UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-QSB
(Mark One)
|X| QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
ACT OF 1934
For the quarterly period ended: September 30, 2004
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OR
|_| TRANSITION REPORT PURSUANT SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
ACT OF 1934
For the transition period from: to
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Commission file number: 000-28399
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Gaming & Entertainment Group, Inc.
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(Exact name of small business issuer as
specified in its charter)
Utah 59-1643698
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(State or other jurisdiction (I.R.S. Employer
of incorporation or organization) Identification No.)
6757 Spencer Street, Las Vegas, Nevada 89119
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(Address of principal executive offices)
(702) 407-2471
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(Issuer's telephone number)
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(Former name, former address and former fiscal year, if changed
since last report)
Check whether the issuer (1) filed all reports required to be filed by Section
13 or 15(d) of the Exchange Act during the past 12 months (or for such shorter
period that the registrant was required to file such reports), and (2) has been
subject to such filing requirements for the past 90 days. YES |X| NO |_|
Applicable Only to Issuers Involved in Bankruptcy Proceedings During the
Preceding Five Years
Check whether the registrant filed all documents and reports required to be
filed by Section 12, 13 or 15(d) of the Exchange Act after the distribution of
securities under a plan confirmed by court. YES |_| NO |_|
Applicable Only to Corporate Issuers
State the number of shares outstanding of each of the issuer's classes of common
equity, as of the latest practicable date:
19,017,352 shares of common stock, $0.01 par value, as of November 15, 2004
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Transitional Small Business Disclosure Format (check one): YES |_| NO |X|
FORM 10-QSB
TABLE OF CONTENTS
PAGE
----
PART I - FINANCIAL INFORMATION....................................................................................3
ITEM 1. FINANCIAL STATEMENTS............................................................................3
Condensed Consolidated Balance Sheet
September 30, 2004 (Unaudited).........................................................3
Condensed Consolidated Statements of Operations
For the Nine and Three Months ended September 30, 2004 and 2003 (Unaudited)............4
Condensed Consolidated Statement of Stockholders' Deficiency
For the Nine Months ended September 30, 2004 (Unaudited)...............................5
Condensed Consolidated Statements of Cash Flows
For the Nine Months ended September 30, 2004 and 2003 (Unaudited)......................6
Notes to Condensed Consolidated Financial Statements (Unaudited)................................7
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OR PLAN OF OPERATION......................................14
Results of Operations..........................................................................16
Liquidity and Capital Resources................................................................20
Risk Factors...................................................................................21
ITEM 3. CONTROLS AND PROCEDURES........................................................................21
PART II - OTHER INFORMATION......................................................................................23
ITEM 1. LEGAL PROCEEDINGS..............................................................................23
ITEM 2. CHANGES IN SECURITIES..........................................................................23
ITEM 3. DEFAULTS UPON SENIOR SECURITIES................................................................23
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS............................................23
ITEM 5. OTHER INFORMATION..............................................................................23
ITEM 6. EXHIBITS.......................................................................................23
SIGNATURE........................................................................................................25
-2-
PART I - FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS.
GAMING & ENTERTAINMENT GROUP, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED BALANCE SHEET SEPTEMBER 30, 2004
(UNAUDITED)
ASSETS
Current Assets
Cash $ 36,646
Accounts receivable 60,000
Prepaid expenses 21,790
-----------
Total current assets 118,436
Equipment, net 161,608
Other Assets 706
-----------
Total assets $ 280,750
===========
LIABILITIES AND STOCKHOLDERS' DEFICIENCY
Current Liabilities
Accounts payable $ 219,496
Accrued expenses 46,428
Current portion of Notes payable - officers 171,600
Foreign taxes payable 148,476
Loan from stockholder 43,007
-----------
Total current liabilities 629,007
Senior secured note payable 250,000
Notes payable - officers, net of current portion 40,891
Total liabilities 919,898
-----------
Commitments and Contingencies
Stockholders' Deficiency
Preferred Stock, par value $10 per share; 10,000,000 shares authorized
Class A convertible preferred stock, par value $10 per share;
1,000,000 shares designated; none issued --
Class B preferred stock, par value $10 per share;
1,000,000 shares designated; none issued --
Common stock, par value $.01 per share; 150,000,000 shares authorized;
19,017,352 shares issued and outstanding 190,173
Additional paid-in capital 5,190,380
Accumulated deficit (6,182,261)
Accumulated other comprehensive income - foreign currency translation gains 162,560
-----------
Total stockholders' deficiency (639,148)
-----------
Total liabilities and stockholders' deficiency $ 280,750
===========
See accompanying notes to condensed consolidated financial statements
-3-
GAMING & ENTERTAINMENT GROUP, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS FOR THE NINE AND THREE
MONTHS ENDED
SEPTEMBER 30, 2004 AND 2003 (UNAUDITED)
Nine Months Ended September 30, Three Months Ended September 30,
2004 2003 2004 2003
------------ ------------ ------------ ------------
Revenues:
Services $ 140,894 $ 528,043 $ 65,554 $ 119,581
Product -- 297,432 -- --
------------ ------------ ------------ ------------
Total revenues 140,894 825,475 65,554 119,581
------------ ------------ ------------ ------------
Cost of revenues:
Services 37,462 189,785 37,462 64,383
Product -- 242,564 -- --
------------ ------------ ------------ ------------
Total cost of revenues 37,462 432,349 37,462 64,383
------------ ------------ ------------ ------------
Gross margin 103,432 393,126 28,092 55,198
------------ ------------ ------------ ------------
Operating expenses:
Research and development 711,772 442,831 207,503 150,228
Selling, general and administrative 2,053,686 948,514 411,409 303,687
Impairment of intellectual property -- 23,028 -- --
------------ ------------ ------------ ------------
Total operating expenses 2,765,458 1,414,373 618,912 453,915
------------ ------------ ------------ ------------
------------
Operating loss (2,662,026) (1,021,247) (590,820) (398,717)
------------ ------------ ------------ ------------
Other income (expense):
Foreign currency transaction loss (14,170) -- -- --
Interest expense (42,009) -- (15,249) --
Interest and dividend income 829 5,266 77 889
Other income 21,769 -- 12,312 --
------------ ------------ ------------ ------------
Total other income (expense) (33,581) 5,266 (2,860) 889
------------ ------------ ------------ ------------
Net loss $ (2,695,607) $ (1,015,981) $ (593,680) $ (397,828)
------------ ------------ ------------ ------------
Weighted average number of shares
outstanding 17,292,412 13,863,487 19,132,084 14,262,756
============ ============ ============ ============
Net loss per share - basic and diluted $ (0.16) $ (0.07) $ (0.03) $ (0.03)
============ ============ ============ ============
See accompanying notes to condensed consolidated financial statements
-4-
GAMING & ENTERTAINMENT GROUP, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENT OF STOCKHOLDERS' DEFICIENCY
FOR THE NINE MONTHS ENDED SEPTEMBER 30, 2004 (UNAUDITED)
Common Stock Additional Accumulated Other
------------------------------ Paid-in Accumulated Comprehensive
Shares Amount Capital Deficit Income (Loss) Total
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Balance at January 1, 2004 11,947,872 $ 11,948 2,538,678 $(3,486,654) 206,766 $ (729,262)
Effects of reverse acquisition 4,058,756 148,118 $ (180,170) -- -- $ (32,052)
Shares and warrants issued through private
placement, net of expenses of $ 2,445,000 24,450 2,118,792 -- -- 2,143,242
Shares issued for services 507,390 5,074 480,241 -- -- 485,315
Shares and warrants issued for equipment 58,334 583 57,751 -- -- 58,334
Options and warrants issued to
consultants for services -- -- 175,088 -- -- 175,088
Foreign currency translation loss (A) -- -- -- -- $ (44,206) $ (44,206)
Net Loss -- -- -- $(2,695,607) -- $(2,695,607)
-----------
Balance at September 30, 2004 19,017,352 190,173 5,190,380 $(6,182,261) 162,560 $ (639,148)
========== ========== =========== =========== =========== ============
(A) Comprehensive loss (net loss plus foreign currency translation loss) for the
nine and three months ended September 30, 2004 totaled $2,739,813 and $597,082
respectively.
See accompanying notes to condensed consolidated financial statements.
-5-
GAMING & ENTERTAINMENT GROUP, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS FOR THE NINE MONTHS ENDED
SEPTEMBER 30, 2004 AND 2003 (UNAUDITED)
2004 2003
----------- -----------
Cash flows from operating activities
Net loss $(2,695,607) $(1,015,981)
Adjustments to reconcile net loss to net cash used in operating
activities:
Provision for bad debts (recoveries) (2,419) 24,355
Impairment of intellectual property -- 23,028
Depreciation expense 29,432 29,621
Shares issued for services 485,315 --
Options and warrants issued to nonemployees for services 175,088 --
Changes in operating assets and liabilities:
Accounts receivable (61,120) 312,762
Prepaid expenses (11,790) --
Accounts payable 179,627 (123,924)
Accrued expenses (14,800) (30,832)
Accrued expenses - employees (48,542) 118,079
Taxes payable 15,499 --
Customer deposits -- (20,000)
----------- -----------
Net cash used in operating activities (1,949,317) (682,892)
----------- -----------
Cash flows from investing activities - Acquisition of equipment (55,207) (3,011)
----------- -----------
Cash flows from financing activities
Repayments of related party loans (458,450) --
Proceeds from the issuance of senior secured note 250,000 --
Proceeds of related party loan 42,852 --
Net proceeds from sale of common stock and warrants 2,143,242 453,539
----------- -----------
Net cash provided by financing activities 1,977,644 453,539
----------- -----------
Effect of exchange rate changes on cash (22,789) 26,952
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Net decrease in cash (49,669) (205,412)
Cash, beginning of period 86,315 281,992
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Cash, end of period $ 36,646 $ 76,580
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Supplemental schedule of noncash investing and financing activities
Shares issued for equipment $ 58,334
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-6-
GAMING & ENTERTAINMENT GROUP, INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
NOTE 1 - BUSINESS AND ORGANIZATION
On or about January 12, 2004, NorStar Group, Inc., a publicly-held company that
was not conducting or developing any commercial operations ("NorStar"),
consummated a series of transactions, including: (i) a 1-for-24.852732 reverse
split of its outstanding shares of common stock; (ii) the issuance of 14,600,000
post-split shares of common stock in exchange for all of the outstanding shares
of common stock of Gaming & Entertainment Group, Inc., a Nevada corporation
("G&EG Nevada"); (iii) the issuance of options and warrants to purchase
4,257,937 post-split shares of common stock in exchange for all of the
outstanding options and warrants to purchase shares of G&EG Nevada; and (iv) a
change in the name of NorStar to Gaming & Entertainment Group, Inc. ("G&EG"). As
a result of the exchange, G&EG Nevada became a subsidiary of G&EG, and the
former stockholders of G&EG Nevada became the holders of 91.25% of the then
outstanding shares of common stock of the combined companies. In addition, the
former directors and officers of G&EG Nevada became the controlling members of
the board of directors and management of the combined companies. Since G&EG
Nevada was the only operating company in the exchange and the former
stockholders of G&EG Nevada received a substantial majority of the voting
securities of the combined companies, the exchange was accounted for as a
"reverse acquisition" and, effectively, as a recapitalization, in which G&EG
Nevada was treated as the accounting acquirer (and the legal acquiree) and
NorStar was the accounting acquiree (and the legal acquirer). Since the exchange
was accounted for as a "reverse acquisition," the accompanying condensed
consolidated financial statements reflect the historical financial statements of
G&EG Nevada, the accounting acquirer, as adjusted for the effects of the
exchange of shares on its equity accounts, the inclusion of the net liabilities
of the accounting acquiree as of January 12, 2004 at their historical basis and
the inclusion of the accounting acquiree's results of operations from that date.
As used herein, the "Company" refers to G&EG Nevada prior to January 12, 2004
and to G&EG, G&EG Nevada and its other subsidiaries from that date forward.
The Company is a developer of central server gaming systems, game content,
gaming devices for the land-based gaming markets of the United States, Canada
and Europe and Internet gaming systems for utilization in regulated gaming
markets.
NOTE 2 - BASIS OF PRESENTATION AND SIGNIFICANT ACCOUNTING POLICIES
Basis of Presentation
The accompanying unaudited condensed consolidated financial statements have been
prepared pursuant to the rules and regulations of the Securities and Exchange
Commission. Certain information and disclosures normally included in financial
statements prepared in accordance with accounting principles generally accepted
in the United States of America have been condensed or omitted from this report,
as is permitted by such rules and regulations; however, in the opinion of
management, the accompanying unaudited condensed consolidated financial
statements reflect all adjustments, consisting of normal recurring adjustments,
necessary for a fair presentation of the Company's financial position as of
September 30, 2004 and its results of operations and cash flows for the interim
periods presented. Results of operations for interim periods are not necessarily
indicative of results for the full years of which they are a part.
-7-
GAMING & ENTERTAINMENT GROUP, INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
The accompanying condensed consolidated financial statements have been prepared
assuming the Company will continue as a going concern. As shown in the financial
statements, the Company has incurred losses of $2,695,607 and $593,680 for the
nine and three months ended September 30, 2004, respectively, and recurring
losses in prior years. As of September 30, 2004, the Company had a working
capital deficiency of $510,571 and an accumulated deficit of $6,182,261. These
conditions raise substantial doubt about the Company's ability to continue as a
going concern. The Company's ability to continue as a going concern is dependent
upon its ability to generate sufficient cash flows from its operations or obtain
sufficient liquid resources from other sources to meet its obligations as they
become due. Through September 30, 2004, the Company has funded its operations
primarily through the issuance of common stock, warrants and options to outside
investors for cash and consultants and others for services. The Company is
attempting to procure additional funding through the issuance of equity
securities, loans from financial institutions and agreements with strategic
partners. Management anticipates that additional funding of not less than
$2,000,000 will be necessary to fund the Company's operations through September
30, 2005. Management believes, but cannot assure, that the Company will be able
to obtain such financing and continue its operations through at least September
30, 2005. If the Company is not able to obtain adequate financing, it may have
to curtail or terminate some, or all, of its operations. The accompanying
condensed consolidated financial statements do not include any adjustments
relating to the recoverability and classification of recorded assets, or the
amounts and classifications of liabilities that might be necessary in the event
the Company cannot continue as a going concern.
Revenue Recognition
Revenue from Internet gaming site development contracts in regulated gaming
markets are reported on the percentage of completion method of accounting using
measurements of progress toward completion appropriate for the work performed.
Stock-Based Compensation
Statement of Financial Accounting Standards No. 123, "Accounting for Stock-Based
Compensation" ("SFAS 123"), provides for the use of a fair value based method of
accounting for employee stock compensation. However, SFAS 123 also allows an
entity to continue to measure compensation cost for stock options granted to
employees using the intrinsic value method of accounting prescribed by
Accounting Principles Board Opinion No. 25, "Accounting for Stock Issued to
Employees" ("APB 25"), which only requires charges to compensation expense for
the excess, if any, of the fair value of the underlying stock at the date a
stock option is granted (or at an appropriate subsequent measurement date) over
the amount the employee must pay to acquire the stock. The Company has elected
to continue to account for employee stock options using the intrinsic value
method under APB 25. By making that election, it is required by SFAS 123 and
Statement of Financial Accounting Standard No. 148, "Accounting for Stock-Based
Compensation - Transition and Disclosure" ("SFAS 148"), to provide pro forma
disclosures of net loss and net loss per common share as if a fair value based
method of accounting had been applied, if such amounts differ materially from
the historical amounts.
-8-
GAMING & ENTERTAINMENT GROUP, INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
The exercise price of all of the options granted to employees has been equal to
or greater than the fair market value at the date of grant and, accordingly, the
Company has not recorded any earned or unearned compensation cost related to
such options in the accompanying condensed consolidated financial statements.
The Company's historical net loss and net loss per share and pro forma net loss
and net loss per share assuming compensation cost had been determined based on
the fair value of the options at the date of grant and amortized over the
vesting period consistent with the provisions of SFAS 123 are set forth below:
Nine Months Ended Three Months Ended
September 30, September 30,
------------------------------------------ --------------------------------------
2004 2003 2004 2003
-------------------- ------------------ ------------------ -----------------
Net loss, as reported $ ($2,695,607 ) $ (1,015,981) $ (593,680) $ (397,828)
Deduct: Total stock-based
employee compensation expense
determined under fair value
based method for all awards (464,307) (771,864) -- (771,864)
-------------------- ------------------ ------------------ -----------------
Pro forma net loss $ (3,159,914) $ (1,787,845) $ (593,580) $ (1,169,692)
==================== ================== ================== =================
Basic and diluted loss per common $ (0.16) $ (0.07) $ (0.03) $ (0.03)
share as reported
==================== ================== ================== =================
Basic and diluted loss per common
share pro forma $ (0.18) $ (0.13) $ (0.03) $ (0.08)
==================== ================== ================== =================
In accordance with the provisions of SFAS 123, all other issuances of common
stock, options or other equity instruments to employees and consultants as
consideration for goods or services received by the Company are accounted for
based on the fair value of the equity instruments issued (unless the fair value
of the consideration received can be more reliably measured). The fair value of
any options or similar equity instruments issued will be estimated based on the
Black-Scholes option-pricing model, which meets the criteria set forth in SFAS
123, and the assumption that all of the options or other equity instruments will
ultimately vest.
Net Loss per Share
The Company presents "basic" earnings (loss) per share and, if applicable,
"diluted" earnings per share pursuant to the provisions of Statement of
Financial Accounting Standards No. 128, "Earnings per Share" ("SFAS 128"). Basic
earnings (loss) per share is calculated by dividing net income or loss by the
weighted average number of shares outstanding during each period. The
calculation of diluted earnings per share is similar to that of basic earnings
per share, except that the denominator is increased to include the number of
additional common shares that would have been outstanding if all potentially
dilutive common shares, such as those issuable upon the exercise of options and
warrants, were issued during the period and the treasury stock method had been
applied. Since the Company had a net loss for the nine and three months ended
September 30, 2004 and 2003, the effects of the assumed exercise of outstanding
options and warrants would have been anti-dilutive and, accordingly, basic and
diluted net loss per share in each period were the same. As of September 30,
2004 and 2003, the Company had options and warrants outstanding for the purchase
of 7,293,377 and 4,216,006 shares of common stock, respectively, that were not
included in the computation of diluted loss per share.
-9-
GAMING & ENTERTAINMENT GROUP, INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
Reclassifications
Certain reclassifications of previously reported amounts have been made to
conform to the current period presentation.
NOTE 3 - COMMITMENTS AND CONTINGENCIES
Operating Leases
In February 2004, the Company entered into a non-cancelable real property lease
agreement for office space in Las Vegas, Nevada. The term of the lease is 65
months. Minimum lease payments are approximately $10,400 per month. The Company
has an option to renew the lease at the end of its initial term for an
additional five-year period. Contingent rental provisions within the lease
agreement require the minimum lease payments to be increased in accordance with
the Consumer Price Index, or CPI, commencing with the thirteenth month of the
lease. Rent expense for the nine months ended September 30, 2004 and 2003 was
$90,891 and $44,934, respectively. Assuming no increase in the CPI, the
aggregate annual rentals for this lease for each of the years subsequent to
December 31, 2003 are $62,400 in 2004, $124,800 in 2005, 2006, 2007 and 2008 and
$62,400 in 2009.
Employment Agreements
In August 2003, the Company entered into employment agreements with Tibor
N. Vertes, Gregory L. Hrncir and William McMaster. The employment agreements
with Messrs. Vertes and Hrncir were for four years and the employment agreement
with Mr. McMaster was for two years, all subject to earlier termination under
certain circumstances. The employment agreement for Mr. Vertes provides for an
annual salary of $185,000, which may be increased by the board of directors, and
an annual cash bonus of $35,000 to $100,000 if certain performance goals are
met. Since September 1, 2004, Mr Vertes has been paid a reduced annual salary of
$130,000. The reduction in salary is not being accrued by the company. The
employment agreement for Mr. Hrncir provides for an annual salary of $175,000,
which may be increased by the board of directors, an allowance of $1,500 per
month for health care and other benefits, and an annual cash bonus of $35,000 to
$100,000 if certain performance goals are met. Since September 1, 2004, Mr
Hrncir has been paid a reduced annual salary of $130,000. The reduction in
salary is not being accrued by the company. In addition, Mr Hrncir's $1,500
monthly allowance has not been paid. This amount is also not being accrued by
the company. The employment agreement for Mr. McMaster provides for an annual
salary of $120,000, which may be increased by the board of directors, and an
annual cash bonus if certain performance goals are met.
In September 2004, the Company entered into an employment agreement with
Mr. Burman for one year, subject to earlier termination under certain
circumstances. The employment agreement for Mr. Burman provides for an annual
salary of $130,000, which may be increased by the board of directors, and an
annual cash bonus of $35,000 to $100,000 if certain performance goals are met.
-10-
GAMING & ENTERTAINMENT GROUP, INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
NOTE 4 - ISSUANCE OF COMMON STOCK
During the nine months ended September 30, 2004, the Company received proceeds
of $2,143,242, net of expenses of $301,758, from the sale of 244.5 units to
investors at a price of $10,000 per unit through a private placement. Each unit
consisted of 10,000 shares of common stock and a warrant to purchase 10,000
shares of common stock at $1.50 per share. The warrants will expire on May 31,
2005.
During the nine months ended September 30, 2004, the Company issued 5.83 units
with a fair value of $58,334 in exchange for equipment. Each unit consisted of
10,000 shares of common stock and a warrant to purchase 10,000 shares of common
stock at $1.50 per share. The warrants will expire on May 31, 2005.
During the nine months ended September 30, 2004, the Company issued 507,390
shares of common stock with a fair value of $485,315 to consultants for
strategic advisory, investment banking and research services. The Company
recognized a charge to selling, general and administrative expenses in the nine
and three months ended September 30, 2004 of $485,315 and $52,925, respectively.
NOTE 5 - STOCK OPTIONS AND WARRANTS
Issuance of Options
During the nine months ended September 30, 2004, the Company granted options to
purchase a total of 112,325 shares of common stock to consultants in exchange
for services. Such options are exercisable over a range of three to ten years,
are fully vested and have exercise prices ranging from $0.75 to $1.31 per share
and a weighted average exercise price of $0.87 per share. The Company recognized
a charge to selling, general and administrative expenses in the nine months
ended September 30, 2004 for the fair value of the options, calculated using the
Black-Scholes option-pricing model, which amounted to $99,751.
A summary of the changes in outstanding stock options during the nine months
ended September 30, 2004 follows:
Shares Weighted-Average
Exercise Price
--------------------- -------------------
Outstanding, December 31, 2003 2,262,989 $ 0.75
Granted to employees 531,584 $ 0.85
Granted to consultants 112,325 $ 0.87
Forfeited (59,643) $ 0.75
---------------------
Outstanding, September 30, 2004 2,847,255 $ 0.77
=====================
Exercisable, September 30, 2004 2,766,005 $ 0.77
=====================
-11-
GAMING & ENTERTAINMENT GROUP, INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
Issuance of Warrants
During the nine months ended September 30, 2004, the Company issued warrants to
purchase 100,000 shares of common stock to consultants in exchange for services.
Such warrants are exercisable for two years commencing January 16, 2004, are
fully vested and have an exercise price of $0.75 per share. The Company
recognized a charge to selling, general and administrative expenses in the nine
months ended September 30, 2004 for the fair value of the warrants, calculated
using a Black-Scholes option-pricing model, which amounted to $75,337.
During the nine months ended September 30, 2004, the Company issued warrants to
purchase a total of 366,750 shares of common stock in exchange for investment
banking consulting services in connection with its private placement of units to
investors (see Note 4) at a price of $10,000 per unit, consisting of 10,000
shares of common stock and a warrant to purchase 10,000 shares of common stock.
Such warrants are exercisable for two years commencing May 31, 2005, are fully
vested and have an exercise price of $1.50 per share.
A summary of the changes in outstanding warrants during the nine months ended
September 30, 2004 follows:
Shares Weighted-Average
Exercise Price
--------------------- ------------------------
Outstanding, December 31, 2003 1,476,039 $ 1.50
Issued to consultants for services 100,000 $ 0.75
Issued in connection with private placement of units 2,811,750 $ 1.50
Issued in exchange for equipment 58,334 $ 1.50
---------------------
Outstanding, September 30, 2004 4,446,123 $ 1.48
=====================
Fair Values of Options and Warrants
The fair values of the options and warrants issued to consultants that were
charged to expense, and the fair values of options issued to employees included
in the determination of pro forma net loss per share during the nine months
ended September 30, 2004 was calculated using the Black-Scholes option-pricing
model in accordance with SFAS 123 based on the following assumptions: expected
life of 6.71 years for consultants and 9.91 years for employees, risk free
interest rate of 4.75%, dividend yield of 0% and volatility of 83.04%.
NOTE 6 - PREFERRED STOCK
The Company is authorized to issue up to 10,000,000 shares, $10 par value, of
Class A convertible preferred stock, of which 1,000,000 shares are designated
and 10,000,000 shares, $10 par value, of Class B preferred stock, of which
1,000,000 shares are designated. As of September 30, 2004, the Company did not
have any shares of preferred stock outstanding.
-12-
GAMING & ENTERTAINMENT GROUP, INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
NOTE 7 - RELATED PARTY TRANSACTIONS
At December 31, 2003, the Company had related party loans payable of $455,491
which the Company repaid during the nine months ended September 30, 2004.
Interest paid during the nine months ended September 30, 2004 on these related
party loans amounted to $26,760.
On September 6, 2004, the Company entered into promissory notes payable with
Tibor Vertes, our CEO and Chairman, and Gregory L Hrncir, our President, for
accrued salary and legal services rendered, respectively. Repayment of the notes
commenced on October 1, 2004 and mature on December 1, 2005 and are non-interest
bearing. Upon the occurrence of an event of default, the principal amount of the
notes shall be increased to reflect accrued interest of ten percent (10%) per
annum from August 1, 2003 to September 6, 2004.
On September 30, 2004, Tibor Vertes, our CEO and Chairman, loaned the Company
$43,007. The loan was repaid in October 2004.
NOTE 8 - SENIOR SECURED NOTE PAYABLE
On September 2, 2004, Gaming & Entertainment Group, Inc., a Utah
corporation (the "Company"), entered into a Senior Secured Bridge Note (the
"Bridge Note") in the amount of $750,000 with GEG Holdings, LLC, a Delaware
limited liability company ("GEG Holdings"). The Bridge Note matures on August
30, 2009.
The terms of the Bridge Note provide for the funding to occur in three
tranches. The first funding of $250,000 occurred on September 2, 2004. The
second and third tranches, each in the amount of $250,000, subject to the
satisfaction of certain conditions, were funded on October 1 and November 1,
2004. The Bridge Note is secured by a perfected first priority security interest
in all of the intellectual property assets of the Company. No principal amount
of this note may be repaid, in whole or in part, without the express written
approval of GEG Holdings at its sole discretion.
The outstanding principal amount of the Bridge Note accrues interest at
the Federal Funds Effective Rate of Interest (currently 2.00%), in effect from
time to time, plus six percent (6%) per annum and accrues semi-annually, in
arrears, on December 1, 2004 and on each June 1 and December 1 thereafter (each
an "Interest Payment Date"). The Bridge Note does not require the Company to
make cash interest payments until maturity. Interest will be payable in cash
only at maturity or, at the option of GEG Holdings, (A) by the issuance on each
Interest Payment Date of an immediately exercisable five (5) year warrant (an
"Interest Warrant") to purchase shares of a new class of convertible preferred
stock (the "Convertible Preferred Stock"), for an exercise price per share of
the lesser of (i) the average of the closing market price of the Company's
common stock, par value $.01 per share (the "Common Stock"), for the thirty (30)
days prior to the applicable Interest Payment Date, but in any event not less
than $0.40 per share, and (ii) $0.54 per share, that number of shares of
Convertible Preferred Stock equal to the interest payment then due, rounded up
to the nearest share; or (B) by the issuance on any subsequent Interest Payment
Date of an Interest Warrant, on the then fully accrued amount.
The Convertible Preferred Stock, upon issuance, would, among
others, have the following rights, preferences and privileges: (i) a liquidation
preference of $0.60 per share; (ii) no dividends; (iii) be convertible into
shares of Common Stock on a one-to-one basis; (iv) rank senior to all other
series of preferred stock outstanding; (v) include full ratchet anti-dilution
protection; (vi) right of first refusal with respect to any equity or
convertible securities issued by the Company; (vii) four immediate demand
registration rights and unlimited customary "piggy-back" rights; and (viii)
certain protective voting rights.
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ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OR PLAN OF OPERATIONS.
Statement on Forward-Looking Information
Certain information included herein contains statements that may be
considered forward-looking statements within the meaning of Section 27A of the
Securities Act and Section 21E of the Securities Exchange Act of 1934, or the
Exchange Act, such as statements relating to plans for product development,
product placement, capital spending and financing sources. Such forward-looking
information involves important risks and uncertainties that could significantly
affect anticipated results in the future and, accordingly, such results may
differ from those expressed in any forward-looking statements made herein. These
risks and uncertainties include, but are not limited to, those relating to our
liquidity requirements, our ability to locate necessary sources of capital to
sustain our operations, the continued growth of the gaming industry, the success
of our product development activities, the acceptance of our products in the
marketplace, vigorous competition in the gaming industry, our dependence on
existing management, changes in gaming laws and regulations (including actions
affecting licensing), our leverage and debt service (including sensitivity to
fluctuations in interest rates) and domestic or global economic conditions.
Overview
On or about January 12, 2004, NorStar Group, Inc., a publicly-held
company that was not conducting or developing any commercial operations
("NorStar"), consummated a series of transactions, including: (i) a
1-for-24.852732 reverse split of its outstanding shares of common stock; (ii)
the issuance of 14,600,000 post-split shares of common stock in exchange for all
of the outstanding shares of common stock of Gaming & Entertainment Group, Inc.,
a Nevada corporation ("G&EG Nevada"), a developer of central server gaming
systems, game content and gaming devices for the land-based gaming markets
located in USA and Canada; (iii) the issuance of options and warrants to
purchase 4,257,937 post-split shares of common stock in exchange for all of the
outstanding options and warrants to purchase shares of G&EG Nevada; and (iv) a
change in the name of NorStar to Gaming & Entertainment Group, Inc. ("G&EG"). As
a result of the exchange, G&EG Nevada became a subsidiary of G&EG and the former
stockholders of G&EG Nevada became the holders of 91.25% of the then outstanding
shares of common stock of the combined companies. In addition, the former
directors and officers of G&EG Nevada became the controlling members of the
board of directors and management of the combined companies. Since G&EG Nevada
was the only operating company in the exchange and the former stockholders of
G&EG Nevada received a substantial majority of the voting securities of the
combined companies, the exchange was accounted for as a "reverse acquisition"
and, effectively, as a recapitalization, in which G&EG Nevada was treated as the
accounting acquirer (and the legal acquiree) and NorStar was the accounting
acquiree (and the legal acquirer). Since the exchange was accounted for as a
"reverse acquisition," the accompanying consolidated financial statements
reflect the historical financial statements of G&EG Nevada, the accounting
acquirer, as adjusted for the effects of the exchange of shares on its equity
accounts, the inclusion of the net liabilities of the accounting acquiree as of
January 12, 2004 at their historical basis and the inclusion of the accounting
acquiree's results of operations from that date.
In this report, the references to "we," "us" or "our" relate to G&EG
Nevada prior to January 12, 2004 and to G&EG, G&EG Nevada and their other
subsidiaries from that date.
Critical Accounting Policies and Estimates
The preparation of financial statements in conformity with accounting
principles generally accepted in the United States of America requires
management to make estimates and assumptions that affect reported amounts and
disclosures, some of which may require revision in future periods. The most
sensitive estimates affecting our financial statements include, or will include
in subsequent periods, future volatility used in valuing equity instruments,
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allowances for bad debts, depreciable lives of gaming equipment in service and
other equipment, amortization periods for certain technology, deferred revenues,
accrued liabilities and deferred tax valuation allowances. By their nature,
these judgments are subject to an inherent degree of uncertainty. Our judgments
are based on our historical experience, our observance of industry trends,
information provided by or gathered from our customers and information available
from other outside sources, as appropriate. There can be no assurance that
actual results will not differ from our estimates. The most critical policies
relate to revenue recognition. The following is a description of our revenues
and our revenue recognition policies. The application of these policies, in some
cases, requires our management to make subjective judgments regarding the effect
of matters that are inherently uncertain.
Description of Revenues
Through September 30, 2004, we have received our revenues from the
development of prospective Internet gaming sites in regulated gaming markets
outside of the United States, as well as maintenance and technical support
contracts. Regarding Internet gaming contracts, we generally receive a license
fee as well as a portion of the gaming revenues generated by our client's sites.
We expect to continue to provide such services to major groups.
In addition, we are focused on the provision of our central server
gaming system and suite of games in the land-based gaming market of Europe and
the United States. Our business model for our land-based initiatives is
primarily based upon recurring revenue to be derived from the placement of our
products. Specifically, we anticipate offering our central server gaming system
in the foregoing markets on a license basis, whereby we will receive a recurring
license fee. Gaming machines will primarily be placed on a revenue sharing or
participation basis with the Company anticipating realizing 15%-30% of the net
win (i.e., coin inserted into a machine less the coin paid out) from the gaming
machines, depending upon the market. Although not our specific focus, from time
to time we anticipate selling our gaming machines. Alternatively, we anticipate
occasionally deploying gaming machines on the basis of part cash payment and a
lower revenue sharing percentage. We also anticipate generating revenues from
maintenance and technical support services in connection with the placement of
our central server gaming system and gaming machines. In all cases, we will
outsource the manufacture of our gaming machines through turnkey third party
manufacturing sources with which we have an alliance.
The placement of gaming equipment on a revenue sharing basis is capital
intensive. In this regard, we are currently negotiating with several financiers
to establish a credit facility sufficient to finance the manufacture and
deployment of our projected roll-out of gaming machines placed on a revenue
sharing basis, as well as the interim manufacturing period where gaming machines
are placed on an outright sale basis.
When we install our gaming machines on a revenue-sharing basis, there
will generally be no cost to our casino clients, as we will share in the
recurring revenues generated from the gaming machines. We will, however, retain
ownership of the gaming machines and the central server gaming system throughout
the term of the revenue-sharing and licensing agreements, respectively, and will
maintain the right to refurbish and redeploy gaming machines returned to us
either upon the expiration or early termination of the revenue-sharing
agreements. We believe that by placing gaming machines on a revenue-sharing
basis we will maximize the amount of placements of our products; however, there
is no assurance that we will be successful in this effort given our current cash
position, not having yet established a credit facility with a third-party
financier given that we have not previously deployed products, or provided
services, to gaming operators in the land-based gaming markets in which we are
entering, and the highly competitive nature of games on casino floors.
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Historically, we have experienced substantial fluctuations in revenues
from period-to-period as a result of our revenues being derived solely from
software development contracts consisting of upfront licensing and periodic
payments as opposed to steady recurring revenues. Moreover, our revenues have
been limited over the last two years as we have been intensely focused on the
finalization of our central server gaming system for the Europe and North
America gaming markets, as well as development of electronic bingo, keno,
instant lottery, video poker and roulette products for deployment in such
markets.
We anticipate that our future revenues will be derived from Internet
gaming contracts as well as the placement of our central server gaming system
and gaming machines on a revenue-sharing and sale basis and, to a lesser extent,
from maintenance and technical support agreements. At this time, it is difficult
to predict the breakdown of anticipated future revenues from each of the
foregoing initiatives.
Revenue Recognition
Revenue from the development of Internet gaming sites in regulated
gaming markets are reported on the percentage of completion method of accounting
using measurements of progress toward completion appropriate for the work
performed.
Revenues from the enhancement, maintenance and technical support of
Internet gaming sites in regulated gaming markets are recognized as the services
are performed or pro rata over the service period. When we receive a percentage
of the gaming revenues generated by our client's Internet gaming sites, we
recognize such revenues upon receipt.
Revenues from the placement of our gaming machines on a revenue-sharing
basis, as well as the placement of our central server gaming system on a license
basis, will be accounted for similar to an operating lease, with the revenues
recognized as earned over the term of the agreement. If we sell gaming machines
outright, revenues will be recognized upon completion of installation and
acceptance by the casino, provided collectibility is reasonably assured. We will
negotiate our portion of the revenues generated under our revenue-sharing
contracts based upon the cost of the equipment installed, the location of a
particular casino, and the estimated daily net win per gaming machine for each
casino client.
RESULTS OF OPERATIONS
COMPARISON OF THREE MONTHS ENDED SEPTEMBER 30, 2004 AND 2003
Revenues
During the three months ended September 30, 2004, we generated revenues
from maintenance and technical support services of $65,554, compared to revenues
from services of $119,581, during the three months ended September 30, 2003. The
$54,027, or 45.2% decrease in revenues from services was due primarily to our
transition from solely focusing on the sale and marketing of online gaming
-16-
systems in regulated gaming markets to the development of land-based gaming
systems and a suite of electronic bingo, keno, instant lottery, video poker and
roulette games using our central server gaming system platform. We anticipate a
slight increase in revenue during the remainder of the year ending December 31,
2004 from Internet gaming contracts as we complete the development of our
land-based gaming products. We anticipate deploying gaming machines in the
United Kingdom on a revenue sharing and sale basis in the next several months.
Cost of Revenues
During the three months ended September 30, 2004, our cost of revenues
was $37,462, compared to costs of $64,383 during the three months ended
September 30, 2003. The $26,921, or 41.8% decrease in the costs of revenues was
directly attributable to decreased activity by the Company in connection with
the development of Internet gaming sites, as compared to the same period in
2003. We do, however, anticipate that our revenues, in future periods, will
escalate from increased Internet gaming activity as well as deployment of our
land-based gaming products.
We realized a gross margin of $28,092 during the three months ended
September 30, 2004, compared to a gross margin of $55,198 during the three
months ended September 30, 2003. The $27,106, or 49.1% decrease, in gross margin
related primarily to our transition from solely marketing and developing
Internet gaming systems for regulated markets to the development of our central
server gaming system and suite of games for land-based gaming markets.
Operating Expenses
For the three months ended September 30, 2004, we incurred total
operating expenses of $618,912, compared to $453,915 for the three months ended
September 30, 2003, an increase of $164,997, or 36.3%. The increase in total
operating expenses related primarily to a $57,275 increase in research and
development expenses associated with our land-based gaming initiatives, and a
$107,722 increase in selling, general and administrative expenses.
During the three months ended September 30, 2004, we incurred research
and development expenses of $207,503, compared to $150,228 during the three
months ended September 30, 2003, an increase of $57,275, or 38.1%. The increase
in our research and development expenses was due primarily to the additional
resources spent towards developing our central server gaming system platform and
related games and other products for deployment in land-based casinos. Research
and development expenses to obtain the necessary certifications and approvals
for each of the foregoing cannot be quantified at this time given the nature of
this process. There are always risks and uncertainties associated with the
development, certification and commercialization of new products or services.
The Company anticipates making its initial deployment of products into
land-based gaming markets in the next several months. While this is new
territory for the Company, it has previously been through the development and
lab certification process on a number of occasions with respect to its Internet
gaming platform. The Company anticipates that, as with the Internet gaming
platform submissions, it will be successful in obtaining certification from the
gaming labs on its various hardware and software products. To reduce the risk
associated with its initial entry into the land-based gaming market, the Company
is utilizing well established third party turnkey manufacturing sources for its
gaming devices and will utilize industry veterans for the installation and
ongoing maintenance of the gaming machines.
During the three months ended September 30, 2004, we incurred selling,
general and administrative expenses of $411,409, compared to $303,687 during the
three months ended September 30, 2003, an increase of $107,722, or 35.5%. The
increase in our selling, general and administrative expenses was due primarily
to increased travel costs, increased costs related to the retention of
professionals, including gaming, intellectual property and other outside
counsel, and non cash compensation expense relating to shares issued to
consultants in consideration of strategic advisory, research, and hardware and
software documentation services. We had costs of $52,925 for the fair value of
shares of restricted common stock issued to consultants in consideration for
strategic advisory, research and hardware and software documentation services
during the three months ended September 30, 2004. The Company does not expect to
incur similar charges for the remainder of the year and, accordingly, we
anticipate that our selling, general and administrative expenses will be lower
in future periods.
-17-
Other Income (Expense)
For the three months ended September 30, 2004, other expense was
$2,860, compared to other income of $889 for the three months ended September
30, 2003, an increase of other expenses of $3,749. The increase in other
expenses related primarily to $15,249 of interest expense, offset, in part, by
$12,389 of interest and other income.
Net Loss
For the three months ended September 30, 2004, we experienced a net
loss of $593,680, compared to a net loss of $397,828 for the three months ended
September 30, 2003, an increased loss of $195,852, or 49.2%. The increase in net
loss was due to a $54,027 decrease in revenues, a $164,997 increase in operating
expenses and a $3,749 increase in other expenses, offset, in part, by a $26,921
decrease in costs of revenues. As previously noted, the increased loss and
trends related to our revenues and operating expenses relate directly to our
transition from solely marketing and placing online gaming systems to the
development of land-based gaming systems and products using our central server
gaming system platform. As our research and development projects are completed,
and commercialization of the products relating thereto occurs, we anticipate
that our revenues will improve considerably.
COMPARISON OF NINE MONTHS ENDED SEPTEMBER 30, 2004 AND 2003
Revenues
During the nine months ended September 30, 2004, we generated revenues
from maintenance and technical support services of $140,894, compared to
revenues from services of $825,475, during the nine months ended September 30,
2003. The $684,581, or 82.9% decrease in revenues from services and the absence
of any revenues from product sales in the nine months ended September 30, 2004
compared to product sales revenues of $297,432 in the nine months ended
September 30, 2003 was due primarily to our transition from solely focusing on
the sale and marketing of online gaming systems in regulated gaming markets to
the development of land-based gaming systems and a suite of electronic bingo,
keno, instant lottery, video poker and roulette games using our central server
gaming system platform. We anticipate a slight increase in revenue during the
remainder of the year ending December 31, 2004 from Internet gaming contracts as
we complete the development of our land-based gaming products. We anticipate
deploying gaming machines in the United Kingdom on a revenue sharing and sale
basis in the next several months.
Cost of Revenues
During the nine months ended September 30, 2004, our cost of revenues
was $37,462, as compared to $432,349 during the nine months ended September 30,
2003. During the nine months ended September 30, 2003, our costs of revenues
consisted of $189,785 attributable to services, and $242,564 attributable to
product sales. The $394,887 decrease in the costs of revenues was attributable
to decreased activity by the Company in connection with the development of
Internet gaming sites, as compared to the same period in 2003. We do, however,
anticipate that our revenues, in future periods, will escalate from increased
Internet gaming activity as well as deployment of our land-based gaming
products.
In terms of gross margin, we realized a gross margin of $103,432 during
the nine months ended September 30, 2004, compared to a gross margin of $393,126
during the nine months ended September 30, 2003. The $289,694, or 73.7% decrease
in gross margin related primarily to our transition from solely marketing and
developing Internet gaming systems for regulated markets to the development of
our central server gaming system and suite of games for land-based gaming
markets.
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Operating Expenses
For the nine months ended September 30, 2004, we incurred total
operating expenses of $2,765,458, compared to $1,414,373 for the nine months
ended September 30, 2003, an increase of $1,351,085, or 95.5%. The increase in
total operating expenses related primarily to a $268,941 increase in research
and development expenses and a $1,105,172 increase in selling, general and
administrative expenses.
During the nine months ended September 30, 2004, we incurred research
and development expenses of $711,772, compared to $442,831 during the nine
months ended September 30, 2003, an increase of $268,941, or 60.7%. The increase
in our research and development expenses was due primarily to the additional
resources spent towards developing our central server gaming system platform and
related games and other products for deployment in land-based casinos. Research
and development expenses to obtain the necessary certifications and approvals
for each of the foregoing cannot be quantified at this time given the nature of
this process. There are always risks and uncertainties associated with the
development, certification and commercialization of new products or services.
The Company anticipates making its initial deployment of products into
land-based gaming markets in the next several months. While this is new
territory for the Company, it has previously been through the development and
lab certification process on a number of occasions with respect to its Internet
gaming platform. The Company anticipates that, as with the Internet gaming
platform submissions, it will be successful in obtaining certification from the
gaming labs on its various hardware and software products. To reduce the risk
associated with its initial entry into the land-based gaming market, the Company
is utilizing well established third party turnkey manufacturing sources for its
gaming devices and will utilize industry veterans for the installation and
ongoing maintenance of the gaming machines.
During the nine months ended September 30, 2004, we incurred selling,
general and administrative expenses of $2,053,686, compared to $948,514 during
the nine months ended September 30, 2003, an increase of $1,105,172, or 116.5%.
The increase in our selling, general and administrative expenses was due
primarily to travel, road shows for our private placement earlier this year,
retention of professionals, including gaming, intellectual property and other
outside counsel, our exhibition at five industry shows and conventions, salaries
related to new employees, and non cash compensation expense of $660,403 relating
to shares, options and warrants issued to consultants in consideration of
strategic services. Included in these costs are $485,315 of expenses relating to
the fair value of shares of restricted common stock issued to consultants in
consideration for strategic advisory, investment banking, research and hardware
and software documentation services during the nine months ended September 30,
2004. The Company does not expect to incur similar charges for the reminder of
the year and, accordingly, we anticipate that our selling, general and
administrative expenses will be lower in future periods.
Other Income (Expense)
For the nine months ended September 30, 2004, other expense was
$33,581, compared to other income of $5,266 for the nine months ended September
30, 2003, an increase of other expenses of $38,847. The increase in other
expenses related primarily to $14,170 of foreign currency transaction losses,
attributable to fluctuations between the Australian dollar, the functional
currency of one of our subsidiaries, and the United States Dollar, $42,009 of
interest expense, offset, in part, by $22,598 of interest and other income.
-19-
Net Loss
For the nine months ended September 30, 2004, we experienced a net loss
of $2,695,607, compared to a net loss of $1,015,981 for the nine months ended
September 30, 2003, an increased loss of $1,679,626. The increase in net loss
was due to a $684,581 decrease in revenues, a $1,351,085 increase in operating
expenses and a $38,847 increase in other expenses, offset, in part, by a
$394,887 decrease in costs of revenues. As previously noted, the increased loss
and trends related to our revenues and operating expenses relate directly to our
transition from the marketing and placement of online gaming systems to the
development of land-based gaming systems and products using our central server
gaming system platform. As our research and development projects are completed,
and commercialization of the products relating thereto occurs, we anticipate
that our revenues will improve considerably.
LIQUIDITY AND CAPITAL RESOURCES
Overview
As of September 30, 2004, we had cash of $36,646, prepaid expenses of
$21,790, accounts receivable of $60,000 and total liabilities of $919,898, of
which $629,007 are current liabilities. Accordingly, as of September 30, 2004,
we had a working capital deficiency of $510,571. During the nine months ended
September 30, 2004, cash on hand decreased $49,669, from $86,315 to $36,646. The
decrease in cash reflected $1,977,644 of net cash provided by financing
activities, offset by $1,949,317 of net cash used in operating activities,
$55,207 of net cash used in investing activities and $22,789 used as a result of
exchange rate changes.
Operating activities used net cash of $1,949,317 during the nine months
ended September 30, 2004, whereas operating activities used net cash of $682,892
during the nine months ended September 30, 2003. The net cash used in operating
activities during the nine months ended September 30, 2004 related primarily to
our net loss of $2,695,607, an increase in accounts payable of $179,627, a
decrease in accrued expenses of $14,800, a decrease in accrued expenses -
employees of $48,542, and a decrease in prepaid expenses of $11,790, offset, in
part, by non-cash costs of investment banking, strategic advisory, research, and
hardware and software documentation services of $660,403 paid through the
issuance of restricted shares of common stock with a fair value of $485,315 and
the issuance of options and warrants with a fair value of $175,088. Issuances of
equity securities as payments for services and compensation result in non-cash
charges to expense. During the nine months ended September 30, 2003, our
operating activities used net cash of $682,892, reflecting our net loss of
$1,015,981 and increase in accrued expenses - employees of $118,079, offset, in
part, by the increase in accounts receivable of $312,762, and a decrease in
accounts payable of $123,924.
Investing activities used $55,207 during the nine months ended
September 30, 2004, compared to $3,011 used during the nine months ended
September 30, 2003. The increased use of cash in investing activities reflects
the costs related to the build-out and relocation of our principal offices to
Las Vegas, Nevada as well as the purchase of gaming machines for research and
development purposes. We anticipate that for the twelve month period ending
September 30, 2005, we will need $2,000,000 for ongoing research and
development, gaming lab certification of our products, gaming licensing,
advertising and marketing and the manufacture of gaming machines to be deployed
on a recurring revenue basis in Europe and North America. The manufacturing
costs associated with all gaming machines sold by us on an outright sale basis
will likely be financed through the purchase terms. All gaming machines placed
on a revenue sharing basis will need to be financed through third party sources.
At this time, the Company has not secured such third party financing, and there
can be no assurance that the Company will do so on acceptable terms, or at all.
-20-
Our financing activities provided net cash of $1,977,644 during the
nine months ended September 30, 2004, compared to $453,539 during the nine
months ended September 30, 2003. The net cash provided by our financing
activities during the nine months ended September 30, 2004 reflects $2,143,242
in net proceeds from the sale of 2,445,000 shares of common stock in a private
placement, $42,852 from stockholder loans, offset by $458,450 used to repay
stockholder loans. The net cash provided by our financing activities during the
nine months ended September 30, 2003 reflects $453,539 in net proceeds from the
sale of 568,200 shares of common stock at $0.75 per share in a private
placement.
Outlook
Until we generate sufficient cash from our operations, we will need to
rely upon private and institutional sources of debt and equity financing. Based
on presently known commitments and plans, we believe that we will be able to
fund our operations and required expenditures through the third quarter of 2005
through cash on hand and cash proceeds from the issuance of debt and equity
securities. In the event that such sources are insufficient or unavailable, we
will need to seek cash from other lending sources, sell certain assets or change
operating plans to accommodate such liquidity issues. No assurances can be given
that we will successfully obtain liquidity sources necessary to fund our
operations to profitability and beyond.
RISK FACTORS
We are subject to a high degree of risk as we are considered to be in
unsound financial condition. The following risks, if any one or more occurs,
could materially harm our business, financial condition or future results of
operations, and the trading price of our common stock could decline. These risks
factors include, but are not limited to, our limited operating history, history
of operating losses, the inability to obtain for additional capital, the failure
to successfully expand our operations, the barriers of entry into new gaming
markets, the competition in the gaming industry from competitors with
substantially greater resources, the legal and regulatory requirements and
uncertainties related to our industry, the inability to enter into strategic
partnerships with manufacturers and distributors, the loss of key personnel,
adverse economic conditions, adverse currency rate fluctuations, the inability
to protect our proprietary information against unauthorized use by third
parties, the unenforceability of agreements with Native American tribes, the
control of our common stock by our management, the classification of our common
stock as "penny stock," the absence of any right to dividends, the costs
associated with the issuance of and the rights granted to additional securities,
the unpredictability of the trading of our common stock and the ability of our
board of directors to issue up to 10,000,000 shares, $10 par value, of Class A
convertible preferred stock and 10,000,000 shares, $10 par value, of Class B
preferred stock.
For a more detailed discussion as to the risks related to Gaming &
Entertainment Group, Inc., our industry and our common stock, please see the
section entitled, "Management's Discussion and Analysis or Plan of Operation -
Risk Factors," in our Annual Report on Form 10-KSB, as filed with the Securities
and Exchange Commission on April 14, 2004.
ITEM 3. CONTROLS AND PROCEDURES
Evaluation of Disclosure Controls
We evaluated the effectiveness of our disclosure controls and
procedures as of September 30, 2004, the end of the period covered by this
Quarterly Report on Form 10-QSB. This evaluation was done with the participation
of our chief executive officer and our president, and with the participation of
our former chief executive officer. Upon the consummation of a share exchange on
January 12, 2004 involving Gaming & Entertainment Group, Inc., a Nevada
corporation, Jay Sanet, our former chief executive officer resigned, and Tibor
N. Vertes and Gregory L. Hrncir were appointed as our chief executive officer
and president, respectively. Mr. Vertes serves as our principal executive
officer and Mr. Hrncir serves as our principal financial and accounting officer.
-21-
Disclosure controls and procedures are controls and other procedures
that are designed to ensure that information required to be disclosed by us in
the reports that we file or submit under the Exchange Act is recorded,
processed, summarized and reported within the time periods specified in the
Securities and Exchange Commission's rules and forms.
Limitations on the Effectiveness of Controls
Our management does not expect that our disclosure controls and
procedures or our internal controls over financial reporting will prevent all
error and all fraud. A control system, no matter how well conceived and
operated, can provide only reasonable, but not absolute, assurance that the
objectives of a control system are met. Further, any control system reflects
limitations on resources, and the benefits of a control system must be
considered relative to its costs. Because of the inherent limitations in all
control systems, no evaluation of controls can provide absolute assurance that
all control issues and instances of fraud, if any, have been detected. These
inherent limitations include the realities that judgments in decision-making can
be faulty and that breakdowns can occur because of simple error or mistake.
Additionally, controls can be circumvented by the individual acts of some
persons, by collusion of two or more people, or by management override of a
control. The design of a control system is also based upon certain assumptions
about the likelihood of future events, there can be no assurance that any design
will succeed in achieving its stated goals under all potential future
conditions; over time, controls may become inadequate because of changes in
conditions, or the degree of compliance with the policies or procedures may
deteriorate. Although unlikely, due to the inherent limitations in a
cost-effective control system, misstatements due to error or fraud may occur and
may not be detected.
Conclusions
Based on this evaluation, our chief executive officer and our president
concluded that, subject to the limitations noted above and as of the evaluation
date, our disclosure controls and procedures are effective to ensure that the
information we are required to disclose in reports that we file or submit under
the Exchange Act is recorded, processed, summarized, and reported in such
reports within the time periods specified in the Securities and Exchange
Commission's rules and forms.
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Changes in Internal Controls
There were no changes in our internal controls over financial reporting
that occurred during the last fiscal quarter, i.e., the three months ended
September 30, 2004, that have materially affected, or are reasonably likely to
materially affect, our internal controls over financial reporting.
PART II - OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS
Not applicable.
ITEM 2. CHANGES IN SECURITIES
In the three months ended September 30, 2004, the Company issued
275,893 shares of restricted common stock to consultants for the provision of
strategic advisory services, investment banking services and software and
hardware documentation. We relied upon the exemption from registration provided
by Section 4(2) of the Securities Act of 1933.
In September 2004, the Company cancelled 200,893 shares of restricted
common stock, issued in July 2004, to a consultant for the provision of
strategic advisory services.
ITEM 3. DEFAULTS UPON SENIOR SECURITIES.
Not applicable.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS.
Not applicable.
ITEM 5. OTHER INFORMATION.
Not applicable.
ITEM 6. EXHIBITS
(a) Exhibits.
31.1 Certifications Pursuant to Section 302 of the Sarbanes-Oxley
Act of 2002.
31.2 Certifications Pursuant to Section 302 of the Sarbanes-Oxley
Act of 2002.
32.1 Certifications Pursuant to Section 906 of the Sarbanes-Oxley
Act of 2002 (18 U.S.C. Section 1350).
(b) Reports on Form 8-K.
(1) On September 2, 2004, Gaming & Entertainment
Group, Inc., a Utah corporation (the "Company"), entered into
a Senior Secured Bridge Note (the "Bridge Note") in the amount
of $750,000 with GEG Holdings, LLC, a Delaware limited
liability company ("GEG Holdings"). The Bridge Note matures on
August 30, 2009.
The terms of the Bridge Note provide for the funding
to occur in three tranches. The first funding of $250,000
occurred on September 2, 2004. The second and third tranches,
each in the amount of $250,000, subject to the satisfaction of
certain conditions, were funded on October 1 and November 1,
2004. The Bridge Note is secured by a perfected first priority
security interest in all of the intellectual property assets
of the Company.
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The outstanding principal amount of the Bridge Note
accrues interest at the Federal Funds Effective Rate of
Interest (currently 2.00%), in effect from time to time, plus
six percent (6%) per annum and accrues semi-annually, in
arrears, on December 1, 2004 and on each June 1 and December 1
thereafter (each an "Interest Payment Date"). The Bridge Note
does not require the Company to make cash interest payments
until maturity. Interest will be payable in cash only at
maturity or, at the option of GEG Holdings, (A) by the
issuance on each Interest Payment Date of an immediately
exercisable five (5) year warrant (an "Interest Warrant") to
purchase shares of a new class of convertible preferred stock
(the "Convertible Preferred Stock"), for an exercise price per
share of the lesser of (i) the average of the closing market
price of the Company's common stock, par value $.01 per share
(the "Common Stock"), for the thirty (30) days prior to the
applicable Interest Payment Date, but in any event not less
than $0.40 per share, and (ii) $0.54 per share, that number of
shares of Convertible Preferred Stock equal to the interest
payment then due, rounded up to the nearest share; or (B) by
the issuance on any subsequent Interest Payment Date of an
Interest Warrant, on the then fully accrued amount.
The Convertible Preferred Stock, upon issuance,
would, among others, have the following rights, preferences
and privileges: (i) a liquidation preference of $0.60 per
share; (ii) no dividends; (iii) be convertible into shares of
Common Stock on a one-to-one basis; (iv) rank senior to all
other series of preferred stock outstanding; (v) include full
ratchet anti-dilution protection; (vi) right of first refusal
with respect to any equity or convertible securities issued by
the Company; (vii) four immediate demand registration rights
and unlimited customary "piggy-back" rights; and (viii)
certain protective voting rights.
(2) On September 30, 2004, the Company filed a
registration statement on Form S-8 with the Securities and
Exchange Commission to register its 2004 Stock Option and
Incentive Plan (the "Plan"). The Plan, which was approved by a
majority of the stockholders of the Company at the 2004 Annual
Stockholders Meeting held on June 14, 2004, provides for the
issuance of up to 3,000,000 shares of common stock upon the
exercise of options issued thereunder.
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SIGNATURE
In accordance with the requirements of the Exchange Act, the registrant
caused this report to be signed on its behalf by the undersigned, thereunto duly
authorized.
GAMING & ENTERTAINMENT GROUP, INC.
(Registrant)
Date: November 15, 2004 By: /s/ Gregory L. Hrncir
---------------------------
Gregory L. Hrncir
Its: President and Secretary
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