-----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, TGY1hrCgP4SmDDQuEELzLKDr3NRyVI9+GdQxIjpz97DPNs7xHHDGE2NT8YNyleIE h+ZJKIGltKCRaabOeTjhlg== 0001096906-02-000284.txt : 20020416 0001096906-02-000284.hdr.sgml : 20020416 ACCESSION NUMBER: 0001096906-02-000284 CONFORMED SUBMISSION TYPE: 10-K PUBLIC DOCUMENT COUNT: 2 CONFORMED PERIOD OF REPORT: 20011231 FILED AS OF DATE: 20020416 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-K SEC ACT: 1934 Act SEC FILE NUMBER: 000-22482 FILM NUMBER: 02612417 BUSINESS ADDRESS: STREET 1: 333 ORVILLE WRIGHT COURT CITY: LAS VEGAS STATE: NV ZIP: 89119 BUSINESS PHONE: 7758233000 MAIL ADDRESS: STREET 1: 333 ORVILLE WRIGHT COURT CITY: LAS VEGAS STATE: NV ZIP: 89119 10-K 1 inngam10k_dec2001.txt 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, 2001 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.) 333 ORVILLE WRIGHT CT LAS VEGAS, NEVADA 89119 ------------ ----- (Address of principal executive offices) (Zip Code) (702) 614-7199 (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. [ ] As of April 10, 2002, 25,756,241 shares of the Registrant's common stock (the "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 Small Cap Market on April 10, 2002, was $11,590,308. For purposes of this computation, affiliates of the Registrant are the Registrant's executive officers and directors. DOCUMENTS INCORPORATED BY REFERENCE PART III - Portions of the Registrant's definitive proxy statement in connection with the annual meeting of the shareholders 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 computerized video gaming machines and multi-station gaming machines to regulated gaming markets world-wide. The Company has two primary product lines: computerized video/slot gaming machines and multi-player/multi-station video based games with a state of the art operating system providing superior graphic and sound capabilities. As of December 31, 2001, the Company had 47 employees. During 2001, the Company's management team was reorganized through the Board's selection of a new Chairman and Chief Executive Officer, Thomas J. Foley, and the appointment of Laus M. Abdo, the Company's Chief Financial Officer, as President. The new management team was charged to reorganize and restructure the Company and refocus the Company's business on its core technology. The Company intends to expand its existing market through new product offerings, including new game themes for its computerized video gaming machines, second screen bonusing features, the introduction of a poker game series and a networked bingo game targeted primarily to Indian casinos. In developing its new product offerings, the Company will utilize the technological advantages of its current computerized video gaming machines, and exploit technological improvements to its operating system such as ticket-in ticket-out, tokenization, multi-game and multi-denomination. The new management team has concentrated the Company's efforts and resources on its core business of developing and installing its computerized gaming machines either through direct sale or under participating agreements where the Company participates in the revenues from the machine on a percentage or flat-fee basis. Accordingly, the Company has terminated pursuits that were not consistent with its strategic business strategy. In December 1999 the Company entered into a merger agreement under which it would have been merged into nMortgage, Inc., a subsidiary of Equitex, Inc. In conjunction with this merger agreement, in February 2000 the Company entered into a separate agreement to sell substantially all of its gaming assets to Xertain, Inc. The Company subsequently determined that the merger with nMortgage was inadvisable and terminated the merger plan. In October 2000, the Company entered into an Agreement and Plan of Merger with Xertain, Inc. and IGCA Acquisition Corp. (the "Xertain Merger Agreement"). The Company subsequently determined that the merger with Xertain was inadvisable and terminated the Xertain Merger Agreement during the fourth quarter of 2001. The Company will continue to pursue opportunities to compliment its internal resources through strategic alliances and acquisitions. The primary purpose of these acquisitions and alliances is to increase new product offerings, reach complimentary markets and acquire additional technological capabilities. This strategy is evidenced by the recent agreement to acquire 100% of GET USA, Inc. On February 15, 2002, the Company entered into an Agreement and Plan of Merger by and among GET USA, Inc., Innovative Gaming Corporation of America and Innovative Gaming Technology Corp. (the "GET Merger Agreement"). GET USA, Inc. is a Nevada corporation formed in 2000 to own certain intellectual property relating to the gaming industry with a focus on Internet and networked gaming systems. GET USA owns a proprietary Internet Casino Operating Platform and proprietary technology with application in a broad range of gaming markets. Pursuant to the GET Merger Agreement, GET USA, Inc. will be merged into Innovative Gaming Technology Corp., a Nevada corporation and wholly owned 3 subsidiary of the Company. Following the merger, GET USA's shareholders will own 49% of the Company. Final closing of the merger is anticipated to occur in late-2002, subject to shareholder, regulatory and various governmental agencies' approval. IGCA's primary target markets have historically been gaming jurisdictions in North America, including the states of Arizona, Colorado, Iowa, Louisiana, Mississippi, Minnesota, Nevada, New Mexico, South Dakota, North Carolina and international markets such as Australia and Holland. The Company has submitted and has pending applications in Connecticut and Indiana. The Company remains registered with Alberta, Manitoba and the Atlantic Lottery Corporation and has an application pending in British Columbia. As of December 2000, the Company's single player computerized video slot machine has been approved for sale in Colorado, Iowa, Louisiana, Minnesota, New Mexico, Nevada and California. The Company distributes its products directly or under lease, sales (for cash or on extended payment terms) or participation agreements. Under participation agreements the Company shares in the revenue from the machines on a percentage or a flat-fee basis. The Company believes that its multi-line, multi-coin, video 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. IGCA employs advanced technology to enhance the entertainment features of its games while retaining many of the popular features of video gaming machines. BUSINESS STRATEGY The Company has embarked on a strategy to emphasize its core business of developing and installing its computerized gaming machines either through direct sale or under participating agreements where the Company participates in the revenues from the machine on a percentage or flat-fee basis. The Company believes that increased focus on the acquisition of revenue streams from participation agreements will allow the Company to approach profitability. To make the revenue-sharing strategy attractive to licensees, IGCA intends to both develop new products and continue producing popular existing games and license games (content) from third-party (independent) game developers. The Company believes that multi-line, multi-coin, video-based games are currently among the most popular games on the casino floor. To tap into this popularity and increase its market share, the Company has enhanced its operating system to include multi-denomination, tokenization and ticket-in, ticket-out technology. In addition, the Company intends to introduce 15 to 20 new game themes annually. The Company is also enhancing its ability to penetrate markets through the licensing of a video poker game series and a networked bingo game. The Company believes it will capitalize on future opportunities by: o developing and licensing innovative new products including proprietary games and operating systems and popular existing games o Implementing technological improvements such as ticket-in, ticket-out, multi-denomination and tokenization o developing new proprietary games and operating systems o focusing on sales and customer service o Continued focus on sales and customer service o expanding the Company's distribution infrastructure in order to bring games to market more rapidly and better serve the Company's customers o expanding and developing the Company's placement of proprietary and licensed games distributed under revenue-sharing arrangements PRODUCTS AND TECHNOLOGY Proprietary & Licensed Games - The Company will continue to develop and license games for sale or participation. In late 2001, IGCA began installing revenue-sharing games. The Company intends to continue installing revenue-sharing games in fiscal year 2002 and hopes to reach new markets and expand its customer base. In addition, the Company has entered into licensing 4 agreements under which it will expand its product offerings. Specifically, the Company expects to introduce 15-20 new titles per year for its video slots, introduce a video poker game and a networked bingo game and will pursue additional licensing agreements with independent game developers. Game Development - IGCA has developed a modular manufacturing process in order to increase efficiency and lower production costs. This modular platform allows IGCA to rapidly bring new games to market, and provides opportunities outside the gaming market for its components. Furthermore, the Company believes its modular platform will allow independent game designers to bring their own game concepts to IGCA in return for royalties since it interfaces easily with the PC-based hardware, Linux operating system and Java programming predominantly used by independent game designers. The Company believes this approach will increase its ability to develop innovative games that will provide streams of revenue while simultaneously minimizing personnel costs. Intellectual Property - IGCA has spent considerable effort and expense developing and implementing its proprietary operating system software for slot machine operations. The Company has applied for patent protection for this technology. PRODUCT STRATEGY Video Slot - The Company plans to continue introducing game content in a variety of cabinet configurations including upright units, slant-top units and bar-top units. Moreover, the Company plans on expanding its current game library by 15 to 20 new game titles during 2002, and each year thereafter. The video cabinets, upright and slant-top will become the high-end product line targeted for multiple denominations for video slot games, video poker platform and other internally developed or licensed games. Low Cost Cabinet - The Company is introducing a low cost cabinet to house its entire video library in 1-cent, 2-cent and higher denominations and/or multi-denomination format. The target market for this product is the tertiary casino operator. This new platform will be printer only, with a bill acceptor, and will be a low-cost alternative to casino offerings. This cabinet is a stand-alone unit and will not require a slot stand. Proprietary Games - The Company intends to develop and license proprietary games from which it will receive a daily rental fee or percentage of revenue for licensing, and is currently working with several game designers on proprietary games for this strategy. PRODUCT DEVELOPMENT STRATEGY The Company's product development strategy is to develop and maintain a competitive advantage by focusing on three key elements: (a) exercising sufficient control over the development and manufacturing process to enable quick reaction to the ever-changing technology environment; (b) concentrating efforts on the development of gaming machine platforms and games that are protected by patents or other property rights, and (c) licensing third party game themes, concepts and technologies. The Company has two primary product lines: computerized video gaming/slot machines and multi-player/multi-station video gaming machines incorporating a state of the art operating system with superior graphics and sound capabilities. VIDEO/SLOT GAMING MACHINES This series of gaming machines incorporates a unique PC based platform. The Company believes the operating system and game software provide powerful performance gains and excellent cost advantages over traditional gaming operating systems. Its modular software structure enables rapid development of new games 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. This product line currently includes the titles Monster Money, Area 51, Tiki Treasure and Wild 5 Jungle with additional titles under development. Video/slot gaming machines accounted for an aggregate of 53% of game sales in 2001, 30% of sales in 2000, and 21% of sales in 1999. 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 7% of game sales in 2001, 26% of sales in 2000, and 21% of sales in 1999. 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 tabletop. 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 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 6% of game sales in 2001, 5% of sales in 2000, and 12% of sales in 1999. 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 25% of game sales in 2001, 30% of sales in 2000, and 20% of sales in 1999. ITEM Platform The Company's newest product line, the ITEM incorporates all of the advantages of the video/slot operating system in addition to a newly designed hardware platform incorporating a multiple monitor array that eliminates the use 6 of static screened graphics for game identification, pay tables, and other traditional uses in gaming machines. The platform additionally conforms to design specifications for use in the Company's new multi-game products. The Company has initiated efforts for patent protection on several elements of this new platform. MANUFACTURING AND SUPPLY ARRANGEMENTS The Company's products are assembled at its production facility in Las Vegas, Nevada at the Company's corporate headquarters. The products collectively are assembled utilizing various parts and components from a large base of vendors. The Company has developed new technology to replace the electronic components previously purchased from its Japanese multi-game vendor and the Company has identified alternate sources of supply for significant parts and components in the event any of its current vendors fail to meet order requirements. INTELLECTUAL PROPERTY The Company has spent considerable effort and expense developing and implementing its proprietary operating system software for slot machine operations. This software revolves around the Linux operating system and Java software and operates on standard PC computer hardware platforms and proprietary interface circuits. The Company has filed for patent protection for these technologies. 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 assets 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 distributing its products directly to gaming markets. In the past, the Company has utilized licensed distributors in certain jurisdictions. The Company may consider working with distributors in the future to the extent they will provide the Company with access to new markets on a cost-effective basis. 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 multi-player games in Australia, New Zealand, and neighboring South Pacific jurisdictions. Pursuant to this agreement, the Company sold an aggregate of 99 games in 1997, 86 games in 1998 and no games in 1999. Due to the declining multi-player game sales in their territory, the Company and Aristocrat terminated the distribution agreement in March 2000. Aristocrat continues to purchase and distribute multi-player games in Australia and New Zealand on a limited basis. 7 The Company has submitted its applications for licensure in New Jersey and Connecticut, and will apply for approval of its various games. As of December 2001, the applications for licensure are still pending. SIGNIFICANT CUSTOMERS During 2001, the Company entered into a licensing agreement accounting for 38% of gross sales and made game sales to Delta Automaten accounting for 26% of gross sales. During 2000, the Company made sales to Delta Automaten and Casino Arizona accounting for 22.26% and 12.76% of gross sales respectively. During 1999, the Company made sales to one customer, a distributor, Black Hills Novelty Co., which accounted for 18.9% of sales for the year. 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 Gaming 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. Furthermore, the Company's single game product is currently in competition with products developed by all of the above-mentioned companies and there can be no assurance that the single player games developed by the Company will have continued acceptance in such competitive markets. There can be no assurance that these competitors, or another competitor, will not develop gaming machines that are similar to the Company's multi player gaming machines in the future. 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. 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 8 celebrations. These games, under IGRA, are regulated exclusively by the respective tribes. Class II gaming includes bingo and, additionally, pull tabs, 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 pari-mutuel 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 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. 9 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 to 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. 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. 10 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 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 11 matters 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. 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 12 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 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 13 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. 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 record keeping 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 Report, 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 31, 2002, the Company had cash of approximately $140,297. Although the Company is in the process of obtaining short-term financing from a third party lender, no assurance can be given that such financing will be obtained. Furthermore, the Company believes that any such financing would result in dilution to the Company's existing shareholders. The Company has experienced negative cash flow from operations of $4.9 million, $1.7 million, and $5.1 million for the years ended December 31, 2001, 2000, and 1999, respectively. The Company estimates that if current sales forecasts are met and its additional financing is 14 obtained, its cash and anticipated funds from operations will be adequate to fund cash requirements through April 18, 2002. Management believes that the costly process of product development and introduction will require the Company to seek additional financing beyond the short term financing to successfully complete any such future development and introduction. There can be no assurance that the Company will be successful in obtaining the proposed short-term financing or any additional financing on terms acceptable to the Company. Failure to obtain short-term financing or additional financing would have a material adverse effect on the Company, and the Company would have to consider liquidating all or part of the Company's assets and potentially discontinuing operations. LACK OF PROFITABILITY - The Company has had losses attributable to common shareholders of $15.1 million in 2001, $2.3 million in 2000 and $13.5 million in 1999. Although management is implementing plans to restore the Company to profitability, there can be no assurance that these plans will be successful. FAILURE TO REGISTER CERTAIN SHARES - The Registration Rights Agreement relating to the Company's recent issuances of the Company's Series K Convertible Preferred Stock requires the Company to register the shares of Common Stock issuable upon conversion of shares of Series K Convertible Preferred Stock within 180 days or pay certain liquidated damages. The liquidated-damages provisions were scheduled to take effect on January 29, 2002, and require the Company to pay 2% of the gross proceeds of the Series K Convertible Preferred Stock sold for the first 30 days after issuance if such Common Stock is not registered by January 29, 2002. In addition, the Company would be required to pay 3.5% of the gross proceeds to a major investor for each successive 30-day period thereafter during which the Common Stock is not registered. For other investors, the Company would be required to pay 2% of the gross proceeds for each successive 30-day period thereafter during which the Common Stock is not registered. Beginning April 1, 2002, the liquidated damages would be approximately $73,125 and would increase substantially each succeeding month, as further disclosed in the Notes to the Company's financial statements. A registration statement relating to such Common Stock was filed on September 28, 2001 and amended on January 16, 2002 and February 12, 2002, but had not been declared effective as of April 1, 2002. Unless the Company can obtain a waiver of such provisions from the holders of the Company's Series K Convertible Preferred Stock, the Company will be contractually required to make such payments, which could have a material adverse impact on the Company's liquidity. 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 15 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. Additionally, the Company has developed other single player games such as its single player video slot machines incorporating state of the art graphics and sound. 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. GOVERNMENT REGULATION - The manufacture and distribution of gaming machines are subject to extensive federal, state, provincial, tribal, international and local regulation. Furthermore, the Company's financing plans may require approval of gaming regulators which may not occur on a timely basis if at all. 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 as a gaming-equipment manufacturer depends on its ability to enhance its existing products, to introduce in a timely manner new products meeting regulatory requirements and evolving customer expectations 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 have been 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 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 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. In addition, the failure of the Company to arrange for delivery of components from suppliers on acceptable terms could have a material adverse effect on the Company. Furthermore, the Company's recent limited cash position and its difficulty obtaining credit from suppliers has made it difficult in some situations to obtain adequate supplies of materials to produce products. 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 16 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. 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 Small Cap 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, 2002 the Company's Common Stock has traded between $0.73 and $0.29 per share. No assurance can be given that the Company's Common Stock will continue to trade above the NASDAQ Small Cap Market minimum requirements or that the Company can maintain its NASDAQ Small Cap 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. Furthermore, on February 14,2002, the Company received a letter from Nasdaq indicating that for the past 30 days the Company's Common Stock had closed below the minimum $1 per share requirement for continued inclusion under Marketplace Rule 4310(c)(4) and that in accordance with Marketplace Rule 4310(c)(8)(D) the Company would be provided 180 days until August 13, 2002, to regain compliance. If the Company's Common Stock doesn't close at or above $1 per share for a minimum of 10 consecutive trading days before August 13, 2002, the Company can obtain an additional six months to regain compliance provided the Company meets the initial listing criteria for the Nasdaq Small Cap Market under Marketplace Rule 4310(c)(2)(A). Finally, the Company's proposed merger with GET USA would most likely require the Company to reapply for listing with the NASDAQ Small Cap Market. A new listing application would require, among other things, a minimum closing bid price of $4.00. 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 of these key personnel 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 17 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. ITEM 2. PROPERTIES The Company leases approximately 15,000 square feet of warehouse and office space in Las Vegas, Nevada for its main facility, which includes administrative, sales, and warehousing operations. The combined rent under the lease, which expires on July 31, 2005, was approximately $238,810 in 2001, with provisions for annual rent increases. The Company also leases approximately 12,534 square feet of warehouse, manufacturing and office space in Las Vegas, Nevada as its technology facility, which includes engineering, manufacturing, and warehousing operations. The rent under the lease, which expires on June 30, 2006, was approximately $41,364 in 2001, with provisions for annual rent increases. The Company leases approximately 4,000 square feet of warehouse and office space in Reno, Nevada for its Reno sales and service operations. The rent under the Reno lease, which expires in September 30, 2006, was approximately $8,400 in 2001, with provisions for annual rent increases. The Company formerly leased approximately 53,100 square feet of warehouse and office space in Reno, Nevada for its Reno manufacturing, sales and service operations. The rent under this Reno lease, which expired on October 31, 2001, was approximately $254,600 in 2001. ITEM 3. LEGAL PROCEEDINGS The Company is plaintiff in a lawsuit filed in Colorado district court which alleges improper use of its proprietary technology. Although the Company believes it will be successful in this lawsuit, the possible financial effects to the Company cannot be predicted. The Company is plaintiff in a lawsuit filed in Washoe County District Court, in Reno, Nevada, which alleges improper use of its proprietary technology. Although the Company believes it will be successful in this lawsuit, the possible financial effects to the Company cannot be predicted. Any other lawsuits will have no substantial financial effect to the company. 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, 2001. ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS PRICE RANGE OF COMMON STOCK Our Common Stock is traded on the NASDAQ SmallCap Market under the symbol "IGCA". Our Common Stock was also traded on the NASDAQ SmallCap Market from May 28, 1993, the date of the Company's initial public offering, through September 20, 1994. During the period from September 21, 1994 until December 22, 2000, our Common Stock was traded on the NASDAQ National Market. The following table summarizes the high and low closing sales prices per share of the Common Stock for the periods indicated as reported on the NASDAQ SmallCap Market or the NASDAQ National Market: FYE 12/31/00 HIGH LOW - ------------ ---- --- First Quarter $2.56 $1.44 Second Quarter 1.81 0.56 Third Quarter 1.06 0.56 Fourth Quarter 1.03 0.44 18 FYE 12/31/01 HIGH LOW - ------------ ---- --- First Quarter $1.13 $0.41 Second Quarter 1.80 0.60 Third Quarter 2.18 0.70 Fourth Quarter 1.00 0.21 On April 10, 2002, the last reported sale price for the Common Stock was $0.45 per share. As of April 11, 2002, the Company had 198 record holders of Common Stock plus an estimated 1,000 additional beneficial holders of Common Stock. IGCA's Board of Directors has not declared any dividend on our Common Stock since the Company's inception, and does not intend to pay out any cash dividends on its Common Stock in the foreseeable future. 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. Recent Sales of Unregistered Securities All sales of unregistered securities made during 2001 are disclosed in the Company's quarterly filings with the Securities and Exchange Commission on Form 10-Q. 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, 2001, 2000, 1999, 1998, and 1997. 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 For the For the For the For the Year Ended Year Ended Year Ended Year Ended Year Ended December 31, December 31, December 31, December 31, December 31, 2001 2000 1999 1998 1997 ------------ ------------ ------------ ------------ ------------- Statement of operations data: Net sales $8,082 $8,936 $4,026 $8,509 $10,292 Gross profit 4,372 4,045 (4,605) 1,375 3,103 Operating loss (11,072) (458) (12,729) (4,444) (2,182) Net loss (12,683) (742) (12,876) (4,338) (1,935) Net loss per common share: (0.85) (0.23) (1.80) (0.63) (0.43) Cash flow data: Cash provided by (used for): Operating activities (4,826) (1,707) (5,123) (2,106) (7,516) Investing activities (199) (98) (38) (92) 555 Financing activities 4,725 1,986 3,684 3,297 4,486 Increase (decrease) in cash and cash equivalents (300) 181 (1,477) 1,099 (2,475) Balance sheet data (end of period): Cash, cash equivalents and available-for-sale 21 321 140 1,617 518 securities Working capital (422) 6,927 4,580 12,100 12,603 Total assets 9,343 11,094 8,058 17,093 18,461 Long-term debt (net of current maturities) 7 578 3,131 856 509 Total stockholders' equity 2,886 8,505 3,189 16,872 16,482
19 ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS The following discussion and this Form 10-K contain 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: the need for and ability to obtain additional financing on terms favorable to the Company, customer acceptance of the Company's products, preferred stock conversions, decline in demand for gaming products or reduction in the growth rate of new markets, failure or delay in obtaining gaming licenses and 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, the ability of the Company to maintain its listing on the NASDAQ Stock Market, 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 its products 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 incorporating state of the art graphics and sound. As noted in Item 1-Business and the Notes to the Company's Consolidated Financial Statements, in December 1999 the Company entered into a merger agreement under which it would have been merged into nMortgage, Inc., a subsidiary of Equitex, Inc. In conjunction with this merger agreement, in February 2000 the Company entered into a separate agreement to sell substantially all of its gaming assets to Xertain, Inc. The Company subsequently determined that the merger with nMortgage was inadvisable and terminated the merger plan. On September 19, 2000, the Company's Board of Directors entered into a letter of intent with Xertain, Inc., whereby the Company would effect a merger with Xertain. On October 12, 2000, the Company entered into an Agreement and Plan of Merger whereby Xertain would become a wholly owned subsidiary of the Company. The Company subsequently determined that the merger with Xertain was inadvisable and terminated the Xertain Merger Agreement during the fourth quarter of 2001. Pursuant to this termination agreement, the Company recognized a loss on the amount of its initial investment in Xertain, as well as amounts due from Xertain. Total amount of the losses recognized was $1,501,000. On February 15, 2002, the Company entered into an Agreement and Plan of Merger by and among GET USA, Inc., Innovative Gaming Corporation of America and Innovative Gaming Technology Corp. (the "GET Merger Agreement"). Pursuant to the GET Merger Agreement, GET USA, Inc. will be merged into Innovative Gaming Technology Corp., a Nevada corporation and wholly owned subsidiary of the Company. Following the merger, GET USA's shareholders will own 49% of the Company. Final closing of the merger is anticipated to occur in late-2002, subject to shareholder, regulatory and various governmental agencies' approval. GET USA, Inc. is a Nevada corporation formed in 2000 to own certain intellectual property relating to Internet gaming. GET USA owns an Internet Casino Operating Platform. RESULTS OF OPERATIONS FOR THE YEAR ENDED DECEMBER 31, 2001 COMPARED TO THE YEAR ENDED DECEMBER 31, 2000 For the year ended December 31, 2001, the Company reported a net loss attributable to common shareholders of $15,101,000, or $ 0.85 per share compared to a net loss attributable to common shareholders of $2,278,000, or $0.23 per 20 share, for the year ended December 31, 2000. Results from operations for both years have been adjusted for preferred stock accretion and preferred stock dividends paid. Sales, cost of sales and gross profit Net sales were $8,082,000 during the year ended December 31, 2001 compared to $8,936,000 for the year ended December 31, 2000, due to decreased sales of gaming machines. The Company attributes these decreased sales to difficulties raising sufficient working capital to develop and produce new products. The following table presents the comparative sales revenue and percentage of revenue derived from each of the Company's product lines recorded for the years ending December 31, 2001 and 2000: Year ended Year ended December 31, 2001 December 31, 2000 --------------------- ---------------------- Sales revenue $8,082,000 $8,936,000 --------------------- --------------------- Product line: Percentage of revenue Percentage of revenue: --------------------- --------------------- Multi-player games 21% 61% Single player games 30% 30% Parts sales and other 4% 6% Lease participation 8% 3% License Sales 37% 0% --------------------- ---------------------- Total 100% 100% ===================== ====================== The Company recorded a gross margin of 54.1% in 2001 compared to a gross margin of 45.3% in 2000. The sale of a one-time license of the Company's technology in the second quarter of 2001 had no associated direct cost, which significantly increased the gross margins for the for the year ending December 31, 2001. The gross margins for the fiscal 2001 periods were also favorably affected by reductions in inventory reserves that were recorded in the fourth quarter of 1999 due to the then-planned divestiture of the Company's gaming assets to Xertain, Inc. These gross margin levels may not be repeated in future periods. Selling, general and administrative expenses Selling, general and administrative expenses for the year ended December 31, 2001 were $15,444,000 compared to $4,503,000 during 2000. The increase in expenses for 2001 was primarily attributable to bad debt expenses for the European market as well as substantial additions to the Company's engineering Department and to corporate management. The Company has reversed the trend of significantly higher selling, general and administrative expenses and reduced its payroll through the elimination of several management positions as well as other professional and non-professional positions since September 2001. Interest income and expense Net interest expense for the year ended December 31, 2001 was $622,000 compared to net interest expense of $284,000 for fiscal year 2000. Interest expense increased due to higher levels of short-term borrowing. Preferred stock accretion adjustment During 2001, the Company recorded accretion adjustments on preferred stock of $1,235,000, compared to $1,373,000 for 2000. These adjustments are explained more fully in the Notes to the financial statements. The increase in 2001 & 2000 was attributable to the Company's increased reliance on convertible preferred stock as a means for raising needed working capital. 21 RESULTS OF OPERATIONS FOR THE YEAR ENDED DECEMBER 31, 2000 COMPARED TO THE YEAR ENDED DECEMBER 31, 1999 For the year ended December 31, 2000, the Company reported a net loss attributable to common shareholders of $2,278,000, or $ 0.23 per share compared to a net loss attributable to common shareholders of $13,547,000, or $1.80 per share, for the year ended December 31, 1999. Results from operations for both years have been adjusted for preferred stock accretion and preferred stock dividends paid. The reduction in net loss in 2000 was primarily due to the Company's efforts at increasing sales revenues and reducing operating costs. Sales, cost of sales and gross profit Net sales were $8,936,735 during the year ended December 31, 2000 compared to $4,026,000 for the year ended December 31, 1999. This increase in sales is due to substantial increases in sales of substantially all of the Company's product lines. The following table presents the comparative sales revenue and percentage of revenue derived from each of the Company's product lines recorded for the years ending December 31, 2000 and 1999: YEAR ENDED YEAR ENDED DECEMBER 31, 2000 DECEMBER 31, 1999 --------------------- --------------------- Sales revenue.................... $ 8,936,735 $ 4,026,000 --------------------- --------------------- Product line:.................... Percentage of revenue Percentage of revenue --------------------- --------------------- Multi-player games............. 61% 53% Single player games............ 30% 21% Parts sales and other.......... 6% 17% Lease participation............ 3% 9% --------------------- --------------------- Total..................... 100% 100% ===================== ===================== The Company recorded a gross margin of 45.3% in 2000 compared to a negative gross margin in 1999. The improvement in 2000 was attributable to better absorption of overhead expenses at the increased level of production. Additionally, there was a write-down of inventory of $1.8 million in 1999 due to the anticipated divestiture of the Company's gaming assets to Xertain, Inc. The Company's sales in 2000 included substantial amounts of product which had previously been included in this market write-down, which also contributed to the improved gross margins. Selling, general and administrative expenses Selling, general and administrative expenses for the year ended December 31, 2000 were $4,503,000 compared to $6,787,000 during 1999. The decrease in expenses for 2000 was primarily attributable to substantial reductions in corporate management and engineering expenses during 2000. Interest income and expense Net interest expense for the year ended December 31, 2000 was $284,000 compared to net interest expense of $147,000 for fiscal year 1999. Interest expense increased due to increased debt service. Preferred stock accretion adjustment During 2000, the Company recorded accretion adjustments on preferred stock of $1,373,000, compared to $547,000 for 1999. These adjustments are explained more fully in the Notes to the financial statements. The increase in 2000 was attributable to the Company's increased reliance on convertible preferred stock as a means for raising additional working capital. 22 LIQUIDITY AND CAPITAL RESOURCES PREFERRED STOCK ISSUES - The Company raised proceeds from the issuance of convertible preferred stock of $6.6 million in 2001, $2.6 million in 2000, $3.7 million in 1999 and $2.8 million in 1998. These stock issuances are discussed more fully in the Notes to the Financial Statements. Preferred stock issuances have represented the Company's primary source of non-operating cash over the most recent four-year period. CONVERTIBLE DEBT FINANCING - During 1999, three-year convertible secured notes totaling $1.5 million were issued to a group of investors including a current shareholder of the Company. Interest was payable quarterly at a rate of 12% per annum, and the notes had an original maturity date of June 1, 2002. During 2000, the holders of $1.3 million of these notes exchanged the notes for preferred stock. Additionally, the holders of $1.0 million of notes previously issued to redeem Common Stock exchanged their notes for preferred stock. These arrangements are more fully discussed in the Notes to the Financial Statements. LIQUIDITY - The Company had $21,000 and $321,000 in cash and cash equivalents as of December 31, 2001 and December 31, 2000, respectively. The Company has experienced negative cash flow from operations of $4.8 million, $1.7 million, $5.1 million and $2.1 million for the years ended December 31, 2001, 2000, 1999, and 1998, respectively. Management believes that the costly process of product development and introduction will require the Company to seek additional financing to successfully compete in the market place. Furthermore, as of March 31, 2002, the Company had approximately $140,297 in cash and cash equivalents. As of such date, the Company was negotiating the terms of some short-term financing with a third party lender. There can be no assurance that the Company will be successful in obtaining such short-term financing or any additional financing on terms acceptable to the Company. The Company believes that any such short-term or long-term financing would be on terms that could be dilutive to the Company's existing shareholders. Failure to obtain short-term or additional financing would have a material adverse effect on the Company, and the Company would have to consider liquidating all or part of the Company's assets and potentially discontinuing operations. The Registration Rights Agreement relating to the Company's recent issuances of the Company's Series K Convertible Preferred Stock requires the Company to register the shares of Common Stock issuable upon conversion of shares of Series K Convertible Preferred Stock within 180 days or pay certain liquidated damages. The liquidated-damages provisions were scheduled to take effect on January 29, 2002, and require the Company to pay 2% of the gross proceeds of the Series K Convertible Preferred Stock sold for the first 30 days after issuance if such Common Stock is not registered by January 29, 2002. In addition, the Company would be required to pay 3.5% of the gross proceeds to a major investor for each successive 30-day period thereafter during which the Common Stock is not registered. For other investors, the Company would be required to pay 2% of the gross proceeds for each successive 30-day period thereafter during which the Common Stock is not registered. Beginning April 1, 2002, the liquidated damages would be approximately $73,125 and would increase substantially each succeeding month, as further disclosed in the Notes to the Company's financial statements. A registration statement relating to such Common Stock was filed on September 28, 2001 and amended on January 16, 2002 and February 12, 2002, but had not been declared effective as of April 1, 2002. Unless the Company can obtain a waiver of such provisions from the holders of the Company's Series K Convertible Preferred Stock, the Company will be contractually required to make such payments, which could have a material adverse impact on the Company's liquidity. The Company has a $1.0m revolving working capital line of credit with NHC, the line can be increased to $3m based upon certain criteria. As of March 31, 2001 the Company had drawn a total of $741,837 leaving $258,163 as unused available credit. COMMON STOCK REDEMPTION - As disclosed in the Notes to the Financial Statements, during 1999 the Company repurchased a total of 1.1 million shares of its outstanding Common Stock in exchange for notes totaling $1.3 million. As noted above in "Convertible Debt Financing" the holders of these notes exchanged them for convertible preferred stock in 2000. 23 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. 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 ability to obtain additional financing through leasing, equity or other arrangements; the inability to successfully develop, license, manufacture and market new products in a timely manner; decline in demand for gaming products or reduction in the growth rate of new markets; increased competition; the effect of economic conditions; a decline in the market acceptability of gaming; political and economic instability in developing international markets; a decrease in the desire of established casinos to upgrade machines in response to added competition from newly constructed casinos; the loss of a distributor; loss or retirement of key executives; approval of pending patent applications or infringement upon existing patents; the effect of regulatory and governmental actions; unfavorable determination of suitability by regulatory authorities with respect to officers, directors or key employees; the limitation, conditioning or suspension of any gaming license; adverse results of significant litigation matters; fluctuation in exchange rates, tariffs and other barriers. Investors are referred to the full discussion of risks and uncertainties associated with forward-looking statements contained in 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. ITEM 7A. Quantitative and Qualitative Disclosures About Market Risk The Company's financial instruments include cash and cash equivalents and long-term debt. 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 into cash. The Company's cash and cash equivalents are not subject to significant interest rate risk due to the short maturities of these instruments. The total outstanding long-term debt of the Company as of December 31, 2001 was $6,500. The Company's long-term debt is not subject to interest rate risk because all of the Company's long-term debt has fixed rates of interest. The Company does not enter into contracts for speculative or investment purposes. Gains and losses on foreign currency transactions are reconciled currently in earnings. The Company's revenues from foreign markets are typically negotiated for payment in United States currency, and the Company does not consider foreign transactions to be a significant risk at this time. 24 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 sheets of Innovative Gaming Corporation of America and subsidiaries as of December 31, 2001 and 2000, and the related consolidated statements of operations, stockholders' equity and cash flows for each of the three years in the period ended December 31, 2001. 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 auditing standards generally accepted in the United States of America. 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 subsidiaries as of December 31, 2001 and 2000, and the results of their operations and their cash flows for each of the three years in the period ended December 31, 2001, in conformity with accounting principles generally accepted in the United States of America. 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 also 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 April 15, 2002 25
INNOVATIVE GAMING CORPORATION OF AMERICA AND SUBSIDIARY Consolidated Balance Sheets (In Thousands, Except Share Data) As of December 31, ----------------------- 2001 2000 -------- -------- ASSETS CURRENT ASSETS: Cash and cash equivalents $ 21 $ 321 Accounts receivable, net of allowances 300 3,168 Current portion of notes receivable 95 93 Inventories, net 4,400 4,123 Prepaid expenses and other 1,212 1,233 -------- -------- Total current assets 6,028 8,938 NOTES RECEIVABLE, less current portion 118 190 INVESTMENT IN XERTAIN, INC. - 989 PROPERTY AND EQUIPMENT, net 770 350 PREPAID NONCURRENT 1,985 - INTANGIBLES ASSETS, net 442 627 -------- -------- TOTAL ASSETS $ 9,343 $ 11,094 ======== ======== LIABILITIES AND STOCKHOLDERS' EQUITY CURRENT LIABILITIES: Accounts payable $ 3,169 $ 1,106 Accrued liabilities 706 715 Accrued Preferred Stock Dividends 319 - Accrued Wages 164 54 Deferred Revenue Lease Back 197 - Notes payable - current portion 1,895 136 -------- -------- Total current liabilities 6,450 2,011 Notes payable - net of current portion 7 578 -------- -------- Total liabilities 6,457 2,589 -------- -------- COMMITMENTS AND CONTINGENCIES (Note 9) - - STOCKHOLDERS' EQUITY: Series B Convertible Preferred Stock, $.01 par value, nonvoting, 4,000 shares authorized, 0 and 30 shares outstanding, respectively - - Series C Convertible Preferred Stock, $.01 par value, nonvoting, 2,000 shares authorized, 0 and 630 shares outstanding, respectively - - Series D Convertible Preferred Stock, $.01 par value, nonvoting, 3,000 shares authorized, 0 and 1,132 shares outstanding, respectively - - Series E Convertible Preferred Stock, $.01 par value, nonvoting, 400,000 shares authorized, 42,000 and 210,000 shares outstanding, respectively - 2 Series F Convertible Preferred Stock, $.01 par value, nonvoting, 400,000 shares authorized, 230,000 and 306,250 shares outstanding, respectively 2 3 Series J convertible preferred stock, $.01 par value, nonvoting, 1,500,000 shares authorized, 50,000 and O shares outstanding, respectively 1 -- Series K convertible preferred stock, $.01 par value, nonvoting, 5,000 shares authorized, 4,553 and O shares outstanding, respectively -- -- Common stock, $.01 par value, 100,000,000 shares authorized, 24,208,339 and 11,930,837 shares issued and outstanding, respectively 242 119 Additional paid-in capital 51,445 42,085 Accumulated deficit (48,804) (33,704) -------- -------- Total stockholders' equity 2,886 8,505 -------- -------- TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY $ 9,343 $ 11,094 ======== ========
The accompanying notes are an integral part of these consolidated balance sheets. 26
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, 2001 2000 1999 -------- -------- -------- NET SALES GAMES $ 5,082 $ 8,936 $ 4,026 NET SALES LICENSES 3,000 -- -- -------- -------- -------- TOTAL NET SALES 8,082 8,936 4,026 COST OF SALES GAMES 3,710 4,891 5,313 WRITE DOWN INVENTORY TO MARKET VALUE -- -- 3,318 -------- -------- -------- Gross profit 4,372 4,045 (4,605) SELLING, GENERAL AND ADMINISTRATIVE EXPENSES 15,444 4,503 6,787 WRITE DOWN ASSETS TO MARKET VALUE -- -- 1,337 -------- -------- -------- Operating loss (11,072) (458) (12,729) OTHER INCOME (EXPENSE), net (622) (284) (147) LOSS ON INVESTMENT IN XERTAIN (989) -------- -------- -------- Loss before income taxes (12,683) (742) (12,876) PROVISION FOR INCOME TAXES -- -- -- -------- -------- -------- Net loss (12,683) (742) (12,876) PREFERRED STOCK DIVIDENDS 1,182 163 124 PREFERRED STOCK ACCRETION 1,235 1,373 547 -------- -------- -------- Net loss attributable to common shareholders ($15,100) ($ 2,278) ($13,547) ======== ======== ======== LOSS PER SHARE OF COMMON STOCK ($ 0.85) ($ 0.23) ($ 1.80) ======== ======== ======== Weighted average common shares outstanding 17,841 9,774 7,525 ======== ======== ========
The accompanying notes are an integral part of these consolidated financial statements. 27
INNOVATIVE GAMING CORPORATION OF AMERICA AND SUBSIDIARY Consolidated Statements of Stockholders' Equity (In Thousands) Convertible Unrealized Common Stock Preferred Stock Additional Gain/(Loss) on ----------------- --------------- Paid-in Accumulated Available-for- Shares Amount Shares Amount Capital Deficit Sale Securities Total ------- ------- ------ ------ --------- --------- --------------- --------- BALANCE, December 31, 1998 7,535 75 3 - 32,676 (17,879) - 14,872 Series C preferred stock issued - - 1 - 1,291 - - 1,291 Series D preferred stock issued - - 3 - 2,389 - - 2,389 Preferred stock conversions to common stock: Series B preferred stock 1,410 14 (2) - (14) - - 0 Series C preferred stock 388 4 - - (4) - - 0 Series D preferred stock 674 7 (1) - (7) - - 0 Series B preferred stock redemption - - (1) - (1,100) - - (1,100) Preferred stock accretion adjustments - - - - 547 (547) - 0 Preferred stock dividends 7 - - - 9 (124) - (115) Repurchase of common stock (1,100) (11) - - (1,302) - - (1,313) Stock options exercised 38 1 - - 40 - - 41 Net loss - - - - - (12,876) - (12,876) -------- -------- -------- -------- -------- -------- -------- -------- BALANCE, December 31, 1999 8,952 $ 90 3 $ - $ 34,525 $(31,426) - $ 3,189 Series E preferred stock issued - - 210 4 4,118 - - 4,122 Series F preferred stock issued - - 306 1 800 - - 801 Preferred stock conversions to common stock: Series B preferred stock 89 1 - - (1) - - - Series C preferred stock 617 6 - - (6) - - - Series D preferred stock 826 8 - - (8) - - - Preferred stock conversions to preferred stock: Series E preferred stock - - (206) (2) (2,058) - - (2,060) Series F preferred stock - - 206 2 2,060 - - 2,062 Preferred stock accretion adjustments - - - - 1,373 (1,373) - - Preferred stock dividends - - - - - (163) - (163) Stock issued for Xertain, Inc. 1,092 11 - - 978 - - 989 Stock options exercised 30 - - - 33 - - 33 Stock issued for expenses 325 3 - - 271 - - 274 Net loss - - - - - (742) - (742) -------- -------- -------- -------- -------- -------- -------- -------- BALANCE, December 31, 2000 11,931 $ 119 519 $ 5 $ 42,085 $(33,704) - $ 8,505 Series E preferred stock issued 55 - 550 550 Series G preferred stock issued - - - - 400 - - 400 Series H preferred stock issued - - - - - - - Series I preferred stock issued - - Series J preferred stock issued 150 2 1,814 1,816 Series K preferred stock issued 5 - 2,603 2,603 Preferred stock conversions to common stock: Series C preferred stock 220 2 (1) (2) - Series E preferred stock 2,579 26 (188) (2) (36) (12) Series F preferred stock 1,381 14 (76) (1) 167 180 Series G preferred stock 1,830 19 (1) (28) (9) Series H preferred stock 1,104 11 (1) (107) (96) Series I preferred stock 1,040 10 (1) (17) (7) Series J preferred stock 1,000 10 (100) (1) (9) - Series K preferred stock 131 1 (1) Preferred stock conversions to preferred stock: Series B (30) (30) Series C (1) (530) (530) Series D (1) (1,132) (1,132) Series E (36) (358) (358) Series G 1 810 810 Series H 1 700 700 Series I 1 624 624 Preferred stock accretion adjustments - - - - 1,235 (1,235) - - Preferred stock dividends - - - - - (1,182) - (1,182) Stock options exercised 173 2 - - 178 - - 180 Stock Issued for Dividends 878 9 779 - 788 Stock issued for expenses 1,905 19 - - 1,739 - 1,758 Stock issued for Emp. stock purchase 36 11 11 Net loss - - - - - (12,683) - (12,683) -------- -------- -------- -------- -------- -------- -------- -------- BALANCE, December 31, 2001 24,208 $ 242 326 $ 3 $ 51,445 $(48,804) - $ 2,886 ======== ======== ======== ======== ======== ======== ======== ======== Theaccompanying notes are an integral part of these consolidated financial statements. 28
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, 2001 2000 1999 ------------ ------------ -------------- OPERATING ACTIVITIES: Net loss ($ 12,683) ($ 742) ($12,876) Adjustments to reconcile net loss to cash flows used for operating activities - Depreciation and amortization 674 593 1,194 Provision for inventory obsolescence (813) (1,678) 1,170 Write down inventory to market value (469) (767) 3,318 Write down assets to market value - - 1,337 Provision for bad debts - - 198 Changes in operating assets and liabilities: Accounts and notes receivable 2,866 (2,236) 470 Inventories 1,023 2,899 29 Prepaid expenses and other 1,304 (303) (272) Accounts payable and accrued expenses 3,272 527 309 -------- -------- -------- Net cash used for operating activities (4,826) (1,707) (5,123) -------- -------- -------- INVESTING ACTIVITIES: Release of restricted investments - - 700 Inventory (capitalized for use in) returned from gaming operations 543 66 (511) Purchases of property and equipment (302) (84) (77) Purchases of intangible assets (42) (80) (150) -------- -------- -------- Net cash provided by (used for) investing activities (199) (98) (38) -------- -------- -------- FINANCING ACTIVITIES: Proceeds from financing agreements 2,858 - 2,028 Payments on long-term obligations (1,979) (559) (840) Preferred stock dividends paid - (99) (125) Net proceeds from sale of common stock 180 33 40 Net proceeds from sale of preferred stock 3,666 2,611 3,681 Payment to redeem preferred stock - - (1,100) -------- -------- -------- Net cash provided by financing activities 4,725 1,986 3,684 -------- -------- -------- INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS (300) 181 (1,477) CASH AND CASH EQUIVALENTS, beginning of period 321 140 1,617 -------- -------- -------- CASH AND CASH EQUIVALENTS, end of period $ 21 $ 321 $ 140 ======== ======== ======== SUPPLEMENTAL DISCLOSURE OF CASH FLOWS INFORMATION: Cash paid for interest $ 361 $ 249 $ 214 ======== ======== ======== Cash paid (refund received) for income taxes $ - $ 1 $ 1 ======== ======== ======== Non-cash transactions: Preferred Stock converted to common stock $ 56 $ 1,008 $ 2,957 ======== ======== ======== Preferred Stock dividends paid with common stock $ 788 $ - $ 9 ======== ======== ======== Preferred Stock issued for expenses $ 1,935 $ - $ - - ======== ======== ======== Expenses paid with common stock $ 1,758 $ 274 $ - ======== ======== ======== Penalty shares issued to preferred stockholders $ 771 $ - $ - ======== ======== ======== Long-term obligations converted to preferred stock $ 550 $ 2,310 $ - ======== ======== ======== Theaccompanying notes are an integral part of these consolidated financial statements. 29
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.("IGI"), is in the business of developing, manufacturing, marketing and distributing computerized gaming equipment. The Company distributes its products to certain gaming markets worldwide. On October 8, 1999, the Company entered into a non-binding letter of intent with Equitex, Inc.("Equitex"), which outlined the terms of a contemplated merger between the Company and Equitex's subsidiary, nMortgage, Inc. ("nMortgage") in a tax-free exchange of stock (the "Merger"). On December 21, 1999, IGCA Acquisition Corporation was created in anticipation of this merger. On December 31, 1999, the Company, Equitex and nMortgage executed a definitive merger agreement governing the Merger. Pursuant to the merger agreement, the stockholders of the Company were to retain 25% of the surviving corporation to the merger on a post-merger basis. As a condition to the Merger, concurrent with the Merger, the Company was to divest substantially all of its gaming assets. In September 2000, the Company and Equitex terminated their merger agreement. Subsequent to canceling the nMortgage merger, in October 2000 the Company entered into a plan to merge Xertain, Inc. into a subsidiary of the Company. The Company subsequently determined that the merger with Xertain was inadvisable and terminated the Xertain merger agreement during the fourth quarter of 2001. In February 2002, the Company entered into a merger agreement with GET USA, Inc. a company involved in Internet gaming and other game development efforts. The details of this agreement are more fully described in Note 10. The Company has experienced negative cash flow from operations of $4.9 million,$1.7 million, $5.1 million and $2.1 million for the years ended December 31, 2001, 2000, 1999, and 1998, respectively. Management believes that the costly process of product development and introduction will require the Company to seek additional financing to successfully compete in the market place. There can be no assurance that the Company will be successful in obtaining any additional financing on terms acceptable to the Company. Failure to obtain additional financing would have a material adverse effect on the Company, and the Company would have to consider liquidating all or part of the Company's assets and potentially discontinuing operations. 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 licenses and product approval in several jurisdictions. Failure to successfully obtain licenses, approvals, or meet other regulatory requirements could materially impact the future operation of the Company. 30 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 subsidiaries, Innovative Gaming, Inc., Innovative Gaming Finance Corp., Innovative Gaming Technology Corp., Game Card Technologies, Inc., Card Technologies, Inc. and IGCA Acquisition Corp. 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. 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. ALLOWANCE FOR DOUBTFUL ACCOUNTS The Company has provided for an allowance for doubtful accounts for the years ended December 31, 2001 and 2000,of $5,176 and $113 respectively based on management's estimate of the collectibility of accounts receivable. 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, 2001, 2000 and 1999 was $446, $375, and $852, respectively. Useful Life 2001 2000 ------------ ------ ------- Office equipment 5 years $567 $913 Display games 5 years 0 66 Gaming operations equipment 2.5 years 532 265 Manufacturing equipment 5 years 757 359 Leasehold improvements Life of 89 321 lease ------ ------- Total property and equipment 1,945 1,924 Less: Accumulated depreciation (857) (1,256) Write down to market value (318) (318) ------ ------- Total property and equipment, net $770 $350 ====== ====== 31 INVENTORIES Inventories are recorded at the lower of cost or market value. Cost is determined according to the weighted average accounting method. Inventories consisted of the following at December 31: 2001 2000 ------- ------- Game components and parts $ 3,828 $ 4,416 Work in process 356 422 Finished goods 1,575 1,926 Inventory reserves (795) (1,608) Write down to market value (564) (1,033) ------- ------- Total inventories, net $ 4,400 $ 4,123 ======= ======= INTANGIBLES The Company amortizes intangibles on a straight-line basis over their estimated economic lives while the technologies are being utilized (See Note 4). PRODUCT SALES/REVENUE RECOGNITION The Company makes product sales for cash, on normal terms of 90 days or less, and over longer term installments until the purchase price is paid. Revenues from the sale of products are 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 2001, the Company made sales to Delta Automaten accounting for 63.5%, during 2000, the Company made sales to Delta Automaten and Casino Arizona accounting for 22.26% and 12.76% of gross sales respectively. During 1999, the Company made sales to a distributor, Black Hills Novelty Co., which accounted for 18.9% of sales for the year. In March 2000, the Company and Aristocrat terminated the distribution agreement. For the years ended December 31, 2000, 1999, and 1998, 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 financial instruments that subject the Company to concentrations of credit risk consists 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, 2001, the following concentrations of credit risk existed: Holland 86% Nevada 6% Other (less than 6% each) 8% ------ Total 100% ====== 32 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 $2,678,$1,190 and $3,309 for the years ended December 31, 2001, 2000 and 1999, respectively. These amounts are included in selling, general and administrative expenses. 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 statements 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). The earnings per 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 that 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 SFAS 121 "Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to be Disposed Of" established 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 impairment exists. For assets which do not produce quantifiable future cash flows, such as intangibles, impairment is measured at the enterprise level. At December 31, 1999, the carrying values of long-lived assets were evaluated, and taking into consideration the planned sale of the gaming assets to Xertain, Inc. which was a prerequisite to the proposed merger with nMortgage.com, the carrying values were reduced to reflect the amount expected to be realized upon the closing of the asset sale and merger. The total impairment amount of $1,337, which is presented separately on the face of the statement of operations, was attributable to the write-down to market value of property and equipment in the amount of $318 and intangible assets in the amount of $1,019. No impairment existed at December 31, 2001 or 2000. 33 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 served on the Board of Directors of the Company until July 16, 1999. 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 a 1998 agreement between the Company and LGI, used multi-player machines that LGI previously purchased from the Company could 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 could be applied to the purchase of one new Bonus Streak game from the Company and with minimum proceeds of $5,000 to be credited to LGI for each game sold by the Company. During 1998, LGI submitted 15 such used multi-player games to the Company for sale under the consignment agreement. In the first quarter of fiscal 1999, the Company delivered 5 Bonus Streak games to casinos managed by LGI in exchange for the used multi-player games submitted to the Company for sale under this agreement. The Company made sales of six Bonus Streak(TM) games and no multi-player machine sales to LGI during 1998 and no machine sales in 1999 and 2000. In April 1999, in order to expedite the timing of gaming regulatory approval in certain jurisdictions, the Company repurchased 700,000 shares of Common Stock from LGI in exchange for convertible notes totaling $875. On November 1, 2000 a portion of these notes were redeemed as discussed in Note 6. 3. 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. The contracts typically have no stated interest to be paid, and interest is imputed at prime plus 2%. At December 31, 2001 and 2000 the face amount of notes receivable was $213 and respectively. The carrying value of notes receivable approximates their fair value. The following table represents the estimated future collections of notes receivable, net of amounts to be recognized as interest income, at December 31, 2001: Years Ending December 31, Estimated Receipts 2002 $ 95 2003 51 2004 40 2005 27 ---------- Total $ 213 ========== 34 4. INTANGIBLE ASSETS: Intangible assets consisted of the following at December 31: Useful Life 2001 2000 ----------- --------- -------- Product patent and technology rights 5 to 10 $ 3,204 $ 3,162 years Nevada distribution rights 10 years 250 250 --------- -------- Total intangible assets 3,454 3,412 Less: accumulated amortization (1,993) (1,766) write down to market value (1,019) (1,019) --------- -------- Total intangible assets, net $ 442 $ 627 ========= ======== Amortization recorded for intangibles was $228, $218 and $977 in the years ended December 31, 2001, 2000 and 1999, respectively. 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 totaling $750. During 1999, $650 of these costs were fully written down based on management's estimation that no economic benefit would be realized in the future. During 2000, the Company entered into agreements with various companies to acquire rights to domain name, technology and intellectual property for use in games which the Company intends to develop, manufacture and market totaling $80. 5. FINANCING ARRANGEMENTS: NOTES PAYABLE Notes payable consists of convertible notes issued for the repurchase of Common Stock of the Company from Lakes Gaming, Inc. and another shareholder, convertible notes issued to a group of investors as part of a financial restructuring to raise operating capital, 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, and an operating capital loan from Finova Capital Corporation. In March 1998, Innovative Gaming, Inc., a wholly-owned subsidiary of the Company, entered into a loan commitment securing available funding of $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. 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. 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 Common Stock beneficially owned by such shareholder in exchange for a four-year convertible note in the amount of $438 and a warrant to purchase 50,000 shares of the Common Stock. On November 1, 2000, $437 was converted to Series E Preferred Stock. In April 1999, the Company redeemed 700,000 shares of Common Stock from Lakes Gaming, Inc. in exchange for a four-year convertible note in the amount of $875 and a warrant to purchase 87,500 shares of Common Stock. This redemption was also undertaken to expedite the timing of gaming regulatory approval in certain jurisdictions. These notes are unsecured, pay interest of 5% per annum and are convertible to Common Stock at $1.09375 and $1.25 per share, respectively. Interest is paid quarterly on the 35 first note and is due at maturity on the second note. The notes may not be converted in the first year following issuance. The exercise price of the warrants is the same as the conversion price of the notes. On November 1, 2000, $575 of the convertible debt was converted to Series E Preferred Stock. On June 1, 1999, the Company completed a financial restructuring which included a private placement of three-year convertible secured notes totaling $1,550 issued to a group of investors. Interest on such notes is paid quarterly at a rate of 12% per annum, and the principal balance is due June 1, 2002. At any time after June 1, 2000, and until the principal balance is paid in full, the holders of the notes may convert the notes into Common Stock at a conversion price of $1.50 per share. The note holders may not convert the notes into Common Stock if such conversion would result in beneficial ownership by such note holder of more than 4.9% of the Company's issued and outstanding Common Stock. These notes are secured by the furniture, fixtures and equipment, inventory and intangible property of the Company. On November 1, 2000, $1,300 of the convertible debt was converted to Series E Preferred Stock. 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. IGT has agreed to accept the return of the slant top slot machines and grant credit for the balance due on the games returned. 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 2000. On April 2, 2001, the Company borrowed $300 and issued an unsecured one-year note. Interest is payable quarterly at an annual rate of 8 percent. The Company also agreed to issue 200,000 shares of its Common Stock as additional consideration for the loan. The shares will be treated as additional interest payments. Also on April 2, 2001, the Company borrowed an additional $100 and issued an unsecured one-year note. Interest is payable quarterly at an annual rate of 8 percent. The Company also agreed to issue 64,000 shares of its Common Stock as additional consideration for the loan. The shares will be treated as additional interest payments. On April 12, 2001, the Company borrowed $1 million on an unsecured 90-day note. Interest is payable at 12 percent, of which $12 was paid in advance and the remaining $17 is due when the note matures. On July 10, 2001, this note was repaid with proceeds from an unsecured six-month note payable to a bank. This note was extended for an additional six months after December 31, 2001. On May 17, 2001, the Company borrowed $300 on an unsecured one-year note. Interest is payable quarterly at an annual rate of 8 percent. The Company also agreed to issue 200,000 shares of its Common Stock as additional consideration for the loan. The shares will be treated as additional interest payments. On December 18, 2001, the company entered into a Bridge Loan Agreement with GET USA, Inc. This loan agreement is for six months at a rate of 10%. GET USA Inc has the irrevocable right to convert all or any portion of the principal balance into share of common stock. On December 18, 2001, the Company borrowed $60 against this loan agreement and on December 28,2001 the Company borrowed another $98. 36 The following table represents the estimated future payments of notes payable at December 31, 2001: Years Ending December 31, Estimated Payments 2002 1,895 2003 0 2004 7 ------ Total $1,902 ====== 6. STOCKHOLDERS' EQUITY: PREFERRED STOCK On May 13, 1998, the Company issued 3,000 shares of Series B Convertible Preferred Stock (the "Series B Preferred Stock") at a price and stated value of $1,000 per share in a private placement for total proceeds of $3,000, prior to any offering expenses. 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. An annual dividend of 4% shall be paid quarterly in arrears either in shares of Series B Preferred Stock 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 a holder of Series B Preferred Stock is unable to convert shares of Series B Preferred Stock into Common Stock at a discount because 1,505,000 shares have been issued at a discount, then the Company may either 1) redeem any unconverted Series B Preferred Stock for cash at a price equal to 115% of the liquidation value of the shares or 2) issue Series C Convertible Preferred Stock in an amount 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 Series B Preferred Stock at 115% of stated value in cash. On June 1 1999, the Company redeemed $1,100 of the Series B Preferred Stock at 100% of stated value in cash. As of December 31, 1999, shares representing $1,620 of Series B Preferred Stock had been converted into Common Stock, and all of the remaining outstanding balance of $280 of Series B Preferred Stock is convertible into Common Stock, at the election of the holder thereof. A holder of Series B Preferred Stock may not convert such stock into Common Stock if, following such conversion, the holder beneficially owns in excess of 4.9% of the Company's Common Stock. The 9% beneficial conversion feature was accounted for as an additional preferred stock dividend, which was determined on the date the Series B Preferred Stock was issued. The total value of the beneficial conversion feature or dividend is $297, which reduces income available for holders of the Company's Common Stock and therefore reduces earnings per share on a pro rata basis over the period from issuance of the Series B 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. During March 2000, 157 shares were converted to 89,015 of common shares. Also in March 2000, 93 shares were converted to 93 shares of Series C. On June 15, 2001 30 shares were converted to Series H. On June 1, 1999, as part of a financial restructuring, the Company issued 1,400 shares of Series C Convertible Preferred Stock (the "Series C Preferred Stock") at a price and stated value of $1,000 per share in a private placement for total proceeds of $1,400 prior to any offering expenses. The par value per share is $.01, resulting in a total par value of fourteen dollars being recorded as 37 Series C Convertible Preferred Stock, and the balance of approximately $1.4 million is included in Additional Paid-in Capital. An annual dividend of 4% shall be paid quarterly in arrears either in shares of Series C Preferred Stock or cash at the Company's discretion. Each share of Series C Preferred Stock is convertible into shares of the Company's Common Stock at a conversion price of 91% of the three consecutive day average of the lowest closing bid price of the Company's Common Stock over the twenty-day trading period ending the day prior to conversion (the "Conversion Price"). The Conversion Price may not exceed $1.877, which represents 135% of the ten day average of the closing bid price of the Company's Common Stock ending on May 28, 1999. As of December 31, 1999, shares representing $500 of Series C Preferred Stock had been converted into Common Stock, and all of the remaining outstanding balance of $900 of Series C Preferred Stock is convertible into Common Stock, at the election of the holder thereof. The maximum number of shares of Common Stock that may be issued upon conversion is 1,331,500. The Company has the right to redeem the Series C Preferred Stock at 115% of stated value in cash beginning August 31, 1999. The effective date of the Registration Statement filed with the Securities and Exchange Commission relating to the Common Stock to be issued upon conversion of the Series C Convertible Preferred Stock was September 24, 1999, and all necessary gaming regulatory approvals have been received. A holder of Series C Preferred Stock may not convert such stock into Common Stock if, following such conversion, the holder beneficially owns in excess of 4.9% of the Company's Common Stock. The 9% beneficial conversion feature was accounted for as an additional preferred stock dividend, which was determined on the date the Series C Preferred Stock was issued. The total value of the beneficial conversion feature or dividend is $138, which reduces income available for holders of the Company's Common Stock and therefore reduces earnings per share on a pro rata basis over the period from issuance of the Series C Preferred Stock to the earliest conversion date. Income available to holders of Common Stock was reduced by approximately $33, $87 and $18 during the second, third and fourth quarters of 1999, respectively. In March 2000, 93 shares of Series B was converted to Series C and later that same month was converted to 57,091 of common shares. During the 4th quarter of 2000, a total of 270 shares were converted to 560,064 of common shares. In January 2001 an additional 100 shares converted to 220,548 of common shares. On June 15, 2001 480 shares and on July 27, 2001 50 shares were converted to Series H. During October 1999, the Company issued a total of 2,450 shares of Series D Convertible Preferred Stock (the "Series D Preferred Stock") at a price and stated value of $1,000 per share in a private placement for total proceeds of $2,450, prior to any offering expenses, and warrants (the "Warrants") to acquire 245,000 shares of the Company's Common Stock at $2.75 per share. The par value per share is $.01, resulting in a total par value of twenty-five dollars being recorded as Series D Preferred Stock, and the balance of approximately $2.4 million is included in Additional Paid-in Capital. An annual dividend of 6% shall be paid quarterly in arrears either in Common Stock of the Company or cash at the Company's discretion. Each share of Series D Preferred Stock is convertible into shares of the Company's Common Stock at a conversion price of the lesser of $3.00 or 75% of the average of closing bid price of the Company's Common Stock for the five consecutive days immediately preceding the conversion date. The Company has reserved 1,750,000 shares of Common Stock for issuance upon conversion of the Series D Preferred Stock and 245,000 shares of Common Stock to be issued upon the exercise of the Warrants. The Company has the right to redeem the Series D Preferred Stock at 135% of stated value in cash if the market price is lower than the market price on the date the Series D Preferred Stock was issued. A registration statement related to the Common Stock to be issued has been filed by, and at the expense of, the Company pursuant to obligations contained in Registration Rights Agreements dated October 14 to 22, 1999. Such Registration Statement was declared effective by the Securities and Exchange Commission on May 18, 2001. The 25% beneficial conversion feature was accounted for as an additional preferred stock dividend, which was determined on the date the Series D Preferred Stock was issued. The total value of the beneficial conversion feature or dividend is $816, which reduces income available for holders of the Company's Common Stock and therefore reduces earnings per share on a pro rata basis over the period from issuance of the Series D Preferred Stock to the earliest 38 conversion date. Income available to holders of Common Stock is being reduced by approximately $408 in the fourth quarter of 1999 and approximately $408 in the first quarter of 2000. All outstanding shares of Series D Preferred Stock will automatically be converted into Common Stock on the fifth anniversary of its issuance. A holder of Series D Preferred Stock may not convert such stock into Common Stock if, following such conversion, the holder beneficially owns in excess of 4.9% of the Company's Common Stock. The Registration Rights Agreements relating to the Company's October 1999 issuance of the Company's Series D Convertible Preferred Stock require the Company to register the shares of Common Stock issuable upon conversion of such preferred shares within 180 days or by April 13, 2000 or pay certain liquidated damages. These provisions include 2% of the gross proceeds of the Series D Convertible Preferred Stock sold (i.e. $49) if such Common Stock is not registered by April 13, 2000 and 3.5% per month (i.e. $86) for each month thereafter that such Common Stock is not registered. A registration statement relating to such Common Stock was filed with the Securities and Exchange Commission on January 13, 2000. A majority of the Company's holders of Series D Convertible Preferred Stock agreed to amend the Registration Rights Agreement relating to such shares to provide that the Company can issue additional shares of Common Stock, at its option, in lieu of any cash payment due for liquidated damages resulting from the delay in having such registration statement declared effective. During the second quarter of 2000, 275 shares were converted to 397,872 of common stock. The third quarter of 2000, 87.5 shares were converted to 198,582 of common stock and the fourth quarter of 2000, an additional 118 shares converted to 229,052 of common stock. In January 2001 632 shares were converted to Series G and during June 2001 500 shares were converted to Series I. On November 1, 2000, the Company issued a total of 416,250 shares of Series E Convertible Preferred Stock (the "Series E Preferred Stock") at a price and stated value of $10 per share in a private placement for total proceeds of $4,162, prior to any offering expenses, and warrants (the "Warrants") to acquire 210,000 shares of the Company's Common Stock at $1.00 per share. The par value per share is $.01, resulting in a total par value of four hundred sixteen dollars being recorded as Series E Convertible Preferred Stock, and the balance of approximately $4,118 is included in Additional Paid in Capital. An annual dividend of 6% shall be paid quarterly in arrears either in Common Stock or cash at the Company's discretion. Each share of Series E Preferred Stock is convertible into shares of Common Stock at a conversion price of the lesser of $.8125 or 70% of the Common Stock's average of closing bid price for the five consecutive days immediately preceding the conversion date. The Company has reserved 1,935,255 shares of Common Stock for issuance upon conversion of the Series E Preferred Stock and 416,250 shares of Common Stock for issuance upon the exercise of the Warrants. The Company has the right to redeem the Series E Preferred Stock at 135% of its stated value in cash if the market price is lower than $1.50 per share. A registration statement relating to such Common Stock was filed February 14, 2001 and was declared effective as of May 18, 2001. The 25% beneficial conversion feature was accounted for as an additional preferred stock dividend, which was determined on the date the Series E Preferred Stock was issued. The total value of the beneficial conversion feature or dividend is $715, which reduces income available for holders of the Company's Common Stock and therefore reduces earnings per share on a pro rata basis over the period from issuance of the Series E Preferred Stock to the earliest conversion date. Income available to holders of Common Stock is being reduced by $715 in the fourth quarter of 2000. All outstanding shares of Series E Preferred Stock will automatically be converted into Common Stock on the fifth anniversary of its issuance. A holder of Series E 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. On June 8, 2001, two long term debts were converted to 25,000 shares of Series E. During the second quarter of 2001 a total of 172,138 shares were converted to 2,196,900 shares of commons. On July 1, 2001 a long term debt was converted to 30,000 shares of Series E. During the third quarter of 2001, 15,091 shares were converted to 185,741 of common and 17,771 shares were converted to Series G. 39 During the fourth quarter of 2001 18,000 shares were converted to 96 shares of Series H and 97 shares of Series I. On November 1, 2000, the Company issued a total of 100,000 shares of Series F Convertible Preferred Stock (the "Series F Preferred Stock") at a stated value and price of $10 per share in a private placement for total proceeds of $1,000, prior to any offering expenses, and warrants (the "Warrants") to acquire 100,000 shares of the Company's Common Stock at $1.00 per share. The par value per share is $.01, resulting in a total par value of one thousand dollars being recorded as Series F Preferred Stock, and the balance of approximately $999 is included as Additional Paid-in Capital. An annual dividend of 6% shall be paid quarterly in arrears either in Common Stock or cash at the Company's discretion. Each share of Series F Preferred Stock is convertible into shares of Common Stock at a conversion price equal to the lesser of $.8125 or 70% of the Common Stock's average closing bid price for the five consecutive days immediately preceding the conversion date. Concurrent with this issuance, the Company converted 206,250 shares of Series F Preferred Stock with a private investor for 206,250 shares of Series F Preferred Stock. The Company has reserved 2,062,096 shares of Common Stock for these issuances upon conversion of the Series F Preferred Stock and 100,000 shares of Common Stock to be issued upon the exercise of the Warrants. The Company has the right to redeem the Series F Preferred Stock at 135% of its stated value in cash if the market price is lower than $1.50 per share. A registration statement relating to such Common Stock was filed February 14, 2001 and was declared effective as of May 18, 2001. The 30% beneficial conversion feature was accounted for as an additional preferred stock dividend, which was determined on the date of the Series F Preferred Stock was issued. The total value of the beneficial conversion feature or dividend is $250, which reduces income available for holders of the Company's Common Stock and therefore reduces earnings per share on a pro rata basis over the period from issuance of the Series F Preferred Stock to the earliest conversion date. Income available to holders of Common Stock is being reduces by $250 in the fourth quarter of 2000. All outstanding shares of Series F Preferred Stock will automatically be converted into Common Stock on the fifth anniversary of its issuance. A holder of Series F 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. In the second quarter of 2001 42,500 shares were converted to 561,167 shares of common. During the third quarter of 2001 20,000 shares were converted to 246,914 shares of common and during the fourth quarter 13,750 shares were converted to 572,916 shares of common. On December 1, 2000, the Company approved the issuance of 3,000 shares of Preferred Stock as Series G 6% Convertible Preferred Stock with a par value of $.01 per share, and a stated value and price of $1,000 per share. Each share of Series G Preferred Stock is convertible into shares of Common Stock at a conversion price equal to the lesser of $3.00 or 75% of mean price of the previous 5 days bid price. In January 2001 632 shares were converted from Series D and on April 6, 2001 400 shares were of new issue. During the first quarter of 2001 375 shares of Series G were converted to 784,109 shares of common and the second quarter of 2001 657 shares were converted to 819,984 shares of common. During September 2001 17,771 shares of Series E were converted to 178 shares of Series G and then converted to 225,616 shares of common during the same month. As of December 31, 2001 no shares remained outstanding under this series. The 25% beneficial conversion feature was accounted for as an additional preferred stock dividend, which was determined on the date of the Series G Preferred Stock was issued. The total value of the beneficial conversion feature or dividend is $274, which reduces income available for holders of the Company's Common Stock and therefore reduces earnings per share on a pro rata basis over the period from issuance of the Series G Preferred Stock to the earliest conversion date. Income available to holders of Common Stock is being reduces by $274 in the first quarter of 2001. All outstanding shares of Series G Preferred Stock will automatically be converted into Common Stock on the fifth anniversary of its issuance. A holder of Series G 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. 40 During June 2001, the Company issued 554 shares of Series H Convertible Preferred Stock (the "Series H Preferred Stock") at a stated value and price of $1,000 per share in exchange for shares representing $30,000 of Series B Preferred Stock, $480,000 of Series C Preferred Stock, and $44,000 of accrued dividends. This was done because prior conversions of Series B and C Preferred Stock had exhausted the shares of Common Stock reserved for issuance to Series B and C Preferred Stock shareholders. The par value of Series H Preferred Stock is $.01, resulting in a total par value of five dollars being recorded as Series H Preferred Stock, and the balance of approximately $500,000 is included in Additional Paid-in Capital. An annual dividend of 6% is payable quarterly in arrears either in Common Stock or cash at the Company's discretion. Each share of Series H Preferred Stock is convertible into shares of Common Stock at a conversion price equal to the lower of $1.27 or 91% of the three consecutive day average of the lowest closing bid price of the Common Stock over the twenty-day trading period ending the day prior to conversion. The 9% beneficial conversion feature was accounted for as an additional preferred stock dividend, which was determined on the date the Series H Preferred Stock was issued. The total value of the beneficial conversion feature or dividend is $106,786, which reduced income available for holders of the Company's Common Stock and therefore reduced earnings per share for the three months ended June 30, 2001. All outstanding shares of Series H Preferred Stock will automatically be converted into Common Stock on the fifth anniversary of its issuance. A holder of Series H 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 outstanding Common Stock. During July 2001, 50 shares of Series C converted to Series H. For the third quarter of 2001 a total of 604 shares were converted to 587,409 shares of common. During December 2001 96 shares of Series E converted to Series H and converted to 520,325 shares of common. During June 2001, the Company issued 527 shares of Series I Convertible Preferred Stock (the "Series I Preferred Stock") at a stated value and price of $1,000 per share in exchange for shares representing $500,000 of Series D Preferred Stock and $27,000 of accrued dividends. This was done because prior conversions of Series D Preferred Stock had exhausted the shares of Common Stock reserved for issuance to Series D Preferred Stock shareholders. The par value of Series I Preferred Stock is $.01, resulting in a total par value of five dollars being recorded as Series I Preferred Stock, and the balance of approximately $500,000 is included in Additional Paid-in Capital. An annual dividend of 6% is payable quarterly in arrears either in Common Stock or cash at the Company's discretion. Each share of Series I Preferred Stock is convertible into shares of the Company's Common Stock at a conversion price of 75% of the Common Stock's average closing bid price for the five consecutive days immediately preceding the conversion date. The 25% beneficial conversion feature was accounted for as an additional preferred stock dividend, which was determined on the date the Series I Preferred Stock was issued. The total value of the beneficial conversion feature or dividend is $90,016, which reduced income available for holders of the Company's Common Stock and therefore reduced earnings per share for the three months ended June 30, 2001. All outstanding shares of Series I Preferred Stock will automatically be converted into Common Stock on the fifth anniversary of its issuance. A holder of Series I 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 outstanding Common Stock. The 75% beneficial conversion feature was accounted for as an additional preferred stock dividend, which was determined on the date the Series H and I Preferred Stock was issued. The total value of the beneficial conversion feature or dividend was $197,000, which reduced income available for holders of the Company's Common Stock and therefore reduced earnings per share for the three months ended June 30, 2001. 41 During June 2001 60 shares were converted to 57,413 shares of common. In the month of July 2001 467 shares were converted to 457,171 shares of common. In December 2001 97 shares were converted from Series E and converted to 525,745 shares of common. During July 2001, the Company issued 150,000 shares of Series J Convertible Preferred Stock (the "Series J Preferred Stock") as payment for expenses totaling $1,979, which is being amortized over five years. Each share of the Series J Preferred Stock is convertible into 10 shares of Common Stock; there is no conversion price. The Series J Preferred Stock does not pay dividends and is not redeemable except through conversion into Common Stock. The par value of the Series J Preferred Stock is $.01, resulting in a total par value of $1,500 being recorded as Series J Preferred Stock, and the balance of approximately $1,978is included as Additional Paid-in Capital. During November 2001 100,000 shares were converted to common stock. During August 2001, the Company issued 4,667 shares of Series K Convertible Preferred Stock (the "Series K Preferred Stock") in exchange for net cash proceeds of approximately $3,402, which represented a 25% discount from the stated value and price of $1,000 per share, less commissions and offering costs. The par value of Series K Preferred Stock is $.01, resulting in a total par value of $47 being recorded as Series K Preferred Stock, and the balance of approximately $3,401 is included in Additional Paid-in Capital. An annual dividend of 7% is payable quarterly in arrears either in Common Stock of the Company or cash at the Company's discretion. Each share of Series K Preferred Stock is convertible into shares of the Company's Common Stock at a conversion price equal to the Common Stock's average closing bid price over the five trading period ending the day prior to conversion. The beneficial conversion feature was accounted for as an additional preferred stock dividend, which was determined on the date the Series K Preferred Stock was issued. The total value of the beneficial conversion feature or dividend is $564, which reduced income available for holders of the Company's Common Stock and therefore reduced earnings per share for the three months ended September 30, 2001. All outstanding shares of Series K Preferred Stock will automatically be converted into Common Stock on the fifth anniversary of its issuance. A holder of Series K 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 outstanding Common Stock. During 2001 114 shares were converted to 131,253 of common shares. 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. In April 1999, the Company redeemed 700,000 shares of Common Stock from Lakes Gaming, Inc. on substantially the same terms as the redemption described above. This redemption was also undertaken to expedite the timing of gaming regulatory approval in certain jurisdictions. These notes are unsecured, pay interest of 5% per annum and are convertible at the closing market price of the Company's Common Stock on the date of the issuance of the notes. The notes may not be converted in the first year following issuance. The exercise price of the warrants will be the same as the conversion price of the notes. The Company also granted "piggyback" registration rights for shares of Common Stock issuable upon conversion of both the notes and the warrants. 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 492,950 shares of 42 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 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. The Company accounts for both stock option plans under Accounting Principles Board ("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, 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: 2001 2000 ---- ---- Net loss: As reported $(15,101) $(2,278) Pro forma $(18,173) $(2,633) Primary and fully-diluted EPS: As reported $ (0.85) $ (0.23) Pro forma $ (1.02) $ (0.26) A summary of the status of the 1992 Employee Stock Option and Compensation Plan at December 31, 2001, 2000 and 1999, and changes during the periods then ended is presented in the tables and narrative below:
December 31, 2001 December 31, 2000 December 31, 1999 ---------------------- --------------------- ---------------------- Wtd Avg Wtd Avg Wtd Avg Number Ex Price Number Ex Price Number Ex Price ----------- ---------- ---------- ---------- ----------- ---------- Outstanding at beginning of period 875,000 $1.37 745,000 $1.53 610,000 $1.56 Granted 0 - 300,000 1.00 250,000 2.06 Exercised (25,000) 1.13 (28,000) 1.13 - - Forfeited (15,000) 1.13 (150,000) 1.88 (115,000) 2.87 Expired - - - - - - --------- -------- -------- Outstanding at end of period 835,000 $1.13 875,000 $1.37 745,000 $1.53 ========= ======== ======== Exercisable at end of period 835,000 $1.13 875,000 $1.37 383,000 $1.30 Weighted average fair value of options granted on grant date $.00 $.99 $1.76
43 Detail composition of options outstanding December 31, 2001: ------------------------------------------------------------------------- Avg. contractual Options Exercise life remaining Options outstanding price (Years) exercisable ---------------- ------------- ----------------- ------------- 35,000 $4.00 3.29 35,000 600,000 1.00 7.00 600,000 200,000 2.0625 8.72 200,000 ------- -------- 835,000 835,000 ======= ======== The fair value of each option granted 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 2000, 1999 and 1998 grants: risk-free interest rate of 5.0, 6.5 and 4.9; expected dividend yield of 0.0 percent; expected lives of 5 years; expected volatility of 179.47, 121.5, and 91.5 percent, respectively. A summary of the status of the 1998 Stock Option Plan at December 31, 2001 and 2000 and changes during the periods then ended is presented in the table and narrative below: December 31, 2001 December 31, 2000 ------------------------ ------------------------- Wtd Avg Wtd Avg Number Ex Price Number Ex Price ----------- ------------ ------------ ------------ Outstanding at beginning of period 314,675 $1.33 414,625 $1.36 Granted 3,074,250 1.01 - - Exercised - - (9,975) 1.08 Forfeited (920,575) 1.04 (89,975) 1.48 Expired - - - - ------- ------- Outstanding at end of period 2,468,350 $1.04 314,675 $1.33 ======= ======= Exercisable at end of period 289,700 $1.06 180,600 $1.33 Weighted average fair value of options granted on grant date $0.87 $ - Detail composition of options outstanding December 31, 2001: - ------------------------------------------------------------------------- Avg. contractual Options Exercise life remaining Options outstanding price (Years) exercisable - ---------------- ------------- ----------------- ------------- 20,000 $0.96 10.79 - 2,205,600 $1.00 10.17 226,900 4,650 1.13 7.02 4,650 43,600 1.18 6.97 43,600 7,500 1.06 6.97 3,500 1,000 1.25 7.40 - 15,000 1.88 7.57 11,050 27,500 1.31 10.67 - 100,000 1.33 10.17 - 44 16,000 1.47 10.50 - 17,500 1.59 10.54 - 10,000 1.77 10.60 - ------- ------- 2,468,350 289,700 ======= ======= The fair value of each option granted under the 1998 Stock Option Plan is estimated on the date of grant using the Black-Scholes option pricing model with the following assumptions used for the 2001 and 1999 grants: risk-free interest rate of 4.38 and 6.5 percent; expected dividend yield of 0.0 percent; expected life of 5 years; expected volatility of 171.98% and 99.5%, respectively. 45 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 550,000 shares of the Company's Common Stock may be granted. A summary of the status of the Directors Option Plan at December 31, 2001, 2000 and 1999, and changes during the periods then ended is presented in the table and narrative below:
December 31, 2001 December 31, 2000 December 31, 1999 ---------------------- --------------------- ---------------------- Wtd Avg Wtd Avg Number Wtd Avg Number Ex Price Number Ex Price Ex Price ----------- ---------- ---------- ---------- ----------- ---------- Outstanding at beginning of period 100,000 $1.00 99,000 $1.42 10,000 $5.13 Granted 250,000 1.00 60,000 1.00 99,000 1.42 Exercised - - - - - - Forfeited - - (59,000) 1.70 (10,000) 5.13 Expired - - - - - - ------- ------- ------- Outstanding at end of period 350,000 $1.00 100,000 $1.00 99,000 $1.42 ======= ======= ====== Exercisable at end of period 195,000 $1.00 90,000 $1.00 15,000 $1.00 Weighted average fair value of options granted on grant date $0.97 $0.96 $1.09
Detail composition of options outstanding December 31, 2001 ------------------------------------------------------------------------- Avg. contractual Options Exercise life remaining Options outstanding price (Years) exercisable ---------------- ------------- ----------------- ------------- 350,000 $1.00 10.21 195,000 ======= ====== The fair value of each option granted 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 2001 and 2000 grants: risk-free interest rate of 4.38 and 5.0 percent; expected dividend yield of 0.0 percent; expected life of 5 years; expected volatility of 164.79% and 182.75%, respectively. 46 The Company has issued stock purchase warrants with a variety of terms and conditions. The following table summarizes stock purchase warrant transactions during the period: Exercise Number Prices --------- -------------- Outstanding December 31, 1998 282,500 3.19 - 13.00 Granted 1,285,000 1.063 - 2.75 Exercised - - Canceled/Expired (177,500) 7.00 - 13.00 --------- -------------- Outstanding December 31, 1999 1,390,000 $1.063 - $9.00 Granted 516,250 1.00 Exercised - - Canceled/Expired (105,00) 1.063 - 3.19 --------- -------------- Outstanding December 31, 2000 1,390,000 $1.063 - $9.00 Granted 3,457,950 0.81 - 10.00 Exercised 120,000 0.75 Canceled/Expired (115,00) 1.50 --------- -------------- Outstanding December 31, 2001 4,612,950 $0.81 - 10.00 ========= ============== At December 31, 2001, 3,312,950 warrants were exercisable. The warrants expire at various dates through September, 2006. At the Company's annual shareholder meeting on June 15, 2001, the Company's shareholders approved the 2001 Employee Stock Purchase Plan (the "Plan") to provide employees of the Company and its subsidiaries (as defined in Section 424(f) of the Internal Revenue Code of 1986, as amended) an opportunity to share in the Company's financial growth through ownership of the Company's Common Stock made available to employees at preferential prices. The Plan is intended as an incentive for continuing employment with the Company and to encourage employees to take an ownership interest in the Company's future. On September 18, 2001, the Company filed a Form S-8 Registration Statement registering 2,000,000 shares of stock for issuance under the Plan. 7. 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, 2001 Dec. 31, 2000 Dec. 31, 1999 ------------- -------------- --------------- Current: Federal $ - $ - $ - State - - - ------------- -------------- --------------- Subtotal - - - Deferred - - - ------------- -------------- --------------- Total $ - $ - $ - ============= ============== =============== 47 The tax effects of temporary differences giving rise to the deferred items are as follows for the years ended December 31: 2001 2000 ------ ------ Deferred tax assets: Net operating loss carry forwards $ 13,786 $ 9,697 Inventory reserves 213 503 Other 3,227 1,500 -------- -------- Total deferred tax assets 17,226 11,700 Valuation allowance (17,226) (11,700) -------- -------- Deferred tax assets, net of $ -- $ -- allowance ====== ====== In accordance with SFAS No. 109, the gross deferred tax asset at December 31, 2001 and 2000, of $17,226 and $11,700, respectively, has been reduced to zero by a full valuation allowance. At December 31, 2001, the Company has approximately $39,388 of net operating loss carry forwards for federal income tax purposes. These losses expire beginning 2009 through 2015. 8. 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 $535, $313 and $317 for the years ended December 31, 2001, 2000 and 1999, respectively. The minimum annual rental commitments under operating leases are as follows for the years ending December 31: 2002 358 2003 370 2004 381 2005 282 2006 76 ---- Total $1,467 ==== SALE-LEASEBACK In October 2001, the company received the first funding from a new $10 million participation line of credit, whereby the Company executes a sale and leaseback of its gaming machines for placement in revenue-sharing arrangements with casinos and other gaming properties. The gains realized are $230 with $33 recorded at December 31, 2001 and $197 was deferred. 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 two to three years at amounts approximating their current levels of compensation. The Company's remaining aggregate commitment at December 31, 2001, 48 under such contracts is approximately $891. Certain of these agreements may also include additional compensation to sales staff related to sales commission bonuses that are contingent on the amount of the Company's sales. The Company and the former Chief Operating Officer entered into a Severance Agreement in March 2002. The year end accrual for the underlying employment agreement was adjusted to conform to the obligations in the Severance Agreement. TERMINATION OF XERTAIN MERGER In October 2001, the company reached an agreement to terminate its planned merger with Xertain, Inc. Pursuant to this termination agreement, the Company recognized a loss on the amount of its initial investment in Xertain, as well as amounts due from Xertain. Total amount of the losses recognized was $1,501. ASSETS PLEDGED The following assets at December 31, 2001 have been pledged to secure financing: Inventories of $4,400 and Fixed Assets of $770. 9. 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 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 Australian 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, there were no sales to this distributor in 1999, and there were no sales to this distributor in the first quarter of 2000. In March 2000, the Company and Aristocrat terminated the distribution 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 provides 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 May 1999, this agreement was renewed for an additional one-year period and expired in May 2000. 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. During 2000 the Company terminated this agreement. 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 49 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. In April 1999, the Company entered into a two-year exclusive agency agreement with Stuart Black, an individual. Under the agreement, the agent represents the Company's products for sale in specific territories in Europe. The agent receives a commission on sales of the Company's products. The Company and Agent 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 an exclusive distributorship agreement with Vista Gaming Corporation. The Company has also an agreement with Vista Gaming for game rights. 10. BAD DEBT ADJUSTMENTS During September 2001, the Company determined that the collectibility of notes receivable from its distributor in Holland was in doubt. Therefore, the Company reserved the amounts of these notes and recorded a loss in the amount of $5,140. Additionally, the Company booked a bad debt adjustment of $500 related to a sale to another distributor that occurred in 2000. In connection with the termination of the Company's planned merger with Xertain, Inc., the Company also booked a bad debt of $512 related to advances made to Xertain. 11. Subsequence Events AGREEMENT FOR MERGER: On February 15, 2002, the Company entered into an Agreement and Plan of Merger by and among GET USA, Inc., Innovative Gaming Corporation of America and Innovative Gaming Technology Corp. (the "GET Merger Agreement"). Pursuant to the GET Merger Agreement, GET USA, Inc. will be merged into Innovative Gaming Technology Corp., a Nevada corporation and wholly owned subsidiary of the Company. Following the merger, GET USA's shareholders will own 49% of the Company. Final closing of the merger is anticipated to occur in late-2002, subject to shareholder, regulatory and various governmental agencies' approval. GET USA, Inc. is a Nevada corporation formed in 2000 to own certain intellectual property relating to Internet gaming. GET USA owns an Internet Casino Operating Platform. SERIES K LIQUIDATED DAMAGES The Registration Rights Agreement relating to the Company's recent issuances of the Company's Series K Convertible Preferred Stock requires the Company to register the shares of Common Stock issuable upon conversion of shares of Series K Convertible Preferred Stock within 180 days or pay certain liquidated damages. The liquidated-damages provisions were scheduled to take effect on January 29, 2002, and require the Company to pay 2% of the gross proceeds of the Series K Convertible Preferred Stock sold for the first 30 days after issuance if such Common Stock is not registered by January 29, 2002. In addition, the Company would be required to pay 3.5% of the gross proceeds to a major investor for each successive 30-day period thereafter during which the Common Stock is not registered. For other investors, the Company would be required to pay 2% of the gross proceeds for each successive 30-day period thereafter during which the Common Stock is not registered. Beginning April 1, 2002, the liquidated damages would be approximately $73,125 and would increase substantially each succeeding month. A registration statement relating to such Common Stock was filed on September 28, 2001 and amended on January 16, 2002 and February 12, 2002, but had not been declared effective as of April 1, 2002. Unless the Company can obtain a waiver of such provisions from the holders of the Company's Series K Convertible Preferred Stock, the Company will be contractually required to make such payments, which could have a material adverse impact on the Company's liquidity. 50
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 and write down to market value: For the year ended 12/31/99 $ 947 4,488 347 5,088 For the year ended 12/31/00 5,088 (882) 1,565 2,641 For the year ended 12/31/01 2,641 (1,078) 204 1,359 Charged/ Description 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 12/31/99 $ 85 $ 198 $ 3 $280 For the year ended 12/31/00 280 0 167 113 For the year ended 12/31/01 113 5,640 577 5,176
PART III ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT The information provided under the caption "Election of Directors" 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, 2000 and forwarded to stockholders prior to the Company's 2002 Annual Meeting of Shareholders (the "2002 Proxy Statement") is incorporated herein by reference. ITEM 11. EXECUTIVE COMPENSATION The information in the 2002 Proxy Statement under the caption "Executive Compensation" is incorporated herein by reference. ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT The information in the 2002 Proxy Statement under the caption "Voting Securities and Principal Holders Thereof" is incorporated herein by reference. ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS The information in the 2002 Proxy Statement under the caption "Certain Transactions" is incorporated herein by reference. 51 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. 25 Consolidated Balance Sheets as of December 31, 2001 and 2000 26 Consolidated Statements of Operations for the years ended December 31, 2001, 2000 and 1999 27 Consolidated Statements of Stockholders' Equity for the years ended December 31, 2001, 2000 and 1999 28 Consolidated Statements of Cash Flows for the years ended December 31, 2001, 2000 and 1999 29 Notes to the Consolidated Financial Statements 30
(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") 3.1(c) Certificate of Designation relating to Series C Convertible Preferred Stock (Incorporated herein by reference to Exhibit 3.1(d) to the Company's Registration Statement on Form S-3 filed August 3, 1999) 3.1(d) Certificate of Designation relating to Series D Convertible Preferred Stock (Incorporated herein by reference to Exhibit 3.1 to the Company's Registration Statement on Form S-3 filed January 13, 2000) 3.1(e) Certificate of Designation relating to Series E Convertible Preferred Stock (Incorporated herein by reference to Exhibit 3.1(f) to the Company's report on Form 8-K filed February 14, 2001) (the "February 14, 2001 8-K") 3.1(f) Certificate of Designation relating to Series F Convertible Preferred Stock (Incorporated herein by reference to Exhibit 3.1(g) to the February 14, 2001 8-K) 3.1(g) Certificate of Designation relating to Series G Convertible Preferred Stock (Incorporated herein by reference to Exhibit 3.1(g) to the February 14, 2001 8-K) 3.1(h) Amended and Restated Certificate of Designation relating to Series H Convertible Preferred Stock (Incorporated herein by reference to Exhibit 3(1) to the Company's report on Form 10-Q filed on August 14, 2001) (the "August 14, 2001 10-Q") 3.1(i) Amended and Restated Certificate of Designation relating to Series I Convertible Preferred Stock (Incorporated herein by reference to Exhibit 3(2) to the August 14, 2001 10-Q) 3.1(j) Amended and Restated Certificate of Designation relating to Series J Convertible Preferred Stock (Incorporated herein by reference to Exhibit 3(3) to the August 14, 2001 10-Q) 3.1(k) Certificate of Designation relating to Series K Convertible Preferred Stock (Incorporated herein by reference to Exhibit 3(4) to the August 14, 2001 10-Q) 3.2 Bylaws (Incorporated herein by reference to Exhibit 3.2 to the SB-2) 52 10.1 1992 Stock Option and Compensation Plan, as amended (Incorporated herein by reference to Annex C to the Company's Schedule 14A filed December 20, 2000) 10.4 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) 10.5 Form of Subscription Agreement dated June 1, 1999 (Incorporated herein by reference to Exhibit 10.8 to the Company's Registration Statement on Form S-3 filed August 3, 1999) 10.6 Securities Purchase Agreement dated October 13, 1999 (Incorporated herein by reference to Exhibits 10.1 to the Company's Registration Statement on Form S-3 filed January 13, 2000) 10.7 Form of Securities Purchase Agreement dated November 1, 2000 (Incorporated herein by reference to Exhibits 10.1 and 10.3 to the February 14, 2001 8-K) 10.8 Form of Securities Purchase Agreement dated December 1, 2000 (Incorporated herein by reference to Exhibit 10.4 to the February 14, 2001 8-K) 10.9 Securities Exchange Agreement dated December 1, 2000 (Incorporated herein by reference to Exhibits 10.6 and 10.7 to the February 14, 2001 8-K) 10.10 Severance Agreement dated October 17, 2001 10.11 Form of Registration Rights Agreement dated June 1, 1999 (Incorporated herein by reference to Exhibit 10.9 to the Company's Registration Statement on Form S-3 filed August 3, 1999) 10.12 Form of Registration Rights Agreement dated October 13, 1999 (Incorporated herein by reference to Exhibit 10.2 to the Company's Registration Statement on Form S-3 filed January 13, 2000) 10.13 Form of Registration Rights Agreement for Series E Convertible Preferred Stock dated November 1, 2000 (Incorporated herein by reference to Exhibit 10.2 to the February 14, 2001 8-K) 10.14 Form of Registration Rights Agreement for Series F Convertible Preferred Stock, dated December 1, 2000 (Incorporated herein by reference to the February 14, 2001 8-K) 10.15 Form of Registration Rights Agreement for Series G Convertible Preferred Stock dated April 2001 (Incorporated herein by reference to the February 14, 2001 8-K) 10.16 Form of Registration Rights Agreement for Series H Convertible Preferred Stock dated April 2001 (Incorporated herein by reference to the February 14, 2001 8-K) 10.17 Form of Registration Rights Agreement for Series K Convertible Preferred Stock dated August 1, 2000 (Incorporated herein by reference to Exhibit 10(4) to the August 14, 2001 10-Q) 10.18 2001 Employee Stock Purchase Plan (Incorporated herein by reference to Annex A to the Company's Schedule 14A filed May 1, 2001) 10.19 1997 Director Stock Option Plan, as amended (Incorporated herein by reference to Annex B to the Company's Schedule 14A filed May 1, 2001) 10.20 1998 Non-Executive Employee Stock Option Plan (Incorporated herein by reference to Exhibit 10.17 to the Company's report on Form 10-K for the fiscal year ended December 31,1998) (the "December 31, 1998 10-K") 53 10.21 Agreement between the Company and Edward G. Stevenson dated January 1, 1999 (Incorporated herein by reference to Exhibit 10.18 to the December 31, 1998 10-K) 10.22 Agreement and Plan of Merger dated December 31, 1999, by and among nMortgage Inc., Equitex Inc., Innovative Gaming Corporation of America and IGCA Acquisition Corp, (Incorporated herein by reference to Annex B to the Company's Schedule 14A filed March 1, 2000) 10.23 Agreement and Plan of Merger by and among Xertain, Inc., Innovative Gaming Corporation of America and IGCA Acquisition Corp., as amended (Incorporated herein by reference to the Company's Preliminary Schedule 14A filed February 15, 2001) 10.24 Amendments No. 2 and No. 3 to the Agreement and Plan of Merger by and among Xertain, Inc., Innovative Gaming Corporation of America and IGCA Acquisition Corp. (Incorporated herein by reference to Exhibits 2(1) and 2(2) to the August 14, 2001 10-Q) 10.25 Note to Blake Capital Partners, LLC, dated April 12, 2001 (Incorporated herein by reference to Exhibit 4(1) to the August 14, 2001 10-Q) 10.26 Securities Purchase Agreement with Blake Capital Partners, LLC, dated April 12, 2001 (Incorporated herein by reference to Exhibit 4(1) to the August 14, 2001 10-Q) 10.27 Amended and Restated Consulting Agreement, dated April 4, 2001 (Incorporated herein by reference to Exhibit 10(2) to the August 14, 2001 10-Q) 10.28 Consultant Agreement, dated July 1, 2001 (Incorporated herein by reference to Exhibit 10(5) to the August 14, 2001 10-Q) 10.29 Form of Change of Control Agreement by and between the Company and each of Roland M. Thomas, Michael Mackenzie, Steven Peterson and Loren A. Piel (Incorporated herein by reference to Exhibit 10(6) to the August 14, 2001 10-Q) 10.30 Factoring Agreement, dated May 22, 2001 (Incorporated herein by reference to Exhibit 10(7) to the August 14, 2001 10-Q) 21 List of Subsidiaries (Incorporated herein by reference to Exhibit 21 to the Company's December 31, 1998 10-K) 23 Consent of Kafoury, Armstrong & Co. (b) Reports on Form 8-K On February 5, 2002, the Company filed a Form 8-K to report the execution of the merger agreement with GET USA, Inc. 54 SIGNATURES In accordance with Section 13 or 15(d) of the Exchange Act, the registrant has caused this report to be signed on its behalf by the undersigned, thereunto duly authorized. INNOVATIVE GAMING CORPORATION OF AMERICA Date: April __, 2002 By: /S/ Thomas J. Foley ------------------------------------ Name: Thomas J. Foley 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 April __, 2002. Name Title ---- ----- /S/ Thomas J. Foley Chief Executive Officer and Chairman - ----------------------------- (principal executive officer, principal accounting officer) /S/ Ronald A. Johnson Director - ----------------------------- /S/ Andrew Tottenham Director - ----------------------------- 55 EX-10.10 3 inngamsepagr_dec2001.txt SEPARATION AGREEMENT THIS SEPARATION AGREEMENT (the "Agreement") is made and entered into this 17th day of October, 2001, by and between Roland M. Thomas ("Thomas") and Innovative Gaming Corporation of America, a Minnesota corporation ("IGCA"). BACKGROUND A. Thomas has resigned from his employment by IGCA. B. The parties have determined to mutually agree regarding the terms and conditions of Thomas' separation from employment. C. For purposes of this Agreement: (1) IGCA means Innovative Gaming Corporation of America and any company related to it in the past or present, and each of them; past or present officers, directors, agents, and employees of IGCA; and any other person who acted on behalf of IGCA or on instructions from IGCA; and (2) Thomas means Roland M. Thomas, his heirs and assigns. NOW, THEREFORE, in consideration of the foregoing, and the terms and conditions set forth below, IGCA and Thomas hereby agree as set forth below. AGREEMENT Section 1. Separation From Employment. Thomas resigned from his employment with IGCA effective October 17, 2001 (the "Effective Date"), and from and after the Effective Date Thomas' employment agreement with IGCA, dated February 16, 2001 (the "Employment Agreement"), and Thomas' change in control agreement with IGCA, dated June 15, 2001 (the "Change in Control Agreement"), shall be terminated. Section 2. Consideration Extended by IGCA. As consideration for this Agreement, IGCA hereby agrees and acknowledges that it will be obligated under this Agreement as set forth below. (a) Severance Payment. IGCA shall furnish Thomas with an amount equal to Ninety Five Thousand and No Dollars ($95,000.00) (such amount to be referred to as the "Severance Payment"). The Severance Payment shall be payable in the ordinary course of payroll. (b) Health Insurance. Thomas may elect to continue his health and dental benefits under COBRA, and in such event IGCA shall pay all COBRA premiums for such continued health-insurance coverage, for a 6-month period following the Effective Date. Thereafter, Thomas shall be responsible for the payment of any premiums. (c) Life Insurance. For a period of one year, IGCA shall pay all premiums on a one-year term life-insurance policy insuring Thomas' life, for the benefit of Thomas or any other person designated by Thomas as the beneficiary of such policy, in the amount of One Million Dollars ($1,000,000). Thomas shall be entitled to retain the cash value of the current whole-life policy previously purchased by the IGCA. (d) Vested Options. Thomas shall be entitled to exercise options to purchase 125,000 shares of IGCA common stock that have vested on the Effective Date (the "Vested Options"). The Vested Options shall remain exercisable for a twenty four-month period immediately following the Separation Agreement _________ _________ 167658.1 Initial Initial Effective Date. All options to purchase shares of IGCA common stock that are unvested on the Effective Date shall expire on the Effective Date. (e) Expenses. IGCA agrees to forgive a maximum of $20,000 of personal expenses of Thomas charged to and paid by IGCA. To the extent personal expenses exceed $20,000, such amount in excess of $20,000 shall be deducted from the Severance Payment. (f) Indemnification for Guarantees. IGCA hereby agrees to indemnify Thomas for the personal guarantees executed and delivered by Thomas to Crowne Bank and Systran Financial Services Corporation, as described on Exhibit I. To the extent that IGCA can raise additional capital within the next 60 days, IGCA agrees that it will, subject to IGCA's ability to pay its obligations in the ordinary course, repay the Crowne Bank obligation in full. (g) No Bonus or Compensation for Accrued Vacation. Thomas shall not be entitled to any bonus under this Agreement nor any other agreement by and between Thomas and IGCA, nor shall Thomas be entitled to any payments for or in connection with accrued vacation time. (h) Automobile. IGCA previously agreed to assume Thomas' obligations with respect to 2000 Dodge Van pursuant to a letter agreement dated September 4, 2001. IGCA shall continue to honor that commitment. Section 3. Consideration Extended by Thomas. As consideration for this Agreement, Thomas hereby agrees and acknowledges that he will be obligated under this Agreement as set forth below. (a) Non-Solicitation. In consideration for the termination of the non-solitication provisions of the Employment Agreement and Change in Control Agreement, Thomas hereby agrees that, except for those employees listed on Schedule A attached hereto, he shall not solicit IGCA employees for his own benefit or the benefit of any third party by: (i) directly or indirectly interfering with the relationship between IGCA and any of its employees; (ii) directly or indirectly soliciting the employment of any IGCA employee; or (iii) inducing or attempting to induce any person who was employed by IGCA during the six-month period immediately preceding the date of this Agreement, to leave employment with IGCA. (b) Non-Competition. In consideration for the termination of the non-competition provisions of the Employment Agreement, Thomas hereby agrees that, except as otherwise provided in a European agreement by and between IGCA and Xertain, Inc. subsequent to the date hereof, he shall not, for a six month period following the Effective Date, compete with IGCA by: (i) directly or indirectly providing services to a competitor of IGCA's Business, in any capacity, including but not limited to as an employee, independent contractor, director, or consultant; (ii) directly or indirectly owning an interest in any commercial activity that competes with IGCA's Business, within any state in the United States or within any country in which IGCA directly markets or currently intends to market, or services products or currently intends to provide services, including but not limited to an interest as a shareholder, partner, joint venturer, or "Affiliate" of any competing entity or business; or (iii) directly or indirectly contacting or soliciting the business of any client, business prospect, or prospective client of IGCA. For purposes of this Agreement, the term "Affiliate" shall mean a role in any capacity in which Thomas (A) has direct or indirect control of, is controlled by, or is under common control with another person or business, (B) is an officer, director, partner, trustee, member, or manager, of a business or other commercial activity described in clause (A) above. For purposes of this Agreement, the term "Business" shall mean the design, manufacture, and distribution of gaming machines. Separation Agreement _________ _________ 167658.1 Initial Initial 2 (c) Inventions. Thomas hereby agrees that all "Inventions" (as defined below) made by Thomas during his employment with IGCA shall be the sole and exclusive property of IGCA, and that he has or will, upon IGCA's request, assign any and all rights to any such Inventions. As used in this Agreement, the term "Inventions" shall mean any discoveries, improvements or ideas (whether or not put in writing or reduced to practice), or works of authorship (whether or not such works can be patented or copyrighted) that Thomas makes, authors, or conceives (either alone or with another person or entity), and that (i) are reasonably related to IGCA's Business, and (ii) Thomas made, authored, conceived, or otherwise developed during his employment with IGCA. Section 4. Confidentiality. In consideration for the termination of the confidentiality provisions contained in the Employment Agreement and the Change in Control Agreement, the terms of this Agreement will be treated as confidential by Thomas and IGCA and, except as provided in this Agreement, will not be disclosed by Thomas to anyone except that: (a) Thomas may make such disclosures to his attorney and accountant, and as required by law or regulation or in connection with a legal or administrative action, proceeding, or investigation; and (b) IGCA may make such disclosures to its executive officers and directors, its accountants, and counsel, and as required by law or regulation or in connection with any legal or administrative action, proceeding, or investigation. Any disclosures permitted by this paragraph will be made on the condition that the person to whom such disclosure is made will agree to in turn keep the terms of this Agreement confidential. Section 5. Mutual Return of Records, Documents, and Property. Thomas has returned or will return to IGCA all of IGCA's property, records, correspondence, and documents in Thomas' possession. IGCA has returned or will return all personal effects and possessions of Thomas in IGCA's possession, and will make reasonable efforts to provide copies of Thomas' personal data or documents in IGCA's information systems as requested by Thomas. Section 6. Mutual Non-Disparagement. Thomas and IGCA agree that they will not issue any press releases or other statements disparaging each other other than disclosures required by law. Section 7. Cooperation. Thomas agrees to cooperate with IGCA now and in the future concerning aspects of IGCA's business, including but not limited to the obligation to answer truthfully any reasonable questions presented to him by IGCA and shall assist IGCA in the defense of any claim against IGCA. Section 8. Non-Admission. Nothing in this Agreement is intended to be, nor will it be deemed to be, an admission of liability by IGCA or Thomas that they have violated any state or federal statute, local ordinance, or principal of common law, or that IGCA or Thomas has engaged in any wrongdoing. Section 9. Release of Claims. In consideration of the benefit of this Agreement, Thomas hereby fully and finally releases, waives, and otherwise relinquishes any and all claims that he has or believes he may have against IGCA through the date of this Agreement. Thomas will not bring any lawsuits or make any other demands against IGCA except as necessary to enforce this Agreement. The benefits that Thomas will receive under this Agreement constitute full and fair consideration for the release of such claims. IGCA does not owe Thomas anything other than what is set forth in this Agreement. The benefit that Thomas will receive hereunder constitutes consideration in excess to anything to which he is entitled. The claims that Thomas is releasing, waiving, and otherwise relinquishing hereunder include all of the rights he has now to any relief of any kind from IGCA, including but not limited to claims for breach of contract, breach of fiduciary duty, fraud or misrepresentation, discrimination claims under the Nevada Fair Employment Practices Act, discrimination claims under the Age Discrimination in Employment Act ("ADEA"), discrimination claims under other Separation Agreement _________ _________ 167658.1 Initial Initial 3 federal, state, or local civil-rights laws, defamation, intentional or negligent infliction of emotional distress, unlawful or wrongful termination of employment, and any other claims for unlawful employment practices. Section 10. Rights and Information Concerning Release. IGCA hereby advises Thomas to consult with an attorney prior to signing this Agreement, and Thomas hereby acknowledges that he has been so advised and given fair opportunity to consult with counsel. Thomas understands that, pursuant to the Older Workers Benefits Protection Act, he has the right to rescind his release of discrimination rights and claims under the ADEA within 45 calendar days of the date upon which he signs this Agreement. He understands that, if he desires to do so, he must put the rescission in writing and deliver it to IGCA, in care of Loren A. Piel, General Counsel, 333 Orville Wright Court, Las Vegas, Nevada 89119, by hand or mail within 45 calendar days of the date of execution of this Agreement. If he delivers a rescission relating to the release of IGCA for claims other than ADEA claims, it must be: (1) postmarked within 15 calendar days of the day on which he signs this Agreement; (2) addressed to General Counsel at the above address; and (3) sent by certified mail, return receipt requested. Thomas understands that if he rescinds his waivers as more fully set forth above, this Agreement is null and void. Pursuant to the Older Workers Benefits Protection Act, IGCA has furnished required information on Schedule B. Section 11. Entire Agreement. This Agreement and any exhibits attached hereto constitute the entire agreement between the parties with respect to the termination of Thomas' employment relationship with IGCA, and the parties agree that there were no other inducements or representations leading to the negotiation, drafting, and execution of this Agreement. Section 12. Severability. If any one or more of the provisions of this Agreement should be declared by a court of competent jurisdiction to be invalid, illegal, or unenforceable in any respect, then the validity, legality, and enforceability of the remaining provisions of this Agreement will not in any way be affected or impaired. Section 13. Amendment and Waiver. This Agreement may be modified or amended only pursuant to a writing signed by both Thomas and IGCA. No failure or delay by either party to enforce any provision of this Agreement or exercise any remedy provided hereunder or under the principles of common law or statute shall constitute a waiver of any provision, right, or remedy of or under this Agreement. No single or partial exercise of any rights or remedies under this Agreement shall preclude a party from otherwise or further exercising any rights or remedies, or any rights or remedies granted to the parties under other agreements, law, or equity. Section 14. Voluntary and Knowing Action. Thomas and IGCA hereby acknowledge that they have read and understand, and voluntarily enter into this Agreement. Section 15. Heirs and Successors. This Agreement shall inure to the benefit of and bind the parties, their heirs, successors, representatives, and assigns. Section 16. Governing Law. This Agreement shall be construed and interpreted in accordance with the laws of the State of Nevada without regard to such state's conflicts-of-law principles. Section 17. Captions. Headings in this Agreement are provided solely for convenience and shall not affect the interpretation of this Agreement. Separation Agreement _________ _________ 167658.1 Initial Initial 4 Section 18. Counterparts. This Agreement may be executed simultaneously in two or more counterparts, each of which will be deemed an original, but all of which together will constitute one and the same instrument. Section 19. Notices. Any notice, request, demand, or communication permitted, required, or otherwise given relating to this Agreement either by IGCA to Thomas or by Thomas to IGCA shall be in writing and, unless otherwise required under the terms of a separate agreement or law or regulation, shall be deemed to have been given to the other when the delivering party deposits such notice or communication in the U.S. Postal Service mail, postage prepaid, certified mail, return receipt requested, properly addressed to the party to whom it is directed, as provided below. Either party may, by notice sent in like manner, designate a different address for notices and communications. If Sent to IGCA: Innovative Gaming Corporation of America c/o General Counsel 333 Orville Wright Court Las Vegas, NV 89119 If Sent to Thomas: Roland M. Thomas 2425 La Casa Henderson, NV 89014-3624 IN WITNESS WHEREOF, the parties have caused this Agreement to be signed on the day and year first above written. INNOVATIVE GAMING CORPORATION OF AMERICA a Minnesota corporation By: /s/ ----------------------------------- Name: Tom Foley ----------------------------------- Title: Chairman & CEO ----------------------------------- /s/ ----------------------------------- Roland M. Thomas Separation Agreement - Signature Page Separation Agreement _________ _________ 167658.1 Initial Initial 5 SCHEDULE A Employees Exempted from Non-Solicitation under Section 3(a) NONE Separation Agreement _________ _________ 167658.1 Initial Initial SCHEDULE B The following information is provided in connection with Section 10 of the Agreement and the Older Workers Benefits Protection Act. A. Information Regarding Persons Released: Title Age ----- --- Chief Executive Officer 50 B. Information Regarding Persons Retained: none. Separation Agreement _________ _________ 167658.1 Initial Initial EXHIBIT II Indemnified Personal Guarantees Attached as Exhibit I are those personal guarantees executed and delivered by Thomas to Crowne Bank and Systran Financial Services Corporation for which IGCA has agreeed, pursuant to Section 2(e) of the Agreement, to indemnify Thomas. Separation Agreement _________ _________ 167658.1 Initial Initial -----END PRIVACY-ENHANCED MESSAGE-----