-----BEGIN PRIVACY-ENHANCED MESSAGE----- Proc-Type: 2001,MIC-CLEAR Originator-Name: webmaster@www.sec.gov Originator-Key-Asymmetric: MFgwCgYEVQgBAQICAf8DSgAwRwJAW2sNKK9AVtBzYZmr6aGjlWyK3XmZv3dTINen TWSM7vrzLADbmYQaionwg5sDW3P6oaM5D3tdezXMm7z1T+B+twIDAQAB MIC-Info: RSA-MD5,RSA, Crzf/cKlYlcYclbolIaWlLEe1RKRNkDTeN2JHKEqAiBnhWDfFuKbJBs/8kVf/fTv uUVdVm6r9sYn9mz8uBh5gg== 0000891618-99-001328.txt : 19990402 0000891618-99-001328.hdr.sgml : 19990402 ACCESSION NUMBER: 0000891618-99-001328 CONFORMED SUBMISSION TYPE: 10-K405 PUBLIC DOCUMENT COUNT: 7 CONFORMED PERIOD OF REPORT: 19981231 FILED AS OF DATE: 19990331 FILER: COMPANY DATA: COMPANY CONFORMED NAME: INNOVATIVE GAMING CORP OF AMERICA CENTRAL INDEX KEY: 0000897795 STANDARD INDUSTRIAL CLASSIFICATION: MISCELLANEOUS MANUFACTURING INDUSTRIES [3990] IRS NUMBER: 411713864 STATE OF INCORPORATION: MN FISCAL YEAR END: 1231 FILING VALUES: FORM TYPE: 10-K405 SEC ACT: SEC FILE NUMBER: 000-22482 FILM NUMBER: 99583467 BUSINESS ADDRESS: STREET 1: 4750 TURBO CIRCLE STREET 2: STE 60 CITY: RENO STATE: NV ZIP: 89502 BUSINESS PHONE: 7028233000 MAIL ADDRESS: STREET 1: 4750 TURBO CIRCLE STREET 2: SUITE 60 CITY: RENO STATE: NV ZIP: 89502 10-K405 1 FORM 10-K 1 SECURITIES AND EXCHANGE COMMISSION WASHINGTON, D.C. 20549 --------------- FORM 10-K [X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 FOR THE FISCAL YEAR ENDED DECEMBER 31, 1998 OR [ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 FOR THE TRANSITION PERIOD FROM _______ TO________ Commission File No. 0-22482 INNOVATIVE GAMING CORPORATION OF AMERICA (Exact name of registrant as specified in its charter) MINNESOTA 41-1713864 (State or other jurisdiction (I.R.S. Employer of incorporation or organization) Identification No.) 4750 TURBO CIRCLE RENO, NEVADA 89502 ------------ ----- (Address of principal executive offices) (Zip Code) (702) 823-3000 (Registrant's telephone number, including area code) Securities registered pursuant to Section 12(b) of the Act: None Securities registered pursuant to Section 12(g) of the Act: Common Stock, $0.01 par value Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes [X] No [ ] Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of the Registrant's knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. [X] As of March 18, 1999, 7,301,175 shares of the Registrant's Common Stock were outstanding. The aggregate market value of the Common Stock held by non-affiliates of the Registrant on such date, based upon the last sale price of the Common Stock as reported on the Nasdaq National Market on March 18, 1999, was $7,832,719. For purposes of this computation, affiliates of the Registrant are the Registrant's executive officers and directors and Lakes Gaming, Inc. DOCUMENTS INCORPORATED BY REFERENCE PART III - Portions of the Registrant's definitive proxy statement in connection with the annual meeting of the shareholders to be held on May 28, 1999, are incorporated by reference into Items 10 through 13, inclusive. 2 ITEM 1. BUSINESS The following discussion contains trend information and other forward-looking statements that involve a number of risks and uncertainties. The actual results of Innovative Gaming Corporation of America (the "Company") could differ materially from the Company's historical results of operations and those discussed in the forward-looking statements. Factors that could cause actual results to differ materially include, but are not limited to, those identified in "Certain Factors." Innovative Gaming Corporation of America ("IGCA") and its wholly owned operating subsidiary, Innovative Gaming, Inc. ("IGI"), together (the "Company"), develop, manufacture, market and distribute multi-station and other specialty gaming machines to regulated gaming markets world-wide. The Company has four primary product lines: multi-player/multi-station video table games; bonus "top box" games that are placed on top of slant top spinning reel slot machines; single player video slot machines incorporating state of the art graphics and sound, and unique specialty gaming machines such as "Mythical Reels(TM)", that projects the slot machine's spinning reels out in front of the box as if spinning in space. The Company also owns the world-wide patent rights to a unique machine that combines elements of roulette play and pinball in a single player machine. The Company's primary target markets have been gaming jurisdictions in North America, including the states of Arizona, Colorado, Louisiana, Mississippi, Minnesota, Nevada, New Mexico, North Carolina and South Carolina, and through distributors in Europe and Australia. In the first quarter of 1997, the Company's multi-station blackjack, roulette and craps games were approved in Nevada. In the third quarter of 1997, the multi-station blackjack and roulette games received interim approval for use in the club market of New South Wales, Australia. Subsequent to receiving such approval, the Company's Australian distributor commenced marketing the Company's products. Throughout 1997 and 1998, the Company continued to expand its markets by obtaining gaming licenses in several jurisdictions such as Colorado, and certain Iowa and New Mexico Native American jurisdictions. The Company has submitted and has pending applications in Connecticut, New Jersey and South Dakota. The Company has received a temporary permit from the Iowa Racing and Gaming Commission, effective April 1, 1999. Previously registered with Quebec and the Atlantic Lottery Corporation, the Company has obtained approval to sell gaming devices in Alberta, Manitoba, Saskatchewan and has applications pending in British Columbia and Ontario. Also in 1998, the Company's Bonus Streak(TM) game received approval in Mississippi and its Mythical Reels (TM) game received approval in Nevada, Louisiana, Colorado, Arizona, New Mexico, and Alberta, Canada. The Company is in the process of obtaining technical game approval of its products in Canada and France. In February 1999, the Company submitted its single player video slot machine to the Nevada Gaming Control Board for approval. The initial Mythical Reels game was installed in Caesar's Palace and Luxor, Las Vegas, in March 1999. The Company distributes its products directly and through distributors, primarily on a cash sales basis. In Nevada, through its internal sales force, the Company places its products under lease, sales (cash or extended payment terms) or participation agreements. Under participation agreements the Company retains ownership and shares in the net win of the games with the casino. In Colorado, the Company sells or leases its products through its distributor. The Company believes that its gaming machines will appeal to casinos/clubs, lotteries and slot route operators seeking to enhance the entertainment experience by providing new and unique forms of gaming. - 2 - 3 BUSINESS STRATEGY The Company's strategy is to develop and maintain a competitive advantage by focusing on two key elements: (a) exercising sufficient control over the development and manufacturing process to enable quick reaction to the ever shortening game replacement life cycle; and (b) concentrating efforts on specialty gaming machines that are protected by patents or other property rights to maintain an exclusive or dominant position in the market. An important added element to the Company's strategy in the Nevada market is to offer machine financing alternatives that address the controversial "participation agreements" currently opposed by most major casino operators. The Company was one of the first to respond to casino operator concerns and offer our specialty machines for sale and/or fixed term participation basis. PRODUCTS The Company has four primary product lines: multi-player/multi-station video table games; bonus "top box" games that are placed on top of slant top spinning reel slot machines; single player video slot machines incorporating state of the art graphics and sound, and unique specialty gaming machines such as "Mythical Reels(TM)", that projects the slot machines spinning reels out in front of the box as if spinning in space. The Company also owns the world-wide patent rights to a unique machine that combines elements of roulette play and pinball in a single player machine. MULTI-PLAYER/MULTI-STATION VIDEO TABLE GAMES BJ BLITZ(TM) AND LIVE VIDEO BLACKJACK(R) are electronic audio/video multi-player blackjack games. Each blackjack machine consists of a central "dealer" and three or five "player" stations that face the dealer in a semicircle, in the same configuration as a live action blackjack table. The dealer and each player station have video display screens. The dealer screen displays the cards as they are shuffled and dealt, and the dealer's hand. The electronic dealer directs the action with spoken instructions, and indicators flash on the video display screen of the player whose turn it is to bet. Each player station has lighted controls that the players can push to hit, stand, bet, double down, split or buy insurance. Between games, players can also push buttons to display the rules and the odds. The machines incorporate electronically generated voices, sound effects, lights and music into the game. A "21 Stud" game is offered by the Company on the blackjack game platform. "21 Stud" is an automated blackjack game with a stud poker game player option. At the end of each hand of blackjack, the player has a chance at additional awards according to a five-card poker hand completed from the dealer's original hand. These blackjack games accounted for an aggregate of 40% of sales in 1998, 49% in 1997 and 14% in 1996. HOT SHOT DICE(TM) AND LIVE VIDEO CRAPS(R) are electronic craps machines management believes are the first entirely electronic multi-player video craps games in the world, which consist of a rectangular table that is approximately half the size of a live action craps table, with a lighted canopy. Each table accommodates six players, two on each side, and one at each end. Except for a border that contains the player controls, the table consists of two large video display screens that reproduce a craps table top. Each player has a hand-sized trackball that the player rotates with his palm to roll the dice. The trackball also controls a video "hand" that the player moves around the playing field to place his bet of video "chips" in the appropriate spot. The odds are displayed as the hand passes over each betting spot on the field. Each - 3 - 4 player has his own distinctly-colored video hand and chips. The video rolling dice are superimposed on the playing field and the roll of the dice responds to the force and direction with which the player spins the track ball. The game incorporates sound effects such as rolling dice, and visual effects such as a croupier rake that wipes away chips, in addition to electronically-generated voices, music and flashing lights. These electronic craps games accounted for an aggregate of 0% of sales in 1998, 5% in 1997 and 7% in 1996. LIGHTNING STRIKE(TM) ROULETTE AND LIVE VIDEO ROULETTE(R) are roulette machines that management believes are the first entirely electronic multi-player video roulette games in the world, which consist of a rectangular table that is approximately half the size of a live action roulette table. The table accommodates five players, two on each side and an additional player at one end. The other end of the table has a stand-up cabinet that incorporates a 29-inch video monitor that employs what the Company believes is the most advanced computer graphics available in the industry today. On the top of the cabinet, a simulated roulette wheel is displayed that incorporates rotating lights coordinated with the play of the game. Except for a border that contains the player controls, the table consists of two large video display screens that reproduce a roulette table betting field. Each player has a hand-sized trackball that the player rotates with his palm to control a video hand that the player moves around the playing field to place his bet of video "chips" in the appropriate spot. The odds are displayed as the hand passes over each betting spot on the field. Each player has his own distinctly colored video hand and chips. The cabinet video monitor displays sharp, 3 dimensional graphics of rotating dealers, roulette wheel action, betting, instructional game play features, and game summary data. These roulette games accounted for an aggregate of 38% of sales in 1998, 38% in 1997 and 70% in 1996. BONUS "TOPBOX" GAMES BONUS STREAK is used in conjunction with a slant top spinning reel slot machine. The video bonus game was the first in the industry to utilize the active, high resolution LCD display. When players catch the Bonus Streak symbol on the reel slot, they qualify for bonus play. Currently the Company markets two such bonus games, the Bonus Streak game and the Cascade of Diamonds(TM) game. The Bonus Streak game starts with a display of 7 cards dealt face up on the LCD display. If there are any matching cards (two 4's, two jacks, etc.), bonus play ends and the player receives a first level award. If there are no matching cards, the player advances to the next award level. Play continues to subsequent award levels until there is a match or 13 unique cards are displayed, at which time the top bonus jackpot is awarded. The bonus game "Cascade of Diamonds" starts after qualifying for bonus action, with a jewel box appearing on the LCD display. When the player presses a button, nine diamonds fall from above, some landing in the box and some not. The player is awarded for the number of diamonds in the jewel box, with nine being the top award. The Bonus Streak game has been approved in the gaming jurisdictions of Nevada, Mississippi, Louisiana and Colorado. The Company sells Bonus Streak to gaming locations under cash or extended payment terms, and, in Nevada, may also place them on a participation basis wherein the Company will receive a percentage of the games' net win at percentages similar to those received by other specialty game suppliers. This participation amount will be shared with the manufacturer of the slant top spinning reel slot machine. Under this agreement with IGT, a wholly-owned subsidiary of International Game Technology, as the supplier of the slant top slot machines, the Company shares equally in the net revenues received from the locations under participation agreements until IGT receives its sales price, after which - 4 - 5 the Company receives 90% and IGT receives 10% of the net revenues. If the Company sells Bonus Streak games under either cash or extended payment terms, IGCA must purchase the slant top spinning reel slot machines from IGT. SINGLE PLAYER VIDEO SLOT MACHINES This new series of slot machines incorporates a unique PC platform. The operating system and software provide what the Company believes is very powerful performance and excellent cost advantages over traditional operating systems. Its modular software structure enables rapid development of new game personalities without affecting basic machine functions. This quick game development capability overcomes a current video slot problem, in that the games are not easily modified/customized as required by most customers. Various game theme options will be available utilizing this new platform. The Company has initiated efforts for patent protection on several elements of this new platform. UNIQUE SPECIALTY GAMES MYTHICAL REELS is a spinning reels slot machine in an oversized or "mini-bertha" cabinet. The spinning reels appear to float in space and are so real in appearance that viewers feel that they can reach out and touch them. The Mythical Reels machine is based on electronic equipment and internal hardware which is already approved in most gaming jurisdictions worldwide. The image projected uses High Definition Volumetric Display (HDVD) technology, for which the Company has acquired sole rights for use in its gaming devices. The Company placed its first Mythical Reels games in Caesar's Palace and Luxor, Las Vegas, Nevada in March 1999. There can be no assurance that this game will be accepted by customers. REVOLVING RINGS(TM): This new product currently under development incorporates a patented entirely different operational concept from any other known gaming devices. The machine contains three horizontal, concentric, counter-rotating rings. Each ring surface incorporates a certain number of holes and spaces. Game play is initiated by the customer who pushes a button which ejects a ball onto the playing field. The ball travels around the circumference of the outer ring, much like the play on a roulette game. A stop device kicks the ball onto the rotating surface of the first ring where it may or may not drop into one of the holes. If the ball does not fall into a hole on the first ring, it will continue rolling onto the second counter-rotating ring where it may or may not drop into a hole. These holes are designated as winners and non-winners. If the ball proceeds past the first and second rings without dropping into a hole, it will roll onto the third and final ring where all holes are winners. This device incorporates the excitement of playing both roulette and pinball. MANUFACTURING AND SUPPLY ARRANGEMENTS The Company's primary products are assembled at its production facility in Reno, Nevada, utilizing various parts and components from a large base of vendors. On February 2, 1996, the Company negotiated fixed pricing for a minimum of two years for specific electronic components with its Japanese suppliers in its efforts to reduce product cost. Deliveries scheduled under this agreement were extended through mid 1999. With certain electronic parts solidified by contract, the Company is utilizing a more domestic base of vendors for the balance of components to reduce the reliance on exchange rate sensitivities and to negotiate more competitive prices on required components. Except for certain electronic components purchased from the Japanese vendor, the Company has identified alternate sources of supply for significant parts and components should any of its current vendors fail to meet order requirements by the Company. - 5 - 6 INTELLECTUAL PROPERTY On February 2, 1996, the Company acquired the balance of all remaining intellectual property including patents, trademarks, picture rights and copyrights for its games from its Japanese suppliers in exchange for an aggregate 225,000 shares of IGCA common stock. The Company has exclusive ownership and licenses pertaining to its blackjack, craps, roulette and Supersuits Progressive Blackjack in gaming markets worldwide. IGCA(R), BJ Blitz(TM), Hot Shot Dice(TM), Lightning Strike Roulette(TM), Live Video Blackjack(R), Live Video Craps(R), Live Video Roulette(R), Bonus Streak(TM), Cascade of Diamonds(TM), Mythical Reels(TM) and Supersuits(R) are all trademarks of Innovative Gaming Corporation of America. The Company has either Federally registered or applied for Federal registration of these trademarks. In November 1997, IGCA received notification that it was granted a Trademark and Design registration for Lightning Strike Roulette in Australia. The Company believes that the technical know-how, trade secrets and creative skills of its employees and contract personnel are substantial rights of the Company. The Company requires customers, employees, contract personnel and other significant contacts of the Company who have access to proprietary information concerning the Company's products to sign non-disclosure agreements. The Company relies on such agreements, other security measures, and trade secret law to protect such proprietary information. No assurance can be given that pending applications for intellectual property will be granted. There also can be no assurance that patents or other intellectual property rights will not be infringed, or that others will not develop technology that will not violate these rights. DISTRIBUTORSHIP AND SALES AGENCY ARRANGEMENTS The Company distributes and/or anticipates to distribute its products both directly to gaming markets and through licensed distributors. In certain jurisdictions the Company may use an existing licensed distributor to sell its products pursuant to any necessary Tribal or regulatory transaction approvals. In February 1996, the Company entered into an exclusive distribution agreement with Aristocrat Leisure Industries of New South Wales, Australia for the marketing and distribution of games in Australia, New Zealand, Papua New Guinea, Taiwan, New Caledonia, Malaysia, the Philippines and Singapore (hereinafter "Australasia"). The Company granted Aristocrat an initial five-year exclusive license expiring February 2001 to distribute its blackjack, craps and roulette games to all legalized Australasia video gaming jurisdictions. Pursuant to such agreement, the Company agreed to sell its games at discounted distributor's pricing in exchange for a minimum purchase quantity of 100 units per year. Aristocrat commenced marketing the Company's blackjack, and roulette games subsequent to obtaining technical approval from New South Wales, Australia gaming authorities in September 1997. Pursuant to this agreement, the Company sold an aggregate of 99 games in 1997 and 86 games in 1998. Due to the declining multi-player game sales in their territory, the Company's sales to this distributor declined in the third and particularly fourth quarters of 1998, and the Company has not forecasted sales to this customer in 1999. In March 1996, the Company entered into exclusive agreements with Ludi S.F.M. and with S.A.M. Eurusa for the exclusive distribution of the Company's games in France, Monaco, Morocco, Tunisia and Italy. Ludi and Eurusa are affiliated entities. Under such agreement, Ludi and Eurusa have been granted - 6 - 7 three-year exclusive licenses, expiring March 1999, to distribute the Company's blackjack, craps and roulette games, subsequent to any and all regulatory approvals. These agreements may be renewed for successive one-year terms upon the agreement of the parties and on the terms and conditions set forth in the distribution agreements or such other terms and conditions as the parties may agree and may be terminated by either party under certain circumstances. Pursuant to the agreement, the Company has agreed to sell its games to Ludi and Eurusa at the Company's then current retail price less a distributor's discount. No sales have been made under this agreement through December 31, 1998. In January 1997, the Company entered into a three-year exclusive agreement with Vista Gaming Corporation ("Vista") for the distribution and service of the Company's products in Colorado. However, if Vista does not distribute on lease at least 20 machines after six months and/or 35 machines after one year, this agreement will revert to a non-exclusive distributorship. The lease rates will be comparable to lease rates charged by other specialty game suppliers. This agreement provides for automatic renewal annually after the original term and may be terminated by either party under certain circumstances. In March 1998, the Company entered into a business consulting agreement with Jean D. Leclair and the Leclair Group ("Consultant"), under which the Consultant provides business consulting services to the Company in Quebec, Canada. Additionally, the Consultant may also assist the Company in securing agreements for the purchase of the Company's products in Quebec and Atlantic Canada. For services to the Company in securing agreements for the purchase of the Company's products, the Consultant will be paid a commission for game sales acquired with Loto Quebec and the Atlantic Lottery Corporation. This agreement is for an initial period of one year, with provision for renewal on a month to month basis upon mutual written agreement. In May 1998, the Company entered into a one-year exclusive agency agreement with Bill Engle, an individual. Under the agreement, the agent represents the Company's products for sale in the Canadian provinces of British Columbia, Ontario, Nova Scotia (for casino customers only), Saskatchewan, Alberta and Manitoba. The agent receives a commission equal to the difference between the amount received for sales initiated by the agent and prices stated in the agreement for each product. This agreement may be renewed for up to two successive one-year terms upon the agreement of the parties and on the terms and conditions set forth in the agency agreement. In December 1998, the Company entered into a three-year exclusive agreement with DGS, Inc. ("DGS") for the distribution and service of the Company's blackjack and 21 Stud products in South Carolina. The Company and DGS will negotiate minimum sales targets for each year of the agreement. If DGS fails to purchase for resale the minimum number of units in any contract year, the Company may give notice to terminate the agreement. This agreement provides for automatic renewal annually after the original term, up to a total of eight years, and may be terminated by either party under certain circumstances. The Company has submitted its applications for licensure in New Jersey and Connecticut, and will apply for approval of its various games. Once the Company is able to sell product in these jurisdictions, it will be represented by Par 4 ("Agent") under terms of a two-year exclusive agency agreement entered into in January 1999. Under the agreement, the agent represents certain of the Company's products for sale in Atlantic City, New Jersey and Connecticut. The Company and Agent will negotiate minimum sales targets for each year of the agreement. If Agent fails to obtain sales orders for at least 75 percent of the target number of units in any contract year, the Company may give notice to terminate the agreement. This agreement provides for automatic renewal annually after the original term and may be terminated by either party under certain circumstances. - 7 - 8 SIGNIFICANT CUSTOMERS During fiscal 1998, a substantial portion of the Company's sales were to one customer, Aristocrat Leisure Industries, which accounted for 54.1% of sales. Such customer accounted for 48.4% of sales in fiscal 1997. Due to the declining multi-player game sales in their territory, the Company's sales to this distributor declined in the third and particularly fourth quarters of 1998, and the Company has not forecasted sales to this customer in 1999. No other single customer accounted for 10% or more of sales. Sales to Lakes Gaming, Inc.("LGI") accounted for less than 1% of sales in fiscal years 1998 and 1997. In addition to providing the Company the opportunity for quantity sales of its products, these agreements provided the Company with initial market and beta test sites for its products, as well as operational and performance data. The Company sold six Bonus Streak games, minimal parts sales and no video gaming machine sales to LGI during 1998. COMPETITION Many gaming equipment companies, several of which are large and well-established, supply the casino and video lottery industries with video gaming machines and other gaming equipment. Management believes that Aristocrat, Alliance Gaming, International Game Technology and WMS Industries are among the largest and most-established gaming machine suppliers. Management believes that none of these companies currently offer video gaming machines that are similar to the Company's multi-station products. However, Sigma Games distributes a multi-player horserace game. There can be no assurance that these competitors, or another competitor, will not develop gaming machines that are similar to the Company's gaming machines in the future. Furthermore, the Company is developing games for the intensely competitive single player game market. There can be no assurance that any single player games developed by the Company will be accepted in such competitive markets. REGULATION GENERAL - The manufacture, sale and distribution of gaming machines are subject to various federal, state, county, tribal, municipal and international laws, regulations and ordinances, which are administered by the relevant regulatory agency or agencies in each jurisdiction (the "Regulatory Authorities"). These laws, regulations and ordinances vary from jurisdiction to jurisdiction, but primarily concern the responsibility, financial stability and character of gaming equipment manufacturers and distributors, as well as persons financially interested or involved with gaming equipment manufacturers and distributors. Furthermore, regulations also require various technical standards and specifications approval and adherence, which are conducted by state and/or private laboratories. There are substantial similarities in the basic provisions which are described below. In the future, Regulatory Authorities may also significantly curtail or eliminate gaming in jurisdictions that currently or hereafter allow gaming. In addition to the jurisdictions which currently allow casino gaming, the Company anticipates doing business in other jurisdictions which may authorize casino gaming in the future, and in jurisdictions which have legalized casino gaming but have not adopted regulations. The Company cannot predict the nature of the regulatory scheme in any such jurisdiction. The licensing and approval process can take several months. Delays or failure to obtain licenses can have a material adverse effect on the Company. - 8 - 9 INDIAN GAMING - The operation of gaming on Indian land, including the terms and conditions of contracts to sell or lease gaming equipment to Indian tribes, is subject to the Indian Gaming Regulatory Act of 1988 ("IGRA"), which has delegated oversight responsibility to the Bureau of Indian Affairs (the "BIA") and the National Indian Gaming Commission ("NIGC"), and also is subject to the provisions of statutes relating to contracts with Indian tribes, which are administered by the BIA. The regulations and guidelines under which the BIA and the National Indian Gaming Commission will administer IGRA are incomplete and evolving. IGRA is subject to interpretation by the Secretary of the Interior and the NIGC and may be subject to judicial and legislative clarification or amendment. The NIGC is empowered to inspect and audit all Indian gaming facilities, to conduct background checks on all persons associated with Indian gaming, to hold hearings, issue subpoenas, take depositions, adopt regulations and to assess fees. Civil penalties for violations of IGRA, and/or other applicable law, may be imposed. In addition, IGRA provides for criminal penalties for illegal gaming on Indian land and for theft from Indian gaming facilities. IGRA classifies games that may be played on Indian land into three categories. Class I gaming includes traditional Indian games and private social games engaged in as a part of; or in connection with, tribal ceremonies or celebrations. These games, under IGRA, are regulated exclusively by the respective tribes. Class II gaming includes bingo and, additionally, pulltabs, lotto, punch boards, tip jars, instant bingo, and other games similar to bingo, if those games are played at a location where bingo is played. Class II gaming explicitly excludes electronic or electromechanical facsimiles of any games of chance or slot machines of any kind. This classification is also reserved for tribal regulation, but under federal oversight. Class II gaming is permitted on Indian land if: (i) the state in which the Indian gaming is located permits such gaming for any purpose by any person, (ii) the gaming is not otherwise specifically prohibited on Indian land by federal law, (iii) the gaming is conducted in accordance with a tribal ordinance which has been approved by the Chairman of the NIGC (provided that gaming may be conducted under unapproved ordinances or resolutions adopted prior to the enactment of IGRA unless and until such ordinances or resolutions are disapproved by the Chairman), (iv) an Indian tribe has sole proprietary interest and responsibility for the conduct of gaming (subject to certain exceptions), (v) the primary management officials, key employees and the facility are tribally licensed; and (vi) several other specified requirements are met, including the existence of any adequate system which ensures background investigations are conducted on primary management officials, all contracts for supplies, services or concessions in excess of $25,000 annually are subject to independent audit and the construction and maintenance of the gaming facility is conducted in a manner which adequately protects the environment and the public health and safety. Class III gaming includes all other forms of gaming, such as video casino games (e.g., video slots, video blackjack), slot machines, table games (e.g., blackjack, craps, roulette), and other gaming (e.g., sports betting and parimutuel wagering). The machines manufactured and distributed by the Company are classified as Class III gaming devices. Class III gaming is permitted on Indian land only if such activity is: (i) authorized by a tribal ordinance meeting the requirements of IGRA and approved by the Chairman of the NIGC (provided that gaming may be conducted under unapproved ordinances or resolutions adopted prior to the enactment of IGRA unless and until such ordinances or resolutions are disapproved by the Chairman), (ii) located in a state that permits gaming defined as Class III by any person for any - 9 - 10 purpose, (iii) governed by requirements similar to those described for Class II gaming, and (iv) conducted in compliance with the terms of a written tribal-state compact entered into between the Indian tribe and the state in which the subject gaming is located and which has been approved by the Secretary. TRIBAL ORDINANCES - Under IGRA, except to the extent otherwise provided in a tribal-state compact, Indian tribal governments have primary regulatory authority over gaming on land within the tribe's jurisdiction Therefore, persons engaged in gaming activities, including the Company, are subject to the provisions of tribal ordinances and regulations regarding gaming. Such ordinances and regulations must be consistent with IGRA and with any applicable tribal-state gaming compact, and cannot impose criminal penalties upon non-Indians. However, the civil remedies imposed by such tribal government regulations, if otherwise valid, will likely apply to the Company and its employees and customers. Tribal ordinances also require participants involved in Indian gaming enterprises to obtain tribal licenses. The Company as a manufacturer/distributor of gaming equipment is usually required to obtain a tribal license before making any equipment sales. Management companies and their officers, directors and significant shareholders are also subject to licensing requirements. Tribes have great discretion to deny such licenses, fail to renew current licenses or revoke such licenses. An Indian tribe has the right to revoke any tribal gaming ordinance and, pursuant to such revocation, render Class III gaming illegal on the lands of the tribe. The Company must also comply with regulations promulgated pursuant to the tribal state compacts entered into between the State and the particular Indian tribe. These compacts vary significantly from state to state. Indian tribes are sovereign nations with their own courts and governmental Systems. The Company intends to seek waivers of Sovereign immunity, where appropriate, from tribes with whom the Company does business although there can be no assurance that such waivers will be obtained. UNITED STATES CODE SECTION 81 - Title 25, Section 81 of the United States Code states that "no agreement shall be made by any person with any tribe of Indians, or individual Indians not citizens of the United States, for the payment or delivery of any money or other thing of value . . . in consideration of services for said Indians relative to their lands . . . unless such contract or agreement be executed and approved" by the Secretary or his or her designee. An agreement or contract for services relative to Indian lands which fails to conform with the requirements of Section 81 will be void and unenforceable. All money or other thing of value paid to any person by any Indian or tribe for or on his or their behalf, on account of such services, in excess of any amount approved by the Secretary or his or her authorized representative will be subject to forfeiture. The Company has sold and intends to sell gaming machines directly to Indian tribes. The Company has not submitted its past gaming machine sales contracts with Indian tribes to the Secretary for approval for a number of reasons. In the Company's opinion, its sales contracts are not for services. The Company believes it is engaged in the sale of goods, namely gaming machines, and therefore Section 81 does not apply to its activities. The Company also believes that its sales of gaming machines are not "relative to Indian lands." Although the gaming machines ultimately may be used on Indian lands, the Company believes the machines themselves are not related to Indian land. The Company intends to continue its practice of not submitting its sales contracts to the Secretary for approval. The position of regulatory authorities relative to approval of contracts of this kind has not been clear. - 10 - 11 NEVADA The manufacture and distribution of gaming devices in Nevada are subject to: (i) the Nevada Gaming Control Act and the regulations promulgated thereunder (collectively, the "Nevada Act"); and (ii) various local regulations. Generally, gaming activities may not be conducted in Nevada unless licenses are obtained from the Nevada Gaming Commission (the "Nevada Commission"), the Nevada State Gaming Control Board (the "Nevada Board"), and appropriate county and municipal licensing agencies. The Nevada Commission, the Nevada Board, and the various county and municipal licensing agencies are collectively referred to as the "Nevada Gaming Authorities." The laws, regulations and supervisory procedures of the Nevada Gaming Authorities are based upon declarations of public policy that are concerned with, among other things: (i) the prevention of unsavory or unsuitable persons from having a direct or indirect involvement with gaming at any time or in any capacity; (ii) the establishment and maintenance of responsible accounting practices and procedures; (iii) the maintenance of effective controls over the financial practices of licensees, including the establishment of minimum procedures for internal fiscal affairs and the safeguarding of assets and revenues, providing reliable record keeping and requiring the filing of periodic reports with the Nevada Gaming Authorities; (iv) the prevention of cheating and fraudulent practices; and (v) to provide a source of state and local revenues through taxation and licensing fees. Change in such laws, regulations and procedures could have an adverse effect on the Company. Manufacturer and distributor licenses require the periodic payment of fees and taxes and are not transferable. No person may become a stockholder of, or receive any percentage of profits from, IGI, the wholly-owned subsidiary of IGCA, without first obtaining licenses and approvals from the Nevada Gaming Authorities. IGCA is registered by the Nevada Commission as a publicly traded corporation ("Registered Corporation") and IGI was granted all requisite licenses in May 1996 to manufacture gaming devices used in Nevada and to distribute such devices, subsequent to technical product approvals. As such, the Company is required periodically to submit detailed financial and operating reports to the Nevada Commission and furnish any other information that the Nevada Commission may require. All gaming devices that are manufactured, sold or distributed for use or play in Nevada, or for distribution outside of Nevada, must be manufactured by licensed manufacturers and distributed or sold by licensed distributors. All gaming devices manufactured for use or play in Nevada must be approved by the Nevada Commission before distribution or exposure for play. The approval process for gaming devices includes rigorous testing by the Nevada Board, a field trial and a determination as to whether the gaming device meets strict technical standards that are set forth in the regulations of the Nevada Commission. The Nevada Gaming Authorities may investigate any individual who has a material relationship to, or material involvement with, the Company in order to determine whether such individual is suitable or should be licensed as a business associate of a gaming licensee. Officers, directors and certain key employees of IGI must file applications with the Nevada Gaming Authorities and are required to be licensed by the Nevada Gaming Authorities. Officers, directors and key employees of IGCA who are actively and directly involved in the gaming activities of IGI may be required to be licensed or found suitable by the Nevada Gaming Authorities. The Nevada Gaming Authorities may deny an application for licensing or a finding of suitability for any cause they deem reasonable. A finding of suitability is - 11 - 12 comparable to licensing, and both require submission of detailed personal and financial information followed by a thorough investigation. The applicant for licensing or a finding of suitability must pay all the costs of the investigation. Changes in licensed positions must be reported to the Nevada Gaming Authorities and in addition to their authority to deny an application for a finding of suitability or licensure, the Nevada Gaming Authorities have jurisdiction to disapprove a change in a corporate position. If the Nevada Gaming Authorities were to find an officer, director or key employee unsuitable for licensing or to continue having a relationship with the Company, the companies involved would have to sever all relationships with such person. In addition, the Nevada Commission may require the Company to terminate the employment of any person who refuses to file appropriate applications. Determinations of suitability or of questions pertaining to licensing are not subject to judicial review in Nevada. The Company is required to submit detailed financial and operating reports to Nevada Gaming Authorities. Substantially all material loans, leases, sales of securities and similar financing transactions by the Company, must be reported to or approved by the Nevada Commission. If it was determined that the Nevada Act was violated by IGI, the gaming licenses it holds could be limited, conditioned, suspended or revoked, subject to compliance with certain statutory and regulatory procedures. In addition, IGI, IGCA and the persons involved could be subject to substantial fines for each separate violation of the Nevada Act at the discretion of the Nevada Commission. Limitation, conditioning or suspension of any gaming license could (and revocation of any gaming license would) materially adversely affect the Company. Any beneficial holder of the Company's voting securities, regardless of the number of shares owned, may be required to file an application, be investigated, and have his suitability as a beneficial holder of the Company's voting securities determined if the Nevada Commission has reason to believe that such ownership would otherwise be inconsistent with the declared policies of the State of Nevada. The applicant must pay all costs of investigation incurred by the Nevada Gaming Authorities in conducting any such investigation. The Nevada Act requires any person who acquires more than 5% of the Company's voting securities to report the acquisition to the Nevada Commission. The Nevada Act requires that beneficial owners of more than 10% of the Company's voting securities apply to the Nevada Commission for a finding of suitability within thirty days after the Chairman of the Nevada Board mails a written notice requiring such filing. Under certain circumstances, an "institutional investor," as defined in the Nevada Act, which acquires more than 10% but not more than 15% of the Company's voting securities, may apply to the Nevada Commission for a waiver of such finding of suitability if such institutional investor holds the voting securities for investment purposes only. An institutional investor shall not be deemed to hold voting securities for investment purposes unless the voting securities were acquired and are held in the ordinary course of business as an institutional investor and not for the purpose of causing, directly or indirectly, the election of a majority of the members of the board of directors of the Company, any change in the Company's corporate charter, bylaws, management, policies or operations of the Company or any of its gaming affiliates, or any other action which the Nevada Commission finds to be inconsistent with holding the Company's voting securities for investment purposes only. Activities that are not deemed to be inconsistent with holding voting securities for investment purposes only include: (i) voting on all matters - 12 - 13 voted on by stockholders; (ii) making financial and other inquiries of management of the type normally made by securities analysts for informational purposes and not to cause a change in its management, policies or operations; and (iii) such other activities as the Nevada Commission may determine to be consistent with such investment intent. If the beneficial holder of voting securities who must be found suitable is a corporation, partnership or trust, it must submit detailed business and financial information including a list of beneficial owners. The applicant is required to pay all costs of investigation. Any person who fails or refuses to apply for a finding of suitability or a license within thirty days after being ordered to do so by the Nevada Commission or the Chairman of the Nevada Board, may be found unsuitable. The same restrictions apply to a record owner if the record owner, after request, fails to identify the beneficial owner. Any stockholder found unsuitable and who holds, directly or indirectly, any beneficial ownership of the common stock of a Registered Corporation beyond such period of time as may be prescribed by the Nevada Commission may be guilty of a criminal offense. The Company is subject to disciplinary action if after it receives notice that a person is unsuitable to be a stockholder or to have any other relationship with the Company, the Company (i) pays that person any dividend or interest upon voting securities of the Company, (ii) allows that person to exercise, directly or indirectly, any voting right conferred through securities held by that person, (iii) pays remuneration in any form to that person for services rendered or otherwise, or (iv) fails to pursue all lawful efforts to require such unsuitable person to relinquish his voting securities for cash at fair market value. Additionally, the Clark County Liquor and Gaming Licensing Board has taken the position that they have the authority to approve all persons owning or controlling the stock of any corporation controlling a gaming license. The Nevada Commission may, in its discretion, require the holder of any debt security of a Registered Corporation to file an application, be investigated and found suitable to own the debt security of a Registered Corporation. If the Nevada Commission determines that a person is unsuitable to own such security, then pursuant to the Nevada Act, the Registered Corporation can be sanctioned, including the loss of its approvals, if without the prior approval of the Nevada Commission, it: (i) pays to the unsuitable person any dividend, interest, or any distribution whatsoever; (ii) recognizes any voting right by such unsuitable person in connection with such securities; (iii) pays the unsuitable person remuneration in any form; or (iv) makes any payment to the unsuitable person by way of principal, redemption, conversion, exchange, liquidation, or similar transaction. The Company is required to maintain a current stock ledger in Nevada that may be examined by the Nevada Gaming Authorities at any time. If any Securities are held in trust by an agent or by a nominee, the record holder may be required to disclose the identity of the beneficial owner to the Nevada Gaming Authorities. A failure to make such disclosure may be grounds for finding the record holder unsuitable. The Company is also required to render maximum assistance in determining the identity of the beneficial owner. The Nevada Commission has the power to require the Company's stock certificates to bear a legend indicating that such securities are subject to the Nevada Act. However, to date, the Nevada Commission has not imposed such a requirement on the Company. The Company may not make a public offering of any securities without the prior approval of the Nevada Commission if the securities or the proceeds therefrom are intended to be used to construct, acquire or finance gaming facilities in Nevada, or to retire or extend obligations incurred for such purposes. Such approval, if given, does not constitute a finding, recommendation or approval by the Nevada Commission or the Nevada Board as to the accuracy or adequacy of the prospectus or the investment merits of the securities. Any representation to the contrary is unlawful. - 13 - 14 Changes in control of the Company through merger, consolidation, stock or asset acquisitions, management or consulting agreements, or any act or conduct by a person whereby he obtains control, may not occur without the prior approval of the Nevada Commission. Entities seeking to acquire control of a Registered Corporation must satisfy the Nevada Board and the Nevada Commission concerning a variety of stringent standards prior to assuming control of such Registered Corporation. The Nevada Commission may also require controlling stockholders, officers, directors and other persons having a material relationship or involvement with the entity proposing to acquire control, to be investigated and licensed as part of the approval process of the transaction. The Nevada legislature has declared that some corporate acquisitions opposed by management, repurchases of voting securities and corporate defense tactics affecting Nevada gaming licensees and Registered Corporations that are affiliated with those operations, may be injurious to stable and productive corporate gaming. The Nevada Commission has established a regulatory scheme to ameliorate the potentially adverse effects of these business practices upon Nevada's gaming industry and to further Nevada's policy to: (i) assure the financial stability of corporate gaming operators and their affiliates; (ii) preserve the beneficial aspects of conducting business in the corporate form; and (iii) promote a neutral environmental for the orderly governance of corporate affairs. Approvals are, in certain circumstances, required from the Nevada Commission before the Company can make exceptional repurchases of voting securities above the current market price thereof and before a corporate acquisition opposed by management can be consummated. The Nevada Act also requires prior approval of a plan of recapitalization proposed by the Company's board of directors in response to a tender offer made directly to the Registered Corporation's stockholders for the purpose of acquiring control of the Registered Corporation. Any person who is licensed, required to be licensed, registered, required to be registered, or is under common control with such persons (collectively, "Licensees"), and who proposes to become involved in a gaming venture outside of Nevada, is required to deposit with the Nevada Board, and thereafter maintain, a revolving fund in the amount of $10,000 to pay the expenses of investigation by the Nevada Board of their participation in such foreign gaming. The revolving fund is subject to increase or decrease in the discretion of the Nevada Commission. Thereafter, Licensees are also required to comply with certain reporting requirements imposed by the Nevada Act. Licensees are also subject to disciplinary action by the Nevada Commission if they knowingly violate any laws of the foreign jurisdiction pertaining to the foreign gaming operation, fail to conduct the foreign gaming operation in accordance with the standards of honesty and integrity required of Nevada gaming operations, engage in activities that are harmful to the State of Nevada or its ability to collect gaming taxes and fees, or employ a person in the foreign operation who has been denied a license or a finding of suitability in Nevada on the ground of personal unsuitability. NEW JERSEY The manufacture and distribution of slot machines and casino gaming activities in New Jersey are subject to extensive state regulation under the New Jersey Casino Control Act, N.J.S.A. 5:12-1 et seq. (the "New Jersey Act"). The New Jersey Act created the New Jersey Casino Control Commission ("New Jersey Commission"), which is authorized to decide all license applications and other matters and to promulgate - 14 - 15 regulations. The New Jersey Act also created the New Jersey Division of Gaming Enforcement (the "New Jersey Division"), which is authorized to investigate all license applications, make recommendations to the New Jersey Commission, and prosecute violations of the New Jersey Act. The New Jersey Act requires any manufacturer or distributor of slot machines to be licensed as a gaming related casino service industry ("CSI") by the New Jersey Commission prior to transacting any business with a casino. The Company's wholly-owned subsidiary, Innovative Gaming, Inc. ("IGI"), has filed an application for a CSI license, but it has not yet been deemed complete by the New Jersey Commission. In order for the requisite CSI license to be issued to IGI and maintained, the Company's and IGI's officers, directors and key employees and all beneficial owners of five percent (5%) or more of the Company's Common Stock must be found qualified by the New Jersey Commission after an investigation by the New Jersey Division. In order to be found qualified, the Company and IGI, its officers, directors, key employees and five percent (5%) or greater shareholders must demonstrate by clear and convincing evidence their good character, honesty and integrity, and their financial stability, integrity and responsibility. However, "institutional investors" (as defined in the New Jersey Act) holding five percent (5%) or more of the shares of the Company may be granted a waiver of the requirement to be found qualified by the New Jersey Commission. Any other shareholder or other person associated with the Company or IGI whom the New Jersey Commission deems appropriate, in its discretion, is also required to be qualified. If a person is required to and fails to submit for qualification or submits for qualification and is found disqualified by the New Jersey Commission, the New Jersey Commission may prohibit casinos in New Jersey from doing business with the Company and IGI. The New Jersey Commission may permit a company to transact business with a casino prior to licensure if the company has filed a complete application for CSI licensure and the New Jersey Division does not object to the transaction. A request for permission to conduct a business transaction with a casino prior to CSI licensure may be made 30 days after the filing of a complete CSI license application with New Jersey Commission. A CSI license is issued for an initial period of two years and is thereafter renewable for four year periods. There is no guarantee that IGI will be granted an initial license or that, following the issuance of an initial CSI license or any renewal thereof, IGI will continue to be granted renewals of the license. Additionally, upon application of the New Jersey Division, the New Jersey Commission may at any time review any license issued by it and determine to suspend, revoke or place conditions on such license. In addition to the required CSI license, the gaming equipment manufactured, distributed or sold by IGI to New Jersey casinos is subject to a technical examination by the New Jersey Division and approval by the New Jersey Commission for, at a minimum, quality, design, integrity, fairness, honesty and suitability. The review process includes the submission of a model of the machine to the New Jersey Division for testing, examination and analysis. Prior to a decision by the New Jersey Commission to approve a particular model of machine, it may require up to a 60 day trial period to test the machine in a casino. During the trial period, the manufacturer or distributor of the machine shall not be entitled to receive revenue of any kind whatsoever. Once a model is approved by the New Jersey Commission, all machines of that model placed in operation in casinos shall operate in conformity with the model approved by the New Jersey Commission. Any changes in the design, function or operation of the machine are subject to prior approval by the New Jersey Commission, after testing by the New Jersey Division. - 15 - 16 OTHER JURISDICTIONS. Each of the other jurisdictions in which the Company does business requires various licenses, permits and approvals in connection with the manufacture and/or distribution of gaming devices typically involving restrictions similar in many respects to those of Nevada. UNITED STATES - FEDERAL - The Federal Gambling Devices Act of 1962 (the "Federal Act") makes it unlawful for a person to manufacture, deliver or receive gaming machines and components thereof across interstate lines unless that person has first registered with the Attorney General of the United States. The Company is so registered and must renew its registration annually. In addition, various recordkeeping and equipment identification requirements are imposed by the Federal Act. Violation of the Federal Act may result in seizure or forfeiture of equipment, as well as other penalties. CERTAIN FACTORS In addition to the factors discussed elsewhere in this Annual Report on Form 10-K, such as regulation, competition and dependence on significant customers, the following are important factors that could cause actual results or events to differ materially from those contained in any forward-looking statements made by or on behalf of the Company. SHORT-TERM LIQUIDITY AND NEED FOR ADDITIONAL FINANCING - As of March 30, 1999, the Company had cash and cash equivalents of approximately $650,000. Management believes, assuming it can achieve its sales forecasts which exceed current sales rates, it will have sufficient cash to fund operations through mid 1999. However, if sales remain at or below their current levels and the Company does not reduce its operative expenses consistent with its sales level, operations will only be funded into May 1999. Management has taken certain steps to address its short-term liquidity and cash flow requirements by entering into a loan commitment to borrow approximately $675,000, on a secured basis, from a third party lender in late March 1999 in addition to attempting to control costs through inventory reductions and other measures. The Company anticipates closing on this loan in early April 1999. With this financing the Company estimates that its current level of cash and anticipated funds from operations, which assumes market acceptance of new games (which cannot be assured), would be adequate to fund cash requirements through 1999. No assurance can be given that this loan will close on a timely basis, if at all, or on the terms contained in the loan commitment letter with such lender. Failure to close on this loan in a timely basis could have a material adverse effect on the Company. In the absence of alternative financing, the Company would have to consider significantly reducing operations, in addition to liquidating all or a portion of the Company's assets. To the extent that the Company does significantly reduce operations, it would have a material adverse effect on the Company's ability to meet its short term revenue projections and would negatively impact the ability to obtain additional financing. Furthermore, to the extent that the Company's revenues are less than anticipated, the Company may require additional short-term financing in 1999. Because of fluctuating limited sales and an extensive research and development program on a new game platform and games, the Company has experienced negative cash flow from operations of $2.1 million, $7.5 million and $2.7 million for the years ended December 31, 1998, 1997 and 1996, respectively. The Company's ability to execute its long-term business strategy also depends to a significant degree on its ability to finance the development, marketing and production of its new products. There can be no assurance that the Company will be successful in obtaining financing on terms acceptable to the Company, if such need arises. Any new investors may seek and obtain substantially better terms than were granted to its present investors and the issuance of such securities would result in dilution to its existing shareholders. PREFERRED STOCK DILUTION AND RISK OF CASH REDEMPTION - In order to meet its research and development, marketing and licensing capital requirements, the Company issued $3 million in Series B Convertible Preferred Stock (the "Preferred Stock") to an institutional investor in May 1998. The Preferred Stock is convertible into the Company's Common Stock at a conversion price equal to 91% of the average of the lowest three consecutive day closing bid price over the 20 day period prior to conversion. The Preferred Stock terms presently prohibit issuing more than 1,505,000 shares of Common Stock at a discount and also limit the ability of the holder to convert if, following the conversion, such holder would own in excess of 4.9% of the Company's Common Stock. Additionally, to the extent that a holder is unable to convert the Preferred Stock to Common Stock, such holder's Preferred Stock must be redeemed for either a) cash or b) Common Stock that is not issued at a discount in addition to cash. Through March 30, 1999, $2.85 million of Preferred Stock had not yet been converted into the Company's Common Stock. As of March 30, 1999, the Company also had cash and cash equivalents of approximately $650,000. If the holders of the Company's Preferred Stock were to attempt to convert on such date, the Company would be required to issue 1,339,036 shares of Common Stock at $.91 per share (91% of the closing sales price on such date), and issue 438,652 shares of Common Stock at $3.375 (the closing sales price of the Company's Common Stock on the date the Preferred Stock was issued) and pay approximately $1.1 million to the holders of the unconverted Preferred Stock pursuant to the present terms of the Preferred Stock. The Company and the holders of the Preferred Stock have been negotiating revised Preferred Stock terms to eliminate the cash redemption feature of the present Preferred Stock terms. No assurance can be given that the Company will be able to eliminate the cash redemption feature or otherwise obtain more favorable Preferred Stock terms. Such revised terms could be very dilutive to the Company's present Common Stock shareholders. Any attempted conversion of Preferred Stock could have a significant material adverse effect on the Company if no alternative arrangements could be reached with the Company's holders of Preferred Stock. The material adverse effects which could occur include, but are not limited to: liquidation of all or part of the Company's assets or sale of additional Common Stock at a discount. LACK OF PROFITABILITY - The Company has had losses of $5.4 million in fiscal 1998, $2.9 million in fiscal 1997, and $6.2 million in fiscal 1996. The Company has not had a profitable quarter since the fourth quarter of fiscal 1997 and does not expect to be profitable until the second quarter of fiscal 1999 at the earliest, if at all. - 16 - 17 DEVELOPMENT RISKS - Although the Company was formed in 1991, the Company continues to face the risks, expenses and difficulties frequently encountered by new and expanding businesses, including, but not limited to, negative cash flow, initial high development costs of new products without corresponding sales pending receipt of corporate and product regulatory approvals and market introduction and acceptance of new products. There is no assurance that the Company's products will be accepted in the marketplace and that regulatory approvals will be obtained. PRODUCT ACCEPTANCE - The Company's success as a gaming machine manufacturer and supplier is dependent upon numerous factors, including its ability to design, manufacture, market and service gaming machines that achieve player and casino acceptance while maintaining product quality and acceptable margins and to compete against gaming machine suppliers with greater financial resources, name recognition and established service networks and customer relationships. To date, the sales of the Company's multi-player games have been significantly lower than anticipated by the Company. In order to diversify and expand sales, the Company has begun licensing, marketing and selling single player games such as Bonus Streak and Mythical Reels. Additionally, the Company has begun the development of other single player games such as Revolving Rings. There can be no assurance that such single player games will be accepted by the market. The Company believes that it will need to develop gaming machines that offer technological advantages or unique entertainment features in order for the Company to be able to compete effectively in the gaming machine market. - 17 - 18 DEPENDENCE ON CUSTOMERS During 1998, a substantial portion of the Company's sales were to one customer, Aristocrat Leisure Industries ("Aristocrat") an Australian-based distributor, which accounted for approximately 54% of sales. Due to the declining multi-player game sales in their territory, the Company's sales to this distributor declined in 1998, and the Company has not forecasted sales to this customer in 1999. Although the Company is attempting to diversify its customer base, no assurance can be given that the Company will be successful in such diversification. The reduction of sales to Aristocrat could have a material adverse impact on the Company if the Company is unable to successfully diversify its customer base. GOVERNMENT REGULATION The manufacture and distribution of gaming machines are subject to extensive federal, state, provincial, tribal, international and local regulation. These regulations are constantly changing and evolving, and may permit additional gaming or curtail gaming in various jurisdictions in the future, which may have a material adverse impact on the Company. The Company and its key personnel undergo extensive investigation before each jurisdictional license is issued. The Company's gaming machines are subjected to independent testing and evaluation prior to approval from each jurisdiction in which the Company does business. Generally, regulatory authorities have broad discretion when granting, renewing or revoking such game approvals and licenses. The failure of the Company, any of its key personnel, or its gaming machines to obtain or retain a license in any jurisdiction could have a material adverse effect on the Company or on the ability of the Company, its key personnel, and its gaming machines to obtain or retain required licenses in other jurisdictions. If the Company enters into lease participation agreements under which the Company shares in the revenues generated by gaming machines, the Company may be subject to additional regulation as a gaming operator. Regulatory authorities may require significant shareholders to submit to background investigations and respond to questions from regulatory authorities, and may deny a license or revoke the Company's licenses based upon their findings. See "Regulation", for additional discussion regarding governmental regulation. RAPIDLY CHANGING TECHNOLOGY - The Company's business is characterized by rapidly changing technology and frequent new product introductions and enhancements. The Company's success will depend in part on its ability to continue to enhance its existing products and to introduce in a timely manner new products that meet existing and future regulatory requirements and evolving customer requirements and to achieve market acceptance. There can be no assurance that the Company will be successful in identifying, developing and marketing new products or enhancing its existing products. The Company's business will be adversely affected if the Company experiences delays in developing new products or enhancements or if such products or enhancements do not meet and receive all regulatory approvals and/or gain customer acceptance. FACTORS AFFECTING PROFITABILITY AND GROWTH - All of the Company's revenues are derived from the gaming industry. The growth of the Company's business is substantially dependent upon factors that are beyond the control of the Company, including, among others, the pace of development, changes in - 18 - 19 gaming regulation, expansion and renovation of casinos and other forms of casino gaming in new jurisdictions, and the continued popularity of casino gaming as a leisure activity. The expansion of the gaming industry has slowed in recent years and the continued expansion of gaming markets is dependent upon political, legal and other factors, which are beyond the control of the Company. As a result of these and other factors, there is no assurance of the Company's continued growth or profitability. DEPENDENCE UPON RELATIONSHIP WITH VENDORS, SUPPLIERS AND DISTRIBUTORS- A significant interruption or delay in the delivery of components from suppliers or the loss of a significant distributor could have a material adverse effect on the Company's results of operations. PRODUCT PROTECTION - The Company's products are technology-based and as such, the Company faces several intellectual property risks. The Company's business is dependent upon its ability to protect its proprietary software, hardware and other intellectual property. The Company relies primarily on a combination of non-disclosure agreements for its key employees, license agreements with its customers and suppliers and trade secret protection to protect such intellectual property. Despite the Company's precautions, it may be possible for unauthorized parties to copy or to "reverse engineer" certain portions of the Company's products or to obtain and use information that the Company believes is proprietary, Therefore, there is no assurance that precautionary steps taken by the Company in this regard will be adequate to deter misappropriation of its intellectual property or independent third party development of functionally equivalent products or that the Company can meaningfully protect its rights to such proprietary intellectual property. The Company relies on a combination of patent, trade secret, copyright and trademark law, nondisclosure agreements and technical security measures to protect its rights pertaining to its products. The Company holds patents for its blackjack, craps and roulette machines. There can be no assurance that such patents are valid. The Company may file for patents on certain features of products that the Company may develop in the future. No assurance can be given that, if applied for, any patents will be issued, or, if issued, that such patents will be valid or will provide any significant competitive protection for such products. Only certain features of the Company's blackjack, craps, and any other products the Company may develop in the future may be eligible for patent protection. Such protection may not preclude competitors from developing products with features similar to the Company's products. Second, although the Company is not aware of any infringement, the Company may be subject to claims from third parties alleging that the Company has infringed the proprietary intellectual property of such third parties. Such claims could have a material adverse effect on the Company given the costs associated with intellectual property litigation, the potential diversion of Management's resources to litigation and the risk of some injunction or other delay in the offering of the Company's products. See "Business - Intellectual Property" for additional discussion regarding product protection. REVENUE VOLATILITY - The Company's operating results have varied substantially from quarter to quarter. Revenues in any quarter are substantially dependent on regulatory approval, receipt of orders and delivery and installation in that quarter. Because the Company's staffing and operating expenses are based on anticipated revenue levels, and a high percentage of the Company's costs are fixed, in the short-term, the loss of any one order, or the failure to obtain new orders as existing orders are completed, could have a material adverse effect or cause significant fluctuations in the Company's revenues and cash flow from quarter to quarter. - 19 - 20 STOCK PRICE VOLATILITY AND NASDAQ LISTING - The market price of the Company's Common Stock has been highly volatile. In order to maintain its listing on the NASDAQ National Market, the Company must maintain a closing sales price of at least $1.00 per share for a certain period of time. Since January 2, 1999, the Company's Common Stock has traded in the range of $0.81 to $1.44 per share, reaching a low of $0.81 on January 14, 1999. No assurance can be given that the Company's Common Stock will continue to trade above the NASDAQ National Market minimum requirements or that the Company can maintain its NASDAQ National Market listing. If the Company fails to maintain the NASDAQ standards for quotation, the Company's Common Stock could be traded in the over-the-counter market, which would make it more difficult to dispose of, or obtain accurate quotations as to the price of the Company's Common Stock. In addition, the Company could then be subject to certain rules of the Securities and Exchange Commission relating to "penny stocks". Such rules require broker-dealers to make a suitability determination for purchasers and to receive the purchaser's prior written consent for a purchase transaction, thus restricting the ability of purchasers and broker-dealers to sell the stock in the open market. DEPENDENCE ON KEY PERSONNEL - The Company is highly dependent upon the personal efforts and abilities of certain key personnel. The loss of the services of any member of management could have a substantial adverse effect on the Company. UNDESIGNATED STOCK - The Board of Directors, without action by the Company's shareholders, is authorized to designate and issue shares in such classes or series (including classes or series of preferred stock) as it deems appropriate and to establish the rights, preferences and privileges of such shares, including dividends, liquidation and voting rights. The rights of holders of preferred stock and other classes of commons stock that may be issued may be superior to the rights granted to the holders of the Company's Common Stock. Further, the ability of the Board of Directors to designate and issue such undesignated shares could impede or deter an unsolicited tender offer or takeover proposal regarding the Company, and the issuance of additional shares having preferential rights could adversely affect the voting power and other rights of holders of Common Stock. - 20 - 21 ITEM 2. PROPERTIES The Company leases approximately 53,100 square feet of warehouse and office space in Reno, Nevada for its main facility, which includes administrative, sales, manufacturing and warehousing operations. The rent under the lease, which expires in October 2001, was approximately $234,000 in 1998, with provisions for annual rent increases. The Company also leases approximately 2,400 square feet of office and warehouse space in Las Vegas, Nevada for sales and service operations. The rent under the lease, which expires in July 1999, is approximately $26,000 annually. ITEM 3. LEGAL PROCEEDINGS The Company is not a party to any material litigation and is not aware of any threatened litigation that would have a material adverse effect on its business. ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS No matter was submitted to a vote of the Company's security holders during the fourth quarter of the fiscal year ended December 31, 1998. EXECUTIVE OFFICERS OF THE REGISTRANT EDWARD G. STEVENSON, AGE 52, has been the Chairman of the Board and Chief Executive Officer since June 1998, and served as President of the Company from February 1996 to October 1998. Prior to joining the Company, Mr. Stevenson served as the President and Chief Operating Officer of Little Six, Inc. d/b/a Mystic Lake Casino in Minneapolis, from January 1995 to March 1996. From 1988-1991 and from October 1992 to January 1995, Mr. Stevenson was the President of CMS International/Summit Casinos of Reno, Nevada. BARRETT V. JOHNSON, AGE 66, joined the Company as Vice President of Engineering in January 1998, and was named President and Chief Operating Officer in October 1998. Prior to joining the Company, Mr. Johnson held the positions of Vice President of Operations and then Director/President of Aristocrat, Inc. from 1993 to 1997. From 1987 to 1993, Mr. Johnson progressed through a variety of positions from Service Technician to General Manager of Universal Distributing of Nevada, Inc. Prior to entering the gaming industry, Mr. Johnson served in the United State Air Force for 30 years. SCOTT H. SHACKELTON, AGE 49, has been Vice President, Chief Financial Officer and Secretary since June 1996. Prior to joining the Company, Mr. Shackelton served as Vice President, Controller and Treasurer of International Game Technology from December 1981 to May 1996. - 21 - 22 PART II ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS PRICE RANGE OF COMMON STOCK Since May 28, 1993, the date of the Company's initial public offering, through September 20, 1994, the Company's Common Stock was traded on NASDAQ Small-Cap Market under the ticker symbol "IGCA". On September 21, 1994 the Company's Common Stock began trading on the NASDAQ National Market. The following table summarizes the high and low prices per share of the Common Stock for the periods indicated as reported on the NASDAQ SmallCap Market or the NASDAQ National Market:
HIGH LOW FYE 12/31/97 First Quarter $6.94 $4.75 Second Quarter 6.00 4.13 Third Quarter 5.75 4.75 Fourth Quarter 4.94 2.13 FYE 12/31/98 First Quarter $4.38 $2.25 Second Quarter 4.13 2.25 Third Quarter 3.88 2.00 Fourth Quarter 2.00 1.00
The Company has never declared or paid any dividends on its Common Stock, and the Board of Directors presently intends to retain all earnings, if any, for use in the Company's business for the foreseeable future. Any future determination as to declaration and payment of dividends will be made at the discretion of the Board of Directors. On March 19, 1999, the last reported sale price for the Common Stock was $1.13 per share. As of March 19, 1999, the Company had 110 shareholders of record and approximately 1,800 beneficial shareholders of Common Stock. - 22 - 23 ITEM 6. SELECTED FINANCIAL DATA The following is a summary of certain consolidated statement of operations, cash flow and balance sheet information for the Company as of and for the years ended December 31, 1998, 1997, 1996 and 1995, and the five months ended December 31, 1994. The following financial information should be read in conjunction with "Management's Discussion and Analysis of Financial Condition and Results of Operations," and the Consolidated Financial Statements of Innovative Gaming Corporation of America and Subsidiary (in thousands except per share data).
For the Year For the Year For the Year For the Year For the Five Ended Ended Ended Ended Months Ended December 31, December 31, December 31, December 31, December 31, 1998 1997 1996 1995 1994 ------------ ------------ ------------ ------------ ------------ Statement of operations data: Net sales $ 8,509 $ 10,292 $ 2,664 $ 6,352 $ 470 Gross profit 1,375 3,103 529 1,589 199 Operating loss (4,444) (2,182) (6,592) (2,765) (2,179) Net loss (5,058) (1,935) (6,179) (2,114) (1,129) Net loss per common share (0.72) (0.43) (0.97) (0.38) (0.20) Cash flow data: Cash provided by (used for): Operating activities (2,106) (7,516) (2,726) 591 (1,226) Investing activities (92) 555 3,784 (4,399) (1,033) Financing activities 3,297 4,486 1,038 (87) (1,044) Increase (decrease) in cash and cash equivalents 1,099 (2,475) 2,096 (3,895) (3,303) Balance sheet data (end of period): Cash, cash equivalents and available-for-sale securities 1,617 518 5,959 8,749 5,796 Working capital 12,100 12,603 11,996 16,039 17,616 Total assets 17,093 19,181 15,976 18,929 21,417 Long-term debt (net of current maturities) 856 509 - - 5 Redeemable Preferred Stock - - - - 983 Total stockholders' equity 14,872 17,202 15,450 18,531 19,693
- 23 - 24 ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS The following discussion and this Form 10-K contains forward-looking statements that involve risks and uncertainties relating to future events. Actual events or the Company's results may differ materially from those discussed in such forward-looking statements. Factors that might cause actual results to differ from those indicated by such forward-looking statements include, but are not limited to: customer acceptance of the Company's products, need for additional financing, Preferred Stock conversions, decline in demand for gaming products or reduction in the growth rate of new markets, failure or delay in obtaining gaming regulatory approvals, delays in developing or manufacturing new products, delays in orders and shipment of products, changing economic conditions, approval of pending patent applications or infringement upon existing patents, the effects of regulatory and governmental actions and increased competition. OVERVIEW - The Company was formed in 1991 to develop, manufacture, market and distribute multi-player and other specialty video gaming machines. The Company manufactures, markets and distributes BJ Blitz(TM), Hot Shot Dice(TM), Lightning Strike Roulette(TM), Supersuits Progressive Blackjack(TM) and Bonus Streak(TM) to certain gaming markets worldwide. Since inception, the Company has focused most of its resources on the development of games, the regulatory approval process and the sale and installation of its games. The Company has begun to expand and diversify its product line by developing and marketing single player games such as Bonus Streak and Mythical Reels. REGULATION - The Company distributes its products both directly to the gaming marketplace and through licensed agents and distributors. The Company is currently licensed and/or has the necessary regulatory approvals as a gaming product manufacturer and distributor in Nevada, Colorado, Mississippi, Louisiana, North Carolina, Minnesota, Iowa, Arizona, certain New Mexico tribal jurisdictions, Quebec and the Atlantic Lottery (four Canadian Maritime provinces). In certain jurisdictions where the Company is licensed, such as Arizona and Colorado, the Company may elect to market its products through a licensed distributor pursuant to any necessary regulatory approvals. In certain jurisdictions where licensure is not required, such as Australia, the Company may use an existing licensed distributor to sell its products pursuant to any necessary regulatory transaction approvals. The Company has obtained approval to sell gaming devices in Alberta, Manitoba, Saskatchewan and has applications pending in British Columbia, Ontario, South Dakota, Connecticut and New Jersey. As of March 1999, technical game approvals are being sought by the Company and/or its distributor in France, Quebec and the Atlantic Lottery. The Company intends to apply for necessary licenses or approvals in other jurisdictions both domestically and internationally where gaming is permitted. In order to expedite the timing of gaming regulatory approval in certain jurisdictions on a timetable acceptable to Management, the Company in March 1999, redeemed 400,000 shares of Common Stock from another shareholder who beneficially owned in excess of 5% of the Company's outstanding Common Stock in exchange for a four year convertible note and a warrant to purchase 50,000 shares of the Company's Common Stock. See "Common Stock Redemption" and Item 1 - "Business - Regulation." DISTRIBUTORS - In February 1996, the Company entered into a five-year distribution agreement with Aristocrat Leisure Industries of New South Wales, Australia to exclusively market and distribute the Company's multi-station products in Australia, New Zealand and surrounding gaming markets. Sales to this Australian distributor declined in the third and particularly fourth quarters of 1998, and the Company has not forecasted sales to this customer in 1999. In March 1996, the Company entered into a three-year exclusive distribution agreement with Ludi S.F.M. of France and its related entity Eurusa, to market and distribute the Company's multi-station products to select western European gaming markets. In January 1997, the Company granted a three-year exclusive distribution license to - 24 - 25 Vista Gaming Corporation to distribute and service the Company's multi-station blackjack and roulette, and Bonus Streak products in Colorado. In March 1998, the Company entered into a one-year business consulting agreement with Jean D. Leclair and the Leclair Group ("Leclair"). Under the agreement Leclair will, in addition to consulting, assist in securing agreements to for the purchase of the Company's products in Quebec and Atlantic Canada. In May 1998, the Company entered into a one-year exclusive agency agreement with Bill Engle to represent certain of the Company's products for sale in specified provinces of Canada. In December 1998, the Company granted a three-year exclusive distribution license to DGS, Inc. to distribute the Company's multi-station blackjack and 21 Stud products in South Carolina. . In January 1999, the Company granted a two-year exclusive distribution license to Par 4 to distribute certain of the Company's products in Atlantic City, New Jersey and Connecticut, subject to the Company's approval to sell products and approval of its products. RELATIONSHIP WITH LAKES GAMING, INC. - Lakes Gaming, Inc. ("LGI") (formerly Grand Casinos, Inc.) is in the business of managing and developing casinos. Under an existing machine purchase agreement, LGI may purchase up to an aggregate of 125 of the Company's multi-station blackjack, craps and roulette games in quantity purchases at distributor level prices. Pursuant to this agreement, the Company has sold 42 blackjack machines, 11 craps machines and 8 roulette machines. Previous quantity sales were also made to LGI at distributor level prices for the purpose of testing, evaluating and marketing the Company's blackjack, craps and roulette games. Under an agreement between the Company and LGI, used multi-player machines which LGI previously purchased from the Company may be placed on consignment with the Company to be refurbished and sold into legal markets. The proceeds from sales of up to three of the consignment games may be applied to the purchase of one new Bonus Streak game from the Company and minimum proceeds of $5,000 must be credited to LGI for each game sold by the Company. There are potentially 31 such used multi-player games which LGI may submit the Company for sale under the consignment agreement. Through December 31, 1998, 17 such used multi-player games were submitted to the Company on consignment under this agreement. The Company made no multi-station machine sales to LGI during 1997. The Company sold six Bonus Streak games and no multi-station machines to LGI in 1998. OTHER - On February 2, 1996, the Company completed the acquisition of all remaining patents, trademarks, copyrights and other intellectual property related to its games from its principal supplier. The Company also signed an agreement to receive discounted pricing on key game components for a two-year period, which is expected to lower its per game manufacturing costs. The Company will receive deliveries under this agreement until July 1999. - 25 - 26 RESULTS OF OPERATIONS FOR THE YEAR ENDED DECEMBER 31, 1998 COMPARED TO THE YEAR ENDED DECEMBER 31, 1997. For the year ended December 31, 1998, the Company reported a net loss of $5,430,000, or $.72 per share, compared to a net loss of $2,889,000, or $.43 per share, for the year ended December 31, 1997. Results from operations for both years have been adjusted for preferred stock accretion and preferred stock dividends paid. The greater loss in 1998 was primarily due to a decline in revenues and gross profit, a tax provision recorded to provide a full valuation allowance on the Company's deferred tax asset and higher expenses for engineering and product development. SALES, COST OF SALES AND GROSS PROFIT Sales decreased to $8,509,000 during the year ended December 31, 1998 compared to $10,292,000 in the year ended December 31, 1997, due to a decrease in multi-station machine sales from 166 in 1997 to 123 in 1998. This decrease was partially offset by an increase in sales of single player Bonus Streak games from 6 in 1997 to 53 in 1998. The following table presents the comparative sales revenue and percentage of revenue derived from each of the Company's product lines for the years ending December 31, 1998 and 1997:
Year ended Year ended December 31, 1998 December 31, 1997 ------------------- ----------------- Sales revenue $ 8,509,000 $10,292,000 =========== =========== Product line: Percentage of Percentage of revenue: revenue: Multi-player games 78% 92% Single player games 9% 1% Parts sales and other 8% 4% Lease participation 5% 3% ----------- ----------- Total 100% 100% =========== ===========
The Company was granted technical game approval of its blackjack machine in Colorado and its three multi-player video machines in Nevada in early 1997, allowing the Company to pursue placement of its products in those jurisdictions. In the third quarter of 1997, the Company's multi-station blackjack and roulette games received interim approval for use in the club market of New South Wales, Australia. Subsequent to receiving such approval, the Company's Australian distributor commenced marketing the Company's products in this market. The decline in multi-station machine sales is partially attributable to reduced purchases by this distributor in 1998. A total of 86 machines were sold to this distributor in 1998, with the majority of those sales occurring in the first and second quarters, compared to 99 machines in 1997. Due to the declining multi-player game sales in their territory, sales to this distributor declined, particularly in the third and fourth quarters of 1998, and the Company has not forecasted sales to this customer in 1999. Also contributing to the decreased revenue were sales to a North Carolina casino, which purchased 12 machines in 1998 compared to 30 machines in 1997. Delays in acquiring required gaming licenses in key gaming jurisdictions have limited the markets available to expand sales of the Company's products in 1998. During 1997 and 1998, the Company has continued its efforts to expand its markets by pursuing licensing in new jurisdictions, however, sales will continue to be volatile until, among other things, the Company obtains new jurisdictional licenses, marketing efforts are successfully completed and products are accepted by the market place. - 26 - 27 The Company also recognized lease/participation revenues in 1998 attributable to placement of games in Colorado and Nevada casinos. In Nevada, game placements under lease/participation agreements have been slower than originally expected due to increasing customer resistance with participation arrangements. The Company has expanded its marketing strategy in Nevada to attract a greater number of casino operators by also offering its games for sale. To date, game placements in Nevada have been fewer than anticipated by management. The gross margin in 1998 was 16.2% compared to 30.1% in 1997. The lower gross margin in 1998 was primarily due to unabsorbed labor and overhead costs attributable to lower production volume in the second half of the year. In the years ended December 31, 1998 and 1997, there were no sales to LGI under their discounted price arrangement. SELLING, GENERAL AND ADMINISTRATIVE EXPENSES Selling, general and administrative expense for the year ended December 31, 1998 was $5,819,000 compared to $5,285,000 during fiscal year 1997. This increase in expense is primarily attributable to higher expenditures for engineering and development costs for new product development. Expenses also increased for professional fees, particularly legal fees and other costs associated with licensing and product approvals. INTEREST INCOME Interest income for the year December 31, 1998 was $106,000 compared to $247,000 for fiscal year 1997. This interest income decrease was due to reduced amounts invested in interest bearing accounts, including interest bearing notes receivable from the sale of product. PROVISION FOR INCOME TAXES In accordance with Statement of Financial Accounting Standards No. 109 - "Accounting for Income Taxes"- (SFAS No. 109), the Company recorded a $720,000 provision for income taxes during the year ended December 31, 1998 to provide a full valuation allowance on its deferred tax asset. As required by SFAS No. 109, and taking into consideration past losses and the ability of the Company to "more likely than not" realize such benefit, the Company recorded the additional valuation reserve. PREFERRED STOCK ACCRETION ADJUSTMENT On May 13, 1998, the Company issued 3,000 shares of Series B Convertible Preferred Stock (the "Series B Preferred Stock") at a price of $1,000 per share in a private placement (see Note 7 of Notes to Consolidated Financial Statements). The Series B Preferred Stock is convertible into shares of the Company's Common Stock at a conversion price of 91% of the average closing bid price of the Company's Common Stock of the three consecutive day average of the lowest closing bid price of the Company's Common Stock over the twenty-day trading period ending the day prior to conversion. The intrinsic value of the beneficial conversion feature was $296,703, which was accreted to Series B Preferred Stock and charged against net income or loss to arrive at net income or loss attributable to common shareholders over the period in which the right to convert the Preferred Stock became vested. The $296,703 value of the beneficial conversion feature was recognized during the second, third and fourth quarters of 1998. On April 11, 1997, the Company issued 4,000 shares of Series A Convertible Preferred Stock (the "Series A Preferred Stock") at a price of $1,000 per share in a private placement (see Note 7 of Notes to Consolidated Financial Statements). The Series A Preferred Stock was convertible into shares of the Company's Common Stock at a conversion price of 82% of the average closing bid price of the Company's Common Stock over the ten-day trading period ending the day prior to conversion. The intrinsic value of the beneficial conversion feature was $878,048, which was accreted to Preferred Stock and charged against net income or loss to arrive at net income or loss attributable to common shareholders over the period in which the right to convert the Preferred Stock became vested. The $878,048 value of the beneficial conversion feature was recognized during the second and third quarters of 1997. - 27 - 28 RESULTS OF OPERATIONS FOR THE YEAR ENDED DECEMBER 31, 1997 COMPARED TO THE YEAR ENDED DECEMBER 31, 1996. For the year ended December 31, 1997, the Company reported a net loss of $2,889,000, or $.43 per share, compared to a net loss of $6,179,000, or $.97 per share, for the year ended December 31, 1996. For the 1997 period, results from operations have been adjusted for preferred stock accretion and preferred stock dividends paid. The greater loss in 1996 was primarily due to a one time restructuring charge of $1,716,000 and lower sales volume. SALES, COST OF SALES AND GROSS PROFIT Sales increased to $10,292,000 during the year ended December 31, 1997 compared to $2,664,000 in the year ended December 31, 1996, due to an increase in unit sales from 33 in 1996 to 172 in 1997. The following table presents the comparative sales revenue and percentage of revenue derived from each of the Company's product lines for the years ending December 31, 1997 and 1996:
Year ended Year ended December 31, 1997 December 31, 1996 ------------------- ----------------- Sales revenue $10,292,000 $2,664,000 =========== ========== Product line: Percentage of Percentage of revenue: revenue: Multi-player games 92% 91% Single player games 1% - % Parts sales and other 4% 9% Lease participation 3% - % ---- --- Total 100% 100% ==== ===
Delays in acquiring required gaming licenses in key gaming jurisdictions limited the markets available to sell the Company's products in 1996. The Company was granted technical game approval of its blackjack machine in Colorado and its three multi-player video machines in Nevada in early 1997, allowing the Company to pursue placement of its products in those jurisdictions. In the third quarter of 1997, the Company's multi-station blackjack and roulette games received interim approval for use in the club market of New South Wales, Australia. Subsequent to receiving such approval, the Company's Australian distributor commenced marketing the Company's products in this market. A total of 99 games were sold to the Australian distributor in 1997. Also contributing to the increased revenue were sales of 30 games, representing replacements and additional games, to a North Carolina casino. The gross margin in 1997 was 30.1% compared to 19.8% in 1996. The improved gross margin in 1997 is primarily attributable to lower cost of games due to design changes to reduce production costs, purchasing materials domestically at more competitive prices than were previously paid to foreign sources, and increased direct customer sales versus discounted sales to distributors. In 1996, all of the games sold by the Company were to distributors, which generally yield lower gross margins than direct sales. Additionally, the product sales mix in 1996 was comprised primarily of lower margin products. In the years ended December 31, 1997 and 1996, there were no sales to LGI under their discounted price arrangement. SELLING, GENERAL AND ADMINISTRATIVE EXPENSES Selling, general and administrative expense for the year ended December 31, 1997 was $5,285,000 compared to $5,405,000 during fiscal year 1996. The decrease is attributable primarily to increased productivity resulting in expenses being incorporated into the cost of assembled games. During 1996, expenses incurred in establishing the production operation were charged to operating expense. In 1997, when production operations commenced, the costs were included in cost of sales as labor and overhead included in the products assembled and sold. This expense reduction more than offset increased product development, marketing and administrative expenses. - 28 - 29 INTEREST INCOME Interest income for the year December 31, 1997 was $247,000 compared to $568,000 for fiscal year 1996. This interest income decrease was due to reduced amounts invested in interest bearing accounts, including interest bearing notes receivable from the sale of product. PREFERRED STOCK ACCRETION ADJUSTMENT On April 11, 1997, the Company issued 4,000 shares of Series A Convertible Preferred Stock (the "Preferred Stock") at a price of $1,000 per share in a private placement (see Note 7 of Notes to Consolidated Financial Statements). The Preferred Stock was convertible into shares of the Company's Common Stock at a conversion price of 82% of the average closing bid price of the Company's Common Stock over the ten-day trading period ending the day prior to conversion. The intrinsic value of the beneficial conversion feature was $878,048, which was accreted to Preferred Stock and charged against net income or loss to arrive at net income or loss attributable to common shareholders over the period in which the right to convert the Preferred Stock became vested. The $878,048 value of the beneficial conversion feature was recognized during the second and third quarters of 1997. LIQUIDITY AND CAPITAL RESOURCES PREFERRED STOCK ISSUES On May 13, 1998, the Company issued 3,000 shares of Series B Convertible Preferred Stock (the "Preferred Stock") at a price of $1,000 per share in a private placement for total proceeds of $3,000,000. The Company received net proceeds of approximately $2,804,000 after the payment of fees and expenses associated with such private placement. An annual dividend of 4% shall be paid quarterly in arrears either in Preferred Stock of the Company or cash at the Company's discretion. Each share of Preferred Stock is convertible into shares of the Company's Common Stock at a conversion price of 91% of the three consecutive day average of the lowest closing bid price of the Company's Common Stock over the twenty-day trading period ending the day prior to conversion (the "Conversion Price"). The Conversion Price may not exceed $5.16, which represents 135 % of the ten day average of the closing bid price of the Company's Common Stock ending on May 12, 1998. The maximum number of shares of Common Stock that may be issued upon conversion is 1,505,000. In the event there is a holder of Preferred Stock that is unable to convert shares of Preferred Stock into Common Stock at a discount because either a) 1,505,000 shares have been issued at a discount or b) such holder would beneficially own in excess of 4.9% of the Company's Common Stock, then the Company may either 1) redeem any unconverted Preferred Stock for cash at a price equal to 115% of the liquidation value of the shares or 2) convert such unconverted shares without a discount into Common Stock and pay cash to the holder of such unconverted shares equal to the economic value that would have been received by such holder if able to convert at a discount. The Company has the right to redeem the Preferred Stock at 115% of par in cash. As of December 31, 1998, all of the Preferred Stock was convertible into Common Stock, at the election of the holder thereof. All outstanding shares of Preferred Stock will automatically be converted into Common Stock on November 13, 1999. A holder of Preferred Stock may not convert such stock into Common Stock if, following such conversion, the holder beneficially owns in excess of 4.9% of the Company's Common Stock. As of December 31, 1998, no Preferred Stock had been converted into Common Stock. A Registration Statement related to the Common Stock was filed by, and at the expense of, the Company pursuant to obligations contained in a Registration Rights Agreement dated May 13, 1998. The effective date of the Registration Statement filed with the Securities and Exchange Commission was September 3, 1998, and all necessary gaming regulatory approvals have been received. - 29 - 30 Through March 30, 1999, $2.85 million of Preferred Stock had not yet been converted into the Company's Common Stock. As of March 30, 1999, the Company also had cash and cash equivalents of approximately $650,000. If the holders of the Company's Preferred Stock were to attempt to convert on such date, the Company would be required to issue 1,339,036 shares of Common Stock at $.91 per share (91% of the closing sales price on such date), and issue 438,652 shares of Common Stock at $3.375 (the closing sales price of the Company's Common Stock on the date the Preferred Stock was issued) and pay approximately $1.1 million to the holders of the unconverted Preferred Stock pursuant to the present terms of the Preferred Stock. The Company and the holders of the Preferred Stock have been negotiating revised Preferred Stock terms to eliminate the cash redemption feature of the present Preferred Stock terms. No assurance can be given that the Company will be able to eliminate the cash redemption feature or otherwise obtain more favorable Preferred Stock terms. Such revised terms could be very dilutive to the Company's present Common Stock shareholders. Any attempted conversion of Preferred Stock could have a significant material adverse effect on the Company if no alternative arrangements could be reached with the Company's holders of Preferred Stock. The material adverse effects which could occur include, but are not limited to: liquidation of all or part of the Company's assets or sale of additional Common Stock at a discount. The 9% beneficial conversion feature is accounted for as an additional Preferred Stock dividend, which was determined on the date the Preferred Stock was issued. The total value of the beneficial conversion feature or dividend is $296,703, which reduces income available for holders of the Company's Common Stock and therefore reduces earnings per share on a pro rata basis over the period from issuance of the Preferred Stock to the earliest conversion date. The $296,703 value of the beneficial conversion feature was recognized during the second, third and fourth quarters of 1998. INVENTORY As of December 31, 1998, inventories totaled $9.4 million, approximately 1.3 times the amount recorded as cost of sales in 1998. This level of inventory was due to lower than expected product sales and fewer than expected placements of games in casinos on a participation basis during 1998. Additionally, sales to the Company's Australian distributor were lower than expected, particularly in the third and fourth quarters when this distributor failed to order games in accordance with forecasts previously provided to the Company. The Company had relied on the forecasts provided by the distributor as a basis for making inventory purchases. Additionally, placements of games in Nevada casinos were fewer than planned as the Company met with resistance to placement of games under revenue sharing agreements. The Company has subsequently revised its marketing strategies to include the option of selling games to casinos in Nevada. Management has evaluated the composition of the inventory for product marketability under its current business plan and recorded reserves to reduce the carrying value to a level it believes is realizable. The Company had long-term debt of $856,000 as of December 31, 1998. LIQUIDITY The Company had $1,617,000 and $518,000 in cash, cash equivalents and available-for-sale securities as of December 31, 1998 and December 31, 1997, respectively. The Company has experienced negative cash flow from operations of $2.1 million, $7.5 million and $2.7 million for the years ended December 31, 1998, 1997 and 1996, respectively. In addition, sales in the first quarter of 1999 have been below managements expectations. As of March 30, 1999, the Company had cash and cash equivalent's of approximately $650,000. Management believes, assuming it can achieve its sales forecasts which exceed current sales rates, it will have sufficient cash to fund operations through mid 1999. However, if sales remain at or below their current levels and the Company does not reduce its operating expenses consistent with its sales level, operations will only be funded May 1999. Management has taken certain steps to address their future liquidity and cash flow requirements by entering into a loan commitment to borrow approximately $675,000, on a secured basis, from a third party lender in late March 1999 in addition to attempting to control costs through inventory reductions and other measures. With this financing the Company estimates that its current level of cash and anticipated funds from operations will be adequate to fund cash requirements through 1999, which assumes market acceptance of new games (which cannot be assured). No assurance can be given that this loan will close on a timely basis, if at all, or on the terms contained in the loan commitment letter with such lender. Failure to close on this loan in a timely basis could have a material adverse effect on the Company. In the absence of alternative financing, the Company would have to consider significantly reducing operations, in addition to liquidating all or a portion of the Company's assets. To the extent that the Company does significantly reduce operations, it would have a material adverse effect on the Company's ability to meet its short term revenue projections and would negatively impact the ability to obtain additional financing. Furthermore, to the extent that the Company's revenues are less than anticipated, the Company may require additional short-term financing, which may not be available. Furthermore, if the Company is required to make a cash payment to redeem any unconverted shares of Preferred Stock, the Company would be unable to make such cash redemption given its current capital resources and would have to consider a liquidation of all or part of the Company's assets or sale of additional common stock at a discount. Additionally, the costly process of product development and introduction may require the Company to seek additional financing to successfully complete any such future development and introduction. There can be no assurance that the Company will be successful in obtaining any additional financing on terms acceptable to the Company if such need arises. Additionally, the Company has taken steps to reduce operating costs. - 30 - 31 COMMON STOCK REDEMPTION In March 1999, in order to expedite the timing of gaming regulatory approval in certain jurisdictions, the Company repurchased 400,000 shares of its outstanding Common Stock, at market price, from a shareholder. The Company entered into a Stock Redemption Agreement with such shareholder pursuant to which the Company redeemed 400,000 shares of Company Common Stock beneficially owned by such shareholder in exchange for a four year convertible note and a warrant to purchase 50,000 shares of the Company's Common Stock. The note is unsecured, paying interest of 5% per annum and will be convertible at the closing market price of the Company's Common Stock on the date of the issuance of the note. The note may not be converted in the first year following issuance. The exercise price of the warrant will be the same as the conversion price of the note. The Company also granted "piggyback" registration rights for shares of Common Stock issuable upon conversion of both the note and the warrant. See Item 1. -- "Business -- Regulation." OTHER In light of the Company's lack of long-term liquidity, the Company retained the investment banking firm of Gerald Klauer Mattison & Co., Inc. on January 5, 1999, to analyze the Company's strategic alternatives, including finding a strategic partner for the Company for a potential sale, joint venture, merger or other form of business combination. Such engagement letter terminates June 30, 1999. At December 31, 1998, Company had a $500,000 standby letter of credit primarily to facilitate acquisition of components and supplies from a foreign vendor. As of December 31, 1998, no amount was outstanding. The facility is collateralized by short-term investments of the Company. Gains and losses on foreign currency transactions are recognized currently in earnings. The Company's revenues from foreign markets are expected to increase in the future, further subjecting the Company to the effects of fluctuations in exchange rates. The Company does not consider this to be a significant risk at this time. YEAR 2000 UPDATE As of December 31, 1998, the Company continued its assessment to identify and evaluate the risks of the Year 2000 issue. The Company's Year 2000 assessment considered the following: (1) the Company's products; (2) the manufacturing process of the products; (3) the Company's vendors and suppliers of materials utilized in either the Company's gaming machine products or the manufacturing process; (4) the Company's internal business information and accounting systems and (5) the Company's principal customers. To implement its assessment, the Company assigned internal staff to monitor and facilitate efficient Year 2000 Compliance. The Company has not utilized third-party consultants to evaluate its Year 2000 readiness. First, none of the Company's products contain software or embedded microprocessors that are time-sensitive. Second, the Company's manufacturing process is not automated to the extent that any part of the process is computerized or relies upon time-sensitive software. The process of manufacturing the Company's games is largely a mechanical process. Third, the Company is seeking to obtain assurance from its primary material vendors and suppliers to determine the extent which the Company is vulnerable to Year 2000 issues because such vendor or supplier is or may not be Year 2000 compliant. With respect to the Company's internal business information and accounting systems, the Company has reviewed its financial reporting systems, IT based and otherwise, to ensure that they are Year 2000 compliant. The Company's software vendors have made assurances that their software is either Year 2000 compliant or that timely updates will be made to ensure that such software will be Year 2000 complaint. In the process of reviewing the Company's internal business information and accounting systems, the Company has determined that some of its personal computers utilized by its corporate staff are not Year 2000 compliant and will have to be replaced. The Company presently anticipates that it will replace such computers by mid-1999. - 31 - 32 Finally, the Company is in the process of evaluating its customers, including major distributors to determine whether such customers Year 2000 readiness could cause a loss of business that could be material to the Company. CONTINGENCY PLANS The Company has not yet seen the need to develop any widespread contingency plans for the Year 2000 issue, but this will continuously be monitored as the Company gains more information about the compliance programs of its vendors and customers. Given that some risks are beyond the control of the Company, the Company does not believe that it can develop a contingency plan that will totally shield the Company from an economic ripple effect throughout the entire economy should others fail to resolve their own Year 2000 problems. COST Based on the Company's current assessment, the costs of addressing potential Year 2000 problems are not expected to be material or have a material adverse impact on the Company's financial position. The current estimated cost of replacing the Company's five or six corporate personal computers should not exceed $15,000. However, the estimated costs relating to the resolution of the Company's Year 2000 compliance issues cannot be fully and finally determined at this time. RISKS While the Company fully anticipates achieving Year 2000 compliance well in advance of January 1, 2000, there are certain risks, which exist with respect to the Company's business and the Year 2000. Those risks range from slight delays and inefficiencies in processing data and carrying out accounting and financial functions to the most reasonable likely worst case scenario, extensive and costly inability to process data, provide vital accounting functions and communicate with customers and suppliers. Furthermore, if significant customers or vendors identify Year 2000 issues in the future and are unable to resolve such issues in a timely manner, it could result in material financial risks. PRIVATE SECURITIES LITIGATION REFORM ACT OF 1995. The foregoing Management's Discussion and Analysis contains various "forward-looking statements" within the meaning of Section 27A of the Securities Act of 1933, as amended, and Sections 21E of the Securities Exchange Act of 1934, as amended, which represent the Company's expectations or beliefs concerning future events, including statements regarding the demand for the Company's products in certain key jurisdictions such as Nevada and Australia. In addition, statements containing expressions such as "believes," "anticipates," "hopeful" or "expects" used in the Company's periodic reports on Forms 10-K and 10-Q filed with the SEC are intended to identify forward looking statements. The Company cautions that these and similar statements included in this report and in previously filed periodic reports including reports filed on Forms 10-K and 10-Q are further qualified by important factors that could cause actual results to differ materially from those in the forward-looking statement, including, without limitation, the following: the inability to successfully develop, license, manufacture and market new products in a timely manner; decline in demand for gaming products or reduction in the growth rate of new markets; increased competition; the effect of economic conditions; a decline in the market acceptability of gaming; ability to obtain additional financing through leasing, equity or other arrangements; political and economic instability in developing international markets; a decrease in the desire of established casinos to upgrade machines in response to added competition from newly constructed casinos; the loss of a distributor; loss or retirement of key executives; approval of pending patent applications or infringement upon existing patents; the effect of regulatory and governmental actions; the Company's expectations as to achieving year 2000 readiness and the cost of achieving such readiness; unfavorable determination of suitability by regulatory authorities with respect to officers, directors or key employees; the limitation, conditioning or suspension of any gaming license; adverse results of significant litigation matters; fluctuation in exchange rates, tariffs and other barriers. Investors are referred to the full discussion of risks and uncertainties associated with forward-looking statements contained in this Form 10-K in ITEM 1. - BUSINESS, under the caption "Certain Factors". Many of the foregoing factors have been discussed in the Company's prior SEC filings and, had the amendments to the Securities Act of 1933 and Securities Exchange Act of 1934 become effective at a different time, would have been discussed in an earlier filing. - 32 - 33 ITEM 8. FINANCIAL STATEMENTS REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS To the Stockholders and Board of Directors of Innovative Gaming Corporation of America: We have audited the accompanying consolidated balance sheet of Innovative Gaming Corporation of America and Subsidiary as of December 31, 1998, and the related consolidated statements of operations, stockholders' equity and cash flows for each of the year then ended. These financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these consolidated financial statements based on our audit. We conducted our audit in accordance with generally accepted auditing standards. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audit provide a reasonable basis for our opinion. In our opinion, the 1998 consolidated financial statements referred to above present fairly, in all material respects, the financial position of Innovative Gaming Corporation of America and Subsidiary as of December 31, 1998, and the results of their operations and their cash flows for the year then ended, in conformity with generally accepted accounting principles. The accompanying consolidated financial statements have been prepared assuming that the Company will continue as a going concern. As discussed in Note 1 to the consolidated financial statements, the Company has suffered recurring negative cash flow from operations that raises substantial doubt about the Company's ability to continue as a going concern. Management's plans in regard to addressing the future liquidity and cash flow requirements of the Company are described in Note 1. The consolidated financial statements do not include any adjustments that might result from the outcome of this uncertainty. Our audit was made for the purpose of forming an opinion on the basic consolidated financial statements taken as a whole. The accompanying schedule is presented for purposes of complying with the Securities and Exchange Commission rules and is not part of the basic financial statements. This schedule has been subjected to the auditing procedures applied in the audit of the basic consolidated financial statements and, in our opinion, fairly states in all material respects the financial data required to be set forth therein in relation to the basic consolidated financial statements taken as a whole. KAFOURY, ARMSTRONG & CO. Reno, Nevada February 26, 1999 - 33 - 34 REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS To the Stockholders and Board of Directors of Innovative Gaming Corporation of America: We have audited the accompanying consolidated balance sheet of Innovative Gaming Corporation of America and Subsidiary as of December 31, 1997, and the related consolidated statements of operations, stockholders' equity and cash flows for each of the two years in the period ended December 31, 1997. These financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these consolidated financial statements based on our audits. We conducted our audits in accordance with generally accepted auditing standards. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion. In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of Innovative Gaming Corporation of America and Subsidiary as of December 31, 1997, and the results of their operations and their cash flows for each of the two years in the period ended December 31, 1997, in conformity with generally accepted accounting principles. The accompanying consolidated financial statements have been prepared assuming that the Company will continue as a going concern. As discussed in Note 1 to the consolidated financial statements, the Company has suffered recurring negative cash flow from operations that raises substantial doubt about the Company's ability to continue as a going concern. Management's plans in regard to addressing the future liquidity and cash flow requirements of the Company are described in Note 1. The consolidated financial statements do not include any adjustments that might result from the outcome of this uncertainty. Our audit was made for the purpose of forming an opinion on the basic consolidated financial statements taken as a whole. The accompanying schedule is presented for purposes of complying with the Securities and Exchange Commission rules and is not part of the basic financial statements. This schedule has been subjected to the auditing procedures applied in the audit of the basic consolidated financial statements and, in our opinion, fairly states in all material respects the financial data required to be set forth therein in relation to the basic consolidated financial statements taken as a whole. ARTHUR ANDERSEN LLP Las Vegas, Nevada March 12, 1998 - 34 - 35 INNOVATIVE GAMING CORPORATION OF AMERICA AND SUBSIDIARY Consolidated Balance Sheets (In Thousands, Except Share Data)
As of December 31, -------------------- 1998 1997 -------- --------- ASSETS CURRENT ASSETS: Cash and cash equivalents $ 1,617 $ 518 Restricted investments 700 1,000 Accounts receivable, net of allowances of $85 and $100 1,186 1,929 Current portion of notes receivable 334 276 Inventories, net 9,244 10,191 Prepaid expenses and other 384 159 -------- -------- Total current assets 13,465 14,073 NOTES RECEIVABLE, less current portion 362 552 PROPERTY AND EQUIPMENT, net 1,389 2,107 DEFERRED INCOME TAXES, net - 720 INTANGIBLES ASSETS, net 1,877 1,729 -------- -------- TOTAL ASSETS $ 17,093 $ 19,181 ======== ======== LIABILITIES AND STOCKHOLDERS' EQUITY CURRENT LIABILITIES: Accounts payable $ 313 $ 568 Accrued liabilities 524 423 Notes payable - current portion 528 322 Customer deposits - 157 -------- -------- Total current liabilities 1,365 1,470 Notes payable - net of current portion 856 509 -------- -------- Total liabilities 2,221 1,979 -------- -------- COMMITMENTS AND CONTINGENCIES (Note 9) - - STOCKHOLDERS' EQUITY: Series B Convertible Preferred Stock, $.01 par value, nonvoting, 4,000 shares authorized, 3,000 and 0 shares outstanding, respectively - - Common stock, $.01 par value, 100,000,000 shares authorized, 7,535,211 shares issued and outstanding 75 75 Additional paid-in capital 32,676 29,575 Accumulated deficit (17,879) (12,448) -------- -------- Total stockholders' equity 14,872 17,202 -------- -------- TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY $ 17,093 $ 19,181 ======== ========
The accompanying notes are an integral part of these consolidated balance sheets. - 35 - 36 INNOVATIVE GAMING CORPORATION OF AMERICA AND SUBSIDIARY Consolidated Statements of Operations (In Thousands, Except Per Share Data)
For the Year For the Year For the Year Ended Ended Ended December 31, December 31, December 31, 1998 1997 1996 ----------- ------------ ------------ NET SALES $ 8,509 $ 10,292 $ 2,664 COST OF SALES 7,134 7,189 2,135 -------- -------- -------- Gross profit 1,375 3,103 529 SELLING, GENERAL AND ADMINISTRATIVE EXPENSES 5,819 5,285 5,405 RESTRUCTURING COSTS - - 1,716 -------- -------- -------- Operating loss (4,444) (2,182) (6,592) INTEREST INCOME, net 106 247 568 -------- -------- -------- Loss before income taxes (4,338) (1,935) (6,024) PROVISION FOR INCOME TAXES 720 - 155 -------- -------- -------- Net loss (5,058) (1,935) (6,179) PREFERRED STOCK DIVIDENDS 75 76 - PREFERRED STOCK ACCRETION 297 878 - -------- -------- -------- Net loss attributable to common shareholders ($ 5,430) ($ 2,889) ($ 6,179) ======== ======== ======== LOSS PER SHARE OF COMMON STOCK ($ 0.72) ($ 0.43) ($ 0.97) ======== ======== ======== Weighted average common shares outstanding 7,535 6,744 6,356 ======== ======== ========
The accompanying notes are an integral part of these consolidated financial statements. - 36 - 37 INNOVATIVE GAMING CORPORATION OF AMERICA AND SUBSIDIARY Consolidated Statements of Stockholders' Equity (In Thousands)
Un- realized Gain/ Class B Non-Voting Convertible Addi- (Loss) on Common Stock Common Stock Preferred Stock tional Accu- Available- ---------------- ------------------ --------------- Paid-in mulated Unearned for-Sale Shares Amount Shares Amount Shares Amount Capital Deficit Compensation Securities Total -------- ------ -------- ------ ------ ------ -------- -------- ------------ ---------- ------- BALANCE, December 31, 1995 4,969 $ 50 1,025 $ 10 - - $ 21,858 $ (3,380) $ (10) 3 $18,531 Class B common stock exchange for common stock 1,025 10 (1,025) (10) - - - - - - - Stock options and warrants exercised 258 3 - - - - 1,014 - - - 1,017 Common stock issued for purchase of intangible assets 225 2 - - - - 2,079 - - - 2,081 Unearned compensation adjustments - - - - - - - - 10 - 10 Unrealized loss on available-for-sale securities - - - - - - - - - (10) (10) Net loss - - - - - - - (6,179) - - (6,179) ------- ------ -------- ------ ------- ------- -------- -------- -------- ------ ------- BALANCE, December 31, 1996 6,477 65 - - - - 24,951 (9,559) - (7) 15,450 Series A preferred stock issued - - - - 4,000 3,122 622 - - - 3,744 Preferred stock accretion adjustment - - - - - 878 - (878) - - 0 Series A preferred stock conversion to common stock 1,055 10 - - (4,000) (4,000) 3,990 - - - 0 Preferred stock dividends paid 3 - - - - - 12 (76) - - (64) Unrealized gain on available-for-sale securities - - - - - - - - - 7 7 Net loss - - - - - - - (1,935) - - (1,935) ------- ------ -------- ------ ------ -------- -------- -------- -------- ------ ------- BALANCE, December 31, 1997 7,535 75 - - - - 29,575 (12,448) - - 17,202 Series B preferred stock issued - - - - 3,000 - 2,804 - - - 2,804 Preferred stock accretion adjustment - - - - - - 297 (297) - - - Preferred stock dividends paid - - - - - - - (76) - - (76) Net loss - - - - - - - (5,058) - - (5,058) ------- ------ -------- ------ ------ ------- ------- -------- -------- ------- ------- BALANCE, December 31, 1998 7,535 $ 75 - $ - 3,000 $ - $32,676 $(17,879) $ - $ - $14,872 ======= ====== ======== ====== ====== ======= ======= ======== ======== ======= =======
The accompanying notes are an integral part of these consolidated financial statements. - 37 - 38 INNOVATIVE GAMING CORPORATION OF AMERICA AND SUBSIDIARY Consolidated Statements Of Cash Flows (In Thousands)
For the Year For the Year For the Year Ended Ended Ended December 31, December 31, December 31, 1998 1997 1996 ------------ ------------ ------------ OPERATING ACTIVITIES: Net loss ($ 5,058) ($ 1,935) ($ 6,179) Adjustments to reconcile net loss to cash flows used for operating activities - Depreciation and amortization 936 889 566 Stock option compensation earned - - 10 Loss on sale of assets - 2 103 Deferred income taxes 720 - 134 Provision for inventory obsolescence 571 112 1,308 Book value of fixed assets charged to cost of sales 26 424 - Provision for bad debts - 9 78 Changes in operating assets and liabilities: Accounts and notes receivable 875 (2,106) 1,202 Inventories 376 (5,574) (232) Prepaid expenses and other (224) 14 177 Accounts payable and accrued expenses (171) 492 107 Customer deposits (157) 157 - -------- -------- -------- Net cash used for operating activities (2,106) (7,516) (2,726) -------- -------- -------- INVESTING ACTIVITIES: Purchases of available-for-sale securities - (1,042) (5,936) Release of restricted investments 300 - - Proceeds from sale of available-for-sale securities - 4,013 10,350 Payment on covenant not to compete - - (92) Inventory (capitalized for use in) returned from gaming operations 363 (2,028) - Proceeds from sale of property and equipment - - 45 Purchases of property and equipment (255) (388) (583) Purchases of intangible assets (500) - - -------- -------- -------- Net cash provided by (used for) investing activities (92) 555 3,784 -------- -------- -------- FINANCING ACTIVITIES: Proceeds from financing agreements 955 873 26 Payments on long-term obligations (402) (67) (5) Preferred stock dividends paid (60) (64) - Net proceeds from sale of common stock - - 1,017 Net proceeds from sale of preferred stock 2,804 3,744 - -------- -------- -------- Net cash provided by financing activities 3,297 4,486 1,038 -------- -------- -------- INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS 1,099 (2,475) 2,096 CASH AND CASH EQUIVALENTS, beginning of period 518 2,993 897 -------- -------- -------- CASH AND CASH EQUIVALENTS, end of period $ 1,617 $ 518 $ 2,993 ======== ======== ======== SUPPLEMENTAL DISCLOSURE OF CASH FLOWS INFORMATION: Cash paid for interest $ 80 $ 1 $ 3 ======== ======== ======== Cash paid (refund received) for income taxes ($ 1) ($ 3) $ 4 ======== ======== ======== Noncash transactions: Preferred Stock converted to common stock $- $ 4,000 $- ======== ======== ======== Preferred Stock dividends paid with common stock $- $ 12 $- ======== ======== ======== Exchange of common stock for intangible assets $- $- $ 2,081 ======== ======== ========
The accompanying notes are an integral part of these consolidated financial statements. - 38 - 39 INNOVATIVE GAMING CORPORATION OF AMERICA AND SUBSIDIARY NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (IN THOUSANDS, EXCEPT SHARES AND PER SHARE DATA) 1. NATURE OF BUSINESS AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES: NATURE OF BUSINESS AND RISK FACTORS Innovative Gaming Corporation of America ("the Company") was incorporated in the State of Minnesota on September 19, 1991. The Company, through its wholly-owned subsidiary, Innovative Gaming, Inc., is in the business of developing, manufacturing, marketing and distributing gaming equipment. The Company distributes its products to certain gaming markets worldwide. The Company has experienced negative cash flow from operations of $2.1 million, $7.5 million and $2.7 million for the years ended December 31, 1998, 1997 and 1996, respectively. In addition, sales in the first quarter of 1999 have been below management's expectations. As of March 30, 1999, the Company had cash and cash equivalents of approximately $650. Management believes assuming it can achieve its sales forecasts which exceed current sales rates, it will have sufficient cash to fund operations through mid 1999. However, if sales remain at or below their current levels, and the Company does not reduce its operating expenses consistent with its sales level operations will only be funded into May 1999. Management has taken certain steps to address its short-term liquidity and cash flow requirements by entering into a loan commitment to borrow approximately $675 on a secured basis from a third party lender in late March 1999. In addition to attempting to control costs through inventory reductions and other measures. The Company anticipates closing on this loan in early April 1999. With this financing the Company estimates that its current level of cash and anticipated funds from operations, which assumes market acceptance of new games (which cannot be assured), will be adequate to fund cash requirements through 1999. No assurance can be given that this loan will close on a timely basis, if at all, or on the terms contained in the loan commitment letter with such lender. Failure to close on this loan in a timely basis could have a material adverse effect on the Company. In the absence of alternative financing, the Company would have to consider significantly reduce operations, in addition to liquidating all or a portion of the Company's assets. To the extent that the Company does significantly reduce operations, it would have a material adverse effect on the Company's ability to meet its short term revenue projections and would negatively impact the ability to obtain additional financing., Furthermore, to the extent that the Company's revenues are less than anticipated, the Company may require additional short-term financing in 1999, which may not be available. Additionally, the Company is continuing its efforts to control operating expenses. The Company's ability to execute its long-term business strategy also depends to a significant degree on its ability to finance the development, marketing and production of its products. There can be no assurance that the Company will be successful in obtaining financing on terms acceptable to the Company, if such need arises. Any new investors may seek and obtain substantially better terms than were granted to its present investors and the issuance of such securities would result in dilution to its existing shareholders. USE OF ESTIMATES The preparation of financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Ultimate results could differ from those estimates. REGULATION The manufacture, distribution and sale of the Company's products are regulated by various jurisdictions and entities, including requirements to obtain licenses and product approval. The Company is presently seeking, or plans to seek, licenses and product approval in several jurisdictions. Failure to successfully obtain licenses, approvals, or meet other regulatory requirements could materially impact the expansion and future operation of the Company. - 39 - 40 CERTAIN RISKS AND UNCERTAINTIES A significant portion of the Company's operations are generated from a limited number of gaming jurisdictions. A change in general economic conditions or the regulatory environment of these jurisdictions could adversely affect the Company's operating results. PRINCIPLES OF CONSOLIDATION The consolidated financial statements include the accounts of Innovative Gaming Corporation of America and its wholly owned subsidiary, Innovative Gaming, Inc. All significant intercompany transactions have been eliminated. CASH AND CASH EQUIVALENTS The Company considers all financial instruments which are highly liquid and have original maturities of three months or less to be cash and cash equivalents which are readily convertible to cash. Cash equivalents consist primarily of demand deposits. The Company classifies all investments which are not cash equivalents as available-for-sale securities with all gross unrealized gains or losses included as a separate component of equity. RESTRICTED INVESTMENTS At December 31, 1998 and 1997, the Company had restricted investments of $700 and $1,000, respectively, Of these amounts, $500 and $1,000, respectively, were pledged as collateral against certain bank credit arrangements. PROPERTY AND EQUIPMENT Property and equipment are carried at cost with depreciation provided for using the straight-line method over the useful lives of the assets or the lease term, whichever is shorter. Maintenance, repairs and minor renewals are expensed when incurred. Depreciation expense recorded in the years ended December 31, 1998, 1997 and 1996 was $584, $537 and $146, respectively.
Useful Life 1998 1997 -------------------------------------- Office equipment 5 years $942 $453 Display games 5 years 142 142 Gaming operations equipment 2.5 years 543 1,459 Manufacturing equipment 5 years 358 345 Leasehold improvements Life of lease 307 303 ---------------------- Total property and equipment 2,292 2,702 Less: Accumulated depreciation (903) (595) ---------------------- Total property and equipment, net $ 1,389 $2,107 ======================
- 40 - 41 INVENTORIES Inventories are recorded at the lower of cost or market value. Cost is determined according to the first-in, first-out accounting method. Inventories consisted of the following at December 31:
1998 1997 ----------------------- Game components and parts $5,021 $6,602 Work in process 231 698 Finished goods 4,939 3,772 Inventory reserves (947) (881) ----------------------- Total inventories, net $9,244 $10,191 ========================
INTANGIBLES The Company amortizes intangibles on a straight-line basis over their estimated economic lives while the technology is being utilized (See Note 5). PRODUCT SALES/REVENUE RECOGNITION The Company makes product sales for cash, on normal terms of 90 days or less, over longer term installments, and, in Nevada, through participation in the net win of the games until the purchase price is paid. Revenue from the sale of products is recognized upon transfer of title and risk of loss to the customer. Deposits received from customers in advance of delivery are deferred. CONCENTRATIONS OF RISK During 1998, a majority of the Company's sales were to one customer, a distributor, Aristocrat Leisure Industries ("Aristocrat"), which accounted for 54.1% of sales. Sales to Aristocrat declined in the third and particularly fourth quarters of 1998 when this distributor failed to order games in accordance with forecasts previously provided to the Company. The Company has not forecasted sales to this customer in 1999. During 1997, a majority of the Company's sales were to two customers. Sales to one distributor, Aristocrat, accounted for 48.4% of sales and direct sales to one customer, Harrah's Smoky Mountain Casino, accounted for 19.4% of sales. During 1996, a majority of the Company's sales were to three distributors. These three distributors accounted for 37%, 32% and 24% of sales, respectively. For the years ended December 31, 1998, 1997 and 1996, no other distributors or customers accounted for greater than 10% of sales. The Company maintains deposits in excess of federally insured limits. Statement of Financial Accounting Standards No. 105 identifies these items as a concentration of risk requiring disclosure, regardless of the degree of risk. The risk is managed by maintaining all deposits in high quality financial institutions. The Company purchases certain key electronic components, which are not available from other sources, from a Japanese supplier, Irem Software Engineering, Inc., at a negotiated fixed price for a period extending to mid-1999. The total purchase commitment remaining at December 31, 1998, was approximately $462. The Company is developing an alternative product design to eliminate dependence on this sole source vendor. - 41 - 42 The financial instruments that subject the Company to concentrations of credit risk consist principally of accounts and notes receivable. Accounts and notes receivable are concentrated in specific legalized gaming jurisdictions. Notes receivable are collateralized by the equipment sold. The Company has no secured interest in the trade accounts receivable. At December 31, 1998, the following concentrations of credit risk existed: Nevada 46% Germany 11% Colorado 10% Canada 10% South Carolina 8% California 8% Delaware and Other 7% ---------------- Total 100% ================
RESEARCH AND DEVELOPMENT COSTS The Company engages in the development of new and existing products. Research and development costs are expensed as incurred. The Company expensed approximately $2,353, $1,884 and $1,132 for the years ended December 31, 1998, 1997 and 1996, respectively. These amounts are included in selling, general and administrative expenses. RESTRUCTURING COSTS In 1996, the Company recognized $1,716 of restructuring costs, which included expenses related to the Company's relocation to Reno, Nevada, management transition and product focus. INCOME TAXES The Company accounts for income taxes in accordance with Statement of Financial Accounting Standards No. 109 -"Accounting for Income Taxes" (SFAS No. 109), whereby deferred tax assets and liabilities are recognized for future tax consequences attributable to differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax bases. Deferred tax assets and liabilities are measured using enacted tax rates expected to apply to taxable income in the year in which those temporary differences are expected to be removed or settled. Under SFAS No. 109, the effect on deferred tax assets and liabilities of a change in tax rates is recognized in income in the period that includes the enactment date. To the extent the amount deductible for income tax purposes from stock option plans exceeds the amount charged to operations for financial statement purposes, the related tax benefits are credited to capital stock when realized. EARNINGS PER SHARE The Company has adopted Statement of Financial Accounting Standards No. 128 "Earnings Per Share"-(SFAS No. 128). SFAS No. 128 is effective for periods ending after December 15, 1997, and replaces previously reported earnings per share with "basic" and "diluted" earnings per share. The earnings per - 42 - 43 share data for all periods presented is based on weighted average common shares outstanding and on the same basis as "basic" earnings per share calculated under SFAS No. 128. Diluted earnings per share is not presented because the resulting earnings per share would be antidilutive for each period reported. FOREIGN CURRENCY TRANSACTIONS Transactions which occur in currencies other than U.S. dollars are translated to U.S. dollars for financial reporting purposes. Gains and losses from this process are recorded in the results of operations. LONG-LIVED ASSETS During 1995, the Company adopted Statement of Financial Accounting Standards No. 121 "Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to be Disposed Of'" - (SFAS No.121). SFAS No.121 establishes accounting standards for the recognition and measurement of impairment of long-lived assets and certain identifiable intangibles and goodwill either to be held or disposed of. Management reviews long-lived assets, including intangibles, for impairment whenever events or changes in circumstances indicate that the carrying amount of the asset may not be recoverable. For assets which produce future cash flows, an estimate of undiscounted future cash flows is compared to the carrying amount to determine if an impairment exists. For assets which do not produce quantifiable future cash flows, such as intangibles, impairment is measured at the enterprise level. No impairment existed at December 31, 1998 and 1997. 2. RELATIONSHIP WITH LAKES GAMING, INC.: Lakes Gaming, Inc. ("LGI") (formerly Grand Casinos, Inc.) is in the business of managing and developing casinos. Lyle Berman, who was Chairman of the Board of the Company until June 24, 1998, is a principal shareholder and Chairman of the Board of LGI, and was Chief Executive Officer of LGI from October 1991 through March 1998. Mr. Berman continues to serve on the Board of Directors of the Company. Under an existing machine purchase agreement, LGI may purchase up to an aggregate of 125 of the Company's multi-station blackjack, craps and roulette games in quantity purchases at distributor level prices. Previous quantity sales were also made to LGI at distributor level prices for the purpose of testing, evaluating and marketing the Company's blackjack, craps and roulette games. Under an agreement between the Company and LGI, used multi-player machines which LGI previously purchased from the Company may be placed on consignment with the Company to be refurbished and sold into legal markets. The proceeds from sales of up to three of the consignment games may be applied to the purchase of one new Bonus Streak game from the Company and minimum proceeds of $5,000 must be credited to LGI for each game sold by the Company. There are potentially 31 such used multi-player games which LGI may submit the Company for sale under the consignment agreement. Through December 31, 1998, 17 such used multi-player games were submitted to the Company on consignment under this agreement. The Company made no multi-station machine sales to LGI during 1997. The Company sold six Bonus Streak games and no multi-station machines to LGI in 1998. 3. AVAILABLE-FOR-SALE SECURITIES: The Company had no available-for-sale securities at December 31, 1998 and 1997. Proceeds from the sale of available-for-sale securities were $4,013 for the year ended December 31, 1997 and $10,350 for the year ended December 31, 1996. - 43 - 44 4. NOTES RECEIVABLE: The Company has granted certain customers extended payment terms under sales contracts. These contracts are generally for terms of one to five years with interest recognized at prevailing rates and are collateralized by the equipment sold. Stated interest rates in the contracts range from 10% to 10.5%. On contracts with no stated interest to be paid, interest is imputed at prime plus 2%. At December 31, 1998, the face amount of notes receivable was $816. The carrying value of notes receivable approximates their fair value. Certain of the Company's notes receivable are pledged as security for a note payable to Finova Capital Corporation. The following table represents the estimated future collections of notes receivable, net of amounts to be recognized as interest income, at December 31, 1998:
Years Ending December 31, Estimated Receipts 1999 $334 2000 117 2001 102 2002 63 2003 and after 80 ------------------ Total $696 ==================
5. INTANGIBLE ASSETS: Intangible assets consisted of the following at December 31:
Useful Life 1998 1997 -------------------------------- Product patent and technology rights 5 to 10 $2,832 $2,332 years Nevada distribution rights 10 years 250 250 ------------------ Total intangible assets 3,082 2,582 Less: accumulated amortization (1,205) (853) ------------------ Total intangible assets, net $1,877 $1,729 =================
Amortization recorded for intangibles was $352, $352 and $420 in the years ended December 31, 1998, 1997 and 1996, respectively. On February 2, 1996, the Company acquired the balance of all remaining intellectual property including patents, trademarks, picture rights and copyrights for its games from its Japanese suppliers in exchange for an aggregate 225,000 shares of IGCA common stock. During 1998, the Company entered into agreements with various companies to acquire rights to technology and intellectual property for use in games which the Company intends to develop, manufacture and market. Under an agreement with Quick Silver Development Co. Inc ("Quick Silver"), a California corporation, the Company purchased the Patent and Technology for a game concept entitled "Revolving Rings Gaming Apparatus", for a purchase price of $50. The Company will also pay a per day game fee to Quick - 44 - 45 Silver for gaming devices embodying the Patent technology and placed in locations under participation agreements between the location and the Company. The per day game fees will vary based upon the number of games placed and are subject to regulatory approval. The cost of this patent and technology will be amortized over the period such technology is used in the Company's products. No such amortization was recorded in 1998. The Company purchased rights to a game concept developed by Vista Gaming ("Vista"), a Colorado corporation, for a purchase price of $100. The Company will also pay game fees to Vista for gaming devices embodying the game concept sold or placed in locations under participation agreements between the location and the Company. The game fees will vary based upon the number of games placed and are subject to regulatory approval. The cost of these game rights will be amortized over the period they are used in the Company's products. No such amortization was recorded in 1998. The Company purchased rights to intellectual property related to two game concepts developed by Gametronics for a purchase price of $500. A note receivable from Gametronics in the amount of $400 was converted and applied toward payment of the purchase price. The Company will also pay game fees to Gametronics for gaming devices embodying the game concept sold or placed in locations under participation agreements between the location and the Company. The game fees for sold games will be at a fixed fee and per day games fees for games placed under participation agreements will vary based upon the number of games placed and are subject to regulatory approval. The rights acquired allow the Company to develop, manufacture, market and distribute the games in Nevada and Mississippi. The cost of this intellectual property will be amortized over the period it is used in the Company's products. No such amortization was recorded in 1998. Under a purchase agreement with Metropolitan Gaming LLC ("Metropolitan"), the Company purchased a sublicense for rights to use three dimensional projection technology in one if its gaming machine products, for a purchase price of $75. The Company will also pay a per day signage technology fee to Metropolitan for gaming devices embodying the technology and placed in locations under participation agreements between the location and the Company. The per game signage technology fees will vary based upon the total number of games placed utilizing the three dimensional projection technology and are subject to regulatory approval. The cost of these technology rights will be amortized over the period such rights are used in the Company's products. No such amortization was recorded in 1998. 6. FINANCING ARRANGEMENTS: LETTER OF CREDIT At December 31, 1998 and 1997, the Company had a standby letter of credit with a bank in the amount of $500 and $1,000, respectively. At December 31, 1998 and 1997, the Company had certificates of deposit of $700 and $1,000, respectively, which were included in the accompanying balance sheets as restricted investments, of which $500 and $1,000, respectively, were pledged as security for the standby letters of credit. This standby letter of credit is primarily to facilitate the acquisition of component parts and supplies. At December 31, 1998 and 1997, no amount was outstanding on the standby letter of credit. - 45 - 46 NOTES PAYABLE Notes payable consists of amounts owed IGT, a wholly-owned subsidiary of International Game Technology, for the purchase of slant top slot machines incorporated in the Company's Bonus Streak game, an operating capital loan from Finova Capital Corporation and financed insurance premiums. Under the agreement with IGT, the Company shares equally in the net revenues received from customers under participation agreement sales until IGT is paid in full for the sales price of the slant top slot machine acquired by the Company. Thereafter the Company receives 90% and IGT receives 10% of the net revenues from the customer. For cash sales, the Company must pay IGT the purchase price of the slant top slot machines from the proceeds of the sale. Management has estimated the portion of current notes payable to represent those amounts expected to be paid to IGT under participation arrangements and from cash sales in 1999. In March 1998, Innovative Gaming, Inc., a wholly-owned subsidiary of the Company, entered into a loan commitment securing $2 million from Finova Capital Corporation. The initial funding of approximately $910 was completed on April 13, 1998. The loan is payable in 36 equal installments including interest paid in arrears at a rate of 12.06 percent. This financing is secured by certain of the Company's long-term receivables and a corporate guarantee from the Company. Additional funding under this arrangement was available through December 1, 1998. The Company's borrowing capacity under this arrangement was dependent upon the level of receivables generated through "bucket sales" agreements. The Company did not borrow any additional amounts under this arrangement. The financed insurance premiums are paid in monthly installments over a period of less than twelve months. The following table represents the estimated future payments of notes payable at December 31, 1998: Years Ending December 31, Estimated Receipts 1999 $528 2000 528 2001 319 2002 9 ----------------- Total $1,384 ================
7. STOCKHOLDERS' EQUITY: PREFERRED STOCK On April 11, 1997, the Company issued 4,000 shares of Series A Convertible Preferred Stock at a price of $1,000 per share in a private placement for total proceeds of $4,000. The Company received net proceeds of approximately $3,744 from such private placement after the payment of fees and expenses associated with such private placement. An annual dividend of 4% was paid quarterly in arrears in cash. Each share of Preferred Stock was convertible into shares of the Company's Common Stock at a conversion price of 82% of the average closing bid price of the Company's Common Stock over the ten- - 46 - 47 day trading period ending the day prior to conversion (the "Conversion Price"). The Conversion Price was not to exceed $8.1725 per share. A holder of Preferred Stock was not permitted to convert such stock into Common Stock if, following such conversion, the holder beneficially would own in excess of 4.9% of the Company's Common Stock. A Registration Statement related to the Common Stock was filed by, and at the expense of, the Company pursuant to obligations contained in a Registration Rights Agreement dated April 10, 1997. The Effective Date of the Registration Statement was July 28, 1997, and all necessary gaming regulatory approvals were received. As of October 22, 1997, all shares of Preferred Stock were converted into an aggregate of 1,058,696 shares of Common Stock. On May 13, 1998, the Company issued 3,000 shares of Series B Convertible Preferred Stock (the "Preferred Stock") at a price of $1,000 per share in a private placement for total proceeds of $3,000. The stated par value per share is $.01, resulting in a total par value of thirty dollars being recorded as Series B Convertible Preferred Stock, and the balance of approximately $3.0 million is included in Additional Paid-in Capital. The Company received net proceeds of approximately $2,804 after the payment of fees and expenses associated with such private placement. An annual dividend of 4% shall be paid quarterly in arrears either in Preferred Stock of the Company or cash at the Company's discretion. Each share of Series B Preferred Stock is convertible into shares of the Company's Common Stock at a conversion price of 91% of the three consecutive day average of the lowest closing bid price of the Company's Common Stock over the twenty-day trading period ending the day prior to conversion (the "Conversion Price"). The Conversion Price may not exceed $5.16, which represents 135 % of the ten day average of the closing bid price of the Company's Common Stock ending on May 12, 1998. The maximum number of shares of Common Stock that may be issued upon conversion is 1,505,000. In the event there is a holder of Preferred Stock that is unable to convert shares of Preferred Stock into Common Stock at a discount because either a) 1,505,000 shares have been issued at a discount or b) such holder would beneficially own in excess of 4.9% of the Company's Common Stock, then the Company may either 1) redeem any unconverted Preferred Stock for cash at a price equal to 115% of the liquidation value of the shares or 2) convert such unconverted shares without a discount into Common Stock and pay cash to the holder of such unconverted shares equal to the economic value that would have been received by such holder if able to convert at a discount. The Company has the right to redeem the Preferred Stock at 115% of par in cash. As of December 31, 1998, all of the Preferred Stock was convertible into Common Stock, at the election of the holder thereof. All outstanding shares of Preferred Stock will automatically be converted into Common Stock on November 13, 1999. A holder of Preferred Stock may not convert such stock into Common Stock if, following such conversion, the holder beneficially owns in excess of 4.9% of the Company's Common Stock. As of December 31, 1998, no Preferred Stock had been converted into Common Stock. A Registration Statement related to the Common Stock was filed by, and at the expense of, the Company pursuant to obligations contained in a Registration Rights Agreement dated May 13, 1998. The effective date of the Registration Statement filed with the Securities and Exchange Commission was September 3, 1998, and all necessary gaming regulatory approvals have been received. The 9% beneficial conversion feature is accounted for as an additional Preferred Stock dividend, which was determined on the date the Preferred Stock was issued. The total value of the beneficial conversion feature or dividend is $297, - 47 - 48 which reduces income available for holders of the Company's Common Stock and therefore reduces earnings per share on a pro rata basis over the period from issuance of the Preferred Stock to the earliest conversion date. Income available to holders of Common Stock was reduced by approximately $141, $144 and $12 during the second, third and fourth quarters of 1998, respectively. STOCK REPURCHASE PLAN On October 20, 1994, the Company's Board of Directors authorized the Company to repurchase up to 500,000 shares of its outstanding common stock from time to time on the open market or in privately negotiated transactions. As of December 31, 1998, the Company had repurchased 248,500 shares at prices ranging from $3.56 to $6.08 per share, for total consideration of $1,199. All such shares were repurchased in 1994 and 1995. No shares were repurchased in 1998. ISSUANCE AND EXCHANGE OF CLASS B STOCK On October 20, 1994, the Company issued 1,025,000 shares of its Class B Non-Voting Common Stock in exchange for 1,025,000 shares of common stock held by Grand Casinos, Inc.("GCI") (Grand Casinos, Inc. subsequently changed its name to Lakes Gaming, Inc.) On December 1, 1995, the Company and GCI amended their earlier agreement to provide that if the Company did not receive certain approvals from the Nevada Gaming Commission ("the Nevada Approvals") on or before December 31, 1995, GCI would, subject to approval of the Minnesota Commissioner of Commerce, exchange its 1,025,000 shares of Class B non-voting common stock for 1,025,000 shares of the Company's common stock. The Company did not receive the Nevada Approvals on or before December 31, 1995. On March 21, 1996, GCI converted 1,025,000 shares of Class B non-voting common stock into 1,025,000 shares of the Company's common stock. At the time of the original exchange, the Company granted GCI certain registration rights and the option to purchase 102,500 shares of common stock at $7.00 per share, increased the number of games GCI may purchase under the existing discount machine purchase agreement by 50 games (up to an aggregate 125 games) and entered into a transition plan with respect to Board of Directors' positions based upon the timing of the Company's receipt of regulatory approvals. STOCK OPTIONS AND WARRANTS The Company has a 1992 Employee Stock Option and Compensation Plan (the "1992 Plan"), pursuant to which options and other awards to acquire an aggregate of 1,350,000 shares of the Company's common stock may be granted. Stock options, stock appreciation rights, restricted stock, other stock and cash awards may be granted under the Plan. All employees are eligible to participate in the 1992 Plan. The Company also has a 1998 Non-Executive Stock Option Plan (the "1998 Plan"), pursuant to which options to acquire an aggregate of 200,000 shares of the Company's common stock may be granted. Non-Executive employees who are full-time employees of the Company are eligible to participate in the 1998 Plan. Both the 1992 Plan and the 1998 Plan are administered by a stock option committee which has the discretion to determine the number and purchase price of shares subject to stock options (which may be below the fair value of the common stock on the date thereof), the term of each option and the time or times during its term when the option becomes exercisable. Options are generally exercisable in equal - 48 - 49 amounts over a five-year period from the date of grant. During 1995 and 1994, the exercise prices of certain options ranging from $6.00 to $15.75 were reduced to $4.00 (fair market value on the date of repricing). On October 8, 1996, the exercise prices of certain options ranging from $7.00 to $11.50 were reduced to $4.75 (fair market value on the date of repricing). In December 1998, current employees of the Company were allowed to elect repricing of outstanding options, adjusting the exercise price to the current market price in exchange for delaying the vesting of one-half of all then unvested options by twelve months. All current employees elected to reprice their options under the terms offered. The existing options were cancelled and the repriced options were recorded as new grants. The new grants to all Non-Executive employees totaled 313,050, which were issued from the 1998 Plan subject to Board of Directors approval to increase the available shares in excess of the 200,000 shares originally authorized. The Company accounts for the both stock option plans under APB Opinion No. 25 - -"Accounting for Stock Options Issued to Employees", under which no compensation cost has been recognized. Statement of Accounting Standards No. 123 -"Accounting for Stock-Based Compensation" (SFAS No. 123), was issued in 1995 and, if fully adopted, changes the methods for recognition of cost on plans similar to that of the Company. Adoption of SFAS No. 123 is optional; however, pro forma disclosures as if the Company had adopted the cost recognition method are required. Had compensation cost for the Plan been determined consistent with SFAS No. 123, the Company's results of operations and earnings per share would have been changed to the following pro forma amounts:
1998 1997 ------- -------- Net loss: As reported $(5,430) $(2,888) Pro forma $(6,140) $(3,831) Primary and fully-diluted EPS: As reported $(0.72) $(0.43) Pro forma $(0.81) $(0.57)
A summary of the status of the 1992 Employee Stock Option and Compensation Plan at December 31, 1998, 1997 and 1996, and changes during the periods then ended is presented in the tables and narrative below:
December 31, 1998 December 31, 1997 December 31, 1996 ---------------------- --------------------- ---------------------- Wtd Avg Wtd Avg Number Wtd Avg Number Ex Price Number Ex Price Ex Price ----------- ---------- ---------- ---------- ----------- ---------- Outstanding at beginning of period 825,400 $4.69 606,500 $4.67 352,600 $3.99 Granted 550,400 1.14 271,550 4.75 540,500 4.75 Exercised - - - - (207,600) 3.94 Forfeited (765,800) 4.63 (52,650) 4.91 (79,000) 4.16 Expired - - - - - - --------- -------- -------- Outstanding at end of period 610,000 $1.56 825,400 $4.69 606,500 $4.67 ========= ======== ======== Exercisable at end of period 361,800 $1.74 290,933 $4.61 131,000 $4.52 Weighted average fair value of options granted on grant date $0.83 $2.91 $2.95
- 49 - 50
Detail composition of options outstanding December 31, 1998: -------------------------------------------------------------------- Avg. contractual Options Exercise life remaining Options outstanding price (Years) exercisable ----------- -------- ---------------- ----------- 11,600 $5.75 8.00 2,400 38,000 4.75 7.70 37,000 1,400 4.13 8.42 1,400 35,000 4.00 5.29 35,000 4,000 2.25 9.00 - - 220,000 1.13 9.96 70,000 300,000 1.00 10.00 216,000 ------------ ---------- 610,000 361,800 ========= ==========
The fair value of each option grant under the 1992 Employee Stock Option and Compensation Plan is estimated on the date of grant using the Black-Scholes option pricing model with the following assumptions used for the 1998, 1997 and 1996 grants: risk-free interest rate of 4.9, 6.5 and 6.2 percent; expected dividend yield of 0.0 percent; expected lives of 5 years; expected volatility of 91.5, 90.3 and 61.8 percent, respectively. A summary of the status of the 1998 Non-Executive Stock Option Plan at December 31, 1998 and changes during the period then ended is presented in the table and narrative below:
December 31, 1998 ----------------------- Wtd Avg Number Ex Price ----------- --------- Outstanding at beginning of period - $ - Granted 313,050 1.11 Exercised - - Forfeited - - Expired - - ---------- Outstanding at end of period 313,050 $1.11 ========== Exercisable at end of period 102,750 $1.11 ========== Weighted average fair value of options granted on grant date $0.81
As of December 31, 1998, the 313,050 options outstanding in the 1998 Non-Executive Stock Option Plan had an average exercise price of $1.11 with a weighted average remaining contractual life of 9.97 years. The options exercisable had exercise prices of $1.00 to $1.18. The fair value of each option grant under the 1998 Non-Executive Stock Option Plan is estimated on the date of grant using the Black-Scholes option pricing model with the following assumptions used for the 1998 grants: risk-free interest rate of 4.9 percent; expected dividend yield of 0.0 percent; expected life of 5 years; expected volatility of 92.4%. - 50 - 51 The Company adopted a Director Stock Option Plan (the "Director Option Plan") in 1997, pursuant to which options and other awards to acquire an aggregate of 100,000 shares of the Company's common stock may be granted. A summary of the status of the Directors Option Plan at December 31, 1998 and 1997, and changes during the periods then ended is presented in the table and narrative below:
December 31, 1998 December 31, 1997 ---------------------- --------------------- Wtd Avg Wtd Avg Number Ex Price Number Ex Price ----------- ---------- ---------- ---------- Outstanding at beginning of period 40,000 $5.06 - $ - Granted - - 40,000 5.06 Exercised - - - - Forfeited (30,000) 5.04 - - Expired - - - - ------- -------- Outstanding at end of period 10,000 $5.13 40,000 $5.06 ======= ======== Exercisable at end of period 10,000 $5.13 10,000 $5.06 Weighted average fair value of options granted on grant date $ - $3.80
As of December 31, 1998, the 10,000 options outstanding in the Director Option Plan had an average exercise price of $5.13, with a weighted average remaining contractual life of 0.5 years. The options exercisable had exercise prices of $5.13. The fair value of each option grant under the Director Stock Option Plan is estimated on the date of grant using the Black-Scholes option pricing model with the following assumptions used for the 1997 grants: risk-free interest rate of 6.5 percent; expected dividend yield of 0.0 percent; expected life of 5 years; expected volatility of 95.1%. The Company has issued stock purchase warrants with a variety of terms and conditions. During 1996, the exercise prices of certain warrants were reduced from $11.00 and $15.00 to $10.00 and $13.00, respectively. - 51 - 52 The following summarizes stock purchase warrant transactions during the period:
Number Exercise Prices Outstanding December 31, 1995 652,500 4.00 - 15.00 Granted - - Exercised (50,000) 4.00 Canceled/Expired - - --------------------------- Outstanding December 31, 1996 602,500 6.90 - 13.00 Granted - - Exercised - - Canceled/Expired - - --------------------------- Outstanding December 31, 1997 602,500 6.90 - 13.00 Granted 5,000 3.19 Exercised - - Canceled/Expired (325,000) 6.90 - 13.00 -------------------------- Outstanding December 31, 1998 282,500 $3.19 - $13.00 ==========================
At December 31, 1998, 282,500 warrants were exercisable. The warrants expire at various dates through September, 2001. 8. INCOME TAXES: The provision for income taxes consists of the following components:
For the Year For the Year For the Year Ended Ended Ended Dec. 31, 1998 Dec. 31, 1997 Dec. 31, 1996 ------------- ------------- -------------- Current: Federal $ - $ - $ 21 State - - - -------------------------------------------- Subtotal - - 21 Deferred 720 - 134 -------------------------------------------- Total $ 720 $ - $155 ============================================
The tax effects of temporary differences giving rise to the deferred items are as follows for the years ended December 31:
1998 1997 ---- ---- Deferred tax assets: Net operating loss carryforwards $4,783 $3,603 Inventory reserves 1,255 1,115 Other 252 787 -------------------- Total deferred tax assets 6,290 5,505 Valuation allowance (6,290) (4,785) -------------------- Deferred tax assets, net of allowance $ - $ 720 ====================
- 52 - 53 In accordance with SFAS No. 109, the gross deferred tax asset at December 31, 1998, of $6,290, has been reduced to zero by a full valuation allowance of $6,290. The Company recorded a $720,000 provision for income taxes during 1998 to provide a full valuation allowance on its deferred tax asset. As required by SFAS No. 109, and taking into consideration past losses, the Company recorded the additional valuation reserve. At December 31, 1998, the Company has approximately $13,667 of net operating loss carryforwards for federal income tax purposes. These losses expire beginning 2009 through 2012. The use of approximately $498 of these losses is limited to approximately $249 per year for the next two years because the loss was generated in a short tax year. 9. COMMITMENTS AND CONTINGENCIES: OPERATING LEASES The Company has entered into certain noncancelable operating lease agreements related to office and warehouse space and equipment. Total lease expense under operating leases was $281, $272 and $222 for the years ended December 31, 1998, 1997 and 1996, respectively. The minimum annual rental commitments under operating leases are as follows for the years ending December 31: 1999 $304 2000 304 2001 241 2002 3 ---- Total $852 ====
LITIGATION The Company is involved in legal actions in the ordinary course of its business. While no reasonable estimates of potential liability can be determined, management believes that such legal actions will be resolved without a material effect on the Company's financial position or results of operations. EMPLOYMENT CONTRACTS The Company has employment contracts with various officers with remaining terms ranging from one to three years at amounts approximating their current levels of compensation. The Company's remaining aggregate commitment at December 31, 1998, under such contracts is approximately $1,439. These agreements may also include additional compensation to officers related to sales commission bonuses that could be equal to two percent of the Company's sales. 10. DISTRIBUTORSHIP AND SALES AGENCY AGREEMENTS: In February 1996, the Company entered into an exclusive distribution agreement with Aristocrat Leisure Industries ("Aristocrat") of New South Wales, Australia for the marketing and distribution of games in Australia, New Zealand, Papua New Guinea, Taiwan, New Caledonia, Malaysia, the Philippines and - 53 - 54 Singapore (hereinafter "Australasia"). The Company has granted Aristocrat an initial five-year exclusive license expiring February 2001 to distribute its blackjack, craps and roulette games to all legalized Australasia video gaming jurisdictions. Pursuant to the agreement, the Company has agreed to sell its games at discounted distributor's pricing in exchange for a minimum purchase quantity of 100 units per year. Aristocrat commenced marketing the Company's blackjack, and roulette games subsequent to obtaining technical approval from New South Wales, Australia gaming authorities in September 1997. Pursuant to this agreement, the Company sold an aggregate of 99 games in 1997 and 86 games in 1998. Due to the declining multi-player game sales in their territory, sales to this distributor declined in the third and particularly fourth quarters of 1998, and the Company has not forecasted sales to this customer in 1999. In March 1998, the Company entered into a business consulting agreement with Jean D. Leclair and the Leclair Group ("Consultant"), under which the Consultant provides business consulting services to the Company in Quebec, Canada. Additionally, the Consultant may also assist the Company in securing agreements for the purchase of the Company's products in Quebec and Atlantic Canada. For services to the Company in securing agreements for the purchase of the Company's products, the Consultant will be paid a commission for game sales acquired with Loto Quebec and the Atlantic Lottery Corporation. This agreement is for an initial period of one year, with provision for renewal on a month to month basis upon mutual written agreement. In May 1998, the Company entered into a one-year exclusive agency agreement with Bill Engle, an individual. Under the agreement, the agent represents the Company's products for sale in the Canadian provinces of British Columbia, Ontario, Nova Scotia (for casino customers only), Saskatchewan, Alberta and Manitoba. The agent receives a commission equal to the difference between the amount received for sales initiated by the agent and prices stated in the agreement for each product. This agreement may be renewed for up to two successive one-year terms upon the agreement of the parties and on the terms and conditions set forth in the agency agreement. In December 1998, the Company entered into a three-year exclusive agreement with DGS, Inc. ("DGS") for the distribution and service of the Company's blackjack and 21 Stud products in the State of South Carolina. The Company and DGS will negotiate minimum sales targets for each year of the agreement. If DGS fails to purchase for resale the minimum number of units in any contract year, the Company may give notice to terminate the agreement. This agreement provides for automatic renewal annually after the original term, up to a total of eight years, and may be terminated by either party under certain circumstances. The Company has submitted its applications for licensure in New Jersey and Connecticut, and will apply for approval of its various games. Once the Company is able to sell product in these jurisdictions, it will be represented by Par 4 ("Agent") under terms of a two-year exclusive agency agreement entered into in January 1999. Under the agreement, the agent represents certain of the Company's products for sale in Atlantic City, New Jersey and the State of Connecticut. The Company and Agent will negotiate minimum sales targets for each year of the agreement. If Agent fails to obtain sales orders for at least 75 percent of the target number of units in any contract year, the Company may give notice to terminate the agreement. This agreement provides for automatic renewal annually after the original term and may be terminated by either party under certain circumstances. The Company also has exclusive distributorship agreements with Vista Gaming Corporation, Ludi S.F.M. and with S.A.M. Eurusa. - 54 - 55 11. SUBSEQUENT EVENTS: REPURCHASE OF COMMON STOCK In March 1999, in order to expedite the timing of gaming regulatory approval in certain jurisdictions, the Company repurchased 400,000 shares of its outstanding Common Stock, at market price, from a shareholder. The Company entered into a Stock Redemption Agreement with such shareholder pursuant to which the Company redeemed 400,000 shares of Company Common Stock beneficially owned by such shareholder in exchange for a four year convertible note and a warrant to purchase 50,000 shares of the Company's Common Stock. The note is unsecured, paying interest of 5% per annum and will be convertible at the closing market price of the Company's Common Stock on the date of the issuance of the note. The note may not be converted in the first year following issuance. The exercise price of the warrant will be the same as the conversion price of the note. The Company also granted "piggyback" registration rights for shares of Common Stock issuable upon conversion of both the note and the warrant. - 55 - 56 INNOVATIVE GAMING CORPORATION OF AMERICA AND SUBSIDIARY Schedule II - Valuation and Qualifying Accounts (In Thousands)
Description Balance Charged to Amount Balance Beginning Costs and Written End of of Period Expenses Off Period ---------- ---------- --------- -------- Reserve for inventory obsolescence: For the year ended 12/31/96 $ 649 $1,308 $ 64 $1,893 For the year ended 12/31/97 1,893 112 1,124 881 For the year ended 12/31/98 881 571 505 947
Description Charged/ Balance (Credited) Amount Balance Beginning to Costs Written End of of Period and Expenses Off Period ---------- ------------- --------- --------- Allowance for doubtful notes and accounts receivable: For the year ended 12/31/96 $ 70 $ 78 $ - $148 For the year ended 12/31/97 148 (48) - 100 For the year ended 12/31/98 100 - 15 85
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE On October 26, 1999, Arthur Andersen LLP (the "Former Accountant") resigned as independent public accountant to the Company. During the Company's two most recent fiscal years and the subsequent interim period through October 26, 1998, there have been no disagreements with the Former Accountants on any matter of accounting principles or practices, financial statement disclosure, or auditing scope or procedure, which disagreements if not resolved to the satisfaction of the Former Accountant would have caused them to make reference thereto in their report on the financial statements for such years. The Former Accountant's report for the fiscal year ended December 31, 1996, for which that firm audited such financial statements, contained no adverse opinion or disclaimer of opinion and was not qualified as to uncertainty, audit scope or accounting principles. The Former Accountant's report for the fiscal year ended December 31, 1997, for which that firm audited such financial statements, indicated that the Company has suffered recurring negative cash flow from operations that raise substantial doubt about the Company's ability to continue as a going concern. A letter from the Former Accountant addresses the Securities and Exchange Commission stating that they agree with the Company's response to this Item is filed with the Commission as an Exhibit to the Company's Form 8-K dated October 30, 1998. On December 14, 1998, the Company retained the services of Kafoury, Armstrong & Co. as its certified public accountants. The Audit Committee of the Company's Board of Directors did not approve of the resignation of the Former Accountant, but did approve of the engagement of Kafoury, Armstrong & Co. - 56 - 57 PART III ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT The information beginning immediately following the caption "Election of Directors" to, but not including, the caption "Executive Compensation" in the Company's Proxy Statement, to be filed with the Securities and Exchange Commission within 120 days after the close of the Company's year ended December 31, 1998 and forwarded to stockholders prior to the Company's 1999 Annual Meeting of Shareholders (the "1999 Proxy Statement"), is incorporated herein by reference. ITEM 11. EXECUTIVE COMPENSATION The information in the 1999 Proxy Statement beginning immediately following the caption "Executive Compensation" to, but not including, the caption "Compensation Committee Interlocks and Insider Participation," is incorporated herein by reference. ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT The information in the 1999 Proxy Statement beginning immediately following the caption "Voting Securities and Principal Holders Thereof " to, but not including, the caption "Election of Directors," is incorporated herein by reference. ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS The information in the 1999 Proxy Statement under the caption "Certain Transactions" is incorporated herein by reference. - 57 - 58 PART IV ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K (a)(1) Financial Statements:
Page ---- Report of Independent Public Accountants - Kafoury, Armstrong .& Co . . . . . 33 Report of Independent Public Accountants - Arthur Andersen LLP . . . . . . . . 34 Consolidated Balance Sheets as of December 31, 1998 and 1997 . . . . . . . . . 35 Consolidated Statements of Operations for the years ended December 31, 1998, 1997 and 1996. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 36 Consolidated Statements of Stockholders' Equity for the years ended December 31, 1998, 1997 and 1996 . . . . . . . . . . . . . . . . . . . . . . . . . . . 37 Consolidated Statements of Cash Flows for the years ended December 31, 1998, 1997 and 1996 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 38 Notes to the Consolidated Financial Statements . . . . . . . . . . . . . . . . 39
- 58 - 59
(a)(3) Exhibits 3.1(a) Articles of Incorporation, as amended (Incorporated herein by reference to Exhibit 3.1 to the Company's Registration Statement on Form SB-2 (File No. 33-61492C) (the "SB-2") 3.1(b) Certificate of Designation relating to Series B Convertible Preferred Stock (Incorporated herein by reference to Exhibit 4 to the Company's report on Form 10-Q for the quarter ended March 31, 1998) (the "March 31, 1998 10-Q") 3.2 Bylaws (Incorporated herein by reference to Exhibit 3.2 to the SB-2) 10.1 1992 Stock Option and Compensation Plan, as amended (Incorporated herein by reference to Annex B to the Company's Schedule 14A filed April 24, 1997) + 10.2 Agreement by and between the Company and Grand Casinos, Inc., dated as of July 28, 1994 (Incorporated herein by reference to Exhibit 10.26 to the Company's report on Form 10-K for the fiscal year ended July 31, 1994) 10.3 Employment Agreement between the Company and Edward G. Stevenson dated February 15, 1996 (Incorporated herein by reference to Exhibit 10.16 to the Company's report on Form 10-K for the fiscal year ended December 31, 1995) (the "December 31, 1995 10-K") 10.4 Exclusive Distributorship Agreement between the Company and Aristocrat Leisure Industries PTY LTD dated February 7, 1996 (Incorporated herein by reference to Exhibit 10.18 to the Company's December 31, 1995 10-K) 10.5 Assignment between the Company, NANAO and IREM dated February 2, 1996 (Incorporated herein by reference to Exhibit 10.19 to the Company's December 31, 1995 10-K) 10.6 Parts Supply Agreement between the Company and IREM dated February 2, 1996 (Incorporated herein by reference to Exhibit 10.20 to the Company's December 31, 1995 10-K) 10.7 Agreement between the Company and H Square Corporation dated April 26, 1996 (Incorporated herein by reference to Exhibit 10.21 to the Company's December 31, 1995 10-K) 10.8 Second Amendment to Share Exchange Agreement between the Company and Grand Casinos, Inc. dated December 1, 1995 (Incorporated herein by reference to Exhibit 10.23 to the Company's December 31, 1995 10-K) 10.9 Exclusive Distributorship Agreement between the Company and Ludi S.F.M. dated March 5, 1996 (Incorporated herein by reference to Exhibit 10.24 to the Company's December 31, 1995 10-K) 10.10 Exclusive Distributorship Agreement between the Company and S.A.M. EURSA dated March 5, 1996 (Incorporated herein by reference to Exhibit 10.25 to the Company's December 31, 1995 10-K) 10.11 Product Development and Revenue Sharing Agreement between the Company and IGT, dated November 18, 1996 (Incorporated herein by reference to Exhibit 10.18 to the Company's report on Form 10-K for the fiscal year ended December 31, 1996) (the "December 31, 1996 10-K") 10.12 Lease agreement between the Company and Dermody Properties, dated July 9, 1996 (Incorporated herein by reference to Exhibit 10.20 to the Company's December 31, 1996 10-K) 10.13 Loan Agreement between the Company and Finova Capital Management dated as of April 13, 1998 (Incorporated herein by reference to Exhibit 10.1 to the Company's March 31, 1998 10-Q) 10.14 Form of Subscription Agreement dated May 13, 1998 (Incorporated herein by reference to Exhibit 10.2 to the Company's March 31, 1998 10-Q) 10.15 Form of Registration Rights Agreement dated May 13, 1998 (Incorporated herein by reference to Exhibit 10.3 to the Company's March 31, 1998 10-Q) 10.16 1997 Director Stock Option Plan (Incorporated herein by reference to Annex A to the Company's Schedule 14A filed April 24, 1997) 10.17 1998 Non-Executive Employee Stock Option Plan 10.18 Agreement between the Company and Edward G. Stevenson dated January 1, 1999 21 List of Subsidiaries 23.1 Consent of Kafoury, Armstrong & Co. 23.2 Consent of Arthur Andersen LLP 27 Financial Data Schedule - which is only submitted electronically to the Securities and Exchange Commission for EDGAR information purposes.
+ Agreement relates to Executive Compensation. - 59 - 60 (b) Reports on Form 8-K. On October 30, 1998, the Company filed a Form 8-K to report the resignation of its independent accountants. - 60 - 61 SIGNATURES In accordance with Section 13 or 15(d) of the Exchange Act, the registrant caused this report to be signed on its behalf by the undersigned, thereunto duly authorized. INNOVATIVE GAMING CORPORATION OF AMERICA Registrant Date: March 30, 1999 By: /s/ Edward G. Stevenson ----------------------------------- Name: Edward G. Stevenson Title: Chief Executive Officer and Chairman In accordance with the Exchange Act, this report has been signed below by the following persons on behalf of the registrant and in the capacities indicated on March 30, 1999.
Name Title /s/ Edward G. Stevenson Chief Executive Officer and Chairman - ------------------------------------- (principal executive officer) Edward G. Stevenson /s/ Scott Shackelton Vice President-Finance, Chief Financial - ------------------------------------- Officer (principal accounting officer) Scott Shackelton /s/ Lyle Berman Director - ------------------------------------- Lyle Berman
- 61 - 62 INDEX TO EXHIBITS
Exhibit Number Description - ------- ----------- 3.1(a) Articles of Incorporation, as amended (Incorporated herein by reference to Exhibit 3.1 to the Company's Registration Statement on Form SB-2 (File No. 33-61492C) (the "SB-2") 3.1(b) Certificate of Designation relating to Series B Convertible Preferred Stock (Incorporated herein by reference to Exhibit 4 to the Company's report on Form 10-Q for the quarter ended March 31, 1998) (the "March 31, 1998 10-Q") 3.2 Bylaws (Incorporated herein by reference to Exhibit 3.2 to the SB-2) 10.1 1992 Stock Option and Compensation Plan, as amended (Incorporated herein by reference to Annex B to the Company's Schedule 14A filed April 24, 1997) + 10.2 Agreement by and between the Company and Grand Casinos, Inc., dated as of July 28, 1994 (Incorporated herein by reference to Exhibit 10.26 to the Company's report on Form 10-K for the fiscal year ended July 31, 1994) 10.3 Employment Agreement between the Company and Edward G. Stevenson dated February 15, 1996 (Incorporated herein by reference to Exhibit 10.16 to the Company's report on Form 10-K for the fiscal year ended December 31, 1995) (the "December 31, 1995 10-K") 10.4 Exclusive Distributorship Agreement between the Company and Aristocrat Leisure Industries PTY LTD dated February 7, 1996 (Incorporated herein by reference to Exhibit 10.18 to the Company's December 31, 1995 10-K) 10.5 Assignment between the Company, NANAO and IREM dated February 2, 1996 (Incorporated herein by reference to Exhibit 10.19 to the Company's December 31, 1995 10-K) 10.6 Parts Supply Agreement between the Company and IREM dated February 2, 1996 (Incorporated herein by reference to Exhibit 10.20 to the Company's December 31, 1995 10-K) 10.7 Agreement between the Company and H Square Corporation dated April 26, 1996 (Incorporated herein by reference to Exhibit 10.21 to the Company's December 31, 1995 10-K) 10.8 Second Amendment to Share Exchange Agreement between the Company and Grand Casinos, Inc. dated December 1, 1995 (Incorporated herein by reference to Exhibit 10.23 to the Company's December 31, 1995 10-K) 10.9 Exclusive Distributorship Agreement between the Company and Ludi S.F.M. dated March 5, 1996 (Incorporated herein by reference to Exhibit 10.24 to the Company's December 31, 1995 10-K) 10.10 Exclusive Distributorship Agreement between the Company and S.A.M. EURSA dated March 5, 1996 (Incorporated herein by reference to Exhibit 10.25 to the Company's December 31, 1995 10-K) 10.11 Product Development and Revenue Sharing Agreement between the Company and IGT, dated November 18, 1996 (Incorporated herein by reference to Exhibit 10.18 to the Company's report on Form 10-K for the fiscal year ended December 31, 1996) (the "December 31, 1996 10-K") 10.12 Lease agreement between the Company and Dermody Properties, dated July 9, 1996 (Incorporated herein by reference to Exhibit 10.20 to the Company's December 31, 1996 10-K) 10.13 Loan Agreement between the Company and Finova Capital Management dated as of April 13, 1998 (Incorporated herein by reference to Exhibit 10.1 to the Company's March 31, 1998 10-Q) 10.14 Form of Subscription Agreement dated May 13, 1998 (Incorporated herein by reference to Exhibit 10.2 to the Company's March 31, 1998 10-Q) 10.15 Form of Registration Rights Agreement dated May 13, 1998 (Incorporated herein by reference to Exhibit 10.3 to the Company's March 31, 1998 10-Q) 10.16 1997 Director Stock Option Plan (Incorporated herein by reference to Annex A to the Company's Schedule 14A filed April 24, 1997) 10.17 1998 Non-Executive Employee Stock Option Plan 10.18 Agreement between the Company and Edward G. Stevenson dated January 1, 1999 21 List of Subsidiaries 23.1 Consent of Kafoury, Armstrong & Co. 23.2 Consent of Arthur Andersen LLP 27 Financial Data Schedule - which is only submitted electronically to the Securities and Exchange Commission for EDGAR information purposes.
EX-10.17 2 1998 NON-EXECUTIVE STOCK OPTION PLAN 1 EXHIBIT 10.17 INNOVATIVE GAMING CORPORATION OF AMERICA 1998 NON-EXECUTIVE STOCK OPTION PLAN AS AMENDED 1. Purpose. The purpose of the 1998 Non-Executive Stock Option Plan (the "Plan") of Innovative Gaming Corporation of America (the "Company") is to increase shareholder value and to advance the interests of the Company by attracting, motivating and retaining non-executive full-time employees of the Company ("Non-Executive Employees") by furnishing Non-Executive Employees non-qualified stock options to purchase Common Stock, $.01, of the Company ("Stock Options"). 2. Administration. The Plan shall be administered by the Compensation Committee of the Company (the "Committee") which Committee shall consist of not less than two directors of the Company and shall be appointed from time to time by the Board of Directors of the Company. A majority of the Committee's members shall constitute a quorum. All action of the Committee shall be taken by the majority of its members. Any action may be taken by a written instrument signed by majority of the members and actions so taken shall be fully effective as if it had been made by a majority vote at a meeting duly called and held. The Committee may appoint a secretary, shall keep minutes of its meetings and shall make such rules and regulations for the conduct of its business as it shall deem advisable. The Committee shall have complete authority to award Stock Options under the Plan, to interpret the Plan, and to make any other determination which it believes necessary and advisable for the proper administration of the Plan. The Committee's decisions and matters relating to the Plan shall be final and conclusive on the Company and its participants. 3. Eligible Employees. Non-Executive Employees of the Company who are full-time employees shall become eligible to receive Stock Options under the Plan when designated by the Committee. For purposes of the Plan, "Non-Executive Employees" shall be any employee of the Company who is not a director or officer of the Company, as defined in Rule 16a-l(f) of the Securities Exchange Act of 1934, as amended (the " 1934 Act"). Non-Executive Employees may be designated individually or by groups or categories (for example, by pay grade) as the Committee deems appropriate. 4. Shares Subject to the Plan. 4.1 Number of Shares. Subject to adjustment as provided in Section 6.5, the number of shares of Common Stock, which may be issued under the Plan shall not exceed 200,000 shares of Common Stock. 4.2 Cancellation. In the event that a Stock Option granted hereunder expires or is terminated or canceled unexercised as to any shares of Common Stock, options relating to such shares may again be issued under the Plan. The Committee may also determine to cancel, and agree to the cancellation of, Stock Options in order to make a participant eligible for the grant of a Stock Option at a lower price than the option to be canceled. 4.3 Type of Common Stock. Common Stock issued under the Plan in connection with Stock Options shall be authorized and unissued shares. 5. Stock Options. A Stock Option is a right to purchase shares of Common Stock from the Company. Each Stock Option granted by the Committee under this Plan shall be subject to the following terms and conditions: 5.1 Price. The option price per share shall be determined by the Committee, subject to adjustment under Section 6.5. 2 5.2 Number. The number of shares of Common Stock subject to the option shall be determined by the Committee, subject to adjustment as provided in Section 6.5. 5.3 Non-Qualified Stock Option. No Stock Option granted under the Plan shall qualify as an incentive stock option (as such term is defined in Section 422A of the Internal Revenue Code of 1986, as amended). 5.4 Duration and Time for Exercise. Subject to earlier termination as provided in Section 6.3, the term of each Stock Option shall be determined by the Committee but shall not exceed ten years and one day from the date of grant. Each Stock Option shall become exercisable at such time or times during its term as shall be determined by the Committee at the time of grant. Except as provided in any Stock Option Agreement approved by the Committee, no Stock Option may be exercised during the first twelve months of its term. Except as provided by the preceding sentence, the Committee may accelerate the exercisability of any Stock Option. Subject to the foregoing and with the approval of the Committee, all or any part of the shares of Common Stock with respect to which the right to purchase has accrued may be purchased by the Company at the time of such accrual or at any time or times thereafter during the term of the option. 5.5 Manner of Exercise. A Stock Option may be exercised, in whole or in part, by giving written notice to the Company, specifying the number of shares of Common Stock to be purchased and accompanied by the full purchase price for such shares. The option price shall be payable in United States dollars upon exercise of the option and may be paid by cash; uncertified or certified check; bank draft; by delivery of shares of Common Stock in payment of all or any part of the option price, which shares shall be valued for this purpose at the Fair Market Value on the date such option is exercised; by instructing the Company to withhold from the shares of Common Stock issuable upon exercise of the Stock Option shares of Common Stock in payment of all or any part of the option price, which shares shall be valued for this purpose at the Fair Market Value or in such other manner as may be authorized from time to time by the Committee. Prior to the issuance of shares of Common Stock upon the exercise of a Stock Option, a participant shall have no rights as a shareholder. 6. General. 6.1 Duration. The Plan shall remain in effect until all Stock Options granted under the Plan have either been satisfied by the issuance of shares of Common Stock or the payment of cash or been terminated under the terms of the Plan and all restrictions imposed on shares of Common Stock in connection with their issuance under the Plan have lapsed. No Stock Options may be granted under the Plan after the tenth anniversary of the date the Plan is approved by the Directors of the Company. 6.2 Non-transferability of Stock Options. No Stock Option may be transferred, pledged or assigned by the holder thereof (except, in the event of the holder's death, by will or the laws of descent and distribution to the limited extent provided in the Plan or in the Stock Option) and the Company shall not be required to recognize any attempted assignment of such rights by any participant. During a participant's lifetime, a Stock Option may be exercised only by him or by his guardian or legal representative. 6.3 Effect of Termination of Employment or Death. In the event that a participant ceases to be an employee of the Company for any reason, including death, any Stock Options may be exercised or shall expire at such times as may be determined by the Committee. 6.4 Additional Condition. Notwithstanding anything in this Plan to the contrary: (a) the Company may, if it shall determine it necessary or desirable for any reason, at the time of award of Stock Option require the recipient of the Stock Option, as a condition to the receipt thereof, to deliver to the Company a written representation of present intention to acquire the Stock Option or the shares of Common Stock issued pursuant thereto for his own account for investment and not for distribution; and (b) if at any time the 3 Company further determines, in its sole discretion, that the listing, registration or qualification (or any updating of any such document) of any Stock Option issuable pursuant thereto is necessary on any securities exchange or under any federal or state securities or blue sky law, or that the consent or approval of any governmental regulatory body is necessary or desirable as a condition of, or in connection with the award of any Stock Option, the issuance of shares of Common Stock pursuant thereto, or the removal of any restrictions imposed on such shares, such Stock Option shall not be awarded or such shares of Common Stock shall not be issued or such restrictions shall not be removed, as the case may be, in whole or in part, unless such listing, registration, qualification, consent or approval shall have been effected or obtained free of any conditions not acceptable to the Company. 6.5 Adjustment. In the event of any merger, consolidation or reorganization of the Company with any other corporation or corporations, there shall be substituted for each of the shares of Common Stock then subject to the Plan, including shares subject to restrictions, options, or achievement of performance share objectives, the number and kind of shares of stock or other securities to which the holders of the shares of Common Stock will be entitled pursuant to the transaction. In the event of any recapitalization, stock dividend, stock split, combination of shares or other change in the Common Stock, the number of shares of Common Stock then subject to the Plan, including shares subject to restrictions, options or achievements of performance shares, shall be adjusted in proportion to the change in outstanding shares of Common Stock. In the event of any such adjustments, the purchase price of any option, the performance objectives of any Stock Option, and the shares of Common Stock issuable pursuant to any Stock Option shall be adjusted as and to the extent appropriate, at the discretion of the Committee, to provide participants with the same relative rights before and after such adjustment. 6.6 Stock Option Plans and Agreements. The terms of each Stock Option shall be stated in an agreement approved by the Committee. 6.7 Withholding. (a) The Company shall have the right to withhold from any payments made under the Plan or to collect as a condition of payment, any taxes required by law to be withheld. At any time when a participant is required to pay to the Company an amount required to be withheld under applicable income tax laws in connection with an exercise of an option, the participant may satisfy this obligation in whole or in part by electing (the "Election") to have the Company withhold from the distribution shares of Common Stock having a value up to the amount required to be withheld. The value of the shares to be withheld shall be based on the Fair Market Value of the Common Stock on the date that the amount of tax to be withheld shall be determined ("Tax Date"). (b) Each Election must be made prior to the Tax Date. The Committee may disapprove of any Election, may suspend or terminate the right to make Elections, or may provide with respect to any Stock Option that the right to make Elections shall not apply to such Stock Option. An Election is irrevocable. 6.8 No Continued Employment or Right to Corporate Assets. No participant under the Plan shall have any right, because of his or her participation, to continue in the employ of the Company for any period of time or to any right to continue his or her present or any other rate of compensation. Nothing contained in the Plan shall be construed as giving an employee, the employee's beneficiaries or any other person any equity or interests of any kind in the assets of the Company or creating a trust of any kind or a fiduciary relationship of any kind between the Company and any such person. 6.9 Amendment of the Plan. The Board may amend or discontinue the Plan at any time. However, no such amendment or discontinuance shall, subject to adjustment under Section 6.5, change or impair, without the consent of the recipient, a Stock Option previously granted. 4 6.10 Immediate Acceleration of Stock Option. Notwithstanding any provision in this Plan or in any Stock Option to the contrary, all outstanding options will become exercisable immediately any of the following events occur: (1) any person or group of persons becomes the beneficial owner of 30% or more of any equity security of the Company entitled to vote for the election of directors; (2) a majority of the members of the Board of Directors of the Company is replaced within the period of less than two years by directors not nominated and approved by the Board of Directors; or (3) the shareholders of the Company approve an agreement to merge or consolidate with or into another corporation or an agreement to sell or otherwise dispose of all or substantially all of the Company's assets (including a plan of liquidation). For purposes of this Section 6. 10, beneficial ownership by a person or group of persons shall be determined in accordance with Regulation 13D (or any similar successor regulation) promulgated by the Securities and Exchange Commission pursuant to the 1934 Act. Beneficial ownership of more than 30% of an equity security may be established by any reasonable method, but shall be presumed conclusively as to any person who files a Schedule 13D report with the Securities and Exchange Commission reporting such ownership. If the restrictions and forfeitability periods are eliminated by reason of provision (1), the limitations of this Plan shall not become applicable again should the person cease to own 30% or more of any equity security of the Company. For purposes of this Section 6. 10, "Continuing Directors" are directors (a) who were in office prior to the time any of provisions (1), (2) or (3) occurred or any person publicly announced an intention to acquire 20% or more of any equity security of the Company, (b) directors in office for a period of more than two years, and (c) directors nominated and approved by the Continuing Directors. 6.11 Definition of Fair Market Value. For purposes of this Plan, the "Fair Market Value" of a share of Common Stock at a specified date shall, unless otherwise expressly provided in this Plan, be the amount which the Committee determines in good faith to be 100% of the fair market value of such a share as of the date in question; provided, however, that notwithstanding the foregoing, if such shares are listed on a U.S. securities exchange or are quoted on the NASDAQ National Market System, then Fair Market Value shall be determined by reference to the last sale price of a share of Common Stock on such U.S. securities exchange or NASDAQ on the applicable date. If such U.S. securities exchange or NASDAQ is closed for trading on such date, or if the Common Stock does not trade on such date, then the last sale price used shall be the one on the date the Common Stock last traded on such U.S. securities exchange or NASDAQ. EX-10.18 3 EMPLOYMENT AGREEMENT 1 EXHIBIT 10.18 EMPLOYMENT AGREEMENT PARTIES: Innovative Gaming Corporation of America, Inc. 4750 Turbo Circle Reno, Nevada 89502 (the "Company") Edward G. Stevenson 7 Kelly Circle Glenbrook, Nevada 89413 (the "Executive") DATE: January 1, 1999 RECITALS: A. The parties hereto entered into an employment agreement dated as of February 15, 1996 (the "First Employment Agreement") to provide for the employment of the Executive as President and Chief Executive Officer of the Company. B. Subsequent to the date of execution of the First Employment Agreement, Executive became Chairman of the Board of the Company and relinquished the position of President of the Company. C. The First Employment Agreement terminates February 15, 1999. D. The parties wish to terminate the First Employment Agreement as of the date hereof and provide for the continued employment of the Executive as the Chairman of the Board and Chief Executive Officer of the Company following the termination of the First Employment Agreement pursuant to the terms and conditions of this Agreement. E. The Executive wishes to receive compensation from the Company for the Executive's continued services, and the Company wants reasonable protection of its confidential business and technical information that has been acquired and is being developed by the Company at substantial expense. F. The Company wishes to obtain reasonable protection against unfair competition from the Executive following termination of employment and to further protect against unfair use of its confidential business and technical information and the Executive is willing to grant the Company the benefits of a covenant-not-to-compete for these purposes. 2 AGREEMENT: The Company and the Executive, each intending to be legally bound, agree as follows: 1. Termination of First Employment Agreement. The First Employment Agreement is hereby terminated. All terms and conditions relating to Executive's employment with the Company are contained in this Agreement. 2. Employment. Subject to all of the terms and conditions of this Agreement, the Company agrees to continue to employ the Executive as the Chairman of the Board and the Chief Executive Officer of the Company, and the Executive accepts such employment. 3. Duties. The Executive will devote substantially all of his business hours to and, during such time, make the best use of his energy, knowledge and training in advancing the Company's interests. The Executive will diligently and conscientiously perform the duties of the Executive's position within the general guidelines to be determined by the Company's Board of Directors (the "Board of Directors"). While the Executive is employed by the Company, Executive will keep the Company informed of any other business activities, and will promptly stop any activity or employment that might conflict with the Company's interests or adversely affect the performance of the Executive's duties for the Company. 4. Term. This Agreement will remain in effect for three (3) years after the date of this Agreement, unless it is terminated in accordance with Section 5 hereof. 5. Termination. Subject to the respective continuing obligations of the Company and the Executive under Sections 7, 8 and 9 hereof: a. The Company may terminate this Agreement immediately upon written notice to the Executive "for cause," which is defined as: (i) dishonesty, fraud, material and deliberate injury or attempted injury, in each case related to the Company or its business, (ii) any criminal activity of a serious nature, or (iii) the continued failure by Executive to satisfactorily perform the duties assigned to him pursuant to Section 3 of this Agreement for a period of 60 days after a written demand by the Board of Directors for such satisfactory performance which specifically identifies the manner in which it is alleged that Executive has not satisfactorily performed such duties. In the event of termination of this Agreement for cause pursuant to this Section 5(a), Executive will be paid at the usual rate Executive's annual Base Salary through the date of 2 3 termination specified in any notice of termination and Executive will have no right to receive any bonus for the period after which the termination occurs or any future periods, provided that such payments will be made within 30 days after termination for cause pursuant to this Section 5(a). Any termination by the Company other than for a reason enumerated in this Section 5(a) shall be deemed to be a termination "without cause." The Executive shall also be deemed to be terminated "without cause" in the event: (i) the Executive is required to relocate from the Reno, Nevada metropolitan area or (ii) the Executive is removed from the office of Chief Executive Officer or (iii) the Executive has had his authority and position diminished from that provided in Section 2; provided, however, that it shall not be deemed to be a diminishment of authority and position if the Company's Board of Directors appoints a Co-Chairman and Co-Chief Executive Officer. b. This Agreement will terminate upon the Executive's death or permanent disability. 6. Compensation. 1. Base Salary. In consideration for the Executive's services under this Agreement, the Company agrees to pay the Executive an initial base salary at a rate of Two Hundred Fifty Thousand Dollars ($250,000.00) per year (the "Base Salary"). Such Base Salary shall be paid no less often than monthly in accordance with the standard payroll practices of the Company. Such Base Salary may be adjusted from time to time by the Board of Directors but may not be decreased during the term of this Agreement. 2. Bonus. In addition to other compensation to be paid under this Section 6, the Company will pay Executive an annual bonus or a merit increase of up to 25% of the current year's Base Salary for each year in which he performs services under this Agreement, the exact amount to be determined by the Board of Directors based upon Executive's and the Company's attainment during the preceding year of specified annual objectives established by the Board of Directors in consultation with the Executive. In addition to such bonus, the Company will pay Executive an additional annual bonus of up to 25% of the current year's Base Salary for each year in which he performs services under this Agreement, the exact amount to be determined pursuant to a profit formula to be determined by the Compensation Committee of the Company's Board of Directors. 3. Reimbursement of Business Expenses. In addition to payment of Base Salary, the Company agrees to reimburse the Executive for all reasonable out-of-pocket business 3 4 expenses incurred by the Executive on behalf of the Company, provided that the Executive properly accounts to the Company for all such expenses in accordance with the rules and regulations of the Internal Revenue Service under the Internal Revenue Code of 1986, as amended, and in accordance with the standard policies of the Company relating to reimbursement of business expenses. 4. Benefits and Vacation. The Executive will be entitled to participate in all benefit plans adopted by the Company to the extent that the terms of such benefit plans permit the Executive to participate. The Executive will be entitled to an annual paid vacation of three weeks and all legal holidays observed by the Company, in each case, in accordance with the Company's policies as in effect from time to time. 5. Termination Without Cause. If the Company terminates this Agreement without cause, (i) all options granted to Executive to purchase Common Stock of the Company shall vest and remain exercisable for thirty-six months following such termination without cause; and (ii) the Company shall pay or grant to Executive: (1) the greater of (a) the Base Salary (or such greater amount as it may be at the time of such termination) for a twelve (12) month period after the date of such termination or (b) base salary for the balance of the remaining Agreement term; (2) any accrued bonus to be paid pursuant to Section 6(b) of this Agreement for the period through the date of termination; (3) the unreimbursed out-of-pocket business expenses incurred by the Executive on behalf of the Company of this Agreement; and (4) a continuation of health, life and disability insurance benefits for a twelve (12) month period after the date of termination on the same basis as Executive's health, life and disability insurance benefits immediately prior to such termination. 7. Inventions. 1. "Inventions," as used in this Section 7, means any discoveries, improvements and ideas (whether or not they are in writing or reduced to practice) or works of authorship (whether or not they can be patented or copyrighted) that the Executive makes, authors, or conceives (either alone or with others) and that: (1) concern directly the Company's business or the Company's present or demonstrably anticipated future research or development; (2) result from any work the Executive performs for the Company; 4 5 (3) use the Company's equipment, supplies, facilities, or trade secret information; or (4) the Executive develops during the time the Executive is performing employment duties for the Company. 2. The Executive agrees that all Inventions made by the Executive during or within six (6) months after the term of this Agreement will be the Company's sole and exclusive property. The Executive will, with respect to any Invention: (1) keep current, accurate, and complete records, which will belong to the Company and be kept and stored on the Company's premises while the Executive is employed by the Company; (2) promptly and fully disclose the existence and describe the nature of the Invention to the Company in writing (and without request); (3) assign (and the Executive does hereby assign) to the Company all of his rights to the Invention, any applications he makes for patents or copyrights in any country, and any patents or copyrights granted to him in any country; and (4) acknowledge and deliver promptly to the Company any written instruments, and perform any other acts necessary in the Company's opinion to preserve property rights in the Invention against forfeiture, abandonment or loss and to obtain and maintain letters patent and/or copyrights to the Invention and to vest the entire right and title to the Invention in the Company. The requirements of this subsection 7(b) do not apply to an Invention for which no equipment, supplies, facility or trade secret information of the Company was used and which was developed entirely on the Executive's own time, and (1) which does not relate directly to the Company's business or to the Company's actual or demonstrably anticipated research or development, or (2) which does not result from any work the Executive performed for the Company. Except as previously disclosed to the Company in writing, the Executive does not have, and will not assert, any claims to or rights under any Inventions as having been made, conceived, authored or acquired by the Executive prior to his employment by the Company. With respect to any obligations performed by the Executive under this subsection 5 6 7(b) following termination of employment, the Company will pay the Executive reasonable hourly compensation (consistent with the last Base salary) and will pay or reimburse all reasonable out-of-pocket expenses. 8. Confidential Information. 1. "Confidential Information," as used in this Section 8, means information that is not generally known and that is proprietary to the Company or that the Company is obligated to treat as proprietary. Any information that the Executive reasonably considers Confidential Information, or that the Company treats as Confidential Information, will be presumed to be Confidential Information (whether the Executive or others originated it and regardless of how the Executive obtained it). 2. Except as specifically permitted by an authorized officer of the Company or by written Company policies, the Executive will never, either during or after his employment by the Company, use Confidential Information for any purpose other than the business of the Company or disclose it to any person who is not also an Executive of the Company. When the Executive's employment with the Company ends, the Executive will promptly deliver to the Company all records and any compositions, articles, devices, apparatus and other items that disclose, describe or embody Confidential Information, including all copies, reproductions and specimens of the Confidential Information in the Executive's possession, regardless of who prepared them and will promptly deliver any other property of the Company in the Executive's possession, whether or not Confidential Information. 9. Competitive Activities. The Executive agrees that, during the term of employment with the Company and the period during which severance is paid, if any, under this Agreement following termination of employment (if this Agreement is terminated by the Company "without cause," then the Executive will not alone, or in any capacity with another firm, 1. directly engage in any commercial activity that competes with the Company's business, as the Company has conducted it during the two (2) years before the Executive's employment with the Company ends, within any state in the United States or within any country in which the Company directly markets or services products or provides services, 2. in any way interfere or attempt to interfere with the Company's relationships with any of its current or potential customers, or 6 7 3. employ or attempt to employ any of the Company's then Executives on behalf of any other entity competing with the Company. This Section 9 shall cease to be applicable to any activity of the Executive from and after such time as the Company (i) shall have ceased all business activities for a period of sixty (60) days or (ii) shall have made a decision through its Board of Directors not to continue, or shall have ceased for a period of sixty (60) days, the business activities with which such activity of the Executive would be competitive. 10. Conflicts of Interest. The Executive agrees that he will not, directly or indirectly, transact business with the Company personally, or as agent, owner, partner or shareholder of any other entity; provided, however, that any such transaction may be entered into if approved by the Board of Directors. 11. No Adequate Remedy. The Executive understands that if the Executive fails to fulfill the Executive's obligations under this Agreement, the damages to the Company would be very difficult to determine. Therefore, in addition to any other rights or remedies available to the Company at law, in equity, or by statute, the Executive hereby consents to the specific enforcement of this Agreement by the Company through an injunction or restraining order issued by an appropriate court. 12. Miscellaneous. 1. Successors and Assigns. This Agreement is binding on and inures to the benefit of the Company's successors and assigns, all of which are included in the term the "Company" as it is used in this Agreement; provided, however, that the Company may assign this Agreement only in connection with a merger, consolidation, assignment, sale or other disposition of substantially all of its assets or business. 2. Modification. This Agreement may be modified or amended only by a written statement signed by both the Company and the Executive. 3. Governing law. The laws of Nevada will govern the validity, construction, and performance of this Agreement. Any legal proceeding related to this Agreement will be brought in an appropriate Nevada court, and both the Company and the Executive hereby consent to the exclusive jurisdiction of that court for this purpose. 4. Construction. Wherever possible, each provision of this Agreement will be interpreted so that it is valid under the applicable law. If any provision of this Agreement is to any extent invalid under the applicable law, 7 8 that provision will still be effective to the extent it remains valid. The remainder of this Agreement also will continue to be valid, and the entire Agreement will continue to be valid in other jurisdictions. 5. Waivers. No failure or delay by either the Company or the Executive in exercising any right or remedy under this Agreement will waive any provision of the Agreement. Nor will any single or partial exercise by either the Company or the Executive of any right or remedy under this Agreement preclude either of them from otherwise or further exercising these rights or remedies, or any other rights or remedies granted by any law or any related document. 6. Captions. The headings in this Agreement are for convenience only and do not affect this Agreement's interpretation. 7. Entire Agreement. This Agreement supersedes all previous and contemporaneous oral negotiations, commitments, writings and understandings between the parties concerning the matters in this Agreement, including without limitation the First Employment Agreement and any policy or personnel manuals of the Company. 8. Notices. All notices and other communications required or permitted under this Agreement shall be in writing and shall be hand delivered or sent by registered or certified first-class mail, postage prepaid, and shall be effective upon delivery if hand delivered, or three (3) days after mailing if mailed to the addresses stated at the beginning of this Agreement. These addresses may be changed at any time by like notice. IN WITNESS WHEREOF, the Company and the Executive have executed this Agreement as of the date first above written. INNOVATIVE GAMING CORPORATION EXECUTIVE OF AMERICA By/s/ Lyle Berman ----------------------------------- /s/ Edward G. Stevenson Its Director ------------------------------- Edward G. Stevenson 8 EX-21 4 LIST OF SUBSIDIARIES 1 EXHIBIT 21 LIST OF SUBSIDIARIES Innovative Gaming, Inc. EX-23.1 5 KAFOURY, ARMSTRONG AND CO. CONSENT 1 EXHIBIT 23.1 CONSENT OF INDEPENDENT PUBLIC ACCOUNTANTS As independent public accountants, we hereby consent to the incorporation by reference of our report included in this Form 10-K, into the Company's previously filed Registration Statements on Form S-8 (File Nos. 33-73764, 333-06669, 333-37813 and 333-37815) and on Form S-3 (File No. 333-53893). KAFOURY, ARMSTRONG & CO. Reno, Nevada March 30, 1999 EX-23.2 6 ARTHUR ANDERSEN CONSENT 1 EXHIBIT 23.2 CONSENT OF INDEPENDENT PUBLIC ACCOUNTANTS As independent public accountants, we hereby consent to the incorporation by reference of our report dated March 12, 1998 covering the consolidated financial statements of Innovative Gaming Corporation of America and Subsidiary as of December 31, 1997 and for the two years then ended, included in this Form 10-K, into the Company's previously filed Registration Statements on Form S-8 (File Nos. 33-73764, 333-06669, 333-37813 and 333-37815) and on Form S-3 (File No. 333-53893). ARTHUR ANDERSEN LLP Las Vegas, Nevada March 30, 1999 EX-27 7 FINANCIAL DATA SCHEDULE
5 1,000 YEAR DEC-31-1998 JAN-01-1998 DEC-31-1998 1,617 700 1,520 0 9,244 13,465 1,389 0 17,093 1,365 0 0 0 75 14,797 17,093 8,509 8,509 7,134 7,134 5,819 0 (106) (4,338) 720 (5,058) 0 0 0 (5,058) (.72) (.72)
-----END PRIVACY-ENHANCED MESSAGE-----