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 MARCH 31, 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 April 30, 2000.
<PAGE>
SILICON GAMING, INC.
QUARTERLY REPORT ON FORM 10-Q
FOR THE PERIOD ENDED MARCH 31, 2000
INDEX
Page
----
PART I FINANCIAL INFORMATION
Item 1. Financial Statements:
Consolidated Balance Sheets--March 31, 2000
and December 31, 1999............................................. 3
Consolidated Statements of Operations--Three months
ended March 31, 2000 and 1999..................................... 4
Consolidated Statements of Cash Flows--Three months
ended March 31, 2000 and 1999..................................... 5
Notes to Consolidated Financial Statements........................ 6
Item 2. Management's Discussion and Analysis of Financial Condition
and Results of Operations......................................... 10
PART II OTHER INFORMATION
Item 1. Legal Proceedings................................................. 21
Exhibits and Reports on Form 8-K.................................. 21
Signature......................................................... 22
<PAGE>
PART I--FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
SILICON GAMING, INC.
CONSOLIDATED BALANCE SHEETS
(IN THOUSANDS, EXCEPT SHARE DATA)
March 31, December 31,
2000 1999
-------- --------
(Unaudited)
ASSETS
CURRENT ASSETS:
Cash and equivalents ............................... $ 837 $ 877
Short-term investments ............................. 1,000
Accounts receivable (net of allowances of $1,044
in 2000 and $1,169 in 1999) ...................... 1,963 1,188
Inventories ........................................ 5,801 7,331
Prepaids and other ................................. 834 1,069
-------- --------
Total current assets ............................ 9,435 11,465
PROPERTY AND EQUIPMENT, NET .......................... 3,313 3,795
OTHER ASSETS, NET .................................... 299 321
-------- --------
TOTAL ASSETS ................................ $ 13,047 $ 15,581
======== ========
LIABILITIES AND SHAREHOLDERS' DEFICIENCY
CURRENT LIABILITIES:
Accounts payable ................................... $ 1,252 $ 1,389
Accrued liabilities ................................ 1,545 1,655
Deferred revenue ................................... 1,131 240
Line of credit ..................................... 622
Current portion of long-term obligations ........... 1,152 1,165
-------- --------
Total current liabilities ....................... 5,080 5,071
OTHER LONG-TERM LIABILITIES .......................... 1,609 1,611
LONG-TERM OBLIGATIONS ................................ 10,379 10,428
LONG-TERM ACCRUED INTEREST ........................... 5,777 5,832
SHAREHOLDERS' DEFICIENCY
Common Stock, $.001 par value; 750,000,000 shares
authorized; shares Outstanding: March 31, 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 March 31, 2000--
39,750 (liquidation preference up to $39.75
million) ......................................... 20,000 20,000
Warrants ........................................... 5,542 5,542
Notes receivable from shareholders ................. (344) (345)
Deferred stock compensation ........................ (4,355) (4,646)
Accumulated deficit ................................ (94,764) (92,035)
-------- --------
Total shareholders' deficiency .................. (9,798) (7,361)
-------- --------
$ 13,047 $ 15,581
======== ========
See notes to consolidated financial statements.
3
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SILICON GAMING, INC.
CONSOLIDATED STATEMENTS OF OPERATIONS
(IN THOUSANDS, EXCEPT PER SHARE DATA)
(UNAUDITED)
Three Months Ended
March 31,
----------------------
2000 1999
------- -------
REVENUE:
Hardware ....................................... $ 1,978 $ 3,672
Software ....................................... 645 1,387
Participation .................................. 448 602
Other ....................................... 32
------- -------
Total revenue .................................. $ 3,103 $ 5,661
OPERATING EXPENSES:
Cost of sales and related
manufacturing expenses ....................... 1,987 4,219
Research and development ....................... 613 2,348
Selling, general and
administrative ............................... 3,136 2,896
Restructuring charges .......................... 3,312
------- -------
Total costs and expenses ....................... 5,736 12,775
------- -------
Loss from operations ...................... 2,633 7,114
Interest expense, net .......................... 96 1,926
NET LOSS ......................................... $ 2,729 $ 9,040
======= =======
Basic and diluted net loss per share ............. $ 0.09 $ 0.64
======= =======
Shares used in computation ....................... 30,959 14,115
See notes to consolidated financial statements.
4
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SILICON GAMING, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
(IN THOUSANDS)
Three Months Ended
March 31,
------------------
2000 1999
------- -------
CASH FLOWS FROM OPERATING ACTIVITIES:
Net loss ............................................... $(2,729) $(9,040)
Reconciliation to net cash used in operating activities:
Depreciation and amortization ........................ 517 1,726
Accrued interest ..................................... (55) 1,125
Accretion of debt discount ........................... 599
Deferred stock compensation .......................... 291
Restructuring charges ................................ 2,566
Deferred rent ........................................ (2) 19
Changes in assets and liabilities:
Accounts receivable .................................. (775) 1,297
Inventories .......................................... 1,530 553
Prepaid and other .................................... 235 10
Participation units .................................. (44) 406
Accounts payable ..................................... (137) (529)
Accrued liabilities .................................. (110) (285)
Deferred revenue ..................................... 891 (285)
------- -------
Net cash used in operating activities .............. (388) (1,838)
------- -------
CASH FLOWS FROM INVESTING ACTIVITIES:
Acquisition of property and equipment .................. -- (311)
Sale of property and equipment ......................... 9 --
Sales and maturities of short-term investments ......... 1,000 --
Other assets, net ...................................... 22 (31)
------- -------
Net cash provided by (used in) investing activities 1,031 (342)
------- -------
CASH FLOWS FROM FINANCING ACTIVITIES:
Proceeds from term loans and line of credit ............ 250
Repayment of bank line of credit ....................... (622) (1,868)
Sale of Common Stock, net of notes receivable .......... -- 48
Collection of note receivable .......................... 1 9
Repayment of term loans ................................ (265) (235)
Repayment of capital lease obligations ................. (47) (76)
------- -------
Net cash provided by financing activities .......... (683) (2,122)
------- -------
NET DECREASE IN CASH AND EQUIVALENTS ..................... (40) (4,302)
Beginning of period .................................... 877 8,399
------- -------
End of period .......................................... $ 837 $ 4,097
======= =======
SUPPLEMENTARY DISCLOSURES OF CASH FLOW INFORMATION:
Cash paid during the period for interest ............... $ 182 $ 173
------- =======
Conversion of preferred stock to Common Stock .......... $ -- $ --
======= =======
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 March 31, 2000, the
consolidated statements of operations for the three months ended March 31, 2000
and 1999, and the consolidated statements of cash flows for the three months
ended March 31, 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 March 31,2000, had an
accumulated deficit of $94,764,000 and a shareholders' deficiency of $9,798,000.
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 $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. 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 2000. The accompanying consolidated
financial statements do not include any adjustments that might result from the
outcome of this uncertainty.
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 reflects 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
aggregating 104,534,555 shares, 116,712,841 shares and 235,092,858 shares,
respectively, as of March 31,2000 and 4,652,569 shares, 919,443 shares and
983,143 shares, respectively, as of March 31, 1999, 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):
Three months ended
March 31,
--------------------
2000 1999
-------- --------
Net Loss (Numerator):
Net Loss, basic and diluted ....................... $ (2,729) $ (9,040)
======== ========
Shares (Denominator)
Weighted average common shares outstanding ........ 30,959 14,277
Weighted average common shares subject
to repurchase ................................... (162)
-------- --------
Shares used in computation ....................... 30,959 14,115
======== ========
Net Loss Per Share, Basic and Diluted ............. $ 0.09 $ 0.64
======== ========
Certain prior year amounts have been reclassified to conform to the current
year presentation.
2. INVENTORIES
Inventories are stated at lower of cost (first-in, first-out) or market and
consist of the following (in thousands):
March 31, December 31,
2000 1999
------- -------
Raw materials ...................... $ 971 $ 849
Work in process .................... 642 111
Finished goods ..................... 4,188 6,371
------- -------
$ 5,801 $ 7,331
======= =======
3. 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 March 31, 2000, two
customers accounted for 18% and 8% of accounts receivable. For the three months
ended March 31, 2000, one customer accounted for 10% of revenue. For the three
months ended March 31, 1999, one customer accounted for 15% of revenue.
7
<PAGE>
4. BORROWING ARRANGEMENTS
The Company had a $4 million secured revolving line of credit agreement
based on the Company's eligible accounts receivable, which expired on
December 31, 1999. The Company subsequently repaid all outstanding balances
under this agreement in February 2000. As of April 30, 2000, the company
was in the process of formalizing a new revolving line of credit. See Note
5.
Borrowing arrangements consist of the following (in thousands):
March 31, December 31,
2000 1999
-------- --------
Senior Discount Notes ........................... $ 9,750 $ 9,500
Capital lease obligations ........................ 8 55
Other long-term obligations ...................... 1,773 2,038
-------- --------
11,531 11,593
Current obligation ............................... (1,152) (1,165)
-------- --------
Long-term portion ................................ $ 10,379 $ 10,428
======== ========
8
<PAGE>
5. SUBSEQUENT EVENTS
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. No adjustments have been made in the accompanying
consolidated financial statements relating to this litigation.
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 arbitration as required by the Distribution
Agreement, seeking to recover outstanding receivables from the distributor when
it received this lawsuit. The Company is still in the preliminary stages of
investigating the allegations contained in the suit and has not yet responded to
the complaint.
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 initially expire in May 2001 (and subject to
automatic renewal provisions), the Company may borrow up to $2 million.
Borrowings will bear interest at the bank's prime rate (9.50% at May 18, 2000)
plus 1.5%. The Company will issue the bank warrants to up 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.
On April 13, 2000 and May 3, 2000, respectively, the company, through one
its wholy-owned subsidiaries, entered into convertible note (the "Convertible
Notes") financing agreements for $2.5 million. The Convertible Notes bear
interest at a rate of 10% per annum with principal and interest to convert
automatically into Series A Convertible Notes Preferred Stock Share to be issued
by the subsidiary company, upon the completion of an additional $3.5 issuance.
The Convertible Notes shall be due and payable in full on demand, on or after
July 12, 2000, unless automatically converted as described above.
9
<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 to design, develop,
manufacture and distribute interactive gaming devices that implement advanced
multimedia technologies using state-of-the-art, off-the-shelf components. In
1997 the Company successfully introduced its first product, ODYSSEY(TM), a
multi-game, video-based slot machine, into the Nevada market. 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. In 1998 the Company
introduced QUEST, a single-game platform that utilizes many of the same
components as the ODYSSEY, and in 1999 the Company introduced a slant-top,
single-game platform, to increase its penetration of the casino floor.
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.
The Company spent much of the first quarter ending March 31, 2000
implementing and executing the different product and market opportunities it
identified in the fourth quarter of 1999, while continuing to address its poor
liquidity position, retaining its key personnel and taking such actions
necessary to enable the Company to continue operating. While product sales
continued to represent a significant portion of the company's business, the
company also established some strategic partnerships to support and enhance the
opportunity it identified in creating custom integrated attractions through its
development group. In so doing, the company believes it has shifted some of the
10
<PAGE>
risk it used to absorb entirely, in creating new products and designs, to some
its new strategic partners, while retaining much of the opportunity, if these
products succeed. The uncertainty surrounding the Company's future, along with
the reductions in the Company's workforce, negatively impacted its ability to
retain some key employees, especially in its sales organizations. These factors
also negatively impacted the Company's sales performance for the three month
period ending March 31, 2000, as compared to the similar period for 1999, as the
Company was forced to rebuild its sales organization. Through these difficult
times, and with less resources, the Company has continued to sell it products in
the marketplace.
Through March 31, 2000, the Company has installed 4,747 ODYSSEY and
QUEST machines in approximately 204 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, 4,491 have been sold outright or placed on a
revenue-sharing basis. After returns, 256 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.
At March 31, 2000 the Company had cash and equivalents of $837,000. The
Company has incurred operating losses each year since inception and as of March
31, 2000 had an accumulated deficit of $94,764,000 and a deficiency of
shareholders' equity of $9,798,000 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
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 the end of 2000.
Prior to March 1997 the Company was in the development stage and its
primary activities were focussed on product development, including system
hardware and software, game concept development and software coding. Towards the
end of 1996 the Company began manufacturing slot machines for commercial
distribution. The Company sold its first product in May 1997 following
completion of a customer evaluation period. Prior to this time the Company did
not generate any revenues from product sales. Once the Company started
generating revenue from product sales, the focus of its expenditures changed
from product development to building its infrastructure to support the sale and
distribution of its products.
11
<PAGE>
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 March 31, 2000 the Company had 89 employees.
RESULTS OF OPERATIONS
The Company had a net loss of $2,729,000 in the quarter ended March 31,
2000, a decrease of $6,311,000, or 70%, from $9,040,000 for the quarter ended
March 31, 1999. In the previous quarter, the Company recorded approximately
$3,300,000 in charges relating to the 35% reduction in its workforce and for
costs associated with the closure of its Mountain View, California manufacturing
facility. Revenue decreased to $3,103,000 in the quarter ended March 31, 2000, a
decrease of $2,558,000, or 45%, from $5,661,000 for the quarter ended March 31,
1999 and decreased by $424,000 or 12% from $3,527,000 in the quarter ended
December 31, 1999. The Company commenced sale of its product in May 1997 and
since that time had increased revenue by introducing its product and new game
titles, entering new markets and jurisdictions, and ramping up its sales in such
markets. This increase in revenue was coupled with increases in resources the
Company had devoted to manufacturing development and production, research and
development, building a sales, support and administrative infrastructure, hiring
additional administrative staff, ramping up the Company's marketing activities,
and financing its operations. The implementation of one of the company's new
strategies involving strategic partnering, resulted in less revenue recognition
as well as lower costs in the research and development area. The company offset
expenses incurred in the quarter by $644,000, which was received and recorded as
reimbursement of development expenses as opposed to revenue. Because the
Company's sales are dependent on a few large orders in each period, quarterly
sales have been and may be expected to remain volatile.
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:
Three Months Ended March 31,
------------------------------------------
2000 1999
---- ----
(in $'000, except for machine numbers)
Hardware sales $2,011 65% $3,672 65%
Software sales 645 21% 1,387 24%
Participation revenue 448 14% 11%
------ --- ------ ---
Total revenue $3,103 100% $5,661 100%
====== ======
Total revenue units 222 407
As can be seen in the above table, the Company's total revenue in the
three-month period ended March 31, 2000 decreased by $2,558,000 or 45% to
$3,103,000 from the $5,661,000 recorded in the three-month period ended March
31, 1999. This also represented a decrease of $424,000 or 12% from the
$3.527,000 recorded in the three-month period ended December 31, 1999. The
average selling price on machines sold outright increased to $9,193 in 2000 from
the $9,022 in 1999 reflecting a resulting lower level of discounts given to
strategic corporate customers compared to the prior year period.
12
<PAGE>
The decreases in participation revenue and in software revenue in 2000
compared to 1999 reflect decisions made by management during 1999 to remove poor
performing machines from the participation programs, which reduced the number of
machines on participation by almost 50%, and by a decision in 1998 to convert
customers from the renewable annual license program, which caused a decrease in
software revenues in 1999. Management believes that eliminating the annual
license program will bring the Company more into line with its competitors and
will result in increased future revenue opportunities as customers will now
purchase new game titles from the Company or engage the services of the new
integrated attractions development group. The Company believes that in the
future, participation revenues will increase in absolute as well as relative
terms as it places more of its new products on a participation basis, and that
in relative terms, hardware sales will increase and software revenues will
decrease from current levels.
During the three-month period ended March 31, 2000, one customer accounted
for 10% of revenue. In the three-month period ended March 31, 1999, one customer
accounted for 15% of revenue. The Company expects that a significant portion of
its revenues will remain concentrated 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 quarter'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
were $1,987,000, or 64% of revenue, as compared to $4,219000, or 75% of revenue,
for the quarters ended March 31, 2000 and 1999, respectively. The decrease in
cost of sales as a percentage of revenue reflects lower manufacturing overhead
costs. The per-unit manufacturing cost has decreased as the Company began to
realize benefits from the tooling of certain of its hardware components, and
from cost reductions in many of the components included in its machines. Due to
significant levels of finished goods inventory, the Company manufactured minimal
product during the quarter ended March 31,2000, and this has prevented it from
obtaining further cost reductions in its products. The Company does not
anticipate that this rate of 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.
Cost of sales and manufacturing expenses are expected to increase in
absolute terms through 1999 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 the 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. See "Risk Factors - Limited Manufacturing Experience
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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, 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 $613,000, or
20% of revenue, as compared to $2,348,000, or 41% of revenue, for the quarters
ended March 31, 2000 and 1999, respectively.
The decrease in R&D expenses are largely the result of one of the Company's
new strategies involving strategic partnering, where $644,000 of the companies
expenses in this category for the current quarter, were subsidized by an outside
strategic partner/customer, as well as by 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. This is
expected to require a continued heavy 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.
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. Approximately 48% of SG&A expenses are headcount related.
SG&A expenses were $3,136,000, or 101% of revenue, as compared to $2,896,000, or
51% of revenue, for the quarters ended March 31, 2000 and 1999, respectively.
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 quarter of 2000, as well
as a stabilization in the number of employees following the reductions in the
Company's workforce in the first quarter of 1999. The Company intends to
restrict the growth in SG&A expenses as much as possible in future periods and
expects SG&A expenses in absolute dollars and as a percentage of revenue to
decline.
INTEREST INCOME AND EXPENSE
Net interest expense was $96,000 for the quarter ended March 31, 2000, as
compared to $1,926,000 for the quarter ended March 31, 1999. Included in these
totals was interest income of $10,000 and $50,000 for the quarter ended March
31, 2000 and 1999, respectively. Changes in interest income over these periods
are directly attributable to fluctuations in the level of average cash and
investments 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 $106,000 and $1,976,000 for the quarters ended March
31, 2000 and 1999, respectively. The decrease in interest expense over these
periods is 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, and did not complete it new
bank arrangement until the second quarter of 2000.
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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'
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 stabilized somewhat since March of
1999. Cash and equivalents had decreased to $837,000 at March 31, 2000 compared
to $1,877,000 at December 31, 1999 and $4,097,000 at March 31, 1999. The
decrease in cash in the current period is due to losses from ongoing operations
that the Company has incurred and due to the repayment of $622,000 from the
Company's revolving line of credit arrangement of February 1999.
As of March 31, 2000 the Company had an accumulated deficit of $94,764,,000
and a shareholder's deficiency of $9,978,000 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. 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 2000.
The net cash used in operating activities was $388,000 and $1,838,000 for
the quarters ended March 31, 2000 and 1999, respectively. This decrease in cash
used in operating activities reflects the amount of non-cash items such as
depreciation and amortization, deferred stock compensation and accrued interest.
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.
Net cash provided by investing activities was $1,031,000 for the three
months ended March 31, 2000 compared to net cash used for investing activities
of $342,000 for the three months ended March 31, 1999. The change was primarily
due to no new acquisition of fixed assets, the sale of property and equipment
and the sale and maturity of short-term investments as the Company's available
cash balances decreased.
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Net cash used in financing activities was $683,000 for the three months
ended March 31, 2000 compared to net cash used in financing activities of
$2,122,000 for the three months ended March 31, 1999. The decrease is related to
the timing of repayments against the Company's bank line of credit in the
current period, as compared to the prior period, and proceeds from a new term
loan in the first quarter of the year 2000.
In March, 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 initially expire in May 2001 (and subject to
automatic renewal provisions), the Company may borrow up to $2 million.
Borrowings will bear interest at the bank's prime rate (9.50% at May 18, 2000)
plus 1.5%. The Company will issue 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 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 arbitration as required by the Distribution
Agreement, seeking to recover outstanding receivables from the distributor when
it received this lawsuit. The Company is still in the preliminary stages of
investigating the allegations contained in the suit and has not yet responded to
the complaint. 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.
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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 over 4157 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, and Hot Reels - a proprietary game type.
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 a premier
casino operator will premier on June 1 in a major gaming jurisdiction. 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, the Company is presently testing
the heavily trafficked waters of the World Wide Web, exploring the myriad
opportunities that the Internet represents.
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.
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FACTORS AFFECTING FUTURE RESULTS
MANAGEMENT OF CHANGING BUSINESS - The Company has spent part of the last
year as well as all of the first quarter 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
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 March
31,2000, the Company had an accumulated deficit of $94,764,000 and a deficiency
of shareholders' equity of $9,798,000. 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 quarter ended March 31, 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
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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 quarter 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 these 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.
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 overlaps, 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.
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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
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 $9.75 million
outstanding at March 31, 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.
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PART II--OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS
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). 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. A fuller description of these
proceedings is set forth under PART I, Note 5 of the financial statements
entitled " Subsequent Events".
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS.
A consent action by a majority of the outstanding shares of common stock of
the company was executed on February 7, 2000, approving an amendment to the
Articles of Incorporation of the company to increase the authorized number of
shares of common stock from 50,000,000 to 750,000,000. The number of shares
voting in favor of the amendment was 15,657,490. No shareholder meeting was held
and no shares were voted against approval of the amendment. The company filed a
14c-2 Information Statement relating to the consent action on January 7, 2000
and delivered the information statement to shareholders on or about January 10,
2000.
ITEM 5. OTHER INFORMATION.
On April 21, 2000, the company commenced an exchange offer whereby
participating shareholders were offered the opportunity to exchange each share
of common stock for a unit consisting of one share of common stock and a warrant
to purchase 3.59662 shares of common stock at an exercise price of $0.1528. The
warrants would not be exercisable for the firs twelve months following their
issuance and would expire, if not earlier terminated or exercised, on the fourth
anniversary date following their issuance. The company announced on May 18,
2000, that it was extending the expiration date of the exchange offer from May
19, 2000, to June 23, 2000. The company issued a press release dated April 21,
2000, announcing the commencement of the exchange offer. The press release was
filed as an exhibit to a Current Report on Form 8-K filed on April 25, 2000. The
company also filed a Schedule TO on April 20, 2000, disclosing the terms of the
exchange offer and filed the Offering Circular and other documents distributed
to shareholders as an exhibit to the Schedule TO.
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K.
(a) Exhibits
None
(b) Reports on Form 8-K.
A Current Report on Form 8-K was filed on February 14, 2000 announcing that
an amendment to the Articles of Incorporation had been filed increasing the
authorized number of shares of common stock from 50,000,000 to 750,000,000. The
amendment was approved by a majority of the outstanding shares of common stock
by consent action.
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SIGNATURE
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: May 22, 2000
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