic three-reel slot game,
places the experience in the context of a player trying to gain access to Fort
Knox, with payouts being depicted as disbursements from a secure vault.
The Company believes that the combination of its attractive machine, high-
level graphics and sound, bonusing features and the pursuit of an interesting
and entertaining story will make SGI's product outperform conventional slot
machines at each of the four phases of slot machine play--initial attraction,
initial play, extended play and completion.
Initial Attraction. The Company believes that the physical appearance of
its machines will be more attractive than conventional machines and will
entice customers to play. In addition to the physical attributes of its
machines, the Company has included a suite of video images that run when
the machine is not being played. These include short vignettes from the
Company's games, as well as a menu page identifying all of the games
available on that particular machine. Information regarding any game can be
viewed through the push of a "?" sign under each game icon. These
information segments feature the same quality of graphics, sound, video and
animation that distinguish all of SGI's games.
Initial Play. In the initial play period, SGI believes it is necessary to
quickly engage the customer in the story line and to avoid any confusion,
unfamiliarity or negative experiences which might cause the customer to
discontinue play. For this reason, the Company intends to produce an
initial suite of games that consist of enhanced versions of traditional
casino games, including reel-based slot games, so that the rules of the
game will be well known. SGI intends to present these games using enhanced
graphics, sound and storyline that will enhance the play experience, but
will not change the fundamental characteristics or objective of the game.
In addition, the machine will offer traditional game controls for those
players unfamiliar or uncomfortable with the touchscreen interface.
25
<PAGE>
Extended Play. The Company believes that the enhancements it has made to
traditional casino games by the addition of high level graphics, sound,
animation and story line will encourage extended play, as well as more
frequent play, and thereby generate greater win per machine than the
unenhanced versions of these games available in conventional machines.
A significant feature of SGI's games, which the Company believes will
contribute significantly to extended play, is the introduction of advanced
play levels in which a player, by virtue of having played a certain amount
of time or achieved a certain number of jackpots at one level, gains access
to a bonus sequence in which larger jackpots become available. In Fort
Knox, for example, a 10-digit master combination to the main vault appears
in the play field. At random time intervals during play, another digit on
the main vault lock is matched. When the main vault is opened, a player may
select from one of three vault drawers to receive an additional bonus.
To facilitate extended play, the Company has developed sophisticated on
line tutorial and help features and play stoppage entertainment. The
tutorial and help features generally consist of video inserts designed to
provide orientation, instruction and assistance before or during the game.
In Fort Knox, for example, Seymour Bucks, the main security guard at Fort
Knox, can appear on demand throughout the game to explain the game and to
provide assistance. If there is a machine malfunction or a call for change
or a machine fill, Professor Jack Potts, the absent-minded slot genius,
will appear to explain the cause of the malfunction and present video clips
advertising the casino's amenities or upcoming promotions and tournaments,
or other commercial material.
Completion. The Company believes that the principal events that lead to
completion of play include the player's running out of money, running out
of time or achieving a targeted jackpot level. The Company believes that
the unique features and entertainment value of its games will entice
players to remain in the extended play phase for longer periods of time
than are generally fostered by current generation slot machines. Moreover,
the design of the Company's platform and games is intended to provide an
entertainment experience that will encourage repeated play.
In addition to features that are designed to enhance the entertainment value
of SGI's machine and its ability to generate incremental revenues for the
casino, SGI's platform incorporates proprietary features that are designed to
overcome certain hurdles that may be involved in the licensing of a slot
machine design, as well as to facilitate easy maintenance and supervision by
casino personnel. See "Proprietary Rights and Licenses" and "Gaming Regulation
and Licensing." These features are as follows:
Random Number Generator. At the core of every gaming machine is a random
number generator which determines the outcome of every gaming proposition.
To eliminate what the Company believes are some of the impediments to
randomness that characterize random number generators, SGI engaged Dr.
Evangelos Yfantis, a recognized authority in the field of random number
algorithms, to develop a proprietary random number generator algorithm for
the Company. The Company has filed a U.S. patent application with respect
to its algorithm.
Software Authentication. A critical element of all gaming machines is an
authentication mechanism to determine that the software being used is
identical to the software that has been approved by regulatory authorities
and is operating correctly. This is necessary to ensure that the game being
played corresponds exactly to that designed by the manufacturer and
approved by regulatory authorities. Traditional slot machine authentication
programs operate only following substantial payouts or at periodic
intervals. Software-based games, including those designed by the Company,
require a different authentication process due to their increased
susceptibility to tampering. The Company has developed a proprietary
authentication process that verifies the integrity of a game each time it
is selected for play. This process combines sophisticated
26
<PAGE>
authentication routines developed by RSA Data Security, Inc. with a
proprietary methodology developed by the Company. The Company has filed for
patent protection for certain aspects of its authentication methodology.
Machine Management System. The Company's Machine Management System is
designed to be a user-friendly maintenance and troubleshooting system that
allows casino floor personnel to quickly and effectively assess the cause
of a play stoppage or other malfunctions or to examine transaction history
where the validity of a jackpot or other transaction must be verified. For
example, if a player asserts that the machine has not given full credit for
a jackpot or has not properly recorded a cash input, a floor manager, using
the touchscreen and a key, can access comprehensive data to review
transaction and event history. With this information, the floor manager can
rapidly evaluate the merit of the player's claim and take appropriate
action. In this way, disputes can be quickly resolved at the machine's
location, without the operator having to consult back office records or
review surveillance videotape.
PRODUCT DEVELOPMENT
The Company's product development efforts, particularly its game development
efforts, will be critical to its success in the gaming market. Research and
development expenses have increased significantly since inception and are
expected to continue to increase in the future. See "Management's Discussion
and Analysis of Financial Condition and Results of Operation." At May 15,
1996, 36 of the Company's 60 full-time employees were engaged in research and
development. The Company expects the number of research and development
personnel to increase to approximately 45 by the end of 1996.
Ideas for new games are derived from customer needs as perceived by the
Company or as ascertained through the Company's market research and direct
feedback from casino slot machine operators. The initial designs for the
Company's games are conceived by a four-person design team, which outlines the
appearance and features of each game. A prototype is developed by a production
team that includes a producer, artists, computer graphics engineers and
entertainment software engineers. The game is then evaluated by SGI's
marketing and sales staff, after which it is modified into its final form. The
Company estimates that the development of a typical game takes approximately
six to eight weeks and costs approximately $200,000 to $300,000.
SGI is seeking to develop a variety of specific games which management
believes will appeal to casino operators and their customers. Currently, the
Company is engaged in the development of games based on traditional slot
machine games such as animated reel slots and video poker. The Company is also
in the process of creating slot machine versions of popular casino games such
as blackjack, roulette and keno. These initial products are intended to help
customers look beyond the unfamiliar technology to recognizable game types. In
addition, the Company is developing a line of Magic WindowsTM type games. The
proprietary Magic WindowsTM game type introduces decision making into a
traditional reel-slot experience by allowing the player to select from a
number of available symbols.
Some of the games that the Company currently has under development or near
completion includes the following:
Fort Knox--A variation on the traditional three-reel slot game in which
the player enters the main vault room of Fort Knox and spins the giant
combination reels. If the symbols match those on the play table, a series
of vault doors swing open, spilling coins into the tray. If the player
matches the numbers to the bonus combination, he will be given access to
the main vault's interior, where he can win an additional jackpot.
Buccaneer Gold--A three-reel slot machine game in which the player aims
his cannons at three combination wheels set in the flank of a pirate ship.
When symbols on the wheels are matched according to the pay table, the
player wins, and the screen displays a jackpot celebration such as gold
coins being spilled from a treasure chest or fired from a musket. Upon
certain
27
<PAGE>
combinations on the reel, a pirate sticks a dagger into the deck railing;
an accumulation of five daggers leads to a bonusing sequence.
Phantom Belle--A game of draw poker played on a 19th century riverboat.
In addition to regular play, the game offers a bonusing feature consisting
of a stack of chips that grows with each hand played. When the player is
dealt a special "playoff" card, a bonus round ensues in which the player
can win the entire stack of chips by beating one of the riverboat's
"regulars" in a one-hand showdown.
Krazy Keno--A version of keno in which balls shoot into the air through a
transparent tube. If enough of the flying balls land on the spots selected
by the player, he wins a jackpot according to the pay table.
Treasure of the Sphinx--A Magic WindowsTM version of a three-reel game in
which the player finds himself in front of a large sphinx uncovered in an
archaeological dig. Embedded in the sphinx are nine stone reels, over which
stone doors close as the reels begin to spin. The player is required to
pick three of the doors to reveal hidden symbols, the object being to match
one of the jackpot combinations on the pay table. After the outcome is
revealed, the remaining symbols are uncovered and the game is ready to
resume.
Win-O-Matic--A classic three-reel slot game reminiscent of that played on
mechanical devices in the 1950's featuring traditional reel symbols like
cherries, lemons and plums. Win-O-Matic combines simplicity of play with
the flexibility of modern game percentaging technology.
Meteors--A Magic WindowsTM version of a traditional three-reel game in
which the player fires three laser blasts at a meteor field. As the meteors
explode and disintegrate, reel symbols are revealed. Symbol combinations
matching the pay table win jackpot awards. As a bonus feature, at random
intervals, the player is sent into "hyperspace" mode where, for a period of
time, all jackpots are doubled.
Roulette Royale--A version of roulette in which the player can place bets
in the same fashion as in a traditional roulette game. The player then
"spins" the wheel on the video screen to determine the outcome based on the
number or color at which the wheel stops.
Completion of the foregoing games is subject to various risks and
uncertainties. Such games are in various stages of development, and, except
for Fort Knox, the Company cannot predict which, if any, of such games will
actually be introduced as currently conceived. Such games may be subject to
further creative decisions that could alter the game implementation or
marketing considerations that could result in a shift of the Company's
development focus to different types of games altogether. Successful
completion of any game will also be subject to risks typically associated with
the creative process, such as the risk that the Company's creative team will
be unable to achieve the desired results in terms of the game's entertainment
quality.
Over time, SGI expects to introduce additional games that offer a wider
range of gaming experiences as players become more familiar with the
capabilities of advanced video gaming platforms. For example, the Company may
introduce games with sports attributes such as baseball, football or golf. The
Company also anticipates developing some of its games for progressive formats
in which the Company's machines would be networked to support a common jackpot
that is significantly larger than that which a stand-alone machine could
offer.
SALES AND MARKETING
The ultimate success of SGI's gaming platform depends on its acceptance by
casino operators and casino patrons. The Company believes that, from the point
of view of casino operators, the attractiveness of any gaming platform depends
on win per machine, ease of upgrade, maintenance
28
<PAGE>
and game change and information management. The Company believes that, from
the casino patron's perspective, the attractiveness of a platform is a
function of entertainment value. SGI's sales and marketing strategy is to
generate product sales by highlighting the advantages presented by its gaming
platform to casino operators, such as potential for increased win per machine,
and by positioning itself as a partner with casino operators. SGI's marketing
strategy also targets casino players and will focus on developing brand
recognition for SGI's games, which the Company believes can be accomplished
through the development of proprietary games that deliver greater
entertainment value for the gaming dollar.
SGI intends to position itself as a partner with casino operators in
establishing the next generation of wagering entertainment. The Company
recognizes the important role that casino operations personnel play in
establishing market acceptance for new machines and thus will target this
group with products, sample game platforms and training. The Company is
working to develop close relationships with casino operators, utilizing its
marketing representatives as consultants to the casino operators on methods to
increase slot machine profitability through the use of SGI's products.
Because SGI's games are software-based, SGI believes that there will be a
significant opportunity for game customization and the development of games
for the exclusive use of one or more casino customers. It is already
commonplace for casinos to ask that conventional slot machines be customized
with the casino's logo or theme. SGI believes that it can significantly exceed
this level of customization by inserting the casino's logo or theme right in
the game, by presenting images of the casino's other games and amenities, or
by creating a new game entirely based on the casino's theme. The Company
intends to charge customers a fee for this work.
THREE-PHASE PRODUCT INTRODUCTION
The Company intends to introduce its product and begin its marketing and
sales efforts in a controlled and deliberate manner, following a three-phase
program through 1998:
1996: In this phase, the Company's primary objective will be to complete
development of the product and to have it licensed and available for sale
in one or more jurisdictions. The Company currently has targeted a first
shipment in late 1996 and a first shipment into Nevada in January 1997. The
Company has received nonbinding commitments to install and evaluate its
gaming platform from several leading Las Vegas casinos.
1997: The Company's plan is to deliberately limit the number of machines it
sells in 1997 so that it can carefully monitor the reactions of gaming
patrons and casino customers to its platform, game software and its product
support features. The Company expects to incorporate any changes it deems
advisable based on these surveys into revised and new versions of its
platform and game. At the same time, the Company will be building its sales
and support infrastructure in gaming markets nationwide in order to
properly support customers when full roll-out in 1998 takes place.
1998: In 1998, the Company expects to broadly market and sell its platform
and software games. Because of the restraints imposed by its product
introduction program, the Company currently believes that 1998 will be the
first year in which a reasonable assessment of the commercial potential of
its products can be made.
The successful introduction of the Company's product will be subject to
substantial risks and uncertainties, including the risk of technical or
manufacturing difficulties, the possibility that the SGI platform will not
receive the hoped for market acceptance and possible delays or hurdles
associated with licensing of the Company's product in various jurisdictions.
See "Risk Factors--Single Product; Risk of Technical Errors; Uncertain Market
Acceptance," "--Regulatory Approval," and "--Limited Manufacturing
Experience."
29
<PAGE>
The Company will be required to be licensed in each jurisdiction in which it
expects to sell products. As of July 3, 1996, the Company had filed
applications to sell its products in Nevada, Mississippi, Missouri and
Colorado. To date, the Company has received corporate approval in Nevada and
Mississippi and has also filed an application for approval of its gaming
platform in Nevada. The Company had filed or intends to file license
applications in the jurisdictions set forth below according to the following
schedule:
<TABLE>
<CAPTION>
3RD 2ND
CORPORATE QUARTER 1ST QUARTER QUARTER
APPROVAL FILED 1996 1997 1997
--------- ----- ------- ----------- -------
<S> <C> <C> <C> <C>
Nevada Colorado Minnesota Connecticut Arizona
Mississippi Missouri New Jersey Illinois Indiana
Iowa Wisconsin
Louisiana
Michigan
</TABLE>
There can be no assurance that the Company will be ready to file future
applications in accordance with the above schedule, or that any licenses will
be granted on a timely basis, or at all.
SALES ORGANIZATION
The Company intends to build a sales and support organization to handle
sales and after-sales service to the Company's casino customers. As of May 15,
1996, the Company had five employees in its sales and support area, and the
Company plans to have approximately 10 by the end of 1996. The Company intends
to sell its products by developing close working relationships with casino
operators, using SGI's direct sales representatives as consultants. Where
appropriate, the Company may enter into distribution arrangements or other
strategic relationships to enter additional markets.
The Company has begun taking orders for trial shipments from casinos,
principally in Las Vegas, for delivery as soon as the Company may legally ship
and install such products. In accordance with industry practice, these casinos
will accept such units, without payment, for a 60-day installation and
evaluation period. During this period, each casino operator will evaluate the
performance of the machine against other machines on its floor or available
for purchase and will make a determination whether or not to purchase units at
the end of the trial period. At the end of the trial period, such customers
may purchase the trial machines. If a casino declines to purchase a machine,
SGI will be unable to record a sale for financial reporting purposes and will
remove the machine from that casino's premises. The Company has received
nonbinding commitments to install and evaluate its gaming platform from
Bally's Las Vegas, Boulder Station Hotel & Casino, Caesars Palace Las Vegas,
Circus Circus Hotel & Casino, Excalibur Hotel Casino, the Flamingo Hilton,
Grand Casino Biloxi, Grand Casino Gulfport, Grand Casino Tunica, Hard Rock
Hotel & Casino, Harrah's Las Vegas, ITT Sheraton Desert Inn, ITT Sheraton
Tunica, the Luxor Hotel Casino, the MGM Grand Hotel/Casino, New York-New York
Hotel/Casino, Palace Hotel & Casino, Station Casino Kansas City, St. Charles
Riverfront Station, Stratosphere Hotel & Casino and Texas Station, each of
which has agreed to install and evaluate from eight to 30 of the Company's
machines. Collectively, these casinos have agreed to install approximately 400
units. The Company has targeted additional Nevada and Mississippi operators as
well as casino operators in other markets, such as New Jersey, Missouri and
Colorado, for initial evaluations.
PRICING
The Company intends to offer its product to casino operators and other
potential purchasers using two alternative purchase programs, consisting
either of (i) the outright sale of the unit bundled with a specific package of
games and other software for a fixed price, or (ii) the sale of a stand-alone
machine combined with a term license of the software, including games. The
Company expects that the price
30
<PAGE>
of both the bundled package described in (i) above and the price of the
machine on a stand-alone basis will be higher than the prices generally
charged for most conventional slot machines. The Company may also consider
cost and revenue sharing arrangements. Because software-based gaming machines
represent a new development for the casino industry, potential purchasers'
preferences in this area have not been established. The Company plans to
evaluate its pricing and sales methods and to incorporate changes as
appropriate. The Company believes that license revenue from game software may
eventually constitute a substantial portion of its revenue.
COMPETITION
The current slot machine market is highly competitive and is dominated by a
small number of manufacturers, all of whom have significantly greater
financial and other resources than the Company. The Company believes that the
principal competitive factors in this market are the appeal of the machine to
players, knowledge of customer requirements and player preferences, service,
support and training, distribution, name and product recognition and price.
The principal competitors in the slot machine market are IGT and Bally Gaming.
IGT may be viewed as a dominant competitor, with a 1995 market share estimated
at 70%; Bally Gaming's 1995 market share is estimated at 15%. Additional
competitors or potential competitors include WMS Industries Inc., Video
Lottery Consultants, Aristocrat Leisure Industries, Universal Distributing,
Sigma Games, Casino Data Systems, Acres Gaming Inc. and Innovative Gaming
Corporation of America. Companies in historically unrelated industries, such
as Sega, have technological resources that could offer them a competitive
advantage in developing multimedia-based gaming machines. Sega currently
offers gaming machines to a limited number of markets and has announced plans
to apply for manufacturing and distribution licenses in Nevada. There can be
no assurance that other companies in the video game or multimedia market will
not successfully enter the market for video slot machines, nor can there be
any assurance that the manufacturers of traditional slot machines will not
develop products that are superior to, or that achieve greater market
acceptance, than the Company's products. In general, the Company's existing
competitors, as well as many potential new competitors, have significantly
greater financial and technical resources than the Company, as well as more
established customer bases and distribution channels, which may afford them
competitive advantages. Increased competition is likely to result in price
reductions, reduced operating margins and loss of market share, any of which
could materially and adversely affect the Company's business, operating
results or financial condition. See "Risk Factors--Competition."
PROPRIETARY RIGHTS AND LICENSES
The Company's computer programs and technical know-how are both novel and
proprietary, and management believes that they can best be protected by use of
technical devices to protect the computer programs and by enforcement of
contracts and covenants not to compete with certain employees and others with
respect to the use of the Company's proprietary information and trade secrets.
The Company has registered copyrights with respect to various aspects of its
games, and has filed several U.S. patent applications for protection of
certain technology it has created or licensed. These patent applications cover
various aspects of the gaming machine hardware and software. No assurance can
be given that the pending applications will be granted, nor can there be any
assurance that the patents will not be infringed or that others will not
develop technology that does not violate such patents. See "Risk Factors--
Limited Protection of Intellectual Property Rights; Risk of Litigation."
SGI has developed a proprietary method of authentication for disk drive-
based gaming machines, for which it has submitted a patent application. Since
modern gaming technology requires the handling and processing of large amounts
of on-line data, establishing a method for storing and retrieving data that
meets the approval of the regulatory authorities while meeting adequate
standards of internal performance requires use of a comprehensive
authentication system to assure both the casino operator and requisite gaming
authorities that the software is an exact copy of what was generated by SGI
and approved by such gaming authorities.
31
<PAGE>
In addition, SGI owns exclusive rights to the algorithm for its random
number generator, the key component of the Company's gaming machines which
determines the outcome of each proposition. SGI's algorithm, which may have
uses outside the gaming industry, was developed by Dr. Evangelos A. Yfantis, a
professor of Computer Science at the University of Nevada, Las Vegas.
EMPLOYEES
As of May 15, 1996, the Company had 60 full-time employees, including 36 in
product development. The Company also retains independent contractors to
provide certain services, primarily in connection with its product development
activities. The Company and its full-time employees are not subject to any
collective bargaining agreements and the Company believes that its relations
with its employees are good. From time to time the Company has retained actors
and/or "voice over" talent to perform in certain of the Company's products,
and expects to continue this practice in the future. The Company's future
success depends in large part on its ability to attract and retain management
and other key personnel. See "Risk Factors--Dependence on Key Personnel."
MANUFACTURING
After receipt of regulatory approval and licensing with respect to its
gaming platform, the Company intends to manufacture products in-house or
contract product assembly to a licensed manufacturer. All of the Company's
initial manufacturing will be performed at the Palo Alto facility, where the
Company intends to invest approximately $750,000 in leasehold improvements and
manufacturing equipment. The Company believes that the manufacturing process
will consist primarily of assembly of components obtained from third-party
suppliers and testing software systems and applications.
FACILITIES
In February 1996, the Company moved from its facilities in Saratoga,
California to a 28,000 square foot leased facility in Palo Alto, California
consisting of 17,000 square feet of office space and 11,000 square feet of
manufacturing space. The Company believes that its existing manufacturing
facility is adequate to meet its production requirements through 1998. The
Company intends to lease a facility in Las Vegas during the third quarter of
1996 as it begins to build its sales and support organization.
GAMING REGULATION AND LICENSING
General Regulation of Shareholders of Publicly Traded Corporations. In most
jurisdictions, any beneficial owner of the Company's Common Stock is subject
on a discretionary basis to being required to file applications with gaming
regulatory authorities, be investigated and found suitable or qualified as
such. In addition, shareholders whose holdings of Common Stock exceed certain
designated percentages are subject to certain reporting and qualification
requirements imposed by state and federal gaming regulators and, any
shareholder, if found to be unsuitable, may be required to immediately dispose
of its holdings of Common Stock. See "--Nevada Regulatory Matters," "--
Missouri Regulatory Matters," "--Colorado Regulatory Matters," "--New Jersey
Regulatory Matters," and "--Mississippi Regulatory Matters."
Nevada Regulatory Matters. The Company must obtain a registration, license,
approval or finding of suitability, and equipment approval in all
jurisdictions before it can offer gaming devices for sale to licensed gaming
operations within those jurisdictions. The licensing process usually involves
the licensing or approval of certain officers, directors, and shareholders of
the corporation, and approval of the specific products that the Company wants
to offer for sale. In many jurisdictions, including the State of Nevada, every
shareholder of a private corporation that manufactures and distributes gaming
devices must complete an application, undergo an extensive background and
financial investigation, and be approved by the Nevada Gaming Commission (the
"Nevada Commission") upon the recommendation of the Nevada State Gaming
Control Board (the "Nevada Board"). Given the number of current shareholders
in SGI and the time and expense associated with receiving these approvals,
this is not a viable licensing structure for SGI. In most jurisdictions,
including
32
<PAGE>
Nevada, certain shareholders of publicly-traded corporations that have been
registered with or licensed by the applicable gaming authorities are not
necessarily required to file applications, undergo investigation, or receive
approvals to be shareholders. SGI will apply in all gaming jurisdictions as a
publicly-traded corporation and will seek approval to become registered or
licensed as a publicly-traded corporation in all gaming jurisdictions. In
order to facilitate the corporate licensing process, SGI has filed the
appropriate documentation with the Nevada Board to become a "publicly-traded
corporation" as defined in the Nevada Gaming Control Act. On June 19, 1996 the
Nevada Commission registered SGI and approved Silicon Gaming-Nevada ("SGI-
Nevada"), a wholly-owned subsidiary of SGI formed in February 1996 as a
manufacturer, distributor and operator of a slot machine route. The Company's
proposed initial public offering was also approved by the Nevada Commission on
June 19, 1996.
The manufacture, sale and distribution of gaming devices for use or play in
Nevada or for distribution outside of Nevada, the manufacture and distribution
of associated equipment for use in Nevada, and the ownership and operation of
slot machine routes in Nevada are subject to: (i) the Nevada Gaming Control
Act and the regulations promulgated thereunder (collectively, "Nevada Act");
and (ii) various local ordinances and regulations. Such activities are subject
to the licensing and regulatory control of the Nevada Commission, the Nevada
Board, and various local, city and county regulatory agencies (collectively
referred to as the "Nevada Gaming Authorities").
The laws, regulations and supervisory procedures of the Nevada Gaming
Authorities are based upon declarations of pubic policy which are concerned
with, among other things: (i) the prevention of unsavory or unsuitable persons
from have a direct or indirect involvement with gaming, or manufacturing or
distribution of gaming devices at any time or in any capacity; (ii) the strict
regulation of all persons locations, practices, associations and activities
related to the operation of licensed gaming establishments and the manufacture
or distribution of gaming devices and equipment; (iii) the establishment and
maintenance of responsible accounting practices and procedures; (iv) the
maintenance of effective controls over the financial practices of licensees,
including the establishment of minimum procedures for internal fiscal affairs
and the safeguarding of assets and revenues, providing reliable record keeping
and requiring the filing of periodic reports with the Nevada Gaming
Authorities; (v) the prevention of cheating and fraudulent practices; and (vi)
to provide a source of state and local revenues through taxation and licensing
fees. Change in such laws, regulations and procedures could have an adverse
effect on the Company's operations.
On June 19, 1996 the Company was registered by the Nevada Commission as a
publicly-traded corporation (a "Registered Corporation"), and SGI-Nevada was
approved as a manufacturer, distributor and operator of a slot machine route.
Such gaming approvals require the periodic payment of fees and taxes and are
not transferable. As a Registered Corporation, the Company is required
periodically to submit detailed financial and operating reports to the Nevada
Commission and furnish any other information which the Nevada Commission may
require. No person may become a shareholder of, or receive any profit from
SGI-Nevada without first obtaining licenses and approvals from the Nevada
Gaming Authorities. The Company and SGI-Nevada have applied for, and in some
cases received, the various registrations, approvals, permits and licenses in
order to engage in manufacturing, distribution and slot route activities in
Nevada.
All gaming devices that are manufactured, sold or distributed for use or
play in Nevada, or for distribution outside of Nevada, must be manufactured by
licensed manufacturers and distributed or sold by licensed distributors. All
gaming devices manufactured for use or play in Nevada must be approved by the
Nevada Commission before distribution or exposure for play. The approval
process for gaming devices includes rigorous testing by the Nevada Board, a
field trial and a determination as to whether the gaming device meets strict
technical standards that are set forth in the regulations of the Nevada
Commission. Associated equipment must be administratively approved by the
Chairman of the Nevada Board before it is distributed for use in Nevada.
33
<PAGE>
The Nevada Gaming Authorities may investigate any individual who has a
material relationship to, or material involvement with, a Registered
Corporation or its subsidiaries in order to determine whether such individual
is suitable or should be licensed as a business associate of a gaming
licensee. Officers, directors and certain key employees of the Company and
SGI-Nevada are required to file applications with the Nevada Gaming
Authorities and may be required to be licensed or found suitable by the Nevada
Gaming Authorities. The Nevada Gaming Authorities may deny an application for
licensing for any cause which they deem reasonable. A finding of suitability
is comparable to licensing, and both require submission of detailed personal
and financial information followed by a thorough investigation. The applicant
for licensing or a finding of suitability must pay all the costs of the
investigation. Changes in licensed positions must be reported to the Nevada
Gaming Authorities and in addition to their authority to deny an application
for a finding of suitability or licensure, the Nevada Gaming Authorities have
jurisdiction to disapprove a change in a corporate position. On June 19, 1996
SGI's Chief Executive Officer, Chief Financial Officer, the required directors
and SGI-Nevada's sole officer and director were found suitable by the Nevada
Commission.
If the Nevada Gaming Authorities were to find an officer, director or key
employee unsuitable for licensing or unsuitable to continue having a
relationship with SGI or SGI-Nevada, the Company would have to sever all
relationships with such person. In addition, the Nevada Commission may require
the Company or SGI-Nevada to terminate the employment of any person who
refuses to file appropriate applications. Determination of suitability or of
questions pertaining to licensing are not subject to judicial review in
Nevada.
The Company and SGI-Nevada will be required to submit detailed financial and
operating reports to the Nevada Commission. Substantially all material loans,
leases, sales of securities and similar financing transactions by the Company
will be required to be reported to or approved by the Nevada Commission.
If it were determined that the Nevada Act was violated by the Company or
SGI-Nevada, the registration and gaming licenses it holds could be limited,
conditioned, suspended or revoked, subject to compliance with certain
statutory and regulatory procedures. In addition, the Company, SGI-Nevada and
the persons involved could be subject to substantial fines for each separate
violation of the Nevada Act at the discretion of the Nevada Commission.
Limitation, conditioning or suspension of any gaming license could (and
revocation of any gaming license would) materially adversely affect the
Company's gaming operations.
Any beneficial holder of a Registered Corporation's voting securities,
regardless of the number of shares owned, may be required to file an
application, be investigated, and have his suitability determined as a
beneficial holder of the Registered Corporation's voting securities if the
Nevada Commission has reason to believe that such ownership would otherwise be
inconsistent with the declared policies of the State of Nevada. The applicant
must pay all costs of investigation incurred by the Nevada Gaming Authorities
in conducting any such investigation.
The Nevada Act requires any person who acquires beneficial ownership of more
than 5% of a Registered Corporation's voting securities to report the
acquisition to the Nevada Commission. The Nevada Act requires that beneficial
owners of more than 10% of a Registered Corporation's voting securities apply
to the Nevada Commission for a finding of suitability within thirty days after
the Chairman of the Nevada Board mails the written notice requiring such
filing. Under certain circumstances, an "institutional investor," as defined
in the Nevada Act, which acquires more than 10% but not more than 15%, of the
Registered Corporation's voting securities may apply to the Nevada Commission
for a waiver of such finding of suitability if such institutional investor
holds the voting securities for investment purposes only. An institutional
investor shall not be deemed to hold voting securities for investment purposes
unless the voting securities were acquired and are held in the ordinary course
of business as an institutional investor and not for the purpose of causing,
directly or indirectly, the election of a majority of the members of the board
of directors of the Registered
34
<PAGE>
Corporation, any change in the Registered Corporation's corporate charter,
bylaws, management, policies or operations of the Registered Corporation, or
any of its gaming affiliates, or any other action which the Nevada Commission
finds to be inconsistent with holding the Registered Corporation's voting
securities for investment purposes only. Activities which are not deemed to be
inconsistent with holding voting securities for investment purposes only
include: (i) voting on all matters voted on by shareholders; (ii) making
financial and other inquiries of management of the type normally made by
securities analysts for informational purposes and not to cause a change in
its management, policies or operations; and (iii) such other activities as the
Nevada Commission may determine to be consistent with such investment intent.
If the beneficial holder of voting securities who must be found suitable is a
corporation, partnership or trust, it must submit detailed business and
financial information including a list of beneficial owners. The applicant is
required to pay all costs of investigation.
Any person who fails or refuses to apply for a finding of suitability or a
license within thirty days after being ordered to do so by the Nevada
Commission or the Chairman of the Nevada Board, may be found unsuitable. The
same restrictions apply to a record owner if the record owner, after request,
fails to identify the beneficial owner. Any shareholder found unsuitable and
who holds, directly or indirectly, any beneficial ownership of the common
stock beyond such period of time as may be prescribed by the Nevada Commission
may be guilty of a criminal offense. The Company will be subject to
disciplinary action if, after it receives notice that a person is unsuitable
to be a shareholder or to have any other relationship with the Company or SGI-
Nevada, the Company (i) pays that person any dividend or interest upon voting
securities of the Company, (ii) allows that person to exercise, directly or
indirectly, any voting right conferred through securities held by that person,
(iii) pays remuneration in any form to that person for services rendered or
otherwise, or (iv) fails to pursue all lawful efforts to require such
unsuitable person to relinquish his voting securities including, if necessary,
the immediate purchase of said voting securities for cash at fair market
value.
The Nevada Commission may, in its discretion, require the holder of any debt
security of a Registered Corporation to file applications, be investigated and
be found suitable to own the debt security of a Registered Corporation. If the
Nevada Commission determines that a person is unsuitable to own such security,
then pursuant to the Nevada Act, the Registered Corporation can be sanctioned,
including the loss of its approvals, if without the prior approval of the
Nevada Commission, it: (i) pays to the unsuitable person any dividend,
interest, or any distribution whatsoever; (ii) recognizes any voting right by
such unsuitable person in connection with such securities; (iii) pays the
unsuitable person remuneration in any form; or (iv) makes any payment to the
unsuitable person by way of principal, redemption, conversion, exchange,
liquidation, or similar transaction.
The Company will be required to maintain a current stock ledger in Nevada
which may be examined by the Nevada Gaming Authorities at any time. If any
securities are held in trust by an agent or by a nominee, the record holder
may be required to disclose the identity of the beneficial owner to the Nevada
Gaming Authorities. A failure to make such disclosure may be grounds for
finding the record holder unsuitable. The Company will also be required to
render maximum assistance in determining the identity of the beneficial owner.
The Nevada Commission has the power to require the stock certificates of the
Company to bear a legend indicating that the securities are subject to the
Nevada Act. However, it is unknown whether the Nevada Commission will impose
such a requirement on the Company.
As a Registered Corporation, the Company may not make a public offering of
its securities, such as an IPO, without the prior approval of the Nevada
Commission if the securities or proceeds therefrom are intended to be used to
construct, acquire or finance gaming facilities in Nevada, or to retire or
extend obligations incurred for such purposes. Approval of a public offering,
if given, does not constitute a finding, recommendation or approval by the
Nevada Commission or the Nevada Board as to the accuracy or adequacy of the
prospectus or the investment merits of the securities offered. Any
representation to the contrary is unlawful.
35
<PAGE>
Changes in control of a Registered Corporation through merger,
consolidation, stock or asset acquisitions, management or consulting
agreements, or any act or conduct by a person whereby he obtains control, may
not occur without the prior approval of the Nevada Commission. Entities
seeking to acquire control of a Registered Corporation must satisfy the Nevada
Board and the Nevada Commission in a variety of stringent standards prior to
assuming control of such Registered Corporation. The Nevada Commission may
also require controlling shareholders, officers, directors and other persons
having a material relationship or involvement with the entity proposing to
acquire control, to be investigated and licensed as part of the approval
process relating to the transaction.
The Nevada legislature has declared that some corporate acquisitions opposed
by management, repurchases of voting securities and corporate defense tactics
affecting Nevada corporate gaming licensees, and Registered Corporations that
are affiliated with those operations, may be injurious to stable and
productive corporate gaming. The Nevada Commission has established a
regulatory scheme to ameliorate the potentially adverse effects of these
business practices upon Nevada's gaming industry and to further Nevada's
policy to: (i) assure the financial stability of corporate gaming licensees
and their affiliates; (ii) preserve the beneficial aspects of conducting
business in the corporate form; and (iii) promote a neutral environment for
the orderly governance of corporate affairs. Approvals are, in certain
circumstances, required from the Nevada Commission before the Registered
Corporation can make exceptional repurchases of voting securities above the
current market price thereof and before a corporate acquisition opposed by
management can be consummated. The Nevada Act also requires prior approval of
a plan of recapitalization proposed by the Registered Corporation's Board of
Directors in response to a tender offer made directly to the Registered
Corporation's shareholders for the purposes of acquiring control of the
Registered Corporation.
License fees and taxes, computed in various ways depending on the type of
gaming or activity involved, are payable to the State of Nevada and to the
counties and cities in which gaming operations are to be conducted. Depending
upon the particular fee or tax involved, these fees and taxes are payable
either monthly, quarterly or annually and are based upon either: (i) a
percentage of the gross revenues received; or (ii) the number of gaming
devices operated. Annual fees are also payable to the State of Nevada for
renewal of licenses as a manufacturer, distributor and operator of a slot
machine route.
Any person who is licensed, required to be licensed, registered, required to
be registered, or is under common control with such persons (collectively,
"Licensees"), and who proposes to become involved in a gaming venture outside
of Nevada, is required to deposit with the Nevada Board, and thereafter
maintain, a revolving fund in the amount of $10,000 to pay the expenses of
investigation by the Nevada Board of their participation in such foreign
gaming. The revolving fund is subject to increase or decrease in the
discretion of the Nevada Commission. Thereafter, Licensees are required to
comply with certain reporting requirements imposed by the Nevada Act.
Licensees are also subject to disciplinary action by the Nevada Commission if
they knowingly violate any laws of the foreign jurisdiction pertaining to the
foreign gaming operation, fail to conduct the foreign gaming operation in
accordance with the standards of honesty and integrity required of Nevada
gaming operations, engage in activities that are harmful to the state of
Nevada or its ability to collect gaming taxes and fees, or employ a person in
the foreign operation who has been denied a license or finding of suitability
in Nevada on the ground of personal unsuitability.
In the future, SGI intends to seek the necessary registrations, licenses,
approvals, and findings of suitability for the Company, its products and its
personnel in other jurisdictions throughout the world. However, there can be
no assurances that such registrations, licenses, approvals or findings of
suitability will be obtained. Many other jurisdictions in which the Company
wishes to do business require various licenses, permits, and approvals in
connection with the manufacture and/or distribution of gaming devices,
typically involving restrictions similar in most respects to those of Nevada.
36
<PAGE>
Missouri Regulatory Matters. Gaming was originally authorized in the state
of Missouri in November 1992. On April 29, 1993, new legislation (the
"Missouri Act") was enacted which replaced the 1992 legislation. In January
1994 the Missouri Supreme Court handed down a decision which held that the
operation of certain games of chance such as traditional slot machines was
prohibited by the constitution of the state of Missouri. On November 8, 1994,
the people of Missouri voted in favor of an amendment to the Missouri
constitution to allow slot machine gaming in the state. The Missouri Act
provides for the licensing and regulation of excursion gambling boat
operations on the Mississippi and Missouri Rivers in the state of Missouri and
the licensing and regulation of persons who distribute gaming equipment and
supplies to gaming licensees. An excursion gambling boat is a boat, ferry or
other floating facility on which gaming is allowed. The Missouri Act limits
the loss per individual on each excursion to $500, but does not otherwise
limit the amount which may be wagered on any bet or the amount of space in the
vessel which may be utilized for gaming.
The Missouri Act is to be implemented and enforced by a five-member Missouri
Commission. The Missouri Commission is empowered to issue such number of
riverboat gaming licenses as it determines to be appropriate. A gaming license
cannot be granted to any gaming operator unless the voters in such operator's
"home dock" city or county have authorized gaming activities on gaming
riverboats.
On September 1, 1993, the Missouri Commission adopted rules and regulations
(the "Missouri Regulations") governing the licensing, operation and
administration of riverboat gaming in the state of Missouri and the form of
application for such licensure. The Missouri Regulations generally provide for
four types of licenses--a Class A owner's license; a Class B operator's
license; a supplier's license; and an occupational license. The Company and
its subsidiary, Silicon Gaming-Missouri, Inc. ("SGI-Missouri") currently are
preparing an application for a supplier's license. There can be no assurance
that the Company or SGI-Missouri will be licensed. In addition, the Missouri
Regulations remain subject to amendment and interpretation, and may further
limit or otherwise adversely affect the Company and its Missouri gaming
operations.
Directors and certain officers and key persons of the Company and SGI-
Missouri must file personal disclosure forms with the gaming license
application and must be found suitable by the Missouri Commission. Further,
the Missouri Regulations require that all employees of SGI-Missouri who are
involved in gaming operations and who are employed on the licensed premises
must file applications for and receive Missouri gaming occupational licenses.
The Missouri regulations require disclosure by the Company and SGI-Missouri of
any person or entity holding any direct or indirect ownership interest in SGI-
Missouri. SGI-Missouri is also required to disclose the names of the holders
of all of the Company's and SGI-Missouri's debt including a description of the
nature and terms of such debt. The Missouri Commission may, in its sole
discretion, request additional information with respect to such holders.
Missouri suppliers' gaming licenses must be renewed annually for a fee of
$5,000 or such greater amount as may be determined by the Commission.
Under Missouri law, gaming licenses are not transferable, and under the
Missouri Regulations the transfer of (i) any ownership interest in a privately
held business entity or (ii) a 5% or greater interest in a publicly traded
company directly or indirectly holding a Missouri gaming license is prohibited
without the approval of the Missouri Commission. Further, without the prior
approval of the Missouri Commission, the Missouri Regulations prohibit
withdrawals of capital, loans, advances or distribution of any assets in
excess of 5% of accumulated earnings by a license holder to anyone with an
ownership interest in the license holder.
The Missouri Regulations specifically provide that any action of the
Missouri Commission shall not indicate or suggest that the Missouri Commission
has considered or passed in any way on the marketability of the applicant or
licensee's securities, or on any other matter, other than the applicant or
licensee's suitability for licensure under Missouri law. A Missouri gaming
license holder can be disciplined in Missouri for gaming related acts
occurring in another jurisdiction which results in disciplinary action in the
other jurisdiction.
37
<PAGE>
The Missouri Commission has broad powers to require additional disclosure by
an applicant during the processing of a gaming application, to deny gaming
licensure and to administratively fine or suspend or revoke a gaming license
for failure to comply with or for violation of the Missouri Act or Missouri
Regulations.
Colorado Regulatory Matters. The State of Colorado created the Division of
Gaming (the "Division") within the Department of Revenue to license,
implement, regulate and supervise the conduct of limited gaming. The Director
of the Division, under the supervision of a five-member Colorado Commission,
has been granted broad power to ensure compliance with the Colorado
Regulations. The Director may inspect, without notice, impound or remove any
gaming device. He may examine and copy any licensee's records, may investigate
the background and conduct of licensees and their employees, and may bring
disciplinary actions against licensees and their employees. He also may
conduct detailed background investigations of persons who loan money to the
Company.
The Colorado Commission is empowered to issue five types of gaming and
gaming-related licenses. The failure or inability of the Company or Silicon
Gaming-Colorado, Inc. (the "Colorado Subsidiary"), the Colorado subsidiary, or
others associated with the Company or the Colorado subsidiary, to obtain or
maintain necessary gaming licenses will have a material adverse affect on the
operations of the Company. All persons employed by the Company and the
Colorado subsidiary and involved, directly or indirectly, in gaming operations
in Colorado also are required to obtain a Colorado gaming license. All
licenses must be renewed annually.
In addition, pursuant to the Colorado Regulations, no manufacturer or
distributor of slot machines may have an interest in any casino operator,
allow any of its officers to have such an interest, employ any person if such
person is employed by a casino operator, or allow any casino operator or
person with a substantial interest therein to have an interest in a
manufacturer's or distributor's business. The Commission has ruled that a
person does not have a "substantial interest" if it directly or indirectly has
less than a five percent (5%) interest of such voting securities of a
licensee. Some Division Staff informally have interpreted the Regulations to
prohibit a casino operator from having any interest in a slot machine
manufacturer or distributor.
Under the Colorado Regulations, any person or entity having any direct or
indirect interest in a gaming licensee or an applicant for a gaming license,
including, but not limited to, the Company and shareholders of the Company,
may be required to supply the Colorado Commission with substantial
information, including, but not limited to, background information, source of
funding information, a sworn statement that such person or entity is not
holding his interest for any other party, and fingerprints. Such information,
investigation and licensing as an "associated person" automatically will be
required of all persons (other than certain institutional investors discussed
below) which directly or indirectly own ten percent (10%) or more of a direct
or indirect legal, beneficial or voting interest in the Colorado subsidiary,
through their ownership in the Company. Such persons must report their
interest and file appropriate applications within 45 days after acquiring such
interest. Persons directly or indirectly having a five percent (5%) or more
interest (but less than 10%) in the Colorado Subsidiary, through their
ownership in the Company, must report their interest to the Colorado
Commission within ten (10) days after acquiring such interest and may be
required to provide additional information and to be found suitable. If
certain institutional investors provide certain information to the Colorado
Commission, such investors, at the Colorado Commission's discretion, may be
permitted to own up to 14.99% of the Colorado Subsidiary, through their
ownership in the Company, before being required to found suitable. All
licensing and investigation fees will have to be paid for by the person in
question. The associated person investigation fee currently is $48.00 per
hour.
The Colorado Commission also has the right to request information from any
person directly or indirectly interested in, or employed by, a licensee, and
to investigate the moral character, honesty, integrity, prior activities,
criminal record, reputation, habits and associations of (i) all persons
licensed
38
<PAGE>
pursuant to the Colorado Limited Gaming Act, (ii) all officers, directors and
shareholders of a licensed privately held corporation, (iii) all officers,
directors and shareholders holding either a five percent (5%) or greater
interest or a controlling interest in a licensed publicly traded corporation,
(iv) all general partners and all limited partners of a licensed partnership,
(v) all persons which have a relationship similar to that of an officer,
director or shareholder of a corporation (such as members and managers of a
limited liability company), (vi) all persons supplying financing or loaning
money to any licensee connected with the establishment or operation of limited
gaming, and (vii) all persons having a contract, lease or ongoing financial or
business arrangement with any licensee, where such contract, lease or
arrangement relates to limited gaming operations, equipment, devices or
premises.
In addition, under the Colorado Regulations, every person who is a party to
a "gaming contract" with an applicant for a license, or with a licensee, upon
the request of the Colorado Commission or the Director, promptly must provide
to the Colorado Commission or Director all information which may be requested
concerning financial history, financial holdings, real and personal property
ownership, interests in other companies, criminal history, personal history
and associations, character, reputation in the community, and all other
information which might be relevant to a determination whether a person would
be suitable to be licensed by the Colorado Commission. Failure to provide all
information requested constitutes sufficient grounds for the Director or the
Colorado Commission to require a licensee or applicant to terminate its
"gaming contract" (as defined below) with any person who failed to provide the
information requested. In addition, the Director or the Colorado Commission
may require changes in "gaming contracts" before an application is approved or
participation in the contract is allowed. A "gaming contract" is defined as an
agreement in which a person does business with or on the premises of a
licensed entity.
An application for licensure or suitability may be denied for any cause
deemed reasonably by the Colorado Commission or the Director, as appropriate.
Specifically, the Colorado Commission and the Director must deny a license to
any applicant who (i) fails to prove by clear and convincing evidence that the
applicant is qualified, (ii) fails to provide information and documentation
requested; (iii) fails to reveal any fact material to qualification, or
supplies information which is untrue or misleading as to a material fact
pertaining to qualification; (iv) has been, or has any director, officer,
general partner, shareholder, limited partner or other person who has a
financial or equity interest in the applicant who has been, convicted of
certain crimes, including the service of a sentence upon conviction of a
felony in a correctional facility, city or county jail, or community
correctional facility or under the state board of parole or any probation
department within ten years prior to the date of the application, gambling-
related offenses, theft by deception or crimes involving fraud or
misrepresentation, is under current prosecution for such crimes (during the
pendency of which license determination may be deferred), is a career offender
or a member or associate of a career offender cartel, or is a professional
gambler; or (v) has refused to cooperate with any state or federal body
investigating organized crime, official corruption or gaming offenses.
If the Colorado Commission determines that a person or entity is unsuitable
to own interests in the Company, then the Company or the Colorado Subsidiary
may be sanctioned, which may include the loss by the Company or the Colorado
Subsidiary of their respective approvals and licenses.
The Colorado Commission does not need to approve in advance a public
offering of securities, but rather requires a filing of notice and additional
documents with regard to such public offering prior to such public offering.
The Company has filed the required notice with the Colorado Commission. Under
the regulations, the Colorado Commission may, in its discretion, require
additional information and prior approval of such public offering.
In addition, the Colorado Regulations prohibit a licensee or affiliated
company thereof, such as the Company, from paying dividends, interest or other
remuneration to any unsuitable person, or recognizing the exercise of any
voting rights by any unsuitable person. Further, the Company may
39
<PAGE>
repurchase the shares of anyone found unsuitable at the lesser of the cash
equivalent to the original investment in the Company or the current market
price. Further, the regulations require anyone with a material involvement
with a licensee, including a director or officer of a holding company, such as
the Company, to file for a finding of suitability if required by the Colorado
Commission.
In addition to its authority to deny an application for a license or
suitability, the Colorado Commission has jurisdiction to disapprove a change
in corporate position of a licensee and may have such authority with respect
to any entity which is required to be found suitable by the Colorado
Commission. The Colorado Commission has the power to require the Company and
the Colorado Subsidiary to suspend or dismiss managers, officers, directors
and other key employees or sever relationships with other persons who refuse
to file appropriate applications or whom the authorities find unsuitable to
act in such capacities, and may have such power with respect to any entity
which is required to be found suitable.
A person or entity may not sell, lease, purchase, convey or acquire a
controlling interest in the Company without the prior approval of the Colorado
Commission. The Company may not sell any interest in the Colorado Subsidiary
without the prior approval of the Colorado Commission.
Limited gaming facilities in Colorado must not exceed certain gaming square
footage limits as a total of each floor and the full building. Casinos in
Colorado may operate only between 8:00 a.m. and 2:00 a.m., and may permit only
individuals 21 years or older to gamble in the casino. The law permits slot
machines, blackjack and poker, with a maximum single bet of $5.00. Casinos may
not provide credit to its gaming patrons.
The Colorado Constitution permits a gaming tax of up to 40% on adjusted
gross gaming proceeds. The Colorado Commission has set a gaming tax rate of 2%
on adjusted gross gaming proceeds of up to and including $2 million, 8% over
$2 million and including $4 million, 15% over $4 million up to and including
$5 million and 18% on adjusted gross gaming proceeds in excess of $5 million.
The Colorado Commission also has imposed an annual device fee of $75 per
gaming device. The Colorado Commission may revise the gaming tax rate and
device fee from time to time. Central City Black Hawk and Cripple Creek each
have imposed annual device fees of approximately $1,000 per gaming device and
may revise the same from time to time.
Colorado has certain unique regulatory laws which, if adversely interpreted
or not modified, may limit or adversely affect the ability of the Company to
enter in, or compete within, the Colorado market. First, as noted, gaming in
Colorado constitutionally is limited to slot machines, blackjack and poker.
Although no manufacturer or distributor has attempted to distribute the
Company's type of interactive game, it should be included within the
definition of "slot machine." In preliminary discussions, Division personnel
have stated that the device likely is a "slot machine," although neither the
Division nor the Commission have formally ruled on the issue and will not do
so until the game is submitted to the Division for approval.
Second, Colorado constitutionally limits the maximum single bet to $5.00.
Colorado statutes define a bet to be an amount placed as a wager in a game of
chance. If the Company's product permits multiple rounds of betting at $5.00
per round, it would be unclear whether Colorado would permit such betting. If
Colorado does not permit multiple round bets in excess of $5.00, then the
Company would need to adjust its machines to limit the total bets to $5.00,
including all rounds.
Third, Commission Regulations define the requirements of slot machines,
including limitations on the ability to alter the slot machine's program and
the internal requirements of the slot machine itself. The Company's proposed
machines do not comply with existing Regulations. Although the Company intends
to seek a change in the Commission's Regulations, there can be no assurance
that such changes will be made. If the Regulations are not changed, then the
Company will need to modify its
40
<PAGE>
machines to conform to Colorado requirements. Even as so modified, the
Company's machines must be approved by the Division as meeting existing
Regulations and there is no assurance that the Company will receive such
approval or will receive such approval in a timely basis.
New Jersey Regulatory Matters. Casino gaming in New Jersey is regulated by
the New Jersey Casino Control Act, N.J.S.A. 5:12-1 et seq., and regulations
promulgated thereunder (the "NJCCA"). The NJCCA created the New Jersey Casino
Control Commission ("NJCCC"), which is authorized to decide all license
applications and other matters and to promulgate regulations, and created the
New Jersey Division of Gaming Enforcement (the "NJDGE"), which is authorized
to investigate all license applications, make recommendations to the NJCCC,
and prosecute violations of the NJCCA. Under the NJCCA, any enterprise
providing goods or services to a casino must register with or be licensed by
the NJCCC.
Business enterprises providing goods or services directly related to casino
gaming or simulcast wagering must be licensed as a gaming related Casino
Service Industry ("CSI") prior to conducting business with New Jersey casino
licensees or must have filed a complete application for CSI licensure with the
NJCCC and received the permission of the NJCCC for each business transaction.
A CSI license application consists of a Business Entity Disclosure Form for
the applicant and each of its holding companies and Personal History
Disclosure Forms for each individual required to be found qualified. The
application fee consists of a non-refundable deposit of $5,000 and an
obligation to pay an additional $5,000 if the processing of the application
requires more than 1,000 but less than 2,000 hours and a further $5,000 if the
processing of the application exceeds 2,000 hours. The same fee structure
applies to any renewal application.
In connection with a license application, the NJDGE conducts an
investigation of the Company to determine its suitability for licensure. In
order for the requisite CSI license to be issued by the NJCCC to the Company
and maintained, the Company's officers, directors and key employees and all
beneficial owners of more than five percent (5%) of the Company's Common Stock
must be found qualified by the NJCCC. In order to be found qualified, the
Company, its officers, directors, key employees and five percent (5%)
shareholders must demonstrate by clear and convincing evidence their good
character, honesty and integrity, their financial stability, integrity and
responsibility and their business ability. Any other stock holder or other
person associated with the Company whom the NJCCC deems appropriate, in its
discretion, is also required to be qualified. If a person is required to and
fails to submit to qualification or submits to qualification and is found
disqualified by the NJCCC, the NJCCC may prohibit casinos in New Jersey from
doing business with the Company.
However, "institutional investors" (as defined in the NJCCC) may be granted
a waiver of the requirement to be found qualified by the NJCCC. An
institutional investor includes any retirement fund administered by a public
agency for the exclusive benefit of federal, state or local public employees,
investment company registered under the Investment Company Act of 1940,
collective investment trust organized by banks under Part Nine of the Rules of
the Comptroller of the Currency, closed end investment trust, chartered or
licensed life insurance company or property and casualty insurance company,
banking and other chartered or licensed lending institution, and investment
advisor registered under The Investment Advisors Act of 1940. In the
discretion of the NJCCC, a waiver of qualification may be granted to such
institutional investors provided the securities are owned for investment
purposes only and the institutional investor certifies that it has no
intention of influencing or affecting the affairs of the issuer or its holding
companies.
After 30 days following the filing of a CSI license application with the
NJCCC, the Company may seek permission from the NJCCC to conduct certain
business transactions with a New Jersey casino. Such "transactional waivers"
will only be granted in the absence of an objection by the NJDGE. Such
approvals are granted for a maximum term of six (6) months subject to renewal.
41
<PAGE>
A CSI license is issued for an initial period of two (2) years and is
thereafter renewable for four (4) year periods. There is no guarantee that the
Company will be granted an initial license or that, following the issuance of
an initial CSI license or any renewal thereof, the Company will continue to be
granted renewals of the license. Additionally, upon application of the NJDGE,
the NJCCC may at any time review any license issued by it and determine to
suspend, revoke or place conditions on such license.
In addition to the required licensure from the NJCCC, the gaming equipment
manufactured, distributed or sold by the Company to New Jersey casinos is
subject to a technical examination by the NJDGE and approval by the NJCCC for,
at a minimum, quality, design, integrity, fairness, honesty and suitability.
The approval process includes the submission of a model of the machine to the
NJDGE for testing, examination and analysis and for comparison with
documentation of the schematics, block diagram, circuit analysis and written
explanation of the method of operation, odds determination and all other
pertinent information. The model remains in the custody of the NJDGE unless
otherwise directed by the NJCCC. All costs of such testing, examination and
analysis are borne by the Company. As part of this approval process, the NJCCC
may require that the manufacturer of any component of the gaming equipment
which the NJCCC, in its discretion, determines is essential to the gaming
operation of the device submit to licensing. Such components would include the
computer control circuitry which causes or allows the device to operate as a
gambling device. The failure or refusal of such a manufacturer to submit to
licensing or the denial of a license by the NJCCC to such manufacturer would
result in the inability of the Company to distribute and market that gambling
device to New Jersey casinos. Prior to a decision by the NJCCC to approve a
particular model of machine, it may require up to 60 days trial period to test
the machine in a licensed casino. During the trial period, the manufacturer or
distributor of the machine shall not be entitled to receive revenue of any
kind whatsoever. Once a model is approved by the NJCCC, all machines of that
model placed in operation in licensed casinos shall operate in conformity with
the model tested by the NJDGE. Any changes in the design, function or
operation of the machine are subject to prior approval by the NJCCC in
consultation with the NJDGE.
Mississippi Regulatory Matters. The manufacture, sale and distribution of
gaming devices for use or play in Mississippi are subject to the Mississippi
Gaming Control Act and the regulations promulgated thereunder (collectively,
the "Mississippi Act"). Such activities are subject to the licensing and
regulatory control of the Mississippi Gaming Commission (the "Mississippi
Commission") and the Mississippi State Tax Commission (collectively referred
to as the "Mississippi Gaming Authorities"). Although not identical, the
Mississippi Act is similar to the Nevada Gaming Control Act and regulations
promulgated thereunder.
On June 20, 1996 the Company was registered by the Mississippi Commission as
a publicly traded corporation (a "Registered Corporation") and the holding
company of Silicon Gaming-Mississippi, Inc. (the "Mississippi Subsidiary").
Also on June 20, 1996 the Mississippi Subsidiary was licensed as a
manufacturer and distributor. SGI and the Mississippi Subsidiary are required
to periodically submit detailed financial and operating reports to the
Mississippi Commission and furnish any other information which the Mississippi
Commission may require. The Company and the Mississippi Subsidiary have
received the various registrations, approvals, permits and licenses in order
to engage in manufacturing, distribution and gaming activities as presently
conducted in Mississippi. Such licenses, registrations and approvals are not
transferable, are initially issued for a two-year period and must be renewed
periodically thereafter.
Similar to Nevada, the Mississippi Commission may investigate and find
suitable any individual who has a material relationship to, or material
involvement with, the Company or the Mississippi Subsidiary, including record
or beneficial holders of any of the voting securities of the Company, holders
of debt obligations, and officers, directors and employees of the Company and
the Mississippi Subsidiary. The Company and the Mississippi Subsidiary are
required to maintain a current stock
42
<PAGE>
ledger in Mississippi which may be examined by the Mississippi Commission at
any time. The Company believes that all required findings of suitability
currently required have been applied for or obtained. Any applicant for a
finding of suitability must pay all investigative fees and costs of the
Mississippi Commission in connection with such an investigation.
The Mississippi Act requires any person who acquires beneficial ownership of
more than 5% of a Registered Corporation's voting securities to report the
acquisition to the Mississippi Commission and such person may be required to
be found suitable. The Mississippi Act requires that beneficial owners of more
than 10% of a Registered Corporation's voting securities apply to the
Mississippi Commission for a finding of suitability. The Mississippi
Commission has generally exercised its discretion to require a finding of
suitability of any beneficial owner of more than 5% of a Registered
Corporation's common stock. Under certain circumstances, an "institutional
investor," as defined by Mississippi Commission policy, which acquires more
than 5%, but not more than 10%, of the Registered Corporation's voting
securities may apply to the Mississippi Commission for a waiver of such
finding of suitability if such institutional investor holds the voting
securities for investment purposes only.
The Company may not make a public offering of its securities without the
approval of the Mississippi Commission if the securities or proceeds therefrom
are intended to be used to construct, acquire or finance gaming facilities in
Mississippi, or to retire or extend obligations incurred for such purposes.
If it were determined that the Mississippi Act was violated by the
Mississippi Subsidiary, the licenses it holds could be limited, condition,
suspended or revoked, subject to compliance with certain statutory and
regulatory procedures, which action, if taken, could materially adversely
affect the Company's manufacturing and distribution.
Federal Regulation. The Federal Gambling Devices Act of 1962 (the "Federal
Act") makes it unlawful, in general, for a person to manufacture, deliver, or
receive gaming machines, gaming machine type devices and components across
state lines or to operate gaming machines unless that person has first
registered with the Attorney General of the United States. The Company is
required to register and renew its registration annually. The Company has
complied with such registration requirements. In addition, various record
keeping equipment identification requirements are imposed by the Federal Act.
Violation of the Federal Act may result in seizure and forfeiture of the
equipment, as well as other penalties.
Native American Gaming. Gaming on Native American lands, including the terms
and conditions under which gaming equipment can be sold or leased to Native
American tribes, is or may be subject to regulation under the laws of the
tribes, the laws of the host state, the Indian Gaming Regulatory Act of 1988
("IGRA"), which is administered by the National Indian Gaming Commission (the
"NIGC") and the Secretary of the U.S. Department of the Interior (the
"Secretary"), and also may be subject to the provisions of certain statutes
relating to contracts with Native American tribes, which are administered by
the Secretary. As a precondition to gaming involving gaming machines, IGRA
requires that the tribe and the state have entered into a written agreement (a
"tribal-state compact") that specifically authorizes such gaming, and that has
been approved by the Secretary, with notice of such approval published in the
Federal Register. Tribal-state compacts vary from state to state. Many require
that equipment suppliers meet ongoing registration and licensing requirements
of the state and/or the tribe and some impose background check requirements on
the officers, directors, and shareholders of gaming equipment suppliers. Under
IGRA, tribes are required to regulate all commercial gaming under ordinances
approved by the NIGC. Such ordinances may impose standards and technical
requirements on gaming hardware and software, and may impose registration,
licensing and background check requirements on gaming equipment suppliers and
their officers, directors, and shareholders.
43
<PAGE>
Application of Future or Additional Regulatory Requirements. In the future,
the Company intends to seek the necessary registrations, licenses, approvals
and findings of suitability for the Company, its products and its personnel in
other jurisdictions throughout the world where significant sales are
anticipated to be made. However, there can be no assurance that such
registrations, licenses, approvals or findings of suitability will be obtained
and will not be revoked, suspended or conditioned or that the Company will be
able to obtain the necessary approvals for its future products as they are
developed in a timely manner, or at all. If a registration, license, approval
or finding of suitability is required by a regulatory authority and the
Company fails to seek or does not receive the necessary registration, license,
approval or finding of suitability, the Company may be prohibited from selling
its products for use in the respective jurisdiction or may be required to sell
its products through other licensed entities at a reduced profit to the
Company.
44
<PAGE>
MANAGEMENT
EXECUTIVE OFFICERS AND DIRECTORS
The executive officers and directors of the Company are as follows:
<TABLE>
<CAPTION>
NAME AGE POSITION
---- --- --------
<S> <C> <C>
Donald J. Massaro....................... 53 President, Chief Executive Officer
and Director
Andrew S. Pascal........................ 30 Executive Vice President--Marketing
and Game Development
Allan E. Alcorn......................... 48 Senior Vice President--Chief
Technical Officer
Thomas E. Carlson....................... 42 Vice President--Chief Financial
Officer
Karen M. Katz........................... 30 Vice President--Sales and Support
Paul D. Mathews......................... 31 Vice President--Government Affairs
Jeffrey D. Friedberg.................... 37 Vice President--Engineering
H. Paul Kurth........................... 59 Vice President--Manufacturing
David S. Morse(1)....................... 53 Chairman of the Board of Directors
Robert M. Fell(2)....................... 53 Director
William Hart(2)......................... 56 Director
Kevin R. Harvey(1)...................... 31 Director
</TABLE>
- --------
(1) Member of the Compensation Committee.
(2) Member of the Audit Committee.
Donald J. Massaro has served as a director of the Company since May 1995 and
its President and Chief Executive Officer since June 1995. Mr. Massaro has
over 20 years of general management experience and has been a director and/or
chairman of the board of directors for a number of public and private Silicon
Valley based technology companies. Prior to joining SGI, Mr. Massaro was
Executive Vice President and General Manager of Worldwide Sales and Marketing
for Conner Peripherals Inc. ("Conner"), a disk drive manufacturer, from July
1994 to May 1995. From January 1991 to June 1994, Mr. Massaro was Chief
Executive Officer of Sjoberg Industries ("Sjoberg"), and Inversion Development
Corporation ("Inversion"), manufacturers of environmental products. Sjoberg
filed for protection under federal bankruptcy statutes in December 1992 and
was acquired by Inversion in March 1993. Prior thereto, he served as President
and Chief Executive Officer of Metaphor Computer Systems ("Metaphor"), a
company he co-founded in 1982 to develop and manufacture client-server based
management information systems. Mr. Massaro's other prior experience includes
positions as Corporate Vice President and President of Xerox Corporation's
Office Products Division and President and Chief Executive Officer of Shugart
Associates, a computer peripherals company he co-founded in 1972.
Andrew S. Pascal has over 10 years of gaming industry experience with an
emphasis in slot marketing, slot merchandising and slot operations. He joined
SGI in October 1994 from Mirage Resorts, Incorporated ("Mirage"), where he
worked from June 1985 to October 1994. Mr. Pascal held the position of
Director of Slot Operations and Marketing at The Mirage Hotel and Casino,
managing a division consisting of 350 employees and annual revenues in excess
of $110 million. Mr. Pascal served on Mirage's eight-member Operating
Committee, which set operating policy and established the strategic direction
for Mirage and its 7,300 employees, from September 1992 to October 1994. Prior
to the opening of The Mirage Hotel and Casino, Mr. Pascal served as the
Director of Slot Marketing for the Golden Nugget Casino-Hotel.
Allan E. Alcorn joined SGI in November 1993 from Digital F/X, Inc., a
developer of professional video equipment, where from December 1991 to October
1993 he was Vice President of Development responsible for designing and
developing video authoring tools for broadcast and industrial markets.
45
<PAGE>
From 1986 to 1991, Mr. Alcorn was a Fellow at Apple Computer, Inc. ("Apple"),
where he was responsible for investigating new personal computer technologies.
Prior to joining Apple, he was a founder and Vice President of Engineering for
Atari, Inc. ("Atari"), where he designed and built PONG, the first
commercially successful video game.
Thomas E. Carlson joined SGI in May 1995 from Conner, where from November
1994 to February 1995 he held the position of Worldwide Research and
Development and Launch Manufacturing Controller. From January 1991 to October
1994 he was Chief Financial Officer of Sjoberg and Inversion. Sjoberg filed
for protection under federal bankruptcy laws in December 1992 and was
ultimately acquired by Inversion in March 1993. From 1984 to 1990 Mr. Carlson
held various positions at Metaphor, including Director of Financial Planning
and Corporate Controller.
Karen M. Katz joined SGI in July 1995 from Conner, where from August 1994 to
July 1995 she held the position of Director of Strategic Programs and was
responsible for developing and implementing the programs and systems for
managing its $2.5 billion disk drive and tape drive businesses. Prior to her
promotion to Director of Strategic Programs, from July 1993 to July 1994 Ms.
Katz served as Conner's Director of Corporate Sales and was responsible for
the global sales management of the Sun Microsystems, Inc. and Digital
Equipment Corporation accounts. Prior to joining Conner in October 1991, Ms.
Katz was a member of the technical staff at AT&T Bell Laboratories.
Paul D. Mathews joined SGI November 1995 from Casino Data Systems, a
designer and manufacturer of casino management information systems and gaming
devices, where from March 1995 to November 1995 he was Director of Regulatory
Compliance responsible for corporate and product licensing in all gaming
jurisdictions. Prior to joining Casino Data Systems, Mr. Mathews spent five
years with the Nevada State Gaming Control Board in the Corporate Securities
and Investigation Divisions.
Jeffrey D. Friedberg joined SGI in March 1995 as Director of Software
Development, a position he held until May 1996, when he was elected Vice
President-Engineering. From December 1994 to March 1995, he worked at Apple as
a consultant identifying third party graphics acceleration strategies. From
May 1991 to November 1994, Mr. Friedberg worked at Kubota Graphics
Corporation, a manufacturer of graphics supercomputers and workstations where
he held various positions including Director of Graphics Software Development.
From October 1986 to May 1991, Mr. Friedberg served as a Principal Engineer
with Digital Equipment Corporation.
H. Paul Kurth joined SGI in November 1995 from Edge Diagnostic Systems, a
manufacturer of computerized automotive diagnostic systems, where he was the
founder and Vice President of Operations responsible for product design,
fabrication and manufacturing from January 1988 to June 1994. Prior to joining
Edge Diagnostic Systems, Mr. Kurth founded Vertex Peripherals, a manufacturer
of high-performance, high-capacity disk drives.
David S. Morse is a founder of the Company and has served as Chairman of the
Board of Directors since its inception. Mr. Morse also currently serves in the
same capacity for LBE Technologies, Inc., a company he founded to develop
virtual reality based auto racing simulations. Mr. Morse is a founder and has
served as Chief Executive Officer of Crystal Dynamics, Inc., an interactive
video game developer and publisher, from July 1992 to June 1993 and from
December 1994 to May 1995. Mr. Morse was founder, President and Chief
Executive Officer of New Technologies Group, Inc. ("NTG"), the company which
developed the original video game technology employed in games developed by
The 3DO Company ("3DO"). NTG was one of the founding partners of 3DO and was
subsequently acquired by 3DO. Mr. Morse served with NTG from July 1989 to June
1993. Prior to founding NTG, Mr. Morse was Chairman of Epyx, Inc. ("Epyx"), a
video game developer, where he led the development of the Lynx portable game
platform, now marketed by Atari. Epyx filed for
46
<PAGE>
protection under federal bankruptcy statutes in October 1989. Mr. Morse was
also the founder, President and Chief Executive Officer of Amiga Computer,
Inc., prior to its acquisition by Commodore Business Machines, Inc. in 1984.
Mr. Morse was a founding general partner of Interactive Partners, a firm
specializing in the creation of interactive media companies.
Robert M. Fell has served as a director of the Company since its inception.
Mr. Fell is also a founding General Partner of Interactive Partners. Mr. Fell
has also served as the Chairman, President and Chief Executive Officer of
Archon Capital Partners, a merchant banking firm from June 1994 to the
present. Since 1978, Mr. Fell has also served as President and Chief Executive
Officer of Fell & Company, Inc., and since 1982 as General Partner of Fell &
Nicholson Technology Resources, both management consulting firms. Mr. Fell is
also a director of Premiere Radio Networks, Inc., a radio programming
syndicator, and several private companies.
William Hart has served as a director of the Company since May 1994. In
addition, Mr. Hart is a general partner of Technology Partners, a venture
capital investment firm founded by Mr. Hart in 1980, which currently manages
$100 million in funds for early stage venture capital investments. Prior to
founding Technology Partners, Mr. Hart held positions with Cresap, McCormick
and Paget, a management consulting firm, and with IBM Corporation. Mr. Hart
serves as a director of Cellnet Data Systems, Inc., Mobex Communications,
Inc., Qualix Group Inc., LBE Technologies, Inc. and Trimble Navigation Ltd.
Kevin R. Harvey has served as a director of the Company since August 1995.
In addition, Mr. Harvey is a General Partner of Benchmark Capital Management
LLC ("Benchmark"), a Silicon Valley venture capital firm founded by Mr. Harvey
in February 1995 which currently manages a $90 million fund. Prior to joining
Benchmark, Mr. Harvey served as the General Manager of the Approach Database
Division of Lotus Development Corporation ("Lotus") from July 1993 to January
1995. He was also the founder and Chief Executive Officer of two software
companies, StyleWare Inc., which was sold to Claris Corporation in July 1988,
and Approach Software Corporation, where Mr. Harvey served as Chief Executive
Officer from August 1990 to July 1993, when it was sold to Lotus. Mr. Harvey
serves as a director of PointCast, Inc. and Broadbase, Inc.
BOARD COMMITTEES
The Compensation Committee, which has responsibility for reviewing the
performance of the officers of the Company and making recommendations to the
Board concerning salaries and incentive compensation for such officers,
currently consists of Messrs. Harvey and Morse.
The Audit Committee, which has responsibility for reviewing the Company's
financial statements and its audit and accounting practices with the Company's
independent auditors and making recommendations to the Board of Directors with
respect thereto, currently consists of Messrs. Hart and Fell.
DIRECTOR COMPENSATION
Directors do not receive any cash compensation for their services as members
of the Board of Directors, although they are reimbursed for their out-of-
pocket expenses incurred in attending Board and committee meetings. In April
1995, Madeline Canepa, who was a director of the Company at the time, was
granted an option to purchase 33,333 shares of Common Stock of the Company
under the Company's 1994 Stock Option Plan (the "1994 Option Plan") at an
exercise price of $0.11 per share. The option has a term of 10 years and vests
at the rate of one-fourth of the shares one year after the date of grant and
one-forty-eighth of the shares each month thereafter. The option is fully
exercisable, subject to the Company's right to repurchase unvested shares at
the original exercise price upon termination of Ms. Canepa's status as a
director or consultant. Ms. Canepa resigned as a director in May 1996 but is
continuing to render consulting services to the Company. The Company has
adopted the 1996 Outside Directors Stock Option Plan, which provides for
formula-based grants of options to non-employee directors. See "--Executive
Compensation--Stock Plans."
47
<PAGE>
EXECUTIVE COMPENSATION
This section discusses compensation earned by certain executive officers of
the Company during the Company's last full fiscal year. Because of a change in
the Company's fiscal year-end, the last full fiscal year covered the nine-
month period from April 1 through December 31, 1995. Where appropriate,
supplemental information is provided concerning compensation earned during the
entire 1995 calendar year.
SUMMARY COMPENSATION TABLE
The following table sets forth information concerning the compensation
received for services rendered to the Company during the fiscal year ended
December 31, 1995, by the Chief Executive Officer of the Company and each of
the two other most highly compensated executive officers whose total salary
for calendar year 1995 exceeded $100,000 (the "Named Executive Officers"):
SUMMARY COMPENSATION TABLE
<TABLE>
<CAPTION>
LONG-TERM
ANNUAL COMPENSATION
COMPENSATION AWARDS
------------ ------------------
SHARES UNDERLYING ALL OTHER
NAME AND PRINCIPAL POSITION SALARY(1) OPTIONS GRANTED(2) COMPENSATION(3)
--------------------------- ------------ ------------------ ---------------
<S> <C> <C> <C>
Donald J. Massaro(4).......... $139,262 416,666 $913
President and Chief Executive
Officer
Andrew S. Pascal ............. $ 93,750(5) 49,999 $991
Executive Vice President--
Marketing and Game
Development
Allan E. Alcorn .............. $ 93,750(5) 16,666 $991
Senior Vice President--Chief
Technical Officer
</TABLE>
- --------
(1) Salary amounts include all compensation deferred under the Company's
401(k) Plan.
(2) Also represents options granted during calendar year 1995.
(3) Represents life insurance premiums paid by the Company for the benefit of
the Named Executive Officer during calendar year 1995.
(4) Mr. Massaro became an executive officer of the Company in June 1995. Mr.
Massaro's compensation reflects an annual salary of $250,000. No
individual served as Chief Executive Officer or acted in a similar
capacity prior to June 1995. Before Mr. Massaro assumed that role, the
duties of the Company's Chief Executive Officer were performed by
Interactive Partners, a partnership of which Robert M. Fell and David S.
Morse, founders and directors of the Company, are general partners. See
"Certain Transactions."
(5) The salary earned by the Named Executive Officer during calendar year 1995
was $125,000.
48
<PAGE>
OPTION GRANTS
The following table provides information concerning grants of options to
purchase the Company's Common Stock made to each of the Named Executive
Officers during the fiscal year ended December 31, 1995:
OPTION GRANTS IN LAST FISCAL YEAR
<TABLE>
<CAPTION>
POTENTIAL REALIZABLE
VALUE AT ASSUMED
NUMBER OF % OF TOTAL ANNUAL RATES OF STOCK
SHARES OPTIONS PRICE APPRECIATION FOR
UNDERLYING GRANTED TO EXERCISE OPTION TERM(4)
OPTIONS EMPLOYEES PRICE PER EXPIRATION -----------------------
NAME GRANTED(1)(2) IN 1995 SHARE(3) DATE 5% 10%
- ---- ------------- ---------- --------- ---------- ----------- -----------
<S> <C> <C> <C> <C> <C> <C>
Donald J. Massaro....... 283,333 26.82% $0.11 06/27/05 $ 19,601 $ 49,672
133,333 12.62% $0.17 10/23/05 $ 14,255 $ 36,125
Andrew S. Pascal........ 16,666 1.58% $0.11 06/27/05 $ 1,153 $ 2,922
33,333 3.16% $0.17 12/11/05 $ 3,564 $ 9,031
Allan E. Alcorn......... 16,666 1.58% $0.11 06/27/05 $ 1,153 $ 2,922
</TABLE>
- --------
(1) The number of shares also represents shares underlying options granted
during calendar year 1995. All options granted in 1995 were granted under
the 1994 Option Plan. The Board of Directors has discretion, subject to
plan limits, to modify the terms of outstanding options and to reprice the
options. See "--Stock Plans."
(2) Each option is fully exercisable from the time of grant, subject to the
Company's right to repurchase any unvested shares at the original exercise
price in the event of the optionee's termination. Shares vest at the rate
of 1/4 of the shares after one year and then 1/48 of the total number of
shares each month thereafter.
(3) The exercise price per share of options granted represented the fair
market value of the underlying shares of Common Stock on the dates the
respective options were granted as determined by the Board of Directors.
The Company's Common Stock was not traded publicly at the time of the
option grants to the Named Executive Officers.
(4) Amounts represent hypothetical gains that could be achieved for the
respective options if exercised at the end of the option term. The assumed
5% and 10% rates of stock price appreciation are provided pursuant to the
rules of the Securities and Exchange Commission and do not represent the
Company's estimate or projection of the future Common Stock price.
OPTION EXERCISES AND HOLDINGS
The following table sets forth certain information regarding unexercised
stock options held by each of the Named Executive Officers as of December 31,
1995:
1995 YEAR-END OPTION VALUES
<TABLE>
<CAPTION>
NUMBER OF SECURITIES
UNDERLYING VALUE OF UNEXERCISED
UNEXERCISED OPTIONS AT IN-THE-MONEY OPTIONS AT
SHARES DECEMBER 31, 1995 (#) DECEMBER 31, 1995 (1)
ACQUIRED ON VALUE ---------------------------- ----------------------------
NAME EXERCISE REALIZED (2) EXERCISABLE(3) UNEXERCISABLE EXERCISABLE(3) UNEXERCISABLE
---- ----------- ------------ -------------- ------------- -------------- -------------
<S> <C> <C> <C> <C> <C> <C>
Donald J. Massaro....... 283,333 $17,000 133,333 -- $8,000 --
Andrew S. Pascal........ 183,333 $11,000 33,333 -- $2,000 --
Allan E. Alcorn......... 83,333 $ 5,000 -- -- -- --
</TABLE>
- --------
(1) Calculated on the basis of the fair market value of the underlying
securities at December 31, 1995, as determined by the Company's Board of
Directors, minus the aggregate exercise price.
(2) All options exercised had exercise prices of $0.11 per share. At the time
of exercise of each option, the fair market value of the Company's Common
Stock, as determined in good faith by the Board of Directors, was $0.17
per share.
(3) All options are fully exercisable, subject to the Company's right to
repurchase any unvested shares at the original exercise price in the event
of the optionee's termination. Shares vest in accordance with the vesting
provisions described above in Note 2 to the table entitled "Option Grants
in 1995."
49
<PAGE>
EMPLOYMENT AGREEMENTS
The Company has entered into an employment agreement dated May 25, 1995 with
Donald J. Massaro, pursuant to which Mr. Massaro is employed as the Company's
President and Chief Executive Officer. The agreement entitles Mr. Massaro to a
salary of $20,833.33 per month and an option to purchase 283,333 shares of
Common Stock under the Company's 1994 Stock Option Plan. Under the agreement,
Mr. Massaro has agreed to serve on the Board of Directors while serving as
Chief Executive Officer and to resign from the Board at such time as his
employment is terminated. The Company has also agreed to make two loans to Mr.
Massaro of up to $75,000 per year for living expenses, secured by any Common
Stock of the Company owned by him. The agreement is subject to termination at
will by either party.
COMPENSATION COMMITTEE INTERLOCKS AND INSIDER PARTICIPATION
The Company did not have a compensation committee until December 12, 1995,
prior to which all decisions concerning executive compensation were made by
the entire Board, of which Mr. Massaro is a member. Mr. Massaro abstained from
all deliberations concerning his own compensation during this period. The
Compensation Committee currently consists of David S. Morse and Kevin R.
Harvey. The Company has entered into certain transactions with Mr. Morse and
with entities affiliated with Messrs. Morse and Harvey. See "Certain
Transactions."
STOCK PLANS
1994 Stock Option Plan. The Board of Directors has reserved a total of
2,866,667 shares of Common Stock for issuance under the 1994 Option Plan,
which amount will automatically be increased on the first day of each fiscal
year of the Company beginning on and after January 1, 1998 by a number of
shares equal to 4% of the number of shares of the Company's Common Stock
issued and outstanding on the last day of the preceding fiscal year. The 1994
Option Plan permits the grant of options intended to qualify as "incentive
stock options" ("ISOs") within the meaning of section 422 of the Internal
Revenue Code of 1986, as amended, as well as nonstatutory stock options.
Without further shareholder approval, no more than 2,777,779 shares may be
available cumulatively for issuance upon exercise of ISOs (the "ISO Share
Limit"), including ISOs that have been granted previously. As of May 31, 1996,
1,316,819 shares subject to repurchase by the Company had been issued upon the
exercise of options granted under the 1994 Option Plan, 449,667 shares were
subject to outstanding options granted under the 1994 Option Plan at a
weighted average exercise price of $2.24 and 1,004,278 shares remained
available for future grant under the 1994 Option Plan. Options may be granted
to employees (including directors and officers who are also employees),
consultants and prospective employees and consultants, although only employees
(including directors and officers who are also employees) may receive
incentive stock options. The exercise price per share in the case of a
nonstatutory stock option must equal at least 85% of the fair market value of
a share of Common Stock on the date of grant, and in the case of ISOs must be
no less than the fair market value of a share of Common Stock on the date of
grant, or 110% of such fair market value in the case of an ISO granted to any
person who owns stock possessing more than 10% of the total combined voting
power of all classes of stock of the Company or any parent or subsidiary (a
"10% Shareholder"). Generally, options granted under the 1994 Option Plan are
immediately exercisable and must be exercised within ten years (or five years
in the case of an ISO granted to a 10% Shareholder), and shares subject to an
option generally vest over four years from the date of grant. In the event an
optionee's service is involuntarily or constructively terminated within 12
months after a change in control (other than for cause or as a result of death
or disability), all shares subject to his or her option will become fully
vested unless such acceleration of vesting would make "pooling of interests"
accounting treatment unavailable in connection with the change in control. The
1994 Option Plan does not have an expiration date, except that ISOs may not be
granted under the 1994 Option Plan later than May 26, 2006, which date will
automatically be extended for 10 years from each date when the Company's
shareholders approve an increase in the share reserve.
50
<PAGE>
1996 Employee Stock Purchase Plan. A total of 300,000 shares of Common
Stock have been reserved for issuance under the Company's 1996 Employee Stock
Purchase Plan (the "Purchase Plan"), none of which have yet been issued. The
Purchase Plan permits eligible employees to purchase Common Stock at a
discount, but only through accumulated payroll deductions, during concurrent
24-month offering periods. Each offering period will be divided into four
consecutive six-month purchase periods, and participants will purchase shares
on the last day of each purchase period. The price at which shares are
purchased under the Purchase Plan is equal to 85% of the fair market value of
a share of Common Stock on the first day of the offering period or the last
day of the purchase period, whichever is lower.
1996 Outside Directors Stock Option Plan. A total of 200,000 shares of
Common Stock have been reserved for issuance under the Company's 1996 Outside
Directors Stock Option Plan (the "Directors Plan"). Prior to the effective
date of this offering, no options have been granted under the Directors Plan.
The Directors Plan provides for the automatic grant of nonstatutory stock
options to directors of the Company who are not employees of the Company
("Outside Directors"). On the effective date of this offering, each Outside
Director automatically will be granted under the Directors Plan an option to
purchase 15,000 shares of Common Stock. Thereafter, each new Outside Director
elected after the effective date of this offering automatically will be
granted on the date of his or her initial election an option to purchase
15,000 shares of Common Stock. In addition, each Outside Director that has
served on the Board for at least six months will thereafter be granted
automatically an option to purchase 5,000 shares of Common Stock at each
annual meeting of the shareholders, provided the Outside Director continues to
serve in such capacity following the annual meeting. The exercise price per
share of options granted under the Directors Plan will be equal to the fair
market value of a share of Common Stock on the date of grant. Shares subject
to an option granted under the Directors Plan will vest over three years, and
options granted under the Directors Plan must be exercised within ten years
from the date of grant.
51
<PAGE>
CERTAIN TRANSACTIONS
In May 1994, Technology Partners Fund V, L.P. ("Technology Partners"), of
which William Hart, a director of the Company, is Managing Partner, purchased
666,666 shares of Series A Preferred Stock of the Company for an aggregate
consideration of $499,999.
In December 1994, January 1995 and March 1995, Technology Partners loaned
the Company the sums of $300,000, $500,000 and $450,000, respectively. The
loans bore interest at 10% per annum. In June 1995, Technology Partners
canceled this indebtedness, along with warrants for 125,000 shares of the
Company's Common Stock at $0.07 per share, in exchange for 1,666,666 shares of
Series A Preferred Stock issued by the Company.
In March 1995, May 1995 and June 1995, Technology Partners loaned the
Company the sums of $50,000, $200,000 and $300,000. The loans bore interest at
10% per annum. All principal and interest under these loans was converted to
Series B Preferred Stock in August 1995, as described below.
In August 1995, Kleiner Perkins Caufield & Byers VII and related entities
purchased 2,192,982 shares of Series B Preferred Stock of the Company for an
aggregate consideration of $2,499,999, Technology Partners purchased 1,105,178
shares of Series B Preferred Stock for an aggregate consideration of
$1,259,902 (including cancellation of indebtedness) and Benchmark Capital
Partners, L.P., and related entities purchased 2,192,982 shares of Series B
Preferred Stock for an aggregate consideration of $2,499,999.
In March 1996, Kleiner Perkins Caufield & Byers VII and related entities
purchased 133,334 shares of Series C Preferred Stock of the Company for an
aggregate consideration of $666,670, Technology Partners purchased 133,334
shares of Series C Preferred Stock for an aggregate consideration of $666,670
and Benchmark Capital Partners, L.P., and related entities purchased 133,332
shares of Series C Preferred Stock for an aggregate consideration of $666,660.
From November 1993 through June 1995, Interactive Partners, a partnership of
which Robert M. Fell and David S. Morse are general partners, provided
management services and administrative support to the Company. For the period
from November 1993 through March 31, 1994, the year ended March 31, 1995 and
the nine-month period ended December 31, 1995, the Company paid Interactive
Partners approximately $30,000, $166,000 and $23,000, respectively, in
exchange for such services.
During the period from November 1993 through June 1995 Morse & Co., of which
Mr. Morse is an executive officer, administered the Company's payroll and also
paid the Company's rent, utility and other expenses, for which it was
reimbursed by the Company. For the period from November 1993 through March 31,
1994, the year ended March 31, 1995, and the nine-month period ended
December 31, 1995, payroll and other expenses, including rent, utilities and
travel, amounting to $106,000, $467,000 and $71,100, respectively, were paid
on behalf of the Company.
The Company has entered into an employment agreement with Donald J. Massaro,
its President and Chief Executive Officer. Under this agreement, the Company
has agreed to loan Mr. Massaro up to $75,000 per year for living expenses,
secured by Common Stock of the Company owned by Mr. Massaro. As of May 29,
1996, $75,000 in principal was outstanding. The loan bears interest at 8% per
annum. See "Management--Employment Agreements."
The Company believes that all transactions between the Company and its
officers, directors, principal shareholders or their affiliates have been on
terms no less favorable to the Company than could be obtained from
unaffiliated parties.
52
<PAGE>
PRINCIPAL SHAREHOLDERS
The following table sets forth certain information regarding the beneficial
ownership of the Company's outstanding Common Stock as of May 31, 1996 by: (i)
each of the directors and Named Executive Officers of the Company; (ii) all
directors and executive officers of the Company as a group; and (iii) each
other person known by the Company to own beneficially more than 5% of the
Company's Common Stock;
<TABLE>
<CAPTION>
PERCENTAGE OF SHARES
NUMBER OF OUTSTANDING(1)
SHARES ------------------------
BENEFICIALLY PRIOR TO AFTER
OWNED (1) OFFERING OFFERING
------------ ---------- ----------
<S> <C> <C> <C>
Robert M. Fell(2)................... 1,133,333 15.9% 10.7%
15260 Ventura Boulevard, Suite 300
Sherman Oaks, CA 91403
David S. Morse(3)................... 660,000 9.3% 6.2%
P.O. Box 7119
Incline Village, NV 89450
SMALLCAP World Fund, Inc. .......... 426,666 6.0% 4.0%
c/o Capital Research and Management
Company
333 South Hope Street
Los Angeles, CA 90071
Donald J. Massaro................... 416,666 5.9% 3.9%
c/o Silicon Gaming, Inc.
2800 West Bayshore Road
Palo Alto, CA 94303
Technology Partners Fund V, 408,889 5.7% 3.9%
L.P.(4)............................
William Hart(4)
1550 Tiburon Blvd., Suite A
Belvedere, CA 94920
Benchmark Capital Management 408,888 5.7% 3.9%
LLC(5).............................
Kevin R. Harvey(5)
2480 Sand Hill Road, Suite 200
Menlo Park, CA 94025
Kleiner Perkins Caufield & 408,888 5.7% 3.9%
Byers(6)...........................
2750 Sand Hill Road
Menlo Park, CA 94025
Andrew S. Pascal.................... 216,666 3.0% 2.0%
Allan E. Alcorn..................... 83,333 1.2% *
All current directors and executive
officers as a group
(12 persons)(7).................... 3,745,839 52.0% 35.0%
</TABLE>
- --------
(1) Beneficial ownership is determined in accordance with the rules of the
Securities and Exchange Commission. In computing the number of shares
beneficially owned by a person and the percentage ownership of that
person, shares of Common Stock subject to options or warrants held by that
person that are currently exercisable or will become exercisable within 60
days after May 31, 1996 are deemed outstanding, while such shares are not
deemed outstanding for purposes of computing percentage ownership of any
other person. In general, options granted under the 1994 Stock Option Plan
are fully exercisable from the date of grant, subject to the Company's
right to repurchase any unvested shares at the original exercise price
upon termination of employment. See "Management--Executive Compensation--
Stock Plans." The information set forth in this table does not include
among shares beneficially owned or outstanding shares of Common Stock
issuable upon conversion of Nonvoting Preferred, which is convertible only
upon 75 days' prior notice to the Company. See "Description of Capital
Stock--Preferred Stock." Unless otherwise indicated in the footnotes
below, the persons and entities named in the table have sole voting and
investment power with respect to all shares beneficially owned, subject to
community property laws where applicable.
(2) Consists of shares held by Mr. Fell as trustee of the Robert M. Fell Living
Trust, Dated 6/14/95.
(3) Includes 626,666 shares held by Mr. Morse and his spouse as Trustees of
the Morse Family Trust dated 12/20/84 and 33,332 shares of Common Stock
held by Mr. Morse's children.
53
<PAGE>
(4) Mr. Hart, a director of the Company, is the Managing Partner of TPW
Management V, L.P. ("TPW"), the general partner of Technology Partners
Fund V, L.P. ("Technology Partners"), and may be deemed to share voting or
investment power with respect to these shares. The other general partners
of TPW are John Ardell and Roger Quy. Each of Messrs. Hart, Ardell and Quy
disclaims beneficial ownership of these shares except to the extent of his
proportionate interest therein. Excludes 1,972,340 shares of Common Stock
issuable upon conversion of Nonvoting Preferred. Assuming conversion of
all outstanding shares of Nonvoting Preferred, Technology Partners would
be the beneficial owner, prior to and after the offering, of 20.9% and
16.0%, respectively, of the Company's outstanding Common Stock.
(5) Consists of 399,616 shares held by Benchmark Capital Partners L.P., and
9,272 shares held by Benchmark Founders' Fund, L.P. Mr. Harvey, a director
of the Company, is a member of Benchmark Capital Management LLC ("BCM"),
the general partner of each of these entities, and may be deemed to share
voting or investment power with respect to shares held by such entities.
The other members of BCM are Andrew Rachleff, Robert Kagle, Bruce Dunlevie
and Val Vaden. Each of Messrs. Harvey, Rachleff, Kagle, Dunlevie and Vaden
disclaims beneficial ownership of these shares except to the extent of his
proportionate interest therein. Excludes 1,141,986 shares of Common Stock
issuable upon conversion of Nonvoting Preferred. Assuming conversion of
all outstanding shares of Nonvoting Preferred, BCM would be the beneficial
owner, prior to and after the offering, of 13.6% and 10.4%, respectively,
of the Company's outstanding Common Stock.
(6) Includes 398,133 shares held by Kleiner Perkins Caufield & Byers VII,
8,533 shares held by KPCB VII Founders Fund and 2,222 shares held by KPCB
Information Sciences Zaibatsu Fund II. KPCB VII Associates, an affiliate
of Kleiner Perkins Caufield & Byers, is general partner of each of these
entities. Excludes 1,141,987 shares of Common Stock issuable upon
conversion of Nonvoting Preferred. Assuming conversion of all outstanding
shares of Nonvoting Preferred, Kleiner Perkins Caufield & Byers would be
the beneficial owner, prior to and after the offering, of 13.6% and 10.0%,
respectively, of the Company's outstanding Common Stock.
(7) Includes 83,332 shares issuable upon exercise of stock options that are
currently exercisable or will become exercisable within 60 days after May
31, 1996. Also includes 408,889 shares held by Technology Partners and
408,888 shares beneficially owned by BCM. Messrs. Hart and Harvey may be
deemed to share voting or investment power with respect to the shares
owned by Technology Partners and BCM, respectively, but disclaim
beneficial ownership of these shares except to the extent of their
proportionate interest therein. See footnotes (4) and (5) above. Excludes
1,972,340 shares and 1,141,986 shares, respectively of Nonvoting Preferred
beneficially owned by Technology Partners and BCM. Assuming conversion of
all outstanding shares of Nonvoting Preferred, the Company's directors and
executive officers as a group would be deemed to be the beneficial owner,
prior to and after the offering, of 59.9% and 45.9%, respectively, of the
Company's outstanding Common Stock.
54
<PAGE>
DESCRIPTION OF CAPITAL STOCK
SGI has authorized capital of 50,000,000 shares of Common Stock, par value
$0.001 per share, and 6,884,473 shares of Preferred Stock, par value $0.001
per share.
COMMON STOCK
As of May 31, 1996, there were 7,119,638 shares of Common Stock outstanding
and held of record by approximately 155 shareholders, as adjusted to reflect
the conversion of the outstanding shares of Series A, B and C Redeemable
Preferred Stock upon the closing of the offering. The Company's Amended and
Restated Articles of Incorporation (the "Restated Articles") provide that
holders of Common Stock are entitled to one vote for each share on all matters
submitted to a vote of the holders of Common Stock. The holders of Common
Stock are entitled to receive such cash dividends, if any, as may be declared
by the Board of Directors out of legally available funds, subject to dividend
preferences of Nonvoting Preferred, as discussed below. Upon liquidation,
dissolution or winding up of the Company, after payment of all debts and
liabilities and after payment of the liquidation preferences described below
of all shares of Nonvoting Preferred then outstanding, the holders of the
Common Stock will be entitled to all assets that are legally available for
distribution. The disposition of all or substantially all of the Company's
assets, or a merger or consolidation of the Company after which the
shareholders of the Company immediately prior to such merger or consolidation
possess less than 50% equity ownership of the combined entity will be treated
as a liquidation, dissolution or winding up of the Company for such purpose.
All outstanding shares of Common Stock are fully paid and nonassessable.
PREFERRED STOCK
Upon the consummation of this offering, the shares of Series A, Series B and
Series C Preferred outstanding as of May 31, 1996, will be converted
automatically into 3,528,349 shares of Common Stock, while 6,384,473 shares of
Nonvoting Preferred will remain outstanding after this offering. All of such
shares of Nonvoting Preferred are fully paid and nonassessable. The Company
will also have an additional 500,000 authorized shares of Preferred Stock,
which may be issued from time to time in one or more series. The Board of
Directors has authority to issue the shares of Preferred Stock in one or more
series, to establish the number of shares to be included in each such series
and to fix the designation, powers, preferences and rights of the shares of
each such series and the qualifications, limitations or restrictions thereof,
without any further vote or action by the shareholders. The issuance of
Preferred Stock could decrease the amount of earnings and assets available for
distribution to holders of Common Stock or adversely affect the rights and
powers, including voting rights, of the holders of the Common Stock, and may
have the effect of delaying, deferring or preventing a change in control of
the Company. The Company has no present plans to issue any shares of Preferred
Stock after the consummation of this offering.
The Nonvoting Preferred has the following rights and preferences:
Voting. Except as required by law, the Nonvoting Preferred has no voting
rights.
Conversion. Each share of Nonvoting Preferred is convertible at the option
of the holder, upon at least 75 days' prior written notice to the Company,
into 0.6667 shares of Common Stock, subject to certain antidilution
adjustments described below. The number of shares of Common Stock into which
each share of Nonvoting Preferred may be converted is equal to the ratio of
the original purchase price of such share of Nonvoting Preferred to the
"conversion price" of such share (which is initially equal to the original
purchase price). The conversion price of each share is subject to adjustment
in proportion to any stock split, reverse stock split or similar event and is
also subject to downward adjustment pursuant to a weighted-average formula in
the event the Company effects a financing transaction in
55
<PAGE>
which it sells Common Stock or equivalents at a price per share less than such
conversion price as then in effect. The Nonvoting Preferred is currently
convertible into two shares of Common Stock for every three shares of
Nonvoting Preferred.
Dividend Preference. The holders of Nonvoting Preferred are entitled to
receive in any fiscal year, when and if declared by the Board of Directors,
out of any assets then legally available therefor, non-cumulative dividends at
the rate of $0.075 per share of Series A1 Redeemable Preferred Stock and
$0.114 per share of Series B1 Redeemable Preferred Stock, as adjusted for any
consolidations, combinations, stock distributions, stock dividends, stock
splits or similar events, before any dividends may be paid to the holders of
Common Stock in such fiscal year.
Liquidation Preference. In the event of any voluntary or involuntary
liquidation, dissolution or winding up of the Company, the assets and funds of
the Company available for distribution to shareholders shall be distributed
first to the holders of Nonvoting Preferred at the rate of $0.75 per share of
Series A1 Redeemable Preferred Stock and $1.14 per share of Series B1
Redeemable Preferred Stock, plus all declared but unpaid dividends, and then
ratably to the holders of Common Stock. In the event the assets to be
distributed are insufficient to satisfy the foregoing preferences, such assets
will be distributed pro rata on the basis of the total preference amount to
which each shareholder is entitled. The merger or consolidation of the Company
into or with another corporation in which the shareholders of the Company
shall own less than 50% of the voting securities of the surviving corporation,
or the sale, transfer or other disposition (but not including a transfer or
disposition by pledge or mortgage to a bona fide lender) of all or
substantially all of the assets of the Company, shall be deemed to be a
liquidation, dissolution or winding up of the Company for purposes of
triggering this liquidation preference.
Redemption. The Nonvoting Preferred is redeemable in three equal
installments at the option of the holders of a majority of the outstanding
Nonvoting Preferred, beginning any time on or after February 28, 2002, at a
price equal to the original purchase price of each share of Nonvoting
Preferred plus an amount equal to all declared but unpaid dividends.
WARRANTS
On October 31, 1995, the Company issued warrants to purchase 40,936 shares
of Common Stock (the "1995 Warrants") to an equipment lessor. All of the 1995
Warrants remained outstanding as of May 31, 1996. The 1995 Warrants have an
exercise price of $1.71 per share and expire on October 31, 2002.
The Company has issued warrants (the "1996 Warrants") to certain financial
advisors in connection with its Series C Preferred Stock financing. The 1996
Warrants are exercisable for 116,666 shares of Common Stock at an exercise
price of $7.50 per share.
In connection with this offering, the Company has agreed to issue warrants
to purchase an aggregate of 177,777 shares of Common Stock (the
"Representatives' Warrants") to Deutsche Morgan Grenfell/C. J. Lawrence Inc.,
Bear, Stearns & Co. Inc., Montgomery Securities and Oppenheimer & Co., Inc.
See "Underwriting."
REGISTRATION RIGHTS
The Company has granted to the holders of approximately 3,528,349 shares of
Common Stock, shares of Nonvoting Preferred that are convertible into
approximately 4,035,205 shares of Common Stock, the 1995 Warrants and the 1996
Warrants (the "Holders") certain rights with respect to the registration of
the shares of Common Stock held by such Holders or issuable upon conversion of
such shares of Nonvoting Preferred or exercise of such warrants ("Registrable
Shares") under the Securities Act of 1933, as amended (the "Securities Act").
Holders of at least 30% of the Registrable
56
<PAGE>
Shares then outstanding shall have the right, at any time after the earlier of
six months after the effective date of the Registration Statement of which
this Prospectus is a part or May 6, 1999, to require the Company, on not more
than two occasions, to file a registration statement covering such Registrable
Shares, provided that such registration covers at least 30% of the aggregate
number of Registrable Shares then outstanding or that such Registrable Shares
have an aggregate offering price of at least $5,000,000. In addition, the
Holders of an aggregate of at least 30% of the Registrable Shares not already
registered may require the Company to file a registration statement on Form S-
3 covering such Registrable Shares, at any time when the Company is entitled
to use such form, provided that such Registrable Shares have an aggregate
offering price of at least $500,000, and provided, further, that the Company
shall not be required to file such a registration statement more than twice in
any 12-month period. Any requested registration also shall be subject to the
Company's right to defer the registration under certain circumstances.
Finally, in the event the Company proposes to register any of its securities
under the Securities Act for its own account or for the account of other
security holders, the Holders are entitled to notice of such registration and
to include their Registrable Shares in such registration at the Company's
expense, subject to marketing and other limitations, provided that after the
Company's initial public offering the underwriters shall not reduce the number
of Registrable Shares included in such registration to fewer than 20% of all
shares included in such registration without the prior consent of at least a
majority of the Holders who have requested their shares to be included in such
registration and underwriting.
TRANSFER AGENT AND REGISTRAR
The Transfer Agent and Registrar for the Common Stock is Boston EquiServe.
57
<PAGE>
SHARES ELIGIBLE FOR FUTURE SALE
Upon completion of this offering, the Company will have outstanding
10,619,638 shares of Common Stock, assuming no exercise of the Underwriters'
over-allotment option and no exercise of outstanding options, and 6,384,473
shares of Nonvoting Preferred, which is convertible into shares of Common
Stock, at the rate of two shares of Common Stock for every three shares of
Nonvoting Preferred, upon 75 days' prior notice and therefore is not counted
in the calculation of beneficial ownership of Common Stock under the rules of
the Securities and Exchange Commission. Of these shares, the 3,500,000 shares
of Common Stock sold in this offering will be freely tradeable without
restriction under the Securities Act, unless purchased by "affiliates" of the
Company as that term is defined in Rule 144 under the Securities Act.
The remaining shares of Common Stock and Nonvoting Preferred outstanding
upon completion of this offering and any of the 4,256,315 shares of Common
Stock that may be issued upon exercise of Nonvoting Preferred will be
"restricted securities" as that term is defined in Rule 144 ("Restricted
Shares"). Restricted Shares may be sold in the public market only if
registered or if they qualify for an exemption from registration under Rules
144, 144(k) or 701 promulgated under the Securities Act, which are summarized
below. Sales of the Restricted Shares in the public market, or the
availability of such shares for sale, could adversely affect the market price
of the Common Stock.
Certain shareholders, including officers, directors and principal
shareholders of the Company, who together will own 7,119,638 shares of Common
Stock after this offering (representing all of the shares of Common Stock
outstanding immediately prior to this offering), have agreed to contractual
"lock-up" provisions set forth in agreements between such shareholders and the
Company and, in some cases, set forth in agreements between such shareholders
and Deutsche Morgan Grenfell/C. J. Lawrence Inc. providing that they will not
offer or sell any Common Stock until the expiration of 180 days following the
date of this Prospectus without the prior consent of the Company, Deutsche
Morgan Grenfell, or both. Of these shares, approximately 3,620,524 shares will
be available for immediate sale in the public market beginning 180 days after
the date of this Prospectus, subject in some cases to the volume and other
restrictions of Rule 144 or Rule 701 under the Securities Act. The foregoing
shareholders also have the right to acquire, upon conversion of shares of
Nonvoting Preferred as described above, an aggregate of 4,256,315 shares of
Common Stock, of which 221,110 shares would be available for immediate sale
beginning 180 days after the date of this Prospectus. Approximately 3,499,114
additional shares of outstanding Common Stock and 4,035,205 shares that are
issuable upon conversion of Nonvoting Preferred will become eligible for sale
following expiration of their two-year holding periods under Rule 144 or
vesting periods that may apply to restricted shares, which will expire from
January 1997 to May 2000.
In general, under Rule 144 as currently in effect, beginning 90 days after
the effective date of this offering a person (or persons whose shares are
aggregated) who has beneficially owned Restricted Shares for at least two
years (including the holding period of any prior owner except an affiliate)
would be entitled to sell within any three-month period a number of shares
that does not exceed the greater of: (i) one percent of the number of shares
of Common Stock then outstanding (which will equal approximately 106,196
shares immediately after this offering); or (ii) the average weekly trading
volume of the Common Stock during the four calendar weeks preceding the filing
of a Form 144 with respect to such sale. Sales under Rule 144 are also subject
to certain manner of sale provisions and notice requirements and to the
availability of current public information about the Company. Under Rule
144(k), a person who is not deemed to have been an affiliate of the Company at
any time during the 90 days preceding a sale, and who has beneficially owned
the shares proposed to be sold for at least three years (including the holding
period of any prior owner except an affiliate), is entitled to sell such
shares without complying with the manner of sale, public information, volume
limitation or notice provisions of Rule 144.
58
<PAGE>
In general, under Rule 701 as currently in effect, beginning 90 days after
the effective date of this offering, certain shares issued upon exercise of
options granted by the Company prior to the date of this Prospectus will also
be available for sale in the public market. Any employee, officer or director
of or consultant to the Company who purchased his or her shares pursuant to a
written compensatory plan or contract may be entitled to rely on the resale
provisions of Rule 701. Rule 701 permits affiliates to sell their Rule 701
shares under Rule 144 without complying with the holding period requirements
of Rule 144. Rule 701 further provides that non-affiliates may sell such
shares in reliance on Rule 144 without having to comply with the public
information, volume limitation or notice provision of Rule 144. In both cases,
a holder of Rule 701 shares is required to wait until 90 days after the date
of this Prospectus before selling such shares.
As of May 31, 1996, options to purchase a total of 449,667 shares of Common
Stock were outstanding under the 1994 Plan, of which options for 13,542 shares
were vested. All options are immediately exercisable, but all shares issued
upon exercise of unvested options are subject to repurchase by the Company
until such shares become vested. Upon expiration of the lock-up provisions 180
days after the effective date of this offering, holders of outstanding vested
options to purchase approximately 21,875 shares will be entitled to sell
shares issued upon exercise of such options. The Company intends to file a
registration statement under the Securities Act approximately 90 days after
the date of this Prospectus to register approximately 1,805,278 shares of
Common Stock issued or reserved for issuance under the Stock Plans.
Prior to this offering, there has been no public market for the Common Stock
of the Company and no predictions can be made as to the effect, if any, that
market sales of shares of Common Stock prevailing from time to time.
Nevertheless, sales of significant numbers of shares of the Common Stock in
the public market could adversely affect the market price of the Common Stock
and could impair the Company's future ability to raise capital through an
offering of its equity securities.
59
<PAGE>
UNDERWRITING
The underwriters named below (collectively, the "Underwriters"), for whom
Deutsche Morgan Grenfell/C. J. Lawrence Inc., Bear, Stearns & Co. Inc.,
Montgomery Securities and Oppenheimer & Co., Inc. are acting as
representatives (the "Representatives"), have severally agreed, subject to the
terms and conditions of the underwriting agreement with the Company (the
"Underwriting Agreement"), to purchase from the Company the number of shares
of Common Stock set forth opposite their respective names below:
<TABLE>
<CAPTION>
NUMBER
UNDERWRITER OF SHARES
----------- ---------
<S> <C>
Deutsche Morgan Grenfell/C. J. Lawrence Inc. ......................
Bear, Stearns & Co. Inc............................................
Montgomery Securities..............................................
Oppenheimer & Co., Inc. ...........................................
---------
Total............................................................ 3,500,000
=========
</TABLE>
The Underwriting Agreement provides that the obligations of the Underwriters
are subject to certain conditions precedent and that the Underwriters will
purchase all shares of Common Stock offered hereby if any such shares are
purchased.
The Company has been advised by the Representatives that the Underwriters
propose to offer the shares of Common Stock to the public at the initial
public offering price set forth on the cover page of this Prospectus. The
Representatives also have advised the Company that sales to certain dealers
that are the members of the National Association of Securities Dealers, Inc.,
may be made at such price less a concession of $ per share. After the
offering, the initial public offering price, concessions and other selling
terms may be varied by the Representatives. The Underwriters do not intend to
sell any of the shares of Common Stock offered hereby on a discretionary
basis.
The Company has granted an option to the Underwriters, exercisable not later
than 30 days after the date of this Prospectus, to purchase up to 525,000
additional shares of Common Stock at the initial public offering price, less
underwriting discounts and commissions. To the extent that the Underwriters
exercise such option, each of the Underwriters will have a firm commitment to
purchase approximately the same percentage thereof that the number of shares
of Common Stock to be purchased by it shown in the above table bears to total
number of shares offered hereby, and the Company will be obligated, pursuant
to the option, to sell such shares to the Underwriters. The Underwriters may
exercise such option only to cover over-allotments, if any, incurred in the
sale of shares of Common Stock offered hereby. The Underwriters will offer
such additional shares, if purchased, on the same terms as those on which the
3,500,000 shares are being offered hereby.
The Company has agreed to issue the Representatives' Warrants to Deutsche
Morgan Grenfell/ C. J. Lawrence Inc., Bear, Stearns & Co. Inc., Montgomery
Securities and Oppenheimer & Co., Inc. The Representatives' Warrants will be
exercisable for an aggregate of 177,777 shares of Common Stock at an exercise
price equal to $ (120% of the initial public offering price of the Common
Stock offered hereby). Alternatively, the Representatives' Warrants will be
convertible into a number of shares of Common Stock having a market value
equal to the spread between the exercise price and the then effective market
price of the shares of Common Stock issuable upon exercise of the
Representatives' Warrants. The Representatives' Warrants will be exercisable
or convertible for a period of four years beginning one year from the date of
this Prospectus. The Representatives' Warrants will be nontransferable except
to one of the Underwriters or to any individual who is either a
60
<PAGE>
partner or an officer of an Underwriter, or by will or the laws of descent and
distribution. Any profit realized by the holders of Representatives' Warrants
upon sale thereof or of the securities for which they may be exercised may be
deemed to be additional underwriting compensation. The Company has agreed to
maintain an effective registration statement at its expense to permit the sale
of the securities underlying the Representatives' Warrants at any time during
the period in which the Representatives' Warrants are exercisable.
Certain shareholders, including affiliates of the Company (as that term is
defined in the Securities Act), have agreed not to offer or sell any Common
Stock until the expiration of 180 days following the closing of this offering
without the prior written consent of Deutsche Morgan Grenfell/C. J. Lawrence
Inc.
The Underwriting Agreement provides for reciprocal indemnification and
contribution between the Company and its controlling persons, on the one hand,
and the Underwriters and their respective controlling persons, on the other
hand, against certain liabilities in connection with the Registration
Statement of which this Prospectus is a part, including liabilities under the
Securities Act.
Deutsche Morgan Grenfell/C. J. Lawrence Inc. acted as a co-manager of a
private placement of Series C Redeemable Preferred Stock of the Company and,
in connection with that placement is entitled to receive compensation
consisting of cash and warrants to purchase Common Stock. In addition, in
April 1996 certain senior investment banking, research and other executives of
Deutsche Morgan Grenfell/C. J. Lawrence Inc. purchased 30,000 shares of the
Series C Redeemable Preferred Stock on the same terms as those on which such
securities were offered to other investors in the Series C placement. These
shares will convert automatically into 20,000 shares of Common Stock upon the
completion of this offering. In May 1996, Oppenheimer & Co., Inc. purchased
from Robert M. Fell, a director of the Company, 150,000 shares of the
Company's Series A Redeemable Preferred Stock at a per share price equivalent
to that at which the Series C Redeemable Preferred Stock was purchased by
third party investors. These shares, which were subsequently purchased from
Oppenheimer & Co., Inc. by certain of its senior investment banking, research
and other executives, will convert automatically into 100,000 shares of Common
Stock upon the completion of this offering.
Prior to this offering, there has been no public market for the Common
Stock. The initial public offering price has been determined by negotiation
between the Company and the Representatives. The principal factors considered
in determining the public offering price included the information set forth in
this Prospectus and otherwise available to the Representatives; the history
and the prospects for the industry in which the Company will compete; the
ability of the Company's management; the prospectus for future earnings of the
Company; the present state of the Company's development and its current
financial condition; the general condition of the securities markets at the
time of the offering; and the recent market prices of, and the demand for,
publicly traded common stock of generally comparable companies. Each of the
Representatives has informed the Company that it currently intends to make a
market in the shares subsequent to the effectiveness of this offering, but
there can be no assurance that the Representatives will take any action to
make a market in any securities of the Company.
61
<PAGE>
LEGAL MATTERS
The validity of the Common Stock offered hereby and general corporate legal
matters will be passed upon for the Company by Gray Cary Ware & Freidenrich, A
Professional Corporation, Palo Alto, California. Stoel Rives LLP, Portland,
Oregon is acting as counsel for the Underwriters in connection with certain
legal matters relating to the sale of the Common Stock offered hereby. The
validity of the statements as to matters of law and legal conclusion
concerning Colorado regulatory matters included under the caption "Business--
Gaming Regulation and Licensing--Colorado Regulatory Matters" in this
Prospectus have been passed upon by Brownstein, Hyatt, Farber & Strickland,
P.C., Denver, Colorado, Colorado gaming counsel for the Company.
EXPERTS
The consolidated financial statements of Silicon Gaming, Inc. as of March
31, 1995 and December 31, 1995, for the period from inception (July 27, 1993)
through March 31, 1994, the year ended March 31, 1995 and the nine months
ended December 31, 1995 included in this Prospectus have been audited by
Deloitte & Touche LLP, independent auditors, as stated in their report
appearing herein, and are included in reliance upon the report of such firm
given upon their authority as experts in accounting and auditing.
The statements as to matters of law and legal conclusion concerning Nevada
gaming laws included under the caption "Business--Gaming Regulation and
Licensing--Nevada Regulatory Matters" have been prepared by Lionel Sawyer &
Collins, Las Vegas, Nevada, Nevada gaming counsel for the Company, and are
included in reliance upon such firm as experts in the gaming laws of the state
of Nevada. Certain partners of Lionel, Sawyer & Collins own an aggregate of
30,000 shares of the Company's Common Stock.
The statements as to matters of law and legal conclusions concerning
Missouri gaming laws included under the caption "Business--Gaming Regulation
and Licensing--Missouri Regulatory Matters" have been prepared by Green,
Schaaf & Margo, P.C., St. Louis, Missouri, Missouri gaming counsel for the
Company, and are included in reliance upon such firm as experts in the gaming
laws of the state of Missouri.
The statements as to matters of law and legal conclusions concerning New
Jersey gaming laws included under the caption "Business--Gaming Regulation and
Licensing--New Jersey Regulatory Matters" have been prepared by Horn,
Goldberg, Gorny, Daniels, Plackter, Weiss & Casiello, Atlantic City, New
Jersey, New Jersey gaming counsel for the Company, and are included in
reliance upon such firm as experts in the gaming laws of the state of New
Jersey.
The statements as to matters of law and legal conclusions concerning
Mississippi gaming laws included under the caption "Business--Gaming
Regulation and Licensing--Mississippi Regulatory Matters" have been prepared
by Waycaster & Warren, Jackson, Mississippi, Mississippi gaming counsel for
the Company, and are included in reliance upon such firm as experts in the
gaming laws of the state of Mississippi.
62
<PAGE>
CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL
DISCLOSURE
In November 1995, the Company engaged Deloitte & Touche LLP ("Deloitte") as
its independent auditor and dismissed its former auditor, Coopers & Lybrand
L.L.P. ("Coopers"). The decision to change auditors was approved by the
Company's Board of Directors. Since the Company's inception, there has been no
auditors' report on the Company's financial statements containing an adverse
opinion or disclaimer of opinion or that was qualified or modified as to
uncertainty, audit scope or accounting principles. During such period, there
were no disagreements with Coopers on any matter of accounting principle or
practice, financial statement disclosure or auditing scope or procedure, which
disagreements, if not resolved to Coopers' satisfaction, would have caused it
to make reference to the subject matter of the disagreements in connection
with its report. Further, during this period, there were no events of the type
required to be reported pursuant to Item 304(a)(1)(v) of Regulation S-K.
During the period from inception through November 1, 1995, the Company did not
consult Deloitte on items that involved either the Company's accounting
principle or the form of its audit opinion.
ADDITIONAL INFORMATION
The Company has filed with the Securities and Exchange Commission a
Registration Statement (which term shall include any amendments thereto) on
Form S-1 under the Securities Act with respect to the Units offered hereby.
This Prospectus, which constitutes a part of the Registration Statement, does
not contain all of the information set forth in the Registration Statement,
certain items of which are contained in exhibits to the Registration Statement
as permitted by the rules and regulations of the Commission. For further
information with respect to the Company and the Common Stock offered hereby,
reference is made to the Registration Statement, including the exhibits
thereto, and the financial statements and notes filed as a part thereof.
Statements made in this Prospectus concerning the contents of any document
referred to herein are not necessarily complete. With respect to each such
document filed with the Commission as an exhibit to the Registration
Statement, reference is made to the exhibit for a more complete description of
the matter involved. The Registration Statement, including the exhibits
thereto and the financial statements and notes filed as a part thereof, as
well as such reports and other information filed with the Commission, may be
inspected without charge at the public reference facilities maintained by the
Commission at 450 Fifth Street, N.W., Washington, D.C. 20549 and at the
regional offices of the Commission located at Seven World Trade Center, 13th
Floor, New York, New York 10048 and Northwestern Atrium Center, 500 West
Madison Street, Suite 1400, Chicago, Illinois 60661. Copies of all or any part
thereof may be obtained from the Commission upon the payment of certain fees
prescribed by the Commission.
The Company intends to furnish to its shareholders annual reports containing
consolidated financial statements audited by an independent public accounting
firm and quarterly reports for the first three quarters of each fiscal year
containing unaudited consolidated financial information.
63
<PAGE>
SILICON GAMING, INC.
INDEX TO FINANCIAL STATEMENTS
<TABLE>
<CAPTION>
PAGE
----
<S> <C>
Independent Auditors' Report............................................... F-2
Balance Sheets............................................................. F-3
Statements of Operations................................................... F-4
Statements of Shareholders' Deficiency..................................... F-5
Statements of Cash Flows................................................... F-6
Notes to Consolidated Financial Statements................................. F-7
</TABLE>
F-1
<PAGE>
INDEPENDENT AUDITORS' REPORT
To the Board of Directors and
Shareholders of Silicon Gaming, Inc.:
We have audited the accompanying balance sheets of Silicon Gaming, Inc. (a
development stage company) as of March 31, 1995 and December 31, 1995, and the
related statements of operations, shareholders' deficiency and cash flows for
the period from inception (July 27, 1993) through March 31, 1994, the year
ended March 31, 1995 and the nine months ended December 31, 1995. These
financial statements are the responsibility of the Company's management. Our
responsibility is to express an opinion on these financial statements based on
our audits.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to
obtain reasonable assurance about whether the financial statements are free of
material misstatement. An audit includes examining, on a test basis, evidence
supporting the amounts and disclosures in the financial statements. An audit
also includes assessing the accounting principles used and significant
estimates made by management, as well as evaluating the overall financial
statement presentation. We believe that our audits provide a reasonable basis
for our opinion.
In our opinion, such financial statements present fairly, in all material
respects, the financial position of Silicon Gaming, Inc. at March 31, 1995 and
December 31, 1995, and the results of its operations and its cash flows for
the periods stated above in conformity with generally accepted accounting
principles.
San Jose, California February 9, 1996 ( as to Note 10)
----------------
To the Board of Directors and Shareholders of Silicon Gaming, Inc.:
The financial statements included herein have been adjusted to give effect
to the two-for-three reverse common stock split as described in the last
paragraph of Note 10 to the financial statements. The above report is in the
form that will be signed by Deloitte & Touche LLP upon the effectiveness of
such events assuming that from June 12, 1996 to the effective date of such
event, no other events shall have occurred that would affect the accompanying
financial statements or notes thereto.
Deloitte & Touche LLP
San Jose, California June 12, 1996
F-2
<PAGE>
SILICON GAMING, INC.
(A DEVELOPMENT STAGE COMPANY)
CONSOLIDATED BALANCE SHEETS
(IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
<TABLE>
<CAPTION>
MARCH 31, DECEMBER 31,
1995 1995 MARCH 31, 1996
--------- ------------ --------------------
ACTUAL PRO FORMA
------- -----------
(UNAUDITED)
<S> <C> <C> <C> <C>
ASSETS
CURRENT ASSETS:
Cash and equivalents......... $ 241 $ 2,399 $ 7,657 14,866
Prepaids and other........... 28 292 202 202
------- ------- ------- -------
Total current assets....... 269 2,691 7,859 15,068
PROPERTY AND EQUIPMENT, Net.... 211 734 1,217 1,217
OTHER ASSETS, Net.............. 6 61 54 54
------- ------- ------- -------
TOTAL.......................... $ 486 $ 3,486 $ 9,130 $16,339
======= ======= ======= =======
LIABILITIES AND SHAREHOLDERS'
DEFICIENCY
CURRENT LIABILITIES:
Accounts payable............. $ 37 $ 365 $ 430 $ 430
Payable to related party..... 37 5 -- --
Accrued liabilities.......... 148 239 134 134
Current portion of capital
lease obligations........... -- 55 141 141
Notes payable to sharehold-
ers......................... 1,300 -- -- --
------- ------- ------- -------
Total current liabilities.. 1,522 664 705 705
------- ------- ------- -------
CAPITAL LEASE OBLIGATIONS...... -- 272 706 706
------- ------- ------- -------
COMMITMENTS (Notes 4 and 5)
REDEEMABLE CONVERTIBLE PRE-
FERRED STOCK--
20,192,802 shares authorized;
shares outstanding: March
31, 1995--1,349,998; Decem-
ber 31, 1995--8,534,997;
March 31, 1996--10,134,997;
March 31, 1996 pro forma--
6,384,473................... 967 8,496 15,996 6,455
------- ------- ------- -------
SHAREHOLDERS' DEFICIENCY:
Common stock, $.001 par val-
ue; 16,666,667 shares autho-
rized; shares outstanding:
March 31, 1995--2,000,000;
December 31, 1995--
2,737,989; March 31, 1996--
3,591,289; March 31, 1996
pro forma--7,119,638........ 3 109 233 16,983
Notes receivable from share-
holders..................... -- (75) (194) (194)
Deficit accumulated during
the development stage....... (2,006) (5,980) (8,316) (8,316)
------- ------- ------- -------
Total shareholders'
deficiency................ (2,003) (5,946) (8,277) 8,473
------- ------- ------- -------
TOTAL.......................... $ 486 $ 3,486 $ 9,130 $16,339
======= ======= ======= =======
</TABLE>
See notes to consolidated financial statements.
F-3
<PAGE>
SILICON GAMING, INC.
(A DEVELOPMENT STAGE COMPANY)
CONSOLIDATED STATEMENTS OF OPERATIONS
(IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
<TABLE>
<CAPTION>
CUMULATIVE
PERIOD FROM FROM
INCEPTION INCEPTION
(JULY 27, THREE MONTHS (JULY 27,
1993) YEAR NINE MONTHS ENDED 1993)
THROUGH ENDED ENDED ----------------------- THROUGH
MARCH 31, MARCH 31, DECEMBER 31, JUNE 30, MARCH 31, MARCH 31,
1994 1995 1995 1995 1996 1996
----------- --------- ------------ ----------- ----------- -----------
(UNAUDITED) (UNAUDITED) (UNAUDITED)
<S> <C> <C> <C> <C> <C> <C>
OPERATING EXPENSES:
Research and
development.......... $ 79 $1,539 $3,137 $ 584 $1,595 $6,350
Selling, general and
administrative....... 61 312 922 168 742 2,037
---- ------ ------ ------ ------ ------
Loss from
operations......... 140 1,851 4,059 752 2,337 8,387
Interest income....... -- (7) (85) (17) (13) (105)
Interest expense...... -- 22 -- 12 34
---- ------ ------ ------ ------ ------
NET LOSS................ $140 $1,866 $3,974 $ 735 $2,336 $8,316
==== ====== ====== ====== ====== ======
PRO FORMA NET LOSS PER
COMMON SHARE........... $ (.50) $ (.10) $ (.27)
====== ====== ======
SHARES USED IN COMPUTING
PRO FORMA PER SHARE
DATA................... 8,023 7,667 8,803
====== ====== ======
</TABLE>
See notes to consolidated financial statements.
F-4
<PAGE>
SILICON GAMING, INC.
(A DEVELOPMENT STAGE COMPANY)
CONSOLIDATED STATEMENTS OF SHAREHOLDERS' DEFICIENCY
PERIOD FROM INCEPTION (JULY 27, 1993) THROUGH MARCH 31, 1996
(IN THOUSANDS, EXCEPT SHARE AND PER SHARE AMOUNTS)
<TABLE>
<CAPTION>
DEFICIT
NOTE ACCUMULATED
COMMON STOCK RECEIVABLE DURING THE
---------------- FROM DEVELOPMENT
SHARES AMOUNT SHAREHOLDERS STAGE TOTAL
--------- ------ ------------ ----------- -------
<S> <C> <C> <C> <C> <C>
September 1993--Sale of
common stock to founders at
$.001 per share ........... 2,000,000 $ 3 $ (1) $ 2
Net loss.................... $ (140) (140)
--------- ---- ----- ------- -------
BALANCES, March 31, 1994.... 2,000,000 3 (1) (140) (138)
Collection of notes receiv-
able....................... 1 1
Net loss.................... (1,866) (1,866)
--------- ---- ----- ------- -------
BALANCES, March 31, 1995.... 2,000,000 3 -- (2,006) (2,003)
Options exercised during the
year for cash and notes
receivable................. 716,222 77 (75) 2
Common stock and warrants
issued to employees and
vendors for services at
$.18 per share............. 21,767 4 4
Warrants issued to vendors.. 25 25
Net loss.................... (3,974) (3,974)
--------- ---- ----- ------- -------
BALANCES, December 31,
1995....................... 2,737,989 109 (75) (5,980) (5,946)
Options exercised for cash
and notes receivable*...... 845,167 122 (119) 3
Common stock issued to
vendors for services at
$.25 per share*............ 8,133 2 2
Net loss*................... (2,336) (2,336)
--------- ---- ----- ------- -------
BALANCES, March 31, 1996*... 3,591,289 $233 $(194) $(8,316) $(8,277)
========= ==== ===== ======= =======
</TABLE>
- --------
* Unaudited
See notes to consolidated financial statements.
F-5
<PAGE>
SILICON GAMING, INC.
(A DEVELOPMENT STAGE COMPANY)
CONSOLIDATED STATEMENTS OF CASH FLOWS
(IN THOUSANDS)
<TABLE>
<CAPTION>
CUMULATIVE
PERIOD FROM FROM
INCEPTION INCEPTION
(JULY 27, THREE MONTHS (JULY 27,
1993) YEAR NINE MONTHS ENDED 1993)
THROUGH ENDED ENDED ----------------------- THROUGH
MARCH 31, MARCH 31, DECEMBER 31, JUNE 30, MARCH 31, MARCH 31,
1994 1995 1995 1995 1996 1996
----------- --------- ------------ ----------- ----------- -----------
(UNAUDITED) (UNAUDITED) (UNAUDITED)
<S> <C> <C> <C> <C> <C> <C>
CASH FLOWS FROM
OPERATING ACTIVITIES:
Net loss.............. $(140) $(1,866) $(3,974) $ (735) $(2,336) $(8,316)
Reconciliation to net
cash used in
operating activities:
Depreciation and
amortization......... 1 47 136 26 105 289
Deferred rent......... -- -- -- -- 32 32
Common stock issued
for services......... -- -- 4 -- 2 6
Accrued interest
exchanged for
preferred stock...... -- -- 10 -- -- 10
Changes in assets and
liabilities:
Prepaids and other... -- (28) (264) (1) 90 (202)
Other assets, net.... (5) (2) (30) 2 7 (30)
Accounts payable..... 10 27 328 218 65 430
Payable to related
party............... 43 (6) (32) (37) (5) --
Accrued liabilities.. 16 132 91 (125) (105) 134
----- ------- ------- ------ ------- -------
Net cash used in
operating
activities......... (75) (1,696) (3,731) (652) (2,145) (7,647)
----- ------- ------- ------ ------- -------
CASH FLOWS FROM
INVESTING ACTIVITIES--
Acquisition of
property and
equipment............ (27) (231) (659) (55) (586) (1,503)
----- ------- ------- ------ ------- -------
CASH FLOWS FROM
FINANCING ACTIVITIES:
Sale of redeemable
convertible preferred
stock, net of
issuance costs....... -- 967 5,457 -- 7,499 13,923
Sale of common stock,
net of notes
receivable........... 2 -- 2 2 2 6
Collection of note
receivable........... -- 1 12 13 13
Proceeds from notes
payable to
shareholders......... 136 1,300 750 500 2,186
Payment on notes
payable to
shareholders......... -- (136) -- -- (136)
Proceeds from
sale/leaseback of
property and
equipment............ -- -- 333 -- 508 841
Repayment of capital
lease obligation..... -- -- (6) -- (20) (26)
----- ------- ------- ------ ------- -------
Net cash provided by
financing
activities......... 138 2,132 6,548 515 7,989 16,807
----- ------- ------- ------ ------- -------
NET INCREASE (DECREASE)
IN CASH AND
EQUIVALENTS........... 36 205 2,158 (192) 5,258 7,657
CASH AND EQUIVALENTS:
Beginning of period... -- 36 241 241 2,399 --
----- ------- ------- ------ ------- -------
End of period......... $ 36 $ 241 $ 2,399 $ 49 $ 7,657 $ 7,657
===== ======= ======= ====== ======= =======
SUPPLEMENTARY
DISCLOSURES OF CASH
FLOW INFORMATION--
Cash paid during the
period for interest.. $ -- $ 1 $ 11 $ -- $ -- $ 12
===== ======= ======= ====== ======= =======
NONCASH INVESTING AND
FINANCING ACTIVITIES:
Issuance of common and
preferred stock for
note receivable...... $ 1 $ 25 $ 75 $ -- $ 119 $ 220
===== ======= ======= ====== ======= =======
Cancellation of
preferred stock and
related noted
receivable........... $ -- $ -- $ 12 $ 12 $ -- $ 12
===== ======= ======= ====== ======= =======
Conversion of note
payable to
shareholder to
preferred stock...... $ -- $ -- $ 2,050 $1,250 $ -- $ 2,050
===== ======= ======= ====== ======= =======
Issuance of common
warrants............. $ -- $ -- $ 25 $ -- $ -- $ 25
===== ======= ======= ====== ======= =======
</TABLE>
See notes to consolidated financial statements.
F-6
<PAGE>
SILICON GAMING, INC.
(A DEVELOPMENT STAGE COMPANY)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(INFORMATION AS OF MARCH 31, 1996, FOR THE THREE-MONTH PERIODS
ENDED JUNE 30, 1995 AND MARCH 31, 1996, AND CUMULATIVE IS UNAUDITED.)
1. BUSINESS AND SIGNIFICANT ACCOUNTING POLICIES
Business--Silicon Gaming, Inc. (the Company) was incorporated on July 27,
1993 to develop and market innovative gaming devices through the use of
advanced multimedia and interactive technologies.
As of December 31, 1995, the Company was a development stage company.
Successful completion of the Company's development program and, ultimately,
the attainment of profitable operations is dependent upon future events,
including obtaining adequate financing to fulfill its development activities,
obtaining regulatory approval of its products, and achieving a level of sales
adequate to support the Company's cost structure.
Fiscal Year End--Effective April 1, 1995, the Company changed its fiscal
year end to December 31 from March 31. Accordingly, the period ended December
31, 1995 is a nine-month period.
Consolidation--The consolidated financial statements include the Company and
its wholly owned subsidiaries (formed in February 1996) after elimination of
intercompany accounts and transactions.
Estimates--The preparation of financial statements in conformity with
generally accepted accounting principles requires management to make estimates
and assumptions that affect the reported amounts of assets and liabilities and
disclosure of contingent assets and liabilities at the date of the financial
statements and the reported amounts of revenues and expenses during the
reporting period. Actual results could differ from those estimates.
Cash Equivalents--The Company considers all highly liquid debt instruments
purchased with an original maturity of three months or less to be cash
equivalents.
Property and Equipment--Property and equipment are stated at cost.
Depreciation and amortization are computed using the straight-line method over
estimated useful lives of three to five years.
Research and Development Expenses--Research and development expenses are
charged to operations as incurred. In connection with the Company's product
development efforts, it develops software applications which are integral to
the operation of the product. The costs to develop such software have not been
capitalized as the Company believes its current software development
process is essentially completed concurrent with the establishment of
technological feasibility and/or development of the related hardware.
Income Taxes--The Company accounts for income taxes in accordance with
Statement of Financial Accounting Standards No. 109, "Accounting for Income
Taxes," which requires an asset and liability approach for financial reporting
of income taxes.
Pro Forma Net Loss Per Share--In connection with the filing by the Company
of a Registration Statement with the Securities and Exchange Commission (SEC)
for a proposed offering of Common Stock (See Note 10), certain shares of
Redeemable Preferred Stock will automatically convert to 3,528,349 shares of
Common Stock. During the twelve-month period prior to the filing of this
Registration Statement, the Company has sold Redeemable Convertible Preferred
Stock and issued
F-7
<PAGE>
SILICON GAMING, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
(INFORMATION AS OF MARCH 31, 1996, FOR THE THREE-MONTH PERIODS
ENDED JUNE 30, 1995 AND MARCH 31, 1996, AND CUMULATIVE IS UNAUDITED.)
options and warrants to purchase Preferred and Common stock at prices less
than the initial filing price. Accordingly, the Company has included pro forma
net loss per share information as it believes this information is the most
meaningful under the circumstances. Pro forma net loss per share is presented
for the most recent fiscal year and interim period and is based on (i) the
weighted average number of shares of Common Stock outstanding; (ii) the
weighted average number of shares of Redeemable Convertible Preferred Stock
issued more than one year prior to the filing date on an as-converted basis
and (iii) all Redeemable Convertible Preferred Stock issued, Common Stock
issued and options and warrants to purchase shares of Common and Preferred
Stock granted during the twelve-month period preceding the filing date which,
under the Rules and Regulations of the SEC, must be considered outstanding
(using the treasury stock method at the assumed offering price) for all
periods presented.
Pro Forma Balance Sheet--The unaudited pro forma balance sheet gives effect
to the April and May 1996 sale of 1,542,000 shares of Series C Redeemable
Preferred Stock for cash and other consideration, the subsequent conversion of
1,998,332 shares of Series A and 4,386,141 shares of Series B Redeemable
Preferred Stock on a one-for-one basis into Series A1 and Series B1 Redeemable
Preferred Stock, respectively, and the conversion upon the completion of the
offering of all outstanding shares of Redeemable Preferred Stock, other than
Series A1 and Series B1 Redeemable Preferred Stock, into 3,528,349 shares of
Common Stock. --See Note 10.
Recently Issued Accounting Standard--In October 1995, the Financial
Accounting Standards Board issued Statement No. 123, "Accounting for Stock-
Based Compensation." The new standard defines a fair value method of
accounting for stock options and other equity instruments, such as stock
purchase plans. Under this method, compensation cost is measured based on the
fair value of the stock award when granted and is recognized as an expense
over the service period, which is usually the vesting period. This standard
will be effective for the Company beginning in 1996, and requires measurement
of awards made beginning in 1995. The new standard permits companies to
continue to account for equity transactions with employees under existing
accounting rules, but requires disclosure in a note to the financial
statements of the pro forma net income and earnings per share as if the
company had applied the new method of accounting. The Company intends to
follow these disclosure requirements for its employee stock plans. As a
result, adoption of the new standard will not impact reported earnings or
earnings per share, and will have no effect on the Company's cash flows.
Interim Financial Statements (Unaudited)--The accompanying balance sheet as
of March 31, 1996, statement of shareholders' deficiency for the three-month
period ended March 31, 1996, and the statements of operations and cash flows
for the three-month periods ended June 30, 1995, March 31, 1996, and
cumulative are unaudited. In the opinion of management, these financial
statements have been prepared on the same basis as the audited financial
statements and include all adjustments, consisting only of normal recurring
adjustments and accruals, necessary for the fair presentation of the financial
position and operating results as of such date and for such periods. The
information disclosed in these notes to financial statements related to these
periods is unaudited.
F-8
<PAGE>
SILICON GAMING, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
(INFORMATION AS OF MARCH 31, 1996, FOR THE THREE-MONTH PERIODS
ENDED JUNE 30, 1995 AND MARCH 31, 1996, AND CUMULATIVE IS UNAUDITED.)
2. PROPERTY AND EQUIPMENT
Property and equipment consists of:
<TABLE>
<CAPTION>
MARCH 31, DECEMBER 31, MARCH 31,
1995 1995 1996
--------- ------------ ---------
(IN THOUSANDS)
<S> <C> <C> <C>
Furniture and fixtures.. $ 37 $ 57 $ 230
Office equipment........ 52 79 95
Computer equipment...... 169 781 1,099
Leasehold improvements.. -- -- 76
---- ----- ------
258 917 1,500
Accumulated depreciation
and amortization....... (47) (183) (283)
---- ----- ------
$211 $ 734 $1,217
==== ===== ======
</TABLE>
3. NOTES PAYABLE TO SHAREHOLDER
At March 31, 1995, the Company had $1,300,000 of notes payable to
shareholders which bore interest at 10% per annum with principal and interest
due in fiscal 1996. In conjunction with obtaining the notes, the Company
issued a warrant to purchase 125,000 shares of its common stock for $0.07 per
share. In June 1995, $1,250,000 of the notes payable were converted to Series
A redeemable convertible preferred stock and the warrant was canceled. Between
April and August 1995, the Company borrowed an additional $750,000 from
existing shareholders, evidenced by notes payable bearing interest at 10% with
principal and interest payable on demand. In August 1995, the remaining
$800,000 notes payable and $10,000 of accrued interest were converted to
Series B redeemable convertible preferred stock.
4. COMMITMENTS
As of December 31, 1995, the Company had entered into two agreements to
license patented core technologies and product development services essential
to the development and production of the Company's product. In connection with
these agreements, upon meeting certain product development milestones (as
defined), the Company is obligated to pay license and development fees
totaling $770,000, of which $140,000 and $560,000 had been paid and $35,000
and $57,000 was included in accrued liabilities as of March 31, 1995 and
December 31, 1995, respectively. These costs have been expensed as incurred.
5. LEASES
In October 1995, the Company obtained a lease line of credit to acquire up
to $1,000,000 of equipment under capital leases with a term of 48 months. The
Company granted the leasing company a warrant to purchase 61,404 shares of its
Series B preferred stock at a price of $1.14 per share; such warrant expires
in the year 2002 and may be net-exercised by the holder. The estimated fair
value of the warrant, $25,000, has been recorded as a deferred financing cost
in other assets, and will be amortized over the term of the related leases. In
December 1995, the Company entered into a sale/leaseback arrangement under
this lease line for equipment with an original cost of $333,000; no gain or
loss was recorded on this transaction. In addition, $508,000 of equipment was
subject to sale/leaseback arrangements in the three-month period ended March
31, 1996.
In September 1995, the Company entered into a lease agreement for new
facilities which it expects to occupy in February 1996. The lease expires in
2006 and requires the Company to incur at least $175,000 for net leasehold
improvements in the first three years of occupancy. The Company has found a
sublessee for its current facility.
F-9
<PAGE>
SILICON GAMING, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
(INFORMATION AS OF MARCH 31, 1996, FOR THE THREE-MONTH PERIODS
ENDED JUNE 30, 1995 AND MARCH 31, 1996, AND CUMULATIVE IS UNAUDITED.)
Future minimum operating and capital lease commitments at December 31, 1995
are as follows:
<TABLE>
<CAPTION>
OPERATING CAPITAL
LEASES LEASE
--------- -------
(IN THOUSANDS)
<S> <C> <C>
1996....................................................... $ 304 $ 84
1997....................................................... 299 101
1998....................................................... 299 112
1999....................................................... 422 103
2000....................................................... 445 --
Thereafter................................................. 2,575 --
------ ----
Total minimum lease payments............................... $4,344 400
======
Amount representing interest............................... (73)
----
Present value of lease payments............................ 327
Current portion............................................ (55)
----
Long-term portion.......................................... $272
====
</TABLE>
Total rent expense (including prorated common area maintenance charges and
utilities) for the period from inception through March 31, 1994, the year
ended March 31, 1995, the nine-month period ended December 31, 1995 and the
three-month period ended March 31, 1996 was $4,000, $49,000, $58,000 and
$117,000, respectively.
6. REDEEMABLE CONVERTIBLE PREFERRED STOCK
Redeemable convertible preferred stock consists of:
<TABLE>
<CAPTION>
AMOUNT, NET
OF NOTES
DESIGNATED OUTSTANDING RECEIVABLE
---------- ----------- --------------
(IN THOUSANDS)
<S> <C> <C> <C>
Series A:
Issued May 1994 at $.75 per share for
cash.................................. 2,999,997 1,299,998 $ 967
Issued October 1994 at $.75 for notes.. 50,000 --
---------- -------
Balances, March 31, 1995................. 1,349,998 967
Cancellation of shares and note in June
1995.................................. (16,667) --
Collection of notes receivable......... 12
Conversion of notes payable at $.75 per
share in June 1995.................... 1,666,666 1,250
---------- -------
Balance, Series A........................ 2,999,997 2,229
Series A1, designated and unissued....... 2,999,997 -- --
Series B--
Issued August 1995 at $1.14 per share
for cash and conversion of $800,000
notes payable and related accrued
interest.............................. 5,596,404 5,535,000 6,267
Series B1, designated and unissued....... 5,596,404 -- --
---------- -------
Balances, December 31, 1995.............. 8,534,997 8,496
Series C (see Note 10)--
Issued March 1996 at $5.00 per share
for cash.............................. 3,000,000 1,600,000 7,500
---------- ---------- -------
Balances, March 31, 1996................. 20,192,802 10,134,997 $15,996
========== ========== =======
</TABLE>
F-10
<PAGE>
SILICON GAMING, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
(INFORMATION AS OF MARCH 31, 1996, FOR THE THREE-MONTH PERIODS
ENDED JUNE 30, 1995 AND MARCH 31, 1996, AND CUMULATIVE IS UNAUDITED.)
Significant terms of the Series A and B redeemable convertible preferred
stock are as follows:
. Each share of Series A and B redeemable preferred stock is convertible
into 0.6667 shares of common stock (subject to adjustment for anti-
dilution) at the election of the holder. Such conversion shall be
automatic in the event of an initial public offering of stock meeting
certain criteria.
. Each share of Series A and B redeemable preferred stock is convertible at
any time into one share of Series A1 and B1 redeemable preferred stock,
respectively, at the option of the holder.
. Each share of Series A and Series B redeemable preferred stock has voting
rights equivalent to the number of shares of common stock into which it
is convertible. Shares of Series A1 and B1 redeemable preferred stock
have no voting rights except as required by law.
. At any time after August 2000, the holders of a majority of the then
outstanding shares of preferred stock may require the Company to redeem
for cash the preferred shares outstanding over a three-year period at a
per share purchase price equal to the original issue price (subject to
certain anti-dilution adjustments) plus all declared but unpaid dividends
on such shares. The Company shall redeem the shares of preferred stock
ratably from the preferred shareholders of record on that date.
. Dividends may be declared at the discretion of the Board of Directors and
are noncumulative. To the extent declared, dividends of $0.075 per share
for Series A and A1 and $0.114 per share for Series B and B1 redeemable
preferred stock must be paid prior to any dividends on common stock. No
dividends have been declared through December 31, 1995.
. In the event of liquidation, dissolution or winding up of the Company,
the preferred shareholders shall receive the initial issue price per
share plus all declared but unpaid dividends. If the assets and funds to
be distributed are insufficient to permit full payment, then the funds
shall be distributed on a pro rata basis. Upon completion of this
distribution, the holders of the common stock will receive a pro rata
distribution of any remaining assets of the Company.
. Holders of the preferred stock have certain registration rights.
7. COMMON STOCK
Common stock was reserved for issuance as follows:
<TABLE>
<CAPTION>
DECEMBER 31, MARCH 31,
1995 1996
------------ ---------
<S> <C> <C>
Conversion of outstanding redeemable convertible
preferred stock................................... 5,689,998 6,756,664
Issuable under stock purchase warrants (see Notes 5
and 10)........................................... 40,936 274,269
Stock Option Plan.................................. 1,340,445 495,278
--------- ---------
7,071,379 7,526,211
========= =========
</TABLE>
Stock Option Plan
Under the 1994 Stock Option Plan (the "1994 Option Plan"), the Company may
grant incentive or nonstatutory stock options. Up to 2,056,667 shares of
common stock have been authorized for issuance under the 1994 Option Plan. The
1994 Option Plan allows the Company to grant incentive stock options and
nonstatutory stock options to key employees, directors and consultants at not
less
F-11
<PAGE>
SILICON GAMING, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
(INFORMATION AS OF MARCH 31, 1996, FOR THE THREE-MONTH PERIODS
ENDED JUNE 30, 1995 AND MARCH 31, 1996, AND CUMULATIVE IS UNAUDITED.)
than the fair market value at the date of grant as determined by the Board of
Directors. Nonstatutory options may be granted at prices ranging from 85% to
110% of fair market value at the date of grant. The options generally expire
five to ten years from the date of grant. Incentive stock options and
nonstatutory options normally vest at a rate of 25% on the first anniversary
of the grant date and 1/48 per month thereafter but may be exercised at any
time, subject to the Company's right to repurchase unvested shares at the
original exercise price upon termination. During the nine-month period ended
December 31, 1995, employees exercised options in exchange for notes payable
to the Company of $75,000. Of the 693,333 exercised shares, 562,536 shares
were not vested at December 31, 1995. (As of March 31, 1996, of the 1,043,703
exercised shares, 925,750 shares were not vested.)
Details of option activity under the Plan are as follows:
<TABLE>
<CAPTION>
NUMBER
OF EXERCISE
SHARES PRICE TOTAL
--------- ----------- ---------
<S> <C> <C> <C>
Granted....................................... 406,667 $0.11 $ 42,700
--------- ---------
Outstanding March 31, 1995.................... 406,667 $0.11 42,700
Granted....................................... 1,096,333 $0.11-$0.17 141,255
Exercised..................................... (716,222) $0.11-$0.17 (77,203)
Canceled...................................... (61,111) $0.11 (6,417)
--------- ---------
Outstanding, December 31, 1995................ 725,667 $0.11-$0.17 100,335
Granted....................................... 178,000 $0.17-$1.50 51,620
Exercised..................................... (845,167) $0.11-$0.17 (122,353)
Canceled...................................... (4,000) $0.11-$0.17 (477)
--------- ---------
Outstanding, March 31, 1996................... 54,500 $0.11-$1.50 $ 29,125
========= =========
</TABLE>
No stock options were granted during the period ended March 31, 1994.
At December 31, 1995, 133,686 options were exercisable and 615,311 shares
were available for future grant. At March 31, 1996, 440,778 shares were
available for future grant.
8. INCOME TAXES
The Company has had losses since inception and therefore has not provided
for income taxes.
Deferred income taxes reflect the net tax effects of temporary differences
between the carrying amount of assets and liabilities for financial reporting
purposes and the amounts used for income tax purposes, as well as operating
loss and tax credit carryforwards. Significant components of the Company's
deferred income tax assets as of March 31, 1995 and December 31, 1995 are as
follows:
<TABLE>
<CAPTION>
MARCH 31, DECEMBER 31,
1995 1995
--------- ------------
(IN THOUSANDS)
<S> <C> <C>
Net deferred tax assets:
Net operating losses................................... $778 $2,031
Research and development credits....................... 112 150
Capitalized research and development costs............. 81 428
Accruals deductible in different periods............... 24 (183)
Depreciation and amortization.......................... (1) 53
---- ------
994 2,479
Valuation allowance...................................... (994) (2,479)
---- ------
Total.................................................... $-- $ --
==== ======
</TABLE>
F-12
<PAGE>
SILICON GAMING, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
(INFORMATION AS OF MARCH 31, 1996, FOR THE THREE-MONTH PERIODS
ENDED JUNE 30, 1995 AND MARCH 31, 1996, AND CUMULATIVE IS UNAUDITED.)
Due to the uncertainty surrounding the realization of the benefits of its
favorable tax attributes in future tax returns, the Company has fully reserved
its net deferred tax assets as of March 31, 1995 and December 31, 1995,
respectively.
At December 31, 1995, the Company has net operating loss carryforwards of
approximately $5,800,000 and $1,000,000 for federal and state income tax
purposes, respectively ($8,100,000 and $1,700,000, respectively as of March
31, 1996). These carryforwards begin to expire in 2000. The net operating loss
carryforwards available for state tax purposes are substantially less than for
federal tax purposes, primarily because research and development costs have
been capitalized for state income tax purposes.
The Company also has research and development credit carryforwards of
approximately $100,000 and $50,000 available to offset future federal and
state income taxes, respectively, as of December 31, 1995 and March 31, 1996.
These carryforwards begin expiring in 2000.
Section 382 of the Internal Revenue Code and the applicable California law
impose annual limitations on the use of net operating loss and tax credit
carryforwards if there is a change in ownership, as defined, within any three-
year period. As a result of certain stock offerings, approximately $3,500,000
of federal net operating loss carryforwards are limited to an annual deduction
of approximately $650,000, until utilized or expired.
9. RELATED PARTIES
For the period from inception through March 31, 1994, the year ended March
31, 1995 and the nine-month period ended December 31, 1995, the Company paid
approximately $30,000, $166,000 and $23,000, respectively, to a partnership in
which a founder is a partner in exchange for management services and
administrative support. Additionally, for the period inception through March
31, 1994, the year ended March 31, 1995, and the nine-month period ended
December 31, 1995, payroll and other expenses, including rent, utilities and
travel, amounting to $106,000, $467,000 and $71,000, respectively, were paid
on behalf of the Company by affiliated companies and were subsequently
reimbursed by the Company.
10. SUBSEQUENT EVENTS
In March 1996, the Company restated its articles of incorporation to
increase the number of authorized common shares to 16,666,667 shares, to
increase the number of authorized preferred shares to 20,192,802 and to
designate 3,000,000 shares of preferred stock as Series C redeemable preferred
stock. Each share of Series C redeemable preferred stock is convertible into
0.6667 shares of common stock at the election of the holder (subject to anti-
dilution adjustment) and will automatically convert upon an initial public
offering of stock meeting certain criteria, has voting rights equal to the
number of shares of common stock into which it is convertible, is entitled to
a non-cumulative dividend of $0.50 per share to the extent declared by the
Board of Directors, and has a liquidation preference consistent with, and
ranking equally with all outstanding preferred stock. The Company also has the
right up to March 1, 1997 to repurchase all of the shares of Series C
redeemable preferred stock held by any stockholder for the original issuance
price in order to facilitate the Company's attempt to obtain a gaming license
in any jurisdiction. In addition, the date upon which all classes of preferred
stockholders may require the Company to redeem their outstanding shares was
extended to February 28, 2002.
F-13
<PAGE>
SILICON GAMING, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
(INFORMATION AS OF MARCH 31, 1996, FOR THE THREE-MONTH PERIODS
ENDED JUNE 30, 1995 AND MARCH 31, 1996, AND CUMULATIVE IS UNAUDITED.)
On March 22, 1996, the Company sold 1,600,000 shares of Series C redeemable
convertible preferred stock for cash consideration of $8,000,000. The Company
incurred issuance costs of approximately $500,000 and issued to the placement
agent warrants to purchase 116,667 shares of common stock at $7.50 per share.
During April 1996, holders of 1,998,332 Series A redeemable convertible
shares converted their shares into Series A1 Redeemable Preferred Stock, and
holders of 4,386,141 Series B redeemable preferred stock converted their
shares into Series B1 Redeemable Preferred Stock.
In May 1996, the Board of Directors of the Company approved an increase in
the number of authorized shares of preferred stock to 20,417,802 and the
designated number of shares of Series C redeemable convertible preferred stock
to 3,225,000. During April and May 1996, the Company sold an additional
1,492,000 shares of Series C redeemable convertible preferred stock for cash
consideration of $7,460,000, issued 50,000 shares of Series C redeemable
convertible preferred stock for other consideration of $250,000 and incurred
an additional $500,000 of issuance costs.
On May 28, 1996, the Board of Directors adopted the following, subject to
shareholder approval (which was received June 12, 1996):
. A three-for-two reverse split of the outstanding shares of common stock
(the "Reverse Split"). All share and per share amounts in these financial
statements have been adjusted to reflect this split.
. An increase in the number of shares of authorized shares of Common Stock
to 50,000,000.
. The authorization of 500,000 additional shares of preferred stock having
such rights, preferences and privileges as may be determined from time to
time by the Board of Directors, subject to the effectiveness of the
Registration Statement described below.
. An increase in the number of shares reserved under the 1994 Stock Option
Plan to 2,866,667.
. The 1996 Employee Stock Purchase Plan and reserved 300,000 shares of
Common Stock for sale to employees at a price no less than 85% of the
lower of fair market value at the beginning of the 24-month offering
period or the end of each six-month purchase period.
. The 1996 Outside Directors Stock Option Plan and reserved 200,000 shares
of Common Stock for grants of options to each outside directors to
purchase 15,000 shares of Common Stock at fair market value as of the
grant date, as well as additional option grants for 5,000 shares to be
issued in each subsequent year.
On May 30, 1996, the Company filed a Registration Statement with the SEC for
the sale of 3,500,000 shares of Common Stock (excluding the underwriters'
over-allotment option for an additional 525,000 shares). Upon the
effectiveness of this offering:
. All outstanding shares of Redeemable Preferred Stock, other than Series
A1 and B1 Nonvoting Redeemable Preferred Stock, will convert to 3,528,349
shares of Common Stock.
. The number of authorized shares of Preferred Stock will be reduced to
6,884,473 including the additional 500,000 shares described above.
F-14
<PAGE>
Photographs depicting sample screens from the Company's Machine Management
System, an on-line help and information system, with the accompanying text, "Our
proprietary, touch-screen controlled Machine Management System offers a full
range of simple, intuitive system diagnostics and game performance assessment
tools."
Sample images from the entertainment video that is projected on the
screen of the platform during play stoppages with the accompanying text,
"Designed to keep players engaged during service delays, the Silicon Gaming
platform plays a series of attention-grabbing entertainment and promotional
videos."
Images of the slot machine's "candle" illuminated in different colors with
the accompanying text, "An informative, multi-state "candle" atop the Silicon
Gaming machine utilizes different colors and flash rates to help casino floor
personnel prioritize their response to customers in need of assistance."
Additional text on this page reads as follows: "SLOT MACHINES and similar
devices are the dominant source of revenue for casino operators in most U.S.
gaming markets.
At Silicon Gaming, our knowledge of the casino industry and its needs has shaped
the entire design of our innovative gaming platform. The machine's modular
construction makes it quick and easy both to service and to upgrade, ensuring
minimal down-time, high serviceability, and a long life. Three service doors
provide quick, ready access to the most frequently serviced components, so
disruptions to players' enjoyment and operators' revenue streams are kept to a
minimum. And our proprietary Machine Management System enables casino personnel
to run diagnostic programs on each unit and review detailed performance data
collected from each machine."
UNDERSTANDING OUR CUSTOMER...THE CASINO OPERATOR.
<PAGE>
- --------------------------------------------------------------------------------
NO DEALER, SALESMAN OR ANY OTHER PERSON HAS BEEN AUTHORIZED TO GIVE ANY IN-
FORMATION OR TO MAKE ANY REPRESENTATIONS OTHER THAN THOSE CONTAINED IN THIS
PROSPECTUS IN CONNECTION WITH THE OFFER MADE BY THIS PROSPECTUS, AND, IF
GIVEN OR MADE, INFORMATION OR SUCH REPRESENTATIONS MUST NOT BE RELIED UPON AS
HAVING BEEN AUTHORIZED BY THE COMPANY OR THE UNDERWRITERS. THIS PROSPECTUS
DOES NOT CONSTITUTE AN OFFER TO SELL OR A SOLICITATION OF ANY OFFER TO BUY
ANY OF THE SECURITIES OFFERED HEREBY IN ANY JURISDICTION TO ANY PERSON TO
WHOM IT IS UNLAWFUL TO MAKE SUCH OFFER OR SOLICITATION. EXCEPT WHERE OTHER-
WISE INDICATED, THIS PROSPECTUS SPEAKS AS OF THE EFFECTIVE DATE OF THE REGIS-
TRATION STATEMENT. NEITHER THE DELIVERY OF THIS PROSPECTUS NOR ANY SALE HERE-
UNDER SHALL UNDER ANY CIRCUMSTANCES CREATE ANY IMPLICATION THAT THERE HAS
BEEN NO CHANGE IN THE AFFAIRS OF THE COMPANY SINCE THE DATE HEREOF.
- --------------------------------------------------------------------------------
TABLE OF CONTENTS
<TABLE>
<CAPTION>
PAGE
----
<S> <C>
Prospectus Summary..................................................... 3
Risk Factors........................................................... 7
Use of Proceeds........................................................ 13
Dividend Policy........................................................ 13
Capitalization......................................................... 14
Dilution............................................................... 15
Selected Consolidated Financial Data................................... 16
Management's Discussion and Analysis of Financial Condition and Results
of Operations......................................................... 17
Business............................................................... 20
Management............................................................. 45
Certain Transactions................................................... 52
Principal Shareholders................................................. 53
Description of Capital Stock........................................... 55
Shares Eligible for Future Sale........................................ 58
Underwriting........................................................... 60
Legal Matters.......................................................... 62
Experts................................................................ 62
Changes in and Disagreements with Accountants.......................... 63
Additional Information................................................. 63
Index to Financial Statements.......................................... F-1
</TABLE>
UNTIL , 1996, (25 DAYS FROM THE DATE OF THIS PROSPECTUS) ALL DEALERS
EFFECTING TRANSACTIONS IN THE REGISTERED SECURITIES, WHETHER OR NOT PARTICI-
PATING IN THIS DISTRIBUTION, MAY BE REQUIRED TO DELIVER A PROSPECTUS. THIS IS
IN ADDITION TO THE OBLIGATION OF DEALERS TO DELIVER A PROSPECTUS WHEN ACTING
AS UNDERWRITERS AND WITH RESPECT TO THEIR UNSOLD ALLOTMENTS OR SUBSCRIPTIONS.
- --------------------------------------------------------------------------------
LOGO
3,500,000 SHARES
COMMON STOCK
DEUTSCHE MORGAN GRENFELL
BEAR, STEARNS & CO. INC.
MONTGOMERY SECURITIES
OPPENHEIMER & CO., INC.
PROSPECTUS
, 1996
