<PAGE> 1
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, DC 20549
FORM 10-Q
[X] QUARTERLY REPORT UNDER SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended: DECEMBER 31, 1998
[ ] 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: 0-28318
Multimedia Games, Inc.
(Exact Name of Registrant as Specified in its Charter)
Texas 74-2611034
- --------------------------------------------------------------------------------
(State or Other Jurisdiction of (IRS Employer Identification Number)
Incorporation)
8900 Shoal Creek Blvd., Suite 300
Austin, Texas 78759
(Address of Principal Executive Offices)
(512) 371-7100
(Registrant's Telephone Number, Including Area Code)
(Former name, former address and former
fiscal year, if changed since last report)
Indicate by check whether the Registrant (1) has filed all reports required to
be filed by Section 13 or 15 (d) of the Exchange Act of 1934 during the past 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
--- ---
As of December 31, 1998 there were 5,451,275 shares of the Company's Common
Stock, par value $.01, outstanding.
<PAGE> 2
FORM 10-Q
INDEX
Part I. Financial Information
Item 1. Financial Statements
Consolidated Balance Sheets
(December 31, 1998 and September 30, 1998)
Consolidated Statements of Operations
(Three months ended December 31, 1998 and 1997)
Consolidated Statements of Cash Flows
(Three months ended December 31, 1998 and 1997)
Notes to Unaudited Consolidated Financial Statements
Report of Review By Independent Accountants
Item 2. Management's Discussion and Analysis
Part II. Other Information
Item 1. Legal Proceedings
Item 6. Exhibits
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MULTIMEDIA GAMES, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
AS OF DECEMBER 31, 1998 AND SEPTEMBER 30, 1998
<TABLE>
<CAPTION>
ASSETS DECEMBER SEPTEMBER
1998 1998
------------ ------------
(Unaudited)
<S> <C> <C>
Current assets:
Cash and cash equivalents $ 697,000 $ 1,881,000
Accounts Receivable:
Trade, net of allowance for doubtful accounts
of $203,000 and $181,000 2,403,000 2,005,000
Other receivables 1,107,000 637,000
Inventory 2,794,000 2,534,000
Prepaid expenses 498,000 568,000
Notes receivable 661,000 783,000
Notes receivable - related parties -- 1,227,000
Deferred tax asset 240,000 246,000
------------ ------------
Total current assets 8,400,000 9,881,000
Restricted cash and cash equivalents 1,667,000 1,636,000
Property and equipment, net 10,696,000 7,653,000
Other assets 113,000 110,000
Goodwill, net 438,000 445,000
------------ ------------
Total assets 21,314,000 19,725,000
============ ============
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Notes Payable 865,000 70,000
Current portion of long-term debt 319,000 336,000
Accounts payable and accrued expenses 4,876,000 4,371,000
Prize fulfillment fees payable 285,000 296,000
------------ ------------
Total current liabilities 6,345,000 5,073,000
------------ ------------
Long - term debt 468,000 531,000
Other long - term liabilities 1,460,000 1,429,000
Deferred tax liability 300,000 15,000
Stockholders' equity:
Preferred stock, Series A, $.01 par value, 2,000,000
shares authorized, 90,789 issued and outstanding 1,000 1,000
Common stock, $.01 par value , 25,000,000 shares
authorized 5,485,274 and 5,439,824 shares issued and
5,451,275 and 5,405,825 shares outstanding 55,000 54,000
Additional paid - in capital 12,890,000 12,803,000
Stockholder notes receivable (817,000) (817,000)
Treasury stock, 33,999 shares at cost (87,000) (87,000)
Retained earnings 699,000 723,000
------------ ------------
Total stockholders' equity 12,741,000 12,677,000
------------ ------------
Total liabilities and stockholders' equity $ 21,314,000 $ 19,725,000
============ ============
</TABLE>
See notes to unaudited consolidated financial statements.
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MULTIMEDIA GAMES, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
FOR THE THREE MONTHS ENDED DECEMBER 31, 1998 AND 1997
(Unaudited)
<TABLE>
<CAPTION>
1998 1997
------------ ------------
<S> <C> <C>
Revenues:
Gaming revenue $ 19,409,000 $ 12,167,000
Electronic player station sales 301,000 44,000
Electronic player station lease revenue 653,000 691,000
Other 389,000 2,000
------------ ------------
Total revenues 20,752,000 12,904,000
Operating costs and expenses:
Bingo prizes and related costs 2,317,000 2,457,000
Allotments to hall operators 13,016,000 7,357,000
Cost of electronic player stations sold 151,000 27,000
Salaries and wages 904,000 685,000
Selling, general and administrative expenses 3,184,000 1,479,000
Amortization and depreciation 1,161,000 635,000
------------ ------------
Total operating costs and expenses 20,733,000 12,640,000
------------ ------------
Operating income 19,000 264,000
Interest income 13,000 102,000
Interest expense (30,000) (26,000)
------------ ------------
Income before income taxes 2,000 340,000
Income taxes (1,000) (128,000)
------------ ------------
Net income $ 1,000 $ 212,000
------------ ------------
Basic earnings per share $ .00 $ .04
------------ ------------
Diluted earnings per share $ .00 $ .03
------------ ------------
</TABLE>
See notes to unaudited consolidated financial statements.
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MULTIMEDIA GAMES, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOW
FOR THE THREE MONTHS ENDED DECEMBER 31, 1998 AND 1997
(Unaudited)
<TABLE>
<CAPTION>
1998 1997
----------- ----------
<S> <C> <C>
Cash flows from operating activities:
Net income $ 1,000 $ 212,000
Adjustments to reconcile net income to cash
provided by (used for) operating activities:
Amortization and depreciation 1,161,000 635,000
Deferred taxes -- 128,000
Other non-cash expenses -- (1,000)
(Increase) decrease in:
Accounts and notes receivable (746,000) 997,000
Inventory (260,000) (540,000)
Prepaid expenses 70,000 266,000
Other assets (3,000) --
Increase (decrease) in:
Accounts payable and accrued expenses 674,000 (355,000)
Prize fulfillment fees payable (11,000) 61,000
---------- ----------
Net cash provided by (used for ) operating activities: 886,000 1,403,000
---------- ----------
Cash flows from investing activities:
Acquisition of property and equipment (2,848,000) (1,239,000)
Advanced to related party -- (1,000,000)
Increase in cash balances in restricted escrow (3,000)
---------- ----------
Net cash provided by (used for) investing activities (2,848,000) (2,242,000)
Cash flows from financing activities:
Proceeds from sale of common stock 88,000 333,000
Increase in notes payable 795,000 --
Principal repayments on debt (80,000) (93,000)
Payment of preferred stock dividends (25,000) (31,000)
---------- ----------
Net cash provided by (used for) financing activities 778,000 209,000
---------- ----------
Net change in cash and cash equivalents (1,184,000) (630,000)
Cash and cash equivalents, beginning of period 1,881,000 2,380,000
---------- ----------
Cash and cash equivalents, end of period $ 697,000 $1,750,000
========== ==========
</TABLE>
See notes to unaudited consolidated financial statements.
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MULTIMEDIA GAMES, INC. AND SUBSIDIARIES
NOTES TO UNAUDITED CONSOLIDATED
FINANCIAL STATEMENTS
1. SIGNIFICANT ACCOUNTING POLICIES
The accompanying financial statements should be read in conjunction with the
Company's financial statements for the twelve months ended September 30, 1998
contained within the Company's Annual Report on Form 10-KSB.
The financial statements included herein as of December 31, 1998 and for each
of the three months ended December 31, 1998 and 1997, have been prepared by
the Company, without an audit, pursuant to generally accepted accounting
principles and the rules and regulations of the Securities and Exchange
Commission. The information presented reflects all adjustments (consisting
solely of normal recurring adjustments) which are, in the opinion of
management, necessary for a fair statement of results for the periods.
Results for the three months ended December 31, 1998, are not necessarily
indicative of the results which will be realized for the year ending
September 30, 1999. The September 30, 1998 consolidated balance sheet data
was derived from audited financial statements, but does not include all
disclosures required by generally accepted accounting principles.
INCOME PER COMMON SHARE - Income per common share is computed in accordance
with Statement of Financial Accounting Standards No. 128 ("FAS 128").
Presented below is a reconciliation of income available to common
shareholders and the differences between actual weighted average shares
outstanding, which are used in computing basic earnings per share and diluted
weighted average shares, which are used in computing diluted earnings per
share.
<TABLE>
<CAPTION>
FOR THE THREE MONTHS ENDED
December 31, 1998
Per Share
Income Shares Amount
--------- -------- ---------
<S> <C> <C> <C>
Net Income $ 1,000
Less: preferred stock dividends (25,000)
---------
Basic EPS:
Income (loss) available to common shareholders (24,000) 5,455,239 $ .00
---------
Effect of Dilutive Securities:
Options, warrants and convertible preferred
stock -- --
--------- ---------
Diluted EPS:
Income available to common shareholders
plus assumed conversions $ (24,000) 5,455,239 $ .00
--------- --------- ---------
</TABLE>
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<TABLE>
<CAPTION>
FOR THE THREE MONTHS ENDED
DECEMBER 31, 1997
Per Share
Income Shares Amount
--------- --------- ---------
<S> <C> <C> <C>
Net Income $ 212,000
Less: preferred stock dividends (30,000)
---------
Basic EPS:
Income(loss) available to common shareholders 182,000 4,964,749 $ .04
---------
Effect of Dilutive Securities:
Options 496,034
Warrants 866,727
Convertible preferred stock 30,000 469,030
--------- ---------
Diluted EPS:
Income available to common shareholders
plus assumed conversions $ 212,000 6,796,900 $ .03
--------- --------- ---------
</TABLE>
At December 31, 1998, options to purchase 1,312,450 shares of common stock at
prices ranging from $2.00 to $5.688, warrants to purchase 2,193,393 shares of
common stock at prices ranging from $1.50 to $9.44 and 90,789 shares of
preferred stock convertible into 435,195 shares of common stock were
outstanding but not included in the computation of diluted EPS because the
assumed exercise of the securities would have an anti-dilutive effect on EPS
due to the loss available to common shareholders in the current period.
2. COMMITMENTS AND CONTINGENCIES
MEGAMANIA LITIGATION. On December 31, 1997, the U.S. Attorney for the Northern
District of Oklahoma filed a civil forfeiture action in Federal District Court
challenging the Class II status of the Company's interactive bingo game,
MegaMania. On October 23, 1998, the District Court issued a judgment holding
that MegaMania was legal Class II gaming. The decision found that MegaMania was
a game of bingo and that the EPS used to play MegaMania were technological aids
to the play of bingo as permitted by IGRA and were not gambling devices. On
January 21, 1999, the District Court denied a motion filed by the U.S. Attorney
that requested the District Court to alter or amend its judgment.
On May 14, 1998, the Assistant U.S. Attorney for the Northern District of
California filed a civil forfeiture in Federal District Court that also
challenged the Class II status of MegaMania. On November 23, 1998, the District
Court issued a Memorandum and Order holding that MegaMania was legal Class II
gaming. As with the decision of the Oklahoma District Court, the Order of the
California District Court found that MegaMania was a game of bingo and that the
EPS used to play MegaMania were technological aids to the play of bingo as
permitted by IGRA and were not gambling devices.
The Company is not able to predict whether either or both of these decisions
will be appealed by the government to the applicable Federal Circuit Court of
Appeals. The Company remains steadfast in its belief that MegaMania is Class II
gaming and intends to vigorously defend any appeal. While the company cannot
predict with certainty the outcome of any such appeal, the Company expects it
would prevail on the merits.
No assurances can be given that there will be no other challenges made to the
legality of the Company's interactive bingo activities or that, if made, the
Company will be successful on the merits. If MegaMania is ultimately determined
to be Class III gaming, the loss of the MegaMania business could have a material
adverse effect upon the Company's financial condition and results of operation.
In addition, if the type of EPS used to aid the play of MegaMania is ultimately
held to be a gambling device, all of the other interactive Class II bingo games
currently offered by the Company and other vendors would likely be adversely
effected which would have a material adverse effect upon the Company's financial
condition and results of operation. Even if the Company is successful on the
merits, the legal fees and expenses to be incurred by the Company
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<PAGE> 8
related to any appeal of the MegaMania litigation or any future litigation
challenging the Company's interactive bingo activities will likely be
significant.
OTHER LITIGATION
NETWORK GAMING LITIGATION. On January 23, 1998, the Company filed a complaint
against Network Gaming International Corporation ("NGI") in the Federal District
Court for the Northern District of Oklahoma alleging breach of contract. On
February 2, 1998, NGI filed a complaint against the Company in the same Federal
District Court alleging, among other things, breach of contract,
misappropriation of trade secrets, fraud and interference with prospective
advantage. The complaint by NGI seeks $62 million in damages and other specified
and unspecified relief and also names Gordon T. Graves, the Company's Chairman
of the Board, and Larry D. Montgomery, the Company's former President, as
individual defendants. These actions are in the very preliminary stages and only
limited discovery has been taken by either party. The Company intends to
vigorously defend against the claims of NGI and to prosecute its own claim.
While the Company believes that it will ultimately prevail on the merits, no
assurances to that effect can be given. In any event, the cost of defending the
actions could be substantial.
SHAREHOLDER CLASS ACTIONS. On May 29, 1998, a shareholder class action was filed
against the Company in the Federal District Court for the Southern District of
California. Also named as defendants were Gordon T. Graves and Larry D.
Montgomery. The action, which seeks an unspecified amount of damages on behalf
of all similarly situated shareholders, alleges that the Company violated
federal securities laws by making allegedly false and misleading statements
regarding the legality of MegaMania. On July 24, 1998, a similar class action
was filed in the Federal Court for the Northern District of Oklahoma. In January
1999, the two cases were consolidated in the Northern District of Oklahoma.
These actions are in very preliminary stages. The Company intends to vigorously
defend against these claims and expects to prevail on the merits, although no
assurances to that effect can be given. In any event, the cost of defending
against the claims could be substantial.
3. RELATED PARTY TRANSACTIONS
On October 1, 1998, the Company purchased 356 electronic player stations and
related equipment (EPS) for $1,349,000 from Equipment Purchasing LLC ("EP LLC"),
a limited liability company owned by an affiliate of Gordon T. Graves, the
Chairman and Chief Executive Officer of the Company. The Company had originally
sold the EPS to EP LLC in June and September 1997 at an aggregate sales price of
approximately $2,436,000. Pursuant to agreements entered into at the time of the
June and September 1997 sale transactions, the Company had an option to
repurchase the EPS from EP LLC at fair market value. While the purchase price
paid by the Company was not the result of an arms-length negotiation with an
unaffiliated third party, the Company believes that such purchase price is
comparable to what the Company would have paid to an unaffiliated third party.
The purchase price was paid by (i) cancellation by the Company of $992,000 in
notes receivable due from EP LLC, (ii) the assumption by the Company of $77,800
in debt owed by the affiliate of Mr. Graves to a financial institution, (iii)
the payment by the Company of $133,000 to EP LLC, (iv) the delivery to EP LLC of
a 6% promissory note of the Company in the principal amount of $133,000 due on
April 1, 1999, (v) the issuance of 50,000 warrants to purchase shares of common
stock of the Company at $3.81 per share expiring on June 30, 2002, and (vi) the
issuance of 50,000 warrants to purchase shares of common stock of the Company at
$3.81 per share expiring on September 30, 2002. On October 1, 1998, the closing
price of the Company's common stock as quoted on the Nasdaq SmallCap market was
$2.50 per share. The warrants, which were valued by the Company and EP LLC at
$12,000, were issued in cancellation of warrants to purchase the same number of
shares that had been granted to EP LLC in connection with the June and September
1997 sale transactions at exercise prices of $11.00 and $13.38 per share. The
$133,000 paid to EP LLC was applied by the affiliate of Mr. Graves to pay a
portion of outstanding notes due the Company by such affiliate.
-8-
<PAGE> 9
INDEPENDENT ACCOUNTANT'S REPORT
To the Board of Directors and Stockholders
Multimedia Games, Inc.
We have reviewed the accompanying consolidated balance sheet of Multimedia
Games, Inc. and Subsidiaries as of December 31, 1998, and the related
consolidated statements of operations and cash flows for the three month period
ended December 31, 1998. These financial statements are the responsibility of
the Company's management.
We conducted our review in accordance with standards established by the
American Institute of Certified Public Accountants. A review of interim
financial information consists principally of applying analytical procedures to
financial data and making inquiries of persons responsible for financial and
accounting matters. It is substantially less in scope than an audit conducted in
accordance with generally accepted auditing standards, the objective of which is
the expression of an opinion regarding the financial statements taken as a
whole. Accordingly, we do not express such an opinion.
Based on our review, we are not aware of any material modifications that
should be made to the accompanying financial statements for them to be in
conformity with generally accepted accounting principles.
We have previously audited, in accordance with generally accepted auditing
standards, the consolidated balance sheet as of September 30, 1998, and the
related consolidated statements of operations, stockholders' equity and cash
flows for the year then ended (not presented herein); and in our report dated
December 4, 1998, we expressed an unqualified opinion on those consolidated
financial statements. In our opinion, the information set forth in the
accompanying consolidated balance sheet as of September 30, 1998 is fairly
stated in all material respects in relation to the consolidated balance sheet
from which it has been derived.
PricewaterhouseCoopers LLP
Tulsa, Oklahoma
February 12, 1999
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<PAGE> 10
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS
GENERAL. The Company designs and develops interactive high-speed Class II bingo
games and related electronic player stations (EPS) and equipment that are
marketed to Native American bingo halls located throughout the United States.
The Company operates its interactive bingo games on behalf of its tribal
customers through a multi-pathed communications network. The network
interconnects EPS located at multiple bingo halls thereby enabling players to
simultaneously participate in a live bingo game and to compete against one
another to win a common pooled prize. The Company also produces high stakes TV
bingo game shows that are televised live to multiple participating Indian bingo
halls linked via closed circuit satellite and broadband telephone communications
networks.
Prior to August 1995, the Company's principal business was providing its TV
bingo game shows. In August 1995, the Company introduced MegaMania, its first
interactive high-speed Class II bingo game. MegaMania, and the other interactive
high speed bingo games subsequently designed, developed and introduced by the
Company, are live Class II bingo games transmitted to EPS that are
interconnected to one another through the Company's communications network. The
EPS enable players to log on to the network, select the bingo cards of their
choice and to interact with the game to make game decisions such as whether to
continue a card in play, daubing or "covering" a number on a card and declaring
a winning bingo. The Company's games and equipment are designed and operated to
meet the requirements for Class II gaming as defined in the Indian Gaming
Regulatory Act of 1988 and are marketed to bingo halls owned and operated on
behalf of American Indian tribes. The Company believes that its interactive
games have significantly increased the bingo hall's earnings per player position
at those bingo halls where its interactive games are played. As of December 31,
1998, there were 3,989 EPS in operation at 64 independently owned Indian bingo
halls located in 11 different states. Also as of December 31, 1998, the
Company's live TV bingo game show, MegaBingo, was being delivered to 47
independently owned Indian bingo halls located in 14 different states.
In May 1998, the Company launched MegaRacing, which transmitted horse racing
signals and provided communications and data services to OTB facilities operated
by Native American tribes pursuant to compacts with the State in which the
tribes are located. Effective February 2, 1999 the Company suspended operations
for MegaRacing as a result of continued losses experienced during fiscal 1998
and the first quarter of fiscal 1999.
RESULTS OF OPERATIONS
THREE MONTHS ENDED DECEMBER 31, 1998 AND 1997
NET INCOME was $1,000 for the first quarter of fiscal 1999 compared to $212,000
for the first quarter of fiscal 1998. Company operations resulted in income
before income taxes of $2,000 for the three months ended December 31, 1998, a
decrease of $338,000 from 1997's $340,000. The Company's earnings before
interest, taxes, depreciation and amortization (EBITDA) amounted to $1,180,000,
for the first fiscal quarter, up 31% from 1997's $899,000. During the second
quarter of fiscal 1998 the Company began recording substantial legal and
professional fees related to the MegaMania and Network Gaming litigation. Legal
and professional fees for the first quarter of fiscal 1999 increased $588,000,
or 308% over the first quarter of fiscal 1998. During the current quarter, the
Company continued the expansion of its market share in the placement of EPS
throughout its network. By December 31, 1998, there were 3,989 EPS in operation
as compared to 3,271 at September 30, 1998 and 1,749 at December 31, 1997. This
rapid deployment of EPS resulted in incremental operating costs for the first
quarter of fiscal 1999 of $805,000, an increase of 63% over the comparable
quarter of the prior year. The amount of depreciation and amortization recorded
for the first quarter of fiscal 1999 increased $526,000, or 82% over the first
quarter of fiscal 1998 primarily due to the increase in the number of EPS placed
in service. MegaRacing, which was not in operation during the first quarter of
fiscal 1998, incurred an operating loss of $71,000 during the three months ended
December 31 1998. Current quarter operations were also adversely effected by the
disappointing performance of two interactive games that were introduced in
fiscal 1998. Another new game was introduced at the end of the current fiscal
quarter and thus far player acceptance has been positive.
REVENUES totaled $20,752,000 for the first quarter of fiscal 1999 compared to
$12,904,000 for the first quarter of fiscal 1998, an increase of $7,848,000, or
61%. This growth was primarily due to the increase in the Company's interactive
games
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<PAGE> 11
which generated revenues of $16,840,000 for the three months ended December 31,
1998 as compared to $8,834,000 in the first quarter of fiscal 1997, an increase
of 91%. The average daily revenue per EPS was $50 for the three months ended
December 31, 1998 (3,769 units) compared to $55 for the three months ended
December 31, 1997 (1,734 units). This reduction in average daily revenue was
primarily the result of a low level of player interest in the two new games
introduced during fiscal 1998. TV bingo game show revenues of $2,569,000
declined $764,000 or 23% for the three months ended December 31, 1998 from
1997's $3,333,000; reflecting the continuation of the trend experienced during
fiscal 1998 of player headcounts declining at most bingo facilities across the
country. In addition, the reduction in the number of halls participating in
MegaBingo during fiscal 1998 also affected first quarter performance.
The Company believes interactive gaming revenues will increase each quarter
through fiscal 1999 over fiscal 1998, primarily as the result of an increase in
the average number of EPS that are expected to be in daily operation. TV bingo
game show revenues, however, may continue to decrease as the result of decreased
MegaBingo play at the halls.
Revenue from the sale of 52 EPS amounted to $301,000 for the first quarter of
fiscal 1999, an increase of $257,000 from 1997's $44,000.
Lease revenues from EPS leased to Native American Tribes decreased from $691,000
in the first quarter of fiscal 1998 to $653,000 in 1999. This decrease was
primarily due to the maturity of lease / purchase contracts during fiscal year
1998.
Other revenues increased to $389,000 in the first quarter of fiscal 1999 mainly
due to the introduction of MegaRacing during 1998 which generated revenue
totaling $322,000 for the current quarter. The remainder of other revenue was
contributed by management fees on the related party equipment contracts totaling
$52,000 and equipment service revenue amounting to $15,000 for the three months
ended December 31, 1998.
OPERATING COSTS AND EXPENSES totaled $20,733,000 for the first quarter of fiscal
1999 compared to $12,640,000 for the first quarter of fiscal 1998, up $8,093,000
or 64%, primarily as the result of the following:
BINGO PRIZES AND RELATED COSTS amounted to $2,317,000 for the three months ended
December 31, 1998 compared to $2,457,000 for the three months ended December 31,
1997, a decrease of $140,000, or 6%. This decrease is less than proportional to
the decline in TV bingo game show revenue due to the level of fixed costs
required to produce the TV bingo game shows. Interactive gaming revenues are
recorded net of prize costs; therefore, the prizes are not reflected in bingo
prizes and related costs.
ALLOTMENTS TO HALL OPERATORS consists of the bingo halls' share of the
interactive gaming revenues after prizes and allocable prize costs. Allotments
to hall operators increased $5,659,000, or 77% to $13,016,000 for the three
months ended December 31, 1998 compared to $7,357,000 for the three months ended
December 31, 1997. The increase was mainly related to the growth in the
Company's interactive gaming network of EPS and the introduction of new games.
Hall commissions related to TV bingo game shows declined as a result of the
decrease in the play of MegaBingo.
COST OF ELECTRONIC PLAYER STATIONS SOLD increased $124,000 to $151,000 for the
three months ended December 31, 1998 from $27,000 for the three months ended
December 31, 1997. The gross margin recorded on EPS sales was $150,000 for the
first quarter of fiscal 1999 compared to $17,000 in the first quarter of fiscal
1998.
SALARIES AND WAGES amounted to $904,000 for the three months ended December 31,
1998 compared to $685,000 for the three months ended December 31, 1997, an
increase of $219,000, or 32%. Most of this increase relates to additional
personnel hired to assist in the installation, training and maintenance related
to the interactive gaming network. Also contributing to this increase were the
labor costs associated with MegaRacing and additions to corporate staff.
SELLING, GENERAL AND ADMINISTRATIVE EXPENSES increased $1,705,000, or 115% to
$3,184,000 for the three months ended December 31, 1998 compared to $1,479,000
for the three months ended December 31, 1997. Approximately 34% or $588,000 of
the increase was for legal and professional fees and expenses related to the
MegaMania and Network Gaming litigation, regulatory and general legal matters.
The aggregate of legal and professional fees amounted to $779,000 for the first
quarter of fiscal 1999 compared to $191,000 in the first quarter of fiscal 1998,
up 308%. MegaRacing added $312,000 to the current quarter operating costs.
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Other contributing factors to the increase in the overall cost structure for
the current quarter versus the comparable quarter of the prior fiscal year were
a direct result of the expansion of the interactive gaming network: consulting
and contract labor - up $175,000, or 103%; rent for facilities and equipment -
up $139,000, or 119%; travel - up $113,000, or 59%; interactive gaming
telecommunications - up $108,000, or 28%; repairs, maintenance and supplies -
up $85,000, or 111%; employee benefits - up $84,000, or 61%; advertising and
promotions - up $31,000, or 27%; and miscellaneous expenses - up $69,000, or
82%.
AMORTIZATION AND DEPRECIATION increased $526,000, or 83% to $1,161,000 for the
three months ended December 31, 1998 compared to $635,000 for the three months
ended December 31, 1997. The increase results from EPS and software programming
costs capitalized during fiscal 1998 and 1997. The Company made $6.0 million in
capital additions during fiscal 1998.
INTEREST INCOME amounted to $13,000 for the three months ended December 31, 1998
compared to $102,000 for the three months ended December 31, 1997, a decrease of
$89,000, or 87%. This was a direct result of the payment of the notes receivable
on related party equipment sales transactions.
INTEREST EXPENSE amounted to $30,000 for the three months ended December 31,
1998 compared to $26,000 for the three months ended December 31, 1997, a
increase of $4,000, or 15%. This increase resulted from the use of a working
capital line of credit put in place during the first quarter of fiscal 1999.
INCOME TAX amounted to $800 for the three months ended December 31, 1998
compared to $128,000 for the three months ended December 31, 1997, a decrease of
approximately $127,000. This decrease is the result of lower pretax income with
an effective tax rate of 40%.
LIQUIDITY AND CAPITAL RESOURCES
During the first quarter of fiscal 1999, $886,000 of cash was provided by
operations versus $1,403,000 provided by operations in the comparable quarter of
fiscal 1997. At December 31, 1998, the Company had unrestricted cash and cash
equivalents of $697,000, a $1,184,000 decrease from September 30, 1998. Working
capital at the end of the first quarter amounted to $2,055,000 compared to
$4,808,000 at September 30, 1998. Working capital was applied in the development
and manufacture of EPS which were distributed into lease / purchase and rental
pools rather than direct cash sales, resulting in the use of cash generated from
operations to finance the growth of the Company's interactive gaming network.
The Company used $2,848,000 in investing activities during the current quarter,
almost entirely for additions of interactive gaming assets. These software
development and manufacturing costs are expected to continue at a fixed level to
meet customer demand for internally financed lease and rental products until
such time that the Company identifies a third party to finance these products
for its customers.
The rapid expansion of the Company's interactive gaming network and the
deployment of over 2,000 EPS over the last twelve months has increased cash
requirements to install, operate, market, maintain and monitor the network.
These expenses are expected to be sustained at a higher level to support the
overall growth in revenue. The Company is planning system and component upgrades
to accommodate next generation game and video technology, which again, will step
up cash requirements through the remainder of fiscal 1999.
The Company will rely on increasing its average daily revenue per EPS and
promoting a higher proportion of cash sales for EPS until external financing can
be secured. Until the Company's current liabilities are satisfied by an external
financing source, hardware production and component upgrades will be held back.
During the first quarter of fiscal 1999 the Company used $825,000 of its
revolving credit line to reduce a back-log of legal and professional service
fees as well as manufacturing billings. At the same time, accounts payable and
accrued expenses increased $505,000, which was mainly related to manufacturing
and legal fees. Legal and professional fees continue at a high level as the
Network Gaming litigation is ramping up as MegaMania litigation costs have begun
to subside. It is expected that legal and professional fees will start to
decline during the third quarter of fiscal 1999, but there are no assurances
that this will be the case.
As a result of the MegaMania litigation, the Company is evaluating alternative
investment strategies to insure that the elimination of one product line will
not subject the Company to financial turmoil in the future. Diversification to
protect the asset base of the Company is being explored to position the Company
for future growth and stability. To accomplish this goal corporate development
staff was hired during fiscal 1998 and in the first quarter of fiscal 1999.
Costs associated
-12-
<PAGE> 13
with this effort are currently funded from operations, but it is expected that
new product lines and/or expanded network opportunities will begin to cover
these development costs during the third or fourth quarters of fiscal 1999.
The growth in the Company's interactive gaming network experienced during fiscal
1998 was fueled by related party financings and the use of internally generated
funds. Concurrently, periodic federal tax payments were foregone during the year
to finance continued growth. This resulted in an accrued liability for federal
and state income taxes totaling approximately $700,000. The Company is
diligently working to secure financing to cover its past due liabilities, as
well as sufficient working capital to continue its growth, but there are no
assurances that this will be the case.
The lack of player acceptance of new games introduced during fiscal 1998 created
a negative cash flow on certain games as the volume was insufficient to cover a
guaranteed prize payout structure. Experimentation with prize pools was used for
player development and resulted in a higher level of prize payouts which have
had a negative impact on game reserves, but increased the overall volume on the
games. At this time the interactive game reserve deficit exceeds $1,000,000.
The addition of three new games and over 2,000 EPS during the last 12 months has
changed the dynamics of the business as the volume and velocity of play has
significantly increased at the hall level. The increase in volume, the number of
games and the number of EPS has lengthened the reconciliation process with the
halls and therefore slowed the timing of collections. The increase in accounts
receivable amounted to $398,000, up 20% compared to growth in total revenue of
61% for the three months ended December 31, 1998.
At the beginning of the first fiscal quarter ended December 31, 1998, the
Company purchased 356 EPS that had been sold in June 1997 and September 1997 to
EP LLC. The combined repurchase (buy-back) price was $1,349,000. It is expected
that revenue derived from these EPS will increase reported revenue and cash flow
by approximately $90,000 per month. It is also expected that the related party
equipment sales transactions in March 1998 and June 1998 will be repurchased
during fiscal 1999. It is expected that revenue derived from these EPS will
increase reported revenue and cash flow by approximately $180,000 per month.
During the quarter ended December 31, 1998, the Company incurred legal and
professional fees and expenses of $779,000, an increase of $588,000 from the
quarter ended December 31, 1997. Most of these fees were incurred in connection
with the Company's response to the December 31, 1997 actions by the Tulsa U.S.
Attorney in attempting to shut-down the Company's MegaMania bingo game. While
legal fees and expenses related to MegaMania and other litigation involving the
Company will continue to be significant in fiscal 1999, such fees and expenses
are not expected to approach the levels experienced throughout fiscal 1998.
In December 1998, the Company renewed its Credit Agreement with a bank, which
provided for a term loan of $561,000. Principal of $9,510 and interest are
payable monthly until October 31, 2000. In addition, the Credit Agreement
provides for a revolving line of credit of $1.0 million. As of December 31,
1998, the Company had drawn $825,000 against this line of credit. The interest
rate is the Chase Manhattan Bank, N.A. prime rate plus 1/2%. The term loan is
collateralized by substantially all of the tangible and intangible assets of the
Company. The debt is also guaranteed by the Company's Chairman and Chief
Executive Officer. The Credit Agreement contains covenants which, among other
things, require the Company to maintain a minimum net worth, debt service
coverage ratio and gross gaming revenues, all as defined by the Credit
Agreement.
The Company believes that its current operations, including the payment of its
expected legal fees and expenses, can be sustained from cash from operations.
However, the payment of accrued professional fees, federal and state income
taxes and the purchase, assembly and installation of additional EPS to further
expand the Company's interactive gaming operations will require funding from
external sources.
-13-
<PAGE> 14
Prior to the initiation of the MegaMania litigation, the Company financed such
activities primarily through the issuance of equity securities and cash flow
from operations. After the initiation of the MegaMania litigation, the
uncertainties relating to the legality of the Company's interactive bingo
activities and the depressed market for the Company's equity securities made it
more difficult and expensive for the Company to obtain financing. As a result,
the Company financed the purchase, assembly and installation of EPS and the
significant cost of defending the MegaMania litigation primarily through the
sale of EPS to private investors, including related parties. The effective cost
of these sales transactions was significantly higher than could have been
obtained by the Company from the more traditional sources of financing had those
sources been available to the Company. Whether the October 23, 1998 and November
23, 1998 decisions of the Oklahoma and California Federal District Courts
holding that MegaMania is legal Class II gaming will significantly change these
conditions cannot be predicted at this time; however, there are early
indications that the Company's ability to obtain financing have improved. The
inability to obtain additional financing when needed could have a material
adverse effect on the Company's ability to achieve its planned objectives as
well as any expectations the market might have about the Company's future
performance.
CONTINGENCIES
For information regarding contingencies, see "PART II - Item 1. Legal
Proceedings."
INFLATION AND OTHER COST FACTORS
The Company's operations have not been, nor are they expected to be, materially
affected by inflation. However, the Company's operational expansion is affected
by the cost of hardware components, which are not considered to be inflation
sensitive, but rather sensitive to changes in technology and competition in the
hardware markets. In addition, the Company expects it will continue to incur
increased legal and other similar costs associated with compliance with
regulatory requirements and the uncertainties present in the operating
environment in which the Company conducts its business.
IMPACT OF YEAR 2000 ("Y2K")
The "Year 2000 Issue" is the result of computer programs that were written using
two digits rather than four to define the applicable year. If the Company's
computer programs with date-sensitive functions are not Y2K compliant, they may
recognize a date using "00" as the Year 1900 rather than the year 2000. This
could result in a system failure or miscalculations causing disruptions of
operations, including, among other things, a temporary inability to process
transactions, send invoices or engage in similar normal business activities.
The Company has identified its Y2K risk in three categories: Internal business
software, interactive game software and TV bingo game show software.
INTERNAL BUSINESS SOFTWARE. During 1997 and 1998, as part of a business
modernization program intended to reduce time and improve profitability, the
Company purchased the windows system of MAS 90, which the software vendor has
indicated is Y2K compliant. The Company is in the implementation phase for this
system and other ancillary financial systems with full implementation scheduled
for July 31, 1999. This system will include a detailed manufacturing and
inventory system. Based on this schedule, the Company expects to be in full Y2K
compliance with its internal financial systems before the year 2000. However, if
due to unforeseen circumstances, the implementation is not completed on a timely
basis, the Y2K could have a material impact on the manufacturing operations of
the Company. Contingency plans have been established in this area, where the
Company believes there is some risk if the system is not implemented before the
year 2000. Those plans include adapting some of the Company's currently existing
MAS 90 systems to be Y2K compliant. The cost of making those adaptations is not
expected to be material and would be expensed in the period incurred.
INTERACTIVE GAME SOFTWARE. The Company's interactive games have been configured
using the Microsoft four digit system which is Y2K compliant. All current games
as well as future games will also be in Y2K compliance.
-14-
<PAGE> 15
TV BINGO GAME SHOW SOFTWARE. The Company is currently gathering data to assess
the impact of the Y2K on its TV bingo game show system. If the Company is unable
to achieve Y2K compliance for this system, the Y2K could have a material impact
on the TV bingo game show operations of the Company. Since the Company is in the
information gathering phase, the Company does not currently have a contingency
plan in place.
FUTURE EXPECTATIONS AND FORWARD LOOKING STATEMENTS
This Quarterly Report and the information incorporated herein by reference
contains various "forward-looking statements" within the meaning of Federal and
state securities laws, including those identified or predicated by the words
"believes," anticipates," "expects," " plans," or similar expressions. Such
statements are subject to a number of uncertainties that could cause the actual
results to differ materially from those projected. Such factors include, but are
not limited to, the uncertainties inherent to the outcome of any litigation of
the type described in this quarterly report under "PART II - Item 1. Legal
Proceedings," as well as those other factors as described under "Item 1.
Description of Business - Risk Factors," contained in the Company's Annual
Report on Form 10-KSB for the fiscal year ended September 30, 1998, which are
incorporated herein by this reference. Given these uncertainties, readers of
this Quarterly Report are cautioned not to place undue reliance upon such
statements.
-15-
<PAGE> 16
PART II
OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS
MEGAMANIA LITIGATION. On December 31, 1997, the U.S. Attorney for the Northern
District of Oklahoma filed a civil forfeiture action in Federal District Court
challenging the Class II status of the Company's interactive bingo game,
MegaMania. On October 23, 1998, the District Court issued a judgment holding
that MegaMania was legal Class II gaming. The decision found that MegaMania was
a game of bingo and that the EPS used to play MegaMania were technological aids
to the play of bingo as permitted by IGRA and were not gambling devices. On
January 21, 1999, the District Court denied a motion filed by the U.S. Attorney
that requested the District Court to alter or amend its judgment.
On May 14, 1998, the Assistant U.S. Attorney for the Northern District of
California filed a civil forfeiture in Federal District Court that also
challenged the Class II status of MegaMania. On November 23, 1998, the District
Court issued a Memorandum and Order holding that MegaMania was legal Class II
gaming. As with the decision of the Oklahoma District Court, the Order of the
California District Court found that MegaMania was a game of bingo and that the
EPS used to play MegaMania were technological aids to the play of bingo as
permitted by IGRA and were not gambling devices.
The Company is not able to predict whether either or both of these decisions
will be appealed by the government to the applicable Federal Circuit Court of
Appeals. The Company remains steadfast in its belief that MegaMania is Class II
gaming and intends to vigorously defend any appeal. While the company cannot
predict with certainty the outcome of any such appeal, the Company expects it
would prevail on the merits.
No assurances can be given that there will be no other challenges made to the
legality of the Company's interactive bingo activities or that, if made, the
Company will be successful on the merits. If MegaMania is ultimately determined
to be Class III gaming, the loss of the MegaMania business could have a material
adverse effect upon the Company's financial condition and results of operation.
In addition, if the type of EPS used to aid the play of MegaMania is ultimately
held to be a gambling device, all of the other interactive Class II bingo games
currently offered by the Company and other vendors would likely be adversely
effected which would have a material adverse effect upon the Company's financial
condition and results of operation. Even if the Company is successful on the
merits, the legal fees and expenses to be incurred by the Company related to any
appeal of the MegaMania litigation or any future litigation challenging the
Company's interactive bingo activities will likely be significant.
DEVELOPING LEGAL ENVIRONMENT. The environment in which the Company conducts its
business is relatively new and presents significant legal and operating
challenges and uncertainties. Fundamental issues concerning the scope and intent
of IGRA remain unresolved, as do issues relating to the jurisdiction and
authority of different Federal, State, local and tribal governments and
agencies. For example, prior to the initiation by the Department of Justice of
the MegaMania litigation, the Company had received and had relied upon opinions
from the NIGC that MegaMania was Class II gaming. While the NIGC has its own
powers of enforcement, the Department of Justice has been maintaining that it
retains enforcement powers over gambling devices and is not bound by NIGC
determinations. As a result, the Company faces uncertainty as to whether other
actions will be initiated by the Department of Justice in the future.
There can be no assurance that the NIGC, either on its own initiative or as the
result of pressure from or cooperation with other agencies such as the
Department of Justice, will not enact additional regulations or reinterpret
existing regulations in a manner that would have a material and adverse effect
upon the Company, including requiring the Company to restructure its existing
contractual arrangements with Indian tribes or requiring changes in the way the
Company's games are conducted so that such games are classified as Class II. Any
such restructuring of the Company's games has the additional risk that such
games will no longer appeal to consumers or be acceptable to the tribes. There
can also be no
-16-
<PAGE> 17
assurance that IGRA or other Federal laws will not be amended, or new
legislation or regulations enacted, so as to limit the authority of tribes to
self-regulate Class II gaming or to change the definition of Class II gaming in
a manner adverse to the Company's business.
NETWORK GAMING LITIGATION. On January 23, 1998, the Company filed a complaint
against Network Gaming International Corporation ("NGI") in the Federal District
Court for the Northern District of Oklahoma alleging breach of contract. On
February 2, 1998, NGI filed a complaint against the Company in the same Federal
District Court alleging, among other things, breach of contract,
misappropriation of trade secrets, fraud and interference with prospective
advantage. The complaint by NGI seeks $62 million in damages and other specified
and unspecified relief and also names Gordon T. Graves, the Company's Chairman
of the Board, and Larry D. Montgomery, the Company's former President, as
individual defendants. These actions are in the very preliminary stages and only
limited discovery has been taken by either party. The Company intends to
vigorously defend against the claims of NGI and to prosecute its own claim.
While the Company believes that it will ultimately prevail on the merits, no
assurances to that effect can be given. In any event, the cost of defending the
actions could be substantial.
SHAREHOLDER CLASS ACTIONS. On May 29, 1998, a shareholder class action was filed
against the Company in the Federal District Court for the Southern District of
California. Also named as defendants were Gordon T. Graves and Larry D.
Montgomery. The action, which seeks an unspecified amount of damages on behalf
of all similarly situated shareholders, alleges that the Company violated
federal securities laws by making allegedly false and misleading statements
regarding the legality of MegaMania. On July 24, 1998, a similar class action
was filed in the Federal Court for the Northern District of Oklahoma. In January
1999, the two cases were consolidated in the Northern District of Oklahoma.
These actions are in very preliminary stages. The Company intends to vigorously
defend against these claims and expects to prevail on the merits, although no
assurances to that effect can be given. In any event, the cost of defending
against the claims could by substantial.
OTHER. The Company is a party to various other lawsuits and claims arising out
of the ordinary course of its business. No accrual for potential loss has been
made in the accompanying financial statements, as management does not believe
that the likelihood of a material loss is probable at this time.
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
(a) The exhibits filed as part of this Quarterly Report on Form 10-Q
are listed in the attached Index to Exhibits.
(b) No reports on Form 8-K were filed by the Company during the quarter
ended December 31, 1998.
SIGNATURES
In accordance with the requirements of the Exchange Act, the registrant caused
this report to be signed on its behalf by the undersigned, thereunto duly
authorized.
Dated February 13, 1999 Multimedia Games, Inc.
By: /S/ George J. Akmon
------------------------------------
George J. Akmon, Vice President and
Chief Financial Officer
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<PAGE> 18
INDEX TO EXHIBITS
<TABLE>
<CAPTION>
EXHIBIT
NUMBER DESCRIPTION
- -------- -----------
<S> <C>
15 Letter regarding Unaudited Interim Financial Information
27 Financial Data Schedule
</TABLE>
-18-
<PAGE> 1
EXHIBIT 15
MULTIMEDIA GAMES, INC. AND SUBSIDIARIES
LETTER REGARDING UNAUDITED INTERIM FINANCIAL INFORMATION
Securities and Exchange Commission
450 Fifth Street, N.W.
Washington, D.C. 20549
Re: Multimedia Games, Inc.
Registration on Forms S-3 and S-8
We are aware that our report dated February 12, 1999 on our review of the
interim financial information of Multimedia Games, Inc. for the periods ended
December 31, 1998 and 1997, and included in this Form 10-Q is incorporated by
reference in the Company's registration statements on Forms S-3 (File No.
333-16729, 333-28367 and 333-36319) and Form S-8 (File No. 333-23123). Pursuant
to Rule 436(c) under the Securities Act of 1933, this report should not be
considered a part of the registration statements prepared or certified by us
within the meaning of Sections 7 and 11 of that Act.
PricewaterhouseCoopers LLP
Tulsa, Oklahoma
February 15, 1999
<TABLE> <S> <C>
<ARTICLE> 5
<LEGEND>
THIS SCHEDULE CONTAINS SUMMARY FINANCIAL INFORMATION EXTRACTED FROM THE
CONSOLIDATED BALANCE SHEET AT DECEMBER 31, 1998 AND THE CONSOLIDATED STATEMENTS
OF OPERATIONS AND FLOWS FOR THE QUARTER ENDED DECEMBER 31, 1998, AND IS
QUALIFIED IN ITS ENTIRETY BY REFERENCE TO SUCH FINANCIAL STATEMENTS.
</LEGEND>
<S> <C>
<PERIOD-TYPE> 3-MOS
<FISCAL-YEAR-END> SEP-30-1999
<PERIOD-END> DEC-31-1999
<CASH> 697,000
<SECURITIES> 0
<RECEIVABLES> 4,872,000
<ALLOWANCES> 203,000
<INVENTORY> 2,794,000
<CURRENT-ASSETS> 8,400,000
<PP&E> 16,440,000
<DEPRECIATION> 5,744,000
<TOTAL-ASSETS> 21,314,000
<CURRENT-LIABILITIES> 6,345,000
<BONDS> 0
0
1,000
<COMMON> 55,000
<OTHER-SE> 12,685,000
<TOTAL-LIABILITY-AND-EQUITY> 21,314,000
<SALES> 301,000
<TOTAL-REVENUES> 20,752,000
<CGS> 151,000
<TOTAL-COSTS> 20,733,000
<OTHER-EXPENSES> 0
<LOSS-PROVISION> 0
<INTEREST-EXPENSE> 30,000
<INCOME-PRETAX> 2,000
<INCOME-TAX> 1,000
<INCOME-CONTINUING> 1,000
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> 1,000
<EPS-PRIMARY> 0.00
<EPS-DILUTED> 0.00
</TABLE>
