10-Q 1 f67225e10-q.txt FORM 10-Q FOR QUARTERLY PERIOD ENDED SEPT.30, 2000 1 UNITED STATES SECURITIES AND EXCHANGE COMMISSION Washington, D.C. 20549 FORM 10-Q [X] Quarterly report pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934 For the quarterly period ended September 30, 2000 ----------------------------------------------- [ ] Transition report pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934 For the transition period from to . ----------------- ------------------- Commission file number 0-22482 . ------------------------------------- INNOVATIVE GAMING CORPORATION OF AMERICA -------------------------------------------------------------------------------- (Exact Name of Registrant as Specified in Its Charter) Minnesota 41-1713864 (State or Other Jurisdiction of (I.R.S. Employer Identification No.) Incorporation or Organization)
4725 Aircenter Circle, Reno, Nevada 89502 -------------------------------------------------------------------------------- (Address of Principal Executive Offices) (775) 823-3000 -------------------------------------------------------------------------------- (Issuer's Telephone Number, Including Area Code) -------------------------------------------------------------------------------- (Former Address, If Changed Since Last Report) Check whether the issuer: (1) filed all reports required to be filed by Section 13 or 15(d) of the Exchange Act during the past 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes [X] No [ ] State the number of shares outstanding of each of the issuer's classes of common equity, as of the latest practicable date: At November 3, 2000 there were 11,028,488 shares of Common Stock, $0.01 par value, outstanding. Page 1 of 18 2 INNOVATIVE GAMING CORPORATION OF AMERICA Form 10-Q Index September 30, 2000 Part I: Financial Information Item 1. Financial Statements Consolidated Condensed Balance Sheets - September 30, 2000 (Unaudited) and December 31, 1999 3 Consolidated Condensed Statements of Operations - for the three and nine months ended September 30, 2000 and 1999 (Unaudited) 4 Consolidated Condensed Statements of Cash Flows - for the nine months ended September 30, 2000 and 1999 (Unaudited) 5 Notes to Consolidated Condensed Financial Statements 6 Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations 12 Part II: Other Information Item 1. Legal Proceedings 17 Item 6. Exhibits and Reports on Form 8-K 17 Signatures 18
Page 2 of 18 3 INNOVATIVE GAMING CORPORATION OF AMERICA AND SUBSIDIARY CONSOLIDATED CONDENSED BALANCE SHEETS (IN THOUSANDS, EXCEPT SHARE DATA) (UNAUDITED)
September 30, December 31, 2000 1999 ------------- ------------ ASSETS CURRENT ASSETS: Cash and cash equivalents $ 107 $ 140 Accounts receivable 537 759 Current portion of notes receivable 65 188 Inventories 4,082 4,576 Prepaid expenses and other 400 655 -------- -------- Total current assets 5,191 6,318 NOTES RECEIVABLE, LESS CURRENT PORTION 237 268 PROPERTY AND EQUIPMENT, NET 351 707 INTANGIBLE ASSETS, NET 668 765 -------- -------- TOTAL ASSETS $ 6,447 $ 8,058 ======== ======== LIABILITIES AND STOCKHOLDERS' EQUITY LIABILITIES: Accounts payable $ 601 $ 585 Accrued liabilities 310 561 Notes payable - current portion 240 592 Customer deposits 338 -- -------- -------- Total current liabilities 1,489 1,738 Notes payable - net of current portion 2,874 3,131 -------- -------- Total liabilities 4,363 4,869 -------- -------- COMMITMENTS AND CONTINGENCIES STOCKHOLDERS' EQUITY: Series B convertible preferred stock, $.01 par value, nonvoting, 4,000 shares authorized, 30 and 280 shares outstanding, respectively -- -- Series C convertible preferred stock, $.01 par value, nonvoting, 2,000 shares authorized, 900 shares outstanding -- -- Series D convertible preferred stock, $.01 par value, nonvoting, 3,000 shares authorized, 1,250 and 1,337.5 shares outstanding -- -- Common stock, $.01 par value, 100,000,000 shares authorized, 9,724,901 and 8,952,366 shares issued and outstanding, respectively 97 90 Additional paid-in capital 34,961 34,525 Accumulated deficit (32,974) (31,426) -------- -------- Total stockholders' equity 2,084 3,189 -------- -------- TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY $ 6,447 $ 8,058 ======== ========
See Notes to Consolidated Condensed Financial Statements. Page 3 of 18 4 INNOVATIVE GAMING CORPORATION OF AMERICA AND SUBSIDIARY CONSOLIDATED CONDENSED STATEMENTS OF OPERATIONS (IN THOUSANDS, EXCEPT PER SHARE DATA) (UNAUDITED)
Three Months Nine Months Ended September 30, Ended September 30, --------------------- --------------------- 2000 1999 2000 1999 ------- ------- ------- ------- SALES $ 2,162 $ 646 $ 5,933 $ 2,897 COST OF SALES 944 1,775 3,371 4,239 ------- ------- ------- ------- Gross profit (loss) 1,218 (1,129) 2,562 (1,342) SELLING, GENERAL AND ADMINISTRATIVE EXPENSE 962 1,732 3,363 4,935 ------- ------- ------- ------- Income (loss) from operations 256 (2,861) (801) (6,277) INTEREST EXPENSE, NET (76) (68) (241) (73) ------- ------- ------- ------- NET INCOME (LOSS) 180 (2,929) (1,042) (6,350) Preferred stock accretion adjustment -- 87 408 120 Preferred stock dividends 32 27 98 84 ------- ------- ------- ------- NET INCOME (LOSS) ATTRIBUTABLE TO COMMON SHAREHOLDERS $ 148 $(3,043) $(1,548) $(6,554) ======= ======= ======= ======= BASIC - INCOME (LOSS) PER SHARE OF COMMON STOCK $ 0.02 $ (0.42) $ (0.17) $ (0.91) ======= ======= ======= ======= WEIGHTED AVERAGE COMMON SHARES OUTSTANDING 9,565 7,187 9,320 7,221 ======= ======= ======= =======
See Notes to Consolidated Condensed Financial Statements. Page 4 of 18 5 INNOVATIVE GAMING CORPORATION OF AMERICA AND SUBSIDIARY CONSOLIDATED CONDENSED STATEMENTS OF CASH FLOWS (IN THOUSANDS) (UNAUDITED)
Nine Months Ended September 30, --------------------- 2000 1999 ------- ------- CASH FLOWS FROM OPERATING ACTIVITIES: Net loss ($1,042) ($6,350) Adjustments to reconcile net loss to cash flows from operating activities - Depreciation and amortization 494 853 Provision for inventory obsolescence (578) 1,169 Changes in operating assets and liabilities 1,639 1,566 ------- ------- CASH FLOWS PROVIDED BY (USED FOR) OPERATING ACTIVITIES 513 (2,762) ------- ------- CASH FLOWS FROM INVESTING ACTIVITIES: Inventory returned from (capitalized for use in) gaming operations 35 (626) Release of restricted investments -- 700 Purchases of property and equipment -- (76) Purchase of intangible assets (75) (150) ------- ------- Cash flows used in investing activities (40) (152) ------- ------- CASH FLOWS FROM FINANCING ACTIVITIES: Preferred stock dividends paid (66) (86) Proceeds from sale of common stock 33 35 Proceeds from sale of preferred stock -- 1,292 Payments to redeem preferred stock -- (1,100) Proceeds from long-term obligations -- 1,950 Payments on long-term obligations (473) (329) ------- ------- Cash flows used in financing activities (506) 1,762 ------- ------- DECREASE IN CASH AND CASH EQUIVALENTS (33) (1,152) CASH AND CASH EQUIVALENTS, BEGINNING OF PERIOD 140 1,617 ------- ------- CASH AND CASH EQUIVALENTS, END OF PERIOD $ 107 $ 465 ======= ======= SUPPLEMENTAL DISCLOSURE OF CASH FLOWS INFORMATION: Cash paid for interest $ 190 $ 132 ======= =======
See Notes to Consolidated Condensed Financial Statements. Page 5 of 18 6 INNOVATIVE GAMING CORPORATION OF AMERICA AND SUBSIDIARY NOTES TO CONSOLIDATED CONDENSED FINANCIAL STATEMENTS SEPTEMBER 30, 2000 (UNAUDITED) (1) BASIS OF FINANCIAL STATEMENT PRESENTATION The accompanying unaudited consolidated condensed financial statements have been prepared by the Company pursuant to the rules and regulations of the Securities and Exchange Commission. Certain information and footnote disclosures normally included in financial statements prepared in accordance with generally accepted accounting principles have been condensed or omitted pursuant to such rules and regulations. Although management believes that the disclosures are adequate to make the information presented not misleading, it is suggested that these interim consolidated condensed financial statements be read in conjunction with the Company's most recent audited consolidated financial statements and notes thereto included in the Company's Annual Report on Form 10-K for the year ended December 31, 1999. In the opinion of management, all adjustments (consisting only of normal recurring adjustments) necessary for a fair presentation of the financial position, results of operations and cash flows for the interim periods presented have been made. Operating results for the nine months ended September 30, 2000 are not necessarily indicative of the results that may be expected for the year ending December 31, 2000. Certain accounts in the prior year financial statements have been reclassified for comparative purposes to conform with the presentation in the current period interim financial statements. These reclassifications had no effect on previously reported net income or stockholders' equity. (2) COMMITMENTS AND CONTINGENCIES On September 19, 2000, the Company and nMortgage, Inc. agreed to terminate the Agreement and Plan of Merger dated December 31, 1999 between the two companies. In conjunction with the termination of the agreement with nMortgage, the Company entered into a Letter of Intent to acquire 14.9% of Xertain, Inc. in exchange for 14.9% of the Company's common stock, and to acquire the balance of Xertain, Inc. common stock following shareholder approval. On October 12, 2000, the Company and Xertain executed a definitive Agreement and Plan of Merger (the "Xertain Merger Agreement") and completed the initial closing of the transaction. In light of certain gaming and NASDAQ regulatory matters, the parties are negotiating an amendment to the Xertain Merger Agreement. As of September 30, 2000, the Company was in default on certain contractual agreements due to failure to make payment in accordance with the terms of such agreements. The obligations in default were i) interest payments of $52,000 to holders of certain convertible notes issued by the Company, ii) a note payment to Finova Capital Corporation of approximately $30,000 and iii) dividend payments to holders of the Company's Series C and D Convertible Preferred Stock in the amount of approximately $29,000. The manufacture, distribution and sale of the Company's products are regulated by various jurisdictions and entities, including requirements to obtain licenses and product approvals in several jurisdictions. The Company has obtained required licenses and product approvals in certain jurisdictions and is continuing efforts to obtain such approvals in other jurisdictions. Failure to successfully obtain and/or maintain such licenses and approvals, or meet other regulatory requirements could materially impact the future operation of the Company. Additionally, there is no assurance that the Company's products will be accepted in the marketplace upon obtaining regulatory approvals. (3) RELATED PARTY TRANSACTIONS In April 1999, in order to expedite the timing of gaming regulatory approval in certain jurisdictions, the Company entered into a Stock Redemption Agreement with Lakes Gaming, Inc. pursuant to which the Company redeemed 700,000 shares of Company Common Stock in exchange for a four-year convertible note (the "Lakes Note") and a warrant to purchase 87,500 shares of the Company's Common Stock. In February 2000, a group of investors including Wayne Mills and Henry Fong, Chairman and Chief Executive Officer of nMortgage, acquired the Lakes Note. The Lakes Note in the amount of $875,000 is unsecured, pays interest of 5% per annum and is convertible at $1.25 per share (the closing market price of the Company's Common Stock on the date of the issuance of the notes). The Lakes Note could not be converted until April 22, 2000. The exercise price of the warrants is $1.25 per share. The Page 6 of 18 7 INNOVATIVE GAMING CORPORATION OF AMERICA AND SUBSIDIARY NOTES TO CONSOLIDATED CONDENSED FINANCIAL STATEMENTS - CONTINUED SEPTEMBER 30, 2000 (UNAUDITED) Company also granted "piggyback" registration rights for shares of Common Stock issuable upon conversion of both the Lakes Note and the warrant. On June 1, 1999, the Company issued an aggregate of $1,550,000 in convertible notes to a group of investors including Wayne Mills. Edward G. Stevenson, then the Chairman, Chief Executive Officer and Chief Financial Officer of the Company, personally guaranteed the repayment of $250,000 of the convertibles notes. In exchange for such personal guarantee, the Company issued Mr. Stevenson two 3-year warrants, each to purchase 25,000 shares of the Company's common stock at $1.25 per share and $1.75 per share, respectively. The shares issuable upon exercise of the warrants were registered on Registration Statement on Form S-3 (Registration No. 333-84413) filed with the Securities and Exchange Commission on August 1, 1999, and amended by Amendment No. 1 to Form S-3 filed on September 23, 1999. On March 5, 1999, the Company and Wayne Mills ("Mills"), who was a director of the Company from July 22, 1999 until September 15, 1999, entered into a Stock Redemption Agreement pursuant to which the Company agreed to redeem 400,000 shares of the Company's Common Stock beneficially owned by Mills (the "Mills Redemption") in exchange for a convertible note (the "Mills Note") and a warrant to acquire 50,000 shares of Common Stock (the "Warrant"). Pursuant to the Mills Redemption, the Company issued the Mills Note with a principal amount of $437,500, convertible into Common Stock at $1.09375 per share, the closing sales price of the Company's Common Stock on the day immediately prior to the date of the consummation of the Mills Redemption. The Mills Note became convertible on March 5, 2000 and is unsecured. The Company may require conversion of all or a portion of the principal amount of the Mills Note after March 5, 2000. Principal and interest on the Mills Note, which is five percent (5%) per annum, is due March 5, 2004. The Warrant has a term of three years and an exercise price of $1.09375 per share, the closing sales price of the Company's Common Stock on the date of the consummation of the Mills Redemption. Neither the Mills Note may be converted nor the Warrant exercised if, immediately following such conversion or exercise, as the case may be, Mills would beneficially own in excess of 4.9% of the Company's outstanding Common Stock. Pursuant to "piggy-back" registration rights, the shares issuable upon exercise of the Warrant were registered on Registration Statement on Form S-3 (Registration No. 333-84413) filed with the Securities and Exchange Commission on August 1, 1999, and amended by Amendment No. 1 to Form S-3 filed on September 23, 1999. Xertain, Inc. ("Xertain") whose primary business is gaming related technologies, gaming facility development and management, and international high technology manufacturing, also represents the Company as a distributor in certain gaming jurisdictions. The Company and Xertain previously entered into an agreement whereby Xertain would purchase substantially all of the Company's gaming assets (See Note 9 - Gaming Asset Divestiture Agreement). On September 19, 2000, the Company entered into a letter of intent with Xertain in order to acquire the stock of and thereby effectuate a merger with Xertain. Also on September 19, 2000, Roland A. Thomas, Chairman and Chief Executive Officer of Xertain was named Chairman and Chief Executive Officer of the Company. On Page 7 of 18 8 INNOVATIVE GAMING CORPORATION OF AMERICA AND SUBSIDIARY NOTES TO CONSOLIDATED CONDENSED FINANCIAL STATEMENTS - CONTINUED SEPTEMBER 30, 2000 (UNAUDITED) October 12, 2000, the Company and Xertain entered into an Agreement and Plan of Merger and completed the initial closing of the merger through a mutual exchange of common stock (See note 10 - Subsequent Event - Agreement for Merger with Xertain, Inc.). The Company made sales totaling $573,000 to Xertain during the three and nine month periods ended September 30, 2000. As of September 30, 2000, the Company had accounts receivable from Xertain of $192,000 and held customer deposits from Xertain of approximately $319,000. (4) INCOME TAXES The Company has adopted Statement of Financial Accounting Standards No. 109- "Accounting for Income Taxes" - (SFAS No. 109) under which deferred income tax assets and liabilities are recognized for differences between financial and income tax reporting basis of assets and liabilities based on currently enacted rates and laws. The Company had cumulative federal net operating loss carry forwards of approximately $23,105,000 as of December 31, 1999. These losses, if not used, begin to expire in 2009 through 2014. Future changes in the ownership of the Company may place limitations on the use of these net operating loss carry forwards. (5) EARNINGS PER SHARE The Company has adopted Statement of Financial Accounting Standards No. 128 "Earnings Per Share"-(SFAS No. 128). The earnings per share data for the periods presented is based on weighted average common shares outstanding, which is equivalent to "basic" earnings per share as calculated under SFAS No. 128. Diluted earnings per share is not presented because the resulting earnings per share would be antidilutive for each period reported. (6) PREFERRED STOCK PRIVATE PLACEMENTS On May 13, 1998, the Company issued 3,000 shares of Series B Convertible Preferred Stock (the "Series B Preferred Stock") at a price of $1,000 per share in a private placement for total proceeds of $3,000,000 prior to any offering expenses. As of September 30, 2000, shares representing $1,870,000 of Series B Preferred Stock had been converted into Common Stock, and the remaining outstanding balance of $30,000 of Series B Preferred Stock is convertible into Common Stock, at the election of the holder thereof. All outstanding shares of Series B Preferred Stock will automatically be converted into Common Stock on June 1, 2001. On June 1, 1999, as part of a financial restructuring, the Company issued 1,400 shares of Series C Convertible Preferred Stock (the "Series C Preferred Stock") at a price of $1,000 per share in a private placement for total proceeds of $1,400,000 prior to any offering expenses. Each share of Series C Preferred Stock is convertible into shares of the Company's Common Stock at a conversion price of 91% of the three consecutive day average of the lowest closing bid price of the Company's Common Stock over the twenty-day trading period ending the day prior to conversion (the "Series C Conversion Price"). The Series C Conversion Price may not exceed $1.877. As of September 30, 2000, shares representing $500,000 of Series C Preferred Stock had been converted into Common Stock, and all of the remaining outstanding balance of $900,000 of Series C Preferred Stock is convertible into Common Stock, at the election of the holder thereof. The maximum number of shares of Common Stock that may be issued upon conversion is 1,331,500. Page 8 of 18 9 INNOVATIVE GAMING CORPORATION OF AMERICA AND SUBSIDIARY NOTES TO CONSOLIDATED CONDENSED FINANCIAL STATEMENTS - CONTINUED SEPTEMBER 30, 2000 (UNAUDITED) All outstanding shares of Series C Preferred Stock will automatically be converted into Common Stock on June 1, 2001. The 9% beneficial conversion feature was accounted for as an additional Preferred Stock dividend, which was determined on the date the Series C Preferred Stock was issued. The total value of the beneficial conversion feature or dividend is $138,462, which reduces income available for holders of the Company's Common Stock and therefore reduces earnings per share on a pro rata basis over the period from issuance of the Series C Preferred Stock to the earliest conversion date. Income available to holders of Common Stock was reduced by approximately $32,885, $87,115 and $18,462 during the second, third and fourth quarters of 1999, respectively. During October 1999, the Company issued a total of 2,450 shares of Series D Convertible Preferred Stock (the "Series D Preferred Stock") at a price of $1,000 per share in a private placement for total proceeds of $2,450,000, prior to any offering expenses, and warrants (the "Warrants") to acquire 245,000 shares of the Company's Common Stock at $2.75 per share. Each share of Series D Preferred Stock is convertible into shares of the Company's Common Stock at a conversion price of the lesser of $3.00 or 75% of the average of closing bid price of the Company's Common Stock for the five consecutive days immediately preceding the conversion date. As of September 30, 2000, shares representing $1,200,000 of Series D Preferred Stock had been converted into Common Stock, and all of the remaining outstanding balance of $1,250,000 of Series D Preferred Stock is convertible into Common Stock, at the election of the holder thereof. The 25% beneficial conversion feature was accounted for as an additional Preferred Stock dividend, which was determined on the date the Series D Preferred Stock was issued. The total value of the beneficial conversion feature or dividend is $816,000, which reduces income available for holders of the Company's Common Stock and therefore reduces earnings per share on a pro rata basis over the period from issuance of the Series D Preferred Stock to the earliest conversion date. Income available to holders of Common Stock was reduced by approximately $408,000 in the fourth quarter of 1999 and approximately $408,000 in the first quarter of 2000. All outstanding shares of Series D Preferred Stock will automatically be converted into Common Stock on the fifth anniversary of its issuance. A holder of Series B, C or D Preferred Stock may not convert such stock into Common Stock if, following such conversion, the holder beneficially owns in excess of 4.9% of the Company's Common Stock. The Registration Rights Agreements relating to the Company's October 1999 issuance of the Company's Series D Convertible Preferred Stock require the Company to register the shares of Common Stock issuable upon conversion of such preferred shares within 180 days or by April 13, 2000 or pay certain liquidated damages. These provisions include 2% of the gross proceeds of the Series D Convertible Preferred Stock sold (i.e. $49,000) if such Common Stock is not registered by April 13, 2000 and 3.5% per month (i.e. $85,750) for each month thereafter that such Page 9 of 18 10 INNOVATIVE GAMING CORPORATION OF AMERICA AND SUBSIDIARY NOTES TO CONSOLIDATED CONDENSED FINANCIAL STATEMENTS - CONTINUED SEPTEMBER 30, 2000 (UNAUDITED) Common Stock is not registered. A registration statement relating to such Common Stock was filed with the Securities and Exchange Commission on January 13, 2000. As of September 30, 2000, the registration statement relating to such Common Stock had not yet been declared effective. A majority of the Company's holders of Series D Convertible Preferred Stock have agreed to amend the Registration Rights Agreement relating to such shares to provide that the Company can issue additional shares of Common Stock, at its option, in lieu of any cash payment in the event such Common Stock is not registered by April 13, 2000, and for each month thereafter. (7) FINANCIAL RESTRUCTURING On June 1, 1999, the Company completed a financial restructuring in which the Company received an aggregate $1,742,000 in net proceeds from a private placement of convertible notes and warrants, and Series C Convertible Preferred Stock. The three-year convertible secured notes totaling $1,550,000 were issued to a group of investors June 1, 1999. Interest on such notes is paid quarterly at a rate of 12% per annum, and the principal balance is due June 1, 2002. At any time after June 1, 2000, and until the principal balance is paid in full, the holders of the notes may convert the notes into Common Stock of the Company at a conversion price of $1.50 per share. The note holders may not convert the notes into Common Stock if such conversion would result in beneficial ownership by such note holder of more than 4.9% of the Company's issued and outstanding Common Stock. These notes are secured by the furniture, fixtures and equipment, inventory and intangible property of the Company. The note holders were also granted an aggregate of 282,500 warrants to purchase shares of the Company's Common Stock at an exercise price of $1.25 per share. In October 2000, holders of $1,300,000 of the convertible notes elected to convert the notes to shares of the Company's Series E Convertible Preferred Stock (See Note 10 - Subsequent Events - Private Placement of Series E Convertible Preferred Stock). As a part of this restructuring, the Company issued 1,400 shares of Series C Convertible Preferred Stock at a price of $1,000 per share in a private placement for total proceeds of $1,400,000 prior to any offering expenses (See Note 6 - "Preferred Stock Private Placement"). Additionally, the holders of the Series B Convertible Preferred Stock agreed to amend the conversion terms the Series B Convertible Preferred Stock, changing the automatic conversion date from November 13, 1999, to June 1, 2001 in exchange for a warrant to acquire 350,000 shares of Common Stock of the Company at $1.50 per share. The amendments also provide that if the holders of the Series B Convertible Preferred Stock are unable to convert such preferred stock to Common Stock of the Company because the maximum number of shares of Common Stock have been issued as allowed under terms of the Series B Convertible Preferred Stock, the Company may redeem the Series B Convertible Preferred Stock at 115% of the liquidation value of such shares or, at the option of the Company, issue Series C Convertible Preferred Stock in an amount equal to the number of Series B Convertible Preferred Stock which cannot be converted into the Company's Common Stock. (8) AGREEMENT FOR MERGER WITH NMORTGAGE On December 31, 1999, the Company, Equitex, Inc. and nMortgage, Inc. executed a definitive merger agreement governing the Merger. In September 2000, the Company and nMortgage agreed to terminate their merger agreement (See Note 2 - Commitments and Contingencies). Page 10 of 18 11 INNOVATIVE GAMING CORPORATION OF AMERICA AND SUBSIDIARY NOTES TO CONSOLIDATED CONDENSED FINANCIAL STATEMENTS - CONTINUED SEPTEMBER 30, 2000 (UNAUDITED) (9) GAMING ASSET DIVESTITURE AGREEMENT On February 1, 2000, the Company entered into a definitive asset purchase agreement with Xertain, Inc. ("Xertain"), pursuant to which Xertain will purchase substantially all of the Company's gaming assets. In September 2000, the Company and nMortgage agreed to terminate their merger agreement. In conjunction with the termination of the merger with nMortgage, the Company and Xertain terminated their asset purchase agreement and entered into a letter of intent whereby the Company would acquire the outstanding capital stock of and thereby effectuate a merger with Xertain (See Note 10 - Subsequent Events - Plan of Merger with Xertain, Inc.) (10) SUBSEQUENT EVENTS: PLAN OF MERGER WITH XERTAIN, INC. On September 19, 2000, the Company entered into a letter of intent with Xertain, Inc. ("Xertain"), pursuant to which the Company would effectuate a merger with Xertain. On October 12, 2000, the Company entered into an Agreement and Plan of Merger by and among Xertain, Inc., Innovative Gaming Corporation of America and IGCA Acquisition Corporation (the "Xertain Merger Agreement"). Pursuant to the Xertain Merger Agreement, Xertain will be merged into IGCA Acquisition Corporation, a Minnesota corporation and wholly-owned subsidiary of the Company. Concurrent with the signing of the Xertain Merger Agreement, the Company and Xertain completed an initial closing by the issuance and mutual purchase of 14.9% of the respective companies' common stock. The parties intend that the merger qualify as a tax-free exchange of stock and reorganization within the meaning of Section 368(a) of the Internal Revenue Code of 1986, as amended. In light of certain gaming and NASDAQ regulatory matters, the parties are negotiating an amendment to the Xertain Merger Agreement. The final closing of the Merger is anticipated to occur in early 2001, subject to shareholder, regulatory and various governmental agencies' approval. PRIVATE PLACEMENT OF SERIES E CONVERTIBLE PREFERRED STOCK During October 2000, the Company received cash proceeds of $1,000,000 in connection with a private placement of Series E Convertible Preferred Stock (the "Series E Preferred Stock") at a price of $10 per share in a private placement. Also during October 2000, holders of approximately $1.86 million of convertible notes issued by the Company agreed to convert the principal amount of their notes into Series E Preferred Stock subject to final documentation. An annual dividend of 6% shall be paid quarterly in arrears either in Common Stock of the Company or cash at the Company's discretion. Each share of Series E Preferred Stock is convertible into shares of the Company's Common Stock at a conversion price of the lesser of $1.25 or 75% of the average of closing bid price of the Company's Common Stock for the five consecutive days immediately preceding the conversion date. The Company has the right to redeem the Series E Preferred Stock at 135% of par in cash if the market price is lower than the market price on the date the Series E Preferred Stock was issued. A Registration Statement related to the Common Stock to be issued must be filed by, and at the expense of, the Company pursuant to obligations contained in Registration Rights Agreements. The total value of the beneficial conversion feature reduces income available for holders of the Company's Common Stock and therefore reduces earnings per share on a pro rata basis over the period from issuance of the Series E Preferred Stock to the earliest conversion date. All outstanding shares of Series E Preferred Stock will automatically be converted into Common Stock on the fifth anniversary of its issuance. As of November 13, 2000, the Company is continuing its offering of Series E Convertible Preferred Stock. Page 11 of 18 12 ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS OVERVIEW On September 19, 2000, the Company's Board of Directors entered into a letter of intent with Xertain, whereby the Company would acquire the outstanding capital stock of and thereby effectuate a merger with Xertain. Also on September 19, 2000, Roland A. Thomas, Chairman and Chief Executive Officer of Xertain was named Chairman and Chief Executive Officer of the Company. On October 12, 2000, the Company entered into an Agreement and Plan of Merger By and Among Xertain, Innovative Gaming Corporation of America and IGCA Acquisition Corporation (the "Xertain Merger Agreement"). Pursuant to the Xertain Merger Agreement, Xertain will be merged into IGCA Acquisition Corporation, a Minnesota corporation and wholly-owned subsidiary of the Company. Concurrent with the execution of the Xertain Merger Agreement, the Company and Xertain completed an initial closing by the issuance and mutual purchase of 14.9% of the respective companies' common stock. The parties intend that the Merger qualify as a tax-free exchange of stock. In light of certain gaming and NASDAQ regulatory matters, the parties are negotiating an amendment to the Xertain Merger Agreement. The Company manufactures, markets and distributes BJ Blitz TM, Hot Shot Dice TM, Lightning Strike Roulette TM, Supersuits Progressive Blackjack TM, Bonus Streak TM and single player video slot machines to certain gaming markets worldwide. Since inception in 1991, the Company has focused most of its resources on the development of games, the regulatory approval process and the sale and installation of its games. The Company has begun to expand and diversify its product line by developing and marketing single player games such as Bonus Streak and single player video slot machines incorporating state of the art graphics and sound. The Company distributes its products both directly to the gaming marketplace and through licensed agents and distributors. The Company is currently licensed and/or has the necessary regulatory approvals as a gaming product manufacturer and distributor in Nevada, Colorado, Mississippi, Louisiana, North Carolina, Minnesota, Iowa, Arizona, South Dakota, certain New Mexico tribal jurisdictions, Quebec and the Atlantic Lottery (four Canadian Maritime provinces). In certain jurisdictions where the Company is licensed, such as Colorado, the Company may elect to market its products through a licensed distributor pursuant to any necessary regulatory approvals. In certain jurisdictions where licensure is not required, such as Australia, the Company may use an existing licensed distributor to sell its products pursuant to any necessary regulatory transaction approvals. Previously registered in Alberta, Manitoba, Saskatchewan, Quebec and the Atlantic Lottery Corporation, the Company has applications pending in British Columbia, Ontario and Nova Scotia. The Company has agents to market its products in Canada and Europe. Page 12 of 18 13 ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS - CONTINUED RESULTS OF OPERATIONS FOR THE THREE AND NINE MONTHS ENDED SEPTEMBER 30, 2000 COMPARED TO SEPTEMBER 30, 1999 For the three months ended September 30, 2000, the Company recorded income attributable to Common Stock shareholders of $148,000, or $.02 per share, compared to a loss of $3,043,000, or $.42 per share, for the three months ended September 30, 1999. For the nine months ended September 30, 2000, the Company recorded a loss attributable to Common Stock shareholders of $1,548,000, or $.17 per share, compared to a loss of $6,554,000, or $.91 per share, for the nine months ended September 30, 1999. The income or loss attributable to common shareholders for each period included adjustments for preferred stock accretion and preferred stock dividends. The favorable change in operating results for the fiscal 2000 periods was primarily attributable to a partial recovery of reserves recorded in the fourth quarter of 1999 due to the planned merger with nMortgage and the related sale of the Company's gaming assets to Xertain, Inc. versus increases in inventory reserves in the fiscal 1999 periods. Increased revenues in the fiscal 2000 periods also contributed to the favorable change in operating results. The operating losses in the fiscal 1999 periods were also unfavorably impacted by low sales volume and higher expenses incurred related to the Company's efforts to develop/enhance and license its products and introduce those products into new markets. SALES, COST OF SALES AND GROSS PROFIT Total sales for the quarter ended September 30, 2000, were $2,162,000 compared to $646,000 recorded in the quarter ended September 30, 1999. This increase in revenues was due to an increase in games sales. Single player game sales increased from 30 in the 1999 period to 87 in the 2000 period. Sales of multi-player games totaled 1 in 1999 to 20 in 2000. Total sales for the nine months ended September 30, 2000, were $5,933,000 compared to $2,897,000 in the nine months ended September 30, 1999. Multi-player game sales increased from 31 in the 1999 period to 59 in the 2000 period and single player game sales increased from 69 in 1999 to 210 in 2000. The table below presents the comparative sales revenue and percentage of revenue derived from each of the Company's product lines for the three and nine-month periods ended September 30, 2000 and 1999:
Three months ended Three months ended Nine months ended Nine months ended September 30, 2000 September 30, 1999 September 30, 2000 September 30, 1999 Sales revenue $2,162,000 $646,000 $5,933,000 $2,897,000 Product line: Percentage of revenue: Percentage of revenue: Percentage of revenue: Percentage of revenue: ---------------------- ---------------------- ---------------------- ---------------------- Multi-player games 60% 9% 61% 51% Single player games 32% 35% 30% 21% Parts sales and other 6% 34% 5% 19% Lease participation 2% 22% 4% 9% Total 100% 100% 100% 100%
Overall Company revenues will continue to be volatile due to, among other things, the ability of the Company to continue financing its operations, fluctuations in demand for the Company's current products, market acceptance of new products introduced by the Company and the Company's ability to obtain licensing and successfully market its products in new jurisdictions. The Company recorded gross margins of 56.3% and 43.2% for the three-month and nine-month periods ended September 30, 2000, respectively, compared to a negative gross margin for the three-month and nine-month periods ended September 30, 1999. The gross margins for the fiscal 2000 periods were favorably affected by a $578,000 reduction in inventory reserves that were recorded in the fourth quarter of 1999 due to the planned merger with nMortgage and the related sale of the Company's gaming assets to Xertain. The agreements for the nMortgage merger and the gaming assets sale were terminated in September 2000. Without the reduction in inventory reserves the gross margins were 29.6% and 33.4% for the three-month and nine-month periods ended September 30, 2000, respectively. In the third quarter of 1999, the Company recorded provisions for inventory obsolescence of approximately $960,000. The negative gross margin in 1999 periods was primarily due to the provisions for inventory obsolescence and unabsorbed labor and overhead costs attributable to low production volume in the first nine months of 1999. Page 13 of 18 14 ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS - CONTINUED RESULTS OF OPERATIONS FOR THE THREE AND NINE MONTHS ENDED SEPTEMBER 30, 2000 COMPARED TO SEPTEMBER 30, 1999 - CONTINUED SELLING, GENERAL AND ADMINISTRATIVE EXPENSES Selling, general and administrative expense for the three months ended September 30, 2000 was $962,000 compared to $1,732,000 for the three months ended September 30, 1999. Selling, general and administrative expense for the nine months ended September 30, 2000 was $3,363,000 compared to $4,935 ,000 for the nine months ended September 30, 1999. In the three months ended September 30, 2000, the Company recorded a recovery of $165,000 in reserves resulting in a decrease in selling, general and administrative expenses. The reserves were recorded in the fourth quarter of 1999 due to the planned merger with nMortgage and the related sale of the Company's gaming assets to Xertain, Inc. This recovery of reserves represents an adjustment of costs for the first nine months of 2000 to recognize those costs based on the carrying value of the Company's assets after the fourth quarter 1999 write-down. Expenses during the 1999 periods included investment in engineering and development costs for new product development and costs associated with applications for licensing in various jurisdictions. These expenses declined in the fiscal 2000 periods as the Company reduced product development efforts and took other measures to reduce expenses in anticipation of the Merger with nMortgage and the sale of gaming manufacturing equipment to Xertain. INTEREST EXPENSE In the quarter ended September 30, 2000, net interest expense was $76,000 compared to $68,000 in the quarter ended September 30, 1999. For the nine months ended September 30, 2000, net interest expense was $241,000 compared to $73,000 in the nine months ended September 30, 1999. These increases in net interest expense were due to a decrease in investments in interest bearing accounts and additional interest expense incurred on increased debt. PREFERRED STOCK ACCRETION ADJUSTMENT During October 1999, the Company issued 2,450 shares of Series D Convertible Preferred Stock (the "Series D Preferred Stock") at a price of $1,000 per share in a private placement. The Series D Preferred Stock is convertible into shares of the Company's Common Stock at a conversion price of the lesser of $3.00 or 75% of the average of closing bid price of the Company's Common Stock for the five consecutive days immediately preceding the conversion date. The intrinsic value of the beneficial conversion feature was $816,721, which was accreted to Series D Preferred Stock and charged against net income or loss to arrive at net income or loss attributable to common shareholders over the period in which the right to convert the Preferred Stock becomes vested. The $816,721 value of the beneficial conversion feature was recognized during the fourth quarter of 1999 and the first quarter of 2000. ACCUMULATED DEFICIT The Company had an accumulated deficit of $32,974,000 as of September 30, 2000. Due to weaker than expected demand for the Company's current products, the Company's short-term capital requirements, the high degree of regulation and other factors of the business environment in which the Company operates, the likelihood of future profitable quarters cannot be predicted. Future short-term results are highly dependent on the Company's ability to, among other things, finance production and distribution new products, gain customer acceptance of its existing and new products and the necessary Company licenses and/or product approvals in various jurisdictions in order to expand its market base. There can also be no assurance as to the time frame during which such anticipated approvals may occur due to uncertain time periods involved in the regulatory approval process. Page 14 of 18 15 ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS - CONTINUED LIQUIDITY AND CAPITAL RESOURCES PREFERRED STOCK ISSUES On May 13, 1998, the Company issued $3,000,000 of Series B Convertible Preferred Stock (the "Series B Preferred Stock"). As of September 30, 2000, Series B Preferred Stock totaling $1,870,000 had been converted into Common Stock of the Company and the Company had redeemed $1,100,000 of the Series B Preferred Stock. The remaining $30,000 of Series B Convertible Preferred Stock is convertible into Common Stock of the Company at the election of the holder thereof. On June 1, 1999, the Company issued $1,400,000 of Series C Convertible Preferred Stock (the "Series C Preferred Stock"). As of September 30, 2000, Series C Preferred Stock totaling $500,000 had been converted into Common Stock of the Company and the remaining $900,000 of Series C Convertible Preferred Stock is convertible into Common Stock of the Company at the election of the holder thereof. During October 1999, the Company issued $2,450,000 of Series D Convertible Preferred Stock (the "Series D Preferred Stock"), and warrants (the "Warrants") to acquire 245,000 shares of the Company's Common Stock at $2.75 per share. As of September 30, 2000, shares representing $1,200,000 of Series D Preferred Stock had been converted into Common Stock, and all of the remaining outstanding balance of $1,250,000 of Series D Preferred Stock is convertible into Common Stock, at the election of the holder thereof. During October 2000, the Company received $1,000,000 in connection with a private placement of Series E Convertible Preferred Stock (the "Series E Preferred Stock"), and warrants (the "Warrants") to acquire shares of the Company's Common Stock. Also during October 2000, holders of approximately $1.86 million of convertible notes issued by the Company agreed to convert the principal amount of their notes into Series E Preferred Stock subject to final documentation. An annual dividend of 6% shall be paid quarterly in arrears either in Common Stock of the Company or cash at the Company's discretion. Each share of Series E Preferred Stock is convertible into shares of the Company's Common Stock at a conversion price of the lesser of $1.25 or 75% of the average of closing bid price of the Company's Common Stock for the five consecutive days immediately preceding the conversion date. The Company has the right to redeem the Series E Preferred Stock at 135% of par in cash if the market price is lower than the market price on the date the Series E Preferred Stock was issued. A Registration Statement related to the Common Stock to be issued must be filed by, and at the expense of, the Company pursuant to obligations contained in Registration Rights Agreements. The total value of the beneficial conversion feature reduces income available for holders of the Company's Common Stock and therefore reduces earnings per share on a pro rata basis over the period from issuance of the Series E Preferred Stock to the earliest conversion date. All outstanding shares of Series E Preferred Stock will automatically be converted into Common Stock on the fifth anniversary of its issuance. As of November 13, 2000, the Company is continuing its offering of Series E Convertible Preferred Stock. LIQUIDITY The Company had $107,000 and $140,000 in cash as of September 30, 2000 and December 31, 1999, respectively. The Company has experienced negative cash flow from operations of $5.1 million, $2.1 million and $7.5 million for the years ended December 31, 1999, 1998, and 1997, respectively. Given the relatively large fluctuations in the frequency and size of the Company's sales, the Company continues to experience significant fluctuations in its cash position. The Company presently estimates that if current sales forecasts are met its cash, anticipated funds from operations and the proceeds from issuance of the Series E Convertible Preferred Stock will be adequate to fund cash Page 15 of 18 16 ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS - CONTINUED LIQUIDITY AND CAPITAL RESOURCES-CONTINUED requirements for the foreseeable future. There can be no assurance that the Company will be successful in achieving its current sales forecast and receivables collections. If current sales forecasts are not met, the Company may require additional financing in order to continue its operations. There can be no assurance that the Company would be successful in obtaining additional financing on terms acceptable to the Company. As of September 30, 2000, the Company was in default on certain contractual agreements due to failure to make payment in accordance with the terms of such agreements. The obligations in default were i) interest payments of $52,000 to holders of certain convertible notes issued by the Company, ii) a note payment to Finova Capital Corporation of approximately $30,000 and iii) dividend payments to holders of the Company's Series C and D Convertible Preferred Stock in the amount of approximately $29,000. The Registration Rights Agreements relating to the Company's October 1999 issuance of the Company's Series D Convertible Preferred Stock require the Company to register the shares of Common Stock issuable upon conversion of such preferred shares within 180 days or by April 13, 2000 or pay certain liquidated damages. These provisions include 2% of the gross proceeds of the Series D Convertible Preferred Stock sold (i.e. $49,000) if such Common Stock is not registered by April 13, 2000 and 3.5% per month (i.e. $85,750) for each month thereafter that such Common Stock is not registered. A registration statement relating to such Common Stock was filed with the Securities and Exchange Commission on January 13, 2000. As of September 30, 2000, the registration statement relating to such Common Stock had not yet been declared effective. A majority of the Company's holders of Series D Convertible Preferred Stock have agreed to amend the Registration Rights Agreement relating to such shares to provide that the Company can issue additional shares of Common Stock, at its option, in lieu of any cash payment in the event such Common Stock is not registered by April 13, 2000, and for each month thereafter. PRIVATE SECURITIES LITIGATION REFORM ACT OF 1995 The foregoing Management's Discussion and Analysis contains various "forward-looking statements" within the meaning of Section 27A of the Securities Act of 1933, as amended, and Sections 21E of the Securities Exchange Act of 1934, as amended, which represent the Company's expectations or beliefs concerning future events, including statements regarding the demand for the Company's products in certain key jurisdictions such as Nevada and Australia. In addition, statements containing expressions such as "believes," "anticipates," "hopeful" or "expects" used in the Company's periodic reports on Forms 10-K and 10-Q filed with the SEC are intended to identify forward looking statements. The Company cautions that these and similar statements included in this report and in previously filed periodic reports including reports filed on Forms 10-K and 10-Q are further qualified by important factors that could cause actual results to differ materially from those in the forward-looking statement, including, without limitation, the following: ability to obtain additional financing through leasing, equity or other arrangements; the ability to achieve current sales forecasts, the inability to successfully develop, license, manufacture and market new products in a timely manner; decline in demand for gaming products or reduction in the growth rate of new markets; increased competition; the effect of economic conditions; a decline in the market acceptability of gaming; political and economic instability in developing international markets; a decrease in the desire of established casinos to upgrade machines in response to added competition from newly constructed casinos; the loss of a distributor; loss or retirement of key executives; approval of pending patent applications or infringement upon existing patents; the effect of regulatory and governmental actions; unfavorable determination of suitability by regulatory authorities with respect to officers, directors or key employees; the limitation, conditioning or suspension of any gaming license; adverse results of significant litigation matters; fluctuation in exchange rates, tariffs and other barriers. Investors are referred to the full discussion of risks and uncertainties associated with forward-looking statements contained in the Company's report on Form 10-K filed with the Securities and Exchange Commission for the fiscal year ended December 31, 1999. Many of the foregoing factors have been discussed in the Company's prior SEC filings and, had the amendments to the Securities Act of 1933 and Securities Exchange Act of 1934 become effective at a different time, would have been discussed in an earlier filing. Page 16 of 18 17 PART II OTHER INFORMATION Item 1. LEGAL PROCEEDINGS None Item 2. CHANGES IN SECURITIES None Item 6. EXHIBITS AND REPORTS ON FORM 8-K (a) Exhibits Exhibit 27 - Financial Data Schedule - which is only submitted electronically to the Securities and Exchange Commission for EDGAR information purposes. (b) Reports on Form 8-K On August 18, 2000, the Company filed a Form 8-K to report that the Company had received a notice from The Nasdaq Stock Market stating that the Company's Common Stock may be delisted from the Nasdaq National Market if the Company's stock does not satisfy listing requirements for minimum bid price. On September 21, 2000, the Company filed a Form 8-K to report the termination of the merger with nMortgage and signing of a Letter of Intent to acquire the common stock of Xertain, Inc. Page 17 of 18 18 SIGNATURES In accordance with the requirements of the Exchange Act, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized. INNOVATIVE GAMING CORPORATION OF AMERICA /s/ Roland M. Thomas ---------------------------------------- Roland M. Thomas Chief Executive Officer Date: November 14, 2000 Page 18 of 18 19 EXHIBIT INDEX
Exhibit No. Description ------- ----------- 27 Financial Data Schedule