<PAGE> 1
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
[X] Quarterly report pursuant to Section 13 or 15(d) of the Securities
Exchange Act of 1934
For the quarterly period ended September 30, 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 0-22482.
INNOVATIVE GAMING CORPORATION OF AMERICA
- - --------------------------------------------------------------------------------
(Exact Name of Registrant as Specified in Its Charter)
<TABLE>
<S> <C>
Minnesota 41-1713864
(State or Other Jurisdiction of (I.R.S. Employer Identification No.)
Incorporation or Organization)
</TABLE>
4750 Turbo Circle, Reno, Nevada 89502
- - --------------------------------------------------------------------------------
(Address of Principal Executive Offices)
(702) 823-3000
- - --------------------------------------------------------------------------------
(Issuer's Telephone Number, Including Area Code)
- - --------------------------------------------------------------------------------
(Former Address, If Changed Since Last Report)
Check whether the issuer: (1) filed all reports required to be filed by
Section 13 or 15(d) of the Exchange Act 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 [ ]
State the number of shares outstanding of each of the issuer's classes of common
equity, as of the latest practicable date: At November 6, 1998 there were
7,535,211 shares of Common Stock, $0.01 par value, outstanding.
Page 1 of 16
<PAGE> 2
INNOVATIVE GAMING CORPORATION OF AMERICA
Form 10-Q Index
September 30, 1998
<TABLE>
<S> <C>
Part I: Financial Information
Item 1. Financial Statements
Consolidated Condensed Balance Sheets -
September 30, 1998 (Unaudited) and December 31, 1997 3
Consolidated Condensed Statements of Operations -
for the three and nine months ended
September 30, 1998 and 1997 (Unaudited) 4
Consolidated Condensed Statements of Cash
Flows for the nine months ended September
30, 1998 and 1997 (Unaudited) 5
Notes to Consolidated Condensed
Financial Statements 6
Item 2. Management's Discussion and Analysis of
Financial Condition and Results of Operations 9
Part II: Other Information
Item 1. Legal Proceedings 15
Item 6. Exhibits and Reports on Form 8-K 15
Signatures 16
</TABLE>
Page 2 of 16
<PAGE> 3
INNOVATIVE GAMING CORPORATION OF AMERICA AND SUBSIDIARY
CONSOLIDATED CONDENSED BALANCE SHEETS
(IN THOUSANDS, EXCEPT SHARE DATA)
(UNAUDITED)
<TABLE>
<CAPTION>
ASSETS
September 30, December 31,
1998 1997
------------- -------------
<S> <C> <C>
CURRENT ASSETS:
Cash and cash equivalents $ 2,726 $ 518
Restricted investments 800 1,000
Accounts receivable 1,582 1,929
Current portion of notes receivable 699 276
Inventories 9,574 10,191
Prepaid expenses and other 214 159
------- -------
Total current assets 15,595 14,073
NOTES RECEIVABLE, LESS CURRENT PORTION 484 552
PROPERTY AND EQUIPMENT, NET 1,390 2,107
DEFERRED INCOME TAXES -- 720
INTANGIBLE ASSETS, NET 1,515 1,729
------- -------
TOTAL ASSETS $18,984 $19,181
======= =======
LIABILITIES AND STOCKHOLDERS' EQUITY
LIABILITIES:
Accounts payable $ 311 $ 568
Accrued liabilities 428 423
Notes payable - current portion 508 322
Customer deposits 27 157
------- -------
Total current liabilities 1,274 1,470
Notes payable - net of current portion 964 509
------- -------
Total liabilities 2,238 1,979
------- -------
COMMITMENTS AND CONTINGENCIES
STOCKHOLDERS' EQUITY:
Series B Convertible Preferred Stock, $.01 par value,
nonvoting, 4,000 shares authorized, 3,000 and 0 shares
outstanding, respectively 2,988 --
Capital stock, $.01 par value, 100,000,000 shares authorized,
7,535,211 shares of Common Stock issued and outstanding 75 75
Additional paid-in capital 29,676 29,575
Accumulated deficit (15,993) (12,448)
------- -------
Total stockholders' equity 16,746 17,202
------- -------
TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY $18,984 $19,181
======= =======
</TABLE>
See Notes to Consolidated Condensed Financial Statements.
Page 3 of 16
<PAGE> 4
INNOVATIVE GAMING CORPORATION OF AMERICA AND SUBSIDIARY
CONSOLIDATED CONDENSED STATEMENTS OF OPERATIONS
(IN THOUSANDS, EXCEPT SHARE AND PER SHARE DATA)
(UNAUDITED)
<TABLE>
<CAPTION>
Three Months Nine Months
Ended September 30, Ended September 30,
----------------------------- -----------------------------
1998 1997 1998 1997
------------- ------------- ------------- -------------
<S> <C> <C> <C> <C>
SALES $ 1,169 $3,873 $ 7,373 $ 5,423
COST OF SALES 1,204 2,355 5,723 3,707
------- ------ ------- -------
Gross profit (35) 1,518 1,650 1,716
SELLING, GENERAL AND ADMINISTRATIVE 1,713 1,240 4,227 4,066
------- ------ ------- -------
Income (loss) from operations (1,748) 278 (2,577) (2,350)
INTEREST INCOME, NET 33 48 83 225
------- ------ ------- -------
INCOME (LOSS) BEFORE INCOME TAXES (1,715) 326 (2,494) (2,125)
PROVISION FOR INCOME TAXES 720 -- 720 --
------- ------ ------- -------
NET INCOME (LOSS) (2,435) 326 (3,214) (2,125)
Preferred stock accretion adjustment 143 252 284 878
Preferred stock dividends 30 34 46 70
------- ------ ------- -------
NET INCOME (LOSS) ATTRIBUTABLE TO COMMON STOCK SHAREHOLDERS $(2,608) $ 40 $(3,544) $(3,073)
======= ====== ======= =======
BASIC - INCOME (LOSS) PER SHARE OF COMMON STOCK $ (0.35) $ 0.01 $ (0.47) $ (0.47)
======= ====== ======= =======
WEIGHTED AVERAGE
COMMON STOCK SHARES OUTSTANDING 7,535 6,630 7,535 6,528
======= ====== ======= =======
</TABLE>
See Notes to Consolidated Condensed Financial Statements.
Page 4 of 16
<PAGE> 5
INNOVATIVE GAMING CORPORATION OF AMERICA AND SUBSIDIARY
CONSOLIDATED CONDENSED STATEMENTS OF CASH FLOWS
(IN THOUSANDS)
(UNAUDITED)
<TABLE>
<CAPTION>
Nine Months
Ended September 30,
-------------------------------
1998 1997
------------- -------------
<S> <C> <C>
CASH FLOWS FROM OPERATING ACTIVITIES:
Net loss $(3,214) $(2,125)
Adjustments to reconcile net loss to
cash flows from operating activities -
Depreciation and amortization 700 596
Deferred income taxes 720 --
Provision for inventory obsolescence 262 60
Loss on sale of securities and investments -- 2
Provision for bad debts -- 9
Changes in operating assets and liabilities (106) (5,231)
-------- -------
Cash flows (used in) operating activities (1,638) (6,689)
-------- -------
CASH FLOWS FROM INVESTING ACTIVITIES:
Purchases of securities and investments -- (1,043)
Proceeds from sale of securities and investments -- 3,906
Inventory returned from (capitalized for use in) gaming operations 487 (2,052)
Purchases of property and equipment (206) (254)
Purchase of intangible assets (50) --
-------- -------
Cash flows provided from investing activities 231 557
-------- -------
CASH FLOWS FROM FINANCING ACTIVITIES:
Proceeds from notes payable 910 524
Payments on notes payable (269) (33)
Net proceeds from sale of preferred stock 2,804 3,752
Preferred stock dividends paid (30) (40)
-------- -------
Cash flows provided from financing activities 3,415 4,203
-------- -------
INCREASE IN CASH AND CASH EQUIVALENTS 2,008 (1,929)
CASH AND CASH EQUIVALENTS, BEGINNING OF PERIOD 1,518 2,993
-------- -------
CASH AND CASH EQUIVALENTS, END OF PERIOD $ 3,526 $ 1,064
======== =======
SUPPLEMENTAL DISCLOSURE OF CASH FLOWS INFORMATION:
Cash paid for interest $ 50 $ 1
======== =======
</TABLE>
See Notes to Consolidated Condensed Financial Statements.
Page 5 of 16
<PAGE> 6
INNOVATIVE GAMING CORPORATION OF AMERICA AND SUBSIDIARY
NOTES TO CONSOLIDATED CONDENSED FINANCIAL STATEMENTS
SEPTEMBER 30, 1998
(UNAUDITED)
(1) BASIS OF FINANCIAL STATEMENT PRESENTATION
The accompanying unaudited consolidated condensed financial statements have been
prepared by the Company pursuant to the rules and regulations of the Securities
and Exchange Commission. Certain information and footnote disclosures normally
included in financial statements prepared in accordance with generally accepted
accounting principles have been condensed or omitted pursuant to such rules and
regulations. Although management believes that the disclosures are adequate to
make the information presented not misleading, it is suggested that these
interim consolidated condensed financial statements be read in conjunction with
the Company's most recent audited consolidated financial statements and notes
thereto included in the Company's Annual Report to Shareholders and Form 10-K
for the year ended December 31, 1997. In the opinion of management, all
adjustments (consisting only of normal recurring adjustments) necessary for a
fair presentation of the financial position, results of operations and cash
flows for the interim periods presented have been made. Operating results for
the nine months ended September 30, 1998 are not necessarily indicative of the
results that may be expected for the year ending December 31, 1998.
(2) COMMITMENTS AND CONTINGENCIES
The manufacture, distribution and sale of the Company's products are regulated
by various jurisdictions and entities, including requirements to obtain licenses
and product approvals in several jurisdictions. The Company has obtained
required licenses and product approvals in certain jurisdictions and is
continuing efforts to obtain such approvals in other jurisdictions. Failure to
successfully obtain and/or maintain such licenses and approvals, or meet other
regulatory requirements could materially impact the expansion and future
operation of the Company. Additionally, there is no assurance that the Company's
products will be accepted in the marketplace upon obtaining regulatory
approvals. As a result, the Company's quarterly results may be volatile until
all product approvals have been obtained, appropriate marketing efforts have
been successfully performed and the Company's products are accepted in major
gaming markets.
The Company purchases certain key electronic components, which are not available
from other sources, from a Japanese supplier at a negotiated fixed price for a
period extending into mid-1999.
(3) RELATED PARTY TRANSACTIONS
Grand Casinos, Inc. ("GCI"), which is in the business of owning, managing and
developing casinos, is a stockholder of the Company. Lyle Berman, who was
Chairman of the Board of the Company until June 24, 1998, is a principal
shareholder and Chairman of the Board of GCI, and was Chief Executive Officer
from October 1991 through March 1998. Mr. Berman continues to serve on the Board
of Directors of the Company. Under an existing machine purchase agreement, GCI
may purchase up to an aggregate of 125 of the Company's blackjack, craps and
roulette games in quantity purchases at distributor level prices. Previous
quantity sales were also made to GCI at distributor level prices for the purpose
of testing, evaluating and marketing the Company's blackjack, craps and roulette
games. Under an agreement between the Company and GCI, used multi-player
machines which GCI previously purchased from the Company may be placed on
consignment with the Company to be refurbished and sold into legal markets. The
proceeds from sales of up to three of the consignment games may be applied to
the purchase of one new Bonus Streak game from the Company and minimum proceeds
of $5,000 must be credited to GCI for each game sold by the Company. There are
potentially 31 such used multi-player games which GCI may submit the Company for
sale under the consignment agreement. The Company made no machine sales to GCI
during the nine-month period ended September 30, 1997 and sales of six Bonus
StreakTM games and no multi-player machine sales to GCI during the nine-month
period ended September 30, 1998.
(4) INCOME TAXES
The Company has adopted Statement of Financial Accounting Standards No. 109-
"Accounting for Income Taxes" - (SFAS No. 109) under which deferred income tax
assets and liabilities are recognized for differences between financial and
income tax reporting basis of assets and liabilities based on currently enacted
rates and laws. The
Page 6 of 16
<PAGE> 7
INNOVATIVE GAMING CORPORATION OF AMERICA AND SUBSIDIARY
NOTES TO CONSOLIDATED CONDENSED FINANCIAL STATEMENTS - CONTINUED
SEPTEMBER 30, 1998
(UNAUDITED)
Company had cumulative federal net operating loss carry forwards of
approximately $10,294,000 as of December 31, 1997. These losses, if not used,
begin to expire in 2009 through 2012. The use of approximately $1,250,000 of
these losses is limited to approximately $250,000 per year for the next five
years because the loss was generated in a short tax year. Future changes in the
ownership of the Company may place limitations on the use of these net operating
loss carry forwards.
The Company recorded a $720,000 provision for income taxes during the quarter
ended September 30, 1998 to provide a full valuation allowance on its deferred
tax asset. As required by SFAS No. 109, and taking into consideration past
losses, the Company recorded the additional valuation reserve.
(5) EARNINGS PER SHARE
The Company has adopted Statement of Financial Accounting Standards No. 128
"Earnings Per Share"-(SFAS No. 128). SFAS No. 128 is effective for periods
ending after December 15, 1997, and replaces previously reported earnings per
share with "basic" and "diluted" earnings per share. The earnings per share data
for the periods presented is based on weighted average common shares
outstanding, which is equivalent to "basic" earnings per share as calculated
under SFAS No. 128. Diluted earnings per share is not presented because the
resulting earnings per share would be antidilutive for each period reported.
(6) FINANCING ARRANGEMENT
In March 1998, Innovative Gaming, Inc., a wholly-owned subsidiary of the
Company, entered into a loan commitment securing $2 million from a third party
lender. The initial funding of approximately $910,000 was completed on April 13,
1998. The loan is payable in 36 equal installments including interest paid in
arrears at a rate of 12.06 percent. This financing is secured by certain of the
Company's long-term receivables and a corporate guarantee from the Company.
Additional funding under this arrangement is available through December 1, 1998.
The Company's borrowing capacity under this arrangement is dependent upon the
level of receivables generated through "bucket sales" agreements.
(7) PREFERRED STOCK PRIVATE PLACEMENT
On May 13, 1998, the Company issued 3,000 shares of Series B Convertible
Preferred Stock (the "Preferred Stock") at a price of $1,000 per share in a
private placement for total proceeds of $3,000,000. The Company received net
proceeds of approximately $2,804,000 after the payment of fees and expenses
associated with such private placement. An annual dividend of 4% shall be paid
quarterly in arrears either in Preferred Stock of the Company or cash at the
Company's discretion.
Each share of Preferred Stock is convertible into shares of the Company's Common
Stock at a conversion price of 91% of the three consecutive day average of the
lowest closing bid price of the Company's Common Stock over the twenty-day
trading period ending the day prior to conversion (the "Conversion Price"). The
Conversion Price may not exceed $5.16, 135 % of the ten day average of the
closing bid price of the Company's Common Stock ending on May 12, 1998. The
maximum number of shares of Common Stock that may be issued upon conversion is
1,505,000. In the event that there is Preferred Stock outstanding after the
issuance of 1,505,000 shares of Common Stock upon conversion, the Company may
either 1) redeem any unconverted Preferred Stock for cash at a price equal to
115% of the liquidation value of the shares or 2) convert such unconverted
shares without a discount into Common Stock and pay cash to the holder of such
unconverted shares equal to the economic value that would have been received by
such holder if able to convert at a discount. See Exhibit 4 to the Company's
Form 10-Q for the quarter ended March 31, 1998. The Company has the right to
redeem the Preferred Stock at 115% of par in cash. As of September 30, 1998,
fifty percent (50%) of the Preferred Stock was convertible into Common Stock, at
the election of the holder thereof. An additional twenty-five percent (25%) of
the Preferred Stock is convertible on October 14,1998, and the remaining (25%)
of the Preferred Stock is convertible on November 14, 1998. All outstanding
shares of Preferred Stock will automatically be converted into Common Stock on
November 13, 1999. A holder of Preferred Stock may not convert such stock into
Common Stock if, following such conversion, the
Page 7 of 16
<PAGE> 8
INNOVATIVE GAMING CORPORATION OF AMERICA AND SUBSIDIARY
NOTES TO CONSOLIDATED CONDENSED FINANCIAL STATEMENTS - CONTINUED
SEPTEMBER 30, 1998
(UNAUDITED)
holder beneficially owns in excess of 4.9% of the Company's Common Stock. As of
September 30, 1998, no Preferred Stock had been converted into Common Stock.
A Registration Statement related to the Common Stock was filed by, and at the
expense of, the Company pursuant to obligations contained in a Registration
Rights Agreement dated May 13, 1998. The effective date of the Registration
Statement filed with the Securities and Exchange Commission was September 3,
1998, and all necessary gaming regulatory approvals have been received. The 9%
beneficial conversion feature is accounted for as an additional Preferred Stock
dividend, which was determined on the date the Preferred Stock was issued. The
total value of the beneficial conversion feature or dividend is $296,703, which
reduces income available for holders of the Company's Common Stock and therefore
reduces earnings per share on a pro rata basis over the period from issuance of
the Preferred Stock to the earliest conversion date. Income available to holders
of Common Stock will be reduced by approximately $140,934, $143,406 and $12,363
during the second, third and fourth quarters of 1998, respectively.
(8) NOTE RECEIVABLE
On June 19, 1998, the Company entered into an agreement loaning $300,000 to a
third party gaming equipment developer, Gametronics, Inc. ("Gametronics"), a
Canadian corporation. The agreement was subsequently amended and the loan
increased to $400,000 on July 20, 1998. Under a subsequent agreement dated
October 22, 1998, the loan balance of $400,000 was converted and applied toward
the purchase price of certain intellectual property for game concepts developed
by Gametronics.
(9) ACQUISITION OF RIGHTS TO TECHNOLOGY AND INTELLECTUAL PROPERTY
The Company has entered into agreements with various companies to acquire rights
to technology and intellectual property for use in games which the Company
intends to develop, manufacture and market.
Under an agreement with Quick Silver Development Co. Inc ("Quick Silver"), a
California corporation, the Company purchased the Patent and Technology for a
game concept entitled "Revolving Rings Gaming Apparatus", for a purchase price
of $50,000. The Company will also pay a per day game fee to Quick Silver for
gaming devices embodying the Patent technology and placed in locations under
participation agreements between the location and the Company. The per day game
fees will vary based upon the number of games placed and are subject to
regulatory approval.
The Company purchased rights to a game concept developed by Vista Gaming
("Vista"), a Colorado corporation, for a purchase price of $100,000. The Company
will also pay game fees to Vista for gaming devices embodying the game concept
sold or placed in locations under participation agreements between the location
and the Company. The game fees will vary based upon the number of games placed
and are subject to regulatory approval.
The Company purchased rights to intellectual property related to two game
concepts developed by Gametronics for a purchase price of $500,000. A note
receivable from Gametronics in the amount of $400,000 was converted and applied
toward payment of the purchase price. The Company will also pay game fees to
Gametronics for gaming devices embodying the game concept sold or placed in
locations under participation agreements between the location and the Company.
The game fees for sold games will be at a fixed fee and per day games fees for
games placed under participation agreements will vary based upon the number of
games placed and are subject to regulatory approval. The rights acquired allow
the Company to develop, manufacture, market and distribute the games in Nevada
and Mississippi.
Under a purchase agreement with Metropolitan Gaming LLC ("Metropolitan"), the
Company purchased a sublicense for rights to use three dimensional projection
technology in one if its gaming machine products, for a purchase price of
$75,000. The Company will also pay a per day signage technology fee to
Metropolitan for gaming devices embodying the technology and placed in locations
under participation agreements between the location and the Company. The per
game signage technology fees will vary based upon the total number of games
placed utilizing the three dimensional projection technology and are subject to
regulatory approval.
Page 8 of 16
<PAGE> 9
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
OVERVIEW
The Company was formed in 1991 to develop, manufacture, market and distribute
group participation and other specialty gaming machines. The Company presently
manufactures, distributes and markets electronic blackjack (including
progressive blackjack), craps, roulette and Bonus StreakTM machines to gaming
markets worldwide. Since inception, the Company has focused most of its
resources on the regulatory approval process and the sale and installation of
its machines and the development of other products.
In February 1997, the Company received technical game approval for its
multi-station blackjack machine from Colorado regulatory authorities. The
Company, through its Colorado distributor, Vista Gaming Corporation, commenced
placing its blackjack games in Colorado casinos on a lease basis in late
February 1997. In February and March 1997, the Nevada Gaming Commission granted
the Company technical game approval of its Hot Shot DiceTM , BJ BlitzTM and
Lightning StrikeTM Roulette machines for use in Nevada. In May 1997, the Nevada
Gaming Commission granted the Company technical game approval of its Bonus
StreakTM specialty game. In September 1997, the Company received interim
approval for its multi-station blackjack and roulette games for use in the club
markets of New South Wales, Australia.
The Company is continuing expansion of its customer markets by submitting
applications for licensing in key jurisdictions and, where licensed, submitting
its products for technical approval. In May 1998, the Company submitted an
application to the New Jersey Casino Control Commission for a casino service
industry license. Also in May 1998, the Company submitted its Bonus Streak
specialty game to the Mississippi Gaming Commission Lab for technical review.
The Company has also submitted gaming supplier registration applications in
major Canadian markets and appointed a sales agent for British Columbia,
Ontario, Quebec, Alberta and the Atlantic Provinces. In July 1998, the Company's
Lightning Strike Roulette game received technical approval from the Quebec
Gaming Laboratory. The game was subsequently placed on field trial at one of the
Quebec casinos operated by the casino operating arm of Loto Quebec. Also in July
1998, a temporary license was granted in Alberta pending review of the
application for a permanent license and the Company's Bonus Streak games were
placed on field trial by the Alberta Gaming and Liquor Commission. The Company
is also pursuing expansion in Native American markets and, in October 1998, was
approved to sell its gaming products to two Iowa Native American tribes.
In November 1998, the Company, in a letter to shareholders, reviewed its
continuing efforts to improve the Company's performance in light of the gaming
industry downturn and the related lower than expected sales of the Company's
multi-play games. The plan includes broadening the Company's product base to
include several less expensive, new single player specialty games that will
return higher margins and increase sales revenues. The Company has already
acquired rights to technology and game concepts for several new games including
Mystic Reels, Revolving Rings and a new video slot product incorporating five
reel, multi-line, multi-coin games. The Company is also negotiating an agreement
to manufacture a 9 reel, spinning reel game with eight pay lines and the ability
to bet up to 32 coins. Additionally, the Company's new state of the art PC based
gaming platform will allow the Company to program new games quickly, and at a
reduced time, cost and product cycle risk compared to most current machines. In
addition, the Company announced that it has retained a New York
investment-banking firm to assist in identifying opportunities for strategic
alliances, joint ventures, and possible mergers/acquisitions.
The Company distributes its products both directly to the gaming marketplace and
through licensed distributors. In certain jurisdictions, the Company has
received technical game approval but has not sought or received its
distributor's license. In certain jurisdictions the Company may use an existing
licensed distributor to sell its products pursuant to any necessary Tribal or
regulatory transaction approvals. The Company has, and/or intends to apply for
necessary licenses or technical game approvals in key jurisdictions both
domestically and internationally where legalized electronic gaming is permitted.
RESULTS OF OPERATIONS FOR THE THREE AND NINE MONTHS ENDED SEPTEMBER 30, 1998
COMPARED TO SEPTEMBER 30, 1997
For the three months ended September 30, 1998, the Company recorded a pretax
loss attributable to Common Stock shareholders of $1,888,000, or $.25 per share
compared to a profit of $40,000, or $.01 per share for the three months ended
September 30, 1997. For the nine months ended September 30, 1998, the Company
recorded a pretax loss attributable to Common Stock shareholders of $2,824,000,
or $.37 per share compared to a loss of $3,073,000, or $.47 per share for the
nine months ended September 30, 1997. The loss attributable to common
shareholders for
Page 9 of 16
<PAGE> 10
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS - CONTINUED
RESULTS OF OPERATIONS FOR THE THREE AND NINE MONTHS ENDED
SEPTEMBER 30, 1998 COMPARED TO SEPTEMBER 30, 1997- CONTINUED
each period included adjustments for preferred stock accretion and preferred
stock dividends. In the quarter ended September 30, 1998, the Company, in
accordance with Statement of Financial Accounting Standards No. 109 "Accounting
for Income Taxes", recorded a $720,000 provision for income taxes representing a
valuation allowance related to a deferred tax asset, which resulted in a net
loss attributable to Common Stock shareholders of $.35 and $.47 per share for
the three and nine month periods ended September 30, 1998, respectively. The
operating loss in the third quarter 1998 was primarily attributable to low sales
volume and gross profit and increased expenses incurred related to the Company's
continuing efforts to develop/enhance and license its products.
SALES, COST OF SALES AND GROSS PROFIT
Total sales for the quarter ended September 30, 1998, were $1,169,000 compared
to $3,873,000 recorded in the quarter ended September 30, 1997. Total sales for
the nine months ended September 30, 1998 were $7,373,000 compared to $5,423,000
recorded in the nine months ended September 30, 1997. The table below summarizes
product sales by geographic region for the three and nine month periods ended
September 30, 1998 and 1997.
<TABLE>
<CAPTION>
Three Months Ended Nine Months Ended
------------------ ------------------
Region of sales 9/30/98 9/30/97 9/30/98 9/30/97
- - --------------- ------- ------- ------- -------
<S> <C> <C> <C> <C>
Australia 11 40 83 54
Europe 1 1 12 10
Nevada 2 - 13 -
Other U.S. - 21 30 22
---- ---- ---- ----
Total 14 62 138 86
==== ==== ==== ====
</TABLE>
Sales to Australia and Europe were made to the
Company's distributors for those regions.
Sales will continue to be volatile until, among other things, the Company's
products are accepted by the market place and new jurisdictional licenses and/or
distribution agreements are obtained. In addition, the Company believes that
sales to its Australian distributor will continue to account for a significant
portion of the Company's 1998 sales. Disruption in sales to this distributor
could have a material adverse affect on the Company's financial position and
1998 results of operations and cash flows.
The Company also recognized lease/participation revenues in 1998 attributable to
placement of games in Colorado and Nevada casinos, subsequent to receiving
regulatory approval in those jurisdictions in the first half of 1997. In Nevada,
game placements under lease/participation agreements have been slower than
originally expected due to increasing customer resistance with participation
arrangements. The Company has expanded its marketing strategy in Nevada to
attract a greater number of casino operators by also offering its games for
sale. To date, game placements in Nevada have been fewer than anticipated by
management.
The Company recorded a negative gross margin for the third quarter of 1998
compared to a gross margin 39.2% for the third quarter of 1997. The gross margin
for the nine months ended September 30, 1998 was 22.4% compared to 31.6% for the
nine months ended September 30, 1997. The lower gross margin in 1998 was
primarily due to unabsorbed labor and overhead costs attributable to low
production volume in the third quarter 1998.
Page 10 of 16
<PAGE> 11
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS - CONTINUED
RESULTS OF OPERATIONS FOR THE THREE AND NINE MONTHS
ENDED SEPTEMBER 30, 1998 COMPARED TO SEPTEMBER 30,
1997 - CONTINUED
SELLING, GENERAL AND ADMINISTRATIVE EXPENSES
Selling, general and administrative expense for the three months ended September
30, 1998 was $1,713,000 compared to $1,240,000 for the three months ended
September 30, 1997. This increase in expense was due primarily to an increased
investment in engineering and development costs for new product development and
incentive payments and service costs. Additionally, in the prior year period
reserves for bad debts were reduced. Selling, general and administrative expense
for the nine months ended September 30, 1998 was $4,227,000 compared to
$4,066,000 for the nine months ended September 30, 1997. This expense increase
is primarily attributable to higher expenditures for product engineering and
development.
INTEREST INCOME
In the quarter ended September 30, 1998, net interest income was $33,000
compared to $48,000 in the quarter ended September 30, 1997. In the nine months
ended September 30, 1998, net interest income was $83,000 compared to $225,000
in the nine months ended September 30, 1997. The decrease in net interest income
was due to a decrease in investments in interest bearing accounts and interest
expense incurred on increased debt.
PROVISION FOR INCOME TAXES
In accordance with Statement of Financial Accounting Standards No. 109 -
"Accounting for Income Taxes"- (SFAS No. 109), the Company recorded a $720,000
provision for income taxes during the quarter ended September 30, 1998 to
provide a full valuation allowance on its deferred tax asset. As required by
SFAS No. 109, and taking into consideration past losses, the Company recorded
the additional valuation reserve.
ACCUMULATED DEFICIT
The Company had an accumulated deficit of $15,993,000 as of September 30, 1998.
Due to weaker than expected demand for the Company's current products, the high
degree of regulation and other factors of the business environment in which the
Company operates, the likelihood of future profitable quarters cannot be
predicted. The Company believes that it will be difficult to achieve
profitability in the fourth quarter of 1998 and the first quarter of 1999.
Future results are highly dependent on the Company's ability to, among other
things, adequately finance and develop new products, obtain the necessary
licenses and/or product approvals in various jurisdictions in order to expand
its market base, and customer acceptance of its existing and new products. There
can be no assurance as to the time frame during which such anticipated approvals
may occur due to uncertain time periods involved in the regulatory approval
process. Due to the unique nature and prices of the Company's products, it is
difficult to predict the appropriate selling cycle time frame involved in each
new jurisdiction. Operating results are also affected by seasonal factors in
certain markets, cycles of casino expansions and equipment replacements,
changing technology and the expansion or addition of gaming markets.
Additionally, the Company will require additional capital to manufacture and
distribute new products.
As a result of these and other factors, the Company expects quarterly results to
be volatile until the Company's products are accepted by the market place and
licenses and approvals are obtained in certain major gaming markets. The Company
has experienced delays in acquiring certain gaming licenses and/or product
approvals in key jurisdictions. Future sales and earnings levels are expected to
continue to be negatively impacted until, among other things, approvals are
received in new jurisdictions and the Company's products are accepted by the
market place. The Company has applied to be licensed in various jurisdictions,
both foreign and domestic, which allow gaming, and has or will apply for
technical game approval of its products in such jurisdictions after appropriate
licenses have been granted by regulatory authorities.
Page 11 of 16
<PAGE> 12
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS - CONTINUED
LIQUIDITY AND CAPITAL RESOURCES
In March 1998, Innovative Gaming, Inc., a wholly-owned subsidiary of the
Company, entered into a loan commitment securing $2 million from a third party
lender. The initial funding of approximately $910,000 was completed on April 13,
1998. The loan is payable in 36 equal installments including interest paid in
arrears at a rate of 12.06 percent. This financing is secured by certain of the
Company's long-term receivables and a corporate guarantee from IGCA. Additional
funding under this arrangement is available through December 1, 1998. The
Company's borrowing capacity under this arrangement is dependent upon the level
of receivables generated through "bucket sales" agreements. The Company does not
anticipate that it will borrow additional amounts under this arrangement.
On May 13, 1998, the Company issued 3,000 shares of Series B Convertible
Preferred Stock (the "Preferred Stock") at a price of $1,000 per share in a
private placement for total proceeds of $3,000,000. The Company received net
proceeds of approximately $2,804,000 after the payment of fees and expenses
associated with such private placement. An annual dividend of 4% shall be paid
quarterly in arrears either in Preferred Stock of the Company or cash at the
Company's discretion.
Each share of Preferred Stock is convertible into shares of the Company's Common
Stock at a conversion price of 91% of the three consecutive day average of the
lowest closing bid price of the Company's Common Stock over the twenty-day
trading period ending the day prior to conversion (the "Conversion Price"). The
Conversion Price may not exceed $5.16, 135 % of the ten day average of the
closing bid price of the Company's Common Stock ending on May 12, 1998. The
maximum number of shares of Common Stock that may be issued upon conversion is
1,505,000. In the event that there is Preferred Stock outstanding after the
issuance of 1,505,000 shares of Common Stock upon conversion, the Company may
either 1) redeem any unconverted Preferred Stock for cash at a price equal to
115% of the liquidation value of the shares or 2) convert such unconverted
shares without a discount into Common Stock and pay cash to the holder of such
unconverted shares equal to the economic value that would have been received by
such holder if able to convert at a discount. See Exhibit 4 to the Company's
Form 10-Q for the quarter ended March 31, 1998. The Company has the right to
redeem the Preferred Stock at 115% of par in cash. As of September 30, 1998,
fifty percent (50%) of the Preferred Stock was convertible into Common Stock, at
the election of the holder thereof. An additional twenty-five percent (25%) of
the Preferred Stock is convertible on October 14,1998, and the remaining (25%)
of the Preferred Stock is convertible on November 14, 1998. All outstanding
shares of Preferred Stock will automatically be converted into Common Stock on
November 13, 1999. A holder of Preferred Stock may not convert such stock into
Common Stock if, following such conversion, the holder beneficially owns in
excess of 4.9% of the Company's Common Stock. As of September 30, 1998, no
Preferred Stock had been converted into Common Stock.
A Registration Statement related to the Common Stock was filed by, and at the
expense of, the Company pursuant to obligations contained in a Registration
Rights Agreement dated May 13, 1998. The effective date of the Registration
Statement filed with the Securities and Exchange Commission was September 3,
1998, and all necessary gaming regulatory approvals have been received.
The 9% beneficial conversion feature is accounted for as an additional Preferred
Stock dividend, which was determined on the date the Preferred Stock was issued.
The total value of the beneficial conversion feature or dividend is $296,703,
which reduces income available for holders of the Company's Common Stock and
therefore reduces earnings per share on a pro rata basis over the period from
issuance of the Preferred Stock to the earliest conversion date. Income
available to holders of Common Stock will be reduced by approximately $140,934,
$143,406 and $12,363 during the second, third and fourth quarters of 1998,
respectively.
Page 12 of 16
<PAGE> 13
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS - CONTINUED
LIQUIDITY AND CAPITAL RESOURCES - CONTINUED
On June 19, 1998, the Company entered into an agreement loaning $300,000 to a
third party gaming equipment developer, Gametronics, Inc. ("Gametronics"), a
Canadian corporation. The agreement was subsequently amended and the loan
increased to $400,000 on July 20, 1998. Under a subsequent agreement dated
October 22, 1998, the loan balance of $400,000 was converted and applied toward
the purchase price of certain intellectual property for game concepts developed
by Gametronics.
As of September 30, 1998, the Company had a $800,000 standby letter of credit
primarily to facilitate acquisition of components and supplies from a foreign
vendor. As of September 30, 1998, no amount was outstanding pursuant to this
facility. This facility is collateralized by short-term investments of the
Company.
The Company had $2,726,000 and $518,000 in cash and cash equivalents as of
September 30, 1998 and December 31, 1997, respectively. The Company presently
believes that its cash and cash equivalents, restricted investments, and
existing debt arrangements will be sufficient to meet the Company's liquidity
and capital requirements until second quarter 1999. The Company will require
additional capital in order to manufacture and distribute new products.
Furthermore, in the event that there is Preferred Stock outstanding after the
issuance of the maximum number of shares of Common Stock available to be issued
at a discount, the Company will be required to issue cash payment to redeem the
unconverted shares. Such payment could have a material adverse affect on the
Company's cash position and liquidity. Long-term capital requirements are
expected to be fulfilled through cash flows from operations and additional debt
and equity financings. No assurance can be given that the Company can obtain, or
obtain on terms acceptable to the Company, such additional debt and equity
financing. The Company had long-term debt of $964,000 as of September 30, 1998.
YEAR 2000 UPDATE
As of September 30, 1998, the Company continued its assessment to identify and
evaluate the risks of the Year 2000 issue. The Company's Year 2000 assessment
considered the following: (1) the Company's products; (2) the manufacturing
process of the products; (3) the Company's vendors and suppliers of materials
utilized in either the Company's gaming machine products or the manufacturing
process; (4) the Company's internal business information and accounting systems
and (5) the Company's principal customers. To implement its assessment, the
Company assigned trained internal staff to monitor and facilitate efficient Year
2000 Compliance. The Company has not utilized third-party consultants to
evaluate its Year 2000 readiness.
First, none of the Company's products contain software or embedded
microprocessors that are time-sensitive. Second, the Company's manufacturing
process is not automated to the extent that any part of the process is
computerized or relies upon time-sensitive software. The process of
manufacturing the Company's games is largely a mechanical process. Third, the
Company is seeking to obtain assurance from its primary material vendors and
suppliers to determine the extent which the Company is vulnerable to Year 2000
issues because such vendor or supplier is or may not be Year 2000 compliant.
With respect to the Company's internal business information and accounting
systems, the Company has reviewed its financial reporting systems, IT based and
otherwise, to ensure that they are Year 2000 compliant. The Company's software
vendors have made assurances that their software is either Year 2000 compliant
or that timely updates will be made to ensure that such software will be Year
2000 complaint. In the process of reviewing the Company's internal business
information and accounting systems, the Company has determined that some of its
personal computers utilized by its corporate staff are not Year 2000 compliant
and will have to be replaced. The Company presently anticipates that it will
replace such computers by mid-1999.
Finally, the Company is in the process of evaluating its customers, including
major distributors to determine whether such customers Year 2000 readiness could
cause a loss of business that could be material to the Company.
Page 13 of 16
<PAGE> 14
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS - CONTINUED
YEAR 2000 UPDATE -CONTINUED
Contingency Plans
The Company has not yet seen the need to develop any widespread contingency
plans for the Year 2000 issue, but this will continuously be monitored as the
Company gains more information about the compliance programs of its vendors and
customers. Given that some risks are beyond the control of the Company, the
Company does not believe that it can develop a contingency plan that will
totally shield the Company from an economic ripple effect throughout the entire
economy should others fail to resolve their own Year 2000 problems.
Cost
Based on the Company's current assessment, the costs of addressing potential
Year 2000 problems are not expected to be material or have a material adverse
impact on the Company's financial position. The current estimated cost of
replacing the Company's five or six corporate personal computers should not
exceed $15,000. However, the estimated costs relating to the resolution of the
Company's Year 2000 compliance issues cannot be fully and finally determined at
this time.
Risks
While the Company fully anticipates achieving Year 2000 compliance well in
advance of January 1, 2000, there are certain risks, which exist with respect to
the Company's business and the Year 2000. Those risks range from slight delays
and inefficiencies in processing data and carrying out accounting and financial
functions to the most reasonable likely worst case scenario, extensive and
costly inability to process data, provide vital accounting functions and
communicate with customers and suppliers. Furthermore, if significant customers
or vendors identify Year 2000 issues in the future and are unable to resolve
such issues in a timely manner, it could result in material financial risks.
PRIVATE SECURITIES LITIGATION REFORM ACT OF 1995.
The foregoing Management's Discussion and Analysis contains various
"forward-looking statements" within the meaning of Section 27A of the Securities
Act of 1933, as amended, and Sections 21E of the Securities Exchange Act of
1934, as amended, which represent the Company's expectations or beliefs
concerning future events, including statements regarding the demand for the
Company's products in certain key jurisdictions such as Nevada and Australia. In
addition, statements containing expressions such as "believes," "anticipates,"
"hopeful" or "expects" used in the Company's periodic reports on Forms 10-K and
10-Q filed with the SEC are intended to identify forward looking statements. The
Company cautions that these and similar statements included in this report and
in previously filed periodic reports including reports filed on Forms 10-K and
10-Q are further qualified by important factors that could cause actual results
to differ materially from those in the forward-looking statement, including,
without limitation, the following: the inability to successfully develop,
license, manufacture and market new products in a timely manner; decline in
demand for gaming products or reduction in the growth rate of new markets;
increased competition; the effect of economic conditions; a decline in the
market acceptability of gaming; ability to obtain additional financing through
leasing, equity or other arrangements; political and economic instability in
developing international markets; a decrease in the desire of established
casinos to upgrade machines in response to added competition from newly
constructed casinos; the loss of a distributor; changes in interest rates
causing a reduction of investment income or in the market interest rate
sensitive investments; loss or retirement of key executives; approval of pending
patent applications or infringement upon existing patents; the effect of
regulatory and governmental actions; the Company's expectations as to achieving
year 2000 readiness and the cost of achieving such readiness; unfavorable
determination of suitability by regulatory authorities with respect to officers,
directors or key employees; the limitation, conditioning or suspension of any
gaming license; adverse results of significant litigation matters; fluctuation
in exchange rates, tariffs and other barriers. Investors are referred to the
full discussion of risks and uncertainties associated with forward-looking
statements contained in the Company's report on Form 10-K filed with the
Securities and Exchange Commission for the fiscal year ended December 31, 1997.
Many of the foregoing factors have been discussed in the Company's prior SEC
filings and, had the amendments to the Securities Act of 1933 and Securities
Exchange Act of 1934 become effective at a different time, would have been
discussed in an earlier filing.
Page 14 of 16
<PAGE> 15
PART II
OTHER INFORMATION
Item 1. LEGAL PROCEEDINGS
None
Item 6. EXHIBITS AND REPORTS ON FORM 8-K
(a) Exhibits
Exhibit 27 - Financial Data Schedule - which is only submitted
electronically to the Securities and Exchange Commission for EDGAR
information purposes.
(b) Reports on Form 8-K
On October 30, 1998, the Company filed a Form 8-K to report the
resignation of its independent accountants.
Page 15 of 16
<PAGE> 16
SIGNATURES
In accordance with the requirements of the Exchange Act, the registrant has duly
caused this report to be signed on its behalf by the undersigned, thereunto duly
authorized.
INNOVATIVE GAMING CORPORATION OF AMERICA
/s/ Scott Shackelton
----------------------------------------
Scott Shackelton
Chief Financial Officer
(Principal Accounting Officer)
Date: November 12, 1998
Page 16 of 16
<PAGE> 17
INDEX TO EXHIBITS
<TABLE>
<CAPTION>
Exhibit
Number Description
- - ------ -----------
<S> <C>
27 Financial Data Schedule
</TABLE>
<TABLE> <S> <C>
<ARTICLE> 5
<MULTIPLIER> 1,000
<S> <C>
<PERIOD-TYPE> 9-MOS
<FISCAL-YEAR-END> DEC-31-1998
<PERIOD-START> JAN-01-1998
<PERIOD-END> SEP-30-1998
<CASH> 2,726
<SECURITIES> 800
<RECEIVABLES> 2,281
<ALLOWANCES> 0
<INVENTORY> 9,574
<CURRENT-ASSETS> 15,595
<PP&E> 1,390
<DEPRECIATION> 0
<TOTAL-ASSETS> 18,984
<CURRENT-LIABILITIES> 1,274
<BONDS> 0
2,988
0
<COMMON> 75
<OTHER-SE> 13,683
<TOTAL-LIABILITY-AND-EQUITY> 18,984
<SALES> 7,373
<TOTAL-REVENUES> 7,373
<CGS> 5,723
<TOTAL-COSTS> 5,723
<OTHER-EXPENSES> 4,227
<LOSS-PROVISION> 0
<INTEREST-EXPENSE> (83)
<INCOME-PRETAX> (2,494)
<INCOME-TAX> 720
<INCOME-CONTINUING> (3,214)
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> (3,214)
<EPS-PRIMARY> (.47)
<EPS-DILUTED> (.47)
</TABLE>
