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Sunday, September 17, 2006

BGII update

I had this on the back burner and the company released the Q2 results yesterday. Most of this was written a week or more ago.

BGII (website, old sec, yahoo) produces and distributes sweepstakes gaming machines. There is the potential that their activities are illegal.
However, as a result of the unique nature of its machines and the fact that the machines are relatively new, there is uncertainty among regulators as to which laws regulate the Company's business activities. This uncertainty appears to be caused by several factors including: (1) the fact that a sweepstakes is by definition a game of chance, although without the element of consideration; (2) the Company's machines one of the first to use a video machine to conduct a sweepstakes; and (3) the Company's machines resemble an "8-liner" which is a gambling device that is subject to various regulations. Although the Company believes it has legal grounds to conclude that its activities are in compliance with law in states that it operates, in certain jurisdictions certain regulators have claimed that the Company's activities are subject to, and in violation of, certain criminal statutes regarding gambling, gambling devices and lotteries.
In 2001 and 2002, they had multiple seizures of cash and machines.

On March 18, 2003, they settled with the SEC which had issued an order directing them to cease and desist from activities relating to anti-fraud and periodic reporting rules.

Reid Funderburk of Austin, TX owns (or owned) 2 million shares and 215K options. Some family members also own shares.

I last looked at BGII here at their unaudited full-year report for the period ending Dec 31, 2005.

They released their Q1 results on their website and on the pink sheets site. It was issued on May 15.

They also released a Rule 15(c)-211(a)(5) disclosure, "Issuer Information Statement" for the period ending 5/15/06, which seems to be essentially the same as the 15c2-11 statement for 12/31/05 issued in March.

The reason for looking at this company is that the stock has been dropping. The last sale was 52 cents. It was 62 cents when I last looked at it.

Q1 2006 Report

Just a quick overview: they have net cash and marketable securities of around $2 million. They had 14.8 million shares at the end of the quarter with 1.2 million options outstanding. Not much dilution in 2005 or Q1 2006. Revenue for Q1 increased to $1.38 million from $1.08 million in the prior year's Q1. Gross margins are over 82%! Operating margins are over 50%! Net margins are over 32%! Net income for Q1 was $449K. Operating cash flow is $543K with depreciation of only $29K. Capex was $81K. The return on working assets is enormous.

I'd assume a totally diluted share count of 18 million shares, which would give them earnings of 2.5 cents per share for Q1. It doesn't seem to be a seasonal business, so they might be expected to earn 10 cents per year (especially given that revenues are rising and they're now expanding into Alabama based on a court ruling). They're also buying back shares. So they have net cash of about 11 cents per share and you might think they'd earn something like 10 cents per share per year. But Q2 results below were down quite a bit. Maybe they'd earn 6 cents per totally diluted share.

Of course there are the legal issues, the question about who they are and can they be trusted, and the fact that the results are not audited. The good thing is that the business is simple and very much cash related.

These results are unaudited. The CEO has a sort of certification on the front page, but that's not the same thing. With auditors, you have people who are outsiders, who spent a long time and a lot of effort to be qualified to serve as auditors, and who don't have all that much to gain by approving statements that misrepresent what's going on in the business (but they have a lot to lose). That doesn't always work as a corruption eliminator, but it certainly helps a lot. You'll always have some cases like Enron, but you'd have a lot more without auditors.

The quarter ends March 31, 2006.

Balance Sheet:
Current Assets:
cash *********************
marketable securities ***
accounts receivable ***

Property Plant and Equip ****................... . = depreciated
minority interest in BrightServe **
Total Assets *********************************

Current Liabilities:
tax payable **
debt, current portion ***
Total Liabilities *****

Equity ****************************

Net Cash + securities *******************

Income Statement:
Revenue                 ****************************
Cost of revenue -----
G and A ---------
tax -----
Net Income *********

Cash Flow Statement:
Operating Activities
Net Income *********************************************
stock based compensation --
depreciation +++
provision for bad debt +
stock/warrants issued for services +
unrealized gain on investments -
increase in accounts receivable ----
decrease in accounts payable -----
increase in taxes payable +++++++++++++++++
Net cash provided by ops *******************************************************

Investing Activities
purchase of securities -
purchase of investment -------------------------
capex --------

Finance Activities

Net increase in cash *********************

$545K of cash in in the bank in excess of FDIC insurance coverage

The "marketable securities" consist of certificates of deposit with remaining maturities of more than 3 months but less than a year.

Straight line depreciation for accounting but accelerated depreciation used for taxes (which explains a lot of the taxes payable liability).

No significant trade credit risk concentration.

Revenue recognition is based on a percentage of revenue generated from the machines less the sweepstakes prizes and is recognized when the revenue is generated. Machine rental is generally billed weekly. Phone card supplies are recognized when the supplies are delivered to the customer, shipped COD.

Unrealized gain seems very straight forward.

PP&E consists mostly of furniture which is almost entirely depreciated. Also $273K of vehicles.

BGII bought a 25% interest in BrightServe LLC for $249K. They provide contractor programs to property insurance companies for insurers to control costs and improve customer service. At 25%, the investment is not consolidated onto the balance sheet. No dividends or distributions. No financial statements yet.

Debt consists of non-interest bearing note payable to machine supplier. $282K current portion. I like this: within note 5, there's a tag saying "See Note 5". Oops.

Operating lease obligations per year are low ($49K, $66K, $55K for each year).

BGII had seizures of equipment in 2001 and 2002. I noted here that they repriced their stock options. In 2004 they repriced all their outstanding options to 3 cents (from a range of 2.5 to 64 cents). BGII recognizes changes in the value of the options.

In Sept 2002, they entered into an agreement with a machine supplier to convert 100 of BGII's machines and place them into Native American gambling casinos in Alabama and Oklahoma. $472K placement fee paid via 75% of machine revenues. The supplier never did it and BGII is trying to get the machines back and remove the fee as a liability.

1.17 million options outstanding.

500K warrants were issued and exercised in 2005 for services.

Q2 2006
Q2 2006 results: This was issued yesterday (Sept 16, 2006)
Revenues are down 5% to $1.2 million. Net income is down to $158K. This is down from $343K in last year's Q2 and down from $449K in Q1 of this year.
Unfortunately the combination of increasing competition and the redeployment of equipment from lesser performing locations to what we believe will be higher performing locations has impacted both revenue and expenses during the second quarter. The challenging environment has continued into the third quarter with the hot dry summer contributing to higher seasonal fluctuation than we have seen in prior years.
Well, overall I'd say it's probably selling for what it's worth, given the long term uncertainties of the business and the lack of auditors.
cat smack

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