OPTIMAL GROUP INC - 10-Q Quarterly Report

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-Q

QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d)

OF THE SECURITIES EXCHANGE ACT OF 1934

For the quarterly period ended March 31, 2005

OPTIMAL GROUP INC.

(Exact name of registrant as specified in its charter)

Canada

(State or Other Jurisdiction of Incorporation)

0-28572 98-0160833

(Commission File Number) (IRS Employer Identification No.)

3500 de Maisonneuve Blvd. W., Suite 1700, Westmount, Québec, Canada H3Z 3C1

(Address of Principal Executive Offices, Including Zip Code)

(514) 738-8885

(Registrant's Telephone Number, Including Area Code)

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.

Yes

No _____

Indicate by check mark whether the registrant is an accelerated filer (as defined in Rule 12b-2 of the Exchange Act).

Yes

No _____

At April 30, 2005, the registrant had 22,743,688 Class “A” shares (without nominal or par value) outstanding.

OPTIMAL GROUP INC.

PART I. FINANCIAL INFORMATION

Item 1. Financial Statements

Consolidated Financial Statements of

(Unaudited)

OPTIMAL GROUP INC.

Three-month periods ended March 31, 2005 and 2004

(expressed in U.S. dollars)

OPTIMAL GROUP INC.

Consolidated Financial Statements

(Unaudited)

Three-month periods ended March 31, 2005 and 2004

(expressed in U.S. dollars)

Financial Statements

Consolidated Balance Sheets	4
Consolidated Statements of Operations	5
Consolidated Statements of Deficit	6
Consolidated Statements of Cash Flows	7
Notes to Consolidated Financial Statements	8

OPTIMAL GROUP INC.

Consolidated Balance Sheets

(Unaudited)

March 31, 2005 and December 31, 2004

(expressed in thousands of U.S. dollars)



	March 31, 2005		December 31, 2004
			(Audited)
Assets
Current assets:
Cash and cash equivalents	$ 100,842		$ 62,937
Cash held as reserves	19,206		18,739
Cash held in escrow	827		3,536
Short-term investments	51,949		88,213
Short-term investments held as reserves	2,104		2,104
Settlement assets	11,317		14,375
Accounts receivable	8,619		8,212
Income taxes receivable and refundable investment tax credits	823		773
Inventory	2,896		3,513
Prepaid expenses and deposits	1,797		1,331

	200,380		203,733
Long-term receivables (note 5)	4,243		3,666
Non-refundable investment tax credits	4,452		4,747
Property and equipment	4,738		4,807
Goodwill and other intangible assets (note 6)	74,940		72,505
Deferred costs	165		—
Deferred compensation cost (note 3 (b))	1,538		1,807
Future income taxes	1,406		3,979

	$ 291,862		$ 295,244

Liabilities and Shareholders’ Equity
Current liabilities:
Bank indebtedness (note 7)	$ 8,146		$ 8,301
Customer reserves and security deposits	75,896		77,574
Accounts payable and accrued liabilities	20,036		23,680
Deferred revenue	2,841		3,201
Current portion of obligations under capital leases	276		578
Future income taxes	917		917

	108,112		114,251
Future income taxes	2,033		3,794
Deferred revenue	300		318
Obligations under capital leases	158		200
Shareholders’ equity:
Share capital (note 8 (a))	188,265		184,191
Additional paid-in capital (note 8 (c))	11,030		10,557
Deficit	(16,552	)	(16,583	)
Cumulative translation adjustment	(1,484	)	(1,484	)

	181,259		176,681
Contingencies (note 9)

	$ 291,862		$ 295,244

See accompanying notes to unaudited consolidated financial statements.

OPTIMAL GROUP INC.

Consolidated Statements of Operations

(Unaudited)

Three-month periods ended March 31, 2005 and 2004

(expressed in thousands of U.S. dollars, except per share amounts)





	2005		2004

Revenues	$ 37,394		$ 10,280
Expenses:
Transaction processing and service costs	21,946		7,323
Amortization of intangibles pertaining to
transaction processing and service costs	1,028		182
Selling, general and administrative	9,944		5,276
Stock-based compensation pertaining to selling,
general and administrative (note 10)	1,895		—
Research and development	618		—
Operating leases	942		734
Inventory write-downs pertaining to service costs	—		501
Amortization of property and equipment	638		181
Foreign exchange gains	(110	)	(153	)

	36,901		14,044

Net earnings (loss) from continuing operations before investment
income and income taxes	493		(3,764	)
Investment income	693		185

Net earnings (loss) from continuing operations before income taxes	1,186		(3,579	)


Income tax provision (recovery) (note 11)	1,155		(328	)

Net earnings (loss) from continuing operations	31		(3,251	)
Earnings from discontinued operations, net of income taxes (note 3 (d))	—		58

Net earnings (loss)	$ 31		$ (3,193	)

Weighted average number of shares:
Basic	22,394,674		14,936,235
Plus impact of stock options and warrants	1,917,251		1,012

Diluted	24,311,925		14,937,247

Earnings (loss) per share :
Continuing operations:
Basic	$ 0.00		$ (0.21	)
Diluted	0.00		(0.21	)
Discontinued operations:
Basic	—		0.00
Diluted	—		0.00
Total:
Basic	0.00		(0.21	)
Diluted	0.00		(0.21	)

See accompanying notes to unaudited consolidated financial statements.

OPTIMAL GROUP INC.

Consolidated Statements of Deficit

(Unaudited)

Three-month periods ended March 31, 2005 and 2004

(expressed in thousands of U.S. dollars)

		2,005		2,004

Deficit, beginning of period	$	(16,583)	$	(7,330)

Net earnings (loss)		31		(3,193)

Deficit, end of period	$	(16,552)	$	(10,523)

See accompanying notes to unaudited consolidated financial statements.

OPTIMAL GROUP INC.

Consolidated Statements of Cash Flows

(Unaudited)

Three-month periods ended March 31, 2005 and 2004

(expressed in thousands of U.S. dollars)





	2005		2004

Cash flows from (used in) operating activities:
Net earnings (loss) from continuing operations	$ 31		$(3,251	)
Adjustments for items not affecting cash:
Amortization	1,666		363
Future income taxes	774		(328	)
Stock-based compensation	1,895		—
Foreign exchange	226		—
Inventory write-downs	—		501
Changes in operating assets and liabilities:
Accounts receivable	(407	)	397
Income taxes receivable and refundable investment tax credits	245		—
Inventory	640		(118	)
Prepaid expenses and deposits	(466	)	(267	)
Accounts payable and accrued liabilities	(3,177	)	136
Change in cash and short-term investments held as reserves	(467	)	—
Settlement assets	3,058		—
Customer reserves and security deposits	(1,678	)	—
Deferred revenue	(378	)	303

	1,962		(2,264	)
Cash flows from financing activities:
Decrease in bank indebtedness	(82	)	(263	)
Repayment of capital leases	(182	)	—
Proceeds from issuance of common shares	2,920		—

	2,656		(263	)
Cash flows from investing activities:
Increase in long-term receivables	(577	)	—
Decrease in cash held in escrow	2,709		—
Proceeds from maturity of short-term investments	36,264		26,677
Purchase of property and equipment	(570	)	(381	)
Proceeds from sale of property and equipment	40		—
Acquisition of Systech Retail Systems (note 3 (a))	—		(3,000	)
Acquisition of MCA, including acquisition costs of $49 (note 3 (f))	(2,689	)	—
Payment on balance of sale on NPS acquisition	(1,500	)	—
Increase in deferred costs	(165	)	(350	)

	33,512		22,946
Effect of exchange rate on cash and cash equivalents during the period	(225	)	—

Net increase in cash and cash equivalents	37,905		20,419
Net increase in cash from discontinued operations	—		1,377
Cash and cash equivalents, beginning of period	62,937		4,212

Cash and cash equivalents, end of period	$ 100,842		$ 26,008

Supplemental disclosure of cash flow information (note 13)

See accompanying notes to unaudited consolidated financial statements.

OPTIMAL GROUP INC.

Notes to Consolidated Financial Statements

(Unaudited)

Three-month periods ended March 31, 2005 and 2004

(expressed in thousands of U.S. dollars)

1.	Interim financial information:

These consolidated financial statements have been prepared by management in accordance with Canadian generally accepted accounting principles (“GAAP”). The unaudited consolidated balance sheet as at March 31, 2005 and the unaudited consolidated statements of operations, deficit and cash flows for the periods ended March 31, 2005 and 2004 reflect all adjustments which, in the opinion of management, are necessary to present a fair statement of the results of the interim periods. The results of operations and cash flows for any quarter are not necessarily indicative of the results or cash flows for an entire year. These interim consolidated financial statements follow the same accounting policies and methods of their application as described in note 3 of the annual audited consolidated financial statements for the year ended December 31, 2004. The interim consolidated financial statements do not include all disclosures required for annual financial statements and should be read in conjunction with the most recent annual audited consolidated financial statements of Optimal Group Inc. (the “Company”) as at and for the year ended December 31, 2004.

All amounts in the attached notes are unaudited unless specifically identified.

2.	Significant accounting policies:
	(a)	Discontinued operations:

As a result of the sale of the U-Scan® self-checkout business referred to in note 3 (d), the results of discontinued operations are included in the net earnings (loss) but presented separately for the prior period.

(b)	Revenue recognition:

As a result of the business acquisitions and disposals referred to in note 3, the Company is engaged in payment services and provides hardware maintenance and repair outsourcing services.

The majority of payment service revenues are generated from fees charged to customers for payment processing services. Customers are charged a discount fee or rate, which is based upon the customer’s monthly charge volume and risk profile, and is calculated as a percentage of the dollar amount of each credit or debit transaction. Higher discount rates are charged for card-not-present transactions than for card-present transactions in order to compensate for the higher cost of underwriting and managing the increased chargeback risk associated with such transactions. The balance of payment service revenues are derived from a variety of fixed transaction or service fees, including set-up fees, fees for monthly minimum charge volume requirements, statement fees, annual fees and fees for other miscellaneous services, such as handling chargebacks. Discount and other fees related to payment transactions are recognized at the time the customer’s transactions are processed. Revenues derived from service fees are recognized at the time the service is performed. Revenues from set-up fees are deferred and amortized over the expected term of the customer relationship, which is approximately five years.

OPTIMAL GROUP INC.

Notes to Consolidated Financial Statements

(Unaudited)

Three-month periods ended March 31, 2005 and 2004

(expressed in thousands of U.S. dollars)

2.	Significant accounting policies (continued):
	(b)	Revenue recognition (continued):

Where the Company is the primary party responsible for providing payment processing services, revenue is recorded on a gross basis and amounts paid to the acquiring processing suppliers are recorded as part of the transaction processing expenses. Where the Company is not the primary party in providing a merchant with processing services, it records revenue net of amounts paid to the acquiring processing supplier.

Revenues from repair services are recognized at the time the services are rendered. Revenues from maintenance contracts are deferred and amortized ratably over the term of the contract.

3.	Business acquisitions and disposals:
	(a)	Systech Retail Systems:

On February 27, 2004, the Company acquired the hardware service division of Systech Retail Systems ("Systech"). The acquisition of Systech resulted in the recognition of goodwill primarily because of the Company’s strategy to re-establish a repair services business in the United States in light of the then anticipated sale of its U-Scan® self-checkout business.

The net assets acquired for cash were approximately $3.5 million. The acquisition is accounted for using the purchase method and the results of Systech are consolidated with those of the Company from the date of acquisition.

The following table summarizes the estimated fair value of the assets acquired and liabilities assumed at the date of acquisition:

			(Audited)
Assets acquired
	Accounts receivable	$	1,428
	Inventory		750
	Property and equipment		1,082
	Prepaid expenses and deposits		65
	Customer contract and customer relationships		612