Overview:

Spectre Gaming, Inc. (the "Company" or "Spectre," "we," "us" or "ours") (formerly OneLink, Inc.) was incorporated in Minnesota in June 1990 under the name MarketLink, Inc. At that time, the Company provided telecommunications-based business-intelligence services to client end users. In January 1997, the Company changed its name to OneLink Communications, Inc., and later in June 2000, changed its name to OneLink, Inc. In July 2002, the Company ceased operating its telecommunications-based business, and in December 2002 sold substantially all of its assets. In September 2003, the Company adopted a new business plan focused on providing interactive electronic games to the Native American and charitable gaming markets, and in January 2004 changed its name to Spectre Gaming, Inc. The Company designs and develops networks, software and content that provide its customers with a comprehensive gaming system.

During the fourth quarter of 2004, the Company began generating revenues for the first time since developing and implementing its new gaming machine and gaming system business. These revenues resulted in gross profits of $18,943 before expenses. During 2004, the Company invested heavily in research and development primarily through a software development transaction with MET Games, Inc. of Oklahoma. The Company increased its selling, general and administrative expenses significantly in 2004 as it built it infrastructure to capitalize on the opportunities in the Native American class II and class III gaming markets. During 2004, the Company raised substantial capital by selling equity in the Company through two private placements and also by issuing notes payable and common stock warrants.

In May 2005, the Company acquired the exclusive license to a proprietary technology for the development and deployment of casino-style redemption or amusement-with-prize ("AWP") games. The Company has begun the development of AWP games and plans to distribute the games to operators at various retail, commercial and entertainment venues in the United States which allow for such devices.

In order to fund its efforts to enter the AWP market, in October 2005, the Company completed a private placement of its Series B Variable Rate Preferred Stock. In December 2005,the Company decided to exit the Class II and Class III markets to focus its efforts solely on the AWP market. Accordingly, the Company has reduced its staff in Tulsa, Oklahoma and El Cajon, California, and has removed nearly all of its gaming devices from the floors of its casino customers. The Company is actively trying to liquidate its inventory of Class II and Class III gaming devices and may not recover the book value of the inventory and other assets. As a result, the Company has taken charges to operations in 2005 of approximately $2,300,000 connection with the closure of the Company's facilities in Oklahoma and California and the liquidation of its inventory and fixed assets in those states. In determining the value of its assets of discontinued operations, the Company relied on estimates provided by potential buyers, industry operators and its own limited sales results. Therefore, the Company cannot assure what it will realize upon the disposition of these assets.

In fiscal 2005, the Company has accounted for the results of operations and assets used in the Class II and Class III markets as discontinued operations. The income or loss from discontinued operations includes the operating loss and the gain or loss on sale, if any, of these assets. Fiscal 2004 results of operations has been reclassified to reflect the Class II and Class III results as discontinued operations.

The Company currently has 20 AWP machines in operation in Florida on a test basis and has agreements signed and a backlog of 2,450 machines as of March 21, 2006. However, the Company's AWP business is still in development. If we do not have or do not expect to have significant sales of our products within this market in the first six-months of fiscal 2006, we will present our financial statements as a development stage company in the first quarter of 2006. Management did not consider the Company to be in the development stage in fiscal 2005 because it continued to develop and market its Class II and Class III games through December 2005.

Results of Operations:

Year Ended December 31, 2005 Compared to Year Ended December 31, 2004

Revenues. The Company's revenues from continuing operations for the years ended December 31, 2005 and 2004 were $0 due to the fact that the Company is new to the AWP business and had no revenue producing sales.

Cost of Revenues and Gross Profit. The Company's cost of revenues from continuing operations for the year ended December 31, 2005 was $1,517, compared to $0 for the year ended December 31, 2004, an increase of 100%. The cost of revenues in 2005 relate to installation of the Company's games on a trial basis.

Gross profit for the year ended December 31, 2005 was ($1,517) compared to $0 for the year ended December 31, 2004. The loss was due to the fact that no revenue from continuing operations had been generated for the initial installation of AWP Products.

Research and Product Development Expenses. Research and product development expenses for continuing operations for the year ended December 31, 2005 were $361,122, compared to $0 for the year ended December 31, 2004. The increase was due to the Company beginning development of its AWP products.

Sales and Marketing Expenses. Sales and marketing expenses for the year ended December 31, 2005 were $642,642, compared to $0 for the year ended December 31, 2004. The increases in expense primarily resulted from the Company commencing operations in the AWP market and consists primarily of amortization of the long-term technology and distribution rights acquired from Bally Gaming.

General and Administrative Expenses. General and administrative expenses from continuing operations for the year ended December 31, 2005 were $2,130,374, compared to $700,422 for the year ended December 31, 2004, an increase of 304%. The increase was due primarily to the addition of corporate staff, increased professional fees and other corporate expenses.

Other Expense. Other expense was $2,950,180 for the year ended December 31, 2005, compared to $781,978 for the year ended December 31, 2004. The increase in other expense is primarily due to interest on increased borrowings along with the amortization of the associated debt issuance costs and the amortization of the original issue discount related to the Company's convertible note payable, short-term debt and bank promissory note.

Loss From Discontinued Operations. The loss from discontinued operations was $4,035,500 and $2,911,791 for the years ended December 31, 2005 and 2004 respectively. The 2005 loss included a charge for $2,268,652 related to the write-down of Class II and Class III inventory and equipment. Without taking into account the effect of this charge, the loss in 2005 was $1,766,848. Losses in 2004 were greater then 2005 primarily due to research and development expenses in 2004 which included $850,000 relating to the acquisition of MET Games, Inc.

Preferred Stock Dividend. The preferred stock dividends of $3,524,144 relate to accrued dividends on the Series B Variable Rate Preferred Stock and a deemed dividend of $3,412,860 associated with a beneficial conversion feature on the Series B Variable Rate Convertible Preferred Stock.

Net Loss Attributable to Common Shareholders. The Company incurred a net loss of $13,645,479 for the year ended December 31, 2005, compared to a net loss of $4,394,191 for the prior year. These increased net losses for 2005 as compared to 2004 are primarily the result of the Company commencing AWP operations, losses from discontinued operations in the Native American and charitable gaming markets which involve significant increases in employee, consulting expense and increased interest expense and preferred dividends of $3,524,144 on the Series B Variable Rate Convertible Preferred Stock.

Liquidity and Capital Resources. The Company had negative working capital of $1,260,338 and positive working capital of $2,473,453 at December 31, 2005 and 2004, respectively. During 2005, cash used in operations was $3,937,338, and the primary uses of cash were to fund the Company's net loss, acquire inventory and reduce payables and accrued expenses. For the year ended December 31, 2004, the cash used in operations was $4,386,270 and the primary use of cash was to fund the Company's net loss, acquire inventory and to prepay license fees. These uses were partially offset by an increase in accounts payable, payroll and related taxes and accrued expenses and non-cash charges related to common stock, stock options and warrants issued for services.

Cash used in investing activities was $2,212,066 and $845,475 for the years ended December 31, 2005 and 2004, respectively. For the year ended December 31, 2005, $2,000,000 of cash was used in the purchase of the technology and distribution rights from Bally. For the year ended December 31, 2004, the Company used cash for capital expenditures, primarily at its El Cajon, California location and to purchase gaming equipment.

Cash provided by financing activities was $5,374,955 and $7,339,350 for the years ended December 31, 2005 and 2004, respectively. In November 2003, the Company began a private placement which ended in March 2004. A majority of the sales of the Company's common stock in this private placement occurred after December 31, 2003. In the private placement, the Company sold a total of 1,796,829 shares of its common stock (of which 1,531,989 were sold in 2004) for a per-share price of $0.75 (i.e., raising a gross total of $1,347,622, $1,148,996 of which was raised in 2004). The Company used an agent for a portion of these sales. As a fee, the Company paid the agent $62,550 in cash and issued the agent fully-vested five-year warrants to purchase up to 83,400 shares of the Company's common stock at an exercise price of $0.75 per share. In addition, the Company incurred legal fees and other expenses of $19,407 related to this private placement.

In November, 2004, the Company completed a private placement of 1,811,429 units, each unit consisting of one share of common stock and a five-year warrant to purchase one additional share of common stock at a purchase price of $3.75 per share. The per-unit price was $2.50 (i.e., raising a gross total of $4,528,573). The Company used two agents in completing the sale of the units in the November 2004 private placement. As a fee, the Company paid the agents an aggregate of $362,286 in cash, and issued the agents fully-vested five-year warrants to purchase up to 181,143 units for an exercise price of $2.50 per unit. In addition, the Company incurred legal fees and other expenses of $70,898 related to this private placement.

On May 20, 2004, the Company received $1,100,000 in a convertible debt investment from Pandora Select Partners, L.P. The note was payable in interest only, at 10% per annum, through August 20, 2004, and thereafter is payable in equal monthly installments over the next 15 months. The note is convertible by Pandora into common stock of Spectre at $2.50 per share, and allows Spectre, subject to certain conditions and limitations, to make monthly installment payments with its common stock at a price per share equal to 90% of the average closing bid price of the common stock over the 30 trading days immediately preceding the payment date. In connection with the financing, Spectre paid a 3% origination fee, issued a fully-vested five-year warrant for the purchase of 200,000 shares of Spectre's common stock at $2.50 per share, and granted Pandora a security interest in the Company's assets. In addition, Spectre agreed to file a registration statement with the SEC, covering the issuance or resale of the shares of Spectre's common stock which may be issued in connection with the note and warrant issued to Pandora. The registration statement was declared effective on January 24, 2005. In connection with the financing, the Company also paid a finder's fee to Blake Capital Advisors, LLC, a Minnesota limited liability company wholly owned by Wayne W. Mills, a greater-than-five-percent shareholder of the Company, of $50,000 and issued a fully-vested five-year warrant for the purchase of 50,000 shares of the Company's common stock at $2.50 per share and a fully-vested five-year warrant for the purchase of 50,000 shares at $3.00 per share. Net cash received by the Company after paying the finders fee, origination fee and legal cost of the lender of $10,000 was $1,007,000. The balance of the note was paid on October 28, 2005.

On September 10, 2004, the Company issued two $750,000 promissory notes accruing interest at 10% per annum. One note was issued to Pandora and the other note was issued to Whitebox Intermarket Partners L.P. The notes were payable interest only through March 10, 2005, at which time the principal became due. In connection with the financing, Spectre paid a 3% origination fee, issued fully-vested five-year warrants for the purchase of 50,000 shares of Spectre's common stock at $3.00 per share to both Pandora and Whitebox, and granted Pandora and Whitebox security interests in the Company's assets. In addition, Spectre agreed to file a registration statement with the SEC, covering the issuance or resale of the shares of Spectre's common stock which may be issued in connection with the warrants issued to Pandora and Whitebox. The registration statement was declared effective on January 24, 2005. Net cash received by the Company after paying the origination fee and legal costs of the lenders of $5,000 was $1,450,000.

On March 10, 2005, the Company signed amendments to the two $750,000 secured promissory notes with Pandora and Whitebox. The amendments extended the due date of the notes to June 10, 2005, and provided the Company with the option to further extend the due date to September 10, 2005. As part of the amendment the Company agreed to maintain assets whose value equals or exceeds the principal interest amounts then owned under the notes. For purposes of valuing the assets for compliance under this provision, the Company's cash is valued at 100%, the Company's accounts receivable are valued at 80% and the Company's inventory and fixed assets are valued at 50% of their book value. As consideration for the amendments, the Company paid Pandora and Whitebox each $18,750. In June 2005, the Company exercised its option to extend the due dates of the two notes to September 10, 2005, and in consideration therefore paid the lenders $18,750 each.

On September 28, 2005, the Company entered into Forbearance and Extension Agreements with both Pandora and Whitebox further extending the maturity dates of the two March 2005 promissory notes until September 30, 2006. Pursuant to these agreements, beginning October 10, 2005 and on the tenth day of each month thereafter, the Company is required to pay the accrued interest on the notes.

On June 21, 2005, the Company secured a $1.5 million loan from Crown Bank of Edina, Minnesota. In connection with this loan the Company paid a 2% origination fee. The loan was guaranteed by two persons, Ronald E. Eibensteiner (the Company's former Chairman and Chief Executive Officer, and then a greater-than-ten-percent shareholder) and D. Bradly Olah. In exchange for their guarantees, the Company issued each of the foregoing guarantors five-year warrants to purchase 150,000 shares of the Company's common stock at the price of $2.20, the closing price of the common stock on the date of issuance.

On September 29, 2005, the Company entered into a Forbearance and Extension Agreement with Crown Bank, extending the due date of the $1.5 million unsecured promissory note until October 31, 2005. On October 28, 2005, the Company paid the balance in full of the unsecured promissory note to Crown Bank.

On September 23, 2005 the Company signed a term sheet with PDS Gaming for a $20 million credit facility to finance its AWP gaming equipment. The term sheet is not a definitive agreement. As currently contemplated, terms of the facility will provide that the Company may make draws in increments of a minimum of $650,000 up to $10 million. Each loan under the facility will be amortized over 36 months with interest at 13% and will be subject to the Company meeting certain financial covenants and other conditions. A 1% fee will be required to be paid at closing of the facility and a 4% fee will be required on each draw. The Company is required to pay the expenses of the lender and paid an expense advance of $22,500 in September 2005. As of March 21, 2006, the Company had not closed on the credit facility.

On October 27, 2005, the Company offered and sold an aggregate of 7,420 shares of Series B Variable Rate Convertible Preferred Stock, together with five-year warrants to purchase an aggregate of 4,637,500 shares of common stock at $1.84 per share. The preferred shares are convertible into an aggregate of 4,637,500 of common stock at a conversion price of $1.60 per share. Of the 7,420 shares of Series B Preferred Stock sold, subscriptions for an aggregate of 1,230 shares were accepted, in lieu of cash, upon conversion of $1,230,000 of the principal amounts of nine unsecured short-term promissory notes made to the Company. Among subscribers converting loans into securities in the private placement were D. Bradly Olah, the President of the Company, and Prolific Publishing, Inc., a company of which Russell C. Mix, the Chief Executive Officer of the Company, is a director. Sales of the Series B Variable Rate Convertible Preferred Stock and warrants raised an aggregate of $7,420,000 in gross proceeds (which figure includes the conversion of $1,230,000 of principal amount of loans made to the Company) less approximately $615,000 in sales commissions payable in cash. In addition to cash compensation, selling agents received five-year warrants to purchase an aggregate of 695,624 shares of the Company's common stock at an exercise price of $1.84 per share.

In connection with the Series B Variable Rate Convertible Preferred Stock offering, the Company was required by the purchase agreement to register the common shares issuable upon conversion of the preferred stock, warrants and other shares issuable under the agreement. The Company filed a registration statement which was declared effective on December 23, 2005.

On June 30, 2004, the Company signed a three-year non-exclusive License Agreement with Bally Gaming Inc., a Nevada corporation. The License Agreement obligates the Company to purchase from Bally Gaming the lesser of (i) 3,000 game cabinets over the term of the agreement or (ii) 70% of its Class II cabinet purchases. In addition, the Company was obligated to purchase at least 100 game cabinets from Bally Gaming, and incur certain minimum license-fee charges of $187,500. The Company has purchased 100 game cabinets from Bally Gaming. The agreement was terminated in August 2005. In connection with the termination, Bally agreed to allow the prepaid license fees of $187,500 to be applied to future Class III title purchases. The Company is in discussions with Bally to allow these fees to be applied against future AWP royalty fees due Bally.

On May 24, 2005, the Company entered into a Redemption Technology and Supply Agreement with Bally Gaming pursuant to which the Company acquired a license for certain AWP technology from Bally Gaming, including exclusive distribution rights to that technology and follow-on exclusive distribution rights for Video Lottery Terminals ("VLT"), if VLT becomes legal. This agreement and the license last for an initial term of five years, but may be extended if the Company meets certain performance targets. Under the agreement, the Company is obligated to pay an upfront fee of $5 million. Of this amount, $1 million was paid in June 2005, $1 million was due on August 15, 2005, and the Company delivered an unsecured two-year promissory note for the remaining $3 million, providing for payments in four equal installments on each successive six-month anniversary of the agreement. The note bears interest at 12% per annum. In addition to the upfront fee, beginning in January 2007 the agreement requires the Company to pay royalties monthly based on the number of in-service redemption games during each day of the agreement's term. On August 15, 2005, the Company received an extension until August 31, 2005 to make the $1 million payment to Bally's that was due on August 15, 2005. On September 9, 2005, the Company received an additional extension until September 29, 2005 to make the required payment. On September 30, 2005, the agreement was amended and Bally agreed to accept a payment from the Company in partial satisfaction of the total amount owed Bally. In addition, Bally agreed to a payment extension for the remaining balance owed (in the principal amount of $1,572,566) plus accrued interest at 18% per annum, with such remaining amount due on October 31, 2005. On October 31, 2005, the Company paid the agreed upon amounts due Bally.

In October 2005, the Company paid Bally Gaming the agreed-upon amounts due as of October 31, 2005 under the Redemption Technology and Supply Agreement as amended, repaid the unsecured promissory note with Crown Bank, repaid the May 2004 convertible note issued to Pandora and converted nine unsecured short-term promissory notes into 1,030 shares of its Series B Variable Rate Convertible Preferred Stock. A portion of the proceeds received from the sale of Series B preferred stock was used to make these payments.

Over the next 12 months, the Company expects to spend a significant amount on capital equipment purchases primarily for AWP machines, and for such purpose expects to seek financing to purchase such equipment.

The following summarizes the Company's contractual obligations at December 31, 2005 (See Notes 9, 11, 16).

                      Total       1 Year or Less    1-3 Years     4-5 Years    Over 5 Years
Short-term debt    $ 1,500,000   $      1,500,000            -             -               -
Long-term debt       2,250,000          1,500,000      750,000
Operating leases       281,796            119,305      161,242         1,249               -
Total              $ 4,031,796   $      3,119,305   $  911,242   $     1,249   $           -

During 2005 and 2004, we did not pay or declare any cash dividends on common stock and do not intend to pay any cash dividends on common stock in the near future.

The Company anticipates that it will expend significant resources in 2006 acquiring machines to be placed in amusement centers on either a fixed lease or a participation basis. Once placed in service these machines are transferred to fixed assets.

Management believes that its cash should be sufficient to satisfy its cash requirements through April 2006. Beyond that point, the Company will need to obtain additional cash to meet its needs, including repaying the Bally, Pandora and Whitebox notes described above and has been actively pursuing additional debt and equity financing.

Off-Balance-Sheet Arrangements

The Company has no off-balance-sheet arrangements.

New Accounting Pronouncements

In November 2004, FASB issued SFAS No. 151 "Inventory Costs" amends the guidance in ARB No. 43, Chapter 4 "Inventory Pricing," to clarify the accounting for abnormal amounts of idle facility expense, freight, handling costs, and wasted material (spoilage). Paragraph 5 pf ARB 43, Chapter 4, previously stated that under some circumstances, items such as idle facility expense, excessive spoilage, double freight, and rehandling costs may be so abnormal as to require treatment as current period charges. SFAS No. 151 requires that those items be recognized as current-period charges regardless of whether they meet the criterion of "so abnormal." In addition, SFAS No, 151 requires that allocation of fixed production overheads to the costs of conversion be based on the normal capacity of the production facilities. SFAS No. 151 shall be effective for inventory costs incurred during fiscal years beginning after June 15, 2005. Earlier application is permitted for inventory costs incurred during fiscal years beginning after the date SFAS No. 151 was issued. SFAS No. 151 shall be applied prospectively. The Company does not expect the adoption of SFAS No. 151 to have a material effect on its financial statements.

In December 2004, FASB issued SFAS No. 123R which requires companies to recognize in the income statement the grant-date fair value of stock options and other equity-based compensation issued to employees, but expressed no preference for the type of valuation model. FASB No. 123R is effective for small business issuers as of the beginning of interim or annual reporting periods that begin after December 15, 2005. The Company will adopt SFAS No. 123R in its first fiscal 2006 quarter. The impact of SFAS No. 123R for 2006 is expected to be approximately $770,000 based on options outstanding at December 31, 2005 which will vest during 2006.

In June 2005, the FASB issued SFAS No. 154, "Accounting Changes and Error Corrections", a replacement of APB Opinion No. 20 and FASB Statement No. 3. The statement applies to all voluntary changes in accounting principle, and changes the requirements for accounting for and reporting of a change in accounting principle. SFAS No. 154 requires retrospective application to prior periods' financial statements of a voluntary change in accounting principle unless it is impracticable. SFAS No. 154 is effective for accounting changes and corrections of errors made in fiscal years beginning after December 15, 2005. Earlier application is permitted for accounting changes and corrections of errors made occurring in fiscal years beginning after June 1, 2005. The statement does not change the transition provisions of any existing accounting pronouncements, including those that are in a transition phase as of the effective date of this statement. The Company does not expect the adoption of SFAS No. 154 to have a material effect on its financial statements.

Critical Accounting Policies

Our critical accounting policies are those both having the most impact to the reporting of our financial condition and results, and requiring significant judgments and estimates. Our critical accounting policies include those related to (a) revenue recognition, (b) property, plant and equipment, (c) inventory,
(d) intangible assets and (e) the valuation of stock-based compensation awarded. The Company derives its gaming revenues primarily two ways, outright sales of machines to customers, and participation arrangements with its customers. Revenue for machine sales is recorded upon shipment. Under the participation arrangements, the Company retains ownership of the equipment installed at a customer site and receives revenue based on a percentage of the hold per day generated by each gaming system, which is generally considered both realizable and earned at the end of each gaming day. The Company accounts for the participation agreements as operating leases. Property, equipment and leasehold improvements and leased gaming equipment were stated at cost. Depreciation of an asset was recognized on the straight-line basis over the asset's estimated useful life ranging from three to five years. Leasehold improvements were amortized using the straight-line method over the shorter of the lease term or the estimated useful life. Maintenance, repairs and minor renewals are expensed when incurred. Inventory, which consists principally of gaming products and related materials, are stated at the lower of cost (determined on the specific . . .