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SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, DC 20549
FORM 10-K
For Annual Reports and Transition Reports Pursuant
to Sections 13 or 15(d) of the Securities Exchange Act of 1934
(Mark One)
[X] Annual Report under Section 13 or 15(d) of the Securities Exchange Act of
1934
For the Fiscal Year ended September 30, 1999
[ ] Transition report under Section 13 or 15(d) of the Securities Exchange Act
of 1934
For the transition period from _______ to _________
Commission file number 0-28318
Multimedia Games, Inc.
(Exact Name of Registrant as Specified in Its Charter)
Texas 74-2611034
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(State or Other Jurisdiction of (I.R.S. Employer
Incorporation or Organization) Identification Number)
8900 Shoal Creek Blvd., Suite 300
Austin, Texas 78757
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(Address of Principal Executive Offices) (Zip Code)
(512) 371-7100
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(Registrant's Telephone Number,
Including Area Code)
Securities Registered Under Section 12(b) of the Exchange Act: NONE
Securities Registered Under Section 12(g) of the Exchange Act: Common Stock, $.01 par value
Class A Warrants
Class B Warrants
Indicate by check mark whether the registrant: (1) has filed all
reports required to be filed by Section 13 or 15(d) of the Securities Exchange
Act of 1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days. Yes x No
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Indicate by check mark if disclosure of delinquent filers pursuant to
Item 405 of Regulation S-K is not contained herein, and will not be contained,
to the best of registrant's knowledge, in definitive proxy or information
statements incorporated by reference in Part III of this Form 10-K or any
amendment to this Form 10-K [ ]
The aggregate market value of the voting and non-voting common equity
held by non-affiliates of the issuer as of November 30, 1999 was $12,414,617.
The number of shares outstanding of the issuer's Common Stock as of
November 30, 1999, was 5,528,149.
Documents incorporated by reference: None
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PART I
ITEM 1. BUSINESS
GENERAL
The Company designs and develops interactive high-speed class II bingo
and Class III video lottery games and related electronic player stations (EPS)
and equipment that are marketed to Native American bingo halls located
throughout the United States. The Company operates its interactive bingo games
on behalf of its tribal customers through a multi-path communications network.
The network interconnects EPS located at multiple bingo halls thereby enabling
players to simultaneously participate in a live bingo game and to compete
against one another to win a common pooled prize. The EPS enable players to log
on to the network, select the bingo cards of their choice and to interact with
the game to make game decisions such as whether to continue a card in play,
daubing or "covering" a number on a card and declaring a winning bingo. The
Company also produces high stakes TV bingo game shows that are televised live to
multiple participating Indian bingo halls linked via closed circuit satellite
and broadband telephone communications networks.
Substantially all of the Company's games and equipment are designed and
operated to meet the requirements for Class II gaming as defined in the Indian
Gaming Regulatory Act of 1988. During fiscal 1999, the Company also designed,
developed and marketed Class III games and equipment in the state of Washington.
As of September 30, 1999, there were 4,420 EPS in operation at 80 independently
owned Indian gaming facilities located in eight states and the District of
Columbia, of which 520 EPS were Class III, located in four bingo halls in the
state of Washington. This compares to 3,271 Class II EPS that were in operation
at September 30, 1998 at 64 bingo halls located in 11 different states. Also as
of September 30, 1999, the Company's live TV bingo game show, MegaBingo, was
being delivered to 32 independently owned Indian bingo halls located in eight
states and the District of Columbia, a decrease of 15 bingo halls compared to
September 30, 1998.
In February 1999, the Company terminated its MegaRacing operation,
which was started in May 1998 to transmit horse racing signals to Indian
operated OTB facilities pursuant to compacts with the state of Oklahoma. During
fiscal 1999, the Company formed Gamebay.com, Inc. as a wholly-owned subsidiary
to pursue the development of non-gambling activities on the Internet using
interactive bingo games as a platform to derive advertising and product sale
revenues. In December 1999, Gamebay.com entered into a licensing agreement with
MGAM to use all of the Company's intellectual property for non-gambling
sweepstakes internet applications, and issued approximately 70% of its shares of
common stock (including shares of preferred stock convertible into common stock)
in a private placement to a group of investors for $5.5 million.
Multimedia Games, Inc. (the "Company") was incorporated under the laws
of the State of Texas on August 30, 1991. Unless the context otherwise requires,
the term the "Company" and "MGAM" includes Multimedia Games, Inc., and its
subsidiaries - TV Games, Inc., MegaBingo, Inc., Multimedia Creative Services,
Inc., American Gaming Network L.L.C., and Gamebay.com, Inc. The Company's
executive offices are located at 8900 Shoal Creek Blvd., Suite 300, Austin,
Texas, 78757, and its telephone number is (512) 371-7100.
MegaBingo(TM), MegaCash(TM), MegaBingo Lite(TM), MegaMania(TM),
FlashCash(TM), Big Cash Bingo(TM), Flash 21 Bingo(TM) and Evergreen(TM) are
trademarks and tradenames of the Company, and all references herein are deemed
to include the applicable tradename or trademark designation.
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RISK FACTORS
The following risk factors should be carefully considered in connection
with the other information and financial statements contained in this Report on
Form 10-K, including Item 7., "Management's Discussion and Analysis of Financial
Condition and Results of Operations."
THE COMPANY OPERATES IN AN UNCERTAIN LEGAL AND REGULATORY ENVIRONMENT. THERE IS
PENDING LITIGATION THAT MAY RESULT IN CERTAIN OF THE COMPANY'S BUSINESS
ACTIVITIES BEING DECLARED ILLEGAL. THERE IS ALSO THE THREAT OF ADDITIONAL
LITIGATION OR CHANGES IN REGULATIONS THAT MAY ADVERSELY AFFECT THE COMPANY'S
BUSINESS.
INDIAN GAMING. All of the Company's business relates to gaming
activities on Indian lands. The operation of gaming on Indian lands is subject
to the Indian Gaming Regulatory Act of 1988 ("IGRA" or the "Gaming Act"), which
also created the National Indian Gaming Commission ("NIGC") to promulgate rules
and regulations to enforce certain aspects of IGRA. Fundamental issues
concerning the scope and intent of IGRA remain unresolved, as do issues relating
to the jurisdiction and authority of the NIGC and other Federal, State, local
and tribal governments and agencies. For example, prior to the initiation by the
Department of Justice of the MegaMania litigation described below, the Company
had received and had relied upon opinions from the NIGC that MegaMania was Class
II gaming. While the NIGC has its own powers of enforcement, the Department of
Justice maintains that it retains enforcement powers over "gambling devices" and
is not bound by NIGC determinations. As a result, the Company faces uncertainty
as to whether it can rely upon NIGC determinations and whether it may face other
actions initiated by the Department of Justice in the future.
While IGRA was intended to preempt state and local regulation of Class
I and Class II gaming, many states are taking an increasingly active role in
attempting to regulate Indian gaming. As a result, the Company faces uncertainty
as to whether actions may be initiated against it by state and local enforcement
agencies.
In addition to the threat of litigation and enforcement actions, this
regulatory uncertainty also increases the cost to the Company of doing business.
Historically, the NIGC has stated that its policy is not to make determinations
as to the Class II status of a game prior to the introduction and actual
operation of the game on Indian lands. As a result, the Company has relied upon
its own interpretation of IGRA and whatever guidance can be found in NIGC
regulations and opinions believed to be analogous. In November, 1999, the NIGC
announced plans to begin ruling on the Class II status of any proposed new game
before it can be introduced. Public hearings on these proposed rules are
scheduled for January, 2000. The outcome of these hearings and proposed rules,
and the impact on new game introduction is uncertain; however, the present
policy requires the Company to make a significant investment in software and
game design without any assurance that the NIGC or others will agree that a game
meets the requirements of Class II gaming. In addition, significant time and
expense is incurred by the Company in communicating and dealing with the
multitude of Federal, State, local and Tribal agencies claiming to have
jurisdiction over aspects of Indian gaming.
MEGAMANIA LITIGATION. The Company has designed and operated its
MegaMania bingo game and related equipment so as to meet the requirements of
Class II gaming under IGRA. Class II gaming is defined by IGRA as including "the
game of chance commonly known as bingo (whether or not electronic, computer or
other technological aids are used in connection therewith)..." However, the
definition of Class II gaming excludes so-called "gambling devices" which are
defined as "electronic or electromechanical facsimiles of any game of chance or
slot machines of any kind." Generally speaking, IGRA allows Class II gaming to
be conducted on Indian lands if the state in which the Indian land is located
permits such gaming for any purpose by any person. Class III gaming, on the
other hand, which includes gaming such as video casino games, slot
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machines, most table games (e.g., blackjack and craps) , most lottery games and
keno, may only be conducted on Indian land pursuant to an agreement between the
Indian tribe and the state in which the tribe is located. The Class III games
and equipment sold and operated by the Company in the state of Washington is
pursuant to an agreement between that state and local Indian tribes.
On December 31, 1997, the U.S. Attorney for the Northern District of
Oklahoma filed a civil forfeiture action in Federal District Court challenging
the Class II status of the Company's interactive bingo game, MegaMania. On
October 23, 1998, the District Court issued a judgment holding that MegaMania
was legal Class II gaming. The decision found that MegaMania was a game of bingo
and that the EPS used to play MegaMania were technological aids to the play of
bingo as permitted by IGRA and were not gambling devices.
On May 14, 1998, the Assistant U.S. Attorney for the Northern District
of California filed a civil forfeiture in Federal District Court that also
challenged the Class II status of MegaMania. On November 23, 1998, the District
Court issued a Memorandum and Order holding that MegaMania was legal Class II
gaming. As with the decision of the Oklahoma District Court, the Order of the
California District Court found that MegaMania was a game of bingo and that the
EPS used to play MegaMania were technological aids to the play of bingo as
permitted by IGRA and were not gambling devices.
The government has appealed both decisions to the applicable Federal
Circuit Court of Appeals. As of December 27, 1999, no action has been taken by
either appellate court on either appeal. The Company is not able to predict what
the outcome of either appeal will be.
If MegaMania is ultimately determined to be Class III gaming, the loss
of the MegaMania business would likely have a material adverse effect upon the
Company's financial condition and results of operation. In addition, if the EPS
used to aid the play of MegaMania are ultimately held to be gambling devices,
all of the other Class II bingo games currently offered by the Company would
likely be adversely effected which would have a material adverse effect upon the
Company's financial condition and results of operations. Even if the Company is
successful on the merits, the legal fees and expenses to be incurred by the
Company related to the MegaMania litigation or any future litigation challenging
the Company's interactive bingo activities will likely be significant.
OTHER CHALLENGES TO INTERACTIVE GAMES; CHANGES IN LAW AND REGULATIONS.
No assurances can be given that there will be no other challenges made to the
legality of the Company's interactive bingo activities or that, if made, the
Company will be successful on the merits. While the Company attempts to design
and operate its Class II games in accordance with IGRA and the regulations and
opinions of the NIGC, it is not always successful in doing so. For example, in
February, 1999, the Company introduced Evergreen as a Class II game. In November
1999, the NIGC issued an opinion that Evergreen was not Class II gaming. As a
result, the Company is modifying those aspects of Evergreen that the NIGC found
objectionable.
There can be no assurance that the NIGC, either on its own initiative
or as the result of pressure from or cooperation with other agencies such as the
Department of Justice, will not enact additional regulations as described above,
or reinterpret existing regulations in a manner that would have a material and
adverse effect upon the Company, including requiring the Company to restructure
its existing contractual arrangements with Indian tribes or requiring changes in
the way the Company's games are conducted so that such games are classified as
Class II. Any such restructuring of the Company's games has the additional risk
that such games will no longer appeal to consumers or be acceptable to the
tribes. There can also be no assurance that IGRA or other Federal laws will not
be amended, or new legislation or regulations enacted, so as to limit the
authority of tribes to self-regulate Class II gaming or to change the definition
of Class II gaming in a manner adverse to the Company's business. In addition,
the NIGC has issued a set of minimum internal control
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standards for Indian bingo hall operations, and will require hall compliance by
February, 2000. Compliance with these standards could have a negative impact on
the Company's interactive games.
THE COMPANY IS ALSO SUBJECT TO OTHER PENDING LITIGATION THAT MAY MATERIALLY AND
ADVERSELY AFFECT ITS FINANCIAL CONDITION. THE COMPANY HAS RECENTLY SETTLED AN
ADVERSE JUDGEMENT WHICH REQUIRES THE COMPANY TO PAY SUBSTANTIAL CASH AMOUNTS IN
THE FUTURE WHICH MAY ADVERSELY EFFECT THE COMPANY'S FUTURE PERFORMANCE.
NETWORK GAMING LITIGATION SETTLEMENT. In December 1999, the Company
entered into an agreement with Network Gaming International Corporation ("NGI")
that settled a $3.1 million verdict against the Company for breach of contract
that had been awarded in November 1999 by a jury in the Federal District Court
for the Northern District of Oklahoma. Pursuant to the settlement, the Company
paid $800,000 to NGI in December 1999, and has agreed to pay NGI an additional
$2.275 million in cash over three years. In addition, the Company delivered
125,000 shares of its Common Stock to NGI. All payments to NGI under the
agreement are secured by a lien on the Company's assets that is junior and
subordinate to the lien of the Company's senior bank lender. If the Company
defaults on its payment obligation to NGI, NGI has reserved the right to pursue
collection of its total judgment, plus interest and attorney's fees, aggregating
$3.5 million, less any amounts previously paid by the Company.
While the Company believes it will be able to meet its obligation to
NGI and its other creditors with cash from operations, there is no assurance
that the Company will be able to do so. In any event, the cash required to pay
NGI and to meet the Company's other obligations will likely have an adverse
effect upon the Company's plans for future growth.
SHAREHOLDER CLASS ACTIONS. On May 29, 1998, a shareholder class action
was filed against the Company in the Federal District Court for the Southern
District of California. Also named as defendants were Gordon T. Graves and Larry
D. Montgomery. The action, which seeks an unspecified amount of damages on
behalf of all similarly situated shareholders, alleges that the Company violated
federal securities laws by making allegedly false and misleading statements
regarding the legality of MegaMania. On July 24, 1998, a similar class action
was filed in the Federal Court for the Northern District of Oklahoma. In January
1999, the two cases were consolidated in the Northern District of Oklahoma. On
March 22, 1999, the class action plaintiffs filed an amended complaint that also
named Clifton E. Lind, the Company's President and Chief Operating Officer, as
an additional defendant and included allegations that the Company violated
federal securities laws by making allegedly false and misleading statements
regarding transactions between the Company and Equipment Purchasing LLC and
Equipment Purchasing II LLC (See Item 13, Certain Relationships and Related
Transactions). On April 19, 1999, the Company filed its Motion to Dismiss all
of the claims of the plaintiffs. The Court has yet to rule on the Company's
Motion. The Company intends to vigorously defend against these claims and
expects to prevail on the merits, although no assurances to that effect can be
given. In any event, the cost of defending against the claims could by
substantial.
THE COMPANY FACES INTENSE COMPETITION.
The Company faces intense competition not only from other providers of
Class II gaming but also from the efforts by many of its existing and potential
Tribal customers to extend into Class III gaming. Given the limitations placed
on Class II gaming, it is difficult for the Company to compete in places where
casino, slot machines and other forms of Class III gaming are permitted.
TO REMAIN COMPETITIVE, THE COMPANY MUST CONTINUE TO DEVELOP NEW PRODUCTS AND
SERVICES THAT APPEAL TO ITS CUSTOMERS AND CONSUMERS.
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The Company believes that an important factor to its future success
will include its continued development of new products that appeal to the tastes
of consumers and the introduction of such products in a timely manner.
Successful product development and introduction depends upon a number of
factors, including the identification of products expected to appeal to consumer
preferences and the timely completion of design and testing. Importantly, any
new or modified gaming products that are intended for the Class II gaming market
will be designed and operated to meet the requirements of Class II gaming. The
Company may or may not solicit the approval of the NIGC that any new or modified
gaming products meet the requirements of Class II gaming. Even if the Company
does solicit NIGC approval, the NIGC may or may not grant approval as the NIGC
has recently indicated an unwillingness to rule on the Class II status of games.
As a result of these and other factors, there can be no assurance that the
Company will continue to develop and introduce new products in a timely manner
that will achieve commercial success.
THE COMPANY IS DEPENDANT UPON A FEW CUSTOMERS.
For the year ended September 30, 1999, one tribe accounted for
approximately 19% of the Company's total gaming revenues, and another tribe
accounted for approximately 12% of the Company's total gaming revenues. Two
tribes each accounted for approximately 17% of gaming revenues in 1998, and one
tribe accounted for approximately 26% of gaming revenues in 1997. No other tribe
accounted for more than 10% of the Company's total gaming revenues in any of
these years. While the Company believes that its relationship with all of its
tribal customers is good, the loss of either of the two tribes would have a
material and adverse effect upon the Company's financial condition and results
of operations.
Approximately 45%, 48% and 45% of gaming revenues during the years
ended September 30, 1999, 1998 and 1997, respectively, were derived from halls
operated by four tribes.
On September 30, 1999, accounts receivable from one tribe accounted for
approximately 22% of total accounts receivable; the same tribe accounted for
approximately 30% of total trade accounts receivable in 1998.
THE COMPANY MAY INCUR PRIZE PAYOUTS IN EXCESS OF GAME REVENUES.
The prizes awarded under the Company's bingo games are based upon
attaining an assumed level of gross game receipts and statistical assumptions as
to the frequency of winners. With respect to its interactive gaming activities,
the Company may experience on any day or over short periods of time a "game
deficit" where the total aggregate amount of prizes paid exceed aggregate game
revenues. In these instances, the Company essentially acts as a "bank" to its
Tribal customers who continue to receive their share of gross game revenues
based upon an assumed level of prize payouts. However, over any statistically
relevant period of time, the Company does not experience any "game deficits" and
is able to replenish any amounts "banked" for its Tribal customers. No
assurances can be given that the Company will not experience abnormally high
rates of jackpot prize wins in the future which may materially and adversely
effect the Company's cash flow on a temporary basis.
With respect to its TV bingo game shows, the Company self-insures
against smaller prizes and obtains insurance through a third party for larger
jackpots. Prize risk is also shared with participating bingo halls through funds
reserved from bingo card sale receipts and deposited into a prize allocation
account.
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THE COMPANY HAS OUTSTANDING A SIGNIFICANT NUMBER OF OPTIONS AND WARRANTS THAT
WOULD DILUTE EXISTING SHAREHOLDERS.
As of September 30, 1999, there were outstanding rights to purchase an
aggregate of 3,313,518 shares of Common Stock at exercise prices ranging from
$2.00 to $9.44 per share (with the vast majority of such rights at exercise
prices ranging from $2.00 to $8.00 per share). Of these outstanding rights,
2,841,099 are immediately exercisable and the remainder become exercisable in
substantially equal annual increments over the next two years. In addition to
such rights, the shares of the Company's Series A Preferred Stock are
immediately convertible into 435,195 shares of Common Stock. To the extent that
such rights and Series A Preferred Stock are exercised or converted, dilution to
the Company's shareholders will occur. Moreover, the terms upon which the
Company will be able to obtain additional equity capital may be adversely
affected, since the holders of such rights and Series A Preferred Stock can be
expected to exercise or convert them at a time when the Company would, in all
likelihood, be able to obtain any needed capital on terms more favorable to the
Company than the exercise terms provided in such securities.
THE COMPANY DOES NOT EXPECT TO PAY ANY DIVIDENDS.
The Company has never declared or paid any cash dividends on its Common
Stock. The Company intends to retain its earnings to finance the growth and
development of its business and therefore does not anticipate paying any cash
dividends on its Common Stock in the foreseeable future.
THIS ANNUAL REPORT CONTAINS FORWARD LOOKING STATEMENTS THAT MAY PROVE
INACCURATE.
This Annual Report on Form 10-K contains various "forward-looking
statements" within the meaning of Federal and state securities laws, including
those identified or predicated by the words "believes," "anticipates,"
"expects," "plans" or similar expressions. Such statements are subject to a
number of uncertainties that could cause the actual results to differ materially
from those projected. Such factors include, but are not limited to, those
described under "Risk Factors". Given these uncertainties, investors are
cautioned not to place undue reliance upon such statements.
PRODUCTS AND SERVICES
GENERAL. The Company designs and develops its own interactive
high-speed bingo games to run over its multi-pathed interactive communications
network. The game design process involves matching game parameters to the needs
of the target consumer group and includes graphics design, software programming
and test feedback. The Company also designs and assembles the electronic player
stations (EPS) used as technological aids to the play of its interactive bingo
games. The EPS, which are essentially smart computer terminals that allow
players to select and play bingo cards by interacting through touching the EPS
screen, are interconnected through a common carrier communications network,
which is the backbone of the Company's multi-pathed interactive network. This
interconnection allows players to compete against one another in a live bingo
game to win a common pooled prize in accordance with the requirements of Class
II gaming. The Company also produces high stakes TV bingo game shows that are
televised live to multiple participating Indian bingo halls linked via closed
circuit satellite and broadband telephone communications networks. The Company
also designs and develops interactive high-speed Class III bingo games for
Indian Tribes in the State of Washington.
In connection with all of these activities, the Company provides its
tribal customers virtually all of the "back office" record keeping necessary to
account for revenues and prize payouts. The Company's systems enable it to
account, by bingo hall and individual EPS, for game revenues and payouts and to
prepare and disseminate reports to its tribal customers.
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INTERACTIVE GAMES. As of December 1, 1999, the Company's offering of
high speed interactive Class II bingo games consisted of MegaMania, FlashCash,
and Big Cash Bingo. The Company has modified and combined aspects of its
FlashCash Bingo and Evergreen Bingo games into a new game called Flash 21 Bingo
which it introduced in December, 1999. All of the interactive games are
variations of bingo and have several attributes in common. For example, to play,
a player first opens an account with a cashier at the bingo hall and is issued a
receipt for the amount deposited containing a personal identification number
("PIN"). Players then use the touch screen on the EPS to input their PIN and
activate the EPS to join a game. Winnings and losses are recorded to each
player's account and the positive balance in a player's account can be claimed
from the cashier at any time. Players can replenish their account by making
additional deposits with the cashier or by inserting money in the bill acceptor
on the EPS. Play commences once the minimum number of players or bingo cards
required for a particular game have logged onto the game. A live ball draw is
conducted at a host Indian bingo hall. The numbers from the ball draw are
transmitted simultaneously via a common carrier digital frame relay
communications network to all other participating bingo halls and appear on the
interconnected EPS participating in the particular game. Players are able to
daub their cards and declare a winning bingo by interacting with the EPS touch
screen or pressing a mechanical button.
The factors that distinguish one game from another are the minimum
number of players or bingo cards required to commence a game, the predetermined
patterns required in order to win a prize, the size and number of prizes, and
the frequency of winning each prize. Each game is also accompanied by its own
unique graphics and sound.
In MegaMania, a game will not begin unless there are at least 48 cards
being played by at least 12 people. Randomly generated cards are displayed at
each EPS and players are given the option of keeping the card(s) displayed,
asking for a different card(s) or not playing the card(s) at all. No player may
play more than eight bingo cards per EPS. Each card played costs an initial 25
cents. The bingo numbers drawn are visually displayed on the EPS screen three at
a time and are also communicated audibly. After each three ball sequence, a
player must take the affirmative step of pressing a "daub" button on the
computer screen to daub, or cover, the called numbers on each card being played.
When a player achieves a straight-line bingo, they are given eight seconds to
declare the "bingo" by using the touch pad on the EPS. If a player fails to
declare the "bingo" within the allotted time, he or she is said to "sleep" the
bingo, and the game continues. After each sequence of three balls are drawn and
announced, the player is given eight seconds to decide whether to continue a
card in play by electing to "ante up" an additional 25 cents per card, or
dropping one or more of the cards from play. Once a card has been dropped, it
cannot be played again during that game. When the first player(s) covers and
declares a straight line "bingo", all players nationwide are notified of the
existence of the bingo. The declaration of "bingo" by a player ends the
straight-line game nationwide. Upon declaring the bingo, the player wins a prize
that is determined by the number of cards being played by all players, the
number of balls that have been drawn, and the number of other players declaring
bingo simultaneously. The largest possible prize comes if a single player is
able to declare bingo after only four balls have been drawn, the lowest
mathematically possible number of ball draws that would allow a player to
declare bingo. Interim prizes are also awarded to each person who covers two
corners of a card based from each three ball draw. A player can win more than
one interim prize by covering more than two corners of the card. If no interim
prize has been awarded prior to a winning straight line bingo, the game
continues until at least one prize is awarded for covering at least two corners
of a card.
In Big Cash Bingo, players win by covering any of 14 basic patterns on
a bingo card: any straight line bingo pattern (12 ways), all four corners (one
way) and a diamond pattern in the middle of the card (one way). Cards costs 25
cents and each player can play up to 15 cards per EPS. A Big Cash Bingo game
ends when a player declares a winning bingo from any one of the 14 winning
patterns. Unlike MegaMania, there is no ante-up feature to keep a card in play
and there are no interim prizes awarded for covering corners. Approximately 40%
of the prize pool is available for the "Near Miss" prize. This is awarded to all
players
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who achieve one of the 14 winning patterns on the next ball drawn after the
initial winning bingo has been declared. Big Cash Bingo also offers a "Grand
Slam" super jackpot for players who pay an extra 25 cents per card at the
beginning of the game and achieve the four number diamond pattern within the
first four balls drawn.
In Flash 21 Bingo, players win by covering any of 21 basic patterns on
a bingo card: any straight line bingo pattern that uses the "free" space (four
ways), any straight line bingo pattern that does not use the "free" space (eight
ways), any corner along with the two spaces adjacent to the corner (four ways),
all four corners (one way) and any corner along with the two adjacent vertical
and horizontal spaces (four ways). Cards costs 25 cents and each player can play
up to 12 cards per EPS. A Flash 21 Bingo game ends when a player declares a
winning bingo from any one of the 21 winning patterns. Unlike MegaMania, there
is no ante-up feature to keep a card in play and there are no interim prizes
awarded for covering corners. Once a winning bingo has been declared, a portion
of the prize pool is awarded to each card that is within one space of having a
winning bingo pattern. In addition, players who achieve a winning bingo within
eight called balls or less are eligible for a "bonus pick" that may award prizes
ranging from $5.00 to $2,500.
VIDEO SCRATCH GAMES. As of December 1, 1999, the Company is one of
three approved suppliers of Class III video lottery systems to Native American
tribes in the State of Washington. Under the terms of the compact between the
tribes and the State, this video lottery system is required to have multiple
servers which distribute the attributes of consideration, chance and prize so
that the only function of each EPS is to graphically display the outcome of each
wager. This system uses EPS substantially similar to the ones used in the
Company's interactive high-speed bingo games.
ELECTRONIC PLAYER STATIONS. The Company currently offers over 8 models
of EPS. Each EPS has a screen that displays the bingo cards being played and the
bingo numbers drawn. The screen also serves as a touch pad that allows a player
to make game decisions, such as which cards to play or drop and to declare a
winning bingo. The EPS house computer terminal equipment that allow the EPS to
communicate with the bingo network. EPS vary according to height, width and
depth (to accommodate, in part, the differing space needs of bingo hall
customers), screen size and other features affecting appearance and the visual
appeal to players.
TV BINGO GAME SHOWS. MegaBingo, MegaCash and MegaBingo Lite are bingo
games and associated TV shows produced by the Company and telecast live to
television monitors at participating bingo halls by means of a closed-circuit,
television satellite and broadband telephone communications network. The
Company's broadcast studio is currently located at a host Indian bingo hall. The
studio houses the equipment used to produce and televise the ball drawings and
verify winning cards, including television production equipment and satellite
up-link equipment. MegaBingo, MegaCash and MegaBingo Lite games are
approximately 12 minutes in duration and represent only a limited percentage of
the total number of bingo games conducted by each participating bingo hall
operator during any given bingo session. MegaBingo affords the opportunity for a
winning player to win a jackpot prize of up to $2,000,000 (paid $100,000 in cash
and the remainder in the form of a 24-year annuity) by having a winning bingo
within a specified number of ball draws and spinning the MegaBingo wheel.
MegaCash, which is conducted on the Company's network each Saturday and Sunday
in matinee sessions, carries a jackpot of $100,000 or, by spinning the MegaBingo
wheel, up to $1,000,000, for players with winning bingos within a specified
number of ball draws. MegaBingo Lite is similar to MegaBingo, but involves fewer
halls and smaller prizes (e.g., jackpot prizes of $25,000). Each game also
carries lesser consolation prizes for players having a winning bingo after more
than a specified number of ball draws. Prizes also vary depending upon the price
paid by a player for a card (e.g.,$2, $3 or $6 per card).
During fiscal 1999, revenues from the Company's TV bingo game shows
were $9.5 million. While the contribution to net margin from these games was
considerably less significant to the Company than from
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its interactive bingo games, the TV bingo game shows are well publicized due to
the potential size of jackpots and offer positive benefits by attracting
additional players to bingo halls.
In support of its live broadcasts, the Company utilizes, among other
things, television production equipment, satellite transmission and reception
equipment, computer hardware and software, conference calling equipment and
specially printed ticket stocks typically imprinted with serial numbers and the
game's logo. The Company has contracted with a vendor for the satellite time
necessary to transmit its telecast games. With the exception of the computer
software, which is custom developed by or on behalf of the Company, all other
gaming equipment and supplies required for the operation of the telecast games
are typically available off-the-shelf from a number of vendors. The Company's
central game computers are located on Indian trust land and communications
equipment is located in the Company's offices in Tulsa, Oklahoma and Austin,
Texas.
GAMING CONTRACTS. Virtually all of the Company's revenues are derived
through contracts with Indian tribes. The Company's contract with each bingo
hall operator typically identifies the games, equipment and services to be
provided by the Company and the terms of payment. In general, the Company and
the tribe share in the "hold" or profit generated from the play of the game in
percentages that vary depending upon levels of profitability. Certain tribes
purchase EPS outright from the Company while others purchase EPS on an
installment basis out of a dedicated percentage of the revenues generated by the
EPS. In some instances, the Company has leased EPS to tribes at rentals based
upon a percentage of the "hold." The video lottery system uses contracts which
have features substantially similar to those for interactive high-speed bingo
games; however, the Company receives a much smaller revenue sharing percentage
than from the high-speed bingo games.
PRIZE FULFILLMENT
INTERACTIVE GAMES. The prizes awarded under the Company's interactive
bingo games are based upon attaining an assumed level of gross game receipts and
statistical assumptions as to the frequency of winners. With respect to its
interactive gaming activities, the Company may experience on any day or over
short periods of time a "game deficit" where the total aggregate amount of
prizes paid exceed aggregate game revenues. In these instances, the Company
essentially acts as a "bank" to its Tribal customers who continue to receive
their share of gross game revenues based upon an assumed level of prize payouts.
However, over any statistically relevant period of time, the Company does not
experience any "game deficits" and is able to replenish any amounts "banked" for
its Tribal customers.
TV BINGO GAME SHOWS. In order to provide protection against the risk
that prizes awarded to players in the MegaBingo, MegaLite and MegaCash games
might exceed game revenues, the terms of the agreements with the various hall
operators that conduct MegaBingo and MegaCash (the "MegaBingo Operators"),
provide that a fixed percentage of gross game receipts from those games (the
"MegaBingo Prize Allocation") is deposited in a prize allocation account from
which prizes, prize fulfillment fees and bank fees are paid ("MegaBingo Prize
Allocation Costs"). The MegaBingo Operator and the Company are each entitled to
a fee (the "MegaBingo Fee") which approximates 15% of gross game receipts
increased by its share of cumulative game surplus and decreased, in the case of
the Company, by 100% of all game deficits. A surplus (or deficit) exists to the
extent that the MegaBingo Prize Allocation exceeds (or is exceeded by) the
MegaBingo Prize Allocation Costs.
Specified initial portions of the MegaBingo Fee are deposited in
separate prize reserve accounts for the MegaBingo Operators from which loans may
be made to the prize allocation account in the event of a game deficit. However,
during the past five years there has never been a game deficit and no loans have
ever been made. Such loans from the MegaBingo Operators' prize reserve accounts
would be liabilities of the Company and would have to be repaid when there are
sufficient funds in the prize allocation account
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available for such purpose. Each MegaBingo Operator is entitled to the return of
its prize reserve funds upon termination of its IGS Agreement. In addition,
those parties who have completed their prize reserve funding obligations are
entitled to receive formula-determined refunds of their respective prize reserve
funds from time to time to the extent it is determined that such funds are not
required to assure the payment of MegaBingo Prize Allocation Costs.
The MegaBingo, MegaLite and MegaCash games are designed assuming a
certain minimum level of gross game receipts, with MegaBingo Prize Allocation
Costs averaged over long periods of time expected to be less than the MegaBingo
Prize Allocation. In order to reduce the need for prize reserve account funds
and to further reduce exposure to game deficits during periods of abnormally
high rates of jackpot prize wins, the Company is party to an agreement (the
"Risk Assumption Agreement") with SCA Promotions, Inc. ("SCA"), which
specializes in prize fulfillment services, to pay jackpot prizes won during the
term of the agreement.
For an administrative fee (based on a fixed percentage of gross game
sales receipts) and prize fulfillment fees (based on a varying percentage of
gross game sales receipts) paid to SCA with funds from the MegaBingo Prize
Allocation, the Company receives an amount equal to the present value of the
jackpot prize payments less a deductible of $13,000. The Company also advances
the first $37,000 of SCA's liability for each prize pay-off, which is
subsequently deducted from fees due SCA. These prize fulfillment funds are then
utilized to satisfy the obligation to the jackpot prize winner through a
lump-sum cash payment or the purchase of an annuity.
SCA may cease its prize fulfillment responsibilities if its total
cumulative prize payouts exceed its fees earned under the contract by
$2,500,000. SCA is required at all times to maintain not less than $500,000 of
prize fulfillment resources in the form of a performance bond or other mutually
acceptable escrow arrangement. The Risk Assumption Agreement expires on December
31, 1999, but has an automatic 30 day extension period during which the Company
expects to negotiate a one year extension to the agreement.
MARKETING, ADVERTISING AND PROMOTION
The Company arranges national and local news coverage of the Company's
games and currently provides press releases to local newspapers regarding recent
jackpot wins as well as the introduction of the Company's games at new network
halls. In addition, the Company uses a variety of focused advertising and
promotion, including direct mailings in localities near network halls
advertising the availability of the Company's games, discount coupons for new
players and the purchase of advertising space in specialized bingo newsletters.
The Company's games typically are prominently featured in the participating
halls' program materials, such as calendars and flyers, and on outdoor
billboards near certain participating halls.
INTELLECTUAL PROPERTY
The Company relies on trade secrets, proprietary know-how and
continuing technological innovation to develop and maintain its competitive
position. However, there can be no assurance that, insofar as the Company relies
on trade secrets and unpatented know-how, others will not independently develop
similar technology or that secrecy will not be breached.
COMPETITION
The Company believes that it competes with virtually all other forms of
gaming, including lotto, table games, sports betting and pari-mutuel wagering.
The intensity of such competition depends upon several factors, including the
nature and accessability of the gaming activity and the demographics of the
players' population. Many of the companies engaged in such gaming activities
have substantially greater financial and personnel resources than the Company.
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The Company also competes with other bingo operations conducted both on
and off Indian lands, including bingo conducted with the use of electronic aids
such as card minders that provide interactivity and enable players to play
multiple numbers of bingo cards simultaneously. Given the limitations placed on
Class II gaming, it is difficult for the Company to compete in places where
casino, slot machines and other forms of Class III gaming are permitted. In
Class II gaming facilities, the Company competes against a growing number of
games and competitors.
EMPLOYEES
As of September 30, 1999, the Company had 173 full-time and part-time
employees, including 12 engaged in field operations, 16 in game design, 13 in
computer operations relating to bingo activities, 14 in accounting functions,
four in the design and assembly of EPS, eight in sales and marketing activities,
four in other general administrative and executive functions and 11 full-time
and part-time bingo hall employees. The Company does not have a collective
bargaining agreement with any of its employees and considers its relationship
with its current employees to be good. The Company also engages five independent
contractors as computer programmers to produce the Company's interactive gaming
software. In addition, approximately 30 individuals were employed by tribes to
operate the Company's games in their respective halls all of whom are reimbursed
by the Company.
GOVERNMENTAL REGULATION
INDIAN GAMING. The operation of gaming on Indian reservations is
subject to the Indian Gaming Regulatory Act of 1988 (25 U.S.C. Sections 2701, et
seq.) (the "Gaming Act" or "IGRA"), which created the National Indian Gaming
Commission (the "NIGC") to promulgate regulations to enforce certain aspects of
IGRA.
IGRA classifies games that may be played on Indian land into three
categories. Class I gaming includes traditional Indian social and ceremonial
games and is regulated only by the tribes. Class II gaming includes bingo,
pull-tabs, lotto, punch boards, tip jars, instant bingo, certain card games
played under limited circumstances and other games similar to bingo if those
games are played at the same location where bingo is played. Class II gaming
does not include gaming conducted with gambling devices which NIGC regulations
have defined as being gambling devices subject to the Johnson Act (see
discussion below). Class III gaming consists of all forms of gaming that are not
Class I or Class II, such as video casino games, slot machines, most table games
and keno.
IGRA provides that Indian tribes may engage in Class II gaming, if (i)
the state in which the Indian reservation is located permits such gaming for any
purpose by any person, (ii) the gaming is not otherwise specifically prohibited
on the Indian reservation by Federal law, (iii) the gaming is conducted in
accordance with a tribal ordinance which has been approved by the NIGC, and (iv)
several other requirements are met, including the requirement that an Indian
tribe shall have the sole proprietary interest and responsibility for the
conduct of gaming, and that primary management officials and key employees must
be licensed by the tribe.
Under IGRA, the NIGC has the power to inspect and examine all Indian
gaming facilities, to conduct background checks on all persons associated with
Class II Indian gaming, to inspect, copy and audit all records of Indian gaming
facilities, and to hold hearings, issue subpoenas, take depositions and adopt
regulations in furtherance of its responsibilities. IGRA authorizes the NIGC to
impose civil penalties for violations of its regulations or of IGRA, and also
imposes Federal criminal sanctions for illegal gaming on Indian reservations and
for theft from Indian gaming facilities.
IGRA also regulates Indian gaming management contracts. IGRA provides
that the NIGC may approve a management contract only after determining that the
contract provides for (i) adequate accounting
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procedures and verifiable financial reports, which must be furnished to the
tribe, (ii) tribal access to the daily operations of the gaming enterprise,
including the right to verify daily gross revenues and income, (iii) minimum
guaranteed payments to the tribe, which must have priority over the retirement
of development and construction costs, (iv) a ceiling on the repayment of
development and construction costs, (v) a contract term not exceeding five years
and a management fee not exceeding thirty percent of net revenues, provided that
the NIGC may approve up to a seven year term and a forty percent return to the
manager if the Chairman of the NIGC is satisfied that the capital investment
required, and the income projections for the particular gaming activity, justify
the larger percentage and longer term. Certain other requirements for approval
of a management contract are specified in the regulations promulgated by the
NIGC.
The NIGC has determined that the agreements pursuant to which the
Company provides its Class II games, equipment and services are service
agreements and not management contracts, thereby allowing the Company to obtain
more favorable terms than would have been permitted had the contracts been
determined to be management contracts. There is no assurance however, that
further review of these agreements by the NIGC are alternative interpretation of
applicable laws and regulations will not require substantial modifications to
the agreements and cause the operations of the Company to be marginally
profitable or even unprofitable.
JOHNSON ACT. Class II gaming is defined by IGRA as including "the game
of chance commonly known as bingo (whether or not electronic, computer or other
technological aids are used in connection therewith)..." However, the definition
of Class II gaming excludes so-called "gambling devices" which are defined as
"electronic or electromechanical facsimiles of any game of chance or slot
machines of any kind." Regulations adopted by the NIGC further define "gambling
devices" as devices prohibited by the so-called Johnson Act.
The Johnson Act defines an illegal gambling device as a "machine or
mechanical device" designed "primarily" for gambling and that, when operated,
delivers money to a player "as the result of the application of an element of
chance." Courts that have considered the scope of the Johnson Act in relation to
IGRA have generally determined that the Johnson Act does not prohibit the use of
electronic aids to bingo that operate to broaden the participation of players to
play against one another rather than against a machine. In the two cases that
specifically addressed the question of the Company's EPS, the two courts also
held that the element of chance was not inherent within the EPS itself (as would
be the case with a slot machine) but rather was inherent to the game of bingo,
thus also taking the Company's EPS outside the scope of the Johnson Act.
OTHER. Existing Federal and state regulations may also impose civil and
criminal sanctions for various activities prohibited in connection with gaming
operations including false statements on applications and failure or refusal to
obtain necessary licenses described in the regulations. Violation of any of
these existing or newly adopted regulations may have a substantial adverse
effect on the Company.
ITEM 2. PROPERTIES
For its operations headquarters in Tulsa, Oklahoma, the Company leases
approximately 9,440 sq. ft. of office space, which expires in October 2001, and
approximately 1,000 sq. ft. of warehouse space which expires in March 2000. For
some of its computer programmers in Dallas, Texas, the Company leases 1,656 sq.
ft. of office space, which expires in December 2002. For its EPS assembly
operations in Austin, Texas, the Company leases approximately 20,000 sq. ft. of
factory space (expiring in February 2001), and for its executive headquarters
leases 3,744 sq. ft. of office space on a month-to-month basis. For its Director
of Software Quality Control, the Company leases 200 sq. ft. of office space in
Ash Grove, Missouri, which expires February 28, 2000. Aggregate annual rentals
under these five leases are approximately $249,000. The Company believes that
such leases will be renewed as they expire or that alternative properties can be
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leased on acceptable terms. At no cost, the Company also houses a portion of its
satellite link equipment in a trailer located adjacent to the Cheyenne-Arapaho
bingo hall in Concho, Oklahoma.
ITEM 3. LITIGATION
See "Item 1. Business-Risk Factors" for a discussion of the material
litigation involving the Company.
In addition, the Company is also the subject of various pending and
threatened claims arising out of the ordinary course of business. Management
believes that any liability resulting from such claims will not have a material
adverse effect on the results of operations or the financial condition of the
Company.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITIES HOLDERS
Not applicable
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PART II
ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS
The Company's Common Stock has been listed on the NASDAQ SmallCap Stock
Market under the symbol MGAM since May 15, 1996. The following table sets forth
the range of the quarterly high and low bid prices for the last two fiscal
years, as reported in the Wall Street Journal.
FISCAL QUARTER HIGH LOW
-------------- ---- ---
First Quarter 1998 $16.875 $13.250
Second Quarter 1998 14.875 8.410
Third Quarter 1998 9.688 2.875
Fourth Quarter 1998 5.125 2.375
First Quarter 1999 7.063 2.500
Second Quarter 1999 7.250 4.125
Third Quarter 1999 7.000 4.250
Fourth Quarter 1999 6.687 5.500
On December 27, 1999, the closing price of the Common Stock as reported
in the Wall Street Journal was $2.468.
There were approximately 150 shareholders of record of the Common Stock
on November 30, 1999, including shares held in street name by Cede & Co. The
Company believes that the shares held in street name are held for more than
1,500 beneficial owners.
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ITEM 6. SELECTED FINANCIAL DATA
The following table presents selected financial information for the
Company as of the end of and for each of the five years in the period ended
September 30, 1999, which has been derived from the audited Financial Statements
of the Company. The selected financial data should be read in conjunction with
the Financial Statements of the Company and notes thereto and "Management's
Discussion and Analysis of Financial Condition and Results of Operations."
1999 1998 1997 1996 1995
-------------- ------------- -------------- ------------- ------------
INCOME STATEMENT DATA:
Revenues $88,856,000 $70,537,000 $39,052,000 $22,887,000 $17,112,000
Operating income (loss) (3,708,000) 3,545,000 997,000 202,000 591,000
Net income (loss) (2,505,000) 2,215,000 1,311,000 40,000 505,000
Earnings (loss) per share:
*Basic (.48) .40 .29 (.04) .26
*Diluted (.48) .35 .23 (.04) .24
- --------------------
*Earnings (loss) per share for 1995 and 1996 have not been changed from amounts
reported in those years. See Note 1 of Notes to Consolidated Financial
Statements - Income Per Common Share.
BALANCE SHEET DATA:
Working capital (deficit) (4,709,000) 4,808,000 3,846,000 172,000 292,000
Total assets 28,880,000 19,725,000 15,400,000 7,431,000 5,118,000
Long-term obligations 3,701,000 1,960,000 2,278,000 2,959,000 1,375,000
Stockholders' equity 10,502,000 12,677,000 10,277,000 2,394,000 2,119,000
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
BUSINESS OVERVIEW
The Company designs and develops interactive high-speed Class II bingo
and Class III video lottery games and related electronic player stations (EPS)
and equipment that are marketed to Native American bingo halls located
throughout the United States. The Company operates its interactive bingo games
on behalf of its tribal customers through a multi-pathed communications network.
The network interconnects EPS located at multiple bingo halls thereby enabling
players to simultaneously participate in a live bingo game and to compete
against one another to win a common pooled prize. The EPS enable players to log
on to the network, select the bingo cards of their choice and to interact with
the game to make game decisions such as whether to continue a card in play,
daubing or "covering" a number on a card and declaring a winning bingo. The
Company also produces high stakes TV bingo game shows that are televised live to
multiple participating Indian bingo halls linked via closed circuit satellite
and broadband telephone communications networks.
Most of the Company's games and equipment are designed and operated to
meet the requirements for Class II gaming as defined in the Indian Gaming
Regulatory Act of 1988. During fiscal 1999, the Company also designed, developed
and marketed Class III games and equipment in the state of Washington. As of
September 30, 1999, there were 4,420 EPS in operation at 80 independently owned
Indian gaming facilities located in eight states and the District of Columbia,
of which 520 EPS were Class III, located in four bingo halls in the state of
Washington. This compares to 3,271 Class II EPS that were in operation at
September 30, 1998 at 64 bingo halls located in 11 different states. Also as of
September 30, 1999, the Company's live TV
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bingo game show, MegaBingo, was being delivered to 32 independently owned Indian
bingo halls located in nine different states, a decrease of 15 bingo halls
compared to September 30, 1998.
In February 1999, the Company terminated its MegaRacing operation,
which was started in May 1998 to transmit horse racing signals to Indian
operated OTB facilities pursuant to compacts with the state of Oklahoma. During
fiscal 1999, the Company formed Gamebay.com, Inc. as a wholly-owned subsidiary
to pursue the development of non-gambling activities on the Internet using
interactive bingo games as a platform to derive advertising and product sale
revenues. In December 1999, Gamebay.com entered into a licensing agreement with
MGAM to use all of MGAM's intellectual property for non-gambling internet
applications for a one time fee of $1.0 million (of which $400,000 is payable
after one year) and a perpetual royalty of five percent of Gamebay's gross
revenue. In connection with the license grant, Gamebay issued approximately 70%
of its shares of common stock (including preferred stock convertible into common
stock) in a private placement to a group of investors for $5.5 million.
RESULTS OF OPERATIONS
An analysis of the Company's gaming revenues and direct gaming expenses
were as follows for the years ended September 30, 1999, 1998 and 1997.
1999 1998 1997
------------ ------------ ------------
Interactive Bingo Gaming:
Gaming Revenue, Net of Prizes(1) ....... $ 73,109,000 $ 49,467,000 $ 20,507,000
Allotments to Hall Operators ........... (54,120,000) (37,846,000) (15,334,000)
------------ ------------ ------------
Net Interactive Gaming Profit .......... $ 18,989,000 $ 11,621,000 $ 5,173,000
============ ============ ============
TV Bingo Game Shows:(2)
Gross Revenues ......................... $ 9,687,000 $ 12,173,000 $ 13,504,000
Bingo Prizes and Related Costs ......... (7,602,000) (8,823,000) (9,381,000)
Allotments to Hall Operators ........... (1,425,000) (1,741,000) (2,568,000)
------------ ------------ ------------
Net TV Bingo Profit .................... $ 660,000 $ 1,609,000 $ 1,555,000
============ ============ ============
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(1) Interactive gaming gross revenues and prizes are netted for financial
statement presentation purposes.
(2) TV bingo game shows consist of MegaBingo, MegaCash and MegaBingo Lite.
The following discussion should be read in conjunction with the
Consolidated Financial Statements and Notes thereto included under Item 8.
Financial Statements.
FISCAL 1999 COMPARED TO FISCAL 1998
REVENUES - Total revenues for fiscal year 1999 were $88.9 million as
compared to $70.5 million in 1998, a 26% increase. This increase is primarily a
result of the increase in gaming revenues from interactive games, which
generated revenues of $73.1 million during 1999 as compared to $49.5 million in
1998, a 48% increase. The increase in interactive gaming revenues for 1999
primarily resulted from newly installed electronic player stations and games,
including approximately $220,000 from Class III video lottery equipment
introduced in 1999.. The Company had an average of approximately 3,600
electronic player stations in daily operation during the year ended September
30, 1999, compared to an average of approximately 2,140 during the year ended
September 30, 1998. TV bingo game show revenues decreased $2.7 million or 22% in
1999 as compared to 1998, primarily as the result of player headcount being down
at most bingo facilities across the country, and several bingo halls electing
not to continue playing MegaBingo during 1999.
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Revenue from sales of electronic player stations decreased by $3.4
million, going from $5.0 million in 1998 to $1.6 million in 1999. The decrease
was primarily due to a discontinuation of the sale of player stations to related
parties.
Lease revenues from electronic player stations leased to Indian tribes
increased slightly from $3.4 million in 1998 to $3.5 million in 1999. In 1999,
$673,000 of lease revenue came from the lease of Class III video lottery
equipment, which is a new product line for MGAM. Other revenue increased from
$458,000 in 1998 to $912,000 in 1999 primarily as a result of a $345,000
increase in revenue from MegaRacing, which was discontinued in February 1999,
and a $75,000 increase in back-office fees associated with the Company's Class
III operations.
BINGO PRIZES AND RELATED COSTS - Bingo prizes and related costs
decreased $1.2 million or 14% during 1999 as compared to 1998. The decrease is
commensurate with the decrease in TV bingo game show revenues discussed above.
Interactive gaming revenues are recorded net of prize costs; therefore, these
prize costs are not reflected in bingo prizes and related costs.
ALLOTMENTS TO HALL OPERATORS - Allotments to hall operators consist of
the halls' share of the gaming income after prizes and allocable prize costs.
Allotments to hall operators increased 40% to $55.5 million in 1999, as compared
to $39.6 million in 1998. The primary reason for the increase is hall
commissions related to interactive gaming where the allotment to hall operators
increased from $37.8 million in 1998 to $54.1 million in 1999, an increase of
43%, which is commensurate with the overall increase in interactive gaming
revenue. The decrease in hall commissions related to TV bingo game shows is
caused primarily by the decrease in MegaBingo revenues discussed above.
COST OF ELECTRONIC PLAYER STATIONS SOLD - Cost of electronic player
stations sold were $1.0 million in 1999 as compared to $2.7 million in 1998, or
a decrease of $1.7 million. The decrease was due to the lower number of
electronic player stations sold in 1999 and the discontinuation of the sale of
player stations to related parties, as discussed above. The gross margin on
electronic player station sales was $661,000 in 1999 and $2.3 million in 1998.
SALARIES AND WAGES - Salaries and wages increased $1.8 million, or 61%
during 1999 as compared to 1998. Most of the increase relates to additional
personnel hired in late fiscal 1998 or during fiscal 1999 to address the needs
of the Company's interactive gaming network, such as installation, training and
maintenance, the operation of interactive game ball draw equipment, increased
manufacturing activities, and the pursuit of new business including the Class
III video lottery business. Accrued vacation increased in the fourth quarter by
approximately $108,000 as the Company agreed to pay an amount that was greater
than the Company's vacation policy upon which prior quarterly accruals during
1999 had been based.
SELLING, GENERAL AND ADMINISTRATIVE EXPENSES - Selling, general and
administrative expenses increased $3.0 million, or 31% during 1999 as compared
to 1998. Approximately $1.1 million, or 35% of the increase was for repair and
maintenance of the Company's larger and older fleet of EPS used in its
interactive gaming activities. This included the cost of new EPS replacement
glass for new games and an adjustment of the repair inventory pool. The Company
reviewed each category of inventory and other property and determined that
approximately $705,000 of inventory and other property should be written down
for a number of reasons, including obsolescence, the discontinuance of the
project or product line to which the property related, and the use of certain
items of finished goods inventory for repair and spare parts. Travel costs
increased $0.3 million, or 37% primarily because of the increase in field
service and repair activity. Rental costs increased $0.6 million because of
frame relay communications expansion associated with expanded interactive gaming
networks. Employee benefits increased $0.5 million because of the larger staff,
including increases in health and life insurance premiums and 401(k)
contributions. The reserve for bad debt increased $0.3 million in fiscal 1999,
primarily due to the nonpayment of accounts due from MegaRacing customers; other
MegaRacing expenses increased $0.3 million in fiscal 1999.
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Contract labor, postage and shipping and advertising each increased by
approximately $200,000 in support of the expanded interactive network. Insurance
expense increased $100,000 for the same reason. These increases were offset by a
reduction in legal expenses of $1.2 million, excluding the NGI lawsuit legal
fees which are classified separately in the Company's statement of operations.
NGI JUDGMENT AND RELATED EXPENSES - The Company's most substantial
expense increase was the $4.5 million in settlement, legal, and other costs
related to the NGI litigation and the resulting judgment against the Company
(see "Item 1, Business-Risk Factors" and Notes 4 and 8 of Notes to Consolidated
Financial Statements).
AMORTIZATION AND DEPRECIATION - Amortization and depreciation increased
$3.2 million, or 108% during 1999 as compared to 1998, primarily as a result of
depreciation on a greater number of EPS in service during 1999 as compared to
1998. The increase is also the result of a $466,000 increase in depreciation on
a greater number of EPS under lease in 1999, amortization of EPS and software
programming costs capitalized during 1998 and 1999, (approximately $400,000 of
the increase) the amortization of EPS units repurchased during fiscal 1999
(approximately $648,000 of the increase), and the rapid write-off (approximately
$459,000 of the increase) of leased Class III EPS as the result of the unusually
short pay back time of these leased units. The Company made $14.0 million in
capital additions during 1999.
INTEREST INCOME - Interest income decreased from $284,000 in 1998 to
$192,000 in 1999 primarily because fewer EPS were sold for cash and notes
receivable.
INCOME TAX - Income tax increased to a tax benefit of $1.3 million in
1999 from an expense of $1.5 million in 1998. The 1998 income tax expense
represents an effective tax rate of 40% on pretax income of $3.7 million. The
tax benefit at an effective rate of 34% in 1999 resulted primarily from
non-deductible expenses for tax purposes.
FISCAL 1998 COMPARED TO FISCAL 1997
REVENUES - Total revenues for fiscal year 1998 were $70.5 million as
compared to $39.1 million in 1997, an 80% increase. The increase was due to an
81% increase in gaming revenues over 1997, primarily as a result of the
Company's interactive games which generated revenues of $49.5 million during
1998 as compared to $20.5 million in 1997. The increase in interactive gaming
revenues for 1998 primarily resulted from newly installed electronic player
stations and games. The Company had an average of approximately 2,140 electronic
player stations in daily operation during the year ended September 30, 1998,
compared to an average of approximately 950 during the year ended September 30,
1997. TV bingo game show revenues decreased $1.3 million or 10% in 1998 as
compared to 1997, primarily as the result of player headcount being down at most
bingo facilities across the country, and several bingo halls electing not to
continue playing MegaBingo during 1998.
Revenue from sales of electronic player stations increased by $1.8
million, going from $3.2 million in 1997 to $5.0 million in 1998, with $1.3
million of the increase coming from related party sales. The increase was
primarily due to the sale of 984 units in 1998 as compared to 616 units in 1997.
Of the 984 units sold in 1998, 663 were sold to Equipment Purchasing II L.L.C.,
an entity controlled by Gordon T. Graves, the
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Company's Chairman of the Board and Chief Executive Officer. Of the 616 units
sold in 1997, 456 were sold to Equipment Purchasing L.L.C., an entity owned and
controlled by Mr. Graves.
Lease revenues from electronic player stations leased to Indian tribes
grew from $1.8 million in 1997 to $3.4 million in 1998. This increase is due to
the expansion of the number of EPS out on lease to various tribes.
Other revenues increased by $.4 million in 1998 as compared to 1997.
The primary reasons for the increase were the introduction of MegaRacing in 1998
with revenues of $280,000 and management fees of $175,000 derived from equipment
sold to Equipment Purchasing L.L.C. and Equipment Purchasing II, L.L.C.
BINGO PRIZES AND RELATED COSTS - Bingo prizes and related costs
decreased $.6 million or 6% during 1998 as compared to 1997. The decrease in
these costs is commensurate with the decrease in TV bingo game show revenues
discussed above. Interactive gaming revenues are recorded net of prize costs;
therefore, the prizes have no effect on bingo prizes and related costs.
ALLOTMENTS TO HALL OPERATORS - Allotments to hall operators consist of
the halls' share of the gaming income after prizes and allocable prize costs.
Allotments to hall operators increased 121% to $39.6 million in 1998, as
compared to $17.9 million in 1997. The primary reason for the increase is hall
commissions related to interactive gaming where the allotment to hall operators
increased from $15.3 million in 1997 to $37.8 million in 1998, an increase of
147%. The decrease in hall commissions related to TV bingo game shows is caused
primarily by the decrease in MegaBingo revenues discussed above.
COST OF ELECTRONIC PLAYER STATIONS SOLD - Cost of electronic player
stations sold were $2.7 million in 1998 as compared to $1.7 million in 1997, or
an increase of $1.0 million. Cost of electronic player stations sold associated
with related party sales were $1.9 million in 1998, or an increase of $.7
million over 1997. The overall increase was due to the higher number of
electronic player stations sold in 1998, as discussed above. The gross margin on
electronic player station sales was $468,000 in 1998 and $270,000 in 1997, and
the gross margin for related party sales was $1.9 million and $1.3 million in
1998 and 1997, respectively.
SALARIES AND WAGES - Salaries and wages increased $.8 million, or 35%
during 1998 as compared to 1997. Most of the increase relates to additional
personnel hired to assist in the installation, training and maintenance related
to the interactive gaming network.
SELLING, GENERAL AND ADMINISTRATIVE EXPENSES - Selling, general and
administrative expenses increased $4.9 million, or 98% during 1998 as compared
to 1997. Approximately 45% or $2.2 million of the increase was the result of the
MegaMania litigation and legal and regulatory activities. The remainder of the
increase was primarily due to an increase in travel of $.4 million, an increase
in interactive gaming telecommunications of $.4 million, an increase in employee
benefits of $.4 million, an increase of $.3 million in advertising and
promotions and an increase in consulting and contract labor of $.2 million, all
related to the expansion of the interactive gaming network. In addition, there
was a write-off of capitalized software cost of $.4 million.
AMORTIZATION AND DEPRECIATION - Amortization and depreciation increased
$1.2 million, or 66% during 1998 as compared to 1997. The increase results from
electronic player stations and software programming costs capitalized during
1998 and 1997. The Company made $6.0 million in capital additions during 1998.
INTEREST INCOME - Interest income increased $255,000 in 1998 primarily
as a result of electronic player stations sold for cash and notes receivable.
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INCOME TAX - Income tax expense increased to $1.5 million in 1998 from
a tax benefit of $.5 million in 1997. The 1998 increase is the result of greater
pretax income in 1998 and reflects an effective tax rate of 40% on pretax income
of $3.7 million. The tax benefit in 1997 resulted from the removal of a
valuation allowance related to net operating losses.
FUTURE EXPECTATIONS AND FORWARD-LOOKING STATEMENTS
This Annual Report and the information incorporated herein by reference
contains various "forward-looking statements" within the meaning of Federal and
state securities laws, including those identified or predicated by the words
"believes," "anticipates," "expects," "plans," or similar expressions. Such
statements are subject to a number of uncertainties that could cause the actual
results to differ materially from those projected. Such factors include, but are
not limited to, those described under "Item 1. Business Risk Factors". Given
these uncertainties, readers of this Annual Report are cautioned not to place
undue reliance upon such statements.
LIQUIDITY AND CAPITAL RESOURCES
At September 30, 1999, the Company had unrestricted cash and cash
equivalents of $1.3 million, a $586,000 decrease from September 30, 1998. During
the years ended September 30, 1999 and 1998, $4.7 million and $5.5 million,
respectively, of cash was provided by operations. The Company used $12.6 million
and $6.0 million, respectively, in investing activities in 1999 and 1998, almost
entirely for additions to fixed assets, consisting primarily of software
development for interactive gaming and hardware for interactive gaming player
stations and game operation. The Company's increase in net cash from financing
activities of $7.3 million in 1999 compared to 1998 resulted from increased
borrowings under a new credit facility with a bank entered into during 1999. The
Company had negative working capital of $4.7 million at September 30, 1999
versus positive working capital at September 30, 1998 of $4.8 million.
During the year ended September 30, 1998, the Company incurred legal and
professional fees and expenses of approximately $3.2 million, or an increase of
$2.6 million when compared to the year ended September 30, 1997. Most of the
increase was incurred in the second quarter of fiscal 1998, as the Company
responded to the December 31, 1997 actions by the Tulsa U.S. Attorney in
attempting to shut-down the Company's MegaMania bingo game. During fiscal 1999,
the Company incurred legal and professional fees of $2.0 million, exclusive of
the NGI litigation and related settlement, or a decrease of $1.2 million
compared to fiscal 1998. While legal fees and expenses related to MegaMania and
other litigation involving the Company will continue to be significant in fiscal
2000, such fees and expenses are not expected to approach the levels seen in
fiscal 1999. However, this expectation could change if the level of activity in
the pending shareholder class action increases from that presently anticipated.
On July 29,1999 the Company entered into a revolving credit facility
with Coast Business Credit, a Division of Southern Pacific Bank, located in Los
Angeles, California. Pursuant to the credit facility, the Company may borrow up
to $10,000,000, or such lesser amount as is permitted under various borrowing
base formulas. As of September 30, 1999, under the most restrictive of the
borrowing base formulas, there was $9,000,000 of borrowings available to the
Company, of which $8,137,000 had been borrowed and was outstanding. The credit
facility expires in July 2002 and is secured by all assets of the Company and
the personal guarantee of $1,500,000 from the Company's Chairman and CEO Gordon
T. Graves. The initial application of the funds available under this facility
were used to pay $1,900,000 of debt owed to two other banks, approximately
$2,400,000 was used for the repurchase of EPS owned by the EP LLC II partnership
and approximately $4,000,000 was used to relieve outstanding accounts payable,
which for the most part included components for the manufacture of Class III
video lottery devices and past due legal and professional fees. Borrowings under
the facility bear interest, payable monthly, at a rate equal to the greater of
9% or 1.75% above the prime rate from time to time in effect. All of the
Company's revenues are deposited into a "blocked" account controlled by the Bank
and disbursements from the "blocked" account may be made only with the approval
of the Bank. In December 1999, the credit facility was amended in connection
with obtaining Coast's consent to the terms of the settlement of the NGI
litigation. The amendment waives any
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defaults that may have resulted from the settlement, increases the early
termination fee payable by the Company in the event the Company prepays the
credit facility prior to its maturity in July 2002, and requires the Company to
pay a $100,000 fee to Coast in consideration for the amendment.
The Company believes that its current operations, including the payment
of its expected legal fees and expenses, and the payments to NGI under the
settlement agreement can be sustained from cash from operations. The Company has
adequate inventory on hand to support the assembly and installation of
approximately 700 additional EPS to further expand the Company's interactive
gaming operations, requiring little cash from future operations. In addition,
the Company has approximately 300 used EPS available for use in its rental pool.
To expand interactive gaming operations beyond this 1,000 unit level will
require funding from external sources. Due to the terms of the credit facility
with Coast Business Credit and the settlement agreement with NGI, including the
fact that both are secured by all of the Company's assets, it is not likely that
the Company can refinance these obligations from other sources in the forseeable
future. The inability to obtain additional financing when needed could have a
material adverse effect on the Company's ability to achieve its planned
objectives as well as any expectations the market might have about the Company's
future performance.
CONTINGENCIES
For information regarding contingencies, see "Item 3. Litigation."
INFLATION AND OTHER COST FACTORS
The Company's operations have not been, nor are they expected to be,
materially affected by inflation. However, the Company's operational expansion
is affected by the cost of hardware components, which are not considered to be
inflation sensitive, but rather sensitive to changes in technology and
competition in the hardware markets. In addition, the Company expects it will
continue to incur increased legal and other similar costs associated with
compliance with regulatory requirements and the uncertainties present in the
operating environment in which the Company conducts its business.
RECENTLY ISSUED ACCOUNTING PRONOUNCEMENTS
In June 1998, the Financial Accounting Standards Board issued Statement
of Financial Accounting Standards No. 133 ("FAS 133"), Accounting for Derivative
Instruments and Hedging Activities. FAS 133 is effective for transactions
entered into after January 1, 2000. FAS 133 requires that all derivative
instruments be recorded on the balance sheet at fair value. Changes in the fair
value of derivatives are recorded each period in current earnings or other
comprehensive income, depending on whether a derivative is designated as part of
a hedge transaction and the type of hedge transaction. The ineffective portion
of all hedges will be recognized in earnings. Because of the Company's minimal
use of derivatives, adoption of this statement will have not have a significant
impact on the Company's results of operations.
IMPACT OF YEAR 2000 ("Y2K")
The "Year 2000 Issue" is the result of computer programs that were
written using two digits rather than four to define the applicable year. If the
Company's computer programs with date-sensitive functions are not Y2K compliant,
they may recognize a date using "00" as the Year 1900 rather than the year 2000.
This could result in a system failure or miscalculations causing disruptions of
operations, including, among other things, a temporary inability to process
transactions, send invoices or engage in similar normal business activities.
The Company has identified its Y2K risk in three categories: Internal
business software, interactive game software and TV bingo game show software.
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INTERNAL BUSINESS SOFTWARE - During 1997 and 1998, as part of a
business modernization program intended to reduce time and improve
profitability, the Company purchased the windows system of MAS 90, which the
software vendor has indicated is Y2K compliant. The Company implemented this
system and other ancillary financial systems during fiscal 1999. This system
includes a detailed manufacturing and inventory system. The Company believes it
is in full Y2K compliance with its internal financial systems for the year 2000.
However, if due to unforeseen circumstances, the Y2K implementation is not
successful, it could have a material impact on the operations. Accordingly,
contingency plans have been established. The cost of making any adaptations is
not expected to be material and would be expensed in the period incurred.
INTERACTIVE GAME SOFTWARE - The Company's interactive games have been
configured using the Microsoft four digit system which is Y2K compliant. All
current games and system components have been tested, and all communication
services vendors have certified that their systems are Y2K compliant.
TV BINGO GAME SHOW SOFTWARE - Printer software and game management
software for the TV game show system has been rewritten, tested and installed to
achieve Y2K compliance. There is a contingency plan to use preprinted cards at
all sites if there is a software or hardware failure.
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
Except for the effects of short term interest rates under the Company's
line of credit, which the Company does not consider material, the Company is not
subject to any other interest rate, exchange rate or commodity price risks.
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
The financial statements filed in this Annual Report on Form 10-K are
listed in the Index to Financial Statements appearing in Part IV, Item 14.
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE
The Company has had no disagreements with its accountants on accounting
or financial disclosure issues. The disclosures called for related to changes in
accountants have been previously reported by the Company in Form 8-K's filed by
the Company with the Securities and Exchange Commission on July 1, 1999 and
October 5, 1999
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PART III
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT.
The executive officers and directors of the Company, and their
respective ages and positions with the Company are as follows:
NAME AGE POSITION
---- --- --------
Gordon T. Graves 62 Chairman of the Board, Chief Executive
Officer and Director
Clifton E. Lind 53 President and Chief Operating Officer
Gordon T. Sjodin 58 President of MegaBingo Inc.
Michael E. Newell 48 Vice President
Robert F. Lannert 44 Vice President
Gary L. Loebig 50 Vice President
Frank W. Rehanek, Jr. 38 Chief Financial Officer
Larry D. Montgomery 61 Vice Chairman of the Board and Director
Thomas W. Sarnoff 71 Director
Ali P. Alizadeh 36 Director
- -----------------------
GORDON T. GRAVES has been Chairman of the Board and a director of the
Company since its inception, and has been Chief Executive Officer since
September 1994. Since December 1993 and from 1989 to 1990, Mr. Graves has been
the President of Graves Management, Inc., a management consultant and investment
company. From 1992 through December 1993, Mr. Graves was president and Chief
Executive Officer of Arrowsmith Technologies, Inc. ("Arrowsmith"), a computer
systems company. From 1991 to 1993, Mr. Graves was employed by KDT Industries,
Inc., a high-tech manufacturing and services company and an affiliate of
Arrowsmith, as, successively, Vice President of Corporate Development and
President. From 1987 to 1989, Mr. Graves was the Chairman of the Board of
Directors of Gamma International Ltd. (currently American Gaming and
Entertainment, Ltd., a company co-founded by him).
CLIFTON E. LIND has been the President and Chief Operating Officer of
the Company since June 1998. From January 1997 until joining the Company as
President, Mr. Lind was President of Celmark, Inc., an Austin, Texas based
company owned by Mr. Lind that provided management and financial consulting
services to start-up companies and that provided financial consulting services
to the Company. From 1991 to 1993, Mr. Lind was the Executive Vice President,
Chief Operating Officer and Chief Financial Officer of KDT Industries, where he
worked with Mr. Graves. From 1994 until January 1997, Mr. Lind was the President
and Chief Executive Officer of KDT Industries
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GORDON T. SJODIN was Vice President of the Company since September 1994
prior to being elected President of the Company's wholly-owned subsidiary,
MegaBingo, Inc., in December 1998. In April 1994, Mr. Sjodin joined MegaBingo,
Inc., as its Vice President - Sales and served in such position until September
1994, when he became Vice President of the Company. From August 1989 until April
1994, Mr. Sjodin was employed by American Gaming and Entertainment ("AGE") as,
successively, Director, Sales and Marketing, and Director, Corporate
Development.
MICHAEL E. NEWELL has been Vice President of the Company since
September 1994. In April 1994, Mr. Newell joined MegaBingo, Inc. as its Vice
President-Chief Operating Officer and served in such position until November
1995, when he became Senior Vice President- of game operations for the Company.
From 1988 until April 1994, Mr. Newell was employed by AGE as Director,
MegaBingo operations.
ROBERT F. LANNERT has been Vice President of the Company since August
1997. Mr. Lannert has been employed by the Company since June 1996 as supervisor
of its computer and data processing operations. From 1988 until August 1995, Mr.
Lannert was Director of data processing for Debartolo Racing at Remington Park,
Oklahoma City, Oklahoma , and from August 1995 until joining the Company, Mr.
Lannert was Vice President of Operations for Spector Entertainment Group.
GARY L. LOEBIG was elected a Vice President of the Company for New
Market Development in December 1998. Since 1984, Mr. Loebig was employed by
Stuart Entertainment, dba Bingo King, Omaha, Nebraska, a publicly traded company
engaged in the manufacture and sale of bingo cards and related equipment and
products. With Bingo King, Mr. Loebig served in various capacities, beginning as
general sales manager and last serving as Senior Vice President - Market and
Product Development.
FRANK W. REHANEK, JR. has been the Chief Financial Officer of the
Company since September, 1999. He has been the Corporate Controller since
February of 1997. In addition, Mr. Rehanek serves as the accounting systems
coordinator, creating custom reports for management using MAS90 accounting
software. Prior to joining the Company, Mr. Rehanek was Controller of the
Oklahoma Corporate Credit Union. A Certified Public Accountant with 15 years of
experience in industry, Mr. Rehanek graduated from Northeastern State University
in Tahlequah in 1983.
LARRY D. MONTGOMERY has been a director of the Company since November
1992. Mr. Montgomery was the President of the Company from November 1992 until
December 1996, having held the position of Chief Executive Officer from November
1992 through September 1994. From December 1991 until December 1993, Mr.
Montgomery was also a private consultant to gaming companies. From 1989 through
1991, Mr. Montgomery was the President of Public Gaming Research Institute, and
from 1987 to 1989 was the Executive Director of the Kansas State Lottery. Mr.
Montgomery is currently an independent consultant to the Company specializing in
regulatory affairs.
ALI P. ALIZADEH has been a Director of the Company since August 1999.
Mr. Alizadeh is currently a Senior Vice President in the Corporate Finance
Department of Jefferies & Company, Inc., an investment banking firm. Mr.
Alizadeh joined Jefferies in May 1999 to focus on origination of transactions in
the gaming and leisure industries. Mr. Alizadeh has completed in excess of $550
million in over 45 transactions for corporate, tribal and vendors in the gaming
industry. He has substantial industry expertise and is a frequent speaker at
various gaming conferences. Prior to joining Jefferies, Mr. Alizadeh spent two
years at Dain Rauscher and five years at Miller & Schroeder. He has also held
corporate finance positions at Citicorp, N.A. in Chicago and New York. He holds
a B.A. in Economics from Macalester College, and an M.B.A. in Finance from the
University of Rochester's Simon School of Business in Rochester, New York.
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THOMAS W. SARNOFF was elected as a director of the Company in December
1997, to fill the vacancy resulting from the resignation of his son, Daniel J.
Sarnoff. Thomas W. Sarnoff was employed by the National Broadcasting Company,
Inc. ("NBC") for over 25 years, holding positions that included Vice President,
Production and Business Affairs, Executive Vice President of West Coast
activities, and last serving as President of NBC Entertainment Corporation from
1969 to 1977. After retiring from NBC in 1977, Mr. Sarnoff has been engaged in
the production of television and film entertainment, primarily through Sarnoff
Entertainment Corporation which was formed in 1981. Mr. Sarnoff serves on many
civic and charitable organizations and is currently the President and a member
of the Board of Directors of the Academy of Television Arts & Sciences
Foundation.
All directors hold office until the next annual meeting of shareholders
or until their successors are elected and qualified. Officers are appointed by
the Board of Directors and serve at the discretion of the Board.
No family relationship exists between any of the directors or executive
officers of the Company, except that Thomas W. Sarnoff is the father of Daniel
J. Sarnoff, the President of the Company's Gamebay.com subsidiary. See Item 13,
Certain Relationships and Related Transactions.
MEETINGS OF BOARD OF DIRECTORS
During the fiscal year ended September 30, 1999, the Board of Directors
held 5 meetings. During that period no Director attended fewer than 100% of the
aggregate of (i) the total number of meetings of the Board of Directors held
during the period for which he was a director, and (ii) the total number of
meetings held by all Committees of the Board of Directors on which he served
during the period that he served on such Committees.
BOARD COMMITTEES MEETINGS AND MEMBERSHIP
The Company has an Audit Committee of the Board of Directors, whose
members are Messrs. Alizadeh, Graves and Montgomery, and a Compensation
Committee whose members are Messrs. Alizadeh, Graves and Sarnoff.
The Audit Committee meets with management and the Company's independent
accountants to determine the adequacy of internal controls and other financial
matters. The Compensation Committee reviews general policy matters relating to
compensation and benefits of employees and officers of the Company and
administers the Company's stock option plans. The Audit Committee held 2
meetings in fiscal 1999, and the Compensation Committee held 1 meeting in fiscal
1999.
REPORT OF THE COMPENSATION COMMITTEE
OVERVIEW AND PHILOSOPHY
The Compensation Committee (the "Committee") of the Board of Directors
regularly reviews and approves all executive officer pay plans and develops
recommendations for stock option grants for approval by the Board of Directors.
These include the following major compensation elements: base salaries, annual
cash incentives, stock options and various benefit plans.
The Committee is composed of Mr. Sarnoff and Mr. Alizadeh, independent,
outside directors, and Mr. Graves, an employee director. It is the Committee's
objective that executive compensation be directly determined by achievement of
the Company's planned business performance. Specifically, the Company's
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executive compensation program is designed to reward exceptional performance
that results in enhanced corporate and share values.
The Committee recognizes that the industry sector in which the Company
operates is both highly competitive and is challenged by significant legal and
regulatory uncertainty with the result that there is substantial demand for
qualified, experienced executive personnel. The Committee considers it crucial
that the Company be assured of retaining and rewarding its top caliber
executives who are essential to the attainment of the Company's ambitious
long-term goals.
For these reasons, the Committee believes the Company's executive
compensation arrangements must remain competitive with those offered by other
companies of similar size, scope, performance levels and complexity of
operations.
CASH COMPENSATION
The Committee believes that annual cash compensation should be paid
commensurate with attained performance. For these reasons, the Company's
executive cash compensation consists of "fixed" base compensation (salary) and
variable incentive compensation (annual bonus). Base salaries for executive
officers are established considering a number of factors, including the
executive's individual performance and measurable contribution to the Company's
success, and pay levels of similar positions with comparable companies in the
industry. The Committee supports the Company's compensation philosophy of
moderate fixed compensation for elements such as base salary. Base salary
decisions are made as part of the Company's structured annual review process.
STOCK OPTIONS
The Committee recommends executive stock options under the Company's
stock option plans to foster executive officer ownership and to provide direct
linkage with shareholder interests. The Committee considers options previously
granted, industry practices, the executive's accountability level, and assumed,
potential stock value in the future when granting stock options. The Committee
recommends option amounts to provide retention considering projected earnings to
be derived from option gains based upon relatively aggressive assumptions
relating to growth and earnings. In this manner, executive gains closely
parallel those of other shareholders over the long-term. Therefore, the stock
option program serves as an effective long-term incentive and retention tool for
the Company's executives, as well as other key employees. The exercise prices of
stock options granted to executive officers are equal to the market value of the
stock on the date of grant. Therefore, stock options provide an incentive to
executives to maximize the Company's profitable growth which ordinarily, over
time, should be reflected in the price of the Company's stock.
BENEFITS
The Company provides benefits to the named executive officers that are
generally available to all Company employees. The amount of executive level
benefits and prerequisites, as determined in accordance with the rules of the
Securities and Exchange Commission relating to executive compensation, did not
exceed 10% of total salary and bonus for fiscal year 1999, for any executive
officer.
CHIEF EXECUTIVE OFFICER PERFORMANCE AND COMPENSATION
In setting Mr. Grave's base salary for fiscal 1999, the Committee took
note of the Company's rapid growth in revenue and earnings in fiscal 1998, the
fact that Mr. Grave's salary was below the norm for the industry, and that he
has never been compensated with any Company stock options. Mr. Grave's
compensation for fiscal 1999 was $122,000 in base salary, with a bonus of
$20,000.
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It is the opinion of the Committee that the aforementioned compensation
policies and structures provide the necessary discipline to properly align the
Company's corporate economic performance and the interest of the Company's
shareholders with progressive and competitive executive compensation practices
in an equitable manner.
THE COMPENSATION COMMITTEE:
Ali P. Alizadeh
Thomas W. Sarnoff
Gordon T. Graves
COMPENSATION COMMITTEE INTERLOCKS AND INSIDER PARTICIPATION IN COMPENSATION
DECISIONS
Mr. Alizadeh is an officer and employee of Jefferies & Company, Inc.,
which has been engaged to act as the exclusive financial advisor to the Company
in connection with financing and acquisition related activities. Mr. Sarnoff is
the father of Daniel J. Sarnoff, the President of the Company's Gamebay.com
subsidiary. Mr. Graves is the Chairman of the Board and Chief Executive Officer
of the Company and is also a Director of Gamebay.com. See Item 13. Certain
Relationships and Related Transactions.
SECTION 16(a) BENEFICIAL OWNERSHIP REPORTING COMPLIANCE.
During the fiscal year ended September 30, 1999, two officers, Gary L.
Loebig and Frank W. Rehanek, Jr., and one director, Ali Alizadeh, were
delinquent in making filings under Section 16(a) of the Securities Exchange Act
of 1934, as amended. Each was delinquent in timely filing Form 3's upon becoming
an officer and a director, respectively, of the Company.
ITEM 11. EXECUTIVE COMPENSATION
SUMMARY COMPENSATION TABLE. The following table sets forth certain
information concerning the annual compensation for the Company's chief executive
officer and for each other executive officer earning more than $100,000 for the
fiscal year ended September 30, 1999 (the "named executive officers"):
SUMMARY COMPENSATION TABLE
LONG-TERM
COMPENSATION
AWARDS
SECURITIES
ANNUAL UNDERLYING
COMPENSATION OPTIONS/ ALL OTHER
FINANCIAL POSITION YEAR AMOUNT WARRANTS(#)(1) COMPENSATION(2)
- ------------------ ---- ------ -------------- ---------------
Gordon T. Graves 1999 $ 142,009 0 $ 3,514
Chairman and CEO 1998 87,308 (3) 4,213
1997 70,000 (4) 3,877
Clifton E. Lind (5) 1999 180,162 0 3,628
President and COO 1998 156,733 338,000 2,492
Larry D. Montgomery(6) 1999 143,000 0 0
1998 171,777 22,500 3,560
1997 115,160 10,000 6,474
Gordon T. Sjodin 1999 120,522 10,000 4,073
Executive Vice President 1998 115,731 10,100 7,647
1997 120,360 5,000 7,222
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(1) Consists of shares of Common Stock underlying options granted pursuant to
the Company's 1994 Employee Stock Option Plan, 1996 Stock Incentive Plan
and President's Plan. (See "Stock Plans" below).
(2) Consists of contributions made by the Company on behalf of the named
executive officers to the Company's 401(k) plan.
(3) Does not include shares of Common Stock underlying warrants issued to
Equipment Purchasing II L.L.C. See Item 13. Certain Relationships and
Related Transactions.
(4) Does not include (i) shares of Common Stock underlying warrants issued to
Equipment Purchasing L.L.C., or (ii) shares of Common Stock issuable upon
the exercise by AGN Ventures of a put right. See Item 13. Certain
Relationships and Related Transactions.
(5) Mr. Lind became President and COO of the Company in June, 1998. Fiscal 1998
compensation includes amounts paid to Mr. Lind since that date and for the
period commencing October 1, 1997 through June, 1998 while Mr. Lind served
as a consultant to the Company. Does not include shares of Common Stock
underlying warrants issued to Equipment Purchasing II L.L.C. See Item 13.
Certain Relationships and Related Transactions.
(6) Mr. Montgomery served as President of the Company during 1996 and 1997 and
resigned as President in December 1997. Mr. Montgomery remained an employee
of the Company until April 1998 at which time he became a consultant.
Amounts paid in 1998 include all amounts paid to Mr. Montgomery while an
employee, and amounts paid to him as a consultant after April 1998. Amounts
paid in 1999 include all amounts paid Mr. Montgomery pursuant to his
consulting agreement with the Company. See Item 13. Certain Relationships
and Related Transactions.
OPTION/WARRANT GRANT TABLE. The following table sets forth certain
information regarding options and warrants granted by the Company during its
fiscal year ended September 30, 1999 to the named executive officers.
OPTION/WARRANT GRANTS IN LAST FISCAL YEAR
Individual Grants
NUMBER OF % OF TOTAL
SECURITIES OPTIONS/
UNDERLYING WARRANTS
OPTIONS/ GRANTED TO
WARRANTS EMPLOYEES IN PRICE EXPIRATION
NAME GRANTED (#) FISCAL YEAR PER SHARE DATE
---- ----------- ----------- --------- ----
Gordon T. Graves -- -- -- --
Clifton E. Lind -- -- -- --
Larry D. Montgomery -- -- -- --
Gordon T. Sjodin 10,000 8.3% $3.81 Nov 2008
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AGGREGATE OPTION/WARRANT EXERCISES AND YEAR-END OPTION TABLE. The
following table sets forth certain information regarding the exercise of stock
options and warrants during the fiscal year ended September 30, 1999, and the
unexercised stock options and warrants held as of September 30, 1999, by the
named executive officers.
NO. OF
SHARES
ACQUIRED VALUE NO. OF SECURITIES VALUE OF UNEXERCISED
UPON REALIZED UNDERLYING UNEXERCISED IN-THE-MONEY OPTIONS AT
NAME EXERCISE $ OPTIONS AT FY-END FY-END (1)
---- -------- ----- ----------------- ----------
EXERCISABLE UNEXERCISABLE EXERCISABLE UNEXERCISABLE
----------- ------------- ----------- -------------
Gordon T. Graves (2) -- -- -- - -- --
Clifton E. Lind (2) -- -- 195,000 143,000 -- --
Larry D. Montgomery -- -- 3,750 11,250 -- --
Gordon T. Sjodin -- -- 52,150 17,450 $ 36,562 --
- -------------------------
(1) Market value of the underlying Common Stock at fiscal year end ($3.3125 per
share), minus the exercise price.
(2) Does not include shares of Common Stock underlying warrants issued to
Equipment Purchasing L.L.C., or Equipment Purchasing II L.L.C.. See Item
13. Certain Relationships and Related Transactions.
STOCK PLANS
In November 1994, the stockholders of the Company approved the
Company's 1994 Employee Stock Option Plan (the "1994 Plan") and the 1994
Director Stock Option Plan ("Director Plan"), under which options to purchase an
aggregate of 360,000 shares and 60,000 shares, respectively, of Common Stock
were reserved for issuance. As of September 30, 1999, options to purchase
135,525 shares and 20,000 shares, respectively, of Common Stock were outstanding
under the 1994 Plan and the Director Plan. After the adoption of the Company's
1996 Stock Incentive Plan, no new options were granted under the 1994 Plan or
the Director Plan.
In August 1996, the Board of Directors adopted the Company's 1996
Incentive Stock Plan, which was amended effective March 1, 1999 (the "1996
Plan") pursuant to which 795,127 shares of Common Stock or Common Stock
equivalents may be issued.
The 1996 Plan is administered by the Board of Directors of the Company
(the "Administrator"). The Administrator has the authority, subject to the terms
of the 1996 Plan, to determine when and to whom to make grants under the 1996
Plan, the number of shares to be covered by the grants, the types and terms of
"Awards" to be granted under the 1996 Plan (which are stock based incentives and
may include incentive stock options, non-qualified stock options, stock
appreciation rights, restricted stock, performance shares and deferred stock
purchases), the exercise or purchase price of the shares of Common Stock and
Common Stock equivalents subject to the Awards, and to prescribe, amend and
rescind rules and regulations relating to the 1996 Plan.
As of September 30, 1999, there were outstanding under the 1996 Plan
options to purchase 352,350 shares of Common Stock, all at an exercise price of
$3.81 per share, except for 10,000 shares at an exercise price of $6.875 per
share.
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31
In connection with the employment of Clifton E. Lind as President of
the Company in June 1998, the Company established the President's Plan pursuant
to which options to purchase 338,000 shares of Common Stock at $3.81 per share
were granted to Mr. Lind. The options are intended to qualify as incentive stock
options, subject to approval of the stockholders of the Company at the next
annual meeting of stockholders. Approximately a third of the options became
exercisable in December 1998, with the balance becoming exercisable in
substantially equal installments over the next three years. Vesting of the
options accelerate if Mr. Lind is terminated without cause or upon a change of
control of the Company.
In connection with the employment of Mr. Loebig in November, 1998, the
Company established the 1998 Senior Executive Stock Option Plan, pursuant to
which Mr. Loebig was granted options to purchase 50,000 shares of Common Stock
at $3.81 per share.
See Note 7 of Notes to Consolidated Financial Statements
STOCK PRICE PERFORMANCE GRAPH
The following graph compares on a cumulative basis the percentage
change, since September 30, 1994, in the total shareholder return on the
Company's Common Stock, with (a) the total return on the NASDAQ Composite Index,
which is being used as the required broad entity market index, and (b) the total
return for a selected peer group index (the "Peer Group"). The Peer Group
consists of Mikohn Gaming, Silicon Gaming, Stuart Entertainment, and Interlott
Technologies. The graph assumes (i) investment of $100 on September 30, 1994 in
the Company's Common Stock, the NASDAQ Composite Index and the common stock of
the Peer Group, and (ii) the reinvestment of all dividends.
NASDAQ
DATE MGAM PEER GROUP COMPOSITE INDEX
- ------------------ ---------------- --------------- ------------------
September 30, 1994 100.00 100.00 100.00
September 30, 1995 122.67 71.88 136.54
September 30, 1996 383.33 73.21 160.53
September 30, 1997 891.67 78.30 220.56
September 30, 1998 177.07 38.37 221.62
September 30, 1999 220.87 26.71 359.31
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ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
The following table sets forth certain information as of September 30,
1999, with respect to the number of shares of Common Stock and of Series A
Preferred Stock owned by (i) each person known by the Company to own
beneficially more than 5% of the outstanding shares of, respectively, the Common
Stock and the Series A Preferred Stock, (ii) each director of the Company, (iii)
each named executive officer, and (iv) all directors and executive officers of
the Company as a group:
COMMON STOCK PREFERRED STOCK
------------ ---------------
NUMBER OF NUMBER OF
SHARES SHARES
BENEFICIALLY PERCENT BENEFICIALLY PERCENT
BENEFICIAL OWNER OWNED OF CLASS(1) OWNED OF CLASS(1)
---------------- ------------ ----------- ------------ -----------
Gordon T. Graves
1604 Crested Butte 1,097,249(2) 19.85 80,175(3) 88.8%
Austin, Texas 78746
Clifton E. Lind
2 Las Brisas 220,717(4) 3.99 -- --
Austin, Texas 78746
Larry D. Montgomery
1920 S. West Union Road 106,934(5) 1.93 1,411 1.5
Topeka, Kansas 66615
Gordon T. Sjodin
5804 E. 104th Street 75,693(6) 1.39 1,272 1.4
Tulsa, Oklahoma 74137
Thomas W. Sarnoff
2451 Century Hill 11,250(7) (8) -- --
Los Angeles, California 90067
All executive officers and directors
as a group 1,600,511(10) 28.98 83,351 91.8
(10 persons)
- -------------
(1) Based upon 5,528,149 shares of Common Stock and 90,789 shares of Series A
Preferred Stock outstanding.
(2) Consists of (i) 581,545 shares owned of record by Graves Properties, Ltd.,
a limited partnership controlled by Mr. Graves, (ii) 51,000 shares owned by
Graves Management, Inc. Defined Benefit Trust (Graves Management, Inc. is a
corporation controlled by Mr. Graves), (iii) 44,200 shares owned of record
by Mr. Graves, (iv) 400,875 shares issuable upon the conversion of the
Series A Preferred Stock, and (v) 19,629 shares issuable upon the
exercising of warrants that are currently exercisable. Does not include an
aggregate of 90,600 shares as to which Mr. Graves disclaims beneficial
ownership, consisting of: (i) 44,100 shares owned of record by Cynthia
Graves, Mr. Graves' wife, and (ii) 46,500 shares beneficially owned by the
Gordon Graves Grandchildren Trust.
(3) Consists of (i) 5,175 shares owned of record by Mr. Graves, and (ii) 75,000
shares owned of record by Graves Properties, Ltd., a limited partnership
controlled by Mr. Graves.
(4) Consists of (i) 6,088 shares owned of record by Mr. Lind, (ii) 195,000
shares issuable upon the exercise of options that are currently
exercisable, and (iii) 19,629 shares that are issuable upon the exercise of
warrants that are currently exercisable.
-32-
33
(5) Consists of (i) 96,129 shares owned of record by Mr. Montgomery, (ii) 7,055
shares issuable upon conversion of the Series A Preferred Stock, and (iii)
3,750 shares issuable upon the exercise of options currently exercisable.
(6) Consists of (i) 13,433 shares owned of record by Mr. Sjodin, (ii) 55,900
shares issuable upon the exercise of stock options that are currently
exercisable (52,150 shares) or are exercisable within the next 60 days
(3,750 shares), and (iii) 6,360 shares issuable upon conversion of the
Series A Preferred Stock.
(7) Consists of shares issuable upon the exercise of stock options that are
currently exercisable.
(8) Less than 1%.
(9) Consists of (i) 798,771 shares owned of record, (ii) 348,000 shares
issuable upon the exercise of stock options that are currently exercisable
(337,263 shares) or are exercisable within the next 60 days (10,937
shares), (iii) 414,290 shares issuable upon conversion of Series A
Preferred Stock, and (iv) 39,250 shares issuable upon the exercise of
warrants that are currently exercisable.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
EQUIPMENT PURCHASES
On October 1, 1998, the Company exercised its option to acquire 356
electronic player stations and related equipment (EPS) for $1,448,000 from
Equipment Purchasing LLC ("EP LLC"), a limited liability company owned by an
affiliate of Gordon T. Graves, the Chairman and Chief Executive Officer of the
Company. The Company had originally sold the EPS to EP LLC in June and September
1997 at an aggregate sales price of approximately $2,436,000. Pursuant to
agreements entered into at the time of the June and September 1997 sale
transactions, the Company had an option to repurchase the EPS from EP LLC at
fair market value. While the purchase price paid by the Company was not the
result of an arms-length negotiation with an unaffiliated third party, the
Company believes that such purchase price is comparable to what the Company
would have paid to an unaffiliated third party. The purchase price was paid by
(i) cancellation by the Company of $992,000 in notes receivable due from EP LLC,
(ii) the assumption by the Company of $77,800 in debt owed by the affiliate of
Mr. Graves to a financial institution, (iii) the payment by the Company of
$133,000 to EP LLC, (iv) the delivery to EP LLC of a 6% promissory note of the
Company in the principal amount of $133,000 due on April 1, 1999 (which was
later extended to September 30, 1999), (v) the issuance of 50,000 warrants to
purchase shares of common stock of the Company at $3.81 per share expiring on
June 30, 2002, and (vi) the issuance of 50,000 warrants to purchase shares of
common stock of the Company at $3.81 per share expiring on September 30, 2002.
On October 1, 1998, the closing price of the Company's common stock as quoted on
the NASDAQ SmallCap market was $2.50 per share. The warrants, which were valued
by the Company and EP LLC at $112,000, were issued in cancellation of warrants
to purchase the same number of shares that had been granted to EP LLC in
connection with the June and September 1997 sale transactions at exercise prices
of $11.00 and $13.38 per share. The $133,000 paid to EP LLC was applied by the
affiliate of Mr. Graves to pay a portion of outstanding notes due the Company by
such affiliate.
On July 31,1999 the Company exercised its option to acquire 663 EPS for
$2,373,623 from Equipment Purchasing II LLC ("EP LLC II), a limited liability
company controlled by an affiliate of Gordon T. Graves, the Chairman and Chief
Executive Officer of the Company, and of which an affiliate of Mr. Graves and
Clifton E. Lind, the Company's President and Chief Operating Officer, each owned
6.36%. The Company had originally sold the EPS to EP LLC II in March and June
1998 at an aggregate sales price of approximately $3,750,000. Pursuant to
agreements entered into at the time of the March and June 1998 sale
transactions, the Company had an option to repurchase the EPS from EP LLC II at
fair market value if, after giving effect to the repayment and the income
previously received by EP LLC II, EP LLC II would receive at least a 20% return
on its net investment. While the purchase price paid by the Company was not the
result of an arms-length negotiation, the Company believes that such purchase
price is comparable to what the Company would have paid to an unaffiliated third
party.
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CONSULTING AGREEMENT
On April 15, 1998, the Company entered into a Consulting Agreement, as
later amended, with Larry D. Montgomery, a Director of the Company. Mr.
Montgomery was the President and COO of the Company until December 1997. The
Consulting Agreement has a term of five years, but may be terminated by either
party with six months notice given at any time after January 1, 1999. The
Company gave notice of termination of the agreement on September 30, 1999, but
expects it will continue to use the services of Mr. Montgomery on a month to
month basis after the agreement expires in March 2000. Mr. Montgomery is
compensated at the rate of $126,000 annually. The Company has also agreed to pay
the cost of all premiums on life, health and disability insurance for Mr.
Montgomery and his family for five years and, during the term of the agreement,
will pay Mr. Montgomery rent of $1,000 per month for the use of office space in
Topeka, Kansas.
ENGAGEMENT OF JEFFERIES & COMPANY
On September 1, 1999, the Company engaged Jefferies & Company, Inc.
("Jefferies"), an investment banking firm located in Santa Monica, California,
to act as the exclusive financial advisor to the Company in connection with
financing and acquisition related activities. Mr. Ali Alizadeh, a Director of
the Company, is an officer and employee of Jefferies. Pursuant to the agreement,
the Company agreed to pay Jefferies a fee of $120,000 (at the rate of $10,000
per month for 12 months). In addition, the Company agreed to pay Jefferies a
"success fee" for any financing or acquisition transaction consummated by the
Company during the term of the agreement which may be terminated by either party
upon notice.
GAMEBAY.COM
During fiscal 1999, the Company established Gamebay.com, Inc.
("Gamebay") as a wholly-owned subsidiary to pursue non-gaming activities on the
Internet. In July 1999, Gamebay granted options to Gordon T. Graves, the
Chairman and Chief Executive Officer of the Company, and to Daniel J. Sarnoff,
the President of Gamebay and the son of Thomas W. Sarnoff, a Director of the
Company, to purchase 29,800 shares and 59,600 shares, respectively, of the
common stock of Gamebay at $1.00 per share. The Company determined the fair
value of these options as of the date of grant and recognized a minimal
compensation expense. In December 1999, Gamebay completed the private placement
of approximately 70% of its common stock (including preferred stock convertible
into common stock) to a group of investors at $5.00 per share. The options
granted to Mr. Graves have been valued at $2,980, which has been reflected in
the Summary Compensation Table as compensation paid to Mr. Graves in 1999.
Gregory N. Stern, a former Director of the Company who resigned in June
1999, was involved with establishing Gamebay while he was a Director of the
Company. In connection with his resignation, the Company agreed to pay Mr. Stern
two percent (2%) of whatever interest the Company retained or received in
Gamebay, including two percent (2%) of the 490,000 shares of common stock of
Gamebay held by the Company and two percent (2%) of any royalties received by
the Company from Gamebay pursuant to a license to use the Company's intellectual
property.
INDEBTEDNESS OF CERTAIN OFFICERS AND DIRECTORS
During fiscal 1999, Mr. Graves was indebted to the Company in the
amount of $755,169, of which $117,066 was repaid during the year, leaving a
balance of $638,103 owed the Company at September 30, 1999. Substantially all of
the amount owed by Mr. Graves bears interest at 6% per annum, which is accrued
and payable upon the maturity of the note in February 2001.
The amount owed by Mr. Montgomery is evidenced by a note due in April
2001, and bears interest at 6% per annum, payable annually.
-34-
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ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K
THE FOLLOWING REPORTS AND FINANCIAL STATEMENTS ARE INCLUDED IN PART II, ITEM 7-
FINANCIAL STATEMENTS:
Independent Certified Public Accountants' Report................................................................39
Report of Independent Certified Public Accountants..............................................................40
Consolidated Balance Sheets, September 30, 1998 and 1999........................................................41
Consolidated Statements of Operations, Years Ended September 30,
1999, 1998 and 1997...................................................................................42
Consolidated Statements of Changes in Stockholders Equity, Years Ended
September 30, 1999, 1998 and 1997.....................................................................43
Consolidated Statements of Cash Flows, Years Ended September 30,
1999, 1998 and 1997...................................................................................44
Notes to Consolidated Financial Statements......................................................................45
Schedule II Valuation and Qualifying Accounts...................................................................68
(a) THE FOLLOWING EXHIBITS ARE FILED AS PART OF THIS ANNUAL REPORT:
EXHIBIT NO. TITLE LOCATION
- ----------- ----- --------
3.1 Amended and Restated Articles of Incorporation (3)
3.2 Bylaws (1)
10.1 Form of Integrated Gaming Services Agreement (1)
10.2 Contingent Grand Prize Risk Assumption Agreement
dated October 1, 1995, between the Company and SCA Promotions, Inc. (2)
10.3 Form of 1992-3 Warrant Certificate Issued by the Company (1)
10.4 Form of 1995 Warrant Certificate Issued by the Company (1)
10.5 Registration Rights Agreement dated January 23, 1995 between the Company
and holders of certain Warrants (1)
10.6 Registration Rights Agreement dated January 23, 1995
between the Company and holders of certain Warrants (1)
10.7 Registration Rights Agreement among the Company and holders of
certain Warrants (2)
10.8 1994 Employee Stock Option Plan (1)
10.9 1994 Director Stock Option Plan (1)
10.10 1996 Stock Incentive Plan, as amended (7)
10.11 President's Plan (6)
10.12 1998 Senior Executive Stock Option Plan (7)
10.13 Form of Class A Warrant (4)
10.14 Form of Class B Warrant (4)
10.15 Warrant Agreement dated November 12, 1996 between
the Company and Corporate Stock Transfer, as Warrant Agent (4)
10.16 Amendment to Warrant Agreement, dated July 18, 1997 (4)
10.17 Consulting Agreement, dated April 15, 1998, between
the Company and Larry D. Montgomery. (6)
10.18 Amendment to Consulting Agreement dated August 31, 1998. (6)
10.19 Shareholder Rights Plan (5)
21.1 Subsidiaries of Registrant (8)
23.1 Consent of PricewaterhouseCoopers LLP (8)
23.2 Consent of BDO Seidman, LLP (8)
24.1 Power of Attorney (included on page 38) (8)
27.1 Financial Data Schedule (8)
- ------------
-35-
36
(1) Indicates incorporated by reference to the Company's Form 10-KSB filed with
the Commission for the fiscal year ended September 30, 1994.
(2) Indicates incorporated by reference to the Company's Form 10-KSB filed with
the Commission for the fiscal year ended September 30, 1996.
(3) Indicates incorporated by reference to the Company's Form 10-QSB filed with
the Commission for the quarter ended March 31, 1997.
(4) Incorporated by reference to the Company's registration statement on Form
8-A, filed with the Commission on July 29, 1997.
(5) Incorporated by reference to the Company's registration statement on Form
8-A, filed with the Commission on October 23, 1998.
(6) Indicates incorporated by reference to the Company's Form 10-KSB filed with
the Commission for the fiscal year ended September 30, 1998.
(7) Incorporated by reference to the Company's Proxy Statement filed with the
Commission on April 8, 1999.
(8) Filed herewith
(b) REPORTS ON FORM 8-K.
On July 1, 1999, the Company filed a Report on Form 8-K to report the
termination of PricewaterhouseCoopers LLP as the independent auditors of the
Company and the engagement of Arthur Andersen & Co. as the Company's new
auditors. On October 5, 1999, the Company filed a Report on Form 8-K to report
the resignation of Arthur Andersen & Co. as the independent auditors of the
Company and the engagement of BDO Seidman, LLP as the Company's new auditors
-36-
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POWER OF ATTORNEY
Know all men by these presents, that each person whose signature
appears below constitutes and appoints Gordon T. Graves and Clifton E. Lind, and
each of them singly, his or her true and lawful attorneys-in-fact and agents,
with full power of substitution and resubstitution, for him or her and in his or
her name, place and stead, in any and all capacities (including his or her
capacity as a director or officer of Multimedia Games, Inc.) to sign any and all
amendments (including post-effective amendments) to this Annual Report, and to
file the same, with all exhibits thereto, and other documents in connection
therewith, with the Securities and Exchange Commission, granting unto said
attorneys-in-fact and agents, and each of them, full power and authority to do
and perform each and every act and thing requisite and necessary to be done in
and about the premises, as fully to all intents and purposes as he or she might
or could do in person, hereby ratifying and confirming all that said
attorneys-in-fact and agents or any of them, or their or his substitute or
substitutes, may lawfully do or cause to be done by virtue thereof.
SIGNATURES
In accordance with Section 13 or 15(d) of the Securities Exchange Act
of 1934, the Registrant has duly caused this report to be signed on its behalf
by the undersigned hereunto duly authorized.
MULTIMEDIA GAMES, INC.
Dated: December 28 , 1999 By: /s/ Frank W. Rehanek, Jr.
-----------------------------------
Frank W. Rehanek, Jr.
Chief Financial Officer
In accordance with the requirements of the Securities Exchange Act of
1934, this Annual Report has been signed by the following persons on behalf of
the Registrant in the capacities and on the dates indicated.
/s/ Gordon T. Graves Chairman of the Board
- ------------------------- Chief Executive Officer and
Gordon T. Graves Director December 28, 1999
/s/ Frank W. Rehanek, Jr. Chief Financial Officer December 28, 1999
- -------------------------
Frank W. Rehanek, Jr.
/s/ Larry D. Montgomery Vice Chairman of the Board
- ------------------------- and Director December 28, 1999
Larry D. Montgomery
/s/ Thomas W. Sarnoff Director December 28, 1999
- -------------------------
Thomas W. Sarnoff
/s/ Ali P. Alizadeh Director December 28, 1999
- -------------------------
Ali P. Alizadeh
-37-
38
SUPPLEMENTAL INFORMATION TO BE
FURNISHED WITH REPORTS FILED PURSUANT TO
SECTION 15(d) OF THE EXCHANGE ACT BY
NON-REPORTING ISSUERS
The Registrant has not sent to its security holders any annual report
covering the Registrant's last fiscal year, or any proxy statement, form of
proxy or other proxy soliciting material with respect to any annual or meeting
of security holders. In connection with its year 2000 annual meeting of
stockholders, the Company anticipates sending its fiscal 1999 annual report
and proxy materials to security holders.
-38-
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INDEPENDENT CERTIFIED PUBLIC ACCOUNTANTS' REPORT
To the Board of Directors
and Stockholders
Multimedia Games, Inc.
We have audited the accompanying consolidated balance sheet of Multimedia Games,
Inc. and subsidiaries at September 30, 1999, and the related consolidated
statements of operations, stockholders' equity, and cash flows for the year then
ended. In connection with our audit of the consolidated financial statements, we
also have audited the financial statement schedule for the year ended September
30, 1999, listed in the accompanying index. These consolidated financial
statements and financial statement schedule are the responsibility of the
Company's management. Our responsibility is to express an opinion on these
consolidated financial statements and financial statement schedule based on our
audit.
We conducted our audit in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audit provides a reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above present
fairly, in all material respects, the consolidated financial position of
Multimedia Games, Inc. and subsidiaries at September 30, 1999, and the results
of their operations and their cash flows for the year then ended in conformity
with generally accepted accounting principles. Also, in our opinion, the related
financial statement schedule for the year ended September 30, 1999, when
considered in relation to the basic consolidated financial statements taken as a
whole, presents fairly, in all material respects, the information set forth
therein.
BDO SEIDMAN, LLP
Houston, Texas
December 27, 1999
-39-
40
REPORT OF INDEPENDENT CERTIFIED PUBLIC ACCOUNTANTS
To the Board of Directors
and Stockholders
Multimedia Games, Inc.
In our opinion, the accompanying consolidated balance sheet and the
related consolidated statements of operations, changes in stockholders' equity
and cash flows present fairly, in all material respects, the financial position
of Multimedia Games, Inc. and Subsidiaries at September 30, 1998, and the
results of their operations and their cash flows for each of the two years in
the period ended September 30, 1998, in conformity with generally accepted
accounting principles. These financial statements are the responsibility of the
Company's management; our responsibility is to express an opinion on these
financial statements based on our audits. We conducted our audits of these
financial statements in accordance with generally accepted auditing standards
which require that we plan and perform the audit to obtain reasonable assurance
about whether the financial statements are free of material misstatement. An
audit includes examining, on a test basis, evidence supporting the amounts and
disclosures in the financial statements, assessing the accounting principles
used and significant estimates made by management, and evaluating the overall
financial statement presentation. We believe that our audits provide a
reasonable basis for the opinion expressed above.
PricewaterhouseCoopers LLP
Tulsa, Oklahoma
December 4, 1998
-40-
41
MULTIMEDIA GAMES, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
AS OF SEPTEMBER 30, 1999 AND 1998
ASSETS 1999 1998
------------ ------------
CURRENT ASSETS:
Cash $ 1,295,000 $ 1,881,000
Accounts Receivable:
Trade 1,897,000 1,556,000
Game reserve 721,000 459,000
Other 291,000 637,000
Allowance for doubtful accounts (527,000) (181,000)
Inventory 3,121,000 2,534,000
Prepaid expenses 559,000 568,000
Notes receivable 490,000 783,000
Notes receivable - related parties -- 1,227,000
Deferred tax asset 1,500,000 246,000
------------ ------------
Total current assets 9,347,000 9,881,000
------------ ------------
Restricted cash and long-term investments 2,075,000 1,636,000
Inventory - non-current 1,300,000 --
Property and equipment, net 15,421,000 7,653,000
Other assets 320,000 110,000
Goodwill, net 417,000 445,000
------------ ------------
Total assets $ 28,880,000 $ 19,725,000
============ ============
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Notes Payable $ 8,137,000 $ 70,000
Current portion of long-term debt 1,586,000 336,000
Accounts payable and accrued expenses 4,161,000 4,371,000
Prize fulfillment fees payable 172,000 296,000
------------ ------------
Total current liabilities 14,056,000 5,073,000
------------ ------------
Long-term debt, less current portion 1,885,000 531,000
Other long-term liabilities 1,816,000 1,429,000
Deferred tax liability 621,000 15,000
Commitments and Contingencies (Note 8)
Stockholders' equity:
Preferred stock, Series A, $.01 par value, 2,000,000 1,000 1,000
shares authorized, 90,789 shares
issued and outstanding
Common stock, $.01 par value, 25,000,000 shares 55,000 54,000
authorized, 5,528,149 and 5,439,824 shares issued and 5,494,150
and 5,405,825 shares outstanding, respectively
Additional paid-in capital 13,173,000 12,803,000
Stockholder notes receivable (758,000) (817,000)
Treasury stock, 33,999 shares at cost (87,000) (87,000)
Retained earnings (deficit) (1,882,000) 723,000
------------ ------------
Total stockholders' equity 10,502,000 12,677,000
------------ ------------
Total liabilities and stockholders' equity $ 28,880,000 $ 19,725,000
============ ============
The accompanying notes are an integral part of the consolidated financial
statements
-41-
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MULTIMEDIA GAMES, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
FOR THE YEARS ENDED SEPTEMBER 30, 1999, 1998 AND 1997
1999 1998 1997
------------ ------------ ------------
REVENUES:
Gaming revenue $ 82,796,000 $ 61,640,000 $ 34,011,000
Electronic player station sales 1,642,000 1,273,000 808,000
Electronic player station sales - related party -- 3,750,000 2,436,000
Electronic player station lease revenue 3,506,000 3,416,000 1,786,000
Other 912,000 458,000 11,000
------------ ------------ ------------
Total revenues 88,856,000 70,537,000 39,052,000
------------ ------------ ------------
Operating costs and expenses:
Bingo prizes and related costs 7,602,000 8,823,000 9,381,000
Allotments to hall operators 55,545,000 39,587,000 17,902,000
Cost of electronic player stations sold 981,000 805,000 538,000
Cost of electronic player stations sold - -- 1,878,000 1,183,000
related party
Salaries and wages 4,850,000 3,017,000 2,227,000
Selling, general and administrative expenses 12,981,000 9,932,000 5,049,000
NGI judgment and related fees 4,461,000 -- --
Amortization and depreciation 6,144,000 2,950,000 1,775,000
------------ ------------ ------------
Total operating costs and expenses 92,564,000 66,992,000 38,055,000
------------ ------------ ------------
Operating income (loss) (3,708,000) 3,545,000 997,000
Interest income 192,000 284,000 29,000
Interest expense (275,000) (125,000) (167,000)
------------ ------------ ------------
Income (loss) before income taxes (3,791,000) 3,704,000 859,000
Income tax benefit (expense) 1,286,000 (1,489,000) 452,000
------------ ------------ ------------
Net income (loss) $ (2,505,000) $ 2,215,000 $ 1,311,000
============ ============ ============
Basic earnings (loss) per share $ (.48) $ .40 $ .29
============ ============ ============
Diluted earnings (loss) per share $ (.48) $ .35 $ .23
============ ============ ============
The accompanying notes are an integral part of the consolidated financial
statements.
-42-
43
MULTIMEDIA GAMES, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS' EQUITY
FOR THE YEARS ENDED SEPTEMBER 30, 1999, 1998, AND 1997
PREFERRED STOCK COMMON STOCK
----------------------- ------------------------
NUMBER NUMBER ADDITIONAL STOCKHOLDER
OF OF PAID-IN NOTES
SHARES AMOUNT SHARES AMOUNT CAPITAL RECEIVABLE
---------- ----------- ----------- ---------- -------------- ------------------
Balance, September 30, 1996 134,318 $ 1,000 2,859,200 $ 29,000 $ 6,296,000 $ (1,271,000)
Exercise of common stock
warrants -- -- 625,216 6,000 3,154,000 (13,000)
Sale of common stock -- -- 1,159,500 12,000 2,800,000 --
Exercise of stock options -- -- 47,750 -- 138,000 --
Conversion of preferred stock
to common stock (25,126) -- 125,630 1,000 (1,000) --
Payment of shareholders notes -- -- -- -- -- 688,000
Registration fees and offering
costs -- -- -- -- (108,000) --
Preferred stock dividends
($1.10 per preferred share) -- -- -- -- -- --
Value of options and warrants
associated with consulting
services -- -- -- -- 10,000 --
Value of warrants associated
with related party
equipment sales -- -- -- -- 8,000 --
Net income -- -- -- -- -- --
---------- ----------- ----------- ---------- -------------- ------------------
Balance, September 30, 1997 109,192 1,000 4,817,296 48,000 12,297,000 (596,000)
Exercise of common stock
warrants -- -- 4,388 - 9,000 (4,000)
Exercise of stock options -- -- 114,125 1,000 288,000 (149,000)
Conversion of preferred stock
to common stock (18,403) -- 92,015 1,000 (1,000) --
Exercise of AGN option -- -- 412,000 4,000 242,000 (68,000)
Registration fees and offering
costs -- -- -- -- (59,000) --
Value of warrants associated
with related party
equipment sales -- -- -- -- 27,000 --
Preferred stock dividends
($1.10 per preferred share) -- -- -- -- -- --
Net income -- -- -- -- -- --
---------- ----------- ----------- ---------- -------------- ------------------
Balance, September 30, 1998 90,789 1,000 5,439,824 54,000 12,803,000 (817,000)
Exercise of stock options -- -- 88,325 1,000 246,000
Value of warrants associated
with related party
equipment purchases 112,000
Gamebay Director's Options -- -- -- -- 12,000 --
Shareholders' notes -- -- -- -- -- 59,000
Preferred stock dividends
($1.10 per preferred share) -- -- -- -- -- --
Net income -- -- -- -- -- --
---------- ----------- ----------- ---------- -------------- ------------------
Balance, September 30, 1999 90,789 $ 1,000 5,528,149 $ 55,000 $ 13,173,000 $ (758,000)
========== =========== =========== ========== ============== ==================
RETAINED TOTAL
TREASURY EARNINGS STOCKHOLDERS'
STOCK (DEFICIT) EQUITY
-------------- --------------- ----------------
Balance, September 30, 1996 $ (87,000) $ (2,574,000) $ 2,394,000
Exercise of common stock
warrants -- -- 3,147,000
Sale of common stock -- -- 2,812,000
Exercise of stock options -- -- 138,000
Conversion of preferred stock
to common stock -- -- --
Payment of shareholders notes -- -- 688,000
Registration fees and offering
costs -- -- (108,000)
Preferred stock dividends
($1.10 per preferred share) -- (123,000) (123,000)
Value of options and warrants
associated with consulting
services -- -- 10,000
Value of warrants associated
with related party
equipment sales -- -- 8,000
Net income -- 1,311,000 1,311,000
-------------- --------------- ----------------
Balance, September 30, 1997 (87,000) (1,386,000) 10,277,000
Exercise of common stock
warrants -- -- 5,000
Exercise of stock options -- -- 140,000
Conversion of preferred stock
to common stock -- -- --
Exercise of AGN option -- -- 178,000
Registration fees and offering
costs -- -- (59,000)
Value of warrants associated
with related party
equipment sales -- -- 27,000
Preferred stock dividends
($1.10 per preferred share) -- (106,000) (106,000)
Net income -- 2,215,000 2,215,000
-------------- --------------- ----------------
Balance, September 30, 1998 (87,000) 723,000 12,677,000
Exercise of stock options -- -- 247,000
Value of warrants associated
with related party
equipment purchases -- -- 112,000
Gamebay Director's Options -- -- 12,000
Shareholders' notes -- -- 59,000
Preferred stock dividends
($1.10 per preferred share) -- (100,000) (100,000)
Net loss -- (2,505,000) (2,505,000)
-------------- --------------- ----------------
Balance, September 30, 1999 $ (87,000) $ (1,882,000) $ 10,502,000
============== =============== ================
The accompanying notes are an integral part of the consolidated financial
statements.
-43-
44
MULTIMEDIA GAMES, INC. AND SUBSIDIARIES
STATEMENTS OF CASH FLOWS
1999 1998 1997
------------ ------------ ------------
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income (loss) $ (2,505,000) $ 2,215,000 $ 1,311,000
Adjustments to reconcile net income (loss) to cash
provided by (used for) operating activities:
Amortization and depreciation 6,144,000 2,950,000 1,775,000
Debt incurred in litigation settlement 3,388,000 -- --
Loss on write-off of software costs -- 395,000 --
Deferred tax benefit (expense) (648,000) 227,000 (458,000)
Other non-cash expenses -- (7,000) 119,000
(Increase) decrease in:
Accounts receivable 260,000 (1,076,000) (1,274,000)
Notes receivable 293,000 (497,000) (286,000)
Notes receivable - related party 235,000 1,210,000 (2,437,000)
Inventory (1,887,000) (2,023,000) (153,000)
Prepaid expenses 9,000 (507,000) 31,000
Other assets (210,000) 381,000 (144,000)
Accounts payable and accrued expenses (235,000) 2,518,000 561,000
Hall's share of surplus -- -- (120,000)
Prize fulfillment fees payable (124,000) (301,000) 277,000
Other 12,000 (13,000) 231,000
------------ ------------ ------------
Net cash provided by (used for) operating activities 4,732,000 5,472,000 (567,000)
------------ ------------ ------------
CASH FLOWS FROM INVESTING ACTIVITIES:
Acquisition of property and equipment (12,569,000) (5,983,000) (4,104,000)
Increase in restricted cash and long-term
investments and other long-term liabilities (52,000) (13,000) (249,000)
------------ ------------ ------------
Net cash used for investing activities (12,621,000) (5,996,000) (4,353,000)
------------ ------------ ------------
CASH FLOWS FROM FINANCING ACTIVITIES:
Proceeds from sale of common stock including
collection of shareholder notes 306,000 264,000 5,877,000
Proceeds from debt 9,432,000 335,000 658,000
Principal payments of debt (2,360,000) (468,000) (620,000)
Payment of preferred stock dividends (75,000) (106,000) (123,000)
------------ ------------ ------------
Net cash provided by financing activities 7,303,000 25,000 5,792,000
------------ ------------ ------------
Net change in cash and cash equivalents (586,000) (499,000) 872,000
Cash and cash equivalents, beginning of period 1,881,000 2,380,000 1,508,000
------------ ------------ ------------
Cash and cash equivalents, end of period $ 1,295,000 $ 1,881,000 $ 2,380,000
============ ============ ============
SUPPLEMENTAL CASH FLOW DATA:
Interest paid $ 275,000 $ 125,000 $ 167,000
============ ============ ============
Income taxes paid $ 290,000 $ 239,000 $ --
============ ============ ============
NON-CASH TRANSACTIONS:
Acquisition of fixed assets with
Notes receivable $ 992,000 -- --
Debt 211,000 -- --
Warrants 112,000 -- --
The accompanying notes are an integral part of the consolidated financial
statements.
-44-
45
MULTIMEDIA GAMES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED
FINANCIAL STATEMENTS
1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
OPERATIONS - The Company designs and develops interactive high-speed Class
II bingo and Class III video lottery games and related electronic player
stations (EPS) and equipment that are marketed to Native American bingo
halls located throughout the United States. The Company operates its
interactive bingo games on behalf of its tribal customers through a
multi-pathed communications network. The network interconnects EPS located
at multiple bingo halls thereby enabling players to simultaneously
participate in a live bingo game and to compete against one another to win
a common pooled prize. The Company also produces high stakes TV bingo game
shows that are televised live to multiple participating Indian bingo halls
linked via closed circuit satellite and broadband telephone communications
networks.
CONSOLIDATION PRINCIPLES - The financial statements include the activities
of Multimedia Games, Inc. and its five wholly owned subsidiaries,
MegaBingo, Inc. ("MBI"), Multimedia Creative Services, Inc., TV Games,
Inc., American Gaming Network L.L.C., and Gamebay.com, Inc.
CASH AND CASH EQUIVALENTS - The Company considers all highly liquid
investments with remaining maturities when purchased of three months or
less to be cash equivalents.
RESTRICTED CASH AND LONG-TERM INVESTMENTS - Restricted cash and long-term
investments include $281,000 and $269,000, as of September 30, 1999 and
1998, respectively, held in reserve for MegaBingo prizes under the
provisions of the Integrated Services Agreements with the tribes and $1.7
million and $1.4 million, as of September 30, 1999 and 1998, respectively,
representing the present value of investments held by the Company's prize
fulfillment firm related to outstanding jackpot prize winner annuities.
INVENTORY-CURRENT - The Company's current inventory consists primarily of
computer equipment components for interactive gaming player stations and
completed interactive gaming player station units expected to be sold
within the Company's fiscal year. Such inventory is carried at the lower of
cost (first-in, first-out) or market. As of September 30, 1999 and 1998,
the Company's current inventory consisted of the following:
Inventory 1999 1998
---------- ----------
Finished Units $1,306,000 $ 813,000
Used Components $ 805,000 $ 579,000
New Components $1,870,000 $1,181,000
Obsolescence Reserve $ (860,000) $ (39,000)
---------- ----------
Net Inventory $3,121,000 $2,534,000
INVENTORY - NON-CURRENT - The Company's non-current inventory consists of
completed interactive gaming player station units expected to be leased to
hall operators under operating leases. Accordingly, such leased units are
transferred from inventory to the Company's property and equipment upon
consummation of such leases. The balance of the Company's non-current
inventory at September 30, 1999 and 1998 was $1,300,000 and $0,
respectively. Such inventory is carried at the lower of cost (first-in,
first-out) or market.
PROPERTY AND EQUIPMENT - Property and equipment are stated at cost. The
cost of property and equipment is depreciated over its estimated useful
life generally using the straight line method. Equipment under leases which
convey ownership to the lessee at the end of the lease term is depreciated
over the shorter of the lease term or three years. Predominately all of the
Company's property and equipment is depreciated over two to five years.
Sales and retirements of depreciable property are recorded by removing the
related cost and accumulated depreciation from the accounts. Gains or
losses on sales and retirements of property are reflected in operations.
Under the provisions of the Integrated Services Agreements with the tribes,
any MegaBingo satellite dishes and monitoring equipment purchased by the
Company and placed at the hall locations revert to the ownership of the
tribe at the end of the agreement. Accordingly, such equipment is
depreciated over the shorter of the term of the agreement or three years.
This provision does not apply to interactive gaming player stations and
related equipment, except for interactive gaming player stations purchased
by the tribe.
GOODWILL - The amount paid for the assets of MegaBingo plus the liabilities
assumed in excess of the fair value of the identifiable assets purchased
has been recorded as goodwill. The Company amortizes goodwill over 20 years
using the straight-line method. Goodwill is reported net of accumulated
amortization in the accompanying financial statements. Accumulated
amortization amounted to $130,000, and $102,000 at September 30, 1999 and
1998, respectively.
-45-
46
MULTIMEDIA GAMES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED
FINANCIAL STATEMENTS
The Company continually re-evaluates the carrying amount of goodwill as
well as the amortization period to determine whether current events and
circumstances warrant adjustments to the carrying value and/or estimates of
useful lives. Estimated future pre-interest cash flows associated with the
assets of the MegaBingo business is used for this evaluation. At this time,
the Company believes that no impairment of goodwill has occurred and that
no reduction of the estimated useful life is warranted.
INCOME TAXES - The Company applies the provisions of Statement of Financial
Accounting Standards No. 109 ("SFAS No. 109"), "Accounting for Income
Taxes." Under SFAS No. 109, deferred tax liabilities or assets arise from
differences between the tax basis of assets or liabilities and their basis
for financial reporting, and are subject to tests of recoverability in the
case of deferred tax assets. The amount of deferred tax liabilities or
assets is calculated by applying the provisions of enacted tax laws to
determine the amount of taxes payable or refundable currently or in future
years. A valuation allowance is provided for deferred tax assets to the
extent realization is not judged to be more likely than not.
TREASURY STOCK - The Company utilizes the cost method for accounting for
its treasury stock acquisitions and dispositions.
ACCOUNTING ESTIMATES - The preparation of financial statements in
conformity with generally accepted accounting principles requires
management to make estimates and assumptions that affect the reported
amounts of assets and liabilities, and disclosure of contingent assets and
liabilities at the date of the financial statements and the reported
amounts of revenues and expenses during the reporting period. Examples
include provisions for bad debts and inventory obsolescence, asset lives of
equipment, deferred tax assets, and the provision for and disclosure of
litigation and loss contingencies. Actual results may differ from these
estimates in the near term.
RECLASSIFICATIONS - Certain 1998 balances have been reclassified to conform
to 1999 reporting.
GAME RESERVE - Prizes awarded under the Company's interactive games are
based upon attaining an assumed level of gross game receipts and
statistical assumptions as to the frequency of winners. A surplus exists
when game receipts exceed prize payouts and a deficit exists when prize
payouts exceed game receipts. Over any statistically relevant period of
time, no material surplus or deficit exists.
INCOME PER COMMON SHARE - Income per common share is computed in accordance
with Statement of Financial Accounting Standards No. 128 ("FAS 128").
Presented below is a reconciliation of income available to common
stockholders and the differences between actual weighted average shares
outstanding, which are used in computing basic earnings per share and
diluted weighted average shares, which are used in computing diluted
earnings per share. Diluted earnings per share for 1999 does not include
the dilutive effect of options, warrants and convertible preferred stock
because to do so would have been anti-dilutive to the Company's loss
available to common stockholders.
-46-
47
MULTIMEDIA GAMES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED
FINANCIAL STATEMENTS
FOR THE YEAR ENDED
9/30/99
Per Share
Loss Shares Amount
--------------- --------------- ----------------
Net loss $ (2,505,000)
Less: preferred stock dividends
Basic and Diluted EPS: (100,000)
---------------
Loss available to common stockholders (2,605,000) 5,454,322 $ (.48)
=============== ================
Effect of potentially Dilutive Securities
not included:
Options 471,293
Warrants 21,807
Convertible preferred stock 435,195
FOR THE YEAR ENDED
9/30/98
Per Share
Income Shares Amount
--------------- --------------- ---------------
Net income $ 2,215,000
Less: preferred stock dividends (106,000)
---------------
Basic EPS:
Income available to common stockholders 2,109,000 5,335,200 $ .40
---------------
Effect of Dilutive Securities:
Options 317,154
Warrants 147,456
Convertible preferred stock 106,000 442,050
--------------- ---------------
Diluted EPS:
Income available to common stockholders
plus assumed conversions $ 2,215,000 6,241,860 $ .35
--------------- --------------- ---------------
FOR THE YEAR ENDED
9/30/97
Per Share
Income Shares Amount
--------------- --------------- ---------------
Net income $ 1,311,000
Less: preferred stock dividends (123,000)
---------------
Basic EPS:
Income available to common stockholders 1,188,000 4,082,231 $ .29
==============
Effect of Dilutive Securities:
Options 339,042
Warrants 332,199
Convertible preferred stock 123,000 527,210
Contingent shares 376,945
Diluted EPS:
Income available to common
stockholders plus assumed conversions $ 1,311,000 5,657,627 $ .23
=============== ============ ==============
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48
MULTIMEDIA GAMES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED
FINANCIAL STATEMENTS
REVENUE - Revenues from the operation of the MegaBingo, MegaCash and
MegaLite bingo games are recognized as the gaming session for which the
cards were purchased occurs. Interactive gaming revenues are recorded net
of prizes awarded. Revenues from TV bingo game shows are recorded on a
gross basis and prizes are not netted.
Lease revenues from the lease of interactive gaming player stations are
generally based on a percentage of revenue generated by the player stations
and are recognized as the revenues are generated by the player stations.
See Note 10.
Revenues from the sale of electronic player stations are recorded when the
player stations are delivered to the purchaser.
STOCK BASED COMPENSATION - The Company applies Accounting Principles Board
Opinion No. 25 ("APB 25") in accounting for its stock option plans rather
than the alternative fair value accounting provided under SFAS No. 123,
"Accounting for Stock-Based Compensation". Under APB 25, no compensation
expense is recognized for grants of options which include an exercise price
equal to or greater than the market price of the stock on the date of
grant. Accordingly, based on the Company's grants in 1999, 1998 and 1997,
no compensation expense has been recognized. Pro forma information
regarding net income and earnings per share under the alternative fair
value accounting is required by SFAS 123 (see Note 7).
RECENTLY ISSUED ACCOUNTING PRONOUNCEMENTS - In June 1998, the Financial
Accounting Standards Board issued Statement of Financial Accounting
Standards No. 133 ("FAS 133"), Accounting for Derivative Instruments and
Hedging Activities. FAS 133 is effective for transactions entered into
after January 1, 2000. FAS 133 requires that all derivative instruments be
recorded on the balance sheet at fair value. Changes in the fair value of
derivatives are recorded each period in current earnings or other
comprehensive income, depending on whether a derivative is designated as
part of a hedge transaction and the type of hedge transaction. The
ineffective portion of all hedges will be recognized in earnings. Because
of the Company's minimal use of derivatives, adoption of this statement
will not have a significant impact on the Company's results of
operations.
2. MEGABINGO TRANSACTIONS; INTEGRATED SERVICES AGREEMENTS
A substantial portion of the Company's revenues are derived from the
Integrated Services Agreements with various tribes. The Company, in its
name or in the name of the predecessor company from which it assumed the
agreements, has written agreements with approximately 50 American Indian
tribes that provide the Company with the right to conduct bingo operations
on their respective Indian lands. Approximately 20 of these agreements were
renewed for five (5) year terms in 1995 and half of the remaining contracts
have unexpired terms of between one and two years. The remaining
contracts are being continued on a month to month basis.
-48-
49
MULTIMEDIA GAMES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED
FINANCIAL STATEMENTS
3. PROPERTY AND EQUIPMENT
At September 30, 1999 and 1998, the Company's property and equipment
consisted of the following:
1999 1998
------------ ------------
Gaming and satellite equipment $ 21,430,000 $ 9,469,000
Software costs 4,706,000 2,599,000
Other 178,000 172,000
------------ ------------
Total property and equipment 26,314,000 12,240,000
Less accumulated depreciation (10,893,000) (4,587,000)
------------ ------------
Property and equipment, net $ 15,421,000 $ 7,653,000
============ ============
Depreciation expense amounted to $6,070,000, $2,900,000 and $1,748,000
during the years ended September 30, 1999, 1998 and 1997 respectively. The
net book value of capitalized software costs at September 30, 1999 and 1998
was $3,131,000 and $1,974,000 respectively. Depreciation expense related to
software cost amounted to $811,000, $621,000 and $310,000 during the years
ended September 30, 1999, 1998 and 1997 respectively.
In addition, in connection with a December 1995 transaction, the Company
capitalized the $500,000 cost of a license acquired from National Gaming
International Corporation ("NGI"), which the Company began amortizing over
the five-year term of the related license agreement. As of September 30,
1998, the Company determined that the then unamortized portion of this
asset and certain additional related software development costs
(aggregating $395,000 at September 30, 1998) had been impaired as a result
of the status of certain litigation (see Note 8) and, accordingly, reduced
the carrying value of the asset to zero.
4. LONG-TERM DEBT
On July 29,1999 the Company entered into a revolving credit facility with
Coast Business Credit, a Division of Southern Pacific Bank, ("Coast")
located in Los Angeles, California. Pursuant to the credit facility, the
Company may borrow up to $10,000,000, or such lesser amount as is permitted
under various borrowing base formulas. As of September 30, 1999, under the
most restrictive of the borrowing base formulas, there was $9,000,000 of
borrowings available to the Company, of which $8,137,000 had been borrowed
and was outstanding. The credit facility expires in July 2002 and is
secured by all assets of the Company and the personal guarantee of
$1,500,000 from the Company's Chairman and CEO Gordon T. Graves. The
initial application of the funds available under this facility were used to
pay $1,900,000 of debt owed to two other banks, approximately $2,400,000
was used for the repurchase of EPS owned by the EP LLC II partnership and
approximately $4,000,000 was used for working capital purposes. Borrowings
under the facility bear interest, payable monthly, at a rate equal to the
greater of 9% or 1.75% above the prime rate from time to time in effect
(10% at September 30, 1999). All of the Company's revenues are deposited
into a "blocked" account controlled by Coast and disbursements from the
"blocked" account may be made only with the approval of Coast. See Note 12
which describes a recent amendment to the credit facility resulting from
the settlement of a lawsuit.
At September 30, 1999, there were no future maturities of long-term debt.
However, as a result of the consummation of the NGI lawsuit settlement (see
Note 8), on December 23, 1999, the Company is obligated to make payments of
$390,000, $615,000, $820,000, and $450,000 in fiscal years 2000, 2001,
2002, and 2003, respectively. In the September 30, 1999 balance sheet,
$1,502,000 of the settlement amount is shown as a short-term liability, and
$1,885,000 as a long-term liability.
-49-
50
MULTIMEDIA GAMES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED
FINANCIAL STATEMENTS
5. INCOME TAXES
The provision for income taxes (benefit) consisted of the following for the
years ended September 30, 1999, 1998 and 1997:
1999 1998 1997
--------------- --------------- ---------------
CURRENT:
Federal $ (300,000) $ 1,128,000 $ --
State (25,000) 134,000 --
DEFERRED (960,000) 227,000 (452,000)
--------------- --------------- ----------------
Net income tax expense $ (1,286,000) $ 1,489,000 $ (452,000)
(benefit) =============== =============== ================
A reconciliation of the expected income tax expense (benefit) based upon
the federal statutory rate of 34% and the taxes reflected in tax expense is
as follows for the years ended September 30, 1999, 1998 and 1997:
1999 1998 1997
--------------- --------------- ---------------
Expected federal income
tax expense (benefit) $ (1,289,000) $ 1,259,000 $ 292,000
State income tax expense (benefit),
net of Federal benefit (151,000) 148,000 --
Nondeductible expenses 32,000 21,000 15,000
1997 Federal tax penalty 51,000 -- --
Use of net operating losses -- -- (307,000)
Change in valuation allowance
of net operating losses -- -- (452,000)
Other 71,000 61,000 --
--------------- --------------- ----------------
Net income tax expense (benefit) $ (1,286,000) $ 1,489,000 $ (452,000)
=============== =============== ================
Differences between the book value and the tax basis of the Company's
assets and liabilities and net operating losses results in deferred tax
assets and liabilities as follows:
1999 1998
--------------- ---------------
Deferred tax asset - current:
Accounts receivable allowance $ 200,000 $ 69,000
Game reserve (273,000) --
Inventory reserve 332,000 --
Accrued liabilities 181,000 83,000
Current portion of lawsuit
settlement 540,000 --
Net operating losses 520,000 94,000
--------------- ---------------
Net current deferred tax asset $ 1,500,000 $ 246,000
=============== ===============
Deferred tax liability - noncurrent: $ $
Lawsuit settlement 835,000 --
Tax credit carryforward -- 5,000
Trademark 15,000 19,000
Goodwill (10,000) (13,000)
Depreciation (1,461,000) (26,000)
--------------- ---------------
Net noncurrent deferred tax
(liability) $ (621,000) $ (15,000)
=============== ===============
At September 30, 1999, the Company's net operating loss carryforward for
income tax purposes was approximately $1,370,000. The Company's net
operating loss carryforwards expire in 2009 through 2019.
-50-
51
MULTIMEDIA GAMES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED
FINANCIAL STATEMENTS
6. STOCKHOLDERS' EQUITY
SERIES A PREFERRED STOCK
During fiscal year 1995, the Company amended its articles of incorporation
to provide for the issuance of up to 2,000,000 shares of preferred stock in
such series and with such rights and preferences as may be approved by the
Board of Directors. In January 1995, the Board of Directors approved a
Series A preferred stock which is cumulative, voting and convertible, and
sold 134,318 shares of such stock for $1,343,318. The Series A preferred
stock is subject to redemption at the election of the Company for $10 per
share.
During 1997, 25,126 outstanding Series A preferred shares were converted
into 125,630 shares of the Company's common stock. During 1998, 18,403
outstanding Series A preferred shares were converted into 92,015 shares of
the Company's common stock.
Based on the number of shares of Series A preferred stock outstanding at
September 30, 1999, an additional 435,195 shares of common stock would be
issued if a full conversion were to occur. Of the Series A preferred stock
outstanding, 80,175 shares (convertible into 400,875 common shares) are
owned by or under the control of the Company's Chairman/Chief Executive
Officer.
The Series A preferred stock has a liquidation preference over the
Company's common stock equal to $10 per share of Series A preferred stock,
or $908,000 in the aggregate at September 30, 1999. The holders of the
Series A preferred stock are entitled to a cumulative preferred dividend,
payable quarterly, at the rate of $1.10 per share per annum. In the event
the Company remains in arrears for more than two quarters, holders of the
Series A preferred stock voting as a class are entitled to elect a majority
of the Company's Board of Directors.
COMMON STOCK
In November 1996, the Company completed a private placement of
approximately 1.2 million shares of the Company's common stock for $3.00
per share. Each of the 1.2 million shares sold was accompanied by a
redeemable warrant to purchase an additional share of the Company's common
stock for $8 commencing in November 1997 (a "Class A Warrant"). After
November 7, 1997, each Class A Warrant may be redeemed by the Company for
$.10 when the closing bid price of the Company's common stock has been at
least $12.00 for 20 consecutive trading days. A total of 350,000 Class B
Warrants were granted to the placement agent in connection with the
November Placement. Each Class B warrant represents the right to purchase
one share of the Company's common stock for $8 commencing in November 1997,
and may be redeemed by the Company for $0.10 per warrant share after
February 7, 1999, when the closing bid price of the Company's common
stock has been at least $12.00 for 20 consecutive trading days.
COMMON STOCK WARRANTS AND OPTIONS
In connection with past financing arrangements and as compensation for
consulting and professional services, the Company has issued warrants and
options to purchase its common stock. The following tables summarize such
warrant and option activity for 1999, 1998 and 1997:
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MULTIMEDIA GAMES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED
FINANCIAL STATEMENTS
1999 ACTIVITY
NUMBER OF NUMBER OF
WARRANTS/ WARRANTS/
EXERCISE OPTIONS OPTIONS
PRICE OUTSTANDING OUTSTANDING EXERCISABLE
PER EXPIRATION OCTOBER 1, EXPIRED/ SEPT. 30, SEPT. 30,
SHARE DATE 1998 GRANTED EXERCISED CANCELED 1999 1999
- -------------- ----------- ---------- ---------- ---------- ---------- ---------- ----------
$ 4.00 Jul 2000 18,750 -- -- -- 18,750 18,750
$ 8.00 Aug 2001 1,792,143 -- -- -- 1,792,143 1,792,143
$ 5.688 Feb 2007 100,000 -- -- -- 100,000 100,000
$ 9.44 Mar 2003 20,000 -- -- -- 20,000 20,000
$ 7.00 Jan 2003 262,500 -- -- -- 262,500 262,500
$ 11.00 May 2002 50,000 -- -- (50,000) -- --
$ 13.38 Sept 2002 50,000 -- -- (50,000) -- --
$ 3.81 May 2002 -- 50,000 -- -- 50,000 50,000
$ 3.81 Sept 2002 -- 50,000 -- -- 50,000 50,000
---------- ---------- ---------- ---------- ---------- ----------
2,293,393 100,000 -- (100,000) 2,293,393 2,293,393
========== ========== ========== ========== ========== ==========
1998 ACTIVITY
NUMBER OF NUMBER OF
WARRANTS/ WARRANTS/
EXERCISE OPTIONS OPTIONS
PRICE OUTSTANDING OUTSTANDING
PER EXPIRATION OCTOBER 1, EXPIRED/ SEPT. 30,
SHARE DATE 1997 GRANTED EXERCISED CANCELED 1998
- -------------- ----------- ---------- ---------- ---------- ---------- ----------
$ 2.00 Sep 97-Jan 98 4,268 -- 4,268 -- --
$ 4.00 Jul 2000 18,750 -- -- -- 18,750
$ 6.60 Jul 98 5,216 -- 120 (5,096) --
$ 8.00 Aug 2001 1,792,143 -- -- -- 1,792,143
$ 5.688 Feb 2007 100,000 -- -- -- 100,000
$ 8.00 Aug 2007 54,000 -- -- (54,000) --
$10.00 Aug 2007 54,000 -- -- (54,000) --
$12.00 Aug 2007 54,000 -- -- (54,000) --
$10.00 Aug 2002 27,000 -- -- (27,000) --
$11.00 May 2002 50,000 -- -- -- 50,000
$13.38 Sept 2002 100,000 -- 50,000 -- 50,000
$ 9.44 Mar 2003 -- 20,000 -- -- 20,000
$ 7.00 Jan 2003 -- 262,500 -- -- 262,500
---------- ---------- ---------- ---------- ----------
2,259,377 282,500 54,388 (194,096) 2,293,393
========== ========== ========== ========== ==========
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MULTIMEDIA GAMES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED
FINANCIAL STATEMENTS
1997 ACTIVITY:
NUMBER OF NUMBER OF
WARRANTS/ WARRANTS/
EXERCISE OPTIONS OPTIONS
PRICE OUTSTANDING OUTSTANDING
PER EXPIRATION OCTOBER 1, EXPIRED/ SEPTEMBER 30,
SHARE DATE 1996 GRANTED EXERCISED CANCELED 1997
- --------- -------------- -------------- ------------- ----------- ------------ ----------------
$ 2.00 Sep 97-Jan 98 102,905 -- 98,637 -- 4,268
$ 2.50 Mar 2000 10,000 -- 10,000 -- --
$ 2.75 May 97-Jul 97 74,765 -- 71,531 (3,234) --
$ 3.50 Jul 2000 175,000 -- 175,000 -- --
$ 4.00 Jul 2000 18,750 -- -- -- 18,750
$ 6.60 Jul 98 23,550 -- 18,334 -- 5,216
$ 5.688 Feb 2007 -- 100,000 -- -- 100,000
$ 8.00 Aug 2007 -- 54,000 -- -- 54,000
$ 10.00 Aug 2007 -- 54,000 -- -- 54,000
$ 12.00 Aug 2007 -- 54,000 -- -- 54,000
$ 8.00 Aug. 2001 523,310 1,518,833 250,000 -- 1,792,143
$ 10.00 May 2002 -- 27,000 -- -- 27,000
$ 11.00 June 2002 -- 50,000 -- -- 50,000
$ 13.38 Sept. 2002 -- 100,000 -- -- 100,000
------------ ------------ ----------- ------------ ----------------
928,280 1,957,833 623,502 (3,234) 2,259,377
============ ============ =========== ============ ================
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54
MULTIMEDIA GAMES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED
FINANCIAL STATEMENTS
7. STOCK OPTION AND EMPLOYEE BENEFIT PLANS
During fiscal year 1993, the Company's Board of Directors approved a
Salaried Employee Participation Plan (the "1993 Plan") and reserved an
aggregate of 200,000 shares of common stock to be issued thereunder.
Options issued under the 1993 Plan vest ratably over a five-year period
from the date of grant. Commencing with the adoption of the 1996 Plan
discussed below, no further grants of options will be made under the 1993
Plan.
In November 1994, the stockholders of the Company approved the Company's
1994 Director Stock Option Plan (the Director Plan) and the Company's 1994
Employee Stock Option Plan (the 1994 Employee Plan) previously adopted by
the Board of Directors, pursuant to which 60,000 shares and 360,000 shares,
respectively, of the Company's common stock were reserved for issuance.
Options issued under the Director Plan and the 1994 Employee Plan vest
ratably over a five-year period from the date of grant. Commencing with the
adoption of the 1996 Plan discussed below, no further grants of options
will be made under either the Director Plan or the 1994 Employee Plan.
In August 1996, the Board of Directors of the Company approved the 1996
Stock Incentive Plan (the 1996 Plan). Under the 1996 Plan, various stock
based incentive awards may be made including incentive stock options,
non-qualified stock options, stock appreciation rights, restricted stock,
performance shares or deferred stock purchases. Options issued under the
1996 Plan vest ratably over a four-year period from the date of grant. The
total number of shares of common stock or common stock equivalents that may
be issued under the 1996 Plan is 795,127. In order to have grants made
which qualify as incentive stock options, the 1996 Plan was approved by the
Company's stockholders in March 1997 and an amendment to increase the
number of shares reserved for issuance under the 1996 Plan was approved by
the Company's stockholders in May 1999.
In June 1998, the Board of Directors of the Company approved the
President's Plan pursuant to which options to purchase 338,000 shares of
common stock were granted to Clifton Lind as an inducement to become the
President and Chief Operating Officer of the Company. The options are
intended to qualify as incentive stock options: All of the options have an
exercise price of $3.81 per share, which was the market value of the Common
Stock on the date of grant. The President's Plan was approved by the
Company's stockholders in May 1999.
In October 1998, the Board of Directors of the Company approved the 1998
Senior Executive Plan pursuant to which options to purchase 205,000 shares
of common stock were granted to George Akmon, Gary Loebig, and Tim Stuart
as an inducement for them to become the Officers of the Company. The
options are intended to qualify as incentive stock options. All of the
options have an exercise price of $3.81 per share, which was the market
value of the Common Stock on the date of grant. The 1998 Senior Executive
Plan was approved by the Company's stockholders in May 1999.
The activity relating to stock option issuances under the above plans are
as follows for each of the three years ending September 30, 1999, 1998 and
1997:
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MULTIMEDIA GAMES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED
FINANCIAL STATEMENTS
1999 ACTIVITY
NUMBER OF NUMBER OF
EXERCISE OPTIONS OPTIONS
PRICE OUTSTANDING EXERCISED/ OUTSTANDING EXERCISABLE
PER EXPIRATION OCTOBER 1, EXPIRED/ SEPTEMBER 30, SEPTEMBER 30,
SHARE DATE 1998 GRANTED CANCELED 1999 1999
- ----------------- -------------- ---------------- ------------- -------------- ----------------- -----------------
1994
DIRECTOR PLAN:
$ 2.50 Jul 2004 40,000 -- (20,000) 20,000 20,000
1994
EMPLOYEE PLAN
$ 2.00 Mar 2005 28,000 -- (23,975) 4,025 4,025
$ 2.50 Jul 2004 110,000 -- (20,000) 90,000 90,000
$ 2.50 Feb 2006 22,500 -- -- 22,500 15,000
$ 2.75 Jul 2005 7,500 -- -- 7,500 7,500
$ 4.00 Apr 2006 14,000 -- (2,500) 11,500 8,625
1996
STOCK INCENTIVE PLAN
$ 3.813 Oct 2006 85,950 -- (14,450) 71,500 29,500
$ 3.813 Jan 2007 15,250 -- (11,750) 3,500 --
$ 3.813 Feb 2007 55,000 -- (36,250) 18,750 8,750
$ 3.813 Mar 2007 2,500 -- (2,500) -- --
$ 3.813 Jan 2008 116,800 -- (4,800) 112,000 28,100
$ 3.813 Jun 2008 101,450 -- (47,350) 54,100 16,363
$ 3.813 Aug 2008 25,000 -- (12,500) 12,500 12,500
$ 3.813 Oct 2008 -- 35,200 -- 35,200 --
$ 3.813 Nov 2008 -- 75,200 (35,000) 40,200 --
$ 6.875 Jun 2009 -- 10,000 -- 10,000 --
-55-
56
MULTIMEDIA GAMES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED
FINANCIAL STATEMENTS
NUMBER OF NUMBER OF
OPTIONS OPTIONS
EXERCISE OUTSTANDING EXERCISED/ OUTSTANDING EXERCISABLE
PRICE EXPIRATION OCTOBER 1, EXPIRED/ SEPTEMBER 30, SEPTEMBER 30,
PER SHARE DATE 1998 GRANTED CANCELED 1999 1999
- ----------------- ------------ --------------- ------------ ------------- ---------------- ---------------
1998
PRESIDENT'S PLAN
$ 3.813 May 2002 27,000 -- -- 27,000 27,000
$ 3.813 Sept 2002 50,000 -- -- 50,000 50,000
$ 3.813 Feb 2007 49,000 -- -- 49,000 24,500
$ 3.813 Aug 2007 162,000 -- -- 162,000 81,000
$ 3.813 Jan 2008 50,000 -- -- 50,000 12,500
1998
SENIOR EXECUTIVE PLAN
$ 3.813 Nov. 1998 -- 75,000 (75,000) -- --
$ 3.813 Nov. 1998 -- 50,000 -- 50,000 12,500
$ 3.813 Nov. 1998 -- 80,000 (60,000) 20,000 20,000
--------------- ------------ ------------- --------------- ---------------
961,950 325,400 (366,075) 921,275 467,863
=============== ============ ============= =============== ===============
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MULTIMEDIA GAMES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED
FINANCIAL STATEMENTS
1998 ACTIVITY:
Number of Number of
Exercise Options Options
Price Outstanding Exercised/ Outstanding Exercisable
Per Expiration October 1, Expired/ September 30, September 30,
Share Date 1997 Granted Canceled 1998 1998
- --------------- ------------ --------------- ----------- ------------- --------------- ---------------
1993 PLAN:
$ 1.50 Oct 97 35,000 -- (35,000) -- --
1994
DIRECTOR PLAN:
$ 2.50 Jul 2004 40,000 -- -- 40,000 40,000
1994
EMPLOYEE PLAN
$ 2.00 Mar 2005 56,000 -- (28,000) 28,000 17,250
$ 2.50 Jul 2004 110,000 -- -- 110,000 110,000
$ 2.50 Feb 2006 30,000 -- (7,500) 22,500 7,500
$ 2.75 Jul 2005 7,500 -- -- 7,500 3,750
$ 4.00 Apr 2006 19,000 -- (5,000) 14,000 7,000
1996
STOCK INCENTIVE PLAN
$ 4.375 Oct 2006 137,000 -- (137,000) -- --
$ 4.750 Jan 2007 17,000 -- (17,000) -- --
$ 5.500 Feb 2007 32,500 -- (32,500) -- --
$ 5.688 Feb 2007 69,000 -- (69,000) -- --
$ 7.141 Feb 2007 10,000 -- (10,000) -- --
$ 8.000 Mar 2007 2,500 -- (2,500) -- --
9.500 Jan 2008 -- 121,100 (121,100) -- --
$ 3.813 Oct 2006 -- 85,950 -- 85,950 10,950
$ 3.813 Jan 2007 -- 17,000 (1,750) 15,250 2,500
$ 3.813 Feb 2007 -- 62,500 (7,500) 55,000 --
$ 3.813 March 2007 -- 2,500 -- 2,500 --
$ 3.813 Jan 2008 -- 118,300 (1,500) 116,800 --
$ 3.813 Jun 2008 -- 101,650 (200) 101,450 --
$ 3.813 Aug 2008 -- 25,000 -- 25,000 --
1998
PRESIDENT'S PLAN
$ 3.813 May 2002 -- 27,000 -- 27,000 --
$ 3.813 Sept 2002 -- 50,000 -- 50,000 --
$ 3.813 Feb 2007 -- 49,000 -- 49,000 --
$ 3.813 Aug 2007 -- 162,000 -- 162,000 --
$ 3.813 Jan 2008 -- 50,000 -- 50,000 --
--------------- ----------- ------------- --------------- ---------------
565,500 872,000 (475,550) 961,950 213,325
=============== =========== ============= =============== ===============
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58
MULTIMEDIA GAMES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED
FINANCIAL STATEMENTS
1997 ACTIVITY:
NUMBER OF NUMBER OF
EXERCISE OPTIONS OPTIONS
PRICE OUTSTANDING EXERCISED/ OUTSTANDING
PER EXPIRATION OCTOBER EXPIRED/ SEPTEMBER
SHARE DATE 1, 1996 GRANTED CANCELED 30, 1997
- ---------------- ------------ ------------- ----------- ----------- --------------
1993 PLAN:
$1.50 Oct 97 45,000 -- (10,000) 35,000
1994 DIRECTOR
PLAN:
$2.50 Jul 2004 40,000 -- -- 40,000
1994 EMPLOYEE
PLAN
$2.00 Mar 2005 56,000 -- -- 56,000
$2.50 Jul 2004 120,000 -- (10,000) 110,000
$2.50 Feb 2006 75,000 -- (45,000) 30,000
$2.75 Jul 2005 15,000 -- (7,500) 7,500
$4.00 Apr 2006 19,000 -- -- 19,000
1996 STOCK
INCENTIVE PLAN
$4.375 Oct 2006 -- 145,000 (8,000) 137,000
$4.750 Jan 2007 -- 17,000 -- 17,000
$5.500 Feb 2007 -- 43,000 (10,500) 32,500
$5.688 Feb 2007 -- 69,000 -- 69,000
$7.141 Feb 2007 -- 10,000 -- 10,000
$8.000 Mar 2007 -- 2,500 -- 2,500
------------- ----------- ----------- --------------
370,000 286,500 (91,000) 565,500
============= =========== =========== ==============
The Company expects to continue to issue stock options to new employees as
they are hired and to current employees as incentives from time to time.
The Company has elected to follow APB Opinion No. 25, "Accounting for Stock
Issued to Employees," in accounting for its employee stock options rather
than the alternative fair value accounting provided for under SFAS No. 123,
"Accounting for Stock-Based Compensation." Accordingly, no compensation
cost has been recognized in fiscal 1999, 1998 and 1997 associated with
employee stock options. Pro forma information regarding net income (loss)
and earnings (loss) per share under the alternative fair value accounting
is required by SFAS No. 123. This information is required to be determined
as if the Company had accounted for its employee stock options granted
subsequent to September 30, 1995, under the fair value method of that
statement. The fair value of options granted in fiscal years 1999, 1998 and
1997 reported below has been estimated at the date of grant using a
Black-Scholes option pricing model with the following assumptions:
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MULTIMEDIA GAMES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED
FINANCIAL STATEMENTS
1999 1998 1997
----------- ------------ ------------
Weighted average Life 3.5 years 3.5 years 3.5 years
Risk-free interest rate 5.70% 5.70% 6.56%
Expected volatility 73% 72% 72%
Expected dividend yield None None None
The Black-Scholes option valuation model was developed for use in
estimating the fair value of traded options that have no vesting
restrictions and are fully transferable. In addition, option valuation
models require the input of highly subjective assumptions, including the
expected stock price volatility. Because the Company's options have
characteristics significantly different from those of traded options, and
because changes in the subjective input assumptions can materially affect
the fair value estimate, in the opinion of management, the existing models
do not necessarily provide a reliable single measure of the fair value of
its options. The weighted average estimated fair value of employee stock
options granted during 1999, 1998 and 1997 was $1.81, $2.33 and $3.22 per
share, respectively. The estimated fair value of options granted during
1999, 1998 and 1997 under the Company's stock option plans totaled
$644,000, $2,012,000 and $631,000, respectively.
OPTION REPRICING. On June 12, 1998, the Board of Directors of the Company
canceled all outstanding options held by optionees under the 1996 Stock
Incentive Plan and granted new options to all such optionees. The new
options were for the same number of shares and upon the same terms of
expiration and vesting as the canceled options, except that the exercise
price for the new options was $3.81 per share, the market value of the
Common Stock on June 12, 1998. In effect, therefore, the Board of Directors
reduced the exercise price of all such outstanding options which had
exercise prices at the time of cancellation ranging from $4.38 per share to
$13.38 per share. In connection with the grant under the President's Plan,
all options and warrants to purchase Common Stock that had previously been
granted to Mr. Lind in consideration of prior financial and consulting
services to the Company (aggregating 338,000 shares at exercise prices
ranging from $5.68 to $13.38 per share) were also canceled. A total of
275,500 options granted to over 65 employees under the 1996 Stock Incentive
Plan were repriced by the June 12, 1998 action. The estimated fair value of
the options canceled in 1998 in connection with the repricing of employee
stock options totaled $879,000.
For purposes of pro forma disclosures, the estimated fair value of the
options is amortized to expense over the options' vesting period. The
Company's pro forma information is as follows:
1999 1998 1997
----------- ---------- ----------
Net income (loss):
As reported $(2,505,000) $2,215,000 $1,311,000
Pro forma (2,795,000) 1,933,000 969,000
Basic earnings (loss) per common share:
As reported $ (.48) $ .40 $ .29
Pro forma $ (.53) $ .34 $ .21
Diluted earnings (loss) per common share:
As reported $ (.48) $ .35 $ .23
Pro forma $ (.53) $ .31 $ .17
The above SFAS No. 123 pro forma disclosures are not necessarily
representative of the effect SFAS No. 123 will have on the pro forma
disclosure of future years.
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60
MULTIMEDIA GAMES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED
FINANCIAL STATEMENTS
During 1994, the Company established an employee savings plan pursuant to
Section 401(K) of the Internal Revenue Code. The plan provides for the
employees to make tax deferred deposits into the plan to the extent of 6%
of their annual base compensation. The Company matches half of the allowed
employee contributions and such Company contributions amounted to $96,000,
$56,000 and $34,000 for the years ended September 30, 1999, 1998 and 1997,
respectively.
8. COMMITMENTS AND CONTINGENCIES
MEGAMANIA LITIGATION. The Company has designed and operates its bingo games
and related equipment so as to meet the requirements of Class II gaming
under the Indian Gaming Regulatory Act of 1988, as amended ("IGRA"). Class
II gaming is defined by IGRA as including "the game of chance commonly
known as bingo (whether or not electronic, computer or other technological
aids are used in connection therewith)..." However, the definition of Class
II gaming excludes so-called "gambling devices" which are defined as
"electronic or electromechanical facsimiles of any game of chance or slot
machines of any kind." Generally speaking, IGRA allows Class II gaming to
be conducted on Indian lands if the state in which the Indian land is
located permits such gaming for any purpose by any person. Class III
gaming, on the other hand, which includes gaming such as video casino
games, slot machines, most table games (e.g., blackjack and craps), most
lottery games and keno, may only be conducted on Indian land pursuant to an
agreement between the Indian tribe and the state in which the tribe is
located. The Class III games and equipment sold and operated by the Company
in the state of Washington is pursuant to an agreement between that state
and local Indian tribes.
On December 31, 1997, the U.S. Attorney for the Northern District of
Oklahoma filed a civil forfeiture action in Federal District Court
challenging the Class II status of the Company's interactive bingo game,
MegaMania. On October 23, 1998, the District Court issued a judgment
holding that MegaMania was legal Class II gaming. The decision found that
MegaMania was a game of bingo and that the EPS used to play MegaMania were
technological aids to the play of bingo as permitted by IGRA and were not
gambling devices.
On May 14, 1998, the Assistant U.S. Attorney for the Northern District of
California filed a civil forfeiture in Federal District Court that also
challenged the Class II status of MegaMania. On November 23, 1998, the
District Court issued a Memorandum and Order holding that MegaMania was
legal Class II gaming. As with the decision of the Oklahoma District Court,
the Order of the California District Court found that MegaMania was a game
of bingo and that the EPS used to play MegaMania were technological aids to
the play of bingo as permitted by IGRA and were not gambling devices.
The government has appealed both decisions to the applicable Federal
Circuit Court of Appeals. As of December 28, 1999, no action has been taken
by either appellate court on either appeal. The Company is not able to
predict what the outcome of either appeal will be.
If MegaMania is ultimately determined to be Class III gaming, the loss of
the MegaMania business would likely have a material adverse effect upon the
Company's financial condition and results of operation. In addition, if the
EPS used to aid the play of MegaMania are ultimately held to be gambling
devices, all of the other Class II bingo games currently offered by the
Company would likely be adversely effected which would have a material
adverse effect upon the Company's financial condition and results of
operation. Even if the Company is successful on the merits, the legal fees
and expenses to be incurred by the Company related to the MegaMania
litigation or any future litigation challenging the Company's interactive
bingo activities will likely be significant.
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61
MULTIMEDIA GAMES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED
FINANCIAL STATEMENTS
OTHER CHALLENGES TO INTERACTIVE GAMES; CHANGES IN LAW AND REGULATIONS. No
assurances can be given that there will be no other challenges made to the
legality of the Company's interactive bingo activities or that, if made,
the Company will be successful on the merits. While the Company attempts to
design and operate its Class II games in accordance with IGRA and the
regulations and opinions of the National Indian Gaming Commission (NIGC),
it is not always successful in doing so. For example, in February, 1999,
the Company introduced Evergreen as a Class II game. In November 1999, the
NIGC issued an opinion that Evergreen was not Class II gaming. As a result,
the Company is modifying those aspects of Evergreen that the NIGC found
objectionable.
There can be no assurance that the NIGC, either on its own initiative or as
the result of pressure from or cooperation with other agencies such as the
Department of Justice, will not enact additional regulations as described
above, or reinterpret existing regulations in a manner that would have a
material and adverse effect upon the Company, including requiring the
Company to restructure its existing contractual arrangements with Indian
tribes or requiring changes in the way the Company's games are conducted so
that such games are classified as Class II. Any such restructuring of the
Company's games has the additional risk that such games will no longer
appeal to consumers or be acceptable to the tribes. There can also be no
assurance that IGRA or other Federal laws will not be amended, or new
legislation or regulations enacted, so as to limit the authority of tribes
to self-regulate Class II gaming or to change the definition of Class II
gaming in a manner adverse to the Company's business. In addition, the NIGC
has issued a set of minimum internal control standards for Indian bingo
hall operations, and will require hall compliance by February, 2000.
Compliance with these standards could have a negative impact on the
Company's interactive games.
OTHER LITIGATION
NETWORK GAMING LITIGATION SETTLEMENT. In December 1999, the Company entered
into an agreement with Network Gaming International Corporation ("NGI")
that settled a $3.1 million verdict against the Company for breach of
contract that had been awarded in November 1999 by a jury in the Federal
District Court for the Northern District of Oklahoma. Pursuant to the
settlement, the Company paid $800,000 to NGI in December 1999, and has
agreed to pay NGI an additional $2.275 million in cash over three years. In
addition, the Company delivered 125,000 shares of its Common Stock to NGI.
All payments to NGI under the agreement are secured by a lien on the
Company's assets that is junior and subordinate to the lien of the
Company's senior bank lender. If the Company defaults on its payment
obligation to NGI, NGI has reserved the right to pursue collection of its
total judgment, plus interest and attorney's fees, aggregating $3.5
million, less any amounts previously paid by the Company.
While the Company believes it will be able to meet its obligation to NGI
and its other creditors with cash from operations, there is no assurance
that the Company will be able to do so.
SHAREHOLDER CLASS ACTIONS. On May 29, 1998, a shareholder class action was
filed against the Company in the Federal District Court for the Southern
District of California. Also named as defendants were Gordon T. Graves and
Larry D. Montgomery. The action, which seeks an unspecified amount of
damages on behalf of all similarly situated shareholders, alleges that the
Company violated federal securities laws by making allegedly false and
misleading statements regarding the legality of MegaMania. On July 24,
1998, a similar class action was filed in the Federal
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62
MULTIMEDIA GAMES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED
FINANCIAL STATEMENTS
Court for the Northern District of Oklahoma. In January 1999, the two cases
were consolidated in the Northern District of Oklahoma. On March 22, 1999,
the class action plaintiffs filed an amended complaint that also named
Clifton E. Lind, the Company's President and Chief Operating Officer, as an
additional defendant and included allegations that the Company violated
federal securities laws by making allegedly false and misleading statements
regarding transactions between the Company and Equipment Purchasing LLC and
Equipment Purchasing II LLC (see Note 9). On April 19, 1999, the Company
filed its Motion to Dismiss all of the claims of the plaintiffs. The Court
has yet to rule on the Company's Motion. The Company intends to vigorously
defend against these claims and expects to prevail on the merits, although
no assurances to that effect can be given. In any event, the cost of
defending against the claims could by substantial.
PRIZE FULFILLMENT FIRM
In order to reduce the need for prize reserve account funds and to further
reduce exposure to game deficits during periods of abnormally high rates of
jackpot prize wins, MBI has engaged a related party firm specializing in
prize fulfillment services to pay jackpot prizes won during the term of a
prize fulfillment agreement. The prize fulfillment agreement specifies a
maximum cumulative liability over the term of the contract, in exchange for
fees based on gross game receipts. Prize fulfillment premiums amounted to
$1,264,000, $1,157,000 and $2,642,000 for the years ended September 30,
1999, 1998 and 1997, respectively. The current arrangements with such firm
expire on December 31, 1999, but has an automatic 30 day extension period
during which the Company expects to negotiate a one year extension to the
agreement.
Under the terms of the prize fulfillment agreement, the Company is
responsible for a deductible of $15,000 per occurrence. Prize winners have
the election of accepting a lump-sum cash payment or the purchase of an
annuity. In those cases where the prize winner accepts a lump-sum cash
payment, the payment is made by the prize fulfillment firm, less the
Company's deductible. In those cases where the prize winner elects an
annuity, the obligation has historically been insured by the prize
fulfillment firm purchasing annuity contracts from insurance companies.
Contingent liability under purchased annuity contracts entered into prior
to April 15, 1994 by an assignor of such contracts to the Company, which
provide for various insurance companies to make payments directly to prize
winners over a specified period of time, amounts to approximately
$1,000,000 as of September 30, 1999. The outstanding amounts include
annuity contracts, which were purchased from an insurance carrier that is
currently under an Order of Rehabilitation to the Michigan State
Commissioner of Insurance. Under this Order, payments under all such
contracts will continue until ordered otherwise by the State of Michigan.
It is unknown at this time as to whether further court actions will result
in reductions in amounts owed under these annuity contracts. There can be
no assurance that this or any other insurance company responsible for
outstanding annuities will continue to fulfill all their obligations under
the annuity contracts.
The Company is not responsible for any obligations to prize winners prior
to April 15, 1994, whether in lieu of annuities or in respect of shortfalls
on annuities or otherwise. Further, the Company is not responsible for
prize annuities awarded during the period April 15, 1994 through December
22, 1994, except as to the obligation to discharge obligations of the
MegaBingo operations with the assets of the MegaBingo operation and under
the indemnification provisions of the AGE Services Agreement.
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63
MULTIMEDIA GAMES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED
FINANCIAL STATEMENTS
The present value of the prize annuities at September 30, 1999 and 1998 of
prize annuities awarded subsequent to December 23, 1994 through September
30, 1999 was approximately $1,733,000 and $1,367,000 respectively, which
has been reflected as restricted investments and other long-term
liabilities in the accompanying financial statements.
OPERATING LEASES
The Company leases its corporate offices, warehouses and certain office
equipment under non-cancelable operating leases. Future minimum rentals by
fiscal year under these arrangements are as follows:
2000 $ 249,000
2001 $ 180,000
2002 $ 82,000
Rental expense during fiscal years 1999, 1998 and 1997 amounted to
$249,000, $229,000 and $131,000, respectively.
9. RELATED PARTY TRANSACTIONS
On October 1, 1998, the Company exercised its option to acquire 356
electronic player stations and related equipment (EPS) for $1,448,000 from
Equipment Purchasing LLC ("EP LLC"), a limited liability company owned by
an affiliate of Gordon T. Graves, the Chairman and Chief Executive Officer
of the Company. The Company had originally sold the EPS to EP LLC in June
and September 1997 at an aggregate sales price of approximately $2,436,000.
Pursuant to agreements entered into at the time of the June and September
1997 sale transactions, the Company had an option to repurchase the EPS
from EP LLC at fair market value. While the purchase price paid by the
Company was not the result of an arms-length negotiation with an
unaffiliated third party, the Company believes that such purchase price is
comparable to what the Company would have paid to an unaffiliated third
party. The purchase price was paid by (i) cancellation by the Company of
$992,000 in notes receivable due from EP LLC, (ii) the assumption by the
Company of $77,800 in debt owed by the affiliate of Mr. Graves to a
financial institution, (iii) the payment by the Company of $133,000 to EP
LLC, (iv) the delivery to EP LLC of a 6% promissory note of the Company in
the principal amount of $133,000 due on April 1, 1999 (which was later
extended to September 30, 1999), (v) the issuance of 50,000 warrants to
purchase shares of common stock of the Company at $3.81 per share expiring
on June 30, 2002, and (vi) the issuance of 50,000 warrants to purchase
shares of common stock of the Company at $3.81 per share expiring on
September 30, 2002. On October 1, 1998, the closing price of the Company's
common stock as quoted on the NASDAQ SmallCap market was $2.50 per share.
The warrants, which were valued by the Company and EP LLC at $112,000, were
issued in cancellation of warrants to purchase the same number of shares
that had been granted to EP LLC in connection with the June and September
1997 sale transactions at exercise prices of $11.00 and $13.38 per share.
The $133,000 paid to EP LLC was applied by the affiliate of Mr. Graves to
pay a portion of outstanding notes due the Company by such affiliate.
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MULTIMEDIA GAMES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED
FINANCIAL STATEMENTS
On July 31,1999 the Company exercised its option to acquire 663 EPS for
$2.4 million from Equipment Purchasing LLC II ("EP LLC II"), a limited
liability company controlled by an affiliate of Gordon T. Graves, the
Chairman and Chief Executive Officer of the Company, and of which an
affiliate of Mr. Graves and Clifton E. Lind, the Company's President and
Chief Operating Officer, each owned 6.36%. The Company had originally sold
the EPS to EP LLC II in March and June 1998 at an aggregate sales price of
approximately $3.8 million. Pursuant to agreements entered into at the time
of the March and June 1998 sale transactions, the Company had an option to
repurchase the EPS from EP LLC II at fair market value if, after giving
effect to the repayment and the income previously received by EP LLC II, EP
LLC II would receive at least a 20% return on its net investment. While the
purchase price paid by the Company was not the result of an arms-length
negotiation, the Company believes that such purchase price is comparable to
what the Company would have paid to an unaffiliated third party.
In March 1998, the Company entered into an agreement to sell electronic
player stations and related equipment to a third party for a sales price of
approximately $2.4 million. The sales price was paid in March 1998 by
delivery to the Company of a promissory note of the third party purchaser
that was due and payable on or before April 30, 1998. Subsequent to March
31, 1998, the third party purchaser assigned its right under the purchase
agreement to a newly-formed limited liability company, EP LLC II. An
affiliate of Gordon T. Graves, the Company's Chairman of the Board and
Chief Executive Officer, and Clifton Lind, the Company's President and
Chief Operating Officer, each owned a 10.5% interest in EP LLC II. Mr.
Graves also owns and controls the corporation having management authority
over EP LLC II. The terms of the sale which was assigned to EP LLC II are
the same as the original terms entered into with the third party purchaser
in March 1998. The promissory note was paid by EP LLC II on May 15, 1998.
In June 1998, the Company sold electronic player stations and related
equipment to EP LLC II for a sales price of approximately $1.4 million,
which included a non-refundable deposit of $140,000 received on the
effective date of the transaction. The sales price was paid in June 1998 by
delivery to the Company of cash of $140,000 and a promissory note of EP LLC
II that was due and payable on or before July 15, 1998 out of funds
contributed to EP LLC II from a group of investors that did not include
either Mr. Graves or Mr. Lind or any other officer, director or employee of
the Company. As a result of the additional contribution, the ownership
interest of each of Mr. Graves and Mr. Lind in EP LLC II was reduced to
6.36%. Mr. Graves continues to own and control the corporation having
management authority over EP LLC II.
The EPS and related equipment purchased by EP LLC II has been leased to a
number of Indian tribes under terms where the Company and EPLLC-2 share in
a percentage of the revenues generated by the use and operation of the EPS
at the tribes' bingo facilities. As an inducement to consummate the March
1998 sale, the Company had agreed to issue to the original third party
issuer, and did issue to EP LLC II, warrants to purchase 20,000 shares of
common stock (exercisable for a period of five years, non-exercisable in
the first year) at an exercise price of $9.44 per share, which was the
market value of the common stock on the date the equipment purchase
agreement was executed. The estimated fair market value of these warrants
was $1,000 and has been recorded as additional cost of sales. As an
inducement to consummate the June 1998 sale, the Company issued to EP LLC
II warrants to purchase 262,500 shares of common stock (exercisable for a
period of five years, non-exercisable in the first year) at an exercise
price of $7.00 per share which was in excess of the market value of the
common stock on the date the equipment purchase agreement was executed
($3.50 per
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MULTIMEDIA GAMES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED
FINANCIAL STATEMENTS
share) The estimated fair market value of these warrants was $26,250 and
has been recorded as additional cost of sales.
In connection with the sales of the electronic player stations to EP LLC
II, the Company recorded revenues of $3,750,000 during the year ended
September 30, 1998 with related costs of sales of $1,878,000.
In June 1997, Graves Properties, Ltd., a limited partnership controlled by
Gordon T. Graves, the Company's Chairman and Chief Executive Officer,
formed Equipment Purchasing L.L.C. ("EP LLC") for the purpose of purchasing
MegaMania player stations from the Company and leasing the stations to
Indian tribes. In June 1997, EP LLC purchased approximately 100 MegaMania
player stations from the Company for a total purchase price of $637,347,
payable in two promissory notes of EP LLC, one a short term note in the
principal amount of $400,000 bearing interest at approximately 7% per
annum, and the other a 12% note in the principal amount of $237,344 due, as
to both principal and interest, in two years. In December 1997, EP LLC paid
the short term note in full. The purchased equipment has been leased to a
tribe under terms where the Company receives a percentage of the revenues
generated by the equipment in consideration of providing the equipment and
the MegaMania game to the tribe. The Company and EP LLC have agreed to a
sharing of such percentage of revenues, with EP LLC receiving a share equal
to the greater of a fixed percentage amount or such amount as is necessary
to satisfy EP LLC's monthly payment on the purchase note due the Company
and to amortize on a monthly basis the cash contributed to EP LLC by Graves
Properties, Ltd.
In September 1997, EP LLC purchased approximately 345 MegaMania player
stations from the Company for a total purchase price of approximately
$1,800,000, of which $990,000 was paid in cash in December 1997, and the
balance with a 12% note of EP LLC in the principal amount of $810,000 due,
as to both principal and interest, in two years. The purchased equipment
has been leased to five different tribes under terms where the Company
receives a percentage of the revenues generated by the equipment which is
shared with EP LLC under terms consistent with those of the June 1997 sale
to EP LLC discussed above.
In connection with the sales of the electronic player stations to EP LLC,
the Company recorded revenues of $2,436,000 during the year ended September
30, 1997 with related costs of sales of $1,183,000.
As an inducement to consummate the June 1997 sale, the Company issued to EP
LLC warrants to purchase 50,000 shares of common stock at an exercise price
of $11.00 per share, which was the market value of the common stock on the
date of issuance. The estimated fair market value of these warrants was
$2,500 and has been recorded as additional cost of sales. As an inducement
to consummate the September 1997 sale, the Company issued to EP LLC
warrants to purchase 100,000 shares of common stock at an exercise price of
$13.38 per share which was the market value of the common stock on the date
of issuance. The estimated fair market value of these warrants was $5,000
and has been recorded as additional cost of sales. The warrants will become
exercisable one year after the date of issue and expire five years after
the date of issue. The warrants are redeemable by the Company at $.10 per
share if the closing price of the common stock for 20 consecutive trading
days has been at least 150% of the applicable exercise price.
In connection with the sale of the equipment, the Company also entered into
a management agreement with EP LLC and EP LLC II whereby the Company is
responsible for proposing,
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MULTIMEDIA GAMES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED
FINANCIAL STATEMENTS
establishing and modifying interactive game procedures and the related game
accounting procedures; supervising and administering the rental agreement
with the Indian tribe; using its best efforts to release the purchased
equipment to other parties if the present rental agreement is terminated;
collecting all rents due under the rental agreement; performing all
necessary repairs and maintenance, but not bearing any risk of loss for
damages; conducting necessary marketing; maintaining insurance; and paying
all sales and use taxes and performing other administrative functions. As
compensation for these services, the Company will receive $10.00 per
electronic player station as a re-leasing fee and $10.00 per electronic
player station per month as a management fee ($15.00 per electronic player
station per month in the case of EP LLC II). The Company has the option to
repurchase the equipment at its then fair market value if after giving
effect to the payment of such repurchase price and the net rental income
received by EP LLC and EP LLC II, respectively, such entity has received a
20% internal rate of return.
On April 15, 1998, the Company entered into a Consulting Agreement, as
later amended, with Larry D. Montgomery, a Director of the Company. Mr.
Montgomery was the President and COO of the Company until December 1997.
The Consulting Agreement has a term of five years, but may be terminated by
either party with six months notice given at any time after January 1,
1999. The Company gave notice of termination of the agreement on September
30, 1999, but expects it will continue to use the services of Mr.
Montgomery on a month to month basis after the agreement expires in March
2000. Mr. Montgomery is compensated at the rate of $126,000 annually, and
received a bonus of $57,500 in September 1998 and an additional bonus of
$3,000 in November 1998. The Company has also agreed to pay the cost of all
premiums on life, health and disability insurance for Mr. Montgomery and
his family for five years and, during the term of the agreement, will pay
Mr. Montgomery rent of $1,000 per month for the use of an office in Topeka,
Kansas.
On September 1, 1999, the Company engaged Jefferies & Company, Inc.
("Jefferies"), an investment banking firm located in Santa Monica,
California, to act as the exclusive financial advisor to the Company in
connection with financing and acquisition related activities. Mr. Ali
Alizadeh, a Director of the Company, is an officer and employee of
Jefferies. Pursuant to the agreement, the Company agreed to pay Jefferies a
fee of $120,000 at the rate of $10,000 per month. In addition, the Company
agreed to pay Jefferies a "success fee" for any financing or acquisition
transaction consummated by the Company during the term of the agreement
which may be terminated by either party upon notice.
Gregory N. Stern, a former Director of the Company who resigned in June
1999, was involved with establishing Gamebay while he was a Director of the
Company. In connection with his resignation, the Company agreed to pay Mr.
Stern two percent (2%) of whatever interest the Company retained or
received in Gamebay, including two percent (2%) of the 490,000 shares of
common stock of Gamebay held by the Company and two percent (2%) of any
royalties received by the Company from Gamebay pursuant to a license to use
the Company's intellectual property.
10. ELECTRONIC PLAYER STATION LEASES
The Company sells its interactive gaming electronic player stations to its
customers for cash or through revenue sharing arrangements. Under the
revenue sharing arrangements, a portion of the revenue from the player
stations is paid to the Company until the sales price of the unit, plus
interest, is recovered. Approximately $3,506,000 was received under such
provisions during 1999, $3,416,000 in 1998, and $1,786,000 in 1997.
Outstanding principal under equipment sales pursuant to such revenue
sharing arrangements amounted to $2,413,000 at September 30, 1999, and
$4,152,000 for 1998. Generally, title to the player stations transfers to
the lessee at the end of the lease period. Revenue from the equipment sales
pursuant to revenue sharing is recorded as revenue as it is earned because
the Company generally must continue to operate the electronic player
station network in order to realize the sales proceeds. There can be no
assurance that the Company will realize the entire amount of $2,413,000 at
September 30, 1999, because customers could elect to remove the player
stations prior to their being fully paid for or because the economic
performance of the player stations at a particular location is not
sufficient to amortize the principal of the revenue sharing obligation.
The cost and net book value at September 30, 1999, and 1998 of electronic
player station lease equipment amounted to $4,774,998 and $1,320,260 and
$3,204,000 and $1,506,000, respectively. Electronic player station lease
equipment is depreciated over a three year period unless the rate of
payments being received in relation to total payments indicates transfer of
title will occur to the lessee on a more rapid rate.
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MULTIMEDIA GAMES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED
FINANCIAL STATEMENTS
11. CONCENTRATIONS OF CREDIT RISK
The Company maintains its cash in bank deposit accounts which at times may
exceed the federal depository insurance limits. As of the years ending
September 30, 1999 and 1998, the Company had concentrations of cash in one
bank totaling approximately $935,000 and $1,400,000 respectively. The
Company has not experienced any losses on such accounts in the past.
Accounts receivable represent short-term credit granted to customers for
which collateral is generally not required. Substantially all of the
Company's accounts receivable are from Native American Indian tribes or
their gaming enterprises. Additionally, a large percentage of these tribes
have their reservations and gaming operations in the state of Oklahoma.
Despite the industry and geographic concentrations related to the Company's
customers, due to the historical experience of the Company on receivable
collections, management considers credit risk limited with respect to
accounts receivable. At September 30, 1999, accounts receivable from one
tribe accounted for approximately 22% of total accounts receivable; the
same tribe accounted for approximately 30% of total trade accounts
receivable in 1998.
Approximately 45%, 48% and 45% of gaming revenues during the years ended
September 30, 1999, 1998 and 1997, respectively, were derived from halls
operated by four tribes. In 1999, two tribes accounted for approximately
19% and 12% of gaming revenues. Two tribes each accounted for approximately
17% of gaming revenues in 1998, and one tribe accounted for approximately
26% of gaming revenues in 1997. No other tribe accounted for more than 10%
of the Company's total gaming revenues in any of these years.
Notes receivable consist of financial instruments issued by customers for
the purchase of EPS. Substantially all of the Company's notes receivable
are from Native American Indian tribes or their gaming enterprises, as
discussed above. All of the Company's notes receivable are collateralized
by the related EPS.
12. SUBSEQUENT EVENTS
In December 1999, the credit facility (described in Note 4 above) was
amended in connection with obtaining Coast's consent to the terms of the
settlement of the NGI litigation. The amendment waives the tangible net
worth covenant violation that resulted from the settlement, increases the
early termination fee payable by the Company in the event the Company
prepays the credit facility prior to its maturity in July 2002, and
required the Company to pay a $100,000 fee to Coast in consideration for
the amendment.
In December 1999, the Company's wholly-owned subsidiary, Gamebay.com,
issued 70% of its equity securities to a group of investors for $5.5
million. In connection with that transaction, the Company granted Gamebay a
license to use the Company's intellectual property for Internet non-gaming
purposes. In consideration of the license grant, the Company received a one
time fee of $1.0 million (of which $400,000 is payable at the end of one
year) and is entitled to a royalty of 5% of Gamebay's gross revenue.
In December 1999, the Company entered into a license agreement with WMS
Gaming, Inc. (WMS) to use the trademarks, logos and other visual-audio
aids and graphics used by WMS in its highly successful Class III gaming
devices. The license is limited to Indian gaming in the State of Washington
and commits the Company to purchase a minimum of 1,000 units a year for
two years at $2,500 per unit, subject to the right of the Company to
terminate the agreement after one year by paying $500 per each remaining
unit under the commitment.
13. FOURTH QUARTER ADJUSTMENTS
In December, 1999, the Company settled a $3.1 million verdict against the
Company in a lawsuit as further described in note 8. The loss resulting
from this lawsuit settlement was accrued by the Company during the fourth
quarter of FY 1999. In addition, during the fourth quarter of FY 1999 the
Company recorded inventory and property and equipment adjustments totaling
approximately $475,000 and $325,000, respectively, to reserve for
obsolescence and as a result of proposed regulatory changes by the NIGC.
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MULTIMEDIA GAMES, INC. AND SUBSIDIARIES
Schedule II - Valuation and Qualifying Accounts
INVENTORY RESERVES
Balance at Balance at
Beginning of Period Additions Deductions End of Period
FY 1999 $ 39,000 $ 821,000 $ -- $ 860,000
FY 1998 $ 8,000 $ 31,000 $ -- $ 39,000
FY 1997 $ -- $ 8,000 $ -- $ 8,000
RESERVE FOR DOUBTFUL ACCOUNTS
Balance at Balance at
Beginning of Period Additions Deductions End of Period
FY 1999 $ 181,000 $ 441,000 $ 95,000 $ 527,000
FY 1998 $ 123,000 $ 131,000 $ 73,000 $ 181,000
FY 1997 $ 129,000 $ 47,000 $ 53,000 $ 123,000
RESERVE FOR CAPITALIZED SOFTWARE PROJECTS
Balance at Balance at
Beginning of Period Additions Deductions End of Period
FY 1999 $ -- $ 200,000 $ -- $ 200,000
FY 1998 $ -- $ -- $ -- $ --
FY 1997 $ -- $ -- $ -- $ --
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EXHIBIT INDEX
EXHIBIT NO. TITLE LOCATION
- ----------- ----- --------
3.1 Amended and Restated Articles of Incorporation (3)
3.2 Bylaws (1)
10.1 Form of Integrated Gaming Services Agreement (1)
10.2 Contingent Grand Prize Risk Assumption Agreement
dated October 1, 1995, between the Company and SCA Promotions, Inc. (2)
10.3 Form of 1992-3 Warrant Certificate Issued by the Company (1)
10.4 Form of 1995 Warrant Certificate Issued by the Company (1)
10.5 Registration Rights Agreement dated January 23, 1995 between the Company
and holders of certain Warrants (1)
10.6 Registration Rights Agreement dated January 23, 1995
between the Company and holders of certain Warrants (1)
10.7 Registration Rights Agreement among the Company and holders of
certain Warrants (2)
10.8 1994 Employee Stock Option Plan (1)
10.9 1994 Director Stock Option Plan (1)
10.10 1996 Stock Incentive Plan, as amended (7)
10.11 President's Plan (6)
10.12 1998 Senior Executive Stock Option Plan (7)
10.13 Form of Class A Warrant (4)
10.14 Form of Class B Warrant (4)
10.15 Warrant Agreement dated November 12, 1996 between
the Company and Corporate Stock Transfer, as Warrant Agent (4)
10.16 Amendment to Warrant Agreement, dated July 18, 1997 (4)
10.17 Consulting Agreement, dated April 15, 1998, between
the Company and Larry D. Montgomery. (6)
10.18 Amendment to Consulting Agreement dated August 31, 1998. (6)
10.19 Shareholder Rights Plan (5)
21.1 Subsidiaries of Registrant (8)
23.1 Consent of PricewaterhouseCoopers LLP (8)
23.2 Consent of BDO Seidman, LLP (8)
24.1 Power of Attorney (included on page 37) (8)
27.1 Financial Data Schedule (8)
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(1) Indicates incorporated by reference to the Company's Form 10-KSB filed with
the Commission for the fiscal year ended September 30, 1994.
(2) Indicates incorporated by reference to the Company's Form 10-KSB filed with
the Commission for the fiscal year ended September 30, 1996.
(3) Indicates incorporated by reference to the Company's Form 10-QSB filed with
the Commission for the quarter ended March 31, 1997.
(4) Incorporated by reference to the Company's registration statement on Form
8-A, filed with the Commission on July 29, 1997.
(5) Incorporated by reference to the Company's registration statement on Form
8-A, filed with the Commission on October 23, 1998.
(6) Indicates incorporated by reference to the Company's Form 10-KSB filed with
the Commission for the fiscal year ended September 30, 1998.
(7) Incorporated by reference to the Company's Proxy Statement filed with the
Commission on April 8, 1999.
(8) Filed herewith