U.S. SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
Form 10-K
(Mark One)
x ANNUAL REPORT UNDER SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
For the fiscal year ended December 31, 2008
¨ TRANSITION REPORT UNDER SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
For the transition period from ______________ to ______________
Commission File Number 333-146705
Octavian Global Technologies, Inc.
(Exact name of registrant as specified in its charter)
| Nevada | | 01-895182 |
| (State or other jurisdiction of | | (I.R.S. Employer |
| incorporation or organization) | | Identification No.) |
1-3 Bury Street Guildford Surrey, GU2 4AW
United Kingdom
(Address of principal executive offices)
(44) 1483 543 543
Registrant’s telephone number, including area code:
Securities registered under Section 12(b) of the Exchange Act:
None.
Securities registered under Section 12(g) of the Exchange Act:
Common Stock, $0.001 par value per share
(Title of Class)
Check whether the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act. Yes ¨ No x
Check whether the registrant is not required to file reports pursuant to Section 13 or 15(d) of the Exchange Act. ¨ No x
Check whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Exchange Act 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 ¨
Check if there is no disclosure of delinquent filers in response to Item 405 of Regulation S-K (§229.405 of this chapter) contained herein, and no disclosure will be contained, to the best of registrant's knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. x
Check whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See 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 ¨ |
| | | |
Non-accelerated Filer ¨ | | Smaller Reporting Company x |
| (Do not check if a smaller reporting company.) | | |
Check whether the issuer is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes o No x
The aggregate market value of the of the common equity of the registrant held by non-affiliates as of March 30, 2009 is not applicable as the common equity was not trading as of the last business day of the registrant’s most recently completed second fiscal quarter.
APPLICABLE ONLY TO CORPORATE REGISTRANTS
As of March 30, 2009, there were 8,016,408 shares of common stock, par value $.001, outstanding.
OCTAVIAN GLOBAL TECHNOLOGIES, INC.
FORM 10-K
FISCAL YEAR ENDED DECEMBER 31, 2008
| Item Number in | | |
| Form 10-K | | | Page |
| | PART I | | |
| 1 | Business | | 1 |
| 1A. | Risk Factors | | 25 |
| 1B. | Unresolved Staff Comments | | 45 |
| 2. | Properties | | 45 |
| 3. | Legal Proceedings | | 45 |
| 4. | Submission of Matters to a Vote of Security Holders | | 46 |
| | PART II | | |
| 5. | Market for Registrant's Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities | | 46 |
| 6. | Selected Financial Data | | 49 |
| 7. | Management's Discussion and Analysis of Financial Condition and Results of Operations | | 50 |
| 7A. | Quantitative and Qualitative Disclosure About Market Risk | | 65 |
| 8. | Financial Statements and Supplementary Data | | 65 |
| 9. | Changes in and Disagreements With Accountants on Accounting and Financial Disclosure | | 65 |
| 9A(T). | Controls and Procedures | | 65 |
| 9B. | Other Information | | 65 |
| | PART III | | |
| 10. | Directors, Executive Officers and Corporate Governance | | 65 |
| 11. | Executive Compensation | | 68 |
| 12. | Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters | | 70 |
| 13. | Certain Relationships and Related Transactions, and Director Independence | | 71 |
| 14. | Principal Accounting Fees and Services | | 76 |
| | PART IV | | |
| 15. | Exhibits, Financial Statement Schedules | | 77 |
THIS ANNUAL REPORT ON FORM 10-K CONTAINS FORWARD-LOOKING STATEMENTS WITHIN THE MEANING OF SECTION 27A OF THE SECURITIES ACT OF 1933, AS AMENDED AND SECTION 21E OF THE SECURITIES EXCHANGE ACT OF 1934 AS AMENDED AND ARE SUBJECT TO RISKS, UNCERTAINTIES, AND OTHER FACTORS WHICH COULD CAUSE ACTUAL RESULTS TO DIFFER MATERIALLY FROM THOSE EXPRESSED OR IMPLIED BY SUCH FORWARD-LOOKING STATEMENTS. SEE ITEM 1. "BUSINESS - A NOTE ABOUT FORWARD LOOKING STATEMENTS."
PART I
Item 1. Description of Business.
The following describes our business. Whenever the terms “our,” “we” and the “Company” are used in this Description of Business, they refer to one or more of the following: Octavian Global, Octavian International and all other direct and indirect subsidiaries of Octavian International identified in this annual report.
GENERAL
Background
The Company was incorporated in the State of Nevada on April 19, 2007 under the name House Fly Rentals, Inc. (“House Fly”), as a development stage company to create a web-based service that lists properties across multiple market areas that are available for rental. Immediately following the Share Exchange, as defined herein – “Share Exchange and Related Transactions,” House Fly merged with Octavian Global Technologies, Inc., a newly formed Nevada corporation and wholly-owned subsidiary of House Fly, with House Fly being the surviving corporation (the “Subsidiary Merger”). Immediately following the Subsidiary Merger, House Fly changed its name to Octavian Global Technologies, Inc. (“Octavian Global”).
Octavian International Limited
Octavian International Limited (“Octavian International”), our wholly-owned subsidiary, was incorporated in England and Wales on March 23, 2001 under the name Eachway Limited. On April 4, 2001, Octavian International’s name was changed to Octavian Projects Overseas Limited and then to its current name, Octavian International Limited, on May 11, 2001. Octavian International currently has the following directly or indirectly wholly-owned or controlled and consolidated operating subsidiaries:
| | · | Argelink SA, a corporation formed under the laws of Argentina; |
| | · | Casino Amusement Technology Supplies Limited (“CATS”), a corporation formed under the laws of England and Wales; |
| | · | Octavian International (Europe) Limited, a corporation formed under the laws of England and Wales; |
| | · | Octavian International (Latin America) Limited, a corporation formed under the laws of England and Wales; |
| | · | Octavian Latin America SA, a corporation formed under the laws of Colombia (89.7% owned); |
| | · | Octavian SPb Limited Partnership, a partnership formed under the laws of Russia; |
| | · | Octavian Ukraine Subsidiary Enterprise, a corporation formed under the laws of Ukraine; |
| | · | Atlantis Limited Company, a limited company formed under the laws of Russia; |
| | · | Tilia International Ltd. (“Tilia”), a company incorporated under the laws of the Republic of Rwanda. |
| | · | Octavian Italy Srl, a company formed under the laws of Italy (50% owned); |
| | · | Octavian Germany Limited, a limited liability company formed under the laws of Germany (51% owned); and |
| | · | Octavian Germany GmbH, a wholly-owned subsidiary of Octavian Germany Limited and a corporation formed under the laws of Germany (51% owned). |
Share Exchange and Related Transactions
On October 30, 2008, House Fly consummated a share exchange agreement by and among Octavian International, House Fly, Robert McCall and the shareholders of Octavian International (the “Share Exchange”). Prior to the Share Exchange, Robert McCall was the Company’s President, Chief Executive Officer, Chief Financial Officer, Secretary, Treasurer and sole Director; and Mr. McCall owned 44.4 percent of its issued and outstanding securities.
Pursuant to the terms of a repurchase agreement we entered into on October 30, 2008 (the “Repurchase Agreement”), House Fly repurchased all of Mr. McCall’s shares of our Company’s common stock, par value $0.001 per share (the “Common Stock”) for a total repurchase price of US$300,000. Immediately after the repurchase of these shares and pursuant to the terms of the Share Exchange: (1) the former shareholders of Octavian International received shares of our Common Stock in exchange for all of their Ordinary Shares of Octavian International, (2) Mr. McCall appointed Mr. Harmen Brenninkmeijer as a director of Octavian Global and (3) Mr. McCall resigned from his House Fly officer positions and from the House Fly board of directors. Immediately thereafter, Mr. Brenninkmeijer appointed Peter Moffitt and Peter Brenninkmeijer to the Company’s board and also appointed all of our current officers.
As a result of the Share Exchange, the Company experienced a change in control and ceased to be a shell company, Octavian International became its wholly-owned subsidiary, and the former shareholders of Octavian International became the owners of approximately 89 percent of the Company’s issued and outstanding shares of our Common Stock (prior to giving effect to the Private Placement, defined herein).
Concurrent with the closing of the Share Exchange, the Company entered into a securities purchase agreement (the “Purchase Agreement”) with certain accredited investors and closed a private placement offering pursuant to which it raised gross proceeds of $13 million and, among other things, issued and sold convertible debentures (“Debentures”) with an aggregate principal amount of US$14,285,700 convertible into shares of the Company’s Common Stock (“Conversion Shares”) at an initial conversion price of US$3.10, subject to adjustment other than for the reverse stock split discussed below (the “Private Placement”). Additionally, investors in the Private Placement received Common Stock purchase warrants to purchase up to an aggregate of 4,193,548 shares of Common Stock (2,096,774 shares at an initial exercise price of $3.10 per share for 5 years and 2,096,774 shares at an initial exercise price of $4.65 per share for 7 years, which exercise prices and the number of shares exercisable thereunder are subject to adjustment other than for the Reverse Stock Split discussed below (the “Warrants”)) and an aggregate of 4,624,327 shares of Common Stock (the “Shares”, together with the Debentures and Warrants, are sometimes referred to hereafter as the “Private Placement Securities”). Austrian Gaming Industries GmbH (“AGI”), Octavian’s principal supplier of casino gaming machines and a holder of 35 percent of Octavian’s capital stock prior to the Share Exchange, participated in the Private Placement by investing US$5 million. The net proceeds received by Octavian Global after the payment of all offering expenses including, without limitation, legal fees, accounting fees and cash commissions paid to certain finders was US$10,199,812.64 (For a more detailed description of these fees, please see the section titled “Certain Relationships and Related Transactions, and Director Independence – Private Placement,” beginning on page 73).
On January 7, 2009, the Company effected a 1-for-5.0174 reverse split of our shares of Common Stock (the “Reverse Stock Split”). Except as otherwise noted, all references to the number of shares of our Common Stock throughout this annual report reflect the Reverse Stock Split.
Trademarks
All Octavian product names are trademarks of Octavian International, while all other product names are trademarks or registered trademarks of their respective owners. This annual report also contains trademarks, trade names and service marks of other companies, which are the property of their respective owners.
Our website is www.octavianinternational.com. The website is not part of this annual report. Our principal corporate executive offices are located at Bury House, 1–3 Bury Street, Guildford, Surrey GU2 4AW, UNITED KINGDOM and our telephone number is: +44 1483 543 543.
OUR COMPANY
We are a global provider of a full end-to-end suite of gaming systems and products. Our solutions offer full life-cycle gaming support and system solutions; the design, manufacture and marketing of computerized games; products for the lottery industry; and third party products. Our primary market focus is on emerging markets that we believe to be fast growing. We offer flexible, tailored, technical and operational support and solutions which, we believe, enable our customers to efficiently scale their operations over multiple locations.
Our products and services are provided through our four core business sectors: (1) OctaSystems; (2) OctaGames; (3) OctaLotto; and (4) OctaSupplies.
OctaSystems
Our OctaSystems business sector is comprised of two main products, our casino management systems and our downloadable games systems.
Casino Management Systems
Our casino management systems provide both local and centralized global solutions by linking electronic gaming machines either within a single casino or globally over multiple venues, to a central data center in order to manage, control and monitor gaming machines. We provide a complete range of services from consulting, through design, procurement, installation, training and operational support for the management of casinos. We believe that our global casino management system, which links multiple casino venues to our central data center, is one of the largest independent casino management system networks worldwide, supporting approximately 29,400 machines worldwide. Our extensive global infrastructure is both flexible and scaleable, providing customer support 24 hours a day and 7 days a week. Our casino management system platform is designed to interface with the machines of virtually all other gaming manufacturers, as well as with other systems such as Point-of-Sale, signage and kiosks. We believe this aspect of our system distinguishes us from others in the gaming industry.
The primary benefit of our casino management system platform is that it allows casino operators the ability to control financial activities, allowing them to reduce the possibility of fraud and theft. In addition, our systems have advanced data extraction and data warehouse capabilities to enable operators to generate reports that allow for an in-depth, real-time understanding of player profiles and business performance and to utilize data for targeted marketing campaigns across multiple locations. The control functions of the casino management system increase availability of machines and reduce down time by immediately identifying machines in need of service and notifying the operator’s service crew automatically. In our experience, developing such a networked gaming system is cost prohibitive for most medium to small operators. We believe that our competitive advantage is that we become an integral part of a gaming operator’s already existing information technology (“IT”) infrastructure, with the aim to increase efficiency and profitability. We believe that our systems can be differentiated from other systems in the industry, in that they are able to interface with the products of a variety of gaming manufacturers.
We offer our casino management systems in a variety of different ways and levels, from our comprehensive, fully automated, end to end system, Octavian e2e GMS, to our entry level, low cost end to end system, Octavian EasyStart. Within our end to end systems clients can purchase individual systems that address specific needs or requirements of an operator, such as our slot machine management system, ACP, our casino reception and marketing system, Octavian GateManager™, and our cash desk management system, Octavian CashManager™.
Our current casino management system solutions include:
Octavian End to End Casino Management System
Our most comprehensive system offering is our Octavian e2e GMS system. Octavian e2e is our complete end to end system and covers and links together slot machines, gaming tables, the cash desk, player registration, reception, security, loyalty systems and marketing. Our entry level end to end system is Octavian EasyStart which requires a minimal upfront investment of hardware with an affordable monthly fees rather than a purchase of software.
For clients that do not wish to have an end to end system but rather seek specific functions within our end to end system, we are able to deliver such functions independently from each other on a stand-alone basis, or modularly, from our end to end system. Our modular systems include Octavian ACP, Octavian GateManager™, Octavian CashManager™ and Octavian Business Intelligence Manager.
Octavian Modular Casino Management Systems
Octavian ACP - Our primary casino management systems for slot machines is Octavian ACP which we believe is a secure, highly flexible and reliable system with the capability to link machines from virtually all manufacturers, in multiple locations globally. The ACP platform, consisting of approximately 1.5 million lines of code that we regularly update, provides the following key ACP functions:
| | · | The Accounting Function: Provides all requested data from every linked machine, machine group, gaming hall and casino within the operator’s business. The system securely stores this data and transforms it into comprehensive reports and financial analysis. The key benefits to operators are the ability to: |
| | o | Identify games that are the most popular with players; |
| | o | Obtain real time information on the casino’s cash position; |
| | o | Track all financial transactions; and |
| | o | Eliminate time consuming manual processes of meter readings. |
| | · | The Control Function: Performs detailed analysis of each machine and enhances system security. This function carries out real-time system diagnosis, including detection and identification of machine malfunctions, notification of unauthorized entry to any machine and monitoring of transmission links. Data can be customized easily to enable a variety of reporting functions and alerts. The key benefits to operators are the ability to quickly respond to machine malfunction to minimize downtime as well as to prevent fraud. In addition, the Control Function maintains a record of all attached systems, including status and physical locations, which is required by regulatory authorities in many jurisdictions. |
| | · | The Progressives Function: Enables connected machines to be linked over multiple locations to both progressive and random or mystery jackpots, also known as a Wide Area Progressive (“WAP”) jackpot system. Jackpot groups can be configured locally or globally according to the operator’s precise business requirements. We believe that the ability to create WAPs increases the number of playing customers and operator revenues by offering bigger and better awards. |
This system is run from one of our three data centers – St Petersburg, Bogota and Buenos Aires.
My ACP Slots Management System. Our “My ACP” is a variation on our Octavian ACP system but is for an in-house casino management system where operators maintain their own central server, software, database and technical center on their own premises, managed by their IT personnel. We offer flexible service agreements including 24 hours, seven days a week hotline support, maintenance visits and periodic software upgrades to the My ACP firmware on the customer’s server.
Octavian ACP System Add-ons. Within Octavian ACP we can also offer optional add-on features that enhance the functionality of the ACP system such as cashless operations that allow players to use a pre-paid “Smart” or RFID card that enables players to play games to accumulate bonus points and gain automatic entry into a bonus jackpot draw.
Octavian GateManager™. Octavian GateManager™ administers and reports player registration, guest services and activity on the gaming floor. It is a fully integrated player tracking system that captures player activity for a loyalty system. A loyalty system automatically enters players into sweepstakes such as jackpots and prize drawings or allows players to exchange accumulated points for cash or prizes, which we believe encourages players to return to our customers’ locations.
Octavian CashManager™. Octavian CashManager™ monitors transactions taking place in the casino gaming area and continuously updates player activity. Although not necessary, we believe that Octavian GateManager™ and Octavian CashManager™ work best when used alongside each other.
Octavian Business Intelligence Manager. Octavian Business Intelligence Manager is a data mining tool, which transforms transaction data into reports that provide operators with information on player behavior, player patterns, tables and slots actual and theoretical wins and jackpot drops, in order to assist with targeted marketing campaigns.
Downloadable Game Systems
Symphony™ is our adaptable, scalable and cost-effective downloadable game system that meets the broadest range of gaming needs. We offer two versions of Symphony™: Symphony™ DE and Symphony™ LE.
Symphony™ DE offers a complete server-based platform for video lottery terminal projects, with the random number generator residing either on the server or gambling terminal dependent on customer and regulatory requirements or supplied from a 3rd party source. Supported by centralized audit, financial reporting and remote download of game content.
Symphony™ LE offers a complete integrated system for the management of electronic instant lottery tickets (pull-tabs and lottery type games), with a central-server providing series ticket storage, security event monitoring, financial reporting and downloadable game series content.
OctaSystems generated 20% of our consolidated revenues in the year ended December 31, 2008. As part of our business strategy, it is our goal to grow our OctaSystems business so that it comprises a greater percentage of our revenues going forward.
OctaGames
We have a portfolio of over 80 games sold globally. We believe our OctaGames business has developed a reputation for developing games that are especially popular in emerging markets and known for their advanced graphics and attractive user interfaces. We support a wide variety of games which are tailored for electronic gaming machines (“EGMs”) and amusement with prizes machines (“AWPs”). EGMs are commonly known as slot machines and are casino gambling machines with three or more reels which spin when a button is pushed, while AWPs, which are popular in arcades, bars and restaurants throughout Europe, incorporate more limited payouts than slot machines with features that allow players to exercise some form of skill and strategy, such as video poker. We deliver our games through: (i) a complete machine with the games software installed on the board running on a terminal; (ii) game software installed on the board that can then be inserted into third party machines; or (iii) software form only, allowing a manufacturer to operate our games on its own games board.
Until recently, our business strategy included the development and sale of our own EGMs. We had devoted a portion of our efforts and some of the capital we previously raised to the development of an EGM which we had planned to market under the name “Maverick®.” We initially believed that the Maverick® would allow us to leverage our technology and games, resulting in higher margins and profitability compared to third party sales, as well as provide recurring revenue through participation and licensing fees. After further review and having had no more than nominal sales of the “Maverick®,” we have decided to terminate our current efforts to develop our own EGMs and continue to focus on the distribution of third party EGMs.
OctaGames generated 5.7% of our consolidated revenues in the year ended December 31, 2008. As part of our business strategy, it is our intention to grow our OctaGames business so that it comprises a greater percentage of our revenues going forward.
OctaLotto
Our OctaLotto business line has developed the SymphonyTM LE platform which provides lottery systems and solutions for state and local lotteries, especially in emerging markets. We develop systems and game content and provide complete end-to-end lottery solutions, from consulting and set-up, to systems implementation and supplier management, as well as marketing, training and ongoing support. The SymphonyTM LE platform has been developed specifically for lottery, video lottery terminals and downloadable games operations. However, for each opportunity we look for the best-fit solution – considering other 3rd party solutions. Recently we have launched a nationwide lottery for Rwanda for which we used a system supplied by Schenzhen G-Lot Technology Ltd., a Hong Kong based company (“G-Lot”).
Key benefits include:
| | · | A one-stop turnkey solution for existing and prospective lottery operators; |
| | · | Innovative systems solutions to enable traditional lottery operators to sell tickets via networked gaming machines/video lottery terminals; |
| | · | Related lottery products, such as traditional online games, mobile gaming, video lottery terminals and scratch cards; |
| | · | The ability to provide wireless, mobile and Internet gaming products; and |
| | · | Discrete services such as business and technology advice, training and mentoring, supplier management and ongoing lottery business development |
We added the OctaLotto business sector to our core business in the fourth quarter 2008, and we have only recognized nominal revenues from this business line. As part of our business strategy, it is our intention to grow our OctaLotto business so that it comprises a meaningful percentage of our revenues going forward.
OctaSupplies
Our OctaSupplies business is a casino and amusement equipment supplier for game equipment and content as well as related services. We offer a full range of products from third-party manufacturers, including gaming machines and other innovative attractions and peripherals. The purchase of new devices in certain international markets is often costly, and where appropriate, we have started to recondition used devices for resale, which we sell on an “as is” basis.
During 2008, we offered products from the following third party suppliers:
Austrian Gaming Industries (a/k/a Novomatic)
We have distributed gaming products for AGI (a/k/a Novomatic) since 2001. The products we have distributed for AGI include Gaminator®, Multi-Gaminator® and Super-V+ Gaminator® (each of which is a multi-game solution that provides a choice of video games to the player). Distribution of AGI’s products have been targeted to selected markets, including substantially all countries in Latin America, other than Chile, Peru and Uruguay and the Commonwealth of Independent States (“CIS”), which includes Armenia, Azerbaijan, Belarus, Georgia, Kazakhstan, Kyrgyzstan, Moldova, Tajikistan, Turkmenistan, Uzbekistan and Ukraine.
International Game Technology (IGT)
We have distributed gaming products for International Game Technology (“IGT”) since 2005. The products we have distributed for IGT include gaming machines (including slot machines and other video gaming terminals) in Russia and IGT EZ Pay® to selected markets across Europe, North Africa and the CIS. Distribution of IGT EZ Pay® is on a non-exclusive basis and covers Europe, Egypt, Morocco, Tunisia, Lebanon, Palestine, Israel, Russia, Belarus, Kazakhstan and Turkmenistan through October 2010. Typical distribution terms with IGT require us to purchase the software, components and parts at a fixed discount and to offer maintenance agreements at a fixed discount.
Until January 29, 2009 we had an agreement with TableMAX Holdings, LLC to distribute, install and support TableMAX Electronic Table Games systems globally, with the exclusion of the North American Free Trade Agreement member countries. That agreement has been terminated and we no longer have any rights or obligations under the agreement.
OctaSupplies generated 74% of our consolidated revenues in the year ended December 31, 2008. In the event that our business strategy to grow our OctaSystems, OctaGames, and OctaLotto businesses succeeds, our OctaSupplies business will comprise a significantly lower percentage of our revenues going forward.
BUSINESS STRATEGY
Our current focus is to grow our proprietary systems and games business and reduce our reliance on offering third party products. Octavian has made significant investments over the past few years to develop our own innovative gaming products as well as systems infrastructure to provide hosted solutions. We intend to leverage these investments to produce a sustainable recurring revenue model with increased profitability.
We are currently executing the following initiatives to drive further expansion and profitability:
| | · | Expand our Operations Outside Russia. Our long-term growth strategy is to derive a lower percentage of our revenues from Russia and from our OctaSupplies business. To date, we have been largely dependent on revenues generated from our operations in Russia, but we are working to expand our operations in other markets. We plan to develop a more geographically diverse business in order to minimize our exposure to volatility in any one market. |
| | · | Increase Proportion of Recurring Revenues and Long-Term Contracts. We have repositioned our business to increase our recurring revenue from our OctaSystems, OctaGames and OctaLotto business lines. We plan to increase sales of our OctaSystems, OctaGames and OctaLotto products and services, as we believe that these will provide us a stronger base of recurring revenues, because of the higher margins that we recognize on these products and services. We believe this will provide a more predictable revenue stream with higher margins, improving financial viability, although we cannot assure you that we will be successful in achieving these results. |
| | · | Increase Focus on Casino Management System. Currently we connect approximately 29,400 machines worldwide and we believe that, based on internal market research, there is an estimated global market opportunity of at least two million machines that are still not linked to a casino management system that could benefit from our systems. Regulators in our target markets have recently signaled greater interest in instituting legislation that would require gaming machines to be electronically connected with a casino management system in order to ensure that all transactions and income are monitored, primarily for tax purposes. Because of our ability to connect other manufacturers’ products to our systems, our goal is to capture a greater market share of the gaming machines that are still offline. Our systems allow casino operators to link machines from multiple manufacturers, which we believe differentiates our service from others in the gaming industry. In addition, we believe that we are well equipped to provide gaming infrastructure for both large and small gaming customers. |
| | · | Continue to Establish Long-Term Relationships with Casino and Amusement with Prize Machine Operators. Our aim is to continue to establish long-term, consulting relationships with customers by becoming an integral part of their operations. By consulting and providing the technological infrastructure for their operations, we seek to leverage our relationships to generate cross-selling opportunities. |
| | · | Expand Portfolio of Service Offerings. We plan to continue to develop new technology and games through our R&D staff in order to provide additional services and create future growth. |
| | · | Expand Product Reach. We plan to enter rapidly growing, emerging markets in Asia and expand in the more regulated areas of Latin America and Europe. Previously, the Company has focused on less regulated, emerging markets, where regulatory approval was not required. We are moving into other markets that may have other regulations. As part of that move, to the extent that these markets have more stringent regulatory requirements, we may obtain approvals and certifications to facilitate compliance with these regulations, such as obtaining certification from Gaming Laboratories International (“GLI”). For a description of GLI certification, please see the section titled “Business – Regulation,” beginning on page 20. We plan to continue developing partnerships with companies more familiar with local regulation, culture and methods to expedite entry into countries that currently allow gaming and those that may permit gaming in the future. |
| | · | Continue Focus on Emerging Market Opportunities. We have been an early mover in nascent gaming markets. We have invested significant time over the last three years establishing relationships with customers and partners in Asia and other emerging markets, including Africa. We believe that these relationships will assist us in being a first mover in these markets. |
| | · | Consolidate the Brand. We believe that the Octavian brand is well recognized in Latin America, the CIS and Europe. As we expand into other markets such as Asia and Africa, we intend to increase our marketing activities, in order to promote the brand both at the local and global levels. With increased exposure at industry events and within trade publications, our goal is for our brand to be recognized as one that provides a full suite of leading systems infrastructure, games and supplies. |
| | · | Expand through Strategic Acquisitions. Historically, we have grown both organically and through acquisitions. Material acquisitions that we have made in the past include our purchase of 50 percent of the shares of Win System International Holdings, Inc. (“WSI”) in 2006. WSI subsequently was dissolved, but we retained the rights to Symphony™. We also purchased the assets of Gaming Solutions International (“GSI”) in July 2008, which has enabled us to enter the lottery market. We believe there exist numerous opportunities to acquire companies with valuable technology and relationships. With further strategic acquisitions, we believe that we will be able to expedite entry into new geographic territories and strengthen our product offering in emerging market sectors that we believe are fast growing. |
MARKET REGIONS
We market our products and services in legalized gaming jurisdictions located in several regions throughout the world. Recently, our most significant market has become Italy, replacing Russia as a result of our continued pursuit to expand into markets outside of Russia, particularly in light of the fact that changing regulations have made it difficult to do business in Russia. A change in regulations in Italy gave us a significant opportunity. Our opportunities, challenges, and successes vary across these jurisdictions.
Russia and the CIS Countries
We commenced our operations in Russia and the CIS countries in 2001. We provided our ACP system and all technical support to one of the first major gaming operators in Russia and the CIS countries. We expanded our presence in the market by providing services to other gaming operators. We also expanded our product and service offerings to include the distribution of third-party products and our proprietary games. We currently have two offices in Russia: our Moscow office focuses on our OctaSupplies business line, while our St. Petersburg office focuses on our OctaSystems, OctaGames, and OctaLotto business lines, research and development, and the operation of one of our global data centers.
Historically, Russia and the CIS countries has been our most significant market, representing 73.1% of our revenues in 2007 and 75.9% of our revenues in 2008. On December 29, 2006, the Russian government enacted legislation (No. 244FZ) that immediately restricted the number and the size of sites that can offer slot-machine operations. In addition, casinos will be limited to four geographic zones after July 1, 2009, and only gaming operators meeting certain specified revenue and assets thresholds would be permitted to operate casinos in these regions. This legislation effectively capped the market and caused a number of gaming suppliers to exit the marketplace. The legislation resulted in a reduction in our revenues from business in Russia and the CIS countries of approximately US$37.0 million (or 68 percent), from US$54.4 million in 2006 to US$17.2 million in 2007. In 2008, our revenues in Russia and the CIS countries increased to $30 million. We believe that our well-established relationships with operators in Russia and the reduction of the number of competitors in Russia places us in a favorable position to serve the remaining Russian gaming industry in the event the Russian legislature passes legislation that permits country-wide gaming to continue. Such an extension would require operators to re-invest in new equipment, providing an opportunity for future growth.
The 2007 legislation did not restrict lottery operations, resulting in the decision of certain slot-machine operators to transfer some of their operations from slot machines to lottery machines. Octavian has been able to capitalize on this new market through our OctaLotto business line. We currently supply video lottery terminals and other lottery systems to several markets in Russia and anticipate continued growth in this area.
Our offices in Russia also serve as our base of operations for our activities in other CIS countries. Our long-term strategy is to diversify our business by increasing the amount of business we do in the CIS countries and reducing our business in Russia. From our Moscow office, we sell third-party machines and gaming supplies to gaming operators in Armenia, Belarus, Georgia, Kazakhstan, Kyrgyzstan and Moldova.
In addition, we also maintain an office in Kiev, Ukraine to service our expanding presence in Ukraine. Our operations in Ukraine currently include our OctaSystems, OctaGames and OctaSupplies business lines.
Latin America and the Caribbean
Legalized gaming is established in approximately 45 territories in this region, which we define as the Caribbean island nations, Mexico, Central America, and South America, with a market for machines in the following categories:
| | · | Bingo operations and arcades. |
We believe that Colombia, with approximately 69,000 machines in 2008 is an important market which offers potential growth opportunities. We expect legislation to be passed this year that will require gaming operators to link their machines to a centralized system. This legislation currently is in draft stage, but we expect it to become effective sometime during the second quarter. Historically, lottery games have received greater acceptance than slot machines and other casino-related gaming machines, but we believe that support for casinos recently has grown, based on the number of well-known operators that have entered the market. Although the size and timing of market growth remain uncertain, we anticipate that opportunities will develop over the course of the next few years.
We believe that Peru is another important market in this region, which also provides opportunities for growth. In 2008 there were approximately 80,000 machines in Peru, with the largest cities having the highest concentration and continuing to grow. Legislation is pending that will require the Ministry of Tourism to certify gaming operators. If it passes, this legislation could increase our opportunities for growth in Peru over the next several years. We believe that certification by the Ministry of Tourism will increase the confidence of gaming companies and consumers in gaming operations, leading to more investment in gaming operations in Peru. We currently have games and machines undergoing certification in Peru, which has certification rules that are different than those of most other countries and uses its own local laboratory for game testing and certification. We currently have one game certified to Peru standards and expect three additional games to be certified in the near future.
Mexico first allowed casinos to begin operations in 2006, and the Mexican gaming industry generated approximately US$2 billion in revenue that year. We believe that Mexico will continue to be the fastest growing territory in Latin America, because new casinos could attract visitors from the United States as well as from Mexico. Based on our own internal research, we believe that there are currently approximately 90,000 machines in Mexico. We recently entered into contracts to deliver bingo games to Mexico, and we expect the installation phase of the first contract to be completed in the near future.
Argentina also is a significant market in this region, with more than 70 casinos and 150 bingo halls and had a total gaming market of approximately US$205 million in 2007. We operate a data center in Argentina, and we also continue to increase our share of machines through competitive pricing and established relationships with gaming operators. We also expect future opportunities in Chile and Ecuador will provide both replacement and expansion growth, although there is no assurance of this or that we will ever enter those markets.
We have a facility in each of Bogotá, Colombia and Buenos Aires, Argentina. Each of these locations hosts a global ACP data center, and we also conduct software research and development at our Buenos Aires location. Our Latin America and Caribbean operations encompass Brazil, Mexico, Argentina, Venezuela, Chile, Colombia, Peru, Puerto Rico, Ecuador, Guatemala, the Dominican Republic, Costa Rica, Trinidad, Tobago, Uruguay, El Salvador, Panama, Bolivia, Jamaica, Honduras, Paraguay, the Bahamas, Nicaragua, Haiti, Barbados, Suriname, Belize, Antigua, Barbuda and Saint Lucia. These operations contributed 17.1% of our revenues in 2008 and 24.2% of our revenues in 2007. We currently operate our Caribbean operations out of our office in Bogotá, Colombia. We derive our revenue in this region from our OctaSystems, OctaGames, and OctaSupplies business groups and also expect to deliver our OctaLotto services in this region in the near future.
Europe
This region includes 21 countries, with an estimated total gaming market of US$28.4 billion in 2007 including approximately two million gaming machines. It encompasses:
| | · | Slot halls and arcades; and |
| | · | Non-casino environments such as restaurants and pubs. |
Germany had a gaming market of approximately US$4.4 billion in revenue and approximately 200,000 gaming machines in 2007. In 2006, Germany began allowing AWP machines on the street market (gaming machines located on the street as opposed to in an enclosed facility). This has resulted in the German market growing to revenues of approximately US$6.4 billion in revenue and approximately 225,000 gaming machines in 2008, surpassing the approximate size of the United Kingdom’s market. We have a joint venture in Germany with an established distributor in that market to sell games we have developed for the German market.
The United Kingdom also is a large market in this region, with approximately 217,000 machines and US$5.3 billion in revenue in 2007. Although additional casinos were expected to open in the United Kingdom during 2008, no casinos were opened and we are not aware of any plans to open new casinos in 2009.
Italy’s market includes approximately 200,000 machines and revenue of approximately $1.5 billion in 2007. Recent regulatory changes have mandated that some games currently in use be replaced with new games with different rules and payout structures. In 2005 we entered into a joint venture in Italy with Euro Gruppo Giochi S.r.l. (“EGG”), a gaming machine manufacturer with a significant presence in Italy, to develop games for EGG that comply with such regulatory changes.
Although France’s total gaming market includes approximately 190 casinos, French legislation makes it extremely difficult to obtain gaming distribution licenses. Because of the stringent regulatory requirements, we do not currently pursue gaming opportunities in France.
As of 2007, Romania had a market of approximately 31,000 machines. There are approximately 8,000 slot arcades (casinos that only have slot machines) and approximately 21 full-service casinos.
Octavian currently does most of its business in Europe in Romania, Italy and Germany. Our European operations represented approximately 7.0% of our revenues in 2008, compared to 2.7% of our revenues in 2007.
Africa
In 2008 there were approximately 29,000 regulated machines in the entire African market. South Africa is the largest market in the region, with approximately US$1.8 billion in annual revenue in 2007. It is highly regulated, and we also believe currently there is only a limited opportunity for new operators to enter the South African market at this time due to this strict regulation. We believe that the next two largest markets are Morocco (725 machines) and Kenya (720 machines), both of which are small but, we believe, growing gaming machine markets.
In Rwanda we have an exclusive license from the Rwandan regulatory body to administer and operate Rwanda’s lottery through 2019. We will distribute lottery terminals, establish a distribution network, administer control procedures for the collection of receipts and payment of jackpots and market Rwanda’s lottery system, on an exclusive basis, throughout the term of the license. Additionally, we have an exclusive license from the Rwandan regulatory body to operate gaming machines, sports betting and horse racing in Rwanda through 2014, which includes the right to extend through 2019.
We are working with local operators to distribute 500 refurbished slot and similar machines in two African countries. We will receive payment equal to a percentage of the sales price of the machines along with a percentage of the profits made by the operators through 2013.
To date, the lottery and gaming markets in Rwanda are in the early stages of development and there can be no assurances that viable markets will ever evolve.
Asia Pacific
Most Asian countries have some form of gaming, including casinos, lotteries, and hotel and club gaming. In 2007, this market generated approximately US$18.3 billion in revenue, with the largest markets being in Macau (part of the People’s Republic of China), Australia, South Korea, Japan, Malaysia, and the Philippines. We currently have no operations in Asia, other than one Octavian GateManager™ and one Octavian CashManager™ installed in Sri Lanka, and have therefore generated only nominal revenues in this region to date. However, we anticipate growing demand in this region, both new and replacement, for machines, parts, games and systems.
MARKETING AND SALES
Octavian primarily markets and sells its products and services through its direct and indirect sales staff (direct sales staff sell to end users, while indirect sales staff is comprised of sales managers who occasionally become involved in direct sales) and senior management, who are located in each of our global locations. As of March 30, 2009, we retain 20 direct and indirect sales representatives. The sales and marketing group is supported by a technical and project management team throughout the sales process.
Our sales process takes place throughout our year and can range from proposals for a small quantity of units to several hundred units. The duration of the sales process varies depending on the type and scale of products and services required, ranging from days for most games and machines, to as long as a year for a highly customized ACP system. Typically, a potential systems customer will participate in a formal evaluation and selection of a system vendor.
The level of sales available to us at any point in time can vary materially due to a number of factors, including the capital budgets of our customers, the availability of new products and services, the timing associated with any required regulatory approvals, and the success and features contained in the products and services sold by our competitors. The price paid for a full system can vary materially from customer to customer, depending on a number of factors, including the size of the gaming operation, the number of functions contained in the system specified and the level of post-sale support provided.
We generally complete our sales on a cash basis and only extend short term credit to customers on a case by case basis.
Although our direct sales force historically has generated most of our sales, we conduct a number of marketing activities including exhibiting at international and regional tradeshows, sponsorship of industry trade publications, and targeted email marketing.
We normally exhibit our products and services at the following annual tradeshows:
| Tradeshow | | Location | | Month |
| | | | | |
| ICE | | London, United Kingdom | | January |
| ENADA Primavera | | Rimini, Italy | | March |
| FADJA | | Bogotá, Colombia | | April |
| ELA | | Mexico City, Mexico | | May |
| G2E Asia | | Macau, China | | June |
| ENADA | | Rome, Italy | | October |
| SAGSE | | Buenos Aires, Argentina | | October |
| G2E | | Las Vegas, United States | | November |
Key sales personnel have already and will continue to attend other exhibitions and conferences, including AmEx (Dublin), GEM (the Philippines), BEGE (Bulgaria), Preview (London), among others, in order to meet with existing clients and to follow up on leads generated from other shows and general activities. In total, we expect to be represented at over 30 international shows throughout 2009.
In addition to attending industry tradeshows, we look for sponsorship opportunities, such as providing official tradeshow lanyards that include our brand name and logo. In addition, our Chief Executive Officer, Harmen Brenninkmeijer, is a regular speaker and moderator at tradeshow symposia and is on the advisory panel for the G2E tradeshows.
To maximize our brand exposure internationally, we have secured exclusive agreements with publications including:
| | 1. | We are the official sponsor of G3 magazine’s semi-annual market reviews – European Market Review and South American Market Review. G3 is a major industry publication published monthly by HP Publishing Limited and also distributed at major tradeshows. Because of Octavian’s sponsorship of the market reviews, our brand name and logo appear on every page of the issue devoted to the market report; the entire inside cover page is devoted to Octavian advertising and two additional advertisements for Octavian products and services appear in the front part of the issue. |
| | 2. | We have sponsored the Casino International wall calendar for calendar years 2008/2009, and we have secured a similar arrangement for 2009/2010. The printed calendar is mailed to almost 5,000 subscribers worldwide and emailed in digital format to another 3,000 online subscribers. |
| | 3. | We have a contract with Casino Review magazine for an Octavian advertisement to appear on the outside back cover of every issue. We have agreed to be the official sponsor of the magazine’s “Supplier News” section that appears in each issue. Casino Review is a monthly publication that is distributed both in print and digital format. It is published by Clarion Gaming, the organizers of the IGE tradeshow, and distributed to each year’s International Gaming Exhibition (“IGE”) exhibitors and attendees. |
| | 4. | We have a long-standing relationship with Yogonet.com, publishers of a daily gaming industry newsletter, distributed by email. Our relationship dates back to the newsletter’s founding in 2003, when it was focused on the Latin American market, in which we have had a well-established presence for several years. Over the past year, it has become one of the industry’s most subscribed global newsletters. Octavian’s contract provides that each issue of the newsletter and the website contain Octavian banner advertisements and our relationship ensures that any story about Octavian is featured among the top five stories for that day. |
We also utilize subscriber based HTML email marketing as a cost-effective, targeted method of publicizing our latest product developments. These emails are distributed to prospects in our sales database. We currently have approximately 3,000 names on our subscription list.
Sales Structures
OctaSystems
OctaSystems sales generally are structured in three ways. The percentage of sales under each structure varies from month to month. The first structure involves the customer purchasing the hardware and then paying a monthly license fee per machine for use of the software. These contracts are generally three years or longer in length, with varying fee structures. The second structure involves the customer purchasing the hardware (Octavian’s “My ACP”) and system (license to operate Octavian’s “My ACP”) outright for a one-time fee plus an ongoing service package from Octavian for support and software updates. Under this structure, the software remains the property of Octavian, and the customer uses components of the hardware to interface its machines to the “My ACP” system. While it is possible for a customer to purchase a system from us without ongoing support, it is extremely rare and we recommend the purchase of ongoing support to all of our customers. The third structure involves the customer purchasing the hardware at a small margin and then paying Octavian a fixed percentage of the customer’s revenues over the life of the system. Under this structure, contracts sometimes provide that the charge for the system is included in the price of the hardware, in which case we charge a higher percentage of revenues over the life of the system. Our goal under this structure is to have the hardware paid for outright by the customer and for our costs in licensing the software to them to be paid for by sharing in the revenues the machines produce. In each case when there is an ongoing service contract, the customer is invoiced monthly for the appropriate fees.
The demand for casino management systems is driven by regulatory requirements in each applicable jurisdiction by casino operators’ competitive need to track device and player activity, and to establish and compile individual device and player profitability and other demographic information. These features also enable casinos to develop or enhance marketing strategies. Our revenues from our casino management systems are derived from selling our products and services to both new and existing customers.
OctaGames
OctaGames sales generally are structured in two ways. The first structure involves the customer purchasing a security-protected license for one or more of our games. A fee is charged for each copy of each game. The second structure involves third-party manufacturers outsourcing to us the development of one or more specific games. When we develop a requested game specifically for a customer, we generally require that a substantial portion of the contract cost be paid upfront and the balance upon acceptance by the customer of the delivered product.
OctaLotto
OctaLotto sales typically involve the customer purchasing the hardware and then paying Octavian a fixed percentage of the customer’s revenues (ticket sales) over the life of the system.
OctaSupplies
OctaSupplies sales generally are structured in two ways. The first involves outright sales of third-party machines which require initial payments on order and then the balance of the payments periodically over the 90 day period following shipment, subject to our having to accept longer payment periods in jurisdictions where our competitors offer payment terms extending as long as 18 months after delivery of the machines. In any event, we generally do not provide customers with payment terms extending more than ten months after delivery of the machines. The second method of payment involves the customer paying a fixed percentage of the machine’s sales over a period of years.
In certain cases, the original manufacturers of these products may be competing with us in markets where we also sell their products.
CUSTOMERS
Our customers fall into four broad categories:
| (1) | major casino operators who purchase OctaSupplies products, casino management systems (including My ACP), other machines, and games; |
| (2) | slot halls and other operations who purchase OctaSupplies products, casino management systems (including My ACP), other machines, and games; |
| (3) | regulatory authorities who purchase and/or accredit casino management systems (including ACP); and |
| (4) | lottery operations who purchase OctaLotto services (including SymphonyTM and video lottery terminal games). |
The demand for gaming devices and systems varies depending on the level of new construction and renovation of casinos and other gaming sites, as well as market conditions that might generate the need for new and replacement equipment and product and service innovation. Gaming devices generally have an average replacement cycle of three to seven years.
Octavian provides products and services on both an ongoing and a one-time basis. The volume of products for specific customers varies from year to year, and a significant customer in one year may not buy our products in a subsequent year.
Future sales of our products and services will be based on, among other elements, continued expansion of our product and service line, the success of our game content, the acceptance of our systems, our customer service levels, expansion into additional markets and our ability to maintain a competitive position against other providers who are producing similar products and services.
COMPETITION
The market for gaming systems, games, lottery systems, and gaming machines is highly competitive, constantly evolving, and subject to technological change. Competition is a significant driver of new product and service development. We believe that principal competitive factors include:
| | · | Product functionality and features; |
| | · | Product and service pricing; |
| | · | Availability and quality of support; |
| | · | Customer acceptance and player preference; |
| | · | Ease and speed of product implementation; |
| | · | Vendor and product reputation; |
| | · | Product architecture and technological innovations; |
| | · | Knowledge of gaming industry practices; |
| | · | Product accuracy and reliability; and |
| | · | Regulatory compliance and Gaming Laboratories International certification. |
We believe we have a global competitive advantage as a result of our:
| | · | Ability to customize products and services; |
| | · | Breadth of product and service offerings; |
| | · | High levels of customer service and support; |
| | · | Long history with customers; |
| | · | Geographic diversification of operations; |
| | · | Seasoned, experienced development staff; |
| | · | Worldwide brand recognition; |
| | · | Diverse library of innovative games; |
| | · | The combined effect of our systems working together being greater than the sum of their parts. |
Our competitors vary in size from small companies with limited resources to several large multi-national corporations with substantially greater financial, marketing and product development resources than ours. Our larger competitors have an advantage in being able to devote more resources to develop new technologies that are attractive to players and customers. Our competitors include, but are not limited to, the following manufacturers, service providers and distributors that have gaming products and services and are either authorized to sell or are in the licensing process in many foreign gaming jurisdictions:
OctaSystems global competitors include but are not limted to: Aristocrat Leisure Limited, Lottomatica S.p.A. (acquired Atronic in 2008), Bally Technologies, Inc., IGT, and Systems in Progress GmbH (owned by WMS Industries, Inc.). Competition is particularly strong in this market because of the number of providers and the limited number of casinos and jurisdictions in which they operate. One of our former competitors, Progressive Gaming International (formerly Mikohn Gaming Corporation) was recently acquired by IGT after failing to fulfill certain bonding requirements and ultimately declaring bankruptcy.
OctaGames global competitors include but are not limted to: Ainsworth Gaming Technology, Aristocrat Leisure Limited, Aruze Corp. (formerly known as Universal Distributing of Nevada), Bally Technologies, Inc., Unidesa Gaming & Systems (part of the Cirsa Group), Franco Gaming, Ltd. (a division of Recreativos Franco), Gauselmann Group, Lottomatica S.p.A. (acquired GTECH Corporation in 2006 and Atronic in 2008), International Game Technology, Konami Co. Ltd., Novomatic Industries (which is controlled by our principal shareholder, AGI), Scientific Games Corporation and WMS Industries, Inc.
OctaLotto global competitors include but are not limted to: Lottomatica S.p.A. (acquired GTECH Corporation in 2006), International Lottery & Totalizator Systems, Inc., IntraLot S.A., Scientific Games Corporation and Win Systems International Holdings, Inc.
OctaSupplies global competitors include but are not limted to: Ainsworth Gaming Technology, Aristocrat Leisure Limited, Lottomatica S.p.A. (acquired Atronic in 2008), Bally Technologies. Inc., Belatra Co., Ltd., Fortuna Gaming Corp., Franco Gaming, Ltd. (a division of Recreativos Franco), Gauselmann Group, , IGT, KARE Technology Company, Konami Co. Ltd., Novomatic Industries and Unicum Gaming (“SmartGames”).
MANUFACTURERS AND SUPPLIERS
We manufacture our hardware products through third-party manufacturers in Australia, Russia and Argentina. In Russia, we have outsourced the manufacturing of the ACP components to an aerospace company based in Moscow under a long-term contract that provides for minimum-order quantities, lead times and a maximum manufacture rate that is eligible for increase at our request. In Argentina, we have outsourced the manufacturing of the ACP components to a local manufacturer. We manufacture these components in Argentina for distribution in Argentina only, for tax and trade law reasons.
We also purchase certain component parts from third-party manufacturers, such as AGI and FutureLogic, Inc.
In general, we hold some spare parts for the items we manufacture, but we do not hold a material amount of final product. We generally order final product only after we have received a non-refundable down payment from the customer equal to approximately 10 percent of the contract value. If the customer subsequently cancels the order, we retain the down payment and generally are able to transfer the product to another pending customer product. We do not order final products other than in response to specific customer orders.
We believe that our sources of supply are generally adequate, and with multiple sources for the same component parts. We have a degree of duplication of the critical components of the system, with the intention of increasing reliability of the system in the event that any of our primary systems fail.
Generally, we do not have long term commitments with suppliers.
CUSTOMER SERVICE
We consider customer service an important aspect of our overall marketing strategy. We provide product delivery, installation, new product training, warranty, after-market technical support, supplemental equipment and spare parts, product retrofitting, game conversions, network systems, downloadable game and system upgrades, and casino operations consulting services. We employ trained customer service personnel in our data center locations, co-located with our R&D personnel, to whom our customer service staff have immediate access.
In addition, we generally offer parts and labor warranty for games and machines. We record warranty expenses for our OctaSupplies sales only. To date, we have not recorded any warranty claims, as they have been immaterial, with a negligible effect on our financial condition.
Octavian provides access to customer support service 24 hours a day, seven days a week. This support is live (24 hours per day, seven days per week, 365 days per year telephone support) for each of our products. In addition to the immediate technical support available via these hotlines, we also offer emergency site visits as needed. For hardware products, we also provide both product support and return service. We also offer field service support programs, spare parts programs and operational consulting to improve performance.
Product information is available through a restricted, user-identification and password-protected area of our website.
RESEARCH AND DEVELOPMENT
Octavian has made significant investments in R&D, developing advanced technical systems that are required to run and develop global gaming businesses. We employ over 71 employees worldwide in product development in dedicated groups including: specification, design, creation and production of machines, hardware, communications, facilities, software, games design, graphics design, sound and video development, operations, installation and support. We believe that our presence in numerous overseas markets exposes us to local industry knowledge that contributes to our ability to innovate. We believe that one of our competitive advantages is our commitment to constant technological innovation, and we plan to develop new products through a combination of licensing, acquisitions and research activities.
Our primary development and support facility is located in St. Petersburg, Russia, with a secondary facility located in Buenos Aires, Argentina. In addition, we conduct some of our product development through outsourcing arrangements with unaffiliated third parties.
Our R&D team in St. Petersburg has been instrumental in the continual development of our ACP slots management system, evolving the product to allow Cashless, Player Tracking and Bonus Club features. The St. Petersburg games department has delivered a portfolio of over 80 titles comprising slot games, bingo, Keno, amusement with prize machines and downloadable games with varied multi-line options for multiple languages, denominations, countries and jurisdictions. Additionally, our team in St Petersburg is focused on the development of our Server Based (Symphony™) platform.
Our R&D employees in Argentina are dedicated to customization of the ACP systems for the Latin American market. This team works closely with our St. Petersburg staff on ACP product development.
Our Australia R&D team focused on two product development initiatives: the development of the Maverick®, which we no longer intend to market or sell, and our Advance Gaming Engine (“AGE”). The AGE is an internal technology that allows Octavian to more efficiently develop games by re-using graphics and animation files and eliminating certain programming steps from games development. Our on-site employees oversee consultants in Australia to whom we have outsourced these R&D functions. These contracts are short-term, month-to-month arrangements.
TECHNOLOGY
We have developed several technologies which serve as the foundation of our systems platform. We also employ technologies and security policies designed to ensure that our operations and customer information are protected and secure. We believe that our technology infrastructure provides a flexible, scalable and reliable platform for the development and deployment of new services and solutions at a low cost. When we commence development of a new game, we use the latest technological architecture available and select long-life components with a goal of ensuring that the game or system remains viable for at least three to five years.
The systems supporting our operations are hosted at three facilities: St. Petersburg, Russia; Bogotá, Colombia; and Buenos Aires, Argentina. The facilities are highly secure environments, with standby systems that provide redundancy. The facilities are continuously staffed by trained personnel and have customer telephone support available 24 hours a day, seven days a week, with two back-up development teams on call. System capacity was built to support major expansion above existing levels and current utilization rarely rises above ten percent. We believe that our systems currently in place have ample power, redundancy, fire suppression capabilities, data transmission capability, and back-up provider arrangements to support current and anticipated near-term growth of the business. In addition, our systems are highly modular and easily can be expanded to handle substantial growth.
We implement security at multiple levels in our hardware and software platform and comply with various local gaming industry standards that are often rigorous and are designed to protect internal operations and customer data. We utilize multilevel enterprise firewalls and monitoring systems for intrusion detection and to filter all incoming network traffic. We operate and maintain the systems that support the web-based ACP access functions completely separately from our main database as an added layer of security.
Currently, our data center systems can service up to 150,000 transactions per minute, and our database capacity is greater than four terabytes of data. Additionally, we have designed our system and database to be easily expandable, as needed, and continuously operational.
All of our international sites are linked by a network allowing for flexible internal communications worldwide. Our communications infrastructure includes satellite links, fiber optics, broadband, wireless technology, fixed telephone lines and dial-up capability. We believe that our communication systems’ safeguards ensure that no data will be lost during power or communications outages.
Intellectual Property
Octavian’s intellectual property is comprised of trade secrets, industry and technical know-how, trademarks, copyrights, and issued and pending patents. Our intellectual property is a significant asset. We rely primarily on Russian intellectual property laws to protect our intellectual property and to a lesser extent on the laws of other jurisdictions in which our intellectual property is used. We also rely on privately negotiated license agreements, third-party non-disclosure and other agreements and other contractual provisions to protect our intellectual property rights. In addition, we use technical measures, such as encryption and other security measures, to protect our intellectual property from theft and piracy.
Our intellectual property includes the concepts, designs, features and manufacturing processes associated with our games, systems and machines. We currently hold more than 30 patents in Russia for various games, systems, systems components and processes. Although we no longer have plans to market and sell the Maverick® electronic gaming machine, we hold trademarks related to the Maverick® in Australia, the European Union and the United States. We also have registered trademarks related to the SymphonyTM in Australia, the European Union and the United States; trademarks related to Octavian GateManager™ in Australia and the European Union and trademarks related to Octavian CashManager™ in Australia and the European Union. Additionally, we currently have a patent application pending with the United States Patent and Trademark Office for the Maverick® electronic gaming machine. We recently decided to abandon the development and sale of the Maverick® and have not yet decided whether we will continue the prosecution of this application.
We do not seek formal legal protection for all of our intellectual property because we have found the expense unjustified after taking into account the potential benefits to be derived. Our products typically have a lifecycle that is shorter than the length of time required securing a patent and enforcing the patent protection. We believe that our contract and technical security measures sufficiently protect the majority of our intellectual property from theft and piracy.
We hold licenses to use third-party intellectual property as components of certain of our games systems. In addition, in order to connect our systems to certain machines, the machine manufacturers often grant us a right to use the portion of their IP that is necessary to allow us to do so and vice versa. Moreover, as part of our joint venture agreements, we often enter into mutual intellectual property exchange arrangements. We also subcontract development of certain system and games components to specialized developers and manufacturers and receive contracts to develop products from other companies. In each of these cases, we seek to ensure that our contracts provide for sufficient protection of our IP rights and assignment to us of all IP invented under subcontracting arrangements. In conjunction with our distribution agreements for our OctaSupplies business, we often obtain the right to use the supplier’s IP in order to provide ongoing service and support.
Our intellectual property is critical to our success and ability to compete, and if we fail to protect our intellectual property rights adequately, our competitors might gain access to, or gain the ability to duplicate or capitalize on, our technology. We negotiate beneficial intellectual property ownership provisions in our contracts and also require employees, consultants, advisors and collaborators to enter into confidentiality agreements in order to protect the confidentiality of our proprietary information and the assignment to us of all IP invented by those under contract to us.
Others may infringe upon or develop products in violation of our IP rights, and the issue of patents under pending applications is not a certainty. We are subject to general litigation risk related to our ability to enforce and maintain patents, copyrights, trademarks, and other IP rights. Seeking enforcement of or declaring our IP rights could result in other parties asserting that our rights are invalid, or alleging rights of their own against us. Our management is not aware of any current or threatened litigation involving our IP.
REGULATION
The distribution of gaming equipment, systems and services is subject to regulation by a variety of government agencies worldwide. Regulatory requirements vary from jurisdiction to jurisdiction and are constantly evolving, but they often include:
| | · | Licenses and/or permits; |
| | · | Findings of suitability of directors, officers, major shareholders, and other key personnel; |
| | · | Technical requirements and approvals for certain equipment; |
| | · | Operational requirements, including data security; |
| | · | Documentation of financial record-keeping; and |
| | · | Responsible gaming compliance. |
In Russia and the Ukraine, there are no gaming-specific regulations directly affecting gaming distributors, but gaming operators are subject to certain regulations, which indirectly affect our ability to sell to them. In addition, Russia requires all manufacturers to meet certain standards established by the International Organization for Standardization (“ISO”) and the Euro-Asian Council for Standardization, Metrology and Certification (“EASC”). ISO 9000 is a family of standards for quality management systems maintained by ISO and administered by accreditation and certification bodies. GOST refers to a set of technical standards maintained by the EASC.
In Europe, we are subject to directives relating to hazardous substances, electrical equipment, conformity markings, safety standards and electromagnetic compliance. With regard to hazardous substances, we are subject to the Directive on the Restriction of the Use of Certain Hazardous Substances in Electrical and Electronic Equipment 2002/95/EC, (commonly referred to as the Restriction of Hazardous Substances Directive or RoHS) which was adopted in 2003 by the European Union and took effect in 2006. It restricts the use of six hazardous materials in the manufacture of various types of electronic and electrical equipment and is required to be enforced and become law in each member state. The RoHS is closely linked with the Waste Electrical and Electronic Equipment Directive 2002/96/EC which sets collection, recycling and recovery targets for electrical goods and is part of a legislative initiative to solve the problem of toxic e-waste. We also are required to obtain the Conformite Europeenne marking, which is a mandatory conformity mark on many products placed on the single market in the European Economic Area. With regard to safety standards, we are required to work closely with Underwriters Laboratories (UL), which is a company that has developed standards and testing systems to ensure products are safe. UL helps the insurance and re-insurance industry manage product liability risk, especially for fire safety. Finally, we are required to comply with the Electromagnetic Compatibility (“EMC”) compliance process.
In addition, Germany has special rules for casino management systems and amusement with prizes games. Our casino management system products comply with Germany’s requirements, and we are in the process of having our amusement with prizes products certified as compliant as well. The United Kingdom also has special requirements, with which we have complied with as necessary.
Italy has adopted special rules for AWP games and all our games are certified by the State Monopolies Autonomous Administration (“AAMS”), as required in this jurisdiction. AAMS is the government body that oversees the Italian gaming industry. In 2002, the government transferred the regulation of all gaming activities to the AAMS, a division of the Ministry of Economy and Finance. In connection with these regulations, Italy has adopted specific legislation referred to as Comma 6A legislation, which requires AWP machines to be equipped with a smart card that allows the AAMS, to access and check internal machine data to prevent fraud and safeguard players. Similarly, all AWP games running on the new machines are required to communicate with the smart card and be fully licensed.
Neither Colombia nor Argentina directly regulates the gaming industry, but Argentina has begun the process of requiring Gaming Laboratories International (“GLI”) certification for gaming equipment.
The nature of the industry and our worldwide operations make compliance with these requirements very time-consuming and require extensive resources. Before we initiate business in a given jurisdiction, we review all applicable policies, laws and regulations in order to ensure our ability to comply. In addition, we maintain a close working relationship with GLI throughout our product development process to ensure that our products meet their standards and those of particular markets. GLI is a widely recognized standard-setting and independent testing authority in the worldwide electronic gaming industry. While it is not a certifying authority, it is an independent gaming test house that is accredited by many gaming regulatory authorities throughout the world. GLI is not the only accepted accreditation standard in the world, but we believe that it is the most widely accepted one. Its clients are gaming regulators in jurisdictions all over the world, nearly 400 in all, and its customers are device and system suppliers that require GLI certification to maintain the distribution viability of their products throughout the gaming industry. GLI helps to ensure the integrity of the gaming industry. As a general rule, regulated markets throughout the world require GLI certification for gaming products sold in their jurisdictions. In unregulated markets, there are both jurisdictions that do not require certification by GLI or any other authority, and there are unregulated markets in which certain customers request products with GLI certification for their own business reasons. Once a gaming product has GLI certification, then, in any jurisdiction that has accredited GLI as a standard-setting body, regulatory approval of that gaming product is automatic. Currently, Octavian’s My ACP system, ExtraCash, and more than 11 games titles meet GLI general global standards.
We anticipate that many of our existing games as well as those in development also will receive GLI approval. It is our corporate policy that, starting in 2008, every Octavian game will be submitted for GLI certification as soon as it has finished development and prior to its release. As part of the GLI certification process, we submit all of a game’s design documentation, source code, object code, compilers and compilation instructions, installation process, and hardware, as well as separate certification of the Random Number Generator software and safety certification.
Our compliance efforts are focused not only on gaming jurisdictional requirements but also on other applicable regulations, such as tax, environmental, excise and customs. Although many regulations at each level are similar or overlapping, we must satisfy all conditions, individually, for each jurisdiction. Determination of compliance in each jurisdiction is independently verified and generally does not depend on a determination of compliance in any other jurisdiction. Penalties for non-compliance can be severe.
Laws of the various gaming regulatory authorities are designed to protect the public and ensure that gaming is conducted honestly, competitively, and in a manner free from corruption. Regulatory oversight additionally ensures that the local authorities receive the appropriate amount of gaming tax revenues. Gaming financial reporting and systems therefore must demonstrate high reliability and integrity.
The gaming industry by its very nature is complex and constantly evolving, particularly in jurisdictions that are first beginning to permit gaming. We continue to devote significant resources to ensure regulatory compliance throughout our company. There can be no assurance, however, that any required licenses, approvals, or findings of suitability will be obtained or, if obtained, will not be conditional, suspended, or revoked, or that we will be able to obtain the necessary approvals for any future products as they are developed. If a license, approval or a finding of suitability is required by a regulatory authority, and we fail to obtain the necessary license, approval or finding, we may be prohibited from selling our products or services in that jurisdiction or we may be required to sell our products and services through other licensed entities at a reduced profit.
Octavian’s current strategy is focused on opportunities in emerging markets. We therefore do not conduct business in the United States and have not applied for a gaming license in any U.S. jurisdiction.
EMPLOYEES
As of March 30, 2009, Octavian employed 162 persons. None of our employees are subject to a collective bargaining arrangement, and we consider our relations with employees to be good. Of these employees, 12 are in management, 12 are in sales and marketing, 14 are in technical support, 71 are in research and development, 20 are in finance, 27 are in product support, and 6 have miscellaneous duties.
RECENT DEVELOPMENTS
Agreements with AGI
Octavian is a non-exclusive distributor for AGI in various countries in Latin America, and CATS is a non-exclusive AGI distributor in Russia and the CIS. As such, AGI is and has been Octavian’s largest supplier and, prior to the closing of the Share Exchange, Octavian had outstanding accounts payables of approximately €18,756,207 as of October 30, 2008 (US$23,979,810.65 based on the October 30, 2008 Exchange Rate of €1=US$1.2785). Pursuant to certain agreements between AGI and Octavian entered into immediately prior to the Share Exchange, AGI and Octavian agreed to the following:
| | · | AGI converted €4 million (US$5,114,000 based on the October 30, 2008 Exchange Rate of €1=US$1.2785) of accounts payable to it by Octavian into 652 Ordinary Shares of Octavian, representing 35 percent of the outstanding share capital of Octavian. |
| | · | AGI restructured an additional €8 million of accounts payable (US$10,876,800 based on the March 25, 2009 Exchange Rate of €1=US$1.3596) into a four-year loan, which accrues interest at a rate of three month USD LIBOR plus four percent (4%) (capped at a maximum rate of eight percent (8%)) per year, and is payable in equal monthly installments of €166,666.67 (US$226,600 based on the March 25, 2009 Exchange Rate of €1=US$1.3596) over a period of 48 months, that commenced on October 31, 2008 (the “AGI Loan”). As of March 25, 2009, we are current in all payments to AGI. As security for the obligation, Octavian granted AGI a security interest in all intellectual property rights (including rights in software) in certain of Octavian’s intellectual property, including the source and object code for Octavian’s Accounting, Control, and Progressives product; Octavian’s Maverick® product and any modifications; and Octavian’s Maverick® games and any modifications, ExtraCash and Advanced Gaming Engine, along with all related materials (the “IP Rights”) |
| | · | AGI invested US$5 million in the Private Placement. |
| | · | Octavian agreed to repay outstanding accounts payable to AGI, as of the closing date of the Private Placement, in an aggregate amount of €6,756,207 (US$8,637,810.65 based on the October 30, 2008 Exchange Rate of €1 = US$1.2785) as follows: €2 million (US$2,557,000 based on the October 30, 2008 Exchange Rate of €1 = US$1.2785) from the proceeds of the Private Placement and the remaining balance in four equal installments of €1,189,051.45 payable on November 30, 2008, December 31, 2008, January 31, 2009 and February 28, 2009. The initial payment of €2 million was made from the proceeds of the Private Placement. The Company is currently late on all of the payments owed to AGI. The aggregate amount of these payments owed is approximately €4.7 million (US$6,390,120 based on the March 25, 2009 exchange rate of € 1 = US$1.3596). As a result of the Company��s failure to make these payments in a timely manner, it is not currently in compliance with certain agreements entered into with AGI in connection with the Share Exchange and financing transactions consummated by the Company on October 30, 2008. The Company is currently having discussions with AGI regarding the settlement of these accounts and based on conversations with AGI, does not believe that AGI currently intends to enforce any rights it may have with respect to the failure to make such payments. |
Agreements with PacificNet
On December 7, 2007, (i) Octavian, Emperor Holdings Limited, a company that was at that time the sole shareholder of Octavian (“Emperor”) and Emperor’s then sole shareholder, Ziria Enterprises Limited (“Ziria”) (a company which is 100 percent indirectly owned by Harmen Brenninkmeijer, our Chief Executive Officer and a director of the Company), entered into an agreement (the “PacificNet Acquisition Agreement”) with (ii) PacificNet, Inc. (“PacificNet”), a Delaware corporation whose securities are publicly traded in the United States and its wholly-owned subsidiary, PacificNet Games International Corporation, a company organized under the laws of the British Virgin Islands. The terms of the PacificNet Acquisition Agreement provided for the acquisition by PacificNet of all of the outstanding securities of Emperor. This acquisition was completed on January 22, 2008, upon which Emperor became a direct wholly-owned subsidiary of PacificNet and Octavian became an indirect wholly-owned subsidiary of PacificNet. The purchase price payable by PacificNet was (i) up to 2,330,000 shares of PacificNet’s common stock, representing approximately 19.5 percent of PacificNet’s then outstanding shares of common stock and (ii) cash of up to US$18.9 million to be paid upon the completion of certain net profit performance targets (the “Earn-Out Amount”). The shares of PacificNet common stock were required to be placed in escrow at closing and were to be released upon the satisfaction of certain requirements under the PacificNet Acquisition Agreement. Additionally, the Earn-Out Amount was to be paid to Octavian over a period of time in installments from 2009 through 2012. In connection with the agreement, Harmen Brenninkmeijer, our Chief Executive Officer and a director of Octavian, was named to the board of directors of PacificNet and entered into an executive service agreement (the “Service Agreement”) with PacificNet. Mr. Brenninkmeijer never performed any services for PacificNet, and neither PacificNet nor Octavian ever compensated him under the terms of the Service Agreement.
On May 14, 2008, all of the parties to the PacificNet Acquisition Agreement entered into a termination agreement (“the PacificNet Termination Agreement”), pursuant to which the PacificNet Acquisition Agreement and all rights and obligations of the parties thereunder were terminated. The Service Agreement also was terminated. As a result of the termination of the PacificNet Acquisition Agreement, neither the remaining consideration shares of PacificNet common stock (being 1.1 million) nor any of the Earn-Out Amount were transferred/paid to Ziria, and all shares of Emperor were returned to Ziria and the 1.2 million shares of PacificNet common stock to Ziria were returned to PacificNet. Upon the consummation of this transaction, Emperor was no longer a direct subsidiary of PacificNet, nor was Octavian any longer an indirect subsidiary of PacificNet. Harmen Brenninkmeijer resigned from the board of directors of PacificNet on May 21, 2008. PacificNet paid Sterne Agee & Leach, Inc., a company that acted as a consultant to Octavian for the PacificNet Acquisition, 30,000 PacificNet shares. As of March 27, 2009, Octavian owes PacificNet US$53,544 to reimburse PacificNet for the issuance of these shares.
In satisfaction of its obligations under the PacificNet Termination Agreement, Octavian issued to PacificNet 61 Ordinary Shares of Octavian International prior to the Share Exchange, which were exchanged for 199,333 shares of our Common Stock. As part of its settlement agreement with PacificNet, Inc., PacificNet was granted the one-time right to purchase up to a number of shares that would cause its ownership of Octavian International as of the date of exercise of the option to equal 5% of the equity of Octavian International provided that such right is exercised prior to May 14, 2009.
PacificNet also agreed, under the terms of the PacificNet Termination Agreement, to issue to Ziria 500,000 shares of PacificNet’s common stock. These PacificNet shares will be subject to a one-year lock up and sale restriction, any sale of these shares must be communicated to PacificNet in advance, PacificNet has the right of refusal to arrange buyers for the shares, and PacificNet will be entitled to half of the net gain on any partial sale of PacificNet shares.
PacificNet and Octavian further agreed, under the terms of the PacificNet Termination Agreement, to use reasonable endeavors to formalize the following business opportunities:
| | · | A non-exclusive distribution agreement and license pursuant to which PacificNet will be appointed as a distributor of Octavian’s products in Macau, provided that eBet Limited, an Australian company (“eBet”), would be the only other distributor permitted to distribute Octavian’s products in that territory; and |
| | · | A joint venture relationship relating to the development of future business opportunities in Macau and other territories in Asia. |
Upon receipt of funding, Octavian agreed to pay PacificNet US$200,000 in consideration for PacificNet’s localization and language translation of Octavian’s products into the Chinese language. Additionally, Octavian agreed to use its reasonable endeavors to meet minimum sales targets from the sale of PacificNet’s machines of: US$4 million during the twelve month period ended mid-year 2009 and US$6 million during the twelve month period ended mid-year 2010. Octavian’s commitment to achieving these targets was agreed to by Octavian undertaking to use its reasonable endeavors to comply. PacificNet agreed to provide appropriate support to assist Octavian in achieving these goals. On January 5, 2009, Octavian received a letter from PacificNet pursuant to which it has asserted a claim against Octavian for certain alleged events of default by Octavian under the PacificNet Termination Agreement (the “Claim”). Pursuant to the Claim, PacificNet has demanded payments, in an aggregate amount of $280,000, for certain services allegedly performed by PacificNet, as well as the reimbursement of certain expenses related to prior transactions between the parties. The Company’s management has reviewed the Claim and believes that it is without merit and plans to defend against any actions taken by PacificNet accordingly.
A NOTE ABOUT FORWARD-LOOKING STATEMENTS
This Annual Report on Form 10-K (including the Exhibits hereto) contains certain “forward-looking statements” within the meaning of the of Section 27A of the Securities Act of 1933, Section 21E of the Securities Exchange Act of 1934, and the Private Securities Litigation Reform Act of 1995, such as statements relating to our financial condition, results of operations, plans, objectives, future performance and business operations. Such statements relate to expectations concerning matters that are not historical fact. Accordingly, statements that are based on management's projections, estimates, assumptions and judgments are forward-looking statements. These forward-looking statements are typically identified by words or phrases such as “believe,” “expect,” “anticipate,” “plan,” “estimate,” “approximately,” “intend,” and other similar words and expressions, or future or conditional verbs such as “should,” “would,” “could,” and “may.” In addition, we may from time to time make such written or oral “forward-looking statements” in future filings with the Securities and Exchange Commission (the “Commission” or “SEC”) (including exhibits thereto), in our reports to shareholders, and in other communications made by or with our approval. These forward-looking statements are based largely on our current expectations, assumptions, plans, estimates, judgments and projections about our business and our industry, and they involve inherent risks and uncertainties. Although we believe that these forward-looking statements are based upon reasonable estimates and assumptions, we can give no assurance that our expectations will in fact occur or that our estimates or assumptions will be correct, and we caution that actual results may differ materially and adversely from those in the forward-looking statements. Forward-looking statements involve known and unknown risks, uncertainties, contingencies and other factors that could cause our or our industry's actual results, level of activity, performance or achievement to differ materially from those discussed in or implied by any forward-looking statements made by or on behalf of us and could cause our financial condition, results of operations or cash flows to be materially adversely effected. Accordingly, investors and all others are cautioned not to place undue reliance on such forward-looking statements. In evaluating these statements, some of the factors that you should consider include those described below under "Risk Factors" and elsewhere in this annual report.
Item 1A. Risk Factors
Our business prospects are subject to various risks and uncertainties that impact our business. You should carefully consider the following discussion of risks, and the other information provided in this annual report. The risks described below are not the only ones facing us. Additional risks that are presently unknown to us or that we currently deem immaterial may also impact our business.
Risks Related to Our Business
Substantially all of our intellectual property has been pledged as security for outstanding indebtedness.
We are a non-exclusive distributor for AGI. AGI is one of our largest suppliers and prior to completion of the Share Exchange, we had outstanding accounts payable of €18,756,207 (US$23,979,811 based on the October 30, 2008 Exchange Rate of €1=US$1.2785) owed to AGI. Pursuant to certain agreements we entered into with AGI immediately prior to the Share Exchange, AGI, in addition to agreeing to take such other actions as described in greater detail in Recent Developments – Agreements with AGI of our Business Section on page 22, restructured a portion of the accounts payable into the AGI Loan, secured by a security interest in the IP Rights. The amounts owed to AGI that are secured by the IP Rights, which as of October 30, 2008 totaled €8 million (US$10,228,000 based on the October 30, 2008 Exchange Rate of €1=US$1.2785), are due and payable October 31, 2012. As of March 25, 2009, we are current in all payments under the AGI Loan. In the event that we are unable to pay the principal and interest owed under the AGI Loan, the intellectual property constituting the IP Rights would be subject to transfer to AGI following a 30-day rectification period for a non-payment default.
A loss of the IP Rights would substantially harm our OctaSystems and OctaGames businesses and could render us unable to provide our systems solutions in the ordinary course if the IP Rights were sold or otherwise transferred to a third party and/or we were no longer permitted to use and incorporate the intellectual property constituting the IP Rights in our products and services.
We face intense competition, and our results of operations will be adversely affected if we fail to compete successfully.
We compete with a number of developers, manufacturers and distributors of similar products and technologies. Because of the high initial costs of installing a computerized monitoring system, customers for such systems generally do not change suppliers once they have installed a system. This may make it difficult for us to attract customers who have existing computerized monitoring systems.
Some of our competitors have greater name recognition, larger customer bases and significantly greater financial, technical, marketing, public relations, sales, distribution and other resources. Our larger competitors may have more resources to devote to research and development and may be able to obtain regulatory approval more efficiently and effectively.
There can be no assurance that our new game themes, products or systems will achieve market acceptance, or that we will be able to compete effectively with these companies. Our ability to remain competitive will depend in part on our ability to:
| | · | Enhance and improve the responsiveness, functionality and other features of the products and services that we offer and plan to offer; |
| | · | Continue to develop our technical expertise; |
| | · | Develop and introduce new services, applications and technologies to meet changing customer needs and preferences; and |
| | · | Integrate the new technologies with existing systems. |
If our competitors continue to develop new game themes and technologically innovative products and systems, and we fail to keep pace, our business could be adversely affected. Competition may result in price reductions, fewer customer orders and reduced gross margins. We may be unsuccessful in our attempts to compete, and competitive pressures may harm our business. In addition, increased competition could cause our sales cycle to lengthen as potential new customers take more time to evaluate competing technologies or delay their purchasing decisions in order to determine which technologies are able to develop mass appeal.
Our success in the gaming and lottery industries depends in large part on our ability to develop innovative products and systems. If we fail to keep pace with rapid innovations in product design and deployment, or if we are unable to quickly adapt our development processes to release innovative products or systems, our business could be negatively impacted.
If we are unable to respond to regulatory or industry standards effectively, or if we are unable to develop and integrate new technologies effectively, our growth and the development of our products and services could be delayed or limited. Our success is heavily dependent on our ability to develop new products and systems that are attractive not only to our customers, namely slot machine and table operators, other gaming enterprises and lottery authorities, but also to their customers, the end players. The demands of our customers and the tastes of their customers are continuously changing. Therefore, our future success depends upon our ability to continue to design and market technologically sophisticated products that meet our customers’ needs, including ease of use and adaptability but that are also unique and entertaining such that they achieve high levels of player appeal and sustainability as well. The success of our business will depend on our ability to develop and integrate new technologies effectively and address the increasingly sophisticated technological needs of our customers in a timely and cost-effective manner.
Our future success and our ability to remain competitive will depend in part on our ability to enhance and improve the responsiveness, functionality and features of our products and services in accordance with regulatory or industry standards in a timely and cost-effective manner. If we are unable to influence these standards or respond to such standards effectively, our growth and the development of certain products and services could be delayed or limited.
Because our revenue growth is partially dependent on the earning power and life span of our games and newer game themes tend to have a shorter life span than more traditional game themes, we face pressure to design and deploy new and successful game themes to maintain our revenue stream and remain competitive. While we feel we have been successful at developing new and innovative products, our ability to do so could be adversely affected by:
| | · | A decline in the popularity of our gaming and lottery products with players; |
| | · | A decision by our customers or the gaming and industry in general to cut back on purchases of new games or systems in anticipation of newer technologies; |
| | · | An inability to introduce new games, services or casino management and lottery systems on schedule as a result of delays in connection with regulatory product approval in the applicable jurisdictions, or otherwise; |
| | · | An increase in the popularity of competitors' games and systems; and |
| | · | A decline in consumer acceptance of our newest innovations. |
We cannot assure that we will be successful in responding to these technological and industry challenges in a timely and cost-effective manner. If we are unable to develop or integrate new technologies effectively or to respond to these changing needs, our margins could decrease and our release of new products and services and our deployment of new technology could be adversely affected.
We rely on highly skilled personnel and, if we are unable to retain or motivate key personnel or hire qualified personnel, we may not be able to maintain our operations or grow effectively.
We are highly dependent on certain key members of our executive management team and technical staff, including, in particular, Harmen Brenninkmeijer, our Chief Executive Officer. We depend on the experience of our key personnel to execute our business strategy. Accordingly, the retention of key members of our executive management team and technical staff is particularly important to our future success. The departure or other loss of any such member of our executive management team or technical staff could harm our ability to effectively market our products. In addition, if we cannot find suitable replacements for such persons in a timely manner, it could have a material adverse effect on our business. We have entered into an employment agreement with Mr. Harmen Brenninkmeijer which expires on December 31, 2013, unless renewed.
Our success also will depend in large part on our ability to continue to attract, retain and motivate qualified highly skilled scientific and technical personnel. Competition for certain employees, particularly development engineers, is intense. We may be unable to continue to attract and retain sufficient numbers of highly skilled employees. If we are unable to attract and retain additional qualified and highly skilled employees, our business, financial condition and results of operations may be adversely affected.
Our success will depend on the continued reliability and performance of third-party manufacturers and suppliers for whom we distribute. Loss of a material supplier could have a material adverse effect on our ability to perform effectively under some contracts and service our customer base effectively.
We currently are a distributor of third-party gaming machines. Historically, the majority of our revenues have come from these sales, the majority of which has been sourced through a single manufacturer, AGI, during 2007 and 2008. In addition, we are materially dependent on a limited number of third parties to produce systems or assemblies necessary for us to produce our products. While we strive to have alternate suppliers provide us with many of our products, a loss of one or more of such suppliers could have a material adverse effect on our ability to operate effectively. An inability to contract with third-party manufacturers and suppliers to provide a sufficient supply of quality products on acceptable terms and on a timely basis could negatively impact our relationships with existing customers and cause us to lose revenue-generating opportunities with current and potential customers. Additionally, if we are unable to replace any of these manufacturers or suppliers promptly and on terms that are equal or not significantly less favorable, this could have a material adverse effect on our business and financial condition.
We could experience manufacturing interruptions, delays, or inefficiencies of our hardware products if we are unable to timely replace short-term supplier agreements or supplier agreements terminated on short-term notice.
Generally, we maintain short-term supplier agreements and supplier agreements that can be terminated on short-term notice. If the supply of a critical hardware product or component is delayed or curtailed due to a cancellation or termination of one of our supplier agreements, we may not be able to ship the related product in desired quantities and in a timely manner. We believe that there are enough alternative suppliers that a cancellation of one of our supplier agreements will not have a material adverse effect on our operations. However, even where multiple sources of supply are available, qualification of the alternative suppliers, and establishment of reliable supplies, could result in delays and a possible loss of sales, which could harm operating results.
We are dependent on certain major customers, and the loss of one of these customers would significantly affect our business and financial results.
Our business to date has been dependent on major contracts from a limited number of customers. Gaming, systems and lottery contracts are generally several years in length but may have varying durations. Some contracts contain cancellation clauses enabling either party to cancel the contract. In addition, after a contract period expires, the customer generally can re-open the contract for competitive bidding. If we fail to obtain additional contracts or if we lose any existing contracts due to cancellation or a competitive bidding situation, we may fail to realize a significant portion of revenues, which would adversely affect our business and financial results.
Customers may fail to pay us, negatively impacting our financial position. We are especially susceptible to this risk in the emerging markets in which we operate.
Customer financing is becoming an increasingly prevalent component of the sales process and therefore increases business risk of non-payment, especially in emerging markets. We maintain material accounts receivable balances with customers that, if we fail to collect on, could have a significant impact on our liquidity. These customer financing arrangements also delay our receipt of cash and can negatively impact our ability to enforce our rights upon default. In addition, if the national currency in markets in which we do business suffers significant depreciation, our customers may be unable to pay us, or we may receive significantly less than the amount owed to us.
If our products or technologies contain defects, our reputation could be harmed and our results of operations may be adversely affected.
Our products are highly complex and sophisticated and, from time to time, may contain design defects that are difficult to detect and correct. There can be no assurance that errors will not be found in new products after commencement of commercial shipments or, if discovered, that we will be able to correct such errors in a timely manner or at all. The occurrence of errors and failures in our products could result in loss of or delay in market acceptance of our products and correcting such errors and failures in our products could require us to expend significant amounts of capital. Our products are integrated into our customers’ networks and equipment and any defects could result in financial losses for our customers. The sale and support of these products may entail the risk of product liability or warranty claims based on damage to such networks and equipment. In addition, the failure of our products to perform to customer expectations could give rise to warranty claims. The consequences of such errors, failures and claims could have a material adverse effect on our business, results of operations and financial condition.
If customers in our industry reject the use of our technology or if our strategic decisions are not in sync with needs of our customers, the deployment of our technology may be delayed, and we may be unable to achieve revenue growth.
Customers in the gaming and lottery industries may delay or reject initiatives that relate to the deployment of our technology in various markets. Such a development would make the achievement of our business objectives in the affected markets difficult or impossible.
Our intellectual property protections may be insufficient to properly safeguard our technology. Expenses incurred with respect to monitoring, protecting and defending our intellectual property rights could adversely affect our business.
Effective protection of intellectual property rights may be unavailable or limited. To protect our intellectual property investments, we rely on a combination of patent, copyright, trademark and trade secret rights, confidentiality procedures and licensing arrangements.
Monitoring infringement and misappropriation of intellectual property can be difficult and expensive and we may not be able to detect infringement or misappropriation of our proprietary rights. In addition, in the event we detect infringement or misappropriation, we may incur significant litigation expenses protecting our intellectual property, which would reduce our ability to fund product initiatives. These expenses could have an adverse effect on our future cash flows and results of operations.
The gaming and lottery industries are constantly employing new technologies in both new and existing markets. Regulations that protect intellectual property generally are established on a country-by-country basis. We rely on a combination of patent and other technical security measures to protect our products and continue to apply for patents protecting such technologies. Notwithstanding these safeguards, we cannot assure that the protection of our proprietary rights will be adequate, or that our competitors will not independently develop similar technologies, duplicate our services or design around any of our patents or other intellectual property rights. Unlicensed copying and use of our intellectual property or illegal infringements of such intellectual property rights represent potential losses of revenue to us.
Furthermore, others may independently develop products similar or superior to ours without infringing on our intellectual property rights. It also is possible that others will independently develop the same or similar technologies or otherwise obtain access to the unpatented technologies upon which we rely for future growth and revenues. Failure to meaningfully protect our trade secrets, know-how or other proprietary information could adversely affect our future growth and revenues.
As part of our confidentiality procedures, we generally enter into non-disclosure agreements with our employees, directors, consultants and corporate partners, and we attempt to control access to and distribution of our technologies, documentation and other proprietary information. Despite these procedures, third parties may copy or otherwise obtain and make unauthorized use of our technologies or other proprietary information or independently develop similar technologies or information. The steps that we have taken to prevent misappropriation of our technologies or other proprietary information may not prevent their misappropriation, particularly outside the United States where laws or law enforcement practices may not protect our proprietary rights as fully as in the United States. We also may be subject to claims of moral rights from employees and developers.
We may be subject to claims of intellectual property infringement or invalidity.
As more companies engage in business activities relating to gaming and lottery technologies and develop corresponding intellectual property rights, it is increasingly likely that claims may arise which assert that some of our products or services infringe upon other parties’ intellectual property rights. These claims could subject us to costly litigation, divert management resources and result in the invalidation of our intellectual property rights. If we are found to infringe on the rights of others, we could be required to pay significant damages, cease production of infringing products, terminate our use of infringing technologies, develop non-infringing technologies or purchase a license to use the intellectual property in question from the owner. In these circumstances, continued use of technologies may require that we acquire such licenses to the intellectual property that is the subject of the alleged infringement. We might not be able to obtain these licenses on commercially reasonable terms or at all. Our use of protected technologies may result in liability that threatens our continuing operation.
The gaming and lottery industries are characterized by the rapid development of new technologies, which requires us to continuously introduce new products, as well as to expand into new markets that may be created. Therefore, our success depends in part on our ability to continually adapt our products and systems to incorporate new technologies and to expand into markets that may be created by new technologies. However, to the extent technologies are protected by the intellectual property rights of others, including our competitors, we may be prevented from introducing new products similar to these technologies or expanding into new markets. If the intellectual property rights of others prevent us from taking advantage of innovative technologies, our financial condition, operating results or prospects may be harmed.
Our future growth will depend on intellectual property provided by third parties, and such intellectual property may be subject to infringement claims and other litigation, which could adversely affect our business.
Our suppliers own the patent rights and other intellectual property rights in some of the products that we distribute. We rely on the ability of these suppliers to maintain and successfully enforce our rights to their technology. If our suppliers’ patents and other intellectual property rights are successfully challenged, invalidated or otherwise eliminated or diminished, we may lose the exclusive rights to such technology, and our competitive advantage in the industry could be adversely affected.
We face risks associated with our suppliers’ patent positions, including the potential and sometimes actual need from time to time to engage in significant legal proceedings to enforce their patents, the possibility that the validity or enforceability of patents may be denied and the possibility that third parties will be able to compete against us without infringing patents. In addition, budgetary concerns may cause us and/or our suppliers not to litigate against known infringers of patent rights, or may cause us or our suppliers not to file for patents or pursue patent protection in all jurisdictions where they may have value. If certain governmental entities infringe on our suppliers’ intellectual property rights, they may enjoy sovereign immunity from such claims. Failure to reliably enforce patent rights against infringers may make competition within the industry more difficult.
Our gaming systems, particularly our casino management system networks, may experience losses due to technical difficulties or fraudulent activities.
Our business relies on information technologies, both in-house and at customer and vendor locations. In addition, many of the systems we sell manage private personal information and protect information and locations involved in sensitive industry functions. Our success depends on our ability to avoid, detect, replicate and correct software and hardware errors and fraudulent manipulation of our products and systems. The protective measures that we use in these systems may not prevent security breaches, and failure to prevent security breaches may disrupt business and damage our reputation. A party who is able to circumvent security measures used in these systems could misappropriate sensitive or proprietary information, gain access to sensitive locations or materials, cause interruptions or otherwise damage products and services. To the extent any of our gaming machines or software experience errors or fraudulent manipulation, our customers may replace our products and services with those of our competitors. If unintended parties obtain sensitive data and information or otherwise sabotage our customers, we may receive negative publicity, incur liability to customers or lose the confidence of customers, any of which may cause the termination or modification of our contracts. In addition, the occurrence of errors in, or fraudulent manipulation of, our gaming machines or software may give rise to claims for lost revenues and related litigation by our customers and may subject us to investigation or other action by gaming regulatory authorities including suspension or revocation of our gaming licenses or disciplinary action. Further, our insurance coverage may be insufficient to cover losses and liabilities that may result from such events.
Additionally, in the event of such issues with our gaming machines or software, substantial engineering and marketing resources may be diverted from other areas to rectify the problem. In addition, we may be required to expend significant capital and other resources to protect us against the threat of security breaches or to alleviate problems caused by these breaches. Such protection or remedial measures may not be available at a reasonable price or at all, or may not be entirely effective if commenced.
Network disruptions could affect the performance of our services.
Our operations rely to a significant degree on the efficient and uninterrupted operation of complex technology systems and networks, which in some cases are integrated with those of third parties. Our hosted technology systems are potentially vulnerable to damage or interruption from a variety of sources including fire, earthquake, power loss, telecommunications or computer systems failure, human error, terrorist acts, war or other events. Although we pursue various measures to manage the risks related to network disruptions, there can be no assurances that these measures will be adequate or that the redundancies built into our systems and network operations will work as planned in the event of a disaster. Any outage in a network or system or other unanticipated problem that leads to an interruption or disruption of our service could have a material adverse effect on our operations, sales and operating results.
If our products or technologies currently in development do not achieve commercial success, our future revenue and business prospects could be adversely affected.
While we are pursuing and will continue to pursue product and technological development opportunities, there can be no assurance that such products or technologies will come to fruition or become successful. Furthermore, while a number of those products and technologies are being tested, we cannot provide any definite date by which they will be commercially viable and available, if at all. We may experience operational problems with such products after commercial introduction that could delay or prevent us from generating revenue or operating profits. Future operational problems could increase our costs, delay our plans or adversely affect our reputation or our sales of other products which, in turn, could materially adversely affect our success. We cannot predict which of the many possible future products or technologies currently in development will meet evolving industry standards and consumer demands. We cannot assure you that we will be able to adapt to technological changes or offer products on a timely basis or establish or maintain a competitive position.
Current borrowings, as well as potential future financings, may substantially increase our current indebtedness.
No assurance can be given that we will be able to generate the cash flows necessary to permit us to meet our fixed charges and payment obligations with respect to our debt, including payments pursuant to the AGI Loan. We could be required to incur additional indebtedness to meet these fixed charges and payment obligations. Any increased indebtedness may, among other things:
| | · | Adversely affect our ability to expand our business, market our products and make investments and capital expenditures; |
| | · | Adversely affect the cost and availability of funds from commercial lenders, debt financing transactions and other sources; and |
| | · | Create competitive disadvantages compared to other companies with lower debt levels. |
Any inability to service our fixed charges and payment obligations, or the incurrence of additional debt, would have an adverse effect on our cash flows, results of operations and business generally.
An inability to maintain sufficient liquidity could negatively affect expected levels of operations and new product development.
Future revenue may not be sufficient to meet operating, product development and other cash flow requirements. Sufficient funds to service our debt and maintain new product development efforts and expected levels of operations may not be available, and additional capital, if and when needed by us, may not be available on terms acceptable to us. If we cannot obtain sufficient capital on acceptable terms when needed, we may not be able to carry out our planned product development efforts and level of operations, which could harm our business.
We may not be able to continue operating as a going concern.
In their report in connection with our financial statements as of December 31, 2008, and for the fiscal year then ended, our auditors included an explanatory paragraph stating that, because we had incurred net losses of US$12,297,830 and accumulated a deficit of $27,256,985 as of December 31, 2008, there is substantial doubt about our ability to continue as a going concern.
If our revenues and gross profit do not increase, we will continue to incur significant losses and will not become profitable. Further, even if we are able to raise additional financing for our operational and financing needs, we also intend to expand our business, which will result in increased expenses related to sales and marketing, research and development, cost of revenues and general and administrative costs. We cannot assure you that our revenues will grow at the same pace as our expenses or at all. Additionally, we may encounter unforeseen difficulties and complications that require additional unexpected expenditures. Our losses may increase in future periods, and there can be no assurance that we ever will achieve positive cash flows from operating activities or reach profitability.
Our financial results vary from quarter to quarter, which could negatively impact our business.
Various factors affect our quarterly operating results, some of which are not within our control. These factors include, among others:
| | · | The financial strength of the gaming industry; |
| | · | Consumers’ willingness to spend money on leisure activities; |
| | · | The timing and introduction of new products and services; |
| | · | The mix of products and services sold; |
| | · | The timing of significant orders from and shipments to customers; |
| | · | Our product and service pricing and discounts; |
| | · | The timing of acquisitions of other companies and businesses or dispositions; and |
| | · | The general economic conditions. |
These and other factors are likely to cause our financial results to fluctuate from quarter to quarter. Based on the foregoing, we believe that quarter-to-quarter comparisons of our results of operations may not be meaningful.
Our sales often reflect a limited number of large transactions, which may not recur on an annual basis. Consequently, revenues and operating results can vary substantially from period to period as a result of the timing of revenue recognition. Our business also could be impacted by natural or man-made disasters. We have taken steps to have disaster recovery plans in place, but such an event could have a significant impact on our business.
Certain market risks may affect our business, results of operations and prospects.
In the normal course of our business, we are routinely subjected to a variety of market risks, examples of which include, but are not limited to, interest rate movements, collectability of receivables and recoverability of residual values on leased assets. Further, some of our customers may experience financial difficulties or may otherwise not pay accounts receivable when due, resulting in increased write-offs. Although we do not anticipate any material losses in these risk areas, no assurances can be made that material losses will not be incurred in these areas in the future.
Demand for our products could be adversely affected by changes in player and operator preferences.
As a supplier of gaming machines, we must offer themes and products that appeal to gaming operators and players. If we are unable to anticipate or timely react to any significant changes in player preferences, such as a negative change in the trend of acceptance of our newest systems innovations or jackpot fatigue (declining play levels on smaller jackpots), the demand for our gaming products could decline. Further, our products could suffer a loss of floor space to table games and operators may reduce revenue sharing arrangements, each of which would harm our sales and financial results. In addition, general changes in consumer behavior, such as reduced travel activity and redirection of entertainment dollars to other venues, could result in reduced demand for our products.
We are exposed to currency risk from our operations in various countries.
A substantial portion of our revenues are now, and may continue to be, realized in several currencies. A significant portion of our operating and manufacturing expenses are paid in various currencies other than U.S. dollars. Fluctuations in the exchange rate between these currencies may have a material effect on our results of operations. In particular, we may be adversely affected by a significant weakening of the U.S. dollar against the Euro. If the rates of exchange move in adverse directions, this could reduce our liquidity, profits and ability to reinvest in future development. To date, we have not engaged in any hedging transactions but may engage in such transactions in the future to reduce our exposure to currency fluctuations.
We may need to hire additional employees or contract labor in the future in order to take advantage of new business opportunities arising from increased demand, which could impede our ability to achieve or sustain profitability.
Although there can be no assurance, we believe that the gaming market will demonstrate increased demand in future periods. Our current staffing levels could affect our ability to respond to increased demand for our services. In addition, to meet any increased demand and take advantage of new business opportunities in the future, we may need to increase our workforce through additional employees or contract labor, which would increase our costs. If we experience such an increase in costs, we may not succeed in achieving or sustaining profitability.
Our insurance coverage may be inadequate.
We maintain third-party insurance coverage against various liability risks and risks of property loss. While we believe that these arrangements are an effective way to insure against liability and property damage risks, the potential liabilities associated with those risks or other events could exceed the coverage provided by such arrangements.
Interpretations and policies regarding revenue recognition could cause us to defer recognition of revenue or recognize lower revenue and profits.
As our transactions increase in complexity with the sale of multi-element products and services, negotiation of mutually acceptable terms and conditions can extend the sales cycle and, in certain situations, may require us to defer recognition of revenue. We believe that we are in compliance with U.S. Generally Accepted Accounting Principles (“U.S. GAAP”); however these future, more complex, multi-product, multi-year transactions may require additional accounting analysis to account for them accurately, which could lead to unanticipated changes in our current revenue accounting practices and may contain terms affecting the timing of revenue recognition.
New products require regulatory approval and may be subject to complex revenue recognition standards, which could materially affect our financial results.
As we introduce new products and transactions become increasingly complex, additional analysis and judgment is required to account for them and to recognize revenues in accordance with U.S. GAAP. These transactions may include multi-element arrangements and/or software components. As our products and transactions change, applicable accounting principles or regulatory product approval delays could change the timing of revenue recognition and could adversely affect our financial results for any given period.
Our ability to bid on new contracts is dependent upon our ability to fund required up-front capital expenditures through our cash from operations or through financings.
Our contracts generally require significant up-front capital expenditures. Historically, we have funded these up-front costs through cash flows generated from operations and available cash on hand. Our ability to continue to procure new contracts will depend on, among other things, our liquidity level and our ability to obtain additional financing at commercially acceptable terms to finance the initial up-front costs. If we do not have adequate liquidity or are unable to obtain financing for these up-front costs on favorable terms or at all, we may not be able to bid on certain contracts, which could restrict our ability to grow and have a material adverse effect on our results of operations.
Our revenues fluctuate due to seasonal, weather and other variations and you should not rely upon our periodic operating results as indications of future performance.
Our revenues are subject to seasonal and weather variations. Revenues usually reflect a limited number of large transactions, which may not recur on an annual basis. Consequently, revenues and operating results can vary substantially from period to period as a result of the timing of revenue recognition for major equipment sales and software license revenue. Our business could also be impacted by natural or man-made disasters such as Hurricane Katrina or the terrorist attack in New York on September 11, 2001. We have taken steps to have disaster recovery plans in place but there can be no assurance that such an event would not have a significant impact on our business.
We are dependent on the success and growth of our customers.
Our success depends on our customers buying our products to expand their existing operations, replace existing gaming machines or equip a new casino. Any slow down in the replacement cycle or delays in expansions or new openings may negatively impact our operations.
Casino operators in the gaming industry are undergoing a period of consolidation. The result of this trend is that a smaller number of companies control a larger percentage of our current and potential customer base. Because a significant portion of our sales come from repeat customers, to the extent one of our customers is sold to or merges with an entity that utilizes more of one of our competitors’ products and services, or that reduces spending on our products, our business could be negatively impacted. Additionally, to the extent the new owner allocates capital to expenditures other than gaming machines, such as hotel furnishings, restaurants and other improvements, or generally reduces expenditures, our business could be negatively impacted.
A substantial portion of our debt is subject to variable interest rates; rising interest rates could negatively impact our business.
Our borrowings from AGI bear interest at a variable rate. In addition, we may incur other variable rate indebtedness in the future. Carrying indebtedness subject to variable interest rates makes us more vulnerable to economic and industry downturns and reduces our flexibility in responding to changing business and economic conditions. Increases in interest rates on this indebtedness would increase our interest expense, which could adversely affect our cash flows and our ability to service our debt as well as our ability to grow the business.
We have limited financial resources which may be inadequate to meet our future financing needs.
Our business is a capital intensive business, and our financial resources are substantially smaller than the financial resources of our principal competitors. To continue our operations according to our business plan we will require additional equity or debt financing. There can be no assurance that we will be able to obtain the additional financial resources required to successfully compete on favorable commercial terms or at all. Failure to obtain such financing could result in the delay or abandonment of some or all of our plans for development and expansion, which could have a material adverse effect on our operating results and financial condition.
Our international operations subject us to additional risks and regulations, including the Foreign Corrupt Practices Act.
We have international operations in many foreign countries, including in Russia, Colombia and Rwanda. These activities are subject to risks inherent in operating in these countries, including government regulation, licensing requirements, currency restrictions and other restraints, burdensome taxes, risks of expropriation, threats to employees, political instability and terrorist activities, including extortion, and risks of action by U.S. and foreign governmental entities in relation to us. Should such circumstances occur, we might need to curtail, cease or alter our activities in a particular region or country. Our ability to deal with these issues may be affected by applicable U.S. laws and, in particular, potential conflicts between the requirements of U.S. law and the need to protect our employees and assets.
In addition, we are required to comply with the United States Foreign Corrupt Practices Act, which prohibits United States companies from engaging in bribery or other prohibited payments to foreign officials for the purpose of obtaining or retaining business. Foreign companies, including some of our competitors, are not subject to these prohibitions. Corruption, extortion, bribery, pay-offs, theft and other fraudulent practices occur from time-to-time in the countries in which we operate, including in Russia and Colombia. If our competitors engage in these practices they may receive preferential treatment from personnel of some companies, giving our competitors an advantage in securing business or from government officials who might give them priority in obtaining new licenses, which would put us at a disadvantage. Although we inform our personnel that such practices are illegal, there can be no assurance that our employees or other agents will not engage in such conduct for which we might be held responsible. If our employees or other agents are found to have engaged in such practices, we could suffer severe penalties.
Our prior association with PacificNet could expose us to claims or litigation.
On December 7, 2007, we entered into an agreement with PacificNet, Inc. relating to our becoming an indirect wholly-owned subsidiary of PacificNet. On May 14, 2008, this agreement and all rights and obligations of the parties thereunder were terminated. As a result, we no longer were an indirect subsidiary of PacificNet. We believe that PacificNet recently has experienced a significant downturn in its financial position, and it is possible that its financial difficulties could expose us to claims or litigation, due to our previous relationship with PacificNet. If we are named in any claims or litigation involving PacificNet, we may incur significant expenses defending or litigating such claims. These expenses could have an adverse effect on our future cash flows and results of operations. In addition, our obligations under our agreements with PacificNet are unclear and open to interpretation, which could lead to litigation if we and PacificNet differ on the interpretation of certain terms in the agreements.
We became public by means of a “reverse merger” transaction, and, as a result, we are subject to the risks associated with the prior activities of the public company.
Additional risks may exist because we became public through a “reverse merger” transaction which was effected through the Share Exchange. Prior to the Share Exchange on October 30, 2008, House Fly Rentals, Inc., our predecessor, was a development stage company with nominal assets and operations. We may require the cooperation or assistance of persons or organizations, such as auditors, previously associated with House Fly in connection with future matters that could be costly or difficult to secure. Although we performed a due diligence review of House Fly, we still may be exposed to undisclosed liabilities resulting from its prior operations and we could incur losses, damages or other costs as a result. In connection with the Share Exchange, claims may not be brought against such shareholders after six months from the closing of the Share Exchange. Therefore, any liabilities associated with the prior operations, capitalization or ownership of securities of our company by the shareholders of House Fly may be borne by our current shareholders.
Our business experiences variability in gross margins.
Our business experiences variability in gross margins on contracts due to numerous factors, including, among other things, the following:
| | · | Delays in project implementation; |
| | · | Failure to achieve add-on sales to existing customers; |
| | · | Changes in governmental regulation; |
| | · | Changes in user specifications; |
| | · | Level of commodity versus proprietary components applicable to customer system specifications; |
| | · | Whether contracts have been extended or renewed and the amount of remuneration associated with such extensions or renewals; |
| | · | Price competition in competitive bids, contract renewals and contract extensions; |
| | · | Variations in costs of materials and manufacturing; |
| | · | Variations in levels of efficiency of our workforce in delivering, implementing and servicing contracts; |
| | · | Seasonality of issuance volumes; |
| | · | Sales mix related to adoption of new products compared to sales of current products; |
| | · | Strategic decisions on new business; |
| | · | Depreciation and amortization of capitalized project costs related to new or upgraded programs; and |
| | · | Variability in the extent to which we are able to allocate personnel expenses to capital projects and thereby amortize such costs over the life of the relevant contract, rather than expensing such costs in the quarter in which they are incurred. |
As a result of the occurrence of one or more of the foregoing, we can expect that there will be fluctuations in our future operating results.
Unfavorable political developments, weak foreign economies, and other foreign risks may negatively impact our financial condition and results of operations.
Our business is dependent on international markets for the majority of our revenues. We expect that receivables with respect to sales outside of the United States will continue to account for a large portion of our total revenues. As a result, our business in these markets is subject to a variety of risks, including:
| | · | Social, political and economic instability; |
| | · | Additional costs of compliance; |
| | · | Tariffs and other trade barriers; |
| | · | Recessions in foreign economies; |
| | · | Expropriation, nationalization and limitation on repatriation of earnings; |
| | · | Fluctuations in foreign exchange rates; |
| | · | Adverse changes in the creditworthiness of parties with whom we have significant receivables; |
| | · | Reduced protection of intellectual property rights in some countries; |
| | · | Longer receivables collection periods and greater difficulty in collecting accounts receivable; |
| | · | Difficulties in managing foreign operations; |
| | · | Unexpected changes in regulatory requirements; |
| | · | Ability to finance foreign operations; |
| | · | Changes in consumer tastes and trends; and |
| | · | Acts of war or terrorism. |
Any of these international developments, or others, could adversely affect our financial condition and results of operations.
Future acquisitions could prove difficult to integrate, disrupt our business, dilute shareholder value and strain our resources.
As part of our business strategy, we intend to acquire businesses, services and technologies that we believe could complement or expand our business, augment our market coverage, enhance our technical capabilities, provide us with valuable customer contacts or otherwise offer growth opportunities. If we fail to achieve the anticipated benefits of any acquisitions we complete, our business, operating results, financial condition and prospects may be impaired. Acquisitions and investments involve numerous risks, including:
| | · | Difficulties in integrating operations, technologies, services, accounting and personnel; |
| | · | Difficulties in supporting and transitioning customers of our acquired companies to our technology platforms and business processes; |
| | · | Diversion of financial and management resources from existing operations; |
| | · | Difficulties in obtaining regulatory approval for technologies and products of acquired companies; |
| | · | Potential loss of key employees; |
| | · | Dilution of our existing shareholders if we finance acquisitions by issuing convertible debt or equity securities, which dilution could adversely affect the market price of our stock; |
| | · | Inability to generate sufficient revenues to offset acquisition or investment costs; and |
| | · | Potential write-offs of acquired assets. |
Acquisitions also frequently result in recording of goodwill and other intangible assets, which are subject to potential impairments in the future that could harm our operating results. It also is possible that at some point in the future we may decide to enter new markets, thus subjecting ourselves to new risks associated with those markets.
It may be difficult for you to enforce a U.S. judgment against us, our executive officers and our directors, or to assert U.S. securities laws claims in the United Kingdom or in other countries in which we operate or to serve process on our executive officers and directors.
All of our executive officers and directors are located outside the United States, and all of our assets and the assets of these persons are located outside the United States. Therefore, a judgment obtained against us or any of them in the United States, including one based on the civil liability provisions of the U.S. federal securities laws may not be collectible in the United States and may not be enforced by a court in the United Kingdom or in other countries in which we operate. Further, if a foreign judgment is enforced by a court in the United Kingdom or in other countries in which we operate, it generally will be payable in a non-U.S. currency. It also may be difficult for you to assert U.S. securities law claims in original actions instituted in the United Kingdom or in other countries in which we operate.
Risks Related to Our Industry
The gaming industry is heavily regulated, and the introduction of new regulation or changes in existing regulation by gaming authorities may adversely impact our ability to operate in our existing markets or expand our business.
The manufacture and distribution of gaming machines and the development of systems for various jurisdictions are subject to extensive federal, state and local regulation by various gaming authorities. Our ability to continue to operate in certain jurisdictions or our ability to expand into new jurisdictions could be adversely affected by:
| | · | Delays in adopting legislation to permit or expand gaming in new and existing jurisdictions; |
| | · | Unfavorable public referendums, such as referendums to increase taxes on gaming revenues; |
| | · | Unfavorable legislation affecting or directed at manufacturers, distributors or gaming operators; |
| | · | Adverse changes in or findings of non-compliance with applicable governmental gaming regulations; |
| | · | Unfavorable determinations or challenges to suitability by gaming regulatory authorities with respect to our officers, directors, major shareholders or key personnel; and |
| | · | The adoption of new laws and regulations, or the repeal or amendment of existing laws and regulations. |
To our knowledge, we and our key personnel have obtained, or applied for, all government licenses, registrations, findings of suitability, permits and approvals necessary to conduct our activities in the various jurisdictions in which we operate. However, there can be no assurance that licenses, registrations, findings of suitability, permits or approvals will be renewed in the future, or that new forms of approval necessary to operate in emerging or existing markets will be granted.
Government regulations and other actions affecting the lottery industry could have a negative effect on our business, results of operations or prospects.
In many jurisdictions where we currently operate or seek to do business, lotteries are not permitted unless expressly authorized by law. The successful implementation of our growth strategy and our business could be materially adversely affected if jurisdictions that do not currently authorize lotteries do not approve lotteries or if those jurisdictions that currently authorize lotteries do not continue to permit such activities.
Once authorized, the ongoing operations of lotteries and lottery operators are typically subject to extensive and evolving regulation. Lottery authorities generally conduct an intensive investigation of the winning vendor and its employees prior to and after the award of a lottery contract. Lottery authorities with which we do business may require the removal of any of our employees deemed to be unsuitable and are generally empowered to disqualify us from receiving a lottery contract or operating a lottery system as a result of any such investigation. Some jurisdictions also require extensive personal and financial disclosure and background checks from persons and entities beneficially owning a specified percentage (typically five percent or more) of our securities. The failure of these beneficial owners to submit to such background checks and provide required disclosure could jeopardize the award of a lottery contract to us or provide grounds for termination of an existing lottery contract. Additional restrictions are often imposed by international jurisdictions upon foreign corporations, such as us, seeking to do business there.
Further, there have been, are currently, and may in the future continue to be, investigations of various types, conducted by governmental authorities into possible improprieties and wrongdoing in connection with efforts to obtain and/or the awarding of lottery contracts and related matters. In light of the fact that such investigations frequently are conducted in secret, we may not necessarily know of the existence of an investigation in which we might be involved. Because our reputation for integrity is an important factor in our business dealings with lottery and other governmental agencies, a governmental allegation or a finding of improper conduct by or attributable to us in any manner or the prolonged investigation of these matters by governmental or regulatory authorities could have a material adverse effect on our results of operations, business or prospects, including our ability to retain existing contracts or to obtain new or renewal contracts. In addition, adverse publicity resulting from any such proceedings could have a material adverse effect on our reputation and business.
Finally, sales generated by lottery games are dependent upon decisions over which we have no control made by lottery authorities with respect to the operation of these games, such as matters relating to the marketing and prize payout features of online lottery games. Because we are typically compensated in whole or in part based on a jurisdiction’s gross lottery sales, lower than anticipated sales due to these factors could have a material adverse effect on our revenues.
If we are unable to obtain GLI certification for a significant number or our games it may be difficult for us to market and sell our games in many of the countries in which we do business.
Once a gaming product has GLI certification, then, in any jurisdiction that has accredited GLI as a standard-setting body, regulatory approval of that gaming product is automatic. If our games are not certified by GLI, it may be difficult for us to market and sell them in jurisdictions in which GLI certification is either required or desirable.
Slow growth in the number of new casinos or the rate of replacement of existing gaming machines could limit or reduce our future profits.
Demand for our products is driven substantially by the replacement of existing gaming machines, the establishment of new gaming jurisdictions and the addition of new casinos or expansion of existing casinos within existing gaming jurisdictions. The establishment or expansion of gaming in any jurisdiction typically requires a public referendum or other legislative action. As a result, gaming continues to be the subject of public debate and there are numerous active organizations that oppose gaming. Opposition to gaming could result in restrictions on or even prohibitions of gaming operations in any jurisdiction.
Gaming opponents persist in their efforts to curtail the expansion of legalized gaming, which, if successful, could limit our existing operations.
Legalized gaming is subject to opposition from gaming opponents. There can be no assurance that this opposition will not succeed in preventing the legalization of gaming in jurisdictions where these activities are presently prohibited or prohibiting or limiting the expansion of gaming where it is currently permitted, in either case to the detriment of our business, financial condition, results and prospects.
Consumer spending on leisure activities is affected by changes in the economy and consumer tastes, as well as other factors that are difficult to predict and beyond our control.
We cannot ensure that demand for our products or services will remain constant. Consumers' willingness to spend money on leisure activities such as gaming is affected by changes in the economy and consumer tastes, both of which are both difficult to predict and beyond our control. Continued adverse developments affecting economies throughout the world, including a general tightening of the availability of credit, increasing interest rates, increasing energy costs, acts of war or terrorism, natural disasters, declining consumer confidence or significant declines in the stock market could lead to a further reduction in discretionary spending on leisure activities adversely affecting our business.
As a result of the many regulations imposed by various regulatory authorities on businesses involved in the gaming industry, there may be a limited number of potential candidates to acquire our business.
The manufacture and distribution of gaming machines and the development of systems for various jurisdictions are subject to extensive regulation, including, in some cases, requirements of suitability by gaming regulatory authorities with respect to major shareholders. As a result of these regulations, we may be unable to consummate the sale of our business to interested takeover candidates, simply because these individuals or entities are unable to comply with certain applicable regulations in the jurisdictions in which we conduct business. Therefore, even if a sale of our business is in the best interest of our shareholders, we may either be unable to complete such sale or we may be required to accept a lower price from a party who is able to complete the acquisition because it complies with the applicable regulations.
Risks Related to our Common Stock
We have not paid dividends in the past and do not expect to pay dividends in the future. Any return on your investment may be limited to the value of our Common Stock.
We never have paid cash dividends on our Common Stock and do not anticipate doing so in the foreseeable future. The payment of dividends on our Common Stock will depend on our earnings, financial condition and other business and economic factors that the board of directors may consider relevant. If we do not pay dividends, our Common Stock may be less valuable, because a return on your investment only will occur if our stock price appreciates.
Our Common Stock may be affected by limited trading volume and price fluctuations, each of which could adversely impact the value of our common stock.
Our Common Stock is listed on the Over the Counter Bulletin Board, and has had limited trading, prior to the date of this annual report, and there can be no assurance that an active trading market in our Common Stock will be maintained. In addition, we believe that factors such as quarterly fluctuations in our financial results and changes in the overall economy or the condition of the financial markets could cause the price of our Common Stock to fluctuate substantially. These fluctuations also may cause short sellers to enter the market from time to time in the belief that we will have poor results in the future. We cannot predict the actions of market participants and, therefore, can offer no assurances that the market for our stock will be stable or appreciate over time.
Because our Common Stock could in the future be deemed a “penny stock,” it might become more difficult for investors to sell shares of our Common Stock, and the market price of our Common Stock could be adversely affected.
Our Common Stock could, in the future, be deemed to be a “penny stock,” if, among other things, the stock price is below US$5.00 per share, the stock is not listed on a national securities exchange and the stock has not met certain net tangible asset or average revenue requirements. Broker-dealers who sell penny stocks must provide purchasers of these stocks with a standardized risk-disclosure document prepared by the Securities and Exchange Commission. A broker must obtain the purchaser’s written agreement to the purchase and must also give the purchaser bid and offer quotations and information regarding broker and salesperson compensation and a written determination that the penny stock is a suitable investment for the purchaser. Broker-dealers also must provide to customers that hold penny stocks in their accounts a monthly statement containing price and market information relating to the penny stock. If a penny stock is sold to an investor in violation of the penny stock rules, the investor may be able to cancel its purchase and obtain a full refund of money paid.
If they become applicable, the penny stock rules may make it difficult for investors to sell their shares of our Common Stock. Because of the rules and restrictions applicable to a penny stock, there is less trading in penny stocks, and the market price of our Common Stock may be adversely affected in the event that these rules and restrictions become applicable to us. Also, many brokers choose not to participate in penny stock transactions. Accordingly, investors may not always be able to resell their shares of our Common Stock publicly at times and prices that they feel are appropriate.
If PacificNet exercises its option to purchase additional shares of our Common Stock, our other shareholders could be diluted.
As part of a settlement agreement with PacificNet, relating to the termination of PacficNet’s acquisition of us, we granted PacificNet the one-time right and option to purchase up to a number of shares that would cause its ownership of our Common Stock as of the date of exercise of the option to equal 5% of our outstanding equity subject to dilution as a result of our issuance of Common Stock to AGI, provided that such option is exercised prior to May 14, 2009.
If it is determined that PacificNet is able to exercise this option and chooses to do so, it could dilute our current and future shareholders or otherwise impact our financial condition.
The price of our Common Stock may be volatile, and our Common Stock may trade at prices below the offering price
We anticipate that the market price of our Common Stock will be subject to wide fluctuations in response to several factors from time to time, including:
| | · | the evolving demand for our services; |
| | · | our ability or inability to arrange for financing; |
| | · | our ability to manage expenses; |
| | · | changes in our pricing policies or our competitors; |
| | · | global economic and political conditions; |
| | · | investors’ perceptions of our prospects; |
| | · | investors’ perceptions of the prospects of the gaming industry and, more broadly, the entertainment industry; |
| | · | differences between our actual financial and operating results and those expected by investors and analysts; |
| | · | changes in analysts’ recommendations or projections; |
| | · | fluctuations in quarterly operating results; |
| | · | announcements by us or our competitors of significant acquisitions, strategic partnerships, or divestitures; |
| | · | changes or trends in our industry, including price volatility, trading volumes, competitive or regulatory changes, or changes in the gaming business; |
| | · | adverse resolution of new litigation against us; |
| | · | additions or departures of key personnel; and |
| | · | broad market fluctuations. |
In particular, announcements of potentially adverse developments, such as proposed regulatory changes, new government investigations, or the commencement or threat of litigation against us, as well as announced changes in our business plans or those of our competitors, could adversely affect the trading price of our Common Stock, regardless of the likely outcome of those developments. Broad market and industry factors may adversely affect the market price of our Common Stock, regardless of our actual operating performance. Our stock price also may be impacted by factors that are unrelated or disproportionate to our operating performance. These market fluctuations may adversely affect the market price of our Common Stock. As a result, our Common Stock may trade at prices significantly below the offering price. Declines in the price of our Common Stock may adversely affect our ability to recruit and retain key employees, including key professional employees.
If the shareholders whose shares of Common Stock are included in a currently pending registration statement became able to, and sell a large number of shares all at once or in blocks, the market price of our shares would most likely decline.
The market price of our Common Stock may fluctuate in the future, and future sales of shares of our Common Stock, could adversely affect the market price of our Common Stock. Shareholders could be diluted by such future sales and be further diluted upon the conversion or exercise of debentures or warrants into our Common Stock.
While none of our shares of Common Stock are currently registered pursuant to an effective registration statement, on January 22, 2009, the Company filed a post-effective amendment on Form S-1 with the SEC in order to resume the effectiveness of the registration statement filed on October 15, 2007 on Form SB-2 with the SEC. If and when this registration statement becomes effective again, the selling shareholders named in the prospectus that is a part of the registration statement will be able to sell their aggregate 747,414 shares of Common Stock. The offer or sale of a large number of these shares at any price may cause the market price to fall. If the selling shareholders sell a large number of shares, the market price of our Common Stock could decline significantly. Moreover, the perception in the public market that these shareholders might sell shares could depress the market price of Common Stock.
We may issue shares of our capital stock or debt securities in the future, which would reduce the equity interest of our security holders and may cause a change in control of our ownership.
Our articles of incorporation authorize the issuance of up to 150,000,000 shares of Common Stock. The issuance of additional shares of our Common Stock:
| | · | may cause a change in control if a substantial number of our shares of Common Stock are issued, which may affect, among other things, our ability to use our net operating loss carry-forwards, if any, and may result in the resignation or removal of our present officers and directors; and |
| | · | may adversely affect prevailing market prices for our Common Stock, to the extent a trading market was to develop in the future. |
Similarly, an issuance of additional debt securities may cause:
| | · | default and foreclosure on our assets if our operating revenues are insufficient to repay our debt obligations; |
| | · | acceleration of our obligations to repay the indebtedness even if we make all principal and interest payments when due if we breach certain covenants that require the maintenance of certain financial ratios or reserves without a waiver or renegotiation of that covenant; |
| | · | our immediate payment of all principal and accrued interest, if any, if the debt security is payable on demand; and |
| | · | our inability to obtain necessary additional financing if the debt security contains covenants restricting our ability to obtain such financing while the debt security is outstanding. |
Provisions contained in our Articles of Incorporation may deter a non-negotiated change of control.
Our Articles of Incorporation currently contain provisions which could be an impediment to a non-negotiated change in control, namely, an ability, without shareholder approval, to issue up to 10,000,000 shares of preferred stock with rights and preferences determined by the board of directors. If we should take this action, it could impede a non-negotiated change in control and thereby prevent shareholders from obtaining a premium for their common stock.
Item 1B. Unresolved Staff Comments
Smaller reporting companies are not required to provide the information required by this item.
Item 2. Properties.
Whenever the terms “our,” “we” and the “Company” are used in this section, they refer to one or more of the following: Octavian Global, Octavian International and all other direct and indirect subsidiaries of Octavian International identified in this annual report.
We expect our current properties will be adequate for our near-term business needs. See Note 16, “Commitments and Contingencies,” to the Consolidated Financial Statements included in this annual report for more information about our lease commitments. Our business segments, as reported in our consolidated financial statements, utilize all of our facilities.
We lease our principal office spaces located at 1-3 Bury Street, Guildford, Surrey, United Kingdom. On May 1, 2008, we renegotiated our Lease Agreement with Bury House Properties Ltd. regarding the lease of our principal office spaces, encompassing a total of 3,331 square feet, pursuant to which we were obligated to pay monthly rent in the amount of British pounds 8,740 (US$16,493.25 based on the Average Exchange Rate for the period between May 1, 2008 and October 31, 2008 of GBP1=US$1.8871) for the period from May 1, 2008 through October 31, 2008 and British pounds 9,005 (US$13,620.96 based on the Average Exchange Rate for the period between November 1, 2008 and December 31, 2008 of GBP1=US$1.5126) for November and December, 2008. We are obligated to pay monthly rent in the amount of British pounds 9,005 (US$13,214 based on the March 25, 2009 Exchange Rate of GBP1=US$1.4674) through April 30, 2010.
Our largest facility is located in St. Petersburg, Russia, where we lease a total of 1040 square meters from Aquatoria LLC. Our systems R&D, customer service and support, data center and marketing and administration functions offices are located at this facility. We conduct worldwide operations from this location. Our lease agreement for this location provided for payment of 930,334 Russian Rubles per month (US$28,012 based on the March 25, 2009 Exchange Rate of RUB1=US$0.03011) and expired on December 31, 2008. We have renewed the lease for an additional year with monthly rental payments of 995,457 Russian Rubles (US$34,263.63 based on the January 8, 2009 Exchange Rate of RUB1 = US$0.03442).
Our second largest facility also is located in St. Petersburg, Russia, where we lease a total of 640 square meters from Vektor LLC. Our games development and production offices are located at this facility. Our lease agreement for this location provides for payment of 464,612 Russian rubles per month (US$13,989 based on the March 25, 2009 Exchange Rate of RUB1=US$0.03011) and expires on September 10, 2009.
Each of our facilities in Bogotá, Colombia and Buenos Aires, Argentina contains a data center that services worldwide operations and sales, technical support and administrative functions. We also lease approximately 400 square meters of bonded warehouse space in Bogotá. Additionally, we lease sales space in Moscow, Russia, in Kiev, Ukraine and in Rwanda.
Item 3. Legal Proceedings.
None.
Item 4. Submission of Matters to a Vote of Security Holders.
On November 27 2008, stockholders of at least a majority of the issued and outstanding shares of our Common Stock (the “Voting Shareholders”) approved amending and restating the articles of incorporation of the Company in order to: (i) increase the total number of shares of our authorized capital stock to 160,000,000 from 75,000,000; (ii) increase the number of shares of our Common Stock to 150,000,000 shares; (iii) create of a new class of blank check preferred stock, par value $0.001 per share, consisting of 10,000,000 authorized shares; and (iv) set certain standard limitation of liability and indemnification provisions relating to our officers, directors and employees, as permitted pursuant to the Nevada Revised Statutes. The Voting Shareholders also approved a reverse split of our shares of Common Stock at a rate of one share for each 5.0174 shares of Common Stock issued and outstanding. All information relating to this vote of our security holders is set forth in the Company’s Current Report on Form 8-K filed with the SEC on December 4, 2008 and is incorporated herein by reference (File No. 333-146705).
PART II
Item 5. Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities.
Market for Common Stock
Our Common Stock is quoted for trading on the OTC Bulletin Board under the symbol “OCTV”. It began being quoted on February 13, 2008 under the symbol “HSLY”, the symbol was changed to “OVGT” on November 14, 2008 and then changed to the current symbol on January 7, 2009. Our Common Stock has had minimal trading.
The following table contains information about the range of high and low bid prices for our Common Stock for each quarterly period indicated, since the inception of quotation on the OTC Bulletin Board on February 13, 2008, based upon reports of transactions on the OTC Bulletin Board. The high and the low bid prices for our common shares for each quarter, during the period from the date our common shares were first listed on the OTC Bulletin Board through December 31, 2008, are not available from the OTC Bulletin Board. In order for the OTC Bulletin Board to report the high and low bid prices for a particular security, there must be three market makers for that security. During the period from the date our common shares were first listed on the OTC Bulletin Board through December 31, 2008, there were not three market makers for our Common Stock. As such, the OTC Bulletin Board has not reported the high or low bid prices for our common shares during that period.
| Fiscal Quarter End | | Low Bid | | | High Bid | |
| February 13, 2008 to March 31, 2008 | | $ | N/A | | | $ | N/A | |
| June 30, 2008 | | $ | N/A | | | $ | N/A | |
| September 30, 2008 | | $ | N/A | | | $ | N/A | |
| December 31, 2008 | | $ | N/A | | | $ | N/A | |
Holders of Our Common Stock
As of March 30, 2009, we have 43 stockholders of record.
Options and Warrants
The Company has outstanding warrants to purchase an aggregate of up to 7,249,864 shares of our Common Stock. Of this amount (i) Ziria Enterprises Limited, a company controlled by Harmen Brenninkmeijer, our Chief Executive Officer and Chairman, holds a seven-year warrant to purchase up to 1,647,500 shares of our Common Stock at an exercise price of US$3.10 per share; (ii) AGI holds a seven-year warrant to purchase up to 1,073,333 shares of our Common Stock at an exercise price of US$3.10 per share; (iii) investors in the Private Placement hold warrants to purchase up to an aggregate of 4,193,548 shares of our Common Stock, 50% of which have a term of five years and an exercise price of US$3.10 per share and the other 50% of which have a term of seven years and an exercise price of US$4.65 per share; and (iv) designees of the finders in the Private Placement hold five-year warrants to purchase up to an aggregate of 335,483 shares of our Common Stock at an exercise price of US$3.10 per share.
Rule 144 Shares
Under SEC Rule 144, shareholders who are non-affiliates of a publicly-reporting company that never was a “shell company” under SEC rules may be able to sell their shares of common stock of the company under Rule 144 within six months after acquiring such shares, without any restrictions, other than such company continuing to remain current in the filing of its periodic reports with the SEC for an additional six months. Affiliates of that company also would be able to sell their shares under Rule 144, but would be subject to volume and trading limitations. Shareholders who purchase securities in a company that is or ever was a shell company or received their shares in a “reverse merger” with a shell company, which would apply to shareholders of the Company who held shares prior to the Share Exchange or who acquired shares in the Share Exchange and/or the Private Placement, are subject to a modified holding period. In this case, the holding period continues until the longer of (i) six months from the date of acquiring the securities and (ii) November 5, 2009 (the date which is one year following the date that the Company filed a current report on Form 8-K reporting that it ceased to be a “shell company.” In addition, if a company ever was a shell company, in order to utilize Rule 144 to effect a sale, the Company must have completed all its periodic report filings with the SEC during the 12-month period preceding such proposed sale. Therefore, the earliest that any shares of our Common Stock will become transferable pursuant to Rule 144 is November 5, 2009, provided that we have filed all of our periodic reports for the twelve-month period immediately prior to such date. Shares held by affiliates of the Company still will be subject to the volume and trading limitations of Rule 144, which will generally limit their sale to one percent of the number of shares of the Company’s Common Stock then outstanding, during any three-month period.
Preferred Stock
Our Amended and Restated Articles of Incorporation authorizes the issuance of up to 10,000,000 shares of blank check preferred stock, par value $.001 per share (the “Preferred Stock”). The Company has not yet issued any of its Preferred Stock.
Dividends and Dividend Policy
We have never paid any cash dividends on our Common Stock and do not anticipate paying cash dividends in the foreseeable future. Our current policy is to retain earnings, if any, to fund operations, and the development and growth of our business. Any future determination to pay cash dividends will be at the discretion of the Board of Directors and will be dependent upon the Company’s financial condition, results from operations, capital requirements, applicable contractual restrictions, restrictions in the organizational documents and any other factors that the Board of Directors deems relevant.
Registration Rights
Investors who participated in the Private Placement were granted piggyback registration rights. Under these rights, investors in the Private Placement have the right to include their shares in any registration that we effect under the Securities Act, subject to customer underwriter cutbacks. The underwriters of any underwritten offering have the right to limit on a pro rata basis the number of shares registered by these holders. We must pay all expenses, except for underwriters’ discounts and commissions, incurred in connection with these piggyback registration rights.
Pending Registration
On January 22, 2009, the Company filed a post-effective amendment on Form S-1 with the SEC in order to resume the effectiveness of the registration statement filed on October 15, 2007 on Form SB-2 with the SEC. If and when this registration statement resumes its effectiveness, the selling shareholders under the prospectus included in the registration statement will be able to sell their aggregate 747,414 shares of Common Stock.
Recent Sales of Unregistered Securities
Pursuant to the Private Placement closed concurrently with the Share Exchange, on October 30, 2008, the Company issued (i) Debentures in an aggregate principal amount of US$14,285,700; (ii) Warrants to investors in the Private Placement to purchase up to an aggregate of 4,193,548 shares of our Common Stock; and (iii) 4,624,327 shares of our Common Stock. The Company raised gross proceeds of US$13 million in the Private Placement. The Share Exchange and Private Placement were discussed in greater detail in the Form 8-K that we filed on November 5, 2008. This offer and sale of securities was made in reliance upon the exemption from registration provided by Regulation S of the Securities Act, Section 4(2) of the Securities Act and Rule 506 of Regulation D promulgated under the Securities Act.
The Company also issued to certain designees of the finders 5-year warrants to purchase up to an aggregate of 335,484 shares of our Common Stock at an exercise price of US$3.10 per share. These warrants are on the same terms and include the same provisions as those issued to investors in the Private Placement.
The Company has also made the following issuances of unregistered securities during the past three years:
House Fly
On May 1, 2007, the Company issued 3,000,000 shares of our Common Stock at a price of US$0.005 per share, an aggregate of US$15,000, to Mr. McCall. These shares of Common Stock were repurchased by the Company concurrent with the Share Exchange. The offer and sale of securities was made in reliance upon the exemption from registration provided by Regulation S of the Securities Act, Section 4(2) of the Securities Act.
During July of 2007, the Company raised gross proceeds of US$28,500 through the sale of 2,850,000 shares of our Common Stock at a price of US$0.01 per share. As a result of the Reverse Stock Split, the number of shares were reduced to 568,023 shares of our Common Stock. The offer and sale of securities was made in reliance upon the exemption from registration provided by Regulation S of the Securities Act, Section 4(2) of the Securities Act.
During August of 2007, the Company raised gross proceeds of US$9,000 through the sale of 900,000 shares of our Common Stock at a price of US$0.01 per share. As a result of the Reverse Stock Split, the number of shares was reduced to 179,376 shares of our Common Stock. The offer and sale of securities was made in reliance upon the exemption from registration provided by Regulation S of the Securities Act, Section 4(2) of the Securities Act.
Octavian
AGI
Under the terms of certain agreements entered into with AGI, Octavian’s largest supplier of gaming supplies, on October 30, 2008, prior to the closing of the Share Exchange, AGI converted €4 million (US$5,114,000 based on the October 30, 2008 Exchange Rate of €1=US$1.2785) of accounts payable to it by Octavian into 652 Ordinary Shares of Octavian, representing 35 percent of the outstanding share capital of Octavian. These 652 Ordinary Shares were exchanged by AGI under the terms of the Share Exchange for 10,770,685 shares of our Common Stock. As a result of the Reverse Stock Split, the number of shares were reduced to 2,146,667 shares of our Common Stock. The offer and sale of securities was made in reliance upon the exemption from registration provided under Section 4(2) of the Securities Act.
Lilac
Lilac Advisors, LLC (“Lilac”) performed consulting services for Octavian in connection with the Share Exchange and Private Placement for which Octavian issued 149 Ordinary Shares of Octavian International in consideration for such services, which were exchanged for 2,470,232 shares of our Common Stock. As a result of the Reverse Stock Split, the number of shares were reduced to 492,333 shares of our Common Stock. The offer and sale of securities was made in reliance upon the exemption from registration provided under Section 4(2) of the Securities Act.
PacificNet
Pursuant to the PacificNet Termination Agreement,, Octavian agreed to issue to PacificNet or its nominee an amount of shares of capital stock of Octavian equal to five percent (5%) of the outstanding shares of Octavian. On October 30, 2008, prior to the closing of the Share Exchange, Octavian issued PacificNet 61 Ordinary Shares of Octavian on in satisfaction of this provision. These 61 Ordinary Shares were exchanged by PacificNet under the terms of the Share Exchange for 1,000,135 shares of our Common Stock. As a result of the Reverse Stock Split, the number of shares were reduced to 199,333 shares of our Common Stock. The offer and sale of securities was made in reliance upon the exemption from registration provided under Section 4(2) of the Securities Act.
Issuer Purchases of Equity Securities
On October 30, 2008, the Company entered into the Repurchase Agreement with Mr. McCall, pursuant to which the Company repurchased from Mr. McCall an aggregate of 3,000,000 pre-Reverse Split shares of our Common Stock, which represented 44.4% of the Company’s shares of Common Stock then issued and outstanding, for an aggregate purchase price of US$300,000.
Item 6. Selected Financial Data
As a “smaller reporting company” as defined by Item 10 of Regulation S-K, the Company is not required to provide this information.
Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations.
Whenever the terms “our,” “we” and the “Company” are used in this section, they refer to one or more of the following: Octavian Global, Octavian International and all other direct and indirect subsidiaries of Octavian International identified in this annual report. The following discussion and analysis is intended to enhance the reader’s understanding of our operation and current business environment. This information should be read in conjunction with our Business Description and Financial Statements and the notes thereto contained herein. Except for the historical information contained herein, the following discussion contains forward-looking statements and involves numerous risks and uncertainties (see “Special Note Regarding Forward-Looking Statements”). These risks and uncertainties include dependence on business from foreign customers sometimes in politically unstable regions, political and governmental decisions about the gaming industry, fluctuations in period-to-period operating results, and other factors discussed in the Risk Factors contained in this annual report. Actual results may differ materially from those contained in any forward-looking statements. Factors that could cause or contribute to such differences include risks detailed the section entitled “Risk Factors” and elsewhere in this annual report. For purposes of this sections, references to “Octavian” refer to Octavian Global, Octavian International and all other consolidated subsidiaries.
OVERVIEW
Octavian is a leading global provider of a full end-to-end suite of gaming systems and products. We are an independent provider of networked CMS, leading edge games, AWPs, lotteries and other advanced gaming products and services in over 30 countries.
Our primary focus is to establish long lasting relationships with customers by providing a full end-to-end suite of innovative gaming solutions. Delivered through our core businesses: OctaSystems, OctaGames, OctaSupplies and OctaLotto, Octavian provides comprehensive solutions and infrastructure systems, which allow both large and small operators to increase efficiency, profitability and control while bringing their customers top-of-the-line, innovative, downloadable and installed games.
We are dedicated to generating financial growth by focusing on the three cornerstones of our business strategy: focusing on casino management systems, establishing participation contracts, and increasing sales of our own products while reducing re-sales of third-party products. Our current research and development efforts are dedicated to developing products that support our business strategy.
We plan to capitalize on new market opportunities to accelerate growth. Some of these opportunities may come from political action as governments look to introduce and regulate gaming to increase tax revenues in support of public programs. We seek to continue to expand our footprint globally, especially in emerging markets in Latin America and Africa. We consider strategic business combinations, investments and alliances to expand our geographic reach, product lines and customer base.
THE SHARE EXCHANGE AND RELATED TRANSACTIONS
On October 30, 2008:
| | | House Fly effected the Repurchase; |
| | | Octavian International and House Fly consummated the Share Exchange; |
| | | House Fly effected the Subsidiary Merger and Name Change; and |
| | | Octavian Global Technologies, Inc. effected the Private Placement and the Reverse Stock Split. |
Please refer to “Certain Relationships and Related Transactions, and Director Independence” for more information about the Share Exchange and Related Transactions.
CONSOLIDATED OPERATING RESULTS – A Year Over Year Comparative Analysis
Significant fluctuations in year-to-year revenue are expected in the gaming industry. Individual contracts generally are of considerable value, and the timing of contracts and sales does not occur in a predictable trend. Contracts to supply hardware to the same customer may not recur or generally do not recur in the short-term. The gross profit margin varies from one contract to another, depending on the size of the contract and competitive market conditions. Accordingly, comparative results between periods are not indicative of trends in revenues or gross profit margins.
| | | Years Ended December 31, | | | Amount Change | | | Percentage Change | |
| | | 2008 | | | 2007 | | | 2008 vs 2007 | | | 2008 vs 2007 | |
| | | Audited | | | Audited | | | | | | | |
| | | | | | | | | | | | | |
| Net Revenue | | $ | 39,627,067 | | | $ | 23,538,458 | | | $ | 16,088,609 | | | | 68.4 | % |
| Cost of Revenue | | $ | 28,244,131 | | | $ | 17,239,584 | | | $ | (11,004,547 | ) | | | 63.8 | % |
| Gross profit | | $ | 11,382,936 | | | $ | 6,298,874 | | | $ | 5,084,062 | | | | 80.7 | % |
| Operating expenses | | | | | | | | | | | | | | | | |
| General, administrative and selling expenses | | $ | 16,792,256 | | | $ | 25,216,672 | | | $ | (8,424,416 | ) | | | (33.4 | )% |
| Research and Development | | $ | 94,005 | | | $ | | | | $ | 94,005 | | | | | |
| Depreciation and amortization | | $ | 800,670 | | | $ | 827,173 | | | $ | (26,503 | ) | | | (3.2 | )% |
| Impairment of goodwill | | $ | | | | $ | 471,611 | | | $ | (471,611) | | | | (100 | )% |
| Total operating expenses | | $ | 17,686,931 | | | $ | 26,515,456 | | | $ | (8,828,525 | ) | | | (33.3 | )% |
| | | | | | | | | | | | | | | | | |
| Income /(Loss) from operations | | $ | (6,303,995 | ) | | $ | (20,216,582 | ) | | $ | 13,921,587 | | | | 68.8 | % |
| | | | | | | | | | | | | | | | | |
| Non-operating income (expense): | | | | | | | | | | | | | | | | |
| Other income (expense) | | $ | 189,969 | | | $ | (24,471 | ) | | $ | 214,439 | | | | (876.3 | )% |
| Interest income (expense) | | $ | (652,011 | ) | | $ | (268,135 | ) | | $ | (401,522 | ) | | | 143.2 | % |
| Share of earnings (loss) of associated co's | | $ | 273,237 | | | $ | (160,610 | ) | | $ | 433,847 | | | | (270.1 | )% |
| Foreign Currency transaction gain (expense) | | $ | (4,103,630 | ) | | $ | 141,620 | | | $ | (4,245,250 | ) | | | (2997.6 | )% |
| Outside stockholders' interests | | $ | (6,276 | ) | | $ | 32,224 | | | $ | (38,500 | ) | | | (119.5 | )% |
| Gain (Loss) on disposal of fixed assets | | $ | 340,824 | | | $ | (34,051 | ) | | $ | 374,875 | | | | (1,100.9 | )% |
| Capital raising fees | | $ | (134,507 | ) | | | | | | | (134,507) | | | | - | |
| Total non-operating income (expense) | | $ | (4,092,395 | ) | | $ | (313,423 | ) | | $ | (3,778,972 | ) | | | 1,205.7 | % |
| | | | | | | | | | | | | | | | | |
| Income before taxation | | $ | (10,396,390 | ) | | $ | (20,530,005 | ) | | $ | 10,133,615 | | | | (49.3 | )% |
| | | | | | | | | | | | | | | | | |
| Taxation | | $ | 387,363 | | | $ | (1,583,546 | ) | | $ | (1,970,909 | ) | | | (124.5 | )% |
| | | | | | | | | | | | | | | | | |
| Net income after taxation | | $ | (10,783,753, | ) | | $ | (18,946,459 | ) | | $ | 8,162,703 | | | | (43.1 | )% |
| | | | | | | | | | | | | | | | | |
| Other comprehensive income | | $ | 4,966,392 | | | $ | (254,186 | ) | | $ | 5,220,578 | | | | (2,053.8 | )% |
| Foreign currency translation gain | | | | | | | | | | | | | | | | |
| | | | | | | | | | | | | | | | | |
| Comprehensive Loss | | $ | (5,817,361 | ) | | $ | (19,200,645 | ) | | $ | 13,383,281 | | | | (69.7 | )% |
| | | | | | | | | | | | | | | | | |
| Weighted average shares outstanding : | | | | | | | | | | | | | | | | |
| Basic and diluted | | | 4,008,388 | | | | 3,294,050 | | | | | | | | | |
| | | | | | | | | | | | | | | | | |
| Loss per share: | | | | | | | | | | | | | | | | |
| Continuing operations | | $ | (2.69 | ) | | $ | (5.75 | ) | | | | | | | | |
Our revenues for the year ended December 31, 2008 were US$39.6 million, representing an increase of US$16.1 million or 68.4 percent compared to 2007, which mainly was the result of higher OctaSupplies and OctaGames sales.
| (amounts in thousands US$) | | Year ended December 31 | | | Variance | | | Percentage Change | |
| | | 2008 | | | 2007 | | | 2008 vs 2007 | | | 2008 vs 2007 | |
| Revenues | | | | | | | | | | | | |
| OctaSystems | | $ | 7,912 | | | $ | 8,261 | | | $ | (349 | ) | | | (4.2 | )% |
| OctaGames | | $ | 2,263 | | | $ | 967 | | | $ | 1,296 | | | | 134.0 | % |
| OctaLotto | | $ | 101 | | | $ | | | | $ | | | | | - | % |
| OctaSupplies | | $ | 29,351 | | | $ | 14,311 | | | $ | 15,030 | | | | 105.0 | % |
| Total | | $ | 39,627 | | | $ | 23,538 | | | $ | 16,089 | | | | 68.4 | % |
| (amounts in thousands US$) | | Year ended December 31 | | | Variance | | | Percentage Change | |
| | | 2008 | | | 2007 | | | 2008 vs 2007 | | | 2008 vs 2007 | |
| OctaSupplies revenues | | | | | | | | | | | | |
| CIS | | $ | 26,001 | | | $ | 12,215 | | | $ | 13,786 | | | | 112.9 | % |
| EMEA | | $ | 573 | | | $ | 350 | | | $ | 223 | | | | 63.6 | % |
| Latin America | | $ | 2,777 | | | $ | 1,746 | | | $ | 1,031 | | | | 59.0 | % |
| Total | | $ | 29,351 | | | $ | 14,311 | | | $ | 15,030 | | | | 105.0 | % |
OctaSupplies sales increased US$15 million or 105 percent in 2008 to US$29.4 million compared to $14.3 million in 2007. Approximately 89 percent of sales in 2008 represented OctaSupplies sales in Russia which rose from US$12.2 million in 2007 to US$26 million in 2008. The increase in sales in Russia was due to the expectation of a legislative change which had previously significantly limited the demand for new gaming products and supplies.
| (amounts in thousands US$) | | Year ended December 31 | | | Variance | | | Percentage Change | |
| | | 2008 | | | 2007 | | | 2008 vs 2007 | | | 2008 vs 2007 | |
| OctaSystems revenues | | | | | | | | | | | | |
| CIS | | $ | 2,910 | | | $ | 4,992 | | | $ | (2,083 | ) | | | (41.7 | )% |
| EMEA | | $ | 1,332 | | | $ | 108 | | | $ | 1,224 | | | | 1,134.1 | % |
| Latin America | | $ | 3,670 | | | $ | 3,160 | | | $ | 510 | | | | 16.1 | % |
| Total | | $ | 7,912 | | | $ | 8,260 | | | $ | (349 | ) | | | (4.2 | )% |
OctaSystems revenue decreased US$0.3 million (4.2 percent) to US$7.9 million in 2008. The legislative change in Russia heavily affected OctaSystems revenue in Russia which decreased US$2.1 million (42 percent) from US$5 million in 2007 to US$2.9 million in 2008. OctaSystems revenue increased in Latin America by US$0.5 million (16.1 percent) from US$3.2 million in 2007 to US$3.7 million in 2008, partly due to the addition of full year results for Argelink, our Argentine subsidiary, wholly owned since 17 August 2007. In addition, new OctaSystems sales were recorded in Europe amounting to US$1.3 million in 2008.
| (amounts in thousands US$) | | Year ended December 31 | | | Variance | | | Percentage Change | |
| | | 2008 | | | 2007 | | | 2008 vs 2007 | | | 2008 vs 2007 | |
| OctaGames revenues | | | | | | | | | | | | |
| CIS | | $ | 1,091 | | | $ | 7 | | | $ | 1,084 | | | | 16,039.2 | % |
| EMEA | | $ | 856 | | | $ | 181 | | | $ | 675 | | | | 373.8 | % |
| Latin America | | $ | 316 | | | $ | 779 | | | $ | (463 | ) | | | (59.4 | )% |
| Total | | $ | 2,263 | | | $ | 967 | | | $ | 1,296 | | | | 134.0 | % |
OctaGames sales increased by US$1.3 million (134 percent) to US$2.3 million in 2008. OctaGames sales in Europe increased US$0.7 million (374 percent) from US$0.2 million in 2007 to US$0.9 million in 2008, primarily as a result of first-time sales of game licenses to the Italian market. There was an increase in sales in Russia of US$1.1 million from nominal sales in 2007. These also related to the development and sales of new games. Sales in Latin America fell by US$0.5 million (59 percent) from US$ 0.8 million to US$ 0.3 million reflecting difficult trading conditions in that market.
| (amounts in thousands US$) | | Year ended December 31 | | | Variance | | | Percentage Change | |
| | | 2008 | | | 2007 | | | 2008 vs 2007 | | | 2008 vs 2007 | |
| OctaLotto revenues | | | | | | | | | | | | |
| CIS | | $ | 72 | | | $ | - | | | $ | 72 | | | | - | % |
| EMEA | | $ | 29 | | | $ | - | | | $ | 29 | | | | - | % |
| Latin America | | $ | - | | | $ | - | | | $ | - | | | | - | % |
| Total | | $ | 101 | | | $ | - | | | $ | 101 | | | | - | % |
OctaLotto sales began in the latter part of 2008 with our operations in Rwanda and development centre in Russia; sales amounted to US$0.1 million in 2008.
| (amounts in thousands US$) | | Year ended December 31 | | | Variance | | | Percentage Change | |
| | | 2008 | | | 2007 | | | 2008 vs 2007 | | | 2008 vs 2007 | |
| | | Audited | | | Audited | | | | | | | |
| Revenues and gross profit | | | | | | | | | | | | |
| Revenues | | $ | 39,627 | | | $ | 23,538 | | | $ | 16,089 | | | | 68.4 | % |
| Cost of Revenues | | $ | 28,244 | | | $ | 17,240 | | | $ | 11,004 | | | | 63.8 | % |
| Gross Profit | | $ | 11,383 | | | $ | 6,299 | | | $ | 5,084 | | | | 80.7 | % |
| | | | 28.7 | % | | | 26.8 | % | | | - | | | | - | |
The increase in margin reflects the higher level of OctaGames in 2008 which crystallise on higher margins compared to our OctaSupplies sales.
Operating Expenses
Sales, general & administrative (“SG&A”) expenses decreased by US$8.4 million, or 33.4 percent, in 2008 which was mainly the result of a provision for bad debt of US$9.4 million in 2007 attributed to several debtors, primarily located in Russia. In 2008, our bad debt expense was reduced by US$8.1 million to US$1.3 million, taking into account debts older than six months.
| (amounts in thousands US$) | | Year ended December 31 | | | Variance | | | Percentage Change | |
| | | 2008 | | | 2007 | | | 2008 vs 2007 | | | 2008 vs 2007 | |
| SG&A cost | | | | | | | | | | | | |
| Staff Costs | | $ | 6,625 | | | $ | 6,916 | | | $ | (291 | ) | | | (4.2 | )% |
| Other cost | | $ | 8,837 | | | $ | 8,869 | | | $ | (32 | ) | | | (0.3 | )% |
| SG&A excluding Bad debt | | $ | 15,462 | | | $ | 15,785 | | | $ | (323 | ) | | | (2.1 | )% |
| Bad Debts | | $ | 1,331 | | | $ | 9,432 | | | $ | (8,101 | ) | | | (85.9 | )% |
| Total SG&A cost incl Bad debt provision | | $ | 16,792 | | | $ | 25,217 | | | $ | (8,424 | ) | | | (33.4 | )% |
Excluding bad debts, SG&A decreased US$0.3 million or 2.1 percent from US$15.8 million in 2007 to US$15.5 million in 2008.
Staffing costs decreased US$0.3 million or 4.2 percent from US$6.9 million in 2007 to US$6.6 million in 2008, due to a reduction in staff numbers across the group between 2007 and 2008.
There was a nominal decrease in other expenses of US$0.03 million or 0.3 percent from US$8.9 million in 2007.
We have accounted for an increase in bad debt reserve of US$0.1 million based on debt outstanding for more than six months for all customers in the group.
| | | Years Ended December 31, | | | Amount Change | | | Percentage
Change | |
| | | 2008 | | | 2007 | | | 2008 vs 2007 | | | 2008 vs 2007 | |
| | | Audited | | | Audited | | | | | | | |
| Operating expenses | | | | | | | | | | | | |
| General, administrative and selling expenses | | $ | 16,792,256 | | | $ | 25,216,672 | | | $ | (8,424,416 | ) | | | (33.4 | )% |
| Research and Development | | $ | 94,005 | | | $ | 0 | | | $ | 94,005 | | | | | |
| Depreciation and amortization | | $ | 800,670 | | | $ | 827,173 | | | $ | (26,503 | ) | | | (3.2 | )% |
| Impairment of goodwill | | $ | 0 | | | $ | 471,611 | | | $ | (471,611 | ) | | | 100 | % |
| Total operating expenses | | $ | 17,686,931 | | | $ | 26,515,456 | | | $ | (8,828,525 | ) | | | (33.3 | )% |
Research and development costs which were not capitalized amounted to US$ 0.1 million in 2008.
Depreciation and amortization decreased by US$0.03 million or 3.2 percent in 2008 compared to 2007 as a result of higher amortization expenses related to additions to our intangible assets more than offset by fixed assets becoming fully depreciated during the year.
In 2007, we took a write-off of goodwill of US$0.5 million when we acquired the remaining 50 percent of the shares in our joint venture in Argentina, Argelink SA (“Argelink”).
Other Income (Expense) and Taxes
Interest expense increased to US$0.7 million due to the extension of bridge loans of US$3.0 million taken with Ebet finally repaid in October 2008. Interest is accrued on the current loan with AGI of EURO 7,500,000 at 31 December 2008 (US$ 10,571,475 based on the December 31, 2008 Exchange Rate of € 1 = US$ 1.40953).
In 2007, our 50 percent joint venture in Italy booked a loss of US$0.2 million due to the delayed implementation of new legislation, which would have expanded the Italian gaming market. As a result of the delay, no new gaming products were allowed to be sold in Italy in 2007. With the implementation of the new legislation Italy has become profitable generating a gain of US$ 0.3 million in 2008.
