Summary of OPTIMAL GROUP INC

ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

The following discussion of the financial condition and results of operations of our company describes our business, our vision and strategy, seasonality and trends within our business environment, the critical accounting policies of our company that will help you understand our consolidated financial statements, the principal factors affecting our results of operations, and our liquidity and capital resources. This discussion should be read in conjunction with our consolidated financial statements, the factors set forth under "Item 1A. Risk Factors" and "Cautionary Statement Regarding Forward-Looking Statements" and all other financial information contained elsewhere in this annual report. All dollar amounts are expressed in United States dollars (unless otherwise stated) and, other than those expressed in millions of dollars, have been rounded to the nearest thousand.

We prepare our consolidated financial statements in accordance with Canadian GAAP, with a reconciliation to U.S. GAAP, as disclosed in note 25 of the notes to our consolidated financial statements. For a description of the material differences between Canadian GAAP and U.S. GAAP as they relate to our consolidated financial statements, see note 25 of the notes to our consolidated financial statements.

Overview

We operated businesses in two segments during 2008. Through WowWee (our business segment established by the acquisition in November 2007, and currently comprised of WowWee Group Limited, WowWee Canada Inc., WowWee USA, Inc. and WW Sablon Holdings), we design, develop, market and distribute technology-based, consumer robotic, toy and entertainment products. Through Optimal Payments Corp. we process credit card payments for retail point-of-sale merchants.

On October 1, 2008, we sold substantially all of the assets of the payments processing segment that were used exclusively in the business of processing payments for "card-not-present" transactions for a cash consideration of $7.0 million, and on August 29, 2008, we sold substantially all of the assets of the payment processing segment that were used exclusively in the business of processing payments for Canadian "card-present" transactions, for cash consideration of $1.5 million with up to an additional $0.5 million receivable in the future, contingent on the achievement of certain earnings goals. The results of operations for these business segments are included in discontinued operations in the consolidated statements of operations, and the remaining assets and liabilities of these segments are classified as discontinued in the consolidated balance sheets. Subsequent to year end, we also entered into agreements for the sale of two portfolios of residual payments from merchant processing transactions for a total consideration of approximately $12.0 million. See note 27 of the notes to our consolidated financial statements. The remaining elements of the payment processing operations consist of two U.S. "card-present" merchant portfolios, both of which process credit card payments primarily for small and medium-sized retail point-of-sale merchants and are wholly reliant on independent sales representatives. We manage these operations through a management services agreement with a third party; we do not employ any people in connection with these two portfolios

On August 29, 2008, we acquired Sablon Distribution S.A., a distributor of toy products in the Benelux countries, Austria and Germany, based in Wauthier-Braine, Belgium. The acquisition strengthens and broadens WowWee's direct distribution model and positions WowWee closer to retailers and end users in Sablon Distribution's markets. The former owners and senior management team of Sablon Distribution remain with the company and they continue to operate in the same capacities. The acquisition was completed at an all-cash price of approximately $5.3 million (EUR3.8 million) paid upon completion of the acquisition plus up to an additional $1.7 million (EUR1.2 million) payable in the first quarter of 2009 based upon the consolidated net equity of Sablon Distribution at the end of 2008, as well as an earnout based on the consolidated net revenues of Sablon Distribution in each of 2009 and 2010.

We expect the unfavorable economic conditions experienced in 2008 to continue into 2009. We also expect WowWee's revenues to be under pressure in 2009 as a result of a continued pull-back in consumers' willingness to spend and retailers' desire to reduce inventories, weakening foreign exchange in international markets, and the sale of fewer entertainment-related products in 2009. As a result, WowWee is managing its business based on reduced revenue assumptions and taking actions intended to improve gross margins and strengthen its balance sheet, including the following:

• WowWee continues to focus on lower price point products

• WowWee continues to renegotiate product costs with vendors

• WowWee is reassessing its advertising spending and strategy with the expectation that 2009 advertising expense will be at the low end of its historical range

• WowWee intends to prudently manage its receivable and inventory levels

• WowWee is planning to tightly manage its capital expenditures.

We intend to focus on gross margins and the preservation of cash in 2009. (See "Liquidity and Capital Resources - Current Economic Environment").

Our Industry Segments

We operated in two segments during 2008: WowWee (consumer, robotic, toy and entertainment products) and Optimal Payments (payment processing) (see note 19 of the notes to our consolidated financial statements).

WOWWEE

Based in Hong Kong, with offices in Carlsbad, California, New York, New York, Wauthier-Braine, Belgium, and Montreal, Quebec, WowWee designs, develops, markets and distributes technology-based, consumer robotic, toy and entertainment products that can be sold at a variety of price points. For 2008, WowWee's product offering encompassed five distinct lines: WowWee Robotics, WowWee Flytech, WowWee Alive, WowWee Technologies and Think Wow Toys. See "Item
1 - Business" for details of WowWee's product lines.

WowWee products are sold in a range of brick and mortar channels. Some of our retail customers in the U.S. also carry certain WowWee products on their Internet sales sites. Online sales of WowWee's products are also made through Internet-based "e-tailers" such as Amazon.com and Buy.com.

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

Within the United States, Canada and Europe, WowWee sells its products directly to its retail customers through its direct sales channel and through independent sales representatives. For retailers across the rest of the world, WowWee utilizes a network of distributors located in various jurisdictions. In 2009, WowWee intends to distribute its products in Europe directly to retailers through Sablon. WowWee products are also available for sale through WowWee's Internet-based store (http://www.wowweestore.com). In 2008, approximately 62% of its products were sold in North America, with the balance being sold internationally. WowWee does not have written agreements with its customers. Instead, sales are made based on purchase orders, primarily against letters of credit. The majority of orders are traditionally written during the first two quarters of the year, with shipments occurring throughout the year as new product becomes available. The majority of product shipments occur during the third and fourth quarters of the year. Revenue is recognized when (i) persuasive evidence of an arrangement exists; (ii) products are shipped to customers who assume risk of loss, (iii) collection of the respective receivable is probable and (iv) sales price is fixed or determinable. Accruals for customer discounts, rebates, incentives and allowances are recorded when the related revenues are recognized, as a reduction of revenues.

WowWee's engineering and design team develops new technologies using internal capabilities and seeks to identify emerging or underutilized innovations that are currently being developed or that are available in the marketplace. In order to leverage the man-hours invested in prior products, older generations of products frequently form the foundation for the next generation of products as well as new product lines. New technologies are then integrated to enhance the overall functionality of the product. In sourcing technologies, WowWee reviews the latest technology innovations at trade-shows, conferences, colleges and universities, on the Internet, and through word-of-mouth. WowWee regularly reviews technologies or product concepts from third party sources that it believes could

have potential synergies with WowWee's current product line or that could be successfully commercialized based upon WowWee's development process. WowWee also licenses third party technologies for development within unique consumer applications developed by WowWee.

Significant Developments in this Segment in 2008

On August 29, 2008, we acquired Sablon Distribution S.A., a distributor of products in the Benelux countries, Austria and Germany, based in Wauthier-Braine, Belgium. The acquisition strengthens and broadens WowWee's direct distribution structure and positions WowWee closer to retailers and end users in Sablon Distribution's markets. The former owners and senior management team of Sablon Distribution remain with the company and they continue to operate in the same capacities. The acquisition was completed at an all-cash price of approximately $5.3 million (EUR3.8 million) paid upon completion of the acquisition plus up to an additional $1.7 million (EUR1.2 million) payable in the first quarter of 2009 based upon the consolidated net equity of Sablon Distribution at the end of 2008, as well as an earnout based on the consolidated net revenues of Sablon Distribution in each of 2009 and 2010.

OPTIMAL PAYMENTS

Optimal Payments Corp. processes credit card payments for retail point-of-sale merchants.

Optimal Payments generates revenues primarily from fees charged to merchants for processing services. Fees charged to merchants typically include a discount rate, based upon a percentage of the dollar amounts processed, and a variety of fixed transaction fees. Merchant fees charged are based upon the merchant's transaction volume. Other fees are derived from a variety of fixed transaction fees, including fees for monthly minimum charge volume requirements, statement fees, annual fees and fees for other miscellaneous items. Discount and other fees related to payment transactions are recognized at the time the merchant's transactions are processed. Revenues derived from service fees are recognized at the time the service is performed.

Significant Developments in this Segment in 2008

On October 1, 2008, we sold substantially all of the assets of the payments processing segment that were used exclusively in the business of processing payments for "card-not-present" transactions for a cash consideration of $7.0 million and on August 29, 2008, we sold substantially all of the assets of the payment processing segment that were used exclusively in the business of processing payments for Canadian "card-present" transactions for cash consideration of $1.5 million with up to an additional $0.5 million receivable in the future, contingent on the achievement of certain earnings goals. The results of operations for these business segments are included in discontinued operations in the consolidated statements of operations, and the remaining assets and liabilities of these segments are classified as discontinued in the consolidated balance sheets. Subsequent to year end, we also entered into agreements for the sale of two portfolios of residual payments from merchant processing transactions for a total consideration of approximately $12.0 million. See note 27 of the notes to our consolidated financial statements. The remaining elements of the payment processing operations consist of two U.S. "card-present" merchant portfolios, both of which process credit card payments primarily for small and medium-sized retail point-of-sale merchants and are wholly reliant on independent sales representatives we manage these operations through a management services agreement with a third party; we do not employ any people in connection with these two portfolios.

Seasonality

Revenue derived from the payments processing business segment is currently not subject to seasonality.

Revenue from the WowWee business segment (consumer robotic, toy and entertainment) is subject to seasonal variability. In 2008, the majority of our net sales were made in the third and fourth quarters. Generally, the first quarter is the period of lowest shipments and sales in our business and the toy industry generally and therefore the least profitable due to various fixed costs. Seasonality factors will cause our operating results to fluctuate significantly from quarter to quarter. Our results of operations may also fluctuate as a result of factors such as the timing of new products (and related expenses), the advertising activities of our competitors, delivery schedules set by our customers and the emergence of new market entrants. We believe, however, that the low retail price of our lower-priced products may be less subject to seasonal fluctuations than our higher priced toy products.

These seasonal purchasing patterns and requisite production lead times causes risk in our business associated with the underproduction of popular toys and the overproduction of toys that do not match consumer demand. Retailers are also attempting to manage their inventories more tightly in recent years, requiring us to ship

products closer to the time the retailers expect to sell the products to consumers. These factors increase the risk that we may not be able to meet demand for certain products at peak demand times, or that our own inventory levels may increase due to the need to pre-build products before orders are placed.

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

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

Critical Accounting Policies and Estimates

Our consolidated financial statements have been prepared in accordance with Canadian GAAP, which requires us to make numerous estimates and assumptions. Financial results as determined by actual events could differ from those estimates and assumptions, and therefore affect our reported results of operations and financial position. Our significant accounting policies are more fully described in notes 3 and 4 of the notes to our consolidated financial statements. The critical accounting policies described here are those that are most important to the depiction of our financial condition and results of operations. The preparation of financial statements also involves significant management judgment in making estimates about the effect of matters that are inherently uncertain. While best estimates have been used for reporting financial statement items subject to measurement uncertainty, management considers that it is possible, based on existing knowledge, that changes in future conditions in the near term could affect the reported amounts of assets and liabilities and disclosures in our consolidated financial statements. "Near term" is considered to be within one year from the date of the financial statements.

Goodwill and Other Intangibles

We account for business acquisitions using the purchase method. Accordingly, the purchase price of a business acquisition is allocated to its identifiable net assets, including identifiable intangible assets, on the basis of estimated fair values as at the date of purchase, with any excess being assigned to goodwill. We estimate the fair value of assets and liabilities acquired at the date of acquisition using a projected discounted cash flow method and other valuation methods. We make a number of significant estimates when calculating fair value using a projected discounted cash flow method. These estimates include estimating projected future cash flows, the number of years used, the discount rate and others. We believe that our estimates and valuation methods are reasonable. They are consistent with our inherent planning and reflect our best estimates, but they have inherent uncertainties that management may not be able to control.

Goodwill is not amortized but rather evaluated under an impairment approach. Factors we consider important which could trigger an impairment review include the following: a) significant underperformance relative to expected historical or projected future operating results; b) significant changes in the manner of our use of the acquired assets or the strategy for our overall business; and c) significant negative industry or economic trends.

Due to the subjective nature of the impairment analysis, significant changes in the assumptions used to develop the estimate could materially affect the conclusion regarding the future cash flows necessary to support the valuation of long-lived assets, including goodwill. The valuation of goodwill involves a high degree of judgment and consists of a comparison of the fair value of a reporting unit with its book value. Based on the assumptions underlying the valuation, impairment is determined by estimating the fair value of a reporting unit and comparing that value to the reporting unit's book value. If the fair value is more than the book value of the reporting unit, an impairment loss is not indicated. If impairment exists, the fair value of the reporting unit is allocated to all of its assets and liabilities excluding goodwill, with the excess amount representing the fair value of goodwill. An impairment loss is measured as the amount by which the book value of the reporting unit's goodwill exceeds the estimated fair value of that goodwill.

To determine the fair value of our reporting units, we generally use a present value technique (discounted cash flow). The factor most sensitive to change with respect to our discounted cash flow analyses is the estimated future cash flows of each reporting unit which is, in turn, sensitive to our estimates of future revenue growth and margins for these businesses. If actual revenue growth and/or margins are lower than our expectations, the

impairment test results could differ. We applied what we believe to be the most appropriate and consistent valuation methodology for each of the reporting units. If we had established different reporting units or utilized different valuation methodologies, the impairment test results could differ.

Other intangible assets with finite lives continue to be amortized over their estimated useful lives. The amounts recorded as intangible assets at the date of acquisition represent the estimated fair value of these assets based on estimated future cash flows discounted at appropriate discount rates. For intangibles with finite lives, we make estimates of future cash flows to be generated from the related assets.

In 2008, we recorded impairment losses of $66.9 million on goodwill and other intangibles relating to continuing operations and an additional $18.3 million are recorded in the results from discontinued operations. See "Results of Operations".

Allowance for Doubtful Accounts

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

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

Revenue Recognition

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

Reserve for Inventory Obsolescence

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

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

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

Income Taxes

We provide for income taxes using the asset and liability method of tax allocation. Under this method, future income tax assets and liabilities are determined based on deductible or taxable temporary differences between financial statement values and tax values of assets and liabilities using substantively enacted income tax rates expected to be in effect for the year in which the differences are expected to reverse. We establish a valuation allowance against future income tax assets if, based on available information, it is more likely than not that some or all of the future income tax assets will not be realized. In assessing the reliability of tax assets, we consider whether

it is more likely than not that some portion or all of the tax assets will not be realized. The ultimate realization of the future tax assets is dependent upon the generation of future taxable income during the periods in which the temporary differences become deductible. We considered the scheduled reversal of tax liabilities, projected future taxable income, and tax planning strategies in making this assessment.

We accrue a tax reserve for additional income taxes and interest, which may become payable in future years as a result of audit adjustments by tax authorities. The reserve is based on management's assessment of all relevant information, and is periodically reviewed and adjusted as circumstances warrant. As of December 31, 2008, our income tax reserves are approximately $8.5 million.

Stock-based Compensation

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

Contingent liabilities

Our former gaming payment processing services segment derived a substantial portion of its revenue prior to October 13, 2006 from processing transactions from U.S. based gaming. Therefore, we may be exposed to adverse consequences as a result of enforcement proceedings, governmental investigations or lawsuits initiated against us in jurisdictions where gaming is restricted or prohibited. Following announcements by the U.S. Attorney's Office in the Southern District of New York relating to its investigation of the U.S. Internet gambling industry, we announced on May 8, 2007 that we had initiated discussions with the U.S. Attorney's Office in the Southern District of New York and were in the process of responding to a voluntary request for information issued by the U.S. Attorney's Office. We have not recorded any provision for this matter because . . .