Logo


UNITED
STATES


SECURITIES
AND EXCHANGE COMMISSION


Washington,
D.C. 20549





FORM
10-Q





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





Commission file number
      0-28572.OPTIMAL
      GROUP INC.(Exact
      name of registrant as specified in its charter)Canada
            98-0160833(State
      or other jurisdiction
            (I.R.S.
      Employerof
      incorporation or organization)
            Identification
      No.)3500
      de Maisonneuve Blvd. West, Suite 800,
            (514)
      738-8885Montreal,
      Quebec, Canada, H3Z 3C1(Address
      of principal executive offices and postal code)
            (Registrant
      telephone number, including area code)





Indicate
      by check mark whether the registrant (1) has filed all reports required to
      be filed by Section 13 or 15 (d) of the Securities Exchange Act of 1934
      during the preceding 12 months (or for such shorter period that the
      registrant was required to file such reports), and (2) has been subject to
      such filing requirements for the past 90 days.
            
            Yes
      x
      No  ̈Indicate
      by check mark whether the registrant has submitted electronically and
      posted on its corporate Web site, if any, every Interactive Data File
      required to be submitted and posted 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 registrant was required to submit and post such
      files).
            
            Yes
       ̈ No  ̈





Indicate by check mark whether the
registrant is a large accelerated filer, an accelerated filer, a non-accelerated
filer, or a smaller reporting company. See the definitions of  “large
accelerated filer”, “accelerated filer” and “smaller reporting company” in Rule
12b-2 of the Exchange Act (Check one):






Large
      Accelerated filer  ̈
            Accelerated
      filer x
            Non-accelerated
      filer  ̈

                (Do
      not check if a smaller reporting company)
            Smaller
      reporting company  ̈






Indicate
      by check mark whether the registrant is a shell company (as defined in
      Rule 12b-2 of the Securities Exchange Act of 1934).
            
            Yes
       ̈ No x








At
November 11, 2009 the registrant had 5,148,735 common shares designated as Class
“A” shares (without nominal or par value) outstanding.










OPTIMAL
GROUP INC.




PART
I. FINANCIAL INFORMATION





Item
1. Financial Statements






Condensed
Consolidated Financial Statements of


(Unaudited)





OPTIMAL
GROUP INC.





Three and
nine months ended September 30, 2009 and 2008


(expressed
in U.S. dollars)


2


OPTIMAL
GROUP INC.


Condensed
Consolidated Financial Statements





Three and
nine months ended September 30, 2009 and 2008


(expressed
in U.S. dollars)








Financial Statements




Condensed Consolidated Balance Sheets
            
            4Unaudited Condensed Consolidated Statements of Operations and
      Comprehensive (Loss) Earnings
            
            5Unaudited Condensed Consolidated Statements of Shareholders’
      Equity
            
            6Unaudited Condensed Consolidated Statements of Cash
      Flows
            
            7Notes to Unaudited Condensed Consolidated Financial
      Statements
            
            8


3





OPTIMAL
      GROUP INC.Condensed
      Consolidated Balance SheetsSeptember
      30, 2009 and December 31, 2008(expressed
      in thousands of U.S. dollars)September
      30,
            
            
            December
      31,2009
            
            
            2008(Unaudited)
            
            
            (Audited)AssetsCurrent
      assets:Cash
      and cash equivalents
            
            $
            21,192
            
            
            $
            32,849Short-term
      investments
            
            
            –
            
            
            
            6,296Accounts
      and other receivables (net of allowance for doubtful accountsof
      $390; 2008 - $758)
            
            
            26,593
            
            
            
            24,169Current
      portion of balance of sale receivable
            
            
            2,127
            
            
            
            –Inventories
            
            
            21,948
            
            
            
            19,364Prepaid
      expenses and others
            
            
            1,575
            
            
            
            1,817Current
      assets related to discontinued operations
            
            
            1,495
            
            
            
            4,35874,930
            
            
            
            88,853Balance
      of sale receivable
            
            
            8,000
            
            
            
            –Property
      and equipment
            
            
            3,988
            
            
            
            4,219Intangible
      assets
            
            
            33,651
            
            
            
            45,109Long-term
      assets related to discontinued operations (note 10 (c))
            
            
            –
            
            
            
            30,837$
            120,569
            
            
            $
            169,018Liabilities
      and Shareholders’ EquityCurrent
      liabilities:Bank
      indebtedness
            
            $
            14,140
            
            
            $
            11,547Accounts
      payable and accrued liabilities
            
            
            37,008
            
            
            
            34,518Accounts
      payable and accrued liabilities related to discontinued
      operations
            
            
            3,944
            
            
            
            5,548Current
      portion of long-term debt
            
            
            915
            
            
            
            1,010Income
      taxes payable
            
            
            3,499
            
            
            
            2,225Deferred
      income taxes
            
            
            838
            
            
            
            83860,344
            
            
            
            55,686Deferred
      income taxes
            
            
            6,892
            
            
            
            6,965Long-term
      debt
            
            
            1,966
            
            
            
            2,005Long-term
      liabilities related to discontinued operations (note 10
    (c))
            
            
            10,383
            
            
            
            10,871Shareholders'
      equity:Share
      capital
            
            
            252,488
            
            
            
            252,488Warrants
            
            
            2,696
            
            
            
            2,696Additional
      paid-in capital
            
            
            65,727
            
            
            
            64,173Deficit
            
            
            (276,910
            )
            
            
            (222,849
            )Accumulated
      other comprehensive loss
            
            
            (3,017
            )
            
            
            (3,017
            )40,984
            
            
            
            93,491Contingencies
      and guarantees (note 10) Subsequent events (note 17)$
            120,569
            
            
            $
            169,018




See
accompanying notes to unaudited condensed consolidated financial
statements.


4




OPTIMAL
      GROUP INC.Condensed
      Consolidated Statements of Operations and Comprehensive (Loss)
      Earnings(Unaudited)Three
      and nine months ended September 30, 2009 and 2008(expressed
      in thousands of U.S. dollars, except per share amounts)Three
      months ended September 30,
            
            
            Nine
      months ended September 30,2009
            
            
            2008
            
            
            2009
            
            
            2008Revenues
            
            $
            33,252
            
            
            $
            52,135
            
            
            $
            41,919
            
            
            $
            72,521Other
      revenues (note 13 (d))
            
            
            829
            
            
            
            8,712
            
            
            
            2,499
            
            
            
            28,040Expenses:Cost
      of sales
            
            
            28,348
            
            
            
            38,308
            
            
            
            36,167
            
            
            
            52,768Selling,
      general and administrative
            
            
            9,945
            
            
            
            10,633
            
            
            
            27,250
            
            
            
            25,342Stock-based
      compensation pertaining to selling, general and
    administrative
            
            
            49
            
            
            
            517
            
            
            
            1,554
            
            
            
            2,895Research
      and development
            
            
            1,020
            
            
            
            861
            
            
            
            2,447
            
            
            
            2,136Operating
      leases
            
            
            277
            
            
            
            268
            
            
            
            838
            
            
            
            742Amortization
      (note 13 (f))
            
            
            3,322
            
            
            
            3,868
            
            
            
            10,032
            
            
            
            11,236Transaction
      processing costs
            
            
            –
            
            
            
            7,566
            
            
            
            –
            
            
            
            25,028Impairment
      loss (note 5)
            
            
            –
            
            
            
            –
            
            
            
            4,000
            
            
            
            –Loss
      from continuing operations before undernoted item
            
            
            (8,880
            )
            
            
            (1,174
            )
            
            
            (37,870
            )
            
            
            (19,586
            )Other
      income
            
            
            297
            
            
            
            260
            
            
            
            884
            
            
            
            1,097Loss
      from continuing operations before income taxes
            
            
            (8,583
            )
            
            
            (914
            )
            
            
            (36,986
            )
            
            
            (18,489
            )Income
      taxes (recovery)
            
            
            (118
            )
            
            
            (211
            )
            
            
            (754
            )
            
            
            692Net
      loss from continuing operations
            
            
            (8,465
            )
            
            
            (703
            )
            
            
            (36,232
            )
            
            
            (19,181
            )Net
      (loss) earnings from discontinued operations, net of income taxes (note 3
      (b))
            
            
            (18,590
            )
            
            
            2,410
            
            
            
            (17,829
            )
            
            
            (35,552
            )Net
      (loss) earnings and comprehensive (loss) earnings
            
            $
            (27,055
            )
            
            $
            1,707
            
            
            $
            (54,061
            )
            
            $
            (54,733
            )Weighted
      average number of shares:Basic
      and diluted
            
            
            5,148,735
            
            
            
            5,165,818
            
            
            
            5,148,735
            
            
            
            5,176,589(Loss)
      earnings per share:Continuing
      operations:Basic
      and diluted
            
            
            (1.64
            )
            
            
            (0.14
            )
            
            
            (7.04
            )
            
            
            (3.70
            )Discontinued
      operations:Basic
      and diluted
            
            
            (3.61
            )
            
            
            0.47
            
            
            
            (3.46
            )
            
            
            (6.87
            )Net:Basic
      and diluted
            
            
            (5.25
            )
            
            
            0.33
            
            
            
            (10.50
            )
            
            
            (10.57
            )




See
accompanying notes to unaudited condensed consolidated financial
statements.


5




OPTIMALGROUPINC.


Condensed
Consolidated Statements of Shareholders’ Equity


(Unaudited)





Nine
months ended September 30, 2009 and 2008


(expressed
in thousands of U.S. dollars)





Class
      “A” shares
            
            
            
            
            
            Addi-tional
      paid-in
            
            
            
            
            
            Accu-mulated
      other compre-hensiveNumber
            
            
            Dollars
            
            
            Warrants
            
            
            capital
            
            
            Deficit
            
            
            loss
            
            
            TotalBalance,
      December 31, 2008
            
            
            5,148,445
            
            
            $
            252,488
            
            
            $
            2,696
            
            
            $
            64,173
            
            
            $
            (222,849
            )
            
            $
            (3,017
            )
            
            $
            93,491Shares
      issued pursuant to share consolidation (note 8)
            
            
            290
            
            
            
            –
            
            
            
            –
            
            
            
            –
            
            
            
            –
            
            
            
            –
            
            
            
            –Stock-based
      compensation
            
            
            –
            
            
            
            –
            
            
            
            –
            
            
            
            1,554
            
            
            
            –
            
            
            
            –
            
            
            
            1,554Net
      loss
            
            
            –
            
            
            
            –
            
            
            
            –
            
            
            
            –
            
            
            
            (54,061
            )
            
            
            –
            
            
            
            (54,061
            )Balance,
      September 30, 2009
            
            
            5,148,735
            
            
            $
            252,488
            
            
            $
            2,696
            
            
            $
            65,727
            
            
            $
            (276,910
            )
            
            $
            (3,017
            )
            
            $
            40,984Balance,
      December 31, 2007
            
            
            5,196,630
            
            
            $
            254,454
            
            
            $
            2,696
            
            
            $
            59,418
            
            
            $
            (111,846
            )
            
            $
            (3,017
            )
            
            $
            201,705Cancellation
      of shares pursuant to stock buyback program
            
            
            (30,812
            )
            
            
            (1,257
            )
            
            
            –
            
            
            
            786
            
            
            
            –
            
            
            
            –
            
            
            
            (471
            )Stock-based
      compensation
            
            
            –
            
            
            
            –
            
            
            
            –
            
            
            
            2,910
            
            
            
            –
            
            
            
            –
            
            
            
            2,910Net
      loss
            
            
            –
            
            
            
            –
            
            
            
            –
            
            
            
            –
            
            
            
            (54,733
            )
            
            
            –
            
            
            
            (54,733
            )Balance,
      September 30, 2008
            
            
            5,165,818
            
            
            $
            253,197
            
            
            $
            2,696
            
            
            $
            63,114
            
            
            $
            (166,579
            )
            
            $
            (3,017
            )
            
            $
            149,411




See
accompanying notes to unaudited condensed consolidated financial
statements.


6





OPTIMAL
      GROUPINC.Condensed
      Consolidated Statements of Cash Flows(Unaudited)Three
      and nine months ended September 30, 2009 and 2008(expressed
      in thousands of U.S. dollars)Three
      months ended September 30,
              
              
              Nine
      months ended September 30,2009
              
              
              2008
              
              
              2009
              
              
              2008Cash
      flows (used in) from operating activities:Net
      (loss) earnings
              
              $
              (27,055
              )
              
              $
              1,707
              
              
              $
              (54,061
              )
              
              $
              (54,733
              )(Add)
      deduct (loss) earnings from discontinued operations
              
              
              (18,590
              )
              
              
              2,410
              
              
              
              (17,829
              )
              
              
              (35,552
              )Net
      loss from continuing operations
              
              
              (8,465
              )
              
              
              (703
              )
              
              
              (36,232
              )
              
              
              (19,181
              )Adjustments
      for items not affecting cash:Amortization
              
              
              3,322
              
              
              
              3,868
              
              
              
              10,032
              
              
              
              11,236Deferred
      income taxes
              
              
              472
              
              
              
              546
              
              
              
              (73
              )
              
              
              11,370Impairment
      of intangibles
              
              
              –
              
              
              
              –
              
              
              
              4,000
              
              
              
              –Stock-based
      compensation
              
              
              49
              
              
              
              517
              
              
              
              1,554
              
              
              
              2,895Foreign
      exchange
              
              
              436
              
              
              
              (161
              )
              
              
              94
              
              
              
              (181
              )Net
      change in operating assets and liabilities (note 13 (a))
              
              
              (1,805
              )
              
              
              (10,121
              )
              
              
              (1,293
              )
              
              
              (10,939
              )Operating
      cash flows from (used in) discontinued operations
              
              
              384
              
              
              
              1,728
              
              
              
              2,397
              
              
              
              (4,802
              )(5,607
              )
              
              
              (4,326
              )
              
              
              (19,521
              )
              
              
              (9,602
              )Cash
      flows from (used in) financing activities:Increase
      in bank indebtedness
              
              
              3,809
              
              
              
              4,802
              
              
              
              2,362
              
              
              
              7,283Repayment
      of long-term debt
              
              
              (47
              )
              
              
              –
              
              
              
              (275
              )
              
              
              –Repurchase
      of Class "A" shares
              
              
              –
              
              
              
              –
              
              
              
              –
              
              
              
              (471
              )3,762
              
              
              
              4,802
              
              
              
              2,087
              
              
              
              6,812Cash
      flows (used in) from investing activities:Purchase
      of property, equipment and intangible assets
              
              
              (917
              )
              
              
              (755
              )
              
              
              (2,049
              )
              
              
              (3,918
              )Business
      acquisitions
              
              
              –
              
              
              
              (6,534
              )
              
              
              –
              
              
              
              (6,534
              )Net
      proceeds from maturity of short-term investments
              
              
              –
              
              
              
              1,167
              
              
              
              6,296
              
              
              
              11,261Proceeds
      from disposition of payment processing businesses
              
              
              –
              
              
              
              –
              
              
              
              1,035
              
              
              
              –Proceeds
      from balance of sale receivable
              
              
              94
              
              
              
              –
              
              
              
              345
              
              
              
              –Transaction
      costs related to business acquisitions and disposals
              
              
              –
              
              
              
              (112
              )
              
              
              (126
              )
              
              
              (112
              )Investing
      cash flows (used in) from discontinued operations
              
              
              –
              
              
              
              (38
              )
              
              
              –
              
              
              
              113(823
              )
              
              
              (6,272
              )
              
              
              5,501
              
              
              
              810Effect
      of exchange rate changes on cash and cash equivalents during the
      period
              
              
              (11
              )
              
              
              (98
              )
              
              
              276
              
              
              
              (107
              )Net
      decrease in cash and cash equivalents
              
              
              (2,679
              )
              
              
              (5,894
              )
              
              
              (11,657
              )
              
              
              (2,087
              )Cash
      and cash equivalents, beginning of period
              
              
              23,871
              
              
              
              51,000
              
              
              
              32,849
              
              
              
              47,193Cash
      and cash equivalents, end of period
              
              $
              21,192
              
              
              $
              45,106
              
              
              $
              21,192
              
              
              $
              45,106




Supplemental
cash flow information (note 13)





See
accompanying notes to unaudited condensed consolidated financial
statements.


7


OPTIMAL GROUP INC.


Notes to
Condensed Consolidated Financial Statements


(Unaudited)





Periods
ended September 30, 2009 and 2008


(expressed
in thousands of U.S. dollars, except share and per share
amounts)








1.
            Basis
      of presentation and future
operations:




Basis
of presentation:





These
condensed consolidated financial statements have been prepared by management in
accordance with U.S. generally accepted accounting principles (“U.S. GAAP”). The
unaudited condensed consolidated financial statements reflect all adjustments
which, in the opinion of management, are necessary to present a fair statement
of the results of the interim periods. With the exception of changes referred to
in note 2, these interim condensed consolidated financial statements follow the
same accounting policies and methods of their application as described in note 4
and note 25 to the annual audited consolidated financial statements for the year
ended December 31, 2008. The condensed consolidated financial statements do not
include all disclosures required for annual financial statements and should be
read in conjunction with the most recent annual audited consolidated financial
statements of Optimal Group Inc. (the "Company") as at and for the year ended
December 31, 2008.





The
Company’s revenues and expenses are subject to seasonal variations. The results
of operations and cash flows for any interim period are not necessarily
indicative of the results or cash flows for an entire year.





All
amounts in the attached notes are unaudited unless otherwise specifically
identified.





Future
operations:




These
financial statements have been prepared on a going-concern basis in accordance
with U.S. GAAP. The going-concern basis of presentation assumes that the Company
will continue its operations for the foreseeable future and be able to realize
its assets and discharge its liabilities and commitments in the normal course of
business.





The
recent banking and financial crisis and the global economic recession have
created an extremely challenging retail and economic environment in the United
States and Canada, which has negatively impacted the Company’s operating
performance and potentially that of our customers and suppliers.





The
Company currently funds the majority of its operations from its cash and cash
equivalents and bank indebtedness. The Company’s balance of cash and cash
equivalents generally decreases during the second and third quarters of the
year, as cash is used to fund product development and production, and increases
in the fourth and first quarters in connection with the shipping and collection
periods. In January 2009, the Company implemented a cost reduction program and
since that time management has taken steps to more closely manage its working
capital.


8


OPTIMAL
GROUP INC.


Notes to
Condensed Consolidated Financial Statements, Continued


(Unaudited)





Periods
ended September 30, 2009 and 2008


(expressed
in thousands of U.S. dollars, except share and per share
amounts)







1.
            Basis
      of presentation and future operations
  (continued):




Future
operations (continued):




Although
the Company currently forecasts that its cash and cash equivalents, together
with cash to be generated from operations, will be adequate to meet the
Company’s needs for at least the next twelve months, if operating performance is
significantly lower than currently forecasted, the Company would thereafter
require financing in order to meet its cash flow requirements and fund its
operations. The Company’s operating performance is impacted by economic,
financial, competitive, legislative and regulatory factors, as well as other
events that are beyond the Company’s control, including the possible negative
impact the current economic environment is having on our customers and
suppliers.





If the
Company was to require financing in order to meet its cash flow requirements and
fund its operations and such financing was not available to the Company, or was
not available to the Company on terms that are acceptable to the Company, there
could, at the time, be significant uncertainty about the Company’s ability to
continue as a going-concern, and its capacity to realize the carrying value of
its assets and repay its existing and future obligations as they generally
become due. These financial statements do not reflect adjustments that would be
necessary if the going-concern assumptions were not appropriate under these
circumstances.





2.
            Changes
      in accounting policies:




(a)
            New
      accounting policies:





Effective
January 1, 2009, the Company prepares its consolidated financial statements in
accordance with U.S. GAAP with reconciliation to Canadian generally accepted
accounting principles (“Canadian GAAP”) as described in note 16. The comparative
periods have also been prepared and presented pursuant to U.S. GAAP. Previously,
the Company’s accounting principles conformed to Canadian GAAP and reconciled
differences with U.S. GAAP through its financial statement disclosures. There
was no effect on the Company’s results for 2009 and 2008 as a consequence of
this change.





SFAS No. 165 - Subsequent
events:





The
Company adopted Statement of Financial Accounting Standards (“SFAS”) No. 165,
Subsequent Events,
which was primarily codified into the Financial Accounting Standards Board
(“FASB”) ASC Topic 855, Subsequent Events, which is
effective for interim periods ending after June 15, 2009. SFAS No. 165
establishes general standards for accounting for, and disclosure of, events that
occur after the balance sheet date but before financial statements are issued.
SFAS No. 165 sets forth the period after the balance sheet date during which the
management of a reporting entity should evaluate events or transactions that may
occur for potential recognition in the financial statements, identifies the
circumstances under which an entity should recognize events or transactions
occurring after the balance sheet date in its financial statements, and the
disclosures that should be made about events or transactions that occur after
the balance sheet date. In preparing these financial statements, the Company
evaluated the events and transactions that occurred between September 30, 2009
through November 13, 2009, the date on which these financial statements were
issued.


9


OPTIMAL
GROUP INC.


Notes to
Condensed Consolidated Financial Statements, Continued


(Unaudited)





Periods
ended September 30, 2009 and 2008


(expressed
in thousands of U.S. dollars, except share and per share
amounts)








2.
            Changes
      in accounting policies (continued):




(a)
            New
      accounting policies (continued):





SFAS No. 141R - Business
combinations:





Effective
January 1, 2009, the Company adopted SFAS No. 141R, Business Combinations,which
was primarily codified into FASB ASC Topic 805, Business Combinations, on a
prospective basis. This standard is a revised standard on accounting for
business combinations. For a summarized description of the major changes to
accounting for business combinations, refer to note 25 (f) of the annual
consolidated financial statements. The adoption of this standard did not have an
impact on the Company’s results as there were no business acquisitions in the
three-month and nine-month periods ended September 30, 2009.





SFAS No. 160 -
Non-controlling interest in consolidated financial
statements:





Effective
January 1, 2009, the Company adopted SFAS No. 160, Non-controlling Interest in
Consolidated Financial Statements,which was primarily codified into FASB
ASC Topic 810, Consolidations. This standard
is a revised standard on accounting for non-controlling interests and
transactions with non-controlling interest holders in consolidated financial
statements. For a summarized description of the major changes resulting from
this standard, refer to note 25 (f) of the annual consolidated financial
statements.





This
standard is applied prospectively to all non-controlling interests, including
any that arose before the effective date. The adoption of this standard did not
have an impact on the Company’s results.





SFAS No. 161 - Disclosures
about derivative instruments and hedging activities, an amendment to FASB
Statement No. 133:





Effective
January 1, 2009, the Company adopted SFAS No. 161, Disclosures About Derivative
Instruments and Hedging Activities, an Amendment to FASB Statement No. 133,which was primarily codified into FASB ASC Topic 815, Derivatives and Hedging.
This standard requires qualitative disclosures about objectives and strategies
for using derivatives, quantitative disclosures about fair value amounts of
gains and losses on derivative instruments, and disclosures about credit-risk
related contingent features on derivative agreements. The adoption of this
standard did not have an impact on the Company’s disclosures.





SFAS No. 162 - The Hierarchy
of Generally Accepted Accounting Principles and SFAS 163 - Accounting for
Financial Guarantee Insurance Contracts:





Effective
January 1, 2009, the Company adopted SFAS No. 162, The Hierarchy of Generally Accepted
Accounting Principles, which was primarily codified into FASB ASC Topic
105, Generally Accepted
Accounting Principles,and SFAS No. 163, Accounting for Financial Guarantee
Insurance Contracts which was primarily codified into FASB ASC Topic
944, Insurance
Activities. The adoption of these standards did not have an impact on the
Company’s results.


10


OPTIMAL
GROUP INC.


Notes to
Condensed Consolidated Financial Statements, Continued


(Unaudited)





Periods
ended September 30, 2009 and 2008


(expressed
in thousands of U.S. dollars, except share and per share
amounts)











2.
            Changes
      in accounting policies (continued):




(a)
            New
      accounting policies (continued):





SFAS No. 168 - The FASB
Accounting Standards Codification and Hierarchy of Generally Accepted Accounting
Principles:





In June
2009, the FASB issued SFAS No. 168, The FASB Accounting Standards Codification
and Hierarchy of Generally Accepted Accounting Principles, which was
primarily codified into FASB ASC Topic 105, Generally Accepted Accounting
Principles. SFAS No. 168 replaces SFAS No. 162, The Hierarchy of Generally Accepted
Accounting Principles, to establish the FASB Accounting Standards
Codification (“Codification”) as the source of authoritative accounting
principles recognized by the FASB to be applied by non-governmental entities in
preparation of financial statements in conformity with generally accepted
accounting principles in the United States of America. SFAS No. 168 is effective
for interim and annual reporting periods ending after September 15, 2009. The
adoption of SFAS No. 168 did not have an impact on the Company’s
results.





FSP No. SFAS 157-4 -
Determining Fair Value When the Volume and Level of Activity for the Asset or
the Liability Have Significantly Decreased and Identifying Transactions That Are
Not Orderly:





In April
2009, the FASB issued FSP No. SFAS 157-4, Determining Fair Value When the
Volume and Level of Activity for the Asset or the Liability Have Significantly
Decreased and Identifying Transactions That Are Not Orderly,which was
primarily codified into FASB ASC Topic 820, Fair Value Measurements and
Disclosures. FSP No. SFAS 157-4 amends SFAS No. 157 to provide additional
guidance on (i) estimating fair value when the volume and level of activity for
an asset or liability have significantly decreased in relation to normal market
activity for the asset or liability, and (ii) circumstances that may indicate
that a transaction is not orderly. FSP No. SFAS 157-4 also requires additional
disclosures about fair value measurements in interim and annual reporting
periods. FSP No. SFAS 157-4 is effective for interim and annual reporting
periods ending after June 15, 2009. The adoption FSP No. SFAS 157-4 did not have
an impact on the Company’s results.





SFAS 115-2 and SFAS 124-2 -
Recognition and Presentation of Other-Than-Temporary
Impairments:





In April
2009, the FASB issued FSP No. SFAS 115-2 and SFAS 124-2, Recognition and Presentation of
Other-Than-Temporary Impairments(“FSP No. SFAS 115-2”), which were
primarily codified into FASB ASC Topic 320,Investments. FSP No. SFAS
115-2 provides additional guidance on the timing of impairment recognition and
greater clarity about the credit and non-credit components of impaired debt
securities that are not expected to be sold. FSP No. SFAS 115-2 also requires
additional disclosures about impairments in interim and annual reporting
periods. FSP No. SFAS 115-2 is effective for interim and annual reporting
periods ending after June 15, 2009. The adoption of  FSP No. SFAS
115-2 did not have a material effect on the Company’s results.


11


OPTIMAL
GROUP INC.


Notes to
Condensed Consolidated Financial Statements, Continued


(Unaudited)





Periods
ended September 30, 2009 and 2008


(expressed
in thousands of U.S. dollars, except share and per share
amounts)









2.
            Changes
      in accounting policies (continued):





(a)
            New
      accounting policies (continued):





FSP No. SFAS 107-1 and APB
28-1 - Interim Disclosures about Fair Value of Financial
Instruments:





In April
2009, the FASB issued FSP No. SFAS 107-1 and APB 28-1, Interim Disclosures about Fair Value
of Financial Instruments, which were primarily codified into FASB ASC
Topic 825, Financial
Instruments. FSP No SFAS 107-1 and APB 28-1 amend SFAS No. 107, Disclosures about Fair Value of
Financial Instruments, to require disclosures about fair value of
financial instruments in interim as well as in annual financial statements. This
FSP also amends Accounting Principles Board (“APB”) Opinion No. 28, Interim Financial Reporting,
to require those disclosures in all interim financial statements. FSP No. SFAS
107-1 and APB 28-1 are effective for interim reporting periods ending after June
15, 2009. The adoption of FSP No. SFAS 107-1 and APB 28-1 did not have a
material effect on the Company’s results.





(b)
            Recent
      accounting pronouncements:





In
September 2009, the FASB issued SFAS No. 166, Accounting for Transfers of
Financial Assets, which was primarily codified into FASB ASC Topic 860,
Transfers and
Servicing. SFAS No. 166 amends SFAS No. 140, Accounting for the Transfers and
Servicing of Financial Assets and the Extinguishments of Liabilities, and
seeks to improve the relevance and comparability of the information that a
reporting entity provides in its financial statements about transfers of
financial assets; the effects of the transfer on its financial position,
financial performance, and cash flows; and a transferor’s continuing
involvement, if any, in transferred financial assets. SFAS No. 166 eliminates
the concept of a qualifying special-purpose entity, creates more stringent
conditions for reporting a transfer of a portion of a financial asset as a sale,
clarifies other sale-accounting criteria, and changes the initial measurement of
a transferor’s interest in transferred financial assets. SFAS No. 166 is
effective for interim and annual reporting periods beginning after November 15,
2009. The Company has not completed its evaluation, but does not expect the
adoption of SFAS No. 166 will have a material impact on its consolidated
financial statements.





The
Accounting Standards Board of the Canadian Institute of Chartered Accountants
(“CICA”) has announced its decision to require all publicly accountable
enterprises to report under International Financial Reporting Standards (“IFRS”)
for the years beginning on or after January 1, 2011. However, the Company is a
domestic registrant in the U.S. and  files its financial statements in
accordance with U.S. GAAP. As such, the Company has decided not to report under
IFRS by 2011 and to continue reporting under U.S. GAAP. In August 2008, the SEC
issued a roadmap for the potential convergence to IFRS for U.S. domestic
registrants. The proposal stipulates that the SEC will decide in 2011 whether to
move forward with the convergence to IFRS with the transition beginning in 2014.
Should the SEC adopt such a proposal, the Company will convert its reporting to
IFRS at such time.


12


OPTIMAL
GROUP INC.


Notes to
Condensed Consolidated Financial Statements, Continued


(Unaudited)





Periods
ended September 30, 2009 and 2008


(expressed
in thousands of U.S. dollars, except share and per share
amounts)








3.
            Business
      acquisitions and disposals:




(a)
            Acquisitions:





On August
29, 2008, the Company acquired all the outstanding shares of Sablon Distribution
S.A. (“Sablon”), a Belgium-based toy distributor operating in the Benelux
countries, France and Germany. In July 2008, the Company purchased certain
assets and liabilities of a toy operation based in New York, USA.





The total
purchase price for both acquisitions was $8,502, consisting of cash
consideration paid of $6,557 and transaction costs of $271 and, in connection
with the Sablon acquisition, additional consideration payable of approximately
$1,674 (EUR 1,200), of which approximately $944 (EUR 715) was paid. Additional
consideration is also payable in each of 2009 and 2010 based on the consolidated
net revenues of Sablon in these years. In connection with the second
acquisition, the agreement provides for an additional payment payable upon the
achievement of defined financial milestones. No additional consideration has
been paid in the period for this acquisition. Any additional contingent
consideration paid for these acquisitions will be accounted for as
goodwill.





The
acquisitions were accounted for using the purchase method, and the results were
consolidated with those of the Company from the dates of acquisition. The
Company has allocated the purchase prices on a preliminary basis to the assets
acquired and the liabilities assumed based on management’s best estimate of
their fair values and taking into account all relevant information available at
that time. Since the Company is still in the process of finalizing the valuation
of identifiable intangible assets as well as other assets acquired and
liabilities assumed at the dates of acquisition, the allocation of the purchase
price is subject to change. The Company expects to finalize the allocation of
the purchase price during 2009 and any changes will be disclosed when
finalized.





(b)
            Disposals:




(i)
            2009
      disposals:




Sale
      of Payment Processing Portfolios:





On
February 2, 2009, the Company entered into an agreement with a buyer, giving the
Company the right to cause the buyer to purchase, and giving the buyer the right
to cause the Company to sell, a portfolio of residual payments from merchants
processing credit card-present transactions. In substance, the transaction
represented the sale of a portfolio of residual payments from merchants
processing credit card-present transactions for proceeds of approximately
$11,000.


13


OPTIMAL
GROUP INC.


Notes to
Condensed Consolidated Financial Statements, Continued


(Unaudited)





Periods
ended September 30, 2009 and 2008


(expressed
in thousands of U.S. dollars, except share and per share
amounts)








3.
            Business
      acquisitions and disposals
(continued):





(b)
            Disposals
      (continued):





(i)
            2009
      disposals (continued):





Sale of
Payment Processing Portfolios (continued):





The
aggregate amount of monthly residuals earned on the portfolio, net of a service
fee, will be set off against and will reduce the balance of sale receivable. The
agreement established that the calculation be based on the results of this
portfolio from November 2008 onwards. The adjustment of $1,077 for the amount
earned between November 2008 to the transaction date is reflected as a reduction
to the proceeds. The discounted balance of sale receivable is increased monthly
by a rate of interest of 1% per month. The interest income earned on the balance
of sale receivable is included in other income on the condensed consolidated
statement of operations and comprehensive (loss) earnings. The Company's right
to cause the buyer to purchase (to effectively settle the balance of sale) may
be exercised any time on or after February 2, 2011. The buyer's right to cause
the Company to sell the portfolio (to effectively settle the balance of sale)
may be exercised at any time up to December 31, 2014. Under the terms of this
agreement, the Company has also received a warrant, exercisable for a nominal
consideration, giving the Company the right to acquire treasury shares,
representing up to 3.5% of the outstanding shares of the purchaser, if the
purchase price is not settled prior to specified dates.




Effective
      February 4, 2009, the Company sold a portfolio of merchant processing
      contracts and associated sales channel contracts for a cash consideration
      of approximately $1,035.





(ii)
            2008
      disposals:





Sale of
Canadian Card-Present and Card-Not-Present Businesses:





During
fiscal 2008, the Company sold substantially all of the payment processing assets
that were used exclusively in the business of processing payments for
“card-not-present” transactions and substantially all of the payment processing
assets that were used exclusively in the business of processing payments for
Canadian card-present business. In connection with the second transaction,
additional proceeds of $500 may be received by the Company based on the
achievement of certain earnings goals by the purchaser. No additional
consideration has been received in the period for this
disposition.


14


OPTIMAL
GROUP INC.


Notes to
Condensed Consolidated Financial Statements, Continued


(Unaudited)





Periods
ended September 30, 2009 and 2008


(expressed
in thousands of U.S. dollars, except share and per share amounts)








3.
            Business
      acquisitions and disposals
(continued):





(b)
            Disposals
      (continued):




The
results of operations for these disposed businesses are included in discontinued
operations in the condensed consolidated statements of operations and
comprehensive (loss) earnings.





The
following table summarizes the book value of the assets and liabilities sold,
relating to discontinued operations:





September
      30,
                2009
              
              
              December
      31,
                2008Current
      assets:Cash
      and short-term investments held in reserve
              
              $
              –
              
              
              $
              6,010Settlement
      assets
              
              
              –
              
              
              
              1,679Accounts
      receivable
              
              
              160
              
              
              
              3,622Inventories
              
              
              74
              
              
              
              12Prepaid
      expenses and deposits
              
              
              –
              
              
              
              215234
              
              
              
              11,538Long-term
      assets:Property
      and equipment
              
              
              72
              
              
              
              738Intangible
      assets
              
              
              11,286
              
              
              
              81111,358
              
              
              
              1,549Current
      liabilities:Accounts
      payable and accrued liabilities
              
              
              –
              
              
              
              4,169Customer
      reserves and security deposits
              
              
              –
              
              
              
              7,868–
              
              
              
              12,037Net
      assets sold
              
              
              11,592
              
              
              
              1,050Proceeds
      from sale, net of transaction cost of $126 and adjustments of $1,019 (2008
      - $312)
              
              
              10,890
              
              
              
              8,188Net
      (loss) gain on sale of net assets
              
              $
              (702
              )
              
              $
              7,138





The
remaining assets and liabilities of these segments are classified separately as
assets and liabilities of discontinued operations in the condensed consolidated
balance sheets.


15


OPTIMAL
GROUP INC.


Notes to
Condensed Consolidated Financial Statements, Continued


(Unaudited)





Periods
ended September 30, 2009 and 2008


(expressed
in thousands of U.S. dollars, except share and per share
amounts)











3.
            Business
      acquisitions and disposals
(continued):




(b)
            Disposals
      (continued):





The
summarized results of operations of the businesses disposed of are as
follows:





Three
      months ended September 30,
              
              
              Nine
      months ended September 30,2009
              
              
              2008
              
              
              2009
              
              
              2008Revenues
              
              $
              –
              
              
              $
              18,715
              
              
              $
              1,441
              
              
              $
              51,830Net
      (loss) earnings before income tax
              
              
              (18,996
              )
              
              
              3,929
              
              
              
              (19,551
              )
              
              
              (24,483
              )Net
      (loss) earnings from discontinued operations, before undernoted
      item
              
              
              (18,590
              )
              
              
              2,410
              
              
              
              (17,127
              )
              
              
              (35,552
              )Net
      loss on disposal of net assets
              
              
              –
              
              
              
              –
              
              
              
              (702
              )
              
              
              –Net
      (loss) earnings from discontinued operations
              
              $
              (18,590
              )
              
              $
              2,410
              
              
              $
              (17,829
              )
              
              $
              (35,552
              )





The
results of operations include management assumptions and adjustments related to
cost allocations, which are inherently subjective. The loss before income tax
for the three and nine months ended September 30, 2009 includes the write-off of
$19,183 from the previously discontinued payment processing business related to
online gambling. (note 10 (c)).





4.
            Inventories:





September
      30,
                2009
              
              
              December
      31,
                2008Raw
      materials
              
              $
              4,592
              
              
              $
              7,286Finished
      goods
              
              
              17,356
              
              
              
              12,078$
              21,948
              
              
              $
              19,364


16


OPTIMAL
GROUP INC.


Notes to
Condensed Consolidated Financial Statements, Continued


(Unaudited)





Periods
ended September 30, 2009 and 2008


(expressed
in thousands of U.S. dollars, except share and per share
amounts)








5.
            Intangible
      assets:





September
      30, 2009Gross
      carrying amount
            
            
            Accumulated
      amortization
            
            
            Net
      book valueCustomer
      relations
            
            $
            30,426
            
            
            $
            10,643
            
            
            $
            19,783ISO/ISA
      relations
            
            
            5,608
            
            
            
            3,982
            
            
            
            1,626Intellectual
      property
            
            
            5,520
            
            
            
            3,527
            
            
            
            1,993Tradename
            
            
            14,797
            
            
            
            5,672
            
            
            
            9,125Other
            
            
            2,191
            
            
            
            1,067
            
            
            
            1,124$
            58,542
            
            
            $
            24,891
            
            
            $
            33,651








December
      31, 2008Gross
      carrying amount
            
            
            Accumulated
      amortization
            
            
            Net
      book valueCustomer
      relations
            
            $
            32,854
            
            
            $
            7,939
            
            
            $
            24,915ISO/ISA
      relations
            
            
            7,180
            
            
            
            3,334
            
            
            
            3,846Intellectual
      property
            
            
            5,520
            
            
            
            2,147
            
            
            
            3,373Tradename
            
            
            14,797
            
            
            
            3,453
            
            
            
            11,344Other
            
            
            2,184
            
            
            
            553
            
            
            
            1,631$
            62,535
            
            
            $
            17,426
            
            
            $
            45,109





At June
30, 2009, the Company tested for impairment the customer relations and ISO/ISA
intangible assets related to certain merchant portfolios that are part of the
payment processing business, as the Company determined that the estimated
attrition rate should be increased based on new information. As a result of this
analysis, the Company recorded a non-cash impairment charge of $4,000 at June
30, 2009 based on an estimated fair value established using a discounted cash
flow methodology. At September 30, 2009, the Company has determined that there
was no triggering event requiring an impairment test for the remaining
intangible assets.





The
recent banking and financial crisis and global recession has negatively impacted
the Company’s operating performance (refer to note 1, Future operations). Other
than the impairment on the payments processing intangibles, the Company has
recorded no impairment charges on the remaining intangible assets during 2009.
However, it is reasonably possible that the Company’s determination that these
intangibles are not impaired could change in the near term should the Company’s
operating performance deteriorate lower than is currently
forecasted.


17


OPTIMAL
GROUP INC.


Notes to
Condensed Consolidated Financial Statements, Continued


(Unaudited)





Periods
ended September 30, 2009 and 2008


(expressed
in thousands of U.S. dollars, except share and per share
amounts)








6.
            Bank
      indebtedness




On August
4, 2009, the Company’s European subsidiaries amended their various credit
facilities to temporarily increase the maximum available credit from
approximately $9,731 (EUR 6,650) to approximately $13,170 (EUR 9,000). As at
November 1, 2009, the maximum available credit has decreased to approximately
$6,585 (EUR 4,500). The borrowings are due on demand, bear interest at the
bank’s prime rate plus a premium of 1%, and are secured by a first ranking
hypothec on certain assets of the subsidiaries. As at September 30, the
subsidiary utilized $10,682 (EUR 7,300) of these facilities. Under this
agreement, the subsidiary is subject to financial covenants, which were not met
on September 30, 2009, however the Company expects to reschedule the repayment
of intercompany debt before year-end which is expected to result in compliance
with the covenants by year-end.





7.
            Long-term
      debt:





September
      30, 2009
            
            
            December
      31, 2008Loan
      payable to a selling shareholder, assumed at date of acquisition, maturing
      in 2011, bearing interest at 7% thereafter (EUR 1,500)
            
            $
            2,195
            
            
            $
            2,231Other
      loans, bearing interest at rates ranging from 5% to 8.4% (Dec 31, 2008 -
      5% to 8.85%) (EUR 469 (Dec 31, 2008 - EUR 562))
            
            
            686
            
            
            
            7842,881
            
            
            
            3,015Less
      current portion
            
            
            915
            
            
            
            1,010Long-term
      debt
            
            $
            1,966
            
            
            $
            2,005





8.
            Share
      capital:




On August
7, 2009, the shareholders of the Company approved an amendment to the Articles
of Continuance of the Company to consolidate all issued and outstanding Class
“A” shares on the basis that each holder of  a Class “A” share shall
receive one (1) Class “A” share for every five (5) Class “A” shares so
consolidated. The share consolidation became effective on August 26, 2009 upon
the filing of the Articles of Amendment and the issuance of a Certificate of
Amendment in respect thereof. As a result, the issued and outstanding Class “A”
shares decreased from 25,742,223 Class “A” shares to 5,148,735 Class “A” shares,
which include 290 shares required to satisfy the fractional share requirements.
All share, stock option, EPS and warrant amounts have been retroactively
adjusted for all periods presented.





On
November 5, 2008, the Board of Directors renewed its stock buyback program
authorizing the Company to purchase up to 5% of its outstanding Class “A” shares
on the open market through the facilities of the NASDAQ Stock Market. The 2008
program will expire on November 20, 2009. All shares purchased under the stock
buyback program will be cancelled. There were no shares repurchased during the
nine months ended September 30, 2009.


18


OPTIMAL
GROUP INC.


Notes to
Condensed Consolidated Financial Statements, Continued


(Unaudited)





Periods
ended September 30, 2009 and 2008


(expressed
in thousands of U.S. dollars, except share and per share
amounts)





9.
            Stock
      options and warrants:




(a)
            Optimal
      Group Inc.:





The
Company has various stock-based incentive plans for employees and directors. A
description of the plans is provided in Note 15 to the 2008 annual audited
consolidated financial statements. During the nine months ended September 30,
2009, the Company cancelled 975,042 options under the plans. This cancellation
resulted in an expense of $1,486, representing the remaining unrecognized
stock-based compensation cost related to the cancelled options. All approvals
required for these cancellations were obtained during the period.





Details
of outstanding stock options are as follows:





Number
      of options
            
            
            Weighted
      average exercise price per shareOptions
      outstanding, December 31, 2008
            
            
            1,094,375
            
            
            $
            31.20Expired
            
            
            (88,133
            )
            
            
            32.20Cancelled
            
            
            (975,042
            )
            
            
            31.45Options
      outstanding, September 30, 2009
            
            
            31,200
            
            
            $
            21.05





During
the nine-month period ended September 30, 2009, no options were
granted.





As at
September 30, 2009, 31,200 (September 30, 2008 – 1,100,908) stock options were
excluded from the calculation of diluted earnings per share because they were
anti-dilutive.





The
remaining options have a weighted average remaining contractual life of 5.13
years, and 15,600 of these options were exercisable as at September 30,
2009.





At
September 30, 2009, there are 164,000 warrants outstanding, exercisable at
$27.80 per share. These warrants expire in November 2014, 82,000 are currently
exercisable and the balance will be exercisable in November 2009. All of these
warrants were excluded from the calculation of diluted earnings per share
because they were anti-dilutive.





(b)
            Terra
      Payments Inc.:




During
the nine-month period ended September 30, 2009, 26,823 U.S. dollar options and
10,877 Canadian dollar options expired. There are no outstanding Terra Payments
Inc.’s options as at September 30, 2009.





As at
September 30, 2008, 39,536 stock options were excluded from the calculation of
diluted earnings per share because they were anti-dilutive.


19


OPTIMAL
GROUP INC.


Notes to
Condensed Consolidated Financial Statements, Continued


(Unaudited)





Periods
ended September 30, 2009 and 2008


(expressed
in thousands of U.S. dollars, except share and per share
amounts)





10.
                Contingencies
      and guarantees:
 
 (a)
                The
      Company is party to litigation arising in the normal course of operations.
      The Company does not expect the resolution of such matters to have a
      material adverse effect on its financial position or results of
      operations. However, the results of legal proceedings cannot be predicted
      with certainty. Should the Company fail to prevail in any of these legal
      matters or should several legal matters be resolved against the Company in
      the same reporting period, the consolidated operating results of a
      particular reporting period could be materially adversely
      affected.
 
 While
best estimates have been used for reporting financial statement items subject to
measurement uncertainty, management considers that it is possible that changes
in future conditions in the near term could require a material change in the
recognized amounts of certain assets and liabilities. “Near term” is considered
to be within one year from the date of the financial statements.
 
 (b)
                In
      the sale or other disposition of assets out of the ordinary course of
      business, in addition to possible indemnification relating to failure to
      perform covenants and breach of representations and warranties, the
      Company might agree to indemnify the buyer against claims from its past
      conduct of its business. Typically, the term and amount of such
      indemnification will be limited by agreement. No provision has been made
      in these financial statements with respect to this item as the Company
      does not expect to make any payments for these items, and the standby
      liability is nominal.
 
 (c)
                As
      previously announced, immediately following the enactment of the Unlawful
      Internet Gambling Enforcement Act of 2006 (the “Act”) on October 13, 2006,
      the Company’s then majority-owned subsidiary, OPIL, ceased to process
      settlement transactions originating from United States consumers. This
      represented a substantial portion of its revenues derived from processing
      transactions from online gambling. The Company is exposed to adverse
      consequences as a result of possible enforcement proceedings, governmental
      investigations or lawsuits initiated against it in jurisdictions where
      online gambling is restricted or
prohibited.




20


OPTIMAL
GROUP INC.


Notes to
Condensed Consolidated Financial Statements, Continued


(Unaudited)





Periods
ended September 30, 2009 and 2008


(expressed
in thousands of U.S. dollars, except share and per share
amounts)











10.
            Contingencies
      and guarantees (continued):




(c)
              (continued):
 
 Following
announcements by the U.S. Attorney’s Office in the Southern District of New York
relating to its investigation of the U.S. Internet gambling industry, the
Company announced on May 8, 2007 that it had initiated discussions with the U.S.
Attorney’s Office in the Southern District of New York and it was in the process
of responding to a voluntary request for information issued by the U.S.
Attorney’s Office. In connection with such ongoing investigation, the Company
announced on May 11, 2007 that it had received a copy of warrants of seizure
issued by the U.S. Attorney’s Office against funds of certain payment processors
that were on deposit with two U.S. banks. These funds included $19,183 on
deposit to the credit of the Company's affiliates. The total amount seized of
$19,183 was presented as long-term asset related to discontinued operations on
the consolidated balance sheets through June 30, 2009. On October 30, 2009, the
Company announced that it has entered into a non-prosecution agreement with the
Office of the United States Attorney for the Southern District of New York.
Under the terms of the non-prosecution agreement, a total of $19,183 will be
forfeited to the United States by the Company and its subsidiaries, as
disgorgement of property involved in and proceeds received from the payment
processing services that were provided by the Company’s subsidiaries to Internet
gambling merchants in relation to U.S. customers of such merchants. The Company
and the U.S. Attorney’s Office have agreed that the $19,183 previously seized
shall be applied to satisfy the forfeiture obligation. Accordingly, the
long-term asset of $19,183 was considered fully impaired at September 30, 2009
with the expense included in the net loss from discontinued operations for the
three-month and nine-month periods ended September 30, 2009.
 
 Furthermore,
as at September 30, 2009, the Company had long-term liabilities related to
discontinued operations of $10,383, which represented payment processing reserve
account balances payable to Internet gambling merchants of its former payments
processing business, which liabilities resulted from the payment processing
services that the Company’s subsidiaries provided to such merchants in relation
to their U.S. customers. Pursuant to the non-prosecution agreement that the
Company entered into with the U.S. Attorney’s Office, it recognized that the
services provided by these merchants violated certain United States laws; on the
basis of advice received by management that a court would not enforce the
Company’s obligation to pay these merchants their respective processing reserve
account balances, should they attempt to enforce payment, these liabilities in
the amount of $10,383 will be derecognized (reversed) during the three months
ending December 31, 2009. The liability will be derecognized in the same period
as the non-prosecution agreement was signed Certain of these merchants may
nevertheless initiate legal proceedings against the Company in an attempt to
enforce payment of the liabilities that are to be derecognized (reversed), which
the Company would be forced to defend. The Company has not recorded any
provision in relation to these potential proceedings because the amount of loss,
if any, is not determinable.
 
 (d)
              OGOP
      Payments Inc. (formerly Optimal Payments Inc.) has received a request for
      information from the U.S. Attorney’s Office in the Eastern District of New
      York pertaining to its former involvement in processing transactions for
      internet pharmacies. OGOP Payments Inc. has had discussions with that
      Office relating to those processing activities. No provision has been
      recorded by OGOP Payments Inc. for this matter because the outcome of
      these discussions and the amount of loss, if any, are not
      determinable.




21


OPTIMAL
GROUP INC.


Notes to
Condensed Consolidated Financial Statements, Continued


(Unaudited)





Periods
ended September 30, 2009 and 2008


(expressed
in thousands of U.S. dollars, except share and per share amounts)





10.
                Contingencies
      and guarantees (continued):
  (e)
                The
      Company has one letter of guarantee, issued by a highly rated financial
      institution to indemnify a third party in the event the Company does not
      perform its contractual obligations. As at September 30, 2009, the maximum
      potential liability under this letter of guarantee was $110. As at
      December 31, 2008, the maximum potential liabilities under these letters
      of guarantee were $110 and $1,232
(CA$1,500).
 
 As at September 30, 2009 and
      December 31, 2008, the Company recorded no liability with respect to these
      guarantees, as the Company does not expect to make any payment for the
      aforementioned items. Management believes that the fair value of the
      non-contingent obligations, to stand ready to perform in the event that
      specified triggering events or conditions occur, approximates the cost of
      obtaining the letter of
guarantee.
 
 11.
                Related
      party transactions
  In
addition to the loan payable (note 7), the Company was party to two transactions
with companies controlled by an officer of a subsidiary of the Company: (a) for
the purchase of advertising and media in Europe for the nine-month period ended
September 30, 2009, $49 (2008 - nil); and (b) the rental of the Company’s
premises in Belgium, $134 (2008 - nil).
 
 12.
                Income
      taxes:
  During
the nine-month period ended September 30, 2009, the Company recorded an income
tax recovery of $754 resulting in an effective tax rate of 2.0%, compared to an
income tax provision of $692 and effective tax rate of (4.0)% for the nine-month
period ended September 30, 2008. The difference is largely due to the write-off
in 2008 of previously recognized deferred income tax assets that no longer met
the criteria for recognition.
 
 The
difference between the effective tax rates and the expected statutory tax rate
of 31% is mainly due to the fact that the Company has recorded a valuation
allowance with respect to certain net operating losses which the Company does
not believe are more likely than not to be realized, as well as a significant
portion of operations being taxable in Hong Kong at a lower effective rate than
in Canada. In assessing the realizability of deferred tax assets, management
considers whether it is more likely than not that some portion or all of the
deferred income tax assets will be realized. The ultimate realization of
deferred tax assets is dependent upon generation of future taxable income, the
reversal of taxable temporary differences, and/or tax planning
strategies.
 22





OPTIMAL
GROUP INC.


Notes to
Condensed Consolidated Financial Statements, Continued


(Unaudited)





Periods
ended September 30, 2009 and 2008


(expressed
in thousands of U.S. dollars, except share and per share
amounts)











13.
            Supplemental
      disclosure of cash flows and other
information:




(a)
            Net
      change in operating assets and
liabilities:





Three
      months ended September 30,
              
              
              Nine
      months ended September 30,2009
              
              
              2008
              
              
              2009
              
              
              2008Accounts
      receivable
              
              $
              (18,219
              )
              
              $
              (18,811
              )
              
              $
              (2,424
              )
              
              $
              (16,747
              )Inventories
              
              
              768
              
              
              
              1,851
              
              
              
              (2,584
              )
              
              
              (11,017
              )Prepaid
      expenses and others
              
              
              (254
              )
              
              
              (152
              )
              
              
              243
              
              
              
              3,511Accounts
      payable and accrued liabilities
              
              
              13,454
              
              
              
              7,062
              
              
              
              2,198
              
              
              
              12,129Income
      taxes payable
              
              
              2,446
              
              
              
              (71
              )
              
              
              1,274
              
              
              
              1,185Net
      change in operating assets and liabilities
              
              $
              (1,805
              )
              
              $
              (10,121
              )
              
              $
              (1,293
              )
              
              $
              (10,939
              )





(b)
            Cash
      and cash equivalents:





September
      30,
            
            
            December
      31,2009
            
            
            2008Cash
      and cash equivalents consist of:Cash
      balances with banks
            
            $
            21,192
            
            
            $
            26,925Short-term
      investments, bearing interest at 2.57%
            
            
            –
            
            
            
            5,924$
            21,192
            
            
            $
            32,849





(c)
            Non-cash
      transactions:





September
      30,
            
            
            September
      30,2009
            
            
            2008Change
      in additions of property, equipment and intangibles included in accounts
      payable and accrued liabilities
            
            $
            8
            
            
            $
            370Adjustments
      to WowWee purchase price equation to goodwill
            
            
            –
            
            
            
            432


23


OPTIMAL
GROUP INC.


Notes to
Condensed Consolidated Financial Statements, Continued


(Unaudited)





Periods
ended September 30, 2009 and 2008


(expressed
in thousands of U.S. dollars, except share and per share
amounts)











13.
            Supplemental
      disclosure of cash flows and other information
  (continued):




(d)
            Other
      revenues:





At
September 30, 2009, the Company continues to operate certain merchant portfolios
that formed part of the payment processing segment. Effective January 1, 2009,
the results of operations of the remaining merchant portfolios are presented on
a net basis and as part of “Other Revenues” in the condensed consolidated
statement of operations and comprehensive (loss) earnings. Included, for the
three months ended September 30, 2009, are gross revenues of $7,567, net of
transaction processing costs and commissions of $6,738, and for the nine months
ended September 30, 2009, gross revenues of $22,376, net of transaction
processing costs and commissions of $19,877. Other expenses related to these
merchant portfolios and not included in “Other Revenues” for the three-month
period ended September 30, 2009 are amortization of intangibles of $384
(September 30, 2008 - $985) and selling, general and administrative expenses of
$138 (September 30, 2008 - $1,393) . The amortization of intangibles for the
nine-month period ended September 30, 2009 was $1,771 (September 30, 2008 -
$2,907) and an impairment loss on intangibles of $4,000 (September 30, 2008 -
nil) and selling, general and administrative expenses of $443 (September 30,
2008 - $4,658).





For the
three-month period ended September 30, 2008, the results of these portfolios are
presented on a gross basis and $595 of selling costs are included in transaction
processing costs. The expense for the nine-month period ended September 30, 2008
was $2,461.





Included
in intangible assets on the condensed consolidated balance sheets is $4,296
(December 31, 2008 - $10,061) of customer and ISO/ISA relations, related to
these remaining portfolios. Total assets related to these portfolios are
comprised mainly of intangible assets.





(e)
            Foreign
      exchange:





Included
in “Selling, general and administrative expenses” in the condensed consolidated
statement of operations and comprehensive (loss) earnings is a foreign exchange
loss relating to financial assets and liabilities of $766 for the three-month
period ended September 30, 2009 (September 30, 2008 - gain of $1,066) and $1,236
for the nine-month period ended September 30, 2009 (September 30, 2008 - gain of
$649).


24


OPTIMAL
GROUP INC.


Notes to
Condensed Consolidated Financial Statements, Continued


(Unaudited)





Periods
ended September 30, 2009 and 2008


(expressed
in thousands of U.S. dollars, except share and per share
amounts)







13.
            Supplemental
      disclosure of cash flow and other information
  (continued):




(f)
            Amortization:





Three
      months ended September 30,
                
                
                Nine
      months ended September 30,2009
                
                
                2008
                
                
                2009
                
                
                2008Amortization
      of intangibles pertaining to cost of sales and transaction
      processing
                
                $
                2,285
                
                
                $
                2,814
                
                
                $
                7,470
                
                
                $
                8,274Amortization
      of equipment pertaining to cost of sales
                
                
                821
                
                
                
                858
                
                
                
                1,945
                
                
                
                2,519Amortization
      of equipment pertaining to selling, general and
    administrative
                
                
                216
                
                
                
                196
                
                
                
                617
                
                
                
                443$
                3,322
                
                
                $
                3,868
                
                
                $
                10,032
                
                
                $
                11,236





14.
            Financial
      instruments:




(a)
            Fair
      values:





The
Company has determined that the fair value of its short-term financial assets
and liabilities approximates their respective fair values as at the balance
sheet dates because of the short-term maturity of those instruments. The
carrying value of the long-term debt also approximates its fair value. The fair
value of the long-term debt is calculated using the present value of future
principal payments discounted at current market rate for the remaining term to
maturity.





(b)
            SFAS
      No. 157 - Fair value adjustments:





Effective
January 1, 2009, The Company adopted SFAS No. 157,which was primarily
codified into FASB ASC Topic 820, Fair Value Measurements and
Disclosures, for all non-financial assets and liabilities that are
measured at fair value on a non-recurring basis, such as goodwill and
identifiable intangible assets. The adoption of SFAS No. 157 for non-financial
assets and liabilities that are measured at fair value on a non-recurring basis
did not impact the Company’s financial position or results of operations for the
three-month and nine-month periods ended September 30, 2009.


25


OPTIMAL
GROUP INC.


Notes to
Condensed Consolidated Financial Statements, Continued


(Unaudited)





Periods
ended September 30, 2009 and 2008


(expressed
in thousands of U.S. dollars, except share and per share
amounts)








14.
            Financial
      instruments (continued):





(c)
            Financial
      income and expense:





(i)
            Other
      income includes interest income earned on cash equivalents and short-term
      investments and on balance of sale
receivable.





(ii)
            The
      Company recorded a bad debt recovery of $91 for the three-month period
      ended September 30, 2009 (September 30, 2008 – nil) in "Selling, general
      and administrative expenses" in the condensed consolidated statement of
      operations and comprehensive (loss) earnings. The expense for the
      nine-month period ended September 30, 2009 was $100 (September 30, 2008 -
      $15).





(d)
            Other:





The
Company seeks to mitigate its exposure to foreign currency transaction risk
which is mainly due to purchases of inventory denominated in foreign currencies
in relation to the Company’s European subsidiary, by monitoring its foreign
currency transaction exposure for the year and partially manage such exposure
using foreign currency swap contracts. At September 30, 2009, the Company had
entered into swap contracts to buy U.S. dollars with a notional amount of $6,800
at rates ranging from 1.460 to 1.465 US/EUR. The contracts mature on October 30,
2009. The Company has also entered into an interest rate swap contract (from
variable rate receive to fixed rate pay) on a notional amount of EUR 1,000. This
contract matures in March 2013. At September 30, 2009, the fair value of these
contracts was not significant. No contracts were outstanding at September 30,
2008.





15.
            Segmented
      information:




During
the period ended September 30, 2009, the Company operated in the consumer
robotic, toy and entertainment products segment. In 2008, the Company also
operated in the payment processing segment, which is now considered a
discontinued operation with the exception of two residual portfolios (refer to
note 13 (d)).


26


OPTIMAL
GROUP INC.


Notes to
Condensed Consolidated Financial Statements, Continued


(Unaudited)





Periods
ended September 30, 2009 and 2008


(expressed
in thousands of U.S. dollars, except share and per share
amounts)












16.
            Canadian/U.S.
      reporting differences:





The
consolidated financial statements of the Company are prepared in accordance with
U.S. GAAP, which conform, in all material respects, with Canadian GAAP, except
as described below:





(a)
            Consolidated
      balance sheets:





Differences
between U.S. and Canadian GAAP in the presentation of share capital, additional
paid-in capital and deficit are as follows:





(i)
            Share
      capital:





September
      30,
            
            
            December
      31,2009
            
            
            2008Share
      capital in accordance with U.S. GAAP
            
            $
            252,488
            
            
            $
            252,488Stock-based
      compensation costs on options exercised: (1)Cumulative
      effect of prior years
            
            
            (39,868
            )
            
            
            (39,868
            )Change
      in reporting currency (2)
            
            
            (2,588
            )
            
            
            (2,588
            )Share
      capital in accordance with Canadian GAAP
            
            $
            210,032
            
            
            $
            210,032





(ii)
            Additional
      paid-in capital:





September
      30,
            
            
            December
      31,2009
            
            
            2008Additional
      paid-in capital in accordance with U.S. GAAP
            
            $
            65,727
            
            
            $
            64,173Stock-based
      compensation costs: (1)Cumulative
      effect of prior years
            
            
            (68,757
            )
            
            
            (68,757
            )Stock-based
      compensation costs on options exercised: (1)Cumulative
      effect of prior years
            
            
            39,868
            
            
            
            39,868Change
      in reporting currency (2)
            
            
            (968
            )
            
            
            (968
            )Additional
      paid-in capital in accordance with Canadian GAAP
            
            $
            35,870
            
            
            $
            34,316


27


OPTIMAL
GROUP INC.


Notes to
Condensed Consolidated Financial Statements, Continued


(Unaudited)





Periods
ended September 30, 2009 and 2008


(expressed
in thousands of U.S. dollars, except share and per share
amounts)







16.
            Canadian/U.S.
      reporting differences (continued):




(a)
            Consolidated
      balance sheets (continued):





(iii)
            Deficit:





September
      30,
            
            
            December
      31,2009
            
            
            2008Deficit
      in accordance with U.S. GAAP
            
            $
            (276,910
            )
            
            $
            (222,849
            )Stock-based
      compensation costs: (1)Cumulative
      effect of prior years
            
            
            68,757
            
            
            
            68,757Stock-based
      compensation to non-employees (1)
            
            
            834
            
            
            
            834Change
      in reporting currency(2)
            
            
            1,189
            
            
            
            1,189Deficit
      in accordance with Canadian GAAP
            
            $
            (206,130
            )
            
            $
            (152,069
            )





(1)
            Stock-based
      compensation:





The
Company accounted for its stock-based compensation plans using the recognition
and measurement provisions of APB No. 25, Accounting for Stock Issued to
Employees, and Related Interpretations, versus a settlement accounting
basis followed for Canadian GAAP up to January 1, 2003. Effective January 1,
2003, the Company adopted the fair value recognition provisions of SFAS No. 123,
Share-based Payments,
which was primarily codified into FASB ASC Topic 718,Compensation – Stock
Compensation, and CICA Handbook 3870, Stock-based Compensation and Other
Stock-based Payments, and therefore there were no further differences
between Canadian GAAP and U.S. GAAP.





(2)
            Change
      in reporting currency:





In 1998,
the Company adopted the U.S. dollar as its reporting currency. Under Canadian
GAAP, at the time of change in reporting currency, the historical financial
statements were presented using a translation of convenience. Under U.S. GAAP,
the financial statements, including prior years, are translated using the
current rate method. Accordingly, the cumulative translation account included as
part of accumulated other comprehensive income in shareholders' equity under
Canadian GAAP does not exist for U.S. GAAP purposes.


28




OPTIMAL
GROUP INC.


Notes to
Condensed Consolidated Financial Statements, Continued


(Unaudited)





Periods
ended September 30, 2009 and 2008


(expressed
in thousands of U.S. dollars, except share and per share
amounts)










16.
            Canadian/U.S.
      reporting differences (continued):





(b)
            Accumulated
      other comprehensive loss:





Accumulated
other comprehensive loss under Canadian GAAP is $(1,484) as at September 30,
2009 and December 31, 2008, which resulted solely from the translation of the
financial statements up to September 30, 2000, the date on which the Company
adopted the United States dollar as its functional currency, in accordance with
the current rate method. Prior to the change in functional currency which
occurred as of September 30, 2000, the Company adopted the United States dollar
as its reporting currency during 1998, and used the current rate method under US
GAAP compared to a translation of convenience method under Canadian
GAAP.





(c)
              New
      accounting policies:





Effective
January 1, 2009, the Company adopted the Canadian Institute of Chartered
Accountants ("CICA") Handbook Section 3064, Goodwill and Intangible
Assets, which replaces Section 3062, Goodwill and Other Intangible
Assets, and Section 3450, Research and Development
Costs. The standard provides guidance on the recognition of intangible
assets in accordance with the definition of an asset and the criteria for asset
recognition, as well as clarifying the application of the concept of matching
revenues and expenses, whether these assets are separately acquired or
internally developed. The adoption of this standard did not have a significant
impact on the Company's financial results.




Effective
January 1, 2009, the Company adopted CICA EIC-173, Credit Risk and the Fair Value of
Financial Assets and Financial Liabilities, which clarifies that the
credit risk of counterparties should be taken into account in determining the
fair value of derivative financial instruments. The adoption of this standard
did not have a significant impact on the Company’s financial
results.





17.
            Subsequent
      events:




On
October 30, 2009, the Company entered into non-prosecution agreement with the
Office of the United States Attorney for the Southern District of New York.
Under the terms of the agreement, a total of $19,183 will be forfeited to the
United States as disgorgement of property involved in and proceeds received from
the payment processing services that were provided by our subsidiaries to
Internet gambling merchants in relation to U.S. customers of such merchants. The
Company and the U.S. Attorney’s Office have agreed that the $19,183 previously
seized, which was presented as restricted cash on the Company’s prior
consolidated balance sheets, shall be applied to satisfy the forfeiture
obligation.





On
October 31, 2009, the Company entered into an agreement to dispose of the
contractual rights relating to a U.S. “card-present” portfolio of merchants
forming part of its remaining payment processing business. Proceeds on sale
comprise a total cash consideration of up to $300 payable on an earn-out basis
over the two-year period following closing of the transaction, and the
assumption of certain liabilities. The Company retains rights to residual
payments and other interests in merchant account portfolios in the payment
processing business not included in this transaction.


29


OPTIMAL
GROUP INC.


Notes to
Condensed Consolidated Financial Statements, Continued


(Unaudited)




Periods
ended September 30, 2009 and 2008


(expressed
in thousands of U.S. dollars, except share and per share
amounts)








18.
            Comparative
      figures:




Certain
of the comparative figures have been reclassified in order to conform with the
current periods’ presentation.


30





Item
      2.
            MANAGEMENT
      DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF
      OPERATIONS




The
following discussion of the financial condition and results of operations of our
Company describes our business, seasonality and trends within our business
environment, the critical accounting policies of our Company that will help you
understand our interim condensed consolidated financial statements, and the
principal factors affecting our results of operations, liquidity and capital
resources. This discussion should be read in conjunction with our consolidated
financial statements and management discussion and analysis for the year ended
December 31, 2008, and the factors set forth below under “Cautionary Statements
Regarding Forward-Looking Statements”. Effective January 1, 2009, we prepare our
interim condensed consolidated financial statements in accordance with generally
accepted accounting principles (“GAAP”) in the United States, with a
reconciliation to Canadian GAAP, as disclosed in note 14 of the notes to our
interim condensed consolidated financial statements. Previously, our accounting
principles conformed to Canadian GAAP and reconciled differences with U.S. GAAP
through our financial statement disclosures.





In this Form
10-Q, except where otherwise indicated, references to “dollars” or “$” are to
United States dollars, references to our “common shares” are to our Class “A”
shares, references to “our interim condensed consolidated financial statements”
are to our interim condensed consolidated financial statements as at and for the
period ended September 30, 2009, which are included in “Item
1.  Financial Statements”, and all dollar amounts, except those
expressed in millions of dollars, are rounded to the nearest thousand. Any
reference in this Form 10-Q to uniform resource locator (URL) website locations
are inactive textual references only and the contents of such websites do not
form a part of this Form 10-Q.




Cautionary
Statements Regarding Forward-Looking Statements





This Form
10-Q contains certain forward-looking statements within the meaning of Section
27A of the Securities Act of 1933 and Section 21E of the Securities Exchange Act
of 1934.Words such
as “expects”, “intends”, “anticipates”, “plans”, “believes”, “seeks”,
“estimates”, or variations of such words and similar expressions are intended to
identify such forward-looking statements. Forward-looking statements include,
but are not limited to, statements about our current expectations with respect
to our future growth strategies, results, opportunities and prospects,
competitive position and industry environment. These forward-looking statements
are subject to a number of risks, uncertainties and other factors that could
cause our actual results, performance, prospects or opportunities, or those of
the markets we serve, to differ materially from those expressed in, or implied
by, these forward-looking statements, including:





·
            general
      economic, legal and business conditions in the markets we
      serve;





·
            while
      we believe that our cash and cash equivalents will be adequate to meet our
      operating needs for
      at least the next 12 months, our existing cash and cash equivalents could
      prove to be inadequate to meet our funding
      requirements;







·
            existing
      and future government regulations and disputes with governmental
      authorities;





·
            our
      ability to continue to satisfy Nasdaq's conditions for continued listing
      of our common shares
      on The NASDAQ Global Market;







·
            consumer
      confidence in the security of financial information transmitted via the
      Internet;





·
            levels
      of consumer and merchant fraud, disputes between consumers and merchants
      and merchant insolvency;





·
            liability
      for merchant chargebacks;





·
            our
      ability to safeguard against breaches of privacy and security when
      processing electronic transactions and use of our payments systems for
      illegal purposes;


31


·
            the
      imposition of and our compliance with rules and practice procedures
      implemented by credit card
associations;





·
            our
      ability to protect our intellectual
property;





·
            our
      relationships with our suppliers and the banking associations that we rely
      upon to process our electronic
transactions;





·
            disruptions
      in the function of our electronic payments systems and technological
      defects;





·
            our
      ability to complete, integrate and benefit from acquisitions,
      divestitures, joint ventures and strategic
  alliances;





·
            our
      ability to retain key personnel;





·
            currency
      exchange rate fluctuations;





·
            our
      ability to successfully implement our strategies for our WowWee
      business;





·
            changing
      consumer preferences for electronics and play
  products;





·
            the
      seasonality of retail sales;





·
            concentration
      among our major retail customers for the products of our WowWee
      business;





·
            economic,
      social and political conditions in China, where WowWee’s products are
      manufactured;





·
            the
      price and supply of raw materials used to manufacture WowWee’s
      products;





·
            product
      liability claims and product
recalls;





·
            increased
      competition;





·
            litigation;
      and





·
            the
      factors described under Item 1A “Risk Factors” in our Annual Report on
      Form 10-K for the year ended December 31, 2008, as amended below in Part
      II at Item 1A.





There may
be additional risks and uncertainties and other factors that we do not currently
view as material or that are not necessarily known. The forward looking
statements made in this document are only made as of the date of this
document.





Except as
required by applicable securities laws, we undertake no obligation to publicly
update or revise any forward-looking statement, whether as a result of new
information, future events, changes in circumstances or any other reason after
the date of this quarterly report.





The
Private Securities Litigation Reform Act of 1995 provides a “safe harbor” for
forward-looking statements to encourage companies to provide prospective
information about their companies without fear of litigation. We are relying on
the “safe harbor” provisions of the Private Securities Litigation Reform Act in
connection with the forward-looking statements included in this quarterly
report.





Future
operations





Our
financial statements have been prepared on a going concern basis in accordance
with U.S. GAAP. The going concern basis of presentation assumes that we will
continue our operations for the foreseeable future and be able to realize our
assets and discharge our liabilities and commitments in the normal course of
business.


32


The
recent banking and financial crisis and the global economic recession have
created an extremely challenging retail and economic environment in the United
States and Canada, which has negatively impacted our operating
performance.





We
currently fund the majority of our operations from our cash and cash equivalents
and bank indebtedness. The balance of cash and cash equivalents, generally
decreases during the second and third quarters of the year, as cash is used to
fund product development and production, and increases in the fourth and first
quarters in connection with the shipping and collection periods. In January
2009, we implemented a cost reduction program and since that time management has
taken steps to more closely manage our working capital.





Although
we currently forecast that our cash and cash equivalents, together with cash to
be generated from operations, will be adequate to meet our needs for at least
the next twelve months, if operating performance is significantly lower than
currently forecasted we would thereafter require financing in order to meet our
cash flow requirements and fund our operations. Our operating performance is
impacted by economic, financial, competitive, legislative and regulatory
factors, as well as other events that are beyond our control.





If we
were to require financing in order to meet our cash flow requirements and fund
our operations and such financing was not available to us, or was not available
to us on terms that are acceptable to us, there could, at the time, be
significant uncertainty about our ability to continue as a going-concern, and
our capacity to realize the carrying value of our assets and repay our existing
and future obligations as they generally become due. Our financial statements do
not reflect adjustments that would be necessary if the going concern assumptions
were not appropriate under these circumstances.





Overview





During
the period ended September 30, 2009, we operated in the consumer robotic, toy
and entertainment product segment through WowWee, which is comprised of WowWee
Group Limited, WowWee Canada Inc., WowWee USA, Inc. and WW Sablon Holdings. We
design, develop, market and distribute technology-based, consumer robotic, toy
and entertainment products.  In 2008, we also operated in the payment
processing segment, which is now primarily considered a discontinued
operation.





WowWee





Based in
Hong Kong, with offices in Carlsbad, California, New York, New York, Montreal,
Quebec, and Wauthier-Braine, Belgium, WowWee designs, develops, markets and
distributes technology-based, consumer robotic, toy and entertainment products
that can be sold at a variety of price points.  For 2009, WowWee’s
product offerings encompass five distinct lines: WowWee Robotics, WowWee
Flytech,WowWee Alive,Think Wow Toys and WowWee Technologies.





WowWee
products are sold in a range of brick and mortar channels, including grocery
stores, pharmacies, toy shops, department stores and high-end consumer
technology stores. A majority of our retail customers in the United States also
carry the full line of WowWee products on their Internet sales sites. WowWee’s
products are available for purchase online at WowWee’s website
(http://www.wowweestore.com) and are also made available through Internet-based
“e-tailers” such as Amazon.com and Buy.com.





WowWee’s
products are produced in China by third party manufacturers, many with whom
WowWee has long-standing relationships. Consistent with industry practice, the
use of third party manufacturers allows WowWee to avoid incurring fixed
manufacturing costs, while improving flexibility, capacity and production
technology. By outsourcing its manufacturing process, WowWee maintains a
flexible business model that enables it to be responsive to changing technology.
In addition, once a product has reached its commercialization phase, WowWee is
able to minimize inventory risk by manufacturing products based upon actual
customer orders; however, certain customer orders may be subject to
cancellation. Upon final assembly, products can be shipped directly from the
manufacturing locations to retailers and distributors, with title to the
products passing to retail customers in the country of origin. Although WowWee
does not conduct the day-to-day manufacturing of its products, it is extensively
involved in the design of the product prototype and production tools, dies and
molds for its products and seeks to ensure quality control by actively reviewing
the production process and testing the products produced by its manufacturers.
WowWee employs quality control inspectors who rotate among its manufacturers’
factories to monitor the production of substantially all of its products.
WowWee’s quality assurance personnel ensure the compliance with applicable
regulations during each phase of product development, and perform compliance
testing, and coordinate third party independent compliance testing, on all
WowWee products. Once pre-production testing has been completed and product
production has been approved, WowWee’s quality assurance personnel monitor
production at the manufacturer’s facility for compliance with WowWee’s quality
requirements.


33


Within
the United States and Canada, WowWee sells its products directly to its retailer
customers through its direct sales channel, through independent sales
representatives and through distributors.  As of January 1, 2009,
WowWee products are sold in most European countries directly through WowWee
Europe, a recently established division resulting from the acquisition of Sablon
Distribution SA, a former independent distributor – see “Recent Developments”
below. For retailers in the rest of the world, WowWee utilizes a network of
distributors located in various jurisdictions. WowWee products are also
available for sale through WowWee’s Internet-based store
(http://www.wowweestore.com). In 2008, approximately 62% of its products were
sold in North America, with the balance being sold internationally.WowWee does
not have written agreements with its customers. Instead, sales are made based on
purchase orders, primarily against letters of credit. The majority of orders are
traditionally written during the first two quarters of the year, with shipments
occurring throughout the year as new product becomes available. The majority of
the product shipments occur during the third and fourth quarters of the year.
Revenue is recognized when (i) persuasive evidence of an arrangement exists;
(ii) products are shipped to customers who assume risk of loss, (iii) collection
of the respective receivable is probable and (iv) sales price is fixed or
determinable. In practice, this results in revenue being recognized when the
product is shipped from Hong Kong.  Accruals for customer discounts,
rebates, incentives and allowances are recorded when the related revenues are
recognized.





WowWee’s
engineering and design team develops new technologies using internal
capabilities and seeks to identify emerging or underutilized innovations that
are currently being developed or that are available in the marketplace. In order
to leverage the man-hours invested in prior products, older generations of
products frequently form the foundation for the next generation of products as
well as new product lines. New technologies are then integrated to enhance the
overall functionality of the product. In sourcing technologies, WowWee reviews
the latest technology innovations at trade-shows, conferences, colleges and
universities, on the Internet, and through word-of-mouth. WowWee regularly
reviews technologies or product concepts from third party sources that it
believes could have potential synergies with WowWee’s current product line or
that could be successfully commercialized based upon WowWee’s development
process. WowWee also licenses third party technologies for development within
unique consumer applications developed by WowWee.





We expect
the unfavorable economic conditions experienced in 2008 to continue throughout
2009. We also expect revenues to be under pressure in 2009 as a result of a
continued reluctance of consumers to spend and desire of retailers to reduce
inventories, weakening foreign exchange in international markets and the sale of
fewer entertainment-related products in 2009. As a result, we are managing our
business based on reduced revenue assumptions.





Recent
Developments





On
October 31, 2009, we entered into an agreement to dispose of the contractual
rights relating to a U.S. “card present” portfolio of merchants forming part of
our remaining payment processing business. Proceeds on sale comprise a total
cash consideration of up to $0.3 million payable on an earn-out basis over the
two-year period following closing of the transaction, and the assumption of
certain liabilities. We retain rights to residual payments and other interests
in merchant account portfolios in the payment processing business not included
in this transaction.





On
October 30, 2009 we entered into a non-prosecution agreement with the Office of
the United States Attorney for the Southern District of New York. Under the
terms of the agreement a total of $19.2 million will be forfeited to the United
States as disgorgement of property involved in and proceeds received from the
payment processing services that were provided by our subsidiaries to Internet
gambling merchants in relation to U.S. customers of such merchants. We and the
U.S. Attorney's Office have agreed that the $19.2 million previously seized,
which was presented as restricted cash on our consolidated balance sheets, shall
be applied to satisfy the forfeiture obligation (see ”Critical Accounting
Policies and Estimates – Contingent Liabilities”below).





On August
7, 2009, our shareholders approved an amendment to our Articles of Continuance
to consolidate all issued and outstanding Class “A” shares on the basis that
each holder of  a Class “A” share shall receive one (1) Class “A”
share for every five (5) Class “A” shares so consolidated. The share
consolidation became effective on August 26, 2009 upon the filing of the
Articles of Amendment and the issuance of a Certificate of Amendment in respect
thereof. As a result, the issued and outstanding Class “A” shares decreased from
25,742,223 Class “A” shares to 5,148,735 Class “A” shares, which includes 290
shares required to satisfy the fractional share requirements. All share, stock
option, EPS and warrant amounts have been retroactively adjusted for all periods
presented.


34


Effective
February 4, 2009, we sold a portfolio of merchant processing contracts and
associated sales channel contracts for a cash consideration of approximately
$1.0 million.





On
February 2, 2009, we entered into an agreement with a buyer, giving us the right
to cause the buyer to purchase, and giving the buyer the right to cause us to
sell, a portfolio of residual payments from merchants processing credit
card-present transactions.  In substance, the transaction represents
the sale of a portfolio of residual payments from merchants processing credit
card-present transactions for proceeds of approximately $11.0 million. The
aggregate amount of monthly residuals earned on the portfolio, net of a service
fee, will be set-off against and will reduce the balance of sale receivable. The
agreement established that the calculation be based on the results of this
portfolio from November 2008 onwards. The adjustment for the amount earned
between November 2008 to the transaction date is reflected as a reduction to the
proceeds. The adjusted balance of sale is increased monthly by a rate of
interest of 1% per month. Our right to cause the buyer to purchase (to
effectively settle the balance of sale) may be exercised any time on or after
February 2, 2011.  The buyer's right to cause us to sell the portfolio
(to effectively settle the balance of sale) may be exercised at any time up to
December 31, 2014.  Under the terms of this agreement, we have also
received a warrant, exercisable for a nominal consideration, giving us the right
to acquire treasury shares, representing up to 3.5% of the outstanding shares of
the purchaser, if the purchase price is not settled prior to specified
dates.





The
results of operations for the portfolios that were disposed of on February 4 and
February 2, 2009, are included as discontinued operations in the interim
condensed consolidated statements of operations and comprehensive loss for the
nine-month period ended September 30, 2009; the results of operations for the
portfolios that were disposed of on February 4 and February 2, 2009, are
included as discontinued operations in the interim condensed consolidated
statements of operations and comprehensive loss for both the three-month and
nine-month periods ended September 30, 2009.





On August
29, 2008 we acquired all the outstanding shares of Sablon Distribution S.A., a
Belgium-based toy distributor operating in the Benelux countries, France and
Germany.





Seasonality





Revenue
in our business is subject to seasonal variability. In 2008, the majority of our
net sales were made in the third and fourth quarters. In our business, and the
toy business in general, the first quarter is the period of lowest shipments and
sales and therefore the least profitable due to various fixed costs. Seasonality
factors will cause our operating results to fluctuate significantly from quarter
to quarter.  Our results of operations may also fluctuate as a result
of factors such as the timing of new products (and related expenses), the
advertising activities of our competitors, delivery schedules set by our
customers and the emergence of new market entrants.





These
seasonal purchasing patterns and requisite production lead times cause risk in
our business associated with the underproduction of popular toys and the
overproduction of toys that do not match consumer demand. Retailers are also
attempting to manage their inventories more tightly in recent years, requiring
us to ship products closer to the time the retailers expect to sell the products
to consumers. These factors increase the risk that we may not be able to meet
demand for certain products at peak demand times, or that our own inventory
levels may increase due to the need to pre-build products before orders are
placed.





In
anticipation of retail sales in the traditional holiday season, we significantly
increase production in advance of the peak selling period, resulting in a
corresponding build-up of inventory levels in the first three quarters of our
fiscal year. Seasonal shipping patterns result in significant peaks in the third
and fourth quarters in the respective levels of inventories and accounts
receivable, which result in seasonal working capital financing
requirements.





We ship
products in accordance with delivery schedules specified by our customers, who
usually request delivery of their products within three to six weeks of the date
of their orders on orders shipped FOB China or Hong Kong and within three days
on orders shipped domestically. Because customer orders may be canceled at any
time without penalty, our backlog may not accurately indicate sales for any
future period.


35


Critical
Accounting Policies and Estimates





Effective
January 1, 2009, we prepare our consolidated financial statements in accordance
with U.S. generally accepted accounting principles (U.S. GAAP) with a
reconciliation to Canadian GAAP as described in note 14 of the notes to our
interim condensed consolidated financial statements. Previously, our accounting
principles conformed to Canadian GAAP and reconciled differences with U.S. GAAP
through our financial statement disclosures.





Our
interim condensed consolidated financial statements have been prepared in
accordance with U.S. GAAP, which requires us to make numerous estimates and
assumptions. Financial results as determined by actual events could differ from
those estimates and assumptions, and therefore affect our reported results of
operations and financial position. Changes in accounting policies are more fully
described in note 25 of the notes to our annual audited consolidated financial
statements included in our Form 10-K Annual Report for the year ended December
31, 2008 and note 2 of the notes to our interim condensed consolidated financial
statements.  Our significant accounting policies are more fully
described in note 4 of the notes to our annual audited consolidated financial
statements included in our Form 10-K Annual Report for the year ended December
31, 2008.  The critical accounting policies described here are those
that are most important to the depiction of our financial condition and results
of operations. The preparation of financial statements also involves significant
management judgment in making estimates about the effect of matters that are
inherently uncertain which are more fully described in note 4 (q) of the notes
to our annual audited consolidated financial statements included in our Form
10-K Annual Report. While best estimates have been used for reporting financial
statement items subject to measurement uncertainty, management considers that it
is possible, based on existing knowledge, that changes in future conditions in
the near term could affect the reported amounts of assets and liabilities and
disclosures of contingent assets and liabilities. “Near term” is considered to
be within one year from the date of the financial statements.





Intangibles





Intangible
assets with finite lives continue to be amortized over their estimated useful
lives. The amounts recorded as intangible assets at the date of acquisition
represent the estimated fair value of these assets based on estimated future
cash flows discounted at appropriate discount rates. Intangibles with finite
lives are reviewed for potential impairment whenever events or changes in
circumstances indicate that the carrying amount may not be recoverable; such
assessments require us to make estimates of future cash flows to be generated
from the related assets. The recent banking and financial crisis and global
recession has negatively impacted our operating performance (refer to note 1 of
the notes to our interim consolidated financial statements). Other than the
impairment on the payments processing intangibles, we have recorded no
impairment charges on the remaining intangible assets during
2009.  However, it is reasonably possible that our determination that
these intangibles are not impaired could change in the near term should our
operating performance deteriorate further than is currently
forecasted.





Allowance
for Doubtful Accounts





Our
allowance for doubtful accounts is based on management’s assessment of the
business environment, customers’ financial condition, historical collection
experience, accounts receivable aging, customer disputes and the collectability
of specific customer accounts. If there were a deterioration of a major
customer’s creditworthiness, or actual defaults were higher than our historical
experience, our estimates of the recoverability of amounts due to us could be
overstated, which could have an adverse impact on our operating results. The
size of the allowance for doubtful accounts is also affected by the timing of
the realization of uncollectible accounts receivable balances as well as the
offsetting allowance.





Major
customers’ accounts are monitored on an ongoing basis; more in depth reviews are
performed based on changes in a customer’s financial condition and/or the level
of credit being extended. When a significant event occurs, such as a bankruptcy
filing by a specific customer, and on a quarterly basis, the allowance is
reviewed for adequacy and the balance adjusted to reflect our current assessment
of credit loss.





Revenue
Recognition





Our
revenue recognition policy is to recognize revenue when persuasive evidence of
an arrangement exists, title transfer has occurred (product shipment), the price
is fixed or readily determinable, and collectability is probable. Sales are
recorded net of sales returns and discounts, which are estimated at the time of
shipment based upon historical data. We routinely enter into arrangements with
our customers to provide sales incentives, support customer promotions, and
provide allowances for returns and defective merchandise. Such programs are
based primarily on customer purchases, customer performance of specified
promotional activities, and other specified factors such as sales to consumers.
Accruals for these programs are recorded as sales adjustments that reduce gross
revenue in the period the related revenue is recognized.


36


Reserve
for Inventory Obsolescence





We value
our inventory at the lower of cost and net realizable value. Based upon a
consideration of quantities on hand, actual and projected sales volume,
anticipated product selling prices and product lines planned to be discontinued,
slow-moving and obsolete inventory is written down to its net realizable
value.





Failure
to accurately predict and respond to consumer demand could result in our
underproducing popular items or overproducing less popular items. Furthermore,
significant changes in demand for our products would impact management’s
estimates in establishing our inventory provision.





Management
estimates are monitored on a quarterly basis and a further adjustment to reduce
inventory to its net realizable value is recorded, as an increase to cost of
sales, when deemed necessary under the lower of cost and net realizable value
standard.





Income
Taxes





We
provide for income taxes using the asset and liability method of tax allocation.
Under this method, deferred income tax assets and liabilities are determined
based on deductible or taxable temporary differences between financial statement
values and tax values of assets and liabilities using enacted income tax rates
expected to be in effect for the year in which the differences are expected to
reverse. We establish a valuation allowance against deferred income tax assets
if, based on available information, it is more likely than not that some or all
of the deferred income tax assets will not be realized. In assessing the
reliability of tax assets, we consider whether it is more likely than not that
some portion or all of the tax assets will not be realized. The ultimate
realization of the deferred tax assets is dependent upon the generation of
future taxable income during the periods in which the temporary differences
become deductible. We consider the scheduled reversal of tax liabilities,
projected future taxable income, and tax planning strategies in making this
assessment.





We accrue
a tax reserve for additional income taxes and interest, which may become payable
in future years as a result of audit adjustments by tax
authorities.  The reserve is based on management’s assessment of all
relevant information, and is periodically reviewed and adjusted as circumstances
warrant.





Stock-based
Compensation





We use
the fair value-based method to account for stock-based compensation and other
stock-based payments, such as stock options. Under the fair value-based method,
compensation cost is measured at fair value at the date of grant and is expensed
over the award’s vesting period. The fair value of stock options granted is
determined at the date of grant using the Black-Scholes option pricing model,
which requires certain assumptions, including future stock price volatility,
risk-free interest rates, and expected time to exercise. Changes to any of these
assumptions, or the use of a different option pricing model, would result in
different fair values for stock-based compensation.





Contingent
liabilities




As
previously announced, immediately following the enactment of the Unlawful
Internet Gambling Enforcement Act of 2006 (the “Act”) on October 13, 2006, our
then majority-owned subsidiary, OPIL, ceased to process settlement transactions
originating from United States consumers. This represented a substantial portion
of our revenues derived from processing transactions from online gambling. We
are exposed to adverse consequences as a result of possible enforcement
proceedings, governmental investigations or lawsuits initiated against us in
jurisdictions where online gambling is restricted or prohibited.





Following
announcements by the U.S. Attorney’s Office in the Southern District of New York
relating to its investigation of the U.S. Internet gambling industry, we
announced on May 8, 2007 that we had initiated discussions with the U.S.
Attorney’s Office in the Southern District of New York and we were in the
process of responding to a voluntary request for information issued by the U.S.
Attorney’s Office. In connection with such ongoing investigation, we announced
on May 11, 2007 that we had received a copy of warrants of seizure issued by the
U.S. Attorney’s Office against funds of certain payment processors that were on
deposit with two U.S. banks. These funds included $19.2 million on deposit to
the credit of our affiliates. The total amount seized of $19.2 million was
presented as long-term asset related to discontinued operations on the
consolidated balance sheets through June 30, 2009. On October 30, 2009, we
announced that we have entered into a non-prosecution agreement with the Office
of the United States Attorney for the Southern District of New York. Under the
terms of the non-prosecution agreement, a total of $19.2 million will be
forfeited to the United States by us and our subsidiaries, as disgorgement of
property involved in and proceeds received from the payment processing services
that were provided by our subsidiaries to Internet gambling merchants in
relation to U.S. customers of such merchants. We and the U.S. Attorney’s Office
have agreed that the $19.2 million previously seized shall be applied to satisfy
the forfeiture obligation.


37


Furthermore,
as at September 30, 2009, we had long-term liabilities related to discontinued
operations of $10.4 million, which represented payment processing reserve
account balances payable to Internet gambling merchants of our former payments
processing business, which liabilities resulted from the payment processing
services that our subsidiaries provided to such merchants in relation to their
U.S. customers. Pursuant to the non-prosecution agreement that we entered into
with the U.S. Attorney’s Office, we have recognized that the services provided
by these merchants violated certain United States laws; on the basis of advice
received by management that a court would not enforce our obligation to pay
these merchants their respective processing reserve account balances, should
they attempt to enforce payment, these liabilities in the amount of $10.4
million will be derecognized (reversed) during the period of three months
ending, and as at, December 31, 2009. Certain of these merchants may
nevertheless initiate legal proceedings against us in an attempt to enforce
payment of the liabilities that are to be derecognized (reversed), which we
would be forced to defend. We have not recorded any provision in relation to
these potential proceedings because the amount of loss, if any, is not
determinable.





OGOP
Payments Inc. (formerly Optimal Payments Inc.) has received a request for
information from the U.S. Attorney’s Office in the Eastern District of New York
pertaining to its former involvement in processing transactions for internet
pharmacies.  OGOP Payments Inc. has had discussions with that Office
relating to those processing activities.  No provision has been
recorded by OGOP Payments Inc. for this matter because the outcome of these
discussions and the amount of any loss, if any, are not
determinable.





We are
also party to litigation arising in the normal course of operations. The results
of legal proceedings cannot be predicted with certainty. Should we fail to
prevail in any of these legal matters or should several legal matters be
resolved against us in the same reporting period, the consolidated operating
results of a particular reporting period could be materially adversely
affected.





Related
Party Transactions





In
addition to the loan payable, refer to note 7 of the notes to our interim
condensed consolidated financial statements, we were party to two transactions
with companies controlled by an officer of one of our subsidiaries: (a) for the
purchase of advertising and media in Europe for the nine-month period ended
September 30, 2009, $0.1 million (2008 - nil); and (b) the rental of our
premises in Belgium, $0.1 million (2008 - nil).




Recent
Accounting Pronouncements





(a)
            New Accounting
      Policies





The
following accounting standards have recently been issued by the Financial
Accounting Standards Board (FASB) and the Canadian Institute of Chartered
Accountants (CICA), that are relevant to us.





Effective
January 1, 2009, we prepare our consolidated financial statements in accordance
with U.S. GAAP with a reconciliation to Canadian GAAP as described in note 14 of
the notes to our interim consolidated financial statements. Previously our
accounting principles conformed to Canadian GAAP and reconciled difference with
U.S. GAAP through its financial statement disclosure.


38


SFAS
No. 165 - Subsequent Events





We
adopted Statement of Financial Accounting Standards (“SFAS”) No. 165, Subsequent Events,which was
primarily codified into FASB ASC Topic 855, Subsequent Events, which is effective for
interim periods ending after June 15, 2009. SFAS No. 165 establishes general
standards for accounting for and disclosure of events that occur after the
balance sheet date but before financial statements are issued. SFAS No. 165 sets
forth the period after the balance sheet date during which management of a
reporting entity should evaluate events or transactions that may occur for
potential recognition in the financial statements, identifies the circumstances
under which an entity should recognize events or transactions occurring after
the balance sheet date in its financial statements, and the disclosures that
should be made about events or transactions that occur after the balance sheet
date. In preparing these financial statements, we evaluated the events and
transactions that occurred between September 30, 2009 through November ·, 2009, the date
these financial statements were issued.





SFAS
No. 141R - Business combinations





Effective
January 1, 2009, we adopted SFAS No. 141R, Business Combinations,which
was primarily codified into FASB ASC Topic 805, Business Combinations, on a
prospective basis. This standard is a revised standard on accounting for
business combinations. For a summarized description of the major changes to
accounting for business combinations, refer to note 25 (f) of the annual
consolidated financial statements. The adoption of this standard did not have an
impact on our results as there were no business acquisitions in the three-month
and nine-month period ended September 30, 2009.





SFAS
No. 160 - Non-controlling interest in consolidated financial
statements





Effective
January 1, 2009, we adopted SFAS No. 160, Non-controlling Interest in
Consolidated Financial Statements,which was primarily codified into FASB
ASC Topic 810, Consolidations. This standard
is a revised standard on accounting for non-controlling interests and
transactions with non-controlling interest holders in consolidated financial
statements. For a summarized description of the major changes resulting from
this standard, refer to note 25 (f) of the annual consolidated financial
statements.





This
standard is applied prospectively to all non-controlling interests, including
any that arose before the effective date. The adoption of this standard did not
have an impact on our results.




SFAS
No. 161 - Disclosures about derivative instruments and hedging activities, an
amendment to FASB Statement No. 133





Effective
January 1, 2009, we adopted SFAS No. 161, Disclosures about derivative
instruments and hedging activities, an amendment to FASB Statement No.
133, which was primarily codified into FASB ASC 815, derivatives and
hedging.  This standard requires qualitative disclosures about
objectives and strategies for using derivatives, quantitative disclosures about
fair value amounts of gains and losses on derivative instruments, and
disclosures about credit-risk related contingent features on derivative
agreements.  The adoption of this standard did not have an impact on
our results.





SFAS
No. 162 - The hierarchy of generally accepted accounting principles and SFAS 163
- Accounting for financial guarantee insurance contracts





Effective
January 1, 2009, we adopted SAFS No. 162, The hierarchy of generally accepted
accounting principles, which was primarily codified into FASB ASC Topic
105, generally accepted
accounting principles and SFAS No. 163, Accounting for financial guarantee
insurance contracts, which was primarily codified into FASB ASC Topic
944, insurance
activities.  The adoption of these standards did not have an
impact on our results.


39


SFAS No. 168 - The FASB Accounting Standards
Codification and Hierarchy of Generally Accepted Accounting
Principles





In June
2009, the FASB issued SFAS No.
168, The FASB Accounting Standards Codification and Hierarchy of Generally
Accepted Accounting Principles, which was primarily codified into FASB
ASC Topic 105, Generally
Accepted Accounting Principles,a replacement of FASB Statement No.
162  SFAS No. 168 replaces SFAS No. 162, The Hierarchy of Generally
Accepted Accounting Principles, to establish the FASB Accounting Standards
Codification (“Codification”) as the source of authoritative accounting
principles recognized by the FASB to be applied by nongovernmental entities in
preparation of financial statements in conformity with generally accepted
accounting principles in the United States of America. SFAS No. 168 is effective
for interim and annual reporting periods ending after September 15, 2009. The
adoption of SFAS No. 168 did not have a material impact on our consolidated
financial statements.





SFAS
157-4, Determining Fair Value When the Volume and Level of Activity for the
Asset or the Liability Have Significantly Decreased and Identifying Transactions
That Are Not Orderly





In April
2009, the FASB issued FSP No. SFAS 157-4, Determining Fair Value When the
Volume and Level of Activity for the Asset or the Liability Have Significantly
Decreased and Identifying Transactions That Are Not Orderly, which were
primarily codified into FASB ASC Topic 820, Fair Value Measurements and
Disclosures. FSP No. SFAS 157-4 amends SFAS No. 157 to provide additional
guidance on (i) estimating fair value when the volume and level of activity for
an asset or liability have significantly decreased in relation to normal market
activity for the asset or liability, and (ii) circumstances that may indicate
that a transaction is not orderly. FSP No. SFAS 157-4 also requires additional
disclosures about fair value measurements in interim and annual reporting
periods. FSP No. SFAS 157-4 is effective for interim and annual reporting
periods ending after June 15, 2009. The adoption of FSP No. SFAS 115-2 did not
have a material effect on our financial statements.





SFAS
115-2 and SFAS 124-2, Recognition and Presentation of Other-Than-Temporary
Impairments





In April
2009, the FASB issued FSP No. SFAS 115-2 and SFAS 124-2, Recognition and Presentation of
Other-Than-Temporary Impairments (“FSP No. SFAS 115-2”), which were
primarily codified into FASB ASC Topic 320, Investments. FSP No. SFAS
115-2 provides additional guidance on the timing of impairment recognition and
greater clarity about the credit and noncredit components of impaired debt
securities that are not expected to be sold. FSP No. SFAS 115-2 also requires
additional disclosures about impairments in interim and annual reporting
periods. FSP No. SFAS 115-2 is effective for interim and annual reporting
periods ending after June 15, 2009. The adoption of  FSP No. SFAS
115-2 did not have a material effect on our financial statements.





SFAS
107-1 and APB 28-1, Interim Disclosures about Fair Value of Financial
Instruments





In April
2009, the FASB issued FSP No. SFAS 107-1 and APB 28-1, Interim Disclosures about Fair Value
of Financial Instruments, which were primarily codified into FASB ASC
Topic 825, Financial
Instruments. FSP No. SFAS 107-1 and APB 28-1 amend SFAS No. 107, Disclosures about Fair Value of
Financial Instruments, to require disclosures about fair value of
financial instruments in interim as well as in annual financial statements. This
FSP also amends Accounting Principles Board (“APB”) Opinion No. 28, Interim Financial Reporting,
to require those disclosures in all interim financial statements. FSP No. SFAS
107-1 and APB 28-1 is effective for interim reporting periods ending after June
15, 2009. The adoption of FSP No. SFAS 107-1 and APB 28-1 did not have a
material effect on our financial statement.





Goodwill
and Other Intangible Assets; Research and Development Costs





Effective
January 1, 2009, we adopted the Canadian Institute of Chartered Accountants
("CICA") Handbook Section 3064, Goodwill and Intangible
Assets, which replaces Section 3062, Goodwill and Other Intangible
Assets, and Section 3450, Research and Development
Costs.  The standard provides guidance on the recognition of
intangible assets in accordance with the definition of an asset and the criteria
for asset recognition, as well as clarifying the application of the concept of
matching revenues and expenses, whether these assets are separately acquired or
internally developed.  The adoption of this standard did not have a
significant impact on our financial results.


40


EIC-173
- Credit Risk and the Fair Value of Financial Assets and Financial
Liabilities





Effective
January 2009, we adopted CICA EIC-173, Credit Risk and the Fair Value of
Financial Assets and Financial Liabilities, which clarifies that the
credit risk of counterparties should be taken into account in determining the
fair value of derivative financial instruments.  The adoption of this
standard did not have a significant impact on our financial
results.





(b)
            Future
      Accounting Pronouncements





The
following accounting pronouncements have recently been issued by the the FASB
and CICA and may be relevant to us.





In
September 2009, FASB issued SFAS No. 166, Accounting for
Transfers of Financial Assets, which was primarily codified into FASB ASC
Topic 860, Transfers and
Servicing— an amendment of FASB Statement No. 140. SFAS No. 166 amends
SFAS No. 140, Accounting for the Transfers and Servicing of Financial Assets and
the Extinguishments of Liabilities, and seeks to improve the relevance and
comparability of the information that a reporting entity provides in its
financial statements about transfers of financial assets; the effects of the
transfer on its financial position, financial performance, and cash flows; and a
transferor’s continuing involvement, if any, in transferred financial assets.
SFAS No. 166 eliminates the concept of a qualifying special-purpose entity,
creates more stringent conditions for reporting a transfer of a portion of a
financial asset as a sale, clarifies other sale-accounting criteria, and changes
the initial measurement of a transferor’s interest in transferred financial
assets. SFAS No. 166 is effective for interim and annual reporting periods
beginning after November 15, 2009. We have not completed our evaluation, but we
do not expect the adoption of SFAS No. 166 to have a material impact on our
consolidated financial statements.





International
Financial Reporting Standards





The
Accounting Standards Board of the Canadian Institute of Chartered Accountants
(“CICA”) has announced its decision to require all publicly accountable
enterprises to report under International Financial Reporting Standards (IFRS)
for the years beginning on or after January 1, 2011. However, we are a domestic
registrant in the U.S. and therefore file our financial statements in accordance
with U.S. GAAP. As such, we have decided not to report under IFRS by 2011 and to
continue reporting under U.S. GAAP. In August 2008, the SEC issued a roadmap for
the potential convergence to IFRS for U.S. domestic U.S. registrants. The
proposal stipulates that the SEC will decide in 2011 whether to move forward
with the convergence to IFRS with the transition beginning in the 2014. Should
the SEC adopt such a proposal, we will convert our reporting to IFRS at such
time.





Financial
Condition





As at
September 30, 2009, cash and cash equivalents, and short-term investments,
totaled $21.2 million compared to $39.1 million as at December 31,
2008.  The decrease in cash and cash equivalents, is primarily due to
the use of cash in operations for the first three quarters. Historically the
first and second quarters are the periods of lowest shipments and sales and
therefore the least profitable due to various fixed costs. However, due to the
unfavorable economic conditions experienced in 2008 and continuing throughout
2009, there is a tendency for customers to place orders later in the year to a
point closer to the expected sale at the retail level. This has resulted in a
weaker third quarter.





We have
various credit facilities through our subsidiaries located in Belgium and Hong
Kong, amounting to approximately $18.3 million, of which $14.1 million was used
at September 30, 2009. On August 4, 2009 our European subsidiaries amended their
various credit facilities to temporarily increase the
maximum  available credit from approximately $9.7 million (EUR 6.7
million) to approximately $13.2 million (EUR 9.0 million). As at November 1,
2009 the maximum available credit has decreased to approximately $6.6 million
(EUR 4.5 million).. As at September 30, 2009 and December 31, 2008, our cash and
cash equivalents and short-term investments, net of bank indebtedness were as
follows:


41





September
      30,
            
            
            December
      31,(U.S.
      dollars, in thousands)
            
            2009
            
            
            2008Cash
      and cash equivalents
            
            
            21,192
            
            
            
            32,849Short-term
      investments
            
            
            -
            
            
            
            6,29621,192
            
            
            
            39,145Less:Bank
      indebtedness
            
            
            (14,140
            )
            
            
            (11,547
            )Net
      cash position
            
            
            7,052
            
            
            
            27,598





Our
portfolio of liquid and investment grade short-term investments as at December
31, 2008, consisted of U.S. denominated discounted and undiscounted notes and
bonds.





Working
capital as at September 30, 2009 was $14.6 million, as compared to $33.2 million
at December 31, 2008. This decrease resulted primarily from the loss from
operations.





Accounts
and other receivables as at September 30, 2009 were $26.6 million, as compared
to $24.2 million at December 31, 2008. The increase is due primarily to the
seasonal increase in revenues in the third quarter of the year. However, due to
the unfavorable economic conditions experienced in 2008 and continuing
throughout 2009, the increase in revenues was weaker than expected.





Inventories
increased by a net amount of $2.5 million from $19.4 million as at December 31,
2008 to $21.9 million as at September 30, 2009. The increase is primarily due to
the buildup of inventory levels in preparation for the anticipated sales in the
last quarter, offset by a write down of our obsolete inventory of $2.2
million.





Intangible
assets decreased by $11.4 million, from $45.1 million as at December 31, 2008 to
$33.7 million as at September 30, 2009, due to amortization of $7.5 million
recorded in the nine-month period ended September 30, 2009 and an impairment
charge of $4.0 million related to certain merchant portfolios that formed part
of the payment processing business.





Long-term
assets related to discontinued operations decreased by $30.8 million since
December 31, 2008. This was due to sale of certain payment processing portfolios
in the first quarter of 2009 and the forfeiture of assets held by the U.S.
Attorney’s Office in the Southern District of New York in connection with a
discontinued payment processing business related to on-line gambling (see
”Critical Accounting Policies and Estimates – Contingent Liabilities”
above).





Shareholders’
equity as at September 30, 2009 was $41.0 million, as compared to $93.5 million
as at December 31, 2008. The decrease is attributable primarily to the loss from
operations which includes the forfeiture of assets held by the U.S. Attorney’s
Office in the Southern District of New York in connection with a discontinued
payment processing business related to on-line gambling (see ”Critical
Accounting Policies and Estimates – Contingent Liabilities”
above) .





Results
of Operations





We expect
the unfavorable economic conditions experienced in 2008 to continue throughout
2009. We also expect revenues to be under pressure in 2009 as a result of a
continued reluctance by consumers to spend and desire by retailers to reduce
inventories, weakening foreign exchange in international markets, and the sale
of fewer entertainment-related products in 2009. Although there are several
external indications that the economic environment is improving, we believe it
is still too early to project when, and how quickly this recovery will impact
our business. As a result, we are managing our business based on reduced revenue
assumptions.





Revenue
is subject to seasonal variability with a significant portion of annual revenues
expected to be generated in the third and fourth quarter of each calendar
year.





42





Nine-month
period ended September 30, 2009 compared to the nine-month period ended
September 30, 2008





Revenues
decreased by $30.6 million, from $72.5 million for the nine-month period ended
September 30, 2008 to $41.9 million for the nine-month period ended September
30, 2009. The decrease is attributed primarily to the continuing unfavorable
economic conditions, as mentioned above, primarily the desire by retailers to
reduce inventories as well as changes in our distribution model whereby we sell
a larger proportion directly to retailers and consumers, who in turn are issuing
purchase orders only later in the buying season.





Effective
January 1, 2009, the results of operations from payment processing are presented
on a net basis as other revenues, whereas the results for the comparative
nine-month period ended September 30, 2008 were reported on a gross basis with
$25.0 million of transaction processing costs reported separately. On a net
basis, other revenues remained relatively constant at $3.0 million for the
nine-month period ended September 30, 2008 to $2.5 million for the nine-month
period ended September 30, 2009.





Cost of
sales decreased by $16.6 million, from $52.8 million for the nine-month period
ended September 30, 2008 to $36.2 million for the nine-month period ended
September 30, 2009. The decrease is consistent with the reduction in revenue.
Furthermore, due to the economic downturn, a focus on monetizing our inventories
has resulted in lower margins on some of our products.





Selling,
general and administrative expenses increased by $2.0 million, from $25.3
million for the nine-month period ended September 30, 2008 to $27.3 million for
the nine-month period ended September 30, 2009. The increase is due primarily to
selling, general and administrative expenses related to Sablon, which we
acquired on August 29, 2008 and the acquisition of Think Wow Toys in July 2008,
offset by a reduction in travel, sales sample expenses and voluntary reduction
of the salaries of certain executive officers in July 2009.





Stock-based
compensation pertaining to selling, general and administrative expense decreased
by $1.3 million, from $2.9 million for the nine-month period ended September 30,
2008 to $1.6 million for the nine-month period ended September 30,
2009.  The decrease is due to the cancellation of 975,042 options
during the nine months ended September 30, 2009, which represented the majority
of the remaining outstanding options.





Research
and development expenses increased by $0.3 million, from $2.1 million for the
nine-month period ended September 30, 2008 to $2.4 million for the nine-month
period ended September 30, 2009.





Amortization
of intangibles pertaining to transaction processing and cost of sales was $7.5
million for the nine-months ended September 30, 2009, compared to $8.3 million
for the comparable period in 2008. The decrease results from a lower unamortized
carrying value due to the impairment charge of $4.0 million in the second
quarter of 2009.





Amortization
of equipment pertaining to cost of sales was $1.9 million for the nine-months
ended September 30, 2009, compared to $2.5 million for the comparable period in
2008. This expense is related to the amortization of moulds used in the
production of our products.





Amortization
of equipment pertaining to selling, general and administrative expense was $0.6
million for the nine-month ended September 30, 2009, compared to $0.4 million
for the comparable period in 2008.





At June
30, 2009, the customer relations and ISO/ISA intangible assets related to
certain merchant portfolios that are part of our former payment processing
segment were tested for impairment, and we determined that the estimated
attrition rate should be increased due to new information.  As a
result of this analysis, we recorded a non-cash impairment charge of $4.0
million at June 30, 2009 based on an estimated fair value established using a
discounted cash flow methodology.





The
provision for income taxes consisted of a recovery of $0.8 million with an
effective tax rate of 2% for the nine-month period ended September 30, 2009
compared to a charge of $0.7 million with an effective tax rate of (4)% for the
nine-month period ended September 30, 2008. The difference is largely due to the
write-off in 2008 of previously recognized future tax assets that no longer met
the criteria for recognition.





Significant
components of the consolidated tax provision for the nine-month period ended
September 30, 2009 included the effect of  tax differences in tax
rates in foreign jurisdictions, an increase of valuation allowances against
certain operating losses carry forward and non-deductible stock-based
compensation. Our operations are taxable in Hong Kong at a lower effective tax
rate than in Canada, which affected the provision by $1.8 million compared to
$1.0 million for the nine-month period ended September 30, 2008.  In
addition, the 2009 tax provision includes the tax effect of non-deductible
stock-based compensation expense in the amount of $0.5 million compared to $0.9
million for the nine-month period ended September 30, 2008.


43


Our tax
provision also includes the effect of future taxes on unrealized foreign
exchange gains and losses, which arise upon the conversion into Canadian dollars
of net monetary assets and liabilities denominated in U.S. dollars for purposes
of determining taxable income under Canadian income tax regulations. Since the
U.S. dollar is our measurement currency and our consolidated financial
statements are presented in U.S. dollars, these foreign exchange gains and
losses do not affect earnings before income taxes.




Our net
loss for the nine-month period ended September 30, 2009 was $54.1 million (or
$10.50 per share), which included the non-cash impairment loss of $4.0 million,
and the charge of $19.2 million from discontinued operations, related to the
non-prosecution agreement with the Office of the United States Attorney for the
Southern District of New York as compared to a net loss of $54.7 million (or
$10.57 per share) for the nine-month period ended September 30, 2008, which
included the non-cash impairment loss from discontinued operations of $29.1
million and the charge of $14.1 million related to future tax assets that no
longer met the criteria for recognition. The net loss in 2009 is attributed
primarily to the continuing unfavorable economic conditions, as mentioned above,
the desire by retailers to reduce inventories as well as changes in our
distribution model whereby we sell a larger proportion directly to retailers and
consumers, who in turn are issuing purchase orders only later in the buying
season.





We
previously used EBITDA to assess our operating performance, which was a non-GAAP
financial measure that excluded non-cash expenses, items that cannot be
influenced by Management in the short-term or items that do not impact core
operating performance. We believe that this measure no longer provides any
additional meaningful information at this time and therefore have discontinued
the use of this measure during the nine-month period ended September 30,
2009.





Three-month
period ended September 30, 2009 compared to the three-month period ended
September 30, 2008





Revenues
decreased by $18.8 million, from $52.1 million for the three-month period ended
September 30, 2008 to $33.3 million for the three-month period ended September
30, 2009. The decrease is attributed primarily to the continuing unfavorable
economic conditions, as mentioned above, primarily the desire by retailers to
reduce inventories as well as changes in our distribution model whereby we sell
a larger proportion directly to retailers and consumers, who in turn are issuing
purchase orders only later in the buying season.





Cost of
sales decreased by $10.0 million, from $38.3 million for the three-month period
ended September 30, 2008 to $28.3 million for the three-month period ended
September 30, 2009. The decrease is consistent with the reduction in revenue.
Furthermore, due to the economic downturn, a focus on monetizing our inventories
has resulted in lower margins on some of our products.





Transaction
processing costs for the three-month period ended September 30, 2008 were $7.6
million, however for the three-month period ended September 30, 2009 there was
no transaction processing expenses presented as the related revenues were
reported net of such costs as part of “other revenues”.





Selling,
general and administrative expenses decreased by $0.7 million, from $10.6
million for the three-month period ended September 30, 2008 to $9.9 million for
the three-month period ended September 30, 2009. The decrease is due primarily
to selling, general and administrative expenses related to Sablon and Think Wow
Toys which were acquired late in the third quarter of 2008, offset by a
reduction in travel, sales sample expenses and a voluntary reduction of the
salaries of certain executive officers in July 2009.





Research
and development expenses remained consistent at approximately $1.0 million for
the three-month period ended September 30, 2009 and for the comparable period in
2008.





Amortization
of intangibles pertaining to transaction processing costs and cost of sales was
$2.3 million for the three-month period ended September 30, 2009 and $2.8
million for the comparable period in 2008. The decrease results from a lower
unamortized carrying value due to the impairment charge of $4.0 million in the
second quarter of 2009.


44


Amortization
of equipment pertaining to cost of sales for the three-month period ended
September 30, 2009 was $0.8 million compared to $0.9 million for the comparable
period in 2008. This expense is related to the amortization of moulds used in
the production of our products.





Amortization
of property and equipment pertaining to selling, general and administrative
remained constant at $0.2 million.





The
provision for income taxes consisted of a recovery of $0.1 million with an
effective tax rate of 1% for the three-month period ended September 30, 2009
compared to a recovery of $0.2 million with an effective tax rate of 23% for the
three-month period ended September 30, 2008. The difference in the effective tax
rate is mainly due to the fact that certain operating losses increased in the
three-month period ended September 30, 2009 and we recorded a valuation
allowance with respect to these net operating losses carry-forward.





Significant
components of the consolidated tax provision for the three-month period ended
September 30, 2009 included the effect of an increase in the valuation allowance
against certain operating losses carry forward and the effect of tax differences
in tax rates in foreign jurisdictions, due to a significant portion of our
operations which are taxable in Hong Kong at a lower effective tax rate than in
Canada.





Our net
loss for the three-month period ended September 30, 2009 was $27.1 million (or
$5.25 per share), compared to a net earnings of $1.7 million (or $0.33 per
share) for the three-month period ended September 30, 2008. The decrease is
attributed primarily to the continuing unfavorable economic conditions, as
mentioned above, primarily the desire by retailers to reduce inventories as well
as changes in our distribution model whereby we sell a larger proportion
directly to retailers and consumers, who in turn are issuing purchase orders
only later in the buying season and a charge of $19.2 million from discontinued
operations due to the  non-prosecution agreement with the Office of
the United States Attorney for the Southern District of New York and an
inventory write-down of $2.2 million.





We
previously used EBITDA to assess our operating performance, which was a non-GAAP
financial measure that excluded non-cash expenses, items that cannot be
influenced by Management in the short-term or items that do not impact core
operating performance. We believe that this measure no longer provides any
additional meaningful information at this time and therefore have discontinued
the use of this measure during the three-month period ended September 30,
2009.





Liquidity
and Capital Resources





As at
September 30, 2009, cash and cash equivalents, and short-term investments,
totaled $21.2 million compared to $39.1 million as at December 31,
2008.  The decrease in cash and cash equivalents, is primarily due to
the use of cash in operations for the first three quarters. Historically the
first and second quarters are the periods of lowest shipments and sales and
therefore the least profitable due to various fixed costs. However, due to the
unfavorable economic conditions experienced in 2008 and continuing throughout
2009, there is a tendency for customers to place their orders later in the year
which has resulted in a weaker third quarter.





We have
various credit facilities through our subsidiaries located in Belgium and Hong
Kong, amounting to approximately $18.3 million, of which $14.1 million was used
at September 30, 2009. On August 4, 2009 our European subsidiaries amended their
various credit facilities to temporarily increase the
maximum  available credit from approximately $9.7 million (EUR 6.7
million) to approximately $13.2 million (EUR 9.0 million). As at November 1,
2009 the maximum available credit has decreased to approximately $8.0 million
(EUR 5.5 million). The borrowings are due on demand, bear interest at the bank’s
prime rate plus a premium of 1%, and are secured by a first ranking hypothec on
certain assets of the subsidiaries. As at September 30, 2009, we utilized $10.7
million (EUR 7.3 million) of these facilities. Under this agreement, we are
subject to financial covenants, which were not met, however we expect to
reschedule the repayment of intercompany debt before year-end which is expected
to result in compliance with the covenants by year-end.





Operating
activities used $5.6 million of cash and cash equivalents in the three-month
period ended September 30, 2009, as compared to using $4.3 million in the
three-month period ended September 30, 2008. This change is due mainly to the
increase in the net loss from continuing operations, and of the timing of the
payments of the trade payables.


45


Financing
activities generated $3.8 million of cash and cash equivalents in the
three-month period ended September 30, 2009, as compared to generating $4.8
million in the three-month period ended September 30, 2008, due primarily to the
increase in bank indebtedness.





Investing
activities used $0.8 million of cash and cash equivalents for the three-month
period ended September 30, 2009, as compared to using $6.3 million of cash and
cash equivalents for the three-month period ended September 30, 2008, primarily
due to the purchase of property, equipment, intangible assets and business
acquisitions in 2008.





Also
refer to the disclosure under “Future Operations” above under this Item
2.





Current
Economic Environment





The
downturn in the global economy had a significant negative effect on the toy
industry and us. Consumer confidence reached low levels in the latter part of
2008, resulting in retail sales weakness in the fourth quarter as consumers,
fearful of the economy’s direction, cut back their discretionary spending. Toy
retailers and manufacturers continue to be impacted by the economic downturn,
with a risk that a number of Chinese toy manufacturers will close their
operations and a significant number of toy sellers in the U.S., U.K., Mexico and
other major markets may close or significantly reduce their operations or enter
bankruptcy.





We expect
the unfavourable economic conditions experienced in 2008 to continue throughout
2009. We also expect revenues to be under pressure in 2009 as a result of a
continued reluctance of consumers to spend and desire of retailers to reduce
inventories, weakening foreign exchange in international markets, and the sale
of fewer entertainment-related products in 2009. As a result, we are managing
our business based on reduced revenue assumptions.





Risk
management strategies are likely to evolve in response to future conditions and
circumstances, including the effects and consequences resulting from the current
economic downturn. These future strategies may not fully insulate us in the near
term from adverse effects, the more significant of which relate to liquidity and
capital resources as well as exposure to credit losses.





We expect
to focus on margins and conserve cash in 2009. As a result, we are attempting to
tightly manage our inventories, capital expenditures and other spending activity
in 2009. We expect that some of our customers and vendors may experience
difficulty in obtaining the liquidity required to buy inventory or raw
materials.





Our focus
in 2009 is on managing costs in line with anticipated reduced revenues with the
goal of improving our results of operations and the cash flows generated by our
business.





We
believe that our cash and cash equivalents will be adequate to meet our needs
for at least the next 12 months. Also refer to the disclosure under “Future
Operations” above under this Item 2.





We have
no off-balance sheet arrangements, other than long-term lease commitments for
our premises in the United States, Canada, Hong Kong and Europe. During the
nine-month period ended September 30, 2009, there have been no material changes
in contractual obligations and commercial commitments from those summarized in
note 16 (a) of the “:Management, Discussion and Analysis” section of our Form
10-K Annual Report for the year ended December 31, 2008.





Item
      3.
            Quantitative
      and Qualitative Disclosures About Market
Risk





There
have been no material changes to the disclosures about market risk contained in
our Annual Report on Form 10-K for the year ended December 31,
2008.





Item
      4.
            Controls
      and Procedures





As of
September 30, 2009 (the “Evaluation Date”), under the supervision and with the
participation of our management, including our Chief Executive Officer and our
Chief Financial Officer, we evaluated the effectiveness of the design and
operation of our disclosure controls and procedures, as defined in Rule
13a-15(e) or 15d-15(e) under the Securities Exchange Act of 1934, as amended
(the “Exchange Act”).  Based upon this evaluation, our Chief Executive
Officer and our Chief Financial Officer concluded that, as of the Evaluation
Date, our disclosure controls and procedures were effective to ensure that
information required to be disclosed by us in the reports filed or submitted by
us under the Exchange Act is recorded, processed, summarized and reported within
the time periods specified in the SEC’s rules and forms.


46


Additionally,
under the supervision and with the participation of our management, including
our Chief Executive Officer and our Chief Financial Officer, we concluded that
there have been no changes in our internal control over financial reporting
during our most recent fiscal quarter that have materially affected, or are
reasonably likely to materially affect, our internal control over financial
reporting.





PART
II. OTHER INFORMATION





Item 1.
            Legal
      Proceedings





There
were no material changes to the disclosure of legal proceedings contained in our
Annual Report on Form 10-K for the year ended December 31, 2008,
except:





Following
announcements by the U.S. Attorney’s Office in the Southern District of New York
relating to its investigation of the U.S. Internet gambling industry, we
announced on May 8, 2007 that we had initiated discussions with the U.S.
Attorney’s Office in the Southern District of New York and we were in the
process of responding to a voluntary request for information issued by the U.S.
Attorney’s Office. In connection with such ongoing investigation, we announced
on May 11, 2007 that we had received a copy of warrants of seizure issued by the
U.S. Attorney’s Office against funds of certain payment processors that were on
deposit with two U.S. banks. These funds included $19.2 million on deposit to
the credit of our affiliates. The total amount seized of $19.2 million was
presented as long-term asset related to discontinued operations on the
consolidated balance sheets through June 30, 2009. On October 30, 2009, we
announced that we have entered into a non-prosecution agreement with the Office
of the United States Attorney for the Southern District of New York. Under the
terms of the non-prosecution agreement, a total of $19.2 million will be
forfeited to the United States by us and our subsidiaries, as disgorgement of
property involved in and proceeds received from the payment processing services
that were provided by our subsidiaries to Internet gambling merchants in
relation to U.S. customers of such merchants. We and the U.S. Attorney’s Office
have agreed that the $19.2 million previously seized shall be applied to satisfy
the forfeiture obligation.





Item
      1A.
            Risk
      Factors





There
were no material changes to the disclosure of risk factors contained in our
Annual Report on Form 10-K for the year ended December 31, 2008, except as
follows:





We
may be subject to litigation from the Internet gambling merchants that used our
former payments processing business for their U.S. Internet gambling business
activities seeking to force us to pay to them related processing reserve account
balances.





Pursuant
to the non-prosecution agreement that we entered into with the Office of the
United States Attorney for the Southern District of New York, on October 30,
2009, we have recognized that the services provided by certain Internet gambling
merchants of our former payments processing business violated certain United
States laws.  On the basis of advice received by management that a
court would not enforce our obligation to pay to these merchants their
respective processing reserve account balances (an aggregate amount of $10.4
million) due to the illegality of their related Internet gambling activities, we
will, for accounting purposes, derecognize (reverse) our liability to pay such
account balances and we will refuse the demand of any such Internet gambling
merchant for the payment of its reserve account balance. Certain of these
merchants may nevertheless initiate legal proceedings against us in an attempt
to enforce payment of their respective account balances, which we would be
forced to defend. We could incur significant costs in the defense or settlement
of any such legal proceedings and there can be no assurance that a court would
not enforce the payment of any particular account balance(s).





Item
      2.
            Unregistered
      Sales of Equity Securities and Use of
Proceeds





There
were no sales of unregistered equity securities and there were no repurchases
under our stock purchase program during the nine-month period ended September
30, 2009.


47


Item
      3.
            Defaults
      Upon Senior Securities





The
registrant has nothing to report under this item.





Item
      4.
            Submission
      of Matters to a Vote of Security
Holders





We held
our annual and special meeting of shareholders on August 7, 2009.  The
following resolutions were adopted:





Resolution
            Votes
      For(2)
            Votes
      Against
            Withheld(2)
            Non-VotedElection
      of  Neil S. Wechsler as Director(1)
            15,576,688
            N/A
            2,155,411
            1Election
      of  James S. Gertler as Director(1)
            15,561,783
            N/A
            2,170,316
            1Election
      of  Thomas D. Murphy as Director(1)
            15,576,235
            N/A
            2,155,864
            1Appointment
      of KPMG LLP as Auditors
            17,430,572
            N/A
            302,874
            1Amendments
      to By-Law No. 1A of the Corporation
            15,949,609
            1,783,856
            N/A
            2Special
      resolution of shareholders consolidating the shares
            15,603,627
            2,129,838
            N/A
            2





(1)
            Neil
      S. Wechsler, James S. Gertler and Thomas D. Murphy were elected to hold
      office until the close of the 2012 annual meeting of
      shareholders.  The following directors did not stand for
      election and continue in office for the following respective
      periods:





Tommy
Boman and Holden L. Ostrin each to hold office until the close of the 2011
annual meeting of shareholders, and  Henry M. Karp and Jonathan J.
Ginns each to hold office until the close of the 2010 annual meeting of
shareholders.




(2)
            These
      votes represent the actual shares voted or withheld prior to the share
      consolidation which became effective on August 26,
  2009.





Item
      5.
            Other
      Information





The
registrant has nothing to report under this item.





Item
      6.
            Exhibits





Exhibit
              Number
            
            Exhibit3.2
            
            By-laws
      as amended.10.1
            
            Base
      Salary Reduction agreement with Neil S. Wechsler.10.2
            
            Base
      Salary Reduction agreement with Holden L. Ostrin.10.3
            
            Base
      Salary Reduction agreement with Gary S. Wechsler.31.1
            
            Certification
      pursuant to Section 302 of the Sarbanes-Oxley Act of
  2002.31.2
            
            Certification
      pursuant to Section 302 of the Sarbanes-Oxley Act of
  2002.32.1
            
            Certification
      pursuant to Section 1350, Chapter 63 of Title 18, United States Code, as
      adopted pursuant to Section 906 of the Sarbanes-Oxley Act of
      2002.32.2
            
            Certification
      pursuant to Section 1350, Chapter 63 of Title 18, United States Code, as
      adopted pursuant to Section 906 of the Sarbanes-Oxley Act of
      2002.


48


Signatures








Pursuant
to the requirements of Section 13 or 15(d) of the Exchange Act, the registrant
has duly caused this report to be signed on its behalf by the undersigned,
thereunto duly authorized.








November
      13, 2009
            Optimal
      Group Inc.By:
            /s/
      NEIL S. WECHSLERNeil
      S. Wechsler, Co-Chairmanand
      Chief Executive Officer(Principal
      Executive Officer)By:
            /s/
      GARY S. WECHSLERGary
      S. Wechsler, Chief Financial Officer(Principal
      Accounting Officer)






49