**SECURITIES AND EXCHANGE COMMISSION**

**Washington, D.C.20549**

 

**FORM 10-Q**

 

| **(Mark One)**                                                                                                                                                                           |   |                                                                                           |
|------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|--------|------------------------------------------------------------------------------------------------|
|                                                                                                                                                                                     |   |                                                                                           |
| **ý**                                                                                                                                                                               |   | **QUARTERLY  REPORT PURSUANT TO SECTION 13 OR 15(d)  OF THE SECURITIES EXCHANGE ACT OF 1934**  |
|                                                                                                                                                                                     |   |                                                                                           |
| **FOR THE QUARTERLY PERIOD ENDED JULY 31, 2003**                                                                                                                                    |
|                                                                                                                                                                                     |   |                                                                                           |
| **OR**                                                                                                                                                                                   |
|                                                                                                                                                                                     |   |                                                                                           |
| **o**                                                                                                                                                                                    |   | **TRANSITION  REPORT PURSUANT TO SECTION 13 OR 15(d)  OF THE SECURITIES EXCHANGE ACT OF 1934** |
|                                                                                                                                                                                     |   |                                                                                           |
| **FOR THE TRANSITION PERIOD FROM              TO              ** |
|                                                                                                                                                                                     |   |                                                                                           |
| **Commission File Number****000-23401**                                                                                                                                                  |

 

**GAMETECH INTERNATIONAL, INC.**

(Exact name of registrant as specified in itscharter)

 
| **DELAWARE**                                                                       |   | **33-0612983**                       |
|------------------------------------------------------------------------------------|--------|--------------------------------------|
| (State or other jurisdiction  of incorporation or organization)                    |   | (I.R.S. Employer Identification No.) |
|                                                                               |   |                                 |
| **900 SANDHILL ROAD, RENO, NEVADA  89521**                                         |
| (Address of principal executive offices)  (Zip code)                               |
|                                                                               |   |                                 |
| Registrant’s telephone number, including area code:  **(775)  850-6000** |

 

Indicate by check mark whether the registrant(1) has filed all reports required to be filed by Section 13 or 15(d) ofthe Securities Exchange Act of 1934 during the preceding 12 months (or for suchshorter period that the registrant was required to file such reports), and (2)has been subject to such filing requirements for the past 90 days  Yes ý  No o

 

Indicate by check mark whether the registrantis an accelerated filer (as defined in Exchange Act Rule 12b-2) Yes o  No ý

 

On September 8, 2003, the registrant had11,737,439 outstanding shares of its Common Stock, par value $0.001 per share.

 

 

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**GAMETECHINTERNATIONAL, INC.**

**QUARTERLYREPORT ON FORM 10 –Q**

**FORTHE QUARTERLY PERIOD ENDED JULY 31, 2003**

**INDEX**

 
| Part I. Financial Information:    |
|-----------------------------------|
|                              | Item 1. | Financial Statements (Unaudited) |
|                              |   |
|                              |   | Condensed Consolidated Balance Sheets  October 31, 2002 and July 31, 2003 |
|                              |   |
|                              |   | Condensed Consolidated Statements of  Operations  Three Months and Nine Months Ended July 31, 2002 and 2003 |
|                              |   |
|                              |   | Condensed Consolidated Statements of Cash Flows  Nine Months Ended July 31, 2002 and 2003 |
|                              |   |
|                              |   | Notes to Condensed Consolidated Financial  Statements |
|                              |   |
|                              | Item 2. | Management’s Discussion and Analysis of Financial Condition and  Results of Operations |
|                              |   |   |
|                              | Item 3. | Quantitative and Qualitative Disclosures About Market Risk |
|                              |   |   |
|                              | Item 4. | Controls and Procedures |
|                              |   |
| Part II.  Other Information: |
|                              |
|                              | Item 1. | Legal Proceedings |
|                              |   |   |
|                              | Item 2. | Changes in Securities and Use of Proceeds |
|                              |   |   |
|                              | Item 3. | Defaults Upon Senior Securities |
|                              |   |   |
|                              | Item 4. | Submission of Matters to a Vote of Security  Holders |
|                              |   |   |
|                              | Item 5. | Other Information |
|                              |   |   |
|                              | Item 6. | Exhibits and Reports on Form 8-K |
|                              |   |
| Signatures                        |
|                              |
| Certifications                    |

 

2

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**GAMETECH INTERNATIONAL, INC.**

**CONDENSEDCONSOLIDATED BALANCE SHEETS**

**(In thousands, except share and per share amounts)**

 
|                                                                                                                                                               |   | **October 31,  2002** |       | **July 31,  2003** |       |
|--------------------------------------------------------------------------------------------------------------------------------------------------------------------|--------|----------------------------|------------|-------------------------|------------|
|                                                                                                                                                               |   |                       | ** ** | **(Unaudited)**         | ** ** |
| **Assets:**                                                                                                                                                        |   |                       |       |                    |       |
| Current assets:                                                                                                                                                    |   |                       |       |                    |       |
| Cash and cash equivalents                                                                                                                                          |   | $                          | 4,233      |                    | $          | 8,354 |   |
| Short-term investments                                                                                                                                             |   | 5,045                      |       | 2,219                   |       |
| Accounts receivable, net                                                                                                                                           |   | 3,906                      |       | 3,781                   |       |
| Deposits                                                                                                                                                           |   | 610                        |       | 66                      |       |
| Refundable income taxes                                                                                                                                            |   | 3,888                      |       | —                  |       |
| Prepaid expenses and other current assets                                                                                                                          |   | 433                        |       | 420                     |       |
| Deferred income taxes                                                                                                                                              |   | 2,278                      |       | 2,278                   |       |
| Total current assets                                                                                                                                               |   | 20,393                     |       | 17,118                  |       |
|                                                                                                                                                               |   |                       |       |                    |       |
| Bingo units, furniture and equipment, net                                                                                                                          |   | 21,620                     |       | 22,398                  |       |
| Intangible and other non-current assets, net                                                                                                                       |   | 1,128                      |       | 2,790                   |       |
| Goodwill                                                                                                                                                           |   | 14,960                     |       | 16,809                  |       |
| Total assets                                                                                                                                                       |   | $                          | 58,101     |                    | $          | 59,115 |   |
|                                                                                                                                                               |   |                       |       |                    |       |
| **Liabilities and stockholders’  equity:**                                                                                                                    |   |                       |       |                    |       |
| Current liabilities:                                                                                                                                               |   |                       |       |                    |       |
| Accounts payable                                                                                                                                                   |   | $                          | 914        |                    | $          | 475 |   |
| Accrued payroll and related obligations                                                                                                                            |   | 805                        |       | 703                     |       |
| Other accrued liabilities                                                                                                                                          |   | 2,099                      |       | 1,778                   |       |
| Current portion of long-term debt                                                                                                                                  |   | 13                         |       | 344                     |       |
| Total current liabilities                                                                                                                                          |   | 3,831                      |       | 3,300                   |       |
|                                                                                                                                                               |   |                       |       |                    |       |
| Long-term debt                                                                                                                                                     |   | —                     |       | 12                      |       |
| Non-current employment obligations                                                                                                                                 |   | 432                        |       | 435                     |       |
| Deferred income taxes                                                                                                                                              |   | 3,348                      |       | 3,348                   |       |
|                                                                                                                                                               |   |                       |       |                    |       |
| Commitments and contingencies                                                                                                                                      |   |                       |       |                    |       |
|                                                                                                                                                               |   |                       |       |                    |       |
| Stockholders’ equity:                                                                                                                                         |   |                       |       |                    |       |
| Common stock, $.001 par value: 40,000,000 sharesauthorized; 13,090,764 shares  issued at October 31, 2002 and 13,592,764 shares issued at July 31,  2003 |   | 13                         |       | 14                      |       |
| Capital in excess of par value                                                                                                                                     |   | 45,716                     |       | 46,246                  |       |
| Retained earnings                                                                                                                                                  |   | 12,857                     |       | 13,856                  |       |
| Less: Treasury stock, at cost: 1,855,325 shares at  October 31, 2002 and at July 31, 2003                                                                |   | (8,096                     | )          | (8,096                  | )          |
| Total stockholders’ equity                                                                                                                                    |   | 50,490                     |       | 52,020                  |       |
| Total liabilities and stockholders’ equity                                                                                                                    |   | $                          | 58,101     |                    | $          | 59,115 |   |

 

See accompanying notes.

 

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**GAMETECH INTERNATIONAL, INC.**

**CONDENSEDCONSOLIDATED STATEMENTS OF OPERATIONS**

**(In thousands, except share and per shareamounts)**

 
|                                                     |   | **Three  Months Ended  July 31,** |       | **Nine  Months Ended  July 31,** |       |
|----------------------------------------------------------|--------|----------------------------------------|------------|---------------------------------------|------------|
|                                                     |   | **2002**                               |       | **2003**                              | ** ** | **2002** | ** ** | **2003** | ** ** |
|                                                     |   | **(Unaudited)**                        | ** ** | **(Unaudited****)**                   | ** ** |
|                                                     |   |                                   |       |                                  |       |   |   |   |   |
| Revenue                                                  |   | $                                      | 12,496     |                                  | $          | 12,776 |   | $ | 36,452 |   | $ | 39,295 |   |
|                                                     |   |                                   |       |                                  |       |   |   |   |   |
| Cost of revenue                                          |   | 4,836                                  |       | 5,905                                 |       | 14,335 |   | 16,768 |   |
| Gross profit                                             |   | 7,660                                  |       | 6,871                                 |       | 22,117 |   | 22,527 |   |
|                                                     |   |                                   |       |                                  |       |   |   |   |   |
| Operating expenses:                                      |   |                                   |       |                                  |       |   |   |   |   |
| General and administrative                               |   | 2,168                                  |       | 2,650                                 |       | 6,295 |   | 8,651 |   |
| Sales and marketing                                      |   | 3,163                                  |       | 2,929                                 |       | 9,280 |   | 9,324 |   |
| Research and development                                 |   | 609                                    |       | 974                                   |       | 1,583 |   | 2,851 |   |
| Total operating expenses                                 |   | 5,940                                  |       | 6,553                                 |       | 17,158 |   | 20,826 |   |
|                                                     |   |                                   |       |                                  |       |   |   |   |   |
| Income from operations                                   |   | 1,720                                  |       | 318                                   |       | 4,959 |   | 1,701 |   |
|                                                     |   |                                   |       |                                  |       |   |   |   |   |
| Interest and other income (expense), net                 |   | 50                                     |       | (14                                   | )          | 85 |   | 13 |   |
|                                                     |   |                                   |       |                                  |       |   |   |   |   |
| Income before provision for income taxes                 |   | 1,770                                  |       | 304                                   |       | 5,044 |   | 1,714 |   |
|                                                     |   |                                   |       |                                  |       |   |   |   |   |
| Provision for income taxes                               |   | 676                                    |       | 52                                    |       | 1,926 |   | 715 |   |
|                                                     |   |                                   |       |                                  |       |   |   |   |   |
| Net income                                               |   | $                                      | 1,094      |                                  | $          | 252 |   | $ | 3,118 |   | $ | 999 |   |
|                                                     |   |                                   |       |                                  |       |   |   |   |   |
| Basic net income per share                               |   | $                                      | 0.10       |                                  | $          | 0.02 |   | $ | 0.28 |   | $ | 0.09 |   |
|                                                     |   |                                   |       |                                  |       |   |   |   |   |
| Diluted net income per share                             |   | $                                      | 0.09       |                                  | $          | 0.02 |   | $ | 0.27 |   | $ | 0.08 |   |
|                                                     |   |                                   |       |                                  |       |   |   |   |   |
| Shares used in the calculation of net  income per share: |   |                                   |       |                                  |       |   |   |   |   |
| Basic                                                    |   | 11,202,609                             |       | 11,732,222                            |       | 11,125,926 |   | 11,682,194 |   |
|                                                     |   |                                   |       |                                  |       |   |   |   |   |
| Diluted                                                  |   | 11,739,270                             |       | 11,749,470                            |       | 11,653,170 |   | 11,800,173 |   |

 

See accompanying notes.

 

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**GAMETECH INTERNATIONAL, INC.**

**CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS**

**(In thousands)**

 
|                                                                               |   | **Nine  Months EndedJuly 31,** | ** ** |
|------------------------------------------------------------------------------------|--------|-------------------------------------|------------|
|                                                                               |   | **2002**                            |       | **2003** | ** ** |
|                                                                               |   | **(unaudited)**                     | ** ** |
| **Cash flows from operating  activities:**                                         |   |                                |       |   |   |
| Net income                                                                         |   | $                                   | 3,118      |   | $ | 999 |   |
| Adjustments to reconcile net income to net cash  provided by operating activities: |   |                                |       |   |   |
| Depreciation, amortization and obsolescence                                        |   | 6,120                               |       | 8,081 |   |
| Changes in operating assets and liabilities:                                       |   |                                |       |   |   |
| Accounts receivable, net                                                           |   | 390                                 |       | 125 |   |
| Deposits, net                                                                      |   | 26                                  |       | 544 |   |
| Refundable income taxes                                                            |   | 1,198                               |       | 3,888 |   |
| Other current assets                                                               |   | (24                                 | )          | 13 |   |
| Accounts payable                                                                   |   | 101                                 |       | (439 | ) |
| Other accrued liabilities                                                          |   | (1,062                              | )          | (420 | ) |
|                                                                               |   |                                |       |   |   |
| Net cash provided by operating activities                                          |   | 9,867                               |       | 12,791 |   |
|                                                                               |   |                                |       |   |   |
| **Cash flows from investing  activities:**                                         |   |                                |       |   |   |
| Decrease (increase) in short-term investments                                      |   | (1,895                              | )          | 2,826 |   |
| Capital expenditures for bingo units, furniture  and equipment                     |   | (10,013                             | )          | (7,255 | ) |
| Payment for the acquisition of International  Gaming Systems, Inc.                 |   | —                              |       | (3,469 | ) |
| Proceeds from settlement of Bingo Technologies  Corporation purchase               |   | 477                                 |       | — |   |
| Purchase of intangible assets                                                      |   | (311                                | )          | (1,109 | ) |
|                                                                               |   |                                |       |   |   |
| Net cash used in investing activities                                              |   | (11,742                             | )          | (9,007 | ) |
|                                                                               |   |                                |       |   |   |
| **Cash flows from financing  activities:**                                         |   |                                |       |   |   |
| Payments on long-term debt                                                         |   | (2,365                              | )          | (194 | ) |
| Proceeds from exercise of stock options                                            |   | 1,065                               |       | 531 |   |
|                                                                               |   |                                |       |   |   |
| Net cash (used) provided by financing activities                                   |   | (1,300                              | )          | 337 |   |
|                                                                               |   |                                |       |   |   |
| Net (decrease) increase in cash and cash  equivalents                              |   | (3,175                              | )          | 4,121 |   |
| Cash and cash equivalents at beginning of period                                   |   | 10,131                              |       | 4,233 |   |
|                                                                               |   |                                |       |   |   |
| Cash and cash equivalents at end of period                                         |   | $                                   | 6,956      |   | $ | 8,354 |   |
|                                                                               |   |                                |       |   |   |
| **Supplemental disclosure of  non-cash investing activities:**                     |   |                                |       |   |   |
| Purchase of intangible assets through the  incurrence of long-term debt            |   | $                                   | —     |   | $ | 537 |   |

 

Seeaccompanying notes.

 

5

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**GAMETECH INTERNATIONAL, INC.**

**NOTESTO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS**

 

**JULY 31, 2003**

**(UNAUDITED)**

 

**NOTE A. BASIS OF PRESENTATION**

 

The accompanying unaudited condensedconsolidated financial statements as of July 31, 2003 have been preparedin accordance with accounting principles generally accepted in the UnitedStates for interim financial information and with the instructions to Form 10-Qand Article 10 of Regulation S-X. Accordingly, they do not include all of the information and footnotesrequired by accounting principles generally accepted in the United States forcomplete financial statements.  In ouropinion, all adjustments (consisting of normal recurring adjustments)considered necessary for a fair presentation have been included.  Operating results for the three- and nine-monthperiods ended July 31, 2003 are not necessarily indicative of the resultsthat may be expected for the fiscal year ending October 31, 2003.

 

The balance sheet at October 31, 2002has been derived from the audited financial statements at that date but doesnot include all of the information and footnotes required by accountingprinciples generally accepted in the United States for complete financialstatements.  For further information,refer to the consolidated financial statements and footnotes thereto includedin our annual report on Form 10-K for the year ended October 31, 2002.

 

Certain amounts in the prior period’scondensed consolidated financial statements have been reclassified to conformto the current period’s presentation.

 

**NOTE B. SIGNIFICANT ACCOUNTING POLICIES**

 

### **REVENUE RECOGNITION**

### ** **

Revenue is recognized for bingo units placedin bingo halls under contracts based on (a) a fixed fee per use persession; (b) a fixed weekly fee per unit; or (c) a percentage of therevenue generated by each unit. Revenue recognition is a key component of ourresults of operations and determines the timing of certain expenses, such ascommissions. We recognize revenue when all of the following factors exist:(a) evidence of an arrangement with the customer; (b) play oravailability of the bingo units; (c) a fixed or determinable fee; and(d) collectibility is reasonably assured.

 

### **ALLOWANCE FOR DOUBTFUL ACCOUNTS**

### ** **

We estimate the possible losses resulting from non-payment ofoutstanding accounts receivable. Our customer base consists primarily ofentities operating in charitable, Native American, and commercial bingo hallslocated throughout the United States. In some jurisdictions, the billing andcollection function is performed as part of a distributor relationship, and inthose instances, we maintain allowances for possible losses resulting fromnon-payment by both the customer and distributor. We perform ongoingevaluations of customers and distributors for credit worthiness, economictrends, changes in customer payment terms, and historical collection experiencewhen evaluating the adequacy of our allowance for doubtful accounts. We alsoreserve a percentage of accounts receivable based on aging category. Indetermining these percentages, we review historical write-offs of receivables,payment trends, and other available information.

 

### **LEGAL CONTINGENCIES**

### ** **

We are currently involved in various claimsand legal proceedings.  Periodically, wereview the status of each significant matter and assess the potential financialexposure.  If the potential loss fromany claim or legal proceeding is considered probable and the amount can beestimated, we accrue a liability for the estimated loss.  Significant judgment is required in both thedetermination of probability and the determination as to whether an

 

6

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exposureis reasonably estimable.  Because ofuncertainties related to these matters, accruals are based only on the bestinformation available at the time.  Asadditional information becomes available, we reassess the potential liabilityrelated to our pending claims and litigation and may revise our estimates.  Such revisions in the estimates of thepotential liabilities could have a material impact on the results of operationsand financial position.  See Note E ofNotes to Condensed Consolidated Financial Statements for a description of ourmaterial legal proceedings.

 

**BINGO UNIT****DEPRECIATIONAND OBSOLESCENCE RESERVES**

 

Bingo units, furniture and equipment arestated at cost and depreciated using the straight-line method over theestimated useful lives of the assets. The estimated useful lives are asfollows:

 

 

| Bingo units                    |   | 3-5 years |   |
|--------------------------------|--------|-----------|--------|
| Office furniture and equipment |   | 5-7 years |   |
| Leasehold improvements         |   | 10 years  |   |

 

We provide reserves for excess or obsoletebingo units on hand, which are not expected to be used. The reserves are basedupon several factors, including estimated forecast of bingo unit demand forplacement into halls.

 

**GOODWILL AND OTHER INTANGIBLE ASSETS**

 

In 2001 the Financial Accounting StandardsBoard (“FASB”) issued Statement of Financial Accounting Standards (“SFAS”) No.142, “*Goodwill and Other Intangible Assets*”(“Statement 142”), which we early adopted as of November 1, 2001. UnderStatement 142, goodwill and intangible assets deemed to have indefinite livesare no longer amortized but are subject to an annual impairment review, anddepending upon the results of that review, the recorded goodwill and intangibleassets may be written down and charged to income from operations when theircarrying value exceeds their estimated fair value.

 

**PRO FORMA STOCK – BASED COMPENSATIONINFORMATION**

 

Pro forma information regarding net incomeand earnings per share is required by SFAS No. 123, “*Accounting for Stock-Based Compensation,*” (“Statement 123”)as amended by SFAS No. 148, “*Accounting forStock-Based Compensation – Transition and Disclosure,*” (“Statement148”), and has been determined as if we had accounted for our employee stockoptions under the fair value method of that statement.

 

Our pro forma information follows:

 

(In thousands,except per share amounts)

 
|                                                                                                                          |   | **Three  Months Ended  July 31,** |       | **Nine  Months Ended  July 31,** |       |
|-------------------------------------------------------------------------------------------------------------------------------|--------|----------------------------------------|------------|---------------------------------------|------------|
|                                                                                                                          |   | **2002**                               |       | **2003**                              | ** ** | **2002** | ** ** | **2003** | ** ** |
|                                                                                                                          |   | **(Unaudited)**                        | ** ** | **(Unaudited)**                       | ** ** |
|                                                                                                                          |   |                                   |       |                                  |       |   |   |   |   |
| Net income, as reported                                                                                                       |   | $                                      | 1,094      |                                  | $          | 252 |   | $ | 3,118 |   | $ | 999 |   |
| Deduct: Total stock-based employee compensation expense determined  under fair value based method, net of related tax effects |   | (138                                   | )          | (133                                  | )          | (512 | ) | (350 | ) |
| Pro forma net income                                                                                                          |   | $                                      | 956        |                                  | $          | 119 |   | $ | 2,606 |   | $ | 649 |   |
|                                                                                                                          |   |                                   |       |                                  |       |   |   |   |   |
| Earnings  per share:                                                                                                          |   |                                   |       |                                  |       |   |   |   |   |
| Basic – as reported                                                                                                      |   | $                                      | 0.10       |                                  | $          | 0.02 |   | $ | 0.28 |   | $ | 0.09 |   |
| Basic – pro forma                                                                                                        |   | $                                      | 0.09       |                                  | $          | 0.01 |   | $ | 0.23 |   | $ | 0.06 |   |
|                                                                                                                          |   |                                   |       |                                  |       |   |   |   |   |
| Diluted – as reported                                                                                                    |   | $                                      | 0.09       |                                  | $          | 0.02 |   | $ | 0.27 |   | $ | 0.08 |   |
| Diluted – pro forma                                                                                                      |   | $                                      | 0.08       |                                  | $          | 0.01 |   | $ | 0.22 |   | $ | 0.06 |   |

 

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**NEW ACCOUNTING PRONOUNCEMENTS**

 

Effective November 1, 2002, we adopted SFAS No. 144, “*Accounting for the Impairment or Disposal ofLong-Lived Assets*” (“Statement 144”).  This statement addresses financial accounting and reporting forthe impairment or disposal of long-lived assets.  The adoption of Statement 144 did not have a material impact onour financial statements and related disclosures.

 

In April 2002, the FASB issued SFAS No. 145, “*Rescission of FASB Statements No. 4, 44 and 64,Amendment of FASB Statement No. 13 and Technical Corrections*”(“Statement 145”). Statement 145 updates, clarifies and simplifies existingaccounting pronouncements. Statement 145 rescinds SFAS No. 4 (“Statement 4”),which required all gains and losses from extinguishment of debt to beaggregated and, if material, classified as an extraordinary item, net ofrelated income tax effect. As a result, the criteria in Accounting Principles Board(“APB”) Opinion No. 30 will now be used to classify those gains and lossesbecause Statement 4 has been rescinded. Statement 145 amends SFAS No. 13 torequire that certain lease modifications that have economic effects similar tosale-leaseback transactions be accounted for in the same manner assale-leaseback transactions. This amendment is consistent with the FASB’s goalof requiring similar accounting treatment for transactions that have similareconomic effects. Statement 145 also makes technical corrections to existingpronouncements. While those corrections are not substantive in nature, in someinstances, they may change accounting practice. We adopted the provisions ofStatement 145 for fiscal 2003, which did not result in a material impact to financialposition, cash flows or results of operations.

 

In July 2002, the FASB issued SFAS No. 146, “*Accounting for Costs Associated with Exit or DisposalActivities*” (“Statement 146”). Statement 146 addresses financialaccounting and reporting for costs associated with exit or disposal activitiesand nullifies Emerging Issues Task Force (“EITF”) Issue No. 94-3, “*Liability Recognition for Certain EmployeeTermination Benefits and Other Costs to Exit an Activity (including CertainCosts Incurred in a Restructuring*)” (“Issue 94-3”). The principaldifference between Statement 146 and Issue 94-3 relates to Statement 146’srequirements for recognition of a liability for a cost associated with an exitor disposal activity. Statement 146 requires that a liability for a costassociated with an exit or disposal activity be recognized when the liabilityis incurred. Under Issue 94-3, a liability for an exit cost as generallydefined in Issue 94-3 was recognized at the date of an entity’s commitment toan exit plan. A fundamental conclusion reached by the FASB in Statement 146 isthat an entity’s commitment to a plan, by itself, does not create an obligationthat meets the definition of a liability. Therefore, Statement 146 eliminatesthe definition and requirements for recognition of exit costs in Issue 94-3.Statement 146 also establishes that fair value is the objective for initialmeasurement of the liability. The provisions of Statement 146 are effective forexit or disposal activities that are initiated after December 31, 2002. Wedo not expect the adoption of Statement 146 will have a material impact onfinancial position, cash flows or results of operations.

 

In November 2002, the EITF reached a consensus on Issue 00-21, “*Multiple-Deliverable Revenue Arrangements*”(“Issue 00-21”). Issue 00-21 addresses how to account for arrangements that mayinvolve the delivery or performance of multiple products, services, and/orrights to use assets. The consensus mandates how to identify whether goods orservices or both that are to be delivered separately in a bundled salesarrangement should be accounted for separately because they are “separate unitsof accounting.” The guidance can affect the timing of revenue recognition forsuch arrangements, even though it does not change rules governing the timing orpattern of revenue recognition of individual items accounted for separately.The final consensus will be applicable to agreements entered into in fiscalyears beginning after June 15, 2003 with early adoption permitted. Additionally,companies will be permitted to apply the consensus guidance to all existingarrangements as the cumulative effect of a change in accounting principle inaccordance with APB Opinion No. 20, *AccountingChanges*. We are assessing, the potential impact of Issue 00-21, butat this point do not believe the adoption of Issue 00-21 will have a materialimpact on our financial position, cash flows or results of operations.

 

8

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In November 2002, the FASB issued Interpretation No. 45, “*Guarantor’s Accounting and Disclosure Requirementsfor Guarantees, Including Indirect Guarantees of Indebtedness of Others*”(“FIN 45”). This interpretation elaborates on the disclosures to be made by aguarantor in its interim and annual financial statements about its obligationsunder certain guarantees that it has issued. It also clarifies that a guarantoris required to recognize, at the inception of a guarantee, a liability for thefair value of the obligation undertaken in issuing the guarantee. Thedisclosure requirements of FIN 45 are effective for interim and annual periodsafter December 15, 2002, and we have adopted those requirements for theconsolidated financial statements included in this Form 10-Q. The initial recognitionand initial measurement requirements of FIN 45 are effective prospectively forguarantees issued or modified after December 31, 2002.  The adoption of the recognition and initialmeasurement requirements of FIN 45 did not have a material impact on our financialposition, cash flows or results of operations.

 

In December 2002, the FASB issued Statement 148, which amendsStatement 123 and provides alternative methods of transition for a voluntarychange to the fair value based method of accounting for stock-based employeecompensation. Statement 148 also amends the disclosure requirements ofStatement 123 to require more prominent and frequent disclosures in financialstatements about the effects of stock-based compensation. The transitionguidance and annual disclosure provisions of Statement 148 are effective forfinancial statements issued for fiscal years ending after December 15,2002. Adoption of Statement 148 did not have a material impact on our financialposition, cash flows or results of operations.

 

In January 2003, the FASB issued Interpretation No. 46, “*Consolidation of Variable Interest Entities - anInterpretation of ARB No. 51*” (“FIN 46”).  FIN 46 addresses consolidation by business enterprises ofvariable interest entities that have certain characteristics.  Transferors to qualifying special-purposeentities and “grandfathered” qualifying special-purpose entities subject to thereporting requirements of Statement 140, “*Accountingfor Transfers and Servicing of Financial Assets and Extinguishments ofLiabilities,*” are excluded from the scope of FIN 46.  FIN 46 is applicable immediately to variableinterest entities created or obtained after April 30, 2003.  We currently have no contractualrelationship or other business relationship with a variable interest entity andtherefore the adoption did not have an effect on our consolidated financialposition or results of operations. However, if we enter into any such arrangement with a variable interestentity in the future, our consolidated financial position or results ofoperations may be adversely impacted.

 

**NOTE C. ACQUISITION OF ASSETS**

 

In November 2002, we acquired certain assets of InternationalGaming Systems, Inc. (“IGS”) for a cash purchase price of$3.4 million.  Among other things,the acquisition added to ouroperations approximately 1,400 fixed-base bingo units in approximately 20additional bingo halls. The acquisition was accounted for as a purchase of abusiness in accordance with SFAS No. 141, “*Business Combinations.*” We determined the appropriate purchase price allocation based onestimated fair values at the date of acquisition for tangible and identifiableintangible assets acquired to be approximately $600,000 for bingo units andsupport equipment and approximately $1.0 million for identifiable intangibleswith a residual amount of approximately $1.8 million assigned to goodwill.

 

**NOTE D. NET INCOME PER SHARE OF COMMON STOCK**

 

The calculation of the basic and diluted earnings per share is the sameexcept for the dilutive effect of outstanding stock options.  The dilution was 536,661 and 17,248 sharesfor the three months ended July 31, 2002 and 2003, respectively.  The dilution was 527,244 and 117,979 sharesfor the nine months ended July 31, 2002 and 2003, respectively. Employee stockoptions to purchase 551,975 and 443,785 shares of the Company’s common stockfor the three months ended July 31, 2003 and 2002, respectively, and551,975 and 503,785 shares for the nine months ended July 31, 2003 and2002, respectively, were not included in the computation of diluted loss pershare because the effect would be anti-dilutive.

 

**NOTE E. LITIGATION**

 

We are inlitigation with a former distributor in Texas in which each party is seekingdamages from the other resulting from alleged material breaches and resultanttermination of the related distributor agreement. As a result of thetermination of the agreement during our fourth quarter of 2002, we fullyreserved our existing accounts receivable from the distributor atOctober 31, 2002, including certain monies received by the distributor andowed to us that have been placed in a bank account subject to the court’scontrol. Subsequent collections by the distributor, if any, against accountsreceivable existing at the contract termination date will also be placed inthat account. In addition, we have posted a deposit of approximately $450,000with the court, which is included in other non-current assets, net on theaccompanying condensed consolidated balance sheet. The disposition of the funds(monies held in the bank account and our deposit) is pending the outcome of thelitigation. The terms of the distributor agreement contain certain contingentcommission liabilities and other liabilities, which if a final judgment wererendered

 

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unfavorable tous, could have a material adverse effect on our financial position and resultsof operations.  The contingentcommission liabilities, only if determined at trial to be payable, would becalculated based on terms included in the terminated distributoragreement.  Those terms call forcommissions on a diminishing percentage of revenues from the relative customersover the three-year period following the termination of the distributoragreement.  For the first year followingtermination, commissions would be calculated on 80% of the revenues, for thesecond year commissions would be calculated on 70% of the revenues, and for thethird year commissions would be calculated on 60% of the revenues.  Assuming revenues for the three-year periodremained constant at the rate earned over the first eleven months followingtermination of the distributor agreement, the contingent liability would amountto approximately $2.4 million.  AMay 10, 2004 trial date has been set and there can be no assurance of afavorable outcome of the litigation. We have not accrued any liability atJuly 31, 2003 for this matter.

 

We are in litigation withCapital Gaming Supplies, Inc. (“Capital”), a distributor in Mississippi forIGS.  Capital claims that we tortiouslyinterfered with alleged existing and prospective customer accounts inMississippi. We have denied the allegations and filed a counter-claim seeking ajudgment that Capital tortiously interfered with our customer accounts.  In addition, Capital has amended itscomplaint, adding other claims against us and other defendants, including aclaim against IGS and its principals. In November 2002, we acquired certain assets of IGS (see footnoteC) and agreed to assume liability for certain claims filed by Capital againstIGS and its principals.  We have notaccrued any liability at July 31, 2003 for this matter and intend tovigorously oppose Capital’s claims. Trial is set for January 28,2004.  While we have a reasonable basisfor believing Capital’s claims are without merit, we cannot provide anyassurance that we will obtain a favorable outcome.

 

In March 2003, the South Carolina Department of Revenue (“Department”) issued a notice to all persons and entities that use electronic daubing devices (such as our portable and fixed-base bingo units) to cease and desist using the devices as of September 4, 2003.  The notice is a reversal of the Department’s previous position provided to us in 1995 regarding the use of such devices.  The Department’s decision was not made due to any violation or improper conduct on our part.  We have filed a Request for Contested Case Hearing regarding the Department’s reversal.  We disagree with the Department’s position and are actively seeking legal and legislative relief so that our electronic daubing devices may continue to be used.  Historically, South Carolina has accounted for less than 5% of our revenues.  We have executed a Memorandum of Understanding (“MOU”) with the Department and other entities involved in the South Carolina bingo industry, which will allow us to continue to operate in South Carolina until March 15, 2004.  We can make no assurances that we will be able to continue to provide equipment to the South Carolina market after March 15, 2004.

 

Weare involved in various other legal proceedings arising out of our operationsin the ordinary course of our business. We do not believe that any of these proceedings will have a materialadverse effect on our business, financial condition, or results of operationsbeyond the immaterial amounts recorded in the accompanying condensedconsolidated financial statements. However, if settlements are not reached andthe lawsuits proceed to trial, unfavorable outcomes could have a materialadverse effect on our financial position and results of operations.

 

**ITEM2****.**  **MANAGEMENT’SDISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS**

 

The following discussion should be read in conjunction with ourcondensed consolidated financial statements and notes thereto includedelsewhere in this report,aswell as our audited consolidated financial statements for the fiscal year endedOctober 31, 2002 contained in our annual report on Form 10-K. Thefollowing discussion contains certain forward-looking statements that involverisks and uncertainties. Our actual results could differ materially from theresults anticipated in these forward-looking statements as a result of thefactors set forth in this report and those risk factors included in our annualreport on Form 10-K for the fiscal year ended October 31, 2002.

 

**OVERVIEW**

 

We design, develop, and market interactive electronic bingo systems. Wecurrently market portable hand-held systems that can be played anywhere withina bingo hall and a fixed-base system with touchscreen or light pen activatedmonitors.For our threemost recent fiscal years ended October 31, 2000, 2001, and 2002, ourportable hand-held units generated approximately 75%, 77% and 77% of ourrevenues, respectively, while, during those same periods, our fixed-based unitsgenerated the balance of our revenues. For the first nine months of fiscal 2003, our hand-held units producedapproximately 74% of our revenues, and our fixed-base units, including thoseacquired from IGS, produced approximately 26% of our revenues.  We have systems in service in states thatallow electronic

 

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bingo systems for use withcharitable and commercial organizations and in Native American bingohalls.  Collectively.  As of July 31, 2003, we had products in35 states and in five countries outside of the United States.

 

We generate revenue by placing electronic bingo systems in bingohalls.  Revenue growth is affected byplayer acceptance of electronic bingo as an addition or an alternative to paperbingo and our ability to expand operations into new markets. Fixed-base bingounits generally generate greater revenue per unit than portable bingo units,but also require a greater initial capital investment.

 

We typically install our electronic bingo systems at no charge to ourcustomers, and we capitalize the costs. We record depreciation of bingoequipment over a three- and five-year estimated useful life using thestraight-line method of depreciation.

 

Our expenses consist primarily of (a) cost of revenue, consistingof expenses associated with technical and operational support of the bingosystems within bingo halls, depreciation of bingo units, repair, refurbishment,and disposals of bingo units and related support equipment, and excess orobsolescence reserves; (b) general and administrative, consisting ofactivities associated with management of our company and related support, whichincludes finance and accounting, legal, compliance, information systems, humanresources, and accounts receivable reserves; (c) sales and marketing,consisting primarily of commissions paid to distributors for promoting andsupporting our products and an internal sales force with a focus upongenerating new customers and upgrades for existing customers; and(d) research and development (R&D), consisting of company-sponsoredR&D activities to provide players with new or enhanced products.

 

During the first nine months of fiscal 2003, the following eventsoccurred that affected, or may in the future affect, our results of operations,or liquidity and capital resources.

 

In November 2002, we acquired certainassets of IGS for a cash purchase price of $3.4 million.  Among other things, the acquisition added toour operations approximately 1,400 fixed-base bingo units in approximately 20additional bingo halls. The acquisition was accounted for as a purchase of abusiness. We determined the appropriate purchase price allocation based onestimated fair values at the date of acquisition for tangible and identifiableintangible assets acquired to be approximately $600,000 for bingo units andsupport equipment and approximately $1.0 million for identifiable intangibleswith a residual amount of approximately $1.8 million assigned to goodwill.

 

We have incurred significantexpenses in aggressively defending or pursuing certain legal issues, includingthe defense of a patent infringement lawsuit in Nevada, our litigation with aformer distributor in Texas, and litigation with a former distributor for IGSin Mississippi.  The terms of theterminated distributor agreement with the former Texas distributor containcertain contingent commission liabilities, which if a final judgment wereunfavorable to us, could have an adverse effect on our financial position,results of operation and liquidity. The contingent commission liabilities, only if determined at trial to bepayable, would be calculated based on terms included in the terminateddistributor agreement. Assuming revenues for the three-year period remainedconstant at the rate earned over the first eleven months following terminationof the distributor agreement, the contingent liability would amount toapproximately $2.4 million.  However, because we do not currently believeit probable that there will be an unfavorable outcome, we have not accrued anyamount related to these contingent liabilities.

 

We havesignificantly increased the staffing of our research and development departmentand have increased expenditures for outside research and developmentcosts.  We anticipate that the higherlevel of research and development expenditures experienced thus far in fiscal2003 will continue.

 

During thefirst nine months of fiscal 2003, our capital expenditures were approximately$7.3 million, $6.7 million of which represented investments in bingo andrelated support equipment, primarily for our color hand-held unit, the TED2 CTM.

 

**CRITICAL ACCOUNTING POLICIES AND ESTIMATES**

 

Management’s Discussion and Analysis of Financial Condition and Resultsof Operations discusses our condensed consolidated financial statements, whichhave been prepared in accordance with accounting principles generally acceptedin the United States. The preparation of these financial statements requires usto make estimates and assumptions that affect the reported amounts of assetsand liabilities and the disclosure of contingent assets and

 

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liabilities at the balancesheet date and reported amounts of revenue and expenses during the reportingperiod. On an ongoing basis, we evaluate our estimates and judgments, includingthose related to revenue recognition, bad debts, bingo unit depreciation,goodwill impairment, contingencies and litigation. We base our estimates andjudgments on historical experience and on various other factors that arereasonable under the circumstances, the results of which form the basis formaking judgments about the carrying values of assets and liabilities that arenot readily apparent from other sources. Actual results may differ from theseestimates under different assumptions or conditions.

 

We believe the following critical accounting policies affect our moresignificant judgments and estimates used in the preparation of our condensedconsolidated financial statements.

 

### ***REVENUE RECOGNITION***

 

Revenue is recognized for bingo units placed in bingo halls undercontracts based on (a) a fixed fee per use per session; (b) a fixedweekly fee per unit; or (c) a percentage of the revenue generated by eachunit. Our revenue recognition is a key component of our results of operations,and determines the timing of certain expenses, such as commissions. Werecognize revenue in accordance with accounting principles generally acceptedin the United States when all of the following factors exist: (a) evidenceof an arrangement with the customer; (b) play or availability of the bingounits; (c) a fixed or determinable fee; and (d) collectibility isreasonably assured. We exercise judgment in assessing the creditworthiness ofour customers and therefore in our determination of whether collectibility isreasonably assured. Should changes in conditions cause us to determine thesecriteria are not met for future transactions, revenue recognized for futurereporting periods could be adversely affected.

 

### ***ALLOWANCE FORDOUBTFUL ACCOUNTS***

 

We estimate the possible losses resulting from non-payment ofoutstanding accounts receivable. We perform ongoing evaluations of ourcustomers and distributors for creditworthiness, economic trends, changes inour customer payment terms, and historical collection experience whenevaluating the adequacy of our allowance for doubtful accounts. We also reservea percentage of our accounts receivable based on aging category. In determiningthese percentages, we review historical write-offs of our receivables, paymenttrends, and other available information. While such estimates have been withinour expectations and the provisions established, a change in financialcondition of specific customers or in overall trends experienced may result infuture adjustments of our estimates of recoverability of our receivables.

 

### ***RESERVE FOR BINGOUNIT OBSOLESCENCE***

 

We provide reserves for excess or obsolete bingo units on hand that wedo not expect to be used. Our reserves are based upon several factors,including our estimated forecast of bingo unit demand for placement into halls.Our estimates of future bingo unit demand may prove to be inaccurate, in whichcase we may have understated or overstated the provision required for excessand obsolete bingo units. Although we attempt to assure the accuracy of ourestimated forecasts, any significant unanticipated changes in demand ortechnological developments could have a significant impact on the value of ourbingo units and our reported operating results.

 

***IMPAIRMENT OFGOODWILL AND INTANGIBLE ASSETS***

 

We are required to perform an annual goodwill impairment review, anddepending upon the results of that measurement, the recorded goodwill may bewritten down and charged to income from operations when its carrying amountexceeds its estimated fair value. In addition, we assess the impairment ofgoodwill whenever events or changes in circumstances indicate that the carryingvalue may not be recoverable, such as a significant adverse change in legalfactors or in the business climate, an adverse action or assessment by aregulator, unanticipated competition, or a loss of key personnel.

 

We assess the impairment of identifiable intangible assets wheneverevents or changes in circumstances indicate

 

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that the carrying value maynot be recoverable. Factors we consider important that could trigger animpairment review include the following:

 

• a significant change in the manner of our useof the acquired assets or the strategy for our overall business;

 

• a significant decrease in the market priceof an asset;

 

• a significant adverse change in legalfactors or in the business climate that could affect the value of an asset,including an adverse action or assessment by a regulator;

 

• a current period operating or cash flow losscombined with a history of operating or cash flow losses or a projection orforecast that demonstrates continuing losses associated with the use of anasset; and

 

• a currentexpectation that, more likely than not, an asset will be sold or otherwisedisposed of significantly before the end of its previously estimated usefullife.

 

Both of theseassessments require management judgment. Any changes in key assumptions aboutthe business and its prospects, or changes in market conditions or otherexternalities, could result in an impairment charge and such a charge couldhave a material adverse effect on our consolidated results of operations.

 

### ***LEGAL CONTINGENCIES***

### ** **

We arecurrently involved in various claims and legal proceedings.  Periodically, we review the status of eachsignificant matter and assess our potential financial exposure.  If the potential loss from any claim orlegal proceeding is considered probable and the amount can be estimated, weaccrue a liability for the estimated loss. Significant judgment is required in both the determination ofprobability and the determination as to whether an exposure can be reasonably estimated.  Because of uncertainties related to thesematters, accruals are based only on the best information available at thetime.  As additional information becomesavailable, we reassess the potential liability related to our pending claimsand litigation and may revise our estimates. Such revisions in the estimates of the potential liabilities could havea material impact on our results of operations and financial position.  See Note E of Notes to CondensedConsolidated Financial Statements for a description of our material legalproceedings.

 

**RESULTS OF OPERATIONS**

 

**Three Months Ended July 31, 2003Compared with Three Months Ended July 31, 2002**

 

REVENUE.  We generated revenue of $12.8 million for the three monthsended July 31, 2003 compared to $12.5 million for the comparableprior-year quarter.  The $280,000, or2.2%, net increase in revenue from the third quarter of fiscal 2002 wasprimarily due to the increase of TED2 C bingo unitplacements and the contribution from the former IGS halls.

 

COST OFREVENUE.  Cost of revenue increased $1.1 million, or22.1%, to $5.9 million for the three months ended July 31, 2003 from $4.8million for the comparable prior-year quarter. Cost of revenue as a percent ofrevenue for the current three-month period increased to 46.2% compared to 38.7%for the three months ended July 31, 2002. The increase in cost of revenueover the prior year was driven by a planned increase of $575,000 in service andoperations, principally for personnel and related costs attributable to thegrowth in service, and an increase of $551,000 in bingo unit depreciation andamortization, primarily as a result of our investment in TED2 C color hand-held units and IGS units.

 

GENERAL AND ADMINISTRATIVE.  General and administrative costs increased $482,000, or 22.2%, to $2.7million for the three months ended July 31, 2003 from $2.2 million for thecomparable prior-year quarter.  Generaland administrative costs as a percent of revenue for the current three-monthperiod were 20.7% compared to 17.4% for the three months ended July 31,2002.  Increased legal and consultingexpenses accounted for most of the increase and were the primary factorsdriving our costs above last year. We believe the elevated level of legalexpenses, including those related to defense of a patent infringement lawsuitin Nevada, litigation with a former distributor in Texas, litigation with aformer distributor of IGS in Mississippi, and other legal proceedings, willcontinue for the balance of fiscal 2003 and into early fiscal 2004.  The fiscal 2003 three-month period benefitedfrom an adjustment of $87,000, the reversal of a portion of the accrual forfuture bonus payments.

 

SALESAND MARKETING.* * Sales, marketing, and commission expensesdecreased $234,000, or 7.4%, to $2.9 million for the three months endedJuly 31, 2003 from $3.2 million for the comparable prior-yearquarter.   Sales, marketing, andcommission expenses as a percent of revenue for the current three-month periodwere 22.9% compared to 25.3% for the three months ended July 31,2002.  Distributor commissions decreased$152,000 to $2.0 million

 

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for the three months ended July 31, 2003 due to an increase inrevenue generated by non-distributor halls. Distributor commission expenses, asa percentage of revenue for the current three-month period were 15.7% comparedto 17.2% for the three months ended July 31, 2002. Commissions willfluctuate as the mix of revenue generated by distributors and those customersserved directly by us varies.

 

RESEARCHAND DEVELOPMENT. Researchand development costs increased $365,000, or 59.9%, to $974,000 for the threemonths ended July 31, 2003 from $609,000 for the comparable prior-yearquarter.  Research and development costsas a percent of revenue for the current three-month period were 7.6% comparedto 4.9% for the three months ended July 31, 2002.  The increase was a result of significantgrowth in the engineering staff and external project costs for new or enhancedproducts.  The accelerated level ofinvestment in research and development costs is expected to continue for thebalance of fiscal 2003 and beyond.

 

PROVISIONFOR INCOME TAXES.  Our income tax provision was adjusted duringthe current quarter to recognize an effective fiscal-year rate of 41.7%;consequently, the rate for the quarter ended July 31, 2003 was 17.1%compared to 38.2% for the quarter ended July 31, 2002.  The effective tax rates reflect certainpermanent differences between financial accounting and tax accounting and theeffect of state and federal income taxes on the pre-tax income.

 

**Nine Months Ended July 31, 2003 Comparedwith Nine Months Ended July 31, 2002**

 

REVENUE.  We generated revenue of $39.3 million for the nine monthsended July 31, 2003 compared to $36.5 million for the comparable prior-yearperiod.  The $2.8 million, or 7.8%, netincrease in revenue from the first nine months of fiscal 2002 was primarily dueto increased TED2 C bingo unit placement and the contributionfrom the IGS halls.

 

COST OFREVENUE.  Cost of revenue increased $2.4 million, or17.0%, to $16.8 million for the nine months ended July 31, 2003 from $14.3million for the comparable prior-year period. Cost of revenue as a percent ofrevenue for the current nine-month period increased to 42.7% compared to 39.3%for the nine months ended July 31, 2002. The increase in cost of revenue was primarily due to a $1.4 millionincrease in service and operations, principally for personnel and related costsattributable to the growth in service and a $2.0 million increase in depreciationand amortization, as a result of our investment in TED2 C color hand-held units and IGS units. These increases were partially offset with an aggregate decrease of $1.0million related to a write-off of a capitalized development project last yearand a decrease in refurbishment expenses and disposals of bingo units andequipment.

 

GENERAL AND ADMINISTRATIVE.  General and administrative costs increased $2.4 million, or 37.4%, to$8.7 million for the nine months ended July 31, 2003 from $6.3 million forthe comparable prior-year period. General and administrative costs as a percent of revenue for the currentnine-month period were 22.0% compared to 17.3% for the nine months endedJuly 31, 2002. The fiscal 2002 period included benefits from a reductionof $236,000 and $332,000 to the October 31, 2001 reserves for managementincentive compensation and bad debts, respectively.  Additionally, legal and consulting expenses increased $1.5million above last year partially due to defense of a patent infringement lawsuitin Nevada, litigation with our former distributor in Texas, litigation with aformer distributor of IGS in Mississippi, and other legal proceedings.

 

SALES ANDMARKETING.* * Sales, marketing, and commission expensesincreased $44,000, or 0.5%, to $9.3 million for the nine months endedJuly 31, 2003.   Sales, marketing,and commission expenses as a percent of revenue decreased for the currentnine-month period to 23.7% from 25.5% for the nine months ended July 31,2002.  Distributor commissions decreased$129,000 to $6.4 million for the nine months ended July 31, 2003.  Distributor commission expenses, as apercentage of revenue, for the current nine-month period were 16.3% compared to17.2% for the nine months ended July 31, 2002.  Commissions will fluctuate as the mix of revenue generated bydistributors and those customers served directly by us varies.

 

RESEARCHAND DEVELOPMENT.  Research and development costs increased $1.3million, or 80.1%, to $2.9 million for the nine months ended July 31, 2003from $1.6 million for the comparable prior-year period.  Research and development costs as a percentof revenue for the current nine-month period was 7.3% compared to 4.3% for thenine months ended July 31, 2002. The increase was a result of significant growth in the engineering staffand external project costs for new or enhanced products.

 

PROVISIONFOR INCOME TAXES.  Our income tax provision was recorded at aneffective rate of 41.7% for the nine-months ended July 31, 2003 comparedto 38.2% for the nine months ended July 31, 2002.  The effective tax rates reflect certainpermanent differences between financial accounting and tax accounting and theeffect of state and federal income taxes on the pre-tax income.

 

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**LIQUIDITYAND CAPITAL RESOURCES**

 

Operating activities provided$12.8 million of cash for the nine months ended July 31, 2003compared to $9.9 million for the nine months ended July 31, 2002. The$12.8 million consisted primarily of net income of $999,000, adjusted by$8.1 million from depreciation, amortization, and obsolescence provisions,$3.9 million from refundable income taxes less a net use of funds of $177,000from other operating assets and liabilities. The $2.9 million increase incash provided from operating activities was the net result of a decline of$2.1 million in net income offset by an increase of $2.0 million indepreciation, amortization and obsolescence reserves, and a net change of$3.0 million, as a source of funds, in operating assets and liabilities.

 

We used approximately $9.0 million of cash in investing activitiesfor the nine months ended July 31, 2003 compared to $11.7 million ofcash for the nine months ended July 31, 2002. The $9.0 millionconsisted of $7.3 million of capital expenditures ($6.7 million ofwhich was expended on bingo units and associated support equipment), thepurchase of certain assets of IGS and other intangible assets for a total of$4.6 million, and a decrease in short-term investments of $2.8 million.

 

Financing activities for the nine months ended July 31, 2003provided $337,000 due to proceeds from stock option exercises of $531,000,offset by payments of $194,000 on long-term debt.  During the first nine months of fiscal 2002, we used $1.3 millionfor financing activities.

 

As of July 31, 2003, we had cash and cash equivalents andshort-term investments of approximately $10.6 million. In addition to ourcash and cash equivalents and short-term investments, we have a$10.0 million line of credit with Wells Fargo Bank, N.A., which has aninterest rate based on the prime rate or London InterBank Offered Rate(“LIBOR”) plus 2.0%, at our option, on which there was no outstanding balanceat July 31, 2003. The revolving credit facility expires on April 2, 2004.  We believe that cash flow from operationsand cash, cash equivalents, and short-term investments on hand, together withfunds available under the revolving credit facility, will be sufficient tosupport our operations and provide for budgeted capital expenditures andliquidity requirements through fiscal 2003. Our long-term liquidityrequirements will depend on many factors, including the rate at which we expandour business and whether we do so internally or through acquisitions. Inaddition, strategic opportunities we may pursue could require us to fund ourportion of operating expenses of such ventures and may require us to advanceadditional amounts should any partners in such ventures be unable to meetunanticipated capital calls or similar funding events. To the extent that thefunds generated from the sources described above are insufficient to fund ouractivities in the long term, we may be required to raise additional fundsthrough public or private financing. No assurance can be given that additionalfinancing will be available or that, if it is available, it will be on termsacceptable to us.

 

**ITEM 3.****  QUANTITATIVEAND QUALITATIVE DISCLOSURES ABOUT MARKET RISK**

 

Our revolving credit facility with Wells Fargo is a $10.0 millionline of credit with an interest rate based on the prime rate or LIBOR plus2.0%, at our option. The line of credit expires on April 2, 2004.

 

Because the interest rate on the revolving credit facility is variable,our cash flow may be affected by increases in interest rates, in that we wouldbe required to pay more interest in the event that both the prime and LIBORinterest rates increase. We do not believe, however, that any risk inherent inthe variable-rate nature of the loan is likely to have a material effect on ourinterest expense or available cash. We currently maintain a zero balance on therevolving credit facility.

 

***Sensitivity Analysis.***   Assuming we had a$2.0 million balance outstanding as of July 31, 2003, the rate ofinterest calculated using the prime rate option would be 4.0%. Our monthlyinterest payment, if the rate stayed constant, would be $6,667. If the primerate rose to 8.0%, which assumes an unusually large increase, our monthlypayment would be $13,333. A more likely increase of 1.0% or 2.0%, given therecent trend of decreasing or relatively low interest rates, would result in amonthly payment of $8,333 or $10,000, respectively. We do not believe the riskresulting from such fluctuations is material or that the payment required wouldhave a material effect on cash flow.

 

**ITEM 4****.  CONTROLS ANDPROCEDURES**

 

We have evaluated, with the participation of our Chief ExecutiveOfficer and Chief Financial Officer, the effectiveness of our disclosurecontrols and procedures are effective to ensure that we record, process,summarize, and report information required to be disclosed by us in ourquarterly reports filed under the Securities Exchange Act within the timeperiods specified by the Securities and Exchange Commission’s rules and forms.  During the

 

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quarterly period covered bythis report, there have not been any changes in our internal controls overfinancial reporting that have materially affected, or is reasonably likely tomaterially affect, our internal control over financial reporting.

 

**CAUTIONARY STATEMENT FOR PURPOSES OF THE“SAFE HARBOR” PROVISIONS OF THE PRIVATE SECURITIES LITIGATION REFORM ACT OF1995**

 

This document includes various “forward-looking statements” within themeaning of Section 27A of the Securities Act of 1933, as amended, andSections 21E of the Securities Exchange Act of 1934, as amended, whichrepresent our expectations or beliefs concerning future events.  Statements containing expressions, such as“believes,” “anticipates,” or “expects,” used in our press releases andperiodic reports on Forms 10-K and 10-Q filed with the Commission, are intendedto identify forward-looking statements. All forward-looking statements involve risks and uncertainties.  Although we believe our expectations arebased upon reasonable assumptions within the bounds of our knowledge of ourbusiness and operations, there can be no assurances that actual results willnot materially differ from expected results. We caution that these and similar statements included in this report arefurther qualified by important factors that could cause actual results todiffer materially from those in the forward-looking statements.  Such factors include those discussed in ourannual report on Form 10-K for the year ended October 31, 2002.  Readers are cautioned not to place unduereliance on forward-looking statements, which speak only as of the datethereof.  We undertake no obligation topublicly release any revisions to such forward-looking statements to reflect eventsor circumstances after the date hereof.

 

**PARTII.  OTHER INFORMATION**

 

**ITEM 1. LEGAL PROCEEDINGS**

 

On March 22, 2001, wefiled a claim in the United States District Court, District of Arizona,GAMETECH INTERNATIONAL, INC. V. TREND GAMING SYSTEMS, LLC, CV 01-540 PHXPGR, seeking a declaratory judgment that we are not in material breach of ourNovember 1, 1999 distribution agreement with Trend Gaming Systems, LLC(“Trend”) and seeking damages for past due payments and wrongful withholdingsby Trend.  Trend has counterclaimed,alleging that its payments are in compliance with its contractual obligationsand that it is entitled to withhold certain monies. Trend also contends that weare in breach of certain of our contractual obligations to Trend or its customers.On December 16, 2002, the court entered at our request an order enjoiningTrend from using approximately $540,000 in funds it had collected on ourbehalf, pending a trial on our ownership interest in those funds. The money hasbeen placed in a bank account subject to the court’s control. In addition,collections of accounts receivable by Trend, if any, will also be placed inthat account, pending the trial of the case. No trial date has been set. Trendfiled a motion for summary judgment alleging that the termination of thedistribution agreement was improper.  OnMay 16, 2003, the court dismissed Trend’s motion for summaryjudgment.  A May 10, 2004 trialdate has been set.  We have denied theallegations and intend to vigorously pursue and defend this matter.  However, we cannot provide assurance that wewill obtain a favorable outcome.  Anunfavorable outcome could have a material adverse effect on our business,financial position, and results of operations.

 

On October 30, 2002,Capital Gaming Supplies filed a claim in the United States District Court,Southern District of Mississippi, CAPITAL GAMING SUPPLIES, INC. V. GAMETECHINTERNATIONAL, INC., 3:02 CV 1636 WS, seeking a judgment that we tortiouslyinterfered with alleged existing and prospective customer accounts. We havedenied the allegations and filed a counter-claim seeking a judgment thatCapital tortiously interfered with our customer accounts.  On April 18, 2003, Capital filed anamended complaint adding other claims against us and other defendants,including a claim for malicious breach of contract against IGS, and itsprincipals.  In November 2002, weacquired certain assets of IGS and we assumed certain claims filed by Capitalagainst IGS and its principals. Capital seeks compensatory and punitive damagesfrom all defendants.  Trial is set forJanuary 28, 2004. We intend to defend and pursue vigorously thismatter.  We believe that Capital’sclaims are without merit. However, we cannot provide assurance that we willobtain a favorable outcome. An unfavorable outcome could have a materialadverse effect on our business, financial position, and results of operations.

 

In March 2003, the South Carolina Department of Revenue (“Department”) issued a notice to all persons and entities that use electronic daubing devices (such as our portable and fixed-base bingo units) to cease and desist using the devices as of September 4, 2003.  The notice is a reversal of the Department’s previous position provided to us in 1995 regarding the use of such devices.  The Department’s decision was not made due to any violation or improper conduct on our part.  We have filed a Request for Contested Case Hearing regarding the Department’s

 

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reversal.  We disagree with the Department’s position and are actively seeking legal and legislative relief so that our electronic daubing devices may continue to be used.  Historically, South Carolina has accounted for less than 5% of our revenues.  We have executed a Memorandum of Understanding (“MOU”) by and between the Department and other entities involved in the South Carolina bingo industry, which will allow us to continue to operate in South Carolina until March 15, 2004.  We can make no assurances that we will be able to continue to provide equipment to the South Carolina market after March 15, 2004.

 

Weare involved in various other legal proceedings arising out of our operationsin the ordinary course of our business. We do not believe that any of theseproceedings will have a material adverse effect on our business, financialcondition, or results of operations beyond the amounts recorded in theaccompanying condensed consolidated financial statements. However, ifsettlement is not reached and the lawsuits proceed to trial, an unfavorableoutcome could have a material adverse effect on our financial position andresults of operations.

 

**ITEM2.  CHANGES IN SECURITIES AND USE OFPROCEEDS.**

 

Not Applicable

 

**ITEM3.  DEFAULTS UPON SENIOR SECURITIES**

 

Not Applicable

 

**ITEM4.  SUBMISSION OF MATTERS TO A VOTE OFSECURITY HOLDERS**

 

Not Applicable

 

**ITEM5.  OTHER INFORMATION**

 

Not Applicable

 

**ITEM6.  EXHIBITS AND REPORTS ON FORM 8-K**

 

a) EXHIBITS:

 

31.1                           Certification of Chief Executive Officer pursuantto Rule 13a-14(a) and Rule 15d-14(a) promulgated under the Securities ExchangeAct of 1934, as amended.

 

31.2                           Certification of Chief Financial Officer pursuantto Rule 13a-14(a) and Rule 15d-14(a) promulgated under the Securities ExchangeAct of 1934, as amended.

 

32.1                           Certification of Chief Executive Officer pursuantto 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of theSarbanes-Oxley Act of 2002.

 

32.2                           Certification of Chief Financial Officer pursuantto 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of theSarbanes-Oxley Act of 2002.

 

b) REPORTS ON FORM 8-K

 

99.3                           On May 22, 2003 we filed a current report onForm 8-K, the May 21, 2003, “Results of Operations and FinancialConditions,” financial results of the second quarter of fiscal 2003 andyear-to-date results.

 

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**SIGNATURES**

 

Pursuant to the requirements of the Securities Exchange Act of 1934,the registrant has duly caused this report to be signed on its behalf by theundersigned, thereunto duly authorized.

 
| **Signature**           |   | **Title**                      |   | **Date**                |
|-------------------------|--------|--------------------------------|--------|-------------------------|
|                    |   |                           |   |                    |
| /S/ Clarence H. Thiesen |   | Chief Executive Officer        |   | September 15, 2003 |
| Clarence H. Thiesen     |   | (Principal Executive Officer)  |   |                    |
|                    |   |                           |   |                    |
| /S/ John P. Hewitt      |   | Chief Financial Officer,       |   | September 15, 2003 |
| John P. Hewitt          |   | (Principal Financial Officer)  |   |                    |
|                    |   |                           |   |                    |
| /S/ Ann D. McKenzie     |   | Corporate Controller,          |   | September 15, 2003 |
| Ann D. McKenzie         |   | (Principal Accounting Officer) |   |                    |

 

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