Table of Contents

 

 

 

**FORM 10-Q**

 

**SECURITIESAND EXCHANGE COMMISSION**

**Washington,D.C. 20549**

 
| **x**                                                                                                                                                                                      | ** ** | **QUARTERLY REPORT PURSUANT TO SECTION 13  OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934**  |
|--------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|---------------------------------------------------------------------------------------------------------|
|                                                                                                                                                                                       |       |                                                                                                    |
| **For  the Quarterly Period Ended September 30, 2009**                                                                                                                                |
|                                                                                                                                                                                       |
| **OR**                                                                                                                                                                                     |
|                                                                                                                                                                                       |       |                                                                                                    |
| **o**                                                                                                                                                                                      | ** ** | **TRANSITION REPORT PURSUANT TO SECTION 13  OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934** |
|                                                                                                                                                                                       |       |                                                                                                    |
| **For  the transition period from              to              .** |

 

**Commissionfile number: 001-32161**

 

**ElixirGaming Technologies, Inc.**

(Exact name ofregistrant as specified in its charter)

 
| **Nevada**                                                       | ** ** | **91-1696010**                        |
|------------------------------------------------------------------|------------|---------------------------------------|
| (State or other  jurisdiction of  incorporation or organization) |       | (I.R.S. Employer  Identification no.) |

 

**Unit2B, 29/F, The Centrium**

**60Wyndham Street**

**Central,Hong Kong**

(Address ofprincipal executive offices, including zip code)

 

**+852-3151-3800**

(Registrant’stelephone number, including area code)

 

**Not Applicable**

(Former name,former address and former fiscal year, if changed since last report)

 

Indicate by check markwhether the registrant (1) has filed all reports required to be filed by Section 13or 15(d) of the Securities Exchange Act of 1934 during the preceding 12months (or for such shorter period that the registrant was required to file suchreports), and (2) has been subject to such filing requirements for thepast 90 days.  Yes x  No o

 

Indicate by check markwhether the registrant has submitted electronically and posted on its corporateWeb site, if any, every Interactive Data File required to be submitted andposted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter)during the preceding 12 months (or for such shorter period that the registrantwas required to submit and post such files).  Yes o  No o

 

Indicate by check markwhether the registrant is a large accelerated filer, an accelerated filer, anon-accelerated filer or a smaller reporting company (as defined in Rule 12b-2of the Act):

 
| Large  accelerated filer o                     | Accelerated  filer o         |
|------------------------------------------------|------------------------------|
|                                           |                         |
| Non-accelerated  filer o                       | Smaller reporting  company x |
| (Do not check if  a smaller reporting company) |                         |

 

Indicate by check markwhether the registrant is a shell company (as defined in Rule 12b-2 of theExchange Act).  Yes o  No x

 

As of November 10,2009, 114,956,667 shares of common stock of Elixir Gaming Technologies, Inc.were outstanding.

 

 

 

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Table of Contents

 

**Table of Contents**

 
| ** **                                    | ** **                                                                                      | **Page** |
|-----------------------------------------------|-------------------------------------------------------------------------------------------------|----------|
|                                          |                                                                                            |     |
| **PART I  — FINANCIAL INFORMATION** |
|                                          |                                                                                            |     |
| **Item 1.**                                   | **Financial Statements**                                                                        | 1        |
|                                          |                                                                                            |     |
|                                          | Consolidated Balance  Sheets                                                                    | 1        |
|                                          |                                                                                            |     |
|                                          | Consolidated  Statements of Operations                                                          | 2        |
|                                          |                                                                                            |     |
|                                          | Consolidated  Statements of Cash Flows                                                          | 3        |
|                                          |                                                                                            |     |
|                                          | Notes to  Consolidated Financial Statements                                                     | 4        |
|                                          |                                                                                            |     |
| **Item 2.**                                   | **Management’s  Discussion and Analysis of Financial Condition and Results of Operations** | 16       |
|                                          |                                                                                            |     |
|                                          | Overview                                                                                        | 17       |
|                                          |                                                                                            |     |
|                                          | Results of Operations                                                                           | 18       |
|                                          |                                                                                            |     |
|                                          | Liquidity and Capital  Resources                                                                | 25       |
|                                          |                                                                                            |     |
|                                          | Critical  Accounting Policies and Estimates                                                     | 26       |
|                                          |                                                                                            |     |
| **Item 3.**                                   | **Quantitative  and Qualitative Disclosures about Market Risk**                                 | 28       |
|                                          |                                                                                            |     |
| **Item 4.**                                   | **Controls and  Procedures**                                                                    | 28       |
|                                          |                                                                                            |     |
| **PART II — OTHER  INFORMATION**    |
|                                          |                                                                                            |     |
| **Item 5.**                                   | **Other Information**                                                                           | 30       |
|                                          |                                                                                            |     |
| **Item 6.**                                   | **Exhibits**                                                                                    | 30       |

 

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Table of Contents

 

**PART I — FINANCIALINFORMATION**

 

**Item 1.****                                  ****FinancialStatements**

 

**ELIXIR GAMING TECHNOLOGIES, INC. ANDSUBSIDIARIES**

 

**Consolidated Balance Sheets**

 
| ** **                                                                                                          | ** ** | **September 30, 2009** | ** ** | **December 31, 2008** | ** ** |
|---------------------------------------------------------------------------------------------------------------------|------------|----------------------------------|------------|---------------------------------|------------|
| ** **                                                                                                          | ** ** | **(Unaudited)**                  | ** ** | ** **                      | ** ** |
| **ASSETS**                                                                                                          |       |                             |       |                            |       |
| Current assets:                                                                                                     |       |                             |       |                            |       |
| Cash and cash equivalents                                                                                           |       | $                                | 4,669,902  |                            | $          | 14,504,433 |   |
| Accounts receivable, trade,  net of allowance for uncollectible of $392,870 in 2009 and $923,603 in  2008      |       | 2,260,455                        |       | 1,336,261                       |       |
| Due from a related party                                                                                            |       | 11,183                           |       | 531,109                         |       |
| Other receivables                                                                                                   |       | 131,280                          |       | 78,082                          |       |
| Inventories                                                                                                         |       | 394,141                          |       | 1,096,046                       |       |
| Prepaid expenses and other  current assets                                                                          |       | 6,593,755                        |       | 1,299,487                       |       |
| Total current assets                                                                                                |       | 14,060,716                       |       | 18,845,418                      |       |
|                                                                                                                |       |                             |       |                            |       |
| Gaming equipment and  systems, net of accumulated depreciation of $12,982,714 in 2009 and  $7,081,817 in 2008       |       | 42,102,286                       |       | 48,351,545                      |       |
| Property and equipment, net  of accumulated depreciation of $3,657,806 in 2009 and $2,917,153 in 2008               |       | 3,449,100                        |       | 3,724,467                       |       |
| Intangible assets, net of  accumulated amortization of $1,638,832 in 2009 and $2,356,271 in 2008                    |       | 3,127,769                        |       | 4,123,403                       |       |
| Goodwill                                                                                                            |       | 84,210                           |       | 84,210                          |       |
| Deposits and other assets                                                                                           |       | 981,854                          |       | 1,284,679                       |       |
| Total assets                                                                                                        |       | $                                | 63,805,935 |                            | $          | 76,413,722 |   |
|                                                                                                                |       |                             |       |                            |       |
| **LIABILITIES  AND STOCKHOLDERS’ EQUITY**                                                                      |       |                             |       |                            |       |
| Current liabilities:                                                                                                |       |                             |       |                            |       |
| Accounts payable                                                                                                    |       | $                                | 828,576    |                            | $          | 806,538 |   |
| Amount due to a related  party                                                                                      |       | 20,956                           |       | 27,672                          |       |
| Accrued expenses                                                                                                    |       | 1,855,390                        |       | 2,712,758                       |       |
| Deferred revenue                                                                                                    |       | 149,087                          |       | —                          |       |
| Short-term debt                                                                                                     |       | —                           |       | 29,372                          |       |
| Notes payable to a related  party, current portion                                                                  |       | 1,554,075                        |       | 5,884,049                       |       |
| Capital lease obligations,  current portion                                                                         |       | 211,540                          |       | 269,371                         |       |
| Customer deposits                                                                                                   |       | 98,424                           |       | 1,525,569                       |       |
| Liabilities related to  discontinued operations                                                                     |       | 247,609                          |       | —                          |       |
| Total current liabilities                                                                                           |       | 4,965,657                        |       | 11,255,329                      |       |
|                                                                                                                |       |                             |       |                            |       |
| Notes payable to a related  party, net of current portion                                                           |       | 7,724,281                        |       | 6,185,088                       |       |
| Capital lease obligations,  net of current portion                                                                  |       | 439,928                          |       | 468,424                         |       |
| Other liabilities                                                                                                   |       | 903,221                          |       | 525,986                         |       |
| Deferred tax liability                                                                                              |       | 842,301                          |       | 495,560                         |       |
| Total liabilities                                                                                                   |       | 14,875,388                       |       | 18,930,387                      |       |
|                                                                                                                |       |                             |       |                            |       |
| Stockholders’ equity:                                                                                          |       |                             |       |                            |       |
| Common stock, $.001 par  value, 300,000,000 shares authorized;  and 114,956,667 shares issued and  outstanding |       | 114,957                          |       | 114,957                         |       |
| Additional paid-in-capital                                                                                          |       | 414,762,732                      |       | 413,987,829                     |       |
| Accumulated other  comprehensive losses                                                                             |       | (1,336,877                       | )          | (2,107,842                      | )          |
| Accumulated deficit                                                                                                 |       | (364,610,265                     | )          | (354,511,609                    | )          |
| Total stockholders’ equity                                                                                     |       | 48,930,547                       |       | 57,483,335                      |       |
| Total liabilities and  stockholders’ equity                                                                    |       | $                                | 63,805,935 |                            | $          | 76,413,722 |   |

 

The notes to consolidated financial statements are an integral part ofthese consolidated statements.

 

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Table of Contents

 

**ELIXIR GAMING TECHNOLOGIES, INC. ANDSUBSIDIARIES**

 

**Consolidated Statements of Operations**

**(Unaudited)**

 
| ** **                                                  | ** ** | **Three Months Ended  September 30,** | ** **       | **Nine Months Ended September 30,** | ** ** |        |
|-------------------------------------------------------------|------------|--------------------------------------------|------------------|------------------------------------------|------------|-------------|
| ** **                                                  | ** ** | **2009**                                   | ** **       | **2008**                                 | ** ** | **2009**    | ** ** | **2008** | ** ** |   |
| Revenues:                                                   |       |                                       |             |                                     |       |        |   |   |   |   |
| Table game products                                         |       |                                       |             |                                     |       |        |   |   |   |   |
| Related party                                               |       | $                                          | —           |                                     | $          | 69,356      |   | $ | 2,975,769 |   | $ |  269,539 |   |   |
| Third party                                                 |       | 571,959                                    |             | 145,248                                  |       | 865,234     |   | 285,901 |   |   |
|                                                        |       | 571,959                                    |             | 214,604                                  |       | 3,841,003   |   | 555,440 |   |   |
| Gaming machine participation                                |       | 1,838,579                                  |             | 1,109,144                                |       | 4,527,376   |   | 2,396,673 |   |   |
| Non-gaming products                                         |       | 1,201,243                                  |             | 2,084,950                                |       | 2,718,537   |   | 6,146,407 |   |   |
|                                                        |       | 3,611,781                                  |             | 3,408,698                                |       | 11,086,916  |   | 9,098,520 |   |   |
| Operating costs and expenses:                               |       |                                       |             |                                     |       |        |   |   |   |   |
| Cost of gaming machine participation                        |       |                                       |             |                                     |       |        |   |   |   |   |
| Machine depreciation                                        |       | 2,533,508                                  |             | 2,255,045                                |       | 7,349,194   |   | 5,643,689 |   |   |
| Write-off of gaming assets                                  |       | 117,351                                    |             | —                                   |       | 496,331     |   | — |   |   |
| Other operating costs                                       |       | 370,203                                    |             | 446,068                                  |       | 885,736     |   | 655,366 |   |   |
| Cost of table game products                                 |       | 274,609                                    |             | 405,960                                  |       | 2,147,670   |   | 670,736 |   |   |
| Cost of non-gaming products                                 |       | 1,204,302                                  |             | 1,791,863                                |       | 2,955,187   |   | 5,262,733 |   |   |
| Selling, general and administrative                         |       | 1,790,759                                  |             | 5,239,356                                |       | 6,663,673   |   | 16,839,463 |   |   |
| Impairment of assets                                        |       | 424,500                                    |             | —                                   |       | 424,500     |   | 1,368,829 |   |   |
| Flood damage losses                                         |       | 98,450                                     |             | —                                   |       | 98,450      |   | — |   |   |
| Research and development                                    |       | 71,744                                     |             | 90,995                                   |       | 201,291     |   | 558,816 |   |   |
| Depreciation and amortization                               |       | 237,169                                    |             | 306,342                                  |       | 801,939     |   | 763,192 |   |   |
| Restructuring charges                                       |       | 3,876                                      |             | —                                   |       | 591,675     |   | 168,276 |   |   |
| Total operating costs and expense                           |       | 7,126,471                                  |             | 10,535,629                               |       | 22,615,646  |   | 31,931,100 |   |   |
|                                                        |       |                                       |             |                                     |       |        |   |   |   |   |
| Loss from operations                                        |       | (3,514,690                                 | )                | (7,126,931                               | )          | (11,528,730 | ) | (22,832,580 | ) |   |
|                                                        |       |                                       |             |                                     |       |        |   |   |   |   |
| Other income/(expense):                                     |       |                                       |             |                                     |       |        |   |   |   |   |
| Interest expense and finance fees                           |       | (145,815                                   | )                | (290,355                                 | )          | (394,011    | ) | (564,876 | ) |   |
| Interest income                                             |       | 10,297                                     |             | 107,420                                  |       | 74,729      |   | 629,606 |   |   |
| Foreign currency gain/(loss)                                |       | (16,324                                    | )                | (3,100                                   | )          | (78,853     | ) | 638,427 |   |   |
| Loss on disposition of assets                               |       | —                                     |             | —                                   |       | (93,698     | ) | (22,776 | ) |   |
| Other                                                       |       | 60,010                                     |             | 85,556                                   |       | 797,860     |   | 268,627 |   |   |
| Total other income/(expense)                                |       | (91,832                                    | )                | (100,479                                 | )          | 306,027     |   | 949,008 |   |   |
|                                                        |       |                                       |             |                                     |       |        |   |   |   |   |
| Loss before income tax and discontinued operations          |       | (3,606,522                                 | )                | (7,227,410                               | )          | (11,222,703 | ) | (21,883,572 | ) |   |
|                                                        |       |                                       |             |                                     |       |        |   |   |   |   |
| Income tax expense                                          |       | (68,548                                    | )                | —                                   |       | (367,642    | ) | (22,498 | ) |   |
|                                                        |       |                                       |             |                                     |       |        |   |   |   |   |
| Net loss from continuing operations                         |       | (3,675,070                                 | )                | (7,227,410                               | )          | (11,590,345 | ) | (21,906,070 | ) |   |
| Net profit/(loss) from discontinued operations, net  of tax |       | 4,919                                      |             | (89,494                                  | )          | 1,546,736   |   | (263,431 | ) |   |
|                                                        |       |                                       |             |                                     |       |        |   |   |   |   |
| Net loss                                                    |       | $                                          |  (3,670,151 | )                                        | $          | (7,316,904  | ) | $ | (10,043,609 | ) | $ |  (22,169,501 | ) |   |
|                                                        |       |                                       |             |                                     |       |        |   |   |   |   |
| Loss per share:                                             |       |                                       |             |                                     |       |        |   |   |   |   |
| Loss from continuing operations                             |       | (0.03                                      | )                | (0.06                                    | )          | (0.10       | ) | (0.19 | ) |   |
| Income from discontinued operations                         |       | 0.00                                       |             | (0.00                                    | )          | 0.01        |   |  (0.00 | ) |   |
| Basic and diluted loss per share                            |       | $                                          |  (0.03      | )                                        | $          |  (0.06 | ) | $ |  (0.09 | ) | $ |  (0.19 | ) |   |
|                                                        |       |                                       |             |                                     |       |        |   |   |   |   |
| Weighted average common shares outstanding                  |       | 114,956,667                                |             | 114,946,671                              |       | 114,956,667 |   | 114,945,602 |   |   |

 

The notes to consolidated financial statements are an integral part ofthese consolidated statements.

 

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**ELIXIR GAMING TECHNOLOGIES, INC. ANDSUBSIDIARIES**

 

**Consolidated Statements of Cash Flows**

**(Unaudited)**

 
| ** **                                                                   | ** ** | **Nine Months Ended September 30,** | ** **  |
|------------------------------------------------------------------------------|------------|------------------------------------------|-------------|
| ** **                                                                   | ** ** | **2009**                                 | ** **  | **2008** | ** ** |
| **Cash flows  from operating activities:**                                   |       |                                     |        |   |   |
| Net loss                                                                     |       | $                                        | (10,043,609 | ) | $ | (22,169,501 | ) |
| Adjustments to reconcile  net loss to net cash used in operating activities: |       |                                     |        |   |   |
| Income tax expense                                                           |       | 367,642                                  |        | 22,498 |   |
| Unrealised foreign currency  (gains)/losses                                  |       | 131,705                                  |        | (638,427 | ) |
| Impairment of assets                                                         |       | 424,500                                  |        | 1,368,829 |   |
| Flood damage losses                                                          |       | 98,450                                   |        | — |   |
| Depreciation of gaming  machines and systems and property and equipment      |       | 8,018,500                                |        | 6,230,422 |   |
| Restructuring charges                                                        |       | 38,195                                   |        | — |   |
| Amortization of intangible  assets                                           |       | 376,132                                  |        | 500,382 |   |
| Amortization of deferred  interest                                           |       | 22,400                                   |        | 20,000 |   |
| Amortization of prepaid  sales commission                                    |       | —                                   |        | 29,971 |   |
| Stock-based compensation  and warrant expense                                |       | 774,903                                  |        | 5,842,642 |   |
| Gain on sale of shuffler  business                                           |       | (1,962,016                               | )           | — |   |
| Loss on disposition of  assets                                               |       | 93,698                                   |        | 22,777 |   |
| Write-off of gaming assets                                                   |       | 496,331                                  |        | — |   |
| Write-down of inventory                                                      |       | (106                                     | )           | 28,412 |   |
| Provision for bad debt  expense                                              |       | 20,594                                   |        | 358,457 |   |
| Changes in operating assets  and liabilities:                                |       |                                     |        |   |   |
| Accounts receivable and  other receivables                                   |       | (722,073                                 | )           | (2,205,895 | ) |
| Inventories                                                                  |       | 141,382                                  |        | 304,515 |   |
| Prepaid expenses and other  current assets                                   |       | (5,189,892                               | )           | 209,352 |   |
| Deposits and other assets                                                    |       | (1,183,273                               | )           | (877,306 | ) |
| Accounts payable                                                             |       | (64,712                                  | )           | (1,196,402 | ) |
| Amount due from related  parties                                             |       | 562,013                                  |        | (1,076,993 | ) |
| Deferred revenue                                                             |       | 149,087                                  |        | — |   |
| Accrued expenses and other  current liabilities                              |       | (495,603                                 | )           | (999,417 | ) |
| Net cash used in operating  activities                                       |       | (7,945,752                               | )           | (14,225,684 | ) |
| ** **                                                                   |       |                                     |        |   |   |
| **Cash flows  from investing activities:**                                   |       |                                     |        |   |   |
| Purchase of property and  equipment                                          |       | —                                   |        | (1,278,898 | ) |
| Sale of shuffler business                                                    |       | 2,800,000                                |        | — |   |
| Purchase of gaming  machines, systems and deposits paid                      |       | (1,753,261                               | )           | (31,698,134 | ) |
| Sale of property and  equipment                                              |       | 79,261                                   |        | 41,054 |   |
| Net cash generated/(used)  in investing activities                           |       | 1,126,000                                |        | (32,935,978 | ) |
| ** **                                                                   |       |                                     |        |   |   |
| **Cash flows  from financing activities:**                                   |       |                                     |        |   |   |
| Proceeds from sale of  stock, warrants and options                           |       | —                                   |        | 70,803 |   |
| Repayment of short-term  debt and leases                                     |       | (258,833                                 | )           | (420,869 | ) |
| Repayment of notes payable                                                   |       | (2,905,327                               | )           | (2,930,864 | ) |
| Net cash used in financing  activities                                       |       | $                                        | (3,164,160  | ) | $ | (3,280,930 | ) |
|                                                                         |       |                                     |        |   |   |
| Effect of exchange rate  change on cash                                      |       | 149,381                                  |        | — |   |
| Decrease in cash and cash equivalents                                        |       | (9,834,531                               | )           | (50,442,592 | ) |
| Cash and cash equivalents  at beginning of period                            |       | 14,504,433                               |        | 68,286,820 |   |
| Cash and cash equivalents  at end of period                                  |       | $                                        | 4,669,902   |   | $ | 17,844,228 |   |
| ** **                                                                   |       |                                     |        |   |   |
| **Non-cash  investing and financing activities:**                            |       |                                     |        |   |   |
| Conversion of related party  payables to trade credit facility agreement     |       | $                                        | —      |   | $ | 15,000,000 |   |
| ** **                                                                   |       |                                     |        |   |   |
| **Supplemental  disclosure of cash flows information**                       |       |                                     |        |   |   |
| Interest paid                                                                |       | $                                        | 319,762     |   | $ | 461,181 |   |

 

The notes to consolidated financial statements are an integral part ofthese consolidated statements.

 

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**ELIXIRGAMING TECHNOLOGIES, INC. AND SUBSIDIARIES**

**Notes to Consolidated Financial Statements**

(Unaudited)

 

**Note1.****                                 ****Description of Businessand Significant Accounting Policies**

 

The principal business activities of Elixir GamingTechnologies, Inc. and its subsidiaries (the “Company”) are the owning andleasing of electronic gaming machines placed in resorts, hotels, and othervenues across certain countries in Asia and the developing and distributing ofproducts related to the gaming and automotive industries. These productsinclude RFID casino chips and component parts for the automotive industry.

 

***Basis ofPresentation***

 

The accompanying unaudited consolidated financialstatements have been prepared in accordance with accounting principlesgenerally accepted in the United States (U.S.) for interim financialinformation and with the instructions to Form 10-Q and Rule 8-03 ofRegulation S-X promulgated by the Securities and Exchange Commission (“SEC”)and reflect all adjustments, consisting of normal recurring adjustments andother adjustments, which management believes are necessary to fairly presentthe financial position, results of operations and cash flows of the Company,for the respective periods presented. The results of operations for an interimperiod are not necessarily indicative of the results that may be expected forany other interim period or the year as a whole. The accompanying unauditedconsolidated financial statements should be read in conjunction with theconsolidated financial statements and notes thereto in the Company’s AnnualReport on Form 10-K for the year ended December 31, 2008, filed withthe SEC on March 30, 2009.

 

***Principles ofConsolidation***

 

These consolidated financial statements include theaccounts of Elixir Gaming Technologies, Inc. and its subsidiaries. Allintercompany accounts and transactions have been eliminated.

 

***Use of Estimates***

 

The Company is required to make estimates, judgmentsand assumptions that it believes are reasonable based on its historicalexperience, contract terms, observance of known trends in the Company and theindustry as a whole, and information available from other outsidesources.  These estimates affect the reported amounts of assets,liabilities, revenues and expenses and related disclosures of contingent assetsand liabilities.  On a regular basis, the Company evaluates its estimates,including those related to revenue recognition, product returns, long-livedassets, inventory obsolescence, stock-based compensation, income taxes, baddebts, warranty obligations, long-term contracts, contingencies andlitigation.  Actual results may differ from those estimates.

 

***Reclassifications***

 

Certain previously reported amounts have beenreclassified to conform to the current period presentation.

 

***Cash and CashEquivalents***

 

All highly liquid instruments with an originalmaturity of three months or less are considered cash equivalents.  TheCompany places its cash with financial institutions.  At September 30,2009, the Company had deposits with financial institutions in excess of FederalDeposit Insurance Corporation (FDIC) insured limits by $4.4 million.

 

***Accounts Receivableand Allowance for Doubtful Accounts***

 

Accounts receivable are stated at face value less anyallowance for doubtful accounts.  Allowance for doubtful accounts aremaintained at levels determined by Company management to adequately provide foruncollectible amounts.  In determining the estimated uncollected amounts,the Company evaluates a combination of factors, including, but not limited to,activity in the related market, financial condition of customers, specificcustomer collection experience and history of write-offs and collections.

 

***Inventories***

 

Inventories are stated at the lower of cost,determined using the first-in, first-out method, or market.  Cost elementsincluded in work-in-process and finished goods include raw materials, directlabor, and manufacturing overheads.

 

***Long-Lived Assets***

 

The Company accounts for impairment of long-livedassets in accordance with FASB ASC 360, *Accountingfor the Impairment or Disposal of Long-Lived Assets*.  Long-lived assets are reviewed for impairmentwhenever events or changes in circumstances indicate that the carrying amountof an asset may not be recoverable.  Insuch instances, the Company estimates the undiscounted future cash flows thatresult from the use of the asset and its ultimate disposition.  If the sum of the undiscounted cash flows isless than the carrying value, the Company recognizes an impairment loss,measured as the amount by which the carrying value exceeds the fair value ofthe asset, determined principally using discounted cash flows.  There are no impairment charges forlong-lived assets for the three months ended September 30, 2009.

 

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***Prepaids, Depositsand Other Current Assets***

 

Prepaids, deposits and other current assets consistprimarily of prepaid value-added taxes in foreign countries, sales tax indispute and deposits.  The Company hasrestricted cash in the amount of $100,000, in the form of a certificate ofdeposit as security on a lease.  Therestriction for the security deposit will be removed in February 2012 upontermination of the lease.  Restrictedcash has been recorded in deposits and other assets in the accompanyingconsolidated balance sheets.

 

During the three-month period ended September 30,2009, the Company paid commitment fees of $5.84 million, to a venue operator inCambodia as a consideration to place additional machines on the casino floor ofthat venue. The Company will be entitled to extra net win sharing until theamount is fully recouped. This amount is recorded as an advance and will beoffset as a reduction of participation revenue upon recoupment of the same orany part thereof.  As of September 30,2009, the Company had a commitment fee balance of $5,540,235 included inprepaids, deposits and other current assets.

 

***ConsignmentInventory***

 

As of September 30, 2009 and December 31,2008, the Company had consignment inventory, service supplies and parts of $NILand $235,318, net of provisions for obsolescence of $NIL and $372,698,respectively.  Revenue is not recognized until ownership of products andtitles pass to the distributor, which occurs upon the distributor’s use of theproducts evidenced by a purchase order or sales to third-party customers.

 

***Gaming Machines andSystems***

 

Gaming machines and systems are stated at cost. The Company depreciates new gaming machines and systems over a five-year usefullife and depreciates refurbished gaming machines over a three-year useful lifeonce placed in service. Depreciation of gaming machines and systems of$2,533,508 and $2,255,045 and $7,349,194 and $5,643,689 are included in cost ofgaming machine participation in the consolidated statements of operations forthe three-month and nine-month periods ended September 30, 2009 and 2008,respectively. Any subsequent costs relating to gaming machine redeployments areexpensed in the period when incurred. During the three-month period ended September 30,2009, the Company incurred approximately $150,000 in machine redeployment costs.

 

***Flood Damage Losses***

**During thethree-month period ended September 30, 2009, the Metro-Manila area of thePhilippines was struck by numerous storms, which produced large typhoons in thearea.  During the strongest of the typhoons, certain casinos and venueswere flooded and the Company’s gaming machines placed in these casinos/venuestherein were either damaged or destroyed entirely. The preliminary assessmentshows total cost of the damage related to this event being approximately$146,000; of which the entire amount (less deductible) is expected to be fullycovered by the Company’s property insurance policy on the gaming machines. TheCompany recorded the deductible amount of $98,450 on the insurance policy,which has been separately presented in the Consolidated Statements ofOperations.

 

***Property andEquipment***

 

Property and equipment items are stated at cost.Depreciation is computed using the straight-line method over the useful livesof the assets currently estimated to be three to five years, which in the caseof leasehold improvements, is limited to the lives of the leases and throughoutthe renewal period so long as renewal is reasonably assured. Depreciation ofproperty and equipment of $68,322 and $100,135 and $243,520 and $307,192 isincluded in cost of operations (gaming products or non-gaming products) in theconsolidated statements of operations for the three-month and nine-monthperiods ended September 30, 2009 and 2008, respectively.

 

***Intangible Assets,including Goodwill***

 

Intangible assets consist of patents, customerrelationships, trademarks and goodwill. They are recorded at cost and areamortized, except goodwill, on the straight-line basis over the period of timethe asset is expected to contribute directly or indirectly to future cash flows,which ranges from ten to 13 years. The straight-line amortization methodis utilized because the Company believes there is not a more reliablydeterminable method of reflecting the pattern for which the economic benefitsof the intangible assets are 

 

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consumed or otherwise used.

 

The Company measures and tests goodwill and intangibleassets for impairment in accordance with FASB ASC 350, *Goodwill and Other Intangible Assets*, and FASBASC 360, *Accounting for the Impairment orDisposal of Long-Lived Assets*, at least annually on December 31or more often if there are indicators of impairment.

 

***Litigation and OtherContingencies***

 

The Company may be involved in legal matters,litigation and claims of various types in the ordinary course of its businessoperations. The Company has regular litigation reviews, including updates fromcorporate and outside counsel, to assess the need for accounting recognition ordisclosure of these contingencies. The status of a significant legal matter issummarized in Note 17.

 

FASB ASC 450, *Accountingfor Contingencies,* requires that liabilities for contingencies berecorded when it is probable that a liability has been incurred and that theamount can be reasonably estimated. Significant management judgment is requiredrelated to contingent liabilities and the outcome of litigation because bothare difficult to predict. For contingencies for which unfavorable outcomes arereasonably possible and which are significant, the Company discloses the natureof the contingency and, where feasible, estimates of the possible losses.

 

***Revenue Recognition***

 

The Company recognizes revenue when all of thefollowing have been satisfied:

 

·                  persuasive evidence of an arrangement exists;

·                  the price to the customer is fixed and determinable;

·                  delivery has occurred and any acceptance terms havebeen fulfilled;

·                  no significant contractual obligations remain; and

·                  collection is reasonably assured.

 

*Gaming and Non-Gaming ProductsRevenues*

 

The Company recognizes revenue from the sale of itsproducts to end users upon shipment against customer contracts or purchaseorders.

 

The Company recognizes revenue from its sales toindependent distributors upon shipments to the distributors against distributorcontracts or purchase orders for products.  The Company recognizes revenueon consignment inventory when ownership of product and title passes to the distributor,which occurs upon the distributor’s use of the product in its serviceorganization or sale to an end user.

 

*Participation Revenues*

 

The Company earns recurring revenue by providingcustomers with electronic gaming machines and casino management systems whichtrack game performance and provide statistics on installed electronic gamingmachines owned by the Company and leased to venue owners.  Revenues are recognized on the contractualterms of the participation agreements between the Company and the venue ownersand are based on the Company’s share of net winnings.

 

Revenues are recognizedas incurred with the exception of one of our venues for which revenues arerecognized as the payment for net winnings are received as the collections fromthis venue were not yet reasonably assured. Net winnings from this venue have been recorded as deferred revenueuntil the collections of such net winnings are reasonably assured.  Deferred revenue was $149,087 and $NIL as of September 30,2009 and December 31, 2008, respectively.

 

***Stock-BasedCompensation***

 

The Company adopted FASB ASC 718, *Share-Based Payments*, to account for allits stock-based compensation beginning January 1, 2006, and elected themodified prospective method of transition. Under the fair value recognitionprovisions of FASB ASC 718, for stock-based compensation accrued to employeesand non-employee directors, the Company recognizes stock-based compensationexpense for all service-based awards with graded vesting schedules on thestraight-line basis over the requisite service period for the entireaward.  Initial accruals of compensationexpense are based on the estimated number of shares for which requisite serviceis expected to be rendered.  Estimatesare revised if subsequent information indicates that forfeitures will differfrom previous estimates, and the cumulative effect on compensation cost of achange in the estimated forfeitures is recognized in the period of thechange.  For 

 

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non-employee awards, the Company remeasurescompensation cost each period until the service condition is complete andrecognizes compensation cost on the straight-line basis over the requisiteservice period.  Option valuation modelsrequire the input of highly subjective assumptions, and changes in theassumptions used can materially affect the fair value estimates. Judgment isrequired in estimating stock price volatility, forfeiture rates, expecteddividends, and expected terms that options remain outstanding.  Stock-based compensation expense totaled$328,733 and $1,475,063, and $774,903 and $5,842,642 for the three-month andnine-month periods ended September 30, 2009 and 2008, respectively, and isincluded in selling, general and administrative expense in the accompanyingconsolidated statements of operations.  See Note 12 for additionalinformation regarding these assumptions.

 

***Research andDevelopment Expenses***

 

Research and development costs are charged to expenseas incurred.  Employee related costs associated with product developmentare included in research and development costs. The Company incurred $71,744 and $90,995 and $201,291 and $558,816 inresearch and development expenses for the three-month and nine-month periodsended September 30, 2009 and 2008, respectively.

 

***Income Taxes***

 

The Company is subject to income taxes in the U.S.(including federal and state) and several foreign jurisdictions in which itoperates. Deferred income tax balances reflect the effects of temporarydifferences between the carrying amounts of assets and liabilities and theirtax basis and are stated at enacted tax rates expected to be in effect whentaxes are actually paid or recovered. FASB ASC 740, *Accounting for Income Taxes*, requires that deferred taxassets be evaluated for future realization and reduced by a valuation allowanceto the extent the Company believes a portion will not be realized. The Companyconsiders many factors when assessing the likelihood of future realization ofits deferred tax assets, including its recent cumulative earnings experienceand expectations of future taxable income by taxing jurisdiction, thecarry-forward periods available to the Company for tax reporting purposes, andother relevant factors.

 

The Company accounts for uncertain tax positions inaccordance with FASB ASC 740, which contains a two-step approach to recognizingand measuring uncertain tax positions. The first step is to evaluate the taxposition for recognition by determining if the weight of available evidenceindicates it is more likely than not that the position will be sustained onaudit, including resolution of related appeals or litigation processes, if any.The second step is to measure the tax benefit as the largest amount, which ismore than 50% likely of being realized upon ultimate settlement. TheCompany considers many factors when evaluating and estimating its tax positionsand tax benefits, which may require periodic****adjustmentsand which may not accurately anticipate actual outcomes.

 

The Company is subject to income tax examinations bytax authorities in the jurisdictions in which it operates. There are currentlyno income tax returns under examination by the U.S. Internal Revenue Service orany other major tax authorities.

 

***Loss Per Share***

 

Basic loss per share is computed by dividing thereported net loss by the weighted average number of shares of common stockoutstanding during the year. There is no difference in diluted loss per sharefrom basic loss per share as the assumed exercise of common stock equivalentswould have an anti-dilutive effect due to losses.

 

***Foreign CurrencyTranslations and Transactions***

 

The functional currency of the Company’s internationalsubsidiaries is the local currency.  For these subsidiaries, the Companytranslates the assets and liabilities at exchange rates in effect at thebalance sheet date and income and expense accounts at average exchange ratesduring the year.  Resulting currency translation adjustments are recordeddirectly to accumulated other comprehensive income/ (losses) withinstockholders’ equity.  Gains and losses resulting from transactions innon-functional currencies are recorded in operations.

 

***Fair ValueMeasurements***

 

Fair value is defined under FASB ASC 820 as theexchange price that would be received for an asset or paid to transfer aliability (an exit price) in the principal or most advantageous market for theasset or liability in an orderly transaction between market participants on themeasurement date. Valuation techniques used to measure fair value under FASBASC 820 must maximize the use of observable inputs and minimize the use ofunobservable inputs. The standard establishes a fair value hierarchy based onthree levels of input, of which the first two are considered observable and thelast unobservable.

 

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·                  Level 1 - Quoted prices in active marketsfor identical assets or liabilities. These are typically obtained fromreal-time quotes for transactions in active exchange markets involvingidentical assets.

 

·                  Level 2 - Input, other than quoted pricesincluded within Level 1, which are observable for the asset or liability,either directly or indirectly. These are typically obtained fromreadily-available pricing sources for comparable instruments.

 

·                  Level 3 - Unobservable input, where thereis little or no market activity for the asset or liability. This input reflectsthe reporting entity’s own assumptions of the data that participants would usein pricing the asset or liability, based on the best information availableunder the circumstances.

 

At September 30, 2009, cash and cash equivalentsincluded $601,736 in bank deposits, which are reported at fair value.  The fair values of cash and cash equivalents,restricted cash, accounts receivable and accounts payable approximate carryingvalues due to the short maturity of these items.

 

***Recently IssuedAccounting Standards***

 

The Financial AccountingStandards Board (FASB) issued FASB Accounting Standards Codification (ASC)effective for financial statements issued for interim and annual periods endingafter September 15, 2009. The ASC is an aggregation of previously issuedauthoritative U.S. generally accepted accounting principles (GAAP) in onecomprehensive set of guidance organized by subject area. In accordance with theASC, references to previously issued accounting standards have been replaced byASC references. Subsequent revisions to GAAP will be incorporated into the ASCthrough Accounting Standards Updates (ASU). 

 

In December 2007, FASB issued ASC 805, *Business Combinations,* which expands onthe required disclosures better defines the acquirer and the acquisition datein a business combination, and establishes principles for recognizing andmeasuring the assets acquired (including goodwill), the liabilities assumed andany non-controlling interests in the acquired business. FASB ASC 805 alsorequires an acquirer to record an adjustment to income tax expense for changesin valuation allowances or uncertain tax positions related to acquiredbusinesses. FASB ASC 805 is effective for all business combinations withan acquisition date in the first annual period following December 15,2008; early adoption is not permitted. The Company adopted this statement as ofJanuary 1, 2009 and the adoption has had no impact to the consolidatedfinancial statements.

 

In February 2008, the FASB amended ASC 820,**whichdeferred the effective date of ASC 820 for one year for certainnon-financial assets and non-financial liabilities. The Company adopted thisstatement as of January 1, 2009 and the adoption has had no impact on theCompany’s financial position and results of operations.

 

In April 2009, the FASB amended ASC 820, in which,if an entity determines that the level of activity for an asset or liabilityhas significantly decreased and that a transaction is not orderly, furtheranalysis of transactions or quoted prices is needed, and a significantadjustment to the transaction or quoted prices may be necessary to estimatefair value in accordance with FASB ASC 820. The Company adopted this amendment duringthe three-month period ended June 30, 2009 and there was no materialimpact on the financial position, results of operations or cash flows.

 

In April 2009, the FASB amended FASB ASC 825 and ASC270, *Interim Disclosures about Fair Value of FinancialInstruments.* The amendment requires an entity to provide disclosuresabout fair value of financial instruments in interim financial information.This amendment is to be applied prospectively and is effective for interim andannual periods ending after June 15, 2009 with early adoption beingpermitted for periods ending after March 15, 2009. The Company adoptedthis amendment in the three-month period ended June 30, 2009 and there wasno impact on the financial position, results of operations or cash flows.

 

In May 2009, the FASB issued ASC 855, *Subsequent Events.*  This Standard sets forth: 1) theperiod after the balance sheet date during which management of a reportingentity should evaluate events or transactions that may occur for potentialrecognition or disclosure in the financial statements; 2) the circumstancesunder which an entity should recognize events or transactions occurring afterthe balance sheet date in its financial statements; and 3) the disclosures thatan entity should make about events or transactions that occurred after thebalance sheet date. This Statement is effective for interim and annual periodsending after June 15, 2009. The Company adopted this statement during thethree-month period ended June 30, 2009 and there was no impact on thefinancial position, results of operations or cash flows.

 

**Note2.****                                 ****Segments**

 

The Company currently conducts business in threeoperating segments: (i) gaming machine participation operations; (ii) tablegame product operations, which after the sale of the shuffler and deck checkerassets that was completed in April 2009 consist exclusively of 

 

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gaming chips; and (iii) non-gaming productoperations, which consist primarily of the Dolphin Advanced Technologies PtyLtd (“Dolphin”) automotive components. The accounting policies of thesesegments are consistent with the Company’s policies for the accompanyingconsolidated financial statements.  Thefollowing table presents the financial information for each of the Company’soperating segments:

 
| ** **                                            | ** ** | **Three  Months Ended September 30,** | ** ** | **Nine  Months Ended September 30,** | ** ** |
|-------------------------------------------------------|------------|--------------------------------------------|------------|-------------------------------------------|------------|
| ** **                                            | ** ** | **2009**                                   | ** ** | **2008**                                  | ** ** | **2009** | ** ** | **2008** | ** ** |
| Revenues:                                             |       |                                       |       |                                      |       |   |   |   |   |
| Gaming machine  participation operations              |       | $                                          | 1,838,579  |                                      | $          | 1,109,144 |   | $ | 4,527,376 |   | $ | 2,396,673 |   |
| Table game  product operations                        |       | 571,959                                    |       | 214,604                                   |       | 3,841,003 |   | 555,440 |   |
| Non-gaming  product operations                        |       | 1,201,243                                  |       | 2,084,950                                 |       | 2,718,537 |   | 6,146,407 |   |
| Total revenues                                        |       | $                                          | 3,611,781  |                                      | $          | 3,408,698 |   | $ | 11,086,916 |   | $ | 9,098,520 |   |
|                                                  |       |                                       |       |                                      |       |   |   |   |   |
| Operating loss:                                       |       |                                       |       |                                      |       |   |   |   |   |
| Gaming machine  participation operations gross margin |       | $                                          | (1,182,483 | )                                         | $          | (1,591,969 | ) | $ | (4,203,885 | ) | $ | (3,902,382 | ) |
| Table game  product operations gross margin           |       | 297,350                                    |       | (191,356                                  | )          | 1,693,333 |   | (115,296 | ) |
| Non-gaming  product operations gross margin           |       | (3,060                                     | )          | 293,087                                   |       | (236,650 | ) | 883,674 |   |
| Corporate and  other operating costs and expenses     |       | (2,626,497                                 | )          | (5,636,693                                | )          | (8,781,528 | ) | (19,698,576 | ) |
| Total operating  loss                                 |       | $                                          | (3,514,690 | )                                         | $          | (7,126,931 | ) | $ | (11,528,730 | ) | $ | (22,832,580 | ) |
|                                                  |       |                                       |       |                                      |       |   |   |   |   |
| Depreciation and  amortization:                       |       |                                       |       |                                      |       |   |   |   |   |
| Gaming machine  participation operations              |       | $                                          | 2,533,508  |                                      | $          | 2,255,045 |   | $ | 7,349,194 |   | $ | 5,643,689 |   |
| Table game  product operations                        |       | 157,877                                    |       | 204,067                                   |       | 502,265 |   | 632,815 |   |
| Non-gaming  product operations                        |       | 25,447                                     |       | 74,637                                    |       | 67,551 |   | 206,013 |   |
| Corporate                                             |       | 122,143                                    |       | 132,317                                   |       | 475,622 |   | 248,287 |   |
| Total  depreciation and amortization                  |       | $                                          | 2,838,975  |                                      | $          | 2,666,066 |   | $ | 8,394,632 |   | $ | 6,730,804 |   |

 

Geographic segment revenues for the three-month andnine-month periods ended September 30, 2009 and 2008 are as follows:

 
| ** ** | ** ** | **Three  Months Ended September 30,** | ** ** | **Nine  Months Ended September 30,** | ** ** |
|------------|------------|--------------------------------------------|------------|-------------------------------------------|------------|
| ** ** | ** ** | **2009**                                   | ** ** | **2008**                                  | ** ** | **2009** | ** ** | **2008** | ** ** |
| Asia       |       | $                                          | 2,438,819  |                                      | $          | 1,323,748 |   | $ | 8,315,823 |   | $ | 3,001,886 |   |
| Australia  |       | 1,020,377                                  |       | 2,084,950                                 |       | 2,618,508 |   | 6,096,634 |   |
| Europe     |       | 61,352                                     |       | —                                    |       | 61,352 |   | — |   |
| Others     |       | 91,233                                     |       | —                                    |       | 91,233 |   | — |   |
|       |       | $                                          | 3,611,781  |                                      | $          | 3,408,698 |   | $ | 11,086,916 |   | $ | 9,098,520 |   |

 

For the three-month and nine-month periods ended September 30,2009, in the table game products segment, the largest customer represented 38%and 86%, respectively, of total gaming chip product sales. For the three-monthand nine-month periods ended September 30, 2009, within the non-gamingproducts segment, one customer represented 26% and 31%, respectively, of totalnon-gaming product sales. For the three-month and nine-month periods ended September 30,2009, in the gaming machine participation segment, one customer represented 54%and 51%, respectively, of total participation revenue.

 

**Note3.****                                 ****Inventories**

 

Inventories consist of the following:

 
| ** **                           | ** ** | **September 30,  2009** | ** ** | **December 31,  2008** | ** ** |
|--------------------------------------|------------|------------------------------|------------|-----------------------------|------------|
| ** **                           | ** ** | **(Unaudited)**              | ** ** | ** **                  | ** ** |
| Raw materials                        |       | $                            | 166,063    |                        | $          | 1,309,765 |   |
| Work-in-progress                     |       | —                       |       | 202,837                     |       |
| Finished goods                       |       | 261,366                      |       | 1,001,108                   |       |
|                                 |       | 427,429                      |       | 2,513,710                   |       |
| Less: allowances  and other reserves |       | (33,288                      | )          | (1,417,664                  | )          |
|                                 |       | $                            | 394,141    |                        | $          | 1,096,046 |   |

 

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**Note 4.****          ****Prepaid Expenses and Other CurrentAssets**

 

Prepaid expenses and other current assets consist ofthe following:

 
| ** **                         | ** ** | **September 30,  2009** | ** ** | **December 31,  2008** | ** ** |
|------------------------------------|------------|------------------------------|------------|-----------------------------|------------|
| ** **                         | ** ** | **(Unaudited)**              | ** ** | ** **                  | ** ** |
| Prepaid taxes                      |       | $                            | 351,183    |                        | $          | 276,042 |   |
| Prepayments to  suppliers          |       | 565,000                      |       | 172,500                     |       |
| Deposits on gaming  machine orders |       | 37,990                       |       | 740,209                     |       |
| Advance commitment fee             |       | 5,540,235                    |       | —                      |       |
| Other                              |       | 99,347                       |       | 110,736                     |       |
|                               |       | $                            | 6,593,755  |                        | $          | 1,299,487 |   |

 

**Note 5.****            ****Receivables**

 

Accounts and other receivables consist of thefollowing:

 
|                                   |   |   |   | **September 30,  2009** |      | **December 31,  2008** |   |
|----------------------------------------|--------|--------|--------|------------------------------|-----------|-----------------------------|--------|
|                                   |   |   |   | **(Unaudited)**              |      |                        |   |
| Trade accounts                         |   |   |   | $                            | 2,653,325 |                        | $      | 2,259,864 |   |
| Other                                  |   |   |   | 131,280                      |      | 78,082                      |   |
|                                   |   |   |   | 2,784,605                    |      | 2,337,946                   |   |
| Less: allowance for doubtful  accounts |   |   |   | (392,870                     | )         | (923,603                    | )      |
| Net                                    |   |   |   | $                            | 2,391,735 |                        | $      | 1,414,343 |   |

 

Bad debt (recovery) /expenses for the three-month andnine-month periods ended September 30, 2009 and 2008 were $(52,149) and$60,826 and $(65,518) and $366,810, respectively, which were recorded inselling, general and administrative expenses in the consolidated statements ofoperations.

 

**Note 6.****            ****Gaming Equipment and Systems**

 

The major categories of gaming equipment and systemsand accumulated depreciation consist of the following:

 
| ** **                      | ** ** | **Useful  Life  (years)** | ** ** | **September 30,  2009** | ** ** | **December 31,  2008** | ** ** |
|---------------------------------|------------|---------------------------|------------|------------------------------|------------|-----------------------------|------------|
| ** **                      | ** ** | ** **                | ** ** | **(Unaudited)**              | ** ** | ** **                  | ** ** |
| Gaming equipment                |       | 3 – 5                |       | $                            | 49,232,906 |                        | $          | 49,282,197 |   |
| Systems                         |       | 5                         |       | 5,852,094                    |       | 6,151,165                   |       |
|                            |       |                      |       | 55,085,000                   |       | 55,433,362                  |       |
| Less: accumulated  depreciation |       |                      |       | (12,982,714                  | )          | (7,081,817                  | )          |
|                            |       |                      |       | $                            | 42,102,286 |                        | $          | 48,351,545 |   |

 

Depreciation expenses for the three-month andnine-month periods ended September 30, 2009 and 2008 were $2,533,508 and$2,255,045,  and $7,349,194 and$5,643,689, respectively, which were recorded in cost of gaming machineparticipation in the consolidated statements of operations.

 

**Note 7.****            ****Property and Equipment**

 

Property and equipment consist of the following:

 
| ** **                                      | ** ** | **Useful  Life  (years)** | ** ** | **September 30,  2009** | ** ** | **December 31,  2008** | ** ** |
|-------------------------------------------------|------------|---------------------------|------------|------------------------------|------------|-----------------------------|------------|
| ** **                                      | ** ** | ** **                | ** ** | **(Unaudited)**              | ** ** | ** **                  | ** ** |
| Equipment rented by  customers                  |       | 3 – 5                |       | $                            | 14,606     |                        | $          | 14,606 |   |
| Equipment and vehicles,  furniture and fixtures |       | 3 – 5                |       | 6,274,272                    |       | 5,789,631                   |       |
| Leasehold improvements                          |       | 5                         |       | 818,028                      |       | 837,383                     |       |
|                                            |       |                      |       | 7,106,906                    |       | 6,641,620                   |       |
| Less accumulated  depreciation                  |       |                      |       | (3,657,806                   | )          | (2,917,153                  | )          |
|                                            |       |                      |       | $                            | 3,449,100  |                        | $          | 3,724,467 |   |

 

At September 30, 2009 and December 31, 2008,the Company’s rented property and equipment by customers that representedassets 

 

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held under capital leases was $14,606.

 

**Note 8.****            ****Intangible Assets, including Goodwill**

 

In accordance with FASB ASC 350 and FASB ASC 360, theCompany reviews goodwill and intangibles for impairment on an annual basis (December 31)or more frequently if events or circumstances indicate that the carrying valuesmay not be recoverable. During the three-month period ended September 30,2009, the Company recorded an impairment loss of $424,500, which relates to awrite down of an intangible asset associated with the chip washer patents.Except for this item, no circumstances during the three-month and nine-monthperiods ended September 30, 2009 indicated any further impairmentprovisions were necessary.

 

The Company’s definite-life intangible assets aresubject to amortization as follows:

 
| ** **                            | ** ** | **Useful  Life  (years)** | ** ** | **September 30,  2009** | ** ** | **December 31,  2008** | ** ** |
|---------------------------------------|------------|---------------------------|------------|------------------------------|------------|-----------------------------|------------|
| ** **                            | ** ** | ** **                | ** ** | **(Unaudited)**              | ** ** | ** **                  | ** ** |
| Patents                               |       | 10                        |       | $                            | 2,577,500  |                        | $          | 4,986,316 |   |
| Less:  impairment  provision     |       |                      |       |                         |       | (695,743                    | )          |
| Less:  accumulated  amortization |       |                      |       | (837,687                     | )          | (1,666,533                  | )          |
|                                  |       |                      |       |                         |       |                        |       |
| Customer relationships                |       | 10-13                     |       | 1,684,101                    |       | 1,684,101                   |       |
| Less:  accumulated  amortization |       |                      |       | (670,478                     | )          | (588,292                    | )          |
|                                  |       |                      |       |                         |       |                        |       |
| Trademarks                            |       | 10-13                     |       | 505,000                      |       | 505,000                     |       |
| Less:  accumulated  amortization |       |                      |       | (130,667                     | )          | (101,446                    | )          |
| Total                                 |       |                      |       | $                            | 3,127,769  |                        | $          | 4,123,403 |   |

 

At September 30, 2009 and December 31, 2008,the Company’s goodwill was $84,210.

 

**Note 9.****            ****Deposits and Other Assets**

 

Deposits and other assetsconsist of the following:

 
| ** **                        | ** ** | **September 30,  2009** | ** ** | **December 31,  2008** | ** ** |
|-----------------------------------|------------|------------------------------|------------|-----------------------------|------------|
| ** **                        | ** ** | **(Unaudited)**              | ** ** | ** **                  | ** ** |
| Office equipment rental  deposits |       | $                            | 89,356     |                        | $          | 83,613 |   |
| Sales tax in dispute              |       | 433,513                      |       | 433,513                     |       |
| Restricted cash                   |       | 112,058                      |       | 419,256                     |       |
| Prepaid value-added tax           |       | 345,434                      |       | 346,213                     |       |
| Other                             |       | 1,493                        |       | 2,084                       |       |
| Total                             |       | $                            | 981,854    |                        | $          | 1,284,679 |   |

 

**Note 10.****          ****Accrued Expenses**

 

Accrued expenses consist ofthe following:

 
| ** **                 | ** ** | **September 30,  2009** | ** ** | **December 31,  2008** | ** ** |
|----------------------------|------------|------------------------------|------------|-----------------------------|------------|
| ** **                 | ** ** | **(Unaudited)**              | ** ** | ** **                  | ** ** |
| Payroll and related  costs |       | $                            | 609,808    |                        | $          | 724,450 |   |
| Interest                   |       | 87,250                       |       | 150,864                     |       |
| Legal, accounting and  tax |       | 197,300                      |       | 23,141                      |       |
| Deposits from customers    |       | 148,167                      |       | 117,834                     |       |
| Accrued tax expenses       |       | 183,870                      |       | 9,518                       |       |
| Deferred rent              |       | 97,351                       |       | 47,790                      |       |
| Litigation (Note 17)       |       | 99,582                       |       | 1,066,190                   |       |
| Other                      |       | 432,062                      |       | 572,971                     |       |
| Total                      |       | $                            | 1,855,390  |                        | $          | 2,712,758 |   |

 

**Note 11.****          ****Debt and Capital Lease Obligations**

 

Debt and capital lease obligations consist of thefollowing:

 

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| ** **                                                                                                  | ** ** | **September 30,  2009** | ** ** | **December 31,  2008** | ** ** |
|-------------------------------------------------------------------------------------------------------------|------------|------------------------------|------------|-----------------------------|------------|
| ** **                                                                                                  | ** ** | **(Unaudited)**              | ** ** | ** **                  | ** ** |
| Note payable to a  related party with interest at 5% (Note 13)                                              |       | $                            | 9,278,356  |                        | $          | 12,069,137 |   |
| Short-term line of  credit at an Australian bank                                                            |       | —                       |       | 29,372                      |       |
| Capital lease  obligations to an Australian bank at various interest rates and collateralized  by equipment |       | 631,673                      |       | 663,400                     |       |
| Capital lease  obligations for furniture, tooling and equipment                                             |       | 19,795                       |       | 74,395                      |       |
| Total                                                                                                       |       | 9,929,824                    |       | 12,836,304                  |       |
| Less current portion                                                                                        |       | (1,765,615                   | )          | (6,182,792                  | )          |
| Long-term portion                                                                                           |       | $                            | 8,164,209  |                        | $          | 6,653,512 |   |

 

On November 6, 2008, in accordance with theamended Trade Credit Facility Agreement, Elixir International Limited (“ElixirInternational”), a wholly-owned subsidiary of Elixir Group Limited, which isthe principal shareholder of the Company, surrendered its initial advance of$15.0 million to the Company in exchange for a new promissory note for theoutstanding principal amount of $12.1 million. The outstanding principal and the interest accrued (revised from 8% to5%) thereon was to be repaid in 24 equal monthly installments reset from January 1,2009. On July 24, 2009, the Company entered into Amendment No. 2 tothe Trade Credit Facility Agreement with Elixir International to defer therepayment of principal and interest on the outstanding principal balance of $9.2million until July 2010.  Repaymentsin 18 equal monthly installments will resume on July 1, 2010.  (see Note 13).

 

**Note 12.****          ****Stock-Based Compensation**

 

**Options**

 

At the annual shareholders meeting on September 8,2008, a new stock option plan, the “2008 Stock Incentive Plan” (the “Plan”),was voted on and became effective January 1, 2009.

 

The Plan allows for incentive awards to eligiblerecipients consisting of:

 

·      Options to purchase shares of commonstock that qualify as incentive stock options within the meaning of theInternal Revenue Code;

 

·      Non-statutory stock options that do notqualify as incentive options;

 

·      Restricted stock awards; and

 

·      Performance stock awards, which aresubject to future achievement of performance criteria or be free of anyperformance or vesting.

 

The maximum number of shares reserved for issuanceunder the Plan is 5,000,000 and the exercise price shall not be less than 100%of the fair market value of one share of common stock on the date of grant,unless the participant owns more than 10% of the total combined voting power ofall classes of stock of the Company or any parent or subsidiary corporation ofthe Company, in which case the exercise price shall then be 110% of the fairmarket value.

 

During the three-month period ended March 31,2009, stock options for the purchase of 500,000 shares of common stock weregranted with a weighted average exercise price of $0.13 and weighted averagefair value of $0.12 and will vest over a six-month and one day period. Therewere no stock options granted during the three-month period ended September 30,2009.

 

Prior to January 1, 2009, the Company had twostock options plans, the Amended and Restated 1999 Stock Option Plan and theAmended and Restated 1999 Directors’ Stock Option Plan (the “Stock Option Plans”),through which 15,000,000 shares and 300,000 shares were authorized,respectively.  Both Stock Option Plansexpired on December 31, 2008.

 

In September 2007, stock options for the purchaseof 5,000,000 shares of common stock were granted by the board of directorsoutside of the Stock Option Plans pursuant to the initial closing of thetransactions under the Purchase and Product Participation Agreement (“ProductParticipation Agreement”) with Elixir Group Limited (“Elixir Group”), tocertain employees and non-employees of Elixir Group and their parent MelcoInternational Development Limited.  Each option had an exercise price of$2.90 per share and vested over three-year and five-year terms.

 

Options for the purchase of 12,433,262 shares ofcommon stock issued and outstanding under the Plan and Stock Option Plans andstock options for purchases of common stock granted in relation to the ProductParticipation Agreement have a weighted average exercise price of $1.86, aweighted average fair value of $0.32 and an aggregate intrinsic value of$613,666 as of September 30, 2009.

 

As of September 30, 2009, 7,326,577 stock optionswere exercisable with a weighted average exercise price of $2.27, a weighted 

 

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average fair value of $0.40, and an aggregateintrinsic value of $185,000.

 
| ** **                                 | ** ** | **Number  of  Shares** | ** ** | **Weighted  Average  Exercise Price** | ** ** | **Weighted  Average  Remaining  Contractual Life  (in years)** | ** ** | **Aggregate  Intrinsic  Value** | ** ** |
|--------------------------------------------|------------|------------------------|------------|---------------------------------------|------------|----------------------------------------------------------------|------------|---------------------------------|------------|
| Outstanding as of December 31,  2008  |       | 15,246,267             |       | $                                     | 2.28       |                                                           | 5.09       |                            | $          | 94,500 |   |
| Granted                                    |       | 500,000                |       | $                                     | 0.13       |                                                           | —     |                            | —     |   |
| Exercised                                  |       | —                 |       | —                                |       | —                                                         |       | —                          |       |
| Cancelled                                  |       | (3,313,005             | )          | $                                     | 3.55       |                                                           | —     |                            | $          | 59,334 |   |
| Outstanding as of September 30,  2009 |       | 12,433,262             |       | $                                     | 1.86       |                                                           | 4.02       |                            | $          | 613,666 |   |
| Exercisable as of September 30,  2009 |       | 7,326,577              |       | $                                     | 2.27       |                                                           | 3.28       |                            | 185,000    |   |

 

**Warrants**

 

A summary of the status of the Company’s warrantsoutstanding at September 30, 2009 and changes during the nine-month periodthen ended is presented in the table below.

 
| ** **                                                          | ** ** | **Warrants** | ** ** | **Weighted  Average  Exercise  Price** | ** ** | **Weighted  Average  Remaining  Contractual Life  (in years)** | ** ** | **Aggregate  Intrinsic  Value** | ** ** |
|---------------------------------------------------------------------|------------|--------------|------------|----------------------------------------|------------|----------------------------------------------------------------|------------|---------------------------------|------------|
| Warrants, as of December 31,  2008 and September 30, 2009 |       | 13,125,000   |       | $                                      | 1.84       |                                                           | 0.61       |                            | —     |   |
| Exercisable as of September 30,  2009                          |       | 13,125,000   |       | —                                 |       | —                                                         |       | —                          |       |
|                                                                     |            |              |            |                                        |            |                                                                |            |                                 |            |  |

 

There were no warrants granted, exercised or cancelledduring the three-month and nine-month periods ended September 30,2009.  Outstanding and exercisablewarrants have no aggregate intrinsic value as of September 30, 2009 due tothe fair market value of the Company’s stock as of that date.

 

*Recognition and Measurement*

 

The fair value of each stock-based award to employeesand non-employee directors is estimated on the measurement date which generallyis the grant date while awards to non-employees are measured at the earlier ofthe performance commitment date or the service completion date using theBlack-Scholes-Merton option-pricing model. Option valuation models require the input of highly subjectiveassumptions, and changes in assumptions used can materially affect the fairvalue estimates.  The Company estimatesthe expected life of the award by taking into consideration the vesting period,contractual term, historical exercise data, expected volatility, blackoutperiods and other relevant factors. Volatility is estimated by evaluating theCompany’s historical volatility data. The risk-free interest rate on the measurement date is based on U.S.Treasury constant maturity rates for a period approximating the expected lifeof the award.  The Company historicallyhas not paid dividends and it does not expect to pay dividends in theforeseeable future.  Therefore, theexpected dividend rate is zero.

 

The following table summarizes the range ofassumptions utilized in the Black-Scholes-Merton option-pricing model for thevaluation of stock options and warrants granted during the nine-month periodsended September 30, 2009 and 2008:

 
| ** **                | ** ** | **September 30,** | ** ** |
|---------------------------|------------|------------------------|------------|
| ** **                | ** ** | **2009**               | ** ** | **2008** | ** ** |
| ** **                | ** ** | **Low**                | ** ** | **High** | ** ** | **Low** | ** ** | **High** | ** ** |
| Range of values:          |       |                   |       |   |   |   |   |   |   |
| Expected volatility       |       | 303.32                 | %          | 303.32 | % | 60.00 | % | 63.59 | % |
| Expected dividends        |       | —                 |       | — |   | — |   | — |   |
| Expected term (in  years) |       | 3.73                   |       | 3.73 |   | 2.54 |   | 10.00 |   |
| Risk free rate            |       | 2.75                   | %          | 2.75 | % | 2.72 | % | 4.01 | % |

 

For stock-based compensation accrued to employees andnon-employee directors, the Company recognizes stock-based compensation expensefor all service-based awards with graded vesting schedules on the straight-linebasis over the requisite service period for the entire award.  Initial accruals of compensation expense arebased on the estimated number of shares for which requisite service is expectedto be rendered.  Estimates are revised ifsubsequent information indicates that forfeitures will differ from previousestimates, and the cumulative effect on compensation cost of a change in theestimated forfeitures is recognized in the period of the change.

 

For non-employee awards, the Company remeasurescompensation costs each period until the service condition is complete and 

 

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recognizes compensation costs on the straight-linebasis over the requisite service period.

 

The Company estimates forfeitures and recognizescompensation costs only for those awards expected to vest, assuming all awardswould vest, and reverses recognized compensation costs for forfeited awardswhen the awards are actually forfeited.

 

For awards with service conditions and graded vestingthat were granted prior to the adoption of FASB ASC 718, the Company estimatesthe requisite service period and the number of shares expected to vest, andrecognizes compensation expense for each tranche on the straight-line basisover the estimated requisite service period.

 

**Note 13.****          ****Related Party Transactions**

 

At September 30, 2009 and December 31, 2008,the note payable to Elixir International relating to purchases of electronicgaming machines, casino management systems and other peripherals hadoutstanding principal amounts of $9.3 million and $12.1 million, respectively.

 

On April 21, 2008, the Company entered into aTrade Credit Facility Agreement (the “Facility Agreement”) with ElixirInternational.  Pursuant to the FacilityAgreement, Elixir International provided trade credits to the Company for itspurchases of electronic gaming machines from Elixir International in exchangefor the Company’s issuance of unsecured notes to Elixir International bearinginterest at a fixed rate of eight percent (8.0%) per annum.  Titles for any gaming machines offered inexchange for the notes passed to the Company upon issuance of the notes.

 

Upon entering into the Facility Agreement, the Companyimmediately issued the first note pursuant to the terms of the FacilityAgreement in the then principal amount of $15,000,000 (the “Initial Advance”).  The Initial Advance extinguished a then tradepayable of an equivalent amount to Elixir International with respect to gamingmachines previously acquired.

 

Pursuant to the Facility Agreement, the Company wasobligated to repay the principal, plus any accrued interest thereon, of theInitial Advance in 24 equal monthly installments after the date of issue.  The Initial Advance is subject to demand byElixir International for immediate payment only if there is either an event ofdefault or a change of control as defined in the Facility Agreement. Pursuantto an amendment to the Facility Agreement dated November 6, 2008 betweenthe parties, Elixir International surrendered the note of Initial Advance tothe Company in exchange for the issuance of a new promissory note (“New Note”)for the then outstanding principal amount of $12.1 million with the followingnew repayment terms: (a)  the outstanding principal amount and theinterest accrued thereon shall be repaid in 24 equal monthly installments resetfrom January 1, 2009; (b) interest shall be accrued on theoutstanding principal at the rate of five percent (5.0%)  per annum starting from January 1, 2009;and no monthly repayment under the New Note is required for the months ofOctober, November and December 2008. On July 24, 2009, the Company entered into another agreement withElixir International to further amend the unsecured promissory note issued bythe Company. Under these recently amended note terms, which are effective as ofJuly 1, 2009, the Company is entitled to defer the repayment of principaland interest on the outstanding principal balance of the note of $9.2 millionuntil July 2010 with interest at the same rate of 5% continuing to accrue(see Note 11).

 

For the three-month and the nine-month periods ended September 30,2009 and 2008, the Company recorded sales of table game products to ElixirInternational of $NIL and $304,021 and $NIL and $373,377, respectively.

 

In addition, during the nine-month periods ended September 30,2009 and 2008, the Company recorded sales of gaming chip products of $NIL and$2,975,769, respectively, to Melco Crown Gaming (Macau) Limited.

 

**Note 14.****          ****Income Taxes**

 

Reported income tax rates for the nine-month periodsended September 30, 2009 and September 30, 2008 were (3.79)% and0.1%, respectively. For the three-month period ended September 30, 2009,the Company recorded taxable income from one of its foreign operations while itincurred a net loss from operations on a consolidated basis. Such foreignoperation is expected to continue to be profitable for the full year of 2009and, accordingly, tax expense is recorded in the three-month period ended September 30,2009 resulting in a negative effective tax rate.

 

**Note 15.****          ****Restructuring Charges**

 

Classified in accordance with FASB ASC 420, *Accounting for Cost Associated with Exit or DisposalActivities*, the Company incurred restructuring charges for thethree-month and nine-month periods ended September 30, 2009 and 2008 of $3,876and $NIL and $591,675 and $168,276, respectively for severance wages andbenefits related to the termination of employees and facility operating leasesvacated by the Company.  The amountsrepresent the contractual and other agreements with employees, which onlyinclude charges for termination benefits measured at the estimated fair valueat the termination date. They do not include charges for services 

 

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to be provided after the termination date.

 

**Note 16.****          ****Discontinued Operations**

 

On March 16, 2009, the Company entered into aPurchase and Settlement Agreement with Shuffle Master, Inc. (the “Purchaseand Settlement Agreement”) pursuant to which it sold to Shuffle Master itsportfolio of automated card verification machines and electronic card shufflingsystems, all related intellectual property, including but not limited to, thetrademarks of Random PlusTM, ShuffleProTM and Deck CheckerTM, and certaininventory of such products. The total consideration paid by Shuffle Masterunder the Purchase and Settlement Agreement was a base amount of $2.4 millionwith an additional $400,000 related to the purchase of inventories.  In April 2009, the Company delivered theinventory items and concluded the transaction, and this resulted in a gain onthe asset disposals of approximately $2.0 million.

 

In relation to this Purchase and Settlement Agreement,the Company terminated a distributorship arrangement of the relevant productswith a distributor in Europe and pursuant to the termination arrangement, theCompany is required to buy back certain inventories of the relevant productskept by the distributor. The estimated liability is $247,609 which is recordedas liabilities related to discontinued operations. After taking into accountsuch buy-back obligation, the Company recognized a gain relating to the assetdisposal of approximately $1.71 million in the three-month period ended June 30,2009.

 

As a result of the sale to Shuffle Master, the Chinafacility became redundant and, therefore, was completely closed at the end of April 2009.This operation was part of the table game segment and the Company classifiedthe China facility as discontinued operations.

 

The following table details selected financialinformation for the discontinued operations in the consolidated statements ofoperations.

 
| ** **                                              | ** ** | **Three  Months Ended September 30,** | ** ** | **Nine  Months Ended September 30,** | ** ** |
|---------------------------------------------------------|------------|--------------------------------------------|------------|-------------------------------------------|------------|
| ** **                                              | ** ** | **2009**                                   | ** ** | **2008**                                  | ** ** | **2009** | ** ** | **2008** | ** ** |
| Income/(loss) from  operations                          |       | $                                          | 4,919      |                                      | $          | (89,494) |   | $ | (167,671 | ) | $ | (263,431 | ) |
| Gain on disposal                                        |       | —                                     |       | —                                    |       | 1,714,407 |   | — |   |
| Income tax  benefit/(expense)                           |       | —                                     |       | —                                    |       | — |   | — |   |
| Income/(loss) from  discontinued operations, net of tax |       | $                                          | 4,919      |                                      | $          | (89,494 | ) | $ | 1,546,736 |   | $ | (263,431 | ) |

 

The estimated effective tax for discontinuedoperations is zero. Therefore, there is no income tax expense associated withthe gain on disposal and income/(loss) from operations.

 

**Note 17.****          ****Commitments and Contingencies**

 

**Legal Matters**

 

The Company was a party to a legal matter as discussedbelow.

 

*Sales Tax Audit*

 

In February 2004, the State of Nevada initiated asales/use tax audit of the Company’s equipment lessors. As of the date of thisfiling, the State of Nevada has not made a determination if there has been adouble tax payment of the sales/use tax. If the State of Nevada determines thatthere was a double tax payment, the outcome may be a refund to the Company.However, the matter is still under review by the Nevada Department of Tax. Asof September 30, 2009, the Company had a receivable balance $433,513relating to the possible refund. The Company will continue to assess thecollectability and make appropriate adjustments when necessary.

 

**Note 18.****          ****Loss Per Share**

 

Basic loss per share is computed by dividing thereported net loss for the period by the weighted average number of commonshares outstanding during the period.  Loss per share is unchanged on adiluted basis since the assumed exercise of common stock equivalents would havean anti-dilutive effect.

 

**Note 19.****          ****Subsequent Events**

 

The Company has evaluatedsubsequent events through November 10, 2009, the date on which thisQuarterly Report on Form 10-Q was filed with the Securities and ExchangeCommission.

 

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*Reduced Size of Board of Directors SupportsEnhanced Efficiency*

 

During the week of September 28, 2009, and inconnection with the recommendations by the Nominating Committee of the Board ofDirectors of the Company on right-sizing the Board of the Company as a means toenhance efficiency, the Company was advised by certain members of its Board ofDirectors, including Lorna Patajo-Kapunan, Maj. Gen. Paul A. Harvey, DanielSham and Ted Chan, that each did not intend to be nominated for re-election tothe Board of Directors at the Company’s 2009 Annual Meeting ofStockholders.  As a result of there-election of the five remaining board members at the Company’s annualshareholder meeting on October 30, 2009, the Company’s current board ofdirectors has been reduced to five from nine members.

 

*Chief Executive Officer Extends Employment Contract*

 

OnNovember 10, 2009, Mr. Clarence Chung, the Company’s Chairman andChief Executive Officer, renewed his employment contract for the position ofChief Executive Officer for a term of three years commencing from January 1,2010 to December 31, 2012.  Thecontract may be renewed thereafter subject to further agreement between theparties. The annual salary remains $1.00 with the provision for a discretionaryperformance bonus of such amount and form (whether in cash or in kind) to bedetermined by the Company’s Compensation Committee payable upon achievement ofcertain objectives set by the Compensation Committee and at such time as may bedeemed appropriate by the Compensation Committee.  Mr. Chung’s current employment contract expireson December 31, 2009.

 

**Item 2.****            ****Management’s Discussion and Analysisof Financial Condition and Results of Operations**

 

***CAUTIONARYSTATEMENT***

 

The following discussion and analysis should be readin conjunction with our unaudited consolidated financial statements and therelated notes thereto contained elsewhere in this report. The informationcontained in this quarterly report on Form 10-Q is not a completedescription of our business or the risks associated with an investment in ourcommon stock. We urge you to carefully review and consider the variousdisclosures made by us in this report and in our other reports filed with theSecurities and Exchange Commission, or SEC, including our annual report on Form 10-Kfor the year ended December 31, 2008, filed with the SEC on March 30,2009 and subsequent reports on Form 8-K, which discuss our business ingreater detail.

 

In this report we make, and from time to time weotherwise make, written and oral statements regarding our business andprospects, such as projections of future performance, statements of management’splans and objectives, forecasts of market trends, and other matters that areforward-looking statements within the meaning of Section 27A of theSecurities Act of 1933 and Section 21E of the Securities Exchange Act of 1934.Statements containing the words or phrases “will likely result,” “are expectedto,” “will continue,” “is anticipated,” “estimates,” “projects,” “believes,” “expects,”“anticipates,” “intends,” “target,” “goal,” “plans,” “objective,” “should” orsimilar expressions identify forward-looking statements, which may appear indocuments, reports, filings with the Securities and Exchange Commission, newsreleases, written or oral presentations made by officers or otherrepresentatives made by us to analysts, stockholders, investors, newsorganizations and others, and discussions with management and other of ourrepresentatives.  For such statements, weclaim the protection of the safe harbor for forward-looking statementscontained in the Private Securities Litigation Reform Act of 1995.

 

Our future results, including results related toforward-looking statements, involve a number of risks and uncertainties. Noassurance can be given that the results reflected in any forward-lookingstatements will be achieved. Any forward-looking statement speaks only as ofthe date on which such statement is made. Our forward-looking statements arebased upon assumptions that are sometimes based upon estimates, data,communications and other information from suppliers, government agencies andother sources that may be subject to revision. Except as required by law, we donot undertake any obligation to update or keep current either (i) anyforward-looking statement to reflect events or circumstances arising after thedate of such statement, or (ii) the important factors that could cause ourfuture results to differ materially from historical results or trends, resultsanticipated or planned by us, or which are reflected from time to time in anyforward-looking statement.

 

In addition to other matters identified or describedby us from time to time in filings with the SEC, there are several importantfactors that could cause our future results to differ materially fromhistorical results or trends, results anticipated or planned by us, or resultsthat are reflected from time to time in any forward-looking statement. Some ofthese important factors, but not necessarily all important factors, areincluded in the section “Risk Factors” in our annual report on Form 10-Kfor the year ended December 31, 2008 filed with the SEC on March 30,2009.

 

We own or have rights to certain trademarks that weused in connection with our business or products, including, but not limitedto, DolphinTM. Other than this trademark, this report also makes reference totrademarks and trade names of other companies.

 

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**Overview**

 

Elixir Gaming Technologies is a provider of gamingtechnology solutions, with a primary focus on leasing electronic gamingmachines on a revenue sharing basis to gaming establishments within Pan Asianmarkets.  We identify and secure venuesfor the placement of electronic gaming machines and casino management systems,which track game performance and provide statistics on each installedelectronic gaming machine owned and leased by us.  We contract with thevenue owners or operators for the placement of the electronic gaming machineson a revenue sharing basis. In addition, we acquire and install the gamingmachines, casino management systems and other gaming peripherals at therelevant gaming venues.

 

In addition to ourprimary gaming machine participation business, our operations also consist oftable game products, which focus on the design, manufacture and distribution oftraditional and RFID casino chips and non-gaming products, which focus on thedesign, manufacture and sale of component parts primarily for the automotiveindustry.

 

During 2009, we have undergone a major reorganizationof our operations and streamlined our cost structure.

 

On March 16, 2009, we entered into a Purchase andSettlement Agreement with Shuffle Master, Inc. (the “Purchase andSettlement Agreement”) pursuant to which we sold to Shuffle Master ourportfolio of automated card verification machines and electronic card shufflingsystems, all related intellectual property, and certain inventory of suchproducts and settled all outstanding litigation between Shuffle Master and theCompany, which traced back to October 5, 2004.  The total consideration paid by ShuffleMaster was $2.8 million, of which $2.4 million was received in March 2009and $400,000 was received in April 2009. In relation to this Purchase and Settlement Agreement, we terminated adistributorship arrangement of the relevant products with our distributor inEurope. Pursuant to the termination arrangement, we were required to buy backcertain inventory of the relevant products kept by the distributor. Aftertaking into account such buy-back obligation, we recognized a gain relating tothe asset disposal of approximately $1.71 million in the second quarter 2009.As a result of the transactions under the Purchase and Settlement Agreement,which were completed in April 2009, the China facility became redundantand, therefore, was closed at the end of April 2009. At March 31,2009, we incurred a restructuring charge of $29,416 relating to the write-downof the remaining plant equipment. We believe that the above transactionprovided significant financial benefits to us as it improved our cash positionand freed resources to focus on addressing market opportunities that furtherour strategy of expanding our core electronic gaming machine participationbusiness.

 

We have successfully executed various cost reductioninitiatives. Such reductions are critical given the current economic climateand provide a much leaner cost structure to expand our core gaming machineparticipation operations and derive greater benefits from the leverage inherentin our operating model.  During thethree-month and nine-month periods ended September 30, 2009, we reducedcash selling, general and administrative expenses by $2.3 million and $5.1 million, respectively, compared to theprior year periods.  Based on our costreduction measures and the current scale of operations, we believe we canmaintain quarterly selling, general and administrative cash expenses in theapproximate range of $1.5 to $1.8 million.

 

As a result of the above efforts, our financialperformance has improved materially during the three-month and nine-monthperiods ended September 30, 2009. Our consolidated revenues for the three-month and nine-month periodsended September 30, 2009 were $3.6 million and $11.1 million, of which revenue from ourgaming machine participation operations, our primary business, comprised 51% and 41%, respectively, of total revenues.  This compares to $3.4 million and $9.1 million for the respective periods in2008, of which revenue from our gaming machine participation operationscomprised 33% and 26%, respectively, of total revenues.

 

During the three-month period ended September 30,2009, we achieved positive adjusted EBITDA (as defined below) for the secondconsecutive quarterly period since our new business model was enacted in September 2007.  Despite the difficult global environment andthe challenges we suffered in our Philippines market due to severe adverseweather that resulted in record flooding in certain regions, we were able toachieve this important target due to the strength of our core gaming machineparticipation operations and the successful execution of our aggressive costreduction initiatives.

 

In addition to ourefforts to reorganize our operations and streamline our cost structure, we havemade progress in improving our liquidity and financial flexibility to pursuegrowth opportunities in our core gaming machine participation business.  On July 24, 2009, we entered into anagreement with Elixir International, a wholly-owned subsidiary of Elixir Group,to amend the unsecured promissory note issued by the Company in April 2008and as amended in November 2008 to Elixir International. This agreement,which became effective July 1, 2009, provides for the deferment of therepayment of principal and accrued interest payments until July 2010 andimmediate cash flow benefits to Elixir Gaming by reducing cash outlays byapproximately $1.6 million per quarter during the deferment period.

 

As of September 30, 2009, our gaming machineoperations were concentrated in two countries, the Philippines and Cambodia.In the Philippines, we had 742 machinesin operation at six venues and in Cambodia we had 385 machines at one venue,NagaWorld, a wholly-owned subsidiary of Hong Kong listed NagaCorp Ltd.(HKSE:3918).

 

To date during the fourth quarter, we have opened onenew venue in the Philippines with approximately 145 machines.   We continue to proactively evaluate ourmachine placements and work with our venue owner partners to develop moretargeted marketing and 

 

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promotional strategies to accelerate growth in gamingmachine placements and net wins.  Weremain encouraged in our ability to improve performance in our markets and areseeking to expand our operations in our existing and new markets in emerginggaming countries in Asia.

 

**Resultsof Operations for the Three-Month and Nine-Month Periods Ended September 30,2009 and 2008**

 

The following is a schedule showing summarizedoperating results on a consolidated basis and separately by each of our threebusiness segments for the three-month and nine-month periods ended September 30,2009 and 2008, namely gaming machine participation, table game products andnon-gaming products.

 

On March 16, 2009, we entered into a Purchase andSettlement Agreement with Shuffle Master, Inc. (the “Purchase andSettlement Agreement”) pursuant to which we sold Shuffle Master our portfolioof automated card verification machines and electronic card shuffling systems,all related intellectual property, including but not limited to, the trademarksof Random PlusTM, ShuffleProTM and Deck CheckerTM, and certain inventories of suchproducts.  All historical revenues andexpenses from these assets sold to Shuffle Master have been reclassified asdiscontinued operations.

 
| ** **                                                   | ** ** | **Three  Months Ended September 30,** | ** ** | **Nine  Months Ended September 30,** | ** ** |
|--------------------------------------------------------------|------------|--------------------------------------------|------------|-------------------------------------------|------------|
| ** **                                                   | ** ** | **2009**                                   | ** ** | **2008**                                  | ** ** | **2009** | ** ** | **2008** | ** ** |
| Total:                                                       |       |                                       |       |                                      |       |   |   |   |   |
| Revenues                                                     |       | $                                          | 3,611,781  |                                      | $          | 3,408,698 |   | $ | 11,086,916 |   | $ | 9,098,520 |   |
| Gross (loss)/ profit                                         |       | $                                          | (888,195   | )                                         | $          | (1,490,238 | ) | $ | (2,747,202 | ) | $ | (3,134,004 | ) |
| Gross margin percentage                                      |       | (25                                        | )%         | (44                                       | )%         | (25 | )% | (34 | )% |
| Adjusted EBITDA (1)                                          |       | $                                          | 337,005    |                                      | $          | (2,907,892 | ) | $ | (775,207 | ) | $ | (8,022,758 | ) |
| Operating loss from  continuing operations                   |       | $                                          | (3,514,690 | )                                         | $          | (7,126,931 | ) | $ | (11,528,730 | ) | $ | (22,832,580 | ) |
| Net loss from  continuing operations                         |       | $                                          | (3,675,070 | )                                         | $          | (7,227,410 | ) | $ | (11,590,345 | ) | $ | (21,906,070 | ) |
|                                                         |       |                                       |       |                                      |       |   |   |   |   |
| Basic and diluted loss  per share from continuing operations |       | $                                          | (0.03      | )                                         | $          | (0.06 | ) | $ | (0.10 | ) | $ | (0.19 | ) |
| Weighted average shares  outstanding                         |       | 114,956,667                                |       | 114,946,671                               |       | 114,956,667 |   | 114,945,602 |   |
|                                                         |       |                                       |       |                                      |       |   |   |   |   |
| Gaming machine  participation:                               |       |                                       |       |                                      |       |   |   |   |   |
| Revenues                                                     |       | $                                          | 1,838,579  |                                      | $          | 1,109,144 |   | $ | 4,527,376 |   | $ | 2,396,673 |   |
| Gross loss                                                   |       | $                                          | (1,182,485 | )                                         | $          | (1,591,969 | ) | $ | (4,203,885 | ) | $ | (3,902,382 | ) |
| Gross margin percentage                                      |       | (64                                        | )%         | (144                                      | )%         | (93 | )% | (163 | )% |
|                                                         |       |                                       |       |                                      |       |   |   |   |   |
| Table game products:                                         |       |                                       |       |                                      |       |   |   |   |   |
| Revenues                                                     |       | $                                          | 571,959    |                                      | $          | 214,604 |   | $ | 3,841,003 |   | $ | 555,440 |   |
| Gross (loss)/profit                                          |       | $                                          | 297,350    |                                      | $          | (191,356 | ) | $ | 1,693,333 |   | $ | (115,296 | ) |
| Gross margin percentage                                      |       | 52                                         | %          | (89                                       | )%         | 44 | % | (21 | )% |
|                                                         |       |                                       |       |                                      |       |   |   |   |   |
| Non-gaming products:                                         |       |                                       |       |                                      |       |   |   |   |   |
| Revenues                                                     |       | $                                          | 1,201,243  |                                      | $          | 2,084,950 |   | $ | 2,718,537 |   | $ | 6,146,407 |   |
| Gross (loss)/profit                                          |       | $                                          | (3,060     | )                                         | $          | 293,087 |   | $ | (236,650 | ) | $ | 883,674 |   |
| Gross margin percentage                                      |       | (0                                         | )%         | 14                                        | %          | (9 | )% | 14 | % |

 

----

(1)          “Adjusted EBITDA” is earnings before interest, taxes,depreciation, amortization, stock-based compensation, and other non-cashoperating income and expenses. Adjusted EBITDA is presented exclusively as asupplemental disclosure because management believes that it is widely used tomeasure the performance, and as a basis for valuation, of gaming companies.Management uses Adjusted EBITDA as a measure of the operating performance ofits segments and to compare the operating performance of its operations withthose of its competitors. The Company also presents Adjusted EBITDA because itis used by some investors as a way to measure a company’s ability to incur andservice debt, make capital expenditures and meet working capital requirements.Gaming companies have historically reported EBITDA as a supplement to financialmeasures in accordance with generally accepted accounting principles in theUnited States (“GAAP”). Adjusted EBITDA should not be considered as analternative to operating income as an indicator of the Company’s performance,as an alternative to cash flows from operating activities as a measure ofliquidity, or as an alternative to any other measure determined in accordancewith GAAP. Unlike net income/(loss), Adjusted EBITDA does not includedepreciation or interest expense and, therefore, 

 

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does not reflect currentor future capital expenditures or the cost of capital. The Company compensatesfor these limitations by using Adjusted EBITDA as only one of severalcomparative tools, together with GAAP measurements, to assist in the evaluationof operating performance. Such GAAP measurements include operating income, netincome/(loss), cash flows from operations and cash flow data. The Company hassignificant uses of cash flows, including capital expenditures, interestpayments, debt principal repayments, taxes and other non-recurring charges,which are not reflected in Adjusted EBITDA. Elixir Gaming’s calculation ofAdjusted EBITDA may be different from the calculation methods used by othercompanies and, therefore, comparability may be limited.

 

A reconciliation of EBITDA, as adjusted, to the netloss is provided below:

 
| ** **                              | ** ** | **Three Months Ended  September 30,** | ** ** | **Nine Months Ended  September 30,** | ** ** |
|-----------------------------------------|------------|--------------------------------------------|------------|-------------------------------------------|------------|
| ** **                              | ** ** | **2009**                                   | ** ** | **2008**                                  | ** ** | **2009** | ** ** | **2008** | ** ** |
| Net loss from  continuing operations    |       | $                                          | (3,675,070 | )                                         | $          | (7,227,410 | ) | $ | (11,590,345 | ) | $ | (21,906,070 | ) |
| Depreciation and  amortization          |       | 2,838,975                                  |       | 2,661,520                                 |       | 8,334,030 |   | 6,714,074 |   |
| Interest expenses                       |       | 145,815                                    |       | 290,355                                   |       | 394,011 |   | 564,876 |   |
| Interest income                         |       | (10,297                                    | )          | (107,420                                  | )          | (74,729 | ) | (629,606 | ) |
| Income tax expenses                     |       | 68,548                                     |       | —                                    |       | 367,642 |   | 22,498 |   |
| Stock option expenses                   |       | 328,733                                    |       | 1,475,063                                 |       | 774,903 |   | 5,842,641 |   |
| Impairment/write-down  of gaming assets |       | 541,851                                    |       | —                                    |       | 920,831 |   | 1,368,829 |   |
| Flood damage losses                     |       | 98,450                                     |       | —                                    |       | 98,450 |   | — |   |
| EBITDA, as adjusted                     |       | $                                          | 337,005    |                                      | $          | (2,907,892 | ) | $ | (775,207 | ) | $ | (8,022,758 | ) |

 

Total revenues for the three-month period ended September 30,2009 increased $203,083 to  $3,611,781from $3,408,698 in the corresponding period in the prior year due to increasesin gaming machine participation and table game products revenue, partiallyoffset by a decrease in non-gaming product sales.  Revenue from gaming machine participationincreased as a result of higher average net win per machine.  Table game product sales increased as aresult of higher gaming chip sales to existing customers.  Revenue from non-gaming products declined asa result of decreased orders from major customers.

 

Gross loss decreased $602,043 to $888,195 for thethree-month period ended September 30, 2009 compared to a gross loss of$1,490,238 in the same period of the prior year primarily as a result of highergross margins for our gaming machine participation and table game productsoperations, partially offset by a lower gross margin for our non-gamingoperations.  Revenue from gaming machineparticipation increased disproportionately greater than depreciation expensesfor our gaming machine participation operations. However, revenues have yet tocover the cost of machine depreciation, which is recorded in cost ofoperations.  Table game products grossmargin improved primarily due to production efficiencies resulting from highergaming chip order volume during the three-month period ended September 30,2009.

 

Operating loss from continuing operations declined$3,612,241 to $3,514,690 for the three-month period ended September 30,2009 compared to an operating loss of $7,126,931 in the same period of theprior year.  Net loss from continuingoperations declined $3,552,340 to $3,675,070 compared to a net loss of$7,227,410 for the same period of the prior year.  The decline in operating and net loss fromcontinuing operations was primarily the result of a lower gross loss andsignificantly reduced operating expenses.

 

Total revenue increased $1,988,396 to $11,086,916 forthe nine-month period ended September 30, 2009 compared to $9,098,520 inthe same period of the prior year due to increases in gaming machineparticipation revenue as a result of improving average win per machine andtable game products sale as a result of a large RFID gaming chip orderdelivered during the three-month period ended June 30, 2009. The increasewas partially offset by a decrease in non-gaming product sales due to decreasedorders from our major customers.

 

Gross loss decreased $386,802 to $2,747,202 for thenine-month period ended September 30, 2009 compared to a gross loss of$3,134,004 in the same period of the prior year primarily as a result of highergross margins for our table game products and gaming machine participationoperations, partially offset by a lower gross margin for our  non-gaming products operations. Table gameproducts gross margin improved primarily due to production efficienciesresulting from a large RFID gaming chip order delivered during the period endedJune 30, 2009.  Revenues from gamingmachine participation increased, but have yet to cover the cost ofdepreciation.

 

Operating loss from continuing operations decreased$11,303,850 to $11,528,730 for the nine-month period ended September 30,2009 compared to a net loss of $22,832,580 in the same period of the prioryear. Net loss from continuing operations decreased $10,315,725 to $11,590,345for the nine-month period ended September 30, 2009 compared to a net lossof $21,906,070 in the same period of the prior year. The operating and netprofit losses were positively impacted by lower gross losses, significantlyreduced operating expenses, gains related to the settlement of the legacylawsuits with Purton and Shuffle Master, and reduced interest expense,partially offset by a write-down of an intangible asset associated with ourchip washer patents, lower interest income, and 

 

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higher income tax expense.

 

**Gaming Machine Participation**

 

In September 2007, we began our electronic gamingmachine participation operations in Asia as part of our primary focus onplacing gaming machines on a revenue sharing basis. Revenue from our gamingmachine participation operations during the three-month period ended September 30,2009 increased $729,435 to $1,838,579 compared to revenue of $1,109,144 forsame period of the prior year. The increase in revenue was primarily the resultof higher average net win per machine compared to the three-month period ended September 30,2008.

 

Gross loss from gaming machine participationoperations decreased $409,486 to $1,182,485 for the three-month period ended September 30,2009 compared to a gross loss of $1,591,969 for the same period of the prioryear  as revenue from gaming machineparticipation increased disproportionately greater than depreciation expensesfor our gaming machine participation operations. However, revenues have yet tocover the cost of machine depreciation, which is recorded in cost ofoperations.  Our cost of goods sold forthe three-month period ended September 30, 2009 included $2,533,508depreciation of electronic gaming machines and $370,203 of other expenses,which include approximately $150,000 in machine redeployment costs.

 

Revenue from our gaming machine participationoperations increased $2,130,703 to $4,527,376 during the nine-month periodended September 30, 2009 compared to revenue of $2,396,673 for the sameperiod of the prior year. The increase in revenue was primarily a result ofhigher average net win per machine compared to the nine-month period ended September 30,2008 when our gaming machines participation operations were still immature.

 

Gross loss from gaming machine participationoperations increased $301,503 to $4,203,885 for the nine-month period ended September 30,2009 compared to a gross loss of $3,902,382 for the same period in the prioryear as cost of goods sold increased at a greater rate than revenues due tohigher depreciation expense, higher gaming machine operating costs, and thewrite-down of gaming assets during the three-month period ended March 31,2009.  Our cost of goods sold for thenine-month period ended September 30, 2009 included $7,349,194 indepreciation of electronic gaming machines and $885,736 of other expenses and$496,331 in write-down of gaming assets.

 

As of September 30, 2009, we had a total numberof 2,191 gaming machines of which 1,064 machines were held in inventory and1,127 machines were in operation.  Of the1,127 gaming machines in operation, 742 machines were in operation in sixvenues in the Philippines and 385 machines were in operation in one venue inone location in Cambodia.

 

During the three-month period ended September 30,2009, we opened two new venues in the Philippines with a total of 194 gamingmachines and closed one under-performing venue in the Philippines with 148gaming machines.  Gaming participationperformance was negatively impacted during the three-month period ended September 30,2009 due to severe adverse weather, which included Tropical Storm Ondoy thatstruck the Philippines on Saturday, September 26, 2009 and resulted inflooding in areas including Metro-Manila. Only two of our venues in operation suffered some water damage but theeffect to our machines and equipment was minimal.   While our venues experienced only minor damageas a result of the storm, it took several weeks for our operations to graduallyresume normal business activity in the affected areas. The Company isin the process of accessing the damage and filing claims with our insurancecarrier. As of September 30, 2009, the Company recorded a flood damageloss of $98,450, which represents the deductible for the insurance claims thathas been separately presented as part of gaming participation operation in the consolidatedstatement of operations.

 

In Cambodia, regulatory changes within the last yearimpacted the competitive landscape of gaming operations in this market.  Due to directives issued by the Cambodiangovernment in December 2008 and February 2009, all slot clubs in thePhnom Penh area, including ours, were closed with the exception of thoseoperated within NagaWorld. NagaWorld operates under an exclusive casino licensewithin a 200 kilometer radius of the capital city of Phnom Penh and ouroperations in NagaWorld are now our sole venue in operation in Cambodia.

 

On December 13, 2008, we entered into a contractwith NagaWorld, a wholly-owned subsidiary of Hong Kong listed NagaCorp Ltd.(HKSE:3918), to place electronic gaming machines on a participation basis atNagaWorld, a luxury hotel casino resort in Cambodia, and the only licensed fullservice casino in Phnom Penh.

 

Under the terms of the agreement, we contracted toplace electronic gaming machines in an assigned area of NagaWorld, and share inthe gross revenue generated by each machine placed.  We have joint control with NagaWorld over theoperation of the electronic gaming machines, including floor staff and auditrights. We are entitled to 25% of the revenue generated by the machines placedin that assigned area and NagaWorld is entitled to 75% of such revenue. Most ofthe costs and expenses related to the operation of the machines placed in therelevant assigned area, such as marketing funds, staff costs and staff mealexpenses, is shared 25% by us and 75% by NagaWorld.  This agreement is valid for a term of fiveyears commencing from the live commercial launch of the operation of ourmachines in this assigned area in NagaWorld on January 24, 2009.

 

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In February, 2009, we entered into another contractwith NagaWorld, which was subsequently rationalized by another contract withNagaWorld dated June 15, 2009, for placement of an additional 58 machinesat another assigned area within NagaWorld casino resort and in consideration ofsuch additional placements, a commitment fee of $1 million was deemed to havebeen paid by the Company by off-setting against accounts receivable fromNagaWorld. Pursuant to the terms of this contract, we are entitled to receive100% of the revenue generated by such additional machines in full unless anduntil we have received an amount equal to the commitment fee of $1 million and,thereafter, we are entitled to 20% of the relevant revenue and NagaWorld shallbe entitled to 80% thereof.

 

On July 25, 2009, we entered into a furtheragreement and an option deed with NagaWorld to place an additional 200electronic gaming machines on a participation basis at NagaWorld casino resortwith an option to place a further maximum of 200 machines by the end of2009.  The option deed includes a firstright of refusal clause for the designated floor space, which extends for 60days after the end of the option term.

 

Under the terms of the agreement, we will place 200additional electronic gaming machines (the “Additional Machines”) in aprescribed area of NagaWorld’s public casino floor of the casino wing and sharein the gross revenue generated by each of these machines. We and NagaWorld havejoint control over the operation of the electronic gaming machines, includingfloor staff and audit rights. In consideration for the placement of theAdditional Machines, we paid a commitment fee of $5.84 million to NagaWorld. Weand NagaWorld share the win per unit per day from the Additional Machines andcertain operating costs related to marketing and floor staff at a 20% / 80%split, respectively, provided that we are entitled to 100% of the win per unitper day from the Additional Machines until we have received a total accumulatedwin per unit per day of $7.3 million (representing $5.84 million plus 20% ofour anticipated share of the win per unit per day). Win per unit per day fromthe Additional Machines is settled and collected daily by us.

 

This agreement is for a term of five years untilSeptember 30, 2014 and if upon any termination of this agreement, we have notreceived a total accumulated amount of $7.3 million, then NagaWorld shall pay,within seven days after termination, the difference between $5.84 million and80% of the win per unit per day actually collected and received by us from thesaid 200 machines during the period from the operation date up to the date oftermination.

 

To date during the fourth quarter, we have addedapproximately 145 machines in one new venue in the Philippines.  Based on our current contracts and rolloutplans we expect placements of 1,300 to 1,400 gaming machines by the end of 2009.  However, total company wide machineplacements can fluctuate due to our strategic efforts to optimize average dailynet wins.  In the event gaming machineperformance at our contracted venues does not meet expectations, we may chooseto withdraw all or a portion of our gaming machines from such venues for futureredeployment in new or existing venues with better performance prospects.

 

**Table Game Products**

 

Table game products revenue increased $357,355 to$571,959 for the three-month period ended September 30, 2009 compared to$214,604 in the corresponding period of the prior year.  The increase was a result of additionalgaming chip reorders from our existing customers.

 

Gross profit on gaming chips products increased$488,706 to $297,350 in the three-month period ended September 30, 2009compared to a gross loss of $191,356 in the corresponding period of the prioryear due to increased revenue and volumes in our RFID gaming chips resulting inproduction efficiencies.

 

Table game products revenue increased $3,285,563 to$3,841,003 for the nine-month month period ended September 30, 2009compared to $555,440 in the corresponding period of the prior year.  The increase was primarily the result of alarge gaming chip order to a new casino in Macau during the three-month periodended June 30, 2009.

 

Our gross profit on gaming chips products increased $1,808,629to $1,693,333 in the nine-month period ended September 30, 2009 comparedto a gross loss of $115,296 in the corresponding period of the prior year dueto increased revenue and volume in our RFID gaming chips resulting inproduction efficiencies.

 

**Non-Gaming Products**

 

Non-gaming products revenue, which consists ofautomotive tooling and parts, decreased by $883,707 to 1,201,243 in thethree-month period ended September 30, 2009 compared to $2,084,950 in thecorresponding period of the prior year.  The decrease was related to salesreductions to our largest customer as they decreased their production for theyear.

 

Gross loss increased $296,147 to a loss of $3,060 forthe three-month period ended September 30, 2009 compared to a gross profitof 

 

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$293,087 in the corresponding period of the prior yeardue to the reduction in sales orders from our major customer and related lossof production efficiencies.

 

Non-gaming products revenue decreased $3,427,870 to$2,718,537 in the nine-month period ended September 30, 2009 compared to$6,146,407 in the corresponding period of the prior year.  The decreaserelated to sales reductions to our largest customer as they decreased theirproduction for the year.

 

Gross loss increased $1,120,324 to a loss of $236,650for the nine-month period ended September 30, 2009 compared to a grossprofit of $883,674 in the corresponding period of the prior year due to thereduction in sales orders from our major customer and resulting loss ofproduction efficiencies.

 

**Operating Expenses**

 

The following is a schedule of expenses on aconsolidated basis:

 
| ** **                           | ** ** | **Three  Months Ended  September 30,** | ** ** | **Nine  Months Ended  September 30,** | ** ** |
|--------------------------------------|------------|---------------------------------------------|------------|--------------------------------------------|------------|
| ** **                           | ** ** | **2009**                                    | ** ** | **2008**                                   | ** ** | **2009** | ** ** | **2008** | ** ** |
| Selling, general and  administrative |       | $                                           | 1,462,026  |                                       | $          | 3,764,293 |   | $ | 5,888,770 |   | 10,996,822 |   |
| Stock-based  compensation expense    |       | 328,733                                     |       | 1,475,063                                  |       | 774,903 |   | 5,842,641 |   |
| Impairment of assets                 |       | 424,500                                     |       | —                                     |       | 424,500 |   | 1,368,829 |   |
| Weather related losses               |       | 98,450                                      |       | —                                     |       | 98,450 |   | — |   |
| Research and  development            |       | 71,744                                      |       | 90,995                                     |       | 201,291 |   | 558,816 |   |
| Depreciation and  amortization       |       | 237,169                                     |       | 306,342                                    |       | 801,939 |   | 763,192 |   |
| Restructuring charges                |       | 3,876                                       |       | —                                     |       | 591,675 |   | 168,276 |   |
|                                 |       | $                                           | 2,626,498  |                                       | $          | 5,636,693 |   | $ | 8,781,528 |   | 19,698,576 |   |

 

**Selling, General and AdministrativeExpenses**

 

Selling, general and administrative expenses decreased$2,302,267 to $1,462,026 for the three-month period ended September 30,2009 compared to $3,764,293 in the prior year period due to our cost reductioninitiatives.  Salaries and wages expensedeclined $1.0 million as a result of headcount reductions and voluntary seniormanagement pay reductions.  Legal expenseand external consultancy and accounting fees declined $0.6 million due togreater reliance of related projects on in-house personnel.  Travel decreased by $0.3 million due toconcerted efforts to reduce employee travel to the bare minimum. Rent, officesupplies and other expenses decreased by $0.4 million due to various costreduction initiatives.

 

Selling, general and administrative expenses decreasedby $5,108,052 to $5,888,770 for the nine-month period ended September 30,2009 compared to $10,996,822 in the prior year period due to our cost reductioninitiatives.  Salaries and wages expensedeclined $2.0 million as a result of headcount reductions and voluntary seniormanagement pay reductions.  Legal expenseand external consultancy and accounting fees declined $1.6 million due togreater reliance of related projects on in-house personnel.  Travel decreased by $0.8 million due toconcerted efforts to reduce employee travel to the bare minimum.  Rent, office supplies and other expensesdecreased by $0.7 million due to various cost reduction initiatives.

 

Based on our cost reduction plans and our currentscale of operations, we anticipate selling, general, and administrativeexpenses can be maintained in the approximate range of $1.5 to $1.8 million perquarter.

 

**Stock-Based Compensation Expense**

 

Stock-based compensation expense decreased by$1,146,330 to $328,733 for the three-month period ended September 30, 2009compared to $1,475,063  in thecorresponding period of the prior year primarily due to re-measurement ofnon-employee awards at fair market value and senior executives who havedeparted and their stock options forfeited.

 

Stock-based compensation expense decreased by$5,067,738 to $774,903 for the nine-month period ended September 30, 2009compared to $5,842,641 in the corresponding period of the prior year due to thesame reasons as stated above.

 

**Impairment of Assets**

 

On January 25, 2007, we issued warrants topurchase up to 16,000,000 shares of our common stock (the “2006 Warrants”) toElixir Group, which at the time was our Asian distributor of table gameproducts, as an incentive to meet certain sales targets.  These warrantswere accounted for in accordance with the FASB ASC 505.  The 2006Warrants were classified in our balance sheet as prepaid commissions subject toamortization to commission expense at a rate of 8% of the gross revenuegenerated by the distributor.

 

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For the first half of 2008, table game revenue did notmeet sales targets.  In addition, futureorder placements indicated the remaining value on September 30, 2008 of$1,368,829 may not be recoverable.  Per FASBASC 360, a long-lived asset (asset group) shall be tested forrecoverability whenever events or changes in circumstances indicate that itscarrying amount may not be recoverable including an accumulation of costssignificantly in excess of the amount originally expected for the acquisition.

 

We estimated fair value using present value techniquesbased on estimates of cash flows.  In accordance with FASB ASC 360,an impairment loss shall be recognized if the carrying amount of an intangibleasset is not recoverable and its carrying amount exceeds its fair value. Afteran impairment loss is recognized, the adjusted carrying amount of theintangible asset shall be its new accounting basis.  Based upon the above,we recorded an impairment to the asset of $1,368,829 and included the amount inloss from operations in our consolidated statements of operations and deficit.

 

Following the closure of the China manufacturingfacility, we decided to exit the chip washer business after evaluating themarket opportunity for this product. Due to lack of future demand, wedetermined the carrying value of related patents may not be recoverable. Duringthe three-month period ended September 30, 2009, the Company recorded an impairment loss of $424,500, which relatesto a write-down of an intangible asset associated with the chip washer patents.

 

**Research and Development Expenses**

 

Research and development expenses decreased $19,251 to$71,744 for the three-month period ended September 30, 2009 compared to$90,995 in the prior year period as a result of the complete closure of ourChina table game product manufacturing facility and related support services inApril 2009.

 

Research and development expenses decreased $357,525to $201,291 for the nine-month period ended September 30, 2009 compared to$558,816 for the prior year period for the same reason as stated above.

 

As a result of the sale to Shuffle Master of ourportfolio of automated card verification machines and electronic card shufflingsystems, all related intellectual property, and certain inventory of suchproducts pursuant to the Purchase and Settlement Agreement as set out abovehave been written off.

 

It is anticipated that future research and developmentwill be focused on potential gaming and/or non-gaming product enhancements.

 

**Depreciation and AmortizationExpenses**

 

Total depreciation and amortization expenses decreased$69,173 to $237,169 for the three-month period ended September 30, 2009compared to $306,342 in the prior year period. The decrease was a result of the closure of our U.S. office and ourChina table game product manufacturing facility.

 

Total depreciation and amortization expenses increased$38,747 to $801,939 for the nine-month period ended September 30, 2009compared to $763,192 in the prior year period. The increase was a result of full year depreciation impact for officeequipment and leasehold improvements in 2009, partially offset by the reduceddepreciation expense from the closure of our U.S. office and our China tablegame product manufacturing facility.

 

**Restructuring Charges**

 

During the three-month period ended September 30,2009, as part of our cost reduction initiatives we incurred restructuringcharges of $3,876 for vacated facility operating leases.  We incurred no restructuring costs for thethree-month period ended September 30, 2008.

 

During the nine-month period ended September 30,2009, as part of our cost reduction initiatives, we incurred restructuringcharges of $591,675 for severance wages and benefits related to the terminationof employees and vacated facility operating leases.  The amount represents contractual and otheragreements with employees including a former executive, which only includescharges for termination benefits measured at the estimated fair value at thetermination date and does not include charges for services yet to be rendered.The Company incurred restructuring charges of $168,276 during the nine-monthperiod ended September 30, 2009 for operating leases the Company ceaseduse of during the three-month period ended March 31, 2008.

 

**Other Income/(Expenses)**

 
| ** **                         | ** ** | **Three  Months Ended  September 30,** | ** ** | **Nine  Months Ended  September 30,** | ** ** |
|------------------------------------|------------|---------------------------------------------|------------|--------------------------------------------|------------|
| ** **                         | ** ** | **2009**                                    | ** ** | **2008**                                   | ** ** | **2009** | ** ** | **2008** | ** ** |
| Interest expense and  finance fees |       | $                                           | (145,815   | )                                          | $          | (290,355 | ) | $ | (394,011 | ) | $ | (564,876 | ) |
| Interest income                    |       | 10,297                                      |       | 107,420                                    |       | 74,729 |   | 629,606 |   |
| Foreign currency  gains/(losses)   |       | (16,324                                     | )          | (3,100                                     | )          | (78,853 | ) | 638,427 |   |
| Loss on dispositions of  assets    |       | —                                      |       | —                                     |       | (93,698 | ) | (22,776 | ) |
| Other                              |       | 60,010                                      |       | 85,556                                     |       | 797,860 |   | 268,627 |   |
| Total                              |       | $                                           | (91,832    | )                                          | $          | (100,479 | ) | $ | 306,027 |   | $ | 949,008 |   |

 

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**Interest Expense and Finance Fees**

 

Interest expense and finance fees decreased $144,540to $145,815 for the three-month period ended September 30, 2009 comparedto $290,355 in the same period of the prior year principally due to lower debtlevels and the reduced interest rate on the Elixir International notes.  In April 2008, we signed a noteagreement for $15.0 million with Elixir International accruing 8% interest and,in November 2008, the agreement was amended and the interest rate wasreduced to 5%.

 

Interest expense and finance fees decreased $170,865to $394,011 for the nine-month period ended September 30, 2009 compared to$564,876 in the same period of the prior year principally due to lower debt levels and the reduced interest rate onnotes from Elixir International.

 

**Interest Income**

 

Interest income decreased $97,123 to $10,297 for thethree-month period ended September 30, 2009 compared to $107,420 in thesame period of the prior year as a result of the decrease in cash and cashequivalents held in overnight money market accounts and the general decrease ininterest rates.  Cash in bank decreasedby $13.2 million to $4.7 million from September 30, 2008 to September 30,2009, respectively, mainly due to payments for the expansion of our operationsat NagaWorld, gaming machine purchases and operating expenses.

 

Interest income decreased $554,877 to $74,729 for thenine-month period ended September 30, 2009 compared to $629,606 in thesame period of the prior year. We received funding from the private placementof common stock in the fourth quarter of 2007 and, as a result, the averagecash position was significantly higher in 2008 and depleted over theyear.  The average cash holdings per month were higher during the ninemonths ended September 30, 2008 compared to the same period in 2009.

 

**Foreign Currency Transactions**

 

The Company reported foreign currency losses of$16,324 for the three-month period ended September 30, 2009 compared tolosses of $3,100 for the same period of the prior year. The losses in thethree-month period ended September 30, 2009 resulted primarily from theunrealized transactional losses on intercompany balances.

 

The Company incurred foreign currency losses of$78,853 for the nine-month period ended September 30, 2009 compared togains of $638,427 for the same period of the prior year.  In the nine-month period ended September 30,2009, the losses resulted from the appreciating value of U.S. dollardenominated payables for our Philippine operations. In the nine-month periodended September 30, 2008, our Philippine operations recorded foreigncurrency transaction gains mainly due to settlement of U.S. dollar denominatedpayables as a result of the appreciating value of the Philippine peso duringthe first quarter of 2008.

 

**Other**

 

Other income decreased $25,546 to $60,010  for the three-month period ended September 30,2009 compared to $85,556 in the prior year period primarily because of adecrease in grants received from the Australia government

 

Other income increased $430,783 to $699,410 for thenine-month period ended September 30, 2009 compared to $268,627 in theprior year period primarily because we recorded a settlement gain of $655,506from the Purton litigation during the three-month period ended June 30,2009.  On June 17, 2009, the Companyentered into a deed of release with William Purton and the other plaintiffsover which he had control for the settlement of all legal claims, disputes andproceedings between the parties.

 

**Income Tax Provisions**

 

Our effective tax rate for the nine-month period endedSeptember 30, 2009 was approximately (3.79)%.  We continue to review the tax losses andincome generated in the future by our foreign subsidiaries to minimize taxationimplication/costs.

 
| ** **            | ** ** | **Nine  Months Ended September 30,** | ** ** | **Increase/(Decrease)** | ** ** |
|-----------------------|------------|-------------------------------------------|------------|-------------------------|------------|
| ** **            | ** ** | **2009**                                  | ** ** | **2008**                | ** ** | **Dollar  Amount** | ** ** | **%  Amount** | ** ** |
| Income tax provisions |       | $                                         | 367,642    |                    | $          | 22,498 |   | $ | 345,144 |   | N/A |   |
|                       |            |                                           |            |                         |            |  |  |  |  |  |  |  |

 

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**FINANCIAL CONDITION**

 

**Liquidity and Capital Resources**

 

On April 21, 2008, we entered into a Trade CreditFacility Agreement (the “Facility Agreement”) with Elixir International. Uponentering into the Agreement, we immediately issued the first note pursuant tothe terms of the Facility Agreement in the then principal amount of $15,000,000(the “Initial Advance”).  The InitialAdvance extinguished a then trade payable of an equivalent amount to ElixirInternational with respect to gaming machines previously acquired.

 

Under the terms as amended on November 6, 2008(the “New Note”), we were obligated to repay the then principal of $12.1million, plus any accrued interest thereon, in equal monthly installments ofapproximately $530,000 from January 1, 2009 to December 1, 2010.  The advances under the Facility Agreement aresubject to demand by Elixir International for immediate payment only if thereis either an event of default or a change of control defined in the FacilityAgreement.

 

We began paying our monthly installments ofapproximately $530,000 under the New Note on January 1, 2009 and paid orsettled six installments during the six-month period ended June 30,2009.  As at June 30, 2009, the thenunpaid principal balance under the New Note was approximately $9.2 million (the“Outstanding Principal”).On July 24, 2009, for the purpose of improvingour financial flexibility as to enable us to capitalize on potential growth andinvestment opportunities such as expansion of slot machine placements andoperations in new venues, at our request, Elixir International entered into anAmendment No. 2 to the Trade Credit Facility Agreement and Related Notewith us (the “Second Facility Amendment Agreement”).  Pursuant to the Second Facility AmendmentAgreement, Elixir International agreed to restructure the payment schedule ofthe Outstanding Principal. Under the revised payment schedule, we are notrequired to make any repayments of principal or interest under the FacilityAgreement until July 1, 2010 provided that interest at the rate of 5%continues to accrue on the Outstanding Principal balance. The repayment of theOutstanding Principal balance and interest accrued thereon shall be repaid in18 equal monthly installments commencing on July 1, 2010.

 

As of September 30,2009, we had total cash and cash equivalents of $4.7 million and a workingcapital balance of $9.1 million.  Ourworking capital was positively impacted by the repayment deferral of principaland interest on the Trade Credit Facility until July 2010 and the sale ofour Deckchecker and card shuffler related intellectual property and remaininginventory in March 2009 for $2.8 million.  However, working capitalwas negatively impacted by the repayment of six monthly installments during theJanuary to June 2009 time period under the New Note due to ElixirInternational.

 

During the nine-monthperiod ended September 30, 2009, we recorded net cash flow used inoperations of approximately $7.9 million. Our current gaming machine inventorylevel is approximately 1,000. In an effort to formulate its future deploymentplans, the Company is commencing an assessment of the usability of thesemachines with a view to optimize machine performance and will determine if apotential adjustment to the valuation of these machines is needed.  In accordance with our contract dated July 25,2009 with NagaWorld, we paid a commitment fee to NagaWorld for $5.84 million onAugust 3, 2009.

 

In addition, we intend topurchase a limited number of gaming machines during 2009 to augment ourexisting inventory of machines and enhance game floor mix to better optimizeperformance at anticipated new and existing venues. With limited exceptions, webelieve we will be able to purchase second-hand machines at discountedprices.  We will also purchase casino management systems during theremainder of 2009 for placement in previously purchased or new gaming machinesdepending upon the execution of our business plan.  Based on our existing growth plans, weanticipate capital expenditures can be limited to approximately $1.2 million forthe remainder of 2009.

 

TheCompany may seek to exercise its option to add up to 200 more gaming machinesat NagaWorld under it July 2009 contract. This option expires on December 31,2009 and has a first right of refusal clause through February 28, 2010. Shouldwe exercise this option, it is likely the initial commitment will be for 100gaming machines and consequently the related commitment fee to NagaWorldrequired under the contract would be funded with cash on hand.

 

We achieved positiveadjusted EBITDA for the second and third quarter periods of 2009.  We anticipate our available working capital,along with cash expected to be generated from operations, will allow us to meetour working capital needs to support ongoing future operations, based on:

 

·                  under the Second Facility AmendmentAgreement dated July 24, 2009 to the Trade Credit Facility, which becameeffective July 1, 2009, we can defer the repayment of principal andinterest payments on the outstanding principal balance until July 2010providing cash flow benefits to us by reducing cash outlays approximately $1.6million per quarter until July 2010 and improved financial flexibility toenable us to pursue growth opportunities in our core electronic gaming machineparticipation business;

 

·                  our extensive cost cutting measures, which involve,among other initiatives, the closure of our China factory and Macau office andsignificant reductions in traveling and entertainment expenses and based on ourcurrent quarterly run-rate, should provide us with annualized selling, generaland administrative cash expense savings of approximately 50% compared to 2008levels;

 

·                  our ability to collect on a daily basis 100% of thewin per unit from NagaWorld for the additional 200 gaming machines  under our contract dated July 25, 2009until such time as the commitment fee of $5.84 million plus Elixir Gaming’s 20%

 

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share of the winper day on these machines are recouped (we made cash collections of $378,706for the period of September 9, 2009, when the first machines of theexpansion became operational, to September 30, 2009 and $764,905 for themonth of October 2009); and

 

·                  our assumption that we will be successful in ourendeavors to ramp up the revenue base by focusing our placement of gamingmachines in strong performing venues and plans to provide value-added services,such as promotion and marketing advisory services, to certain venues with agoal to improving net win per machine.

 

However, should weendeavor to commit to any future large projects to expand our gamingparticipation operations, we may require additional funding at such time. Inthis case, we will look into the options for raising additional funds throughvarious financing sources, including the procurement of commercial debtfinancing and/or vendor financing and/or the sale of debt or equitysecurities.  However, there can be noguarantees that such funds will be available on commercially reasonable terms,if at all. If such financing is not available on satisfactory terms, we may beunable to expand or continue our business as desired and operating results maybe adversely affected.  Any debtfinancing will increase expenses and must be repaid regardless of operatingresults and may involve restrictions limiting our operating flexibility and anyequity financing will be dilutive to our present stockholders.

 

**CashFlows Summary**

 
| ** **                              | ** ** | **Nine  Months Ended September 30,** | ** ** | ** **  | ** ** |
|-----------------------------------------|------------|-------------------------------------------|------------|-------------|------------|
| ** **                              | ** ** | **2009**                                  | ** ** | **2008**    | ** ** | **Increase  (Decrease)** | ** ** |
| Cash  provided by/ (used in):           |       |                                      |       |        |       |   |   |
| Operations                              |       | $                                         | (7,945,752 | )           | $          | (14,225,684 | ) | $ | (6,279,932 | ) |
| Investing                               |       | 1,126,000                                 |       | (32,935,978 | )          | (34,061,978 | ) |
| Financing                               |       | (3,164,160                                | )          | (3,280,930  | )          | (116,770 | ) |
| Effect  of exchange rate change in cash |       | 149,381                                   |       | —      |       | (149,381 | ) |
|                                    |       | $                                         | (9,834,531 | )           | $          | (50,442,592 | ) | $ | (40,608,061 | ) |

 

**Operations**

 

Cash used in operationsdecreased as a result of the decrease in year-to-date operating losses beforedepreciation and amortization.

 

**Investing**

 

Cash provided byinvesting activities increased as a result of the sale of assets to ShuffleMaster and significant reductions in purchasing of gaming machines and systemsafter the first year of operations.  Electronic gaming machines andproperty, plant and equipment of $1.8 million were purchased in the nine-monthperiod ended September 30, 2009.

 

**Financing**

 

Cash used in financingactivities decreased as a result of lower repayments on short-term debt andleases.

 

**CRITICALACCOUNTING POLICIES AND ESTIMATES**

 

Our consolidatedfinancial statements were prepared in conformity with accounting principlesgenerally accepted in the United States. Accordingly, we are required to makeestimates incorporating judgments and assumptions we believe are reasonable basedon our historical experience, contract terms, observance of known trends in ourCompany and the industry as a whole, as well as information available fromother outside sources. Our estimates affect amounts recorded in the financialstatements and actual results may differ from initial estimates.

 

We consider the followingaccounting estimates to be the most critical to fully understanding andevaluating our reported financial results. They require us to make subjectiveor complex judgments about matters that are inherently uncertain or variable.Senior management have discussed the development, selection and disclosure ofthe following accounting estimates, considered most sensitive to changes fromexternal factors, with the audit committee of our board of directors.

 

**IntangibleAssets, including Goodwill**

 

Intangible assets consistof patents, customer relationships, trademarks and goodwill. They are recordedat cost and are amortized, except for goodwill, on the straight-line basis overthe period of time the asset is expected to contribute directly or indirectlyto future cash flows, which range from 10 to 13 years. The straight-lineamortization method is utilized because we believe there is not a more reliablydeterminable method of reflecting the pattern in which the economic benefits ofthe intangible assets are consumed or otherwise used up.

 

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We adopted FASB ASC 350,*Goodwill and Other Intangible Assets*and FASB ASC 360, *Accounting for theImpairment or Disposal of Long-Lived Assets*, effective January 1,2002.  Under FASB ASC 350, goodwill is no longer amortized but issubject to periodic impairment tests. Other intangible assets with finitelives, such as patents, customer relationships and trademarks will continue tobe amortized over their useful lives.

 

**Inventory**

 

The determination ofobsolete or excess inventory requires us to estimate the future demand for ourproducts within specific time horizons, generally one year or less. If weexperience a significant unexpected decrease in demand for our products or ahigher occurrence of inventory obsolescence because of changes in technology orcustomer requirements, we could be required to increase our inventoryprovisions.

 

**GamingMachines and Systems**

 

Gaming machines andsystems are stated at cost.  We depreciate new gaming machines and systemsover a five-year useful life and depreciate refurbished gaming machines over athree-year useful life once placed in service. Trends in market demand and technological obsolescence may require us toreview and evaluate the recoverability of our investment, as well as theestimated useful lives used to depreciate these assets.

 

**Propertyand Equipment**

 

We are required toestimate salvage values and useful lives for our property and equipment. Trends in market demand and technological obsolescence may require us to recordimpairment charges in accordance with the provisions of FASB ASC 360.

 

**RevenueRecognition**

 

We recognize revenue whenall of the following have been satisfied:

 

·                  persuasive evidence of an arrangement exists;

 

·                  the price to the customer is fixed and determinable;

 

·                  delivery has occurred and any acceptance terms havebeen fulfilled;

 

·                  no significant contractual obligations remain; and

 

·                  collection is reasonably assured.

 

*Gamingand Non-Gaming Product Revenues*

 

We recognize revenue fromthe sale of our products to end users upon shipment against customer contractsor purchase orders.

 

We recognize revenue fromour sales to independent distributors upon shipment to the distributor againstdistributor contracts or purchase orders of our product.  We recognizerevenue on consignment inventory when ownership of the product and title passesto the distributor which occurs upon the distributor’s use of the product inits service organization or to an end user.

 

*ParticipationRevenues*

 

We earn recurring revenueby providing customers with electronic gaming machines and casino managementsystems which track game performance and provide statistics on installedelectronic gaming machines owned by us and leased to venue owners.  Revenues are recognized on the contractualterms of the participation agreements between ourselves and the venue ownersand are based on our share of net winnings.

 

Revenues are recognizedas incurred with the exception of one of our venues for which revenues arerecognized as the payment for net winnings are received as the collections fromthis venue were not yet reasonably assured. Net winnings from this venue have been recorded as deferred revenueuntil the collections of such net winnings are reasonably assured.  Deferred revenue was $149,087 and $NIL as of September 30,2009 and December 31, 2008, respectively.

 

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**Stock-BasedCompensation**

 

We adopted FASB ASC 718,*Share-Based Payment*, to accountfor stock-based compensation beginning January 1, 2006, and elected themodified prospective method of transition. Under the fair value recognition provisionsof FASB ASC 718, for stock-based compensation accrued to employees andnon-employee directors, we recognize stock-based compensation expense for allservice-based awards with graded vesting schedules on the straight-line basisover the requisite service period for the entire award.  Initial accruals of compensation expense arebased on the estimated number of shares for which requisite service is expectedto be rendered.  Estimates are revised ifsubsequent information indicates that forfeitures will differ from previousestimates, and the cumulative effect on compensation costs of a change in theestimated forfeitures is recognized in the period of the change.  For non-employee awards, we remeasurecompensation costs each period until the service condition is complete andrecognizes compensation costs on the straight-line basis over the requisiteservice period.  Option valuation modelsrequire the input of highly subjective assumptions, and changes in the assumptionsused can materially affect the fair value estimate. Judgment is required inestimating stock price volatility, forfeiture rates, expected dividends, andexpected terms that options remain outstanding. Stock-based compensation expense totaled $328,733 and $1,475,063 and$774,903 and $5,842,641 for the three-month and nine-month periods ended September 30,2009 and 2008, respectively, and is included in selling, general andadministrative expense in the accompanying consolidated statements ofoperations.

 

**IncomeTaxes**

 

We are subject to incometaxes in the U.S. (including federal and state) and several foreignjurisdictions in which we operate. Deferred income tax balances reflect theeffects of temporary differences between the carrying amounts of assets andliabilities and their tax bases and are stated at enacted tax rates expected tobe in effect when taxes are actually paid or recovered. FASB ASC 740, *Accounting for Income Taxes*, requires thatdeferred tax assets be evaluated for future realization and reduced by avaluation allowance to the extent we believe a portion will not be realized. Weconsider many factors when assessing the likelihood of future realization ofour deferred tax assets, including our recent cumulative earnings experienceand expectations of future taxable income by taxing jurisdiction, thecarry-forward periods available to us for tax reporting purposes, and otherrelevant factors.

 

Significant judgment isrequired in evaluating our tax positions and determining our provision forincome taxes. During the ordinary course of business, there are manytransactions and calculations for which the ultimate tax determination isuncertain. Effective January 1, 2007, we adopted the provisions of FASB ASC 740,which contains a two-step approach to recognizing and measuring uncertain taxpositions. The first step is to evaluate the tax position for recognition bydetermining if the weight of available evidence indicates it is more likelythan not that the position will be sustained on audit, including resolution ofrelated appeals or litigation processes, if any. The second step is to measurethe tax benefit as the largest amount which is more than 50% likely of beingrealized upon ultimate settlement. We consider many factors whenevaluating and estimating our tax positions and tax benefits, which may requireperiodic adjustments and which may not accurately anticipate actual outcomes.

 

We are subject to incometax examination by tax authorities from 2003 through the present period injurisdictions in which we operate. There are currently no income tax returnsunder examination by the U.S. Internal Revenue Service or any other major taxauthorities.

 

**RecentlyIssued Accounting Standards**

 

For a description ofaccounting changes and recent accounting pronouncements, including the dates ofadoption and estimated effects, if any, on our consolidated condensed financialstatements, see “Note 1: “Description of Business and Significant AccountingPolicies” in the Notes to Consolidated Condensed Financial Statements of this Form 10-Q.

 

**Item 3.            Quantitativeand Qualitative Disclosures about Market Risk**

 

Not applicable.

 

## **Item 4.            Controlsand Procedures**

##  

*(a)  Evaluation of Disclosure Controls andProcedures*.

 

Ourmanagement, with the participation of our chief executive officer and chief accountingofficer, has evaluated the effectiveness of our disclosure controls andprocedures pursuant to Rule 13a-15 under the Securities Exchange Act of 1934,as amended (the “Exchange Act”). Based on this evaluation, our managementconcluded that our disclosure controls and procedures were not effective as ofSeptember 30, 2009 due to material weakness as identified at December 31, 2008.While we have implemented additional control procedures to mitigate the risksassociated with these material weaknesses, these controls have not been testedas of September 30, 2009. Thus, our material weaknesses will not be consideredremediated until testing has been completed and provides management a basis toconclude that these controls are properly designed and operating effectively.

 

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As previously reported inour Annual Report on Form 10-K, as filed with the Securities and ExchangeCommission on March 30, 2009, in connection with our assessment of theeffectiveness of our internal control over financial reporting at the end ofits last fiscal year, management identified four material weaknesses (i) trackingand accounting of electronic gaming machines (EGMs), (ii) foreign currencytransaction and translation, (iii) calculation and recording ofstock-based compensation, and (iv) valuation of inventory, receivables andintangible assets, in our internal control over financial reporting as of December 31,2008. This section of Item 4, “Controls and Procedures,” should be read inconjunction with Item 9A, “Controls and Procedures,” included in our Form 10-Kfor the year ended December 31, 2008, for additional information onManagement’s Report on Internal Controls Over Financial Reporting. Managementis committed to remediate the material weaknesses as timely as possible and hasimplemented the following additional control procedures during the quarterended September 30, 2009 when preparing the unaudited quarterlyconsolidated financial statements in accordance with generally acceptedaccounting principles in the United States.

 

·                  In order to ensure our EGMs balance was correct as of September 30,2009, a physical count of EGMs at September 30, 2009 was conducted with nomaterial discrepancies noted.

 

·                  Management performed a thorough review of there-measurement of foreign currency balances at September 30, 2009.

 

·                  Management performed a thorough review of thecalculation and recording of stock-based compensation for the three-monthperiod ended September 30, 2009.

 

·                  Management performed thorough reviews of and morerobust analyses on certain critical estimates and account balances at September 30,2009.

 

(b)  *Changes in internal control over financial reporting.*

 

Except as indicated insection (a) above, there were no other changes in our internal controlsover financial reporting that occurred during the three-month period ended September 30,2009 that have materially affected, or are reasonably likely to materiallyaffect, our internal controls over financial reporting.

 

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# **PART II — OTHER INFORMATION**

#  

## **Item 5.            OtherInformation**

 

On November 10, 2009, we entered into an employment agreement datedNovember 10, 2009 with our president and chief executive officer, ClarenceChung.  Pursuant to the agreement, wehave agreed to retain Mr Chung, and Mr. Chung has agreed to serve, as ourpresident and chief executive officer through December 31, 2012.  Mr. Chung had been serving as president andchief executive officer pursuant to an employment agreement dated April 30,2009 that was due to expire on December 31, 2009.  Other than the extended term of employment,the new agreement is on terms substantially similar to the employment agreementdated April 30, 2009. Pursuant to the terms of the new employment agreement,Mr. Chung will be paid an annual salary of US$1.00 and will be entitled to adiscretionary performance bonus of such amount and form (whether in cash or inkind) to be determined by the compensation committee of our board of directors,payable upon achievement of certain objectives set by the compensationcommittee and at such time as may be deemed appropriate by the compensationcommittee.

 

## **Item 6.            Exhibits**

 
| **Exhibit  No.** | ** ** | **Description**                                                                                                                                                               | ** ** | **Method of Filing** |
|------------------|------------|-------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|--------------------------------|
|             |       |                                                                                                                                                                          |       |                           |
| 10.1             |       | Employment Agreement dated November 10, 2009 between  Elixir Gaming Technologies, Inc. and Clarence Chung*                                                                    |       | Filed electronically herewith  |
|             |       |                                                                                                                                                                          |       |                           |
| 31.1             |       | Certifications Pursuant  to Section 302 of the Sarbanes-Oxley Act of 2002.                                                                                               |       | Filed electronically  herewith |
|             |       |                                                                                                                                                                          |       |                           |
| 31.2             |       | Certifications Pursuant  to Section 302 of the Sarbanes-Oxley Act of 2002.                                                                                               |       | Filed electronically  herewith |
|             |       |                                                                                                                                                                          |       |                           |
| 32.1             |       | Certification of  Principal Executive Officer and Principal Financial Officer pursuant to  Section 906 of the Sarbanes-Oxley Act of 2002 (18 U.S.C.  Section 1350). |       | Filed electronically  herewith |

 

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* Indicatesmanagement compensatory plan, contract or arrangement.

 

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**SIGNATURES**

 

In accordance with therequirements of the Exchange Act, the registrant caused this report to besigned on its behalf by the undersigned, thereunto duly authorized.

 
| ** ** | ** **             | **ELIXIR  GAMING TECHNOLOGIES, INC.** |
|------------|------------------------|---------------------------------------|
|       |                   | (Registrant)                          |
|       |                   |                                  |   |
|       |                   |                                  |   |
| Date:      | November 10, 2009 | By:                                   | /s/ Clarence Chung |
|       |                   |                                  | Clarence Chung |
|       |                   | Its:                                  | President and Chief  Executive Officer |
|       |                   |                                  |   |
|       |                   |                                  |   |
| Date:      | November 10, 2009 | By:                                   | /s/ Andy Tsui |
|       |                   |                                  | Andy Tsui |
|       |                   | Its:                                  | Chief Accounting  Officer |

 

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