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PTEK > SEC Filings for PTEK > Form 10-K on 14-Mar-2013All Recent SEC Filings

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Form 10-K for POKERTEK, INC.


14-Mar-2013

Annual Report


Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations.

You should read the following discussion of our results of operations and financial condition together with the Selected Financial Data and the audited historical consolidated financial statements and related notes included elsewhere. This discussion contains forward-looking statements and involves numerous risks and uncertainties, including, but not limited to, those described in the "Risk Factors" section of this prospectus. Actual results may differ materially from those contained in any forward-looking statements.
Forward-looking statements speak only as of the date they are made. We undertake no obligation to update or revise such statements to reflect new circumstances or unanticipated events as they occur, and you are urged to review and consider disclosures that we make in this and other reports that discuss factors germane to our business.

Company Overview and Business Strategy

We are engaged in the development, manufacture and marketing of electronic table games and related products for casinos, cruise lines, racinos, card clubs and lotteries worldwide. We distribute our electronic table games using an internal sales force, complemented by distributors and sales agents in select geographic areas, generally on a recurring revenue participation model, recurring revenue fixed license fee model or as a sale of hardware combined with recurring license and support fees. As of December 31, 2012, our installed base consisted of 2,310 gaming positions, composed of 2,160 PokerPro and 150 ProCore positions.

PokerPro is a 10-seat electronic poker table that allows operators to offer the most popular player-banked games and tournaments. The PokerPro system offers cash games, single-table tournaments and multi-table tournaments with an extensive game library including Texas Hold'em, Omaha, Razz, and Seven Card Stud. Game rules and limits, including blinds, antes, rake structures and house rules, are completely configurable.

ProCore is a unique electronic table game platform that expands on the PokerPro technology and allows multiple house-banked games to be run on a single, efficient, economical platform. The versatility of the ProCore system allows operators to add new game content as it is released. Games and house rules can be customized easily to meet property and regulatory requirements, making it an ideal choice for operators looking to add an automated solution to their gaming floor.

We distribute our electronic table games using an internal sales force, complemented by distributors and sales agents in select geographic areas, generally on a recurring revenue participation model, recurring revenue fixed license fee model or as a sale of hardware combined with recurring license and support fees.

We use an analytical approach and segment the market for our electronic table games into three categories: those with no competition from manual table games; those with limited competition from manual table games; and those markets characterized by a high level of saturation of manual table games. We intentionally focus the majority of our sales and marketing effort on those markets that have either no or limited competition from manual table games. We also opportunistically place tables in markets with higher saturation of manual table games where we have a unique value proposition for the operators and players. This approach allows us to narrow our focus, directing our limited resources in a targeted approach, and has significantly improved customer retention.

In those identified markets, we plan to increase our dominant position in electronic poker with our PokerPro system. With the recent addition of the ProCore platform, the addressable opportunities are expanded with blackjack and other electronic house-banked games. The market for electronic poker is a smaller niche where we enjoy a dominant market position. The market for electronic blackjack and specialty player-banked games is larger, but also characterized by more competition. We believe our products offer significant competitive advantages over other competing systems and platforms and, as a result, we are well-positioned to increase our market share of the electronic poker market, while increasing the market for electronic house-banked games and displacing competitor products in those markets.


We have identified key markets worldwide that meet our market segmentation criteria and we believe those markets provide actionable opportunities to grow significantly. We are also monitoring changes in regulation at the state, federal and international level and believe that budgetary, legislative and other factors are becoming favorable for expansion of gaming and electronic table games in particular.

Results of Operations

Statement of Operations - Selected Data

                                                         Year Ended December 31,
                                                    2012             2011         Change
Revenue
  License and service fees                       $ 4,367,132     $  4,964,232       -12.0 %
  Sales of systems and equipment                     810,147        1,532,191       -47.1 %
   Total revenue                                   5,177,279        6,496,423       -20.3 %

Gross profit                                       3,757,928        4,554,759       -17.5 %
  Percentage of revenue                                 72.6 %           70.1 %

Operating expenses                                 4,448,060        6,051,966       -26.5 %

Interest expense, net                                 69,351           93,844       -26.1 %
Income tax provision                                  86,908           50,569        71.9 %

Net loss from continuing operations                 (846,391 )     (1,641,620 )      48.4 %
Net income (loss) from discontinued operations        52,263         (169,032 )     130.9 %
Net loss                                            (794,128 )     (1,810,652 )      56.1 %

Results of Operations for the Year Ended December 31, 2012 Compared to the Year Ended December 31, 2011

Revenue.?Revenue from North America increased with new installations in Canada and the United States in the second half of 2012. However, revenue comparisons to the prior year were impacted by several factors, including the timing of our reentry in Mexico, a trend of declining economic conditions in Eastern Europe, and a shift in our revenue mix from hardware sales to more recurring revenue in 2012. As a result, total annual revenue was $5.2 million in 2012 compared to $6.5 million in 2011, a reduction of 20.3%.

Revenue from license and service fees was $4.4 million for the year ended December 31, 2012 compared to $5.0 million for the year ended December 31, 2011. In 2012, our revenue was more heavily weighted towards recurring revenue license and service fees, whereas the prior year was more heavily weighted towards sales of systems and equipment. The change in sales mix creates unfavorable total revenue comparisons to prior year, but also represents an increase in the base of recurring revenue carrying forward to 2013.

Gross profit.?Gross profit was $3.8 million for year ended December 31, 2012 compared to $4.6 million for the year ended December 31, 2011, a decrease of 17.5%. Gross profit as a percent of revenue was 72.6% and 70.1% for the years ended December 31, 2012 and 2011, respectively. Gross profit margins improved primarily due to changes in sales mix which are more heavily weighted to higher margin recurring revenue, as well as reduced product costs and depreciation.

Operating expenses.?Operating expenses decreased by $1.6 million (26.5%) to $4.5 million for the year ended December 31, 2012 compared to $6.1 million for the year ended December 31, 2011 as we implemented cost reduction initiatives which have streamlined our overhead and reduced spending on personnel, regulatory approvals, and professional fees.

Interest expense, net.?Interest expense decreased 26.1% to $69,351 for the year ended December 31, 2012 from $93,844 for the year ended December 31, 2011. The decrease is primarily attributable to lower interest expense on lower balances of the Founders' Loans (described below), lower fees associated with our credit facility at Silicon Valley bank (described below), and the payoff of the capital lease obligations in 2011.

Income tax provision.?Income tax provision was $86,908 for the year ended December 31, 2012 and $50,569 in the comparable period of 2011. The increase in income tax provision was attributable to higher withholdings in foreign jurisdictions. The income tax provision increased as compared to the prior year due to increased revenue from Canada and other foreign jurisdictions subject to withholding and also included a non-recurring true-up related to income taxes withheld in Romania.


Net loss from continuing operations.?Net loss from continuing operations for the year ended December 31, 2012 was $0.8 million, an improvement of $0.8 million (48.4%) from $1.6 million for the year ended December 31, 2011. Net loss from continuing operations was $0.11 per share for the year ended December 31, 2012, an improvement of $0.13 (54.2%) per share compared to $0.24 for the comparable period of 2011. The improvement in net loss from continuing operations resulted primarily from reductions in operating expenses.

Net income (loss) from discontinued operations.?Net income from discontinued operations for the year ended December 31, 2012 was $52,263 ($0.01 per share) compared to a net loss from discontinued operations of $169,032 ($0.03 per share) for the year ended December 31, 2011

Net loss.?Net loss for the year ended December 31, 2012 was $0.8 million, an improvement of $1.0 million (56.1%) from $1.8 million for the year ended December 31, 2011. Net loss per share was $0.10 for the year ended December 31, 2012, an improvement of $0.17 (63.0%) per share compared to a net loss per share of $0.27 for the comparable period of 2011. The improvement in net loss resulted primarily from reductions in operating expenses.

Liquidity and Capital Resources

We have incurred net losses for all annual periods since inception. We have typically funded our operating costs, research and development activities, working capital investments and capital expenditures associated with our growth strategy with proceeds from the issuances of our common stock and other financing arrangements. In order to finance our operations, we entered into equity transactions to raise capital and also maintained a credit facility, which are described in more detail below and in the notes to our financial statements included elsewhere in this report. We expect our revenues and earnings to increase in future periods, and we expect to reinvest these earnings in additional inventory and working capital to fund anticipated grown in our recurring revenue business.

Discussion of Statement of Cash Flows

                                                        Years Ended December 31,
                                                  2012            2011           Change
Continuing Operations:
  Net cash used in operating activities        $  (842,870 )   $  (882,230 )   $    39,360
  Net cash used in investing activities             (1,378 )       (18,925 )   $    17,547
  Net cash provided by financing activities        405,049         817,261     $  (412,212 )
   Net cash used in continuing operations         (439,199 )       (83,894 )      (355,305 )
Net cash provided by operating activities of
discontinued operations                             68,727          23,944          44,783
Net increase (decrease) in cash and cash
equivalents                                       (370,472 )       (59,950 )
Cash and cash equivalents, beginning of year       606,229         666,179
Cash and cash equivalents, end of period       $   235,757     $   606,229

For the year ended December 31, 2012, net cash used in operating activities from continuing operations was essentially unchanged, improving 4.5% to $842,870 compared to $882,230 for the year ended December 31, 2011. While net loss from continuing operations improved by approximately $0.8 million, non-cash add-backs decreased by approximately $1.0 million on lower depreciation, shared-based compensation expense and doubtful accounts, and cash used for working capital decreased by approximately $0.2 million as compared with 2011.

Net cash used in investing activities decreased $17,547 to $1,378 for the year ended December 31, 2012 compared to $18,925 for the year ended December 31, 2011. As part of our ongoing cost reduction measures, we have curtailed capital expenditures, with the exception of investments required to support operations, including replacing aged equipment where necessary.

Net cash provided by financing activities was $405,049 for the year ended December 31, 2012, compared to net cash provided by financing activities of $817,261 for the year ended December 31, 2011. Cash provided by financing activities is due primarily to the issuance of common stock in the years ended December 31, 2012 and 2011. As our operating results improved in 2012, we reduced the level of our common stock being issued to fund our operations as compared to the prior year.

Net cash provided by operating activities of discontinued operations was $68,727 for the year ended December 31, 2012 compared to $23,944 for the year ended December 31, 2011. This increase is attributable to the sale of the remaining discontinued inventory during 2012.


Equity Offerings?

Private Placement Transactions

During August 2012, we sold 361,239 shares of our common stock to four unaffiliated accredited investors (as defined under the Securities Act) at a price of $0.675 for an aggregate purchase price of $240,000 in a transaction exempt from the registration requirements of the Securities Act pursuant to
Section 4(5) and Rule 506 of Regulation D promulgated under the Securities Act.

On March 1, 2013, we sold 460,000 shares of our common stock to ten unaffiliated accredited investors (as defined under the Securities Act) at a price of $1.05 per share for an aggregate purchase price of $483,000 in a transaction exempt from the registration requirements of the Act pursuant to Section 4(5) and Rule 506 of Regulation D promulgated under the Act. This private placement transaction occurred subsequent to December 31, 2012 and is therefore not reflected in the accompanying consolidated financial statements.

Lincoln Park Transaction

In 2010, we entered into a Purchase Agreement with Lincoln Park Capital, LLC ("LPC"), pursuant to which we had the right, subject to the satisfaction of certain conditions, to sell and LPC was obligated to purchase from us up to $5,000,000 worth of shares of our common stock. One of those conditions was that the shares had to be covered by an effective registration statement at the time of sale. In 2012, we sold an aggregate of 263,511 shares of our common stock to LPC for gross proceeds of $189,608 under the Purchase Agreement. As of December 31, 2012, all of the shares covered by the registration statement filed in connection with the Purchase Agreement had been issued.

The registration statement that we filed with respect to the LPC Purchase agreement was declared effective on November 10, 2010. On March 25, 2011 we filed a prospectus supplement to the prospectus included in that registration statement that included our Annual Report on Form 10-K for the year ended December 31, 2010 (the "2010 Annual Report"). The 2010 Annual Report, including our audited financial statements as of and for the year ended December 31, 2010, and the notes thereto, were physically attached and incorporated into the prospectus supplement. At the time, we believed that the filing of this prospectus supplement fulfilled our obligation to update the registration with current financial information pursuant to Section 10(a)(3) of the Securities Act. However, we were subsequently advised that the proper manner for updating a registration statement is to file a post-effective amendment. As a result, 93,175 shares sold pursuant to that prospectus in open market transactions from December 30, 2010 through January 23, 2011 violated Section 5 of the Securities Act, and the purchasers of those shares may have rescission rights (if they still own the shares) or claims for damages (if they no longer own the shares). Shares that are subject to rescission or redemption requirements that are outside of our control are classified outside of permanent equity until they are no longer subject to rescission or redemption. Accordingly, we reclassified $71,183 as common stock subject to rescission. To date, no claims for rescission or damages have been made.

Warrants

As of December 31, 2012, the following warrants were outstanding: 20,000 common stock warrants at an exercise price of $2.50 with an expiration date of March 31, 2015 issued in connection with a private placement in May 2010, and 40,000 common stock warrants at an exercise price of $2.75 with an expiration date of December 29, 2015 issued in connection with the LPC transaction.

Debt Financings

Founders' Loan

On March 24, 2008, we entered into a Note Purchase Agreement (the "Note Purchase Agreement") for $2.0 million with Lyle A. Berman, James T. Crawford, Arthur L. Lomax and Gehrig H. White (collectively, the "Lenders"), all of whom were founders of PokerTek and members of our Board of Directors at the time. Pursuant to the terms of the Note Purchase Agreement, the Lenders loaned us $2.0 million (the "Founders' Loan"). Since that time the principal balance of the debt outstanding under the Founders' Loan has been reduced to $300,000 through a series of transactions, including the transaction described below which took place during the year ended December 31, 2012. The Founders' Loan contains no restrictive covenants and is collateralized by security interests in 18 PokerPro systems. Such security interests have been subordinated to the SVB Credit Facility.

On July 23, 2012, we entered into a Second Loan Modification Agreement (the "Second Loan Modification Agreement") with Messrs. Lomax and White, the remaining makers of the Founders' Loan. Pursuant to the Second Loan Modification Agreement, $100,000 of the remaining principal balance of the Founders' Loan was converted into 133,334 shares of our common stock, reflecting a conversion price of $0.75 per share, the closing price of a share of our common stock on Friday, July 20, 2012 as reported by The NASDAQ Capital Market.


On September 18, 2012, we issued 405,405 shares of our common stock to Gehrig H. White in full satisfaction of the entire outstanding principal amount of a note held by Mr. White. The shares were valued at $0.74 per share, which represented the consolidated closing bid price per share on the NASDAQ Capital Market on September 17, 2012.

As a result of this transaction, the remaining principal balance on the Founders' Loan was reduced to $300,000.

As a result of the modifications described above, the terms of the Founders' Loan as of December 31, 2012 are as follows:

(i) From July 23, 2012 through December 31, 2012, payments continued to be interest only, calculated at the rate of 9% per annum, on the remaining principal balance ($300,000).

(ii) Beginning February 1, 2013 and the first day of each calendar month thereafter until January 1, 2017, we will make monthly payments of interest and principal in the amount of $7,465.51, the amount required to fully amortize the remaining principal balance and the accrued interest thereon over 48 months. In the event of a prepayment, the monthly amount would be recalculated.

(iii) The remaining principal balance of the Founders' Loan and all accrued but unpaid interest thereon is finally due and payable on December 31, 2016.

Credit Facility

We maintain a credit facility with Silicon Valley Bank to support our working capital needs (the "SVB Credit Facility"). As of March 1, 2013, we entered into the "Seventh Amendment to Loan and Security Agreement", which extended the maturity date for the facility to January 16, 2014. Maximum advances are determined based on the composition of our eligible accounts receivable and inventory balances with a facility limit of $625,000. The SVB Credit Facility bears interest at an annual rate equal to the greater of 6.5% or prime plus 2.0%. As of December 31, 2012 $550,000 was available under the SVB Credit Facility, based on our accounts receivable and inventory levels, and there were no amounts outstanding under the facility.

Operations and Liquidity Management

Historically, we have incurred net losses and used cash from financing activities to fund our operations in each annual period since inception. In recent years, we refocused our business strategies, significantly improved our margins, and reduced our operating expenses, while also expanding our growth opportunities and significantly improving our operating results. We also closed several equity transactions, reduced our long-term debt, and renewed our credit facility to improve our liquidity and provide capital to grow our business.

As of December 31, 2012, our cash balance was $236,000 and availability from our credit line was $550,000. Cash used in operations for the year ended December 31, 2012 was $843,000 including inventory purchases. The level of additional cash needed to fund operations and our ability to conduct business for the next year is influenced primarily by the following factors:

? The pace of growth in our recurring-revenue gaming business, the related investments in inventory and level of spending on development and regulatory efforts;

? The launch of new additional products, entry into new markets, and investments in regulatory approvals;

? Our ability to control growth of operating expenses as we grow the business, expand with new products in new markets;

? Our ability to negotiate favorable payment terms with our customers and vendors;

? Our ability to access the capital markets and maintain availability under our credit line;

? Demand for our products, and the ability of our customers to pay us on a timely basis; and

? General economic conditions as well as political events and legal and regulatory changes.

Our operating plans call for entering new markets, launching new products and accelerating revenue growth while controlling operating expense and working capital levels. As we execute our growth plans, we intend to carefully monitor the impact of growth on our working capital needs and cash balances. We have demonstrated a trend of improving operating results over the past two years, and we expect those improving trends to continue into 2013.

We believe the capital resources available to us from our cash balances, credit facility, cash generated by improving the results of our operations and cash from financing activities will be sufficient to fund our ongoing operations and to support our operating plans for at least the next 12 months. However, we may seek to raise additional capital or expand our credit facility to fund growth. We cannot assure you that, in the event we need additional working capital, adequate additional working capital will be available or, if available, will be on terms acceptable to us. If we are unable to raise additional capital or expand our credit facilities, our ability to conduct business and achieve our growth objectives would be negatively impacted.


Impact of Inflation

To date, inflation has not had a material effect on our net sales, revenues or income from continuing operations.

Off-Balance Sheet Arrangements

We have no off-balance sheet arrangements.

Contractual Obligations

The table below sets forth our known contractual obligations as of December 31,
2012:

                                                  Less than                                             More than
                                     Total          1 year        1 - 3 years       3 - 5 years          5 years

Debt obligations(1)               $   300,000     $   59,571     $     240,429     $            -     $           -
Operating lease obligations(2)        496,344        136,344           360,000                  -                 -
Purchase obligations(3)               434,673        434,673                 -                  -                 -
Other long-term liabilities (4)       323,598        104,104           219,494                  -                 -
      Total                       $ 1,554,615     $  734,692     $     819,923     $            -     $           -

(1) Represents the outstanding principal amount and interest on the Founders' Loan.

(2) Represents operating lease agreements for office and storage facilities and office equipment. We recently exercised an option to extend this lease through August 31, 2016. The operating lease obligations in the table above have been adjusted to reflect that lease as if the extension had been in effect as of December 31, 2012.

(3) Represents open purchase orders with our vendors.

(4) Represents purchase of gaming inventory from Aristocrat International Pty. Limited and its Affiliates ("Aristocrat"), our former international distribution agent.

Customer Dependence

For the year ended December 31, 2012, five of our customers made up approximately 73.2% of our total revenues from continuing operations, with one accounting for 39.8%, a second accounting for 12.3%, a third accounting for 9.2%, a fourth accounting for 6.5%, and a fifth accounting for 5.4%. The loss of any of these customers or changes in our relationship with any of them could have a material adverse effect on our business.

Critical Accounting Policies

The discussion and analysis of our financial condition and results of operations are based on our consolidated financial statements, which have been prepared in accordance with accounting principles generally accepted in the United States. The preparation of these consolidated financial statements requires us to make certain estimates and judgments that affect the reported amounts of assets, liabilities, revenues and expenses and related disclosures. On an ongoing basis, we evaluate these estimates. We base our estimates on historical experience and on various other assumptions that are believed to be reasonable under the circumstances, the results of which form the basis for making judgments about the carrying values of assets and liabilities that are not readily apparent from other sources. Actual results may differ from these estimates under different assumptions or conditions.

We believe that of our significant accounting policies, which are described in Note 1 - "Nature of Business and Significant Accounting Policies" to our consolidated financial statements appearing elsewhere in this report, the following accounting policies involve a greater degree of judgment and complexity. Accordingly, these are the policies we believe are the most critical to aid in fully understanding and evaluating our consolidated financial condition and results of operations.

We completed a 2.5-to-1 reverse stock split on February 24, 2011. As a result of the reverse stock split, every 2.5 shares of common stock were combined into 1 share of common stock. All consolidated financial statements and notes to the consolidated financial statements for periods prior to February 24, 2011 have been retroactively restated to reflect the reverse stock split.

Research and development

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