Item 1. Business.
We are a North Carolina corporation. Our corporate offices are located at 1150 Crews Road, Matthews, North Carolina 28105 and our telephone number is (704) 849-0860. We develop, manufacture, and market electronic table games and related products for casinos, cruise lines, racinos, card clubs and lotteries worldwide. We distribute our electronic table games using an internal sales force, complemented by distributors and sales agents in select geographic areas, generally on a recurring revenue participation model, recurring revenue fixed license fee model or as a sale of hardware combined with recurring license and support fees. We offer two electronic table gaming platforms: PokerPro and ProCore. As of December 31, 2013, our installed base consisted of 2,272 gaming positions, composed of 2,170 PokerPro and 102 ProCore positions.
Products
Our electronic tables are multi-station gaming devices that facilitate the play of casino games in an efficient and cost-effective manner. The tables fully automate the shuffling, dealing, cash handling, enforcement of game rules, awarding of pots and other aspects of the game. Players view their cards, place bets, and take other actions using individual touch screens. Each table also has a center monitor that allows all players to easily view community information specific to the game being played, such as dealer/house cards, community cards, player bet amounts, pot size and winning hand announcements.
The tables are part of a server-based system, which allows for system security, scalability and data visibility. Getting players into the game is easy, as PokerTek’s products are account-based and utilize a casino player card or PokerTek account card. Players setup a PIN-protected account and perform deposits and withdrawals via a cashier at the system’s Customer Management System (CMS). To get into the game, players swipe their card at the table, enter their PIN and indicate how much money they want to bring to the game. All transactions are tracked, giving operators unparalleled reporting of game statistics, player tracking and financial data. Sophisticated administrative tools give operators control to manage all aspects of the system.
Both PokerPro and ProCore support multiple languages and currencies.
PokerPro
PokerPro is a 10-seat electronic poker table that allows operators to offer the most popular player-banked games and tournaments. The PokerPro system offers cash games, single-table tournaments and multi-table tournaments with an extensive game library including Texas Hold’em, Omaha, Razz, and Seven Card Stud. Game rules and limits, including blinds, antes, rake structures and house rules, are completely configurable.
ProCore
ProCore is an electronic table game platform that expands on the PokerPro technology and allows multiple house-banked games to be run on a single, efficient, economical platform. The versatility of the ProCore system allows operators to add new game content as it is released. Games and house rules can be customized easily to meet customer and regulatory requirements, making it an ideal choice for operators looking to add an automated solution to their gaming floor.
Mobile Gaming
We intend to deploy our game content on a mobile gaming platform that will allow players to access and play games such as poker, blackjack, roulette and slots from any laptop, tablet or mobile device within a customer’s property. We have been working with third-party developers during the second half of 2013 to port our game content to their platform and to customize their mobile gaming applications to the specific needs of a prospective customer. We anticipate launching this mobile gaming platform in the second half of 2014 with our first customer. However, we cannot provide any assurance that we will be successful in developing the mobile gaming platform or that any customers will ever deploy the platform.
Market and Strategy for Electronic Table Games
We use an analytical approach to evaluating worldwide gaming markets and segmenting those geographic markets and individual properties where our sales and marketing efforts are to be directed. We segment the market into three categories: those with no manual table games; those with limited manual table games; and those characterized by greater density of manual table games. We intentionally focus the majority of our sales and marketing effort on those markets that either have no or a limited number of manual table games. We also opportunistically place tables in markets with higher density of manual table games where we believe we offer a value proposition for the operators and players. This approach allows us to narrow our focus, directing our limited resources in a targeted approach, and has significantly improved customer retention and operating margins.
Based on our most recent analysis, we have identified a number of markets that we plan to target for increased sales and marketing activity. Given the particulars of these markets, we believe we can to increase our dominant position in electronic poker in these markets with our PokerPro system. With the addition of the ProCore platform, the addressable opportunities are expanded to include blackjack, baccarat and other house-banked games. The market for poker is a smaller niche where we enjoy a dominant market position. The market for electronic blackjack, baccarat and specialty house-banked games is larger, but also characterized by more competition. We believe our product offerings have significant advantages over the competition and, as a result, we have the opportunity to expand our dominance in poker while increasing the market for electronic house-banked games and displacing competitor products in those markets.
We have identified key markets worldwide that meet our market segmentation criteria and we believe those markets provide actionable opportunities to grow significantly. We are also monitoring changes in regulation at the state, federal and international level and believe that budgetary, legislative and other factors are creating a favorable environment for expanding the market for gaming in general and electronic table games in particular.
Distribution Method
We distribute our gaming products on a direct basis using our own internal sales force and third-party sales agents and distributors in select markets. Our salespeople are generally organized based on geography and customer relationship, and continue to be closely involved with our customers following the deployment of tables to provide product and marketing consulting as well as account relationship management.
Competition
The overall market for gaming devices is mature and characterized by numerous competitors that develop and license proprietary table games. We are aware of several other companies offering automated table games, including poker and blackjack products, and additional competitors could emerge. Potential competitors may have brand recognition and greater resources than we have. Potential competitors also could offer lower cost products manufactured in less regulated or lower cost foreign markets.
Some of the gaming supply companies that may offer competitive electronic table games include: Bally Technologies, Inc., Lightning Gaming, Inc., DigiDeal, Inc., Amaya Gaming Group, Inc., Gaming, and Zitro S.A.R.L. We are also aware of other competitors offering electronic table games products in Eastern Europe, South America and other markets.
We also compete with slot machines and other gaming products for space on the customers’ floor and for share of customers’ budget. In addition, we compete with manual table games, internet poker websites and other forms of internet gaming.
Manufacturing and Product Supply
We purchase all parts, including hardware components, signs and accessories for the PokerPro and ProCore systems from third-party suppliers. We assemble our electronic tables from such component parts and purchased cabinetry and other materials at our facility in Matthews, North Carolina.
We believe that we have sufficient capacity to meet demand and that our sources of supply are adequate. Several key components we use in the manufacture of our products are proprietary and are currently manufactured by a single third party supplier. These components include complex integrated circuits which are critical to our product designs. Changing manufacturers for any of these components would require significant time and effort on the part of our management team, may require additional engineering development work, and could have a disruptive impact on our operations.
Key components are produced primarily in Taiwan and China and are subject to lead times and other challenges associated with managing an international supply chain. Furthermore, we compete with other companies for the production capacity of third-party manufacturers and suppliers for displays and for other components. We believe that our suppliers have adequate capacity to meet our requirements and sources of supply are adequate. However, because our supply chain originates in the Far East and we rely on third parties, our ability to satisfy demand for our products depends on their performance as well as our ability to provide accurate production forecasts and manage long logistical lead times.
Research and Development
We conduct research and development activities primarily to develop, commercialize, customize and enhance our electronic table hardware, software, game content and related products. Our research and development expenses were $0.7 million and $0.7 million during the fiscal years ended December 31, 2013 and December 31, 2012, respectively, consisting primarily of internal product development salaries, benefits and other expenses related to third-party engineering, prototyping and product testing.
The focus of our software and hardware development is to improve our gaming products through the addition of new games and features, to improve manufacturability and to adapt our products to customer preferences and the legal and regulatory requirements specific to the jurisdiction in which the particular product will be deployed.
Gaming Regulations and Licensing
Regulatory Overview
We are subject to a wide range of complex laws and regulations applicable to the gaming industry in the markets (both foreign and domestic) in which we manufacture or distribute gaming products. Those jurisdictions generally require us to be licensed, our key personnel to be found suitable, qualified or licensed, and our products to be reviewed and approved before placement. These requirements serve to protect the public and ensure that gaming and related activities are conducted fairly and free from corruption, and jurisdictions generally evaluate the overall responsibility, internal control processes, our financial stability and the moral character of our executives, owners and other stakeholders who may be in a position to exercise influence over our operations. Violations or perceived violations in one jurisdiction could result in additional scrutiny or disciplinary actions in other jurisdictions.
Furthermore, most jurisdictions have ongoing reporting requirements for certain transactions and are concerned with our accounting practices, internal controls, business relationships and the fair operation of our products. Gaming regulatory requirements vary from jurisdiction to jurisdiction and licensing, approvals and processes related to findings of suitability, qualifications or licenses, our products, key personnel and certain shareholders can be lengthy and expensive.
We intend to maintain our existing licenses and may seek additional licenses, approvals, qualifications and findings of suitability for PokerTek, our products and/or our management personnel in new jurisdictions where we anticipate sales or leasing opportunities.
We have never been denied a license, permit or approval necessary to do business in any jurisdiction, nor had a license suspended or revoked. However, there can be no assurance that new licenses, approvals, qualifications or findings of suitability will be obtained or that our existing licenses will be renewed or will not be revoked, suspended, conditioned or subject to a disciplinary action. If a license, approval, qualification or finding of suitability is required by a regulatory authority and we fail to seek or do not receive the necessary license, qualification or finding of suitability, then we may be prohibited from distributing our products for use in the respective jurisdiction. There can also be no assurance that we will be able to obtain the necessary approvals for our products as they are developed. In addition, changes in legislation or in judicial or regulatory interpretations could occur which could adversely affect us.
Federal Registration
As a manufacturer and distributor of gaming devices, the Federal Gambling Devices Act of 1962 (the “Johnson Act”) requires us to register with the Criminal Division of the United States Department of Justice. In order to manufacture, sell, deliver or operate our gaming devices, we must renew our federal registration annually and comply with its various record-keeping and equipment identification requirements. The Federal Act makes it unlawful for a person or business entity to manufacture, deliver, receive, operate, lease or sell gaming devices in interstate or foreign commerce unless that person or entity has first registered with the Attorney General of the United States. Violation of the Federal Act may result in seizure and forfeiture of the equipment, as well as other penalties
State Licensing
We are subject to licensing requirements in each state in which we seek to conduct business. We are licensed in several commercial gaming jurisdictions. See “Regulatory Approvals” section below for a list of all jurisdictions where we maintain gaming licenses. Each state license is considered to be a privilege license and is subject to regulatory, technical, and statutory requirements.
We are subject to the Nevada Gaming Control Act (the “Nevada Act”) and to the licensing and regulatory control of the Nevada State Gaming Control Board (the “Nevada Board”), the Nevada Gaming Commission (the “Nevada Commission”) and various local, city and county regulatory agencies (collectively, 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:
● the prevention of unsavory or unsuitable persons from having a direct or indirect involvement with gaming at any time or in any capacity;
● the establishment and maintenance of responsible accounting practices;
● 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;
● the prevention of cheating and fraudulent practices; and
● providing a source of state and local revenues through taxation and licensing fees.
We are registered with the Nevada Commission as a publicly traded corporation and are licensed as a manufacturer and distributor of gaming devices or equipment. These licenses are not transferable and require periodic payment of fees. The Nevada Gaming Authorities may limit, condition, suspend or revoke a license, registration, approval or finding of suitability for any cause it deems reasonable. If the Nevada Commission determines that we violated applicable gaming laws, it may limit, condition, suspend, or revoke any previously granted approvals and licenses and we, and the individuals involved, could be subject to substantial fines for each separate violation of the gaming laws at the discretion of the Nevada Commission. Each type of gaming device manufactured, distributed, leased, licensed or sold in Nevada must first be approved by the Nevada Board and, in some cases, the Nevada Commission. We must regularly submit detailed financial and operating reports to the Nevada Board. Certain loans, leases, sales of securities and similar financing transactions must also be reported to or approved by the Nevada Commission.
Certain officers, directors and key employees are required to be found suitable by the Nevada Commission and employees associated with gaming must obtain work registrations which are subject to immediate suspension under certain circumstances. An application for suitability may be denied for any cause deemed reasonable by the Nevada Commission. Changes in specified key positions must be reported to the Nevada Commission. In addition to its authority to deny an application for a license, the Nevada Commission has jurisdiction to disapprove a change in position by an officer, director or key employee. The Nevada Commission has the power to require licensed gaming companies to suspend or dismiss officers, directors or other key employees and to sever relationships with other persons who refuse to file appropriate applications or whom the authorities find unsuitable to act in such capacities.
The Nevada Commission may also require anyone having a material relationship or involvement with us to be found suitable or licensed, in which case those persons are required to pay the costs and fees of the Nevada Board in connection with the investigation. Any person who acquires more than 5% of any class of our voting securities must report the acquisition to the Nevada Commission. Any person who becomes a beneficial owner of more than 10% of any class of our voting securities is required to apply for a finding of suitability. Under certain circumstances, an “Institutional Investor,” as such term is defined in the regulations of the Nevada Commission, which acquires more than 10% but not more than 25% of any class of our voting securities, may apply to the Nevada Commission for a waiver of such finding of suitability requirements, provided the Institutional Investor holds the voting securities for investment purposes only. (It should be noted that in many other states the requirement of a suitability finding or of a licensure applies to any holder of 5% or more of our stock, unless the owner is eligible for and obtains an exemption or waiver.) The Nevada Commission has amended its regulations pertaining to Institutional Investors to allow an Institutional Investor to beneficially own more than 25%, but not more than 29%, if the ownership percentage results from a stock repurchase program. In addition, an Institutional Investor not previously granted a waiver may nevertheless own more than 10% but not more than 11% of any class of our voting securities without being required to apply to the Nevada Commission for a finding of suitability or a waiver and is subject only to reporting requirements as prescribed by the chairman of the Nevada Board (unless otherwise notified by the chairman of the Nevada Board), if such additional ownership results from a stock repurchase program. These Institutional Investors may not acquire any additional shares that would result in an increase in its ownership percentage. An Institutional Investor will be deemed to hold voting securities for investment purposes only if 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 our board of directors, any change in our corporate charter, bylaws, management, policies or operations, or any of our gaming affiliates, or any other action which the Nevada Commission finds to be inconsistent with holding our voting securities for investment purposes only.
Any person who fails or refuses to apply for a finding of suitability or a license within 30 days after being ordered to do so by the Nevada Commission may be found unsuitable based solely on such failure or refusal. The same restrictions apply to a record owner if the record owner, when requested, fails to identify the beneficial owner. Any security holder found unsuitable and who holds, directly or indirectly, any beneficial ownership of the common stock beyond such period of time as may be prescribed by the Nevada Commission may be guilty of a gross misdemeanor. We are subject to disciplinary action if, after we receive notice that a person is unsuitable to be a security holder or to have any other relationship with us, we:
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pay that person any dividend or interest upon our voting securities;
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allow that person to exercise, directly or indirectly, any voting right conferred through securities held by that person; or
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give remuneration in any form to that person.
If a security holder is found unsuitable, then we may be found unsuitable if we fail to pursue all lawful efforts to require such unsuitable person to relinquish his or her voting securities for cash at fair market value.
The Nevada Commission may, in its discretion, require the holder of any of our debt securities to file an application, be investigated, and be found suitable to hold the debt security. If the Nevada Commission determines that a person is unsuitable to own such security, then pursuant to the Nevada Act, we can be sanctioned, which may include the loss of our approvals, if without the prior approval of the Nevada Commission, we:
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pay to the unsuitable person any dividend, interest, or any distribution whatsoever
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recognize any voting right by such unsuitable person in connection with such securities;
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pay the unsuitable person remuneration in any form; or
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make any payment to the unsuitable person by way of principal, redemption, conversion, exchange, liquidation or similar transaction.
We are required to maintain a current stock ledger that may be examined by the Nevada Gaming Authorities at any time.
We may not make certain public offerings of our securities, without the prior approval of the Nevada Commission. 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 offered. Any representation to the contrary is unlawful.
Changes in control through merger, consolidation, acquisition of assets, management or consulting agreements or any form of takeover cannot occur without prior investigation by the Nevada Board and approval by the Nevada Commission. Entities seeking to acquire control of us must satisfy the Nevada Board and the Nevada Commission concerning a variety of stringent standards prior to assuming control of us. The Nevada Commission may also require controlling shareholders, officers, directors and other persons having a material relationship or involvement with the entity proposing to acquire control, to be investigated and licensed as part of the approval process of the transaction.
Approvals are required from the Nevada Commission before we can make exceptional repurchases of voting securities above the current market price and before a corporate acquisition opposed by management can be consummated.
Native American Gaming
Gaming on Native American lands is governed by tribal and federal law and tribal-state compacts. The Federal Indian Gaming Regulatory Act of 1988 (the "Act") created a framework for the various responsibilities of the tribal, state, and federal authorities over tribal gaming operations. The Act is interpreted and enforced by the National Indian Gaming Commission, which has the authority to issue regulations and to otherwise regulate tribal gaming activities. In addition, because federally recognized Native American tribes are independent governments with sovereign powers, Native American tribes can enact their own laws and regulate gaming operations and contracts, and generally enjoy sovereign immunity from lawsuits similar to that of the individual states and the United States. They have also established tribal gaming commissions or agencies that regulate gaming operations on their tribal lands. Finally, compacts between tribes and states also may impose conditions and requirements on tribal gaming operations. We are required to comply with all such sources of law, which may impose different requirements with respect to licensing, product approvals, and operations.
International Gaming
The international regulatory environment is complex and varies by jurisdiction. Certain foreign countries permit the importation, sale and operation of gaming equipment in casino and non-casino environments. In foreign jurisdictions where formal company and product approval processes exist, we have obtained or are in the process of obtaining all licenses, permits, approvals or waivers required by jurisdictions having legalized gaming.
In foreign jurisdictions where formal policies do not exist, we work with the relevant authorities to ensure that we have obtained the licenses, permits, approvals, or waivers necessary to distribute product in those jurisdictions. The regulatory requirements in those jurisdictions are subject to change over time, and we believe that international jurisdictions are trending towards increased regulation and oversight of gaming activities. We evaluate the requirements for each jurisdiction independently prior to entering new markets.
Card Clubs and Charity Gaming Rooms
States that allow card games to be played in card clubs or charity gaming room are generally not subject to a nationwide regulatory system. Regulation for this market is generally on a state-by-state basis though, in some cases, it is regulated by county commissions or other local government authorities.
Cruise Ship Market
Cruise ships represent a significant portion of our business, accounting for in excess of 30% of our annual revenue. Cruise ships are regulated by various maritime laws, regulations, treaties and other legal requirements and maritime laws generally governed by the country in which the ship is registered and flagged. Casinos operations aboard ships are generally not subject to United States federal or state regulatory oversight and are allowed to open for gaming activities only when ships are at sea in international waters or when otherwise permitted by local laws.
Product Approval
Each of our products is subject to extensive testing and reviews by multiple state, jurisdictional or third party laboratories. The time required for product testing can be extensive and is subject to a wide range of formal and informal standards that can lead to great uncertainty as to the length of the regulatory approval process. Additionally, product testing is subject to changing standards, as a result of which, we may be required to upgrade or revise our products.
Regulatory Approvals
As of December 31, 2013 we have obtained approvals from the following regulatory bodies:
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Nevada Gaming Control Board;
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Société des Casinos du Québec Inc.;
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Arkansas Racing Commission;
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State of California Gambling Control Commission;
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Indiana Gaming Commission;
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Mississippi Gaming Commission;
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Tuolumne Me-Wuk Tribal Gaming Agency;
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Eastern Band of Cherokee Indians Tribal Gaming Commission;
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Atlantic Lottery Corporation;
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Alcohol and Gaming Commission of Ontario;
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Victorian Commission for Gambling Regulation (Australia); and
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Ho-Chunk Nation Gaming Commission
We also have a license from the Washington State Gambling Commission but that jurisdiction has not approved our PokerPro system.
We have received product certifications from Gaming Laboratories International, an independent testing laboratory, for PokerPro and ProCore. Other electrical, communications and safety certifications include certifications from:
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Conformité Européenne, a mandatory European marking for certain product groups to indicate conformity with the essential health and safety requirements set out in European Directives;
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The U.S. Federal Communications Commission, which regulates radio emissions of electronic devices;
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The RoHS Directive, which bans the placing on the European Union market of new electrical and electronic equipment containing more than agreed levels of certain hazardous materials;
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Underwriters Laboratories, Inc., a product safety compliance testing laboratory; and
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NOM (Norma Official Mexicana), a product safety compliance testing standard.
Research and Development
We spend a significant amount of money to develop, customize and enhance our electronic table hardware, software, game content and related products. Our research and development expenses were $0.7 million and $0.7 million during the fiscal years ended December 31, 2013 and December 31, 2012, respectively, consisting primarily of internal product development salaries and expenses and costs related to third-party engineering, prototyping and product testing.
The focus of our software and hardware development is to improve our gaming products through the addition of new games and features, to improve manufacturability and to adapt our products to customer preferences and the legal and regulatory requirements specific to the jurisdiction in which our product will be deployed.
Intellectual Property
Trademarks
“PokerTek®” is a registered trademark with the U.S. Patent and Trademark Office. “PokerTek®” and “PokerPro®” are registered trademarks with the Canadian Intellectual Property Office.
We also currently use the following trademarks: PokerPro™ and ProCore™. We currently plan to file trademark applications with the U.S. Patent and Trademark office with respect to these and additional trademarks that we have developed or may develop in the future.
Patents
We currently have the following issued patents:
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D512,446 (United States) - Design patent for an electronic poker table top
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7,556,561 (United States) - A seat request button allowing players seated at an electronic poker table to request a different seat
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7,618,321 (United States) - System and method for detecting collusion between poker players
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7,758,411 (United States) - System and method for providing an electronic poker game
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7,699,695 (United States) - Electronic card table and method with variable rake
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7,794,324 (United States) - Electronic player interaction area with player customer interaction features (pre-selecting actions)
At various times, we have domestic and foreign patent applications pending that relate to various aspects of our products. As we develop new technology, we may file patent applications with respect to such technology. We can provide no assurance that any current or future patent applications will result in issued patents.
Other
We have registered the www.pokertek.com internet domain name.
Seasonality and Business Fluctuations
Our business is not generally subject to seasonality. However, quarterly revenue and net income or loss may vary based on the timing of product sales, the introduction of new products and changes in our installed base of PokerPro systems. In addition, revenues from cruise ships and casinos may vary from quarter to quarter depending on a number of factors, including the time of year, cruise itinerary and length, and player demographics.
Backlog
We are generally able to fulfill customer orders with relatively short lead-times and do not carry a significant backlog of unshipped orders.
Customer Dependence
For the year ended December 31, 2013, five customers accounted for approximately 76.7% of our total revenues from continuing operations, with one accounting for 39.0%, a second accounting for 19.8%, a third accounting for 7.2%, a fourth accounting for 6.1%, and a fifth accounting for 4.6%. The loss of any of these customers or changes in our relationship with any of them could have a material adverse effect on our business.
Employees
As of December 31, 2013, we had 25 full-time employees. We consider our relationships with our employees to be good. None of our employees is covered by a collective bargaining agreement.
Corporate History
We were founded on August 26, 2003 and initially organized as National Card Club Corporation, which owned a majority interest in an affiliated limited liability company called PokerTek, LLC. On July 27, 2004, PokerTek, LLC merged with and into National Card Club Corporation, which simultaneously changed its name to PokerTek, Inc.
We completed our initial public offering on October 13, 2005 and our common stock trades on the NASDAQ Capital Market under the ticker symbol “PTEK.”
Available Information
We make available free of charge through our website, www.pokertek.com, our annual report on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K, proxy statements and amendments to those reports and statements filed pursuant to Section 13(a) or 15(d) of the Securities and Exchange Act of 1934, as amended (the “Exchange Act”), as soon as reasonably practicable after we file such material with, or furnish it to, the SEC. The public may read and copy any materials we file with or furnish to the Securities and Exchange Commission (“SEC”) at the SEC’s Public Reference Room at 100 F Street, N.E., Washington, D.C. 20549, on official business days during the hours of 10:00 am to 3:00 pm. The public may also obtain information on the operation of the Public Reference Room by calling the SEC at 1-800-SEC-0330. Furthermore, the SEC maintains a free website (www.sec.gov) which includes reports, proxy and information statements, and other information regarding us and other issuers that file electronically with the SEC. Our website and the information contained therein or connected thereto are not intended to be incorporated into this Annual Report on Form 10-K. Additionally, we make available free of charge on our internet website: our Code of Business Conduct and Ethics; the charter of our Nominating and Governance Committee; the charter of our Compensation Committee; and the charter of our Audit Committee.
Financial Information
For information with respect to revenue, operating profitability and identifiable assets attributable to our business segments and geographic areas, see Note 15 to our consolidated financial statements as of and for the year ended December 31, 2013 included elsewhere in this Report.
Item 1A.
Item 1A. Risk Factors.
Investing in our common stock involves risks. Prospective investors in our common stock should carefully consider, among other things, the following risk factors in connection with the other information and financial statements contained in this Report. We have identified the following factors that could cause actual results to differ materially from those projected in any forward looking statements we may make from time to time.
We operate in a continually changing business environment in which new risk factors emerge from time to time. We can neither predict these new risk factors, nor can we assess the impact, if any, of these new risk factors on our business or the extent to which any factor, or combination of factors, may cause actual results to differ materially from those projected in any forward looking statement. If any of these risks, or combination of risks, actually occur, our business, financial condition and results of operations could be seriously and materially harmed, and the trading price of our common stock could decline. All forward-looking statements in this document are based on information available to us as of the date hereof, and we assume no obligations to update any such forward-looking statements.
Our business is closely tied to the casino industry and factors that negatively impact the casino industry may also negatively affect our ability to generate revenues.
Factors that may negatively impact the casino industry may also negatively impact our future revenues. If casinos experience reduced patronage, our revenue will be adversely impacted because casinos will purchase fewer systems and the installed systems will generate less revenue. In some cases our systems may be taken off of the casino floor altogether. The levels of casino patronage, and therefore our revenues, are affected by a number of factors beyond our control, including:
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general economic conditions;
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levels of disposable income of casino patrons;
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downturn or loss in popularity of the gaming industry in general and table and slot games in particular;
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the relative popularity of entertainment alternatives to casino gaming;
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the growth and number of legalized gaming jurisdictions;
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local conditions in key gaming markets, including seasonal and weather-related factors;
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increased transportation costs;
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acts of terrorism and anti-terrorism efforts;
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changes or proposed changes to tax laws;
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increases in gaming taxes or fees;
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legal and regulatory issues affecting the development, operation and licensing of casinos;
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the availability and cost of capital to construct, expand or renovate new and existing casinos;
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the level of new casino construction and renovation schedules of existing casinos; and
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competitive conditions in the gaming industry and in particular gaming markets, including the effect of such conditions on the pricing of our games and products.
These factors significantly impact the demand for our products and technologies.
Our business would suffer if demand for gaming in general, or poker in particular, decreases.
We derive a significant portion of our revenues from distribution of the PokerPro system and from providing related maintenance and support services. To the extent the popularity of gaming or poker decreases, and/or industry regulation increases, demand for our products could decline and our business could suffer.
We are impacted by the size of the market for electronic table games as well as changes in consumer spending in general, and specifically with regard to discretionary spending on gaming activities.
We derive our revenues from the distribution of electronic table games. Moreover, the market for electronic gaming systems is limited. Although we believe that there is a significant opportunity for our products, the number of venues in which our products can be placed is finite, as the number of jurisdictions in which gaming is legal is limited.
In addition, a prolonged decline in consumer spending on gaming activities could have a significant impact on our customers and our vendors and demand for electronic table games. Accordingly, such a prolonged downturn could have a significant impact on our business operations and financial condition.
We have debt financing arrangements, which could have a material adverse effect on our financial health and our ability to obtain financing in the future, and may impair our ability to react quickly to changes in our business.
Our exposure to debt financing could limit our ability to satisfy our obligations, limit our ability to operate our business and impair our competitive position. For example, it could:
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increase our vulnerability to adverse economic and industry conditions, including interest rate fluctuations, because a portion of our borrowings are at variable rates of interest;
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require us to dedicate future cash flows to the repayment of debt, reducing the availability of cash to fund working capital, capital expenditures or other general corporate purposes;
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limit our flexibility in planning for, or reacting to, changes in our business and industry; and
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limit our ability to obtain additional debt or equity financing due to applicable financial and restrictive covenants contained in our debt agreements.
We may also incur additional indebtedness in the future, which could materially increase the impact of these risks on our financial condition and results of operations.
Our ability to repay our debt and fund our operations depends on many factors beyond our control. We may raise equity capital in the future, which may significantly dilute the holdings of our existing shareholders. If we are unable to raise sufficient capital in the future, we may seek other avenues to fund the business, including sale/leaseback arrangements, transitioning from a capital intensive leasing strategy to a product sale strategy, or seeking to sell assets of all, or a portion of, our operations.
Payments on our debt will depend on our ability to generate cash or secure additional financing in the future. This ability, to an extent, is subject to general economic, financial, competitive, legislative, regulatory and other factors beyond our control. If our business does not generate sufficient cash flow from operations, and sufficient future financing is not available to us, we may not be able to repay our debt, operate our business or fund our other liquidity needs. If we cannot meet or refinance our obligations when they become due, this may require us to attempt to raise capital, sell assets, reduce expenditures or take other actions which we may be unable to successfully complete or, even if successful, could have a material adverse effect on us. If such sources of capital are not available or not available on sufficiently favorable terms, we may seek other avenues to fund the business, including sale/leaseback arrangements, transitioning from a capital intensive leasing strategy to a product sale strategy, or seeking to sell assets of all, or a portion of, our operations. If we decide to raise capital in the equity markets or take other actions, our shareholders could incur significant dilution or diminished valuations, or, if we are unable to raise capital, our ability to effectively operate our business could be impaired.
In addition, if we are successful in raising capital in the equity markets to repay our indebtedness, or for any other purpose, our existing shareholders may incur significant dilution.
The agreements and instruments governing our debt contain restrictions and limitations which could significantly impact our ability to operate our business.
Our credit facility with Silicon Valley Bank contains covenants that could adversely impact our business by limiting our ability to obtain future financing, withstand a future downturn in our business or the economy in general, conduct operations or otherwise take advantage of business opportunities that may arise. The credit facility includes covenants requiring the achievement of specified financial ratios and thresholds and contains other terms and conditions qualifying the terms upon which Silicon Valley Bank is required to extend funds. Our ability to comply with these provisions may be affected by events beyond our control.
We depend on a small number of key suppliers and customers. Changes in our relationships with these parties, or changes in the economic or regulatory environments in which they operate, could have a material adverse effect on our business, financial condition, results of operations and cash flows.
Our revenues are concentrated with a small number of customers. The loss of any of these customers or changes in our relationship with them could have a material adverse effect on our business. A significant portion of our revenue is derived from a single customer operating casinos aboard cruise ships. Any economic, regulatory, or consumer preference changes that impact the cruise industry, and specifically gaming aboard cruise ships, could have a material adverse effect on our business, financial condition and results of operations.
To manufacture our gaming products, we purchase components from independent manufacturers, many of whom are located in the Far East. An extended interruption in the supply of these products or suitable substitute inventory would disrupt our operations, which could have a material adverse effect on our business, financial condition and results of operations.
For a number of our key inventory components, we rely on a single supplier. We cannot estimate with any certainty the length of time that would be required to establish alternative supply relationships, or whether the quantity or quality of materials that could be so obtained would be sufficient. Furthermore, we may incur additional costs in sourcing materials from alternative producers. The disruption of our inventory supply, even in the short-term, could have a material adverse effect on our business, financial condition and results of operations.
A significant portion of our business is conducted with customers and suppliers located outside of the United States. Currency, economic, regulatory, political, and other risks associated with our international operations could adversely affect our operating results.
Our revenues from international customers and our inventory costs from international suppliers are exposed to the potentially adverse effects of currency exchange rates, local economic conditions, political instability and other risks associated with doing business in foreign countries. To the extent that our revenues and purchases from international business partners increase in the future, our exposure to changes in foreign economic conditions and currency fluctuations will increase.
Our dependence on foreign customers and suppliers means, in part, that we may be affected by changes in the relative value of the U.S. dollar to foreign currencies. Changes in the applicable currency exchange rates might negatively affect the profitability and business prospects of our customers and vendors. This, in turn, might cause such vendors to demand higher prices, delay shipments, or discontinue selling to us. This also might cause such customers to demand lower prices, delay or discontinue purchases of our products or demand other changes to the terms of our relationships. These situations could in turn ultimately reduce our revenues or increase our costs, which could have a material adverse effect on our business, financial condition and results of operations.
We have a limited operating history and a history of losses. We may be unable to generate sufficient net revenue in the future to achieve or sustain profitability.
We have experienced net losses for substantially all quarterly and annual periods since our inception in August 2003 and we expect to continue to experience losses and cash flow deficits for the foreseeable future. Even if we achieve profitability, we may not be able to sustain or increase profitability on a quarterly or annual basis, and our failure to do so would adversely affect our business and the market price of our common stock and require us to raise additional capital, which may not be available on terms acceptable to us or at all.
Our success depends on achieving and maintaining acceptance by casinos and players worldwide.
Our success depends on increasing the market acceptance of our gaming products among casinos and players. Casinos and players may not prefer to use our gaming products for a number of reasons, including preference for live dealers, mistrust of technology and perceived lack of reliability.
Our success depends, in part, on our ability to continually enhance and improve our existing products and to develop new products that will be accepted in the market. If we fail in these endeavors, our business may not grow.
Our success depends, in part, on our ability to continue to improve and enhance our existing products and to develop new products that help us maintain our competitive advantage and expand in existing markets and penetrate new markets. For example, the launch of ProCore has given us the opportunity to compete in the market for house-banked games. We also recognize the need for us to develop mobile gaming applications in order to remain competitive. The success of our new product introductions or upgrades to existing products depends on a number of factors, including our ability to anticipate and manage product development and design, supply chain issues, manufacturing issues, sales and marketing programs, customer service and support and overall costs. Specifically, the cost of developing, designing, manufacturing, distributing, maintaining and supporting new products could be significant and our current capital resources may be insufficient to support such an effort. Nevertheless, if we fail to undertake new product development our business is unlikely to grow and we could lose whatever competitive advantages we currently have. We cannot assure you that we will successfully meet all the challenges associated with developing new products and/or applications or enhancing our existing products.
If we fail to obtain or maintain gaming licenses and regulatory approvals, we may be unable to license or sell our gaming products. Changes in gaming regulations, or interpretation of gaming regulations, by governmental entities could have a significant negative impact on our business operations and financial condition.
The manufacture and distribution of gaming machines is subject to extensive federal, state, local and tribal regulation. Most jurisdictions require licenses, permits and other forms of approval for gaming devices. Most, if not all, jurisdictions also require licenses, permits and documentation of suitability, including evidence of financial stability, for the manufacturers and distributors of such gaming devices and for their officers, directors, major shareholders and key personnel. Our failure to obtain regulatory approval in any jurisdiction will prevent us from distributing our products and generating gaming revenue in that jurisdiction.
Any registrations, licenses, approvals or findings of suitability that we currently have or may obtain in the future may be revoked, suspended or conditioned at any time. The revocation or denial of a license in a particular jurisdiction will prevent us from distributing our gaming products in that jurisdiction, and could adversely affect our ability to obtain and/or maintain licenses in other jurisdictions.
In addition, we also operate in several jurisdictions where the regulatory framework is less mature and potentially more subject to changes in regulatory interpretation. For example, in Mexico, we exited that market in 2011 due to changes in the government’s interpretation of the gaming rules and the allowable products that casinos could legally operate in that market. In 2012, we re-entered that market as the government changed its interpretations and began allowing casinos to operate card and roulette based products. In 2013, we exited the Ohio Charity market due to changes in the Attorney General’s interpretation regarding the allowable devices that could be used by a charity in that state. We cannot predict with certainty whether the charity regulations will be reinterpreted in the future, or whether we will be allowed to re-enter the market. We also cannot guarantee that other jurisdictions might not also have changes to laws, regulations or interpretations that could adversely affect our operating results or financial position in the future.
Gaming authorities in various jurisdictions may require that some or all of our executive officers, key employees, directors and significant shareholders meet their suitability standards. The inability of an executive officer, key employee, director or significant shareholder to meet these standards may adversely affect the sale or licensing of our gaming products in that jurisdiction.
We are subject to the authority of various government agencies that regulate the gaming industry. The regulatory authorities may investigate some or all of our executive officers, key employees, directors and significant shareholders to determine whether they are unsuitable to serve or have an ownership interest in us. If a gaming authority in any jurisdiction finds that any of our executive officers, key employees, directors or shareholders is unsuitable, it may deny us the permits or licenses that we require to operate in their jurisdiction. A finding of suitability is generally determined based upon numerous facts and circumstances surrounding the entity or individual in question, and many gaming authorities have broad discretion in determining whether a particular entity or individual is suitable. We are unaware of circumstances that would categorically prevent a gaming authority from finding any of our officers, key employees, directors or significant shareholders suitable.
If any executive officer, key employee, director or significant shareholder that is required to meet the suitability standards of a particular jurisdiction fails to do so, we would be prevented from leasing, licensing or selling our gaming products in that jurisdiction as long as the individual or entity in question remained an officer, key employee, director or a significant shareholder. Such an occurrence would likely delay introduction of our gaming products into such jurisdiction or prevent us from introducing our gaming products in such jurisdiction altogether. Depending on how material such a jurisdiction is to our plan of operations, failure to obtain such findings of suitability could have a material adverse effect on our results of operations. In addition, a finding that one of our executive officers, certain key employees, directors or significant shareholders is not suitable in any jurisdiction may hinder our ability to obtain necessary regulatory approvals in other jurisdictions. Conversely, however, a finding of suitability by one or more gaming authorities does not ensure that similar suitability determinations will be obtained from any other gaming authorities.
Although we have the ability to terminate the employment of an executive officer or key employee in the event that such executive officer or key employee fails to meet the requisite suitability standards, such termination would disrupt the management of our company, may trigger severance provisions under certain employment agreements and would likely have an adverse effect on our business and results of operations. In addition, the removal of a director under the provisions of our Restated Bylaws requires action on the part of our shareholders at a shareholders’ meeting. Our Restated Articles of Incorporation provide that we may redeem at fair market value any or all shares of our capital stock held by any person or entity whose status as a shareholder, in the opinion of our Board, jeopardizes the approval, continued existence, or renewal of any federal, state, local or tribal license we hold. However, we may not have the funds available for to redeem our shares under such circumstances, especially if the shareholder in question holds a significant amount of our common stock. We have not determined what action we would take in such an event. We will also be prevented from effecting such a redemption if it would violate North Carolina law.
In addition, not all of our Board members or officers have been investigated by all of the jurisdictions where we operate. If those jurisdictions decide to require new investigations of any Board members or officers, we could incur significant costs or elect to withdraw from certain jurisdictions to avoid incremental licensing costs.
If our products are found to be in violation of the Johnson Act, the Department of Justice may institute criminal and/or civil proceedings against us.
The Johnson Act generally makes it unlawful for a person to manufacture, deliver, or receive gaming machines, gaming machine-type devices, and components across state lines or to operate gaming machines unless that person has first registered with the U.S. Department of Justice. We are registered with the Department of Justice. In addition, the Johnson Act imposes various record keeping, annual registration, equipment registration, and equipment identification requirements. Violation of the Revised Johnson Act may result in seizure and forfeiture of the equipment as well as other penalties. Any change in law or regulation, or an unfavorable interpretation of any law or regulation, could adversely impact our ability to earn revenue or could require us to substantially modify our products or operations at significant expense.
We could face substantial competition, which could reduce our market share and negatively impact our net revenue.
There are a number of companies that manufacture and distribute automated gaming machines. These companies may have greater financial and other resources than we have. The primary barriers to entry are the establishment of relationships with the owners and operators of casinos and card clubs, the receipt of necessary regulatory approvals and the development of the technology necessary to create an automated poker table. It is likely that our potential competitors could include manufacturers of gaming devices that have already established such relationships and that have received some, if not all, of the regulatory approvals that would be required to market and sell automated poker tables in our target markets. Therefore, the barriers to entry discussed above may not pose a significant obstacle for such manufacturers if they sought to compete with us.
If we fail to protect our intellectual property rights, competitors may be able to use our technology, which could weaken our competitive position, reduce our net revenue and increase our costs.
Our long-term success will depend to some degree on our ability to protect the proprietary technology that we have developed or may develop or acquire in the future. Patent applications can take many years to issue and we can provide no assurance that any of these patents will be issued. If we are denied any or all of these patents, we may not be able to successfully prevent our competitors from imitating the PokerPro system or using some or all of the processes that are the subject of such patent applications. Such imitation may lead to increased competition within the finite market for the PokerPro system. Even if our pending patents are issued, our intellectual property rights may not be sufficiently comprehensive to prevent our competitors from developing similar competitive products and technologies. Although we may aggressively pursue anyone whom we reasonably believe is infringing upon our intellectual property rights, initiating and maintaining suits against third parties that may infringe upon our intellectual property rights will require substantial financial resources. We may not have the financial resources to bring such suits and if we do bring such suits, we may not prevail. Regardless of our success in any such actions, we could incur significant expenses in connection with such suits.
Third party claims of infringement against us could adversely affect our ability to market our products and require us to redesign our products or seek licenses from third parties.
We are susceptible to intellectual property lawsuits that could cause us to incur substantial costs, pay substantial damages or prohibit us from distributing our products. Whether a product infringes a patent involves complex legal and factual issues, the determination of which is often uncertain. In addition, because patent applications can take many years to issue, there may be applications now pending of which we are unaware, which later may result in issued patents that our products may infringe. If any of our products infringe a valid patent, we could be prevented from distributing that product unless and until we can obtain a license or redesign it to avoid infringement. A license may not be available or may require us to pay substantial royalties. We also may not be successful in any attempt to redesign the product to avoid any infringement. Infringement and other intellectual property claims, with or without merit, can be expensive and time-consuming to litigate, and we may not have the financial and human resources to defend ourselves against any infringement suits that may be brought against us.
Defects in, and fraudulent manipulation of, our products could reduce our revenue, increase our costs, burden our engineering and marketing resources, involve us in litigation and adversely affect our gaming licenses.
Our success will depend on our ability to avoid, detect and correct software and hardware defects and prevent fraudulent manipulation of our products. Our electronic gaming products are subject to rigorous internal testing, and additional testing by regulators in certain gaming jurisdictions. We may not be able to maintain products that are free from defects or manipulation and that continue to satisfy these tests. Although we have taken steps to prevent defects, our products could suffer such defects and our products could be subject to manipulation after they have been widely distributed.
Although we do not believe it is likely, it is possible that an individual could breach the security systems of a casino or card club, gain access to the server and fraudulently manipulate its operations. The occurrence of such fraudulent manipulation or of defects or malfunctions could result in financial losses for our customers and the subsequent termination of agreements, cancellation of orders, product returns and diversion of our resources. Even if our customers do not suffer financial losses, customers may replace our products if they do not perform according to expectations. Any of these occurrences could also result in the loss of or delay in market acceptance of our products, loss of sales and, in the case of gaming products, loss of regulatory approvals.
In addition, the occurrence of defects or fraudulent manipulation may give rise to claims for lost revenues and related litigation by our customers and may subject us to investigation or other disciplinary action by regulatory authorities that could include suspension or revocation of our regulatory approvals.
The use of our electronic table games could result in product liability claims that could be expensive and that could damage our reputation and harm our business.
Our business exposes us to the risk of product liability claims. Subject to contractual limitations, we will face financial exposure to product liability claims if our products fail to work properly and cause monetary damage to either players or casinos and card clubs. In addition, defects in the design or manufacture of our products might require us to recall those products. Although we maintain product liability insurance, the coverage limits of policies available to us may not be adequate to cover future claims. If a successful claim brought against us is in excess or outside of our insurance coverage, we may be forced to divert resources from the development of new products, the pursuit of regulatory approvals and other working capital needs in order to satisfy such claims.
The loss of key personnel or the inability of replacements to quickly and successfully perform in their new roles could adversely affect our business.
All of our existing personnel, including our executive officers, are employed on an “at-will” basis. If we lose or terminate the services of one or more of our current executives or key employees or if one or more of our current or key employees joins a competitor or otherwise competes with us, it could impair our business and our ability to successfully implement our business plan. Additionally, if we are unable to timely hire qualified replacements for our executive and other key positions, our ability to execute our business plan would be harmed. Even if we can timely hire qualified replacements, we would expect to experience operational disruptions and inefficiencies during any transition.
If we fail to manage our growth, our business and operating results could be harmed.
If we do not effectively manage our growth, our ability to develop and market systems and products could suffer, which could negatively affect our operating results. Our management believes that in order to be successful we must appropriately manage the size of our business. This may mean reducing costs and overhead in certain economic periods, and selectively growing in periods of economic expansion. In addition, we may be required to implement operational, financial and management information procedures and controls that are efficient and appropriate for the size and scope of our operations. The management skills and systems currently in place may not be adequate and we may not be able to manage any significant reductions or growth effectively.
Our success will depend on the reliability and performance of third-party distributors, manufacturers and suppliers.
We compete with other companies for the production capacity of third-party suppliers for components. Certain of these competing companies have substantially greater financial and other resources than we have and thus we may be at a competitive disadvantage in seeking to procure production capacity. Our inability to contract with third-party manufacturers and suppliers to provide a sufficient supply of our products on acceptable terms and on a timely basis could negatively impact our relationships with existing customers and cause us to lose revenue-generating opportunities with potential customers.
We also rely on distributors to market and distribute our products, and we rely on casino operators to operate our electronic gaming equipment. If our operators or distributors are unsuccessful, we may miss revenue-generating opportunities that might have been recognized.
Our failure to obtain any necessary additional financing would have a material adverse effect on our business.
In order to grow our business, we may need to seek additional equity or debt financing. We may not be able to obtain such additional equity or debt financing when we need it or at all. Even if such financing is available, it may not be available on terms that are favorable to us or in sufficient amounts to satisfy our requirements. If we require, but are unable to obtain, sufficient additional financing in the future we may be unable to further protect our intellectual property sufficiently, meet customer demand or withstand adverse operating results. More importantly, if we are unable to raise additional capital when needed, our continued operations may have to be scaled down or even terminated and our ability to generate revenues would be negatively affected.
Enforcement of remedies or contracts against Native American tribes could be difficult.
Contracts with Native American tribes are subject to sovereign immunity and tribal jurisdiction. If a dispute arises with respect to any of those agreements, it could be difficult for us to protect our rights. Native American tribes generally enjoy sovereign immunity from suit similar to that enjoyed by individual states and the United States. In order to sue a Native American tribe (or an agency or instrumentality of a Native American tribe), the tribe must have effectively waived its sovereign immunity with respect to the matter in dispute. Moreover, even if a Native American tribe were to waive sovereign immunity, such waiver may not be valid and in the absence of an effective waiver of sovereign immunity by a Native American tribe, we could be precluded from judicially enforcing any rights or remedies against that tribe.
The concentration of our common stock ownership by our founders will limit your ability to influence corporate matters.
Members of our Board of Directors and our executive officers, in the aggregate, own approximately 36.7% of the outstanding shares of our common stock and therefore have significant influence over our management and affairs and over all matters requiring shareholder approval, including the election of directors and significant corporate transactions, such as a merger, a sale of the company or a sale of our assets. This concentrated control will limit your ability to influence corporate matters and, as a result, we may take actions that some of our shareholders do not view as beneficial. In addition, such concentrated control could discourage others from initiating changes of control. As a result, the market price of our common stock could be adversely affected.
Our ability to issue “blank check” preferred stock and any anti-takeover provisions we adopt may depress the value of our common stock.
Our authorized capital includes 5,000,000 shares of “blank check” preferred stock. Our Board has the power to issue any or all of the shares of such preferred stock, including the authority to establish one or more series and to fix the powers, preferences, rights and limitations of such class or series, without seeking shareholder approval, subject to certain limitations on this power under the listing requirements of the NASDAQ Stock Market LLC. We may, in the future, consider adopting certain other anti-takeover measures. The authority of our Board to issue “blank check” preferred stock and any future anti-takeover measures we may adopt may delay, deter or prevent takeover attempts and other changes in control of our company not approved by our Board. As a result, our shareholders may lose opportunities to dispose of their shares at favorable prices generally available in takeover attempts or that may be available under a merger proposal and the market price of our common stock and the voting and other rights of our shareholders may also be affected.
There are certain limitations on ownership of five percent or more of our common stock and we will have the right to redeem your shares of common stock if your ownership jeopardizes any regulatory certifications, licenses or approvals we hold.
Our Restated Articles of Incorporation provide that no person or entity may become the beneficial owner of 5% or more of our outstanding shares of common stock unless such person or entity agrees to provide personal background and financial information to, consent to a background investigation by and respond to questions from the applicable gaming authorities in any jurisdiction in which we do business or desire to do business. Our Restated Articles of Incorporation also provides that we may redeem any or all shares of common stock held by any person or entity whose status as a shareholder, in the opinion of our Board, jeopardizes the approval, continued existence or renewal of any regulatory approval we hold. The amount that we will pay for such redeemed shares will equal the highest closing price of our common stock, as reported on the NASDAQ Capital Market or other exchange or quotation service on which our common stock is then listed or quoted, during the 30 days immediately preceding the date on which notice of redemption is given. This provision may force you to sell your shares of common stock before you would choose to do so and may cause you to realize a loss on your investment.
Our common stock price has been volatile. Fluctuations in our stock price could impair our ability to raise capital and make an investment in our securities undesirable.
Historically, the market price of our common stock has fluctuated significantly. We believe factors such as the market’s acceptance of our products and the performance of our business relative to market expectations, as well as general volatility in the securities markets, could cause the market price of our common stock to fluctuate substantially. In addition, the stock markets have experienced price and volume fluctuations, resulting in changes in the market prices of the stock of many companies, which may not have been directly related to the operating performance of those companies. Fluctuations in our stock price could impair our ability to raise capital and make an investment in our securities undesirable. During the year ended December 31, 2013, the closing price of our common stock as quoted on the NASDAQ Capital Market ranged from a low of $0.96 to a high of $1.62.
If our Common Stock is delisted from NASDAQ, you may have difficulty selling shares of our Common Stock.
If our stock is delisted, you may find it difficult to dispose of or obtain accurate quotations as to the market value of your shares. In addition, securities not listed on an exchange may be subject to the “penny stock” rules, which may further limit its liquidity. The “penny stock” rules apply to any security that is not listed on an exchange and that trades below $5.00 per share. Broker-dealers who recommend “penny stocks” to persons other than established customers and accredited investors must satisfy special sales practice requirements. The broker-dealer must make an individualized written suitability determination for the purchaser, considering such purchaser’s financial situation, investment experience and investment objectives, with respect to “penny stock” transactions and receive the purchaser’s written consent prior to the transaction. Our common stock may be considered a “penny stock” if it trades below $5.00 per share and we do not meet certain net asset or revenue thresholds. The “penny stock” rules severely limit the liquidity of securities in the secondary market, and many brokers choose not to participate in “penny stock” transactions. As a result, there is generally less trading in “penny stocks.” Accordingly, you may not always be able to resell shares of our common stock publicly at the time and prices that you feel are fair or appropriate. In addition, if we are subject to the “penny stock” rules it may be more difficult for us to raise additional capital.
We do not intend to pay dividends on our common stock.
We have never declared or paid any cash dividend on our common stock. We currently intend to retain any future earnings and do not expect to pay any dividends in the foreseeable future.
Item 1B.
Item 1B. Unresolved Staff Comments.
None.
Item 2.
Item 2. Properties.
We currently lease our corporate office and manufacturing facility. This facility is approximately 14,400 square feet and is located in Matthews, North Carolina. Our leased space is in good order and condition, and is adequate to satisfy our current needs. We have extended this lease through August 31, 2016. This facility is leased from an entity owned and controlled by our President and our Vice Chairman of the Board. (See Note 14 - “Related Party Transactions.”)
Item 3.
Item 3. Legal Proceedings.
None.
Item 4.
Item 4. Mine Safety Disclosures.
Not applicable.
PART II
Item 5.
Item 5. Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities.
Stock Listing
Our common stock is traded on The NASDAQ Capital Market under the symbol “PTEK.” The table below shows the high and low sales prices for our common stock for the periods indicated, as reported by The NASDAQ Capital Market.
As of March 21, 2014, there were approximately 2,060 beneficial holders and 52 holders of record of our common stock.
Transfer Agent
Our transfer agent is Colonial Stock Transfer and is located at 66 Exchange Place, Salt Lake City, UT 84111, (801) 355-5740.
Dividends
To date no cash dividends have been paid with respect to our common stock and current policy of the Board is to retain any earnings to provide for growth. The payment of cash dividends in the future, if any, will depend on factors such as earnings levels, capital requirements, our overall financial condition and any other factors deemed relevant by our Board.
Item 6.
Item 6. Selected Financial Data.
The following selected financial data has been derived from audited financial statements for the years ended December 31, 2013, 2012, 2011, 2010, and 2009. The selected financial data set forth below should be read together with Item 7
Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations.
You should read the following discussion of our results of operations and financial condition together with the Selected Financial Data and our audited consolidated financial statements as of and for the year ended December 31, 2013 including the notes thereto, included in this Report. The discussion below contains forward-looking statements and involves numerous risks and uncertainties, including, but not limited to, those described in Item 1A. "Risk Factors." Actual results may differ materially from those contained in any forward-looking statements. Forward-looking statements speak only as of the date they are made. We undertake no obligation to update or revise such statements to reflect new circumstances or unanticipated events as they occur, and you are urged to review and consider disclosures that we make in this and other reports that discuss factors germane to our business.
Company Overview and Business Strategy
We develop, manufacture and market electronic table games and related products for casinos, cruise lines, racinos, card clubs and lotteries worldwide. We distribute our electronic table games using an internal sales force, complemented by distributors and sales agents in select geographic areas, generally on a recurring revenue participation model, recurring revenue fixed license fee model or as a sale of hardware combined with recurring license and support fees. As of December 31, 2013, our installed base consisted of 2,272 gaming positions, composed of 2,170 PokerPro and 102 ProCore positions.
PokerPro is a 10-seat electronic poker table that allows operators to offer the most popular player-banked games and tournaments. The PokerPro system offers cash games, single-table tournaments and multi-table tournaments with an extensive game library including Texas Hold’em, Omaha, Razz, and Seven Card Stud. Game rules and limits, including blinds, antes, rake structures and house rules, are completely configurable.
ProCore is an electronic table game platform that expands on the PokerPro technology and allows multiple house-banked games to be run on a single, efficient, economical platform. The versatility of the ProCore system allows operators to add new game content as it is released. Games and house rules can be customized easily to meet property and regulatory requirements, making it an ideal choice for operators looking to add an automated solution to their gaming floor.
We plan to increase our presence in electronic poker with our PokerPro system in various markets that we have identified. We have limited competition from other providers of electronic poker tables and are recognized by casino operators as market leader offering superior products, reliable service and customer support. With the addition of the ProCore platform, our addressable market opportunities expand from electronic poker to also include blackjack, baccarat and other house-banked games. While electronic poker is a niche market where we enjoy a dominant market position, the market for blackjack, baccarat and specialty house-banked games is larger, but also characterized by more competition. We believe our product offerings have significant advantages over the competition and, as a result, we have the opportunity to expand our market position in both electronic poker and for electronic house-banked games.
We have identified key markets worldwide that meet our market segmentation criteria and we believe those markets provide actionable opportunities to grow significantly. We are also monitoring changes in regulation at the state, federal and international level and believe that budgetary, legislative and other factors are creating a favorable environment for expanding the market for gaming in general and electronic table games in particular.
Results of Operations
Statement of Operations - Selected Data
Results of Operations for the Year Ended December 31, 2013 Compared to the Year Ended December 31, 2012
Revenue. Total revenue increased 7.1% to $5.5 million for the year ended December 31, 2013, with revenues from license and service fees increasing 11.1% and revenue from sales of systems and equipment decreasing 14.1%. Total revenue for the year ended December 31, 202 was $5.2 million.
Revenue from license and service fees increased to $$4.9 million for the year ended December 31, 2013 compared to $4.4 million for the year ended December 31, 2012. License and service fees from Canada, Mexico and cruise ships increased with several new installations generating revenue in the current year period. Increases in those markets were offset, however, by reductions in revenue from Europe and other international markets.
Revenue from sales of systems and equipment decreased to $0.7 million for the year ended December 31, 2013 compared to $0.8 million for the year ended December 31, 2012. During both periods, systems and equipment sales revenue benefited from customers in the United States electing to purchase their leased gaming equipment. Sales of systems and equipment decreased on lower revenues from equipment sales in Europe and reduced lease conversions in the United States, partially offset by increased equipment sales in Asia.
Over the past several years, our revenue mix has become more heavily weighted towards recurring license and service fees and a lower percentage of systems and equipment sales. In 2013, license and service fees represented 87% of total revenue, compared to 84% in 2012.
Gross profit. Gross profit was $4.0 million for year ended December 31, 2013 compared to $3.8 million for the year ended December 31, 2012, an increase of 6.9%. Gross profit as a percent of revenue was relatively unchanged at 72.5% and 72.6% for the years ended December 31, 2013 and 2012, respectively.
Operating expenses. Operating expenses increased by $0.1 million (2.8%) to $4.6 million for the year ended December 31, 2013 compared to $4.5 million for the year ended December 31, 2012. The modest increase in operating expenses was attributable to higher spending on regulatory approvals and increased bad debt expense, partially offset by lower employee compensation expense and professional fees.
Interest expense, net. Interest expense decreased 44.9% to $38,191 for the year ended December 31, 2013 from $69,351 for the year ended December 31, 2012. The decrease is primarily attributable to lower outstanding principal balances on the Founders’ Loan and lower fees associated with our SVB credit facility. (See discussion under “Debt Financings” below.)
Income tax provision. Income tax provision decreased 51.3% to $42,310 for the year ended December 31, 2013 from $86,908 for the year ended December 31, 2012. The decrease in income tax provision was attributable to lower withholdings in foreign jurisdictions.
Net loss from continuing operations. Net loss from continuing operations improved 25.1% to $0.6 million for the year ended December 31, 2013 compared to $0.8 million for the year ended December 31, 2012. Net loss from continuing operations was $0.07 per share for the year ended December 31, 2013, an improvement of $0.04 per share compared to a net loss per share of $0.11 for the comparable period of 2012. The improvement in net loss from continuing operations resulted primarily from growth in revenue combined with reductions in interest and income taxes.
Net income from discontinued operations. Net income from discontinued operations for the year ended December 31, 2013 was $535 ($0.00 per share) compared to $52,263 ($0.01 per share) for the year ended December 31, 2012. We completed the disposition of these operations and do not expect to realize additional income or loss from discontinued operations in future periods
Net loss. Net loss for the year ended December 31, 2013 was $0.6 million, an improvement of $0.2 million (20.3%) from $0.8 million for the year ended December 31, 2012. Net loss per share was $0.07 for the year ended December 31, 2013, an improvement of $0.03 per share compared to a net loss per share of $0.10 for the comparable period of 2012. The improvement in net loss resulted primarily from growth in revenue combined with reductions in interest and income taxes.
Liquidity and Capital Resources
We have incurred net losses for all annual periods since inception. We have typically funded our operating costs, research and development activities, working capital investments and capital expenditures with proceeds from the issuances of our common stock and other financing arrangements.
Discussion of Statement of Cash Flows
For the year ended December 31, 2013, net cash used in operating activities improved 83.9% to $0.1 million, compared to $0.8 million for the year ended December 31, 2012. The improvement in cash provided by operating activities was primarily due to improved operating results and favorable working capital comparisons, primarily gaming equipment and deferred revenue, partially offset by reductions in accounts payable and accrued liabilities.
Net cash used in investing activities increased to $10,190 for the year ended December 31, 2013 from $1,378 for the year ended December 31, 2012. Investing activities in both periods are comprised of minor capital expenditures for leasehold improvements, office and manufacturing equipment.
Net cash provided by financing activities was $0.3 million for the year ended December 31, 2013 compared to $0.4 million for the year ended December 31, 2012. Net cash provided by financing activities primarily consists of proceeds from sales of common stock in both periods. Principal payments on long-term debt totaled $60 thousand for the year ended December 31, 2013 and $0 for the year ended December 31, 2012.
Net cash provided by operating activities of discontinued operations was less than $1 thousand for the year ended December 31, 2013 compared to $69 thousand for the year ended December 31, 2012. We do not expect to realize additional cash from discontinued operations in future periods.
Equity Offerings 
On March 1, 2013, we sold 460,000 shares of our common stock to ten unaffiliated accredited investors at a price of $1.05 per share, realizing gross proceeds of $483 thousand and net proceeds of $474 thousand. The offering was exempt from the registration requirements of the Securities Act of 1933, as amended (the “Securities Act”) pursuant to Section 4(5) of the Act and Rule 506 of Regulation D promulgated under the Act.
Warrants
As of December 31, 2013, we had outstanding the following common stock purchase warrants:
·
20,000 with an exercise price of $2.50 and an expiration date of March 31, 2015 issued in connection with a private placement in May 2010; and
·
40,000 with an exercise price of $2.75 and an expiration date of December 29, 2015 issued in connection with the LPC transaction.
Debt Financings
Founders’ Loan
On March 24, 2008, we entered into a Note Purchase Agreement (the “Note Purchase Agreement”) with Lyle A. Berman, James T. Crawford, Arthur L. Lomax and Gehrig H. White (collectively, the “Lenders”), all of whom were founders of PokerTek and members of our Board of Directors at the time. Pursuant to the terms of the Note Purchase Agreement, the Lenders loaned us $2.0 million (the “Founders’ Loan”). The Founders’ Loan contains no restrictive covenants and is collateralized by security interests in 18 PokerPro systems. Such security interests have been subordinated to the SVB Credit Facility.
The principal balance of the debt outstanding under the Founders’ Loan has been reduced through a series of transactions since 2008. On July 23, 2012, we entered into a Second Loan Modification Agreement (the “Second Loan Modification Agreement”) with Messrs. Lomax and White, the remaining makers of the Founders’ Loan. Pursuant to the Second Loan Modification Agreement, $100,000 of the remaining principal balance of the Founders’ Loan was converted into 133,334 shares of our common stock, reflecting a conversion price of $0.75 per share, the closing price of a share of our common stock on Friday, July 20, 2012 as reported by The NASDAQ Capital Market.
On September 18, 2012, we issued 405,405 shares of our common stock to Gehrig H. White in full satisfaction of the entire outstanding principal amount of a note held by Mr. White. The shares were valued at $0.74 per share, which represented the consolidated closing bid price per share on The NASDAQ Capital Market on September 17, 2012.
As a result of the modifications described above, the unpaid principal balance on the Founders’ Loan at December 31, 2013 was $240,429. The outstanding principal balance of the Founders Loan and the interest accruing thereon is payable as follows:
(i)
Beginning February 1, 2013 and the first day of each calendar month thereafter until January 1, 2017, we make monthly payments of interest and principal in the amount of $7,465.51, the amount required to fully amortize the remaining principal balance and the accrued interest thereon over 48 months. In the event of a prepayment, the monthly amount would be recalculated.
(ii)
The remaining principal balance of the Founders’ Loan and all accrued but unpaid interest thereon is finally due and payable on December 31, 2016.
Credit Facility
We maintain a credit facility with Silicon Valley Bank to support our working capital needs (the “SVB Credit Facility”). As of February 27, 2014, we entered into the “Eighth Amendment to Loan and Security Agreement”, which extended the maturity date for the facility to January 16, 2015. Maximum advances are determined based on the composition of our eligible accounts receivable and inventory balances with a facility limit of $625,000. The SVB Credit Facility bears interest at an annual rate equal to the greater of (i) 6.5% or (ii) prime plus 2.0%. As of December 31, 2013 $470,000 was available under the SVB Credit Facility, based on our accounts receivable and inventory levels, and there were no amounts outstanding under the facility.
Operations and Liquidity Management
Historically, we have incurred net losses and used cash from financing activities to fund our operations in each annual period since inception. Over the past four years, we refocused our business strategies, significantly improved our margins, and reduced our operating expenses, while also expanding our growth opportunities and significantly improving our operating results. We also closed several equity transactions, reduced our long-term debt, and renewed our credit facility to improve our liquidity and provide capital to grow our business.
As of December 31, 2013, our cash balance was $415,500 and cash available under our credit line was $470,000. Cash used in operations for the year ended December 31, 2013 was $135,000 including inventory purchases. The level of additional cash needed to fund operations and our ability to conduct business for the next year is influenced primarily by the following factors:
·
the pace of growth in our recurring-revenue gaming business, the related investments in inventory and level of spending on development and regulatory efforts;
·
the level of investment in development and approval of new products, entry into new markets, and investments in regulatory approvals;
·
our ability to control growth of operating expenses as we grow the business, expand with new products in new markets;
·
our ability to negotiate and maintain favorable payment terms with our customers and vendors;
·
our ability to access the capital markets and maintain availability under our credit line;
·
demand for our products, and the ability of our customers to pay us on a timely basis; and
·
general economic conditions as well as political events and legal and regulatory changes.
Our operating plans for 2014 include placing existing inventory, entering new markets, commercializing new products and accelerating revenue growth while controlling operating expense and working capital levels. As we execute our growth plans, we intend to carefully monitor the impact of growth on our working capital needs and cash balances.
We believe the capital resources available to us from our cash balances, credit facility, and cash available from financing activities will be sufficient to fund our ongoing operations and to support our operating plans for at least the next 12 months. However, we may seek to raise additional capital or expand our credit facility to fund growth. We cannot assure you that, in the event we need additional working capital, adequate additional working capital will be available or, if available, will be on terms acceptable to us. If we are unable to raise additional capital or expand our credit facilities, our ability to conduct business and achieve our growth objectives would be negatively impacted.
Impact of Inflation
To date, inflation has not had a material effect on our net sales, revenues or income from continuing operations.
Off-Balance Sheet Arrangements
We have no off-balance sheet arrangements.
Contractual Obligations
The table below sets forth our known contractual obligations as of December 31, 2013:
(1)
Represents the outstanding principal amount and interest on the Founders’ Loan.
(2)
Represents operating lease agreements for office and storage facilities and office equipment.
(3)
Represents open purchase orders with our vendors.
(4)
Represents purchase of gaming inventory from Aristocrat International Pty. Limited and its Affiliates (“Aristocrat”), our former international distribution agent.
Customer Dependence
For the year ended December 31, 2013, five of our customers made up approximately 76.7% of our total revenues from continuing operations, with one accounting for 39.0%, a second accounting for 19.8%, a third accounting for 7.2%, a fourth accounting for 6.1%, and a fifth accounting for 4.6%. The loss of any of these customers or changes in our relationship with any of them could have a material adverse effect on our business.
Critical Accounting Policies and Estimates
The discussion and analysis of our financial condition and results of operations are based on our consolidated financial statements, which have been prepared in accordance with accounting principles generally accepted in the United States. The preparation of these consolidated financial statements requires us to make certain estimates and judgments that affect the reported amounts of assets, liabilities, revenues and expenses and related disclosures. On an ongoing basis, we evaluate these estimates. We base our estimates on historical experience and on various other assumptions that are believed to be reasonable under the circumstances, the results of which form the basis for making judgments about the carrying values of assets and liabilities that are not readily apparent from other sources. Actual results may differ from these estimates under different assumptions or conditions.
We believe that of our significant accounting policies, which are described in Note 1 - “Nature of Business and Significant Accounting Policies” to our consolidated financial statements appearing elsewhere in this report, the following accounting policies involve a greater degree of judgment and complexity. Accordingly, these are the policies we believe are the most critical to aid in fully understanding and evaluating our consolidated financial condition and results of operations.
Revenue recognition. 
We derive our revenue primarily from the lease or sale of electronic gaming tables and from maintenance, installation and support services related to those products. We account for revenue using the guidance in Accounting Standards Codification (“ASC”) Topic 605, “Revenue Recognition” and recognize revenue only when all of the following criteria have been satisfied.
·
persuasive evidence of an arrangement exists
·
delivery has occurred
·
the customer’s price is fixed and determinable
·
collectability is reasonably assured.
Our arrangements with customers generally include a combination of hardware, software and services. We also follow the guidance in ASU No. 2009-14 Software (Topic 985): Certain Revenue Arrangements That Include Software Elements, and ASU No. 2009-13, Revenue Recognition (Topic 605): Multiple-Deliverable Revenue Arrangements. ASU 2009-14 amended industry specific revenue accounting guidance for software and software related transactions to exclude from its scope tangible products containing software components and non-software components that function together to deliver the product’s essential functionality. ASU 2009-13 amended the accounting for multiple-deliverable arrangements to provide guidance on how the deliverables in an arrangement should be separated and requires revenue to be allocated using the relative selling price method.
For contracts considered multiple-deliverable arrangements, we evaluate each deliverable to determine whether they represent a separate unit of accounting. The delivered item constitutes a separate unit of accounting when it has stand-alone value and there are no customer-negotiated refunds or return rights for the delivered items where performance of the undelivered item is not considered probable and substantially in our control. In instances when the aforementioned criteria are not met, the deliverable is combined with the undelivered items and revenue recognition is determined for the combined unit as a single unit of accounting. We determine the allocation of arrangement consideration at inception on the basis of each unit’s relative selling price.
Our multiple-deliverable product offerings generally include both the sale and lease of gaming system hardware with embedded software, and the provision of professional services and post contract services (“PCS”). The gaming system hardware and the embedded software are considered a single unit of accounting on a combined basis as the software is essential to the functionality of the hardware, and the software is never sold separately from the hardware. The professional services and PCS are each considered separate units of accounting.
When a sale or lease arrangement contains multiple deliverables, we allocate revenues to each unit of accounting based on the selling price hierarchy specified in ASC Topic 605:
·
Vendor specific objective evidence (“VSOE”). When available, VSOE must be used to determine the selling price of a deliverable. We have not been able to establish VSOE for its deliverables as we do not sell our products separately regularly and/or have only a limited sales history.
·
Third-party evidence (“TPE”). When VSOE is not available, we then determine whether TPE is available. TPE is determined based on competitor prices for similar deliverables when sold separately. We are unable to reliably determine and verify the pricing of similar competitor products on a stand-alone basis and have not been able to establish TPE for its deliverables.
·
Best estimate of selling price (“BESP”). When TPE is not available, then the BESP is used. As we have not established VSOE or TPE for our deliverables, it uses BESP in its allocation of the arrangement consideration for contracts.
The objective of BESP is to determine the price at which we would transact a sale if the product or service were sold on a stand-alone basis. We determine BESP for product or service considering multiple factors and data points, including, but not limited to, internal costs, gross margin objectives and pricing practices when products are sold with other deliverables. Market conditions and competitive factors are taken into account in determining pricing practices. We limits the amount of revenue recognized for delivered items to the amount of BESP that is not contingent on the future delivery of products or services, future performance obligations or subject to customer-specified return or refund privileges.
For sales of gaming systems with multiple deliverables, revenue is generally recognized for the hardware and embedded software unit of accounting at time of delivery based on the relative selling price method (using BESP). Revenue related to professional services (installation and training) is recognized as those services are delivered, which usually occurs at or near the time of delivery of the gaming system (i.e., the hardware and embedded software unit of accounting). Revenue allocated to PCS services is recognized as those services are delivered on a ratable basis over the PCS term. Revenue recognized from the delivery of gaming systems and installation and training services are limited to those amounts that are not contingent upon the delivery of future PCS or other services.
Our lease arrangements are generally accounted for as operating leases as the terms are typically less than 75% of the economic life of the leased product, they do not contain bargain purchase options, transfer of ownership or have minimum lease payments greater than 90% of the fair value of the leased equipment. Otherwise, the lease arrangements would be accounted for as capital leases. For lease arrangements containing multiple deliverables, revenue from fixed-fee leases of hardware and embedded software is generally recognized on a straight-line basis over the contract term. For leases with participation features, where consideration varies based on the monthly amount of revenue earned by the customer, revenue is generally recognized on a monthly basis as the lease price for each period becomes fixed and determinable. To the extent that installation and training services are provided in a lease arrangement, those professional services are treated as separate units of accounting and the allocated amounts are recognized as those services are delivered, limited to the amount that is not contingent upon the delivery of future services.
If a customer initially leases gaming systems and subsequently purchases that leased equipment, revenue is recorded on the effective date of the purchase agreement and when all other relevant revenue recognition criteria have been met.
In addition to selling multiple-deliverable arrangements, we occasionally sell certain products and services on a stand-alone basis such as the sale of complete gaming system with no services (a rare occurrence), the sale of spare parts and of other peripheral equipment separately from the delivery of other products and services under multiple-deliverable arrangements. Regardless of whether a transaction is a multiple-deliverable transaction subject to ASU 2009-13 and ASU 2009-14 or a stand-alone transaction, revenue is recognized only when persuasive evidence of an arrangement exists, shipment has occurred, the sales price is fixed or determinable, and collection of the resulting receivable is reasonably assured. If customer arrangements require formal notification of acceptance by the customer, revenue is recognized upon meeting such acceptance criteria.
We make judgments and use estimates in recognizing revenue, include the allocation of proceeds from multiple-deliverable arrangements to individual units of accounting, the determination of BESP, the estimated useful lives of our gaming systems, and the appropriate timing or deferral of revenue recognition.
Sales and value added taxes collected from customers and remitted to governmental authorities are accounted for on a net basis and are excluded from revenue in the Consolidated Statements of Operations.
Gaming systems and property and equipment
Our gaming systems represent equipment owned by us. The majority of this equipment is operated at customer sites pursuant to contractual license agreements. Our gaming systems may also include equipment used by us for demonstration or testing purposes.
Our gaming systems are transferred from our respective inventory accounts to the gaming systems account at the time the units are fully assembled, configured, tested and otherwise ready for use by a customer. Because the configuration of each gaming system is unique to the specific customer environment in which it is being placed, the final steps to configure and test the unit generally occur immediately prior to shipment. Depreciation expense for our gaming systems begins in the month of transfer of each gaming system from our inventory account to the gaming systems account.
Our gaming systems and property and equipment are stated at cost, less accumulated depreciation. We include an allocation of direct labor, indirect labor and overhead for each gaming system. Costs not clearly related to the procurement, manufacture and implementation are expensed as incurred. As gaming systems are returned from customer sites, the hardware components are dismantled and transferred to inventory at depreciated cost, and all labor, overhead and installation costs capitalized in connection with the original installation are expensed immediately. As the gaming systems are returned to our warehouse, the various hardware components are individually disassembled, inspected, tested, thoroughly cleaned and refurbished with new components as needed for redeployment. Unusable parts are scrapped. Refurbished systems are transferred from inventory to the gaming systems account and depreciated over their estimated useful life in a manner consistent with new gaming systems described above. In addition, when our products have been delivered but the revenue associated with the arrangement has been deferred, we transfer the balance from inventory to gaming systems. This balance is then charged to cost of revenue as the related deferred revenue is recognized.
Depreciation is computed using the straight-line method over the estimated useful life of the asset. Estimated useful lives are generally three to five years for gaming systems and five years for internal-use equipment and office furniture. Leasehold improvements are amortized over the shorter of the term of the lease or the useful life of the improvement. Expenditures for maintenance and repairs are expensed as incurred.
We evaluate property and equipment for impairment as an event occurs or circumstances change that would more likely than not reduce the fair value of the property and equipment below the carrying amount. If the carrying amount of property and equipment is not recoverable from its undiscounted cash flows, then we would recognize an impairment loss for the difference between the carrying amount and the current fair value. Further, we evaluate the remaining useful lives of property and equipment at each reporting period to determine whether events and circumstances warrant a revision to the remaining depreciation periods.
Share-based compensation
We value our stock options issued based upon the Black-Scholes option pricing model and recognize the compensation over the period in which the options vest. We value restricted and unrestricted share grants and restricted stock units based on the closing market price of the shares at the date of grant and recognize compensation expense over the period in which the shares vest. There are inherent estimates made by management regarding the calculation of stock option expense, including volatility, expected life and forfeiture rate. (See Note 12 - “Shareholders’ Equity - Stock Incentive Plans.”)
We recognize compensation expense for options, shares and units that vest over time using the straight-line attribution approach. For performance-based options and shares issued to third parties, compensation expense is determined at each reporting date in accordance with the fair value method. Until the measurement date is reached, the total amount of compensation expense remains uncertain. Compensation expense is recorded based on the fair value of the award at the reporting date and then revalued, or the total compensation is recalculated, based on the current fair value at each subsequent reporting date.
Research and development
Research and development costs are charged to expense when incurred and are included in the consolidated statements of operations, except when certain qualifying expenses are capitalized. Capitalization of development costs of software products begins once the technological feasibility of the product is established. Capitalization ceases when such software is ready for general release, at which time amortization of the capitalized costs begins. As of December 31, 2013 and 2012, no amounts were capitalized as technological feasibility is generally established at or near the time of general release. Research and development costs include salaries, benefits, travel and other internal costs allocated to software and hardware development efforts, as well as purchased components, engineering services and other third-party costs.
Inventories
Inventories are stated at the lower of cost or market, where cost is determined on a first-in, first-out basis. Inventories also include parts from gaming systems that have been used at customer sites and returned for refurbishment and subsequent redeployment with customer. Those inventory items are stated at the lower of cost or market, where cost is determined based on the undepreciated cost of the returned items. We regularly review inventory for slow moving, obsolete and excess characteristics and evaluate whether inventory is sated at the lower of cost or net realizable value.
Fair Value Measurements
At the beginning of 2012, we adopted an ASU issued in January 2010 requiring separate disclosure of purchases, sales, issuances, and settlements of fair value instruments within the Level 3 reconciliation. Additionally, we adopted an ASU issued in May 2011 amending fair value measurements for US GAAP and IFRS convergence. The adoption of these ASUs did not have a material impact on our financial statements.
Recently Issued Accounting Standards
Recently issued accounting pronouncements not yet adopted
In March 2013, the FASB issued ASU No. 2013-05, “Foreign Currency Matters - Parent's Accounting for the Cumulative Translation Adjustment upon Derecognition of Certain Subsidiaries or Groups of Assets within a Foreign Entity or of an Investment in a Foreign Entity” (“ASU No. 2013-05”) which permits companies to release cumulative translation adjustments into earnings when an entity ceases to have a controlling financial interest in a subsidiary or group of assets that is a business within a foreign entity. Accordingly, the cumulative translation adjustment should be released into earnings only if the sale or transfer results in the complete or substantially complete liquidation of the foreign entity in which the subsidiary or group of assets had resided, or, if a controlling financial interest is no longer held. ASU No. 2013-05 is effective for annual reporting periods beginning on or after December 15, 2013. We do not expect it will have a significant impact on our consolidated results of operations, financial condition and cash flows.
In July 2013, the FASB issued ASU No. 2013-11, “Presentation of an Unrecognized Tax Benefit When a Net Operating Loss Carryforward, a Similar Tax Loss, or a Tax Credit Carryforward Exists (Topic 740)” (“ASU No. 2013-11”) to provide explicit guidance and eliminate the diversity in practice on the financial statement presentation of an unrecognized tax benefit when a net operating loss carryforward, a similar tax loss, or a tax credit carryforward exists. ASU No. 2013-11 is effective for annual reporting periods beginning on or after December 15, 2013. We do not expect it will have a significant impact on our consolidated results of operations, financial condition and cash flows.
Recently issued accounting pronouncements adopted in the current year
In December 2011, the FASB issued ASU No. 2011-11, "Disclosures about Offsetting Assets and Liabilities" ("ASU No. 2011-11") to require new disclosures about offsetting assets and liabilities which requires an entity to disclose information about financial instruments that have been offset and related arrangements to enable users of its financial statements to understand the effect of those arrangements on its financial position. Entities will be required to provide both net (offset amounts) and gross information in the notes to the financial statements for relevant assets and liabilities that are offset. ASU No. 2011-11 is for annual reporting periods beginning on or after January 1, 2013, and interim periods within those annual periods. We adopted this guidance as of January 1, 2013 with no significant impact on our consolidated results of operations, financial condition and cash flows.
In February 2013, the FASB issued ASU No. 2013-02, “Comprehensive Income - Reporting of Amounts Reclassified Out of Accumulated Other Comprehensive Income” (“ASU No. 2013-02”) to improve the reporting of reclassifications out of accumulated other comprehensive income. ASU No. 2013-02 is effective for annual reporting periods beginning on or after December 15, 2012. We adopted this guidance as of January 1, 2013 with no significant impact on our consolidated results of operations, financial condition and cash flows
Item 7A.
Item 7A. Quantitative and Qualitative Disclosures about Market Risk.
We are subject to market risks in the ordinary course of business from both changes in interest rates and foreign exchange rates. A discussion of our primary market risks is presented below:
Cash and investments. Our cash and cash equivalents are not subject to significant interest rate risk due to the short maturities of these instruments. As of December 31, 2013, the carrying value of our cash and cash equivalents approximated fair value.
Fixed rate debt. As market interest rates fluctuate, the fair value of the fixed-rate Founders’ Loan will also fluctuate. The estimated fair value of the Founders’ Loan as of December 31, 2013 was $249,000. We estimate a 10% increase in interest rates would decrease the fair value by approximately $8,700. These changes would impact the fair value disclosures for this financial instrument, but would have no impact on interest expense paid or recognized in the consolidated statement of operations.
Variable rate debt. Our SVB Credit Facility bears interest at variable rates based on spreads over the prime rate. As of December 31, 2013, availability was $470,000 with no borrowings outstanding. A change in average interest rates would not have had a significant effect on net interest expense during 2013, as there were no balances outstanding under the SVB Credit Facility. As of December 31, 2013, the carrying value of our variable rate debt instruments approximated fair value. The SVB Credit Facility amended as of February 27, 2014. See “Debt Financings - Credit Facility” in Item 7 above.
Foreign currency risk. Our revenues from international customers and our inventory costs from international suppliers are exposed to the potentially adverse effects of currency exchange rates, local economic conditions, political instability, and other risks associated with doing business in foreign countries. To the extent that our revenues and purchases from international business partners increase in the future, our exposure to changes in foreign economic conditions and currency fluctuations will increase.
Our dependence on foreign customers and suppliers means, in part, that we are affected by changes in the relative value of the U.S. dollar to foreign currencies, particularly the Euro, Canadian dollar, Mexican peso, Chinese RMB, and Taiwan dollar. Although receipts from foreign customers and our purchases of foreign products are principally negotiated and paid for in U.S. dollars, as our business becomes more international, payments denominated in foreign currencies may increase in the future. In addition, changes in the applicable currency exchange rates might negatively affect the profitability and business prospects of our customers and vendors. This, in turn, might cause such vendors to demand higher prices, delay shipments or discontinue selling to us. This also might cause such customers to demand lower prices, delay or discontinue purchases of our products or demand other changes to the terms of our relationships. These situations could in turn ultimately reduce our revenues or increase our costs, which could have a material adverse effect on our business, financial condition or results of operations.
We do not use derivative financial instruments for speculation or trading purposes or engage in any other hedging strategies with regard to our foreign currency risk.
Item 8.
Item 8. Financial Statements and Supplementary Data.
·
Financial Statements
The information required by this Item is submitted as a separate section of this Report commencing on page 34, attached hereto.
·
Supplementary Data
Selected quarterly financial data for 2013 and 2012 is as follows:
Item 9.
Item 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure.
None.
Item 9A.
Item 9A. Controls and Procedures.
Evaluation of Disclosure Controls and Procedures
Our management, with the participation of our Chief Executive Officer and Chief Financial Officer, evaluated the effectiveness of our “disclosure controls and procedures” (as defined in Rule 13a-15(e) and Rule 15d-15(e) promulgated under the Exchange Act) as of the end of the period covered by this Report (the “Evaluation Date”). Our disclosure controls and procedures are designed to ensure that information required to be disclosed in our financial reports have been made known to management, including our Chief Executive Officer and Chief Financial Officer, and other persons responsible for preparing such reports so that such information may be recorded, processed, summarized and reported in a timely manner. Based upon that evaluation, the Chief Executive Officer and Chief Financial Officer concluded that as of the Evaluation Date, our disclosure controls and procedures are effective to ensure that information required to be disclosed by us in the reports that we file or submit under the Exchange Act is (i) recorded, processed, summarized and reported within the time periods specified in the SEC’s rules and forms and (ii) accumulated and communicated to our management, including our Chief Executive Officer and Chief Financial Officer, as appropriate to allow timely decisions regarding required disclosure.
Management’s Report on Internal Control over Financial Reporting
Our management is responsible for establishing and maintaining adequate internal control over our financial reporting, as defined in Rule 13a-15(f) under the Exchange Act. Internal control over financial reporting is a process to provide reasonable assurance regarding the reliability of our financial reporting for external purposes and preparation of financial statements in accordance with accounting principles generally accepted in the United States. Internal control over financial reporting includes maintaining records that in reasonable detail accurately and fairly reflect our transactions; providing reasonable assurance that receipts and expenditures of our assets are made in accordance with management authorization; and providing reasonable assurance that unauthorized acquisition, use or disposition of our assets that could have a material effect on the financial statements would be prevented or detected on a timely basis. Because of its inherent limitations, internal control over financial reporting is not intended to provide absolute assurance that a misstatement of our financial statements would be prevented or detected. Also, projections of any evaluation of effectiveness to future periods are subject to risk that controls may become inadequate because of changes in conditions or that the degree of compliance with the policies or procedures may deteriorate.
Under the supervision and with the participation of our Chief Executive Officer and Chief Financial Officer, management conducted an evaluation of the effectiveness of our internal control over financial reporting as of December 31, 2013 based on the framework in Internal Control - Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission and in accordance with the interpretive guidance issued by the SEC in Release No. 34-55929. Based on that evaluation, management concluded that our internal control over financial reporting was effective as of December 31, 2013.
Changes in Internal Control over Financial Reporting
There were no changes in internal control over financial reporting identified in managements’ evaluation during the quarter ended December 31, 2013 that materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.
Item 9B.
Item 9B. Other Information.
None.
PART III
Item 10.
Item 10. Directors, Executive Officers and Corporate Governance.
Information called for by this item may be found in our definitive Proxy Statement in connection with our 2014 Annual Meeting of Shareholders to be filed with the SEC under the headings “Board of Directors and Management,” “Section 16(a) Beneficial Ownership Reporting Compliance” and “Corporate Governance Matters” and is incorporated herein by reference.
Item 11.
Item 11. Executive Compensation.
Information called for by this item may be found in our definitive Proxy Statement in connection with our 2014 Annual Meeting of Shareholders to be filed with the SEC under the headings “Executive Compensation” and “Corporate Governance Matters” and is incorporated herein by reference.
Item 12.
Item 12. Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters.
Information called for by this item may be found in our definitive Proxy Statement in connection with our 2014 Annual Meeting of Shareholders to be filed with the SEC under the headings “Equity Compensation Plan Information” and “Security Ownership of Certain Beneficial Owners and Management” and is incorporated herein by reference.
Item 13.
Item 13. Certain Relationships and Related Transactions, and Director Independence.
Information called for by this item may be found in our definitive Proxy Statement in connection with our 2014 Annual Meeting of Shareholders to be filed with the SEC under the headings “Related Person Transactions” and “Corporate Governance Matters” and is incorporated herein by reference.
Item 14.
Item 14. Principal Accountant Fees and Services.
Information called for by this item may be found in our definitive Proxy Statement in connection with our 2014 Annual Meeting of Shareholders to be filed with the SEC under the headings “Independent Registered Public Accounting Firm Fee Information” and “Audit Committee Pre-Approval Policy” and is incorporated herein by reference.
PART IV
Item 15.
Item 15. Exhibits and Financial Statement Schedules.
(a) The following documents are filed as a part of this Form 10-K:
1. Financial Statements
The following financial statements are included in a separate section of this Report beginning on page 33:
·
Report of Independent Registered Public Accounting Firm;
·
Consolidated Statements of Operations for the years ended December 31, 2013 and 2012;
·
Consolidated Balance Sheets as of December 31, 2013 and 2012;
·
Consolidated Statements of Shareholders’ Equity for the years ended December 31, 2013 and 2012;
·
Consolidated Statements of Cash Flows for the years ended December 31, 2013 and 2012; and
·
Notes to Consolidated Financial Statements.
2. Financial Statement Schedules
The following financial statement schedule is included in a separate section of this Report on page 54:
·
Valuation and Qualifying Accounts and Reserves
Other financial statement schedules are omitted because they are not required or are not applicable, or the required information is provided in the consolidated financial statements or notes described in Item 15(a)(1) above.
3. Exhibits
The Exhibits listed in the Exhibit Index, which appears immediately following the signature page and is incorporated herein by reference, are filed as part of this Report.
INDEX TO CONSOLIDATED FINANCIAL STATEMENTS
Page
Report of Independent Registered Public Accounting Firm
Consolidated Balance Sheets as of December 31, 2013 and 2012
Consolidated Statements of Operations for the years ended December 31, 2013 and 2012
Consolidated Statements of Shareholders’ Equity for the years ended December 31, 2013 and 2012
Consolidated Statements of Cash Flows for the years ended December 31, 2013 and 2012
Notes to Consolidated Financial Statements
Consolidated Financial Statement Schedules:
II. Valuation and Qualifying Accounts and Reserves
Report of Independent Registered Public Accounting Firm
To the Board of Directors and Shareholders
PokerTek, Inc.
Matthews, North Carolina
We have audited the accompanying consolidated balance sheets of PokerTek, Inc. and subsidiaries (“PokerTek” or the “Company”) as of December 31, 2013 and 2012, and the related consolidated statements of operations and other comprehensive loss, stockholders' equity, and cash flows for the years then ended. Our audits also included the financial statement schedule of PokerTek listed in Item 15(a). These financial statements and financial statement schedule are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements and schedule based on our audits.
We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. The Company is not required to have, nor were we engaged to perform, an audit of its internal control over financial reporting. Our audits included consideration of internal control over financial reporting as a basis for designing audit procedures that are appropriate in the circumstances, but not for the purpose of expressing an opinion on the effectiveness of the Company’s internal control over financial reporting. Accordingly, we express no such opinion. An audit also includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, 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 PokerTek and subsidiaries as of December 31, 2013 and 2012, and the results of its operations and its cash flows for the years then ended, in conformity with U.S. generally accepted accounting principles. Also, in our opinion, the related financial statement schedule, when considered in relation to the basic consolidated financial statements taken as a whole, presents fairly in all material respects the information set forth therein.
/s/ McGladrey LLP
Charlotte, North Carolina
March 21, 2014
POKERTEK, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2013
Note 1. Nature of Business and Basis of Presentation
PokerTek, Inc. (the “Company”) and its subsidiaries are engaged in developing, manufacturing and marketing of electronic table games and related products for casinos, cruise lines, racinos, card clubs and lotteries worldwide.
These consolidated financial statements include the accounts of the Company and its consolidated subsidiaries, including PokerTek Mexico S DE RL DE CV and PokerTek Canada, Inc. They have been prepared by the Company in accordance with accounting principles generally accepted in the United States. The financial statements of the Company’s foreign subsidiary are measured using the U.S. dollar as the functional currency. All significant intercompany transactions and accounts have been eliminated in consolidation.
Significant Accounting Policies
Accounting estimates. The preparation of the consolidated financial statements in conformity with accounting principles generally accepted in the United States requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the consolidated financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates.
Cash and cash equivalents. The Company considers all cash accounts and highly liquid instruments purchased with an original maturity of three months or less to be cash equivalents.
Concentrations of credit risk. Financial instruments that subject the Company to credit risk primarily consist of cash and cash equivalents, marketable securities and accounts receivables. The Company’s credit risk is managed by investing primarily in high-quality money market instruments and accounts guaranteed by the U.S. government and its agencies.
Receivables and allowance for doubtful accounts. The Company monitors its exposure for credit losses on its customer receivable balances and the credit worthiness of its customers on an ongoing basis and records related allowances for doubtful accounts. Allowances are estimated based upon specific customer balances, where a risk of default has been identified, and also include a provision for non-customer specific defaults based upon historical experience and aging of accounts. As of December 31, 2013 and December 31, 2012, the Company recorded an allowance for doubtful accounts of $117,000 and $185,700, respectively. If circumstances related to specific customers change, estimates of the recoverability of receivables could also change.
Deferred licensing fees. Deferred licensing fees consist of amounts paid to various regulatory agencies. As approvals are obtained, the Company begins expensing the fees over the estimated term of the license. Deferred licensing fees are included in other assets on the consolidated balance sheets.
Patents. Legal fees and application costs related to the Company’s patent application process are expensed as incurred. There is a high degree of uncertainty in the outcome of approval for any of the Company’s patents.
Research and development. Research and development costs are charged to expense when incurred and are included in the consolidated statements of operations, except when certain qualifying expenses are capitalized. Capitalization of development costs of software products begins once the technological feasibility of the product is established. Capitalization ceases when such software is ready for general release, at which time amortization of the capitalized costs begins. Our research and development expenses were $0.7 million and $0.7 million during the fiscal years ended December 31, 2013 and December 31, 2012, respectively, consisting primarily of internal product development salaries and expenses and costs related to third-party engineering, prototyping and product testing.
Advertising. Advertising and promotional costs are expensed as incurred. Advertising costs for the years ended December 31, 2013 and 2012 were $800 and $16,500, respectively.
Inventories. Inventories are stated at the lower of cost or market, where cost is determined on a first-in, first-out basis. Inventories may include parts from gaming systems that have been previously operated at customer sites and returned for refurbishment and subsequent redeployment. Those inventory items are stated at the lower of cost or market, where cost is determined based on the depreciated cost of the returned items. The Company regularly reviews inventory for slow moving, obsolete and excess characteristics in relation to historical and expected usage and establishes reserves to value inventory at the lower of cost or estimated net realizable value. If expectations related to customer demand change or the Company changes its product offering in the future, estimates regarding the net realizable value of inventory could also change.
Revenue recognition. The Company derives its revenue primarily from the lease or sale of its electronic gaming tables and from maintenance, installation and support services related to those products. The Company accounts for revenue using the guidance in Accounting Standards Codification (“ASC”) Topic 605, “Revenue Recognition” and recognizes revenue only when all of the following criteria have been satisfied:
· persuasive evidence of an arrangement exists
· delivery has occurred
· the customer’s price is fixed and determinable; and
· collectability is reasonably assured.
The Company’s arrangements with its customers generally include a combination of hardware, software and services. The Company also follows the guidance in ASU No. 2009-14 Software (Topic 985): Certain Revenue Arrangements That Include Software Elements, and ASU No. 2009-13, Revenue Recognition (Topic 605): Multiple-Deliverable Revenue Arrangements. ASU 2009-14 amended industry specific revenue accounting guidance for software and software related transactions to exclude from its scope tangible products containing software components and non-software components that function together to deliver the product’s essential functionality. ASU 2009-13 amended the accounting for multiple-deliverable arrangements to provide guidance on how the deliverables in an arrangement should be separated and requires revenue to be allocated using the relative selling price method.
For contracts considered multiple-deliverable arrangements, the Company evaluates each deliverable to determine whether they represent a separate unit of accounting. The delivered item constitutes a separate unit of accounting when it has stand-alone value and there are no customer-negotiated refunds or return rights for the delivered items where performance of the undelivered item is not considered probable and substantially in the Company’s control. In instances when the aforementioned criteria are not met, the deliverable is combined with the undelivered items and revenue recognition is determined for the combined unit as a single unit of accounting. The Company determines the allocation of arrangement consideration at inception on the basis of each unit’s relative selling price.
The Company’s multiple-deliverable product offerings generally include both the sale and lease of gaming system hardware with embedded software, and the provision of professional services and post contract services (“PCS”). The gaming system hardware and the embedded software are considered a single unit of accounting on a combined basis as the software is essential to the functionality of the hardware, and the software is never sold separately from the hardware. The professional services and PCS are each considered separate units of accounting.
When a sale or lease arrangement contains multiple deliverables, the Company allocates revenues to each unit of accounting based on the selling price hierarchy specified in ASC Topic 605:
·
Vendor specific objective evidence (“VSOE”). When available, VSOE must be used to determine the selling price of a deliverable. The Company has not been able to establish VSOE for its deliverables as it does not sell its products separately regularly and/or has only a limited sales history.
·
Third-party evidence (“TPE”). When VSOE is not available, the Company then determines whether TPE is available. TPE is determined based on competitor prices for similar deliverables when sold separately. The Company is unable to reliably determine and verify the pricing of similar competitor products on a stand-alone basis and has not been able to establish TPE for its deliverables.
·
Best estimate of selling price (“BESP”). When TPE is not available, then the BESP is used. AS the Company has not established VSOE or TPE for its deliverables, it uses BESP in its allocation of the arrangement consideration for contracts.
The objective of BESP is to determine the price at which the Company would transact a sale if the product or service were sold on a stand-alone basis. The Company determines BESP for product or service considering multiple factors and data points, including, but not limited to, internal costs, gross margin objectives and pricing practices when products are sold with other deliverables. Market conditions and competitive factors are taken into account in determining the Company’s pricing practices. The Company limits the amount of revenue recognized for delivered items to the amount of BESP that is not contingent on the future delivery of products or services, future performance obligations or subject to customer-specified return or refund privileges.
For the Company’s sales of gaming systems with multiple deliverables, revenue is generally recognized for the hardware and embedded software unit of accounting at time of delivery based on the relative selling price method (using BESP). Revenue related to professional services (installation and training) is recognized as those services are delivered, which usually occurs at or near the time of delivery of the gaming system (i.e., the hardware and embedded software unit of accounting). Revenue allocated to PCS services is recognized as those services are delivered on a ratable basis over the PCS term. Revenue recognized from the delivery of gaming systems and installation and training services are limited to those amounts that are not contingent upon the delivery of future PCS or other services.
The Company’s lease arrangements are generally accounted for as operating leases as the terms are typically less than 75% of the economic life of the leased product, they do not contain bargain purchase options, transfer of ownership or have minimum lease payments greater than 90% of the fair value of the leased equipment. Otherwise, the lease arrangements would be accounted for as capital leases. For lease arrangements containing multiple deliverables, revenue from fixed-fee leases of hardware and embedded software is generally recognized on a straight-line basis over the contract term. For leases with participation features, where consideration varies based on the monthly amount of revenue earned by the customer, revenue is generally recognized on a monthly basis as the lease price for each period becomes fixed and determinable. To the extent that installation and training services are provided in a lease arrangement, those professional services are treated as separate units of accounting and the allocated amounts are recognized as those services are delivered, limited to the amount that is not contingent upon the delivery of future services.
If a customer initially leases gaming systems and subsequently purchases that leased equipment, revenue is recorded on the effective date of the purchase agreement and when all other relevant revenue recognition criteria have been met.
In addition to selling multiple-deliverable arrangements, the Company also occasionally sells certain products and services on a stand-alone basis such as the sale of complete gaming system with no services (a rare occurrence), the sale of spare parts, and of other peripheral equipment separately from the delivery of other products and services under multiple-deliverable arrangements. Regardless of whether a transaction is a multiple-deliverable transaction subject to ASU 2009-13 and ASU 2009-14 or a stand-alone transaction, revenue is recognized only when persuasive evidence of an arrangement exists, shipment has occurred, the sales price is fixed or determinable, and collection of the resulting receivable is reasonably assured. If customer arrangements require formal notification of acceptance by the customer, revenue is recognized upon meeting such acceptance criteria.
The Company makes judgments and uses estimates in recognizing revenue, include the allocation of proceeds from multiple-deliverable arrangements to individual units of accounting, the determination of BESP, the estimated useful lives of its gaming systems, and the appropriate timing or deferral of revenue recognition.
Gaming systems and property and equipment. The Company’s gaming systems represent equipment owned by the Company. The majority of this equipment is operated at customer sites pursuant to contractual license agreements. Gaming systems may also include equipment used by the Company for demonstration or testing purposes.
Gaming systems are transferred from the Company’s respective inventory accounts to the gaming systems account at the time the units are fully assembled, configured, tested and otherwise ready for use by a customer. Because the configuration of each gaming system is unique to the specific customer environment in which it is being placed, the final steps to configure and test the unit generally occur immediately prior to shipment. Depreciation expense for gaming systems begins in the month of transfer of each gaming system from the Company’s inventory account to the gaming systems account.
Gaming systems and property and equipment are stated at cost, less accumulated depreciation. The Company includes an allocation of direct labor, indirect labor and overhead for each gaming system. Costs not clearly related to the procurement, manufacture and implementation are expensed as incurred. As gaming systems are returned from customer sites, the hardware components are dismantled and transferred to inventory at depreciated cost, and all labor, overhead and installation costs capitalized in connection with the original installation are expensed immediately. As the systems are returned to the Company’s warehouse, the various hardware components are individually taken apart, inspected, tested, thoroughly cleaned and refurbished with new components as needed for redeployment. Unusable parts are scrapped. Refurbished systems are transferred from inventory to the gaming systems account and depreciated over their estimated useful life in a manner consistent with new gaming systems described above. In addition, when the Company’s products have been delivered but the revenue associated with the arrangement has been deferred, the Company transfers the balance from inventory to gaming systems. This balance is then charged to cost of revenue as the related deferred revenue is recognized.
Depreciation is computed using the straight-line method over the estimated useful life of the asset. Estimated useful lives are generally three to five years for gaming systems and five years for internal-use equipment and office furniture. Leasehold improvements are amortized over the shorter of the term of the lease or the useful life of the improvement. Expenditures for maintenance and repairs are expensed as incurred.
The Company evaluates property and equipment for impairment as an event occurs or circumstances change that would more likely than not reduce the fair value of the property and equipment below the carrying amount. If the carrying amount of property and equipment is not recoverable from its undiscounted cash flows, then the Company would recognize an impairment loss for the difference between the carrying amount and the current fair value. Further, the Company evaluates the remaining useful lives of property and equipment at each reporting period to determine whether events and circumstances warrant a revision to the remaining depreciation periods.
Offering costs. Offering costs incurred in connection with the Company’s equity offerings, consisting principally of legal, accounting and underwriting fees, are charged to additional paid in capital as incurred.
Income taxes. The Company accounts for income taxes and uncertain tax positions in accordance with generally accepted accounting principles. Deferred tax assets and liabilities are recognized for the future tax consequences attributable to differences between the financial statement carrying amounts of 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 years in which those temporary differences are expected to be recovered or settled. The effect on deferred tax assets and liabilities of a change in tax rates is recognized in the period that includes the enactment date.
The accounting for income taxes involves significant judgments and estimates and deals with complex tax regulations. The recoverability of certain deferred tax assets is based in part on estimates of future income and the timing of temporary differences. (See Note 13 - “Income Taxes.”)
Earnings (loss) per share. The Company computes earnings (loss) per share (“EPS”) in accordance with generally accepted accounting principles which require presentation of both basic and diluted earnings per share on the face of the statement of operations. Basic EPS is computed by dividing net income (loss) available to common shareholders by the weighted-average number of shares outstanding during the period. Diluted EPS reflects the potential dilution that could occur if securities or other contracts to issue common stock were exercised or converted to common stock. In computing Diluted EPS, the average stock price for the period is used in determining the number of shares assumed to be purchased from the exercise of stock options or warrants. Diluted net loss per share was the same as basic net loss per share for all periods presented, since the effects of any potentially dilutive securities are excluded as they are antidilutive due to the Company’s net losses. The following were excluded from the computation of diluted net loss per share for 2013 and 2012 as their inclusion would be antidilutive:
·
Stock options to purchase 724,703 shares of common stock as of both December 31, 2013 and December 31, 2012;
·
253,312 and 356,000 restricted stock units as of December 31, 2013 and December 31, 2012, respectively; and
·
60,000 common stock purchase warrants as of both December 31, 2013 and December 31, 2012.
Share-based compensation.  The Company values its stock options issued based upon the Black-Scholes option pricing model and recognize the compensation over the period in which the options vest. The Company values restricted and unrestricted share grants and restricted stock units based on the closing market price of the shares at the date of grant and recognize compensation expense over the period in which the shares vest. There are inherent estimates made by management regarding the calculation of stock option expense, including volatility, expected life and forfeiture rate. (See Note 12 - “Shareholders’ Equity - Stock Incentive Plans.”)
The Company recognizes compensation expense for options, shares and units that vest over time using the straight-line attribution approach. For performance-based options and shares issued to third parties, compensation expense is determined at each reporting date in accordance with the fair value method. Until the measurement date is reached, the total amount of compensation expense remains uncertain. Compensation expense is recorded based on the fair value of the award at the reporting date and then revalued, or the total compensation is recalculated, based on the current fair value at each subsequent reporting date.
Warrants. The Company evaluates its outstanding warrants at issuance and at each quarter end. As a result of its evaluation and analysis, management determined that its warrants should be classified as equity instruments in the accompanying consolidated balance sheets.
Shipping costs. The Company includes all of the outbound freight, shipping and handling costs associated with the shipment of products to customers in cost of revenue. Any amounts paid by customers to the Company for shipping and handling are recorded as revenue on the consolidated statement of operations.
Fair Value of Financial Instruments. Under generally accepted accounting principles, fair value is defined as “the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date.” The fair value hierarchy for measurement and disclosure of the fair value for financial instruments is as follows: Level 1 inputs as quoted prices in active markets for identical assets or liabilities; Level 2 inputs as observable inputs other than Level 1 prices, such as quoted market prices for similar assets or liabilities or other inputs that are observable or can be corroborated by market data; and Level 3 inputs as unobservable inputs that are supported by little or no market activity and that are financial instruments whose value is determined using pricing models or instruments for which the determination of fair value requires significant management judgment or estimation.
The fair value of financial assets and liabilities is determined at each balance sheet date and future declines in market conditions, the future performance of the underlying investments or new information could affect the recorded values of the Company’s investments.
Subsequent Events. Management has evaluated all events and transactions that occurred from January 1, 2014 through the date these consolidated financial statements were issued for subsequent events requiring recognition or disclosure in the financial statements.
Recent Accounting Pronouncements
Recently issued accounting pronouncements not yet adopted
In March 2013, the FASB issued ASU No. 2013-05, “Foreign Currency Matters - Parent's Accounting for the Cumulative Translation Adjustment upon Derecognition of Certain Subsidiaries or Groups of Assets within a Foreign Entity or of an Investment in a Foreign Entity” (“ASU No. 2013-05”) which permits companies to release cumulative translation adjustments into earnings when an entity ceases to have a controlling financial interest in a subsidiary or group of assets that is a business within a foreign entity. Accordingly, the cumulative translation adjustment should be released into earnings only if the sale or transfer results in the complete or substantially complete liquidation of the foreign entity in which the subsidiary or group of assets had resided, or, if a controlling financial interest is no longer held. ASU No. 2013-05 is effective for annual reporting periods beginning on or after December 15, 2013. The Company does not expect it will have a significant impact on its consolidated results of operations, financial condition and cash flows.
In July 2013, the FASB issued ASU No. 2013-11, “Presentation of an Unrecognized Tax Benefit When a Net Operating Loss Carryforward, a Similar Tax Loss, or a Tax Credit Carryforward Exists (Topic 740)” (“ASU No. 2013-11”) to provide explicit guidance and eliminate the diversity in practice on the financial statement presentation of an unrecognized tax benefit when a net operating loss carryforward, a similar tax loss, or a tax credit carryforward exists. ASU No. 2013-11 is effective for annual reporting periods beginning on or after December 15, 2013. The Company does not expect it will have a significant impact on its consolidated results of operations, financial condition and cash flows.
Recently issued accounting pronouncements adopted in the current year
In December 2011, the FASB issued ASU No. 2011-11, "Disclosures about Offsetting Assets and Liabilities" ("ASU No. 2011-11") to require new disclosures about offsetting assets and liabilities which requires an entity to disclose information about financial instruments that have been offset and related arrangements to enable users of its financial statements to understand the effect of those arrangements on its financial position. Entities will be required to provide both net (offset amounts) and gross information in the notes to the financial statements for relevant assets and liabilities that are offset. ASU No. 2011-11 is for annual reporting periods beginning on or after January 1, 2013, and interim periods within those annual periods. The Company adopted this guidance as of January 1, 2013 with no significant impact on its consolidated results of operations, financial condition and cash flows.
In February 2013, the FASB issued ASU No. 2013-02, “Comprehensive Income - Reporting of Amounts Reclassified Out of Accumulated Other Comprehensive Income” (“ASU No. 2013-02”) to improve the reporting of reclassifications out of accumulated other comprehensive income. ASU No. 2013-02 is effective for annual reporting periods beginning on or after December 15, 2012. The Company adopted this guidance as of January 1, 2013 with no significant impact on its consolidated results of operations, financial condition and cash flows
Fair Value Measurements
At the beginning of 2012, the Company adopted an ASU issued in January 2010 requiring separate disclosure of purchases, sales, issuances, and settlements of fair value instruments within the Level 3 reconciliation. Additionally the Company adopted an ASU issued in May 2011 amending fair value measurements for US GAAP and IFRS convergence. The adoption of these ASUs did not have a material impact on the Company’s financial statements.
Note 2. Operations and Liquidity Management
Historically, the Company has incurred net losses and used cash from financing activities to fund its operations in each annual period since inception. Over the past four years, the Company refocused its business strategies, significantly improved its margins, and reduced its operating expenses, while also expanding its growth opportunities and significantly improving its operating results. The Company also closed several equity transactions, reduced its long-term debt, and renewed its credit facility to improve its liquidity and provide capital to grow its business.
As of December 31, 2013, the Company’s cash balance was $415,500 and cash available under its credit line was $470,000. Cash used in operations for the year ended December 31, 2013 was $135,363 including inventory purchases. The level of additional cash needed to fund operations and the Company’s ability to conduct business for the next year is influenced primarily by the following factors:
·
the level of investment in development and approval of new products, entry into new markets, and investments in regulatory approvals;
·
its ability to control growth of operating expenses as it grows the business and expands with new products in new markets;
·
its ability to negotiate and maintain favorable payment terms with customers and vendors;
·
its ability to access the capital markets and maintain availability under its credit line;
·
demand for its products, and the ability of its customers to pay on a timely basis; and
·
general economic conditions as well as political events and legal and regulatory changes.
The Company’s operating plans for 2014 include placing existing inventory, entering new markets, commercializing new products and accelerating revenue growth while controlling operating expense and working capital levels. As the Company executes its growth plans, it intends to carefully monitor the impact of growth on its working capital needs and cash balances.
The Company believes the capital resources available to it from its cash balances, credit facility, cash generated by improving the results of its operations and cash from financing activities will be sufficient to fund its ongoing operations and to support its operating plans for at least the next 12 months. However, the Company may seek to raise additional capital or expand its credit facility to fund growth. The Company cannot assure you that, in the event it needs additional working capital, adequate additional working capital will be available or, if available, will be on terms acceptable to it. If the Company is unable to raise additional capital or expand its credit facilities, the Company’s ability to conduct business and achieve its growth objectives would be negatively impacted.
Note 3. Discontinued Operations
In August 2010, the Company decided to exit the amusement business due to declining demand and reduced pricing power for its Heads-Up Challenge product.
The results of operations and related non-recurring costs associated with the amusement business have been presented as discontinued operations for all periods. Additionally, the assets and liabilities of the discontinued operations have been segregated in the accompanying consolidated balance sheets. The statements of operations for the discontinued operations for the years ended December 31, 2013 and 2012 consisted of the following:
Operating expenses of discontinued operations consist primarily of selling expenses, shipping charges, bad debts, and product certification expenses.
The Company has completed the disposition of the assets of its discontinued operation and does not expect to realize additional income or loss or cash flows from discontinued operations in future periods.
Note 4. Accounts Receivable
Accounts receivable at December 31, 2013 and 2012 consist of the following:
Note 5. Inventory
Inventory at December 31, 2013 and 2012 consist of the following:
Note 6. Prepaid Expenses and Other Assets
Prepaid expenses and other assets at December 31, 2013 and 2012 consist of the following:
Note 7. Gaming Systems
Gaming systems at December 31, 2013 and 2012 consist of the following:
Note 8. Property and Equipment
Property and equipment at December 31, 2013 and 2012 consist of the following:
Capitalized software consists of purchased software, consulting and capitalized internal costs related to the purchase and implementation of an internal-use enterprise resource management system. Accumulated depreciation on capitalized software was $157,067 at December 31, 2013 and 2012.
Note 9. Accrued Liabilities
Accrued liabilities at December 31, 2013 and 2012 consist of the following:
Note 10. Debt
The Company’s outstanding debt balances as of December 31, 2013 and 2012 consist of the following:
SVB Credit Facility.  We maintain a credit facility with Silicon Valley Bank to support our working capital needs (the “SVB Credit Facility”). As of February 27, 2014, we entered into the “Seventh Amendment to Loan and Security Agreement”, which extended the maturity date for the facility to January 14, 2015. Maximum advances are determined based on the composition of our eligible accounts receivable and inventory balances with a facility limit of $625,000. The SVB Credit Facility bears interest at an annual rate equal to the greater of 6.5% or prime plus 2.0%.
Based on the Company’s accounts receivable and inventory levels on December 31, 2013, as of such date cash available under the SVB Credit Facility was approximately $470,000 with no amounts outstanding. The SVB Credit Facility includes covenants requiring the achievement of specified financial ratios and thresholds and contains other terms and conditions customary for this type of credit facility. As of December 31, 2013, the Company was in compliance with these covenants. The SVB Credit Facility is collateralized by security interests in substantially all of the assets of the Company and is senior to the Founders’ Loan (described below).
As of December 31, 2013, there were no amounts drawn under the SVB Credit Facility.
Founders’ Loan
On March 24, 2008, the Company entered into a Note Purchase Agreement (the “Note Purchase Agreement”) with Lyle A. Berman, James T. Crawford, Arthur L. Lomax and Gehrig H. White (collectively, the “Lenders”), all of whom were founders of PokerTek and members of our Board of Directors at the time. Pursuant to the terms of the Note Purchase Agreement, the Lenders loaned $2.0 million to the Company (the “Founders’ Loan”). The Founders’ Loan contains no restrictive covenants and is collateralized by security interests in 18 PokerPro systems. Such security interests have been subordinated to the SVB Credit Facility.
The principal balance of the debt outstanding under the Founder’s Loan has been reduced through a series of transactions since 2008. On July 23, 2012, the Company entered into the Second Loan Modification Agreement (the “Second Loan Modification Agreement”) which amended and modified the terms of the Note Purchase Agreement, as previously amended. Pursuant to the Second Loan Modification Agreement $100,000 of the outstanding principal balance of the Founders’ Loan was converted into 133,334 shares of common stock, reflecting a conversion price of $0.75 per share, the closing price of a share of common stock on Friday, July 20, 2012, as reported by the NASDAQ Capital Market.
On September 18, 2012, the Company issued 405,405 shares of its common stock to Gehrig H. White in full satisfaction of the entire outstanding principal balance of Mr. White’s share of the Founders’ Loan, which at the time of issuance of the shares, was $300,000. The shares were valued at $0.74 per share, which represented the consolidated closing bid price per share on the NASDAQ Capital Market on September 17, 2012. As a result of the modifications described above, the unpaid principal balance of the Founders Loan at December 31, 2013 was $240,429. The outstanding principal balance of the Founders Loan, and the interest accruing thereon, is payable as follows:
(i)
Beginning February 1, 2013 and the first day of each calendar month thereafter until January 1, 2017, the Company will make monthly payments of interest and principal in the amount of $7,465.51, the amount required to fully amortize the remaining principal balance and the accrued interest thereon over 48 months. In the event of a prepayment, the monthly amount would be recalculated.
(ii)
The remaining principal balance of the note and all accrued but unpaid interest thereon is finally due and payable on December 31, 2016.
As of December 31, 2013, the carrying value of the Founders’ Loan was $240,429 and its approximately fair value was $250,000. During 2013 and 2012, the Company made $24,925 and $54,912, respectively, in aggregate interest payments in cash.
Note 11. Employee Benefit Plan
The Company has established a salary deferral plan under Section 401(k) of the Internal Revenue Code covering substantially all employees. The plan allows eligible employees to defer up to 96% of their annual compensation, subject to annual limitations established by the Internal Revenue Service. The Company matches the contributions equal to 100% on the first 3% of the deferral and 50% on the deferral from 3% to 5%. For the years ended December 31, 2013 and 2012, the Company’s expenses related to the plan were $47,900 and $48,900, respectively.
Note 12. Shareholders’ Equity
Common and Preferred Stock
Common Stock. There are 100,000,000 authorized shares of the Company’s common stock of which 9,363,434 and 8,625,498 were outstanding as of December 31, 2013 and December 31, 2012, respectively.
Private Placement Transactions
During August 2012, the Company entered into binding subscription agreements with unaffiliated accredited investors pursuant to which such investors have agreed to purchase approximately $240,000 worth of “restricted” shares of the Company’s common stock at a price equal to 90% of the consolidated closing bid price of a share of common stock as reported on the NASDAQ Capital Market on the last trading day immediately preceding the closing date of the transaction. These transactions were completed in the quarter ended September 30, 2012. There was no placement agent or other intermediary involved in this private placement transaction and the Company is not obligated to register the shares of common stock to be issued to the investors.
During August and September 2012, Gehrig H. White cancelled $400,000 of principal due under the Founders’ Loan as the consideration for share purchases. (See Note 10 “Debt.”)
On March 1, 2013, the Company sold 460,000 shares of its common stock to accredited investors (as defined under the Securities Act of 1933, as amended (the “Act”)) at a price of $1.05 per share (the “Private Placement”), yielding gross proceeds of $483,000 and net proceeds of approximately $474,000. The Private Placement was exempt from the registration requirements of the Act pursuant to Section 4(5) and Rule 506 of Regulation D promulgated under the Act.
LPC Transaction
In 2010 the Company entered into a Purchase Agreement (the “Purchase Agreement”) with Lincoln Park Capital, LLC (“LPC”). From 2010 through 2012, the Company sold and/or issued an aggregate of 798,373 shares of its common stock and a warrant to purchase an additional 40,000 shares of its common stock at $2.75 per share at any time prior to December 29, 2015, to LPC for an aggregate of $764,594, including 263,511 shares sold in 2012 for gross proceeds of $189,608. The warrant contains a call provision exercisable by the Company in the event the Company’s common stock trades above $7.50 per share for 20 consecutive days. As of December 31, 2013 and 2012, all of the shares covered by the registration statement remained had been issued thereunder
Warrants
As of December 31, 2013, the following common stock purchase warrants were outstanding:
·
20,000 common stock warrants at an exercise price of $2.50 with an expiration date of March 31, 2015 issued in connection with a private placement in May 2010; and
·
40,000 common stock warrants at an exercise price of $2.75 with an expiration date of December 29, 2015 issued in connection with the LPC transaction.
Preferred Stock. There are 5,000,000 authorized shares of preferred stock, none of which are outstanding as of December 31, 2012 and December 31, 2011.
Stock Incentive Plans
The Company’s shareholders have approved stock incentive plans, authorizing the issuance of stock option, restricted stock, restricted stock units (RSU), and other forms of equity compensation. Pursuant to the approved stock incentive plans 617,559 shares remained available for future grant as of December 31, 2013. The Company has historically issued stock options and restricted shares as compensation, although it has the authority to use other forms of equity compensation instruments in the future.
Principal assumptions used in determining the fair value of option awards include the following: (a) expected future volatility for the Company's stock price, which is based on the Company’s historical volatility, (b) expected dividends, (c) expected term and forfeiture rates, based on historical exercise and forfeiture activity, and (d) the risk-free rate is the rate on U.S. Treasury securities with a maturity equal to, or closest to, the expected life of the options. The assumptions used to determine the fair value of option awards for the years ended December 31, 2013 and 2012 were as follows:
A summary of stock option activity and changes during the year for the year ended December 31, 2013 is as follows:
No options were granted in 2013. The total intrinsic value of options exercised during the years ended December 31, 2013 and 2012 was zero, as there was no option exercise activity during those periods.
A summary of the status of non-vested options as of December 31, 2013, and changes during the year ended December 31, 2013 is presented below:
As of December 31, 2013, there was $7,000 of total unrecognized compensation cost related to non-vested options. This cost is expected to be recognized over a weighted-average period of 11.70 months. The amount of related expense calculated using the Black-Scholes option pricing model and recognized in 2013 and 2012 was $301,000 and $352,000, respectively. The total fair value of options vested during the years ended December 31, 2013 and 2012 was $1,458,000 and $1,406,000, respectively. The total intrinsic value of vested options as of December 31, 2013 and 2012 was $0.
A summary of restricted stock activity and changes during the year ended December 31, 2013 is as follows:
The grant date fair value of restricted stock is based on the closing market price of the stock at the date of grant. Compensation cost is amortized to expense on a straight-line basis over the requisite service periods, which ranged from zero to two years. As of December 31, 2013, there was $0 of unrecognized compensation cost related to non-vested restricted stock. This cost is expected to be recognized over a weighted average period of nine months.
A summary of RSU activity and changes during the year ended December 31, 2013 is as follows:
The grant date fair value of restricted stock units is based on the closing market price of the stock at the date of grant. Compensation cost is amortized to expense on a straight-line basis over the requisite service periods, which ranged from eighteen to twenty-four months. As of December 31, 2013, there was $121,141 of unrecognized compensation cost related to non-vested restricted stock units. This cost is expected to be recognized over a weighted average period of approximately twenty months.
Note 13. Income Taxes
The total income tax expense (benefit) provided on pretax income and its significant components were as follows:
A reconciliation of the statutory federal income tax expense (benefit) at 34% to loss before income taxes and the actual income tax expense (benefit) is as follows:
Deferred income taxes result from temporary differences between the reporting of amounts for financial statement purposes and income tax purposes. The net deferred tax assets and liabilities included in the consolidated financial statements include the following amounts:
As of December 31, 2013 and December 31, 2012, the Company has federal net operating loss carryforwards of approximately $28,810,000 and $30,365,000, respectively, North Carolina net economic loss carryforwards of approximately $13,803,000 and $14,395,000, respectively and other state net operating losses in the amounts of approximately $1,147,000 and $1,397,000, respectively. Included in the federal net operating loss carryforward is a deduction for the exercise of nonqualified stock options. However, the net operating loss attributable to the excess of the tax deduction for the exercised nonqualified stock options over the cumulative expense recorded in the consolidated financial statements is not recorded as a deferred tax asset. The benefit of the excess deduction of $37,000 will be recorded to additional paid in capital when the Company realizes a reduction in its current taxes payable. These carryforwards can be used to offset taxable income in future years, which expire through 2032. The Company also has research and experimentation tax credit carryforwards for federal of approximately $419,000. These credit carryforwards may be used to offset federal income taxes in future years through their expiration in 2027.
The Company records a valuation allowance when it is more likely than not that some portion or all of the deferred tax assets will not be realized. The Company has assessed its earnings history and anticipated earnings, the expiration date of the carryforwards and other factors and has determined that valuation allowances should be established against the deferred tax assets as of December 31, 2013 and 2012. The change in the valuation allowance of ($393,282) for the year ended December 31, 2013 was due to the decrease in net deferred tax assets, principally driven by decreases in deferred tax assets related to loss carryforwards.
The following table summarizes the changes to the amount of unrecognized tax benefits for the years ended December 31, 2013 and 2012:
The Company files U.S. federal, U.S. state, Canadian and Mexican tax returns. The tax years 2008 through 2013 remain subject to examination by the IRS for U.S. federal tax purposes, as do U.S. state tax returns by the appropriate state taxing authorities, Canadian tax returns by the Canada Revenue Agency and the Mexican tax returns by the Mexican Secretariat of Finance and Public Credit.
The utilization of the Company's net operating losses may be subject to a substantial limitation should a change of ownership occur or have occurred, as defined under Section 382 of the Internal Revenue Code and similar state provisions. Such limitation could result in the expiration of the federal and state net operating loss carryforwards before their utilization. Currently, a valuation allowance equal to the total deferred tax assets has been established. As such, any limitation resulting from the expiration of the federal or state net operating loss and credit carryforwards would have no effect on the Company’s consolidated results of operations.
Based on a §382 analysis performed internally by the Company, management believes that no change in ownership has occurred in prior periods. However, at this time, management has not obtained a formal study and would intend to do so prior to any significant utilization of the carryovers. While management does not believe a change in ownership has occurred in prior periods, if a formal study were to find that a change in ownership had in fact occurred, management estimates that the utilization of federal net operating loss and credit carryforwards could potentially be limited to approximately $100,000 to $500,000 per year over the following 19 years. If such a limitation were found to exist, at that time, the company would reduce its gross deferred tax asset and its valuation allowance related to the net operating loss and credit carryforwards to reflect the amounts that could be utilized after limitation.
Note 14. Related Party Transactions
Private Placement Transactions
During 2012, the Company completed private placement transactions in which members of the Company’s board and management purchased shares of common stock. In addition, in 2012, a board member cancelled principal due under the Founders’ Loan as the consideration for share purchases. (See Note 10 “Debt” and Note 12 “Shareholders’ Equity.”)
Office Lease
The Company currently leases its office and manufacturing facility from an entity owned and controlled by the Company’s President and Vice Chairman of the Board of Directors. The entity purchased the building while the Company was already a tenant. The lease terms were negotiated on an arm’s length basis and are consistent with the rent paid by other tenants in the building and comparable market rents in the area. Rent expense recorded for the leased space for the years ended December 31, 2013 and 2012 were $135,000 and $135,000, respectively.
In February 2013 the Company exercised an option to extend this lease through August 31, 2016. No other significant portions of the lease were modified, monthly rent continues at $11,250 per month, and provisions to allow the Company to buy out the lease or reduce its space commitment under certain circumstances prior to the expiration of the lease were carried forward.
Founders’ Loan
The Company has loans outstanding with members of its board of directors. (See Note 10 “Debt.”)
Other
On October 18, 2012, Gehrig H. White, a director, purchased a 33% interest in Gaming Equipment Rental Co., LLC (“Gaming Equipment”) a customer of the Company at that time, for an investment of $10,000 in cash. Gaming Equipment operated a charity gaming facility in Ohio and leased gaming equipment from the Company. During August 2013, Mr. White and Gaming Equipment Rental Co, LLC entered into Interest Purchase Agreement whereby Mr. White’s initial investment of $10,000 was refunded to him in full by Gaming Equipment and his ownership interest in Gaming Equipment ceased as of that date.
Revenue from Gaming Equipment of $212,760 and $148,258 was recognized for the years ended December 31, 2013 and December 31, 2012, respectively. Effective as of June 30, 2013, the Company and Gaming Equipment agreed to convert $82,055 of trade accounts receivable to an unsecured note with payments due monthly over a 24 month term. On September 7, 2013, Gaming Equipment ceased operations in response to a notice it received from the Attorney General of Ohio. The notice indicated that, in the opinion of the Attorney General of Ohio, any gaming device containing a video screen was deemed to be a slot machine under state regulatory definitions and, therefore, was not permitted under current charity gaming regulations.
As of September 30, 2013, the Company wrote off outstanding accounts and notes receivable totaling $227,198 due from Gaming Equipment as they were deemed to be uncollectible following the closure of the facility. As of December 31, 2012, the accompanying Consolidated Balance Sheets included $78,858 of trade accounts receivable from Gaming Equipment.
Note 15. Segment Information
The Company reports segment information based on the “management approach.” The management approach designates the internal reporting used by management for making decisions and assessing performance as the source of the Company’s reportable segments. Following the Company’s exit from its amusement business, the Company’s operations are entirely focused on gaming products. Based on the criteria specified in ASC Topic 280, Segment Reporting, the Company has one reportable segment. The results of operations for the amusement products have been reported as discontinued operations for all periods presented.
For the year ended December 31, 2013, five customers accounted for approximately 76.7% of our total revenues from continuing operations, with one accounting for 39.0%, a second accounting for 19.8%, a third accounting for 7.2%, a fourth accounting for 6.1%, and a fifth accounting for 4.6%. The loss of any of these customers or changes in our relationship with any of them could have a material adverse effect on our business.
Revenues by geographic area are determined based on the location of the Company’s customers. For fiscal 2013 and 2012, revenues from customers outside the United States accounted for 33.0% and 23.3% of consolidated revenue, respectively. The following is revenues and long-lived assets by geographic area as of and for the years ended December 31:
Note 16. Commitments and Contingencies
Leases
The Company leases its corporate office and manufacturing facility. The lease requires the Company to pay insurance and maintenance. This facility is approximately 14,400 square feet and is located in Matthews, North Carolina. This facility is leased by an entity owned and controlled by the Company’s President and Vice Chairman of the Board of Directors. In February 2013 the Company exercised an option to extend this lease through August 31, 2016. (See Note 14 - “Related Party Transactions.”)
During the year ended December 31, 2013, the Company, as lessor, leased a portion of the Company’s leased office space under a three-year operating lease agreement. The lease has two, one-year renewal options at rents to be determined at renewal. The lease provides that the lessee is required to make rental payments of $1,600 per month.
The Company also leases certain equipment under lease agreements with terms up to two years and storage facilities.
Information with respect to the rents to be received/paid under the leases described above is summarized as follows:
Rent expense for the years ended December 31, 2013 and 2012 was $135,000 and $135,000, respectively. Rent income for the years ended December, 31, 2013 and 2012 was $8,000 and none, respectively.
Employment Agreements
The Company has entered into employment agreements with certain officers that include commitments related to base salaries and certain benefits. These agreements have terms of two years.
Reviews and Audits by Regulatory Authorities
The Company’s operations are subject to a number of regulatory authorities, including various gaming regulators, the Internal Revenue Service, and other state and local authorities. From time to time, the Company is notified by such authorities of reviews or audits they wish to conduct. The Company may be subject to other income, property, sales and use, or franchise tax audits in the normal course of business.
Indemnification
The Company has entered into a indemnification agreements with the members of its Board and corporate officers, which provides for indemnification for related expenses including attorneys’ fees, judgments, fines and settlement amounts incurred in any action or proceeding.
The Company also indemnifies its casino customers from any claims or suits brought by a third party alleging infringement of a United States patent, copyright or mask work right. The Company agrees to pay all costs and damages, provided the customer provides prompt written notice of any claim.
Legal Proceedings
The Company is subject to claims and assertions in the ordinary course of business. Legal matters are inherently unpredictable and the Company’s assessments may change based on future unknown or unexpected events.
The Company is not a party to any material legal proceeding as of the date hereof.
SCHEDULE II-VALUATION AND QUALIFYING ACCOUNTS AND RESERVES
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.
Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the registrant and in the capacities and on the dates indicated.
EXHIBIT INDEX
Exhibit No.
Description
3.1
Restated Articles of Incorporation (incorporated by reference to Exhibit 3.1 to our Registration Statement on Form S-1 filed on August 4, 2005 (No. 333-127181)).
3.1(a) Form of Articles of Amendment to the Restated Articles of Incorporation (incorporated by reference to Appendix A to our Definitive Schedule 14A filed on May 18, 2010).
3.2
Bylaws (as amended and restated through July 29, 2005) (incorporated by reference to Exhibit 3.2 to our Registration Statement on Form S-1 filed on August 4, 2005 (No. 333-127181)).
4.1
Specimen Common Stock certificate (incorporated by reference to Exhibit 4.1 to Amendment No. 2 to our Registration Statement on Form S-1 filed on October 5, 2005(No. 333-127181)).
10.1
Trademark Assignment Agreement among PokerTek, Inc., James Crawford and Gehrig H. White, effective July 13, 2005 (incorporated by reference to Exhibit 10.5 to our Registration Statement on Form S-1 filed on August 4, 2005 (No. 333-127181)).
10.2
PokerTek, Inc. 2007 Stock Incentive Plan (incorporated by reference to Exhibit 99 to our Registration Statement on Form S-8 filed on June 6, 2007 (No. 333-143552)).*
10.3
Form of Employee Incentive Stock Option Agreement for PokerTek, Inc. 2007 Stock Incentive Plan (incorporated by reference to Exhibit 10.3 to our Form 10-Q for the quarterly period ending June 30, 2007 filed on August 14, 2007).*
10.4
Form of Employee Nonqualified Stock Option Agreement for PokerTek, Inc. 2007 Stock Incentive Plan (incorporated by reference to Exhibit 10.4 to our Form 10-Q for the quarterly period ending June 30, 2007 filed on August 14, 2007).*
10.5
Form of Director Nonqualified Stock Option Agreement for PokerTek, Inc. 2007 Stock Incentive Plan (incorporated by reference to Exhibit 10.5 to our Form 10-Q for the quarterly period ending June 30, 2007 filed on August 14, 2007).*
10.6
Form of Independent Contractor Nonqualified Stock Option Agreement for PokerTek, Inc. 2007 Stock Incentive Plan (incorporated by reference to Exhibit 10.6 to our Form 10-Q for the quarterly period ending June 30, 2007 filed on August 14, 2007).*
10.7
Form of Restricted Stock Award Agreement for PokerTek, Inc. 2007 Stock Incentive Plan (incorporated by reference to Exhibit 10.7 to our Form 10-Q for the quarterly period ending June 30, 2007 filed on August 14, 2007).*
10.8
PokerTek, Inc. 2005 Stock Incentive Plan (incorporated by reference to Exhibit 10.6 to our Registration Statement on Form S-1 filed on August 4, 2005 (No. 333-127181)).*
10.9
Form of Stock Option Agreement for PokerTek, Inc. 2005 Stock Incentive Plan (incorporated by reference to Exhibit 10.7 to Amendment No. 1 to our Registration Statement on Form S-1 filed on September 13, 2005 (No. 333-127181)).*
10.10
Form of Non-Employee Director Stock Option Agreement for PokerTek, Inc. 2005 Stock Incentive Plan (incorporated by reference to Exhibit 99.2 to our Current Report on Form 8-K filed on March 6, 2006).*
10.11
PokerTek, Inc. 2004 Stock Incentive Plan (as amended and restated through July 29, 2005) (incorporated by reference to Exhibit 10.8 to our Registration Statement on Form S-1 filed on August 4, 2005 (No. 333-127181)).*
10.12
Form of Stock Option Agreement for 2004 Stock Incentive Plan (incorporated by reference to Exhibit 10.9 to our Registration Statement on Form S-1 filed on August 4, 2005(No. 333-127181)).*
10.13
Note Purchase Agreement by and between PokerTek, Inc. and Lyle A. Berman, James T. Crawford, III, Arthur Lee Lomax and Gehrig H. “Lou” White, dated March 24, 2008 (incorporated by reference to Exhibit 10.4 to our Form 10-Q for the quarterly ended March 31, 2008 filed on May 15, 2008).
10.14
Loan and Security Agreement, effective July 25, 2008, between PokerTek, Inc. and Silicon Valley Bank (incorporated by reference to Exhibit 10.1 to our Form 10-Q for the quarterly period ended June 30, 2008 filed August 14, 2008).
10.15
Export-Import Bank Loan and Security Agreement, dated July 25, 2008, between PokerTek, Inc. and Silicon Valley Bank (incorporated by reference to Exhibit 10.2 to our Form 10-Q for the quarterly period ended June 30, 2008 filed August 14, 2008).
10.16
Borrower Agreement, dated July 25, 2008, made and entered into by PokerTek, Inc. in favor of the Export-Import Bank of the United States and Silicon Valley Bank (incorporated by reference to Exhibit 10.3 to our Form 10-Q for the quarterly period ended June 30, 2008 filed on August 14, 2008).
10.17
First Amendment to Loan and Security Agreement, dated December 23, 2008, between PokerTek, Inc. and Silicon Valley Bank (incorporated by reference to Exhibit 10.1 to our Form 10-Q for the quarterly period ended March 31, 2009 filed on May 14, 2009).
10.18
First Amendment to Export-Import Bank Loan and Security Agreement, dated December 23, 2008, between PokerTek, Inc. and Silicon Valley Bank (incorporated by reference to Exhibit 10.2 to our Form 10-Q for the quarterly period ended March 31, 2009 filed on May 14, 2009).
10.19
Second Amendment to Loan and Security Agreement, dated July 23, 2009, between PokerTek, Inc. and Silicon Valley Bank (incorporated by reference to Exhibit 10.1 to our Form 10-Q for the quarterly period ended June 30, 2009 filed on August 14, 2009).
10.20
Second Amendment to Export-Import Bank Loan and Security Agreement, dated July 23, 2009, between PokerTek, Inc. and Silicon Valley Bank (incorporated by reference to Exhibit 10.2 to our Form 10-Q for the quarterly period ended June 30, 2009 filed on August 14, 2009).
10.21
Indemnification Agreement, dated July 15, 2009, between PokerTek, Inc. and Joseph J. Lahti (incorporated by reference to Exhibit 10.7 to our Form 10-Q for the quarterly period ended June 30, 2009 filed on August 14, 2009).
10.22
Indemnification Agreement, dated July 15, 2009, between PokerTek, Inc. and Arthur L. Lomax (incorporated by reference to Exhibit 10.8 to our Form 10-Q for the quarterly period ended June 30, 2009 filed on August 14, 2009).
10.23
Indemnification Agreement, dated July 15, 2009, between PokerTek, Inc. and James T. Crawford, III (incorporated by reference to Exhibit 10.9 to our Form 10-Q for the quarterly period ended June 30, 2009 filed on August 14, 2009).
10.24
Indemnification Agreement, dated July 15, 2009, between PokerTek, Inc. and Gehrig H. White (incorporated by reference to Exhibit 10.10 to our Form 10-Q for the quarterly period ended June 30, 2009 filed on August 14, 2009).
10.25
Indemnification Agreement, dated July 15, 2009, between PokerTek, Inc. and Mark D. Roberson (incorporated by reference to Exhibit 10.11 to our Form 10-Q for the quarterly period ended June 30, 2009 filed on August 14, 2009).
10.26
Amendment No. 1 to a $2.0 million Secured Promissory Note between PokerTek, Inc. and Lyle Berman, Gehrig H. White, James T. Crawford, III, and Arthur L. Lomax, effective as of July 9, 2009 (incorporated by reference to Exhibit 10.14 to our Form 10-Q for the quarterly period ended June 30, 2009 filed on August 14, 2009).
10.27
Amendment No. 2 to Secured Promissory Note and Amendment No. 1 to Note Purchase Agreement and Security Agreement, dated September 10, 2009 (incorporated by reference to Exhibit 10.2 to our Form 10-Q for the quarterly period ended September 30, 2009 filed on November 13, 2009).
10.28
PokerTek, Inc. 2009 Stock Incentive Plan (incorporated by reference to Appendix A to our Definitive Schedule 14A filed on August 7, 2009).*
10.29
Third Amendment to Loan and Security Agreement, dated August 27, 2010, between us and Silicon Valley Bank (incorporated by reference to Exhibit 10.2 from our Form 10-Q filed on November 15, 2010).
10.30
Amendment to the PokerTek, Inc. 2009 Stock Incentive Plan effective as of June 2, 2011 (incorporated by reference to Appendix A to our Definitive Schedule 14A filed on April 29, 2011).*
10.31
Loan Modification Agreement, dated June 2, 2011, by and among us and our founders (incorporated by reference to Exhibit 10.1 from our Form 8-K filed on June 7, 2011).
10.32
Employment letter, dated March 4, 2014, from us to Mark D. Roberson (incorporated by reference to Exhibit 10.2 from Current Report on Form 8-K filed on March 4, 2014).*
10.33
Employment letter, dated March 4, 2014, from us to James T. Crawford (incorporated by reference to Exhibit 10.3 from Current Report on Form 8-K filed on March 4, 2014).*
10.34
Office/Warehouse Lease Amendment No. 2 between us and Crawford White Investments, LLC dated August 11, 2011 (incorporated by reference to Exhibit 10.1 from our Form 10-Q filed on August 8, 2011).
10.35
Fifth Amendment to the Loan and Security Agreement between us and Silicon Valley Bank (incorporated by reference to Exhibit 10.1 from our Form 8-K filed on November 14, 2011)
10.36
Sixth Amendment to the Loan and Security Agreement between us and Silicon Valley Bank (incorporated by reference to Exhibit 10.1 from our Form 8-K filed on February 23, 2012).
10.37
Seventh Amendment to the Loan and Security Agreement between us and Silicon Valley Bank (incorporated by reference to Exhibit 10.1 from our Form 8-K filed on March 7, 2013).
10.38
Eighth Amendment to the Loan and Security Agreement between us and Silicon Valley Bank (incorporated by reference to Exhibit 10.1 from Current Report on Form 8-K filed on March 4, 2014).
10.39
Form of Employee Incentive Stock Option Agreement for the PokerTek, Inc. 2009 Stock Incentive Plan (incorporated by reference to Exhibit 10.38 from our Form 10-K for the year ended December 31, 2011 filed on March 27, 2012).*
10.40
Form of Employee Nonqualified Stock Option Agreement for the PokerTek, Inc. 2009 Stock Incentive Plan (incorporated by reference to Exhibit 10.39 from our Form 10-K for the year ended December 31, 2011 filed on March 27, 2012).*
10.41
Form of Director Nonqualified Stock Option Agreement for the PokerTek, Inc. 2009 Stock Incentive Plan (incorporated by reference to Exhibit 10.40 from our Form 10-K for the year ended December 31, 2011 filed on March 27, 2012).*
10.42
Form of Independent Contractor Nonqualified Stock Option Agreement for the PokerTek, Inc. 2009 Stock Incentive Plan (incorporated by reference to Exhibit 10.41 from our Form 10-K for the year ended December 31, 2011 filed on March 27, 2012).*
10.43
Form of Restricted Stock Award Agreement for the PokerTek, Inc. 2009 Stock Incentive Plan (incorporated by reference to Exhibit 10.42 from our Form 10-K for the year ended December 31, 2011 filed on March 27, 2012).*
10.44
Form of Loan Modification Agreement, dated as of July 23, 2012, by and among the Registrant and Gehrig White and Arthur Lomax (incorporated by reference to Exhibit 10.1 from our Form 8-K filed on July 27, 2012).
List of Subsidiaries (incorporated by reference to Exhibit 21 from our Form 10-K for the year ended December 31, 2011 filed on March 27, 2012).
Consent of Independent Registered Public Accounting Firm
31.1
Certification of Chief Executive Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.
31.2
Certification of Chief Financial Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.
32.1
Certification of Chief Executive Officer and Chief Financial Officer pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.
101.INS
XBRL Instance Document.
101.SCH
XBRL Taxonomy Extension Schema.
101.CAL
XBRL Taxonomy Calculation Linkbase.
101.DEF
XBRL Taxonomy Extension Definition Linkbase.
101.LAB
XBRL Taxonomy Extension Label Linkbase.
101.PRE
XBRL Taxonomy Extension Presentation Linkbase.
*
Compensatory plan or arrangement or management contract