UNITED
STATESSECURITIES AND EXCHANGE COMMISSION
Washington,
D.C. 20549
Form
10-K
(Mark
One)
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ANNUAL
REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF
1934
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For
the fiscal year ended December 31,
2008
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OR
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TRANSITION
REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF
1934
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For
the transition period from:___________ to ___________
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Commission
file number: 000-51703
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FortuNet,
Inc.
(Exact
name of Registrant as specified in its charter)
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Nevada
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88-0252188
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(State
or other jurisdiction of
incorporation
or organization)
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(I.R.S.
Employer
Identification
Number)
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2950
South Highland Drive, Suite C
Las
Vegas, Nevada 89109
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(Address
of principal executive offices including Zip Code)
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Registrant’s
telephone number, including area code: (702)
796-9090
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Securities
registered pursuant to Section 12(b) of the Act: None
Securities
registered pursuant to Section 12(g) of the Act:
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Common
Stock, $0.001 par value
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(Title
of Class)
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Indicate
by check mark if the registrant is a well-known seasoned issuer, as defined in
Rule 405 of the Securities Act.
Yes
x
No
Indicate
by check mark if the registrant is not required to file reports pursuant to
Section 13 or Section 15(d) of the Act.
Yes
x
No
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.
x
Yes
No
Indicate
by check mark if disclosure of delinquent filers pursuant to Item 405 of
Regulation S-K (§ 229.405 of this chapter) 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.
x
Indicate
by check mark whether the registrant is a large accelerated filer, an
accelerated filer, or a non-accelerated filer. See definition of “accelerated
filer,” ” large accelerated filer” and “smaller reporting company” in
Rule 12b-2 of the Exchange Act. (Check one):
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Large
accelerated filer
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Accelerated
filer
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Non-accelerated
filer
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Smaller
reporting company
x
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(Do not check if a smaller reporting
company)
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Indicate
by check mark whether the registrant is a shell company (as defined in Rule
12b-2 of the Act).
Yes
x
No
As of
December 31, 2008, the aggregate market value of the registrant’s common stock
held by non-affiliates was approximately $2,620,000 (based on a closing sale
price of $1.71 per share as reported by the Nasdaq Global Market). Shares of
common stock beneficially held by executive officers and directors and by each
person who beneficially owns 5% or more of the outstanding common stock have
been excluded since such persons may be deemed affiliates. This determination of
affiliate status is not necessarily a conclusive determination for other
purposes.
There
were 11,042,011 shares of the registrant’s common stock issued and outstanding
as of February 27, 2009.
Documents
Incorporated by Reference
Portions
of the registrant’s definitive Proxy Statement for the Annual Meeting of
Stockholders to be held on May 6, 2009 are incorporated by reference in Part III
of this Form 10-K to the extent stated herein. Except as expressly incorporated
by reference, the registrant’s Proxy Statement shall not be deemed to be a part
of this Form 10-K.
FORTUNET,
INC.
ANNUAL
REPORT ON FORM 10-K
FOR
THE YEAR ENDED DECEMBER 31, 2008
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Page
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PART
I
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ITEM
1.
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Business
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5
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ITEM
1A.
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Risk
Factors
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18
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ITEM
2.
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Properties
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32
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ITEM
3.
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Legal
Proceedings
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32
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ITEM
4.
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Submission
of Matters to a Vote of Security Holders
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32
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PART
II
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ITEM
5.
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Market
for the Registrant’s Common Equity, Related Stockholder Matters and Issuer
Repurchases of Equity Securities
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33
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ITEM
6.
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Selected
Financial Data
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34
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ITEM
7.
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Management’s
Discussion and Analysis of Financial Condition and Results of
Operations
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34
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ITEM
7A.
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Quantitative
and Qualitative Disclosure about Market Risk
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41
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ITEM
8.
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Financial
Statements and Supplementary Data
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41
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ITEM
9.
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Changes
in and Disagreements With Accountants on Accounting and Financial
Disclosure
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59
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ITEM
9A.
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Controls
and Procedures
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59
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ITEM
9B.
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Other
Information
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60
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PART
III
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ITEM
10.
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Directors,
Executive Officers and Corporate Governance
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60
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ITEM
11.
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Executive
Compensation
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60
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ITEM
12.
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Security
Ownership of Certain Beneficial Owners and Management and Related
Stockholder Matters
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61
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ITEM
13.
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Certain
Relationships and Related Transactions, and Director
Independence
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61
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ITEM
14.
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Principal
Accountant Fees and Services
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61
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PART
IV
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ITEM
15.
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Exhibits
and Financial Statement Schedules
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62
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Signatures
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64
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SPECIAL
NOTE REGARDING FORWARD-LOOKING STATEMENTS
This
Annual Report on Form 10-K contains forward-looking statements within the “safe
harbor” provisions of the Private Securities Litigation Reform Act of 1995. All
statements included in this Annual Report, other than statements that are purely
historical, are forward-looking statements. Words such as “anticipate,”
“contemplate,” “expect,” “intend,” “plan,” “believe,” “seek,” “estimate,”
“will,” “will continue to be,” or the negative of foregoing and similar
expressions regarding beliefs, plans expectations or intentions regarding the
future also identify forward-looking statements. Forward-looking statements in
this Annual Report include, without limitation, the following:
(1) Our belief that we should adapt a
conservative view on the near-term economic viability of traditional casino
games, such as poker, slots and keno, to be played on our mobile gaming
platform, even if it is approved, for use in Nevada casinos, because the
economic reality in Nevada gaming industry drastically worsened in 2008 and in
our opinion, it is not likely to quickly improve, at least in 2009 and possibly
well beyond 2009,(2) our belief that in the new economic environment, casinos
have excessive capacity of slot machines and gaming tables on their main casino
floors and are therefore not motivated to promote playing of traditional casino
games in the auxiliary gaming areas, such as bingo halls, sports books and bars,
since such gaming would involve additional costs to casinos, (3) our belief that
during the hard times, casinos are unlikely to cannibalize the main casino
floors for the sake of generating some additional revenues in the auxiliary
areas; whereas at the times of economic prosperity, the extra revenues generated
in the auxiliary gaming areas would be welcome;
(4) our belief that the
adoption of our plan to continue to reduce the principal of ARS in our portfolio
is financially prudent and advisable; (5) our belief that the failed auctions
that we experienced during 2008 are not a result of the deterioration of the
underlying credit quality of the auction rate securities, although valuation of
them is subject to uncertainties that are difficult to predict; (6) our belief
that any unrealized gain or loss associated with the auction rate securities
will be temporary and will be recorded in accumulated other comprehensive income
(loss) in our financial statements; (7) our belief that it is prudent and
advisable to continue to monitor the market for our auction rate securities and
consider its impact if any) on the fair market value of our investments; (8) our
belief that we will have the ability to hold any auction rate securities for
which auctions fail until the market recovers; (9) our belief that based on our
cash and cash equivalents balances at December 31, 2008, the current lack of
liquidity in the credit market and capital markets will not have a material
impact on our liquidity, cash flows, financial flexibility, or our ability to
fund our operations; (10) our belief that it is prudent and advisable and in the
Company’s best interest to continue to make a significant investment in product
development, as needed; and to continue to focus on research and development and
pursue product development opportunities; (11) our belief that it is prudent and
advisable and in the best interest of the Company to continue to
introduce new products for the gaming market; (12) our belief that
our research and development efforts have made our mobile gaming platform
compliant with the wireless gaming regulations promulgated by the Nevada Gaming
Commission to date; (14) our belief that it is prudent, advisable and in the
best interest of the Company to offer to current and potential customers an
option of purchasing our gaming platforms for use in conducting traditional
casino games, in addition to an option of entering into lease contracts, as we
do now in the case of bingo games, or pursuant to purchase options contained in
lease agreements; (15) our belief and expectation that current legal claims and
proceedings pending against us, if any, will not have a significant effect on
our financial position or results of operations; (16) our expectation that we
will continue to incur similar costs associated with the stock grants to our
directors; (17) our belief and anticipation that our
leasing revenue will be sufficient to fund our current operating expenses in the
short term; (18) our belief that the lack of liquidity associated with our
Auction Rate Securities (“ARS”) will not adversely affect our business in the
immediate future; (19) our belief that our cash flow from operations combined
with our available liquid resources will be adequate to meet our expenditures
for the next 12 months and foreseeable future; (20) our expectation that we will
incur significant additional expenses in connection with the further development
of our manufacturing infrastructure including our bingo paper printing presses
and electronic assembly lines as well as the procurement of components for the
manufacturing of additional stationary and wireless player terminals primarily
to stabilize our revenues in the worsening economic market; (21) our
anticipation that lease expenses will consume a substantial portion if not all
of our recurring lease revenues as well as our accumulated investment funds;
(22) our belief that the final resolution of any of pending litigation is not
likely to have a material adverse effect on our business, cash flow, results of
operations or financial position; (23) our expectation that competition will
increase and intensify as the market for mobile gaming devices develops; (24)
our expectation of fierce competition from multiple large competitors dominating
their respective markets in our expansion efforts, such as Aristocrat Leisure,
Ltd., International Game Technology, Inc., Alliance Gaming Corporation, WMS
Gaming Inc. and Shuffle Master, Inc., that may enter the market for mobile
gaming devices; (25) our anticipation that competition in the mobile gaming
market will become even more fierce when and if, other licensed operators of
mobile gaming systems including, International Game Technology, Inc., Sona
Mobile, Inc. and GameTech International, Inc. enter the market; (26) our
expectation that sufficient long term cash will be generated from existing
operations and potentially through selling or leasing our
products
in new markets; (27) our belief that the acceptance of our wireless gaming
terminals by gaming establishments and their players will depend on our ability
to demonstrate the economic and other benefits of our products; (28) our belief
that our intention to offer our customers equipment lease agreements under which
we will lease our wireless gaming terminals and the associated equipment is
prudent, advisable, and in the best interest of the Company; (29) our
expectation that the Company will enter into agreements with customers that
operate casinos and bingo halls in more than one location; (30) our belief and
expectation that our agreements with multi-location customers will provide that
the customer will be responsible for providing, at its expense, a dedicated
high-speed computer network connection between our server-based gaming systems
in the various locations operated by the customer to a remote central gaming
server supporting such systems; (31) our belief and expectation that a
substantial portion of our future growth will be dependant upon and result from
the potential general expansion of the gaming industry; (32) our belief that
there will be an increase in demand for our consumable bingo products; (33) our
belief that our plan to temporarily postpone our growth plans in order to
concentrate our efforts and resources on adapting to the recent economic
downturn is prudent, advisable and in the best interest of the Company; (34) our
belief that the Company has the ability to hold the remaining unliquidated ARS
securities throughout the currently estimated recovery period; and (35) our
belief and expectation that the recent negative trend in our financial
performance may continue at least in the near future.
Our
expectations, beliefs, objectives, anticipations, intentions and strategies
regarding the future, including, without limitation, those concerning expected
operating results, revenues and earnings are not guarantees of future
performance and are subject to risks and uncertainties that could cause actual
results to differ materially from results contemplated by the forward-looking
statements including, but not limited to: unexpected difficulties in
penetrating new markets as a result of regulatory, competitive or other
barriers; inability to devote additional resources to our marketing efforts;
inability to devote additional resources to our research and development
initiatives to enhance product development; unexpected changes to zoning laws
that effect our ability to continue to manufacture products in our current
facility; inability to cut our costs resulting in a loss of our existing
customers to our competitors; legality of our electronic bingo players; our
inability to create or introduce new products for the conventional bingo market;
our failure to gain approval for our gaming platforms to play traditional casino
games; unanticipated decreases in our manufacturing capabilities; unfavorable
outcome of our ongoing litigation matters; increased costs related to defending
our pending litigation matters; loss of existing distributors or our failure to
further broaden our distribution channels; inability to accurately predict the
impact of a loss of a major portion of revenue from a certain distributor on our
revenues for 2008; unanticipated substantial decrease or increase in our
research and development expenses; unexpected changes to credit ratings of the
auction rate securities; difficulty in evaluating the value of the auction rate
securities; unexpected need for additional cash and cash equivalents due to an
increase in our capital expenditures; inability to accurately value the
underlying assets supporting auction rate securities; changes in default rates
applicable to the underlying assets, underlying collateral value, and the
strength and quality of the market and liquidity; inability to accurately
predict the impact of the recordation of any unrealized gain or loss associated
with auction rate securities in our financial statements; unexpected changes in
our liquidity, cash flows due to unexpected changes in the credit and capital
markets; inability to predict the impact of market changes with respect to our
auction rate securities; unanticipated need to liquidate our auction rate
securities; an unanticipated need for additional funds for operating expenses,
new business opportunities, recession, decrease in consumer spending, or other
events; inability to protect and defend our intellectual property
rights; the failure of the overall gaming industry to expand at the rate we
expect; unexpected need to expand our operations and inability to enter into a
new manufacturing lease; unanticipated drop or increase in inventory levels;
inability of our leasing revenue to meet our operating expenses in the short and
long term; inability to finance additional expenses related to the procurement
of equipment and the manufacturing of equipment and component parts in order to
expand our production efforts; unanticipated increase in expenditures during the
next 12 months; lack of growth in the gaming industry; inability to procure
additional customers and enter into new lease agreements; rapid technological
changes in the gaming industry that render our technology obsolete; difficulties
demonstrating the economic benefits of our products; inability to
meet the evolving industry standards of casino and player demands; failure to
achieve market acceptance of our products; lack of demand for our consumable
bingo products; inability to predict the length of the economic decline;
inability to predict the timing of expenses related to the development of our
manufacturing infrastructure; inability to predict the amount of investment
funds that will be consumed in order to develop our manufacturing
infrastructure; inability to penetrate new jurisdictions and markets; and
inability to improve our financial, accounting and operation systems and
controls.
We assume
no obligation to update any forward-looking statements. Readers are cautioned
not to place undue reliance on forward-looking statements, which speak only as
of the date of this Annual Report on Form 10-K. Readers should also review the
cautionary statements and discussion of the risks of our business set forth
elsewhere
herein
under the heading “Risk Factors” under Part I, Item 1A and our other filings
with the Securities and Exchange Commission (“SEC”).
ITEM
1. BUSINESS
General
We are an established manufacturer of
multi-game and multi-player server-based gaming platforms. We have historically
been profitable, however, because of the recent and continuing severe downturn
in the local, state, national and worldwide economy, and the resulting material
adverse impact on gaming, we can give no assurances of profitability in the
future. Our gaming platforms include networks of both wireless and
stationary player terminals, cashier-based point-of-sale terminals, self-service
point-of-sale kiosks and game file servers that conduct and control bingo games.
Our gaming platforms have been adapted (although not yet approved for sales in
Nevada) to conduct traditional casino games, such as keno, poker and slots, in
addition to, and concurrently with, bingo. Our gaming platforms enable patrons
to play bingo using either our wireless or our stationary player terminals. In
addition, our gaming platforms have been adapted (although not yet approved for
sales in Nevada) to enable patrons to play traditional casino games using our
stationary player terminals.
Based on our belief that
our
research and development efforts have made our mobile gaming platform compliant
with the wireless gaming regulations promulgated by the Nevada Gaming Commission
on March 23, 2006 and Mobile Gaming System Policies published by Nevada Gaming
Commission on July 21, 2006, we submitted our mobile gaming platform for review
by the Nevada gaming authorities in 2006. At the very end of the third quarter
of 2008, we have received a communication from the Nevada Gaming Control Board
(the “NGCB”) raising new additional questions regarding certain software and
hardware aspects of our mobile gaming platform. Although we believe that we have
expeditiously developed software and hardware modifications adequately
responding to the raised questions, we can provide no assurances that the latest
modifications may be acceptable to the NGCB. Even assuming that the
modifications are acceptable to the NGCB, we are concerned that the NGCB
analysis of the new modifications may delay significantly the overall process of
reviewing of our mobile gaming platform. If our wireless gaming devices are
eventually approved by the Nevada gaming authorities and the economy revives,
Nevada casino patrons will be able to play traditional casino games using our
wireless player terminals. However, there can be no assurance that we will
obtain such approval in the foreseeable future or at all. See
also, “Risk Factors” under Part I, Item 1A.
If we
obtain the necessary approvals, we will continue to market our wireless gaming
platform to Nevada casinos, most likely commencing with casinos with bingo halls
where our mobile gaming platforms are already in use for playing bingo
games. We believe the addition of traditional casino games to our
mobile platform will potentially increase these casino operators’
revenues. However, we do not believe the market will be ready to
adapt mobile gaming of traditional casino games in the near future due to the
worsening economic environment. When and if the Nevada market does accept mobile
gaming of traditional casino games, we expect to subsequently expand our
marketing to additional Nevada casinos that may be attracted to our mobile
gaming platform by the potential of new gaming revenues generated in the
auxiliary gaming and peripheral public areas of casinos where playing of
traditional casino games, such as poker, keno and slots, was previously not
available. In such a case, we expect to subsequently expand marketing efforts
for our wireless gaming platform beyond Nevada.
Meanwhile,
we believe that we should adapt a conservative view on the near-term economic
viability of traditional casino games, such as poker, slots and keno, to be
played on our mobile gaming platform, even if it is approved for use in Nevada
casinos. As evidenced and widely publicized in numerous city, state
and national publications, including the Las Vegas Review Journal, the New York
Times, and the Wall Street Journal, the Center for Business and Economic
Research at the University of Nevada, Las Vegas, as well as investment banking
gaming industry analysts, including Deutsche Bank, the economic health of the
Nevada gaming industry drastically worsened in 2008, and in our opinion, it is
not likely to quickly improve, at least in 2009 and possibly well beyond
2009. In this recessionary economic environment, we believe
that casinos have excessive capacity of slot machines and gaming tables on their
main casino floors and are therefore not motivated to promote playing of
traditional casino games in the auxiliary gaming areas, such as bingo halls,
sports books and bars, since such gaming would involve additional costs to
casinos. During the hard times of economic contraction, we believe that casinos
are unlikely to cannibalize the main casino floors for the sake of generating
some additional revenues in the auxiliary areas; whereas in times of economic
prosperity and expansion, when the main casino floors are more fully utilized,
we
believe that the extra revenues generated in the auxiliary gaming areas would be
welcome. See also, “Risk Factors” under Part I, Item
1A.
Yet,
having essentially finished the necessary preparations for field deployment of
our casino mobile gaming platform and having started volume manufacturing of the
platform in the anticipation of such a deployment, we believe that we now have
to start the field deployment of our newest mobile gaming models from the bingo
applications only. Moreover, we believe that at least in the immediate future,
we have to reconsider our overall strategy in favor of concentrating our
energies and resources in the field of bingo gaming rather than in the field of
traditional casino gaming. See also, “Risk Factors” under Part I,
Item 1A.
We
currently own and lease to our customers an inventory of third- and
fourth-generation wireless and stationary player terminals, marketed under the
BingoStar® brand name, that are deployed in casinos and bingo halls in 27
jurisdictions in North America, including Nevada casinos operated by several
major casino operators. We derive essentially all of our revenue from leasing
our gaming platform to our customers. Our contracts are typically based on a
fixed fee per use per bingo session, a fixed weekly fee per player terminal or a
percentage of the revenue generated by each player terminal.
We were
incorporated in Nevada in 1989. In 1993, the Nevada Gaming Commission
licensed us as a gaming equipment manufacturer and distributor. In
1994, we received Nevada regulatory approval for our server-based, concurrent
multi-gaming, video gaming network, Mega Fortune®. In 2003, the Nevada Gaming
Commission granted us an Operator of Inter-Casino Linked Systems, or OILS,
license. The OILS license permits us to operate progressive jackpot linked
casino games offered simultaneously at a number of participating casinos. In
September of 2006, the Nevada Gaming Commission granted us an Operator of Mobile
Gaming Systems license.
In
January 2004, we became the 100% owner of Millennium Games, Inc., or Millennium,
which enabled us to consolidate our worldwide distribution rights and to
significantly reduce our overall distribution and operational costs. Millennium
serves as a distribution channel for our bingo products in Native American or
tribal jurisdictions as well as other jurisdictions outside of Nevada. In 2008,
we have established two additional wholly owned subsidiaries, Star Bingo
Holdings, LLC, and Star Bingo Supplies, LLC, in order to further facilitate our
business.
The
FortuNet Gaming Platform
Our core
technology is embodied in the FortuNet® gaming platform that we currently lease
to casinos and bingo halls throughout North America. Our gaming platform serves
as the core foundation on which all of our mobile gaming platforms are based,
including our BingoStar electronic bingo gaming platform and our WIN-WIN mobile
casino gaming platform. The FortuNet gaming platform includes the following
major structural elements:
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Central
game file servers that conduct and control the playing of bingo and
traditional casino games on our wireless and stationary player
terminals;
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a
comprehensive player tracking, accounting, inventory management and
reporting software package marketed under our Accounting and Inventory
Management System, or AIMS™, brand
name;
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a
flexible gaming software package that executes on our multi-game,
multi-player gaming platform and provides a variety of downloadable
traditional casino games;
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interactive
wireless and stationary player terminals that display the outcomes of the
games determined by the central game file
servers;
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Cashier-operated
POS terminals and self-service POS kiosks, issuing money deposit receipts
and dispensing payouts; and
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Internally
developed hardware and software wireless technology enabling efficient, RF
noise-tolerant and reliable bi-directional RF communications between
central game file servers and wireless player terminals secured through
the use of our downloadable and disposable authentication
keys.
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BingoStar
Gaming Platform and Products
Our
BingoStar platform of integrated, multi-game, multi-player wireless and
stationary player terminals allows patrons to play over 4,000 bingo cards with
the option of concurrently playing entertainment games, such as solitaire. Our
BingoStar platform enables many variations of bingo, including fast-paced
30-number bingo, 90-number British-style bingo, bonanza bingo, pari-mutuel
bingo, progressive-jackpot bingo, Class-II slot-style bingo and multi-site
linked bingo. BingoStar enables automatic and semi-automatic daubing of players’
electronic bingo cards that facilitates playing of numerous bingo cards in each
bingo game, yielding higher revenues for bingo hall operators.
We have
developed several proprietary sets of electronic bingo cards for generic and
custom applications, such as bonanza bingo games and double-action bingo games.
No card in our sets duplicates any card in any commercial set of paper bingo
cards known to us. In addition, our wireless and stationary player terminals are
capable of storing in electronic format complete facsimiles of third-party
commercial sets of paper bingo cards. As a result, our player terminals can
monitor both paper and electronic bingo cards.
BingoStar
also allows the playing of do-it-yourself bingo cards, akin to a lottery ticket,
on the player’s terminal by registering all electronic and paper do-it-yourself
cards. The central game file server verifies all do-it-yourself cards and
automatically rejects all void and unregistered cards, which results in a high
degree of security and integrity for do-it-yourself bingo games. BingoStar will
automatically disable a wireless player terminal if a POS cashier voids a
player’s bingo cards. This feature prevents an unscrupulous cashier from
pocketing the proceeds of the voided bingo cards.
In 2007,
we have supplemented our BingoStar platform with a broad new line of bingo
products, dubbed Smart (patents pending). The Smart product line includes
progressive signs, solid state bingo flashboards, bar coded bingo balls and
automatic bingo ball blowers. We have started field deployment of the Smart
progressive signs and flashboards in 2007, and in 2008, we started field
deployment of Smart bingo ball blowers. Also in 2008, we have started commercial
deliveries of our innovative bar coded Smart paper bingo cards printed on our
advanced printing presses that allow us to supply bingo halls with secure paper
bingo cards in high volumes.
Accounting
and Inventory Management System (AIMS)
Our
gaming platform includes a comprehensive accounting and inventory management
software package marketed under the brand name AIMS. Our AIMS software is a
distributed software package running on our central game file servers and POS
terminals. The AIMS software package runs in a mixed Windows-XP and Linux
environment and is an assembly of numerous functional modules, each addressing
the specific management needs of casinos and bingo halls. For example, AIMS
includes a comprehensive player tracking module that analyzes and reports
players’ spending and automatically issues electronic coupons that provide
players with incentives to play multiple bingo sessions. AIMS also automatically
tracks in real time the inventory of bingo packs as they are sold through POS
terminals or directly on the gaming floor. In addition, AIMS automatically
computes all payouts owed to bingo players and accrues progressive prizes,
including the reserve accounts for the prizes. Because AIMS includes data
exporting and importing modules that are fully compatible and integrated with
commercial casino management packages running on casino mainframes, AIMS
delivers full transparency into the operational results of our gaming platform
to casino management.
WIN-WIN
Mobile Gaming Platform
We intend
to market our mobile casino gaming platforms under the WIN-WIN brand name. These
platforms are comprised of our central game file servers, gaming software,
wireless player terminals and POS terminals and POS kiosks operated through our
wireless communication technology, as described below. Once the gaming market
turns around, we anticipate deploying our WIN-WIN platforms in Nevada casinos
upon obtaining the required product approvals from the Nevada gaming
authorities.
Redundant
Central Game File Servers
The
central game file server of our gaming platform is where bingo and traditional
casino games are actually conducted. Game outcomes are then displayed on our
wireless and stationary player terminals. Our redundant central game file
servers are internally developed, PC-compatible computers equipped with
non-modifiable and
verifiable
memory circuitry that we believe complies with Nevada’s gaming device standards.
Our central game file servers run on a reliable operating system and facilitate
the concurrent playing of multiple types of bingo games along with traditional
casino games. In addition, our central game file servers generate all random
factors that determine the outcomes of the games played. The central game file
servers also generate unique, disposable encryption and authentication keys that
are downloaded into the wireless player terminals and redundantly preserve game
and financial transaction histories.
Flexible
Gaming Software Package with Download Capabilities
Our
internally developed modular gaming software allows us to customize our gaming
packages to meet the regulatory requirements of specific jurisdictions. The
architecture of our software is designed to provide multi-game, multi-player
functionality and facilitates modifications of existing games as well as the
ability to download a variety of traditional casino games to the wireless player
terminals. The package is written in the efficient C programming language and is
executed in the reliable Linux environment.
Wireless
Player Terminals
Our
wireless player terminal is a key component of the FortuNet gaming platform. It
reflects many years of research and development in the areas of wireless
technology, communication security, software and hardware architecture, and
ergonomic user interface design. While available in a variety of models and
formats including smaller, monochrome units, the current models of our wireless
player terminals are fourth generation products that incorporate either an 8.40
inch color liquid crystal display and measure 9.75 inches long by 2.00 inches
wide and are 8.13 inches tall or 10.4 inch color liquid crystal display and
measure 9.5 inches long by 0.6 inches wide and are 8.25 inches tall. The
wireless player terminals are equipped with fast-recharge battery circuitry and
sustain continuous operation for at least 12 hours. In 2008, we started volume
production of our latest model of wireless player terminals capable of playing
bingo along with traditional casino games. The latest model includes a super
bright 10.40-inch color LCD.
Our color
wireless player terminals are capable of playing not only bingo but also
traditional casino games. If required approvals are obtained and the economic
environment improves, our wireless player terminals will allow players to play
traditional casino games anywhere within permitted public areas of the casino.
By providing a means to play in a comfortable environment, our wireless player
terminals may stimulate players to play longer and will, in essence, expand the
casino floor to auxiliary gaming and peripheral public areas while
simultaneously reducing energy and labor costs.
We
believe that our mobile gaming platform complies with the standards being
promulgated by the Nevada Gaming Commission for mobile gaming devices, as well
as many of the standards for conventional slot machines. In particular, our
internal testing indicates that our wireless player terminal is equipped with
tamper-evident features and alarms that render the unit inoperable following a
tampering event.
Stationary
Player Terminals
Our
stationary player terminals are secure PC-compatible computers equipped with
high-resolution, 15 inch flat liquid crystal color touch screens and are
available in different formats, such as slant-top, upright, coin-operated and
cashless ultra-thin video terminals. These high-end terminals allow players to
watch and listen to close-circuit television programs in adjustable
picture-in-picture windows while playing bingo or traditional casino games. Our
stationary player terminals are housed in custom-made metal, slot-machine-like
cabinets. Our stationary player terminals run essentially the same software as
our wireless player terminals.
Cashier-operated
POS terminals and self-service POS kiosks
Players
make all money deposits and receive payouts and refunds at our secure
PC-compatible cashier-operated POS terminals or at our self-service POS kiosks.
The functions of both POS configurations are nearly identical, as both POS
configurations issue bar-coded transaction receipts to the player, register the
player’s identification from the player’s card, and register those transactions
with the central game file servers. The only difference is that in the case of
the cashier-operated terminals, it is the cashier who accepts payments and hands
out refunds and prizes, whereas, a kiosk acts much like a bank automated teller
machine.
Both POS
configurations have optional features, such as the ability to accept credit
cards where permitted by law. The kiosk is configurable to dispense bills, coins
or redeemable bar-coded vouchers and is also configurable to include a charger
rack housing wireless player terminal. In jurisdictions other than Nevada, the
kiosk may also optionally house the central file server that operates games on
the wireless player terminals dispensed from the kiosk. With optional wheels, a
mobile kiosk can be transported to different multi-use facilities, such as
theaters. The kiosk incorporates a player-operated touch screen that doubles as
an advertising channel when the kiosk is not in use. The kiosk’s internal
systems are securely locked and alarmed and are accessible only to authorized
personnel who must identify themselves with a magnetic stripe user card and a
password entered on the kiosk touch screen.
Because
self-service kiosks do not require cashiers, they can potentially yield
operators significant savings in labor costs. In addition, kiosks shorten the
waiting lines, especially in bingo halls, and free more time for the patrons to
play casino games.
Internally
Developed, Secure and Reliable Wireless Communication Technology
Our
mobile casino gaming platform uses our internally developed, fast-response,
secure, bi-directional spread-spectrum and narrow-band radio frequency, or RF,
communication hardware and software for wireless communications. Our
communication hardware and software offer reliable and secure data delivery to
and from our wireless player terminals, even in the noisy environments
characteristic of modern casinos that are saturated with cellular telephones and
security radio telephones. We use disposable downloadable encryption and
authentication keys to prevent hacking of our RF channels.
Our
wireless player terminals are also equipped with a close-proximity, secure,
infrared communication channel to download our authentication keys. At the
cashier-operated POS terminals and the self-service POS kiosks, we download each
wireless player terminal with a unique file containing many disposable
encryption and authentication keys. Each key is used only once, to encrypt and
authenticate a single gaming transaction performed over the RF channel. For
example, each poker hand dealt by the file server to the player terminal is
encoded separately with a unique key.
Our
mobile gaming platform can detect and automatically terminate operations on the
wireless player terminals when they are taken beyond permitted areas by
automatically destroying the encryption and authentication keys. Our wireless
player terminals are also equipped with player identification circuitry to,
among other things, prevent under-age gaming.
Manufacturing
and Assembly
We
develop and own all technical documentation and intellectual property rights to
manufacturing tools, such as plastic molding forms and printed circuit board
layout masks used to manufacture our wireless player terminals.
Once a
product is designed and tested at our facility, we typically contract the volume
production of parts and subassemblies to outside vendors. We contract
subassembly manufacturing jobs to a number of reputable second-source suppliers.
As a result, if demand for our products increases significantly, we can increase
our production capabilities by placing additional orders with multiple
manufacturers.
In
addition to contracting the manufacturing of our custom subassemblies, we also
purchase standard off-the-shelf components, such as video monitors, power
supplies and batteries in volume. In order to achieve economies of scale, we
carefully research the component markets for the best prices available and often
adjust our designs to incorporate cost-efficient components that we can purchase
in large volumes.
Upon
receipt of ordered parts and subassemblies, we assemble the finished products at
our facility in Las Vegas. We believe that our recently expanded manufacturing
facilities are adequate for manufacturing sufficient volume of mobile gaming
products to satisfy the initially anticipated demand. Currently, we operate only
one work shift. However, we can add up to two extra work shifts at our current
facilities if necessary.
Competition
We
experience intense competition from a number of established suppliers of gaming
equipment to the bingo market and the casino market. Many of our competitors
have longer operating histories, long-standing relationships
with
gaming establishments and suppliers, greater name recognition and greater
financial, technical and marketing resources than we do. As a result, our
competitors may have substantial competitive advantages over us. Additionally,
the casino market is characterized by a cautious attitude toward the reliability
and security of emerging wireless gaming platforms, creating additional
marketing challenges for us. We may not be able to exploit new or emerging
technologies, adapt to changes in customer requirements more quickly than our
competitors or devote the necessary resources to the marketing of our products
and services. See also, “Risk Factors” under Part I, Item
1A.
Bingo
Market
Currently,
we believe that our primary competitors in our existing electronic bingo market
are Planet Bingo, LLC (recently merged with Melange Computer Services, Inc.),
VKGS, LLC, or Video King, formerly a division of BK Entertainment Corp. and
GameTech International, Inc., or GameTech. What we believe to be one
of the largest bingo products company in the world, Arrow International, Inc.,
that in the past did not manufacture any electronic player units, has recently
entered into the electronic bingo market with their own portable bingo
terminals. In addition to Planet Bingo, Video King, GameTech, and
Arrow, a number of other companies compete in the electronic bingo market
including Blue Dog, Inc., Electronic Gaming Solutions, Inc., California
Concepts, Inc and a recent new entrant in the market Bingo,
Inc. Arrow is much larger than us, has a substantial generally known
and acknowledged presence in the market, and we believe has greater financial
resources than us. GameTech is a public company that is larger than
us, with significant financial resources. The other companies are
private companies, therefore, specific information on their relative financial
strength, and market presence and their ability to impact the market and our
company is not publically available, and is very limited. Therefore,
we are unable to ascertain the strength of and the impact of these competitors
on us or our market with any degree of specificity or certainty at this
time. Once additional information becomes available and is otherwise
known, it could reveal that they could have a material and adverse effect on our
electronic bingo market and our company.
We
believe that we can effectively compete with these other companies because we
are focused on the high performance segment of the electronic bingo market,
while we believe that many of our competitors focus on and primarily serve the
mass-market segment where bingo player terminals are less expensive and have
fewer features and technological capabilities.
Potential
Mobile Gaming Market
The
casino markets are highly regulated, have stringent product requirements and
high system integrity and security requirements. We anticipate that these
factors will continue to pertain as the Nevada mobile gaming market may develop
after the economy revives. In the potential mobile gaming market, we expect to
encounter competition from existing and new entrants who may seek to meet these
market requirements.
Cantor
Fitzgerald LLP offers wireless sports betting in the United Kingdom, has already
obtained Nevada’s approval to test its technology in the field. In
addition, large gaming equipment manufacturers in the Nevada slot machine
market, including Aristocrat Leisure, Ltd., Alliance Gaming Corporation and WMS
Gaming Inc., may also attempt to enter the emerging mobile gaming market. At
least two prominent gaming equipment manufacturers, International Game
Technology, or IGT and Shuffle Master, Inc. have already expressed interest in
entering the future mobile gaming market, and traditional casino operators may
attempt to enter the mobile gaming markets at some point in the
future. These companies are much larger than we are, have greater
recourses than we do, and are well entrenched in the existing gaming
market. See also, “Risk Factors” under Part I, Item 1A.
Research
and Development
Since our
inception in 1989, we have continuously developed innovative gaming and
entertainment products for our customers. We have internally developed all
critical aspects of our gaming platform and have outsourced only the volume
manufacturing of parts and subassemblies. We design all of our software,
including all of our source code and all of our user interfaces and graphic art
for our player terminals. We also design all of our hardware, including both
electronic and mechanical components, all printed circuit board diagrams and
layouts, and all 3D and 2D mechanical drawings for all our plastic and metal
parts. We expect to continue to emphasize the research and development aspect of
our business. Research and development costs including those capitalized for the
fiscal years ending December 31, 2008 and 2007, were $1,359,035 and $1,494,724,
respectively.
We plan
to continue to invest in the research and development of our mobile gaming and
Smart electronic and paper bingo products.
Customers
Currently,
our customers are bingo hall operators in the commercial casino, tribal casino
and charitable bingo markets. As the mobile gaming market may develop in Nevada,
we anticipate selling or leasing our mobile gaming platform products to a
broader group of casino operators in Nevada and in other jurisdiction, if mobile
gaming is approved in these jurisdictions, and the operation of our mobile
gaming devices is specifically approved in these jurisdictions.
We
generate almost all our revenue from domestic customers. During 2008 and 2007,
our domestic revenues were 99% and 98%, respectively.
Although
we have a broadly diversified and geographically dispersed customer base, sales
to a single distributor of bingo products in the Texas charitable bingo market,
K&B Sales Incorporated, represented approximately 37% of our revenues during
2008. Due to reasons beyond our control, future sales to this Texas distributor
may become less certain. See also, “Risk Factors” under Part I,
Item 1A.
Sales,
Marketing and Distribution
Except
where we are contractually or statutorily prohibited from doing so, we market
our products to customers through direct and indirect channels. Our direct
channel consists of our own marketing efforts as well as marketing through
Millennium, our wholly-owned subsidiary.
We also
distribute our products to our customers through our indirect channel consisting
of a network of authorized distributors, operating in the United States, Canada,
the United Kingdom and Australia. Our distributor agreements typically have one
or more year’s initial terms with successive one-year automatic renewals. Our
distributors provide valuable services to our customers, including immediate
on-site customer support. During 2008, sales attributable to our single largest
distributor, K&B Sales Incorporated, doing business as Good Time Bingo,
represented approximately 37% of our revenues. See also, “Risk Factors” under
Part I, Item 1A, regarding, specifically, Good Time Bingo.
Generally,
the profit margins from the distributor-facilitated accounts are lower than the
profit margins typical for our direct accounts because the latter do not involve
commissions paid to distributors.
Customer
Support
We
provide comprehensive support services to our customers either directly or
through our distributors. We also provide 24/7 hotline support to our customers.
Although most of the technical problems are typically resolved over the
telephone or by replacing failed equipment with spare parts, in critical cases,
our field service personnel have to perform on-site maintenance and technical
training. The on-site maintenance is provided by us as an accommodation to our
customers and is not required by our contracts. We do not provide any
performance, fitness of use or similar warranty or guaranty to our
customers.
An
important part of customer service is the initial installation and training of
customer personnel. From time to time, we also perform customer service at
locations directly serviced by our distributors, particularly when a distributor
is new or inexperienced. Our personnel, particularly our management team, is
well experienced in the gaming field, and its advice is well regarded by our
customers. We continually advise our customers regarding our gaming platforms
and compliance with regulatory matters related to our gaming
platforms.
Our
BingoStar platform can be on-site configured by bingo hall personnel for
virtually any desired bingo games, patterns, prizes and sessions, without the
involvement of ourselves or the local distributor. Our BingoStar platform allows
our technicians to reprogram all stationary and wireless player terminals
on-site. Where permitted by law and authorized by our customers, we can also
remotely reprogram most of the components of our BingoStar platform utilizing
secure communication protocols.
Intellectual
Property
We hold
two United States patents expiring in 2010, which relate to a lottery-type
wagering game, and one United States patent expiring in 2012, which relates to a
magnetic bingo board. We do not rely on any licensing revenue related to any of
these patents, and we do not expect the expiration of these patents to have a
material adverse effect on our business or financial condition. We have also
filed additional patent applications that are currently pending in the United
States Patent and Trademark Office.
We are
the registered owner of trademarks FortuNet®, Mega Fortune® and BingoStar®, as
well as pending trademark applications, including WIN-WIN™ and
AIMS™.
In
addition, each of our employees has executed an agreement to maintain the
confidentiality of our trade secrets and to assign to us any intellectual
property that they may conceive of in the scope of and during their employment
with us.
Government
Regulation
The
gaming industry and the gaming equipment manufacturing industry exist within a
stringently controlled regulatory environment and are subject to federal, state,
tribal, local and foreign regulation. Companies participating in these
industries must hold the required gaming licenses, permits or other approvals in
all jurisdictions in which they conduct business. Many jurisdictions also
require the licensing or a finding of suitability of officers, directors, major
stockholders and key employees, the termination or disassociation with such
officer, director, key employee or major stockholder that fails to file an
application or to obtain a license or finding of suitability; the submission of
detailed financial and operating reports; and the submission of reports of
material loans, leases and financing statements; and the regulatory approval of
some commercial transactions, such as the transfer or pledge of equity interests
in the company. These regulatory burdens are imposed upon gaming-related
suppliers or vendors on an ongoing basis. The regulatory agencies that oversee
these jurisdictions not only continually scrutinize license holders, but in some
cases also approve the types of products that can be sold by equipment
manufacturers and used by operators. The standards for product approval vary
from jurisdiction to jurisdiction, although the Nevada standards are generally
the most stringent.
Various
aspects of our business are subject to gaming regulation. Depending on the
nature of the noncompliance, our failure to comply with these regulations may
result in the suspension or revocation of any license or registration at issue,
as well as the imposition of civil fines and criminal penalties.
Our
electronic bingo products, including the wireless and stationary units, are
subject to stricter scrutiny than traditional paper bingo products. We believe
electronic bingo player units are legal in all tribal jurisdictions, United
States Armed Forces bases, 27 states, and in a growing number of foreign
jurisdictions.
Electronic
bingo in charitable bingo halls is less widely permitted than paper bingo,
largely because many states’ laws and regulations were written before electronic
bingo technology was available. We believe that electronic bingo is permitted in
27 of the 48 states in the United States in which paper bingo is legal.
Favorable changes in this regulatory environment occurred in the recent
decade.
Licensing
Requirements
Currently,
we are licensed as a gaming equipment manufacturer or distributor in several
states and tribal jurisdictions. We intend to seek the necessary licenses,
approvals and findings of suitability for our products and our personnel in
other jurisdictions where there is an opportunity to market our products. We
cannot assure you that we will obtain the necessary licenses, approvals or
findings of suitability in a timely fashion or at all. If obtained, we cannot
assure that the licenses, approvals or findings of suitability will not be
revoked, suspended or conditioned or that we will be able to obtain the
necessary approvals for our future products as they may be developed. If a
license, approval or finding of suitability is required by a regulatory
authority and we fail to receive the necessary license, approval or finding of
suitability, we may be prohibited from distributing our products for use in the
applicable jurisdiction or may be required to distribute our products through
other licensed entities at a reduced profit. See also, “Risk Factors”
under Part I, Item 1A.
Nevada
Regulation
The Nevada Mobile Gaming
Law
On June
6, 2005, Nevada enacted the Nevada Mobile Gaming Law. This law enabled the
Nevada Gaming Commission, with the advice and assistance of the Nevada Gaming
Control Board, to promulgate regulations governing the operation of mobile
gaming and the licensing of operators, manufacturers and distributors of mobile
gaming equipment and systems in Nevada. Before adopting the regulations, the
Nevada Mobile Gaming Law required the Nevada Gaming Commission to determine that
mobile gaming systems could be operated in compliance with all applicable laws,
be secure and reliable and provide reasonable assurance that gaming devices
would be operated only by players of lawful age and only in approved
areas. These determinations were made and the original set of
applicable regulations under the Nevada Mobile Gaming Law was adopted on March
23, 2006.
The
Nevada Mobile Gaming Law defines “mobile gaming” as conducting gaming through
communication technology and devices that allow a player to transmit information
to a computer that assists in placing a bet or wager and corresponding
information related to the display of the game and its outcome. “Communications
technology” is defined to mean the method and components employed by a gaming
establishment to facilitate the transmission and reception of information,
including wireless networks, wireless fidelity, wire, cable, radio, microwave,
light, optics or computer data networks. Mobile gaming can only be conducted in
“public areas” of a gaming establishment that operate at least 100 slot machines
and at least one other game. Public areas specifically exclude hotel rooms or
living accommodations. The regulations as adopted define “mobile gaming
systems,” “operator of a mobile gaming system,” “equipment associated with
mobile gaming” and “public areas” for purposes of the law.
The
Nevada Mobile Gaming Law mandated that the revenue of operators and
manufacturers of mobile gaming systems will be subject to the same licensing fee
provisions to which currently licensed casinos are subject with respect to the
operation of other games and gaming devices and that mobile gaming devices will
be subject to the same fees and taxes as are slot machines. Based upon the
regulations as adopted, we believe that our current non-restricted gaming
licenses allow us to manufacture and distribute our mobile gaming platforms in
Nevada without additional licensing requirements. Our mobile gaming platforms
for playing traditional casino games will however, be required to be approved
before they may be deployed in Nevada casinos. See
also, “Risk Factors” under Part I, Item 1A.
Policy Concerns of Nevada
Gaming Laws
The laws,
regulations and supervisory practices of most gaming authorities are based upon
declarations of public policy. In the case of Nevada, these public policy
concerns include, among other things:
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preventing
unsavory or unsuitable persons from being directly or indirectly involved
with gaming or the manufacture or distribution of gaming devices at any
time or in any capacity;
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establishing
and maintaining responsible accounting practices and
procedures;
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maintaining
effective controls over the financial practices of licensees, including
establishing minimum procedures for internal fiscal affairs, and
safeguarding assets and revenue, providing reliable record keeping and
requiring the filing of periodic reports with the Nevada gaming
authorities;
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preventing
cheating and fraudulent practices;
and
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providing
a source of state and local revenue based on taxation and licensing
fees.
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Changes
in these laws, regulations and procedures could have significant negative
effects on our operations, financial condition and results of
operations. See also, “Risk Factors” under Part I, Item
1A.
Individual Licensing
Requirements
The
Nevada gaming authorities may investigate any individual who has a material
relationship to, or material involvement with, us in order to determine whether
the individual is suitable for and/or should be licensed as a
business
associate of a gaming licensee. Although licensing of an individual
is not a prerequisite for becoming an officer of our company, such person
becoming an officer is required to file necessary disclosures with Nevada gaming
authorities within thirty (30) days of becoming an officer. Currently, only our
Chief Executive Officer, and Chief Financial Officer, Yuri Itkis, Chief
Technology Officer, Boris Itkis, and Chief Compliance Officer, or CCO, Jack
Coronel are licensed individuals. Licensing is not a prerequisite to becoming an
independent director of FortuNet, and we do not anticipate that any of our
independent directors will be required to be licensed as a result of serving as
a director on the Company’s board of directors. The Nevada gaming authorities
may deny any application for any cause they deem reasonable. Granting of an
individual license requires a concomitant determination of suitability of the
applicant. A finding of suitability and grant of an individual license requires
submission of detailed personal and financial information, followed by a
thorough investigation. An applicant for licensing or a finding of suitability
must pay for all the costs of the investigation. We reimbursed our employees for
the cost of seeking and maintaining licenses obtained at our request, including
Yuri Itkis, Boris Itkis, and Jack B. Coronel. Changes in licensed positions must
be reported to the Nevada gaming authorities and, in addition to their authority
to deny an application for a finding of suitability or licensing, the Nevada
gaming authorities may disapprove a change in a corporate position, such as a
change in job title or substantive job responsibilities.
If the
Nevada gaming authorities were to find any of our personnel required to be
licensed unsuitable for licensing, we would have to sever all relationships with
that person. In addition, the Nevada Gaming Commission may require us to
terminate the employment of any person who refuses to file appropriate
applications or refuses to pay the required investigative fees. Determinations
of suitability or of questions pertaining to licensing are not subject to
judicial review in Nevada. See also, “Risk Factors” under Part I,
Item 1A.
Consequences of Violating
Gaming Laws
If the
Nevada Gaming Commission determines we violated the Nevada Gaming Control Act or
any of its regulations, it could limit, condition, suspend or revoke our
registrations and gaming licenses. In addition, we and the persons involved
could be subject to substantial fines for each separate violation of the Nevada
Gaming Control Act, or the regulations of the Nevada Gaming Commission, at the
discretion of the Nevada Gaming Commission. Limitation, conditioning or
suspension of our gaming licenses or related registrations could, and revocation
of any gaming license or registration would, have a material adverse effect on
our gaming operations. See also, “Risk Factors” under Part I, Item
1A.
Requirements for Beneficial
Securities Holders
Unless we
are registered as a publicly traded corporation by the Nevada Gaming Commission,
no person may become a stockholder of, or receive any percentage of profits
from, us without first obtaining the necessary licenses and approvals from the
Nevada Gaming Commission. We have also requested and obtained approval from the
Nevada Gaming Commission for exemptions available under the Nevada Gaming
Control Act that will generally exempt the beneficial holders of our securities
from the mandatory licensing requirements. This exemption will apply to current
and future beneficial holders of our securities.
Regardless
of the number of shares held, any beneficial holder of our voting securities,
may be required to file an application, be investigated, and have that person’s
suitability as a beneficial holder of voting securities determined if the Nevada
Gaming Commission has reason to believe that the ownership would otherwise be
inconsistent with the declared policies of the State of Nevada. An exemption
from the licensing requirements does not have the effect of exempting a
beneficial owner from a suitability determination if the Nevada Gaming
Commission requires such determination. If the beneficial owner of our voting
securities who must be found suitable is a corporation, partnership, limited
partnership, limited liability company or trust, it must submit detailed
business and financial information including a list of beneficial owners. The
applicant must pay all costs of investigation incurred by the Nevada gaming
authorities in conducting any investigation.
The
Nevada Gaming Control Act requires any person who acquires five percent or more
of any class of the voting securities of a registered company to report the
acquisition to the Nevada Gaming Commission. The Nevada Gaming Control Act
requires beneficial owners of 10 percent or more of a registered company’s
voting securities to apply to the Nevada Gaming Commission for a finding of
suitability within 30 days after the Chairman of the Nevada Gaming Control Board
mails the written notice requiring the filing. Under certain circumstances, an
“institutional investor,” as defined in the Nevada Gaming Control Act, which
acquires 10 percent or more, but not more than 15 percent, of the registered
company’s voting securities may apply to the Nevada Gaming Commission
for a
waiver of the finding of suitability if the institutional investor holds the
voting securities for investment purposes only. An application to be considered
as an institutional investor is a separate application and the applicant is
required to pay the applicable investigative fees.
An
institutional investor will not be deemed to hold voting securities for
investment purposes unless the voting securities were acquired and are held in
the ordinary course of its business as an institutional investor and were not
acquired and are not held for the purpose of causing, directly or indirectly,
the election of a majority of the members of the board of directors of the
registered company, a change in the corporate charter, bylaws, management,
policies or operations or the registered company or any of its gaming affiliates
or any other action that the Nevada Gaming Commission finds to be inconsistent
with holding our voting securities for investment purposes only. Activities that
are not deemed to be inconsistent with holding voting securities for investment
purposes only include:
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voting
on all matters voted on by stockholders or interest
holders;
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making
financial and other inquiries of management of the type normally made by
securities analysts for informational purposes and not to cause a change
in management, policies or operations;
and
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other
activities the Nevada Gaming Commission may determine to be consistent
with the investment intent.
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Our CEO,
Chairman of the Board of Directors, and Chief Financial Officer, Yuri Itkis, our
CTO, Boris Itkis, and our CCO, Jack Coronel have been found suitable for
licensing by various gaming authorities. If a gaming authority in any
jurisdiction fails to find any of our officers, directors or significant
stockholders suitable, we may be prohibited from leasing, licensing or selling
our products in that jurisdiction. We are unaware of any facts or circumstances
that would categorically prevent a gaming authority from finding any of our
officers, directors or significant stockholders suitable.
Consequences of Being Found
Unsuitable
Any
person who fails or refuses to apply for a finding of suitability or a license
within 30 days after being ordered to do so by the Nevada Gaming Commission or
the Chairman of the Nevada Gaming Control Board, or who refuses or fails to pay
the investigative costs incurred by the Nevada gaming authorities in connection
with the investigation of its application, may be found unsuitable. The same
restrictions apply to an owner of record if the owner of record, after request,
fails to identify the beneficial owner. Any person found unsuitable and who
holds, directly or indirectly, any beneficial ownership of any voting security
or debt security of a registered company beyond the period of times as may be
prescribed by the Nevada Gaming Commission may be guilty of a criminal offense.
We will be subject to disciplinary action if, after we receive notice that a
person is unsuitable to hold an equity interest in us or to have any other
relationship with us, we:
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pay
that person any dividend upon any voting
securities;
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allow
that person to exercise, directly or indirectly, any voting right held by
that person relating to us;
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pay
remuneration in any form to that person for services rendered or
otherwise; or
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fail
to pursue all lawful efforts to require the unsuitable person to
relinquish such person’s voting securities including, if necessary, the
immediate purchase of the voting securities for cash at fair market
value.
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A finding
of suitability is generally determined based upon a myriad of facts and
circumstances surrounding the entity or individual in question and many gaming
authorities have broad discretion in determining whether a particular entity or
individual is suitable. We are unaware of any facts or circumstances
that would categorically prevent a gaming authority from finding any of our
officers, directors or significant stockholders suitable.
Gaming Laws Relating to
Securities Ownership
The
Nevada Gaming Commission may, in its discretion, require the holder of any
common stock, debt or similar security of a registered company to file
applications, be investigated and be found suitable to own the
common
stock, debt or other security of the registered company if the Nevada Gaming
Commission has reason to believe that the ownership would otherwise be
inconsistent with the declared policies of the State of Nevada. If the Nevada
Gaming Commission determines that a person is unsuitable to own the security,
then under the Nevada Gaming Control Act, the registered company may be
sanctioned, including the loss of its approvals, if without the prior approval
of the Nevada Gaming Commission, it:
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pays
to the unsuitable person any dividend, interest, or other
distribution;
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Recognizes
any voting right by the unsuitable person in connection with the
securities;
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pays
the unsuitable person remuneration in any form;
or
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makes
any payment to the unsuitable person by way of principal, redemption,
conversion, exchange, liquidation or similar
transaction.
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We are
required to maintain a current stock ledger in Nevada that may be examined by
the Nevada gaming authorities at any time. If any securities are held in trust
by an agent or by a nominee, the record owner may be required to disclose the
identity of the beneficial owner to the Nevada gaming authorities. A failure to
make the disclosure may be grounds for finding the record owner unsuitable. We
will be required to render maximum assistance in determining the identity of the
beneficial owners of our voting securities.
The
Nevada Gaming Commission has the power to require the stock certificates of any
registered company to bear a legend stating that the securities are subject to
the Nevada Gaming Control Act, but has not imposed this requirement on us. If
the Nevada Gaming Commission were to impose this requirement, we expect that we
would seek an exemption from this requirement.
Approval of Changes in
Control
As a
registered company, we must obtain prior approval of the Nevada Gaming
Commission with respect to a change in control through a merger, consolidation,
stock or asset acquisitions, management or consulting agreements, or any act or
conduct by which anyone obtains control of us.
Entities
seeking to acquire control of a registered company must satisfy the Nevada
Gaming Control Board and the Nevada Gaming Commission with respect to a variety
of stringent standards before assuming control of a registered company. The
Nevada Gaming Commission also may require controlling stockholders, officers,
directors and other persons who have a material relationship or involvement with
the entity proposing to acquire control to be investigated and licensed as part
of the approval process relating to the transaction.
Approval of Defensive
Tactics
The
Nevada legislature has declared that some corporate acquisitions opposed by
management, repurchases of voting securities and corporate defense tactics
affecting Nevada gaming licensees, and registered companies that are affiliated
with those operations, may be harmful to stable and productive corporate gaming.
The Nevada Gaming Commission has established a regulatory scheme to reduce the
potentially adverse effects of these business practices upon Nevada’s gaming
industry and to further Nevada’s policy to:
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assure
the financial stability of corporate gaming licensees and their
affiliates;
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preserve
the beneficial aspects of conducting business in the corporate form;
and
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promote
a neutral environment for the orderly governance of corporate
affairs.
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Because
we are a registered company, approvals may be required from the Nevada Gaming
Commission before we can make exceptional repurchases of voting securities above
their current market price and before a corporate acquisition opposed by
management can be consummated. The Nevada Gaming Control Act also requires prior
approval of a plan of recapitalization proposed by a registered company’s board
of directors in response to a tender offer made directly to its stockholders for
the purpose of acquiring control. See also, “Risk Factors” under Part
I, Item 1A.
Fees and
Taxes
We pay
license fees and taxes computed in various ways depending on the type of gaming
or activity involved. These fees and taxes, depending upon their nature, are
payable monthly, quarterly or annually and are based upon either a percentage of
the gross revenues received or the number of gaming devices operated. Annual
fees are also payable to the State of Nevada for renewal of our manufacturers
and distributors licenses, OILS license and our Mobile Gaming license. Our cost
of fees and taxes for the years ending December 31, 2008 and 2007 were $98,836
and $87,515 respectively.
Foreign Gaming
Investigations
Any
person who is licensed, required to be licensed, registered, required to be
registered, or who is under common control with those persons, collectively,
“licensees,” and who proposes to become involved in a gaming venture outside of
Nevada, is required to deposit with the Nevada Gaming Control Board, and
thereafter maintain, a revolving fund in the amount of $25,000 to pay the
expenses of investigation by the Nevada Gaming Control Board of the licensee’s
or registrant’s participation in foreign gaming. We currently comply with this
requirement. The revolving fund is subject to increase or decrease at the
discretion of the Nevada Gaming Commission. Licensees and registrants are
required to comply with the reporting requirements imposed by the Nevada Gaming
Control Act. A licensee or registrant is also subject to disciplinary action by
the Nevada Gaming Commission if it:
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knowingly
violates any laws of the foreign jurisdiction pertaining to the foreign
gaming operation;
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fails
to conduct the foreign gaming operation in accordance with the standards
of honesty and integrity required of Nevada gaming
operations;
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engages
in any activity or enters into any association that is unsuitable because
it poses an unreasonable threat to the control of gaming in Nevada,
reflects or tends to reflect, discredit or disrepute upon the State of
Nevada or gaming in Nevada, or is contrary to the gaming policies of
Nevada;
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engages
in activities or enters into associations that are harmful to the State of
Nevada or its ability to collect gaming taxes and fees;
or
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employs,
contracts with or associates with a person in the foreign operation who
has been denied a license or a finding of suitability in Nevada on the
ground of unsuitability.
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Federal
Registration
The
Federal Gambling Devices Act of 1962, the “Johnson Act,” makes it unlawful for a
person to manufacture, transport, or receive gambling machines, gambling devices
or components across interstate lines unless that person has first registered
with the United States Attorney General. We have complied with the registration
requirements of the Johnson Act. Gambling devices must also be identified and we
must keep certain records in accordance with the Johnson Act’s requirements. If
we violate the Johnson Act, our equipment may be seized or forfeited and we may
be subject to other penalties. See also, “Risk Factors” under Part I,
Item 1A.
Tribal
Gaming Regulation
When
contracting with tribal owned or controlled gaming establishments, we become
subject to tribal laws and regulations that may differ materially from the
non-tribal laws and regulations under which we generally operate. In addition to
tribal gaming regulations that may require us to provide disclosures or obtain
licenses or permits to conduct our business on tribal lands, we may also become
subject to tribal laws that govern our contracts. These tribal governing laws
may not provide us with processes, procedures and remedies that enable us to
enforce our rights as effectively and advantageously as the processes,
procedures and remedies that would be afforded to us under non- tribal laws, or
to enforce our rights at all, and may expose us to an increased risk of contract
repudiation as compared to that inherent in dealing with non-tribal customers.
Many tribal laws permit redress to a tribal adjudicatory body to resolve
disputes; however, such redress is largely untested in our experience. We may be
precluded
from enforcing our rights against a tribal body under the legal doctrine of
sovereign immunity. See also, “Risk Factors” under Part I, Item 1A.
Gaming on
tribal lands, including the terms and conditions under which gaming equipment
can be sold or leased to tribal users, is governed by federal law, tribal-state
compacts and tribal gaming regulations. The Indian Gaming Regulatory Act of
1988, or IGRA, provides the framework for federal and state control over all
gaming on tribal lands and is administered by the National Indian Gaming
Commission and the Secretary of the United States Department of the Interior.
IGRA requires that the tribe and the state enter into a written agreement, a
tribal-state compact that governs the terms of certain types of gaming
activities. We are not aware of any state in which a tribal-state compact seeks
to regulate bingo.
The
regulations and ordinances adopted by tribal authorities vary but generally
impose standards and technical requirements on gaming hardware and software, and
may impose registration, licensing and background check requirements on gaming
equipment suppliers and their officers, directors and stockholders similar to
typical requirements imposed by Nevada gaming authorities.
Traditional
Casino Game Regulation
Traditional
casino games, such as poker, keno and video slots, are regulated much more
stringently than bingo games. The number of jurisdictions in which traditional
casino games are currently permitted is relatively small in comparison to the
number of jurisdictions in which bingo is permitted. The State of California
just entered into compacts with a large number of tribal authorities. The
evolution of the regulation of traditional casino games is very difficult to
predict, and no assurance can be provided that our planned entrance into the
traditional casino game market with mobile gaming platforms will be
successful.
Employees
As of
December 31, 2008, we had employed 50 employees, including 25 employees in the
manufacturing and service departments, 15 employees in the engineering and
programming departments and 10 employees in the administration and sales
departments. All of our employees are located in the State of Nevada, and none
of our employees are covered by collective bargaining agreements. We consider
our employee relations to be good.
ITEM 1A.
RISK FACTORS
Set forth
below and elsewhere in this Annual Report on Form 10-K, and in other documents
we filed with the SEC, are risks and uncertainties that could cause actual
results to differ materially from the results expressed or implied by the
forward-looking statements contained in this Annual Report.
The risk factors set
forth below entitled:
“Changes in technology may make our
inventory obsolete and cause significant losses”, ”Our failure to properly
manage growth would adversely affect our business operations”, Our inability to
lease suitable facilities may harm, delay or prevent our operations”, “Our stock
may be delisted by Nasdaq”, and “Ownership of our stock is highly
concentrated”,
have been added to this Annual Report on Form
10-K. Additionally, the risk factors set forth below entitled “
Losing any of our limited number of
independent distributors (such as K&B Sales Incorporated) upon whom we
depend for a significant portion of our revenue, or losing the business of a
significant number of customers of those distributors, would negatively impact
our operations
”,
has
been materially changed from the risk factor set forth in our Annual Report on
Form 10-K for the year ended December 31, 2007 and our latest Quarterly Report
for the quarter ended September 30, 2008 on Form 10-Q filed on November 13,
2008.
Risks
Relating to Our Business
Our
bingo revenues and potential mobile gaming revenues may be negatively affected
or not realized at all due to the general decline in the local, regional,
national and international economic environment.
The
recent deterioration in the worldwide economic environment has materially
negatively impacted the gaming market, including the bingo segment and the
potential mobile gaming market. Over the course of the last quarter, attendance
at gaming establishments and the per player revenues reported at gaming
establishments have significantly decreased. The abrupt and sudden worsening of
the economic environment has already negatively impacted and is likely to
continue to negatively impact our bingo revenues. The economic decline has also
diminished
our prospects for generating revenues in the potential mobile gaming market
because casinos currently have a substantial underutilized gaming floor space
for slot machines and gaming tables. The underutilized gaming floor
space of casinos may deter casinos from utilizing mobile gaming devices in the
auxiliary gaming areas, such as bingo halls, keno parlors, sports and race books
and bars. Moreover, additional capital expenditures and/or lease payments
required for mobile gaming devices in auxiliary gaming areas may deter casinos
from operating such mobile gaming devices because of the lower costs associated
with operating already existing games on the main gaming floors of
casinos.
If
we are unable to comply fully with the mobile gaming regulations, we may incur
substantial additional development costs and delays or completely preclude us
from entering into the mobile gaming market.
Nevada
gaming laws and regulations require that our mobile gaming systems be approved
by the Nevada Gaming Commission before we may distribute these systems to Nevada
casinos. The Nevada Gaming Commission (through the NGCB) continues to apply
stringent requirements regarding the overall security and integrity of mobile
gaming systems. To the extent that our mobile gaming platform currently being
reviewed by the NGCB may not comply with the latest such requirements, we would
need to undertake additional research and development activities that may be
costly, time consuming or require the procurement of components that are costly
and scarce in supply. Despite undertaking additional research and development
activities, we may not be able to design or develop a mobile gaming platform
that fully complies with the NGCB’s evolving requirements, in which case we
would be unable to manufacture, distribute or operate wireless player terminals
that enable casino players to play traditional casino games in the public areas
of gaming establishments, and therefore be unable to fully execute the growth
strategy we pursued so far, and instead, we may have to change our focus in
favor of stabilization of our core bingo business.
Losing
any of our limited number of independent distributors (such as K&B Sales
Incorporated) upon whom we depend for a significant portion of our revenue, or
losing the business of a significant number of customers of those distributors,
would negatively impact our operations.
We are
dependent upon a small number of independent distributors to market and sell our
products to casinos and bingo halls. For the quarter ended December 2008
approximately 61% of our revenues were derived through 11
distributors. During the same period, we derived approximately 37% of
our revenue from our single largest distributor, K&B Bingo Sales
Incorporated, doing business as Good Time Bingo (“K&B Bingo”). Due to our
payment of commissions to distributors, our customer contracts derived from
distributors generate lower profit margins than our contracts derived from
direct sales, or house accounts. Because we do not directly control our
distributors or their customer intake practices, contracts with customers
derived from distributors may be susceptible to higher default rates and lower
profit margins than our house accounts.
Some of
our distributors are not contractually prohibited from marketing or selling
products of our competitors. Our contracts with our distributors typically cover
one to three year terms and are automatically renewed for one year unless
terminated upon the expiration of the then current term. Upon the expiration of
a contract term, we may not be able to renew any of these contracts on terms
that are favorable to us, or at all. Our competitors may provide incentives to
our distributors to market and sell their products in addition to or in lieu of
ours. The loss of any of our distributors or the loss of business from any
customer of any of our distributors may result in a material reduction in our
revenue, resulting in a material adverse effect on our business, financial
condition and results of operations. Towards the end of 2007 and at
the beginning of 2008, we lost a significant portion of revenues from charitable
bingo hall customer locations that were serviced through one of our distributors
in the amount of approximately $1,500,000.
K&B
Bingo of Dallas, Texas is one of our largest distributors and generates
approximately 37% of our revenue. K&B Bingo is a wholly owned subsidiary of
Aces Wired of Dallas, Texas. Aces Wired is currently being investigated by the
Texas gaming authorities for alleged violations of Texas Penal Code provisions
relating to gambling promotion; keeping a gambling place; possession of a
gambling device, equipment or paraphernalia; and engaging in organized criminal
activity relating to same. As reported on the Form 8-K filed by Aces
Wired with the SEC on October 15, 2008, no criminal charges had been filed as of
that date, by authorities against Aces Wired or any of its officers, directors
or other employees. However, Aces Wired has been advised that local
authorities are seeking to develop charges against Aces Wired and certain of its
officers, directors and other employees consistent with the allegations in the
search and arrest warrants executed on May 21, 2008. In that regard, on October
9, 2008, the District Attorney of Bexar County, Texas sent formal notification
advising Aces Wired that it was conducting an
investigation
into violations of state criminal laws by certain of Aces Wire’s officers,
directors and other employees (including former directors and employees)
involving gambling, fiduciary misapplication of funds, securities fraud,
organized crime and money laundering.
We have
previously relied upon publically filed information for current information on
the status of the Texas investigation of Aces Wired. However, as of
December 3, 2008 Aces Wired is no longer a public reporting
company. Since current public information will no longer be available
to us by access to the SEC filings, monitoring and determining the current
status of the investigation and the condition of Aces Wired with any degree of
certainty will be much more difficult, if not impossible, in the
future.
The
ongoing investigation of Aces Wired by the Texas Attorney General and local
authorities may potentially impact the operations of K&B Bingo throughout
the state of Texas. While the investigation of Aces Wired has not impacted our
ability to generate revenues in Texas through K&B Bingo to date, in the
event that K&B Bingo’s activities are suspended in Texas, the loss of
revenues generated by K&B Bingo could have a material impact upon our
results of operations. Currently the Company does not hold a bingo distributor
license in the state of Texas. If our relationship with K&B Bingo
terminates or is terminated and we cannot obtain a bingo distributor license in
Texas in order to maintain our relationship with existing end users, the loss of
end users in Texas would have a material adverse affect upon our business and
operations.
Our
past trend of accumulating investment funds may reverse and may result in a
depletion of the funds due to the impending needs to upgrade both our
manufacturing infrastructure and our fleet of rental equipment in the
field.
Due to
the increasing competitive pressures in our core bingo market, we may no longer
be able to postpone a costly upgrade of our existing fleet of rental equipment
with the new models that we have developed in the process of pursuing mobile
gaming opportunities. For the same reasons, we may no longer be able to postpone
a costly upgrade of our manufacturing infrastructure, including very expensive
web printing presses. The combined cost of such upgrades may not only prevent us
from continuing our trend of accumulating cash resources but may also result in
a substantial, or even complete, depletion of our investment funds and we
redeploy such funds into these upgrades. In such a case, the interest we earn on
available investment funds that currently constitutes a substantial portion of
our net income may drastically decrease, since such interest is generally
proportional to the amount of funds invested.
We
may have to refocus our business strategy from that of growth into the mobile
gaming market to a strategy of stability and maintenance of our core bingo
business in the near term.
We may
not be able to implement our growth strategy primarily due to the recent drastic
decline in the economic environment and its resultant impact on the gaming
market. Our ability to implement our growth strategy is dependent on a number of
factors which are outside of our control, including market demand for our gaming
products, our ability to obtain licenses, permits and other forms of approval
from gaming regulators, participation levels in discretionary leisure activities
of consumers, higher fuel and transportation costs and an economic slowdown.
Among other things, implementation of our growth strategy may be adversely
affected if: we are not able to maintain and attract a sufficient number of
customers to meet required levels of profitability that will enable us to
continue to pursue our growth strategy, we are unable to adequately penetrate
new jurisdictions and markets at reasonable cost thereby limiting the future
demand for our products below the level assumed by our growth strategy, or we
are forced to significantly alter our business strategy to meet changes in our
consumer markets. Therefore in the near term, we anticipate that we will delay
our mobile gaming growth plans in order to concentrate our efforts and resources
on adapting our core bingo business to the recent economic decline that we
expect to continue at least in the near future. Consumable bingo
products, such as paper bingo products, may carry a different gross profit
margin than electronic bingo products. In order to remain competitive in the
bingo market, we believe that we may find it necessary to increase the volume of
consumable bingo products that we provide to our customers, which may affect our
overall profitability.
We
operate in a highly competitive industry and expect the market for mobile gaming
devices to become increasingly competitive, which may negatively affect our
operations and our ability to maintain relationships with gaming
establishments.
The
market for gaming devices generally is intensely competitive, and we expect
competition to increase and intensify as the market for mobile gaming devices
develops. We currently compete with other providers of electronic bingo
products, such as VKGS, LLC, or Video King, formerly a division of BK
Entertainment Corp., GameTech International, Inc., the merged Planet Bingo, LLC
and Melange Computer Services, Inc., Blue Dog, Inc., Electronic Game Solutions,
Inc
.
and California
Concepts, Inc. in the marketing of our BingoStar wireless bingo
systems. We expect to face competition with several new entrants in
the market, including I-bingo, Inc. and eQube, Inc . Although none of our
competitors that manufacture mobile bingo devices is currently licensed in
Nevada other than GameTech International, Inc., we may face competition from
these providers in the market for mobile gaming devices in the future. Given the
market penetration, name recognition, marketing resources and familiarity with
the gaming device industry generally, traditional casino game device
manufacturers could be a significant competitive threat to us. We expect fierce
competition in our expansion efforts from multiple large competitors dominating
their respective markets, such as Aristocrat Leisure, Ltd., International Game
Technology, Inc., Alliance Gaming Corporation, WMS Gaming Inc. and Shuffle
Master, Inc., that may enter the market for mobile gaming devices. In
addition, we may face a strong competition from Cantor Fitzgerald Ltd., that
already offers wireless sports betting in the United Kingdom, holds an Operator
of Mobile Gaming Systems license in Nevada, and in April of 2008 started field
testing of mobile gaming system in Las Vegas, NV. The competition in
the potentially lucrative Nevada market for mobile gaming systems is anticipated
to become even more fierce when other of Nevada’s currently licensed Operators
of Mobile Gaming Systems, including International Game Technology, Inc., Sona
Mobile, Inc. and GameTech International, Inc. enter the market.
Additionally,
traditional casino operators, most of whom are much larger than us, may attempt
to enter the emerging mobile gaming market. Some of our competitors and
potential competitors have significant advantages over us, including greater
name recognition, longer operating histories, pre-existing relationships with
current or potential customers, proprietary technology, significantly greater
financial, marketing and other resources and more readily available access to
capital that could allow them to respond more quickly to new or changing
opportunities.
Finally,
other providers of electronic bingo products have in the past reduced, and may
in the future continue to reduce, the prices of their products to gaming
establishments in order to win those gaming establishments as customers and to
gain market share. Electronic and paper bingo competitors may have
greater financial, marketing, technical or other resources, and greater ability
to respond to pricing pressures than we do. They may also have broader product
lines, ability to reduce price through product bundling, greater experience with
high-volume manufacturing, greater customer service capabilities, or larger and
more established sales organizations and customer bases. To maintain or capture
a position in the market, we must develop new and enhanced electronic and paper
bingo products and introduce them at competitive prices on a timely basis, while
managing our research and development costs. Competition in the bingo market
tends to increase when there is an overall decline in the economy. In
particular, pricing pressure increases the number of new entrants into the bingo
market and could adversely affect our revenues. To the extent that competitive
pressures force us to reduce our prices or provide other incentives to establish
or maintain relationships with gaming establishments, our business and operating
results could be adversely affected.
Our
failure to obtain approvals under the regulations promulgated under the Nevada
Mobile Gaming Law will negatively impact our strategy.
Notwithstanding
our receipt of an Operator of Mobile Gaming Systems license by the Nevada Gaming
Commission, the regulations promulgated under the Nevada Mobile Gaming Law
require us to obtain specific approval of our mobile gaming devices for use in
Nevada casinos. If we are unable to obtain or maintain approval of our mobile
gaming platform as required by the regulations, we will be unable to
manufacture, distribute and operate wireless player terminals that enable casino
players to play casino games in public areas of gaming establishments as
permitted by the Nevada Mobile Gaming Law which would have a material adverse
affect on our business and operations.
Our
failure to maintain our current licenses and regulatory approvals or failure to
maintain or obtain licenses or approvals for our gaming devices in any
jurisdiction will prevent us from operating in that jurisdiction and possibly
other jurisdictions, leading to reduced overall revenue.
As a
manufacturer, distributor and operator of gaming platforms, we currently hold
licenses in a number of jurisdictions, including Nevada. Our officers, including
our major stockholder, Yuri Itkis, are required to obtain and maintain licenses,
permits and other forms of approval in certain jurisdictions. We are
under continuous scrutiny by
the
applicable regulatory authorities. Our officers’ current regulatory
approvals may be revoked, suspended or curtailed at any time. Our
officers’ failure to obtain or maintain regulatory approval in any jurisdiction
may prevent us from obtaining or maintaining regulatory approval in other
jurisdictions. The failure to maintain a license in a single jurisdiction or a
denial of a license by any new jurisdiction may cause a negative “domino effect”
in which the loss of a license in one jurisdiction could lead to regulatory
investigation and possible loss of a license in other
jurisdictions.
Some
jurisdictions also require licenses, permits or other forms of approval for
specific gaming devices. If other jurisdictions adopt mobile gaming laws, these
approval requirements may vary from jurisdiction to jurisdiction and the
license, permit and approval process may be costly and more difficult to obtain
that the licenses we have obtained in Nevada pursuant to the Nevada Mobile
Gaming Law. As a general matter, the regulatory approval of devices involving
traditional casino games is more difficult to obtain than those for bingo
products. Some jurisdictions require the regulatory approval of entities and
individuals before the pursuit of regulatory approval of specific gaming
devices, but other jurisdictions allow the pursuit of such regulatory approvals
concurrently. Although we (and the individuals associated with us) may obtain
regulatory approval in a particular jurisdiction, we may not be able to
manufacture, distribute or operate our mobile gaming platforms in that
jurisdiction without separate and specific regulatory approval of our mobile
gaming platform. Any failure of our gaming platform to meet the requirements for
approval or to obtain the approval in any jurisdiction will cause us to not be
able to distribute our gaming platforms in the jurisdiction, which would have a
material adverse affect upon our business and operations.
Our
failure to retain and extend our existing contracts with customers and to win
new customers would negatively impact our operations.
All of
our lease contracts relate to our electronic bingo products. In the year ended
December 31, 2008, we derived 8% of our revenues and cash flow from our
portfolio of contracts to lease electronic bingo products to gaming
establishments, such as casinos, and bingo halls. Our contracts are typically
for a term ranging from one to three years in duration and several are on a
month-to-month basis. Not all of our contracts preclude our customers from using
bingo devices of our competitors. Upon the expiration of one of our contracts, a
gaming establishment may award a contract through a competitive procurement
process, in which we may be unsuccessful in winning the new contract or forced
to reduce the price that we charge the gaming establishment in order to renew
our contract. In addition, some of our contracts permit gaming establishments to
terminate the contract at any time for our failure to perform and for other
specified reasons. The termination of or failure to renew or extend one or more
of our contracts, or the renewal or extension of one or more of our contracts on
materially altered terms could, depending upon the circumstances, have a
material adverse effect on our business, financial condition, results and
prospects.
We derive
a substantial portion of our revenue from direct sales to our customers, or
house accounts, which we service ourselves, without any involvement of outside
distributors. Although such accounts typically involve higher profit margins,
the competition for these accounts is very keen. We typically negotiate one to
three year, automatically renewable leases for our bingo units with our direct
customers. The house account contracts tend to be challenging to maintain and
enforce, especially those with tribal gaming operators, and therefore, we may
not be able to retain lucrative house accounts indefinitely. A loss of any such
account may have a severe negative impact on our revenue.
If
we are unable to retain our senior employees or attract other key personnel our
operations may suffer.
Our
future success depends to a significant degree on the skills, experience and
efforts of our key personnel. We depend heavily on the ability and experience of
a small number of senior executives who have experience with our operations and
the electronic gaming device industry, including, Itkis, our Chief Executive
Officer, Chairman of the Board of Directors; and Chief Financial Officer, Jack
Coronel, our Chief Compliance Officer; and Boris Itkis, our Chief Technical
Officer, Vice President of Engineering and member of the Company’s Board of
Directors. The loss of any of these senior executives or the failure of any of
these senior executives to obtain or maintain the requisite regulatory licenses,
permits or determination of suitability may have a material adverse effect on
our business and operations.
Changes
in licensed positions must be reported to the Nevada gaming authorities and, in
addition to their authority to deny an application for a finding of suitability
or licensing, the Nevada gaming authorities may disapprove a change in a
corporate position, such as a change in job title or substantive job
responsibilities. Any
such
disapproval would prevent us from re-deploying our senior executive talent in
new functional roles even if management desires to do so. A loss of
one of our senior executives due to a finding of disapproval from the Nevada
gaming authorities could have a material adverse effect on our business and
operations.
Our
future success depends upon our ability to attract, train and retain key
marketing personnel and key managers as we further develop our products and as
we enter new markets and expand in existing markets. In connection with the
audit of our financial statements for 2007 and 2008, our management, together
with our independent registered public accounting firm, identified a significant
deficiency in our internal control over financial reporting arising from the
current level of staffing in our accounting department; our efforts to augment
our staffing with qualified individuals on a timely basis may not remediate this
significant deficiency. Due to licensing requirements of these personnel that
may be imposed by gaming authorities, our pool of potential employees may be
more limited than in other industries. Competition for individuals with the
skills required is intense, and we may not be successful in recruiting such
personnel. In addition, we may not be able to retain such individuals as they
may leave our company and go to work for our competitors. If we are unable to
attract or retain key personnel, our business, financial condition and operating
results could be materially adversely affected. We rely heavily on a corporate
culture of lean staffing. While helpful to our efforts to contain our
costs, our lean staffing exposes us to increased risks of internal control
deficiencies and increased harm upon employee departures.
If
other gaming jurisdictions do not adopt mobile gaming legislation similar to the
Nevada Mobile Gaming Law, or on any terms at all, we will be unable to implement
our growth strategy outside of Nevada.
Our
ability to execute fully our growth strategy in jurisdictions other than Nevada
depends upon other gaming jurisdictions adopting mobile gaming legislation
involving traditional casino games. Currently, Nevada is the first and the only
state to enact legislation authorizing mobile gaming for traditional casino
games. Although we are not aware of any tribal gaming authority that has
specifically prohibited mobile casino gaming involving traditional casino games,
we are also not aware of any that have approved it, even though many tribal
gaming authorities in practice allow mobile bingo gaming. The adoption of gaming
legislation can be affected by a variety of political, social and public policy
forces and gaming jurisdictions other than Nevada may not adopt mobile gaming
legislation involving traditional casino games in the foreseeable future. To the
extent that other jurisdictions do adopt mobile gaming legislation involving
traditional casino games, we may not be able to comply fully with the
legislation without incurring substantial additional development costs, or at
all. If we are required to modify our mobile gaming platform to comply with such
potential legislation, we may suffer the increased costs of maintaining multiple
variants of our mobile gaming platform to comply with the differing legislation
of different jurisdictions. If other gaming jurisdictions fail to adopt mobile
gaming legislation involving traditional casino games or we are unable to comply
with such legislation without substantial additional costs, we may be unable to
execute our growth strategy.
Our
failure to obtain gaming licenses or other regulatory approvals in other
jurisdictions would preclude us from expanding our operations into and
generating revenue from these jurisdictions.
The
manufacture and distribution of gaming devices are subject to extensive federal,
state, local and tribal regulation. Some jurisdictions require licenses, permits
and other forms of approval for gaming devices. Most jurisdictions require
licenses, permits or other forms of approval of the manufacturers, distributors
and operators of gaming devices, including evidence of financial stability, and
of the suitability of their officers, directors, major stockholders and key
employees. The regulatory agencies conduct in-depth investigations of gaming
device manufacturer licensees as well as detailed personal background checks of
key employees and major stockholders of the licensees. Obtaining requisite
approvals of state and tribal gaming authorities is a time-consuming and costly
process. Even after incurring significant time and expense in seeking regulatory
approvals, we may not be able to obtain them. Our failure or the failure of our
officers, directors, major stockholders or key personnel to obtain regulatory
approval in any jurisdiction will prevent us from distributing our products and
generating revenue in that jurisdiction.
A
material reduction in the yield on our investment of the proceeds of our initial
public offering and our retained earnings could materially and adversely affect
our net income and earnings per share.
Because
we have not yet begun full-scale production of mobile gaming devices under the
Nevada Mobile Gaming Law, we have invested the bulk of the proceeds of our
initial public offering and retained earnings. Our net income and earnings per
share for the quarter ended December 31, 2008 depended substantially on the
yield that we achieved on these investments. Approximately 32% of our income
before tax resulted from these investments.
Our
primary investment objective is to preserve principal while maximizing yield
without significantly increasing our risk. Some of our investments consist of
non-taxable auction rate securities, or ARS. Our ARS investments totaled
$9,750,000 at December 31, 2008. As of February 18, 2009, only $3,200,000 of ARS
investments were not liquidated.
The ARS
that we purchase consist of municipal bonds with maturities greater than five
years and have credit ratings of at least AAA, and do not include
mortgage-backed instruments. The auction process for ARS is intended, in part,
to provide a liquid market for these securities. In the event of an
auction failure, the interest rate on the security is reset according to the
contractual terms in the underlying indenture. The funds associated
with failed auctions will not be accessible until a successful auction occurs,
the issuer calls or restructures the underlying security, the underlying
security matures and is paid or a buyer outside the auction process emerges. The
auction process for some of our ARS began to deteriorate during 2007, and during
the first quarter of 2008, we began to reduce the principal amount of ARS in our
portfolio, which we have continued to do through the third quarter of 2008.
Although we did not suffer any auction failures of our ARS during 2007, a few of
the ARS we hold experienced auction failures during the first quarter of 2008.
As a result, when we attempted to liquidate some of our ARS through auction, we
were unable to do so. We believe that the failed auctions that
we have experienced are not a result of the deterioration of the underlying
credit quality of these securities, although valuation of them is subject to
uncertainties that are difficult to predict, such as changes to credit ratings
of the securities and/or the underlying assets supporting them, default rates
applicable to the underlying assets, underlying collateral value, discount
rates, counterparty risk and ongoing strength and quality of market credit and
liquidity. We believe that any unrealized gain or loss associated with
these securities will be temporary and will be recorded in accumulated other
comprehensive income (loss) in our financial statements.
The
credit and capital markets have continued to deteriorate in
2008. Continuation or acceleration of instability in these markets and/or
deterioration in the ratings of our investments may affect our ability to
liquidate these securities, and therefore may affect our financial condition,
and cash flows. We believe that, based on our cash and cash equivalents balances
during 2008, the current lack of liquidity in the credit and capital markets
will not have a material impact on our liquidity, cash flows, financial
flexibility or ability to fund our obligations.
We
continue to monitor the market for our ARS and consider its impact (if any) on
the fair market value of our investments. If the market conditions of 2008
continue through 2009, in which some auctions for ARS fail, or the anticipated
recovery in market values does not occur, we may be required to record
additional unrealized losses or impairment charges in 2009. As auctions have
closed successfully in 2008, we have converted our investments in ARS to money
market funds. We believe we will have the ability to hold any ARS for which
auctions fail until the market recovers. We do not anticipate having to sell
these securities in order to operate our business.
Although
we have invested these proceeds in relatively conservative investments, based on
the current market conditions, there can be no assurance that we will continue
to enjoy the same yields on our investments as we did during 2008. Moreover,
there can be no assurance that these investments will continue to generate a
positive yield. Assuming no other changes in our sources of revenues, any
decrease in the yield on these investments, and any loss on these investments,
would directly and materially reduce our revenues.
Difficulties
with the limited number of manufacturers and suppliers upon whom we rely for
components of our products would negatively impact our production capacity,
customer relationships and operations.
We
purchase most of the parts, components and subassemblies necessary for the
manufacture of our products from outside sources. We assemble these parts,
components and subassemblies into finished products in our manufacturing
facility. While most of the parts, components and subassemblies are produced by
more than one manufacturer and can be purchased through more than one supplier,
we currently rely upon approximately 12 vendors from whom we purchase
substantially all of our components. We currently obtain the touch screens for
our wireless gaming terminals from a single supplier. While changing suppliers
for this component is not impossible, doing so would require significant time
and effort on the part of our engineering and management teams and may cause us
to miss revenue generating opportunities until we are able to obtain touch
screen monitors from a new supplier. In addition, the supplies of the central
processing units, memory and peripheral drives for our mobile gaming platforms
are often uncertain and subject to significant backlogs from time to time due to
spikes in general demand for such products. We compete with other companies for
the production capacity of third party manufacturers and suppliers of these and
other components. Certain of these competing companies have
substantially
greater financial and other resources than we have and thus we may be at a
competitive disadvantage in seeking to procure production capacity.
To
procure certain parts, components and subassemblies, we sometimes commit to
supply contracts in which we commit to purchase large quantities over extended
periods of time. By doing so, we are exposed to a number of risks. If the market
prices of these components drop below the prices at which we are committed to
purchase them, our purchase commitments may preclude us from taking advantage of
reductions in market prices. If the components are surpassed by superior
technology that becomes available after we make our purchase commitments, our
purchase commitments may preclude us from taking advantage of technological
advancements. If a change in the design or specifications of our products
results in a substitution or elimination of a component, we may be forced to
write off a substantial quantity of obsolete inventory of components or to sell
such components in the open market at a loss.
Our
inability to contract with third-party manufacturers and suppliers to provide a
sufficient supply of our components on acceptable terms and on a timely basis
could negatively impact our relationships with customers and materially and
adversely harm our business. For those components that we procure under supply
contracts, if any of such supply contracts were to be terminated or breached, we
may not be able to procure an alternate supply on terms as favorable to us in
time, or at all. We may suffer lengthy delays in our manufacturing process while
we seek to procure an alternate supply. A delay in our ability to manufacture
products may adversely affect our goodwill with customers, expose us to
liability to customers and result in the loss of business opportunities. Any
alternate supply of parts, components or subassemblies may be more expensive to
us or may require us to undertake additional engineering activities to integrate
the alternate supply into our products or manufacturing process.
Certain
parts, components and subassemblies for our products are manufactured outside of
the United States, which exposes us to the risks of foreign currency
fluctuations, political and economic instability and limited protection of
intellectual property.
If
our wireless gaming terminals do not achieve and maintain widespread acceptance
by gaming establishments and casino game players as a means to play traditional
casino games, our business operations will not grow as anticipated.
Our
current business depends on the preferences of gaming establishment players that
play bingo games, and our growth strategy depends on the preferences of gaming
establishment players that play traditional casino games, such as poker, keno
and slots. The tastes and preferences of players of bingo and traditional casino
games are known to change over time. If the bingo games or traditional casino
games that we enable gaming establishment players to play using our wireless
gaming terminals do not appeal to players to the degree anticipated, our mobile
gaming platforms will not be fully utilized and our business will
suffer.
The
success of our growth strategy will depend to a large extent on broad market
acceptance of our wireless gaming terminals among casinos and their players who
play traditional casino games. The only market acceptance that our wireless
gaming terminals currently enjoy is as a means to play bingo games
electronically. Even if we are successful in deploying mobile gaming platforms
that enable casino players to play traditional casino games, gaming
establishments and their players may still not use our wireless gaming terminals
for a number of reasons, including preference for live dealers, preference to
play casino games in a traditional environment using traditional equipment,
mistrust of technology and perceived lack of reliability. We believe that the
acceptance of our wireless gaming terminals by gaming establishments and their
players will depend on our ability to demonstrate the economic and other
benefits of our products to gaming establishments, casino players becoming
comfortable with using our wireless gaming terminals, the attractiveness of the
casino games that players can play using our wireless gaming terminals, ease of
use, and the reliability of the hardware and software that comprise our mobile
gaming platforms.
Initially,
we intend to offer our customers equipment lease agreements under which we will
lease our wireless gaming terminals and the associated equipment. However, if
and when market acceptance of our wireless gaming platforms has been
established, we may be required to sell wireless gaming platforms to customers
rather than lease them because of the prevailing practices of casino operators
to purchase rather than lease equipment. However, if our wireless gaming
terminals fail to quickly achieve market acceptance as a means to play
traditional casino games, our customers may not renew their leases or may not
purchase our mobile gaming platforms, which would have a material adverse effect
on our business, financial condition and results of operation.
Any
change in our business model from the lease of wireless gaming terminals to the
sale of gaming terminals may result in an eventual reduction of our
revenues.
We
currently derive substantially all of our revenues by leasing our wireless
gaming terminals and associated equipment to our gaming establishment customers.
If and when market acceptance of our wireless gaming terminals is established,
our gaming establishment customers may prefer to purchase our wireless gaming
terminals rather than lease them. If we sell our wireless gaming terminals in
the future, we must price them in a manner that reflects the ongoing lease
revenues that leasing them generates. If we are unable to sell our wireless
gaming terminals for a sales price in excess of the lease revenues that we would
otherwise receive, our revenues may eventually decline.
Our
failure to comply with tribal regulation and tribal laws would preclude us from
operating in tribal jurisdictions and deriving revenue there from.
We are
required to obtain licenses and approvals from tribal authorities in order to
operate in tribal jurisdictions. When seeking approvals from or licensing with
tribal-owned or tribal-controlled gaming establishments, we become subject to
tribal laws and regulations. These laws and regulations may differ materially
from the non-tribal laws and regulations under which we generally operate. A
change in tribal laws and regulations or our inability to obtain required
licenses of our gaming platforms or licenses to operate on tribal lands could
have a material adverse effect on our business, financial condition and
operating results.
We
may not be able to enforce our contractual rights against tribal governments or
agencies, which may negatively impact our operations.
In
addition to tribal gaming regulations that may require us to provide disclosures
or obtain licenses or permits to conduct our business on tribal lands, we may
also become subject to tribal laws that govern our contracts. These tribal
governing laws may not provide us with processes, procedures and remedies that
enable us to enforce our rights as effectively and advantageously as the
processes, procedures and remedies that would be afforded to us under non-tribal
laws, or to enforce our rights at all. Many tribal laws permit redress to a
tribal adjudicatory body to resolve disputes; however, such redress is largely
untested in our experience and tribal judiciaries are not always independent. We
may be precluded from enforcing our rights against a tribal body under the legal
doctrine of sovereign immunity. Our inability to enforce our contract rights
under tribal law could negatively impact our operations.
Disrupted
operation of our server-based gaming systems caused by the network
infrastructure of the casinos in which they are installed would cause
dissatisfaction among customers and gaming establishments and may harm our
operating results.
We expect
to enter into agreements with customers that operate casinos and bingo halls in
more than one location. In such cases, we anticipate that our agreements with
such customers will provide that the customer will be responsible for providing,
at its expense, a dedicated high-speed computer network connection between our
server-based gaming systems in the various locations operated by the customer to
a remote central gaming server supporting such systems. Failures or disruptions
of a customer’s dedicated high-speed connection that result in the stoppage of
play or in reduced performance of our server-based gaming system could disrupt
players’ gaming experience, adversely affect the casinos’ or bingo halls’
satisfaction with our gaming devices, delay market acceptance of our mobile
gaming platforms and harm our reputation, business, operating results and
financial condition. In addition, our customers have to reserve, for our
exclusive use, certain RF channels of adequate capacity to accommodate reliable
and expedient wireless communication between our wireless player terminals and
central game file servers.
We
expect to spend substantial amounts on research and development, but these
efforts may fail or lead to operational problems that could negatively impact
our operations.
In order
to compete effectively in an era of technological changes, we must continuously
enhance our existing products and develop, introduce and market new products and
services. As a result, we expect, as needed, to continue to make a significant
investment in product development. Our development of products is dependent on
factors such as assessing market trends and demands and obtaining requisite
governmental approvals. Although we are pursuing and will continue to pursue
product development opportunities, we may fail to develop any new products or
services or enhancements to existing products. Even if new products or services
are developed, these
products
or services may not prove to be commercially viable, or we may not be able to
obtain the various gaming licenses and approvals necessary to manufacture and
distribute these products or provide these services to our customers. We may
experience operational problems with such products after commercial introduction
that could delay or defeat the ability of such products to generate revenue or
operating profits. Future operational problems could increase our costs, delay
our plans or adversely affect our reputation or our sales of other products,
which, in turn, could materially adversely affect our success. We cannot predict
which of the many possible future products will meet evolving industry standards
and casino or player demands.
Defects
in, and fraudulent manipulation of, our gaming platforms could reduce our
revenue, increase our costs, burden our engineering and marketing resources,
involve us in litigation and adversely affect our gaming licenses.
The real
and perceived integrity and security of mobile gaming is critical to its ability
to attract players. We strive to set exacting standards of system security for
the systems that we provide to gaming establishments, and our reputation in this
regard is an important factor in our business dealings with our customers and
regulators, such as the Nevada Gaming Commission and other governmental
agencies. For this reason, an actual or alleged system security defect or
failure attributable to us could have a material adverse effect upon our
business, financial condition, results and prospects, including our ability to
retain existing contracts or obtain new contracts.
Our
success will depend on our ability to avoid, detect and correct software and
hardware defects and prevent fraudulent manipulation of our mobile gaming
platforms. Although our mobile gaming platforms are subject to rigorous internal
testing and will be subject to additional testing by regulators in certain
gaming jurisdictions, we may not be able to build and maintain products that are
free from defects or manipulations and that satisfy these tests. Although we
have taken rigorous steps to prevent defects and manipulations, our gaming
platforms could suffer from such defects and manipulation after they are put
into operation.
Although
we do not believe it is likely, it is possible that an individual could breach
the security systems of a casino or bingo hall, gain access to the central game
file server on which our server-based mobile gaming platform operates and
fraudulently manipulate its operations. The occurrence of such fraudulent
manipulation or of defects or malfunctions could result in financial losses for
our customers and, in turn, termination of leases, cancellation of orders,
product returns and diversion of our resources. Even if our customers do not
suffer financial losses, casinos and bingo halls may replace our gaming
platforms if they do not perform according to expectations. Any of these
occurrences could also result in the loss of or delay in market acceptance of
our server-based gaming platform and loss of licenses, leases and
sales.
In
addition, the occurrence of defects in, or fraudulent manipulation of, our
gaming platforms may give rise to claims for lost revenue and related litigation
by our gaming establishment customers and may subject us to investigation or
other disciplinary action by regulatory authorities that could include
suspension or revocation of our regulatory approvals.
Improper
conduct of our employees could harm our reputation and adversely affect our
business operations.
The real
and perceived integrity and security of mobile gaming is critical to its ability
to attract players. We strive to set exacting standards of personal integrity
for our employees and reliable security for the gaming platforms that we provide
to our customers, and our reputation in this regard is an important factor in
our business dealings with Nevada Gaming Commission and other governmental
agencies. For this reason, any allegation or a finding of improper conduct on
our part, or on the part of one or more of our employees, or an actual or
alleged security defect with our gaming platform or failure attributable to us,
could have a material adverse effect upon our business, financial condition,
results and prospects, including our ability to retain existing contracts or
obtain new or renewal contracts, or the loss of gaming licenses or other
regulatory approvals.
Possible
future acquisitions could prove difficult to integrate, disrupt our business,
dilute stockholder value and strain our resources.
As part
of our business strategy, we may seek to acquire businesses, services and
technologies that we believe could complement or expand our business, augment
our market coverage, enhance our technical capabilities, provide us with
valuable customer contacts or otherwise offer growth opportunities. If we fail
to achieve the
anticipated
benefits of any acquisitions we may complete, our business, operating results,
financial condition and prospects may be impaired. Acquisitions and investments
involve numerous risks, including:
|
·
Difficulties
in integrating operations, technologies, services, accounting and
personnel;
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·
Difficulties
in supporting and transitioning customers of our acquired companies to
our
technology
platforms and business processes;
|
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·
Diversion
of financial and management resources from existing
operations;
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·
Potential
loss of key employees;
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·
Inability
to generate sufficient revenues to offset acquisition or investment costs;
and
|
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·
Potential
write-offs of acquired assets.
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Acquisitions
also frequently result in recording of goodwill and other intangible assets,
which are subject to potential impairments in the future that could harm our
operating results. In addition, if we finance acquisitions by issuing
convertible debt or equity securities, our existing stockholders may be diluted.
Such dilution could adversely affect the market price of our stock. It is also
possible that at some point in the future we may decide to enter new markets,
thus subjecting ourselves to new risks associated with those
markets.
Our
patents and proprietary rights may not be enforceable, may not be cost effective
to enforce or may not provide significant competitive advantage, which could
negatively impact our operations.
Our
success depends to a significant degree upon protecting our intellectual
property rights. We have three United States patents relating to our products
and corresponding patents in certain foreign countries. Of the three patents,
two expire in 2010 and one expires in 2012. The patents that we own now or in
the future may not provide us with significant competitive advantages or may be
impaired by challenges to the validity or enforceability of such patents. For
example, in the past the validity of one of our patents has been repeatedly
challenged. Others may independently develop similar or more advanced
technologies or products or design around aspects of our technology that may be
patented.
It is
possible that third parties may copy or otherwise obtain and use our information
and proprietary technology without our authorization or otherwise infringe on
our intellectual property rights. We may have to rely on litigation to enforce
our intellectual property rights and contractual rights. If
litigation that we initiate is unsuccessful, we may not be able to protect the
value of our intellectual property and our business could be adversely
affected.
We have
patent applications that are currently pending before the United States Patent
and Trademark Office. These patent applications may not result in any patents
being issued. If these patent applications do not become issued patents, our
competitors would not be prevented from using these inventions described in the
applications.
In
addition, we may not be able to deter current and former employees, consultants,
and other parties from breaching confidentiality agreements with us and
misappropriating proprietary information from us. If we are unable to adequately
protect our intellectual property, it could have a material adverse effect on
the value of our intellectual property, our reputation, our business and our
operating results.
In
addition, we may face claims of infringement that could interfere with our
ability to use technology or other intellectual property rights that are
material to our business operations. If a claim of infringement against us is
successful, we may be required to pay royalties to use technology or other
intellectual property rights that we had been using or we may be required to
enter into a license agreement and pay license fees, or we may be required to
stop using the technology or other intellectual property rights that we had been
using. We may be unable to obtain necessary licenses from third parties at a
reasonable cost or within a reasonable time. Any litigation of this type,
whether successful or unsuccessful, could result in substantial costs to the
Company and divert our resources, which may have a material adverse effect on
our growth initiatives.
We
may not be able to obtain additional financing if required, which could harm our
operations and ability to generate revenue.
Our
ability to manufacture our gaming platforms on a large scale may require us to
obtain additional financing necessary for the manufacture of such hardware
components and expansion of our inventory. The net proceeds that we have
received from the sale of the shares of common stock in our initial public
offering together with revenue that we generate from operations may not be
sufficient to execute our growth strategy.
If we are
unable to generate sufficient revenue or if our working capital and
manufacturing capacity is not capable of keeping up with demand, we will need to
seek additional equity or debt financing to provide the capital required to
maintain or expand our production capabilities. We may not be able to obtain
needed additional equity or debt financing on terms that are favorable to us, or
at all. If we are able to obtain such financing, existing stockholders may
suffer dilution and the equity or debt securities issued to raise such financing
may have rights, preferences and privileges senior to those of existing
stockholders. If we require, but are unable to obtain, sufficient additional
financing in the future we may be unable to implement our business plan, respond
to changing business or economic conditions, withstand adverse operating results
and compete effectively. More importantly, if we are unable to raise further
financing when and if required, our continued operations may have to be scaled
down or even ceased and our ability to generate revenues would be materially
impaired.
Changes in technology may make our
inventory obsolete and cause significant losses
.
Future
technological advances in the gaming equipment market may result in the
availability of new products or increase the efficiency of existing products. We
may not be able to adapt to such technological changes. If a technology becomes
available that is more cost-effective or creates a superior product, we may be
unable to access such technology or its use may involve substantial capital
expenditures that we may be unable to finance. Existing, proposed or as yet
undeveloped technologies may render our technology less viable, less profitable
or obsolete. We may not have available the financial and other resources to
compete effectively against companies possessing such technologies. If we were
to fail to develop our product and service offerings to take advantage of
technological developments, we may fall behind our competitors and our business,
financial condition, results and prospects could suffer. If technological
advances render our current inventory of products obsolete, we may suffer
significant revenue losses and write-downs of our assets.
Our failure to properly manage growth
would adversely affect our business operations
.
In order
to implement our business strategy, we must effectively manage rapid growth in
our manufacturing, sales and customer support operations. This rapid growth will
strain our existing management, financial and other resources. To manage any
future growth effectively, we will have to expand our management team, integrate
new personnel and augment our marketing and production capabilities. To rapidly
produce large volumes of wireless gaming terminals, we will have to formulate
and implement design, production planning, manufacturing and quality assurance
plans that are unlike those we have used in the past. These plans may strain our
manufacturing and industrial engineering capabilities and resources. Rapid
growth would also require us to improve our financial, accounting and
operational systems and controls. Expansion into new geographic areas would
further strain our limited operational and marketing resources. If we are unable
to effectively manage our growth, we may fail to execute our business strategy
and our operations and financial results may be adversely affected.
Our
inability to lease suitable facilities may harm, delay or prevent our
operations.
The
long-term lease for our Las Vegas, Nevada facilities expires in December of
2013. These facilities provide us with a convenient central location from which
to service our customers. We may not be able to extend the leases on the current
terms or, if required, locate new adequate manufacturing facilities on
commercially reasonable terms or at all.
Our stock may be delisted by
Nasdaq
.
During
the forth quarter of 2008, our stock price briefly dropped to $1.25 per share
level. Should our stock price drop below $1.00 for a consecutive period of 30
days after April 19, 2009, we may receive a notification from Nasdaq that our
stock may be delisted. If subsequently, we are unable to comply with applicable
Nasdaq listing requirements, and our stock may eventually be delisted. In the
latter case, our stock may become less liquid and less valuable
.
If we are
delisted, and we fail to continue to meet certain SEC standards, our common
stock will become subject to the SEC’s “penny stock” rules. The term “penny
stock” generally refers to low-priced (below $5), speculative securities of very
small companies. While penny stocks generally are quoted over-the-counter, such
as on the OTC Bulletin Board or in the Pink Sheets, they may also trade on
securities exchanges, including foreign securities exchanges. In addition, penny
stocks include the securities of certain private companies with no active
trading market.
Before a
broker-dealer can sell a penny stock, SEC rules require the firm to first
approve the customer for the transaction and receive from the customer a written
agreement to the transaction. The firm must furnish the customer a document
describing the risks of investing in penny stocks. The firm must tell the
customer the current market quotation, if any, for the penny stock and the
compensation the firm and its broker will receive for the trade. Finally, the
firm must send monthly account statements showing the market value of each penny
stock held in the customer’s account.
Penny stocks may trade infrequently,
which means that it may be difficult to sell penny stock shares once you own
them. Because it may be difficult to find quotations for certain penny stocks,
they may be impossible to accurately price. Investors in penny stocks should be
prepared for the possibility that they may lose their whole
investment
.
Ownership
of our stock is highly concentrated.
As of the
date of the filing of this report, our Chairman of the Board, Chief Executive
Officer, and Chief Financial Officer, Yuri Itkis, beneficially owned 74.86
percent of our stock. Such a high concentration of control by a
single individual may make change of Company’s control less likely and may
negatively affect the price of our stock. This means that Mr. Itkis can approve
or reject all matters on which the Company needs approval by not less than a
majority of stockholders, including mergers, acquisitions, sales of assets,
amending the Company’s Certificate of Incorporation, electing the Company’s
Board of Directors, among other things, and essentially gives Mr. Itkis control
of the management and day to day operations of the Company. This
might make the Company less attractive for strategic partners or tender offers
which might suppress the value of our common stock.
Risks
Relating to Our Industry
A
decline in the popularity of gaming could reduce the demand for our
products.
We
provide mobile gaming platforms to gaming establishments to enable players to
play bingo in several jurisdictions, including Nevada, and traditional casino
games on cruise lines. When legally permitted, we intend to provide mobile
gaming platforms to enable players to play traditional casino games using our
wireless player terminals in Nevada. As a result, our business depends on
consumer demand for the games that we enable. Gaming is a discretionary leisure
activity, and unfavorable changes in general economic conditions including
recession, economic slowdown, or higher fuel and transportation cost, may reduce
the participation in discretionary leisure activities as a result of consumers
having less disposable income. Therefore, during periods of economic
contraction, our revenue may decrease while some of our costs remain fixed,
resulting in decreased earnings. Gaming activity may also decline based on
changes in consumer confidence related to general economic conditions or
outlook, fears of war, future acts of terrorism, or other factors. A reduction
in tourism could also result in a decline in gaming activity. Finally, a
legislature or regulatory authority may prohibit all or some gaming activities
all together in its jurisdiction. A decline in gaming activity as a result of
these or any other factors would have a material adverse effect on our business
and operating results.
Changes
in consumer preferences could also harm our business. Gaming competes with other
leisure activities as a form of consumer entertainment, and may lose popularity
as new leisure activities arise or as other leisure activities become more
popular. In addition, gaming in traditional gaming establishments competes with
Internet-based gaming for gaming players, and we do not serve the Internet
gaming market. The popularity and acceptance of gaming is also influenced by the
prevailing social mores, and changes in social mores could result in reduced
acceptance of gaming as a leisure activity. To the extent that the popularity of
gaming in traditional gaming establishments declines as a result of either of
these factors, the demand for our gaming platforms may decline and our business
may be adversely affected.
Expansion
of the gaming industry faces opposition that could limit our access to some
markets and impair our growth.
We expect
a substantial portion of our future growth to result from the general expansion
of the gaming industry. The expansion of gaming activities in new markets can be
very controversial and may depend heavily on the support of national, local and
tribal governments. Changes in government leadership, failure to obtain
requisite voter support in referenda, failure of legislators to enact enabling
legislation and limitations on the volume of gaming activity that is permitted
in particular jurisdictions may prevent us from expanding our operations into
new
markets.
A failure by the gaming industry to expand at the rate that we expect could have
a material adverse effect on our business, growth rates, financial condition and
operating results.
Gaming
opponents continue to persist in efforts to curtail the expansion of legalized
gaming. Unfavorable public referendums, anti-gaming legislation or unfavorable
legislation affecting or directed at manufacturers or operators of gaming
products may materially and adversely impair our business and growth prospects.
Gaming opponents may be successful in preventing the legalization of mobile
gaming in jurisdictions where mobile gaming may be presently prohibited or in
limiting the expansion of mobile gaming where it is currently permitted, in
either case to the detriment of our business, financial condition, results and
prospects.
Future
acts of terrorism, as well as other factors affecting discretionary consumer
spending and air travel, may impact our industry and may harm our operating
results.
Future
terrorist attacks similar to those of September 11, 2001, may have a significant
impact on the travel and tourism industries upon which the gaming industry, and
we in turn, depend. In general, our Nevada-based gaming establishment customers
are adversely affected by disruptions in air travel, regardless of cause.
Although, our gaming establishment customers in markets outside of Nevada, which
are not as dependent on air travel, may not experience as much business
disruption, the potential for future terrorist attacks, the national and
international responses to terrorist attacks and other acts of war or hostility
have created many economic and political uncertainties that could adversely
affect our business and results of operations. Future acts of terror in the
United States or an outbreak of hostilities involving the United States may
reduce players’ willingness to travel, with the result that our operations will
suffer. The amounts that our customers pay to us are based on usage of our
devices. Accordingly, reduced usage results in reduced payments to us. Although
the revenue we generate from our gaming devices may decline as a result of
reductions in air travel or consumer spending, our contracts do not generally
provide our customers with the right to terminate their contracts with us as a
result of reductions in air travel or consumer spending.
We
operate our business in regions subject to natural disasters and other severe
catastrophic events, including hurricanes. We have suffered casualty losses as a
result of natural disasters (e.g. Hurricanes Katrina and Ike), and any
disruption to our business resulting from natural disasters will adversely
affect our revenue and results of operations.
The
strength and profitability of our business depends on player demand for our
products at gaming establishments. The impact of natural disasters, the outbreak
of infectious diseases and other factors affecting discretionary consumer
spending could negatively affect gaming activity and consequently, the demand
for and use of our products at affected gaming establishments. Disruptions of
gaming establishment operations, as a result of natural disasters and other
catastrophic events beyond our control, would also reduce the number of gaming
establishments that offer our products.
We
operate our business primarily through gaming platforms, including wireless and
stationary player terminals, cashier-based POS terminals and self-service POS
kiosks, used by players at gaming establishments and bingo halls. Accordingly, a
substantial portion of our physical assets are in locations beyond our direct
control, including areas of Louisiana and Texas that sustained major damage as a
result of Hurricane Katrina and Hurricane Ike. Generally, our business may also
be adversely affected by any damage to or loss of equipment that we install at
gaming establishments resulting from theft, vandalism, terrorism, flood, fire or
any other natural disaster. Our insurance may not be adequate to recover our
losses from these events. The amounts that our customers pay to us are based on
usage of our devices. Accordingly, reduced usage results in reduced payments to
us. Although the revenue we generate from our gaming devices may decline as a
result of a natural disaster, our contracts do not generally provide our
customers with the right to terminate their contracts with us as a result of a
natural disaster.
Beneficial
holders of our securities are subject to regulation by the Nevada gaming
authorities, which may result in required applications for license, findings of
suitability and mandatory redemption of shares.
Because
we are a registered company under the Nevada Gaming Control Act, any person who
acquires five percent or more of any class of our voting securities is required
to report the acquisition to the Nevada Gaming Commission. The Nevada Gaming
Control Act requires any person who acquires 10 percent or more of our voting
securities to apply to the Nevada Gaming Commission for a finding of suitability
within 30 days after the Chairman of the Nevada Gaming Control Board mails a
written notice requiring the filing. If such person fails or refuses to
apply for
a finding of suitability or license within 30 days after being ordered to do so
by the Nevada gaming authorities, or if such person refuses or fails to pay the
investigative costs incurred by the Nevada gaming authorities in connection with
such person’s application, the person may be found unsuitable. The same
restrictions apply to the owner of record if the owner of record, after request,
fails to identify the beneficial owner. Any person found unsuitable and who
holds any voting security may be guilty of a criminal offense. We will be
subject to disciplinary action if, after we receive notice that a person is
unsuitable to hold an equity interest or to have any other relationship with us,
we:
|
·
|
Allow
that person to exercise, directly or indirectly, any voting right relating
to us held by the person;
|
|
·
|
Pay
remuneration in any form to that person for services rendered or
otherwise; or
|
|
·
|
Fail
to pursue all lawful efforts to require the unsuitable person to
relinquish such person’s voting securities
including,
if necessary, the immediate purchase of the voting securities for cash at
fair market value.
|
Our
Amended and Restated Articles of Incorporation provide that persons who acquire
five percent or more of the beneficial ownership of our outstanding capital
stock notify us and consent to any background investigation or other
requirements imposed by any gaming authority. Our Amended and Restated Articles
of Incorporation also provide for mandatory redemption of its shares if the
beneficial owner fails to comply with any applicable gaming law
requirements.
Certain
Nevada statutes have potential anti-takeover effects that could delay or prevent
a change in control of our company and depress the price of our common
stock.
Nevada
statutes regulating business combinations, takeovers and control share
acquisitions may hinder or delay a change in control of our company. In
addition, under Nevada law, the Nevada gaming authorities must also approve any
change of control of our company. Other jurisdictions may have similar
requirements. These statutes could limit the price that investors might be
willing to pay in the future for shares of our common stock and may limit our
stockholders’ ability to receive a premium on their shares by discouraging
takeovers and tender offer bids, even if such events could be viewed as
beneficial by our stockholders.
ITEM
2. PROPERTIES
We
conduct our operations at our two adjacent facilities located at 2950 and 3000
South Highland Drive, Las Vegas, Nevada, 89109. In aggregate, these facilities
occupy approximately 33,000 square feet and are utilized for our administrative
office, product showroom, research and development, and manufacturing functions.
The lease of these facilities expires in December of 2013. Although we believe
that our current facilities are adequate for manufacturing a sufficient volume
of mobile gaming products to satisfy the anticipated demand through the existing
lease terms, we may be forced to lease additional manufacturing space if demand
for our growing line of products should exceed our capability to manufacture the
products in our currently leased facilities
ITEM
3. LEGAL
PROCEEDINGS
In the
regular course of business, the Company may be involved in various civil
litigations. The Company believes that the final resolution of pending
litigation is not likely to have a material adverse effect on the Company’s
business, cash flow, and results of operations or financial
position.
ITEM
4. SUBMISSION
OF MATTERS TO A VOTE OF SECURITY HOLDERS
None.
PART
II
|
ITEM
5.
|
MARKET
FOR REGISTRANT’S COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND ISSUER
PURCHASES OF EQUITY SECURITIES
|
Market
Information
Since our
initial public offering on January 31, 2006, our common stock has traded on the
Nasdaq Global Market (formerly the Nasdaq National Market) under the symbol
“FNET”. Prior to that time, there was no public market for our
stock.
The
following table sets forth, for the indicated periods, the high and low closing
sale prices of our common stock:
|
Year Ended
December 31, 2007
|
High
|
|
Low
|
|
|
First
Quarter
|
|
$
|
10.67
|
|
|
$
|
7.30
|
|
|
Second
Quarter
|
|
|
10.77
|
|
|
|
7.92
|
|
|
Third
Quarter
|
|
|
10.74
|
|
|
|
7.26
|
|
|
Fourth
Quarter
|
|
|
9.89
|
|
|
|
7.25
|
|
|
Year Ended
December 31, 2008
|
High
|
|
Low
|
|
|
First
Quarter
|
|
$
|
8.34
|
|
|
$
|
5.58
|
|
|
Second
Quarter
|
|
|
7.00
|
|
|
|
5.78
|
|
|
Third
Quarter
|
|
|
6.60
|
|
|
|
4.09
|
|
|
Fourth
Quarter
|
|
|
6.00
|
|
|
|
1.25
|
|
On
February 26, 2009, the closing sale price of our common stock on the Nasdaq
Global Market was $1.50.
Holders of Common Stock
As of
December 31, 2007, our stock was held by approximately 10 stockholders of
record. Because many of our shares of common stock are held by brokers and other
institutions on behalf of stockholders, we are unable to estimate the total
number of beneficial stockholders represented by these record
holders.
On
December 30, 2008, we bought back a block of 321,268 shares of our common stock
at the price of $1.75 per share resulting in a reduction of the total number of
outstanding shares from 11,351,279 to 11,042,011.
Dividends
During
2005, which was prior to our initial public offering, we paid dividends to
holders of our common stock on a quarterly basis. The dividends paid during 2005
were $2,370,000 in the aggregate. Since becoming a publicly traded entity in
2006 we have paid no dividends, and we do not anticipate paying any dividends on
our common stock in the future. We may retain our future earnings, if
any, to finance our business and for general corporate purposes. As long as
there are funds legally available to do so, any future determination to pay cash
dividends will be at the discretion of our board of directors and will depend
upon earnings, financial condition, operating results, capital requirements, any
contractual restrictions and other factors that our board of directors deems
relevant. The terms of any future debt or credit facility may preclude us from
paying dividends on our common stock.
Use
of Proceeds
We
completed an initial public offering of our common stock during the first
quarter of 2006. Our registration statement on Form S-1 under the Securities Act
(File No. 333-128391) was declared effective on January 30, 2006. The aggregate
net proceeds to us were approximately $23,728,995.
We have
invested all of the net proceeds from our initial public offering in interest
bearing investment grade securities. We may utilize a significant amount of
proceeds from our initial public offering along with the additional monetary
resources we accumulated since the initial public offering to acquire parts and
components for the manufacture of our gaming products and to expand and improve
our manufacturing infrastructure. However, we
may not
commence procuring any significant amounts of component parts for manufacturing
of our mobile gaming products until the current slow down in the economy
reverses and we are more able to determine the duration of the currently
ongoing reviewing process of our mobile gaming systems by the Nevada gaming
authorities. We may also utilize a substantial portion, if not most, of the
available funds to acquire one or more businesses.
ITEM
6. SELECTED
FINANCIAL DATA
This
Annual Report does not include information described under Item 6 of Form 10-K
pursuant to the rules of the Securities and Exchange Commission that permit
“smaller reporting companies” to omit such information.
|
ITEM
7.
|
MANAGEMENT’S
DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF
OPERATION
|
Overview
We are an
established and historically profitable manufacturer of multi-game and
multi-player server-based gaming platforms. Our gaming platforms include
networks of both wireless and stationary player terminals, cashier-based
point-of-sale terminals, self-service point-of-sale kiosks and game file servers
that conduct and control bingo games. Our gaming platforms have been adapted to
conduct traditional casino games, such as keno, poker and slots, in addition to
bingo. We have recently started commercial deliveries of consumable (paper)
bingo products and Smart bingo flashboards and ball blowers.
Having
believed that the research and developments efforts have made our mobile gaming
platform compliant with the wireless gaming regulations promulgated by the
Nevada Gaming Commission,, we submitted our mobile gaming platform for
review by Nevada gaming authorities in 2006. Our gaming platforms currently
enable patrons to play bingo using either our wireless or our stationary player
terminals. In addition, our gaming platforms currently enable patrons to play
traditional casino games using our stationary player terminals if permitted by
applicable laws and regulations. If our wireless gaming devices are approved by
the Nevada gaming authorities and the economy revives, Nevada casino patrons
will be able to play traditional casino games using our wireless player
terminals. However, there can be no assurance that we will obtain such approval
in the foreseeable future or at all or that an economic turnaround will occur in
the foreseeable future.
We
currently generate revenue by placing electronic bingo systems in bingo halls
under contracts based on (a) a fixed fee per use per session; (b) a fixed weekly
fee per terminal; or (c) a percentage of the revenue generated by each terminal.
Our revenue is affected by player acceptance of electronic bingo as an addition
or an alternative to paper bingo in our existing client establishments, our
ability to at least maintain our market share and potentially expand operations
into new markets. Our stationary bingo player terminals generate greater revenue
per player terminal than our wireless bingo player terminals, but also require a
greater initial capital investment. As our customer base changes from period to
period through the addition of new customers or the occasional loss of existing
customers, we experience an increase in sales revenue due to the addition of
customers and a decrease in sales revenue due to the loss of customers. Our
sales revenue is also affected from period to period as a result of changes in
operations at our existing customer locations that result from numerous factors
over which we have little or no control.
We
typically install our electronic bingo systems at no charge to our customers and
we capitalize all direct costs. We record depreciation of bingo equipment over a
five-year estimated useful life using the straight-line method of
depreciation.
We
anticipate that at some point in time, we may begin selling our gaming platforms
for use in conducting traditional casino games, instead of entering into lease
contracts as we do now. At that time, our revenue may include product revenue
from sales of equipment, in addition to our leasing revenue. At such time, our
product revenue will be influenced by the then current price for our products
and our unit-volume sales.
We
envision that if we do develop significant product revenue sales, we will also
see some recurring revenue component for both software upgrades and maintenance
of the software components of our sold products.
Our
expenses currently include:
(a) cost
of revenue, depreciation of bingo terminals and other capitalized equipment
under lease to customers, maintenance, repair and refurbishment of equipment in
the field and related support of the equipment, and cost of shipping.
Installation costs and initial shipment expenses associated with new customer
lease contracts are expensed as cost of revenue in the period in which the
equipment is deployed. Expenses related to maintenance, repair and refurbishment
of our existing equipment that has been deployed at customer locations are
expensed as cost of revenue in the period in which the maintenance, repair or
refurbishment is performed. These expenses are incurred to, among other things,
maintain our existing equipment in working order, provide our customers with
updated equipment, fix software bugs, if any, provide new functionality and
minimize the number of different installation configurations that we must
support. We are not obligated to perform maintenance, repair or refurbishment
under the terms of our rental agreements with our customers, but we do so in
order to improve the quality and reliability of our products;
(b) general and administrative
expenses, including the costs of activities associated with the management of
our company and related support, which includes all payroll and benefits other
than payroll in connection with research and development activities, travel
costs, professional fees, facility lease expenses and bad debt expense
reserves;
(c)
sales and marketing expenses, consisting primarily of commissions paid to
distributors for promoting and supporting our products and related marketing
costs;
(d) costs
of research and development activities geared to the further development of our
gaming products including labor costs and costs of hardware and software
testing, prototyping and development tools; and
(e) cost
of maintaining, upgrading and expanding our manufacturing infrastructure
including electronic assembly lines and web printing presses
We
envision that the development of our product revenue may require us to record
cost of products sold (rather than leased) revenue that include materials,
labor, and direct and indirect manufacturing costs and associated warranty
costs.
Millennium,
our wholly owned subsidiary, distributes our bingo products in selected
territories in the United States. All of our other operations, including the
operation and maintenance of our bingo products and the exclusive distribution
of our bingo products in Nevada, Texas and Washington, are conducted by
FortuNet. Prior to November 2003, Yuri Itkis held approximately 72% of the
voting control over Millennium. In November 2003 Millennium purchased its
outstanding shares held by stockholders other than Yuri Itkis. In January 2004,
we became the 100% owner of Millennium through Yuri Itkis’ contribution to us of
the remaining outstanding shares. This enabled us to consolidate our worldwide
distribution rights and enabled significant expense reduction in our overall
distribution and operational costs.
In 2008,
we incurred $623,250 in legal and professional fees as compared to $406,489 in
2007; the increase in legal and professional fees was primarily the result of an
increase of expenses related to the litigations against defendants Planet Bingo,
LLC, Melange Computer Services, Inc., and Gametech International,
Inc.
Application
of Critical Accounting Policies and Estimates
Our
consolidated financial statements have been prepared in accordance with United
States generally accepted accounting principles. The preparation of these
financial statements requires us to make estimates and assumptions that affect
the reported amounts of assets and liabilities and the disclosure of contingent
assets and liabilities at the reporting date and reported amounts of revenue and
expenses during the reporting period. On an ongoing basis, we evaluate our
estimates and judgments, including those related to revenue recognition, bad
debts, bingo unit depreciation and litigation. We base our estimates and
judgments on historical experience and on various other factors that are
reasonable under the circumstances, the results of which form the basis for
making judgments about the carrying values of assets and liabilities that are
not readily apparent from other sources. Actual results may differ from these
estimates under different assumptions or conditions.
We
believe the following critical accounting policies affect our more significant
judgments and estimates used in the preparation of our consolidated financial
statements.
Revenue
Recognition
Revenue
is currently recognized for bingo terminals placed in bingo halls under lease
contracts based on (a) a fixed weekly fee per terminal available for bingo (even
though our contracts are generally on a month to month basis); (b) a fixed fee
per usage per bingo session; or (c) a percentage of the revenue generated by
each terminal for bingo sessions played. We do not enter into any financing
leases or sales type contracts with our customers. Our platform provides reports
of daily usage for billing and reporting purposes for the latter two types of
contracts. We bill our customers on a weekly and monthly basis for these
revenues and recognize the revenue for the period the units are used or prorate
for weekly fees. Existing revenue recognition is a key component of our results
of operations, and determines the timing of certain expenses, such as
commissions, which are reported in the same period when related revenues are
recognized. We recognize revenue in accordance with accounting principles
generally accepted in the United States when all of the following factors exist:
(a) evidence of an arrangement with the customer; (b) installation of our gaming
platform; (c) a fixed or determinable fee; and (d) collectability is reasonably
assured. We exercise judgment in assessing the credit worthiness of our
customers and therefore in our determination of whether collectability is
reasonably assured. Should changes in conditions cause us to determine these
criteria are not met for future transactions, revenue recognized for future
reporting periods could be adversely affected.
Allowance
for Doubtful Accounts
We
estimate the possible losses resulting from non-payment of outstanding accounts
receivable. We perform ongoing evaluations of our customers and distributors for
credit worthiness, economic trends, changes in our customer payment terms, and
historical collection experience when evaluating the adequacy of our allowance
for doubtful accounts. In determining these percentages, we review historical
write-offs of our receivables, payment trends and other available information.
While such estimates have been within our expectations and the provisions
established, a change in financial condition of specific customers or in overall
trends experienced may result in future adjustments of our estimates of
recoverability of our receivables.
Depreciation
The
declining balance method of depreciation is used for furniture and fixtures,
machinery and equipment and vehicles with a useful life of five to seven years.
This method was selected because the productive usefulness of those assets
decline at a rate more rapid than straight line. Leasehold improvements are
depreciated over the life of the lease. Our rental assets are depreciated over
five years using the straight line method. Our printing equipment assets are
depreciated over eleven years using the
declining
balance
method. The straight line method is used because we believe this
method most accurately matches the costs with the revenues over the useful life
of the product. We annually assess whether there is a possible impairment of the
assets and equipment and to date have concluded that no impairments
exist.
Investments
Securities
The
auction process for ARS historically provided a liquid market for these
securities. In 2007, however, this process began to deteriorate. During 2008,
the Company began to reduce its investment amount of ARS in its portfolio. While
its portfolio was not affected by the auction process deterioration in 2008,
some of the ARS the Company holds experienced auction failures during 2008. As a
result, when the Company attempted to liquidate them through auction, it was
unable to do so. In the event of an auction failure, the interest rate on the
security is reset according to the contractual terms in the underlying
indenture. As of January 31, 2009, the Company has received all scheduled
interest payments associated with these securities.
Due to
the absence of observable market quotes, the Company’s investments in auction
rate securities are classified within level 3 and we have valued these assets
using discounted cash flow models. The Company’s investment in long-term
investment securities assessment as level 3 fair value is based on the
underlying investment, the present value of future principal and interest
payments discounted at rates considered to reflect the uncertainty of current
market conditions and the overall capital market liquidity. As of December 31,
2008, the Company’s long-term investment securities portfolio included $3.2
million par value. Based on the fair value estimate using the
discounted
cash flow model, par approximates fair value. These municipal bonds
are tax exempt and the Company has received monthly interest
payments.
In
November 2008, the Company entered into an agreement with the broker that sold
the Company $6,550,000 of its auction rate securities that gives the Company the
right to sell its existing auction rate securities back to the broker at par, an
non-transferable right (“Put Right Agreement”), plus accrued interest, beginning
on January 1, 2009 through January 4, 2011.
The
Company considers the Put Right to be a freestanding financial instrument and
the Company has accounted for it separately from the ARS. The Company has
elected the fair value option to account for the Put Right pursuant to SFAS No.
159, “The Fair Value Option for Financial Assets and Financial Liabilities,” and
have recorded the instrument as an asset of approximately $1.1 million on our
balance sheet with the short-term investment security as of December 31, 2008
with a corresponding gain recorded in other income, net. In February
2009 the Company exercised the Agreement and converted its ARS at par
value.
Simultaneously,
the Company made an election under SFAS No. 115 to transfer our ARS from
available-for-sale to trading securities. The transfer to trading securities
reflects our intent to exercise the Put Right. Prior to entering into the
agreement, our intent was to hold the ARS until the market recovered. At the
time of the transfer, the unrealized loss on the ARS was immediately recognized
in earnings of $1.1 million, as a component of other income, net.
We
estimated the fair value of our ARS using the discounted cash flow model where
we estimated the present value of future principal and interest payments
discounted at rates considered to reflect the uncertainty of current market
conditions and the overall capital market liquidity. The value derived through
the discounted cash flow model was generally consistent with the quoted price
indicated by the broker which holds our ARS at December 31, 2008.
We
calculated the fair value of the Put Right based on the net present value of the
difference between the par value and the fair value of the ARS on December 31,
2008.
Treasury
Stock Policy
The
Company has accounted for the repurchase of its 321,268 shares using the Cost
method under ARB 43 with the gross cost of the shares reacquired charged to the
contra equity account “Treasury Stock.”
Income
Taxes
In June
2006, the FASB issued FASB Interpretation No. 48,
Accounting for Uncertainty in
Income Taxes
, or FIN No. 48, which clarifies the accounting
for uncertainty in income taxes recognized in an entity’s financial statements
in accordance with SFAS No. 109. FIN 48 prescribes a recognition
threshold and measurement attribute to the financial statement recognition and
measurement of a tax position taken or expected to be taken in a tax return. In
addition, FIN 48 provides guidance on derecognition, classification,
interest and penalties, accounting in interim periods, disclosure and
transition. FIN 48 is effective for fiscal years beginning after
December 15, 2006. We adopted FIN 48 on January 1, 2007. The
adoption of FIN 48 did not have a material impact on our financial position
or results of operations. We believe it is reasonably possible that
the total amount of previously unrecognized tax benefits may decrease within
twelve months of the reporting date.
Software
Development Cost Policy
We have
capitalized certain software development costs since the achievement of the
technological feasibility of our mobile gaming system. We have recorded these
costs in accordance with the Statement of Financial Accounting Standards No. 86
“Accounting for the Costs of Computer Software to Be Sold, Leased, or Otherwise
Marketed.” Since in the last quarter of 2008, our latest generation of mobile
gaming terminals became generally available to customers at least for playing
bingo games, we have stopped further capitalization of the respective software
development costs and started to amortize previously accumulated capitalized
software development costs of $2,106,733 utilizing the five-year straight-line
amortization schedule.
Legal
Contingencies
We are
currently involved in various legal claims and legal proceedings. In
management’s opinion, these matters are not expected to have a significant
effect on our financial position or results of operations.
Results
of Operations
The
following table sets forth our results of operations as a percentage of revenue
for each of the periods indicated:
Consolidated
Income Statement
|
|
|
Years
Ended
December
31,
|
|
|
|
|
2008
|
|
|
2007
|
|
|
Revenue
|
|
|
100.0
|
%
|
|
|
100.0
|
%
|
|
Cost
of revenue
|
|
|
15.9
|
%
|
|
|
14.9
|
%
|
|
Gross
profit
|
|
|
84.1
|
%
|
|
|
85.1
|
%
|
|
Operating
expenses:
|
|
|
|
|
|
|
|
|
|
General
and administrative
|
|
|
32.9
|
%
|
|
|
28.0
|
%
|
|
Sales
and marketing
|
|
|
27.5
|
%
|
|
|
29.9
|
%
|
|
Research
and development
|
|
|
6.4
|
%
|
|
|
3.2
|
%
|
|
Total
operating expenses
|
|
|
66.8
|
%
|
|
|
61.1
|
%
|
|
Income
from operations
|
|
|
17.3
|
%
|
|
|
23.0
|
%
|
|
Other
income
|
|
|
5.7
|
%
|
|
|
9.5
|
%
|
|
Income
before income taxes
|
|
|
23.0
|
%
|
|
|
33.5
|
%
|
|
Provision
for income taxes
|
|
|
5.1
|
%
|
|
|
9.
|
%
|
|
Net
income
|
|
|
17.9
|
%
|
|
|
24.0
|
%
|
Years
Ended December 31, 2008 and December 31, 2007
In the
year ending December 31, 2008 our revenues and profits decreased while our costs
increased as detailed below.
Sales revenue.
Sales revenue
was $16,019,207 in the year ended December 31, 2008, compared to $16,488,565 in
the year ended December 31, 2007. The decrease of $469,358, or 2.8%, This
decrease was due primarily to the reduction of revenue from charitable bingo
halls, partially offset by the deployment of new units in the
field.
For the
year ended December 31, 2008, the net change in our revenue as a result of
changes in our customer base was a decrease in revenue of $1,630,697 compared to
the prior year, and the net change in revenue as a result of changes in
operations at our existing customer locations was an increase of revenue of
$1,161,339 over the same period in the prior year.
Cost of revenue.
The cost of
revenue was $2,549,696 or 15.9% of revenue in 2008, compared to $2,456,557 or
14.9% of revenue in 2007, an increase of $93,139, or 3.8%. The increase is the
result of amortization of software development cost, partially offset by a
slight reduction in repairs and upgrade cost.
General and administrative.
The general and administrative expenses were $5,266,352 or 32.9% of revenue in
2007, as compared to $4,623,322 or 28.0% of revenue in 2007, an increase of
$643,030 or 13.9. The increase in general and administrative expenses was
attributable primarily to a substantial increase in labor costs during the
year.
Sales and marketing.
The
sales and marketing expenses were $4,414,699, or 27.6% of revenue in 2008, as
compared to $4,930,823, or 29.9% of revenue in 2007, a decrease of $516,124, or
10.5%. This decrease was primarily attributable to the reduction of commissions
paid to distributors.
Research and development.
The
research and development expenses were $1,017,974 or 6.4% of revenue in 2008,
compared to $533,149 or 3.2% of revenue in 2007, an increase of $484,825 or
90.9%. The overall increase in
research
and development costs was primarily attributable to a reduction in capitalized
labor costs related to the ongoing development of our Mobile Gaming Platform. In
2008, $341,000 of research and development costs was capitalized as compared to
$961,575 capitalized in 2007. In addition, there were no research and
development costs capitalized in the fourth quarter of 2008 that would otherwise
have amounted to $102,000.
Other income and expense.
Other income was $919,813, or 5.7% of revenue in 2008, as compared to
$1,558,729, or 9.5% of revenue in 2007, a decrease of $638,916. The decrease in
other income was attributable primarily to the reduction in the amount of
interest earned on our investment funds due to the ongoing liquidation of our
auction rate securities and the transfer of released funds into liquid accounts
that yield lower interest rates than the ARS. Note also that in 2007, $469,586
was collected from a prior legal settlement positively affecting the 2007 “other
income” category.
Provision for income taxes.
An income tax provision of $812,754 with an effective tax rate of 22.0% was
recorded in 2008, as compared to $1,555,895 with an effective tax rate of 29.7%
recorded in 2007, a decrease of $743,141 or 47.8%. The decrease in the tax
provision is primarily attributable to the decrease in the taxable income for
the year ended December 31, 2008 combined with the positive effect of the
reversal of the FIN 48 liability and other tax credits.
Liquidity
and Capital Resources
Since
inception, we have financed our operations primarily with revenue generated from
the leasing of our bingo products. At December 31, 2008, our principal sources
of liquidity were cash, cash equivalents and current investment securities of
$26,448,214 and accounts receivable (net of allowance for doubtful accounts) of
$1,509,583. During February 2009 we converted our investment securities from ARS
to a liquid fund. We anticipate that our leasing revenue, which is our principal
source of revenue today, will be sufficient to fund our operating expenses in
the short term. Long term cash is expected to be generated from existing
operations and potentially, also through selling or leasing of our products in
new markets.
We expect
to incur significant additional expenses in connection with the procurement of
equipment and components and the manufacture of additional stationary and
wireless player terminals to take advantage of business opportunities. We
anticipate that these expenses will consume a substantial portion, if not all,
of our recurring lease revenues. Except to the extent we become obligated under
supply contracts that we enter into to procure equipment and components, our
fixed payment commitments are limited to our facilities lease.
We
believe that our cash flow from operations will be adequate to meet our
anticipated future requirements for working capital and capital expenditures for
the next 12 months and for the foreseeable future. Although no additional
capital raise is currently being contemplated, we may seek, if necessary or
otherwise advisable, additional financing through bank borrowings or public or
private debt or equity financings. Additional financing, if needed, may not be
available to us, or, if available, the financing may not be on terms favorable
to us. The terms of any financing that we may obtain in the future could impose
additional limitations on our operations and management structure. Our estimates
of our anticipated liquidity needs may not be accurate or new business
development opportunities or other unforeseen events may occur, resulting in the
need to raise additional funds.
Summary
of Combined and Consolidated Statements of Cash Flow
|
|
Years Ended December
31,
|
|
|
|
2008
|
|
2007
|
|
|
|
|
|
|
|
|
Net
cash provided by operating activities
|
|
$
|
3,685,
967
|
|
|
$
|
6,543,103
|
|
|
Net
cash provided by (used in) investing activities
|
|
|
11,698,312
|
|
|
|
(5,522,976
|
)
|
|
Net
increase in cash and cash equivalents
|
|
|
15,384,279
|
|
|
|
1,020,127
|
|
|
Cash
and cash equivalents, beginning
|
|
|
4,513,935
|
|
|
|
3,493,808
|
|
|
Cash
and cash equivalents, ending
|
|
$
|
19,898,214
|
|
|
$
|
4,513,935
|
|
Operating
Activities
For the
year ended December 31, 2008, the net cash of $3,685,967 provided by our
operating activities was primarily due to the net income of $2,877,545, the
depreciation and amortization of $2,215,679, the issuing of common stock for
certain services of $205,872 and the change in operating assets and liabilities
of $1,613,129. In comparison, for the year ended December 31, 2007, the net cash
of $6,543,103 provided by our operating activities was primarily due to the net
income of $3,947,548, the depreciation and amortization of $1,905,730, the
issuing of common stock for certain services of $164,614 and the change in
operating assets and liabilities of $525,211. The overall cash increase of
$15,384,279 in 2008 as compared to 2007 was primarily due to the liquidation of
auction rate securities in 2008.
Investing
Activities
For the
year 2008, $11,698,312 of net cash was provided by investing activities, with
$1,847,439 spent on other capital expenditures and $18,575,000 of marketable
securities sold and $5,029,249 of marketable securities purchased during the
period.
For the
year 2007, $5,522,976 of net cash was used for investing activities, with
$3,372,976 being used to fund the manufacture of equipment for lease to our
customers and $2,150,000 was used to invest in marketable
securities.
Financing
Activities
For the
years 2008 and 2007, no cash was provided by or used for financing
activities.
Off-Balance
Sheet Arrangements
As of
December 31, 2008, we have no off-balance sheet arrangements as defined in Item
303(a)(4) of the Securities and Exchange Commission’s Regulation
S-K.
Contractual
Obligations
The
following table describes our commitments to settle contractual obligations in
cash as of December 31, 2008:
|
|
|
Payments Due By
Period
|
|
|
|
|
Less
Than
1
Year
|
|
|
1
to 3
Years
|
|
|
3
to 5
Years
|
|
|
More
Than
5
Years
|
|
|
Total
|
|
|
Facilities
leases
|
|
$
|
213,388
|
|
|
$
|
716,966
|
|
|
$
|
196,425
|
|
|
$
|
—
|
|
|
$
|
1,126,779
|
|
|
|
|
$
|
213,388
|
|
|
$
|
716,966
|
|
|
$
|
196,425
|
|
|
$
|
—
|
|
|
$
|
1,126,779
|
|
Recent
Accounting Pronouncements
SFAS
141R
In
December 2007, the FASB issued SFAS No. 141R, “Business Combinations,”
which replaces FASB Statement No. 141, “Business Combinations.”
SFAS No. 141R requires an acquirer to recognize the identifiable
assets acquired, the liabilities assumed, any non-controlling interest in the
acquiree at the acquisition date, measured at their fair values as of that date,
with limited exceptions specified in the statement. SFAS No. 141R
applies prospectively to business combinations for which the acquisition date is
on or after the beginning of an entity’s fiscal year that begins after
December 15, 2008. The Company is in the process of evaluating the impact
of this standard; however, the Company does not expect the adoption of
SFAS No. 141R will have a material effect on its financial condition,
results of operations or cash flows.
SFAS
160
In
December 2007, the FASB issued SFAS No. 160, “Non-controlling
Interests in Consolidated Financial Statements,” which changes the accounting
and reporting standards for the non-controlling interests in a subsidiary in
consolidated financial statements. SFAS 160 recharacterizes minority
interests as non-controlling interests and
requires
non-controlling interests to be classified as a component of shareholders’
equity. SFAS 160 is effective January 1, 2009 and requires
retroactive adoption of the presentation and disclosure requirements for
existing minority interests. The Company does not expect the adoption of
SFAS No. 160 to have a material effect on its financial condition, results of
operations or cash flows.
ITEM
7A. QUANTITATIVE
AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
This
Annual Report does not include information described under Item 7A of Form 10-K
pursuant to the rules of the Securities and Exchange Commission that permit
“smaller reporting companies” to omit such information.
ITEM
8. FINANCIAL
STATEMENTS AND SUPPLEMENTARY DATA
CONSOLIDATED FINANCIAL STATEMENTS
|
|
|
Page
|
|
|
Report
of Independent Registered Public Accounting Firm
|
|
|
42
|
|
|
|
Consolidated
Balance Sheets as of December 31, 2008 and 2007
|
|
|
43
|
|
|
|
Consolidated
Statements of Income for the years ended December 31, 2008 and
2007
|
|
|
44
|
|
|
|
Consolidated
Statements of Stockholders’ Equity for the years ended December 31,
2008 and 2007
|
|
|
45
|
|
|
|
Consolidated
Statements of Cash Flows for the years ended December 31, 2008 and
2007
|
|
|
46
|
|
|
|
Notes
to Consolidated Financial Statements
|
|
|
47
|
|
|
___________________________
REPORT OF
INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
The Board
of Directors and Stockholders
FortuNet,
Inc.
Las
Vegas, Nevada
We have
audited the accompanying consolidated balance sheet of FortuNet, Inc and
subsidiaries as of December 31, 2008 and 2007 and the related consolidated
statements of income, changes in stockholders' equity and cash flows for each of
the two years in the period ended December 31, 2008. These consolidated
financial statements are the responsibility of the Company's management. Our
responsibility is to express an opinion on these consolidated financial
statements based on our audits.
We
conducted our audits in accordance with the standards of the Public Company
Accounting Oversight Board (United States). Those standards require that we plan
and perform the audit to obtain reasonable assurance about whether the financial
statements are free of material misstatement. The company is not required to
have, nor were we engaged to perform, an audit of its internal control over
financial reporting. Our audit included consideration of internal control over
financial reporting as a basis for designing audit procedures that are
appropriate in the circumstances, but not for the purpose of expressing an
opinion on the effectiveness of the Company's internal control over financial
reporting. Accordingly, we express no such opinion. An audit includes examining,
on a test basis, evidence supporting the amounts and disclosures in the
financial statements. An audit also includes assessing the accounting principles
used and significant estimates made by management, as well as evaluating the
overall financial statement presentation. We believe that our audits provide a
reasonable basis for our opinion.
In our
opinion, the financial statements referred to above present fairly, in all
material respects, the financial position of FortuNet, Inc and subsidiaries as
of December 31, 2008 and 2007 and the results of its operations and their cash
flows for each of the two years in the period ended December 31, 2008, in
conformity with accounting principles generally accepted in the United States of
America.
/s/
Schechter Dokken Kanter Andrews & Selcer Ltd.
Minneapolis,
Minnesota
March 10,
2009
FORTUNET,
INC.
CONSOLIDATED
BALANCE SHEETS
|
|
|
December
31,
|
|
|
|
|
|
|
|
|
|
|
|
|
2008
|
|
|
2007
|
|
|
Assets:
|
|
|
|
|
|
|
|
Current
assets:
|
|
|
|
|
|
|
|
Cash
and cash equivalents
|
|
$
|
19,898,214
|
|
|
$
|
4,513,935
|
|
|
Investment
securities and related Put Right Agreement (short term)
|
|
|
6,550,000
|
|
|
|
|
|
|
Accounts
receivable, net of allowance for doubtful accounts
|
|
|
1,509,583
|
|
|
|
1,431,721
|
|
|
Refundable
income taxes
|
|
|
160,649
|
|
|
|
156,031
|
|
|
Inventories
|
|
|
2,363,430
|
|
|
|
1,200,512
|
|
|
Prepaid
expenses
|
|
|
155,617
|
|
|
|
313,414
|
|
|
Deferred
tax asset
|
|
|
294,957
|
|
|
|
135,858
|
|
|
Total
current assets
|
|
|
30,932,450
|
|
|
|
7,751,471
|
|
|
Property
and equipment, net of
|
|
|
|
|
|
|
|
|
|
accumulated
depreciation
|
|
|
5,866,847
|
|
|
|
6,438,187
|
|
|
Investment
securities (long term)
|
|
|
3,200,000
|
|
|
|
25,125,000
|
|
|
Canadian
certificate of deposit - guaranteed investment contract
|
|
|
1,829,249
|
|
|
|
|
|
|
Other
assets, net of accumulated amortization
|
|
|
2,054,619
|
|
|
|
1,819,980
|
|
|
Deferred
tax asset
|
|
|
574,425
|
|
|
|
780,454
|
|
|
Total
assets
|
|
$
|
44,457,590
|
|
|
$
|
41,915,092
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Liabilities
and stockholders’ equity:
|
|
|
|
|
|
|
|
|
|
Current
liabilities:
|
|
|
|
|
|
|
|
|
|
Accounts
payable
|
|
$
|
221,557
|
|
|
$
|
499,201
|
|
|
Commissions
payable
|
|
|
109,049
|
|
|
|
178,060
|
|
|
Accrued
expenses
|
|
|
233,456
|
|
|
|
349,944
|
|
|
Treasury
stock payable
|
|
|
568,644
|
|
|
|
|
|
|
Income
tax liability
|
|
|
|
|
|
|
102,400
|
|
|
Total
current liabilities
|
|
|
1,132,706
|
|
|
|
1,129,605
|
|
|
|
|
|
|
|
|
|
|
|
|
Stockholders’
equity:
|
|
|
|
|
|
|
|
|
|
Common
stock
|
|
|
|
|
|
|
|
|
|
.001
par value 150,000,000 shares authorized, 11,351,279
|
|
|
|
|
|
|
|
|
|
Issued
and outstanding at December 31, 2007
and 11,042,011
|
|
|
|
|
|
|
|
|
|
shares
issued and outstanding at December 31, 2008
|
|
|
11,363
|
|
|
|
11,351
|
|
|
Treasury
stock, at cost; 321,268 shares
|
|
|
(568,644
|
)
|
|
|
|
|
|
Additional
paid in capital
|
|
|
30,086,162
|
|
|
|
29,855,678
|
|
|
Retained
earnings
|
|
|
13,796,003
|
|
|
|
10,918,458
|
|
|
Total
stockholders’ equity
|
|
|
43,324,884
|
|
|
|
40,785,487
|
|
|
Total
liabilities and
|
|
|
|
|
|
|
|
|
|
stockholders’
equity
|
|
$
|
44,457,590
|
|
|
$
|
41,915,092
|
|
See notes
to consolidated financial statements.
FORTUNET,
INC.
CONSOLIDATED
STATEMENTS OF INCOME
|
|
|
Years
ended
|
|
|
|
|
December
31,
|
|
|
|
|
2008
|
|
|
2007
|
|
|
Revenue
|
|
$
|
16,019,207
|
|
|
$
|
16,488,565
|
|
|
Cost
of revenue
|
|
|
2,549,696
|
|
|
|
2,456,557
|
|
|
Gross
profit
|
|
|
13,469,511
|
|
|
|
14,032,008
|
|
|
Operating
expenses:
|
|
|
|
|
|
|
|
|
|
General
and administrative
|
|
|
5,266,352
|
|
|
|
4,623,322
|
|
|
Sales
and marketing
|
|
|
4,414,699
|
|
|
|
4,930,823
|
|
|
Research
and development
|
|
|
1,017,974
|
|
|
|
533,149
|
|
|
Total
operating expenses
|
|
|
10,699,025
|
|
|
|
10,087,294
|
|
|
Income
from operations
|
|
|
2,770,486
|
|
|
|
3,944,714
|
|
|
|
|
|
|
|
|
|
|
|
|
Interest
income, net
|
|
|
918,527
|
|
|
|
1,087,809
|
|
|
Other
income
|
|
|
1,138,986
|
|
|
|
470,920
|
|
|
Other
expense
|
|
|
(1,137,700
|
)
|
|
|
|
|
|
Income
before income taxes
|
|
|
3,690,299
|
|
|
|
5,503,443
|
|
|
Provision
for income taxes
|
|
|
812,754
|
|
|
|
1,555,895
|
|
|
Net
income
|
|
$
|
2,877,545
|
|
|
$
|
3,947,548
|
|
|
Weighted
average shares – basic
|
|
|
11,351,950
|
|
|
|
11,345,849
|
|
|
Earnings
per share – basic
|
|
$
|
.25
|
|
|
$
|
.35
|
|
|
Weighted
average shares – diluted
|
|
|
11,357,106
|
|
|
|
11,349,096
|
|
|
Earnings
per share – diluted
|
|
$
|
.25
|
|
|
$
|
.35
|
|
See notes
to consolidated financial statements.
FORTUNET,
INC.
CONSOLIDATED
STATEMENTS OF STOCKHOLDERS’ EQUITY
|
|
|
Common
|
|
|
Common
|
|
|
Treasury
|
|
|
Additional
|
|
|
|
|
|
Total
|
|
|
|
|
Outstanding
|
|
|
Stock
|
|
|
Stock
|
|
|
Paid-in
|
|
|
Retained
|
|
|
Stockholders'
|
|
|
|
|
Shares
|
|
|
Dollars
|
|
|
Dollars
|
|
|
Capital
|
|
|
Earnings
|
|
|
Equity
|
|
|
Balance,
January 1, 2007
|
|
|
11,341,612
|
|
|
$
|
11,342
|
|
|
|
|
|
$
|
29,620,830
|
|
|
$
|
6,970,910
|
|
|
$
|
36,603,082
|
|
|
Stock
issued for services
|
|
|
9,667
|
|
|
|
9
|
|
|
|
|
|
|
77,843
|
|
|
|
|
|
|
|
77,852
|
|
|
Stock
option cost
|
|
|
|
|
|
|
|
|
|
|
|
|
|
157,005
|
|
|
|
|
|
|
|
157,005
|
|
|
Net
income
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
3,947,548
|
|
|
|
3,947,548
|
|
|
Balance,
December 31, 2007
|
|
|
11,351,279
|
|
|
$
|
11,351
|
|
|
|
|
|
$
|
29,855,678
|
|
|
$
|
10,918,458
|
|
|
$
|
40,785,487
|
|
|
Stock
issued for services
|
|
|
12,000
|
|
|
|
12
|
|
|
|
|
|
|
74,388
|
|
|
|
|
|
|
|
74,400
|
|
|
Stock
option cost
|
|
|
|
|
|
|
|
|
|
|
|
|
|
156,096
|
|
|
|
|
|
|
|
156,096
|
|
|
Stock
repurchase
|
|
|
(321,268
|
)
|
|
|
|
|
|
$
|
(568,644
|
)
|
|
|
|
|
|
|
|
|
|
|
(568,644
|
)
|
|
Net
income
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
2,877,545
|
|
|
|
2,877,545
|
|
|
Balance,
December 31, 2008
|
|
|
11,042,011
|
|
|
$
|
11,363
|
|
|
$
|
(568,644
|
)
|
|
$
|
30,086,162
|
|
|
$
|
13,796,003
|
|
|
$
|
43,324,884
|
|
See notes
to consolidated financial statements.
FORTUNET,
INC.
CONSOLIDATED
STATEMENTS OF CASH FLOWS
|
|
|
Twelve
months ended
December
31,
|
|
|
|
|
2008
|
|
|
2007
|
|
|
Cash
flows from operating activities:
|
|
|
|
|
|
|
|
Net
income
|
|
$
|
2,877,545
|
|
|
$
|
3,947,548
|
|
|
Adjustments
to reconcile net income to net cash provided by operating
activities:
|
|
|
|
|
|
|
|
|
|
Depreciation
|
|
|
2,102,342
|
|
|
|
1,784,027
|
|
|
Amortization
|
|
|
113,337
|
|
|
|
121,703
|
|
|
Stock
issued for services
|
|
|
205,872
|
|
|
|
164,614
|
|
|
Deferred
taxes
|
|
|
46,930
|
|
|
|
57,115
|
|
|
Change
in operating assets and liabilities:
|
|
|
|
|
|
|
|
|
|
Accounts
receivable
|
|
|
(77,862
|
)
|
|
|
4,878
|
|
|
Refundable
income taxes
|
|
|
(4,618
|
)
|
|
|
133,458
|
|
|
Inventories
|
|
|
(1,162,918
|
)
|
|
|
355,122
|
|
|
Prepaid
expenses
|
|
|
157,797
|
|
|
|
(156,031
|
)
|
|
Other
assets
|
|
|
(6,915
|
)
|
|
|
(1,584
|
)
|
|
Accounts
payable
|
|
|
(277,644
|
)
|
|
|
362,860
|
|
|
Commissions
payable
|
|
|
(69,011
|
)
|
|
|
118,750
|
|
|
Accrued
expenses
|
|
|
(116,488
|
)
|
|
|
(116,549
|
)
|
|
Income
tax liability
|
|
|
(102,400
|
)
|
|
|
(232,808
|
)
|
|
Net
cash provided by operating activities
|
|
|
3,685,967
|
|
|
|
6,543,103
|
|
|
|
|
|
|
|
|
|
|
|
|
Cash
flows from investing activities:
|
|
|
|
|
|
|
|
|
|
Purchase
of equipment and property
|
|
|
(1,847,439
|
)
|
|
|
(3,372,976
|
)
|
|
Sale
of investment securities
|
|
|
18,575,000
|
|
|
|
9,950,000
|
|
|
Purchase
of investment securities
|
|
|
(5,029,249
|
)
|
|
|
(12,100,000
|
)
|
|
Net
cash provided by (used in) investing activities
|
|
|
11,698,312
|
|
|
|
(5,522,976
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net
increase in cash and cash equivalents
|
|
|
15,384,279
|
|
|
|
1,020,127
|
|
|
|
|
|
|
|
|
|
|
|
|
Cash
and cash equivalents, beginning
|
|
|
4,513,935
|
|
|
|
3,493,808
|
|
|
Cash
and cash equivalents, ending
|
|
$
|
19,898,214
|
|
|
$
|
4,513,935
|
|
|
|
|
|
|
|
|
|
|
|
|
Supplemental
disclosure of cash flow information:
|
|
|
|
|
|
|
|
|
|
Cash
paid for income taxes
|
|
$
|
766,800
|
|
|
$
|
1,904,543
|
|
|
Cash
paid for interest
|
|
|
|
|
|
$
|
19,459
|
|
|
Non-cash
investing and financing activities:
|
|
|
|
|
|
|
|
|
|
Stock
options capitalized as software development costs
|
|
$
|
24,624
|
|
|
$
|
70,243
|
|
|
Treasury
stock purchased, not yet paid
|
|
$
|
568,644
|
|
|
|
|
|
See notes
to consolidated financial statements.
FORTUNET,
INC.
NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS
1. Nature
of business and summary of significant accounting policies:
Nature
of business:
FortuNet,
Inc. (FortuNet) and its wholly-owned subsidiaries, Millennium Games
(Millennium), Star Bingo Holdings, LLC and Star Bingo Supply, LLC (collectively
the Company); FortuNet was incorporated in 1989 in Nevada. FortuNet is engaged
primarily in the business of designing, manufacturing, field maintenance
and leasing electronic gaming and entertainment systems throughout North
America.
The
Company derives substantially all revenues from the gaming industry in the
United States and Canada. Changes in laws and regulations related to gaming in
each state or province can affect the Company’s revenues in any given state or
province.
Basis
of accounting and principles of consolidation:
The
Company has not elected to adopt the option available under Financial Accounting
Standards Board No. 159, The Fair Value Option for Financial Assets and
Financial Liabilities, to measure any of its eligible financial instruments or
other items. Accordingly, the Company continues to measure all of its assets and
liabilities on the historical cost basis of accounting except as otherwise
disclosed herein.
The
consolidated financial statements for years 2008 and 2007 include the accounts
of FortuNet and its wholly-owned subsidiaries. All inter-company transactions
have been eliminated for all periods presented.
Cash
and cash equivalents:
The
Company considers all highly liquid investments which have maturities of three
months or less, when acquired, to be cash equivalents. The carrying amount
reported in the balance sheet for cash and cash equivalents approximates its
fair value. Cash and cash equivalents subject the Company to concentrations of
credit risk. At December 31, 2008 and 2007, the Company had invested
approximately $17.1 million and $3.0 million respectively, in cash equivalents
in the form of money market funds with four major investment companies and held
approximately $3.4 million and $1.5 million, respectively, in a single
commercial bank.
Investment
securities (see also note 3):
In
accordance with Statement of Financial Accounting Standards No.115, “
Accounting for Certain Debt and
Equity Securities
,” investments are classified as available-for-sale
except for the portion of our Auction Rate Securities (“ARS”) that are
classified as short term investments. Available-for-sale securities are carried
at fair value, with the unrealized gains and losses reported in comprehensive
income (loss). Realized gains and losses and declines in value judged to be
other-than-temporary, if any, on available-for-sale securities are included in
other income or expense. In computing realized gains and losses, the Company
computes the cost of its investments on a specific identification basis.
Interest and dividends on securities classified as available-for-sale are
included in interest income.
As
of December 31, 2008, certain equity securities held in short-term investments
related to our ARS are classified as trading securities. Investments designated
as trading securities are carried at fair value on the balance sheet, with the
unrealized gains or losses recorded in other income in the period incurred.
These
securities are subject to a Put Right Agreement described in Note 3 that was
received in settlement from the selling broker enabling the ARS to be redeemed
by such selling broker at par during a stated period, and they were so redeemed
subsequent to December 31, 2008. The Put Right Agreement, issued in the fourth
quarter of 2008, was recorded as a separate asset (and other income) at its
estimated fair value equal to the estimated impairment adjustment to the related
ARS.
In
accordance with Statement of Financial Accounting Standards (“SFAS”) No. 157,
“
Fair Value
Measurements
,” and FASB Staff Position FAS 157-3, “
Determining the Fair Value of a
Financial Asset When the
FORTUNET,
INC.
NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS - Continued
Market for That Asset is Not
Active
” to value our financial assets and liabilities that are carried at
fair value. SFAS 157 defines fair value as the price that would be received to
sell an asset or paid to transfer a liability (an exit price) in an orderly
transaction between market participants at the reporting date.
Due to
the absence of observable market quotes, the Company’s investments in ARS are
classified within level 3 and valued using a discounted cash flow model. The
municipal bonds underlying the Company’s investment ARS that are classified as
noncurrent are tax exempt, and the Company has been receiving monthly interest
payments
when due.
Based on its discounted cash flow analysis of future principal and interest
payments further discounted to reflect the uncertainty of current market
conditions and the overall capital market liquidity of the ARS
instruments, management has concluded that these securities are not
presently impaired and that their estimated fair value is equal to
par.
The funds
associated with failed auctions will not be accessible until a successful
auction occurs, the issuer calls or restructures the underlying security, the
underlying security matures and is paid or a buyer outside the auction process
emerges. The Company believes that the failed auctions experienced to date are
not a result of the deterioration of the underlying credit quality of these
securities, although valuation of them is subject to uncertainties that are
difficult to predict, such as changes to credit ratings of the securities and/or
the underlying assets supporting them, default rates applicable to the
underlying assets, underlying collateral value, discount rates, counterparty
risk and ongoing strength and quality of market credit and liquidity. The
Company believes that any unrealized gain or loss associated with these
securities will be temporary and will be recorded in accumulated other
comprehensive income (loss) in its financial statements.
The
credit and capital markets have continued to deteriorate in 2008. Continuation
or acceleration of the current instability in these markets and/or deterioration
in the ratings of the Company’s investments may affect its ability to liquidate
these securities, and therefore may affect its future financial condition, cash
flows and earnings.
The
Company continues to monitor the market for auction rate securities and consider
its impact (if any) on the fair market value of its investments. If the current
market conditions continue, in which some auctions for ARS fail, or the
anticipated recovery in market values does not occur, the Company may be
required to record unrealized losses or impairment charges in 2009. As auctions
have closed successfully, the Company has converted its investments in ARS to
money market funds. The Company believes it will have the ability to hold
any auction rate securities for which auctions fail until the market recovers.
It does not anticipate having to sell these securities in order to operate its
business.
Inventories:
Inventories,
consisting primarily of parts and components to be used for assembly and
installation of products to be leased or sold, are valued at the lower of cost
or market, as determined by the first-in, first-out basis. Also classified as
inventories are Work In Process (WIP) components for installs that are being
produced for a future period. The following schedule details inventory between
parts and assemblies and work in process:
|
|
|
2008
|
|
|
2007
|
|
|
Parts
and assemblies
|
|
$
|
1,680,031
|
|
|
$
|
1,103,612
|
|
|
Work
in process
|
|
|
683,399
|
|
|
|
96,900
|
|
|
|
|
$
|
2,363,430
|
|
|
$
|
1,200,512
|
|
Property
and equipment:
Property
and equipment are stated at cost. Depreciation is provided using the declining
balance method except for rental assets for which the straight line method is
used. Estimated lives used for depreciation are as follows:
FORTUNET,
INC.
NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS - Continued
|
Rental
assets
|
|
|
5
years
|
|
Furniture
and fixtures
|
|
|
5-7
years
|
|
Machinery
and equipment
|
|
|
5
years
|
|
Printing
equipment
|
|
|
11
years
|
|
Vehicles
|
|
|
5
years
|
|
Improvements
|
|
|
2-7
years
|
Software
development capitalization:
The
Company capitalizes internally developed software costs in accordance with SFAS
No. 86,
Accounting for
the Costs of Computer Software to be Sold, Leased or Otherwise Marketed.
Capitalization of development costs of software products begins once the
technological feasibility of the product is established. Capitalization ceases
when such software is ready for general release, at which time amortization of
the capitalized costs begins. Starting in April 2006 through September 2008 the
Mobile Gaming System internal software development costs have been capitalized
as technological feasibility of the product was established in April 2006. Since
the latest generation of our mobile gaming platform became generally available
for distribution to at least our current bingo customers in the fourth quarter
of 2008, we have stopped capitalizing the respective software development costs
and started to amortize the previously accumulated capitalized software
development cost on the applicable five-year amortization schedule (see note
5).
Revenue
recognition:
The
Company leases its products, using operating leases directly to gaming
facilities and through several regional distributors. The agreements generally
require lessees to pay rent for player terminals only when they are actually
used based upon an automated reporting system whereby each day’s usage by
customer is reported to the Company or a self-reporting system where the
customer submits sales information to the Company which is used as the basis for
determining revenue. The Company recognizes revenue as the devices are used in
accordance with each lease agreement. Most leases are on a per-use arrangement
with some lease payments being determined as a percentage of revenue that the
devices generates for the lessee and some devices are leased at a flat weekly
amount. The terms range from one to eight years duration with annually renewable
leases; and also include month-to-month leases. . The Company recognizes revenue
as the devices are used based upon the automated reporting system or
self-reporting system described above. Sales taxes collected from customers are
excluded from revenue, but rather are recorded as a liability payable to the
appropriate taxing authority and included in accrued expenses.
Cost
of revenue:
The cost
of revenue includes depreciation of our capitalized leased equipment and the
cost of shipping to and installation of equipment in the field as well as the
cost of subsequent repairs and upgrades of installed equipment. Repairs are
expensed as incurred upon the return of the malfunctioning and/or damaged
equipment from the field subsequent to the re-deployment of equipment back to
the field. Upgrades either for the hardware or the software components of our
systems that have been deployed at customer locations are expensed in the period
in which the upgrades are actually performed. Installation costs allocated with
the new lease contracts are expensed in the period in which the equipment is
deployed in the field.
We do not
provide any product warranties to any of our customers. However, it is in our
best interest to maintain our equipment in good working order. We apply our best
effort to promptly repair and/or replace equipment in good working order. We
apply our best effort to promptly repair and/or replace equipment returned from
customers. The cost of the repairs is expensed in the period incurred.
Accordingly, no liability has been established by the Company for future costs
to repair our products.
Accounts receivable and allowance for
doubtful accounts
:
The
Company’s receivables are recorded when revenue is recognized in accordance with
its revenue recognition policy and represent claims against third parties that
will be settled in cash. The Company estimates the possible losses resulting
from non-payment of outstanding accounts receivable. The Company evaluates
the
FORTUNET,
INC.
NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS – Continued
allowance
for doubtful accounts using current year account activity, historical trend
information and specific account identification. After all attempts to collect a
receivable have deemed to be futile, the receivable is written off against the
allowance. Balances greater then ninety days old are considered past due and are
considered by management when determining the allowance for doubtful accounts.
The carrying value of the Company’s receivables, net of allowance for doubtful
accounts, represents their estimated net realizable value. The maximum losses
that the Company could incur if a customer failed to pay would be limited to the
amount due after the related allowances provided plus the net carring value of
the leased equipment if not returned.
Income
taxes:
The
Company accounts for income taxes in accordance with SFAS No. 109, “
Accounting for Income Taxes.”
SFAS No. 109 requires the recognition of deferred tax assets, net of
applicable reserves and liabilities for the estimated future tax consequences
attributable to differences between financial statement carrying amounts of
existing assets and liabilities and their respective tax bases and operating
loss and tax credit carry forwards. Deferred tax assets and liabilities are
measured using enacted tax rates in effect for the year in which those temporary
differences are expected to be recovered or settled. The effect of a change in
tax rates on the income tax provision and deferred tax assets and liabilities is
recognized in the results of operations in the period that includes the
enactment date.
The
Company’s income tax returns are subject to examination by the Internal Revenue
Service and other tax authorities in the locations where it operates. The
Company assesses potentially unfavorable outcomes of such examinations based on
the criteria of FASB Interpretation No. 48,
Accounting for Uncertainty in
Income Taxes
, or FIN No. 48, which clarifies the accounting
for uncertainty in income taxes recognized in an entity’s financial statements
in accordance with SFAS No. 109. FIN 48 prescribes a recognition
threshold and measurement attribute to the financial statement recognition and
measurement of a tax position taken or expected to be taken in a tax
return.
Treasury Stock
Policy
:
The
Company has accounted for the repurchase of its 321,268 shares using the Cost
method under ARB 43 with the gross cost of the shares reacquired charged to the
contra equity account “Treasury Stock.”
Use
of estimates:
The
preparation of financial statements in conformity with generally accepted
accounting principles requires management to make estimates and assumptions that
affect certain reported amounts and disclosures. The principal estimate is the
5 year life of rental assets. While actual results could differ from those
estimates, management believes that the estimates are
reasonable.
Earnings
per share:
In
accordance with the provisions of SFAS No. 128,
Earnings Per Share,
earnings
per share is computed by dividing net income by the weighted average number of
common shares outstanding during the period. The calculation excludes 44,000 and
50,000 options that are outstanding at December 31, 2008 and 2007 respectively,
but are deemed to be anti-dilutive as their exercise price exceeds the average
closing price used in the calculation of diluted earnings per
share.
FORTUNET,
INC.
NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS - Continued
|
|
|
Years
ended
December
31,
|
|
|
|
|
2008
|
|
|
2007
|
|
|
Net
income
|
|
$
|
2,877,545
|
|
|
$
|
3,947,548
|
|
|
Weighted
average shares – basic
|
|
|
11,351,950
|
|
|
|
11,345,849
|
|
|
Earnings
per share – basic
|
|
$
|
.25
|
|
|
$
|
.35
|
|
|
Weighted
average shares – diluted
|
|
|
11,357,106
|
|
|
|
11,349,096
|
|
|
Earnings
per share – diluted
|
|
$
|
.25
|
|
|
$
|
.35
|
|
Fair
value of financial instruments:
The
carrying amount reflected in the balance sheets for financial assets not carried
at fair value (note 3), including cash and cash equivalents, accounts receivable
and all liabilities, approximate the respective fair values due to the short
maturities of those instruments.
Stock-based
compensation:
On
January 1, 2006, the Company adopted SFAS No. 123R, “
Share-Based Payments
” (“SFAS
No. 123R”). Prior to 2006 the Company had not issued any employee stock options
and, therefore, had not adopted any policy for accounting for
them. Accordingly, the adoption of SFAS No. 123R was not an
accounting change.
The
outstanding stock options as of December 31, 2008 were all issued in 2006 and no
stock options were issued in 2008. The fair value of the Company’s employee
stock options was estimated at the date of grant using a Black-Scholes
option-pricing model with the following weighted-average assumptions for all
options granted:
|
|
|
|
|
|
|
Range
|
Average
|
|
Weighted
|
Expected
volatility
|
59.67
- 78.4%
|
59.98%
|
|
Average
|
Expected
dividend yield
|
0.00%
|
0.00%
|
|
Assumptions
|
Expected
life(term)
|
3.5
years
|
3.5
years
|
|
|
Risk-free
interest rate
|
4.71%
|
4.71%
|
The
risk-free interest rate is based upon the U.S. Treasury yield curve at the time
of the grant. The expected life of options was determined by using the
simplified method of Staff Accounting Bulletin 107. Expected volatility of stock
was calculated using historical and implied volatilities. The company applied an
estimated forfeiture rate of 22% to the options granted in 2006, and there were
no options granted in 2008. This rate was calculated based upon an estimate of
granted shares not expected to vest. If actual forfeitures differ from the
expected rate, the Company may be required to make additional adjustments to
compensation expense in future period.
Concentrations:
Financial
instruments which potentially subject the Company to a concentration of credit
risk are cash and cash equivalents, investment securities consisting of ARS
through accounts with investment bankers, and accounts receivable. The Company
maintains its cash and securities at a number of financial institutions
primarily in the form of interest bearing accounts, money market funds and
certificates of deposits that at times the balances exceed federally insured
limits. The possible loss, if any, to be incurred in the event of a future
failure of a financial institution cannot be estimated at this
time.
The
Company’s accounts receivable are due from gaming establishments and gaming
distributors. The Company does not require collateral to extend credit to their
customers but perform ongoing credit evaluations of their customers’ financial
condition. One customer made up 37%, and 34% of sales revenues in 2008 and
2007,
FORTUNET,
INC.
NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS - Continued
respectively. The
loss of this customer, without replacing it, could have a significant impact on
our revenues, earnings and cash flows.
The
United States is experiencing a recession accompanied by, among other things,
reduced casino gaming and nationwide, instability in the commercial and
investment banking systems and reduced credit availability, and is also engaged
in war, all of which are likely to have far-reaching effects on economic
activity in the country for an indeterminate period. The effects and probable
duration of these conditions and related risks and uncertainties on the Company
and its future operations and cash flows cannot be estimated at this time but
could be significant.
Third-party
assemblers:
The
Company depends on one third-party assemblers for a majority of the
subassemblies for the Company’s gaming systems. If these assemblers were to
cease doing business with the Company, replacement assemblers would need to be
located. The Company believes that a number of other assemblers could be located
to manufacturer the subassemblies for the Company’s gaming systems. However, the
Company may not be able to substitute, or produce new gaming systems without
interruption of the production line or a cost increase.
Litigation
costs:
The
Company does not accrue for future litigation costs, if any to be incurred in
connection with outstanding litigation and other dispute matters but rather
records such costs when the legal and other services are rendered.
Reclassification:
Capitalized
software development costs of $1,765,673 as of December 31, 2007 have been
reclassified from property and equipment, net of accumulated depreciation on the
current balance sheets to other assets, net of accumulated amortization to
correct an error in classification. The error correction had no
effect on earnings or net income.
2. Property
and equipment:
Property
and equipment includes assets used in the daily operations of the Company and
assets leased to the Company’s customers through operating leases Rental Assets
include player terminals and supporting equipment necessary to operate the
system. Assets not yet placed in service consist of equipment for additional
revenue producing products. During 2008, the Company placed into service
approximately $1,487,713 of web press printing equipment. Property
and equipment and rental assets and the related accumulated depreciation consist
of the following:
|
|
|
December
31,
|
|
|
|
|
2008
|
|
|
2007
|
|
|
Furniture
and fixtures
|
|
$
|
71,735
|
|
|
$
|
68,099
|
|
|
Machinery
and equipment
|
|
|
406,521
|
|
|
|
392,191
|
|
|
Printing
Equipment
|
|
|
2,027,075
|
|
|
|
--
|
|
|
Vehicles
|
|
|
130,959
|
|
|
|
100,905
|
|
|
Leasehold
improvements
|
|
|
193,119
|
|
|
|
177,226
|
|
|
|
|
|
2,829,409
|
|
|
|
738,421
|
|
|
Accumulated
depreciation
|
|
|
(774,261
|
)
|
|
|
(517,727
|
)
|
|
|
|
|
2,055,148
|
|
|
|
220,694
|
|
|
Lease
assets
|
|
|
17,010,693
|
|
|
|
16,103,952
|
|
|
Accumulated
depreciation
|
|
|
(13,198,994
|
)
|
|
|
(11,374,172
|
)
|
|
|
|
|
3,811,699
|
|
|
|
4,729,780
|
|
|
Assets
not yet placed in service
|
|
|
--
|
|
|
|
1,487,713
|
|
|
|
|
$
|
5,866,847
|
|
|
$
|
6,438,187
|
|
FORTUNET,
INC.
NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS - Continued
3. Investment
Securities:
On
January 1, 2007, we adopted the methods of fair value as described in SFAS
157 to value our financial assets carried at fair value pursuant to SFAS 115.
There was not effect, however, on the 2007 financial statements of this change.
SFAS 157 defines fair value as the price that would be received to sell an asset
or paid to transfer a liability (an exit price) in an orderly transaction
between market participants at the reporting date. SFAS 157 establishes
consistency and comparability by providing a fair value hierarchy that
prioritizes the inputs to valuation techniques into three broad levels, which
are described below:
|
|
•
|
|
Level
1 inputs are quoted market prices in active markets for identical assets
or liabilities (these are observable market inputs).
|
|
|
|
|
|
|
|
•
|
|
Level
2 inputs are inputs other than quoted prices included within Level 1 that
are observable for the asset or liability (includes quoted market prices
for similar assets or identical or similar assets in markets in which
there are few transactions, prices that are not current or vary
substantially).
|
|
|
|
|
|
|
|
•
|
|
Level
3 inputs are unobservable inputs that reflect the entity’s own assumptions
in pricing the asset or liability (used when little or no market data is
available).
|
SFAS 157
requires the use of observable market inputs (quoted market prices) when
measuring fair value and requires a Level 1 quoted price be used to measure fair
value whenever possible.
Financial
assets and liabilities included in our financial statements and measured at fair
value on a recurring basis as of December 31, 2008 are classified based on the
above valuation method are provided in the table below:
|
|
|
|
|
|
|
Fair
Value Measurement at December 31, 2008
|
|
Description
|
|
Total
|
|
Level
1
|
|
Level
2
|
|
Level
3
|
|
|
|
Assets:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Auction
rate securities (current)
|
|
$
|
5,412,300
|
|
|
|
—
|
|
|
|
|
|
|
$
|
5,412,300
|
|
|
Put
Right Agreement
|
|
|
1,137,700
|
|
|
|
|
|
|
|
|
|
|
|
1,137,700
|
|
|
Auction
rate securities (long term)
|
|
|
3,200,000
|
|
|
|
—
|
|
|
|
|
|
|
|
3,200,000
|
|
|
|
|
Total
assets at fair value
|
|
$
|
9,750,000
|
|
|
|
|
|
|
|
|
|
|
$
|
9,750,000
|
|
The
following table presents the Company’s activity for level 3assets as defined in
SFAS 157, which are measured at fair value on a recurring basis using
significant unobservable inputs for the year ending December 31,
2008:
|
|
|
Auction
Rate
|
|
|
|
|
Securities
and
|
|
|
|
|
Put
Right
|
|
|
|
|
Agreement
|
|
|
Balance
at December 31, 2007
|
|
$
|
-----
|
|
|
Transfer
to Level 3
|
|
|
9,750,000
|
|
|
Total
gains or (losses) (realized or unrealized) included in
earnings
|
|
|
-----
|
|
|
Purchases
and settlements (net)
|
|
|
-----
|
|
|
Balance
at December 31, 2008
|
|
$
|
9,750,000
|
|
In
November 2008, the Company entered into an agreement with the broker that sold
the Company $6,550,000 of its auction rate securities that gives the Company the
right to sell its existing auction rate securities back to the
FORTUNET,
INC.
NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS - Continued
broker at
par, an non-transferable right (“Put Right Agreement”), plus accrued interest,
beginning on January 1, 2009 through January 4, 2011.
The
Company considers the Put Right Agreement to be a freestanding intangible asset
and the Company has accounted for it separately from the ARS. The Company has
recorded the instrument as an asset of approximately $1.1 million on its balance
sheet and presented it together with the related short-term ARS investment
security as of December 31, 2008, with a corresponding gain recorded in other
income.
In
connection with the receipt of the Put Right Agreement, the Company made an
election under SFAS No. 115 to reclassify the related ARS from
available-for-sale to trading securities. The transfer to trading securities
reflects management’s intent to exercise the Put Right Agreement. At the time of
the reclassification, the estimated unrealized impairment loss of $1.1 million
on the related ARS was immediately recognized in earnings, as a component of
other expense.
The
Companies estimated fair value derived through the discounted cash flow model
was generally consistent with the quoted price indicated by the broker which
holds its short-term ARS at December 31, 2008.
Management
estimated the fair value of the Put Right Agreement to be equal to the net
present value of the difference between the par value and the fair value of the
ARS on December 31, 2008, with no discounting since it was immediately
exercisable.
The
following table summarizes the original cost basis, the aggregate fair value and
gross unrealized holding gains and losses at December 31, 2008 and 2007,
respectively.
|
|
|
|
|
|
Fair
|
|
|
Unrealized
Holding
|
|
|
|
|
Cost
Basis
|
|
|
Value
|
|
|
Gains
|
|
|
(Losses)
|
|
|
Net
|
|
|
2007:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Maturities
greater than five years:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Municipal
Bonds (ARS)
|
|
$
|
25,125,000
|
|
|
$
|
25,125,000
|
|
|
$
|
—
|
|
|
$
|
—
|
|
|
$
|
—
|
|
|
2008:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Maturities
less than one year
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Municipal
Bonds (ARS and
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
related)
Put Right Agreement
|
|
$
|
6,550,000
|
|
|
$
|
6,550,000
|
|
|
$
|
1,137,700
|
|
|
$
|
1,137,700
|
|
|
$
|
6,550,000
|
|
|
Maturities
greater than five years:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Municipal
Bonds (ARS)
|
|
$
|
3,200,000
|
|
|
$
|
3,200,000
|
|
|
$
|
—
|
|
|
$
|
—
|
|
|
$
|
—
|
|
The
original cost basis of investment securities includes the direct costs to
acquire the securities.
4.
Canadian certificate of deposit -
guaranteed investment contract:
The
Company holds a Canadian investment in a guaranteed investment contract with a
fixed term and rate through a Canadian bank. The Company uses this Canadian bank
for transactions with its Canadian customer and other activities using Canadian
dollars and converts to U.S. dollars as of December 31, 2008.
5. Other
assets:
Other
assets include the cost of the fully amortized signing bonus the Company paid in
accordance with the terms of a five-year lease agreement to lease gaming devices
to a customer. This signing bonus was paid to allow the lessee to prepare the
location for the installation of our equipment. The signing bonus was amortized
over the initial lease period of 60 months, which began in 2004, amortization
expense for the year ended December 31, 2008 and
FORTUNET,
INC.
NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS - Continued
2007 was
$8,000 and $24,000, respectively. During 2008, the Company reclassified
$1,765,673 of previously accumulated capitalized software development costs from
fixed assets to other assets and capitalized $341,060 in 2008 of additional
software development costs. In the fourth quarter of 2008, the Company began to
amortize these software development costs in accordance with SFAS No. 86 (see
Note 7).
|
|
|
December
31,
|
|
|
|
|
2008
|
|
|
2007
|
|
|
Signing
bonus
|
|
|
120,000
|
|
|
|
120,000
|
|
|
Accumulated
amortization
|
|
|
(120,000
|
)
|
|
|
(112,000
|
)
|
|
|
|
|
--
|
|
|
|
8,000
|
|
|
Software
development cost
|
|
|
2,106,733
|
|
|
|
1,765,673
|
|
|
Accumulated
amortization
|
|
|
(105,337
|
)
|
|
|
--
|
|
|
|
|
|
2,001,396
|
|
|
|
1,765,673
|
|
|
Other
|
|
|
53,223
|
|
|
|
46,307
|
|
|
|
|
$
|
2,054,619
|
|
|
$
|
1,819,980
|
|
The
following schedule details the yearly amortization of capitalized software
development cost for the next five years:
|
Year
|
|
Amortization
|
|
2009
|
|
421,347
|
|
2010
|
|
421,347
|
|
2011
|
|
421,347
|
|
2012
|
|
421,347
|
|
2013
|
|
316,008
|
6. Commitments:
The
Company has operating lease agreements for office space and production
facilities, which expire in September 2013. The leases contain escalating rent
payments clauses. The minimum rental payments for the remainder of the term of
the lease are as follows:
|
Year
|
|
Amount
|
|
|
2009
|
|
213,388
|
|
|
2010
|
|
220,109
|
|
|
2011
|
|
243,562
|
|
|
2012
|
|
253,295
|
|
|
2013
|
|
196,425
|
|
Lease
expenses are recognized on a straight-line basis over the leases terms. Rental
expenses on all operating leases were $190,288 and $145,764 in 2008 and 2007,
respectively.
7. Income
taxes:
The
income tax provisions consist of the following:
FORTUNET, INC.
NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS - Continued
|
|
|
2008
|
|
|
2007
|
|
|
Current:
|
|
|
|
|
|
|
|
Federal
|
|
$
|
611,697
|
|
|
$
|
1,287,143
|
|
|
State
|
|
|
144,138
|
|
|
|
211,637
|
|
|
Total
current
|
|
|
755,835
|
|
|
|
1,498,780
|
|
|
Deferred:
|
|
|
|
|
|
|
|
|
|
Federal
|
|
|
46,065
|
|
|
|
49,050
|
|
|
State
|
|
|
10,854
|
|
|
|
8,065
|
|
|
Total
deferred
|
|
|
56,919
|
|
|
|
57,115
|
|
|
|
|
$
|
812,754
|
|
|
$
|
1,555,895
|
|
The
Company has revenues derived from Canada, but in our opinion, the Company is not
obligated to pay Canadian income taxes in view of the Canada Exemption under the
Canada-US Tax Convention, whereby residents of the USA with no permanent
establishment situated in Canada are taxable only in the USA.
The
following are the principal components of deferred tax assets occurring as a
result of transactions being reported in different years for financial and tax
reporting:
|
|
|
December 31,
|
|
|
|
|
2008
|
|
|
2007
|
|
|
Deferred
tax assets:
|
|
|
|
|
|
|
|
Allowance
for doubtful accounts
|
|
$
|
63,498
|
|
|
$
|
12,544
|
|
|
Difference
in tax and financial amortization lives
|
|
|
392,394
|
|
|
|
421,996
|
|
|
Inventories,
primarily due to capitalization for tax purposes
|
|
|
92,896
|
|
|
|
28,363
|
|
|
Property
and equipment primarily due to differences in depreciation
|
|
|
182,030
|
|
|
|
358,458
|
|
|
Accrued
expenses
|
|
|
138,564
|
|
|
|
94,951
|
|
|
|
|
$
|
869,382
|
|
|
$
|
916,312
|
|
Amounts
recognized in the consolidated balance sheets consist of:
|
|
December 31,
|
|
|
|
2008
|
|
2007
|
|
|
Deferred
tax asset:
|
|
|
|
|
|
Current
|
|
$
|
294,957
|
|
|
$
|
135,858
|
|
|
Long-term
|
|
|
574,425
|
|
|
|
780,454
|
|
|
|
|
$
|
869,382
|
|
|
$
|
916,312
|
|
Reconciliation
of the statutory federal income tax rate to the Company’s effective tax rate is
as follows:
|
|
|
Years ended
December
31,
|
|
|
|
2008
|
|
|
2007
|
|
|
Federal
statutory tax rate
|
|
|
34.0
|
%
|
|
34.0
|
%
|
|
State
income taxes, net of federal income tax benefit
|
|
|
4.2
|
|
|
4.2
|
|
|
Municipal
bond interest income
|
|
|
(7.7
|
)
|
|
(6.9
|
)
|
|
Other
permanent differences
|
|
|
(1.5
|
)
|
|
(1.8
|
)
|
|
Federal
tax credits
|
|
|
(4.6
|
)
|
|
|
|
|
Other
|
|
|
(2.4
|
)
|
|
.2
|
|
|
Effective
tax rate
|
|
|
22.0
|
%
|
|
29.7
|
%
|
FORTUNET,
INC.
NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS - Continued
As a
result of the adoption of FIN 48, as amended by FIN 48-1, at the beginning of
fiscal 2007, we reclassified $102,000 to income tax liability. This liability
for previously unrecognized tax benefits relates to state income taxes from
prior years. At the end of 2008, $102,000 was a recognized tax benefit as this
possible tax liability expired.
8. Research
and development:
Research
and development costs are primarily the uncapitalized costs of software and
hardware development and the costs of continued enhancements for the electronic
gaming systems that the Company leases to customers. Research and development
costs relating principally to the improvements in products generating revenues
are expensed as incurred. Hardware, tools and tooling that have an alternative
future use, such as for manufacturing, are capitalized. Hand tools used in
research and development, as well as special purpose fixtures are expensed when
incurred. Software development costs totaling $341,060 and $961,575 were
capitalized in 2008 and 2007, respectively in accordance with SFAS No. 86,
Accounting for the Costs of
Computer Software to be Sold, Leased or Otherwise Marketed.
In
accordance with SFAS No. 86, the Company determined at the beginning of the
fourth quarter of 2008 that Company’s mobile gaming platform became generally
available for distribution, at least to our current bingo customers, and
accordingly, started to amortize the previously capitalized software development
costs. The amortization amount for the year ended December 31, 2008 was
$105,337.
9. Retirement
plan:
The
Company sponsors a 401(k) plan in which employees may defer up to 15% of their
earnings. The Company may make contributions to the 401(k) at the discretion of
the board of directors. The Company has made no contributions to the plan so
far.
10. Litigation:
The
Company is currently involved in various legal claims and legal proceedings. In
management’s opinion, although these matters are not expected to have a
significant effect on our financial position or results of operations,
managements unable to estimate minimum losses, if any to be incurred and,
therefore, no provision has been made.
In 2007,
the Company received a one-time collection payment on a prior legal settlement
in the amount of $469,586 that was included in the other income category in the
consolidated statements of income.
11. Allowance
for doubtful accounts:
|
|
|
|
Balance
at
beginning
of
period
|
|
Additions
charged
to
expenses
|
|
Other
|
|
Write-offs,
net
of
collections
|
|
Balance
at end
of
period
|
|
|
Allowance
for doubtful accounts, deducted from accounts receivable, for the year
ended December 31:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
2007
|
|
$
|
34,366
|
|
|
--
|
|
|
--
|
|
|
--
|
|
$
|
34,366
|
|
|
|
2008
|
|
$
|
34,366
|
|
|
139,600
|
|
|
--
|
|
|
--
|
|
$
|
173,966
|
|
FORTUNET,
INC.
NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS - Continued
12. Share-Based
compensation:
On
October 21, 2005, the Company’s Board of Directors adopted two equity incentive
plans, the 2005 Stock Incentive Plan and the 2005 Stock Incentive Plan for
Independent Directors. The 2005 Stock Incentive Plan provides for the grant of
stock options, stock appreciation rights, restricted stock, phantom stock
rights, bonus stock and awards for employees or independent contractors.
Participation in the 2005 Stock Incentive Plan for Independent Directors is
limited to those individuals whom, on the date of issue of the award, are
non-employee directors, as defined in Rule 16b-3 under the Securities Act. A
total of 725,000 shares of common stock have been reserved for issuance under
the 2005 Stock Incentive Plan and 100,000 shares has been reserved for issuance
under the 2005 Stock Incentive Plan for Independent Directors.
The
exercise price for each incentive stock option granted under the 2005 Stock
Incentive Plan may not be less than 85% of the fair market value of the common
stock on the date of the grant. The plans will terminate ten years after the
date of its adoption, unless earlier terminated by the Board of Directors.
Options have been granted during 2006 of 76,000 shares and no options were
granted in 2007 and 2008. During 2008 and 2007, 6,000 and 11,000 options were
forfeited, respectively, leaving a balance of 44,000 share options to purchase
shares of our common stock under these plans at December 31, 2008. All options
granted in 2006 have a three year vesting period and a five year life. Option
costs that were expensed were $131,472 and $85,853 and option cost capitalized
$24,624 and $70,243 in 2008 and 2007, respectively.
On March
3, 2007, the Company issued 10,000 shares of restricted stock to its’
independent members of the board of directors, 2,000 of these shares were
forfeited by two members who were not re-elected to the Board of Directors. On
May 9, 2007, 2,667 shares were granted to a new board member, the 10,667 shares
were vested at December 31, 2007. On March 13, 2008, the Company issued 12,000
shares of restricted stock to its’ independent members of the board of
directors.
Compensation
cost for value related to restricted stock issued for the year ended December
31, 2008 and 2007, totaled $74,400 and $164,614 respectively. These expenses are
included in general and administrative expenses.
A summary
of the Company’s incentive stock option activity and related information for the
years ended December 31, 2007 and 2008 is shown in the following
table:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Weighted
Average
|
|
|
Aggregate
|
|
|
|
|
|
|
|
Shares
|
|
|
Exercise
Price
|
|
|
Intrinsic
Value
|
|
|
Grant
Date FV
|
|
|
Outstanding
January 1, 2007:
|
|
|
61,000
|
|
|
$
|
14.73
|
|
|
$
|
---
|
|
|
$
|
7.06
|
|
|
Vested
and exercisable
|
|
|
-
|
|
|
$
|
-
|
|
|
|
|
|
|
$
|
-
|
|
|
Non-vested
|
|
|
61,000
|
|
|
$
|
14.73
|
|
|
$
|
---
|
|
|
$
|
7.06
|
|
|
Forfeited
|
|
|
(11,000
|
)
|
|
$
|
14.62
|
|
|
|
|
|
|
$
|
6.98
|
|
|
Outstanding
December 31, 2007:
|
|
|
50,000
|
|
|
$
|
14.73
|
|
|
$
|
---
|
|
|
$
|
7.06
|
|
|
Vested
and exercisable
|
|
|
16,667
|
|
|
$
|
14.73
|
|
|
$
|
---
|
|
|
$
|
7.06
|
|
|
Non-vested
|
|
|
33,333
|
|
|
$
|
14.73
|
|
|
$
|
---
|
|
|
$
|
7.06
|
|
|
2008
Activity:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Forfeited
|
|
|
(6,000
|
)
|
|
$
|
14.62
|
|
|
$
|
----
|
|
|
$
|
6.98
|
|
|
Outstanding
December 31, 2008:
|
|
|
44,000
|
|
|
$
|
14.78
|
|
|
$
|
----
|
|
|
$
|
7.06
|
|
|
Vested
and exercisable
|
|
|
29,333
|
|
|
$
|
14.78
|
|
|
$
|
----
|
|
|
$
|
7.06
|
|
|
Non-vested
|
|
|
14,667
|
|
|
$
|
14.78
|
|
|
$
|
----
|
|
|
$
|
7.06
|
|
At
December 31, 2008, option exercise prices were $14.62 for 43,000 options and,
$21.56 for 1,000 options, and the weighted-average remaining contractual life
was 27 months.
As of
December 31, 2008, the total compensation cost related to nonvested stock-based
awards granted to employees under the Company’s stock option plans but not yet
recognized was $34,320. The cost will be amortized
FORTUNET,
INC.
NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS - Continued
on a
weighted average basis over the remaining vesting period of the stock options
which was 3 months at December 31, 2008.
The
aggregate intrinsic value represents the difference between the closing price of
our common stock on December 31, 2008, which was $1.71, and the exercised price,
multiplied by the number of stock options as of the same date. This represents
the amount that would have been gained or lost by the stock option holders if
they all had exercised their stock options on December 31, 2008. Since the stock
price was below the exercise price on December 31, 2008 and December 31, 2007,
it is anticipated that there will be no stock option exercises, and the
aggregate intrinsic value is zero at each respective date. In future periods,
this amount may change depending on fluctuations in our stock
price.
13. Quarterly
financial information (unaudited)
Summarized
unaudited quarterly financial information for the years 2008 and 2007 are noted
below:
|
|
|
Year
Ending December 31, 2008 (unaudited)
|
|
|
|
|
First
|
|
|
Second
|
|
|
Third
|
|
|
Fourth
|
|
|
|
|
Quarter
|
|
|
Quarter
|
|
|
Quarter
|
|
|
Quarter
|
|
|
Revenue
|
|
$
|
4,121,633
|
|
|
$
|
3,974,999
|
|
|
$
|
3,922,447
|
|
|
$
|
4,000,128
|
|
|
Gross
Profit
|
|
$
|
3,440,653
|
|
|
$
|
3,390,704
|
|
|
$
|
3,389,102
|
|
|
$
|
3,249,052
|
|
|
Income
(loss) from operations
|
|
$
|
954,423
|
|
|
$
|
754,500
|
|
|
$
|
662,048
|
|
|
$
|
399,515
|
|
|
Net
income (loss)
|
|
$
|
943,551
|
|
|
$
|
866,336
|
|
|
$
|
611,580
|
|
|
$
|
456,078
|
|
|
Net
income (loss) per share:
|
|
$
|
.08
|
|
|
$
|
.08
|
|
|
$
|
.05
|
|
|
$
|
.04
|
|
|
|
|
Year
Ending December 31, 2007 (unaudited)
|
|
|
|
|
First
|
|
|
Second
|
|
|
Third
|
|
|
Fourth
|
|
|
|
|
Quarter
|
|
|
Quarter
|
|
|
Quarter
|
|
|
Quarter
|
|
|
Revenue
|
|
$
|
4,332,668
|
|
|
$
|
4,163,890
|
|
|
$
|
4,273,737
|
|
|
$
|
3,718,270
|
|
|
Gross
Profit
|
|
$
|
3,785,132
|
|
|
$
|
3,532,418
|
|
|
$
|
3,686,346
|
|
|
$
|
3,028,112
|
|
|
Income
from operations
|
|
$
|
1,032,150
|
|
|
$
|
999,403
|
|
|
$
|
1,287,518
|
|
|
$
|
625,637
|
|
|
Net
income
|
|
$
|
1,271,522
|
|
|
$
|
929,663
|
|
|
$
|
1,132,920
|
|
|
$
|
613,439
|
|
|
Net
income per share:
|
|
$
|
.11
|
|
|
$
|
.08
|
|
|
$
|
.10
|
|
|
$
|
.06
|
|
ITEM
9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE
None.
ITEM
9A. CONTROLS AND PROCEDURES
Evaluation
of Disclosure Controls and Procedures
We are
required to maintain disclosure controls and procedures that are designed to
provide reasonable assurance that information required to be disclosed in our
reports under the Securities Exchange Act is recorded, processed, summarized and
reported within the time period specified in the Securities and Exchange
Commission’s rules and forms and that such information is accumulated and
communicated to our management, including our Chief Executive Officer and Chief
Financial Officer, as appropriate, to allow timely decisions regarding required
disclosure. Although throughout the entire year 2008, the offices of the Chief
Executive Officer and of the Chief Financial Officer were carried by two
separate persons, as of January 5, 2009 our Chief Executive Officer temporarily
carries the additional duties of acting Chief Financial Officer.
As
required by Rule 13a-15(b) promulgated under the Securities Exchange Act, our
management, with the participation of our Chief Executive Officer and Chief
Financial Officer, evaluated the design and operating
effectiveness
as of December 31, 2008 of our disclosure controls and procedures, as defined in
Rule 13a-15(e) promulgated under the Securities Exchange Act. Based on this
evaluation our Chief Executive Officer and Chief Financial Officer concluded
that our disclosure controls and procedures were not effective during at least a
portion of 2008, at the reasonable assurance level to enable the Company to
record, process, summarize and report information required under the Securities
and Exchange Commission’s rules in a timely fashion. Such conclusion resulted
from the identification of deficiencies that were determined to be significant
deficiencies. Specifically, we did not have appropriate internal controls in the
following area:
|
|
•
|
|
Lack of separation of duties
within the accounting department:
At the end of 2008, we have
reviewed our financial reporting and investment procedures and have
determined that even though we did fill a position of Controller with a
qualified person, we still need to achieve a higher level of separation of
duties within the accounting
department.
|
Notwithstanding
management’s assessment that our internal control over financial reporting was
ineffective during at least a portion of 2008 including the significant
deficiency described above, we believe that the financial statements included in
this Annual Report on Form 10-K correctly present in all material respects our
financial position, results of operations and cash flows for the periods covered
therein.
Changes in Internal Controls Over
Financial Reporting
There
have been no changes in our internal control over financial reporting that
occurred during 2008 that have materially affected, or are reasonably likely to
materially affect our internal controls over financial reporting.
ITEM
9B. OTHER INFORMATION
None.
PART
III
ITEM
10. DIRECTORS,
EXECUTIVE OFFICERS AND CORPORATE GOVERNANCE
Information
regarding our executive officers and directors required by this Item is
incorporated by reference to the section entitled “Proposal One — Election of
Directors” in the Company’s Definitive Proxy Statement in connection with the
2009 Annual Meeting of Stockholders (the “Proxy Statement”), which will be filed
with the Securities and Exchange Commission within 120 days after the fiscal
year ended December 31, 2008. Information required by Item 405 of Regulation S-K
is incorporated by reference to the section entitled “Section 16(a) Beneficial
Ownership Reporting Compliance” in the Proxy Statement. Information required by
10A-3(d) of the Exchange Act is incorporated by reference to the section
entitled “Board and Corporate Governance Matters” in the Proxy
Statement.
We have
adopted a Code of Ethics that applies to our directors, officers and employees,
including our principal executive officer, principal financial officer and
principal accounting officer. Our Code of Ethics is available in print to any
stockholder upon request. Requests for a copy of our Code of Ethics may be may
be made by contacting us at our corporate offices. We may revise these policies
from time to time. If we grant any waiver from a provision of the Code of Ethics
to our Chief Executive Officer or Chief Financial Officer, we will disclose the
nature of such amendment or waiver on a Current Report on Form 8-K will be filed
within 4 business days of the amendment or waiver.
We have
filed, as an exhibit to this Annual Report on Form 10-K, the certification
required by Section 302 of the Sarbanes-Oxley Act of 2002 and the rules
promulgated there under regarding the quality of our public
disclosure.
ITEM
11. EXECUTIVE
COMPENSATION
Information
required by this Item is incorporated by reference to the section entitled
“Executive Compensation” in the Proxy Statement.
|
ITEM
12.
|
SECURITY
OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND RELATED
STOCKHOLDER MATTERS
|
Information
regarding security ownership of certain beneficial owners and management is
incorporated by reference to the section entitled “Security Ownership of Certain
Beneficial Owners and Management” in the Proxy Statement.
EQUITY
COMPENSATION PLAN INFORMATION
The
following table sets forth certain information regarding compensation plans and
arrangements under which shares of the Company’s common stock may be issued,
including compensation plans that were approved by the Company’s stockholders as
well as compensation plans that were not approved by the Company’s stockholders.
Information in the table is as of December 31, 2008.
|
Plan
Category
|
|
Number
of
Securities
to be
Issued
upon Exercise
of
Outstanding
Options,
Warrants
and
Rights
(a)
|
|
Weighted-
average
Exercise
Price
of Outstanding
Options,
Warrants
and
Rights
|
|
Number of
Securities
Remaining
Available for
Future Issuance
under Equity
Compensation
Plans
(excluding
securities
reflected
in
column (a))
|
|
|
|
|
|
|
|
|
|
Equity
compensation plans approved by stockholders(1)
|
|
44,000
|
|
$14.78
|
|
691,721
|
|
Equity
compensation plans not approved by stockholders
|
|
—
|
|
—
|
|
—
|
|
Total
/ Weighted Ave. / Total
|
|
44,000
|
|
$14.78
|
|
691,721
|
|
(1)
Represents 51,000 shares of the Company’s common stock issuable upon
exercise of options outstanding under the Company’s 2005 Stock Incentive
Plan.
|
We have
established two equity compensation plans: our 2005 Stock Incentive Plan and our
2005 Stock Incentive Plan for Independent Directors. A total of 725,000
shares of our common stock has been reserved for issuance under the 2005 Stock
Incentive Plan and 100,000 shares have been reserved for issuance under the 2005
Stock Incentive Plan for Independent Directors. As of December 31, 2008, 61,112
shares of our common stock had been issued under our 2005 Stock Incentive Plan,
and 28,167 shares of our common stock had been issued under our 2005 Stock
Incentive Plan for Independent Directors.
|
ITEM
13.
|
CERTAIN
RELATIONSHIPS AND RELATED TRANSACTIONS, AND DIRECTOR
INDEPENDENCE
|
Information
required by this Item is incorporated by reference to the sections entitled
“Transactions with Related Persons” and “Director Independence” in the Proxy
Statement.
ITEM
14. PRINCIPAL
ACCOUNTANT FEES AND SERVICES
Information
required by this item is incorporated by reference to the sections entitled
“Audit and Non-Audit Fees” and “Audit Committee Pre-Approval of Audit and
Permissible Non-Audit Services of Independent Registered Public Accounting Firm”
in the Proxy Statement.
PART
IV
ITEM
15. EXHIBITS
AND FINANCIAL STATEMENT SCHEDULES
(a) The
following documents are filed as part of this Annual Report on Form
10-K:
|
|
1.
|
Financial
Statements
|
|
|
|
Report
of Schechter Dokken Kanter Andrews & Selcer Ltd., Independent
Registered Public Accounting Firm
|
|
|
|
Consolidated
Balance Sheets as of December 31, 2008 and 2007
|
|
|
|
Consolidated
Statements of Income and Comprehensive Income for the two years ended
December 31, 2008
|
|
|
|
Consolidated
Statement of Stockholder’s Equity (Deficiency) for the two years ended
December 31, 2008
|
|
|
|
Consolidated
Statements of Cash Flows for the two years ended December 31,
2008
|
|
|
|
Notes
to Consolidated Financial Statements
|
|
|
|
|
|
|
2.
|
Financial
Statement Schedules
|
|
|
|
|
|
|
|
All
schedules have been omitted as they are either not required or not
applicable or the required information is included in the consolidated
financial statements or notes thereto.
|
|
|
|
|
|
|
3.
|
See
Item 15(b)
|
|
|
|
|
(b) Exhibits:
|
Number
|
|
Description
|
|
|
|
|
|
|
3
|
.1
|
|
Amended
and Restated Articles of Incorporation of FortuNet, Inc.
(2)
|
|
3
|
.2
|
|
Amended
and Restated Bylaws of FortuNet, Inc.
(3)
|
|
4
|
.1
|
|
Form
of Certificate Representing Common Stock, $.001 Par Value Per Share, of
FortuNet, Inc.
(2)
|
|
*10
|
.1
|
|
Exempt
Employment Agreement between FortuNet, Inc. and Jack B. Coronel, dated as
of September 9, 2002
(1)
|
|
*10
|
.2
|
|
Amendment
No. 1 to Exempt Employment Agreement between FortuNet, Inc. and Jack
B. Coronel, dated as of September 9, 2002
(1)
|
|
*10
|
.3
|
|
Exempt
Employment Agreement between FortuNet, Inc. and William R.
Jacques, Jr., dated as of January 10, 2005
(1)
|
|
*10
|
.4
|
|
FortuNet,
Inc. 2005 Stock Incentive Plan
(2)
|
|
*10
|
.5
|
|
FortuNet,
Inc. 2005 Stock Option Plan for Independent Directors
(2)
|
|
10
|
.6
|
|
Standard
Industrial/ Commercial Multi-Tenant Lease between FortuNet, Inc. and FKC
Highland LLC, dated as of May 15, 2005
(1)
|
|
10
|
.7
|
|
Capital
Markets Consulting Agreement between FortuNet, Inc. and Spiegel Partners,
LLC, dated as of July 5, 2005
(1)
|
|
10
|
.8
|
|
Equipment
Lease Agreement between K&B Sales, Inc., d/b/a Goodtime Bingo, and
FortuNet, Inc., dated as of January 4, 1999
(1)
|
|
*10
|
.9
|
|
Form
of Stock Grant - FortuNet, Inc. 2005 Stock Incentive Plan
(4)
|
|
*10
|
.10
|
|
Form
of Stock Grant - FortuNet, Inc. 2005 Stock Incentive Plan for Independent
Directors
(4)
|
|
*10
|
.11
|
|
Letter
from FortuNet, Inc. to Merle Berman dated January 20, 2006 regarding
director compensation
(4)
|
|
*10
|
.12
|
|
Letter
from FortuNet, Inc. to Harlan W. Goodson dated January 20, 2006 regarding
director compensation
(4)
|
|
10
|
.13
|
|
Amendment
to Capital Markets Consulting Agreement Between FortuNet, Inc. and Spiegel
Partners, LLC dated as of January 30, 2006
|
|
*10
|
.14
|
|
Amendment
No.3 to Exempt Employment Agreement between FortuNet, Inc. and Jack B.
Coronel, dated as of April 1, 2007
(5)
|
|
*10
|
.15
|
|
Amendment
No. 1 to Exempt Employment Agreement between FortuNet, Inc. and William R.
Jacques, dated as of April 1, 2007
(5)
|
|
*10
|
.16
|
|
Exempt
Employment Agreement between FortuNet, Inc and Kevin A. Karo, dated as of
October 15, 2007
(6)
|
|
*10
|
.17
|
|
Amendment
No.1 to FortuNet, Inc. Exempt Employment Agreement, by and between
FortuNet, Inc. and Kevin A. Karo, dated as of December 3, 2007
(6)
|
|
21
|
.1
|
|
Subsidiaries
of FortuNet, Inc.
(1)
|
|
23
|
.1
|
|
Consent
of Schechter Dokken Kanter Andrews & Selcer Ltd.
|
|
24
|
.1
|
|
Powers
of Attorney (included on signature page hereto)
|
|
31
|
.1
|
|
Certification
of Yuri Itkis, Chairman of the Board of Directors, Chief Executive
Officer, and Chief Financial Officer of FortuNet, Inc. dated March 11,
2009 in accordance with Rules 13a-14(a) and 15d-14(a) of the
Securities Exchange Act, as amended, as adopted pursuant to
Section 302 of the Sarbanes-Oxley Act of 2002.
|
|
32
|
.1
|
|
Certification
of Yuri Itkis, Chairman of the Board of Directors, Chief Executive
Officer, and Chief Financial Officer of FortuNet, Inc. dated March 11,
2009 in accordance with 18 U.S.C. 1350, as adopted pursuant to
Section 906 of the Sarbanes-Oxley Act of 2002.
|
|
(1)
|
Incorporated
by reference to the Company’s Registration Statement filed on Form S-1
(File No. 333-128391) filed with the Commission on September 16,
2005.
|
|
(2)
|
Incorporated
by reference to Amendment No.1 of the Company’s Registration Statement
filed on Form S-1 (File No. 333-128391) filed with the Commission on
October 27, 2005.
|
|
(3)
|
Incorporated
by reference to Amendment No.3 of the Company’s Registration Statement
filed on Form S-1 (File No. 333-128391) filed with the Commission on
November 21, 2005.
|
|
(4)
|
Incorporated
by reference to Amendment No.5 of the Company’s Registration Statement
filed on Form S-1 (File No. 333-128391) filed with the Commission on
January 24, 2006.
|
|
(5)
|
Incorporated
by Reference to Form 8-K filed with the Commission on April 1,
2007.
|
|
(6)
|
Incorporated
by Reference to Form 8-K filed with the Commission on December 6,
2007.
|
*
Management contracts or compensatory plans or arrangements.
SIGNATURES
Pursuant
to the requirements of Section 13 or 15(d) of the Securities Exchange Act of
1934, as amended, the registrant has duly caused this report to be signed on its
behalf by the undersigned, thereunto duly authorized.
|
|
FortuNet,
Inc.
|
|
|
|
|
|
|
By
|
/s/
Yuri Itkis
|
|
|
|
Yuri
Itkis, Chief Executive Officer,
|
|
|
|
Chairman
of the Board and Chief Financial Officer
|
|
|
|
|
Date:
March 11, 2009
POWER
OF ATTORNEY
KNOW ALL
MEN BY THESE PRESENTS, that each person whose signature appears below
constitutes and appoints Yuri Itkis, and Boris Itkis, and each of them, his true
and lawful attorneys-in-fact and agents, with full power of substitution and
resubstitution fro him in his name, place and stead, in any and all capacities,
to sign any and all amendments to this Form 10-K Annual Report, and to file the
same, with all exhibits thereto, and other documents in connection therewith
with the Securities and Exchange Commission, granting onto such
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 and to all intent and purposes as he might or
could do in person hereby ratifying and confirming all that such
attorneys-in-fact and agents, or his substitute or substitutes, may lawfully do
or cause to be done by virtue hereof.
Pursuant
to the requirements of the Securities Exchange Act of 1934, this report has been
signed below by the following persons on behalf of the registrant and in the
capacities and on the dates indicated.
|
|
|
|
|
|
|
Signature
|
|
Title
|
|
Date
|
|
/s/
Yuri Itkis
|
|
Chief
Executive Officer and Chairman of the Board
|
|
March
11, 2009
|
|
Yuri
Itkis
|
|
|
|
|
|
/s/
Boris Itkis
|
|
Director,
Vice President of Engineering and Chief Technical Officer
|
|
March
11, 2009
|
|
Boris
Itkis
|
|
|
|
|
|
/s/
Merle Berman
|
|
Director
|
|
March
11, 2009
|
|
Merle
Berman
|
|
|
|
|
|
/s/
Harlan W. Goodson
|
|
Director
|
|
March
11, 2009
|
|
Harlan
W. Goodson
|
|
|
|
|
|
/s/
Darrel Johnson
|
|
Director
|
|
March
11, 2009
|
|
Darrel
Johnson
|
|
|
|
|