UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-Q
(MARK ONE)
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
ACT OF 1934 FOR THE QUARTERLY PERIOD ENDED JUNE 30, 2000
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934 FOR THE TRANSITION PERIOD FROM TO
COMMISSION FILE NUMBER 0-28294
SILICON GAMING, INC.
(Exact Name of Registrant as Specified in Its Charter)
California 77-0357939
(State or Other Jurisdiction of (I.R.S. Employer
Incorporation or Organization) Identification Number)
2800 W. Bayshore Road
Palo Alto, CA 94303
(Address of Principal Executive Offices)
Telephone: (650) 842-9000
(Registrant's Telephone Number, Including Area Code)
Indicate by check mark whether the Registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months (or for such shorter period that the Registrant was
required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days.
Yes [X] No [ ]
Indicate the number of shares outstanding of each of the issuer's classes of
Common Stock, as of the latest practicable date.
30,978,831 shares of Common Stock, $.001 par value,
were outstanding as of July 31, 2000.
<PAGE>
SILICON GAMING, INC.
QUARTERLY REPORT ON FORM 10-Q
FOR THE PERIOD ENDED JUNE 30, 1999
INDEX
Page
----
PART I FINANCIAL INFORMATION
Item 1. Financial Statements:
Consolidated Balance Sheets--June 30, 2000
and December 31, 1999 ........................................... 3
Consolidated Statements of Operations--Three months
and six months ended June 30, 2000 and June 30, 1999............. 4
Consolidated Statements of Cash Flows--Six months
ended June 30, 2000 and June 30, 1999............................ 5
Notes to Consolidated Financial Statements....................... 6
Item 2. Management's Discussion and Analysis of Financial Condition
and Results of Operations........................................ 9
PART II OTHER INFORMATION
Item 5. Other Information................................................ 20
Item 6. Exhibits and Reports on Form 8-K................................. 21
Signature........................................................ 21
<PAGE>
PART I--FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
SILICON GAMING, INC.
CONSOLIDATED BALANCE SHEETS
(In thousands, except share data)
JUNE 30, DECEMBER 31,
2000 1999
-------- --------
(Unaudited)
ASSETS
CURRENT ASSETS:
Cash and equivalents ............................... $ 2,467 $ 877
Short-term investments ............................. -- 1,000
Accounts receivable (net of allowances of $1,091
in 2000 and $1,169 in 1999) ...................... 2,165 1,188
Inventories ........................................ 5,058 7,331
Prepaids and other ................................. 382 1,069
-------- --------
Total current assets .......................... 10,412 11,465
PROPERTY AND EQUIPMENT, NET .......................... 3,224 3,795
OTHER ASSETS, NET .................................... 382 321
-------- --------
$ 14,018 $ 15,581
======== ========
LIABILITIES AND SHAREHOLDERS' DEFICIENCY
CURRENT LIABILITIES:
Accounts payable ................................... $ 1,814 $ 1,389
Accrued liabilities ................................ 1,592 1,655
Deferred revenue ................................... 233 240
Line of credit ..................................... 750 622
Current portion of long-term obligations ........... 997 1,165
-------- --------
Total current liabilities ..................... 5,386 5,071
OTHER LONG-TERM LIABILITIES .......................... 1,606 1,611
LONG-TERM OBLIGATIONS ................................ 13,548 10,428
LONG-TERM ACCRUED INTEREST ........................... 5,635 5,832
SHAREHOLDERS' DEFICIENCY
Common Stock, $.001 par value; 750,000,000
shares authorized; shares outstanding:
June 30, 2000-- 30,978,831; December 31,
1999-- 30,949,273 ................................ 64,123 64,123
Preferred stock, $.001 par value; 6,884,473
shares authorized; shares outstanding
at June 30, 2000-- 39,750: (liquidation
preference up to $39.75 million) ................ 20,000 20,000
Warrants ........................................... 5,576 5,542
Notes receivable from shareholders ................. (344) (345)
Deferred stock compensation ...................... (4,065) (4,646)
Accumulated deficit ................................ (97,447) (92,035)
-------- --------
Total shareholders' deficiency ................ (12,157) (7,361)
-------- --------
$ 14,018 $ 15,581
======== ========
See notes to consolidated financial statements.
3
<PAGE>
SILICON GAMING, INC.
CONSOLIDATED STATEMENTS OF OPERATIONS
(In thousands, except per share data)
(unaudited)
<TABLE>
<CAPTION>
Three Months Ended Six Months Ended
June 30, June 30,
-------------------- ------------------
2000 1999 2000 1999
-------- ------- ------- -------
<S> <C> <C> <C> <C>
REVENUE:
Hardware ............................... $ 3,571 $ 3,609 $ 5,549 $ 7,322
Software ............................... 691 1,502 1,336 2,888
Participation and other ................ 562 616 1,042 1,178
-------- ------- ------- -------
Total revenue .......................... $ 4,824 $ 5,727 $ 7,927 $11,388
OPERATING EXPENSES:
Cost of sales and related
manufacturing expenses ............... 2,967 2,965 4,954 7,184
Research and development ............... 1,252 1,483 1,865 3,831
Selling, general and
administrative ....................... 3,275 2,587 6,411 5,483
Restructuring charges .................. (35) 3,277
-------- ------- ------- -------
Total costs and expenses ............... 7,494 7,000 13,230 19,775
-------- ------- ------- -------
Loss from operations ................. 2,670 1,273 5,303 8,387
Interest expense, net .................. 13 1,926 109 3,852
-------- ------- ------- -------
NET LOSS ................................. $ 2,683 $ 3,199 $ 5,412 $12,239
======== ======= ======= =======
Basic and diluted net loss per share...... $ 0.09 $ 0.22 $ 0.17 $ 0.86
======== ======= ======= =======
Shares used in computation ............... 30,979 14,376 30,969 14,275
======== ======= ======= =======
</TABLE>
See notes to consolidated financial statements.
4
<PAGE>
SILICON GAMING, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
(In thousands)
(unaudited)
<TABLE>
<CAPTION>
Six Months Ended
June 30,
--------------------
2000 1999
------- --------
<S> <C> <C>
CASH FLOWS FROM OPERATING ACTIVITIES:
Net loss .................................................... $(5,412) $(12,239)
Reconciliation to net cash used in operating activities:
Depreciation and amortization ............................. 956 2,570
Accrued interest .......................................... (197) 2,251
Accretion of debt discount ................................ -- 1,207
Deferred rent ............................................. (5) (111)
Restructuring charges ..................................... -- 3,277
Provision for bad debt .................................... -- (98)
Deferred stock compensation ............................... 581 --
Loss on disposal of property ......................... 38 --
Changes in assets and liabilities:
Accounts receivable ....................................... (977) 1,109
Inventories ............................................... 2,273 1,165
Prepaid and other ......................................... 319 (655)
Participation units ....................................... (210) 1,628
Accounts payable .......................................... 425 (80)
Accrued liabilities ....................................... (63) (1,808)
Other liabilities ......................................... -- 177
Deferred revenue .......................................... (7) (737)
------- --------
Net cash used in operating activities ................... (2,279) (2,344)
------- --------
CASH FLOWS FROM INVESTING ACTIVITIES:
Acquisition of property and equipment ....................... (235) (221)
Proceeds from disposal of property and equipment ............ 23 --
Sales and maturities of short-term investments .............. 1,000 --
Other assets, net ........................................... -- (39)
------- --------
Net cash provided by (used in) investing activities 788 (260)
------- --------
CASH FLOWS FROM FINANCING ACTIVITIES:
Sales of Common Stock, net of notes receivable .............. -- 74
Collection of note receivable ............................... -- 13
Proceeds from Debt financing ............................. 3,500 --
Proceeds from term loans and line of credit ................. 750 --
Repayment of bank line of credit ............................ (622) (2,057)
Repayment of term loans ..................................... (492) (478)
Repayment of capital lease obligations ...................... (55) (153)
------- --------
Net cash provided by (used in) financing activities ..... 3,081 (2,601)
------- --------
NET DECREASE IN CASH AND EQUIVALENTS .......................... 1,590 (5,205)
Beginning of period ......................................... 877 8,399
------- --------
End of period ............................................... $ 2,467 $ 3,194
======= ========
SUPPLEMENTARY DISCLOSURES OF CASH FLOW INFORMATION:
Cash paid during the period for interest .................... $ 175 $ 313
======= ========
NONCASH INVESTING AND FINANCING ACTIVITIES:
Conversion of preferred stock to Common Stock ............... $ -- $ 410
Issuance of Common Stock Warrants ........................... $ 34 $ --
======= ========
</TABLE>
See notes to consolidated financial statements.
5
<PAGE>
SILICON GAMING, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
1. BASIS OF PRESENTATION
The accompanying consolidated balance sheet as of June 30, 2000, the
consolidated statements of operations for the three and six months ended June
30, 2000 and 1999, and the consolidated statements of cash flows for the six
months ended June 30, 2000 and 1999, 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 dates and for such
periods. The unaudited information should be read in conjunction with the
audited consolidated financial statements of Silicon Gaming, Inc. ("Silicon
Gaming" or the "Company") and the notes thereto for the year ended December 31,
1999 included in the Company's Annual Report on Form 10-K filed with the
Securities and Exchange Commission.
The accompanying consolidated financial statements have been prepared
assuming that the Company will continue as a going concern. The Company has
incurred operating losses every year since its inception and at June 30,2000,
had an accumulated deficit of $97,447,000 and a shareholders' deficiency of
$12,157,000. The Company has been required to obtain additional financing every
year to be able to fund its ongoing operations. Based on historical levels of
cash usage, the above factors raise substantial doubt about the Company's
ability to continue as a going concern. In the fourth quarter of 1999 the
Company completed a substantial restructuring of its capitalization whereby
$39.75 million of Senior Discount Notes and approximately $8.3 million of
accrued interest were converted into Preferred Stock, and the remaining terms of
the Senior Discount Notes were modified to reduce the interest rate thereon and
extend the payment terms. Concurrent with the restructuring, the Company
borrowed $3 million under new Senior Discount Notes and established a facility
whereby up to an additional $2 million of new Senior Discount Notes may be
issued upon meeting certain financial and operational milestones. Management
continues to review financing and other strategic alternatives available to the
Company such as additional equity or debt offerings in the Company or certain of
its subsidiaries, joint ventures, alternative distribution channels, direct
investment by third parties into several of the Company's strategic business
opportunities and sale of all or part of the Company's assets to improve the
Company's liquidity position. Management believes that these steps, plus sales
related to proposed new product introductions, will provide sufficient cash and
working capital for the Company to meet its ongoing obligations and to allow it
to continue operating as a going concern through at least March 31, 2001. The
accompanying consolidated financial statements do not include any adjustments
that might result from the outcome of this uncertainty.
2. NET LOSS PER SHARE
Basic earnings per share excludes dilution and is computed by dividing net
income by the weighted average of common shares outstanding for the period.
Diluted earnings per share reflect the potential dilution that would occur if
securities or other contracts to issue Common Stock were exercised or converted
into Common Stock. Common share equivalents including stock options, warrants
and Redeemable Convertible Preferred Stock have been excluded from all periods
presented, as their effect would be antidilutive.
6
<PAGE>
The following is a reconciliation of the numerators and denominators of the
basic and diluted net loss per share computations (in thousands except per share
amounts):
<TABLE>
<CAPTION>
Three months ended Six months ended
June 30, June 30
--------------------- ---------------------
2000 1999 2000 1999
-------- -------- -------- --------
<S> <C> <C> <C> <C>
Net Loss (Numerator):
Net Loss, basic and diluted .............. $ (2,683) $ (3,199) $ (5,412) $(12,239)
======== ======== ======== ========
Shares (Denominator)
Weighted average common shares outstanding 30,979 14,437 30,969 14,367
Weighted average common shares subject to
repurchase ........................... (61) (92)
-------- --------
Shares used in computation .............. 30,979 14,376 30,969 14,715
======== ======== ======== ========
Net Loss Per Share, Basic and Diluted .... $ 0.09 $ 0.22 $ 0.17 $ 0.86
======== ======== ======== ========
</TABLE>
3. INVENTORIES
Inventories are stated at lower of cost (first-in, first-out) or market and
consist of the following (in thousands):
JUNE 30, DECEMBER 31,
2000 1999
------ ------
Raw materials ..................... $1,317 $ 849
Work in process ................... 747 111
Finished goods .................... 2,994 6,371
------ ------
$5,058 $7,331
====== ======
4. CONCENTRATION OF CREDIT RISK
Financial instruments which potentially subject the Company to
concentrations of credit risk consist primarily of cash equivalents and trade
accounts receivable. The Company invests only in high credit quality short-term
debt with its surplus funds. The Company performs ongoing credit evaluations of
its customers' financial condition and limits the amount of credit extended when
deemed necessary but generally requires no collateral. The Company maintains
reserves for estimated potential credit losses. As of June 30, 2000, three
customers accounted for 15%, 9% and 9% of accounts receivable, respectively. As
of December 31, 1999, one customer accounted for 19% of accounts receivable. For
the three months ended June 30, 2000, two customers accounted for 17% and 10% of
revenue and for the six months ended June 30, 2000, two customers accounted for
11% and 6% of revenue. For the three months ended June 30, 1999 two customers
accounted for 27% and 13% of revenue and for the six months ended June 30, 1999,
one customer accounted for 18% of revenue.
5. BORROWING ARRANGEMENTS
In May 2000, the Company executed on a $2 million secured revolving line of
credit agreement based on the Company's eligible accounts receivable which
expires May 25, 2001. Borrowings bear interest at the Bank's prime rate (9.5% at
June 30, 2000) plus 1.5%. As of June 30, 2000, the Company had $750,000
outstanding under this facility. This agreement requires the Company to maintain
certain ratios of tangible net worth to total debt among other covenants (as
defined in the agreement) and the Company was in non-compliance with the
agreement as of June 30, 2000. The lender has given the company an informal
notice of forbearance which is to expire on August 15, 2000. The company expects
to cure this violation upon the closing of the Series A Convertible Preferred
Stock as discussed in FOOTNOTE 7 below.
7
<PAGE>
Borrowing arrangements consist of the following (in thousands):
June 30, December 31,
2000 1999
-------- --------
Senior Discount Notes .............. $ 10,500 $ 9,500
Capital lease obligations .......... -- 55
Other long-term obligations ........ 1,545 2,038
Subsidiary's Series A Bridge Loans . 2,500 --
-------- --------
14,545 11,593
Current obligation ................. (997) (1,165)
-------- --------
Long-term obligation ............... $ 13,548 $ 10,428
======== ========
On June 22, 2000, the company, on behalf of one of its wholly owned
subsidiary companies, entered into a lease for commercial space in the city of
San Francisco for the purpose of conducting the business of its subsidiary at
this location. The lease covers a three year period with total consideration
over the term of the lease to be approximately $875,000. The Company shall also
be obligated for certain costs in operating said premises as well as certain
buildout costs which are expected to be approximately $150,000.
6. OPERATING SEGMENTS
During the second quarter, Silicon Gaming completed a realignment of its
resources around market opportunities by creating a separate business unit to
investigate market opportunities in the growing market for Internet gaming. The
Company incurred expenses for its On-line division of approximately $663,000 for
the three and six-month period ended June 30, 2000.
7. SUBSEQUENT EVENTS
On April 13, 2000 and May 3, 2000, respectively, the company, through one
its wholy owned subsidiaries, obtained bridge loan financing in the amount of
$2.5 million dollars from two different parties. The terms of the financing
contain an automatic conversion feature into a Series A Convertible Preferred
Stock Share in the subsidiary company, which conversion feature occurs upon the
completion of at least, an additional $3.5 million dollar financing under
similar terms for the Series A Convertible Preferred Stock. The Series A
Convertible Preferred Stock shall be convertible into one share of the common
stock of the subsidiary upon the occurance of several factors, including, but
not limited to either an initial public offering of the common stock of the
subsidiary or a change in control of the subsidiary, as defined in the term
sheet. The loans bear interest at the rate of 10%, and are due and payable in
full on demand, on or after July 12, 2000, unless automatically converted as
described above, in which case no interest will be due. The holders of the
Series A Preferred Stock shall be entitled to a liquidation preference in the
subsidiary equal to the amount paid per share (currently assumed to be $1 per
share), as well as certain other information rights and participation rights in
subsequent equity offerings of the subsidiary. As of July 31, 2000, additional
funding in the amount of $2 million dollars, has been received as part of the
total financing of this Series A Convertible round, and is currently being held
in escrow pending the receipt of the additional funding from other investors. As
of August 21, 2000, the initial funding investors have agreed not to demand
payment in full, as per the bridge loan agreement, pending the anticipated close
of this round.
8. NEW ACCOUNTING PRONOUNCEMENTS
In December 1999, the Securities and Exchange Commission (SEC) issued Staff
Accounting Bulletin (SAB) No. 101, "Revenue Recognition in Financial
Statements," which provided the SEC staff's views on selected revenue
recognition issues. The guidance in SAB 101 must be adopted during the fourth
quarter of fiscal 2000 and the effects, if any, are required to be recorded
through a retroactive, cumulative-effect adjustment as of the beginning of the
fiscal year, with a restatement of all prior interim quarters in the year. Our
management has not completed its evaluation of the effects, if any, that SAB 101
will have on the Company's income statement presentation, operating results or
financial position.
8
<PAGE>
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
THIS DISCUSSION INCLUDES A NUMBER OF FORWARD-LOOKING STATEMENTS WHICH
REFLECT THE COMPANY'S CURRENT VIEWS WITH RESPECT TO FUTURE EVENTS AND FINANCIAL
PERFORMANCE. THESE FORWARD-LOOKING STATEMENTS ARE SUBJECT TO CERTAIN RISKS AND
UNCERTAINTIES, INCLUDING THOSE REFERRED TO IN THE RISK FACTORS SECTION BELOW AND
ELSEWHERE HEREIN AND CONTAINED IN THE COMPANY'S PREVIOUSLY FILED ANNUAL REPORT
ON FORM 10-K, THAT COULD CAUSE ACTUAL RESULTS TO DIFFER MATERIALLY FROM
HISTORICAL RESULTS OR THOSE ANTICIPATED. IN THIS DISCUSSION, THE WORDS
"ANTICIPATES," "BELIEVES," "EXPECTS," "INTENDS," "FUTURE" AND SIMILAR
EXPRESSIONS IDENTIFY FORWARD-LOOKING STATEMENTS. READERS ARE CAUTIONED NOT TO
PLACE UNDUE RELIANCE ON THESE FORWARD-LOOKING STATEMENTS, WHICH SPEAK ONLY AS OF
THE DATE HEREOF.
THE FOLLOWING DISCUSSION SHOULD BE READ IN CONJUNCTION WITH THE UNAUDITED
CONSOLIDATED FINANCIAL STATEMENTS AND NOTES THERETO INCLUDED IN PART I--ITEM 1
OF THIS REPORT AND THE AUDITED CONSOLIDATED FINANCIAL STATEMENTS AND NOTES
THERETO INCLUDED IN THE COMPANY'S ANNUAL REPORT ON FORM 10-K FILED WITH THE
SECURITIES AND EXCHANGE COMMISSION.
OVERVIEW
The Company was incorporated on July 27, 1993 with a charter to design,
develop, manufacture and distribute a new breed of interactive gaming machines.
It was the Company's strategy to implement a new product paradigm in which
software-based gaming platforms would displace the traditional fixed-application
slot machines. Through early 1997, the Company focussed on executing it's
product development plans while at the same time preparing to initiate
operations. Substantial investments were made in the infrastructure required to
sell, build, fulfill, and ultimately service machines in each of the major U.S.
gaming markets.
In the third quarter of 1997, the Company introduced the Odyssey gaming
platform and it's suite of six gambling applications. The marketing strategy
called for a conservative, focussed roll-out in which the initial units were
installed in a limited number of Southern Nevada casinos. After an initial
evaluation period the product was refined and ultimately distributed into nearly
every major US market, as well as select international markets. Since that time
the Company has rolled out ODYSSEY into other jurisdictions including
Connecticut, Illinois, Indiana, Iowa, Kansas, Louisiana, Michigan, Minnesota,
Mississippi, Missouri, New Jersey, New Mexico, certain Canadian provinces,
certain international cruise line routes and Uruguay. Since the Company's
initial product launch, it has developed and distributed nearly 40 different
game applications and achieved an installed base of over 4,500 gaming platforms.
The Company's products 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 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 on the video screen by providing multiple levels of
achievement within certain games so that, through successful play over a period
of time, a player may advance to a bonusing sequence and win additional
jackpots. SGI believes that by utilizing these features, it 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. The Company has
designed its machines with a number of unique player features, such as play
stoppage entertainment(TM). In addition, the product's modular components and
Machine Management System(TM) software provide easy-to-use diagnostics designed
to minimize player inconvenience and machine down time. The Company currently
offers several products including ODYSSEY(TM), a multi-game machine that can
play up to six different games on the same machine, and QUEST, a single-game
machine.
9
<PAGE>
The Company's initial business model was dependent on the proliferation of
its gaming platforms. However, management believes that due to a number of
factors including price resistance, stagnant market growth, increased
competition, and a slower rate of adoption, the Company was unable to achieve
its projected sales volumes. As such the market for high-margin replacement
software never materialized.
In the Spring of '99 the Company re-formulated it's business strategy and
implemented a new plan. The strategy called for the company to more fully
leverage it's development capabilities while minimizing the expenses related to
maintaining it's distribution channel. The result was a 35% reduction in
operating expenses, and the formation of three distinct business units, the
Wagering Content Studio, Product Sales, and WagerWorks.com. The Wagering Content
Studio is focussed on creating new game experiences that can be distributed
off-line into the domestic casino markets through the Product Sales division,
and on-line both domestically and internationally through it's Internet
division.
The Company spent much of the second quarter, ending June 30, 2000,
executing it's three-tier business plan. The Wagering Content Studio completed
The Family Feud product suite, which was launched in Las Vegas in partnership
with MGM MIRAGE, Inc. This new gambling experience consists of an enhanced
platform, new package design, three different game applications, a highly
interactive bonus event, and a 3,500 square foot boutique casino venue. All of
these elements have been combined to create what the Company believes is the
industry's first Wagering Attraction, a gambling experience that has the ability
to drive new business. The Product Sales division continued to place and sell
gaming platforms along with new game applications created by our Content Studio.
The Company capitalized on the opening of the California market with sales into
each of the major tribal casinos. In addition, the Company formalized its
Internet strategy and initiated the business development and product development
aspects of it's plan.
Through June 30, 2000, the Company has installed 4,572 ODYSSEY, QUEST and
FAMILY FEUD machines in approximately 208 properties throughout Connecticut,
Iowa, Indiana, Louisiana, Michigan, Minnesota, Mississippi, Missouri, Nevada,
New Mexico, certain Canadian provinces, certain international cruise line routes
and Uruguay. Of these machines, 4,322 have been sold outright or placed on a
revenue-sharing basis. After returns, 250 machines remain installed on a trial
basis and the casino operators are required to purchase the machine outright,
participate in SGI's revenue sharing plan or return the machine to the Company
within a defined trial period. This compares to a restated installed base of
4,157 machines at March 31, 2000, of which, 256 machines were installed on a
trial basis.
At June 30, 2000 the Company had cash and equivalents of $2,467,000. The
Company has incurred operating losses each year since inception and as of June
30, 2000 had an accumulated deficit of $97,447,000 and a deficiency of
shareholders' equity of $12,157,000. The Company has been required to obtain
additional financing each year to be able to fund its ongoing operations. Based
on historical levels of cash usage, the above factors raise substantial doubt
about the Company's ability to continue as a going concern. In late 1998 and
early 1999 the Company took steps to reduce the level of operating expenses and
made a number of management decisions which resulted in total reductions of the
Company's work force by approximately 70% and made significant cuts in
expenditures across the Company. Management also announced the relocation of its
manufacturing to its Las Vegas, Nevada facility and the closure of its Mountain
View, California manufacturing facility. In November 1999, the Company, with the
consent of the holders of its Senior Discount Notes, was able to convert
approximately $40 million principal amount of debt plus $8.3 million in accrued
interest into a 57% equity stake in the Company, and to obtain commitments for
additional financing from the debt holders. The aforementioned actions resulted
in the Company reducing its operating expenses by approximately 40%, its
interest obligations by approximately 80%, and reduced the cash used in
operations by approximately 80% from the levels of the prior year. Management
has recently obtained a line of credit with a new bank on more favorable terms
so that this financing source remains available to the Company. Management is
also reviewing financing alternatives available to the Company such as
additional share or debt offerings in the Company or certain of its
subsidiaries, joint ventures, alternative distribution channels and sale of a
10
<PAGE>
portion of the Company's assets, to improve the Company's liquidity position.
Management believes that these steps, plus sales related to new product
introductions will provide sufficient cash and working capital for the Company
to meet its ongoing obligations and to allow it to continue operating as a going
concern through at least March 31, 2001.
Silicon Gaming is headquartered in Palo Alto, California and has sales
offices in Reno and Las Vegas, Nevada, and in Gulfport, Mississippi. The
Company's products are now manufactured at the Company's location in Las Vegas,
Nevada. At June 30, 2000 the Company had 86 employees.
REVENUE
The Company generates hardware revenue from the sale of its products and
related parts and accessories. All products are sold with licensed software and
customers have the choice of either a paid-up or renewable annual license. The
Company places products in casinos under a participation program where it
receives 20% of the net win generated by the product as revenue. Total revenue
units include machines sold outright as well as machines placed under the
participation programs.
The Company generated revenues as follows:
<TABLE>
<CAPTION>
Three Months Ended June 30, Six Months Ended June 30,
-------------------------------------- --------------------------------------
2000 1999 2000 1999
----------------- ----------------- ----------------- -----------------
(in $'000 except for machine numbers)
<S> <C> <C> <C> <C> <C> <C> <C> <C>
Hardware sales $ 3,571 74% $ 3,609 63% $ 5,549 70% $ 7,322 64%
Software sales 691 14% 1,502 26% 1,336 17% 2,888 25%
Participation revenue 562 12% 616 11% 1,042 13% 1,178 11%
------- ------- ------- ------- ------- ------- ------- -------
Total revenue $ 4,824 100% $ 5,727 100% $ 7,927 100% $11,388 100%
======= ======= ======= =======
Total revenue units 755 468 977 895
======= ======= ======= =======
</TABLE>
Total revenue units consist of machines sold outright to customers as well
machines owned by the Company placed in casinos under a participation program.
For the three months ended June 30, 2000, revenue units consisted of 378
machines sold outright, and 377 machines on casino floors under a participation
program. For the six month period ended June 30, 2000, revenue units consisted
of 600 machines sold outright and 377 machines on casino floors under a
participation program.
Revenue for the quarter ended June 30, 2000 was $4,824,000, a decrease of
$903,000, or 16%, from $5,727,000 for the quarter ended June 30, 1999. This also
represents an increase of $1,721,000, or 55%, from the $3,103,000 recorded in
the three-month period ended March 31, 2000. The change in sales mix reflects an
increase in direct sales relative to sales on a participation basis as a result
of introducing the Family Feud game in June, and the benefit of sales to the new
jurisdiction of California. The average selling price on hardware sales
increased to $9,773 in the quarter ended June 30, 2000 compared to $7,771 in the
quarter ended June 30, 1999,. This reflected the effect of the higher priced
Family Feud game and a lower level of discounts given to strategic corporate
customers compared to the prior year period, offset slightly by some lower
selling prices due to the Company selling used equipment to certain customers
during 2000.
The decrease in software revenues for the three months ended June 30, 2000
of $811,000, or 54%, compared to the same period in 1999 is a direct result of
the lower number of Odyssey units sold outright, the lower selling prices of
used equipment in the current year and the impact of focussing on and delivering
the Family Feud Suite of games in the current period. Participation revenues
decreased by $54,000, or 9%, compared to the comparable period in 1999 due
largely to a reduction in the number of machines on participation programs as
customers have either purchased those machines outright or returned them to the
Company.
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Revenue for the six months ended June 30, 2000 was $7,927,000, a decrease
of $3,461,000, or 30%, from $11,388,000 for the six months ended June 30, 1999.
For the six month period ended June 30, 2000 total software sales decreased by
$1,552,000, or 54%, compared to the same period in 1999 reflecting a shift in
the company's model for software sales as a percentage of total revenue. Total
participation revenues decreased by $136,000, or 12%, due to the reductions in
the number of machines on participation as the Company has converted these units
to sales or were returned to the Company by its customers.
During the three-month period ended June 30, 2000, two different customers
accounted for 17% and 10% of revenue. In the three-month period ended June 30,
1999, two different customers accounted for 27% and 13% of revenue. For the six
month period ended June 30, 2000, two different customers accounted for 11% and
6% of revenue and in the six-months ended June 30, 1999, one customer
represented 18% of revenue. The Company expects that a significant portion of
its revenues will remain consolidated within a limited number of strategic
customers within the gaming industry due to the increasing consolidation that is
taking place among casino operators. As an equipment vendor to the gaming
industry, the Company sells infrequently to many customers and the volume of
sales to any particular customer may vary significantly from period to period.
As a result, there can be no assurance that the above strategic customers will
continue to account for a significant percentage of the Company's revenue in the
future. The loss of any strategic customer would adversely affect the Company's
business and results of operations.
The Company believes the revenue generated from sales will increase in the
current year over the first half year's results, as the Company's base of
installed units continues to increase, and the Company believes participation
revenue will increase as a percentage of total revenue and in absolute dollars.
Anticipated increases in revenue, however, are subject to a number of risks and
uncertainties. See "Factors Affecting Future Results - Management of Changing
Business; "Liquidity", "Customer Retention" , "Changing Legislative
Environment", "Intellectual Property Rights", and "Rapidly Changing Technology".
COST OF SALES
Cost of sales includes the direct costs of product sales as well as the
unabsorbed costs of the Company's manufacturing operations. Cost of sales also
includes license fees and royalties paid to third parties as well as
depreciation on machines placed on the participation programs. Cost of sales was
$2,967,000, or 62% of revenue, as compared to $2,965,000, or 52% of revenue, for
the quarters ended June 30, 2000 and 1999, respectively. Cost of sales was
$4,954,000, or 62% of revenue, as compared to $7,184,000, or 63% of revenue, for
the six months ended June 30, 2000 and 1999, respectively.
The increase in cost of sales as a percentage of revenue for the three
month period is a reflection of several factors. The introduction of the Family
Feud suite of games, a unique, fully integrated specialty product, had the
effect of raising per unit costs on that portion of cost of sales that
represented the cost of this product. This was offset slightly by lower
manufacturing overhead costs associated with the refurbishing and reselling of
used machines taken back by the company, benefits derived from the tooling of
certain of its hardware components, and from some cost reductions in some of the
components included in its machines other than the Family Feud suite of games.
Due to significant levels of finished goods inventory, the Company manufactured
minimal new product outside of the new Family Feud games during the quarter
ended June 30, 2000, and this has prevented it from obtaining further cost
reductions in its products. The Company does not anticipate that cost reduction
will continue into future periods. The Company believes that as it introduces
more unique, fully integrated specialty products, per-unit costs may increase in
future periods.
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Cost of sales and manufacturing expenses are expected to increase in
absolute terms through 2000 as the Company increases sales volume for its
product, while gross margins are expected to remain volatile due to the
products' sensitivity to volume levels. The Company believes that it will be
able to continue seeing some benefits of decreased aggregate manufacturing costs
due to the relocation of its manufacturing activities to its Las Vegas, Nevada
location. The anticipated manufacturing expenses are subject to a number of
risks and uncertainties.
RESEARCH AND DEVELOPMENT
Research and development ("R&D") expenses include payroll and related costs
of employees engaged in ongoing design and development activities of the Company
and its subsidiary companies, costs paid to outside contractors and specialists,
prototype development expenses, overhead costs, equipment depreciation and costs
of supplies. To date, the Company has expensed all costs associated with the
research, design and development of its product. R&D expenses were $1,252,000,
or 26% of revenue, as compared to $1,483,000, or 26% of revenue, for the
quarters ended June 30, 2000 and 1999, respectively. R&D expenses were
$1,865,000, or 24% of revenue, as compared to $3,831,000, or 34% of revenue for
the six months ended June 30, 2000 and 1999, respectively.
Of the $1,252,000 in R&D expenses incurred in the second quarter period,
$391,000 or 31% was incurred in launching the activity of the Company's new
wholly owned subsidiary, Wager Works Inc., which did not contribute any revenue
to the company. The decrease in R&D expenses are largely the result of one of
the Company's new strategies involving strategic partnering, where a portion of
the Company's expenses incurred for the Wagering Content Studio were subsidized
by an outside strategic partner/customer, as well as lower personnel costs
attributable to the Company's reductions in its workforce and lower use of
engineering consultants, offset by higher license fees and similar costs
associated with the acquisition of outside technologies. Since the comparable
period in 1999, the focus of the Company's R&D activities has changed to
emphasize new game development, the introduction of new product platforms, and
the introduction of new game types. The Company is focussed on offering
additional features in its products that will fully utilize the underlying
technology used as well as continuing to procure new strategic partner
relationships to help subsidize a portion of this effort.. This is expected to
require a continued investment in R&D resources to continue the development of
the product platform and new platforms to facilitate the elaborate requirements
of the game development process in future periods. With the continuing efforts
to successfully launch the business of its new subsidiary company, Wager Works,
Inc., management believes the absolute level of R&D expenses may increase in
future periods.
SELLING, GENERAL AND ADMINISTRATIVE
Selling, general and administrative ("SG&A") expenses include payroll and
related costs for administrative and executive personnel, sales and
customer-support organization personnel, marketing and licensing personnel,
overhead costs, legal and associated costs, costs associated with obtaining and
retaining corporate and product licenses in various jurisdictions and fees for
professional services. SG&A expenses were $3,275,000, or 68% of revenue, as
compared to $2,587,000, or 45% of revenue for the quarters ended June 30, 2000
and 1999, respectively. SG&A expenses were $6,411,000, or 81% of revenue, as
compared to $5,483,000, or 48% of revenue for the six months ended June 30, 2000
and 1999, respectively. For the six months ended June 30, 2000 and 1999,
respectively, approximately 47% of 2000 expenses and 59% of 1999 expenses were
headcount related.
The increase in SG&A expenses in 2000 reflects higher legal fees in
connection with ongoing patent infringement cases that the Company was party to
during 1999 and a suit by a Company distributor in South Carolina, costs
associated with applying for corporate and product licenses as the Company began
selling product into new jurisdictions during the first two quarters of 2000, as
well as costs incurred in launching the activity of its new wholly owned
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subsidiary, Wager Works, Inc.. The Company intends to restrict the growth in
SG&A expenses as much as possible in future periods and believes SG&A expenses
in absolute dollars may increase and may decline as a percentage of total
revenue.
INTEREST INCOME AND EXPENSE
Net interest expense was $13,000 for the quarter ended June 30, 2000, as
compared to $1,926,000 for the quarter ended June 30, 1999. Net interest expense
was $109,000 for the six months ended June 30, 2000, as compared to $3,852,000
for the six months ended June 30, 1999. Included in these totals was interest
income of $17,000 and $22,000 for the quarter ended June 30, 2000 and 1999,
respectively, and $27,000 and $75,000 for the six months ended June 30, 2000 and
1999, respectively. Changes in interest income over these periods are directly
attributable fluctuations in the level of average cash and investment balances
that the Company holds. The timing of share offerings, issuance of Senior
Discount Notes, and the rate of spending on operations have impacted the average
level of cash and investments.
Interest expense was $30,000 and $1,948,000 for the quarters ended June 30,
2000 and 1999, respectively, and $136,000 and $3,927,000 for the six months
ended June 30, 2000 and 1999, respectively. The decrease in interest expense
over these periods is substantially due to the restructuring the Company
underwent in the November of 1999. The holders of the Senior Discount Notes
exchanged $39.75 million principal notes and accrued interest of $8.3 million
for Preferred Stock that is convertible into a 57% voting interest in the
Company. Concurrent with this conversion, the holders of the Senior Discount
Notes invested an additional $2 million of New Senior Discount Notes in the
Company. The company also paid off it revolving line of credit with its former
bank in the first quarter of 2000, did not complete it new bank arrangement
until the second quarter of 2000 and didn't begin to use its line of credit
until the end of May 2000. The company also reduced its amount of equipment
financing in 2000 as well as reducing the principal due on capital leases and
other equipment related borrowings in the second quarter of 2000.
INCOME TAXES
The Company has not been required to pay income taxes due to the fact that
it has had net operating losses in each period since the Company's inception.
The Tax Reform Act of 1986 and the California Act of 1987 impose restrictions on
the utilization of net operating loss and tax credit carryforwards in the event
of an "ownership change" as defined by the Internal Revenue Code. The Company's
ability to utilize its net operating loss and tax credit carryforwards is
subject to limitation pursuant to these restrictions. The Company underwent an
ownership change as of the date of the debt restructuring in November, 1999. As
a result, the Company lost the potential tax benefits of the net operating loss
carryforwards and the tax credit carryforwards that existed at that time.
A valuation allowance has been recorded for any deferred tax assets due to
uncertainty regarding the ultimate realization of these assets resulting from
the lack of earnings history of the Company.
LIQUIDITY AND CAPITAL RESOURCES
The Company's financial condition has continued to stabilize since June of
1999. Cash and equivalents had increased to $2,467,000 at June 30, 2000 compared
to $877,000 at December 31, 1999 and decreased compared to $3,194,000 at June
30, 1999. The increase in cash in the current period as compared to December 31,
1999 is due primarily to new financing obtained from additional borrowings on
the Senior Discount Notes, the securing of Bridge Loan financing for the
Company's wholly owned subsidiary, Wager Works, Inc., and the Company's
continuing successful efforts to convert inventory into cash, offset by losses
from ongoing operations.
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As of June 30, 2000 the Company had an accumulated deficit of $97,447,000
and a shareholder's deficiency of $12,157,000 and has had operating losses every
year since its inception. The Company has been required to obtain additional
financing each year to be able to fund its ongoing operations. In the fourth
quarter of 1999 the Company completed a substantial restructuring of its
capitalization whereby $39.75 million of Senior Discount Notes and approximately
$8.3 million of accrued interest were converted into Preferred Stock, and the
remaining terms of the Senior Discount Notes were modified to reduce the
interest rate thereon and extend the payment terms. Concurrent with the
restructuring, the Company borrowed $2 million under new Senior Discount Notes
and established a facility whereby up to an additional $3 million of new Senior
Discount Notes may be issued upon meeting certain financial and operational
milestones. In the quarter ended June 30, 2000, the Company met one of the
operational milestones identified and established as part if it's November 1999
restructuring plan. The company borrowed an additional $1 million of Senior
Discount Notes, and an additional $2 million of new Senior Discount Notes may be
issued in the future depending upon the Company's ability to meet certain other
financial and operational milestones. Management continues to review financing
and other strategic alternatives available to the Company such as additional
equity or debt offerings in the Company or certain of its subsidiaries, joint
ventures, alternative distribution channels, direct investment by third parties
into several of the Company's strategic business opportunities and sale of all
or part of the Company's assets to improve the Company's liquidity position.
Management believes that these steps, plus sales related to proposed new product
introductions, will provide sufficient cash and working capital for the Company
to meet its ongoing obligations and to allow it to continue operating as a going
concern through at least the end of March 31, 2001.
The Company's net cash used in operating activities was $2,279,000 and
$2,344,000 for the six months ended June 30, 2000 and 1999, respectively. This
modest decrease in cash used in operating activities reflects the amount of
non-cash items such as depreciation and amortization and deferred stock
compensation. The Company was able to reduce its investments in inventory and
increase its level of payables, offset by an increase in its level of
receivables, as it has improved its asset management and focussed on converting
its existing assets into cash to improve its liquidity situation. For the six
month period ended June 30, 1999, the company experienced a significantly higher
loss from operations, which was mainly offset by substantial non cash charges to
that period for restructuring charges, accrued interest on a higher level of
debt, and accretion of debt discount. These items were not a factor in the
Company's current six month period for 2000 due to the restructuring of the
Company's balance sheet as a result of the old Senior Note restructuring that
occurred in November of 1999.
Net cash provided by investing activities was $788,000 for the six months
ended June 30, 2000 compared to net cash used for investing activities of
$260,000 for the six months ended June 30, 1999. The change was primarily due to
the sale of property and equipment and the sale and maturity of short-term
investments as the Company's available cash balances decreased.
Net cash provided by financing activities was $3,081,000 for the six months
ended June 30, 2000 compared to net cash used in financing activities of
$2,601,000 for the six months ended June 30, 1999. The increase is related
primarily to the additional debt funding the Company obtained through exercising
some of its Senior Discount Note funding it was entitled to through its
restructuring agreement in November of 1999 and the Series A Preferred Bridge
Loan Financing it obtained for its subsidiary, Wager Works, Inc. in the current
period. The period covering the six months of 2000 also included the conversion
of its old line of credit from one banking facility into another, as compared to
the period ending June 30, 1999, which included a substantial net reduction in
its line of credit.
In March 2000, the Company entered into a secured revolving line of credit
with a new bank based upon eligible accounts receivable. Under the terms of this
borrowing arrangement, which will expire in May 2001 (and subject to automatic
renewal provisions), the Company may borrow up to $2 million. Borrowings bear
interest at the bank's prime rate (9.50% at June 30, 2000) plus 1.5%. The
Company has issued the bank warrants to acquire $35,000 worth of shares of
Common Stock at a per share price not to exceed $.35 (35 cents) per share, which
may be exercised over a five-year period. The exercise price of the warrants
adjust to the fair market value of the underlying common stock, at the date of
exercise, with a maximum cumulative exercise value of $35,000. In May 2000, the
Company finalized its contract involving this revolving line of credit, and
borrowed $750,000, which is the outstanding amount due as of June 30, 2000.
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In March 2000 the Company was served papers in connection with a patent
infringement lawsuit filed against it and one other slot machine manufacturer by
International Game Technology, Inc. (IGT). As disclosed in November 1999, IGT is
alleging infringement of a patent issued to IGT in September 1999 entitled "Game
Machine and Method Using Touch Screen". The Company has not yet responded to the
lawsuit and the Company's management denies the assertions of infringement. The
Company is presently unable to determine the financial impact, if any, of this
litigation. The costs of defending this lawsuit may be substantial and may
require significant amounts of senior management time. Any adverse result from
such litigation could materially and adversely affect the Company's liquidity
and capital resources.
In March 2000, a former distributor of the Company's products, filed suit
against the Company in the United States District Court for the District of
South Carolina. The distributor seeks repayment of $1 million, plus damages, in
connection with machines previously shipped to the distributor in 1998. The
Company is in the process of seeking arbitration as required by the Distribution
Agreement, seeking to recover outstanding receivables from the distributor. The
distributor filed in South Carolina an action to stay the arbitration portion of
the agreement between the Company and the distributor and was granted such a
stay. The company filed a motion on August 14th,2000 appealing the decision to
the United States Court of Appeals for the Fourth Circuit. The Company is
currently awaiting a decision from the Court of Appeals. The costs of responding
to and/or defending this lawsuit may be substantial and may require significant
amounts of senior management time. Any adverse result from such litigation could
materially and adversely affect the Company's liquidity and capital resources.
OUTLOOK
This outlook section and other sections in this Quarterly Report on Form
10-Q contain a number of forward-looking statements that reflect the Company's
current views with respect to future events and future financial performances.
Because they relate to future activities, there is a high degree of risk that
such events will not materialize and readers should not place undue reliance
upon them as actual results may differ materially.
To date the Company has focused many of its resources on creating a
business based on the high-volume manufacturing and sale of slot machines. The
Company has historically emphasized the selling of its hardware platforms but
has relied on frequent releases of new game software to drive market
penetration.
The Company has struggled in its endeavors against many competitors who are
significantly larger and who have much greater resources than the Company. In
addition, there have been certain changes in the competitive landscape since the
Company was formed. These changes have led the Company to develop and implement
a new, three-pronged business strategy.
The Company has established separate, internal business units that will
focus on what the Company believes are its most promising opportunities, given
the current market conditions and the Company's core competencies. The business
units are: Product Sales, the Wagering Content Studio, and On-Line.
The Company remains committed to supporting and growing its installed base
of slot machines. To date, the Company has sold or placed on a participation
basis over 4572 units. The Company's sales and support team is, once again,
fully staffed and new products are in development for both the slant-top and the
upright platform. The Company intends to change its focus from one of frequent
game releases to one that emphasizes the quality and feature content of new game
titles. It will also offer product extensions and variations of existing
successful game titles. The most recently released games are performing at or
near the top of the market for their respective categories and denominations.
These titles include: Banana-Rama Deluxe, Cash Cruise, Hot Reels - a proprietary
game type, Silver Belle Express and Hitsville.
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In addition to the continued sale of slot machines, the Company's Wagering
Content Studio will develop and bring to market a new class of brand-based,
wagering attraction. These attractions represent a more complete environmental
experience and call for a minimum level of marketing and promotional support.
The Wagering Content Studio is an outgrowth of the Company's need to more fully
exploit the technology inherent in its game platforms and the creative
capabilities of its development organization. The Company is also seeking to
develop proprietary versions of its wagering attractions for a limited number of
customers/partners, and has already entered into one such development
relationship. The result of this relationship between the Company and MGM Grand,
Inc. premiered on June 2 in the MGM Grand Hotel and Casino in Las Vegas, Nevada.
The Company is currently in negotiation with additional casino operators, other
slot manufacturers, and other intellectual property and brand-based content
holders. By partnering with outside parties the Company believes it can offset
its development risk and costs, achieve higher revenues and increase the
likelihood of product success.
With respect to the On-Line business unit, Wager Works, Inc., the Company
is exploring the varying opportunities that the Internet represents through
applications on the World Wide Web.
The Company also intends to continue its program of improving and
solidifying its financial position. The Company is considering raising
additional capital in either the parent company or directly into certain of its
subsidiaries, in order to fund new product and system development. Management
also intends to simplify the business and focus resources so that it can
continue to minimize the level of cash usage as the Company transitions to a
business model that takes advantage of revenue-sharing opportunities.
The Company's future results of operations and the other forward-looking
statements contained in this outlook - in particular the statements regarding
potential partnerships with casino operators or other third parties, and the
possible raising of additional capital - involve a number of risks and
uncertainties. In addition to the factors discussed above, the following could
also cause actual results to differ materially: the success of the Company's
game titles, changes in customer order patterns, competitive factors such as new
competitor products or game introductions or changes in pricing strategies,
reluctance of casino operators to use participation-based products or to partner
with the Company in product development, the Company's level of financial
resources and adequate cash flows, the stability of the Company's management
team and workforce, and the ability of the Company to meet all initial and
ongoing licensing requirements of the jurisdictions in which it sells products.
The Company believes that it has the product offerings, facilities,
personnel, and competitive resources needed for business success, but future
revenue, costs, margins, and profits are all influenced by a number of factors,
including those discussed above and the need for the Company to raise additional
funds, all of which are inherently difficult to predict.
FACTORS AFFECTING FUTURE RESULTS
MANAGEMENT OF CHANGING BUSINESS - The Company has spent part of the last
year as well as all of the first helf of the year 2000, trying to shift its
business strategy from one of high-volume manufacturing and placement of slot
machines with a goal of capturing market share, to a strategy that emphasizes
the quality and feature content of new game titles and takes advantage of
revenue-sharing opportunities. The Company plans on offering product extensions
and variations of successful existing games in 2000, however the emphasis will
shift from volume-based to one of providing a unique, fully-integrated gaming
experience. This transition represents a significant challenge for the Company
and its management and employees, and places increased demand on its systems and
controls. The Company's ability to manage this change will require the Company
to continue to change, expand and improve its operational, management and
financial systems and controls to manage any outsourcing or relocation of
existing activities. Key to effecting this change in business is the ability of
the Company to sell its existing inventory of ODYSSEY and QUEST products in a
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timely manner and to resolve outstanding collections issues with customers to
provide sufficient working capital during this transition process. If the
Company is not able to generate adequate funds from its working capital in a
timely manner, the Company's business, operating results and financial condition
will be materially and adversely affected.
LIQUIDITY - The Company has funded its operations to date primarily through
private and public offerings of its equity securities, the issuance of Senior
Discount Notes, term and equipment loans and from bank borrowings. At June 30,
2000, the Company had an accumulated deficit of $97,447,000 and a deficiency of
shareholders' equity of $12,157,000. The Company has repaid all amounts due
under the former line of credit and has negotiated a new line of credit with a
different financial institution on better terms. Management is also reviewing
financing alternatives available to the Company such as additional share or debt
offerings in the Company or certain of its subsidiaries, joint ventures,
alternative distribution channels and sale of all or a portion of the Company's
assets. If the plans that management has undertaken to improve the Company's
liquidity position are not successfully completed in a timely manner it is
probable that insufficient funds will exist to satisfy the Company's operating
requirements. The Company will be required to make adjustments to its operating
activities to operate within the restrictions of its liquidity and this could
have a material adverse affect upon the Company's business, operating results
and financial condition. To the extent that the Company sells additional shares
or issues any convertible debt securities, this could result in additional
dilution to existing shareholders. There can be no assurance that the Company
will be able to raise additional funds when and if needed.
VOLATILITY OF STOCK - The market price of the Company's stock has been
highly volatile and subject to large fluctuations. The Company's stock price may
be affected by factors such as actual or unanticipated fluctuations in the
Company's results of operations, new product or technical introductions by the
Company or any of its competitors, developments with respect to patents,
copyrights or proprietary rights, conditions or trends in the gaming industry,
changes in or failure by the Company to meet securities analysts' expectations,
general market conditions and other factors. The Company's stock now trades on
the Over The Counter (OTC) Bulletin Board. This may affect the level of trading
activity in the Company's stock, result in higher bid/ask spreads, and increase
the cost of raising additional equity for the Company, as well as result in
higher levels of volatility in the price of the Company's stock.
RETENTION OF 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. The
Company has experienced some turnover among its senior management during 1999
and the half year ended June 30, 2000. In February 1999, the Company announced
the appointment of a new Chief Executive Officer. The Company also reduced its
workforce by approximately 20% in December 1998 and by a further 40% in March
1999. These factors, combined with the Company's poor operating results and the
significant decrease in the price of the Company's Common Stock may have an
adverse affect on the Company's ability to retain and motivate its key
employees. Competition is intense for highly skilled product development
employees in particular. In addition, the Company's officers and key employees
are not bound by non-competition agreements that extend beyond their employment
at the Company, and there can be no assurance that employees will leave the
Company or compete against the Company. The Company's failure to attract
additional qualified employees or to retain its existing employees could have a
material adverse affect on the Company's operating results and financial
condition..
CUSTOMER RETENTION - The Company's ability to sell product may be hampered
due to the financial position of the Company which presents risks to customers
that the Company may not be able to fulfill its obligations under license
agreements or be available to provide warranty, repair or upgrade services on
products that it has already sold. The Company experienced negative reaction
from customers who held these views during 1999 and, to a lesser extent, in the
first half of the year 2000. These customers have indicated that they may not
purchase additional product from the Company. Completion of the Company's debt
restructuring in November 1999 mitigates these risks, however, the Company
continues to experience some negative sentiments from its customers. Certain of
the Company's competitors who have significantly greater financial and marketing
resources than the Company are also trying to take advantage of the Company's
financial position and are fueling the speculation about the Company's financial
position. To the extent that this results in the loss of any of the Company's
strategic customers or results in a loss of sales opportunities, the Company's
business, operating results and financial condition may be adversely affected.
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INTELLECTUAL PROPERTY RIGHTS - The Company regards its product as
proprietary and relies primarily on a combination of patent, 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 costly, and there can be no assurance that the Company will be
able to effectively protect its technology from misappropriation by competitors.
As the number of software products in the gaming industry increases and the
functionality of these products further overlap, software developers and
publishers or competitors 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 with a desire
to disrupt the Company's business. The Company and three of its competitors were
notified by one of its competitors, IGT, of a potential infringement claim
during November 1999. This required senior management to work with the other
defendants to provide information to IGT that it believes repudiates the claims
alleged by IGT. In March 2000, the Company and one other slot machine
manufacturer were notified by one of its competitors, IGT, of a patent
infringement lawsuit filed against it. The company has not yet presently
responded to this latest lawsuit. Any such claims or litigation can be costly
and 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, operating results and
financial condition.
CHANGING LEGISLATIVE ENVIRONMENT -The opening of new casinos, including
casinos in jurisdictions where gaming has recently been legalized historically
has driven growth for demand in slot machines. However, in recent years, the
legalization of gaming in new jurisdictions has been reduced; therefore demand
based on new openings may be largely limited to new projects in existing
markets. Certain markets, which currently permit gaming, are contemplating
legislation to limit, reduce or eliminate gaming. If successful such legislation
could limit growth opportunities for the Company. As a result of these factors,
there can be no assurance that the slot machine market will sustain the rate of
growth that was possible in the first half of this decade.
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. The Company has not updated its
product offering to take advantage of enhanced hardware components since 1998.
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 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.
DEPENDENCE ON SINGLE-SOURCE SUPPLIERS - The Company currently obtains
certain systems components from single-source suppliers. In particular the
touchscreen and picture tube that comprise the video display are supplied by
MircoTouch Systems, Inc. and Philips Display Components Company, respectively.
The Company does not have long-term supply contracts with these suppliers but
rather obtains these components on a purchase order basis. Although the design
of these components is not unique or proprietary and the Company believes that
it could identify alternative sources of supply, if necessary, there can be no
assurance that the Company would be able to procure, substitute or produce such
components without a significant interruption in its assembly process in the
event that these single sources were unable to supply these components. Even
where the Company has multiple sources of supply for a component, industry-wide
component shortages, such as those that have occurred with various computer
components, could significantly delay productivity, increase costs or both. The
Company is also considering exclusive outsourcing arrangements whereby a single
third party contract manufacturer will assemble all or a significant portion of
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new products that the Company is planning to introduce. The failure or delay by
any supplier to furnish the Company with the required components or products
would have a material adverse effect on the Company's business, financial
condition and results of operations.
ITEM 7A
Market Risk Disclosures: The following discussion about the Company's
market risk disclosures involves forward-looking statements. Actual results
could differ materially from those projected in the forward-looking statements.
The Company is exposed to market risk related to changes in interest rates and
equity security price risk. The Company does not have derivative financial
instruments for speculative or trading purposes.
The Company has fixed rate long-term debt of approximately $10.5 million
outstanding at June 30, 2000 and a hypothetical ten percent increase or decrease
in interest rates would not have a material impact on the fair market value of
this debt. The fair value of the Company's Senior Discount Notes may be lower
than the recorded value, but the Company is unable to estimate the fair value at
this time. The Company does not hedge any interest rate exposures.
PART II--OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS
In March 2000, a former distributor of the Company's products, filed suit
against the Company in the United States District Court for the District of
South Carolina. The distributor seeks repayment of $1 million, plus damages, in
connection with machines previously shipped to the distributor in December of
1998. The Company responded to the complaint requesting that the proceeding be
stayed while the parties went through arbitration in accordance with the
Distribution Agreement pursuant to which the machines were shipped. The
distributor filed a response requesting the court to reject the stay. The court
ruled in favor of the Distributor and the Company appealed the decision to the
United States Court of Appeals for the Fourth Circuit on August 14, 2000. The
Company is awaiting a decision from the Court of Appeals.
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ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
(a) Exhibits.
Number Exhibit Description
------ -------------------
27.1 Financial Data Schedule
(b) Reports on Form 8-K.
A Current Report on Form 8-K was filed on April 25, 2000 announcing
the commencement of an exchange offer by the Company whereby the Company offered
to exchange a unit consisting of one share of common stock and a warrant to
purchase 3.59662 shares of common stock for each share of common stock
outstanding. A Current Report on Form 8-K was filed announcing an extension of
the exchange offer from May 19, 2000 to June 23, 2000. The exchange offer
terminated on June 30, 2000. The Company's exchange agent received 541 election
notices representing 11,585,457 shares of common stock participating in the
exchange offer.
Pursuant to the requirements of the Securities Exchange Act of 1934, the
Registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
SILICON GAMING, INC.
By /s/ ANDREW S. PASCAL
-------------------------------------
Andrew S. Pascal
President, Chief Executive Officer,
Acting Chief Financial Officer
(Principal Financial and Chief
Accounting Officer)
Date: August 21, 2000
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