UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934.
For the quarterly period ended: September 30, 2003
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[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934 for the transition period from ______to______
Commission File Number: 000-22752
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MIKOHN GAMING CORPORATION
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(Exact name of registrant as specified in its charter)
Nevada 88-0218876
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(State or other jurisdiction of (IRS Employer
incorporation or organization) Identification Number)
920 Pilot Road, Las Vegas, NV 89119
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(Address of principal executive office and zip code)
(702) 896-3890
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(Registrant's telephone number, including area code)
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(Former name, former address and former fiscal year, if changed since last
report)
Indicate by a 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 whether the registrant is an accelerated filer (as
defined in Exchange Act Rule 12b-2) YES [ ] NO [ X ]
APPLICABLE ONLY TO CORPORATE ISSUERS:
Indicate the number of shares outstanding of each of the issuer's classes
of common stock as the latest practicable date:
21,706,886 as of November 7, 2003
------------------ ------------------
(Amount Outstanding) (Date)
MIKOHN GAMING CORPORATION
TABLE OF CONTENTS
Page
Part I FINANCIAL INFORMATION ------
Item 1. Condensed Consolidated Financial Statements
Condensed Consolidated Balance Sheets at June 30,
2003 (Unaudited) and December 31, 2002 2
Condensed Consolidated Statements of Operations for
the Three and Six Months Ended June 30, 2003 and
2002 (Unaudited) 4
Condensed Consolidated Statements of Cash Flows for
the Six Months Ended June 30, 2003 and 2002
(Unaudited) 6
Notes to Condensed Consolidated Financial
Statements (Unaudited) 8
Item 2. Management's Discussion and Analysis of Financial
Condition and Results of Operations 25
Item 3. Quantitative and Qualitative Disclosures About
Market Risk 42
Item 4. Controls and Procedures 42
Part II OTHER INFORMATION
Item 6. Exhibits and Reports on Form 8-K 43
` Signatures 44
MIKOHN GAMING CORPORATION
CONDENSED CONSOLIDATED BALANCE SHEETS
September 30,
(Amounts in thousands) 2003 December 31,
(Unaudited) 2002
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ASSETS
Current assets:
Cash and cash equivalents $ 13,942 $ 16,275
Accounts and notes receivable, net 13,172 14,799
Inventories, net 8,061 10,578
Prepaid expenses 1,843 4,063
Deferred tax asset 3,313 3,313
------- -------
Total current assets 40,331 49,028
Notes receivable, net 107 408
Property and equipment, net 17,584 21,824
Intangible assets, net 56,062 57,838
Goodwill 2,860 2,860
Other assets 8,608 10,035
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Total assets $125,552 $141,993
======== ========
See notes to condensed consolidated financial statements.
MIKOHN GAMING CORPORATION
CONDENSED CONSOLIDATED BALANCE SHEETS
September 30,
(Amounts in thousands) 2003 December 31,
except share data) (Unaudited) 2002
------- -------
LIABILITIES AND STOCKHOLDERS' DEFICIT
Current liabilities:
Trade accounts payable $ 5,090 $ 8,715
Customer deposits 2,158 3,928
Current portion of long-term debt
and notes payable 788 1,654
Accrued liabilities 12,213 11,241
Deferred revenues and license fees 1,325 1,501
------- -------
Total current liabilities 21,574 27,039
Long-term debt and notes payable,
net of unamortized discount of
$4,106 and $4,732 101,400 101,330
Other long-term liabilities 2,963 4,422
Deferred tax liability 16,114 16,114
------- -------
Total liabilities 142,051 148,905
------- -------
Commitments and contingencies (Note 5)
Stockholders' deficit:
Preferred stock, $0.10 par value,
5,000,000 shares authorized,
none issued and outstanding - -
Common stock, $0.10 par value,
100,000,000 shares authorized,
13,461.383 and 13,049,773 shares
issued and outstanding 1,346 1,305
Additional paid-in capital 69,060 67,299
Foreign currency translation (569) (858)
Accumulated deficit (85,624) (73,946)
------- -------
Subtotal (15,787) (6,200)
Less treasury stock, 194,913 shares,
at cost (712) (712)
------- -------
Total stockholders' deficit (16,499) (6,912)
------- -------
Total liabilities and stockholders'
deficit $125,552 $141,993
======== ========
See notes to condensed consolidated financial statements.
MIKOHN GAMING CORPORATION
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS (UNAUDITED)
(Amounts in thousands, Three Months Ended Nine Months Ended
except per share amounts) September 30, September 30,
2003 2002 2003 2002
------ ------ ------ ------
Revenues:
Gaming operations $ 8,201 $ 11,165 $ 27,511 $ 33,300
Product sales 12,405 18,469 39,287 42,175
------- ------- ------- -------
Total revenues 20,606 29,634 66,798 75,475
Operating costs:
Gaming operations 8,190 11,691 24,886 28,081
Product sales 10,599 21,174 33,026 43,973
Corporate expense 2,229 3,858 8,528 9,790
Restructuring expense - 5,618 - 5,618
Severance expense - 4,774 575 4,774
Impairment loss - 6,261 - 6,261
------- ------- ------- -------
Total operating costs
and expenses 21,018 53,376 67,015 98,497
Operating income (loss):
Gaming operations 11 (526) 2,625 5,219
Product sales 1,806 (2,705) 6,261 (1,798)
Corporate expense (2,229) (3,858) (8,528) (9,790)
Restructuring expense - (5,618) - (5,618)
Severance expense - (4,774) (575) (4,774)
Impairment loss - (6,261) - (6,261)
------- ------- ------- -------
Total operating loss (412) (23,742) (217) (23,022)
Interest expense (3,838) (3,977) (11,576) (11,788)
Other income 9 36 124 150
------- ------- ------- -------
Loss from continuing
operations before
income tax provision (4,241) (27,683) (11,669) (34,660)
Income tax provision (3) (936) (9) (1,426)
------- ------- ------- -------
Loss from continuing
operations (4,244) (28,619) (11,678) (36,086)
Loss from discontinued
operations, net of taxes - (1,621) - (1,896)
------- ------- ------- -------
Net loss $ (4,244) $(30,240) $(11,678) $(37,982)
======== ======== ======== ========
Weighted average common shares:
Basic 13,129 12,849 12,973 12,817
Diluted 13,129 12,849 12,973 12,817
======== ======== ======== ========
Basic and diluted loss per share:
Loss from continuing
operations $ (0.32) $ (2.22) $ (0.90) $ (2.81)
Loss from discontinued
operations - (0.13) - (0.15)
------- ------- ------- -------
Net loss per share $ (0.32) $ (2.35) $ (0.90) $ (2.96)
======== ======== ======== ========
See notes to condensed consolidated financial statements.
MIKOHN GAMING CORPORATION
CONDENSED CONSOLIDATED STATEMENTS OF COMPREHENSIVE LOSS (UNAUDITED)
(Amounts in thousands) Three Months Ended Nine Months Ended
September 30, September 30,
2003 2002 2003 2002
------ ------ ------ ------
Net loss $ (4,244) $(30,240) $(11,678) $(37,982)
Other comprehensive income,
net of tax:
Foreign currency
translation gain 29 71 289 236
------- ------- ------- -------
Comprehensive loss $ (4,215) $(30,169) $(11,389) $(37,746)
======== ======== ======== ========
See notes to condensed consolidated financial statements.
MIKOHN GAMING CORPORATION
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS (Unaudited)
Nine Months Ended
(Amounts in thousands) September 30,
2003 2002
------- -------
Cash flows from operating activities:
Net loss $(11,678) $(37,982)
Adjustments to reconcile net loss to net
cash provided by operating activities:
Depreciation 8,323 6,985
Amortization 2,128 2,648
Provision for (recovery of) bad debts (548) 4,744
Provision for obsolete inventory 424 4,115
Amortization of debt discount and
debt issue costs 1,732 1,656
Impairment loss - 6,261
Discontinued operations - 1,896
Loss on disposition of assets 162 509
Other 93 476
Changes in assets and liabilities:
Accounts and notes receivable 2,476 2,362
Inventories 2,167 991
Other assets 2,416 (1,270)
Trade accounts payable (3,625) (2,741)
Accrued expenses 134 14,233
Other liabilities (2,206) 729
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Net cash provided by operating activities 1,998 5,612
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Cash flows from investing activities:
Purchase of property and equipment (3,983) (3,681)
Cash provided by discontinued operations - 71
Increase in intangible assets (150) (710)
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Net cash used in investing activities (4,133) (4,320)
------- -------
Cash flows from financing activities:
Proceeds from long-term debt - 32
Principal payments on long-term debt (119) (217)
Principal payments on capital leases (1,351) (1,701)
Principal payments on deferred license
fees (361) (325)
Proceeds from notes receivable -
stockholders - 114
Purchase of common stock for treasury - (222)
Issuance of common stock 1,633 654
------- -------
Net cash used in financing activities (198) (1,665)
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Decrease in cash and cash equivalents (2,333) (373)
Cash and cash equivalents,
beginning of period 16,275 15,206
------- -------
Cash and cash equivalents, end of period $ 13,942 $ 14,833
======== ========
(Continued)
MIKOHN GAMING CORPORATION
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS (Unaudited)-(Continued)
Nine Months Ended
(Amounts in thousands) September 30,
2003 2002
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Supplemental disclosure of cash flow information:
Cash paid during the period for:
Interest $ 6,895 $ 7,296
Federal and state income taxes $ 28 $ 55
======== ========
See notes to condensed consolidated financial statements.
MIKOHN GAMING CORPORATION
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Unaudited)
1. GENERAL
These unaudited condensed consolidated financial statements have been
prepared in accordance with accounting principles generally accepted in the
United States of America for interim financial information and with the
instructions to Form 10-Q and Rule 10-01 of Regulation S-X. Accordingly, they
do not include all of the information and notes required by accounting
principles generally accepted in the United States of America for complete
financial statements. Unless indicated otherwise, "Mikohn," the "Company,"
"we," "us" and "our" refer to Mikohn Gaming Corporation. These statements
should be read in conjunction with the audited consolidated financial
statements and notes thereto included in the Company's Annual Report on Form
10-K for the year ended December 31, 2002. In the opinion of the Company, the
accompanying unaudited condensed consolidated financial statements contain all
adjustments (consisting of normal accruals and charges) necessary to present
fairly the financial position of the Company at September 30, 2003, and the
results of its operations for the three and nine months ended September 30,
2003 and 2002 and cash flows for the nine months ended September 30, 2003 and
2002. The results of operations for the three and nine months ended September
30, 2003 are not necessarily indicative of the results to be expected for the
entire year.
Certain items reported in the prior period have been reclassified to follow
the Company's current reporting practice. Additionally, all intercompany
activity has been eliminated.
Amounts disclosed in the accompanying footnote tables are rounded to the
nearest thousand while amounts included in text are disclosed in actual
amounts.
2. SIGNIFICANT ACCOUNTING POLICIES
Estimates. Our consolidated financial statements are prepared in conformity
with accounting principles generally accepted in the United States. Certain of
our accounting policies, including the estimated lives assigned to our assets,
the determination of bad debts, inventory valuation reserves and asset
impairment require that we apply significant judgment in defining the
appropriate assumptions for calculating financial estimates. By their nature,
these judgments are inherently subject to a degree of uncertainty. Our
judgments are based on our historical experience, terms of existing contracts,
our observance of industry trends, information provided by or gathered from our
customers and information available from other outside sources, as appropriate.
There can be no assurance that actual results will not differ from our
estimates.
Revenue Recognition. The Company recognizes revenue depending on the
nature of the transaction as follows:
Product sales are executed by a signed contract or customer purchase order.
Revenue is recognized when the completed product is delivered and, if required,
installed and all elements of the sale have been completed and accepted by the
customer.
System sales consist of a suite of products (some of which are sold
separately) that enable gaming entities to track customer gaming activity,
account for slot machine activity and operate progressive jackpot systems.
There are proprietary hardware and software components to the systems. The
Company accounts for system sales in accordance with Statement of Position 97-2
- - Software Revenue Recognition ("SOP 97-2"). System sales are considered
multiple element arrangements because they include hardware, software,
installation, training and post-sale customer support. System sales are
evidenced by a signed contract. Follow-up spare parts and hardware-only sales
are evidenced by a purchase order. Revenue for system sales is recognized
when: (i) there is a signed contract with a fixed determinable price; (ii)
collectibility of the sale is probable; and (iii) the hardware and software
have been delivered, installed, training has been completed and acceptance has
occurred.
Not all systems contracts require installation. Examples include sales of
hardware only to (i) previous customers that are expanding their systems, (ii)
customers that have multiple locations and install the system themselves and
require an additional software license and hardware and (iii) customers
purchasing spare parts.
Maintenance and support are sold under agreements with established vendor-
specific objective evidence of price. These contracts are generally for a
period of 12 months and revenue is recognized ratably over the contract service
period.
Further training is also sold under agreements with established vendor-
specific objective evidence of price, which is based on daily rates and is
recognized upon delivery.
The leasing of proprietary table games to customers occurs under signed
lease agreements. Table game lease contracts are typically for a 36-month
period with a 30-day cancellation clause. The lease revenue is recognized on a
monthly basis.
The leasing of proprietary slot machines or software licensing rights occurs
under signed lease agreements. These contracts will either be on a revenue
participation or a fixed-rental basis. Slot machine lease contracts are
typically for a month-to-month period with a 30-day cancellation clause. On a
revenue participation basis, the Company earns a share of the revenue that the
casino earns from these slot machines. On a fixed-rental basis, the Company
charges a fixed amount per slot machine per day. Revenues from each type of
lease or license arrangement are recognized on the accrual basis.
Receivables and Allowance for Doubtful Accounts. We regularly evaluate the
collectibility of our trade receivable balances based on a combination of
factors. When a customer's account becomes past due, we initiate dialogue with
the customer to determine the cause. If it is determined that the customer will
be unable to meet its financial obligation to us, such as in the case of a
bankruptcy filing, deterioration in the customer's operating results or
financial position or other material events impacting their business, we record
a specific reserve for bad debt to reduce the related receivable to the amount
we expect to recover given all information presently available. We also record
reserves for bad debt for all other customers based on certain other factors
including the length of time the receivables are past due and historical
collection experience with individual customers. If circumstances related to
specific customers change, our estimates of the recoverability of receivables
could materially change.
Inventory and Obsolescence. We regularly evaluate the realizability of our
inventory based on a combination of factors including the following: historical
usage rates, forecasted sales or usage, estimated service period, product end
of life dates, estimated current and future market values, service inventory
requirements and new product introductions, as well as other factors.
Purchasing requirements and alternative usage avenues are explored within these
processes to mitigate inventory exposure. Raw materials and work in progress
with quantities in excess of forecasted usage are reviewed at least quarterly
by our engineering and operating personnel for obsolescence. Such raw material
and work in progress write-downs are typically caused by engineering change
orders or product end of life adjustments. Finished goods are reviewed at least
quarterly by product marketing and operating personnel to determine if
inventory carrying costs exceed market selling prices. Service inventory is
systematically reserved for based on the estimated remaining service life of
the inventory. We record reserves for inventory based on the above factors and
take into account worldwide quantities and demand in our analysis. If
circumstances related to our inventories change, our estimates of the
realizability of inventory could materially change.
Long-Lived Asset Impairment. Long-lived assets and intangible assets with
determinable lives are reviewed for impairment quarterly or whenever events or
circumstances indicate that the carrying amount of assets may not be
recoverable in accordance with Statement of Financial Accounting Standards
("SFAS") No. 144, "Accounting for the Impairment or Disposal of Long-Lived
Assets." We evaluate recoverability of assets to be held and used by comparing
the carrying amount of an asset to future net undiscounted cash flows to be
generated by the asset. If such assets are considered to be impaired, the
impairment to be recognized is measured as the amount by which the carrying
amount of the assets exceeds the fair value of the assets. Such reviews assess
the fair value of the assets based upon our estimates of the future cash flows
we expected the assets to generate. In response to changes in industry and
market conditions, we may be required to strategically realign our resources in
the future, which could result in an impairment of long-lived assets.
For indefinite-lived assets including perpetual licenses and goodwill, an
independent valuation is performed at least annually to determine if any
impairment has occurred.
Stock-Based Compensation. At September 30, 2003, the Company had one stock-
based employee plan, one director compensation plan and an employee stock
incentive plan. The Company accounts for these plans in accordance with
Accounting Principles Board No. 25, "Accounting For Stock Issued to Employees",
and related interpretations. The following table illustrates the effect on net
income and earnings per share if the Company had applied the fair value
recognition provisions of SFAS No. 123, "Accounting for Stock-Based
Compensation".
Nine Months Ended
(Amounts in thousands, September 30,
except per share amounts) 2003 2002
------ ------
Net loss, as reported $(11,678) $(37,982)
Add back: Reported stock-based compensation
expense 169 668
Deduct: Pro forma stock-based employee
compensation expense determined under fair
value method (720) (748)
------- -------
Pro forma net loss $(12,229) $(38,062)
======== ========
Loss per share:
As reported
Basic and diluted $ (0.90) $ (2.96)
Pro forma
Basic and diluted $ (0.94) $ (2.97)
======== ========
Guarantees. In November 2002, the FASB issued FIN No. 45, ("FIN 45"),
"Guarantor's Accounting and Disclosure Requirements for Guarantees, including
Indirect Guarantees of Indebtedness of Others - an interpretation of FASB
Statements No. 5, 57 and 107 and rescission of FIN 34". The following is a
summary of the agreements that the Company has determined are within the scope
of FIN 45.
Under its bylaws, the Company has agreed to indemnify its officers and
directors for certain events or occurrences arising as a result of the officer
or director's serving in such capacity. The term of the indemnification period
is for the officer's or director's lifetime. The Company has a separate
indemnification agreement with one of its directors that requires it, subject
to certain exceptions, to indemnify him to the fullest extent authorized or
permitted by its bylaws. The maximum potential amount of future payments the
Company could be required to make under these indemnification agreements is
unlimited. However, the Company has a directors and officers liability
insurance policy that limits its exposure and enables it to recover a portion
of any future amounts paid. As a result of its insurance policy coverage, the
Company believes the estimated fair value of these indemnification agreements
is minimal and has no liabilities recorded for these agreements as of September
30, 2003.
The Company enters into indemnification provisions under its agreements
with other companies in its ordinary course of business, typically with
landlords. Under these provisions the Company generally indemnifies the
indemnified party for losses suffered or incurred by the indemnified party as a
result of the Company's activities. These indemnification provisions generally
survive termination of the underlying agreement. The Company has not incurred
material costs to defend lawsuits or settle claims related to these
indemnification agreements. As a result, the Company believes the estimated
fair value of these agreements is minimal. Accordingly, the Company has no
liabilities recorded for these agreements as of September 30, 2003.
Recently issued accounting standards. In May 2003, the Financial Accounting
Standards Board issued Statement of Financial Accounting Standards No. 150,
"Accounting for Certain Financial Instruments with Characteristics of both
Liabilities and Equity" ("SFAS No. 150"). This statement affects the
classification, measurement and disclosure requirements of the following three
types of freestanding financial instruments; 1) mandatory redeemable shares,
which the issuing company is obligated to buy back with cash or other assets;
2) instruments that do or may require the issuer to buy back some of its shares
in exchange for cash or other assets, which includes put options and forward
purchase contracts; and 3) obligations that can be settled with shares, the
monetary value of which is fixed, tied solely or predominately to a variable
such as a market index, or varies inversely with the value of the issuers'
shares. In general, SFAS No. 150 is effective for all financial instruments
entered into or modified after May 31, 2003, and otherwise is effective at the
beginning of the first interim period beginning after June 15, 2003. The
adoption of SFAS No. 150 did not have an impact on the Company's consolidated
financial position or disclosures.
3. INVENTORIES
Inventories at September 30, 2003 and December 31, 2002 consist of the
following:
September 30, December 31,
(Amounts in thousands) 2003 2002
------ ------
Raw materials $ 9,141 $ 9,689
Finished goods 1,636 3,924
Work-in-progress 891 1,037
------- -------
Subtotal 11,668 14,650
Reserve for obsolete inventory (3,607) (4,072)
------- -------
Total $ 8,061 $ 10,578
======== ========
4. GOODWILL AND OTHER INTANGIBLE ASSETS
In accordance with SFAS No. 142, the Company performs an impairment
analysis on all of its long-lived and intangible assets on a quarterly basis.
For indefinite lived assets including perpetual licenses and goodwill, an
independent valuation is performed at least annually, to determine if any
impairment has occurred. An independent valuation test as of September 30,
2002, did not result in any impairment.
The net carrying value of goodwill and other intangible assets as of
September 30, 2003 is comprised of the following:
Net Amount Allocated by Segment
(Amounts in thousands) Gaming Product
Operations Sales Corporate Total
Goodwill $ 2,471 $ 389 $ - $ 2,860
Indefinite life intangible asset
(perpetual license) 50,532 - - 50,532
Definite life intangible assets
(see detail below) 3,286 583 1,661 5,530
------- ------- ------- -------
Total $ 56,289 $ 972 $ 1,661 $ 58,922
======== ======== ======== ========
The net carrying value of goodwill ($2.9 million) as of September 30, 2003
is included in the geographic operations of North America ($2.5 million) and
Australia/Asia ($0.4 million).
Definite life intangible assets as of September 30, 2003, subject to
amortization, are comprised of the following:
(Amounts in thousands) Gross Carrying Accumulated
Amount Amortization Net
Patent / trademark rights $ 10,212 $ (6,589) $ 3,623
Covenants not to compete 9,847 (9,654) 193
Software development costs 2,158 (1,061) 1,097
Proprietary rights / other 1,084 (467) 617
------- ------- -------
Total $ 23,301 $(17,771) $ 5,530
======== ======== ========
Amortization expense for definite life intangible assets was approximately
$1.9 million for the nine months ended September 30, 2003 compared to $2.4
million for the nine months ended September 30, 2002
5. COMMITMENTS AND CONTINGENCIES
The Company is involved in routine litigation, including bankruptcies,
collection efforts, disputes with former employees and other matters in the
ordinary course of its business operations. Management knows of no matter,
pending or threatened, that in its judgment would reasonably be expected to
have a material adverse effect on the Company or its operations.
In March 2002, the Company entered into a contractual commitment to purchase
a minimum of 125 slot machines each calendar quarter beginning July 1, 2002
through June 30, 2003 for a new slot machine introduction. As of September 30,
2003, the Company has not purchased any slot machines under this agreement and
had paid $0.3 million to the supplier to be used as an advance towards future
slot machine purchases or as part of an underordered machine payment. In
October 2003, the Company paid an additional $0.2 million to the supplier and
no longer has an outstanding financial obligation under the terms of the
contractual commitment.
A former supplier to the Company has alleged that the Company has an
outstanding commitment to purchase certain electronic components in the amount
of approximately $0.5 million. The Company does not believe that the amount or
the alleged contractual relationship are valid and does not plan to acquire the
components. The Company has not accrued any amounts related to this matter.
A lease agreement for a building in Las Vegas, NV contains a minimum net
worth requirement stating that if the net worth of the Company falls below a
specified threshold, the Company must provide the landlord with a letter of
credit to secure future rent payments. During the years ended December 31, 2001
and 2002, the Company's minimum net worth did not meet the requirements under
the lease agreement. Because of the minimum net worth shortfall, the Company
paid $0.9 million for a letter of credit to secure future rent payments and
potentially could be obligated to purchase an additional $2.1 million letter of
credit.
6. LOSS PER SHARE
The following table provides a reconciliation of basic and diluted loss
per share:
Dilutive
(Amounts in thousands, Stock
except per share amounts) Basic Options Diluted
------- ------- -------
For the three months ended September 30, 2003:
Net loss $ (4,244) $ - $ (4,244)
Weighted average shares 13,129 13,129
Per share amount $ (0.32) $ - $ (0.32)
======== ======== ========
For the three months ended September 30, 2002:
Net loss $(30,240) $ - $(30,240)
Weighted average shares 12,849 12,849
Per share amount $ (2.35) $ - $ (2.35)
======== ======== ========
For the nine months ended September 30, 2003:
Net loss $(11,678) $ - $(11,678)
Weighted average shares 12,973 12,973
Per share amount $ (0.90) $ - $ (0.90)
======== ======== ========
For the nine months ended September 30, 2002:
Net loss $(37,982) $ - $(37,982)
Weighted average shares 12,817 12,817
Per share amount $ (2.96) $ - $ (2.96)
======== ======== ========
Dilutive stock options of approximately 735,000 and 5,000 for the three
months ended September 30, 2003 and 2002, respectively, have not been included
in the computation of diluted net loss per share as their effect would be
antidilutive. Dilutive stock options of approximately 164,000 and 496,000 for
the nine months ended September 30, 2003 and 2002, respectively, have not been
included in the computation of diluted net loss per share as their effect would
be antidilutive.
7. 2002 RESTRUCTURING PLAN
During the third quarter of 2002, the Company initiated a restructuring plan
for certain of its operations. The restructuring plan was designed to achieve
various objectives, principally related to reducing costs, streamlining
operations and improving financial performance on an ongoing basis. The
Company's Board of Directors approved the plan in August 2002, which was
subsequently acted upon by management during that quarter. The principal
restructuring initiatives included:
- Separation of the Chief Executive Officer, Chief Financial Officer and
certain other executives from the Company and replacement of such
executives
- Elimination of approximately 20% of the Company's permanent work force
- Divestiture of non-core business units and product lines
- Disposition of under-utilized assets
- Consolidation of interior sign production capacity into one facility,
- Streamlining certain of the Company's warehousing and slot route
assembly operations, and
- Outsourcing and streamlining certain of the Company's international
sign operations
As a result of implementing the above initiatives, the Company recorded
certain restructuring expenses, severance expenses, a loss from discontinued
operations and certain other significant operating costs during 2002. The
Company also recorded an impairment loss relating to certain of its indefinite
and definite-lived intangible assets, property and equipment and inventories.
These impairment charges were recorded based on valuation analyses whereby it
was determined that cash flow, earnings and other key operational criteria no
longer supported the carrying values of these assets. In addition, the Company
took a charge to write-down the assets of its exterior sign operations, net of
expected proceeds. The charges totaled $27.4 million.
Restructuring expense. Included in the restructuring expense caption for
2002 is approximately $0.9 million of principally non-officer employee
severance costs for approximately 130 terminated employees related to a
restructuring plan. Excluding the Company's research and development and sales
personnel, all employee groups within the Company were affected by the
terminations. As of September 30, 2003, all severance payments described above
have been made.
Included in restructuring expense for 2002 was a charge of approximately
$3.3 million taken to accrue the present value of long-term building lease
commitments, net of expected sub lease payments, which, in accordance with the
actions taken by the Company, will not be utilized as of specified dates as
certain business operations have been streamlined, consolidated or divested.
The leases are for one building located in Gulfport, Mississippi and for two
buildings located in Las Vegas, Nevada. The building lease in Mississippi has
a term which expires in August 2015, while the two leases in Nevada have terms
expiring in July 2004 and in December 2017. On a quarterly basis through July
2004, the Company plans to remit cash of approximately $0.3 million under the
lease agreements. Subsequent to July 2004, the Company plans to remit cash of
approximately $0.1 million quarterly through December 2017. At September 30,
2003 approximately $2.8 million of this accrual remains. The Company is
subleasing one of the Las Vegas buildings and is currently seeking tenants for
subleasing the other buildings.
Also included in restructuring expenses were write-downs of certain property
and equipment to their net realizable value in relation to the curtailment of
planned business operations with certain assembly facilities and the sale of
certain real estate. Specifically, a charge for approximately $1.5 million was
recorded for various leasehold improvements, machinery and equipment and real
estate. Of the $1.5 million, a building owned by the Company in Las Vegas,
Nevada, was sold for approximately $0.5 million less than its book value of
$2.2 million. The Company realized net cash proceeds of $1.7 million from this
sale in November 2002.
Severance Expense. Severance expense in 2002 consists of charges for the
separation and post-employment agreements of the Company's former CEO, CFO and
another officer. Including severance and other provisions of the agreements,
the total charge was approximately $4.8 million of which $2.0 million was paid
to these individuals during the year ended December 31, 2002. Approximately
$0.6 million of the severance expense was applied by the former CEO and CFO to
repay outstanding loans and advances owed to the Company. In March 2003, the
Company paid its former CEO all remaining amounts owed him totaling $1.4
million in conjunction with his retirement as Chairman of the Board of
Directors. Severance expense totaling approximately $1.8 million has been paid
to these individuals during the nine months ended September 30, 2003. From
October 2003 through August 2006, the Company's is required to pay
approximately $0.2 million annually. At September 30, 2003, approximately $0.4
million remained unpaid.
Impairment Loss. An impairment loss was recorded in 2002 for certain
definite-lived intangible assets. Management ascertained that the actual and
targeted revenues, earnings and cash flows generated from the assets, no longer
supported certain of its definite-lived intangible assets. Based thereon, the
Company recorded approximately $3.9 million in write-downs of these impaired
intangible assets. The write-downs consisted primarily of a license agreement
related to certain table game hardware of approximately $1.0 million, software
costs related to Monopoly(r) table games of approximately $0.6 million,
proprietary rights and software development costs related to our table game
tracking system of approximately $1.5 million and capitalized costs associated
with patents that are no longer deemed useful of approximately $0.7 million.
The Company maintains certain indefinite-lived intangible assets as part of
its consolidated financial statements, principally in a perpetual license
related to its casino table game operations and, to a limited extent, goodwill
related to its slot route operations and international operations. A valuation
test as of January 1, 2002 did not result in any impairment. However, as a
result of the Company's divestiture of its Latin American subsidiary, goodwill
related to the Latin American subsidiary was deemed to have been impaired
during the quarter ended September 30, 2002. Therefore, the Company recorded a
goodwill impairment loss of approximately $0.4 million.
In connection with the restructuring initiatives and a third quarter 2002
valuation review of its long-lived assets, the Company determined that the
assets described below no longer generated sufficient cash flow to support
their carrying value. These assets are comprised of approximately 200 reel-
spinning slot machines and certain non-branded assets including MoneyTime(tm),
a proprietary jackpot system consisting of slot machines, signs, meters and
related electronics. The impairment charge recorded in 2002 related to these
assets totaled approximately $1.7 million. Additionally, the Company decided
to no longer use certain trade show equipment, after returning from its annual
trade show in September 2002, and recorded a charge for approximately $0.2
million in 2002.
8. 2003 SEVERANCE COSTS
Included in severance expense in the Condensed Consolidated Statements of
Operations for the nine months ended September 30, 2003 is approximately $0.6
million of employee severance costs for approximately 80 terminated employees
principally from reductions in service, international and management personnel.
At September 30, 2003, approximately $0.1 million remained unpaid.
9. RELATED PARTY TRANSACTIONS
David J. Thompson announced his resignation as chief executive officer
effective August 16, 2002 and, on March 21, 2003, Mr. Thompson announced his
retirement as chairman of the board of directors. According to the provisions
of Mr. Thompson's chief executive officer severance agreement, the Company
recorded a charge of approximately $3.3 million, of which $1.5 million in cash
payments were made during the year ended December 31, 2002. In addition,
approximately $0.3 million of the chief executive officer severance agreement
was applied by Mr. Thompson to repay outstanding loans and advances owed to the
Company. In March 2003, as part of his retirement package, the Company paid
the remaining amounts owed Mr. Thompson totaling approximately $1.4 million and
agreed to pay certain legal costs incurred by him in the approximate amount of
$0.5 million. These amounts, excluding the legal costs of approximately $0.5
million, are included in the severance expense amounts discussed in Note 7.
10. ACQUISITION/ DIVESTITURE OF SUBSIDIARIES
During the third quarter of 2002, in connection with its restructuring plan,
the Company decided to divest its exterior sign operations in the Product Sales
segment. On October 1, 2002, the Company reached a definitive agreement to sell
the exterior sign operations. The transaction closed on October 31, 2002 for
$1.7 million consisting of cash payments received in September and October 2002
of $0.5 million and $0.7 million, respectively, and a note for $0.5 million
which was paid on December 31, 2002. As a result of the sale, a charge of
approximately $1.1 million related to the impairment of the exterior sign
operations assets, net of the expected proceeds, was recorded as was the loss
from normal operations of the business. The loss from discontinued operations
is shown net of an income tax benefit of 34% applied to the pretax loss from
the discontinued operations. The operating results of this business were
previously included in the "Product Sales" segment and are presently reflected
as Discontinued Operations in the accompanying condensed consolidated
statements of operations.
The operating results of discontinued operations for the three and nine
months ended September 30, 2002 are as follows:
Three Months Ended Nine Months Ended
September 30, September 30,
(Amounts in thousands) 2002 2002
------ ------
Revenues $ 1,246 $ 5,717
Operating costs and expenses 2,623 7,497
------- -------
Operating loss (1,377) (1,780)
Other expense (1) (13)
Loss on sale of operations (1,079) (1,079)
------- -------
Net loss before income taxes (2,457) (2,872)
Income tax benefit 836 976
------- -------
Loss from discontinued operations $ (1,621) $ (1,896)
======== ========
On September 20, 2002 the Company completed the sale of its remaining 50%
interest in its Latin American subsidiary as part of the restructuring
initiatives. The interest was sold for approximately $0.4 million consisting
of a cash payment of $0.1 million and a note for approximately $0.3 million
which was paid in full on November 15, 2002, in accordance with the terms of
the agreement. A charge of approximately $1.8 million was recorded to reflect
the write-off of an intercompany debt from the subsidiary to the Company. As a
result of the Company's divestiture of its Latin American Subsidiary, goodwill
related to the Latin American subsidiary was deemed to have been impaired
during the quarter ended September 30, 2002. Therefore, the Company recorded a
goodwill impairment loss of approximately $0.4 million, which is included in
the impairment loss discussed in Note 7.
11. SEGMENT REPORTING
The Company's worldwide operations are concentrated in two principal
business segments: gaming operations and product sales. The gaming
operations business segment was established in 1993 to develop, acquire,
manufacture and distribute proprietary games, and these games have become
increasingly important to its business. Increased attention has been given
to gaming operations due to the high recurring revenues and profit margin
potential for this business line. Mikohn owns or licenses the rights to
several categories of proprietary games, which it places in casinos under
lease arrangements. These leases either provide for a fixed rental payment
or a participation in the game's operating results. Sales of proprietary
games are reflected in the reported results of the Company's product sales
business segment, while revenues derived from leases are included in the
results of its gaming operations business segment. The Company's product
sales business segment has been providing gaming products and equipment
around the world since 1987. Initially, the Company sold progressive
jackpot systems and then expanded to manufacturing signs, jackpot meters,
and related products. The Company's gaming products are found in almost
every major gaming jurisdiction and include: (i) interior casino signage
and electronic components used in progressive jackpot systems, (ii) player
tracking and accounting systems and (iii) gaming machines.
Business segment information for the three and nine months ended
September 30, 2003 and 2002 consists of:
Three Months Ended Nine Months Ended
(Amounts in thousands) September 30, September 30,
Business Unit Segments 2003 2002 2003 2002
------ ------ ------ ------
Revenues:
Gaming operations
Slot operations $ 4,734 $ 7,161 $ 16,396 $ 20,813
Table games 3,467 4,004 11,115 12,487
------- ------- ------- -------
8,201 11,165 27,511 33,300
------- ------- ------- -------
Product sales:
Signage and electronic
components 8,369 16,264 29,016 34,877
Player tracking and systems 3,782 1,715 9,516 5,293
Gaming machines 254 490 755 2,005
------- ------- ------- -------
12,405 18,469 39,287 42,175
------- ------- ------- -------
Total $ 20,606 $ 29,634 $ 66,798 $ 75,475
======== ======== ======== ========
Operating income (loss):
Gaming operations $ 11 $ (526) $ 2,625 $ 5,219
Product sales 1,806 (2,705) 6,261 (1,798)
Corporate (2,229) (3,858) (8,528) (9,790)
Restructuring expense - (5,618) - (5,618)
Severance expense - (4,774) (575) (4,774)
Impairment loss - (6,261) - (6,261)
------- ------- ------- -------
Total $ (412) $(23,742) $ (217) $(23,022)
======== ======== ======== ========
Depreciation and amortization:
Gaming operations $ 2,788 $ 2,225 $ 7,687 $ 6,241
Product sales 229 166 675 753
Corporate 702 999 2,089 2,639
------- ------- ------- -------
Total $ 3,719 $ 3,390 $ 10,451 $ 9,633
======== ======== ======== ========
September 30, December 31,
2003 2002
------ ------
Total assets:
Gaming operations $ 78,849 $ 85,572
Product sales 19,315 25,777
Corporate 27,388 30,644
------- -------
Total $125,552 $141,993
======== ========
The Company attributes revenue and expenses to a geographic area based
on the location from which the product was shipped or the service was
performed. Geographic segment information for the three and nine months
ended September 30, 2003 and 2002 consist of:
Three Months Ended Nine Months Ended
(Amounts in thousands) September 30, September 30,
Geographic Operations 2003 2002 2003 2002
------ ------ ------ ------
Revenues:
North America $ 16,830 $ 24,190 $ 55,289 $ 63,149
Australia / Asia 2,033 3,001 3,906 6,129
Europe / Africa 1,743 2,443 7,603 6,213
South America - - - (16)
------- ------- ------- -------
Total $ 20,606 $ 29,634 $ 66,798 $ 75,475
======== ======== ======== ========
Operating income (loss):
North America $ (1,105) $ (6,725) $ (528) $ (5,660)
Australia / Asia 379 (29) (377) (264)
Europe / Africa 314 (335) 1,263 (429)
South America - - - (16)
Restructuring expense - (5,618) - (5,618)
Severance expense - (4,774) (575) (4,774)
Impairment loss - (6,261) - (6,261)
------- ------- ------- -------
Total $ (412) $(23,742) $ (217) $(23,022)
======== ======== ======== ========
Depreciation and amortization
North America $ 3,672 $ 3,368 $ 10,324 $ 9,530
Australia / Asia 17 - 37 43
Europe / Africa 30 22 90 59
South America - - - -
------- ------- ------- -------
Total $ 3,719 $ 3,390 $ 10,451 $ 9,632
======== ======== ======== ========
September 30, December 31,
2003 2002
------ ------
Total assets:
North America $117,641 $133,576
Australia / Asia 3,792 4,377
Europe / Africa 4,119 4,040
South America - -
------- -------
Total $125,552 $141,993
======== ========
12. GUARANTOR FINANCIAL STATEMENTS
The Company's domestic subsidiaries are 100% owned and have provided full
and unconditional guarantees on a joint and several basis on the payment of
the Company's 11.875% Senior Secured Notes due 2008. The financial statements
for the guarantor subsidiaries follow:
CONDENSED CONSOLIDATING BALANCE SHEETS (Unaudited)
(Amounts in thousands) September 30, 2003
Non-
Guarantor Guarantor Elim-
Parent Subsidiaries Subsidiaries inations Consolidated
------ -------- -------- -------- ----------
ASSETS
Current Assets:
Cash $ 11,666 $ 2 $ 2,274 $ - $ 13,942
Accounts and notes
receivable, net 5,907 4,768 2,497 - 13,172
Inventories, net 3,841 2,209 2,011 - 8,061
Other current assets 2,065 2,908 183 - 5,156
------- ------- ------- ------- -------
Total current assets 23,479 9,887 6,965 - 40,331
Property and equipment, net 6,465 10,563 556 - 17,584
Intangible assets, net 53,177 5,355 390 - 58,922
Investments in subsidiaries 7,923 - - (7,923) -
Other assets 7,435 1,280 - - 8,715
------- ------- ------- ------- -------
Total assets $ 98,479 $ 27,085 $ 7,911 $ (7,923) $125,552
======== ======== ======== ======== ========
LIABILITIES AND STOCKHOLDERS'
EQUITY (DEFICIT)
Current liabilities $ 16,815 $ 2,509 $ 2,250 $ - $ 21,574
Intercompany transactions (20,104) 15,089 5,015 - -
------- ------- ------- ------- -------
Total current liabilities (3,289) 17,598 7,265 - 21,574
Long-term debt, net 101,216 110 74 - 101,400
Other liabilities, long term 2,950 13 - - 2,963
Deferred tax liability 14,101 2,013 - - 16,114
Stockholders' equity (deficit) (16,499) 7,351 572 (7,923) (16,499)
------- ------- ------- ------- -------
Total liabilities and stock-
holders' equity (deficit) $ 98,479 $ 27,085 $ 7,911 $ (7,923) $125,552
======== ======== ======== ======== ========
CONDENSED CONSOLIDATING BALANCE SHEETS
(Amounts in thousands) December 31, 2002
Non-
Guarantor Guarantor Elim-
Parent Subsidiaries Subsidiaries inations Consolidated
------ -------- -------- -------- ----------
ASSETS
Current Assets:
Cash $ 14,444 $ (14) $ 1,845 $ - $ 16,275
Accounts receivable, net 7,414 4,280 3,105 - 14,799
Inventories, net 5,311 2,903 2,364 - 10,578
Other current assets 1,935 5,142 299 - 7,376
------- ------- ------- ------- -------
Total current assets 29,104 12,311 7,613 - 49,028
Property and equipment, net 7,086 14,307 431 - 21,824
Intangible assets, net 54,939 5,370 389 - 60,698
Investments in subsidiaries 6,128 - - (6,128) -
Other assets 8,898 1,545 - - 10,443
------- ------- ------- ------- -------
Total assets $106,155 $ 33,533 $ 8,433 $ (6,128) $141,993
======== ======== ======== ======== ========
LIABILITIES AND STOCKHOLDERS'
EQUITY (DEFICIT)
Current liabilities $ 18,207 $ 4,367 $ 4,465 $ - $ 27,039
Inter-company transactions (24,174) 19,790 4,384 - -
------- ------- ------- ------- -------
Total current liabilities (5,967) 24,157 8,849 - 27,039
Long-term debt, net 100,694 580 56 - 101,330
Other liabilities, long term 4,239 183 - - 4,422
Deferred tax liability 14,101 2,013 - - 16,114
Stockholders' equity (deficit) (6,912) 6,600 (472) (6,128) (6,912)
------- ------- ------- ------- -------
Total liabilities and stock-
holders' equity (deficit) $106,155 $ 33,533 $ 8,433 $ (6,128) $141,993
======== ======== ======== ======== ========
CONDENSED CONSOLIDATING STATEMENTS OF OPERATIONS (Unaudited)
(Amounts in thousands) Three Months Ended September 30, 2003
Non-
Guarantor Guarantor Elim-
Parent Subsidiaries Subsidiaries inations Consolidated
------ -------- -------- -------- ----------
Revenues $ 11,751 $ 5,401 $ 3,777 $ (323) $ 20,606
Cost of sales 5,379 1,788 2,287 (323) 9,131
Selling, general and
admin expenses 5,350 5,741 796 - 11,887
------- ------- ------- ------- -------
Operating income (loss) 1,022 (2,128) 694 - (412)
Equity in earnings of
subsidiaries (1,518) - - 1,518 -
Interest expense (3,749) (26) (63) - (3,838)
Other income 4 2 3 - 9
------- ------- ------- ------- -------
Income (loss) before income
tax provision (4,241) (2,152) 634 1,518 (4,241)
Income tax provision (3) - - - (3)
------- ------- ------- ------- -------
Net income (loss) $ (4,244) $ (2,152) $ 634 $ 1,518 $ (4,244)
======== ======== ======== ======== ========
CONDENSED CONSOLIDATING STATEMENTS OF OPERATIONS (Unaudited)
(Amounts in thousands) Three Months Ended September 30, 2002
Non-
Guarantor Guarantor Elim-
Parent Subsidiaries Subsidiaries inations Consolidated
------ -------- -------- -------- ----------
Revenues $ 18,465 $ 9,279 $ 5,443 $ (3,553) $ 29,634
Cost of sales 11,634 5,260 4,866 (2,435) 19,325
Selling, general and
admin expenses 12,293 4,163 942 - 17,398
Restructuring expense 3,476 1,857 285 - 5,618
Severance expense 4,774 - - - 4,774
Impairment loss 4,521 1,740 - - 6,261
------- ------- ------- ------- -------
Operating loss (18,233) (3,741) (650) (1,118) (23,742)
Equity in earnings of
subsidiaries (5,804) - - 5,804 -
Interest expense (3,816) (63) (98) - (3,977)
Other income and (expense) (1,676) 1,635 77 - 36
------- ------- ------- ------- -------
Income (loss) from continuing
operations before income tax
provision (29,529) (2,169) (671) 4,686 (27,683)
Income tax provision (711) (225) - - (936)
------- ------- ------- ------- -------
Income (loss) from continuing
operations (30,240) (2,394) (671) 4,686 (28,619)
Loss from discontinued
operations, net of tax benefit - (1,621) - - (1,621)
------- ------- ------- ------- -------
Net income (loss) $(30,240) $ (4,015) $ (671) $ 4,686 $(30,240)
======== ======== ======== ======== ========
CONDENSED CONSOLIDATING STATEMENTS OF OPERATIONS (Unaudited)
(Amounts in thousands) Nine Months Ended September 30, 2003
Non-
Guarantor Guarantor Elim-
Parent Subsidiaries Subsidiaries inations Consolidated
------ -------- -------- -------- ----------
Revenues $ 37,488 $ 19,095 $ 11,510 $ (1,295) $ 66,798
Cost of sales 16,775 7,117 7,384 (1,295) 29,981
Selling, general and
admin expenses 17,321 15,898 3,240 - 36,459
Severance expense 425 58 92 - 575
------- ------- ------- ------- -------
Operating income (loss) 2,967 (3,978) 794 - (217)
Equity in earnings of
subsidiaries (3,347) - - 3,347 -
Interest expense (11,281) (111) (184) - (11,576)
Other income and (expense) (8) (6) 138 - 124
------- ------- ------- ------- -------
Income (loss) before income
tax provision (11,669) (4,095) 748 3,347 (11,669)
Income tax provision (9) - - - (9)
------- ------- ------- ------- -------
Net income (loss) $(11,678) $ (4,095) $ 748 $ 3,347 $(11,678)
======== ======== ======== ======== ========
CONDENSED CONSOLIDATING STATEMENTS OF OPERATIONS (Unaudited)
(Amounts in thousands) Nine Months Ended September 30, 2002
Non-
Guarantor Guarantor Elim-
Parent Subsidiaries Subsidiaries inations Consolidated
------ -------- -------- -------- ----------
Revenues $ 44,046 $ 27,622 $ 12,326 $ (8,519) $ 75,475
Cost of sales 23,348 12,789 9,720 (6,060) 39,797
Selling, general and
admin expenses 25,572 13,161 3,314 - 42,047
Restructuring expense 3,476 1,857 285 - 5,618
Severance expense 4,774 - - - 4,774
Impairment loss 4,521 1,740 - - 6,261
------- ------- ------- ------- -------
Operating loss (17,645) (1,925) (993) (2,459) (23,022)
Equity in earnings of
subsidiaries (6,723) - - 6,723 -
Interest expense (11,262) (226) (300) - (11,788)
Other income and (expense) (1,677) 1,509 318 - 150
------- ------- ------- ------- -------
Income (loss) from continuing
operations before income tax
provision (37,307) (642) (975) 4,264 (34,660)
Income tax provision (675) (751) - - (1,426)
------- ------- ------- ------- -------
Income (loss) from continuing
operations (37,982) (1,393) (975) 4,264 (36,086)
Loss from discontinued
operations, net of tax benefit - (1,896) - - (1,896)
------- ------- ------- ------- -------
Net income (loss) $(37,982) $ (3,289) $ (975) $ 4,264 $(37,982)
======== ======== ======== ======== ========
CONDENSED CONSOLIDATING CASH FLOW STATEMENTS (Unaudited)
(Amounts in thousands) Nine Months Ended September 30, 2003
Non-
Guarantor Guarantor Elim-
Parent Subsidiaries Subsidiaries inations Consolidated
------ -------- -------- -------- ----------
Net cash provided by (used in)
operating activities $ (2,558) $ 3,875 $ 681 $ - $ 1,998
------- ------- ------- ------- -------
Cash flows from investing
activities:
Purchase of property and
equipment (1,009) (2,746) (228) - (3,983)
Other investing activities (150) - - - (150)
------- ------- ------- ------- -------
Net cash used in investing
activities (1,159) (2,746) (228) - (4,133)
------- ------- ------- ------- -------
Cash flows from financing
activities:
Principal payments on long-
term debt and capital leases (333) (1,113) (24) - (1,470)
Principal payments of deferred
license fees (361) - - - (361)
Issuance of common stock 1,633 - - - 1,633
------- ------- ------- ------- -------
Net cash provided by (used in)
financing activities 939 (1,113) (24) - (198)
------- ------- ------- ------- -------
Increase (decrease) in cash and
cash equivalents (2,778) 16 429 - (2,333)
Cash and cash equivalents,
beginning of period 14,444 (14) 1,845 - 16,275
------- ------- ------- ------- -------
Cash and cash equivalents,
end of period $ 11,666 $ 2 $ 2,274 $ - $ 13,942
======== ======== ======== ======== ========
CONDENSED CONSOLIDATING CASH FLOW STATEMENTS (Unaudited)
(Amounts in thousands) Nine Months Ended September 30, 2003
Non-
Guarantor Guarantor Elim-
Parent Subsidiaries Subsidiaries inations Consolidated
------ -------- -------- -------- ----------
Net cash provided by operating
activities $ 1,381 $ 3,764 $ 467 $ - $ 5,612
------- ------- ------- ------- -------
Cash flows from investing
activities:
Purchase of property and
equipment (717) (2,769) (195) - (3,681)
Cash provided by discontinued
operations - 71 - - 71
Other investing activities (710) - - - (710)
------- ------- ------- ------- -------
Net used in investing activities (1,427) (2,698) (195) - (4,320)
------- ------- ------- ------- -------
Cash flows from financing
activities:
Proceeds from long-term debt - - 32 - 32
Principal payments on long-
term debt and capital leases (766) (1,084) (68) - (1,918)
Principal payments of deferred
license fees (325) - - - (325)
Proceeds from issuance of common
stock and warrants 654 - - - 654
Proceeds from notes receivable-
stockholders 114 - - - 114
Purchase of common stock for
treasury (222) - - - (222)
------- ------- ------- ------- -------
Net cash used in financing
activities (545) (1,084) (36) - (1,665)
------- ------- ------- ------- -------
Increase (decrease) in cash and
cash equivalents (591) (18) 236 - (373)
Cash and cash equivalents,
beginning of period 14,354 (185) 1,037 - 15,206
------- ------- ------- ------- -------
Cash and cash equivalents,
end of period $ 13,763 $ (203) $ 1,273 $ - $ 14,833
======== ======== ======== ======== ========
13. LONG-LIVED ASSETS
The Company amended its service agreement with Aristocrat Technologies, Inc.
("ATI") in January 2003 to allow ATI to provide slot machines for the Company's
slot route. The agreement contemplated the replacement of the Company's
operating slot machines with ATI's slot machines over 18 to 24 months beginning
March 2003. As a result of this amendment to the ATI agreement, the Company
determined that the estimated remaining useful life of its slot machines has
been reduced to 24 months. Consequently, the Company has accelerated the
depreciation of these slot machines resulting in additional depreciation
expense of approximately $0.5 million and $1.5 million for the three and nine
months ended September 30, 2003, respectively, and an estimated additional
expense of $2.0 million for the years ended December 31, 2003 and December 31,
2004. In June 2003, the Company and ATI terminated its agreement. The Company
will continue to depreciate its slot machines based on the current estimated
useful lives of the equipment and in accordance with its desire to pursue
similar agreements to utilize other manufacturers' slot machines on a going-
forward basis.
14. EMPLOYEE STOCK INCENTIVE PLAN
In May 2003, the Company's shareholders approved the Employee Stock
Incentive Plan, which provides for the issuance of up to 500,000 shares of
common stock to Company employees through grants. All grants will include
conditions on vesting and all shares subject to a grant will be forfeited
unless the conditions, which include stock price targets, are met within the
term of the grant, which in no case shall exceed a period of ten years. During
the second quarter of 2003, the Company issued approximately 225,000 restricted
shares to certain employees.
15. LONG-TERM DEBT
In February 2002, the Company completed the acquisition of a $17.5 million
working capital revolving line of credit facility (the "Facility") with
Foothill Capital Corporation ("Foothill"). As of September 30, 2003, the
Company had not drawn on this Facility but was not in compliance with its
covenant to maintain EBITDA of $20.0 million for the twelve months ended
September 30, 2003. Foothill intends to issue the Company a limited one-time
waiver of the covenant default for the period ended September 30, 2003.
Foothill intends plans to amend the terms of the Facility whereby the Company's
EBITDA covenant would be adjusted to approximately $14.0 million to $16.0
million over the next four calendar quarters.
16. SUBSEQUENT EVENT
On October 22, 2003, the Company announced that it has completed its
previously announced sale of 8.4 million shares of its Common Stock at a
price of $5.34 per share and warrants to acquire an additional 2.1 million
shares at an exercise price of $5.875 per share. Proceeds from the
transaction were used to repurchase and retire $40.0 million of the Company's
11.875% Senior Secured Notes ("Notes") due August 2008. As a result of this
transaction, the Company's annual cash interest payments will decrease by
approximately $4.8 million resulting in a revised cash interest payment of
approximately $7.7 million per year.
As a result of the above transaction, the Company will take a charge in
the fourth quarter of 2003 of approximately $1.6 million for the premium paid
on the repurchase of the Notes. In addition, non-cash charges will be taken
to write-off approximately $2.0 million and approximately $1.6 million of the
portions of unamortized bond issue costs and unamortized bond discount,
respectively, related to the $40.0 million of Notes repurchased. Additionally,
as a consequence of the transaction, the Company's usage of its existing net
operating losses ("NOL") will be limited to approximately $3.8 million
annually over the next several years. Unused amounts of the $3.8 million of
the annual NOL may be carried-forward to subsequent years.
MIKOHN GAMING CORPORATION
Item 2. - MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
CAUTIONARY NOTICE
This report contains forward-looking statements in which management shares
its knowledge and judgment about factors that it believes may materially
affect Company performance in the future. Terms expressing future
expectations, enthusiasm or caution about future potential and anticipated
growth in sales, revenues and earnings and like expressions typically
identify such statements.
All forward-looking statements, although we believe to be reasonable and
made in good faith, are subject to the uncertainties inherent in predicting
the future including the successful completion of the restructuring
transactions, overall industry environment, customer acceptance of the
Company's new products, delay in the introduction of new products, the
further approvals of regulatory authorities, adverse court rulings,
production and/or quality control problems, the denial, suspension or
revocation of privileged operating licenses by governmental authorities,
competitive pressures and general economic conditions as well as the
Company's, and debt service obligations.
Forward-looking statements speak only as of the date they are made.
Readers are warned that we undertake no obligation to update or revise such
statements to reflect new circumstances or unanticipated events as they
occur, and are urged to review and consider disclosures we make in this and
other reports that discuss factors germane to our business. See particularly
our reports on Forms 10-K, 10-K/A, 10-Q, 10-Q/A and 8-K filed from time to
time with the Securities and Exchange Commission.
GENERAL INFORMATION
Amounts disclosed in the accompanying tables are rounded to the nearest
thousand while amounts included in text are disclosed in actual amounts. All
percentages reported are based on those rounded numbers.
ACQUISITION / DIVESTITURE OF SUBSIDIARIES
During the third quarter of 2002, in connection with its restructuring
plan, the Company decided to divest its exterior sign operations in the
Product Sales segment. On October 1, 2002, the Company reached a definitive
agreement to sell the exterior sign operations. The transaction closed on
October 31, 2002 for $1.7 million consisting of cash payments received in
September and October 2002 of $0.5 million and $0.7 million, respectively,
and a note for $0.5 million which was paid on December 31, 2002. As a result
of the sale, a charge of approximately $1.1 million related to the impairment
of the exterior sign operations assets, net of the expected proceeds, was
recorded as was the loss from normal operations of the business. The loss
from discontinued operations is shown net of an income tax benefit of 34%
applied to the pretax loss from the discontinued operations. The operating
results of this business were previously included in the Product Sales
segment and are presently reflected as Discontinued Operations in the
accompanying condensed consolidated statements of operations.
On September 20, 2002 the Company completed the sale of our remaining 50%
interest in its Latin American subsidiary as part of the restructuring
initiatives. The interest was sold for approximately $0.4 million consisting
of a cash payment of $0.1 million and a note for approximately $0.3 million
which was paid in full on November 15, 2002, in accordance with the terms of
the agreement. A charge of approximately $1.8 million was recorded to reflect
the forgiveness of an intercompany debt from the subsidiary to the Company.
As a result of the Company's divestiture of its Latin American Subsidiary,
goodwill related to the Latin American subsidiary was deemed to have been
impaired during the quarter ended September 30, 2002. Therefore, the Company
recorded a goodwill impairment loss of approximately $0.4 million.
RELATED PARTY TRANSACTIONS
David J. Thompson announced his resignation as chief executive officer
effective August 16, 2002 and, on March 21, 2003, Mr. Thompson announced his
retirement as chairman of the board of directors. According to the provisions
of Mr. Thompson's chief executive officer severance agreement, the Company
recorded a charge of approximately $3.3 million, of which $1.5 million in
cash payments were made during the year ended December 31, 2002. In
addition, approximately $0.3 million of the chief executive officer severance
agreement was applied by Mr. Thompson to repay outstanding loans and advances
owed to the Company. In March 2003, as part of his retirement package, the
Company paid the remaining amounts owed Mr. Thompson totaling approximately
$1.4 million and agreed to pay certain legal costs incurred by him in the
approximate amount of $0.5 million. These amounts, excluding the legal costs
of approximately $0.5 million, are included in the severance expense amounts
discussed in the "2002 Restructuring Plan" subsection below.
2002 RESTRUCTURING PLAN
During the third quarter of 2002, the Company initiated a restructuring
plan for certain of its operations. The restructuring plan was designed to
achieve various objectives, principally related to reducing costs,
streamlining operations and improving financial performance on an ongoing
basis. The Company's Board of Directors approved the plan in August 2002,
which was subsequently acted upon by management during that quarter. The
principal restructuring initiatives included:
- Separation of the Chief Executive Officer, Chief Financial Officer
and certain other executives from the Company and replacement of
such executives
- Elimination of approximately 20% of the Company's permanent work
force
- Divestiture of non-core business units and product lines
- Disposition of under-utilized assets
- Consolidation of interior sign production capacity into one
facility, and
- Streamlining certain of the Company's warehousing and slot route
assembly operations
- Outsourcing and streamlining certain of the Company's international
sign operations
As a result of implementing the above initiatives, the Company recorded
certain restructuring expenses, severance expenses, a loss from discontinued
operations and certain other significant operating costs during 2002. The
Company also recorded an impairment loss relating to certain of its
indefinite and definite-lived intangible assets, property and equipment and
inventories. These impairment charges were recorded based on valuation
analyses whereby it was determined that cash flow, earnings and other key
operational criteria no longer supported the carrying values of these assets.
In addition, the Company took a charge to write-down the assets of its
exterior sign operations, net of expected proceeds. The charges totaled $27.4
million.
Restructuring expense. Included in the restructuring expense caption for
2002 is approximately $0.9 million of principally non-officer employee
severance costs for approximately 130 terminated employees related to a
restructuring plan. Excluding the Company's research and development and
sales personnel, all employee groups within the Company were affected by the
terminations.
Included in restructuring expense for 2002 was a charge of approximately
$3.3 million taken to accrue the present value of long-term building lease
commitments, net of expected sub lease payments, which, in, accordance with
the actions taken by the Company, will not be utilized as of specified dates
as certain business operations have been streamlined, consolidated or
divested. The leases are for one building located in Gulfport, Mississippi
and for two buildings located in Las Vegas, Nevada. The building lease in
Mississippi has a term which expires in August 2015, while the two leases in
Nevada have terms expiring in July 2004 and in December 2017. On a quarterly
basis through July 2004, the Company plans to remit cash of approximately
$0.3 million under the lease agreements. Subsequent to July 2004, the
Company plans to remit cash of approximately $0.1 million quarterly through
December 2017. The Company is subleasing one of the Las Vegas buildings and
is currently seeking tenants for subleasing the other buildings.
Also included in restructuring expenses were write-downs of certain
property and equipment to their net realizable value in relation to the
curtailment of planned business operations with certain assembly facilities
and the sale of certain real estate. Specifically, a charge for approximately
$1.5 million was recorded for various leasehold improvements, machinery and
equipment and real estate. Of the $1.5 million, a building owned by the
Company in Las Vegas, Nevada, was sold for approximately $0.5 million less
than its book value of $2.2 million. The Company realized net cash proceeds
of $1.7 million from this sale in November 2002.
The restructuring expense is not included in the calculation of operating
income in the tables below.
Severance Expense. Severance expense in 2002 consists of charges for the
separation and post-employment agreements of the Company's former CEO, CFO
and another officer. Including severance and other provisions of the
agreements, the total charge was approximately $4.8 million of which $2.0
million was paid to these individuals during the year ended December 31,
2002. Approximately $0.6 million of the severance expense was applied by the
former CEO and CFO to repay outstanding loans and advances owed to the
Company. In March 2003, the Company paid its former CEO all remaining amounts
owed him totaling $1.4 million in conjunction with his retirement as Chairman
of the Board of Directors. Severance expense totaling approximately $1.8
million has been paid to these individuals during the nine months ended
September 30, 2003. From October 2003 through August 2006, the Company's is
required to pay approximately $0.2 million annually.
The severance expense is not included in the calculation of operating
income in the tables below.
Impairment Loss. An impairment loss was recorded in 2002 for certain
definite-lived intangible assets. Management ascertained that the actual and
targeted revenues, earnings and cash flows generated from the assets, no
longer supported certain of its definite-lived intangible assets. Based
thereon, the Company recorded approximately $3.9 million in write-downs of
these impaired intangible assets. The write-downs consisted primarily of a
license agreement related to certain table game hardware of approximately
$1.0 million, software costs related to Monopoly(r) table games of
approximately $0.6 million, proprietary rights and software development costs
related to our table game tracking system of approximately $1.5 million and
capitalized costs associated with patents that are no longer deemed useful of
approximately $0.7 million.
The Company maintains certain indefinite-lived intangible assets as part
of its consolidated financial statements, principally in a perpetual license
related to its casino table game operations and, to a limited extent,
goodwill related to its slot route operations and international operations.
A valuation test as of January 1, 2002 did not result in any impairment.
However, as a result of the Company's divestiture of its Latin American
subsidiary, goodwill related to the Latin American subsidiary was deemed to
have been impaired during the quarter ended September 30, 2002. Therefore,
the Company recorded a goodwill impairment loss of approximately $0.4
million.
In connection with the restructuring initiatives and a third quarter 2002
valuation review of its long-lived assets, the Company determined that the
assets described below no longer generated sufficient cash flow to support
their carrying value. These assets are comprised of approximately 200 reel-
spinning slot machines and certain non-branded assets including MoneyTime(tm),
a proprietary jackpot system consisting of slot machines, signs, meters and
related electronics. The impairment charge recorded in the 2002 related to
these assets totaled approximately $1.7 million. Additionally, the Company
decided to no longer use certain trade show equipment, after returning from
its annual trade show in September 2002, and recorded a charge of
approximately $0.2 million in 2002.
The impairment loss is not included in the calculation of operating income
in the tables below.
Operating Costs and Expenses. The Company recorded various charges
totaling approximately $4.0 million for inventory write-downs and
approximately $4.3 million principally for provisions for doubtful
receivables during 2002. These charges are included under the caption
"Operating Costs and Expenses" in the consolidated statements of operations.
Certain inventories were deemed obsolete during 2002 as the Company, in
accordance with its restructuring plan, entered into arrangements to
outsource certain international sign assembly operations and to discontinue
the pursuit of certain European system sales related to the tracking of
arcade devices. These charges amounted to approximately $1.0 million.
Additionally, the Company wrote down slow moving inventories for specialized
electronic meters, slot machines and finished signs in the amount of
approximately $3.0 million as targeted sales levels were not achieved.
On September 20, 2002, the Company completed the sale of its 50% interest
in its Latin American subsidiary as part of the restructuring initiatives. A
charge of approximately $1.8 million was recorded to reflect the forgiveness
of an intercompany debt from the subsidiary to the Company.
Also during 2002, the Company recorded additional provisions for doubtful
accounts totaling $2.5 million which includes $1.5 million to reserve a loan
made to a company which in turn granted the Company an exclusive license to
manufacture and distribute its video poker games. Based on the debtor's
financial condition and uncertainties surrounding the future business plan
related to the proprietary games, a reserve was recorded. Various other
uncertainties with other debtors caused the Company to record an additional
$1.0 million of doubtful account provisions.
2003 SEVERANCE EXPENSE
Included in the severance expense caption in the Consolidated Statements
of Operations for the nine months ended September 30, 2003, is approximately
$0.6 million of employee severance costs for approximately 80 terminated
employees principally from reductions in service, international and
management personnel.
The severance expense is not included in the calculation of operating
income in the tables below.
RESULTS OF OPERATIONS
Three Months Ended September 30, 2003 and 2002
REVENUES
(Amounts in thousands) Change
Business Segment 2003 2002 Amount % Comment
- ------------------ ------ ------ ------- ------ -------
Gaming operations $ 8,201 $ 11,165 $ (2,964) (26.5)% 1
Product sales 12,405 18,469 (6,064) (32.8)% 2
------- ------- -------
Total $ 20,606 $ 29,634 $ (9,028) (30.5)%
======== ======== ========
Percentage of total revenues:
Gaming operations 39.8% 37.7%
Product sales 60.2% 62.3%
----- -----
Total 100.0% 100.0%
===== =====
1. Gaming operations revenues during the three months ended September 30,
2003 were approximately $8.2 million, a decrease of approximately $3.0
million from revenues of approximately $11.2 million during the three
months ended September 30, 2002. This net decrease resulted from:
(i) a decrease in recurring revenues from leased slot machines of
approximately $2.5 million, from approximately $7.2 million in the
prior year quarter, to approximately $4.7 million in the current
quarter. This decline was attributable to a decrease in the average
number of branded slot machines leased to customers from
approximately 2,350 in the three months ended September 30, 2002, to
approximately 1,880 for the three months ended September 30, 2003.
Management believes that increased competition with other suppliers
for limited casino floor space contributed to this decline.
Additionally, a reduction in the average net win per day per branded
slot machine, from approximately $29.40 in the prior year quarter to
approximately $22.10 in the current year quarter, contributed to
this decline. Management believes delays in offering technological
specifications offered by competitors, such as ticket-in, ticket-out
and multi-denominational pay tables on its slot machines
significantly contributed to the decline in leased slot machines in
casinos and win per day. The Company presently provides these
technological specifications in several markets and regulatory
approvals are in process for remaining markets. Revenue from non-
branded slot machines decreased from approximately $0.8 million for
the three months ended September 30, 2002 to approximately $0.3
million for the three months ended September 30, 2003. This decrease
was due primarily to a decrease in average machines outstanding from
approximately 350 in the prior year quarter to approximately 190 for
the current year quarter. The average win per day for non-branded
machines decreased from approximately $23.20 in the prior year
quarter to approximately $19.60 in the current year quarter.
Additionally, the Company received approximately $0.4 million in the
2003 quarter from its participation in an average of approximately
300 licensed games for which the Company does not provide hardware
for the games compared to revenues of less than $0.1 million and an
average of 131 games in the 2002 quarter. The Company intends to
continue its pursuit of revenue leasing arrangements whereby the
Company would supply the software component to a third party which
would use hardware not otherwise owned or leased by the Company.
These games earned the Company approximately $14.00 per day in the
current quarter compared to approximately $4.50 per day in the prior
year quarter. Also during the quarter ended September 30, 2003, the
Company sold 100 software licenses of certain proprietary game
content to a customer for approximately $0.2 million, net of
royalties. At September 30, 2003, the Company maintained 1,760,
122 and 303 of branded, non-branded and licensed games without
hardware, respectively. At September 30, 2002, the Company
maintained 2,371, 376 and 204 of branded, non-branded and licensed
games without hardware, respectively, and
(ii) a decrease of approximately $0.5 million in table games revenues.
The decrease in revenues in the quarter ended September 30, 2003 was
caused primarily by a decline in the number of outstanding tables
and in the average monthly lease revenue in domestic markets offset,
in part, by an increase in table game revenues from the Company's
European subsidiary. For the quarter ended September 30, 2003,
revenues from leased casino table games were approximately $3.5
million compared with approximately $4.0 million in the quarter
ended September 30, 2002. The decrease was due primarily to a
decrease in the average number of leased casino table games from
approximately 1,070 during the quarter ended September 30, 2002 to
approximately 990 during the quarter ended September 30, 2003.
Management believes that the industry trend to reduce the number of
table games in casinos in the last several years in favor of slot
machines, as well as increased competition from competitors selling
"felt only" table games, have contributed to the decline in the
Company's table game placements. The average monthly lease charge
for table games was approximately $1,160 and $1,250 for the three
months ending September 30, 2003 and 2002, respectively. The monthly
lease revenue includes royalties and commencement fees paid during
the respective quarters. The decrease in the average monthly lease
charge in the current quarter was due primarily to competitive
pricing adjustments, principally within the Company's domestic
markets. The Company maintained 1,002 and 1,061 table games at
September 30, 2003 and 2002, respectively.
2. Product sales revenues during the three months ended September 30, 2003
were $12.4 million, a decrease of approximately $6.1 million from
revenues of $18.5 million in the 2002 comparable period. This net
decrease during the current period was due principally to:
(i) decreases in sales of interior signage, electronic displays and
other products of approximately $8.2 million, from $16.8 million in
the 2002 quarter to $8.6 million in the 2003 quarter. The decrease
was due primarily to a reduction in interior signage sales of $3.5
million and a decrease in sales from electronic displays of $3.5
million. The 2002 quarter included two sizeable sales not duplicated
in the 2003 quarter. The decrease in revenues was also attributable
to decreases from sales of the Company's specialty slot machines and
slot glass revenues of approximately $0.9 million, partially offset
by
(ii) an increase of approximately $2.1 million, or 120%, in systems
sales from approximately $1.7 million in the 2002 quarter to
approximately $3.8 million in the 2003 quarter. The improvement was
due primarily to increased hardware sales to Canadian customers,
which continued to expand their casino slot operations during the
period, and the proliferation of wide-area-progressive sales to
Australian customers.
OPERATING INCOME (LOSS)
(Amounts in thousands) Change
Business Segment 2003 2002 Amount % Comment
- ------------------ ------ ------ ------- ------ -------
Gaming operations $ 11 $ (526) $ 537 102.1 % 1
Product sales 1,806 (2,705) 4,511 166.8 % 2
------- ------- -------
Segment operating income 1,817 (3,231) 5,048 156.2 %
Corporate (2,229) (3,858) 1,629 42.2 % 3
------- ------- -------
Total operating income
(loss) $ (412) $ (7,089) $ 6,677 94.2 %
======== ======== ========
Depreciation and amortization:
Gaming operations $ 2,788 $ 2,225 $ 563 25.3 %
Product sales 229 166 63 38.0 %
Corporate 702 999 (297) (29.7)%
------- ------- -------
Total $ 3,719 $ 3,390 $ 329 9.7 % 4
======== ======== ========
1. Gaming operations reported operating results during the three months
ended September 30, 2003 of approximately break even compared to an
operating loss of approximately $0.5 million in the 2002 comparable
period. This improvement of $0.5 million was primarily due to:
(i) improved slot operations' operating results of approximately $0.7
million between the quarterly periods ended September 30, 2003 and
2002. The improvement was due primarily to lower operating costs to
service, refurbish and maintain the slot route and lower segment
expenses. This was partially offset by the previously discussed
revenue decline and an increase in depreciation expense in the 2003
quarterly period. Maintenance and refurbishment costs for slot
machines decreased from $3.0 million in the prior year period to
$1.1 million in the current period, due primarily to the decrease in
the average number of slot machines leased during the current period
and significant refurbishment costs for a new product theme incurred
during the prior period. Segment expenses decreased from
approximately $3.6 million in the 2002 quarter to approximately $1.8
million in the 2003 quarter related to decreases in salaries and
related costs as a result of reductions in the work force during
late 2002 and early 2003 and a charge to the provision for bad debts
of $1.5 million in the prior period. Depreciation and amortization
for the three months ended September 30, 2003 and 2002 was
approximately $2.4 million and $1.8 million, respectively. The
increase was due primarily to accelerating the depreciation of
certain slot machines in the current quarter as the result of the
agreement with Aristocrat Technologies, Inc. ("ATI") to replace our
existing slot machines placed in casinos with ATI versions of these
machines. Management believes the acceleration of depreciation
expense for its slot machines continues to be appropriate although
the ATI agreement has been terminated as the Company will continue
to pursue replacement of its existing slot machines. Slot rental
expense for both quarterly periods remained constant at $1.4
million, partially offset by
(ii) a decrease of $0.2 million in table games' operating results
primarily due to the previously discussed decrease in recurring
revenues from leased casino table games, partially offset by an
improvement in cost of revenues. Total cost of revenues, exclusive
of segment expenses, for the three months ended September 30, 2003
and 2002 totaled approximately $0.4 million and $0.9 million,
respectively. Costs of revenues as a percentage of revenues
decreased to 12% in the 2003 quarter from 23% in the 2002 quarter.
This improvement was due primarily to a decrease in refurbishment
costs. Segment expenses, excluding depreciation and amortization,
were approximately $0.6 million for the 2003 quarter compared to
$0.5 million for the 2002 quarter. Depreciation and amortization for
the quarters ended September 30, 2003 and 2002 was approximately
$0.4 million.
2. Product sales reported operating income during the three months ended
September 30, 2003 of approximately $1.8 million, compared to an
operating loss of approximately $2.7 million in the 2002 comparable
period. This improvement of $4.5 million in operating income resulted
principally from:
(i) an increase in operating results from the Company's interior
signs, electronic displays and other product sales of approximately
$4.2 million, primarily due to higher gross profit margins and a
decrease in segment expenses, partially offset by the previously
discussed decrease in revenues. Gross margins improved from 11% in
the prior year period to 33% in the current period. This increase
in the current period was caused principally by lower manufacturing
costs as a result of the consolidation of manufacturing operations
in August 2002. The prior year quarter was also adversely affected
by a provision for obsolete inventories related to the restructuring
plan of approximately $3.1 million. Segment expenses, excluding
depreciation and amortization, decreased from approximately $4.9
million in the 2002 quarter to $1.6 million in the 2003 quarter.
This decrease was due primarily to a decrease in the work force and
other cost saving measures initiated in the third quarter of 2002 as
part of the restructuring plan and a provision for bad debts in the
2002 quarterly period of $2.5 million, principally related to a
receivable from the Company's unconsolidated subsidiary in Latin
America. Depreciation and amortization for the three months ended
September 30, 2003 and 2002 was approximately $0.2 million and $0.1
million, respectively, and
(ii) an increase in the operating results from the Company's systems
business of approximately $0.3 million. The increase was due
primarily to the previously discussed increase in revenues,
partially offset by a decrease in gross profit margins and an
increase in segment expenses. Gross margins decreased from 76% in
the prior year period to 54% in the current period. The decrease
was the result of a shift in the sales mix from higher margin
software sales during the quarter ended September 30, 2002 to lower
margin hardware sales during the quarter ended September 30, 2003.
Segment expenses, excluding depreciation and amortization, increased
from approximately $0.8 million in the 2002 period to approximately
$1.2 million in the 2003 period. The increase was due primarily to
increases in engineering and sales expenses. Depreciation and
amortization for both of the three months ended September 30, 2003
and 2002 was less than $0.1 million.
3. Corporate expenses during the three months ended September 30, 2003
were approximately $2.2 million, a decrease of approximately $1.7
million from $3.9 million in the 2002 comparable period. The decrease
was due primarily to lower costs from the result of a decrease in the
work force and other cost saving measures initiated in the third
quarter of 2002 as part of the restructuring plan and a decrease in
legal and regulatory licensing fees. Depreciation and amortization
decreased from approximately $1.0 million in the 2002 quarter to
approximately $0.7 million in the 2003 quarter.
4. Depreciation and amortization for the three months ended September 30,
2003 and 2002 was approximately $3.7 million and $3.4 million,
respectively. The increase was due primarily to the previously
discussed increase in depreciation related to leased slot machines,
partially offset by the decrease in corporate depreciation and
amortization.
INTEREST EXPENSE
Interest expense during the three months ended September 30, 2003 was $3.8
million, a slight decrease compared to $4.0 million during the three months
ended September 30, 2002. The decrease was due principally to a decrease in
the Company's capital lease obligations.
OTHER INCOME AND EXPENSE
Other income and expense, excluding interest income, during each of the
three months ended September 30, 2003 and 2002 was a net expense of less than
$0.1 million. The expense for both periods was principally related to losses
from the disposition of assets. Interest income decreased slightly from
approximately $0.1 million in the 2002 quarter to less than $0.1 million in
the 2003 quarter.
LOSS FROM DISCONTINUED OPERATIONS
D uring the three months ended September 30, 2002, the Company recorded
losses from discontinued operations, net of income tax benefits calculated at
a 34% tax rate, of approximately $1.6 million. The losses relate to the
Company's exterior sign operation, which was sold effective October 31, 2002.
INCOME TAXES
During the three months ended September 30, 2003, the Company recorded a
tax provision of less than $0.1 million compared to a provision of
approximately $0.9 million for the three months ended September 30, 2002. The
primary component of the income tax provision for the current year period was
state income taxes. The primary component of the income tax provision for
the prior year period was certain state tax adjustments in addition to an
offset to a tax benefit recorded relative to discontinued operations losses.
The tax provision offsets the tax benefit from the discontinued operations
losses for the period. No tax benefit was recognized by the Company related
to its loss from continuing operations, as the benefit has been fully
reserved.
LOSS PER SHARE
Both basic and diluted loss per share for the three months ended September
30, 2003 were $0.32 on basic and diluted weighted average common shares
outstanding of approximately 13,129,000. Both basic and diluted loss per
share for the three months ended September 30, 2002 were $2.35 on basic and
diluted weighted average common shares outstanding of approximately
12,849,000. Dilutive stock options have not been included in the computations
of diluted net loss per share as their effect would be antidilutive.
Nine Months Ended September 30, 2003 and 2002
REVENUES
(Amounts in thousands) Change
Business Segment 2003 2002 Amount % Comment
- ------------------ ------ ------ ------- ------ -------
Gaming operations $ 27,511 $ 33,300 $ (5,789) (17.4)% 1
Product sales 39,287 42,175 (2,888) (6.8)% 2
------- ------- -------
Total $ 66,798 $ 75,475 $ (8,677) (11.5)%
======== ======== ========
Percentage of total revenues:
Gaming operations 41.2% 44.1%
Product sales 58.8% 55.9%
----- -----
Total 100.0% 100.0%
===== =====
1. Gaming operations revenues during the nine months ended September 30,
2003 were $27.5 million, a decrease of approximately $5.8 million from
revenues of $33.3 million in the 2002 comparable period. This net
decrease resulted from:
(i) a decrease in recurring revenues from leased slot machines of
approximately $4.4 million, from approximately $20.8 million in the
nine months ended September 30, 2002, to approximately $16.4 million
in the current year nine-month period. This decline was
attributable to a decrease in the average number of branded slot
machines leased to customers from approximately 2,525 during the
nine months ended September 30, 2002, to approximately 2,100 during
the nine months ended September 30, 2003. Management believes that
increased competition with other suppliers for limited casino floor
space contributed to this decline. Additionally, a reduction in the
average net win per day per branded slot machine, from approximately
$27.30 during the nine-month period ended September 30, 2002 to
approximately $22.60 in the current year nine-month period,
contributed to this decline. Management believes delays in its
ability to offer technological specifications offered by
competitors, such as ticket-in, ticket-out and multi-denominational
pay tables, on its slot machines caused the decline in leased slot
machines in casinos and win per day. The Company presently offers
these technological specifications in certain gaming jurisdictions
and is seeking regulatory approvals in other jurisdictions. Revenue
from non-branded slot machines decreased from approximately $1.9
million in the 2002 nine-month period to approximately $1.7 million
in the similar 2003 period. Average non-branded machines outstanding
were approximately 350 and 400 for the 2003 and 2002 periods,
respectively. Also, the average win per day for non-branded machines
decreased slightly from approximately $17.80 in the 2002 nine-month
period to approximately $17.50 in the 2003 nine-month.
Additionally, the Company received approximately $1.2 million in the
2003 period from its participation in an average of approximately
320 licensed games compared to revenues from participation of less
than $0.1 million and approximately 131 average games in the 2002
period for which the Company does not provide hardware for the
games. The Company intends to continue its pursuit of revenue
leasing arrangements whereby the Company would supply the software
component to a third party which would use hardware not otherwise
owned or leased by the Company. These games earned the Company
approximately $12.30 and $4.50 per day in the 2003 and 2002 nine-
month periods, respectively. Also during the nine months ended
September 30, 2003, the Company sold 300 software licenses of
certain proprietary game content to a customer for approximately
$0.6 million, net of royalties, and
(ii) a decrease of approximately $1.4 million in table games revenues.
This decrease in the nine months ended September 30, 2003 was caused
primarily by a decline in the number of outstanding tables and in
the average monthly lease revenue in domestic markets offset, in
part, by an increase in table game revenues from the Company's
European subsidiary. For the nine months ended September 30, 2003,
revenues from leased casino table games were approximately $11.1
million compared with approximately $12.5 million for the nine
months ended September 30, 2002. The decrease was due primarily to a
decrease in the average number of leased casino table games from
approximately 1,090 during the 2002 nine-month period to 1,030 in
the similar nine-month period of 2003. Management believes that the
industry trend to reduce the number of table games in casinos in the
last several years in favor of slot machines, as well as increased
competition from competitors selling "felt only" table games, have
contributed to the decline in the Company's table game placements.
The average monthly lease charge for table games was approximately
$1,200 and $1,275 for the nine-month periods ending September 30,
2003 and 2002, respectively. The monthly lease revenue includes
royalties and commencement fees paid during the respective periods.
Management believes the decrease in the average monthly lease charge
in the 2003 nine-month period was due primarily to alternative "felt
only" game products offered by competitors.
2. Product sales revenues during the nine months ended September 30, 2003
were $39.3 million, a decrease of $2.9 million from revenues of $42.2
million in the 2002 comparable period. This net decrease during the
current period was due principally to:
(i) decreases in sales of interior signage of approximately $1.5
million and in sales of electronic displays of approximately $4.3
million. These decreases were due primarily to a slowdown in casino
operators upgrading or replacing their interior signage and displays
in the 2003 period. In addition, sales from the Company's specialty
slot machines decreased by approximately $1.3 million during the
current year. These decreases were partially offset by,
(ii) an increase of approximately $4.2 million in systems sales to
approximately $9.5 million in the nine months ended September 30,
2003 period from $5.3 million in the nine months ended September 30,
2002. The improvement was due primarily to increased sales to
certain Canadian and Australian customers, which expanded casino
slot operations and enhanced wide-area-progressive systems during
the period, and increases in sales of table tracking systems in the
current year period.
OPERATING INCOME (LOSS)
(Amounts in thousands) Change
Business Segment 2003 2002 Amount % Comment
- ------------------ ------ ------ ------- ------ -------
Gaming operations $ 2,625 $ 5,219 $ (2,594) (49.7)% 1
Product sales 6,261 (1,798) 8,059 448.2 % 2
------- ------- -------
Segment operating income 8,886 3,421 5,465 159.7 %
Corporate (8,528) (9,790) 1,262 12.9 % 3
------- ------- -------
Total operating income
(loss) $ 358 $ (6,369) $ 6,727 105.6 %
======== ======== ========
Depreciation and amortization:
Gaming operations $ 7,687 $ 6,240 $ 1,447 23.2 %
Product sales 675 753 (78) (10.4)%
Corporate 2,089 2,639 (550) (20.8)%
------- ------- -------
Total $ 10,451 $ 9,632 $ 819 8.5 % 4
======== ======== ========
1. Gaming operations reported operating income during the nine months
ended September 30, 2003 of approximately $2.6 million compared to
operating income of approximately $5.2 million in the 2002 period.
This net decrease of approximately $2.6 million was primarily due to:
(i) a decrease in the slot operations' operating results of
approximately $1.6 million, due primarily to the previously
discussed decrease in recurring revenues from leased slot machines
and an increase in depreciation and amortization, partially offset
by a decrease in the operating costs to service, refurbish and
maintain the Company's slot route and lower segment expenses in the
current period. Slot operations' depreciation and amortization
during the nine months ended September 30, 2003 and 2002 was $6.6
million and $5.2 million, respectively. The increase was due
primarily to accelerating the depreciation of certain slot machines
in the 2003 nine-month period as the result of the agreement with
Aristocrat Technologies, Inc. ("ATI") to replace our existing slot
machines placed in casinos with ATI versions of these machines.
Management believes the acceleration of depreciation expense for its
slot machines continues to be appropriate although the ATI agreement
has been terminated as the Company will continue to pursue
replacement of its existing slot machines. Slot rental expense
increased slightly to $4.2 million in the 2003 period as compared to
$4.1 million in the 2002 period. Maintenance and refurbishment costs
for slot machines decreased from $7.0 million in the prior year
period to $4.6 million in the current period, due primarily to the
decrease in the average number of slot machines leased during the
current period and significant refurbishment costs for a non-branded
product incurred during the prior period. Segment expenses,
excluding slot rent expense and depreciation and amortization
expense, for the nine-month period ended September 30, 2003 were
approximately $4.7 million compared to expenses of approximately
$6.6 million for the same period in 2003. The decrease is due
primarily to lower salaries and related costs as a result of
reductions in the work force during late 2002 and early 2003 and a
charge to the provision for bad debts of $1.5 million in the prior
period, and
(ii) a decrease in table games' operating results of approximately
$1.0 million, due primarily to the previously discussed decrease in
recurring revenues from leased casino table games and an increase in
segment expenses, partially offset by lower cost of revenues as a
percentage of revenues. Total cost of revenues, exclusive of segment
expenses, for the nine months ended September 30, 2003 and 2002
totaled approximately $1.6 million and $2.3 million, respectively.
The decrease in the current period was due primarily to a decrease
in the average number of leased table games and lower refurbishment
costs. Costs of revenues as a percentage of revenues improved to 14%
in the current year period compared to 18% in the prior year period.
Segment expenses, excluding depreciation and amortization, were
approximately $2.1 million and $1.8 million for the nine-month
periods ended September 30, 2003 and 2002, respectively. This
increase was due primarily to increases in engineering costs and
sales and related costs. Depreciation and amortization for both of
the nine-month periods ended September 30, 2003 and 2002 was
approximately $1.1 million.
2. Product sales reported operating income during the nine months ended
September 30, 2003 of approximately $6.3 million, compared to an
operating loss of approximately $1.8 million in the 2002 comparable
period. This improvement of $8.1 million in operating results was
principally from:
(i) an increase in operating results from the Company's interior
signs, electronic displays and other product sales of approximately
$7.4 million, primarily due to higher gross profit margins and lower
segment expenses, partially offset by the previously discussed
decrease in revenues. Gross margins improved to 36% during the nine
months ended September 30, 2003 as compared to 23% in the similar
2002 nine-month period. This improvement in 2003 was caused
principally by lower manufacturing costs as a result of the
consolidation of manufacturing operations in August 2002. The prior
year period was also adversely affected by a provision for obsolete
inventories related to the restructuring plan of approximately $3.9
million. Total costs of sales, exclusive of segment expenses, for
the nine months ended September 30, 2003 were $19.1 million compared
to approximately $28.3 million for the nine months ended September
30, 2002. Segment expenses, excluding depreciation and amortization,
decreased from approximately $10.3 million in the 2002 period to
$5.1 million in the 2003 period. This decrease was due primarily to
a decrease in the work force and other cost saving measures
initiated in the third quarter of 2002 as part of the restructuring
plan and $2.5 million in bad debt charges in the 2002 nine-month
period. Depreciation and amortization decreased slightly during the
nine months ended September 30, 2003 to $0.6 million from $0.7
million for the nine months ended September 30, 2002, and
(ii) an increase in the operating results from the Company's systems
business of approximately $0.7 million. The increase in the nine
months ended September 30, 2003 was due primarily to the previously
discussed increase in revenues, partially offset by a decrease in
gross profit margins and an increase in segment expenses. Gross
margins decreased from 60% in the nine-month period ended September
30, 2002 to 51% in the similar 2003 period. This decrease was
caused principally by a shift in the sales mix from higher margin
software sales to lower margin hardware sales in the nine months
ended September 30, 2003. Costs of sales for the systems business
were $4.7 million during the nine months ended September 30, 2003
compared to $2.1 million during the same period in 2002. Segment
expenses, excluding depreciation and amortization, increased from
approximately $2.5 million in the 2002 period to approximately $3.4
million in the 2003 period due primarily to increases in engineering
costs and sales and related costs. Depreciation and amortization
for the nine months ended September 30, 2003 and 2002 was
approximately $0.1 million for both periods.
3. Corporate expenses during the nine months ended September 30, 2003 were
$8.5 million, a decrease of approximately $1.3 million from $9.8
million in the 2002 comparable period. The decrease was due primarily
to lower salaries and related costs from the result of the reduction in
the work force during the third quarter of 2002 and a decrease in
marketing expenses, partially offset by increases in legal and
regulatory licensing fees, which include legal expenses incurred by the
former CEO and by the Company in connection with licensing issues in
several jurisdictions and audit fees related to the reaudit of the
Company's 2000 and 2001 financial statements. Also, depreciation and
amortization for the 2003 period was approximately $2.1 million, a
decrease of approximately $0.5 million compared to $2.6 million for the
2002 period.
4. Depreciation and amortization during the nine months ended September
30, 2003 was approximately $10.4 million, an increase of $0.8 million,
compared to $9.6 million in the 2002 comparable period. This increase
was primarily due to the previously discussed increase in depreciation
related to leased slot machines, partially offset by the decrease in
corporate depreciation and amortization.
INTEREST EXPENSE
Interest expense during the nine months ended September 30, 2003 was $11.6
million, a slight decrease compared to $11.8 million during the nine months
ended September 30, 2002. The decrease was due principally to a decrease in
the Company's capital lease obligations.
OTHER INCOME AND EXPENSE
Other income and expense, excluding interest income, during the period
ended September 30, 2003, was a net expense of less than $0.1 million
compared to a net expense of approximately $0.3 million in the comparable
2002 period. The net expense for both periods was principally related to
losses from the disposition of assets. Interest income for the nine months
ended September 30, 2003 was approximately $0.2 million compared to interest
income for the nine months ended September 30, 2002 of approximately $0.4
million. This decrease was due primarily to a decrease in average interest
rates during the current period.
LOSS FROM DISCONTINUED OPERATIONS
During the nine months ended September 30, 2002, the Company recorded
losses from discontinued operations, net of income tax benefits calculated at
a 34% tax rate, of approximately $1.9 million. The losses relate to the
Company's exterior sign operation, which was sold effective October 31, 2002.
INCOME TAXES
During the nine months ended September 30, 2003, the Company recorded a
tax provision of less than $0.1 million compared to a provision of
approximately $1.4 million for the nine months ended September 30, 2002. The
primary component of the income tax provision for the current period was
state income taxes. The primary component of the income tax provision for
the prior year period was state tax adjustments in addition to an offset to a
tax benefit recorded relative to discontinued operations losses. The tax
provision offsets the tax benefit from the discontinued operations losses for
the period. No tax benefit was recognized by the Company related to its loss
from continuing operations, as the benefit has been fully reserved.
LOSS PER SHARE
Both basic and diluted loss per share for the nine months ended September
30, 2003 were $0.90 on basic and diluted weighted average common shares
outstanding of approximately 12,973,000. Both basic and diluted loss per
share for the nine months ended September 30, 2002 were $2.96 on basic and
diluted weighted average common shares outstanding of approximately
12,817,000. Dilutive stock options have not been included in the computations
of diluted net loss per share as their effect would be antidilutive.
LIQUIDITY AND CAPITAL RESOURCES
For the nine months ended September 30, 2003, the Company incurred a net
loss of approximately $11.7 million. Net cash and cash equivalents at
September 30, 2003 were $13.9 million, a decrease of approximately $2.4
million from $16.3 million at December 31, 2002. Working capital decreased
from $22.0 million at December 31, 2002 to $18.8 million at December 31,
2002. The working capital decrease of approximately $3.2 million was due
principally to decreases in; cash and cash equivalents of approximately $2.4
million, accounts and notes receivable of approximately $1.6 million,
inventories of approximately $2.5 million and prepaid expenses of
approximately $2.2 million and an increase in accrued liabilities of
approximately $1.0 million, partially offset by decreases in; trade accounts
payable of approximately $3.6 million, current maturities of long-term debt
of approximately $0.9 million and customer deposits of approximately $1.8
million.
Cash provided by operating activities was approximately $2.0 million for
the nine months ended September 30, 2003. The significant items affecting
this amount were a net loss of approximately $11.7 million, offset by non-
cash charges of $10.5 million for depreciation and amortization and $1.7
million for amortization of debt discount and issue costs. Significant
changes in operating assets and liabilities also affecting cash provided by
operating activities were net decreases in accounts and notes receivable and
prepaid expenses, partially offset by decreases in accounts payable and
customer deposits.
Cash used in investing activities was approximately $4.1 million during
the nine months ended September 30, 2003 primarily for purchases of property
and equipment.
Cash used in financing activities was approximately $0.2 million during
the nine months ended September 30, 2003, primarily as a result of principal
payments on debt, deferred license fees and capital leases of approximately
$1.8 million offset, in part, by proceeds of approximately $1.6 million from
the issuance of common stock.
The following table summarizes the Company's contractual obligations at
September 30, 2003, for long-term debt, capital leases, operating leases,
license fees, slot machine purchases and employment agreements for the
periods shown:
(Amounts in thousands) Less than 1-3 4-5 After 5
Contractual Obligations Total 1 year years years years
- ----------------------- ----- ------ ----- ----- -----
Long-term debt $105,486 $ 125 $ 361 $105,000 $ -
Capital lease obligations 808 663 145 - -
Operating leases 23,103 6,017 4,943 4,347 7,796
License fees 668 503 165 - -
Purchase of slot machines 300 300 - - -
Employment agreements 3,233 1,862 1,301 70 -
------- ------- ------- ------- -------
Total $133,598 $ 9,470 $ 6,915 $109,417 $ 7,796
======== ======== ======== ======== ========
The above table includes accretion of debt discount of $4.1 million and
excludes accounts payable and accrued expenses as disclosed on the
accompanying condensed consolidated balance sheet for September 30, 2003.
On August 22, 2001, the Company completed the private placement of $105.0
million of its 11.875% Senior Secured Notes ("Notes") due 2008 and warrants
to purchase an aggregate of 420,000 shares of its common stock at a price of
$7.70 per share. Interest payments of approximately $6.2 million are due on
May 1 and November 1 until 2008. The Notes are secured by a security interest
in certain of the Company's assets and certain assets of its subsidiaries. On
or after August 15, 2005, the Company will have the right to redeem all or
some of the notes at a price that will decrease over time from 105.938% of
the principal amount in 2005 to 100.0% of the principal amount in 2007, plus
accrued and unpaid interest. The Notes include a covenant whereby the Company
may only purchase additional slot machines if it maintains $5.0 million of
available liquidity, as defined. The Company is in compliance with this
covenant as of September 30, 2003. On October 22, 2003, the Company
completed its sale of 8.4 million shares of its Common Stock and warrants to
acquire an additional 2.1 million shares to repurchase and retire $40.0
million of the Notes. This transaction is discussed further in the
"Subsequent Event" subsection below.
Following each fiscal year, if the Company has excess cash flow for such
fiscal year, the Company will offer to purchase up to an aggregate principal
amount of notes equal to 50.0% of such excess cash flow at a price equal to
100.0% of the principal amount plus accrued and unpaid interest.
In February 2002, the Company completed the acquisition of a $17.5 million
working capital revolving line of credit facility (the "Facility") with
Foothill Capital Corporation ("Foothill"). Borrowings under the Facility are
based on (i) eligible accounts receivable, as defined, up to $7.5 million
with interest at LIBOR plus 2.75% or prime plus 0.75% and (ii) Table Game
EBITDA, as defined, up to $10.0 million with interest at prime plus a range
of 2.0% to 3.5% depending on Debt Coverage Ratios, as defined in the
Facility. Any borrowings under the Facility are secured by a first secured
interest in substantially all of the Company's assets. The Company pays a
0.5% per annum unused line fee. The Facility has early payoff penalties
during the term of the line at 3.0% during the first year, 2.0% during the
second year, and 1.0% during the third year. The Facility has an initial term
of three years and includes certain restrictive financial covenants,
including maintenance of $20.0 million of annual EBITDA, minimum table games
revenue of $0.8 million monthly and a table game installed base of not less
than 600 games. The Company and Foothill subsequently amended the EBITDA
covenant to require the Company to maintain a trailing twelve months EBITDA
of $15.0 million for each of the quarters ended September 30, 2002, December
31, 2002 and March 31, 2003. The calculation of EBITDA was also amended to
allow for certain non-cash charges to be excluded. The EBITDA covenant
increased to $17.0 million for the quarter ended June 30, 2003 and increases
to the original amount of $20.0 million for the quarter ended September 30,
2003 and each quarter thereafter for the remaining term of the Facility. The
capacity of the Facility will be $12.5 million until the Company has achieved
EBITDA of $20.0 million for three consecutive quarters, at which point the
capacity of the Facility will revert to the original $17.5 million. As of
September 30, 2003, the Company had not drawn on this Facility but was not in
compliance with its covenant to maintain EBITDA of $20.0 million for the
twelve months ended September 30, 2003. Foothill intends to issue the Company
a limited one-time waiver of the covenant default for the twelve months ended
September 30, 2003. Foothill also intends to amend the terms of the Facility
whereby the Company's EBITDA covenant would be adjusted to approximately
$14.0 million to $16.0 million over the next four calendar quarters.
However, management can give no assurance that the waiver or the amendment of
the terms of the Facility will be accomplished.
Based on the amount of cash and cash equivalents held of approximately
$13.9 million, cash generated from operations, and the capacity of $12.5
million under the Facility, management believes the Company has sufficient
working capital on both a short- and long-term basis.
CAPITAL EXPENDITURES AND OTHER
During the nine months ended September 30, 2003, the Company spent
approximately $4.0 million for purchases of property and equipment. The
Company presently plans to spend approximately $0.5 million for property and
equipment during the remaining portion of the year ending December 31, 2003.
The Company plans to purchase machines for lease to others only if specific
machines not currently on lease or participation at casinos are used.
However, in accordance with the provisions of capital and operating lease
agreements, the Company may purchase the residual buy-out of up to 1,700
machines at a purchase price of approximately $1,000 per machine over the
next 12 months. Purchases of property and equipment are limited to $6.0
million annually under the terms of the Company's Facility.
In March 2002, the Company entered into a contractual commitment to
purchase a minimum of 125 slot machines each calendar quarter beginning July
1, 2002 through June 30, 2003 for a new slot machine introduction. As of
September 30, 2003, the Company has not purchased any slot machines under
this agreement and had paid $0.3 million to the supplier to be used as an
advance towards future slot machine purchases or as part of an underordered
machine payment. In October 2003, the Company paid an additional $0.2 million
to the supplier and no longer has an outstanding financial obligation under
the terms of the contractual commitment.
In October 2002, the Company entered into a development and licensing
agreement with ATI whereby ATI will be an exclusive supplier of hardware for
our branded slot machine products in certain North America jurisdictions.
Under the agreement, we will be responsible for game development and theme
licensing and ATI will integrate the games onto its latest game platforms. In
January 2003, this agreement was expanded to allow us to outsource our
servicing, maintenance and refurbishing requirements to ATI, so we may focus
our efforts on game development, including game conceptualization, art and
software program design. ATI will receive royalties for service and hardware
rendered per game per day. On a jurisdiction-by-jurisdiction basis, we plan
to replace our existing slot machines placed in casinos with ATI versions of
these machines. In June 2003, the Company and ATI terminated the agreement
and the Company plans to pursue other outsourcing arrangements similar to the
terminated agreement with ATI. However, the Company can give no assurances
that such arrangements will be achieved and may continue to operate its slot
business using existing slot machines which may require as much as $3,000 per
device to upgrade to technologically current specifications.
Presently, the Company owns or leases approximately 900 machines which are
not currently in use at casinos. Due to the number of slot machines owned or
leased by the Company which are not currently in use at casinos, planned
purchases for slot machines (inventory leased to others) for the remaining
portion of 2003 should be significantly less than in previous years.
A former supplier to the Company has alleged that the Company has an
outstanding commitment to purchase certain electronic components in the
amount of approximately $0.5 million. The Company does not believe that the
amount or the alleged contractual relationship are valid and does not plan to
acquire the components.
The Company is a party to post-employment agreements entered into in
August 2002 with its former CEO and CFO. The agreements require payments
subsequent to December 31, 2002 of approximately $2.0 million plus medical
costs through August 2006. In March 2003, the Company reached an agreement
with its former CEO whereby he resigned from the Company's board of directors
and specifically as chairman of the board. In March 2003, the Company paid
its former CEO all outstanding future payments totaling approximately $1.4
million and agreed to pay certain legal costs incurred by the former CEO in
the approximate amount of $0.5 million.
SHARE REPURCHASE PLAN
On August 13, 2002 the Company's Board of Directors authorized the
purchase of up to $2.0 million of the Company's common stock. The purchases
will be made from time to time in the open market. The timing and actual
number of shares to be purchased will depend on market conditions. The
Company did not purchase any shares of its common stock during the nine
months ended September 30, 2003. Through September 30, 2003, the Company has
purchased approximately 76,000 shares of its common stock for approximately
$0.2 million. As of September 30, 2003, the Company had approximately
195,000 shares of common stock held in treasury.
SUBSEQUENT EVENT
On October 22, 2003, the Company announced that it has completed its
previously announced sale of 8.4 million shares of its Common Stock at a
price of $5.34 per share and warrants to acquire an additional 2.1 million
shares at an exercise price of $5.875 per share. Proceeds from the
transaction were used to repurchase and retire $40.0 million of the Company's
11.875% Senior Secured Notes ("Notes") due August 2008. As a result of this
transaction, the Company's annual cash interest payments will decrease by
approximately $4.8 million resulting in a revised cash interest payment of
approximately $7.7 million per year.
As a result of the above transaction, the Company will take a charge in
the fourth quarter of 2003 of approximately $1.6 million for the premium paid
on the repurchase of the Notes. In addition, non-cash charges will be taken
to write-off approximately $2.0 million and approximately $1.6 million of the
portions of unamortized bond issue costs and unamortized bond discount,
respectively, related to the $40.0 million of Notes repurchased. Additionally,
as a consequence of the transaction, the Company's usage of its existing net
operating losses ("NOL") will be limited to approximately $3.8 million
annually over the next several years. Unused amounts of the $3.8 million of
the annual NOL may be carried-forward to subsequent years.
CRITICAL ACCOUNTING POLICIES
Estimates. Our consolidated financial statements are prepared in
conformity with accounting principles generally accepted in the United
States. Certain of our accounting policies, including the estimated lives
assigned to our assets, the determination of bad debts, inventory valuation
reserves and asset impairment require that we apply significant judgment in
defining the appropriate assumptions for calculating financial estimates. By
their nature, these judgments are inherently subject to a degree of
uncertainty. Our judgments are based on our historical experience, terms of
existing contracts, our observance of industry trends, information provided
by or gathered from our customers and information available from other
outside sources, as appropriate. There can be no assurance that actual
results will not differ from our estimates.
Revenue Recognition. The Company recognizes revenue depending on the
nature of the transaction as follows:
Product sales are executed by a signed contract or customer purchase
order. Revenue is recognized when the completed product is delivered and, if
required, installed and all elements of the sale have been completed and
accepted by the customer.
System sales consist of a suite of products (some of which are sold
separately) that enable gaming entities to track customer gaming activity,
account for slot machine activity and operate progressive jackpot systems.
There are proprietary hardware and software components to the systems. The
Company accounts for system sales in accordance with Statement of Position
97-2 - Software Revenue Recognition ("SOP 97-2"). System sales are
considered multiple element arrangements because they include hardware,
software, installation, training and post-sale customer support. System
sales are evidenced by a signed contract. Follow-up spare parts and
hardware-only sales are evidenced by a purchase order. Revenue for system
sales is recognized when: (i) there is a signed contract with a fixed
determinable price; (ii) collectibility of the sale is probable; and (iii)
the hardware and software have been delivered, installed, training has been
completed and acceptance has occurred.
Not all systems contracts require installation. Examples include sales of
hardware only to (i) previous customers that are expanding their systems,
(ii) customers that have multiple locations and install the system themselves
and require an additional software license and hardware and (iii) customers
purchasing spare parts.
Maintenance and support are sold under agreements with established vendor-
specific objective evidence of price. These contracts are generally for a
period of 12 months and revenue is recognized ratably over the contract
service period.
Further training is also sold under agreements with established vendor-
specific objective evidence of price, which is based on daily rates and is
recognized upon delivery.
The leasing of proprietary table games to customers occurs under signed
lease agreements. Table game lease contracts are typically for a 36-month
period with a 30-day cancellation clause. The lease revenue is recognized on
a monthly basis.
The leasing of proprietary slot machines or software licensing rights
occurs under signed lease agreements. These contracts will either be on a
revenue participation or a fixed-rental basis. Slot machine lease contracts
are typically for a month-to-month period with a 30-day cancellation clause.
On a revenue participation basis, the Company earns a share of the revenue
that the casino earns from these slot machines. On a fixed-rental basis, the
Company charges a fixed amount per slot machine per day. Revenues from each
type of lease or license arrangement are recognized on the accrual basis.
Receivables and Allowance for Doubtful Accounts. We regularly evaluate
the collectibility of our trade receivable balances based on a combination of
factors. When a customer's account becomes past due, we initiate dialogue
with the customer to determine the cause. If it is determined that the
customer will be unable to meet its financial obligation to us, such as in
the case of a bankruptcy filing, deterioration in the customer's operating
results or financial position or other material events impacting their
business, we record a specific reserve for bad debt to reduce the related
receivable to the amount we expect to recover given all information presently
available. We also record reserves for bad debt for all other customers based
on certain other factors including the length of time the receivables are
past due and historical collection experience with individual customers. If
circumstances related to specific customers change, our estimates of the
recoverability of receivables could materially change.
Inventory and Obsolescence. We regularly evaluate the realizability of our
inventory based on a combination of factors including the following:
historical usage rates, forecasted sales or usage, estimated service period,
product end of life dates, estimated current and future market values,
service inventory requirements and new product introductions, as well as
other factors. Purchasing requirements and alternative usage avenues are
explored within these processes to mitigate inventory exposure. Raw materials
and work in progress with quantities in excess of forecasted usage are
reviewed at least quarterly by our engineering and operating personnel for
obsolescence. Such raw material and work in progress write-downs are
typically caused by engineering change orders or product end of life
adjustments. Finished goods are reviewed at least quarterly by product
marketing and operating personnel to determine if inventory carrying costs
exceed market selling prices. Service inventory is systematically reserved
for based on the estimated remaining service life of the inventory. We record
reserves for inventory based on the above factors and take into account
worldwide quantities and demand in our analysis. If circumstances related to
our inventories change, our estimates of the realizability of inventory could
materially change.
Long-Lived Asset Impairment. Long-lived assets and intangible assets with
determinable lives are reviewed for impairment quarterly or whenever events
or circumstances indicate that the carrying amount of assets may not be
recoverable in accordance with Statement of Financial Accounting Standards
("SFAS") No. 144, "Accounting for the Impairment or Disposal of Long-Lived
Assets." We evaluate recoverability of assets to be held and used by
comparing the carrying amount of an asset to future net undiscounted cash
flows to be generated by the asset. If such assets are considered to be
impaired, the impairment to be recognized is measured as the amount by which
the carrying amount of the assets exceeds the fair value of the assets. Such
reviews assess the fair value of the assets based upon our estimates of the
future cash flows we expected the assets to generate. In response to changes
in industry and market conditions, we may be required to strategically
realign our resources in the future, which could result in an impairment of
long-lived assets.
For indefinite-lived assets including perpetual licenses and goodwill, an
independent valuation is performed at least annually to determine if any
impairment has occurred.
RECENTLY ISSUED ACCOUNTING STANDARDS
In May 2003, the Financial Accounting Standards Board issued Statement of
Financial Accounting Standards No. 150, "Accounting for Certain Financial
Instruments with Characteristics of both Liabilities and Equity" ("SFAS No.
150"). This statement affects the classification, measurement and disclosure
requirements of the following three types of freestanding financial
instruments; 1) mandatory redeemable shares, which the issuing company is
obligated to buy back with cash or other assets; 2) instruments that do or
may require the issuer to buy back some of its shares in exchange for cash or
other assets, which includes put options and forward purchase contracts; and
3) obligations that can be settled with shares, the monetary value of which
is fixed, tied solely or predominately to a variable such as a market index,
or varies inversely with the value of the issuers' shares. In general, SFAS
No. 150 is effective for all financial instruments entered into or modified
after May 31, 2003, and otherwise is effective at the beginning of the first
interim period beginning after June 15, 2003. The adoption of SFAS No. 150
did not have an impact on the Company's consolidated financial position or
disclosures.
Item 3. - QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
Refer to Part I, Item 7A, of the Company's annual report on Form 10-K for
the fiscal year ended December 31, 2002. There have been no material changes
in market risks since the fiscal year end.
Item 4. - CONTROLS AND PROCEDURES
The Company maintains disclosure controls and procedures (as defined in
Exchange Act Rules 13a-15(e) and 15d-15(e)) designed to ensure that it is
able to collect the information it is required to disclose in the reports it
files with the SEC, and to process, summarize and disclose this information
within the time periods specified in the rules of the SEC. These disclosure
controls and procedures are designed and maintained by or under the
supervision of the Company's Chief Executive Officer and Chief Financial
Officer, as required by the rules of the SEC. The Company's Chief Executive
Officer and Chief Financial Officer are responsible for evaluating the
effectiveness of the disclosure controls and procedures. Based on their
evaluation of the Company's disclosure controls and procedures which took
place as of the end of the period covered by this report, the Chief Executive
and Chief Financial Officers believe that these controls and procedures are
effective to ensure that the Company is able to collect, process and disclose
the information it is required to disclose in the reports it files with the
SEC within the required time periods.
During the period covered by this report, there have been no changes in
the Company's internal controls over financial reporting that have materially
affected, or are reasonably likely to materially affect, the Company's
internal control over financial reporting.
MIKOHN GAMING CORPORATION
PART II - OTHER INFORMATION
Item 6 - Exhibits and Reports on Form 8-K
A. Exhibits:
31.1 Certificate of Chief Executive Officer pursuant to Rule 13a-14(a)
or Rule 15d-14(a)
31.2 Certificate of Chief Financial Officer pursuant to Rule 13a-14(a)
or Rule 15d-14(a)
32.1 Certification Pursuant to Section 906 of the Sarbanes-Oxley Act
of 2002.
B. Reports on Form 8-K:
A report filed on Form 8-K with the Securities and Exchange Commission
on July 30, 2003, to disclose the Company's unaudited financial results
for the second quarter of 2003.
A report filed on Form 8-K with the Securities and Exchange Commission
on September 15, 2003, to announce that the Company is evaluating
various strategies to recapitalize its balance sheet. The Company also
disclosed its expected revenues and loss per share for the quarter
ended September 30, 2003.
A report filed on Form 8-K with the Securities and Exchange Commission
on September 29, 2003 to announce a pending sale of 8.4 million shares
of its Common Stock along with warrants to acquire 2.1 million shares
of Common Stock. The proceeds from the issuance of the Common Stock
will be used to purchase approximately $40.0 million of the Company's
Senior Secured Notes.
SIGNATURE
Pursuant to the requirements of the Securities Exchange Act of 1934, the
Registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto authorized.
MIKOHN GAMING CORPORATION, Registrant
/s/ John M. Garner
-----------------------
JOHN M. GARNER
Chief Financial Officer
November 12, 2003