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SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
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FORM 10-K
[X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
ACT OF 1934
FOR THE FISCAL YEAR ENDED DECEMBER 31, 1998
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
FOR THE TRANSITION PERIOD FROM _______ TO________
Commission File No. 0-22482
INNOVATIVE GAMING CORPORATION OF AMERICA
(Exact name of registrant as specified in its charter)
MINNESOTA 41-1713864
(State or other jurisdiction (I.R.S. Employer
of incorporation or organization) Identification No.)
4750 TURBO CIRCLE
RENO, NEVADA 89502
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(Address of principal executive offices) (Zip Code)
(702) 823-3000
(Registrant's telephone number, including area code)
Securities registered pursuant to Section 12(b) of the Act: None
Securities registered pursuant to Section 12(g) of the Act: Common Stock, $0.01
par value
Indicate by check mark whether the registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months (or for such shorter period that the registrant was
required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days.
Yes [X] No [ ]
Indicate by check mark if disclosure of delinquent filers pursuant to Item 405
of Regulation S-K is not contained herein, and will not be contained, to the
best of the Registrant's knowledge, in definitive proxy or information
statements incorporated by reference in Part III of this Form 10-K or any
amendment to this Form 10-K. [X]
As of March 18, 1999, 7,301,175 shares of the Registrant's Common Stock were
outstanding. The aggregate market value of the Common Stock held by
non-affiliates of the Registrant on such date, based upon the last sale price of
the Common Stock as reported on the Nasdaq National Market on March 18, 1999,
was $7,832,719. For purposes of this computation, affiliates of the Registrant
are the Registrant's executive officers and directors and Lakes Gaming, Inc.
DOCUMENTS INCORPORATED BY REFERENCE
PART III - Portions of the Registrant's definitive proxy statement in connection
with the annual meeting of the shareholders to be held on May 28, 1999, are
incorporated by reference into Items 10 through 13, inclusive.
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ITEM 1. BUSINESS
The following discussion contains trend information and other forward-looking
statements that involve a number of risks and uncertainties. The actual results
of Innovative Gaming Corporation of America (the "Company") could differ
materially from the Company's historical results of operations and those
discussed in the forward-looking statements. Factors that could cause actual
results to differ materially include, but are not limited to, those identified
in "Certain Factors."
Innovative Gaming Corporation of America ("IGCA") and its wholly owned operating
subsidiary, Innovative Gaming, Inc. ("IGI"), together (the "Company"), develop,
manufacture, market and distribute multi-station and other specialty gaming
machines to regulated gaming markets world-wide. The Company has four primary
product lines: multi-player/multi-station video table games; bonus "top box"
games that are placed on top of slant top spinning reel slot machines; single
player video slot machines incorporating state of the art graphics and sound,
and unique specialty gaming machines such as "Mythical Reels(TM)", that projects
the slot machine's spinning reels out in front of the box as if spinning in
space. The Company also owns the world-wide patent rights to a unique machine
that combines elements of roulette play and pinball in a single player machine.
The Company's primary target markets have been gaming jurisdictions in North
America, including the states of Arizona, Colorado, Louisiana, Mississippi,
Minnesota, Nevada, New Mexico, North Carolina and South Carolina, and through
distributors in Europe and Australia. In the first quarter of 1997, the
Company's multi-station blackjack, roulette and craps games were approved in
Nevada. In the third quarter of 1997, the multi-station blackjack and roulette
games received interim approval for use in the club market of New South Wales,
Australia. Subsequent to receiving such approval, the Company's Australian
distributor commenced marketing the Company's products. Throughout 1997 and
1998, the Company continued to expand its markets by obtaining gaming licenses
in several jurisdictions such as Colorado, and certain Iowa and New Mexico
Native American jurisdictions. The Company has submitted and has pending
applications in Connecticut, New Jersey and South Dakota. The Company has
received a temporary permit from the Iowa Racing and Gaming Commission,
effective April 1, 1999. Previously registered with Quebec and the Atlantic
Lottery Corporation, the Company has obtained approval to sell gaming devices in
Alberta, Manitoba, Saskatchewan and has applications pending in British Columbia
and Ontario. Also in 1998, the Company's Bonus Streak(TM) game received approval
in Mississippi and its Mythical Reels (TM) game received approval in Nevada,
Louisiana, Colorado, Arizona, New Mexico, and Alberta, Canada. The Company is in
the process of obtaining technical game approval of its products in Canada and
France. In February 1999, the Company submitted its single player video slot
machine to the Nevada Gaming Control Board for approval. The initial Mythical
Reels game was installed in Caesar's Palace and Luxor, Las Vegas, in March 1999.
The Company distributes its products directly and through distributors,
primarily on a cash sales basis. In Nevada, through its internal sales force,
the Company places its products under lease, sales (cash or extended payment
terms) or participation agreements. Under participation agreements the Company
retains ownership and shares in the net win of the games with the casino. In
Colorado, the Company sells or leases its products through its distributor.
The Company believes that its gaming machines will appeal to casinos/clubs,
lotteries and slot route operators seeking to enhance the entertainment
experience by providing new and unique forms of gaming.
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BUSINESS STRATEGY
The Company's strategy is to develop and maintain a competitive advantage by
focusing on two key elements: (a) exercising sufficient control over the
development and manufacturing process to enable quick reaction to the ever
shortening game replacement life cycle; and (b) concentrating efforts on
specialty gaming machines that are protected by patents or other property rights
to maintain an exclusive or dominant position in the market.
An important added element to the Company's strategy in the Nevada market is to
offer machine financing alternatives that address the controversial
"participation agreements" currently opposed by most major casino operators. The
Company was one of the first to respond to casino operator concerns and offer
our specialty machines for sale and/or fixed term participation basis.
PRODUCTS
The Company has four primary product lines: multi-player/multi-station video
table games; bonus "top box" games that are placed on top of slant top spinning
reel slot machines; single player video slot machines incorporating state of the
art graphics and sound, and unique specialty gaming machines such as "Mythical
Reels(TM)", that projects the slot machines spinning reels out in front of the
box as if spinning in space. The Company also owns the world-wide patent rights
to a unique machine that combines elements of roulette play and pinball in a
single player machine.
MULTI-PLAYER/MULTI-STATION VIDEO TABLE GAMES
BJ BLITZ(TM) AND LIVE VIDEO BLACKJACK(R) are electronic audio/video multi-player
blackjack games. Each blackjack machine consists of a central "dealer" and three
or five "player" stations that face the dealer in a semicircle, in the same
configuration as a live action blackjack table. The dealer and each player
station have video display screens. The dealer screen displays the cards as they
are shuffled and dealt, and the dealer's hand. The electronic dealer directs the
action with spoken instructions, and indicators flash on the video display
screen of the player whose turn it is to bet. Each player station has lighted
controls that the players can push to hit, stand, bet, double down, split or buy
insurance. Between games, players can also push buttons to display the rules and
the odds. The machines incorporate electronically generated voices, sound
effects, lights and music into the game. A "21 Stud" game is offered by the
Company on the blackjack game platform. "21 Stud" is an automated blackjack game
with a stud poker game player option. At the end of each hand of blackjack, the
player has a chance at additional awards according to a five-card poker hand
completed from the dealer's original hand. These blackjack games accounted for
an aggregate of 40% of sales in 1998, 49% in 1997 and 14% in 1996.
HOT SHOT DICE(TM) AND LIVE VIDEO CRAPS(R) are electronic craps machines
management believes are the first entirely electronic multi-player video craps
games in the world, which consist of a rectangular table that is approximately
half the size of a live action craps table, with a lighted canopy. Each table
accommodates six players, two on each side, and one at each end. Except for a
border that contains the player controls, the table consists of two large video
display screens that reproduce a craps table top. Each player has a hand-sized
trackball that the player rotates with his palm to roll the dice. The trackball
also controls a video "hand" that the player moves around the playing field to
place his bet of video "chips" in the appropriate spot. The odds are displayed
as the hand passes over each betting spot on the field. Each
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player has his own distinctly-colored video hand and chips. The video rolling
dice are superimposed on the playing field and the roll of the dice responds to
the force and direction with which the player spins the track ball. The game
incorporates sound effects such as rolling dice, and visual effects such as a
croupier rake that wipes away chips, in addition to electronically-generated
voices, music and flashing lights. These electronic craps games accounted for an
aggregate of 0% of sales in 1998, 5% in 1997 and 7% in 1996.
LIGHTNING STRIKE(TM) ROULETTE AND LIVE VIDEO ROULETTE(R) are roulette machines
that management believes are the first entirely electronic multi-player video
roulette games in the world, which consist of a rectangular table that is
approximately half the size of a live action roulette table. The table
accommodates five players, two on each side and an additional player at one end.
The other end of the table has a stand-up cabinet that incorporates a 29-inch
video monitor that employs what the Company believes is the most advanced
computer graphics available in the industry today. On the top of the cabinet, a
simulated roulette wheel is displayed that incorporates rotating lights
coordinated with the play of the game. Except for a border that contains the
player controls, the table consists of two large video display screens that
reproduce a roulette table betting field. Each player has a hand-sized trackball
that the player rotates with his palm to control a video hand that the player
moves around the playing field to place his bet of video "chips" in the
appropriate spot. The odds are displayed as the hand passes over each betting
spot on the field. Each player has his own distinctly colored video hand and
chips. The cabinet video monitor displays sharp, 3 dimensional graphics of
rotating dealers, roulette wheel action, betting, instructional game play
features, and game summary data. These roulette games accounted for an aggregate
of 38% of sales in 1998, 38% in 1997 and 70% in 1996.
BONUS "TOPBOX" GAMES
BONUS STREAK is used in conjunction with a slant top spinning reel slot machine.
The video bonus game was the first in the industry to utilize the active, high
resolution LCD display. When players catch the Bonus Streak symbol on the reel
slot, they qualify for bonus play. Currently the Company markets two such bonus
games, the Bonus Streak game and the Cascade of Diamonds(TM) game. The Bonus
Streak game starts with a display of 7 cards dealt face up on the LCD display.
If there are any matching cards (two 4's, two jacks, etc.), bonus play ends and
the player receives a first level award. If there are no matching cards, the
player advances to the next award level. Play continues to subsequent award
levels until there is a match or 13 unique cards are displayed, at which time
the top bonus jackpot is awarded. The bonus game "Cascade of Diamonds" starts
after qualifying for bonus action, with a jewel box appearing on the LCD
display. When the player presses a button, nine diamonds fall from above, some
landing in the box and some not. The player is awarded for the number of
diamonds in the jewel box, with nine being the top award.
The Bonus Streak game has been approved in the gaming jurisdictions of Nevada,
Mississippi, Louisiana and Colorado. The Company sells Bonus Streak to gaming
locations under cash or extended payment terms, and, in Nevada, may also place
them on a participation basis wherein the Company will receive a percentage of
the games' net win at percentages similar to those received by other specialty
game suppliers. This participation amount will be shared with the manufacturer
of the slant top spinning reel slot machine. Under this agreement with IGT, a
wholly-owned subsidiary of International Game Technology, as the supplier of the
slant top slot machines, the Company shares equally in the net revenues received
from the locations under participation agreements until IGT receives its sales
price, after which
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the Company receives 90% and IGT receives 10% of the net revenues. If the
Company sells Bonus Streak games under either cash or extended payment terms,
IGCA must purchase the slant top spinning reel slot machines from IGT.
SINGLE PLAYER VIDEO SLOT MACHINES
This new series of slot machines incorporates a unique PC platform. The
operating system and software provide what the Company believes is very powerful
performance and excellent cost advantages over traditional operating systems.
Its modular software structure enables rapid development of new game
personalities without affecting basic machine functions. This quick game
development capability overcomes a current video slot problem, in that the games
are not easily modified/customized as required by most customers. Various game
theme options will be available utilizing this new platform. The Company has
initiated efforts for patent protection on several elements of this new
platform.
UNIQUE SPECIALTY GAMES
MYTHICAL REELS is a spinning reels slot machine in an oversized or "mini-bertha"
cabinet. The spinning reels appear to float in space and are so real in
appearance that viewers feel that they can reach out and touch them. The
Mythical Reels machine is based on electronic equipment and internal hardware
which is already approved in most gaming jurisdictions worldwide. The image
projected uses High Definition Volumetric Display (HDVD) technology, for which
the Company has acquired sole rights for use in its gaming devices. The Company
placed its first Mythical Reels games in Caesar's Palace and Luxor, Las Vegas,
Nevada in March 1999. There can be no assurance that this game will be accepted
by customers.
REVOLVING RINGS(TM): This new product currently under development incorporates a
patented entirely different operational concept from any other known gaming
devices. The machine contains three horizontal, concentric, counter-rotating
rings. Each ring surface incorporates a certain number of holes and spaces. Game
play is initiated by the customer who pushes a button which ejects a ball onto
the playing field. The ball travels around the circumference of the outer ring,
much like the play on a roulette game. A stop device kicks the ball onto the
rotating surface of the first ring where it may or may not drop into one of the
holes. If the ball does not fall into a hole on the first ring, it will continue
rolling onto the second counter-rotating ring where it may or may not drop into
a hole. These holes are designated as winners and non-winners. If the ball
proceeds past the first and second rings without dropping into a hole, it will
roll onto the third and final ring where all holes are winners. This device
incorporates the excitement of playing both roulette and pinball.
MANUFACTURING AND SUPPLY ARRANGEMENTS
The Company's primary products are assembled at its production facility in Reno,
Nevada, utilizing various parts and components from a large base of vendors. On
February 2, 1996, the Company negotiated fixed pricing for a minimum of two
years for specific electronic components with its Japanese suppliers in its
efforts to reduce product cost. Deliveries scheduled under this agreement were
extended through mid 1999. With certain electronic parts solidified by contract,
the Company is utilizing a more domestic base of vendors for the balance of
components to reduce the reliance on exchange rate sensitivities and to
negotiate more competitive prices on required components. Except for certain
electronic components purchased from the Japanese vendor, the Company has
identified alternate sources of supply for significant parts and components
should any of its current vendors fail to meet order requirements by the
Company.
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INTELLECTUAL PROPERTY
On February 2, 1996, the Company acquired the balance of all remaining
intellectual property including patents, trademarks, picture rights and
copyrights for its games from its Japanese suppliers in exchange for an
aggregate 225,000 shares of IGCA common stock. The Company has exclusive
ownership and licenses pertaining to its blackjack, craps, roulette and
Supersuits Progressive Blackjack in gaming markets worldwide.
IGCA(R), BJ Blitz(TM), Hot Shot Dice(TM), Lightning Strike Roulette(TM), Live
Video Blackjack(R), Live Video Craps(R), Live Video Roulette(R), Bonus
Streak(TM), Cascade of Diamonds(TM), Mythical Reels(TM) and Supersuits(R) are
all trademarks of Innovative Gaming Corporation of America. The Company has
either Federally registered or applied for Federal registration of these
trademarks. In November 1997, IGCA received notification that it was granted a
Trademark and Design registration for Lightning Strike Roulette in Australia.
The Company believes that the technical know-how, trade secrets and creative
skills of its employees and contract personnel are substantial rights of the
Company. The Company requires customers, employees, contract personnel and other
significant contacts of the Company who have access to proprietary information
concerning the Company's products to sign non-disclosure agreements. The Company
relies on such agreements, other security measures, and trade secret law to
protect such proprietary information. No assurance can be given that pending
applications for intellectual property will be granted. There also can be no
assurance that patents or other intellectual property rights will not be
infringed, or that others will not develop technology that will not violate
these rights.
DISTRIBUTORSHIP AND SALES AGENCY ARRANGEMENTS
The Company distributes and/or anticipates to distribute its products both
directly to gaming markets and through licensed distributors. In certain
jurisdictions the Company may use an existing licensed distributor to sell its
products pursuant to any necessary Tribal or regulatory transaction approvals.
In February 1996, the Company entered into an exclusive distribution agreement
with Aristocrat Leisure Industries of New South Wales, Australia for the
marketing and distribution of games in Australia, New Zealand, Papua New Guinea,
Taiwan, New Caledonia, Malaysia, the Philippines and Singapore (hereinafter
"Australasia"). The Company granted Aristocrat an initial five-year exclusive
license expiring February 2001 to distribute its blackjack, craps and roulette
games to all legalized Australasia video gaming jurisdictions. Pursuant to such
agreement, the Company agreed to sell its games at discounted distributor's
pricing in exchange for a minimum purchase quantity of 100 units per year.
Aristocrat commenced marketing the Company's blackjack, and roulette games
subsequent to obtaining technical approval from New South Wales, Australia
gaming authorities in September 1997. Pursuant to this agreement, the Company
sold an aggregate of 99 games in 1997 and 86 games in 1998. Due to the declining
multi-player game sales in their territory, the Company's sales to this
distributor declined in the third and particularly fourth quarters of 1998, and
the Company has not forecasted sales to this customer in 1999.
In March 1996, the Company entered into exclusive agreements with Ludi S.F.M.
and with S.A.M. Eurusa for the exclusive distribution of the Company's games in
France, Monaco, Morocco, Tunisia and Italy. Ludi and Eurusa are affiliated
entities. Under such agreement, Ludi and Eurusa have been granted
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three-year exclusive licenses, expiring March 1999, to distribute the Company's
blackjack, craps and roulette games, subsequent to any and all regulatory
approvals. These agreements may be renewed for successive one-year terms upon
the agreement of the parties and on the terms and conditions set forth in the
distribution agreements or such other terms and conditions as the parties may
agree and may be terminated by either party under certain circumstances.
Pursuant to the agreement, the Company has agreed to sell its games to Ludi and
Eurusa at the Company's then current retail price less a distributor's discount.
No sales have been made under this agreement through December 31, 1998.
In January 1997, the Company entered into a three-year exclusive agreement with
Vista Gaming Corporation ("Vista") for the distribution and service of the
Company's products in Colorado. However, if Vista does not distribute on lease
at least 20 machines after six months and/or 35 machines after one year, this
agreement will revert to a non-exclusive distributorship. The lease rates will
be comparable to lease rates charged by other specialty game suppliers. This
agreement provides for automatic renewal annually after the original term and
may be terminated by either party under certain circumstances.
In March 1998, the Company entered into a business consulting agreement with
Jean D. Leclair and the Leclair Group ("Consultant"), under which the Consultant
provides business consulting services to the Company in Quebec, Canada.
Additionally, the Consultant may also assist the Company in securing agreements
for the purchase of the Company's products in Quebec and Atlantic Canada. For
services to the Company in securing agreements for the purchase of the Company's
products, the Consultant will be paid a commission for game sales acquired with
Loto Quebec and the Atlantic Lottery Corporation. This agreement is for an
initial period of one year, with provision for renewal on a month to month basis
upon mutual written agreement.
In May 1998, the Company entered into a one-year exclusive agency agreement with
Bill Engle, an individual. Under the agreement, the agent represents the
Company's products for sale in the Canadian provinces of British Columbia,
Ontario, Nova Scotia (for casino customers only), Saskatchewan, Alberta and
Manitoba. The agent receives a commission equal to the difference between the
amount received for sales initiated by the agent and prices stated in the
agreement for each product. This agreement may be renewed for up to two
successive one-year terms upon the agreement of the parties and on the terms and
conditions set forth in the agency agreement.
In December 1998, the Company entered into a three-year exclusive agreement with
DGS, Inc. ("DGS") for the distribution and service of the Company's blackjack
and 21 Stud products in South Carolina. The Company and DGS will negotiate
minimum sales targets for each year of the agreement. If DGS fails to purchase
for resale the minimum number of units in any contract year, the Company may
give notice to terminate the agreement. This agreement provides for automatic
renewal annually after the original term, up to a total of eight years, and may
be terminated by either party under certain circumstances.
The Company has submitted its applications for licensure in New Jersey and
Connecticut, and will apply for approval of its various games. Once the Company
is able to sell product in these jurisdictions, it will be represented by Par 4
("Agent") under terms of a two-year exclusive agency agreement entered into in
January 1999. Under the agreement, the agent represents certain of the Company's
products for sale in Atlantic City, New Jersey and Connecticut. The Company and
Agent will negotiate minimum sales targets for each year of the agreement. If
Agent fails to obtain sales orders for at least 75 percent of the target number
of units in any contract year, the Company may give notice to terminate the
agreement. This agreement provides for automatic renewal annually after the
original term and may be terminated by either party under certain circumstances.
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SIGNIFICANT CUSTOMERS
During fiscal 1998, a substantial portion of the Company's sales were to one
customer, Aristocrat Leisure Industries, which accounted for 54.1% of sales.
Such customer accounted for 48.4% of sales in fiscal 1997. Due to the declining
multi-player game sales in their territory, the Company's sales to this
distributor declined in the third and particularly fourth quarters of 1998, and
the Company has not forecasted sales to this customer in 1999. No other single
customer accounted for 10% or more of sales. Sales to Lakes Gaming, Inc.("LGI")
accounted for less than 1% of sales in fiscal years 1998 and 1997. In addition
to providing the Company the opportunity for quantity sales of its products,
these agreements provided the Company with initial market and beta test sites
for its products, as well as operational and performance data. The Company sold
six Bonus Streak games, minimal parts sales and no video gaming machine sales to
LGI during 1998.
COMPETITION
Many gaming equipment companies, several of which are large and
well-established, supply the casino and video lottery industries with video
gaming machines and other gaming equipment. Management believes that Aristocrat,
Alliance Gaming, International Game Technology and WMS Industries are among the
largest and most-established gaming machine suppliers. Management believes that
none of these companies currently offer video gaming machines that are similar
to the Company's multi-station products. However, Sigma Games distributes a
multi-player horserace game. There can be no assurance that these competitors,
or another competitor, will not develop gaming machines that are similar to the
Company's gaming machines in the future. Furthermore, the Company is developing
games for the intensely competitive single player game market. There can be no
assurance that any single player games developed by the Company will be accepted
in such competitive markets.
REGULATION
GENERAL - The manufacture, sale and distribution of gaming machines are subject
to various federal, state, county, tribal, municipal and international laws,
regulations and ordinances, which are administered by the relevant regulatory
agency or agencies in each jurisdiction (the "Regulatory Authorities"). These
laws, regulations and ordinances vary from jurisdiction to jurisdiction, but
primarily concern the responsibility, financial stability and character of
gaming equipment manufacturers and distributors, as well as persons financially
interested or involved with gaming equipment manufacturers and distributors.
Furthermore, regulations also require various technical standards and
specifications approval and adherence, which are conducted by state and/or
private laboratories. There are substantial similarities in the basic provisions
which are described below. In the future, Regulatory Authorities may also
significantly curtail or eliminate gaming in jurisdictions that currently or
hereafter allow gaming.
In addition to the jurisdictions which currently allow casino gaming, the
Company anticipates doing business in other jurisdictions which may authorize
casino gaming in the future, and in jurisdictions which have legalized casino
gaming but have not adopted regulations. The Company cannot predict the nature
of the regulatory scheme in any such jurisdiction.
The licensing and approval process can take several months. Delays or failure to
obtain licenses can have a material adverse effect on the Company.
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INDIAN GAMING - The operation of gaming on Indian land, including the terms and
conditions of contracts to sell or lease gaming equipment to Indian tribes, is
subject to the Indian Gaming Regulatory Act of 1988 ("IGRA"), which has
delegated oversight responsibility to the Bureau of Indian Affairs (the "BIA")
and the National Indian Gaming Commission ("NIGC"), and also is subject to the
provisions of statutes relating to contracts with Indian tribes, which are
administered by the BIA. The regulations and guidelines under which the BIA and
the National Indian Gaming Commission will administer IGRA are incomplete and
evolving. IGRA is subject to interpretation by the Secretary of the Interior and
the NIGC and may be subject to judicial and legislative clarification or
amendment.
The NIGC is empowered to inspect and audit all Indian gaming facilities, to
conduct background checks on all persons associated with Indian gaming, to hold
hearings, issue subpoenas, take depositions, adopt regulations and to assess
fees. Civil penalties for violations of IGRA, and/or other applicable law, may
be imposed. In addition, IGRA provides for criminal penalties for illegal gaming
on Indian land and for theft from Indian gaming facilities.
IGRA classifies games that may be played on Indian land into three categories.
Class I gaming includes traditional Indian games and private social games
engaged in as a part of; or in connection with, tribal ceremonies or
celebrations. These games, under IGRA, are regulated exclusively by the
respective tribes.
Class II gaming includes bingo and, additionally, pulltabs, lotto, punch boards,
tip jars, instant bingo, and other games similar to bingo, if those games are
played at a location where bingo is played. Class II gaming explicitly excludes
electronic or electromechanical facsimiles of any games of chance or slot
machines of any kind. This classification is also reserved for tribal
regulation, but under federal oversight. Class II gaming is permitted on Indian
land if: (i) the state in which the Indian gaming is located permits such gaming
for any purpose by any person, (ii) the gaming is not otherwise specifically
prohibited on Indian land by federal law, (iii) the gaming is conducted in
accordance with a tribal ordinance which has been approved by the Chairman of
the NIGC (provided that gaming may be conducted under unapproved ordinances or
resolutions adopted prior to the enactment of IGRA unless and until such
ordinances or resolutions are disapproved by the Chairman), (iv) an Indian tribe
has sole proprietary interest and responsibility for the conduct of gaming
(subject to certain exceptions), (v) the primary management officials, key
employees and the facility are tribally licensed; and (vi) several other
specified requirements are met, including the existence of any adequate system
which ensures background investigations are conducted on primary management
officials, all contracts for supplies, services or concessions in excess of
$25,000 annually are subject to independent audit and the construction and
maintenance of the gaming facility is conducted in a manner which adequately
protects the environment and the public health and safety.
Class III gaming includes all other forms of gaming, such as video casino games
(e.g., video slots, video blackjack), slot machines, table games (e.g.,
blackjack, craps, roulette), and other gaming (e.g., sports betting and
parimutuel wagering). The machines manufactured and distributed by the Company
are classified as Class III gaming devices. Class III gaming is permitted on
Indian land only if such activity is: (i) authorized by a tribal ordinance
meeting the requirements of IGRA and approved by the Chairman of the NIGC
(provided that gaming may be conducted under unapproved ordinances or
resolutions adopted prior to the enactment of IGRA unless and until such
ordinances or resolutions are disapproved by the Chairman), (ii) located in a
state that permits gaming defined as Class III by any person for any
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purpose, (iii) governed by requirements similar to those described for Class II
gaming, and (iv) conducted in compliance with the terms of a written
tribal-state compact entered into between the Indian tribe and the state in
which the subject gaming is located and which has been approved by the
Secretary.
TRIBAL ORDINANCES - Under IGRA, except to the extent otherwise provided in a
tribal-state compact, Indian tribal governments have primary regulatory
authority over gaming on land within the tribe's jurisdiction Therefore, persons
engaged in gaming activities, including the Company, are subject to the
provisions of tribal ordinances and regulations regarding gaming. Such
ordinances and regulations must be consistent with IGRA and with any applicable
tribal-state gaming compact, and cannot impose criminal penalties upon
non-Indians. However, the civil remedies imposed by such tribal government
regulations, if otherwise valid, will likely apply to the Company and its
employees and customers. Tribal ordinances also require participants involved in
Indian gaming enterprises to obtain tribal licenses. The Company as a
manufacturer/distributor of gaming equipment is usually required to obtain a
tribal license before making any equipment sales. Management companies and their
officers, directors and significant shareholders are also subject to licensing
requirements. Tribes have great discretion to deny such licenses, fail to renew
current licenses or revoke such licenses. An Indian tribe has the right to
revoke any tribal gaming ordinance and, pursuant to such revocation, render
Class III gaming illegal on the lands of the tribe.
The Company must also comply with regulations promulgated pursuant to the tribal
state compacts entered into between the State and the particular Indian tribe.
These compacts vary significantly from state to state.
Indian tribes are sovereign nations with their own courts and governmental
Systems. The Company intends to seek waivers of Sovereign immunity, where
appropriate, from tribes with whom the Company does business although there can
be no assurance that such waivers will be obtained.
UNITED STATES CODE SECTION 81 - Title 25, Section 81 of the United States Code
states that "no agreement shall be made by any person with any tribe of Indians,
or individual Indians not citizens of the United States, for the payment or
delivery of any money or other thing of value . . . in consideration of services
for said Indians relative to their lands . . . unless such contract or agreement
be executed and approved" by the Secretary or his or her designee. An agreement
or contract for services relative to Indian lands which fails to conform with
the requirements of Section 81 will be void and unenforceable. All money or
other thing of value paid to any person by any Indian or tribe for or on his or
their behalf, on account of such services, in excess of any amount approved by
the Secretary or his or her authorized representative will be subject to
forfeiture.
The Company has sold and intends to sell gaming machines directly to Indian
tribes. The Company has not submitted its past gaming machine sales contracts
with Indian tribes to the Secretary for approval for a number of reasons. In the
Company's opinion, its sales contracts are not for services. The Company
believes it is engaged in the sale of goods, namely gaming machines, and
therefore Section 81 does not apply to its activities. The Company also believes
that its sales of gaming machines are not "relative to Indian lands." Although
the gaming machines ultimately may be used on Indian lands, the Company believes
the machines themselves are not related to Indian land. The Company intends to
continue its practice of not submitting its sales contracts to the Secretary for
approval. The position of regulatory authorities relative to approval of
contracts of this kind has not been clear.
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NEVADA
The manufacture and distribution of gaming devices in Nevada are subject to: (i)
the Nevada Gaming Control Act and the regulations promulgated thereunder
(collectively, the "Nevada Act"); and (ii) various local regulations. Generally,
gaming activities may not be conducted in Nevada unless licenses are obtained
from the Nevada Gaming Commission (the "Nevada Commission"), the Nevada State
Gaming Control Board (the "Nevada Board"), and appropriate county and municipal
licensing agencies. The Nevada Commission, the Nevada Board, and the various
county and municipal licensing agencies are collectively referred to as the
"Nevada Gaming Authorities."
The laws, regulations and supervisory procedures of the Nevada Gaming
Authorities are based upon declarations of public policy that are concerned
with, among other things: (i) the prevention of unsavory or unsuitable persons
from having a direct or indirect involvement with gaming at any time or in any
capacity; (ii) the establishment and maintenance of responsible accounting
practices and procedures; (iii) the maintenance of effective controls over the
financial practices of licensees, including the establishment of minimum
procedures for internal fiscal affairs and the safeguarding of assets and
revenues, providing reliable record keeping and requiring the filing of periodic
reports with the Nevada Gaming Authorities; (iv) the prevention of cheating and
fraudulent practices; and (v) to provide a source of state and local revenues
through taxation and licensing fees. Change in such laws, regulations and
procedures could have an adverse effect on the Company.
Manufacturer and distributor licenses require the periodic payment of fees and
taxes and are not transferable. No person may become a stockholder of, or
receive any percentage of profits from, IGI, the wholly-owned subsidiary of
IGCA, without first obtaining licenses and approvals from the Nevada Gaming
Authorities. IGCA is registered by the Nevada Commission as a publicly traded
corporation ("Registered Corporation") and IGI was granted all requisite
licenses in May 1996 to manufacture gaming devices used in Nevada and to
distribute such devices, subsequent to technical product approvals. As such, the
Company is required periodically to submit detailed financial and operating
reports to the Nevada Commission and furnish any other information that the
Nevada Commission may require.
All gaming devices that are manufactured, sold or distributed for use or play in
Nevada, or for distribution outside of Nevada, must be manufactured by licensed
manufacturers and distributed or sold by licensed distributors. All gaming
devices manufactured for use or play in Nevada must be approved by the Nevada
Commission before distribution or exposure for play. The approval process for
gaming devices includes rigorous testing by the Nevada Board, a field trial and
a determination as to whether the gaming device meets strict technical standards
that are set forth in the regulations of the Nevada Commission.
The Nevada Gaming Authorities may investigate any individual who has a material
relationship to, or material involvement with, the Company in order to determine
whether such individual is suitable or should be licensed as a business
associate of a gaming licensee. Officers, directors and certain key employees of
IGI must file applications with the Nevada Gaming Authorities and are required
to be licensed by the Nevada Gaming Authorities. Officers, directors and key
employees of IGCA who are actively and directly involved in the gaming
activities of IGI may be required to be licensed or found suitable by the Nevada
Gaming Authorities. The Nevada Gaming Authorities may deny an application for
licensing or a finding of suitability for any cause they deem reasonable. A
finding of suitability is
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comparable to licensing, and both require submission of detailed personal and
financial information followed by a thorough investigation. The applicant for
licensing or a finding of suitability must pay all the costs of the
investigation. Changes in licensed positions must be reported to the Nevada
Gaming Authorities and in addition to their authority to deny an application for
a finding of suitability or licensure, the Nevada Gaming Authorities have
jurisdiction to disapprove a change in a corporate position.
If the Nevada Gaming Authorities were to find an officer, director or key
employee unsuitable for licensing or to continue having a relationship with the
Company, the companies involved would have to sever all relationships with such
person. In addition, the Nevada Commission may require the Company to terminate
the employment of any person who refuses to file appropriate applications.
Determinations of suitability or of questions pertaining to licensing are not
subject to judicial review in Nevada.
The Company is required to submit detailed financial and operating reports to
Nevada Gaming Authorities. Substantially all material loans, leases, sales of
securities and similar financing transactions by the Company, must be reported
to or approved by the Nevada Commission.
If it was determined that the Nevada Act was violated by IGI, the gaming
licenses it holds could be limited, conditioned, suspended or revoked, subject
to compliance with certain statutory and regulatory procedures. In addition,
IGI, IGCA and the persons involved could be subject to substantial fines for
each separate violation of the Nevada Act at the discretion of the Nevada
Commission. Limitation, conditioning or suspension of any gaming license could
(and revocation of any gaming license would) materially adversely affect the
Company.
Any beneficial holder of the Company's voting securities, regardless of the
number of shares owned, may be required to file an application, be investigated,
and have his suitability as a beneficial holder of the Company's voting
securities determined if the Nevada Commission has reason to believe that such
ownership would otherwise be inconsistent with the declared policies of the
State of Nevada. The applicant must pay all costs of investigation incurred by
the Nevada Gaming Authorities in conducting any such investigation.
The Nevada Act requires any person who acquires more than 5% of the Company's
voting securities to report the acquisition to the Nevada Commission. The Nevada
Act requires that beneficial owners of more than 10% of the Company's voting
securities apply to the Nevada Commission for a finding of suitability within
thirty days after the Chairman of the Nevada Board mails a written notice
requiring such filing. Under certain circumstances, an "institutional investor,"
as defined in the Nevada Act, which acquires more than 10% but not more than 15%
of the Company's voting securities, may apply to the Nevada Commission for a
waiver of such finding of suitability if such institutional investor holds the
voting securities for investment purposes only. An institutional investor shall
not be deemed to hold voting securities for investment purposes unless the
voting securities were acquired and are held in the ordinary course of business
as an institutional investor and not for the purpose of causing, directly or
indirectly, the election of a majority of the members of the board of directors
of the Company, any change in the Company's corporate charter, bylaws,
management, policies or operations of the Company or any of its gaming
affiliates, or any other action which the Nevada Commission finds to be
inconsistent with holding the Company's voting securities for investment
purposes only. Activities that are not deemed to be inconsistent with holding
voting securities for investment purposes only include: (i) voting on all
matters
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<PAGE> 13
voted on by stockholders; (ii) making financial and other inquiries of
management of the type normally made by securities analysts for informational
purposes and not to cause a change in its management, policies or operations;
and (iii) such other activities as the Nevada Commission may determine to be
consistent with such investment intent. If the beneficial holder of voting
securities who must be found suitable is a corporation, partnership or trust, it
must submit detailed business and financial information including a list of
beneficial owners. The applicant is required to pay all costs of investigation.
Any person who fails or refuses to apply for a finding of suitability or a
license within thirty days after being ordered to do so by the Nevada Commission
or the Chairman of the Nevada Board, may be found unsuitable. The same
restrictions apply to a record owner if the record owner, after request, fails
to identify the beneficial owner. Any stockholder found unsuitable and who
holds, directly or indirectly, any beneficial ownership of the common stock of a
Registered Corporation beyond such period of time as may be prescribed by the
Nevada Commission may be guilty of a criminal offense. The Company is subject to
disciplinary action if after it receives notice that a person is unsuitable to
be a stockholder or to have any other relationship with the Company, the Company
(i) pays that person any dividend or interest upon voting securities of the
Company, (ii) allows that person to exercise, directly or indirectly, any voting
right conferred through securities held by that person, (iii) pays remuneration
in any form to that person for services rendered or otherwise, or (iv) fails to
pursue all lawful efforts to require such unsuitable person to relinquish his
voting securities for cash at fair market value. Additionally, the Clark County
Liquor and Gaming Licensing Board has taken the position that they have the
authority to approve all persons owning or controlling the stock of any
corporation controlling a gaming license.
The Nevada Commission may, in its discretion, require the holder of any debt
security of a Registered Corporation to file an application, be investigated and
found suitable to own the debt security of a Registered Corporation. If the
Nevada Commission determines that a person is unsuitable to own such security,
then pursuant to the Nevada Act, the Registered Corporation can be sanctioned,
including the loss of its approvals, if without the prior approval of the Nevada
Commission, it: (i) pays to the unsuitable person any dividend, interest, or any
distribution whatsoever; (ii) recognizes any voting right by such unsuitable
person in connection with such securities; (iii) pays the unsuitable person
remuneration in any form; or (iv) makes any payment to the unsuitable person by
way of principal, redemption, conversion, exchange, liquidation, or similar
transaction.
The Company is required to maintain a current stock ledger in Nevada that may be
examined by the Nevada Gaming Authorities at any time. If any Securities are
held in trust by an agent or by a nominee, the record holder may be required to
disclose the identity of the beneficial owner to the Nevada Gaming Authorities.
A failure to make such disclosure may be grounds for finding the record holder
unsuitable. The Company is also required to render maximum assistance in
determining the identity of the beneficial owner. The Nevada Commission has the
power to require the Company's stock certificates to bear a legend indicating
that such securities are subject to the Nevada Act. However, to date, the Nevada
Commission has not imposed such a requirement on the Company.
The Company may not make a public offering of any securities without the prior
approval of the Nevada Commission if the securities or the proceeds therefrom
are intended to be used to construct, acquire or finance gaming facilities in
Nevada, or to retire or extend obligations incurred for such purposes. Such
approval, if given, does not constitute a finding, recommendation or approval by
the Nevada Commission or the Nevada Board as to the accuracy or adequacy of the
prospectus or the investment merits of the securities. Any representation to the
contrary is unlawful.
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<PAGE> 14
Changes in control of the Company through merger, consolidation, stock or asset
acquisitions, management or consulting agreements, or any act or conduct by a
person whereby he obtains control, may not occur without the prior approval of
the Nevada Commission. Entities seeking to acquire control of a Registered
Corporation must satisfy the Nevada Board and the Nevada Commission concerning a
variety of stringent standards prior to assuming control of such Registered
Corporation. The Nevada Commission may also require controlling stockholders,
officers, directors and other persons having a material relationship or
involvement with the entity proposing to acquire control, to be investigated and
licensed as part of the approval process of the transaction.
The Nevada legislature has declared that some corporate acquisitions opposed by
management, repurchases of voting securities and corporate defense tactics
affecting Nevada gaming licensees and Registered Corporations that are
affiliated with those operations, may be injurious to stable and productive
corporate gaming. The Nevada Commission has established a regulatory scheme to
ameliorate the potentially adverse effects of these business practices upon
Nevada's gaming industry and to further Nevada's policy to: (i) assure the
financial stability of corporate gaming operators and their affiliates; (ii)
preserve the beneficial aspects of conducting business in the corporate form;
and (iii) promote a neutral environmental for the orderly governance of
corporate affairs. Approvals are, in certain circumstances, required from the
Nevada Commission before the Company can make exceptional repurchases of voting
securities above the current market price thereof and before a corporate
acquisition opposed by management can be consummated. The Nevada Act also
requires prior approval of a plan of recapitalization proposed by the Company's
board of directors in response to a tender offer made directly to the Registered
Corporation's stockholders for the purpose of acquiring control of the
Registered Corporation.
Any person who is licensed, required to be licensed, registered, required to be
registered, or is under common control with such persons (collectively,
"Licensees"), and who proposes to become involved in a gaming venture outside of
Nevada, is required to deposit with the Nevada Board, and thereafter maintain, a
revolving fund in the amount of $10,000 to pay the expenses of investigation by
the Nevada Board of their participation in such foreign gaming. The revolving
fund is subject to increase or decrease in the discretion of the Nevada
Commission. Thereafter, Licensees are also required to comply with certain
reporting requirements imposed by the Nevada Act. Licensees are also subject to
disciplinary action by the Nevada Commission if they knowingly violate any laws
of the foreign jurisdiction pertaining to the foreign gaming operation, fail to
conduct the foreign gaming operation in accordance with the standards of honesty
and integrity required of Nevada gaming operations, engage in activities that
are harmful to the State of Nevada or its ability to collect gaming taxes and
fees, or employ a person in the foreign operation who has been denied a license
or a finding of suitability in Nevada on the ground of personal unsuitability.
NEW JERSEY
The manufacture and distribution of slot machines and casino gaming activities
in New Jersey are subject to extensive state regulation under the New Jersey
Casino Control Act, N.J.S.A. 5:12-1 et seq. (the "New Jersey Act"). The New
Jersey Act created the New Jersey Casino Control Commission ("New Jersey
Commission"), which is authorized to decide all license applications and other
matters and to promulgate
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<PAGE> 15
regulations. The New Jersey Act also created the New Jersey Division of Gaming
Enforcement (the "New Jersey Division"), which is authorized to investigate all
license applications, make recommendations to the New Jersey Commission, and
prosecute violations of the New Jersey Act. The New Jersey Act requires any
manufacturer or distributor of slot machines to be licensed as a gaming related
casino service industry ("CSI") by the New Jersey Commission prior to
transacting any business with a casino. The Company's wholly-owned subsidiary,
Innovative Gaming, Inc. ("IGI"), has filed an application for a CSI license, but
it has not yet been deemed complete by the New Jersey Commission.
In order for the requisite CSI license to be issued to IGI and maintained, the
Company's and IGI's officers, directors and key employees and all beneficial
owners of five percent (5%) or more of the Company's Common Stock must be found
qualified by the New Jersey Commission after an investigation by the New Jersey
Division. In order to be found qualified, the Company and IGI, its officers,
directors, key employees and five percent (5%) or greater shareholders must
demonstrate by clear and convincing evidence their good character, honesty and
integrity, and their financial stability, integrity and responsibility. However,
"institutional investors" (as defined in the New Jersey Act) holding five
percent (5%) or more of the shares of the Company may be granted a waiver of the
requirement to be found qualified by the New Jersey Commission. Any other
shareholder or other person associated with the Company or IGI whom the New
Jersey Commission deems appropriate, in its discretion, is also required to be
qualified. If a person is required to and fails to submit for qualification or
submits for qualification and is found disqualified by the New Jersey
Commission, the New Jersey Commission may prohibit casinos in New Jersey from
doing business with the Company and IGI.
The New Jersey Commission may permit a company to transact business with a
casino prior to licensure if the company has filed a complete application for
CSI licensure and the New Jersey Division does not object to the transaction. A
request for permission to conduct a business transaction with a casino prior to
CSI licensure may be made 30 days after the filing of a complete CSI license
application with New Jersey Commission.
A CSI license is issued for an initial period of two years and is thereafter
renewable for four year periods. There is no guarantee that IGI will be granted
an initial license or that, following the issuance of an initial CSI license or
any renewal thereof, IGI will continue to be granted renewals of the license.
Additionally, upon application of the New Jersey Division, the New Jersey
Commission may at any time review any license issued by it and determine to
suspend, revoke or place conditions on such license.
In addition to the required CSI license, the gaming equipment manufactured,
distributed or sold by IGI to New Jersey casinos is subject to a technical
examination by the New Jersey Division and approval by the New Jersey Commission
for, at a minimum, quality, design, integrity, fairness, honesty and
suitability. The review process includes the submission of a model of the
machine to the New Jersey Division for testing, examination and analysis. Prior
to a decision by the New Jersey Commission to approve a particular model of
machine, it may require up to a 60 day trial period to test the machine in a
casino. During the trial period, the manufacturer or distributor of the machine
shall not be entitled to receive revenue of any kind whatsoever. Once a model is
approved by the New Jersey Commission, all machines of that model placed in
operation in casinos shall operate in conformity with the model approved by the
New Jersey Commission. Any changes in the design, function or operation of the
machine are subject to prior approval by the New Jersey Commission, after
testing by the New Jersey Division.
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<PAGE> 16
OTHER JURISDICTIONS.
Each of the other jurisdictions in which the Company does business requires
various licenses, permits and approvals in connection with the manufacture
and/or distribution of gaming devices typically involving restrictions similar
in many respects to those of Nevada.
UNITED STATES - FEDERAL - The Federal Gambling Devices Act of 1962 (the "Federal
Act") makes it unlawful for a person to manufacture, deliver or receive gaming
machines and components thereof across interstate lines unless that person has
first registered with the Attorney General of the United States. The Company is
so registered and must renew its registration annually. In addition, various
recordkeeping and equipment identification requirements are imposed by the
Federal Act. Violation of the Federal Act may result in seizure or forfeiture of
equipment, as well as other penalties.
CERTAIN FACTORS
In addition to the factors discussed elsewhere in this Annual Report on Form
10-K, such as regulation, competition and dependence on significant customers,
the following are important factors that could cause actual results or events to
differ materially from those contained in any forward-looking statements made by
or on behalf of the Company.
SHORT-TERM LIQUIDITY AND NEED FOR ADDITIONAL FINANCING - As of March 30, 1999,
the Company had cash and cash equivalents of approximately $650,000. Management
believes, assuming it can achieve its sales forecasts which exceed current sales
rates, it will have sufficient cash to fund operations through mid 1999.
However, if sales remain at or below their current levels and the Company does
not reduce its operative expenses consistent with its sales level, operations
will only be funded into May 1999. Management has taken certain steps to address
its short-term liquidity and cash flow requirements by entering into a loan
commitment to borrow approximately $675,000, on a secured basis, from a third
party lender in late March 1999 in addition to attempting to control costs
through inventory reductions and other measures. The Company anticipates closing
on this loan in early April 1999. With this financing the Company estimates that
its current level of cash and anticipated funds from operations, which assumes
market acceptance of new games (which cannot be assured), would be adequate to
fund cash requirements through 1999. No assurance can be given that this loan
will close on a timely basis, if at all, or on the terms contained in the loan
commitment letter with such lender. Failure to close on this loan in a timely
basis could have a material adverse effect on the Company. In the absence of
alternative financing, the Company would have to consider significantly reducing
operations, in addition to liquidating all or a portion of the Company's assets.
To the extent that the Company does significantly reduce operations, it would
have a material adverse effect on the Company's ability to meet its short term
revenue projections and would negatively impact the ability to obtain additional
financing. Furthermore, to the extent that the Company's revenues are less than
anticipated, the Company may require additional short-term financing in 1999.
Because of fluctuating limited sales and an extensive research and development
program on a new game platform and games, the Company has experienced negative
cash flow from operations of $2.1 million, $7.5 million and $2.7 million for the
years ended December 31, 1998, 1997 and 1996, respectively. The Company's
ability to execute its long-term business strategy also depends to a significant
degree on its ability to finance the development, marketing and production of
its new products. There can be no assurance that the Company will be successful
in obtaining financing on terms acceptable to the Company, if such need arises.
Any new investors may seek and obtain substantially better terms than were
granted to its present investors and the issuance of such securities would
result in dilution to its existing shareholders.
PREFERRED STOCK DILUTION AND RISK OF CASH REDEMPTION - In order to meet its
research and development, marketing and licensing capital requirements, the
Company issued $3 million in Series B Convertible Preferred Stock (the
"Preferred Stock") to an institutional investor in May 1998. The Preferred Stock
is convertible into the Company's Common Stock at a conversion price equal to
91% of the average of the lowest three consecutive day closing bid price over
the 20 day period prior to conversion. The Preferred Stock terms presently
prohibit issuing more than 1,505,000 shares of Common Stock at a discount and
also limit the ability of the holder to convert if, following the conversion,
such holder would own in excess of 4.9% of the Company's Common Stock.
Additionally, to the extent that a holder is unable to convert the Preferred
Stock to Common Stock, such holder's Preferred Stock must be redeemed for either
a) cash or b) Common Stock that is not issued at a discount in addition to cash.
Through March 30, 1999, $2.85 million of Preferred Stock had not yet been
converted into the Company's Common Stock. As of March 30, 1999, the Company
also had cash and cash equivalents of approximately $650,000. If the holders of
the Company's Preferred Stock were to attempt to convert on such date, the
Company would be required to issue 1,339,036 shares of Common Stock at $.91 per
share (91% of the closing sales price on such date), and issue 438,652 shares of
Common Stock at $3.375 (the closing sales price of the Company's Common Stock on
the date the Preferred Stock was issued) and pay approximately $1.1 million to
the holders of the unconverted Preferred Stock pursuant to the present terms of
the Preferred Stock. The Company and the holders of the Preferred Stock have
been negotiating revised Preferred Stock terms to eliminate the cash redemption
feature of the present Preferred Stock terms. No assurance can be given that the
Company will be able to eliminate the cash redemption feature or otherwise
obtain more favorable Preferred Stock terms. Such revised terms could be very
dilutive to the Company's present Common Stock shareholders. Any attempted
conversion of Preferred Stock could have a significant material adverse effect
on the Company if no alternative arrangements could be reached with the
Company's holders of Preferred Stock. The material adverse effects which could
occur include, but are not limited to: liquidation of all or part of the
Company's assets or sale of additional Common Stock at a discount.
LACK OF PROFITABILITY - The Company has had losses of $5.4 million in fiscal
1998, $2.9 million in fiscal 1997, and $6.2 million in fiscal 1996. The Company
has not had a profitable quarter since the fourth quarter of fiscal 1997 and
does not expect to be profitable until the second quarter of fiscal 1999 at the
earliest, if at all.
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<PAGE> 17
DEVELOPMENT RISKS - Although the Company was formed in 1991, the Company
continues to face the risks, expenses and difficulties frequently encountered by
new and expanding businesses, including, but not limited to, negative cash flow,
initial high development costs of new products without corresponding sales
pending receipt of corporate and product regulatory approvals and market
introduction and acceptance of new products. There is no assurance that the
Company's products will be accepted in the marketplace and that regulatory
approvals will be obtained.
PRODUCT ACCEPTANCE - The Company's success as a gaming machine manufacturer and
supplier is dependent upon numerous factors, including its ability to design,
manufacture, market and service gaming machines that achieve player and casino
acceptance while maintaining product quality and acceptable margins and to
compete against gaming machine suppliers with greater financial resources, name
recognition and established service networks and customer relationships. To
date, the sales of the Company's multi-player games have been significantly
lower than anticipated by the Company. In order to diversify and expand sales,
the Company has begun licensing, marketing and selling single player games such
as Bonus Streak and Mythical Reels. Additionally, the Company has begun the
development of other single player games such as Revolving Rings. There can be
no assurance that such single player games will be accepted by the market. The
Company believes that it will need to develop gaming machines that offer
technological advantages or unique entertainment features in order for the
Company to be able to compete effectively in the gaming machine market.
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<PAGE> 18
DEPENDENCE ON CUSTOMERS
During 1998, a substantial portion of the Company's sales were to one customer,
Aristocrat Leisure Industries ("Aristocrat") an Australian-based distributor,
which accounted for approximately 54% of sales. Due to the declining
multi-player game sales in their territory, the Company's sales to this
distributor declined in 1998, and the Company has not forecasted sales to this
customer in 1999. Although the Company is attempting to diversify its customer
base, no assurance can be given that the Company will be successful in such
diversification. The reduction of sales to Aristocrat could have a material
adverse impact on the Company if the Company is unable to successfully diversify
its customer base.
GOVERNMENT REGULATION
The manufacture and distribution of gaming machines are subject to extensive
federal, state, provincial, tribal, international and local regulation. These
regulations are constantly changing and evolving, and may permit additional
gaming or curtail gaming in various jurisdictions in the future, which may have
a material adverse impact on the Company. The Company and its key personnel
undergo extensive investigation before each jurisdictional license is issued.
The Company's gaming machines are subjected to independent testing and
evaluation prior to approval from each jurisdiction in which the Company does
business. Generally, regulatory authorities have broad discretion when granting,
renewing or revoking such game approvals and licenses. The failure of the
Company, any of its key personnel, or its gaming machines to obtain or retain a
license in any jurisdiction could have a material adverse effect on the Company
or on the ability of the Company, its key personnel, and its gaming machines to
obtain or retain required licenses in other jurisdictions. If the Company enters
into lease participation agreements under which the Company shares in the
revenues generated by gaming machines, the Company may be subject to additional
regulation as a gaming operator. Regulatory authorities may require significant
shareholders to submit to background investigations and respond to questions
from regulatory authorities, and may deny a license or revoke the Company's
licenses based upon their findings. See "Regulation", for additional discussion
regarding governmental regulation.
RAPIDLY CHANGING TECHNOLOGY - The Company's business is characterized by rapidly
changing technology and frequent new product introductions and enhancements. The
Company's success will depend in part on its ability to continue to enhance its
existing products and to introduce in a timely manner new products that meet
existing and future regulatory requirements and evolving customer requirements
and to achieve market acceptance. There can be no assurance that the Company
will be successful in identifying, developing and marketing new products or
enhancing its existing products. The Company's business will be adversely
affected if the Company experiences delays in developing new products or
enhancements or if such products or enhancements do not meet and receive all
regulatory approvals and/or gain customer acceptance.
FACTORS AFFECTING PROFITABILITY AND GROWTH - All of the Company's revenues are
derived from the gaming industry. The growth of the Company's business is
substantially dependent upon factors that are beyond the control of the Company,
including, among others, the pace of development, changes in
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<PAGE> 19
gaming regulation, expansion and renovation of casinos and other forms of casino
gaming in new jurisdictions, and the continued popularity of casino gaming as a
leisure activity. The expansion of the gaming industry has slowed in recent
years and the continued expansion of gaming markets is dependent upon political,
legal and other factors, which are beyond the control of the Company. As a
result of these and other factors, there is no assurance of the Company's
continued growth or profitability.
DEPENDENCE UPON RELATIONSHIP WITH VENDORS, SUPPLIERS AND DISTRIBUTORS- A
significant interruption or delay in the delivery of components from suppliers
or the loss of a significant distributor could have a material adverse effect on
the Company's results of operations.
PRODUCT PROTECTION - The Company's products are technology-based and as such,
the Company faces several intellectual property risks. The Company's business is
dependent upon its ability to protect its proprietary software, hardware and
other intellectual property. The Company relies primarily on a combination of
non-disclosure agreements for its key employees, license agreements with its
customers and suppliers and trade secret protection to protect such intellectual
property. Despite the Company's precautions, it may be possible for unauthorized
parties to copy or to "reverse engineer" certain portions of the Company's
products or to obtain and use information that the Company believes is
proprietary, Therefore, there is no assurance that precautionary steps taken by
the Company in this regard will be adequate to deter misappropriation of its
intellectual property or independent third party development of functionally
equivalent products or that the Company can meaningfully protect its rights to
such proprietary intellectual property.
The Company relies on a combination of patent, trade secret, copyright and
trademark law, nondisclosure agreements and technical security measures to
protect its rights pertaining to its products. The Company holds patents for its
blackjack, craps and roulette machines. There can be no assurance that such
patents are valid. The Company may file for patents on certain features of
products that the Company may develop in the future. No assurance can be given
that, if applied for, any patents will be issued, or, if issued, that such
patents will be valid or will provide any significant competitive protection for
such products. Only certain features of the Company's blackjack, craps, and any
other products the Company may develop in the future may be eligible for patent
protection. Such protection may not preclude competitors from developing
products with features similar to the Company's products.
Second, although the Company is not aware of any infringement, the Company may
be subject to claims from third parties alleging that the Company has infringed
the proprietary intellectual property of such third parties. Such claims could
have a material adverse effect on the Company given the costs associated with
intellectual property litigation, the potential diversion of Management's
resources to litigation and the risk of some injunction or other delay in the
offering of the Company's products. See "Business - Intellectual Property" for
additional discussion regarding product protection.
REVENUE VOLATILITY - The Company's operating results have varied substantially
from quarter to quarter. Revenues in any quarter are substantially dependent on
regulatory approval, receipt of orders and delivery and installation in that
quarter. Because the Company's staffing and operating expenses are based on
anticipated revenue levels, and a high percentage of the Company's costs are
fixed, in the short-term, the loss of any one order, or the failure to obtain
new orders as existing orders are completed, could have a material adverse
effect or cause significant fluctuations in the Company's revenues and cash flow
from quarter to quarter.
- 19 -
<PAGE> 20
STOCK PRICE VOLATILITY AND NASDAQ LISTING - The market price of the Company's
Common Stock has been highly volatile. In order to maintain its listing on the
NASDAQ National Market, the Company must maintain a closing sales price of at
least $1.00 per share for a certain period of time. Since January 2, 1999, the
Company's Common Stock has traded in the range of $0.81 to $1.44 per share,
reaching a low of $0.81 on January 14, 1999. No assurance can be given that the
Company's Common Stock will continue to trade above the NASDAQ National Market
minimum requirements or that the Company can maintain its NASDAQ National Market
listing. If the Company fails to maintain the NASDAQ standards for quotation,
the Company's Common Stock could be traded in the over-the-counter market, which
would make it more difficult to dispose of, or obtain accurate quotations as to
the price of the Company's Common Stock. In addition, the Company could then be
subject to certain rules of the Securities and Exchange Commission relating to
"penny stocks". Such rules require broker-dealers to make a suitability
determination for purchasers and to receive the purchaser's prior written
consent for a purchase transaction, thus restricting the ability of purchasers
and broker-dealers to sell the stock in the open market.
DEPENDENCE ON KEY PERSONNEL - The Company is highly dependent upon the personal
efforts and abilities of certain key personnel. The loss of the services of any
member of management could have a substantial adverse effect on the Company.
UNDESIGNATED STOCK - The Board of Directors, without action by the Company's
shareholders, is authorized to designate and issue shares in such classes or
series (including classes or series of preferred stock) as it deems appropriate
and to establish the rights, preferences and privileges of such shares,
including dividends, liquidation and voting rights. The rights of holders of
preferred stock and other classes of commons stock that may be issued may be
superior to the rights granted to the holders of the Company's Common Stock.
Further, the ability of the Board of Directors to designate and issue such
undesignated shares could impede or deter an unsolicited tender offer or
takeover proposal regarding the Company, and the issuance of additional shares
having preferential rights could adversely affect the voting power and other
rights of holders of Common Stock.
- 20 -
<PAGE> 21
ITEM 2. PROPERTIES
The Company leases approximately 53,100 square feet of warehouse and office
space in Reno, Nevada for its main facility, which includes administrative,
sales, manufacturing and warehousing operations. The rent under the lease, which
expires in October 2001, was approximately $234,000 in 1998, with provisions for
annual rent increases. The Company also leases approximately 2,400 square feet
of office and warehouse space in Las Vegas, Nevada for sales and service
operations. The rent under the lease, which expires in July 1999, is
approximately $26,000 annually.
ITEM 3. LEGAL PROCEEDINGS
The Company is not a party to any material litigation and is not aware of any
threatened litigation that would have a material adverse effect on its business.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
No matter was submitted to a vote of the Company's security holders during the
fourth quarter of the fiscal year ended December 31, 1998.
EXECUTIVE OFFICERS OF THE REGISTRANT
EDWARD G. STEVENSON, AGE 52, has been the Chairman of the Board and Chief
Executive Officer since June 1998, and served as President of the Company from
February 1996 to October 1998. Prior to joining the Company, Mr. Stevenson
served as the President and Chief Operating Officer of Little Six, Inc. d/b/a
Mystic Lake Casino in Minneapolis, from January 1995 to March 1996. From
1988-1991 and from October 1992 to January 1995, Mr. Stevenson was the President
of CMS International/Summit Casinos of Reno, Nevada.
BARRETT V. JOHNSON, AGE 66, joined the Company as Vice President of Engineering
in January 1998, and was named President and Chief Operating Officer in October
1998. Prior to joining the Company, Mr. Johnson held the positions of Vice
President of Operations and then Director/President of Aristocrat, Inc. from
1993 to 1997. From 1987 to 1993, Mr. Johnson progressed through a variety of
positions from Service Technician to General Manager of Universal Distributing
of Nevada, Inc. Prior to entering the gaming industry, Mr. Johnson served in the
United State Air Force for 30 years.
SCOTT H. SHACKELTON, AGE 49, has been Vice President, Chief Financial Officer
and Secretary since June 1996. Prior to joining the Company, Mr. Shackelton
served as Vice President, Controller and Treasurer of International Game
Technology from December 1981 to May 1996.
- 21 -
<PAGE> 22
PART II
ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS
PRICE RANGE OF COMMON STOCK
Since May 28, 1993, the date of the Company's initial public offering, through
September 20, 1994, the Company's Common Stock was traded on NASDAQ Small-Cap
Market under the ticker symbol "IGCA". On September 21, 1994 the Company's
Common Stock began trading on the NASDAQ National Market.
The following table summarizes the high and low prices per share of the Common
Stock for the periods indicated as reported on the NASDAQ SmallCap Market or the
NASDAQ National Market:
<TABLE>
<CAPTION>
HIGH LOW
<S> <C> <C>
FYE 12/31/97
First Quarter $6.94 $4.75
Second Quarter 6.00 4.13
Third Quarter 5.75 4.75
Fourth Quarter 4.94 2.13
FYE 12/31/98
First Quarter $4.38 $2.25
Second Quarter 4.13 2.25
Third Quarter 3.88 2.00
Fourth Quarter 2.00 1.00
</TABLE>
The Company has never declared or paid any dividends on its Common Stock, and
the Board of Directors presently intends to retain all earnings, if any, for use
in the Company's business for the foreseeable future. Any future determination
as to declaration and payment of dividends will be made at the discretion of the
Board of Directors.
On March 19, 1999, the last reported sale price for the Common Stock was $1.13
per share. As of March 19, 1999, the Company had 110 shareholders of record and
approximately 1,800 beneficial shareholders of Common Stock.
- 22 -
<PAGE> 23
ITEM 6. SELECTED FINANCIAL DATA
The following is a summary of certain consolidated statement of operations, cash
flow and balance sheet information for the Company as of and for the years ended
December 31, 1998, 1997, 1996 and 1995, and the five months ended December 31,
1994. The following financial information should be read in conjunction with
"Management's Discussion and Analysis of Financial Condition and Results of
Operations," and the Consolidated Financial Statements of Innovative Gaming
Corporation of America and Subsidiary (in thousands except per share data).
<TABLE>
<CAPTION>
For the Year For the Year For the Year For the Year For the Five
Ended Ended Ended Ended Months Ended
December 31, December 31, December 31, December 31, December 31,
1998 1997 1996 1995 1994
------------ ------------ ------------ ------------ ------------
<S> <C> <C> <C> <C> <C>
Statement of operations data:
Net sales $ 8,509 $ 10,292 $ 2,664 $ 6,352 $ 470
Gross profit 1,375 3,103 529 1,589 199
Operating loss (4,444) (2,182) (6,592) (2,765) (2,179)
Net loss (5,058) (1,935) (6,179) (2,114) (1,129)
Net loss per
common share (0.72) (0.43) (0.97) (0.38) (0.20)
Cash flow data:
Cash provided by (used for):
Operating activities (2,106) (7,516) (2,726) 591 (1,226)
Investing activities (92) 555 3,784 (4,399) (1,033)
Financing activities 3,297 4,486 1,038 (87) (1,044)
Increase (decrease) in cash
and cash equivalents 1,099 (2,475) 2,096 (3,895) (3,303)
Balance sheet data (end of period):
Cash, cash equivalents and
available-for-sale securities 1,617 518 5,959 8,749 5,796
Working capital 12,100 12,603 11,996 16,039 17,616
Total assets 17,093 19,181 15,976 18,929 21,417
Long-term debt (net of
current maturities) 856 509 - - 5
Redeemable Preferred Stock - - - - 983
Total stockholders' equity 14,872 17,202 15,450 18,531 19,693
</TABLE>
- 23 -
<PAGE> 24
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
The following discussion and this Form 10-K contains forward-looking statements
that involve risks and uncertainties relating to future events. Actual events or
the Company's results may differ materially from those discussed in such
forward-looking statements. Factors that might cause actual results to differ
from those indicated by such forward-looking statements include, but are not
limited to: customer acceptance of the Company's products, need for additional
financing, Preferred Stock conversions, decline in demand for gaming products or
reduction in the growth rate of new markets, failure or delay in obtaining
gaming regulatory approvals, delays in developing or manufacturing new products,
delays in orders and shipment of products, changing economic conditions,
approval of pending patent applications or infringement upon existing patents,
the effects of regulatory and governmental actions and increased competition.
OVERVIEW - The Company was formed in 1991 to develop, manufacture, market and
distribute multi-player and other specialty video gaming machines. The Company
manufactures, markets and distributes BJ Blitz(TM), Hot Shot Dice(TM), Lightning
Strike Roulette(TM), Supersuits Progressive Blackjack(TM) and Bonus Streak(TM)
to certain gaming markets worldwide. Since inception, the Company has focused
most of its resources on the development of games, the regulatory approval
process and the sale and installation of its games. The Company has begun to
expand and diversify its product line by developing and marketing single player
games such as Bonus Streak and Mythical Reels.
REGULATION - The Company distributes its products both directly to the gaming
marketplace and through licensed agents and distributors. The Company is
currently licensed and/or has the necessary regulatory approvals as a gaming
product manufacturer and distributor in Nevada, Colorado, Mississippi,
Louisiana, North Carolina, Minnesota, Iowa, Arizona, certain New Mexico tribal
jurisdictions, Quebec and the Atlantic Lottery (four Canadian Maritime
provinces). In certain jurisdictions where the Company is licensed, such as
Arizona and Colorado, the Company may elect to market its products through a
licensed distributor pursuant to any necessary regulatory approvals. In certain
jurisdictions where licensure is not required, such as Australia, the Company
may use an existing licensed distributor to sell its products pursuant to any
necessary regulatory transaction approvals. The Company has obtained approval to
sell gaming devices in Alberta, Manitoba, Saskatchewan and has applications
pending in British Columbia, Ontario, South Dakota, Connecticut and New Jersey.
As of March 1999, technical game approvals are being sought by the Company
and/or its distributor in France, Quebec and the Atlantic Lottery. The Company
intends to apply for necessary licenses or approvals in other jurisdictions both
domestically and internationally where gaming is permitted.
In order to expedite the timing of gaming regulatory approval in certain
jurisdictions on a timetable acceptable to Management, the Company in March
1999, redeemed 400,000 shares of Common Stock from another shareholder who
beneficially owned in excess of 5% of the Company's outstanding Common Stock in
exchange for a four year convertible note and a warrant to purchase 50,000
shares of the Company's Common Stock. See "Common Stock Redemption" and Item 1 -
"Business - Regulation."
DISTRIBUTORS - In February 1996, the Company entered into a five-year
distribution agreement with Aristocrat Leisure Industries of New South Wales,
Australia to exclusively market and distribute the Company's multi-station
products in Australia, New Zealand and surrounding gaming markets. Sales to this
Australian distributor declined in the third and particularly fourth quarters of
1998, and the Company has not forecasted sales to this customer in 1999. In
March 1996, the Company entered into a three-year exclusive distribution
agreement with Ludi S.F.M. of France and its related entity Eurusa, to market
and distribute the Company's multi-station products to select western European
gaming markets. In January 1997, the Company granted a three-year exclusive
distribution license to
- 24 -
<PAGE> 25
Vista Gaming Corporation to distribute and service the Company's multi-station
blackjack and roulette, and Bonus Streak products in Colorado. In March 1998,
the Company entered into a one-year business consulting agreement with Jean D.
Leclair and the Leclair Group ("Leclair"). Under the agreement Leclair will, in
addition to consulting, assist in securing agreements to for the purchase of the
Company's products in Quebec and Atlantic Canada. In May 1998, the Company
entered into a one-year exclusive agency agreement with Bill Engle to represent
certain of the Company's products for sale in specified provinces of Canada. In
December 1998, the Company granted a three-year exclusive distribution license
to DGS, Inc. to distribute the Company's multi-station blackjack and 21 Stud
products in South Carolina. . In January 1999, the Company granted a two-year
exclusive distribution license to Par 4 to distribute certain of the Company's
products in Atlantic City, New Jersey and Connecticut, subject to the Company's
approval to sell products and approval of its products.
RELATIONSHIP WITH LAKES GAMING, INC. - Lakes Gaming, Inc. ("LGI") (formerly
Grand Casinos, Inc.) is in the business of managing and developing casinos.
Under an existing machine purchase agreement, LGI may purchase up to an
aggregate of 125 of the Company's multi-station blackjack, craps and roulette
games in quantity purchases at distributor level prices. Pursuant to this
agreement, the Company has sold 42 blackjack machines, 11 craps machines and 8
roulette machines. Previous quantity sales were also made to LGI 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
LGI, used multi-player machines which LGI 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 LGI for each game sold by the
Company. There are potentially 31 such used multi-player games which LGI may
submit the Company for sale under the consignment agreement. Through December
31, 1998, 17 such used multi-player games were submitted to the Company on
consignment under this agreement. The Company made no multi-station machine
sales to LGI during 1997. The Company sold six Bonus Streak games and no
multi-station machines to LGI in 1998.
OTHER - On February 2, 1996, the Company completed the acquisition of all
remaining patents, trademarks, copyrights and other intellectual property
related to its games from its principal supplier. The Company also signed an
agreement to receive discounted pricing on key game components for a two-year
period, which is expected to lower its per game manufacturing costs. The Company
will receive deliveries under this agreement until July 1999.
- 25 -
<PAGE> 26
RESULTS OF OPERATIONS FOR THE YEAR ENDED DECEMBER 31, 1998 COMPARED TO THE YEAR
ENDED DECEMBER 31, 1997.
For the year ended December 31, 1998, the Company reported a net loss of
$5,430,000, or $.72 per share, compared to a net loss of $2,889,000, or $.43 per
share, for the year ended December 31, 1997. Results from operations for both
years have been adjusted for preferred stock accretion and preferred stock
dividends paid. The greater loss in 1998 was primarily due to a decline in
revenues and gross profit, a tax provision recorded to provide a full valuation
allowance on the Company's deferred tax asset and higher expenses for
engineering and product development.
SALES, COST OF SALES AND GROSS PROFIT
Sales decreased to $8,509,000 during the year ended December 31, 1998 compared
to $10,292,000 in the year ended December 31, 1997, due to a decrease in
multi-station machine sales from 166 in 1997 to 123 in 1998. This decrease was
partially offset by an increase in sales of single player Bonus Streak games
from 6 in 1997 to 53 in 1998. The following table presents the comparative sales
revenue and percentage of revenue derived from each of the Company's product
lines for the years ending December 31, 1998 and 1997:
<TABLE>
<CAPTION>
Year ended Year ended
December 31, 1998 December 31, 1997
------------------- -----------------
<S> <C> <C>
Sales revenue $ 8,509,000 $10,292,000
=========== ===========
Product line: Percentage of Percentage of
revenue: revenue:
Multi-player games 78% 92%
Single player games 9% 1%
Parts sales and other 8% 4%
Lease participation 5% 3%
----------- -----------
Total 100% 100%
=========== ===========
</TABLE>
The Company was granted technical game approval of its blackjack machine in
Colorado and its three multi-player video machines in Nevada in early 1997,
allowing the Company to pursue placement of its products in those jurisdictions.
In the third quarter of 1997, the Company's multi-station blackjack and roulette
games received interim approval for use in the club market of New South Wales,
Australia. Subsequent to receiving such approval, the Company's Australian
distributor commenced marketing the Company's products in this market. The
decline in multi-station machine sales is partially attributable to reduced
purchases by this distributor in 1998. A total of 86 machines were sold to this
distributor in 1998, with the majority of those sales occurring in the first and
second quarters, compared to 99 machines in 1997. Due to the declining
multi-player game sales in their territory, sales to this distributor declined,
particularly in the third and fourth quarters of 1998, and the Company has not
forecasted sales to this customer in 1999. Also contributing to the decreased
revenue were sales to a North Carolina casino, which purchased 12 machines in
1998 compared to 30 machines in 1997.
Delays in acquiring required gaming licenses in key gaming jurisdictions have
limited the markets available to expand sales of the Company's products in 1998.
During 1997 and 1998, the Company has continued its efforts to expand its
markets by pursuing licensing in new jurisdictions, however, sales will continue
to be volatile until, among other things, the Company obtains new jurisdictional
licenses, marketing efforts are successfully completed and products are accepted
by the market place.
- 26 -
<PAGE> 27
The Company also recognized lease/participation revenues in 1998 attributable to
placement of games in Colorado and Nevada casinos. 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 gross margin in 1998 was 16.2% compared to 30.1% in 1997. The lower gross
margin in 1998 was primarily due to unabsorbed labor and overhead costs
attributable to lower production volume in the second half of the year. In the
years ended December 31, 1998 and 1997, there were no sales to LGI under their
discounted price arrangement.
SELLING, GENERAL AND ADMINISTRATIVE EXPENSES
Selling, general and administrative expense for the year ended December 31, 1998
was $5,819,000 compared to $5,285,000 during fiscal year 1997. This increase in
expense is primarily attributable to higher expenditures for engineering and
development costs for new product development. Expenses also increased for
professional fees, particularly legal fees and other costs associated with
licensing and product approvals.
INTEREST INCOME
Interest income for the year December 31, 1998 was $106,000 compared to $247,000
for fiscal year 1997. This interest income decrease was due to reduced amounts
invested in interest bearing accounts, including interest bearing notes
receivable from the sale of product.
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 year ended December 31, 1998 to provide a
full valuation allowance on its deferred tax asset. As required by SFAS No. 109,
and taking into consideration past losses and the ability of the Company to
"more likely than not" realize such benefit, the Company recorded the additional
valuation reserve.
PREFERRED STOCK ACCRETION ADJUSTMENT
On May 13, 1998, the Company issued 3,000 shares of Series B Convertible
Preferred Stock (the "Series B Preferred Stock") at a price of $1,000 per share
in a private placement (see Note 7 of Notes to Consolidated Financial
Statements). The Series B Preferred Stock is convertible into shares of the
Company's Common Stock at a conversion price of 91% of the average closing bid
price of the Company's Common Stock 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 intrinsic value of the
beneficial conversion feature was $296,703, which was accreted to Series B
Preferred Stock and charged against net income or loss to arrive at net income
or loss attributable to common shareholders over the period in which the right
to convert the Preferred Stock became vested. The $296,703 value of the
beneficial conversion feature was recognized during the second, third and fourth
quarters of 1998.
On April 11, 1997, the Company issued 4,000 shares of Series A Convertible
Preferred Stock (the "Series A Preferred Stock") at a price of $1,000 per share
in a private placement (see Note 7 of Notes to Consolidated Financial
Statements). The Series A Preferred Stock was convertible into shares of the
Company's Common Stock at a conversion price of 82% of the average closing bid
price of the Company's Common Stock over the ten-day trading period ending the
day prior to conversion. The intrinsic value of the beneficial conversion
feature was $878,048, which was accreted to Preferred Stock and charged against
net income or loss to arrive at net income or loss attributable to common
shareholders over the period in which the right to convert the Preferred Stock
became vested. The $878,048 value of the beneficial conversion feature was
recognized during the second and third quarters of 1997.
- 27 -
<PAGE> 28
RESULTS OF OPERATIONS FOR THE YEAR ENDED DECEMBER 31, 1997 COMPARED TO THE YEAR
ENDED DECEMBER 31, 1996.
For the year ended December 31, 1997, the Company reported a net loss of
$2,889,000, or $.43 per share, compared to a net loss of $6,179,000, or $.97 per
share, for the year ended December 31, 1996. For the 1997 period, results from
operations have been adjusted for preferred stock accretion and preferred stock
dividends paid. The greater loss in 1996 was primarily due to a one time
restructuring charge of $1,716,000 and lower sales volume.
SALES, COST OF SALES AND GROSS PROFIT
Sales increased to $10,292,000 during the year ended December 31, 1997 compared
to $2,664,000 in the year ended December 31, 1996, due to an increase in unit
sales from 33 in 1996 to 172 in 1997. The following table presents the
comparative sales revenue and percentage of revenue derived from each of the
Company's product lines for the years ending December 31, 1997 and 1996:
<TABLE>
<CAPTION>
Year ended Year ended
December 31, 1997 December 31, 1996
------------------- -----------------
<S> <C> <C>
Sales revenue $10,292,000 $2,664,000
=========== ==========
Product line: Percentage of Percentage of
revenue: revenue:
Multi-player games 92% 91%
Single player games 1% - %
Parts sales and other 4% 9%
Lease participation 3% - %
---- ---
Total 100% 100%
==== ===
</TABLE>
Delays in acquiring required gaming licenses in key gaming jurisdictions limited
the markets available to sell the Company's products in 1996. The Company was
granted technical game approval of its blackjack machine in Colorado and its
three multi-player video machines in Nevada in early 1997, allowing the Company
to pursue placement of its products in those jurisdictions. In the third quarter
of 1997, the Company's multi-station blackjack and roulette games received
interim approval for use in the club market of New South Wales, Australia.
Subsequent to receiving such approval, the Company's Australian distributor
commenced marketing the Company's products in this market. A total of 99 games
were sold to the Australian distributor in 1997. Also contributing to the
increased revenue were sales of 30 games, representing replacements and
additional games, to a North Carolina casino.
The gross margin in 1997 was 30.1% compared to 19.8% in 1996. The improved gross
margin in 1997 is primarily attributable to lower cost of games due to design
changes to reduce production costs, purchasing materials domestically at more
competitive prices than were previously paid to foreign sources, and increased
direct customer sales versus discounted sales to distributors. In 1996, all of
the games sold by the Company were to distributors, which generally yield lower
gross margins than direct sales. Additionally, the product sales mix in 1996 was
comprised primarily of lower margin products. In the years ended December 31,
1997 and 1996, there were no sales to LGI under their discounted price
arrangement.
SELLING, GENERAL AND ADMINISTRATIVE EXPENSES
Selling, general and administrative expense for the year ended December 31, 1997
was $5,285,000 compared to $5,405,000 during fiscal year 1996. The decrease is
attributable primarily to increased productivity resulting in expenses being
incorporated into the cost of assembled games. During 1996, expenses incurred in
establishing the production operation were charged to operating expense. In
1997, when production operations commenced, the costs were included in cost of
sales as labor and overhead included in the products assembled and sold. This
expense reduction more than offset increased product development, marketing and
administrative expenses.
- 28 -
<PAGE> 29
INTEREST INCOME
Interest income for the year December 31, 1997 was $247,000 compared to $568,000
for fiscal year 1996. This interest income decrease was due to reduced amounts
invested in interest bearing accounts, including interest bearing notes
receivable from the sale of product.
PREFERRED STOCK ACCRETION ADJUSTMENT
On April 11, 1997, the Company issued 4,000 shares of Series A Convertible
Preferred Stock (the "Preferred Stock") at a price of $1,000 per share in a
private placement (see Note 7 of Notes to Consolidated Financial Statements).
The Preferred Stock was convertible into shares of the Company's Common Stock at
a conversion price of 82% of the average closing bid price of the Company's
Common Stock over the ten-day trading period ending the day prior to conversion.
The intrinsic value of the beneficial conversion feature was $878,048, which was
accreted to Preferred Stock and charged against net income or loss to arrive at
net income or loss attributable to common shareholders over the period in which
the right to convert the Preferred Stock became vested. The $878,048 value of
the beneficial conversion feature was recognized during the second and third
quarters of 1997.
LIQUIDITY AND CAPITAL RESOURCES
PREFERRED STOCK ISSUES
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, which represents 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 there is a holder of Preferred Stock that
is unable to convert shares of Preferred Stock into Common Stock at a discount
because either a) 1,505,000 shares have been issued at a discount or b) such
holder would beneficially own in excess of 4.9% of the Company's Common Stock,
then 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. The Company has
the right to redeem the Preferred Stock at 115% of par in cash. As of December
31, 1998, all of the Preferred Stock was convertible into Common Stock, at the
election of the holder thereof. 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 December 31, 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.
- 29 -
<PAGE> 30
Through March 30, 1999, $2.85 million of Preferred Stock had not yet been
converted into the Company's Common Stock. As of March 30, 1999, the Company
also had cash and cash equivalents of approximately $650,000. If the holders of
the Company's Preferred Stock were to attempt to convert on such date, the
Company would be required to issue 1,339,036 shares of Common Stock at $.91 per
share (91% of the closing sales price on such date), and issue 438,652 shares
of Common Stock at $3.375 (the closing sales price of the Company's Common Stock
on the date the Preferred Stock was issued) and pay approximately $1.1 million
to the holders of the unconverted Preferred Stock pursuant to the present terms
of the Preferred Stock. The Company and the holders of the Preferred Stock have
been negotiating revised Preferred Stock terms to eliminate the cash redemption
feature of the present Preferred Stock terms. No assurance can be given that the
Company will be able to eliminate the cash redemption feature or otherwise
obtain more favorable Preferred Stock terms. Such revised terms could be very
dilutive to the Company's present Common Stock shareholders. Any attempted
conversion of Preferred Stock could have a significant material adverse effect
on the Company if no alternative arrangements could be reached with the
Company's holders of Preferred Stock. The material adverse effects which could
occur include, but are not limited to: liquidation of all or part of the
Company's assets or sale of additional Common Stock at a discount.
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. The $296,703
value of the beneficial conversion feature was recognized during the second,
third and fourth quarters of 1998.
INVENTORY
As of December 31, 1998, inventories totaled $9.4 million, approximately 1.3
times the amount recorded as cost of sales in 1998. This level of inventory was
due to lower than expected product sales and fewer than expected placements of
games in casinos on a participation basis during 1998. Additionally, sales to
the Company's Australian distributor were lower than expected, particularly in
the third and fourth quarters when this distributor failed to order games in
accordance with forecasts previously provided to the Company. The Company had
relied on the forecasts provided by the distributor as a basis for making
inventory purchases. Additionally, placements of games in Nevada casinos were
fewer than planned as the Company met with resistance to placement of games
under revenue sharing agreements. The Company has subsequently revised its
marketing strategies to include the option of selling games to casinos in
Nevada. Management has evaluated the composition of the inventory for product
marketability under its current business plan and recorded reserves to reduce
the carrying value to a level it believes is realizable. The Company had
long-term debt of $856,000 as of December 31, 1998.
LIQUIDITY
The Company had $1,617,000 and $518,000 in cash, cash equivalents and
available-for-sale securities as of December 31, 1998 and December 31, 1997,
respectively. The Company has experienced negative cash flow from operations of
$2.1 million, $7.5 million and $2.7 million for the years ended December 31,
1998, 1997 and 1996, respectively. In addition, sales in the first quarter of
1999 have been below managements expectations. As of March 30, 1999, the Company
had cash and cash equivalent's of approximately $650,000. Management believes,
assuming it can achieve its sales forecasts which exceed current sales rates, it
will have sufficient cash to fund operations through mid 1999. However, if sales
remain at or below their current levels and the Company does not reduce its
operating expenses consistent with its sales level, operations will only be
funded May 1999. Management has taken certain steps to address their future
liquidity and cash flow requirements by entering into a loan commitment to
borrow approximately $675,000, on a secured basis, from a third party lender in
late March 1999 in addition to attempting to control costs through inventory
reductions and other measures. With this financing the Company estimates that
its current level of cash and anticipated funds from operations will be adequate
to fund cash requirements through 1999, which assumes market acceptance of new
games (which cannot be assured). No assurance can be given that this loan will
close on a timely basis, if at all, or on the terms contained in the loan
commitment letter with such lender. Failure to close on this loan in a timely
basis could have a material adverse effect on the Company. In the absence of
alternative financing, the Company would have to consider significantly reducing
operations, in addition to liquidating all or a portion of the Company's assets.
To the extent that the Company does significantly reduce operations, it would
have a material adverse effect on the Company's ability to meet its short term
revenue projections and would negatively impact the ability to obtain additional
financing. Furthermore, to the extent that the Company's revenues are less than
anticipated, the Company may require additional short-term financing, which may
not be available. Furthermore, if the Company is required to make a cash payment
to redeem any unconverted shares of Preferred Stock, the Company would be unable
to make such cash redemption given its current capital resources and would have
to consider a liquidation of all or part of the Company's assets or sale of
additional common stock at a discount. Additionally, the costly process of
product development and introduction may require the Company to seek additional
financing to successfully complete any such future development and introduction.
There can be no assurance that the Company will be successful in obtaining any
additional financing on terms acceptable to the Company if such need arises.
Additionally, the Company has taken steps to reduce operating costs.
- 30 -
<PAGE> 31
COMMON STOCK REDEMPTION
In March 1999, in order to expedite the timing of gaming regulatory approval in
certain jurisdictions, the Company repurchased 400,000 shares of its outstanding
Common Stock, at market price, from a shareholder. The Company entered into a
Stock Redemption Agreement with such shareholder pursuant to which the Company
redeemed 400,000 shares of Company Common Stock beneficially owned by such
shareholder in exchange for a four year convertible note and a warrant to
purchase 50,000 shares of the Company's Common Stock. The note is unsecured,
paying interest of 5% per annum and will be convertible at the closing market
price of the Company's Common Stock on the date of the issuance of the note. The
note may not be converted in the first year following issuance. The exercise
price of the warrant will be the same as the conversion price of the note. The
Company also granted "piggyback" registration rights for shares of Common Stock
issuable upon conversion of both the note and the warrant. See Item 1. --
"Business -- Regulation."
OTHER
In light of the Company's lack of long-term liquidity, the Company retained the
investment banking firm of Gerald Klauer Mattison & Co., Inc. on January 5,
1999, to analyze the Company's strategic alternatives, including finding a
strategic partner for the Company for a potential sale, joint venture, merger or
other form of business combination. Such engagement letter terminates June 30,
1999.
At December 31, 1998, Company had a $500,000 standby letter of credit primarily
to facilitate acquisition of components and supplies from a foreign vendor. As
of December 31, 1998, no amount was outstanding. The facility is collateralized
by short-term investments of the Company.
Gains and losses on foreign currency transactions are recognized currently in
earnings. The Company's revenues from foreign markets are expected to increase
in the future, further subjecting the Company to the effects of fluctuations in
exchange rates. The Company does not consider this to be a significant risk at
this time.
YEAR 2000 UPDATE
As of December 31, 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 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.
- 31 -
<PAGE> 32
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.
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; 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 this Form
10-K in ITEM 1. - BUSINESS, under the caption "Certain Factors". 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.
- 32 -
<PAGE> 33
ITEM 8. FINANCIAL STATEMENTS
REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS
To the Stockholders and Board of Directors of Innovative Gaming Corporation of
America:
We have audited the accompanying consolidated balance sheet of Innovative Gaming
Corporation of America and Subsidiary as of December 31, 1998, and the related
consolidated statements of operations, stockholders' equity and cash flows for
each of the year then ended. These financial statements are the responsibility
of the Company's management. Our responsibility is to express an opinion on
these consolidated financial statements based on our audit.
We conducted our audit in accordance with generally accepted auditing standards.
Those standards require that we plan and perform the audit to obtain reasonable
assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audit provide a reasonable basis for our opinion.
In our opinion, the 1998 consolidated financial statements referred to above
present fairly, in all material respects, the financial position of Innovative
Gaming Corporation of America and Subsidiary as of December 31, 1998, and the
results of their operations and their cash flows for the year then ended, in
conformity with generally accepted accounting principles.
The accompanying consolidated financial statements have been prepared assuming
that the Company will continue as a going concern. As discussed in Note 1 to the
consolidated financial statements, the Company has suffered recurring negative
cash flow from operations that raises substantial doubt about the Company's
ability to continue as a going concern. Management's plans in regard to
addressing the future liquidity and cash flow requirements of the Company are
described in Note 1. The consolidated financial statements do not include any
adjustments that might result from the outcome of this uncertainty.
Our audit was made for the purpose of forming an opinion on the basic
consolidated financial statements taken as a whole. The accompanying schedule is
presented for purposes of complying with the Securities and Exchange Commission
rules and is not part of the basic financial statements. This schedule has been
subjected to the auditing procedures applied in the audit of the basic
consolidated financial statements and, in our opinion, fairly states in all
material respects the financial data required to be set forth therein in
relation to the basic consolidated financial statements taken as a whole.
KAFOURY, ARMSTRONG & CO.
Reno, Nevada
February 26, 1999
- 33 -
<PAGE> 34
REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS
To the Stockholders and Board of Directors of Innovative Gaming Corporation of
America:
We have audited the accompanying consolidated balance sheet of Innovative Gaming
Corporation of America and Subsidiary as of December 31, 1997, and the related
consolidated statements of operations, stockholders' equity and cash flows for
each of the two years in the period ended December 31, 1997. These financial
statements are the responsibility of the Company's management. Our
responsibility is to express an opinion on these consolidated financial
statements based on our audits.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of material
misstatement. An audit includes examining on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above present
fairly, in all material respects, the financial position of Innovative Gaming
Corporation of America and Subsidiary as of December 31, 1997, and the results
of their operations and their cash flows for each of the two years in the period
ended December 31, 1997, in conformity with generally accepted accounting
principles.
The accompanying consolidated financial statements have been prepared assuming
that the Company will continue as a going concern. As discussed in Note 1 to the
consolidated financial statements, the Company has suffered recurring negative
cash flow from operations that raises substantial doubt about the Company's
ability to continue as a going concern. Management's plans in regard to
addressing the future liquidity and cash flow requirements of the Company are
described in Note 1. The consolidated financial statements do not include any
adjustments that might result from the outcome of this uncertainty.
Our audit was made for the purpose of forming an opinion on the basic
consolidated financial statements taken as a whole. The accompanying schedule is
presented for purposes of complying with the Securities and Exchange Commission
rules and is not part of the basic financial statements. This schedule has been
subjected to the auditing procedures applied in the audit of the basic
consolidated financial statements and, in our opinion, fairly states in all
material respects the financial data required to be set forth therein in
relation to the basic consolidated financial statements taken as a whole.
ARTHUR ANDERSEN LLP
Las Vegas, Nevada
March 12, 1998
- 34 -
<PAGE> 35
INNOVATIVE GAMING CORPORATION OF AMERICA AND SUBSIDIARY
Consolidated Balance Sheets
(In Thousands, Except Share Data)
<TABLE>
<CAPTION>
As of December 31,
--------------------
1998 1997
-------- ---------
ASSETS
<S> <C> <C>
CURRENT ASSETS:
Cash and cash equivalents $ 1,617 $ 518
Restricted investments 700 1,000
Accounts receivable, net of
allowances of $85 and $100 1,186 1,929
Current portion of notes receivable 334 276
Inventories, net 9,244 10,191
Prepaid expenses and other 384 159
-------- --------
Total current assets 13,465 14,073
NOTES RECEIVABLE, less current portion 362 552
PROPERTY AND EQUIPMENT, net 1,389 2,107
DEFERRED INCOME TAXES, net - 720
INTANGIBLES ASSETS, net 1,877 1,729
-------- --------
TOTAL ASSETS $ 17,093 $ 19,181
======== ========
LIABILITIES AND STOCKHOLDERS' EQUITY
CURRENT LIABILITIES:
Accounts payable $ 313 $ 568
Accrued liabilities 524 423
Notes payable - current portion 528 322
Customer deposits - 157
-------- --------
Total current liabilities 1,365 1,470
Notes payable - net of current portion 856 509
-------- --------
Total liabilities 2,221 1,979
-------- --------
COMMITMENTS AND CONTINGENCIES (Note 9) - -
STOCKHOLDERS' EQUITY:
Series B Convertible Preferred Stock,
$.01 par value, nonvoting,
4,000 shares authorized, 3,000 and
0 shares outstanding, respectively - -
Common stock, $.01 par value,
100,000,000 shares authorized,
7,535,211 shares issued and outstanding 75 75
Additional paid-in capital 32,676 29,575
Accumulated deficit (17,879) (12,448)
-------- --------
Total stockholders' equity 14,872 17,202
-------- --------
TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY $ 17,093 $ 19,181
======== ========
</TABLE>
The accompanying notes are an integral part of these
consolidated balance sheets.
- 35 -
<PAGE> 36
INNOVATIVE GAMING CORPORATION OF AMERICA AND SUBSIDIARY
Consolidated Statements of Operations
(In Thousands, Except Per Share Data)
<TABLE>
<CAPTION>
For the Year For the Year For the Year
Ended Ended Ended
December 31, December 31, December 31,
1998 1997 1996
----------- ------------ ------------
<S> <C> <C> <C>
NET SALES $ 8,509 $ 10,292 $ 2,664
COST OF SALES 7,134 7,189 2,135
-------- -------- --------
Gross profit 1,375 3,103 529
SELLING, GENERAL AND ADMINISTRATIVE EXPENSES 5,819 5,285 5,405
RESTRUCTURING COSTS - - 1,716
-------- -------- --------
Operating loss (4,444) (2,182) (6,592)
INTEREST INCOME, net 106 247 568
-------- -------- --------
Loss before income taxes (4,338) (1,935) (6,024)
PROVISION FOR INCOME TAXES 720 - 155
-------- -------- --------
Net loss (5,058) (1,935) (6,179)
PREFERRED STOCK DIVIDENDS 75 76 -
PREFERRED STOCK ACCRETION 297 878 -
-------- -------- --------
Net loss attributable to common shareholders ($ 5,430) ($ 2,889) ($ 6,179)
======== ======== ========
LOSS PER SHARE OF COMMON STOCK ($ 0.72) ($ 0.43) ($ 0.97)
======== ======== ========
Weighted average common shares outstanding 7,535 6,744 6,356
======== ======== ========
</TABLE>
The accompanying notes are an integral part of these
consolidated financial statements.
- 36 -
<PAGE> 37
INNOVATIVE GAMING CORPORATION OF AMERICA AND SUBSIDIARY
Consolidated Statements of Stockholders' Equity
(In Thousands)
<TABLE>
<CAPTION>
Un-
realized
Gain/
Class B Non-Voting Convertible Addi- (Loss) on
Common Stock Common Stock Preferred Stock tional Accu- Available-
---------------- ------------------ --------------- Paid-in mulated Unearned for-Sale
Shares Amount Shares Amount Shares Amount Capital Deficit Compensation Securities Total
-------- ------ -------- ------ ------ ------ -------- -------- ------------ ---------- -------
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C> <C> <C>
BALANCE,
December 31, 1995 4,969 $ 50 1,025 $ 10 - - $ 21,858 $ (3,380) $ (10) 3 $18,531
Class B common stock
exchange for
common stock 1,025 10 (1,025) (10) - - - - - - -
Stock options and
warrants exercised 258 3 - - - - 1,014 - - - 1,017
Common stock
issued for purchase
of intangible assets 225 2 - - - - 2,079 - - - 2,081
Unearned compensation
adjustments - - - - - - - - 10 - 10
Unrealized loss on
available-for-sale
securities - - - - - - - - - (10) (10)
Net loss - - - - - - - (6,179) - - (6,179)
------- ------ -------- ------ ------- ------- -------- -------- -------- ------ -------
BALANCE,
December 31, 1996 6,477 65 - - - - 24,951 (9,559) - (7) 15,450
Series A preferred
stock issued - - - - 4,000 3,122 622 - - - 3,744
Preferred stock
accretion adjustment - - - - - 878 - (878) - - 0
Series A preferred
stock conversion to
common stock 1,055 10 - - (4,000) (4,000) 3,990 - - - 0
Preferred stock
dividends paid 3 - - - - - 12 (76) - - (64)
Unrealized gain on
available-for-sale
securities - - - - - - - - - 7 7
Net loss - - - - - - - (1,935) - - (1,935)
------- ------ -------- ------ ------ -------- -------- -------- -------- ------ -------
BALANCE,
December 31, 1997 7,535 75 - - - - 29,575 (12,448) - - 17,202
Series B preferred
stock issued - - - - 3,000 - 2,804 - - - 2,804
Preferred stock
accretion adjustment - - - - - - 297 (297) - - -
Preferred stock
dividends paid - - - - - - - (76) - - (76)
Net loss - - - - - - - (5,058) - - (5,058)
------- ------ -------- ------ ------ ------- ------- -------- -------- ------- -------
BALANCE,
December 31, 1998 7,535 $ 75 - $ - 3,000 $ - $32,676 $(17,879) $ - $ - $14,872
======= ====== ======== ====== ====== ======= ======= ======== ======== ======= =======
</TABLE>
The accompanying notes are an integral part
of these consolidated financial statements.
- 37 -
<PAGE> 38
INNOVATIVE GAMING CORPORATION OF AMERICA AND SUBSIDIARY
Consolidated Statements Of Cash Flows
(In Thousands)
<TABLE>
<CAPTION>
For the Year For the Year For the Year
Ended Ended Ended
December 31, December 31, December 31,
1998 1997 1996
------------ ------------ ------------
<S> <C> <C> <C>
OPERATING ACTIVITIES:
Net loss ($ 5,058) ($ 1,935) ($ 6,179)
Adjustments to reconcile net loss to
cash flows used for operating activities -
Depreciation and amortization 936 889 566
Stock option compensation earned - - 10
Loss on sale of assets - 2 103
Deferred income taxes 720 - 134
Provision for inventory obsolescence 571 112 1,308
Book value of fixed assets charged to
cost of sales 26 424 -
Provision for bad debts - 9 78
Changes in operating assets and liabilities:
Accounts and notes receivable 875 (2,106) 1,202
Inventories 376 (5,574) (232)
Prepaid expenses and other (224) 14 177
Accounts payable and accrued expenses (171) 492 107
Customer deposits (157) 157 -
-------- -------- --------
Net cash used for operating activities (2,106) (7,516) (2,726)
-------- -------- --------
INVESTING ACTIVITIES:
Purchases of available-for-sale securities - (1,042) (5,936)
Release of restricted investments 300 - -
Proceeds from sale of available-for-sale
securities - 4,013 10,350
Payment on covenant not to compete - - (92)
Inventory (capitalized for use in) returned
from gaming operations 363 (2,028) -
Proceeds from sale of property and equipment - - 45
Purchases of property and equipment (255) (388) (583)
Purchases of intangible assets (500) - -
-------- -------- --------
Net cash provided by (used for)
investing activities (92) 555 3,784
-------- -------- --------
FINANCING ACTIVITIES:
Proceeds from financing agreements 955 873 26
Payments on long-term obligations (402) (67) (5)
Preferred stock dividends paid (60) (64) -
Net proceeds from sale of common stock - - 1,017
Net proceeds from sale of preferred stock 2,804 3,744 -
-------- -------- --------
Net cash provided by financing activities 3,297 4,486 1,038
-------- -------- --------
INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS 1,099 (2,475) 2,096
CASH AND CASH EQUIVALENTS, beginning of period 518 2,993 897
-------- -------- --------
CASH AND CASH EQUIVALENTS, end of period $ 1,617 $ 518 $ 2,993
======== ======== ========
SUPPLEMENTAL DISCLOSURE OF CASH FLOWS INFORMATION:
Cash paid for interest $ 80 $ 1 $ 3
======== ======== ========
Cash paid (refund received) for income taxes ($ 1) ($ 3) $ 4
======== ======== ========
Noncash transactions:
Preferred Stock converted to common stock $- $ 4,000 $-
======== ======== ========
Preferred Stock dividends paid with
common stock $- $ 12 $-
======== ======== ========
Exchange of common stock for intangible
assets $- $- $ 2,081
======== ======== ========
</TABLE>
The accompanying notes are an integral part of these
consolidated financial statements.
- 38 -
<PAGE> 39
INNOVATIVE GAMING CORPORATION OF AMERICA AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(IN THOUSANDS, EXCEPT SHARES AND PER SHARE DATA)
1. NATURE OF BUSINESS AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES:
NATURE OF BUSINESS AND RISK FACTORS
Innovative Gaming Corporation of America ("the Company") was incorporated in the
State of Minnesota on September 19, 1991. The Company, through its wholly-owned
subsidiary, Innovative Gaming, Inc., is in the business of developing,
manufacturing, marketing and distributing gaming equipment. The Company
distributes its products to certain gaming markets worldwide.
The Company has experienced negative cash flow from operations of $2.1 million,
$7.5 million and $2.7 million for the years ended December 31, 1998, 1997 and
1996, respectively. In addition, sales in the first quarter of 1999 have been
below management's expectations. As of March 30, 1999, the Company had cash and
cash equivalents of approximately $650. Management believes assuming it can
achieve its sales forecasts which exceed current sales rates, it will have
sufficient cash to fund operations through mid 1999. However, if sales remain
at or below their current levels, and the Company does not reduce its operating
expenses consistent with its sales level operations will only be funded into May
1999. Management has taken certain steps to address its short-term liquidity and
cash flow requirements by entering into a loan commitment to borrow
approximately $675 on a secured basis from a third party lender in late March
1999. In addition to attempting to control costs through inventory reductions
and other measures. The Company anticipates closing on this loan in early April
1999. With this financing the Company estimates that its current level of cash
and anticipated funds from operations, which assumes market acceptance of new
games (which cannot be assured), will be adequate to fund cash requirements
through 1999. No assurance can be given that this loan will close on a timely
basis, if at all, or on the terms contained in the loan commitment letter with
such lender. Failure to close on this loan in a timely basis could have a
material adverse effect on the Company. In the absence of alternative financing,
the Company would have to consider significantly reduce operations, in addition
to liquidating all or a portion of the Company's assets. To the extent that the
Company does significantly reduce operations, it would have a material adverse
effect on the Company's ability to meet its short term revenue projections and
would negatively impact the ability to obtain additional financing.,
Furthermore, to the extent that the Company's revenues are less than
anticipated, the Company may require additional short-term financing in 1999,
which may not be available. Additionally, the Company is continuing its efforts
to control operating expenses.
The Company's ability to execute its long-term business strategy also depends to
a significant degree on its ability to finance the development, marketing and
production of its products. There can be no assurance that the Company will be
successful in obtaining financing on terms acceptable to the Company, if such
need arises. Any new investors may seek and obtain substantially better terms
than were granted to its present investors and the issuance of such securities
would result in dilution to its existing shareholders.
USE OF ESTIMATES
The preparation of financial statements in conformity with generally accepted
accounting principles requires management to make estimates and assumptions that
affect the reported amounts of assets and liabilities at the date of the
financial statements and the reported amounts of revenues and expenses during
the reporting period. Ultimate results could differ from those estimates.
REGULATION
The manufacture, distribution and sale of the Company's products are regulated
by various jurisdictions and entities, including requirements to obtain licenses
and product approval. The Company is presently seeking, or plans to seek,
licenses and product approval in several jurisdictions. Failure to successfully
obtain licenses, approvals, or meet other regulatory requirements could
materially impact the expansion and future operation of the Company.
- 39 -
<PAGE> 40
CERTAIN RISKS AND UNCERTAINTIES
A significant portion of the Company's operations are generated from a limited
number of gaming jurisdictions. A change in general economic conditions or the
regulatory environment of these jurisdictions could adversely affect the
Company's operating results.
PRINCIPLES OF CONSOLIDATION
The consolidated financial statements include the accounts of Innovative Gaming
Corporation of America and its wholly owned subsidiary, Innovative Gaming, Inc.
All significant intercompany transactions have been eliminated.
CASH AND CASH EQUIVALENTS
The Company considers all financial instruments which are highly liquid and have
original maturities of three months or less to be cash and cash equivalents
which are readily convertible to cash. Cash equivalents consist primarily of
demand deposits.
The Company classifies all investments which are not cash equivalents as
available-for-sale securities with all gross unrealized gains or losses included
as a separate component of equity.
RESTRICTED INVESTMENTS
At December 31, 1998 and 1997, the Company had restricted investments of $700
and $1,000, respectively, Of these amounts, $500 and $1,000, respectively, were
pledged as collateral against certain bank credit arrangements.
PROPERTY AND EQUIPMENT
Property and equipment are carried at cost with depreciation provided for using
the straight-line method over the useful lives of the assets or the lease term,
whichever is shorter. Maintenance, repairs and minor renewals are expensed when
incurred. Depreciation expense recorded in the years ended December 31, 1998,
1997 and 1996 was $584, $537 and $146, respectively.
<TABLE>
<CAPTION>
Useful Life 1998 1997
--------------------------------------
<S> <C> <C> <C>
Office equipment 5 years $942 $453
Display games 5 years 142 142
Gaming operations equipment 2.5 years 543 1,459
Manufacturing equipment 5 years 358 345
Leasehold improvements Life of lease 307 303
----------------------
Total property and equipment 2,292 2,702
Less: Accumulated depreciation (903) (595)
----------------------
Total property and equipment, net $ 1,389 $2,107
======================
</TABLE>
- 40 -
<PAGE> 41
INVENTORIES
Inventories are recorded at the lower of cost or market value. Cost is
determined according to the first-in, first-out accounting method. Inventories
consisted of the following at December 31:
<TABLE>
<CAPTION>
1998 1997
-----------------------
<S> <C> <C>
Game components and parts $5,021 $6,602
Work in process 231 698
Finished goods 4,939 3,772
Inventory reserves (947) (881)
-----------------------
Total inventories, net $9,244 $10,191
========================
</TABLE>
INTANGIBLES
The Company amortizes intangibles on a straight-line basis over their estimated
economic lives while the technology is being utilized (See Note 5).
PRODUCT SALES/REVENUE RECOGNITION
The Company makes product sales for cash, on normal terms of 90 days or less,
over longer term installments, and, in Nevada, through participation in the net
win of the games until the purchase price is paid. Revenue from the sale of
products is recognized upon transfer of title and risk of loss to the customer.
Deposits received from customers in advance of delivery are deferred.
CONCENTRATIONS OF RISK
During 1998, a majority of the Company's sales were to one customer, a
distributor, Aristocrat Leisure Industries ("Aristocrat"), which accounted for
54.1% of sales. Sales to Aristocrat declined in the third and particularly
fourth quarters of 1998 when this distributor failed to order games in
accordance with forecasts previously provided to the Company. The Company has
not forecasted sales to this customer in 1999. During 1997, a majority of the
Company's sales were to two customers. Sales to one distributor, Aristocrat,
accounted for 48.4% of sales and direct sales to one customer, Harrah's Smoky
Mountain Casino, accounted for 19.4% of sales. During 1996, a majority of the
Company's sales were to three distributors. These three distributors accounted
for 37%, 32% and 24% of sales, respectively. For the years ended December 31,
1998, 1997 and 1996, no other distributors or customers accounted for greater
than 10% of sales.
The Company maintains deposits in excess of federally insured limits. Statement
of Financial Accounting Standards No. 105 identifies these items as a
concentration of risk requiring disclosure, regardless of the degree of risk.
The risk is managed by maintaining all deposits in high quality financial
institutions.
The Company purchases certain key electronic components, which are not available
from other sources, from a Japanese supplier, Irem Software Engineering, Inc.,
at a negotiated fixed price for a period extending to mid-1999. The total
purchase commitment remaining at December 31, 1998, was approximately $462. The
Company is developing an alternative product design to eliminate dependence on
this sole source vendor.
- 41 -
<PAGE> 42
The financial instruments that subject the Company to concentrations of credit
risk consist principally of accounts and notes receivable. Accounts and notes
receivable are concentrated in specific legalized gaming jurisdictions. Notes
receivable are collateralized by the equipment sold. The Company has no secured
interest in the trade accounts receivable. At December 31, 1998, the following
concentrations of credit risk existed:
<TABLE>
<S> <C>
Nevada 46%
Germany 11%
Colorado 10%
Canada 10%
South Carolina 8%
California 8%
Delaware and Other 7%
----------------
Total 100%
================
</TABLE>
RESEARCH AND DEVELOPMENT COSTS
The Company engages in the development of new and existing products. Research
and development costs are expensed as incurred. The Company expensed
approximately $2,353, $1,884 and $1,132 for the years ended December 31, 1998,
1997 and 1996, respectively. These amounts are included in selling, general and
administrative expenses.
RESTRUCTURING COSTS
In 1996, the Company recognized $1,716 of restructuring costs, which included
expenses related to the Company's relocation to Reno, Nevada, management
transition and product focus.
INCOME TAXES
The Company accounts for income taxes in accordance with Statement of Financial
Accounting Standards No. 109 -"Accounting for Income Taxes" (SFAS No. 109),
whereby deferred tax assets and liabilities are recognized for future tax
consequences attributable to differences between the financial statement
carrying amounts of existing assets and liabilities and their respective tax
bases. Deferred tax assets and liabilities are measured using enacted tax rates
expected to apply to taxable income in the year in which those temporary
differences are expected to be removed or settled. Under SFAS No. 109, the
effect on deferred tax assets and liabilities of a change in tax rates is
recognized in income in the period that includes the enactment date.
To the extent the amount deductible for income tax purposes from stock option
plans exceeds the amount charged to operations for financial statement purposes,
the related tax benefits are credited to capital stock when realized.
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
- 42 -
<PAGE> 43
share data for all periods presented is based on weighted average common shares
outstanding and on the same basis as "basic" earnings per share 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.
FOREIGN CURRENCY TRANSACTIONS
Transactions which occur in currencies other than U.S. dollars are translated to
U.S. dollars for financial reporting purposes. Gains and losses from this
process are recorded in the results of operations.
LONG-LIVED ASSETS
During 1995, the Company adopted Statement of Financial Accounting Standards No.
121 "Accounting for the Impairment of Long-Lived Assets and for Long-Lived
Assets to be Disposed Of'" - (SFAS No.121). SFAS No.121 establishes accounting
standards for the recognition and measurement of impairment of long-lived assets
and certain identifiable intangibles and goodwill either to be held or disposed
of.
Management reviews long-lived assets, including intangibles, for impairment
whenever events or changes in circumstances indicate that the carrying amount of
the asset may not be recoverable. For assets which produce future cash flows, an
estimate of undiscounted future cash flows is compared to the carrying amount to
determine if an impairment exists. For assets which do not produce quantifiable
future cash flows, such as intangibles, impairment is measured at the enterprise
level. No impairment existed at December 31, 1998 and 1997.
2. RELATIONSHIP WITH LAKES GAMING, INC.:
Lakes Gaming, Inc. ("LGI") (formerly Grand Casinos, Inc.) is in the business of
managing and developing casinos. 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 LGI, and was Chief Executive Officer of LGI 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, LGI may purchase up to an
aggregate of 125 of the Company's multi-station blackjack, craps and roulette
games in quantity purchases at distributor level prices. Previous quantity sales
were also made to LGI 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 LGI, used multi-player machines which
LGI 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 LGI for each game sold by the Company. There are potentially 31 such
used multi-player games which LGI may submit the Company for sale under the
consignment agreement. Through December 31, 1998, 17 such used multi-player
games were submitted to the Company on consignment under this agreement. The
Company made no multi-station machine sales to LGI during 1997. The Company sold
six Bonus Streak games and no multi-station machines to LGI in 1998.
3. AVAILABLE-FOR-SALE SECURITIES:
The Company had no available-for-sale securities at December 31, 1998 and 1997.
Proceeds from the sale of available-for-sale securities were $4,013 for the year
ended December 31, 1997 and $10,350 for the year ended December 31, 1996.
- 43 -
<PAGE> 44
4. NOTES RECEIVABLE:
The Company has granted certain customers extended payment terms under sales
contracts. These contracts are generally for terms of one to five years with
interest recognized at prevailing rates and are collateralized by the equipment
sold. Stated interest rates in the contracts range from 10% to 10.5%. On
contracts with no stated interest to be paid, interest is imputed at prime plus
2%. At December 31, 1998, the face amount of notes receivable was $816. The
carrying value of notes receivable approximates their fair value. Certain of the
Company's notes receivable are pledged as security for a note payable to Finova
Capital Corporation. The following table represents the estimated future
collections of notes receivable, net of amounts to be recognized as interest
income, at December 31, 1998:
<TABLE>
<CAPTION>
Years Ending December 31, Estimated
Receipts
<S> <C> <C>
1999 $334
2000 117
2001 102
2002 63
2003 and after 80
------------------
Total $696
==================
</TABLE>
5. INTANGIBLE ASSETS:
Intangible assets consisted of the following at December 31:
<TABLE>
<CAPTION>
Useful Life 1998 1997
--------------------------------
<S> <C> <C> <C>
Product patent and technology rights 5 to 10 $2,832 $2,332
years
Nevada distribution rights 10 years 250 250
------------------
Total intangible assets 3,082 2,582
Less: accumulated amortization (1,205) (853)
------------------
Total intangible assets, net $1,877 $1,729
=================
</TABLE>
Amortization recorded for intangibles was $352, $352 and $420 in the years ended
December 31, 1998, 1997 and 1996, respectively.
On February 2, 1996, the Company acquired the balance of all remaining
intellectual property including patents, trademarks, picture rights and
copyrights for its games from its Japanese suppliers in exchange
for an aggregate 225,000 shares of IGCA common stock.
During 1998, the Company 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. The Company will also pay a per day game fee to Quick
- 44 -
<PAGE> 45
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 cost of this patent and technology will be
amortized over the period such technology is used in the Company's products. No
such amortization was recorded in 1998.
The Company purchased rights to a game concept developed by Vista Gaming
("Vista"), a Colorado corporation, for a purchase price of $100. 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 cost of these game rights will be
amortized over the period they are used in the Company's products. No such
amortization was recorded in 1998.
The Company purchased rights to intellectual property related to two game
concepts developed by Gametronics for a purchase price of $500. A note
receivable from Gametronics in the amount of $400 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. The cost of this intellectual property will be amortized over
the period it is used in the Company's products. No such amortization was
recorded in 1998.
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.
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. The cost of these technology rights will be amortized over
the period such rights are used in the Company's products. No such amortization
was recorded in 1998.
6. FINANCING ARRANGEMENTS:
LETTER OF CREDIT
At December 31, 1998 and 1997, the Company had a standby letter of credit with a
bank in the amount of $500 and $1,000, respectively. At December 31, 1998 and
1997, the Company had certificates of deposit of $700 and $1,000, respectively,
which were included in the accompanying balance sheets as restricted
investments, of which $500 and $1,000, respectively, were pledged as security
for the standby letters of credit. This standby letter of credit is primarily to
facilitate the acquisition of component parts and supplies. At December 31, 1998
and 1997, no amount was outstanding on the standby letter of credit.
- 45 -
<PAGE> 46
NOTES PAYABLE
Notes payable consists of amounts owed IGT, a wholly-owned subsidiary of
International Game Technology, for the purchase of slant top slot machines
incorporated in the Company's Bonus Streak game, an operating capital loan from
Finova Capital Corporation and financed insurance premiums.
Under the agreement with IGT, the Company shares equally in the net revenues
received from customers under participation agreement sales until IGT is paid in
full for the sales price of the slant top slot machine acquired by the Company.
Thereafter the Company receives 90% and IGT receives 10% of the net revenues
from the customer. For cash sales, the Company must pay IGT the purchase price
of the slant top slot machines from the proceeds of the sale. Management has
estimated the portion of current notes payable to represent those amounts
expected to be paid to IGT under participation arrangements and from cash sales
in 1999.
In March 1998, Innovative Gaming, Inc., a wholly-owned subsidiary of the
Company, entered into a loan commitment securing $2 million from Finova Capital
Corporation. The initial funding of approximately $910 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 was available through December 1,
1998. The Company's borrowing capacity under this arrangement was dependent upon
the level of receivables generated through "bucket sales" agreements. The
Company did not borrow any additional amounts under this arrangement.
The financed insurance premiums are paid in monthly installments over a period
of less than twelve months.
The following table represents the estimated future payments of notes payable at
December 31, 1998:
<TABLE>
Years Ending December 31, Estimated
Receipts
<S> <C> <C>
1999 $528
2000 528
2001 319
2002 9
-----------------
Total $1,384
================
</TABLE>
7. STOCKHOLDERS' EQUITY:
PREFERRED STOCK
On April 11, 1997, the Company issued 4,000 shares of Series A Convertible
Preferred Stock at a price of $1,000 per share in a private placement for total
proceeds of $4,000. The Company received net proceeds of approximately $3,744
from such private placement after the payment of fees and expenses associated
with such private placement. An annual dividend of 4% was paid quarterly in
arrears in cash. Each share of Preferred Stock was convertible into shares of
the Company's Common Stock at a conversion price of 82% of the average closing
bid price of the Company's Common Stock over the ten-
- 46 -
<PAGE> 47
day trading period ending the day prior to conversion (the "Conversion Price").
The Conversion Price was not to exceed $8.1725 per share. A holder of Preferred
Stock was not permitted to convert such stock into Common Stock if, following
such conversion, the holder beneficially would own in excess of 4.9% of the
Company's 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 April 10, 1997. The Effective Date of
the Registration Statement was July 28, 1997, and all necessary gaming
regulatory approvals were received. As of October 22, 1997, all shares of
Preferred Stock were converted into an aggregate of 1,058,696 shares of Common
Stock.
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. The stated par value per share
is $.01, resulting in a total par value of thirty dollars being recorded as
Series B Convertible Preferred Stock, and the balance of approximately $3.0
million is included in Additional Paid-in Capital. The Company received net
proceeds of approximately $2,804 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 Series B 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, which represents 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 there is a holder of Preferred
Stock that is unable to convert shares of Preferred Stock into Common Stock at a
discount because either a) 1,505,000 shares have been issued at a discount or b)
such holder would beneficially own in excess of 4.9% of the Company's Common
Stock, then 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. The
Company has the right to redeem the Preferred Stock at 115% of par in cash. As
of December 31, 1998, all of the Preferred Stock was convertible into Common
Stock, at the election of the holder thereof. 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 December 31, 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 $297,
- 47 -
<PAGE> 48
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 was reduced by approximately $141, $144 and
$12 during the second, third and fourth quarters of 1998, respectively.
STOCK REPURCHASE PLAN
On October 20, 1994, the Company's Board of Directors authorized the Company to
repurchase up to 500,000 shares of its outstanding common stock from time to
time on the open market or in privately negotiated transactions. As of December
31, 1998, the Company had repurchased 248,500 shares at prices ranging from
$3.56 to $6.08 per share, for total consideration of $1,199. All such shares
were repurchased in 1994 and 1995. No shares were repurchased in 1998.
ISSUANCE AND EXCHANGE OF CLASS B STOCK
On October 20, 1994, the Company issued 1,025,000 shares of its Class B
Non-Voting Common Stock in exchange for 1,025,000 shares of common stock held by
Grand Casinos, Inc.("GCI") (Grand Casinos, Inc. subsequently changed its name to
Lakes Gaming, Inc.) On December 1, 1995, the Company and GCI amended their
earlier agreement to provide that if the Company did not receive certain
approvals from the Nevada Gaming Commission ("the Nevada Approvals") on or
before December 31, 1995, GCI would, subject to approval of the Minnesota
Commissioner of Commerce, exchange its 1,025,000 shares of Class B non-voting
common stock for 1,025,000 shares of the Company's common stock. The Company did
not receive the Nevada Approvals on or before December 31, 1995. On March 21,
1996, GCI converted 1,025,000 shares of Class B non-voting common stock into
1,025,000 shares of the Company's common stock.
At the time of the original exchange, the Company granted GCI certain
registration rights and the option to purchase 102,500 shares of common stock at
$7.00 per share, increased the number of games GCI may purchase under the
existing discount machine purchase agreement by 50 games (up to an aggregate 125
games) and entered into a transition plan with respect to Board of Directors'
positions based upon the timing of the Company's receipt of regulatory
approvals.
STOCK OPTIONS AND WARRANTS
The Company has a 1992 Employee Stock Option and Compensation Plan (the "1992
Plan"), pursuant to which options and other awards to acquire an aggregate of
1,350,000 shares of the Company's common stock may be granted. Stock options,
stock appreciation rights, restricted stock, other stock and cash awards may be
granted under the Plan. All employees are eligible to participate in the 1992
Plan. The Company also has a 1998 Non-Executive Stock Option Plan (the "1998
Plan"), pursuant to which options to acquire an aggregate of 200,000 shares of
the Company's common stock may be granted. Non-Executive employees who are
full-time employees of the Company are eligible to participate in the 1998 Plan.
Both the 1992 Plan and the 1998 Plan are administered by a stock option
committee which has the discretion to determine the number and purchase price of
shares subject to stock options (which may be below the fair value of the common
stock on the date thereof), the term of each option and the time or times during
its term when the option becomes exercisable. Options are generally exercisable
in equal
- 48 -
<PAGE> 49
amounts over a five-year period from the date of grant. During 1995 and 1994,
the exercise prices of certain options ranging from $6.00 to $15.75 were reduced
to $4.00 (fair market value on the date of repricing). On October 8, 1996, the
exercise prices of certain options ranging from $7.00 to $11.50 were reduced to
$4.75 (fair market value on the date of repricing). In December 1998, current
employees of the Company were allowed to elect repricing of outstanding options,
adjusting the exercise price to the current market price in exchange for
delaying the vesting of one-half of all then unvested options by twelve months.
All current employees elected to reprice their options under the terms offered.
The existing options were cancelled and the repriced options were recorded as
new grants. The new grants to all Non-Executive employees totaled 313,050, which
were issued from the 1998 Plan subject to Board of Directors approval to
increase the available shares in excess of the 200,000 shares originally
authorized.
The Company accounts for the both stock option plans under APB Opinion No. 25
- -"Accounting for Stock Options Issued to Employees", under which no compensation
cost has been recognized. Statement of Accounting Standards No. 123 -"Accounting
for Stock-Based Compensation" (SFAS No. 123), was issued in 1995 and, if fully
adopted, changes the methods for recognition of cost on plans similar to that of
the Company. Adoption of SFAS No. 123 is optional; however, pro forma
disclosures as if the Company had adopted the cost recognition method are
required. Had compensation cost for the Plan been determined consistent with
SFAS No. 123, the Company's results of operations and earnings per share would
have been changed to the following pro forma amounts:
<TABLE>
<CAPTION>
1998 1997
------- --------
<S> <C> <C>
Net loss: As reported $(5,430) $(2,888)
Pro forma $(6,140) $(3,831)
Primary and fully-diluted EPS: As reported $(0.72) $(0.43)
Pro forma $(0.81) $(0.57)
</TABLE>
A summary of the status of the 1992 Employee Stock Option and Compensation Plan
at December 31, 1998, 1997 and 1996, and changes during the periods then ended
is presented in the tables and narrative below:
<TABLE>
<CAPTION>
December 31, 1998 December 31, 1997 December 31, 1996
---------------------- --------------------- ----------------------
Wtd Avg Wtd Avg Number Wtd Avg
Number Ex Price Number Ex Price Ex Price
----------- ---------- ---------- ---------- ----------- ----------
<S> <C> <C> <C> <C> <C> <C>
Outstanding at
beginning of period 825,400 $4.69 606,500 $4.67 352,600 $3.99
Granted 550,400 1.14 271,550 4.75 540,500 4.75
Exercised - - - - (207,600) 3.94
Forfeited (765,800) 4.63 (52,650) 4.91 (79,000) 4.16
Expired - - - - - -
--------- -------- --------
Outstanding at end of
period 610,000 $1.56 825,400 $4.69 606,500 $4.67
========= ======== ========
Exercisable at end of
period 361,800 $1.74 290,933 $4.61 131,000 $4.52
Weighted average fair
value of options
granted on grant date $0.83 $2.91 $2.95
</TABLE>
- 49 -
<PAGE> 50
<TABLE>
<CAPTION>
Detail composition of options outstanding December 31, 1998:
--------------------------------------------------------------------
Avg. contractual
Options Exercise life remaining Options
outstanding price (Years) exercisable
----------- -------- ---------------- -----------
<S> <C> <C> <C>
11,600 $5.75 8.00 2,400
38,000 4.75 7.70 37,000
1,400 4.13 8.42 1,400
35,000 4.00 5.29 35,000
4,000 2.25 9.00 - -
220,000 1.13 9.96 70,000
300,000 1.00 10.00 216,000
------------ ----------
610,000 361,800
========= ==========
</TABLE>
The fair value of each option grant under the 1992 Employee Stock Option and
Compensation Plan is estimated on the date of grant using the Black-Scholes
option pricing model with the following assumptions used for the 1998, 1997 and
1996 grants: risk-free interest rate of 4.9, 6.5 and 6.2 percent; expected
dividend yield of 0.0 percent; expected lives of 5 years; expected volatility of
91.5, 90.3 and 61.8 percent, respectively.
A summary of the status of the 1998 Non-Executive Stock Option Plan at December
31, 1998 and changes during the period then ended is presented in the table and
narrative below:
<TABLE>
<CAPTION>
December 31, 1998
-----------------------
Wtd Avg
Number Ex Price
----------- ---------
<S> <C> <C>
Outstanding at beginning of
period - $ -
Granted 313,050 1.11
Exercised - -
Forfeited - -
Expired - -
----------
Outstanding at end of period 313,050 $1.11
==========
Exercisable at end of period 102,750 $1.11
==========
Weighted average fair value
of options granted on grant date $0.81
</TABLE>
As of December 31, 1998, the 313,050 options outstanding in the 1998
Non-Executive Stock Option Plan had an average exercise price of $1.11 with a
weighted average remaining contractual life of 9.97 years. The options
exercisable had exercise prices of $1.00 to $1.18.
The fair value of each option grant under the 1998 Non-Executive Stock Option
Plan is estimated on the date of grant using the Black-Scholes option pricing
model with the following assumptions used for the 1998 grants: risk-free
interest rate of 4.9 percent; expected dividend yield of 0.0 percent; expected
life of 5 years; expected volatility of 92.4%.
- 50 -
<PAGE> 51
The Company adopted a Director Stock Option Plan (the "Director Option Plan") in
1997, pursuant to which options and other awards to acquire an aggregate of
100,000 shares of the Company's common stock may be granted.
A summary of the status of the Directors Option Plan at December 31, 1998 and
1997, and changes during the periods then ended is presented in the table and
narrative below:
<TABLE>
<CAPTION>
December 31, 1998 December 31, 1997
---------------------- ---------------------
Wtd Avg Wtd Avg
Number Ex Price Number Ex Price
----------- ---------- ---------- ----------
<S> <C> <C> <C>
Outstanding at
beginning of period 40,000 $5.06 - $ -
Granted - - 40,000 5.06
Exercised - - - -
Forfeited (30,000) 5.04 - -
Expired - - - -
------- --------
Outstanding at end of
period 10,000 $5.13 40,000 $5.06
======= ========
Exercisable at end of
period 10,000 $5.13 10,000 $5.06
Weighted average fair
value of options
granted on grant date $ - $3.80
</TABLE>
As of December 31, 1998, the 10,000 options outstanding in the Director Option
Plan had an average exercise price of $5.13, with a weighted average remaining
contractual life of 0.5 years. The options exercisable had exercise prices of
$5.13.
The fair value of each option grant under the Director Stock Option Plan is
estimated on the date of grant using the Black-Scholes option pricing model with
the following assumptions used for the 1997 grants: risk-free interest rate of
6.5 percent; expected dividend yield of 0.0 percent; expected life of 5 years;
expected volatility of 95.1%.
The Company has issued stock purchase warrants with a variety of terms and
conditions. During 1996, the exercise prices of certain warrants were reduced
from $11.00 and $15.00 to $10.00 and $13.00, respectively.
- 51 -
<PAGE> 52
The following summarizes stock purchase warrant transactions during the period:
<TABLE>
<CAPTION>
Number Exercise Prices
<S> <C> <C>
Outstanding December 31, 1995 652,500 4.00 - 15.00
Granted - -
Exercised (50,000) 4.00
Canceled/Expired - -
---------------------------
Outstanding December 31, 1996 602,500 6.90 - 13.00
Granted - -
Exercised - -
Canceled/Expired - -
---------------------------
Outstanding December 31, 1997 602,500 6.90 - 13.00
Granted 5,000 3.19
Exercised - -
Canceled/Expired (325,000) 6.90 - 13.00
--------------------------
Outstanding December 31, 1998 282,500 $3.19 - $13.00
==========================
</TABLE>
At December 31, 1998, 282,500 warrants were exercisable. The warrants expire at
various dates through September, 2001.
8. INCOME TAXES:
The provision for income taxes consists of the following components:
<TABLE>
<CAPTION>
For the Year For the Year For the Year
Ended Ended Ended
Dec. 31, 1998 Dec. 31, 1997 Dec. 31, 1996
------------- ------------- --------------
<S> <C> <C> <C>
Current:
Federal $ - $ - $ 21
State - - -
--------------------------------------------
Subtotal - - 21
Deferred 720 - 134
--------------------------------------------
Total $ 720 $ - $155
============================================
</TABLE>
The tax effects of temporary differences giving rise to the deferred items are
as follows for the years ended December 31:
<TABLE>
<CAPTION>
1998 1997
---- ----
<S> <C> <C>
Deferred tax assets:
Net operating loss carryforwards $4,783 $3,603
Inventory reserves 1,255 1,115
Other 252 787
--------------------
Total deferred tax assets 6,290 5,505
Valuation allowance (6,290) (4,785)
--------------------
Deferred tax assets, net of allowance $ - $ 720
====================
</TABLE>
- 52 -
<PAGE> 53
In accordance with SFAS No. 109, the gross deferred tax asset at December 31,
1998, of $6,290, has been reduced to zero by a full valuation allowance of
$6,290. The Company recorded a $720,000 provision for income taxes during 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.
At December 31, 1998, the Company has approximately $13,667 of net operating
loss carryforwards for federal income tax purposes. These losses expire
beginning 2009 through 2012. The use of approximately $498 of these losses is
limited to approximately $249 per year for the next two years because the loss
was generated in a short tax year.
9. COMMITMENTS AND CONTINGENCIES:
OPERATING LEASES
The Company has entered into certain noncancelable operating lease agreements
related to office and warehouse space and equipment. Total lease expense under
operating leases was $281, $272 and $222 for the years ended December 31, 1998,
1997 and 1996, respectively. The minimum annual rental commitments under
operating leases are as follows for the years ending December 31:
<TABLE>
<S> <C>
1999 $304
2000 304
2001 241
2002 3
----
Total $852
====
</TABLE>
LITIGATION
The Company is involved in legal actions in the ordinary course of its business.
While no reasonable estimates of potential liability can be determined,
management believes that such legal actions will be resolved without a material
effect on the Company's financial position or results of operations.
EMPLOYMENT CONTRACTS
The Company has employment contracts with various officers with remaining terms
ranging from one to three years at amounts approximating their current levels of
compensation. The Company's remaining aggregate commitment at December 31, 1998,
under such contracts is approximately $1,439. These agreements may also include
additional compensation to officers related to sales commission bonuses that
could be equal to two percent of the Company's sales.
10. DISTRIBUTORSHIP AND SALES AGENCY AGREEMENTS:
In February 1996, the Company entered into an exclusive distribution agreement
with Aristocrat Leisure Industries ("Aristocrat") of New South Wales, Australia
for the marketing and distribution of games in Australia, New Zealand, Papua New
Guinea, Taiwan, New Caledonia, Malaysia, the Philippines and
- 53 -
<PAGE> 54
Singapore (hereinafter "Australasia"). The Company has granted Aristocrat an
initial five-year exclusive license expiring February 2001 to distribute its
blackjack, craps and roulette games to all legalized Australasia video gaming
jurisdictions. Pursuant to the agreement, the Company has agreed to sell its
games at discounted distributor's pricing in exchange for a minimum purchase
quantity of 100 units per year. Aristocrat commenced marketing the Company's
blackjack, and roulette games subsequent to obtaining technical approval from
New South Wales, Australia gaming authorities in September 1997. Pursuant to
this agreement, the Company sold an aggregate of 99 games in 1997 and 86 games
in 1998. Due to the declining multi-player game sales in their territory, sales
to this distributor declined in the third and particularly fourth quarters of
1998, and the Company has not forecasted sales to this customer in 1999.
In March 1998, the Company entered into a business consulting agreement with
Jean D. Leclair and the Leclair Group ("Consultant"), under which the Consultant
provides business consulting services to the Company in Quebec, Canada.
Additionally, the Consultant may also assist the Company in securing agreements
for the purchase of the Company's products in Quebec and Atlantic Canada. For
services to the Company in securing agreements for the purchase of the Company's
products, the Consultant will be paid a commission for game sales acquired with
Loto Quebec and the Atlantic Lottery Corporation. This agreement is for an
initial period of one year, with provision for renewal on a month to month basis
upon mutual written agreement.
In May 1998, the Company entered into a one-year exclusive agency agreement with
Bill Engle, an individual. Under the agreement, the agent represents the
Company's products for sale in the Canadian provinces of British Columbia,
Ontario, Nova Scotia (for casino customers only), Saskatchewan, Alberta and
Manitoba. The agent receives a commission equal to the difference between the
amount received for sales initiated by the agent and prices stated in the
agreement for each product. This agreement may be renewed for up to two
successive one-year terms upon the agreement of the parties and on the terms and
conditions set forth in the agency agreement.
In December 1998, the Company entered into a three-year exclusive agreement with
DGS, Inc. ("DGS") for the distribution and service of the Company's blackjack
and 21 Stud products in the State of South Carolina. The Company and DGS will
negotiate minimum sales targets for each year of the agreement. If DGS fails to
purchase for resale the minimum number of units in any contract year, the
Company may give notice to terminate the agreement. This agreement provides for
automatic renewal annually after the original term, up to a total of eight
years, and may be terminated by either party under certain circumstances.
The Company has submitted its applications for licensure in New Jersey and
Connecticut, and will apply for approval of its various games. Once the Company
is able to sell product in these jurisdictions, it will be represented by Par 4
("Agent") under terms of a two-year exclusive agency agreement entered into in
January 1999. Under the agreement, the agent represents certain of the Company's
products for sale in Atlantic City, New Jersey and the State of Connecticut. The
Company and Agent will negotiate minimum sales targets for each year of the
agreement. If Agent fails to obtain sales orders for at least 75 percent of the
target number of units in any contract year, the Company may give notice to
terminate the agreement. This agreement provides for automatic renewal annually
after the original term and may be terminated by either party under certain
circumstances.
The Company also has exclusive distributorship agreements with Vista Gaming
Corporation, Ludi S.F.M. and with S.A.M. Eurusa.
- 54 -
<PAGE> 55
11. SUBSEQUENT EVENTS:
REPURCHASE OF COMMON STOCK
In March 1999, in order to expedite the timing of gaming regulatory approval in
certain jurisdictions, the Company repurchased 400,000 shares of its outstanding
Common Stock, at market price, from a shareholder. The Company entered into a
Stock Redemption Agreement with such shareholder pursuant to which the Company
redeemed 400,000 shares of Company Common Stock beneficially owned by such
shareholder in exchange for a four year convertible note and a warrant to
purchase 50,000 shares of the Company's Common Stock. The note is unsecured,
paying interest of 5% per annum and will be convertible at the closing market
price of the Company's Common Stock on the date of the issuance of the note. The
note may not be converted in the first year following issuance. The exercise
price of the warrant will be the same as the conversion price of the note. The
Company also granted "piggyback" registration rights for shares of Common Stock
issuable upon conversion of both the note and the warrant.
- 55 -
<PAGE> 56
INNOVATIVE GAMING CORPORATION OF AMERICA AND SUBSIDIARY
Schedule II - Valuation and Qualifying Accounts
(In Thousands)
<TABLE>
<CAPTION>
Description Balance Charged to Amount Balance
Beginning Costs and Written End of
of Period Expenses Off Period
---------- ---------- --------- --------
<S> <C> <C> <C> <C>
Reserve for inventory obsolescence:
For the year ended 12/31/96 $ 649 $1,308 $ 64 $1,893
For the year ended 12/31/97 1,893 112 1,124 881
For the year ended 12/31/98 881 571 505 947
</TABLE>
<TABLE>
<CAPTION>
Description Charged/
Balance (Credited) Amount Balance
Beginning to Costs Written End of
of Period and Expenses Off Period
---------- ------------- --------- ---------
<S> <C> <C> <C> <C>
Allowance for doubtful notes and
accounts receivable:
For the year ended 12/31/96 $ 70 $ 78 $ - $148
For the year ended 12/31/97 148 (48) - 100
For the year ended 12/31/98 100 - 15 85
</TABLE>
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON
ACCOUNTING AND FINANCIAL DISCLOSURE
On October 26, 1999, Arthur Andersen LLP (the "Former Accountant") resigned as
independent public accountant to the Company. During the Company's two most
recent fiscal years and the subsequent interim period through October 26, 1998,
there have been no disagreements with the Former Accountants on any matter of
accounting principles or practices, financial statement disclosure, or auditing
scope or procedure, which disagreements if not resolved to the satisfaction of
the Former Accountant would have caused them to make reference thereto in their
report on the financial statements for such years. The Former Accountant's
report for the fiscal year ended December 31, 1996, for which that firm audited
such financial statements, contained no adverse opinion or disclaimer of opinion
and was not qualified as to uncertainty, audit scope or accounting principles.
The Former Accountant's report for the fiscal year ended December 31, 1997, for
which that firm audited such financial statements, indicated that the Company
has suffered recurring negative cash flow from operations that raise substantial
doubt about the Company's ability to continue as a going concern. A letter from
the Former Accountant addresses the Securities and Exchange Commission stating
that they agree with the Company's response to this Item is filed with the
Commission as an Exhibit to the Company's Form 8-K dated October 30, 1998. On
December 14, 1998, the Company retained the services of Kafoury, Armstrong & Co.
as its certified public accountants. The Audit Committee of the Company's Board
of Directors did not approve of the resignation of the Former Accountant, but
did approve of the engagement of Kafoury, Armstrong & Co.
- 56 -
<PAGE> 57
PART III
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
The information beginning immediately following the caption "Election of
Directors" to, but not including, the caption "Executive Compensation" in the
Company's Proxy Statement, to be filed with the Securities and Exchange
Commission within 120 days after the close of the Company's year ended December
31, 1998 and forwarded to stockholders prior to the Company's 1999 Annual
Meeting of Shareholders (the "1999 Proxy Statement"), is incorporated herein by
reference.
ITEM 11. EXECUTIVE COMPENSATION
The information in the 1999 Proxy Statement beginning immediately following the
caption "Executive Compensation" to, but not including, the caption
"Compensation Committee Interlocks and Insider Participation," is incorporated
herein by reference.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
The information in the 1999 Proxy Statement beginning immediately following the
caption "Voting Securities and Principal Holders Thereof " to, but not
including, the caption "Election of Directors," is incorporated herein by
reference.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
The information in the 1999 Proxy Statement under the caption "Certain
Transactions" is incorporated herein by reference.
- 57 -
<PAGE> 58
PART IV
ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K
(a)(1) Financial Statements:
<TABLE>
<CAPTION>
Page
----
<S> <C>
Report of Independent Public Accountants - Kafoury, Armstrong .& Co . . . . . 33
Report of Independent Public Accountants - Arthur Andersen LLP . . . . . . . . 34
Consolidated Balance Sheets as of December 31, 1998 and 1997 . . . . . . . . . 35
Consolidated Statements of Operations for the years ended December 31, 1998,
1997 and 1996. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 36
Consolidated Statements of Stockholders' Equity for the years ended December
31, 1998, 1997 and 1996 . . . . . . . . . . . . . . . . . . . . . . . . . . . 37
Consolidated Statements of Cash Flows for the years ended December 31, 1998,
1997 and 1996 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 38
Notes to the Consolidated Financial Statements . . . . . . . . . . . . . . . . 39
</TABLE>
- 58 -
<PAGE> 59
<TABLE>
<CAPTION>
(a)(3) Exhibits
<S> <C>
3.1(a) Articles of Incorporation, as amended (Incorporated herein by reference
to Exhibit 3.1 to the Company's Registration Statement on Form SB-2
(File No. 33-61492C) (the "SB-2")
3.1(b) Certificate of Designation relating to Series B Convertible Preferred
Stock (Incorporated herein by reference to Exhibit 4 to the Company's
report on Form 10-Q for the quarter ended March 31, 1998) (the "March
31, 1998 10-Q")
3.2 Bylaws (Incorporated herein by reference to Exhibit 3.2 to the SB-2)
10.1 1992 Stock Option and Compensation Plan, as amended (Incorporated
herein by reference to Annex B to the Company's Schedule 14A filed
April 24, 1997) +
10.2 Agreement by and between the Company and Grand Casinos, Inc., dated as
of July 28, 1994 (Incorporated herein by reference to Exhibit 10.26 to
the Company's report on Form 10-K for the fiscal year ended July 31,
1994)
10.3 Employment Agreement between the Company and Edward G. Stevenson dated
February 15, 1996 (Incorporated herein by reference to Exhibit 10.16 to
the Company's report on Form 10-K for the fiscal year ended December
31, 1995) (the "December 31, 1995 10-K")
10.4 Exclusive Distributorship Agreement between the Company and Aristocrat
Leisure Industries PTY LTD dated February 7, 1996 (Incorporated herein
by reference to Exhibit 10.18 to the Company's December 31, 1995 10-K)
10.5 Assignment between the Company, NANAO and IREM dated February 2, 1996
(Incorporated herein by reference to Exhibit 10.19 to the Company's
December 31, 1995 10-K)
10.6 Parts Supply Agreement between the Company and IREM dated February
2, 1996 (Incorporated herein by reference to Exhibit 10.20 to the
Company's December 31, 1995 10-K)
10.7 Agreement between the Company and H Square Corporation dated April 26,
1996 (Incorporated herein by reference to Exhibit 10.21 to the Company's
December 31, 1995 10-K)
10.8 Second Amendment to Share Exchange Agreement between the Company and
Grand Casinos, Inc. dated December 1, 1995 (Incorporated herein by
reference to Exhibit 10.23 to the Company's December 31, 1995 10-K)
10.9 Exclusive Distributorship Agreement between the Company and Ludi S.F.M.
dated March 5, 1996 (Incorporated herein by reference to Exhibit 10.24
to the Company's December 31, 1995 10-K)
10.10 Exclusive Distributorship Agreement between the Company and S.A.M. EURSA
dated March 5, 1996 (Incorporated herein by reference to Exhibit 10.25
to the Company's December 31, 1995 10-K)
10.11 Product Development and Revenue Sharing Agreement between the Company
and IGT, dated November 18, 1996 (Incorporated herein by reference to
Exhibit 10.18 to the Company's report on Form 10-K for the fiscal year
ended December 31, 1996) (the "December 31, 1996 10-K")
10.12 Lease agreement between the Company and Dermody Properties, dated July
9, 1996 (Incorporated herein by reference to Exhibit 10.20 to the
Company's December 31, 1996 10-K)
10.13 Loan Agreement between the Company and Finova Capital Management dated
as of April 13, 1998 (Incorporated herein by reference to Exhibit 10.1
to the Company's March 31, 1998 10-Q)
10.14 Form of Subscription Agreement dated May 13, 1998 (Incorporated herein
by reference to Exhibit 10.2 to the Company's March 31, 1998 10-Q)
10.15 Form of Registration Rights Agreement dated May 13, 1998 (Incorporated
herein by reference to Exhibit 10.3 to the Company's March 31, 1998
10-Q)
10.16 1997 Director Stock Option Plan (Incorporated herein by reference to
Annex A to the Company's Schedule 14A filed April 24, 1997)
10.17 1998 Non-Executive Employee Stock Option Plan
10.18 Agreement between the Company and Edward G. Stevenson dated January 1,
1999
21 List of Subsidiaries
23.1 Consent of Kafoury, Armstrong & Co.
23.2 Consent of Arthur Andersen LLP
27 Financial Data Schedule - which is only submitted electronically to the
Securities and Exchange Commission for EDGAR information purposes.
</TABLE>
+ Agreement relates to Executive Compensation.
- 59 -
<PAGE> 60
(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.
- 60 -
<PAGE> 61
SIGNATURES
In accordance with Section 13 or 15(d) of the Exchange Act, the registrant
caused this report to be signed on its behalf by the undersigned, thereunto duly
authorized.
INNOVATIVE GAMING CORPORATION OF AMERICA
Registrant
Date: March 30, 1999 By: /s/ Edward G. Stevenson
-----------------------------------
Name: Edward G. Stevenson
Title: Chief Executive Officer and Chairman
In accordance with the Exchange Act, this report has been signed below by the
following persons on behalf of the registrant and in the capacities indicated on
March 30, 1999.
<TABLE>
<CAPTION>
Name Title
<S> <C>
/s/ Edward G. Stevenson Chief Executive Officer and Chairman
- ------------------------------------- (principal executive officer)
Edward G. Stevenson
/s/ Scott Shackelton Vice President-Finance, Chief Financial
- ------------------------------------- Officer (principal accounting officer)
Scott Shackelton
/s/ Lyle Berman Director
- -------------------------------------
Lyle Berman
</TABLE>
- 61 -
<PAGE> 62
INDEX TO EXHIBITS
<TABLE>
<CAPTION>
Exhibit
Number Description
- ------- -----------
<S> <C>
3.1(a) Articles of Incorporation, as amended (Incorporated herein by reference
to Exhibit 3.1 to the Company's Registration Statement on Form SB-2
(File No. 33-61492C) (the "SB-2")
3.1(b) Certificate of Designation relating to Series B Convertible Preferred
Stock (Incorporated herein by reference to Exhibit 4 to the Company's
report on Form 10-Q for the quarter ended March 31, 1998) (the "March
31, 1998 10-Q")
3.2 Bylaws (Incorporated herein by reference to Exhibit 3.2 to the SB-2)
10.1 1992 Stock Option and Compensation Plan, as amended (Incorporated
herein by reference to Annex B to the Company's Schedule 14A filed
April 24, 1997) +
10.2 Agreement by and between the Company and Grand Casinos, Inc., dated as
of July 28, 1994 (Incorporated herein by reference to Exhibit 10.26 to
the Company's report on Form 10-K for the fiscal year ended July 31,
1994)
10.3 Employment Agreement between the Company and Edward G. Stevenson dated
February 15, 1996 (Incorporated herein by reference to Exhibit 10.16 to
the Company's report on Form 10-K for the fiscal year ended December
31, 1995) (the "December 31, 1995 10-K")
10.4 Exclusive Distributorship Agreement between the Company and Aristocrat
Leisure Industries PTY LTD dated February 7, 1996 (Incorporated herein
by reference to Exhibit 10.18 to the Company's December 31, 1995 10-K)
10.5 Assignment between the Company, NANAO and IREM dated February 2, 1996
(Incorporated herein by reference to Exhibit 10.19 to the Company's
December 31, 1995 10-K)
10.6 Parts Supply Agreement between the Company and IREM dated February
2, 1996 (Incorporated herein by reference to Exhibit 10.20 to the
Company's December 31, 1995 10-K)
10.7 Agreement between the Company and H Square Corporation dated April 26,
1996 (Incorporated herein by reference to Exhibit 10.21 to the Company's
December 31, 1995 10-K)
10.8 Second Amendment to Share Exchange Agreement between the Company and
Grand Casinos, Inc. dated December 1, 1995 (Incorporated herein by
reference to Exhibit 10.23 to the Company's December 31, 1995 10-K)
10.9 Exclusive Distributorship Agreement between the Company and Ludi S.F.M.
dated March 5, 1996 (Incorporated herein by reference to Exhibit 10.24
to the Company's December 31, 1995 10-K)
10.10 Exclusive Distributorship Agreement between the Company and S.A.M. EURSA
dated March 5, 1996 (Incorporated herein by reference to Exhibit 10.25
to the Company's December 31, 1995 10-K)
10.11 Product Development and Revenue Sharing Agreement between the Company
and IGT, dated November 18, 1996 (Incorporated herein by reference to
Exhibit 10.18 to the Company's report on Form 10-K for the fiscal year
ended December 31, 1996) (the "December 31, 1996 10-K")
10.12 Lease agreement between the Company and Dermody Properties, dated July
9, 1996 (Incorporated herein by reference to Exhibit 10.20 to the
Company's December 31, 1996 10-K)
10.13 Loan Agreement between the Company and Finova Capital Management dated
as of April 13, 1998 (Incorporated herein by reference to Exhibit 10.1
to the Company's March 31, 1998 10-Q)
10.14 Form of Subscription Agreement dated May 13, 1998 (Incorporated herein
by reference to Exhibit 10.2 to the Company's March 31, 1998 10-Q)
10.15 Form of Registration Rights Agreement dated May 13, 1998 (Incorporated
herein by reference to Exhibit 10.3 to the Company's March 31, 1998
10-Q)
10.16 1997 Director Stock Option Plan (Incorporated herein by reference to
Annex A to the Company's Schedule 14A filed April 24, 1997)
10.17 1998 Non-Executive Employee Stock Option Plan
10.18 Agreement between the Company and Edward G. Stevenson dated January 1,
1999
21 List of Subsidiaries
23.1 Consent of Kafoury, Armstrong & Co.
23.2 Consent of Arthur Andersen LLP
27 Financial Data Schedule - which is only submitted electronically to the
Securities and Exchange Commission for EDGAR information purposes.
</TABLE>
<PAGE> 1
EXHIBIT 10.17
INNOVATIVE GAMING CORPORATION OF AMERICA
1998 NON-EXECUTIVE STOCK OPTION PLAN
AS AMENDED
1. Purpose. The purpose of the 1998 Non-Executive Stock Option Plan (the
"Plan") of Innovative Gaming Corporation of America (the "Company") is to
increase shareholder value and to advance the interests of the Company by
attracting, motivating and retaining non-executive full-time employees of the
Company ("Non-Executive Employees") by furnishing Non-Executive Employees
non-qualified stock options to purchase Common Stock, $.01, of the Company
("Stock Options").
2. Administration. The Plan shall be administered by the Compensation
Committee of the Company (the "Committee") which Committee shall consist of not
less than two directors of the Company and shall be appointed from time to time
by the Board of Directors of the Company. A majority of the Committee's members
shall constitute a quorum. All action of the Committee shall be taken by the
majority of its members. Any action may be taken by a written instrument signed
by majority of the members and actions so taken shall be fully effective as if
it had been made by a majority vote at a meeting duly called and held. The
Committee may appoint a secretary, shall keep minutes of its meetings and shall
make such rules and regulations for the conduct of its business as it shall deem
advisable. The Committee shall have complete authority to award Stock Options
under the Plan, to interpret the Plan, and to make any other determination which
it believes necessary and advisable for the proper administration of the Plan.
The Committee's decisions and matters relating to the Plan shall be final and
conclusive on the Company and its participants.
3. Eligible Employees. Non-Executive Employees of the Company who are
full-time employees shall become eligible to receive Stock Options under the
Plan when designated by the Committee. For purposes of the Plan, "Non-Executive
Employees" shall be any employee of the Company who is not a director or officer
of the Company, as defined in Rule 16a-l(f) of the Securities Exchange Act of
1934, as amended (the " 1934 Act"). Non-Executive Employees may be designated
individually or by groups or categories (for example, by pay grade) as the
Committee deems appropriate.
4. Shares Subject to the Plan.
4.1 Number of Shares. Subject to adjustment as provided in
Section 6.5, the number of shares of Common Stock, which may be
issued under the Plan shall not exceed 200,000 shares of Common
Stock.
4.2 Cancellation. In the event that a Stock Option granted
hereunder expires or is terminated or canceled unexercised as to
any shares of Common Stock, options relating to such shares may
again be issued under the Plan. The Committee may also determine
to cancel, and agree to the cancellation of, Stock Options in
order to make a participant eligible for the grant of a Stock
Option at a lower price than the option to be canceled.
4.3 Type of Common Stock. Common Stock issued under the Plan in
connection with Stock Options shall be authorized and unissued
shares.
5. Stock Options. A Stock Option is a right to purchase shares of Common
Stock from the Company. Each Stock Option granted by the Committee under this
Plan shall be subject to the following terms and conditions:
5.1 Price. The option price per share shall be determined by the
Committee, subject to adjustment under Section 6.5.
<PAGE> 2
5.2 Number. The number of shares of Common Stock subject to the
option shall be determined by the Committee, subject to
adjustment as provided in Section 6.5.
5.3 Non-Qualified Stock Option. No Stock Option granted under
the Plan shall qualify as an incentive stock option (as such
term is defined in Section 422A of the Internal Revenue Code of
1986, as amended).
5.4 Duration and Time for Exercise. Subject to earlier
termination as provided in Section 6.3, the term of each Stock
Option shall be determined by the Committee but shall not exceed
ten years and one day from the date of grant. Each Stock Option
shall become exercisable at such time or times during its term
as shall be determined by the Committee at the time of grant.
Except as provided in any Stock Option Agreement approved by the
Committee, no Stock Option may be exercised during the first
twelve months of its term. Except as provided by the preceding
sentence, the Committee may accelerate the exercisability of any
Stock Option. Subject to the foregoing and with the approval of
the Committee, all or any part of the shares of Common Stock
with respect to which the right to purchase has accrued may be
purchased by the Company at the time of such accrual or at any
time or times thereafter during the term of the option.
5.5 Manner of Exercise. A Stock Option may be exercised, in
whole or in part, by giving written notice to the Company,
specifying the number of shares of Common Stock to be purchased
and accompanied by the full purchase price for such shares. The
option price shall be payable in United States dollars upon
exercise of the option and may be paid by cash; uncertified or
certified check; bank draft; by delivery of shares of Common
Stock in payment of all or any part of the option price, which
shares shall be valued for this purpose at the Fair Market Value
on the date such option is exercised; by instructing the Company
to withhold from the shares of Common Stock issuable upon
exercise of the Stock Option shares of Common Stock in payment
of all or any part of the option price, which shares shall be
valued for this purpose at the Fair Market Value or in such
other manner as may be authorized from time to time by the
Committee. Prior to the issuance of shares of Common Stock upon
the exercise of a Stock Option, a participant shall have no
rights as a shareholder.
6. General.
6.1 Duration. The Plan shall remain in effect until all Stock
Options granted under the Plan have either been satisfied by the
issuance of shares of Common Stock or the payment of cash or
been terminated under the terms of the Plan and all restrictions
imposed on shares of Common Stock in connection with their
issuance under the Plan have lapsed. No Stock Options may be
granted under the Plan after the tenth anniversary of the date
the Plan is approved by the Directors of the Company.
6.2 Non-transferability of Stock Options. No Stock Option may be
transferred, pledged or assigned by the holder thereof (except,
in the event of the holder's death, by will or the laws of
descent and distribution to the limited extent provided in the
Plan or in the Stock Option) and the Company shall not be
required to recognize any attempted assignment of such rights by
any participant. During a participant's lifetime, a Stock Option
may be exercised only by him or by his guardian or legal
representative.
6.3 Effect of Termination of Employment or Death. In the event
that a participant ceases to be an employee of the Company for
any reason, including death, any Stock Options may be exercised
or shall expire at such times as may be determined by the
Committee.
6.4 Additional Condition. Notwithstanding anything in this Plan
to the contrary: (a) the Company may, if it shall determine it
necessary or desirable for any reason, at the time of award of
Stock Option require the recipient of the Stock Option, as a
condition to the receipt thereof, to deliver to the Company a
written representation of present intention to acquire the Stock
Option or the shares of Common Stock issued pursuant thereto for
his own account for investment and not for distribution; and (b)
if at any time the
<PAGE> 3
Company further determines, in its sole discretion, that the
listing, registration or qualification (or any updating of any
such document) of any Stock Option issuable pursuant thereto is
necessary on any securities exchange or under any federal or
state securities or blue sky law, or that the consent or
approval of any governmental regulatory body is necessary or
desirable as a condition of, or in connection with the award of
any Stock Option, the issuance of shares of Common Stock
pursuant thereto, or the removal of any restrictions imposed on
such shares, such Stock Option shall not be awarded or such
shares of Common Stock shall not be issued or such restrictions
shall not be removed, as the case may be, in whole or in part,
unless such listing, registration, qualification, consent or
approval shall have been effected or obtained free of any
conditions not acceptable to the Company.
6.5 Adjustment. In the event of any merger, consolidation or
reorganization of the Company with any other corporation or
corporations, there shall be substituted for each of the shares
of Common Stock then subject to the Plan, including shares
subject to restrictions, options, or achievement of performance
share objectives, the number and kind of shares of stock or
other securities to which the holders of the shares of Common
Stock will be entitled pursuant to the transaction. In the event
of any recapitalization, stock dividend, stock split,
combination of shares or other change in the Common Stock, the
number of shares of Common Stock then subject to the Plan,
including shares subject to restrictions, options or
achievements of performance shares, shall be adjusted in
proportion to the change in outstanding shares of Common Stock.
In the event of any such adjustments, the purchase price of any
option, the performance objectives of any Stock Option, and the
shares of Common Stock issuable pursuant to any Stock Option
shall be adjusted as and to the extent appropriate, at the
discretion of the Committee, to provide participants with the
same relative rights before and after such adjustment.
6.6 Stock Option Plans and Agreements. The terms of each Stock
Option shall be stated in an agreement approved by the
Committee.
6.7 Withholding.
(a) The Company shall have the right to withhold from any
payments made under the Plan or to collect as a
condition of payment, any taxes required by law to be
withheld. At any time when a participant is required to
pay to the Company an amount required to be withheld
under applicable income tax laws in connection with an
exercise of an option, the participant may satisfy this
obligation in whole or in part by electing (the
"Election") to have the Company withhold from the
distribution shares of Common Stock having a value up to
the amount required to be withheld. The value of the
shares to be withheld shall be based on the Fair Market
Value of the Common Stock on the date that the amount of
tax to be withheld shall be determined ("Tax Date").
(b) Each Election must be made prior to the Tax Date. The
Committee may disapprove of any Election, may suspend or
terminate the right to make Elections, or may provide
with respect to any Stock Option that the right to make
Elections shall not apply to such Stock Option. An
Election is irrevocable.
6.8 No Continued Employment or Right to Corporate Assets. No
participant under the Plan shall have any right, because of his
or her participation, to continue in the employ of the Company
for any period of time or to any right to continue his or her
present or any other rate of compensation. Nothing contained in
the Plan shall be construed as giving an employee, the
employee's beneficiaries or any other person any equity or
interests of any kind in the assets of the Company or creating a
trust of any kind or a fiduciary relationship of any kind
between the Company and any such person.
6.9 Amendment of the Plan. The Board may amend or discontinue
the Plan at any time. However, no such amendment or
discontinuance shall, subject to adjustment under Section 6.5,
change or impair, without the consent of the recipient, a Stock
Option previously granted.
<PAGE> 4
6.10 Immediate Acceleration of Stock Option. Notwithstanding any
provision in this Plan or in any Stock Option to the contrary,
all outstanding options will become exercisable immediately any
of the following events occur:
(1) any person or group of persons becomes the beneficial
owner of 30% or more of any equity security of the Company
entitled to vote for the election of directors;
(2) a majority of the members of the Board of Directors of
the Company is replaced within the period of less than two years
by directors not nominated and approved by the Board of
Directors; or
(3) the shareholders of the Company approve an agreement
to merge or consolidate with or into another corporation or an
agreement to sell or otherwise dispose of all or substantially
all of the Company's assets (including a plan of liquidation).
For purposes of this Section 6. 10, beneficial ownership by a person or
group of persons shall be determined in accordance with Regulation 13D (or any
similar successor regulation) promulgated by the Securities and Exchange
Commission pursuant to the 1934 Act. Beneficial ownership of more than 30% of an
equity security may be established by any reasonable method, but shall be
presumed conclusively as to any person who files a Schedule 13D report with the
Securities and Exchange Commission reporting such ownership. If the restrictions
and forfeitability periods are eliminated by reason of provision (1), the
limitations of this Plan shall not become applicable again should the person
cease to own 30% or more of any equity security of the Company.
For purposes of this Section 6. 10, "Continuing Directors" are directors
(a) who were in office prior to the time any of provisions (1), (2) or (3)
occurred or any person publicly announced an intention to acquire 20% or more of
any equity security of the Company, (b) directors in office for a period of more
than two years, and (c) directors nominated and approved by the Continuing
Directors.
6.11 Definition of Fair Market Value. For purposes of this Plan,
the "Fair Market Value" of a share of Common Stock at a specified
date shall, unless otherwise expressly provided in this Plan, be
the amount which the Committee determines in good faith to be
100% of the fair market value of such a share as of the date in
question; provided, however, that notwithstanding the foregoing,
if such shares are listed on a U.S. securities exchange or are
quoted on the NASDAQ National Market System, then Fair Market
Value shall be determined by reference to the last sale price of
a share of Common Stock on such U.S. securities exchange or
NASDAQ on the applicable date. If such U.S. securities exchange
or NASDAQ is closed for trading on such date, or if the Common
Stock does not trade on such date, then the last sale price used
shall be the one on the date the Common Stock last traded on such
U.S. securities exchange or NASDAQ.
<PAGE> 1
EXHIBIT 10.18
EMPLOYMENT AGREEMENT
PARTIES:
Innovative Gaming Corporation of America, Inc.
4750 Turbo Circle
Reno, Nevada 89502 (the "Company")
Edward G. Stevenson
7 Kelly Circle
Glenbrook, Nevada 89413 (the "Executive")
DATE: January 1, 1999
RECITALS:
A. The parties hereto entered into an employment agreement dated as of
February 15, 1996 (the "First Employment Agreement") to provide for the
employment of the Executive as President and Chief Executive Officer of
the Company.
B. Subsequent to the date of execution of the First Employment Agreement,
Executive became Chairman of the Board of the Company and relinquished
the position of President of the Company.
C. The First Employment Agreement terminates February 15, 1999.
D. The parties wish to terminate the First Employment Agreement as of the
date hereof and provide for the continued employment of the Executive as
the Chairman of the Board and Chief Executive Officer of the Company
following the termination of the First Employment Agreement pursuant to
the terms and conditions of this Agreement.
E. The Executive wishes to receive compensation from the Company for the
Executive's continued services, and the Company wants reasonable
protection of its confidential business and technical information that
has been acquired and is being developed by the Company at substantial
expense.
F. The Company wishes to obtain reasonable protection against unfair
competition from the Executive following termination of employment and
to further protect against unfair use of its confidential business and
technical information and the Executive is willing to grant the Company
the benefits of a covenant-not-to-compete for these purposes.
<PAGE> 2
AGREEMENT:
The Company and the Executive, each intending to be legally bound, agree as
follows:
1. Termination of First Employment Agreement. The First Employment
Agreement is hereby terminated. All terms and conditions relating to Executive's
employment with the Company are contained in this Agreement.
2. Employment. Subject to all of the terms and conditions of this
Agreement, the Company agrees to continue to employ the Executive as the
Chairman of the Board and the Chief Executive Officer of the Company, and the
Executive accepts such employment.
3. Duties. The Executive will devote substantially all of his business
hours to and, during such time, make the best use of his energy, knowledge and
training in advancing the Company's interests. The Executive will diligently and
conscientiously perform the duties of the Executive's position within the
general guidelines to be determined by the Company's Board of Directors (the
"Board of Directors"). While the Executive is employed by the Company, Executive
will keep the Company informed of any other business activities, and will
promptly stop any activity or employment that might conflict with the Company's
interests or adversely affect the performance of the Executive's duties for the
Company.
4. Term. This Agreement will remain in effect for three (3) years after
the date of this Agreement, unless it is terminated in accordance with Section 5
hereof.
5. Termination. Subject to the respective continuing obligations of the
Company and the Executive under Sections 7, 8 and 9 hereof:
a. The Company may terminate this Agreement immediately upon
written notice to the Executive "for cause," which is defined as: (i)
dishonesty, fraud, material and deliberate injury or attempted injury,
in each case related to the Company or its business, (ii) any criminal
activity of a serious nature, or (iii) the continued failure by
Executive to satisfactorily perform the duties assigned to him pursuant
to Section 3 of this Agreement for a period of 60 days after a written
demand by the Board of Directors for such satisfactory performance which
specifically identifies the manner in which it is alleged that Executive
has not satisfactorily performed such duties. In the event of
termination of this Agreement for cause pursuant to this Section 5(a),
Executive will be paid at the usual rate Executive's annual Base Salary
through the date of
2
<PAGE> 3
termination specified in any notice of termination and Executive will
have no right to receive any bonus for the period after which the
termination occurs or any future periods, provided that such payments
will be made within 30 days after termination for cause pursuant to this
Section 5(a). Any termination by the Company other than for a reason
enumerated in this Section 5(a) shall be deemed to be a termination
"without cause." The Executive shall also be deemed to be terminated
"without cause" in the event: (i) the Executive is required to relocate
from the Reno, Nevada metropolitan area or (ii) the Executive is removed
from the office of Chief Executive Officer or (iii) the Executive has
had his authority and position diminished from that provided in Section
2; provided, however, that it shall not be deemed to be a diminishment
of authority and position if the Company's Board of Directors appoints a
Co-Chairman and Co-Chief Executive Officer.
b. This Agreement will terminate upon the Executive's death or
permanent disability.
6. Compensation.
1. Base Salary. In consideration for the Executive's services
under this Agreement, the Company agrees to pay the Executive an initial
base salary at a rate of Two Hundred Fifty Thousand Dollars
($250,000.00) per year (the "Base Salary"). Such Base Salary shall be
paid no less often than monthly in accordance with the standard payroll
practices of the Company. Such Base Salary may be adjusted from time to
time by the Board of Directors but may not be decreased during the term
of this Agreement.
2. Bonus. In addition to other compensation to be paid under
this Section 6, the Company will pay Executive an annual bonus or a
merit increase of up to 25% of the current year's Base Salary for each
year in which he performs services under this Agreement, the exact
amount to be determined by the Board of Directors based upon Executive's
and the Company's attainment during the preceding year of specified
annual objectives established by the Board of Directors in consultation
with the Executive. In addition to such bonus, the Company will pay
Executive an additional annual bonus of up to 25% of the current year's
Base Salary for each year in which he performs services under this
Agreement, the exact amount to be determined pursuant to a profit
formula to be determined by the Compensation Committee of the Company's
Board of Directors.
3. Reimbursement of Business Expenses. In addition to payment of
Base Salary, the Company agrees to reimburse the Executive for all
reasonable out-of-pocket business
3
<PAGE> 4
expenses incurred by the Executive on behalf of the Company, provided
that the Executive properly accounts to the Company for all such
expenses in accordance with the rules and regulations of the Internal
Revenue Service under the Internal Revenue Code of 1986, as amended, and
in accordance with the standard policies of the Company relating to
reimbursement of business expenses.
4. Benefits and Vacation. The Executive will be entitled to
participate in all benefit plans adopted by the Company to the extent
that the terms of such benefit plans permit the Executive to
participate. The Executive will be entitled to an annual paid vacation
of three weeks and all legal holidays observed by the Company, in each
case, in accordance with the Company's policies as in effect from time
to time.
5. Termination Without Cause. If the Company terminates this
Agreement without cause, (i) all options granted to Executive to
purchase Common Stock of the Company shall vest and remain exercisable
for thirty-six months following such termination without cause; and (ii)
the Company shall pay or grant to Executive: (1) the greater of (a) the
Base Salary (or such greater amount as it may be at the time of such
termination) for a twelve (12) month period after the date of such
termination or (b) base salary for the balance of the remaining
Agreement term; (2) any accrued bonus to be paid pursuant to Section
6(b) of this Agreement for the period through the date of termination;
(3) the unreimbursed out-of-pocket business expenses incurred by the
Executive on behalf of the Company of this Agreement; and (4) a
continuation of health, life and disability insurance benefits for a
twelve (12) month period after the date of termination on the same basis
as Executive's health, life and disability insurance benefits
immediately prior to such termination.
7. Inventions.
1. "Inventions," as used in this Section 7, means any
discoveries, improvements and ideas (whether or not they are in writing
or reduced to practice) or works of authorship (whether or not they can
be patented or copyrighted) that the Executive makes, authors, or
conceives (either alone or with others) and that:
(1) concern directly the Company's business or the
Company's present or demonstrably anticipated future research or
development;
(2) result from any work the Executive performs for the
Company;
4
<PAGE> 5
(3) use the Company's equipment, supplies, facilities,
or trade secret information; or
(4) the Executive develops during the time the Executive
is performing employment duties for the Company.
2. The Executive agrees that all Inventions made by the Executive during
or within six (6) months after the term of this Agreement will be the Company's
sole and exclusive property. The Executive will, with respect to any Invention:
(1) keep current, accurate, and complete records, which
will belong to the Company and be kept and stored on the
Company's premises while the Executive is employed by the
Company;
(2) promptly and fully disclose the existence and
describe the nature of the Invention to the Company in writing
(and without request);
(3) assign (and the Executive does hereby assign) to the
Company all of his rights to the Invention, any applications he
makes for patents or copyrights in any country, and any patents
or copyrights granted to him in any country; and
(4) acknowledge and deliver promptly to the Company any
written instruments, and perform any other acts necessary in the
Company's opinion to preserve property rights in the Invention
against forfeiture, abandonment or loss and to obtain and
maintain letters patent and/or copyrights to the Invention and
to vest the entire right and title to the Invention in the
Company.
The requirements of this subsection 7(b) do not apply to an Invention
for which no equipment, supplies, facility or trade secret information
of the Company was used and which was developed entirely on the
Executive's own time, and (1) which does not relate directly to the
Company's business or to the Company's actual or demonstrably
anticipated research or development, or (2) which does not result from
any work the Executive performed for the Company. Except as previously
disclosed to the Company in writing, the Executive does not have, and
will not assert, any claims to or rights under any Inventions as having
been made, conceived, authored or acquired by the Executive prior to his
employment by the Company. With respect to any obligations performed by
the Executive under this subsection
5
<PAGE> 6
7(b) following termination of employment, the Company will pay the
Executive reasonable hourly compensation (consistent with the last Base
salary) and will pay or reimburse all reasonable out-of-pocket expenses.
8. Confidential Information.
1. "Confidential Information," as used in this Section 8, means
information that is not generally known and that is proprietary to the Company
or that the Company is obligated to treat as proprietary. Any information that
the Executive reasonably considers Confidential Information, or that the Company
treats as Confidential Information, will be presumed to be Confidential
Information (whether the Executive or others originated it and regardless of how
the Executive obtained it).
2. Except as specifically permitted by an authorized officer of the
Company or by written Company policies, the Executive will never, either during
or after his employment by the Company, use Confidential Information for any
purpose other than the business of the Company or disclose it to any person who
is not also an Executive of the Company. When the Executive's employment with
the Company ends, the Executive will promptly deliver to the Company all records
and any compositions, articles, devices, apparatus and other items that
disclose, describe or embody Confidential Information, including all copies,
reproductions and specimens of the Confidential Information in the Executive's
possession, regardless of who prepared them and will promptly deliver any other
property of the Company in the Executive's possession, whether or not
Confidential Information.
9. Competitive Activities. The Executive agrees that, during the term of
employment with the Company and the period during which severance is paid, if
any, under this Agreement following termination of employment (if this Agreement
is terminated by the Company "without cause," then the Executive will not alone,
or in any capacity with another firm,
1. directly engage in any commercial activity that competes with
the Company's business, as the Company has conducted it during the two
(2) years before the Executive's employment with the Company ends,
within any state in the United States or within any country in which the
Company directly markets or services products or provides services,
2. in any way interfere or attempt to interfere with the
Company's relationships with any of its current or potential customers,
or
6
<PAGE> 7
3. employ or attempt to employ any of the Company's then
Executives on behalf of any other entity competing with the Company.
This Section 9 shall cease to be applicable to any activity of the Executive
from and after such time as the Company (i) shall have ceased all business
activities for a period of sixty (60) days or (ii) shall have made a decision
through its Board of Directors not to continue, or shall have ceased for a
period of sixty (60) days, the business activities with which such activity of
the Executive would be competitive.
10. Conflicts of Interest. The Executive agrees that he will not,
directly or indirectly, transact business with the Company personally, or as
agent, owner, partner or shareholder of any other entity; provided, however,
that any such transaction may be entered into if approved by the Board of
Directors.
11. No Adequate Remedy. The Executive understands that if the Executive
fails to fulfill the Executive's obligations under this Agreement, the damages
to the Company would be very difficult to determine. Therefore, in addition to
any other rights or remedies available to the Company at law, in equity, or by
statute, the Executive hereby consents to the specific enforcement of this
Agreement by the Company through an injunction or restraining order issued by an
appropriate court.
12. Miscellaneous.
1. Successors and Assigns. This Agreement is binding on and
inures to the benefit of the Company's successors and assigns, all of
which are included in the term the "Company" as it is used in this
Agreement; provided, however, that the Company may assign this Agreement
only in connection with a merger, consolidation, assignment, sale or
other disposition of substantially all of its assets or business.
2. Modification. This Agreement may be modified or amended only
by a written statement signed by both the Company and the Executive.
3. Governing law. The laws of Nevada will govern the validity,
construction, and performance of this Agreement. Any legal proceeding
related to this Agreement will be brought in an appropriate Nevada
court, and both the Company and the Executive hereby consent to the
exclusive jurisdiction of that court for this purpose.
4. Construction. Wherever possible, each provision of this
Agreement will be interpreted so that it is valid under the applicable
law. If any provision of this Agreement is to any extent invalid under
the applicable law,
7
<PAGE> 8
that provision will still be effective to the extent it remains valid.
The remainder of this Agreement also will continue to be valid, and the
entire Agreement will continue to be valid in other jurisdictions.
5. Waivers. No failure or delay by either the Company or the
Executive in exercising any right or remedy under this Agreement will
waive any provision of the Agreement. Nor will any single or partial
exercise by either the Company or the Executive of any right or remedy
under this Agreement preclude either of them from otherwise or further
exercising these rights or remedies, or any other rights or remedies
granted by any law or any related document.
6. Captions. The headings in this Agreement are for convenience
only and do not affect this Agreement's interpretation.
7. Entire Agreement. This Agreement supersedes all previous and
contemporaneous oral negotiations, commitments, writings and
understandings between the parties concerning the matters in this
Agreement, including without limitation the First Employment Agreement
and any policy or personnel manuals of the Company.
8. Notices. All notices and other communications required or
permitted under this Agreement shall be in writing and shall be hand
delivered or sent by registered or certified first-class mail, postage
prepaid, and shall be effective upon delivery if hand delivered, or
three (3) days after mailing if mailed to the addresses stated at the
beginning of this Agreement. These addresses may be changed at any time
by like notice. IN WITNESS WHEREOF, the Company and the Executive have
executed this Agreement as of the date first above written.
INNOVATIVE GAMING CORPORATION EXECUTIVE
OF AMERICA
By/s/ Lyle Berman
----------------------------------- /s/ Edward G. Stevenson
Its Director -------------------------------
Edward G. Stevenson
8
<PAGE> 1
EXHIBIT 21
LIST OF SUBSIDIARIES
Innovative Gaming, Inc.
<PAGE> 1
EXHIBIT 23.1
CONSENT OF INDEPENDENT PUBLIC ACCOUNTANTS
As independent public accountants, we hereby consent to the incorporation by
reference of our report included in this Form 10-K, into the Company's
previously filed Registration Statements on Form S-8 (File Nos. 33-73764,
333-06669, 333-37813 and 333-37815) and on Form S-3 (File No. 333-53893).
KAFOURY, ARMSTRONG & CO.
Reno, Nevada
March 30, 1999
<PAGE> 1
EXHIBIT 23.2
CONSENT OF INDEPENDENT PUBLIC ACCOUNTANTS
As independent public accountants, we hereby consent to the incorporation by
reference of our report dated March 12, 1998 covering the consolidated financial
statements of Innovative Gaming Corporation of America and Subsidiary as of
December 31, 1997 and for the two years then ended, included in this Form 10-K,
into the Company's previously filed Registration Statements on Form S-8 (File
Nos. 33-73764, 333-06669, 333-37813 and 333-37815) and on Form S-3 (File No.
333-53893).
ARTHUR ANDERSEN LLP
Las Vegas, Nevada
March 30, 1999
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