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UNITED STATES SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-K
[_] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
For the fiscal year ended: October 31, 1998,
or
[_] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
For the transition period from ______________to___________________
Commission file number: 0-13063
AUTOTOTE CORPORATION
(Exact name of registrant as specified in its charter)
Delaware 81-0422894
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
750 Lexington Avenue, 25th Floor
New York, New York 10022
(Address of principal executive offices)
Registrant's telephone number: (212) 754-2233
Securities registered pursuant to Section 12(b) of the Act:
Title of each class Name of each exchange on which registered
Class A Common Stock, $.01 par value American Stock Exchange
Securities registered pursuant to Section 12(g) of the Act: None
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 X No__
Indicate by check mark if disclosure of delinquent filers pursuant to Item
405 of Regulation S-K is not contained herein, and will not be contained, to the
best of the registrant's knowledge, in definitive proxy or information
statements incorporated by reference in Part III of this Form 10-K or any
amendment to this Form 10-K. _ _
As of January 22, 1999, the aggregate market value of voting stock held by
non-affiliates of the registrant was approximately $76,555,494.
Common shares outstanding as of January 22, 1999 were 36,026,115.
DOCUMENTS INCORPORATED BY REFERENCE
The following document is incorporated herein by reference:
Document Parts Into Which Incorporated
Proxy Statement for the Company's 1999 Annual Part III
Meeting of Stockholders
EXHIBIT INDEX APPEARS ON PAGE 71
================================================================================
PART I
When used herein, the words "believe," "anticipate," "think," "intend,"
"will be" and similar expressions identify forward-looking statements within the
meaning of the Private Securities Litigation Reform Act of 1995. Such statements
are not guarantees of future performance and involve certain risks and
uncertainties discussed herein, which could cause actual results to differ
materially from those in the forward-looking statements. Readers are cautioned
not to place undue reliance on the forward-looking statements which speak only
as of the date hereof. Readers are also urged to carefully review and consider
the various disclosures made by the Company which attempt to advise interested
parties of the factors which affect the Company's business, including the
disclosures made under the caption "Management's Discussion and Analysis of
Financial Condition and Results of Operations."
All references to a fiscal year are to the Company's fiscal year, which
ends October 31. References to "Autotote" or the "Company" include Autotote
Corporation and its subsidiaries.
ITEM 1. BUSINESS
Overview
Autotote Corporation is a leading technology supplier and operator of
wagering systems, related equipment and gaming venues in North America and
worldwide. The Company provides technology, services and operations management
primarily to two major segments of the industry: i) pari-mutuel wagering
(whereby wagers are placed in a pool and winnings are calculated and paid as a
percentage of that pool), consisting primarily of wagering conducted on horse
racing, greyhound racing and jai-alai and ii) government sponsored or licensed
lotteries.
Autotote is the leading provider of computerized pari-mutuel wagering
systems to the North American Racing Industry and is also a leading provider of
computerized pari-mutuel systems worldwide, with systems in racetracks and OTBs
in Europe, Central and South America, and the Asia-Pacific region. The Company
is the exclusive licensed operator of substantially all off-track betting
("OTB") in the State of Connecticut and is the exclusive licensed operator of
all pari-mutuel wagering in The Netherlands. In addition, the Company is the
leading provider of Racing Industry simulcasting services in the United States
through its broadcasting of live racing events via satellite to other racetracks
and OTBs and also provides these services in Europe. The Company designs, sells
and services video gaming machines ("VGMs") for use at racetracks and in lottery
operations in North America. Also in 1998, the Company designed, implemented and
began providing a national voice/data network, known as the North American
Simulcast Racing Information Network ("NASRIN(TM)").
Autotote is also a major provider of lottery systems, equipment and
services to government-sponsored and privately operated lotteries. The Company
currently supports such lotteries in North America, Latin America and Europe.
The Company's proprietary pari-mutuel wagering systems process the sale and
cashing of wagers through ticket-issuing terminals, accumulate wagering data,
calculate pari-mutuel odds, distribute information to display systems and
provide management information and marketing services for its customers. The
wagering systems utilize high-volume, real-time transaction and data processing
networks, managed by central computers, communications equipment, special
purpose microcomputer-based terminals, peripheral and display equipment, and
operations and applications software. The Company generally receives revenues
based on a percentage of the gross monies wagered ("Handle"), a daily or monthly
fee or through outright product sales.
The growth in OTB, telephone and inter-track wagering, together with the
Company's extensive penetration of the North American pari-mutuel wagering
market, have enabled the Company to generate increased revenues. The Company has
achieved this because it (i) is the leading provider of pari-mutuel wagering
systems to the leading racetracks whose live racing events are in the greatest
demand for off-track wagering, (ii) is a leading provider of computerized
pari-mutuel wagering systems and automated telephone betting equipment to OTBs
and racetracks accepting wagers on simulcasted racing events, (iii) is the
leading simulcaster of live horse and greyhound racing and jai alai events to
racing facilities, OTBs and casinos in North America, and (iv) owns the
Connecticut OTB
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system. The Company believes that it will realize additional benefits to the
extent that states and foreign jurisdictions enact further legislation that
facilitates growth in simulcasting and OTB, inter-track, telephone and other
remote wagering.
The Company's lottery operations utilize proprietary technology that is
similar to that used for pari-mutuel wagering, but specialized for lottery
operations. The Company (i) provides wagering equipment and services to operate
the Connecticut State Lottery, a nationwide lottery in Barbados and a nationwide
lottery in the Dominican Republic, (ii) provides support and maintenance
services for other on-line lotteries, and (iii) sells lottery equipment to
various markets, including Italy. On December 15, 1997, the Company signed an
agreement with the Connecticut Lottery Corporation to service the Connecticut
State Lottery through May 2003, and provides the lottery five one-year options
to extend the contract through May 2008. Under the terms of the agreement, in
the third quarter of fiscal 1998, the Company manufactured and installed
approximately 3,200 new PROBE(*)L lottery terminals. The Company partially
financed its obligations under this agreement by entering into a term loan
arrangement in May 1998 (see Item 7. Management's Discussion and Analysis of
Financial Condition and Results of Operations-Liquidity and Capital Resources).
In fiscal 1998, the Company also signed a seven-year contract with the Montana
State Lottery for an on-line lottery system to be installed in 1999.
Additionally, in 1998, the Company began shipping to an Italian distributor the
first of up to 20,000 Extrema(TM) lottery terminals for use in Italy in the
SISAL Sport Italia SpA lottery operations.
For information concerning the Company's business and geographic segments,
see Note 18 to Consolidated Financial Statements.
Pari-Mutuel Operations
Pari-mutuel Operations accounted for 89%, 85% and 73% of the Company's
total revenues for the fiscal years 1998, 1997 and 1996, respectively.
Pari-mutuel wagering is currently authorized in 43 states in the United States,
all provinces in Canada, and approximately 100 other countries around the world.
North American Wagering Systems
Autotote is the leading supplier of pari-mutuel wagering systems to the
North American market. The Company believes its pari-mutuel wagering systems
processed approximately 65% of the estimated $20 billion of gross monies wagered
("Handle") in North America. The Company owns and operates over 22,000
pari-mutuel wagering terminals in use throughout North America. The Company's
wagering systems and/or related equipment process wagers at approximately 100
racetracks in North America, including 10 of the top 15 largest thoroughbred
racetracks and at over 800 OTB facilities.
In North America, the Company typically enters into long-term (five-years
or longer) service contracts with its customers pursuant to which the Company
provides the pari-mutuel wagering system, as well as the operations, maintenance
and supervisory personnel necessary to operate the pari-mutuel wagering system.
The Company maintains ownership of the pari-mutuel wagering systems, which
enables it to employ such equipment in more than one racetrack at different
times during the year.
The pari-mutuel wagering systems provided by the Company in North America
typically include the terminals that issue the wagering tickets, the central
processing unit which calculates the betting odds of a particular event and
tabulates and accounts for the Handle, the display board which indicates the
betting odds of a particular event and the communication equipment necessary for
additional wagering from sources outside the wagering facility. The systems
utilize high volume, real-time transaction and data processing networks managed
by central computers, communications equipment, special purpose
microcomputer-based terminals, peripheral and display equipment and operations
and applications software. The type of central processing unit and the number of
ticket issuing terminals used in a system are generally determined by the amount
of wagering at, and physical layout of, the facility. The Company generally does
not, however, employ the clerks who issue wagering tickets using the Company's
teller-operated terminals. The Company also provides additional software and
other support functions.
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The Company typically receives revenue for its services in North America as
a percentage of Handle, which generally ranges up to approximately 0.55% of the
Handle on a particular event (with a weighted average of approximately 0.35% of
the Handle), subject, in many instances, to minimum fees which are usually
exceeded under normal operating conditions. Minimum fees under the Company's
service contracts are generally based on the number of days the facility
operates, as well as other factors, including the type of system and number of
terminals installed at the facility.
In addition to payments received for wagering which takes place at a
location where the Company operates a wagering system, the Company also
typically receives an "Interface Fee" of 0.125% for wagers that are made from
remote sites. This Interface Fee is charged and typically collected from the
remote site where the wager is placed whether or not such site is a customer of
the Company. As inter-track and off-track wagering has increased, the percentage
of total North American Racing Industry Handle on which Interface Fees are
charged has grown.
In recent years, the Company has focused on the creation of regional
networks of large and medium sized racetracks and OTB networks, rather than
single facilities at smaller racetracks. These networks allow the Company to
achieve economies of scale by centralizing its service operations and more
efficiently utilizing its installed base of computer hardware. Additionally,
when linked to the Company's other regional and national pari-mutuel wagering
networks, these networks provide the Company's customers with access to new
markets and revenue sources by increasing the number and variety of wagering
opportunities that customers can offer to their patrons. The Company believes
its established wagering networks will give the Company a competitive advantage
in renewing existing contracts and winning new contracts in regions where such
networks exist because of the Company's ability to offer customers greater
services more efficiently than its competitors. The Company currently operates
its regional pari-mutuel wagering networks in California, Connecticut, Florida,
Illinois, Louisiana, Michigan, New York, Oregon, Pennsylvania, Washington,
Puerto Rico, Alberta, British Columbia and Ontario.
An additional outlet for the Company's pari-mutuel wagering systems is the
casino market. The Company operates pari-mutuel wagering systems for all of the
casinos in Atlantic City that offer wagering on racing events and provides
wagering systems for use at the Mohegan Sun Casino in Connecticut. Services
provided to these casinos are similar to those provided directly to OTBs.
In its service contracts, the Company makes certain warranties regarding
the operation, performance, implementation and reliability of its wagering
systems relating to, among other things, data accuracy, repairs and validation
procedures. The Company's warranties in its wagering systems contracts are
negotiated and, accordingly, vary on a case-by-case basis.
Connecticut OTB
In 1993, the Company purchased from the State of Connecticut the exclusive
right to operate substantially all off-track betting within that state. Since
the Company commenced operating the Connecticut OTB, it has implemented several
important product and service enhancements, including expanded simulcasting from
over 60 thoroughbred, harness and greyhound racetracks and jai alai frontons
across the country, common-pool wagering, seven day per week operations at nine
locations and expanded telephone betting. These improvements have helped
increase the Connecticut OTB Handle from approximately $133 million in fiscal
1993, the last year that the State operated the Connecticut OTB, to
approximately $210 million in fiscal 1998. The Company believes its expertise
developed in operating the Connecticut OTB provides it with a competitive
advantage in obtaining future OTB operations through privatization, a strategy
which recently resulted in the Company's acquisition of all pari-mutuel wagering
operations in the Netherlands. The Company currently operates thirteen OTB
locations statewide, including two simulcasting teletheaters in New Haven and
Windsor Locks, three simulcasting race view centers as well as a telephone
account betting operation in New Haven. The Company's approximately 39,000
square feet Bradley Teletheater in Windsor Locks and approximately 55,000 square
feet facility in New Haven, Sports Haven(R), feature pari-mutuel wagering on
thoroughbred, harness, greyhound and jai alai events shown live on large screens
and televisions throughout the facility. Since the opening of the Sports
Haven(R), facility in 1995, wagering in New Haven has increased from
approximately $35.0 million to $55.0 million annually.
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The exclusive right to operate the Connecticut OTB is subject to state
regulations with respect to such matters as the location of OTBs, hours of
operation and certain financial and operational standards. The Company must pay
liquidated damages to the state if these standards are not met. The Company is
also subject to a pari-mutuel tax of 3.5% of all monies wagered. The percentage
of the total Handle which the Company may receive as the operating revenues from
the Connecticut OTB is determined by the track where the event is held and
ranges from 15% to 25%, depending on the racetrack and type of wagers.
The Company believes operation of the Connecticut OTB further strengthens
its competitive position in attracting certain new racetrack customers to the
extent that the Connecticut OTB does not already accept wagers for such
racetrack's racing events. The Company can enhance a proposal for its services
by offering the racetrack the opportunity to have its racing events wagered upon
at the Connecticut OTB. In return, racetracks generally receive a fee from
Connecticut OTB, of between 3% and 6% of the pari-mutuel wagers made at the
Connecticut OTB.
In 1996, the Company received legislative approval to expand its operations
to seven days a week subject to local approval. Currently nine Connecticut OTB
locations operate seven days a week. In June 1997, the State of Connecticut
passed legislation authorizing the Company to simulcast live racing events in up
to six locations. The Company currently simulcasts at five locations: its
Bradley Teletheater and Sports Haven(R) locations as well as at its race view
centers in New Britain, Bristol and Hartford, and is pursuing development of an
additional teletheater location in western Connecticut. Such legislation also
authorized racetracks and jai alai frontons within Connecticut to retain a
larger portion of the Handle from pari-mutuel pools. The Connecticut OTB
typically retains the same amount as the racetrack or fronton where the event is
held. Due to the legislation, the amount the Connecticut jai alai fronton and
racetracks retained increased during fiscal 1998, and as a result, the Company's
gross profit improved by $0.9 million on the approximately $56 million wagered
at the Connecticut OTB on events which took place within Connecticut.
In fiscal 1998, the Company entered into a seven year agreement with the
Mohegan Tribal Gaming Authority to provide wagering and simulcasting services
for a new Race Book to be located at the Mohegan Sun Casino located in
Uncasville, CT. The Race Book, which commenced operations on September 3, 1998,
is a state-of-the-art facility which incorporates the latest wagering technology
and the most advanced audio and video signals for simulcasting from over 60
thoroughbred, harness and greyhound racetracks and jai alai frontons throughout
North America.
Simulcasting Systems & Communication Services
The Company is the leading simulcast provider of live horse and greyhound
racing and jai alai events to racing facilities, OTBs and casinos in North
America. The Company simulcasts racing events from over 60 racetracks and jai
alai frontons to over 150 racetracks and over 750 OTBs throughout North America.
Simulcasting is the process of transmitting the audio and video signal of a
live racing event from a live facility for reception by wagering facilities in
other locations, usually by satellite. Simulcasting provides racetracks the
opportunity to increase revenues by sending their signals to as many wagering
locations as possible, such as other racetracks, OTBs and casinos. Sending live
audio and video broadcasts of remote racing events generates increased revenues
for the Company and its customers by (i) increasing the consumer base for the
remote events and (ii) maximizing the number of events available to a patron for
wagering by utilizing idle time between races at racetracks to broadcast remote
events.
In its simulcasting operations, the Company leases satellite transponders
and uses digital compression technology to increase the number of events that
may be simulcasted at one time. The Company owns mobile earth stations which
uplink the video and audio signals of racetrack and jai alai events to Company
controlled satellite transponders and owns integrated receiver/decoders which
are used by racetracks and OTBs to receive and decode the transmission signals.
In general, the Company receives fees for simulcasting as follows: (i) a
daily fee charged to racetracks for the broadcast transmission services,
including the earth station, operator and the use of satellite time controlled
by the Company; and (ii) a fee charged to receiving sites for the use of the
Company's decoders to unscramble the
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transmission. In addition, the Company often sells excess satellite transponder
capacity to other users of satellite communications outside the Racing Industry.
From time to time, the Company has sold such excess capacity under long-term
contracts.
The Company, in partnership with AT&T, the Company's primary service
provider, was selected by the Thoroughbred Racing Association to implement and
manage NASRIN(TM). This system is designed to link all racing and simulcasting
locations in North America and to be a platform for future technology
developments. Built around AT&T's international frame relay network, NASRIN(TM)
securely transmits betting data at a fraction of the cost previously paid by the
racetracks and other facilities. In December 1998, the Company and Churchill
Downs Incorporated ("Churchill Downs") announced the signing of a letter of
intent to merge Autotote's NASRIN(TM) and Churchill Downs' Tracknet
telecommunications business units. The new company, which will continue to be
called NASRIN(TM), will be owned 70% by the Company and 30% by Churchill Downs
and will provide the equipment and management to administer and maintain the
nationwide network, and handle all subscriber billings.
International Pari-Mutuel Operations
In Europe, the Company owns the license to and operates all pari-mutuel
wagering in the Netherlands and provides and operates pari-mutuel wagering
systems at racetracks in France, Germany and Austria. The Company also provides
simulcast services to customers in Germany and the Netherlands and sells
pari-mutuel wagering equipment to customers in other countries in Europe. In
other foreign jurisdictions, the Company generally sells systems and equipment.
The Company maintains a significant presence in Europe. In July 1998, the
Company acquired the rights and began operating all pari-mutuel wagering in the
Netherlands. In Germany, the Company is operating under a 10-year contract to
provide comprehensive wagering services to the majority of the racetracks in the
country. Also in Germany, the Company has the right to develop a limited number
of OTB locations and phone wagering and is pursuing these opportunities. In
France and Austria, the Company provides and operates wagering systems pursuant
to long-term contracts. In fiscal 1998, the Company also signed a 10-year
contract, which is to begin in April 1999, to sell a pari-mutuel wagering system
and to provide ongoing maintenance and operating services to Tote Ireland Ltd.,
a wholly-owned subsidiary of the Irish Horseracing Authority.
In fiscal 1998, the Company derived approximately $9.9 million in service
and sales revenues from its French pari-mutuel wagering operations and $4.0
million in service and sales revenues from its German and Austrian pari-mutuel
wagering operations. During the four months following acquisition of the
Netherlands business, the Company recognized $4.8 million in service revenues
from its operations in the Netherlands.
In its other international markets, the Company generally sells, delivers
and installs pari-mutuel wagering systems in racetracks and OTBs rather than
operating them pursuant to service contracts. The Company generally designs a
customized system to meet the needs of each customer, including game designs,
language preferences, network communication standards and other key elements.
The sale of a pari-mutuel wagering system includes a license for use of the
Company's proprietary system software, as well as technical assistance, support,
accessories and spare parts. The Company's personnel participate in the system
installation and then the training of customer's personnel. The Company has sold
its systems in approximately 25 countries.
Video Gaming Machines ('VGMs')
The Company has developed a proprietary line of VGMs, which combine full
gaming functionality, such as video poker, blackjack, simulated spinning reels
and keno, with full race betting functionality and picture-in-picture
capabilities, providing multiple opportunities for revenue generation at
racetracks where VGM wagering is permitted. The Company's latest VGM terminal,
the PROBE(R) XLC, allows patrons to play card games, wager on horse races and
watch simulcasted races or other televised programs on a picture-in-picture
video window, while continuing to wager on the selected video game. The Company
has contracts to supply terminals to all the pari-mutuel operators in West
Virginia with the Company's progressive terminals added in Mountaineer and soon
to be installed in Charlestown. Currently the Company has installed
approximately 1,300 PROBE(R) XLC terminals, for
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which it receives a percentage of income generated by the terminals. The Company
believes its penetration of the pari-mutuel wagering business positions it to
become a significant provider of VGMs if video gaming is approved in more
racetracks across the country. The Company has also sold VGMs to the Manitoba
Lottery Commission.
Casino/Race and Sports Wagering
In October 1996, the Company sold the casino/race and sports wagering
service business ("CBS") which provided sports wagering systems to 107 of the
113 casinos in Nevada and to the leading operator of sports wagering facilities
in Mexico. Through a distributor affiliated with the purchaser of CBS, the
Company expects to continue to provide pari-mutuel wagering terminals and parts
to the casinos and sports wagering facilities that generally use systems
manufactured by the Company.
In connection with the sale of CBS, the Company entered into an agreement
not to compete anywhere in the world with respect to the purchaser's race and
sports book business for a minimum of five years. In addition, the contract for
the sale of CBS provides that the Company and CBS will offer each other certain
rights of first refusal with respect to business opportunities in the race and
sports book business internationally. At October 31, 1998, the Company and the
purchaser of CBS have a proposed agreement to settle litigation resulting from
the sale of CBS. This proposed agreement, in part, is expected to substantially
reduce the scope of, or eliminate in their entirety, the non-compete and first
right of refusal provisions described above. The Company does not believe that
the original agreements or the proposed agreement will have a material impact on
its ability to conduct its business.
Lottery Operations
Lottery Operations accounted for 11%, 15%, and 27% of the Company's total
revenues for the fiscal years 1998, 1997 and 1996, respectively.
The Company designs, installs, operates and maintains on-line
computer-based lottery systems and provides equipment for lottery systems both
in the United States and internationally. Lottery systems are required to
process very large transaction volumes. Such high performance requirements
dictate the need for sophisticated software applications that necessitate
expertise in software engineering and development. In the United States, the
Company operates the Connecticut Lottery and has a contract to install and
operate a lottery system and terminals for the Montana State Lottery.
Internationally, the Company has provided central processing systems and/or
terminals which are currently being used in lotteries operating in Barbados, the
Dominican Republic and Italy. In the fourth quarter of 1998, the Company also
began shipping terminals to SISAL Sport Italia SpA. pursuant to a contract to
deliver up to 20,000 of the Company's Extrema(TM) terminals.
In connection with the Connecticut State Lottery, the Company provides all
equipment, personnel and services necessary to operate the lottery network of
approximately 3,200 terminals while retaining title to the equipment. On
December 15, 1997, the Company signed an agreement with the Connecticut Lottery
Corporation to service the Connecticut State Lottery through May 2003, with five
one-year options to extend the contract through May 2008. Under the terms of the
agreement, the Company manufactured and installed approximately 3,200 new
PROBE(*)L lottery terminals. Revenues received by the Company from its operation
of the Connecticut State Lottery are based on a percentage of amounts wagered in
the lottery.
The Company's lottery products consist primarily of central processing
systems, including data communication networks, and on-line and on-line/off-line
computer-based lottery terminals. The lottery management system portion of the
product includes a lottery administration client-server network and relational
database. Lottery terminals are generally on-line to the central system via
telephone lines connected to the system's communication front-end processors.
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Sale of European Lottery Business
On April 15, 1997, the Company completed the sale of its European lottery
business for cash consideration of approximately $26.6 million, including
contingent consideration of approximately $1.6 million based upon a balance
sheet of the European lottery business, prepared as of such date. At closing,
the Company provided the purchaser with a letter of credit to secure certain
obligations under the sales agreement. The letter of credit, which had an
outstanding balance of $1.5 million at October 31, 1997, expired in October
1998. The Company recorded additional gains on the sale of its European lottery
business in the amount of approximately $1.2 million in fiscal 1998 and
approximately $1.8 in fiscal 1997.
Under the terms of the sale, the purchaser has the right to license and
purchase certain of the Company's terminals for use in lottery applications.
Currently neither the European lottery business nor the purchaser manufactures
on-line lottery wagering terminals. Also under the agreement, the purchaser has
a right of first refusal to purchase the Company's remaining lottery business
until April 1999. The Company, however, currently has no plans to sell this
business and remains committed to serving the North American lottery market and
its existing customers worldwide.
In connection with the sale of the European lottery business, the Company
agreed not to compete for three years in the on-line lottery business outside of
the United States and Canada except with respect to (a) existing customers not
served by the European lottery business and (b) certain identified proposed
customers and jurisdictions. The non-competition covenants do not apply to the
Company's right to sell certain terminals for lottery applications anywhere,
except to existing customers of the European lottery business.
Contract Procurement
Contract awards by horse and greyhound racetracks, OTBs and casino/sports
wagering facilities and from state and foreign governments often involve a
lengthy competitive bid process, spanning from specification development to
contract negotiation and award. Contracts have a high dollar value and are
technically and commercially complex and may require substantial initial cash
outlays. Start up costs associated with contract awards typically involve
expenditures for items such as software development/customization, assembly of
wagering systems, and installation costs including electrical and carpentry
work, transportation and placement of equipment, and system implementation. Such
costs are primarily comprised of labor related expenses due to the relative
magnitude of software development and customization in the start up phase. In
the United States, lottery authorities generally commence the contract award
process by issuing a request for proposals inviting bids and proposals from
various lottery vendors. Internationally, lottery authorities do not typically
utilize such a formal bidding process, but rather negotiate proposals with one
or more potential vendors.
The Company's contracts for the provision of pari-mutuel services are
typically for terms of five years. Contracts representing 5%, 9%, 15% and 10% of
the Company's annual North American pari-mutuel service revenues are scheduled
to expire in fiscal years 1999, 2000, 2001 and 2002, respectively. The Company's
contract to operate the Connecticut State Lottery was renewed in December 1997
for five years and provides the lottery five one-year renewal options. The
Company historically has been successful in renewing its largest contracts as
they have come due for renewal. However, there can be no assurance that the
Company will continue to be able to renew pari-mutuel systems operating
contracts with its largest customers or to further renew the lottery contract
with the State of Connecticut, and, if it is unable to do so, there would be a
material adverse effect on the Company.
Service and Support
The Company employs approximately 595 persons, including regional and
national managers and trained maintenance and field service personnel, to
support the operation of the Company's systems and communications networks. The
Company's personnel support its systems by performing routine system maintenance
and repairs of systems and equipment when needed.
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Research and Product Development
The Company believes that its ability to attract new wagering system
customers and retain existing customers depends in part on its ability to
continue to incorporate technological advances into, and to improve, its product
lines. The Company maintains a development program directed toward systems
development as well as toward the improvement and refinement of its present
products and the expansion of their uses and applications. The Company employs
approximately 50 people in connection with software, engineering and product
development.
Intellectual Property
The Company maintains patent protection on certain of its pari-mutuel
wagering and lottery products and has a number of registered trademarks and
other common law trademark rights for certain of its products. The software and
control systems for the Company's wagering systems are also protected by
copyright and/or trade secret laws.
Production Processes; Sources and Availability of Components
Production of the Company's wagering systems and component products
primarily involves the assembly of electronic components into more complex
systems and products. The Company primarily produces its terminal products at
the Company's manufacturing facility in Ballymahon, Ireland. In 1997, the
Company began limited terminal assembly at its Newark, Delaware administration
and development facility. Other manufacturing is contracted out to third party
vendors, as needed.
The Company normally has sufficient lead time between reaching an agreement
to serve a wagering facility and commencing actual operations at such facility.
In the event the current suppliers of central processing units were no longer
available, the Company believes that it would be able to adapt its application
software to hardware available from other sources within a time frame sufficient
to allow it to meet new contractual obligations, although the price
competitiveness of the Company's products might diminish. The lead-time for
obtaining most of the electronic components used by the Company is approximately
90 days. The Company believes that this is consistent with its competitors' lead
times and is also consistent with the needs of its customers.
Backlog
The backlog of the Company's orders for sales of its products was
approximately $31 million as of October 31, 1998. The majority of the backlog is
associated with the agreement with SISAL Sport Italia SpA to manufacture and
deliver Extrema(TM) terminals to upgrade SISAL's network of terminals used in
their Italian lottery operations. Approximately 73% of the backlog as of October
31, 1998 is expected to be filled in fiscal 1999. Backlog as of October 31, 1998
does not include revenues attributable to multi-year wagering systems contracts,
multi-year lottery service contracts, revenue attributable to the operation of
the Connecticut OTB, or maintenance contracts.
Competition
A significant portion of the Company's revenue is generated from providing
pari-mutuel wagering systems to racetracks and OTBs. The market for pari-mutuel
wagering systems is competitive, and certain of the Company's competitors may
have substantially greater financial and other resources than the Company. The
Company competes primarily on the basis of design, performance, reliability and
pricing of its products as well as customer service. To effectively compete, the
Company expects to make continued investments in product development and/or
acquisitions of technology.
As a major portion of the Company's revenue is based on a percentage of
wagering Handle, including its Connecticut OTB revenues, the Company's revenue
may be affected by competition for the wagering dollar. Any new non-racing
wagering products in a given market may result in increased competition for
wagering dollars. Competition for wagers comes from casinos, lotteries and other
forms of legal and illegal gambling.
9
The Company's two principal competitors in the North American pari-mutuel
wagering systems business are AmTote International, Inc and Powerhouse
Technologies Inc. ("Powerhouse"), which operates its pari-mutuel wagering
systems business through its subsidiary United Tote. Video Gaming industry
terminal suppliers include Powerhouse, International Game Technology, WMS
Industries Inc., Alliance Gaming, Inc. and several smaller companies. The
Company's competition outside of North America is more fragmented, with
competition being provided by several international and regional companies. No
single company maintains the leading market position internationally, although
certain companies possess regional strengths.
Competition in the simulcasting business in North America currently is
fragmented. Other than the Company, only Roberts Television International, Inc.
has achieved a significant share of the market.
The on-line lottery business is also highly competitive. State and foreign
governments normally award contracts based on competitive bidding procedures.
Significant factors which influence the award of lottery contracts include
price, the ability to optimize lottery revenues through marketing capability and
applications knowledge, the quality, dependability and upgrade capability of the
network, the experience, financial condition and reputation of the vendor, and
the satisfaction of other requirements and qualifications which the lottery
authority may impose. The Company's principal competitors in the on-line lottery
business are Gtech Holdings Corp. and Powerhouse, through its subsidiary
Automated Wagering, Inc.
The market for the Company's products is affected by changing technology,
new legislation and evolving industry standards. The Company's ability to
anticipate such changes and to develop and introduce new and enhanced products
on a timely basis will be a significant factor in the Company's ability to
expand, remain competitive, attract new customers and retain existing contracts.
There can be no assurance that the Company will have the financial or other
resources to respond to such changes or to develop and introduce new products on
a timely basis.
In connection with the sales of CBS and the European lottery business, the
Company entered into certain agreements not to compete , which the Company
believes will not have a material impact on the Company's ability to conduct its
business.
Regulation
General
Pari-mutuel wagering, sports wagering, video gaming and on-line lotteries
may be conducted in jurisdictions that have enacted enabling legislation. In
jurisdictions that currently permit various wagering activities, regulation is
extensive and evolving. Regulators in such jurisdictions review many facets of
an applicant/holder of a license including, among other items, financial
stability, integrity and business experience. The Company believes that it is
currently in substantial compliance with all regulatory requirements in the
jurisdictions where it operates. Any failure to receive a material license or
the loss of a material license that the Company currently holds could have a
material adverse effect on the overall operations and financial condition of the
Company.
In 1996, the United States Congress passed legislation authorizing a
comprehensive study of gaming, including segments of the gaming industry served
by the Company. The Company is unable to predict whether this study will result
in legislation that would impose regulations on gaming industry operators,
including the Company, or whether such legislation, if any, would have a
material adverse effect on the Company.
The Company has developed and implemented an extensive internal compliance
program in an effort to assure the Company's compliance with legal requirements
imposed in connection with its wagering-related activities, as well as legal
requirements generally applicable to all publicly traded corporations. The
compliance program is run on a day-to-day basis by a full-time compliance
officer, and is overseen by the Compliance Committee of the Company's Board of
Directors. While the Company is firmly committed to full compliance with all
applicable laws, there can be no assurance that such steps will prevent the
violation of one or more laws or regulations, or that a
10
violation by the Company or an employee of the Company will not result in the
imposition of a monetary fine or suspension or revocation of one or more of the
Company's licenses.
Pari-Mutuel Wagering
Forty-three states, Puerto Rico, all of the Canadian provinces, Mexico and
many other foreign countries have authorized pari-mutuel wagering on horse races
and 19 states and many foreign countries, including Mexico, have authorized
pari-mutuel wagering on dog races. In addition, Connecticut, Rhode Island,
Nevada, Florida and Mexico also allow pari-mutuel betting on jai alai matches.
Companies that manufacture, distribute and operate pari-mutuel wagering
systems in these jurisdictions are subject to the regulations of the applicable
regulatory authorities there. These authorities generally require the Company,
as well as its directors, officers, certain employees and holders of 5% or more
of the Company's common stock, to obtain various licenses, permits and
approvals. Regulatory authorities may also conduct background investigations of
the Company and its key personnel and stockholders in order to insure the
integrity of the wagering system. These authorities have the power to refuse,
revoke or restrict a license for any cause they deem reasonable. The loss of a
license in one jurisdiction may cause the Company's licensing status to come
under review in other jurisdictions as well.
A subsidiary of the Company that provides pari-mutuel wagering equipment
and/or services to certain casinos located in Atlantic City, New Jersey is
licensed by the New Jersey Casino Control Commission ("New Jersey Commission")
as a gaming related casino service industry in accordance with the New Jersey
Casino Control Act ("Casino Control Act") for an initial period of two years and
then for renewable periods of four years thereafter. An applicant for a gaming
related casino service industry license is required to establish, by clear and
convincing evidence, financial stability, integrity and responsibility; good
character, honesty and integrity; and sufficient business ability and experience
to conduct a successful operation. The Company must also qualify under the
standards of the Casino Control Act. The Company and its licensed subsidiary may
also be required to produce such information, documentation and assurances as
required by the regulators to establish the integrity of all financial backers,
who may be required to seek qualification or waiver of qualification. For casino
holding companies, the New Jersey Commission traditionally has granted informal
waivers at the staff level for non institutional investors holding less than 15%
of a debt issue and for institutional investors holding less than 50% of a debt
issue and less than 20% of the issuer's overall debt.
The New Jersey Commission has broad discretion in licensing matters and may
at any time condition a license or suspend or revoke a license or impose fines
upon a finding of disqualification or non-compliance. The New Jersey Commission
may require that persons holding five percent or more of the Class A Common
Stock of the Company qualify under the Casino Control Act. Under the Casino
Control Act, a security holder is rebuttably presumed to control a
publicly-traded corporation if the holder owns at least five percent of such
corporation's equity securities; however, for passive institutional investors,
qualification is generally not required for a position of less than 10%, and
upon a showing of good cause, qualification may be excused for a position of 10%
or more. Failure to qualify could jeopardize the Company's license. In addition,
the New Jersey Racing Commission also licenses this subsidiary and retains
concurrent regulatory oversight over this subsidiary with the New Jersey
Commission.
The Company's rights to operate the Connecticut OTB system shall continue
as long as the Company holds all licenses required for the operation of the
system. In addition, the officers and directors and certain other employees of
the Company must be licensed. Licensees are generally required to submit to
background investigations and provide required disclosures. The Division of
Special Revenue of the State of Connecticut (the "Division") may revoke the
license to operate the system under certain circumstances, including a false
statement in the licensing disclosure materials, a transfer of ownership of the
licensed entity without Division approval and failure to meet financial
obligations. The approval of the Connecticut regulatory authorities is required
before any off-track betting facility is closed or relocated or any new branch
or simulcast facility is established.
While in the past and at present the Company has been the subject of
enforcement proceedings instituted by one or more regulatory bodies, the Company
has been able to consensually resolve any such proceedings upon its
11
implementation of remedial measures and/or the payment of settlements or
monetary fines to such bodies. The Company does not believe that any of these
proceedings, past or pending, will have a materially adverse effect on the
Company. However, there can be no assurance that similar proceedings in the
future will be similarly resolved, or that such proceedings will not have a
material adverse impact on the Company's ability to retain and renew existing
licenses or to obtain new licenses in other jurisdictions.
Video Gaming
Coin or voucher operated gambling devices offering electronic, video
versions of spinning reels, poker, blackjack and similar games are known as VGMs
or video lottery terminals ("VLTs"), depending on the jurisdiction. These
devices represent a growing area in the wagering industry. The Company or its
subsidiaries manufacture and supply terminals and wagering systems designed for
use as VGMs or VLTs.
Twenty-four states and Puerto Rico authorize wagering on VGMs or VLTs at
casinos, riverboats, racetracks and/or other licensed facilities. Although some
states, such as Rhode Island and West Virginia, currently restrict VGMs or VLTs
to already existing wagering facilities, others permit these devices to be
placed at bars and restaurants as well. Several Indian tribes throughout the
United States are also authorized to operate these devices on reservation lands.
In addition, several Canadian provinces and various foreign countries have
authorized their use.
Government officials in other states are considering proposals to legalize
or expand video gaming, or video lottery in their states. Legislators have been
enthusiastic about the potential of video gaming to raise significant additional
revenues. Some officials, however, are reluctant to expand gaming industry
opportunities or have expressed a desire to limit video gaming to established
wagering facilities if video gaming is authorized in their jurisdiction at all.
Companies that manufacture, sell or distribute VGMs or VLTs are subject to
various provincial, state, county and municipal laws and regulations. The
primary purposes of these rules are (i) to insure the responsibility, financial
stability and character of equipment manufacturers and their key personnel and
stockholders through licensing requirements, (ii) to insure the integrity and
randomness of the machines, and (iii) to prohibit the use of VGMs or VLTs at
unauthorized locations or for the benefit of undesirable individuals or
entities. The regulations governing VGMs and VLTs generally resemble the
pari-mutuel and sports wagering regulations in all the basic elements described
above.
However, every jurisdiction has differing terminal design and operational
requirements, and terminals generally must be certified by local regulatory
authorities before being distributed in any particular jurisdiction. These
requirements may require the Company or its subsidiaries to modify its terminals
to some degree in order to achieve certification in particular locales. In
addition, the intrastate movement of such devices in a jurisdiction where they
will be used by the general public is usually allowed only upon prior
notification and/or approval of the relevant regulatory authorities.
West Virginia has licensed the Company or its subsidiaries to supply VLTs
to authorized locations in that state. The Manitoba Gaming Control Commission of
Manitoba, Canada has granted an interim registration to one of the subsidiaries
of the Company as a gaming related supplier to the Manitoba Lotteries
Corporation. The Company is in compliance with the terms and conditions of the
Interim registration.
The Company may apply for all necessary licenses in other jurisdictions
that may now or in the future authorize video gaming or video lottery
operations. The Company cannot predict the nature of the regulatory schemes or
the terminal requirements that will be adopted in any of these jurisdictions,
nor whether the Company or any subsidiaries can obtain any required licenses and
equipment certifications or will be found suitable.
Federal law also affects the Company's video gaming industry activities.
The Federal Gambling Devices Act of 1962 (the "Devices Act") makes it unlawful
for any person to manufacture, deliver or receive gambling devices, including
VGMs and VLTs, across interstate lines unless that person has first registered
with the Attorney General of the United States, or to transport such devices
into jurisdictions where their possession is not specifically authorized
12
by state law. The Devices Act permits states to exempt themselves from its
prohibition on transportation, and several states that authorize the manufacture
or use of such devices within their jurisdictions have done so. Certain of the
Company's products, such as the PROBE(R) XLC terminal, are gaming devices
subject to the Devices Act and state laws governing such devices. The Devices
Act does not apply to machines designed for pari-mutuel betting at a racetrack,
such as the Company's pari-mutuel wagering terminals. The Company has registered
under the Devices Act, and believes that it is substantially in compliance with
all of the Devices Act's record-keeping and equipment identification
requirements.
Lottery Operations
At the present time, 37 states, the District of Columbia, Puerto Rico, all
the Canadian provinces, Mexico and many other foreign countries authorize
lotteries. Once authorized, the award of lottery contracts and ongoing operation
of lotteries in the United States is highly regulated. Although certain of the
features of a lottery, such as the percentage of gross revenues which must be
paid back to players in prize money, are usually established by legislation, the
lottery authorities generally exercise significant authority, including the
determination of the types of games played, the price of each wager, the manner
in which the lottery is marketed and the selection of the vendors of equipment
and services.
To ensure the integrity of the contract award and wagering process, most
jurisdictions require detailed background disclosure on a continuous basis from,
and conduct background investigations of, the vendor, its subsidiaries and
affiliates and its principal shareholders. Background investigations of the
vendor's employees who will be directly responsible for the operation of the
system are also generally conducted, and most states reserve the right to
require the removal of employees whom they deem to be unsuitable or whose
presence they believe may adversely affect the operational security or integrity
of the lottery. Certain jurisdictions also require extensive personal and
financial disclosure and background checks from persons and entities
beneficially owning a specified percentage (typically five percent or more) of
the Company's securities. The failure of such beneficial owners to submit to
such background checks and provide such disclosure could result in the
imposition of penalties upon such beneficial owners and could jeopardize the
award of a lottery contract to the Company or provide grounds for termination of
an existing lottery contract.
The international jurisdictions in which the Company markets its lottery
systems also usually have legislation and regulations governing lottery
operations. The regulation of lotteries in these international jurisdictions
typically varies from the regulation of lotteries in the United States. In
addition, restrictions are often imposed on foreign corporations seeking to do
business in such jurisdictions. United States and international regulations
affecting lotteries are subject to change. The Company cannot predict with
certainty the impact on its business of changes in regulations.
Simulcasting
The Federal Communications Commission (the "FCC") regulates the use and
transfer of earth station licenses used to operate the Company's simulcasting
operations.
At present, 43 states, Puerto Rico, all of the Canadian provinces, Mexico
and many other foreign countries authorize inter-state and/or intra-state
pari-mutuel wagering, which may involve the simulcasting of such races.
Licensing and other regulatory requirements associated with such simulcasting
activities are similar to those governing pari-mutuel wagering, and are
generally enforced by pari-mutuel regulators. In addition, contracts with host
tracks whose races are simulcast by the Company or its subsidiaries to other
facilities within or outside the jurisdictions in which such races are held may
be subject to approval by regulatory authorities in the jurisdictions from
and/or to which the races are simulcast. The Company believes that it and/or its
subsidiaries are in substantial compliance with applicable regulations and that
the Company, its subsidiaries, and/or the appropriate third parties have entered
into contracts and obtained the necessary regulatory approvals to lawfully
conduct current simulcast operations.
13
Nevada Regulatory Matters
The Company and certain of its wholly owned subsidiaries are applicants or
will be applicants for certain registrations, approvals, findings of suitability
and licenses in the State of Nevada (collectively, the "Applications"). There
can be no assurances that the pending Applications of the Company and the Nevada
Operating Subsidiaries will be approved or that if approved, they will be
approved on a timely basis or without conditions or limitations.
The manufacture, sale and distribution of gaming devices for use or play in
Nevada or for distribution outside of Nevada, the manufacture and distribution
of associated equipment for use in Nevada, the operation of an off-track
pari-mutuel wagering system in Nevada, the operation an off-track pari-mutuel
sports wagering system in Nevada and the operation of slot machine routes in
Nevada are subject to: (i) The Nevada Gaming Control Act and the regulations
promulgated thereunder (collectively, "Nevada Act"); and (ii) various local
ordinances and regulations. Such activities are subject to the licensing and
regulatory control of the Nevada Gaming Commission ("Nevada Commission"), the
Nevada State Gaming Control Board ("Nevada Board"), and various local, city and
county regulatory agencies (collectively referred to as the "Nevada Gaming
Authorities").
The laws, regulations and supervisory procedures of the Nevada Gaming
Authorities are based upon declarations of public policy which are concerned
with, among other things: (i) the prevention of unsavory or unsuitable persons
from having a direct or indirect involvement with gaming, or manufacturing or
distribution of gaming devices at any time or in any capacity; (ii) the strict
regulation of all persons, locations, practices, associations and activities
related to the operation of licensed gaming establishments and the manufacture
or distribution of gaming devices and equipment; (iii) the establishment and
maintenance of responsible accounting practices and procedures; (iv) the
maintenance of effective controls over the financial practices of licensees,
including the establishment of minimum procedures for internal fiscal affairs
and the safeguarding of assets and revenues, providing reliable record keeping
and requiring the filing of periodic reports with the Nevada Gaming Authorities;
(v) the prevention of cheating and fraudulent practices; and (vi) to provide a
source of state and local revenues through taxation and licensing fees. Changes
in such laws, regulations and procedures could have an adverse effect on the
Company's various Applications in the event they are granted. No assurances can
be given that the Applications will be granted by the Nevada Gaming Authorities.
The grant or denial of the Applications is within the discretion of the Nevada
Gaming Authorities.
The Company is an applicant for registration by the Nevada Commission as a
publicly traded corporation (a "Registered Corporation") and is or will be an
applicant to be found suitable to own the stock, both directly and indirectly of
various wholly owned subsidiaries which are or will be applicants for approvals
and licensing as a manufacturer, distributor an operator of a slot machine
route, an operator of an off-track pari-mutuel wagering system and an operator
of an off-track pari-mutuel sports wagering system (the "Nevada Operating
Subsidiaries"). As a Registered Corporation, the Company will be required
periodically to submit detailed financial and operating reports to the Nevada
Commission and furnish any other information that the Nevada Commission may
require. No person may become a stockholder of, or receive any percentage of
profits from, the Nevada Operating Subsidiaries without first obtaining licenses
and approvals from the Nevada Gaming Authorities. The Company and the Nevada
Operating Subsidiaries have or will apply to the Nevada Gaming Authorities for
the various registrations, approvals, permits, findings of suitability and
licenses (collectively "Gaming Licenses") in order to engage in manufacturing,
distribution, slot route activities, and off-track pari-mutuel wagering systems
operations in Nevada. The following regulatory requirements will apply to the
Company and its Nevada Operating Subsidiaries if they are approved and licensed.
All gaming devices and cashless wagering systems that are manufactured, sold or
distributed for use or play in Nevada, or for distribution outside of Nevada,
must be manufactured by licensed manufacturers and distributed or sold by
licensed distributors. All gaming devices manufactured for use or play in Nevada
must be approved by the Nevada Commission before distribution or exposure for
play. The approval process for gaming devices includes rigorous testing by the
Nevada Board, a field trial and a determination as to whether the gaming device
meets strict technical standards that are set forth in the regulations of the
Nevada Commission. Associated equipment must be administratively approved by the
Chairman of the Nevada Board before it is distributed for use in Nevada.
14
The Nevada Gaming Authorities may investigate any individual who has a
material relationship to, or material involvement with, the Company or the
Nevada Operating Subsidiaries in order to determine whether such individual is
suitable or should be licensed as a business associate of a gaming licensee.
Officers, directors and certain key employees of the Nevada Operating
Subsidiaries are required to file applications with the Nevada Gaming
Authorities and may be required to be licensed or found suitable by the Nevada
Gaming Authorities. Officers, directors and key employees of the Company who are
actively and directly involved in the licensed activities of the Nevada
Operating Subsidiaries may be required to be licensed or found suitable by the
Nevada Gaming Authorities. The Nevada Gaming Authorities may deny an application
for licensing for any cause that they deem reasonable. A finding of suitability
is comparable to licensing, and both require submission of detailed personal and
financial information followed by a thorough investigation. The applicant for
licensing or a finding of suitability must pay all the costs of the
investigation. Changes in licensed positions must be reported to the Nevada
Gaming Authorities and in addition to their authority to deny an application for
a finding of suitability or licensure, the Nevada Gaming Authorities have
jurisdiction to disapprove a change in a corporate position.
If the Nevada Gaming Authorities were to find an officer, director or key
employee unsuitable for licensing or unsuitable to continue having a
relationship with the Company, the Nevada Operating Subsidiaries, the companies
involved would have to sever all relationships with such person. In addition,
the Nevada Commission may require the Company and the Nevada Operating
Subsidiaries to terminate the employment of any person who refuses to file
appropriate applications. Determination of suitability or of questions
pertaining to licensing are not subject to judicial review in Nevada.
The Company and the Nevada Operating Subsidiaries will be required to
submit detailed financial and operating reports to the Nevada Commission.
Substantially all material loans, leases, sales of securities and similar
financing transactions by the Nevada Operating Subsidiaries will be required to
be reported to or approved by the Nevada Commission. If it were determined that
the Nevada Act was violated by the Company or any of the Nevada Operating
Subsidiaries, the licenses they hold could be limited, conditioned, suspended or
revoked, subject to compliance with certain statutory and regulatory procedures.
In addition, any of the Nevada Operating Subsidiaries, the Company and the
persons involved could be subject to substantial fines for each separate
violation of the Nevada Act at the discretion of the Nevada Commission.
Limitation, conditioning or suspension of the licenses held by the Company and
the Nevada Operating Subsidiaries could (and revocation of any license would)
materially adversely affect the Company's manufacturing, distribution and system
operations in Nevada.
Any beneficial holder of the Company's voting securities, regardless of the
number of shares owned, may be required to file an application, be investigated,
and have his suitability determined as a beneficial holder of the Company's
voting securities if the Nevada Commission has reason to believe that such
ownership would otherwise be inconsistent with the declared policies of the
state of Nevada. The applicant must pay all costs of investigation incurred by
the Nevada Gaming Authorities in conducting any such investigation. The Nevada
Act requires any person who acquires beneficial ownership of more than 5% of a
Registered Corporation's voting securities to report the acquisition to the
Nevada Commission. The Nevada Act requires that beneficial owners of more than
10% of a Registered Corporation's voting securities apply to the Nevada
Commission for a finding of suitability within thirty days after the Chairman of
the Nevada Board mails the written notice requiring such filing. Under certain
circumstances, an "institutional investor," as defined in the Nevada Act, which
acquires more than 10%, but not more than 15%, of the Registered Corporation's
voting securities may apply to the Nevada Commission for a waiver of such
finding of suitability if such institutional investor holds the voting
securities for investment purposes only. An institutional investor shall not be
deemed to hold voting securities for investment purposes unless the voting
securities were acquired and are held in the ordinary course of business as an
institutional investor and not for the purpose of causing, directly or
indirectly, the election of a majority of the members of the board of directors
of the Registered Corporation, any change in the Registered Corporation's
corporate charter, bylaws, management, policies or operations of the Registered
Corporation, or any of its gaming affiliates, or any other action which the
Nevada Commission finds to be inconsistent with holding the Registered
Corporation's voting securities for investment purposes only. Activities which
are not deemed to be inconsistent with holding voting securities for investment
purposes only include: (i) voting on all matters voted on by stockholders; (ii)
making financial and other inquiries of management of the type normally made by
securities analysts for informational purposes and not to cause a change in its
management, policies or operations; and (iii) such other activities as the
Nevada Commission may determine to
15
be consistent with such investment intent. If the beneficial holder of voting
securities who must be found suitable is a corporation, partnership or trust, it
must submit detailed business and financial information including a list of
beneficial owners. The applicant is required to pay all costs of investigation.
Any person who fails or refuses to apply for a finding of suitability or a
license within thirty days after being ordered to do so by the Nevada Commission
or the Chairman of the Nevada Board, may be found unsuitable. The same
restrictions apply to a record owner if the record owner, after request, fails
to identify the beneficial owner. Any stockholder found unsuitable and who
holds, directly or indirectly, any beneficial ownership of the common stock
beyond such period of time as may be prescribed by the Nevada Commission may be
guilty of a criminal offense. The Company will be subject to disciplinary action
if, after it receives notice that a person is unsuitable to be a stockholder or
to have any other relationship with the Company, the Nevada Operating
Subsidiaries or the Company (i) pays that person any dividend or interest upon
voting securities of the Company, (ii) allows that person to exercise, directly
or indirectly, any voting right conferred through securities held by that
person, (iii) pays remuneration in any form to that person for services rendered
or otherwise, or (iv) fails to pursue all lawful efforts to require such
unsuitable person to relinquish his voting securities including, if necessary,
the immediate purchase of said voting securities for cash at fair market value.
The Nevada Commission may, in its discretion, require the holder of any
debt security of a Registered Corporation to file applications, be investigated
and be found suitable to own the debt security of a Registered Corporation if
the Nevada Commission has reason to believe that his acquisition of such debt
security would otherwise be inconsistent with the declared policy of the State
of Nevada. If the Nevada Commission determines that a person is unsuitable to
own such security, then pursuant to the Nevada Act, the Registered Corporation
can be sanctioned, including the loss of its approvals, if without the prior
approval of the Nevada Commission, it: (i) pays to the unsuitable person any
dividend, interest, or any distribution whatsoever; (ii) recognizes any voting
right by such unsuitable person in connection with such securities; (iii) pays
the unsuitable person remuneration in any form; or (iv) makes any payment to the
unsuitable person by way of principal, redemption, conversion, exchange,
liquidation, or similar transaction.
The Company and the Nevada Operating Subsidiaries will be required to
maintain a current stock ledger in Nevada, which may be examined by the Nevada
Gaming Authorities at any time. If any securities are held in trust by an agent
or by a nominee, the record holder may be required to disclose the identity of
the beneficial owner to the Nevada Gaming Authorities. A failure to make such
disclosure may be grounds for finding the record holder unsuitable. The Company
is also required to render maximum assistance in determining the identity of the
beneficial owner. The Nevada Commission has the power to require the stock
certificates of the Company to bear a legend indicating that the securities are
subject to the Nevada Act.
After becoming a Registered Corporation, the Company may not make a public
offering of its securities without the prior approval of the Nevada Commission
if the securities or proceeds therefrom are intended to be used to construct,
acquire or finance gaming facilities in Nevada, or to retire or extend
obligations incurred for such purposes. Such approval, if given, does not
constitute a finding, recommendation or approval by the Nevada Commission or the
Nevada Board as to the accuracy or adequacy of the prospectus or the investment
merits of the securities offered. Any representation to the contrary is
unlawful. Changes in control of a Registered Corporation through merger,
consolidation, stock or asset acquisitions, management or consulting agreements,
or any act or conduct by a person whereby he obtains control, may not occur
without the prior approval of the Nevada Commission. Entities seeking to acquire
control of a Registered Corporation must satisfy the Nevada Board and the Nevada
Commission in a variety of stringent standards prior to assuming control of such
Registered Corporation. The Nevada Commission may also require controlling
stockholders, officers, directors and other persons having a material
relationship or involvement with the entity proposing to acquire control, to be
investigated and licensed as part of the approval process relating to the
transaction.
The Nevada Legislature has declared that some corporate acquisitions
opposed by management, repurchases of voting securities and corporate defense
tactics affecting Nevada corporate gaming licensees, and Registered Corporations
that are affiliated with those operations, may be injurious to stable and
productive corporate gaming. The Nevada Commission has established a regulatory
scheme to ameliorate the potentially adverse effects of these
16
business practices upon Nevada's gaming industry and to further Nevada's policy
to: (i) assure the financial stability of corporate gaming licensees and their
affiliates; (ii) preserve the beneficial aspects of conducting business in the
corporate form; and (iii) promote a neutral environment for the orderly
governance of corporate affairs. Approvals are, in certain circumstances,
required from the Nevada Commission before the Registered Corporation can make
exceptional repurchases of voting securities above the current market price
thereof and before a corporate acquisition opposed by management can be
consummated. The Nevada Act also requires prior approval of a plan of
recapitalization proposed by the Registered Corporation's Board of Directors in
response to a tender offer made directly to the Registered Corporation's
stockholders for the purposes of acquiring control of the Registered
Corporation.
License fees and taxes, computed in various ways depending on the type of
gaming or activity involved, are payable to the State of Nevada and to the
counties and cities in which gaming operations are to be conducted. Depending
upon the particular fee or tax involved, these fees and taxes are payable either
monthly, quarterly or annually and are based upon either: (i) a percentage of
the gross revenues received; or (ii) the number of gaming devices operated.
Annual fees are also payable to the State of Nevada for renewal of licenses as a
manufacturer, distributor, operator of a slot machine route and operator of an
off-track pari-mutuel wagering system.
Any person who is licensed, required to be licensed, registered, required
to be registered, or is under common control with such persons (collectively,
"Licensees"), and who proposes to become involved in a gaming venture outside of
Nevada, is required to deposit with the Nevada Board, and thereafter maintain, a
revolving fund in the amount of $10,000 to pay the expenses of investigation by
the Nevada Board of their participation in such foreign gaming. The revolving
fund is subject to increase or decrease in the discretion of the Nevada
Commission. Thereafter, Licensees are required to comply with certain reporting
requirements imposed by the Nevada Act. Licensees are also subject to
disciplinary action by the Nevada Commission if it knowingly violates any laws
of the foreign jurisdiction pertaining to the foreign gaming operation, fails to
conduct the foreign gaming operation in accordance with the standards of honesty
and integrity required of Nevada gaming operations, engages in activities that
are harmful to the state of Nevada or its ability to collect gaming taxes and
fees, or employs a person in the foreign operation who has been denied a license
or finding of suitability in Nevada on the ground of personal unsuitability.
Application of Additional or Future Regulatory Requirements
In the future, the Company intends to seek the necessary licenses,
approvals and findings of suitability for the Company, its personnel and
products in other jurisdictions throughout the world wherever significant sales
are anticipated to be made. There can be no assurance, however, that such
licenses, approvals or findings of suitability will be obtained or, if obtained,
will not be conditioned, suspended or revoked or that the Company will be able
to obtain the necessary approvals for its future products as they are developed.
If a license, approval or a finding of suitability is required by a regulatory
authority and the Company fails to obtain the necessary license, the Company may
be prohibited from selling its products for use in the respective jurisdiction
or may be required to sell its products through other licensed entities at a
reduced profit to the Company.
Employees
As of October 31, 1998, the Company employed approximately 980 persons. Of
this total, approximately 595 persons were engaged in full-time field
operations, 205 in part-time tellering/cashiering, approximately 50 in
engineering and software product development, approximately 30 in marketing and
approximately 100 in financial, administration and other positions. Most of the
North American pari-mutuel employees of the Company involved in field operations
and repairs are represented by the International Brotherhood of Electrical
Workers under two separate contracts which have been renewed through May 2000
and October 2001. The Company considers its employee relations to be
satisfactory.
17
Executive Officers of the Company
Certain information concerning the executive officers of the Company as of
January 22, 1999 is set forth below:
Name Age Position
A. Lorne Weil...................... 52 Chairman of the Board, President and Chief Executive Officer
DeWayne E. Laird................... 50 Vice President and Chief Financial Officer
Gerald Lawrence.................... 59 Executive Vice President
Martin E. Schloss.................. 52 Vice President, General Counsel and Secretary
Executive Officers of the Company hold office for an indefinite term,
subject to the discretion of the Board of Directors of the Company.
Mr. A. Lorne Weil has been a director of the Company since December 1989,
Chairman of the Board since October 31, 1991, Chief Executive Officer of the
Company since April 1992 and President of the Company since August 1997. Mr.
Weil held various senior management positions with the Company and its
subsidiaries from October 1990 to April 1992 and was a director and consultant
to Autotote Systems, Incorporated from 1982 until it was acquired by the Company
in 1989. Mr. Weil was the President of Lorne Weil, Inc., a firm providing
strategic planning and corporate development services to high technology
industries, from November 1979 to November 1992. Mr. Weil is currently a
director of Fruit of the Loom, Inc. and General Growth Properties, Inc.
Mr. DeWayne E. Laird has been Vice President and Chief Financial Officer of
the Company since November 1998 and Corporate Controller of the Company since
April 1996. From January 1992 to March 1996, Mr. Laird was President of Laird
Associates, PC, a CPA firm providing financial consulting services to the water
utility industry. From April 1984 to December 1991, he held various senior
positions with Philadelphia Suburban Corporation, including Chief Financial
Officer and Treasurer.
Mr. Gerald Lawrence has been Executive Vice President of the Company and
interim President of Autotote Enterprises, Inc., a division of the Company,
since June 1998. Mr. Lawrence served as President of the Company's pari-mutuel
division, Autotote Systems, Inc., from March 1996 to June 1998 and as Vice
President of the Company from November 1994 to June 1998. From January 1991 to
August 1994, he held the position of Executive Vice President of The New York
Racing Association, Inc. From November 1984 through December 1990, he served as
Executive Vice President and Chief Operating Officer of Churchill Downs
Incorporated.
Mr. Martin E. Schloss has been Vice President and General Counsel of the
Company since December 1992 and Secretary since May 1995. Mr. Schloss provided
consulting services to the Company from July 1992 until he became employed by
the Company in September 1992. From 1976 to 1992, Mr. Schloss served in various
positions in the legal department of General Instrument Corporation, with the
exception of a hiatus of approximately one and one-half years.
Mr. William Luke served as Vice President and Chief Financial Officer of
the Company from February 1996 through fiscal 1998, and resigned the aforesaid
positions in November 1998. Mr. DeWayne E. Laid assumed the positions of Vice
President and Chief Financial Officer of the Company coincident with Mr. Luke's
resignation (see above).
18
ITEM 2. PROPERTIES
The Company conducts its business principally from the following leased and
owned facilities:
Leased Facilities:
Location Segment Purpose Square feet
- -------- ------- ------- -----------
New York, NY corporate headquarters 12,000
Ballymahon, Ireland manufacturing 10,000
Newark, DE pari-mutuel administration and R&D 40,000
Gelsenkirchen,
Germany pari-mutuel operations 2,000
Englewood, NJ pari-mutuel operations and warehousing 3,000
various cities, CT pari-mutuel OTB facilities 44,000
New Haven, CT pari-mutuel OTB administration 2,000
Valencia, CA pari-mutuel administration and operations 6,688
Rocky Hill, CT lottery administration and operations 16,000
The Company also leases a total of 28,500 of warehouse space in Newark, DE
and New Haven, CT.
Owned Facilities:
Location Segment Purpose Square feet
- -------- ------- ------- -----------
Cedex, France pari-mutuel administration and operations 10,000
Windsor Locks, CT pari-mutuel OTB wagering facility 39,000
New Haven, CT pari-mutuel OTB administration, operations
and wagering facility 55,000
The Company believes that its present facilities are adequate for its
reasonably foreseeable needs.
ITEM 3. LEGAL PROCEEDINGS
Although the Company is a party to various claims and legal actions arising
in the ordinary course of business, management believes, on the basis of
information presently available to it, that the ultimate disposition of these
matters will not likely have a material adverse effect on the financial position
or results of operations of the Company.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
No matters were submitted to a vote of security holders during the fourth
quarter of fiscal 1998.
19
PART II
ITEM 5. MARKET FOR THE REGISTRANT'S COMMON STOCK AND RELATED STOCKHOLDER MATTERS
The Company's Class A Common Stock is traded under the symbol "TTE" on the
American Stock Exchange. The following table sets forth, for the periods
indicated, the range of high and low closing prices of the Company's Class A
Common Stock.
Fiscal 1997 Fiscal 1998
------------------ -----------------
High Low High Low
------------------ -----------------
First Quarter ................. $1.75 1.06 3.00 1.88
Second Quarter ................ 1.50 1.00 2.81 2.25
Third Quarter ................. 2.06 1.06 2.94 2.38
Fourth Quarter ................ 3.13 1.63 2.56 1.25
On January 22, 1999, the last reported sales price for the Class A Common
Stock on the American Stock Exchange was $2.13 per share. The approximate number
of holders of record of the Class A Common Stock as of January 22, 1999 was
2,121.
The Company has never paid any cash dividends on its Class A Common Stock.
The Board presently intends to retain all earnings, if any, for use in the
Company's business. Any future determination as to payment of dividends will
depend upon the financial condition and results of operations of the Company and
such other factors as are deemed relevant by the Board. Further, under the terms
of the Indenture governing the Company's 10 7/8% Senior Notes due 2004, the
Company and its Restricted Subsidiaries are not permitted to pay any cash
dividends or make certain other restricted payments (other than stock dividends)
on its Class A Common Stock.
Recent Sales of Unregistered Securities; Uses of Proceeds From Registered
Securities
During fiscal 1998, warrants to purchase an aggregate of 466,667
unregistered shares (the "Shares") of the Company's Class A Common Stock were
exercised at the aggregate price of $0.6 million. The warrants, which were
scheduled to expire in April 1998, were issued by the Company in January 1996 to
various banks that were party to the Company's prior senior bank credit
facility, in connection with the Company entering into an amendment to such
facility as of January 26, 1996. The Shares were issued by the Company in
reliance upon the exemption from registration provided for under Section 4(2) of
the Securities Act of 1933, as amended.
In addition, in fiscal 1998, the Company repurchased warrants to purchase
an aggregate of 58,338 Shares at a cost of approximately $0.1 million (see Note
11 to Consolidated Financial Statements).
20
ITEM 6. SELECTED FINANCIAL DATA
Selected historical financial data presented below as of and for the five
years ended October 31, 1998 have been derived from the audited consolidated
financial statements of the Company, which financial statements have been
audited by KPMG LLP, independent certified public accountants. The following
financial information reflects the acquisitions and dispositions of certain
businesses during the period 1994 through 1998 and should be read in conjunction
with Item 7, Management's Discussion and Analysis of Financial Condition and
Results of Operations, and the Consolidated Financial Statements of the Company
and the notes thereto, included in Item 8.
FIVE YEAR SUMMARY OF SELECTED
FINANCIAL DATA
(in thousands, except per share amounts)
Year Ended October 31,
-----------------------------------------------------------------
1998 1997 1996 1995 1994
--------- ------- ------- ------- ------
Selected Statement of Operations Data:
Operating Revenues:
Services ................................................ $ 135,790 132,989 137,794 132,260 98,592
Sales ................................................... 23,523 24,343 38,441 20,924 50,458
--------- ------- ------- ------- ------
159,313 157,332 176,235 153,184 149,050
--------- ------- ------- ------- ------
Costs and Expenses:`
Cost of services ........................................ 88,916 80,496 86,674 78,569 61,158
Cost adjustments and strike expenses .................... -- -- -- -- 6,781
Cost of sales ........................................... 15,739 15,396 25,864 15,661 35,753
Selling, general & administrative ....................... 26,205 28,444 31,921 36,540 25,298
Restructuring and write-off of assets ................... -- -- (649) 18,241 8,576
Depreciation and amortization ........................... 29,489 36,728 40,853 35,463 25,418
Interest expense ........................................ 15,521 14,367 14,837 16,362 6,408
Other (income) expense .................................. (1,064) 79 560 (436) (952)
Litigation settlement ................................... -- -- 6,800 -- --
(Gain) loss on sale of businesses ....................... 66 (1,823) 1,127 -- --
--------- ------- ------- ------- ------
Total costs and expenses .................................. 174,872 173,687 207,987 200,400 168,440
--------- ------- ------- ------- ------
Loss before income tax expense
(benefit) and extraordinary item .......................... (15,559) (16,355) (31,752) (47,216) (19,390)
Income tax expense (benefit) ................................. 321 906 2,443 2,673 (1,462)
--------- ------- ------- ------- ------
Loss before extraordinary item ............................... (15,880) (17,261) (34,195) (49,889) (17,928)
Extraordinary item ........................................... -- (426) -- -- (4,222)
--------- ------- ------- ------- ------
Net loss ..................................................... $ (15,880) (17,687) (34,195) (49,889) (22,150)
========= ======= ======= ======= =======
Net loss per basic share and diluted share ................... $ (0.44) (0.51) (1.09) (1.72) (0.79)
========= ======= ======= ======= =======
Selected Balance Sheet Data (End of Period):
Total assets ................................................. $ 156,500 153,541 196,793 241,021 241,597
Total long-term debt, including current installments ......... $ 158,870 149,857 169,024 177,264 143,955
Stockholders' equity (deficit) ............................... $ (48,638) (33,240) (20,196) 11,857 55,721
Weighted average number of shares used in per share
calculation .................................................. 35,696 34,469 31,305 28,965 28,174
21
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
Background
The Company operates in two business segments, Pari-mutuel Operations and
Lottery Operations. Pari-mutuel Operations include the North American and
international on-track and OTB pari-mutuel operations, simulcasting services,
Connecticut OTB operations, video gaming and CBS (the Company's sports wagering
service business which was sold in October 1996). Lottery Operations include
both domestic and international lottery operations (including Tele Control, the
Company's European lottery business, which was sold in April 1997), as well as
systems and equipment sales.
The Company is the leading provider of computerized pari-mutuel wagering
systems to the North American Racing Industry and is also a leading provider of
such systems worldwide. The Company also owns and operates the Connecticut OTB,
is the exclusive licensed operator of Pari-mutuel wagering in the Netherlands
and is the leading provider of Racing Industry simulcasting services in the
United States. Additionally, the Company provides technologically advanced VGMs
to the North American Racing Industry for use at racetracks. The Company also
provides lottery systems and equipment in the United States and internationally.
Historically, the Company's revenues have been derived from two principal
sources: service revenues and sales revenues. Service revenues are earned
pursuant to multi-year contracts to provide wagering systems and other services,
which are typically based on a percentage of Handle and/or daily or monthly
fees; or are derived from wagering by customers at facilities owned by the
Company. Sales revenues are derived from sales contracts for wagering equipment,
services and software. The first quarter of the fiscal year and a portion of the
second fiscal quarter traditionally comprise the weakest season for wagering
service revenue. Wagering equipment sales revenues usually reflect a limited
number of large transactions which do not recur on an annual basis, but which
historically have given rise to additional terminal and systems software sales
to existing customers. Consequently, revenues and operating results can vary
substantially from period to period as a result of the timing of revenue
recognition for major equipment sales.
The Company's business strategy over the past several years has been to
refocus its activities on its core businesses, which generate recurring revenues
rather than one-time equipment sales, and to reduce its operating expenses.
Consistent with this strategy, the Company (i) in October 1996, sold its
casino/sports wagering business for approximately $3.0 million and (ii) in April
1997, sold its European lottery business for approximately $26.6 million. The
proceeds from the sales of these businesses were used to reduce the Company's
outstanding indebtedness.
The sales of the casino/sports wagering business and the European lottery
business described above, as well as the acquisitions of simulcasting operations
and the French pari-mutuel business in fiscal 1995 and the acquisitions of the
Dutch pari-mutuel business in fiscal 1998, which were accounted for as
purchases, affect the comparability of operations from period to period (see
Note 2 to Consolidated Financial Statements). In addition, one-time equipment
sales that can vary significantly from period to period can also significantly
affect the comparability of operations from year to year.
22
Results of Operations:
Years ended October 31,
----------------------------------------------
1998 1997 1996
-------- -------- --------
(in thousands)
Pari-mutuel Operations
Operating Revenues:
Service revenue ....................................................... $126,573 119,360 118,267
Sales revenue ......................................................... 14,693 14,866 10,172
-------- -------- --------
Total Revenue ...................................................... $141,266 134,226 128,439
======== ======== ========
Gross Profit (excluding depreciation and amortization) ................... $ 49,345 51,709 48,688
======== ======== ========
Lottery Operations
Operating Revenues:
Service revenue ....................................................... $ 9,217 13,629 19,527
Sales revenue ......................................................... 8,830 9,477 28,269
-------- -------- --------
Total Revenue ...................................................... $ 18,047 23,106 47,796
======== ======== ========
Gross Profit (excluding depreciation and amortization) ................... $ 5,313 9,731 15,009
======== ======== ========
Company Total
Operating Revenues:
Service revenue ....................................................... $135,790 132,989 137,794
Sales revenue ......................................................... 23,523 24,343 38,441
-------- -------- --------
Total Revenue ...................................................... $159,313 157,332 176,235
======== ======== ========
Gross Profit (excluding depreciation and amortization) ................... $ 54,658 61,440 63,697
======== ======== ========
Fiscal 1998 Compared to Fiscal 1997
Revenue Analysis
Revenues increased 1.3% or $2.0 million to $159.3 million in the fiscal
year ended October 31, 1998 ("fiscal 1998") from $157.3 million in the fiscal
year ended October 31, 1997 ("fiscal 1997").
Pari-mutuel Operations service revenues of $126.6 million for fiscal 1998
improved $7.2 million or 6.0% from $119.4 million in the prior year. This
improvement includes $4.8 million from the Company's Netherlands operations,
which were acquired in July 1998, and revenue increases of $3.8 million as a
result of growth in Handle in the Company's North American pari-mutuel and
Connecticut OTB operations and the start-up of the NASRIN(TM) business in
October 1998. The growth in Handle during fiscal 1998 compared to fiscal 1997 is
attributable to the addition of six new North American racetracks and OTB sites,
full card simulcasting at three North American racetrack customers, the increase
in the number of VGM machines, the expansion of OTB operations in Connecticut to
seven days a week in the first quarter of fiscal 1998, and the addition of the
new German simulcasting business. These increases were partially offset by lower
revenues in the North American simulcasting operations due to lower ad hoc sales
of satellite time following the reduction in number and realignment of leased
transponders due to the failure of the Galaxy IV satellite, and by the loss of a
service contract in the Company's French operations. Sales revenue, primarily
consisting of export sales, were $14.7 million in fiscal 1998, a decrease of
$0.2 million from $14.9 million in the prior year.
Lottery Operations service revenues decreased $4.4 million from $13.6
million in fiscal 1997 to $9.2 million in fiscal 1998, primarily because of the
sale of the European lottery business in April 1997. Sales revenues decreased
$0.7 million from $9.5 million in fiscal 1997 to $8.8 million in fiscal 1998.
This decrease is primarily attributable to the non-recurring sale of terminals
to the Israel lottery in fiscal 1997, partially offset by the sale in fiscal
1998 of terminals for use in Italy in the SISAL Sport Italia SpA lottery
operations.
23
Gross Profit Analysis
Total gross profits earned by the Company, exclusive of depreciation and
amortization, decreased $6.7 million, or 11%, to $54.7 million in fiscal 1998
from $61.4 million in fiscal 1997.
Gross profits earned by the Pari-mutuel Operations of $49.3 million in
fiscal 1998 decreased $2.4 million from $51.7 million in fiscal 1997,
principally due lower profit on the Company's French pari-mutuel operations,
primarily as a result of the loss of a operations service contract and the
resulting costs arising from the termination of 14 employees and the resizing of
the business to better serve the reduced French market. Also contributing was
the lost profits on sales of excess transponder time as a result of the decrease
in leased and available transponders following the failure of the Galaxy IV
satellite in May 1998. These decreases were partially offset by the improved
profitability at the North American pari-mutuel and OTB business units.
Gross profits earned by the Lottery Operations totaled $5.3 million for
fiscal 1998, a decrease of $4.4 million from $9.7 million in fiscal 1997. This
decline is attributable to a $3.3 million decline in European lottery gross
profits due to the sale of the business unit in April 1997, coupled with lower
domestic lottery margins as the result of the installation of the new
Connecticut lottery terminals and lower margins on equipment sales, reflecting a
change in the mix of products sold in each period.
Total gross profits on equipment sales were 33% for fiscal 1998, compared
to gross profits on such sales of 37% in fiscal 1997. The decrease is due to the
sale of the European lottery business in 1997, coupled with the lower margins on
fiscal 1998 equipment sales reflecting the change in mix of products sold in
each period. Gross profits on services were approximately 35% for fiscal 1998,
or 4% below margins earned in fiscal 1997, reflecting lower margins on the
recently acquired business in the Netherlands, higher transponder lease costs in
simulcasting, lower margins in the European pari-mutuel operations as a result
of efforts to start-up and expand business opportunities, extra costs incurred
in connection with the Connecticut lottery installation, and start-up costs for
the NASRIN(TM) business.
Expense Analysis
Selling, general and administrative expenses decreased $2.2 million or 8%
to $26.2 million in fiscal 1998 from $28.4 million in fiscal 1997, partially
reflecting the absence of expenses for businesses sold in fiscal 1997. Excluding
businesses sold, selling, general and administrative expenses decreased 6% or
$1.8 million as a result of lower bad debt and legal expenses arising from the
collection of receivables previously reserved as doubtful due to concerns about
their recoverability, and cost savings programs in Europe. Partially offsetting
these decreases are the added expenses of the recently acquired Netherlands
operations and the expense of completing the test phase and initial rollout of
the NASRIN(TM) communication network.
Depreciation and amortization expenses decreased $7.2 million or 20% to
$29.5 million in fiscal 1998 compared to $36.7 million in fiscal 1997.
Approximately $3.0 million of the decrease is attributable to the absence of
expenses related to the businesses sold in fiscal 1997. Excluding businesses
sold, depreciation and amortization expenses decreased $4.2 million or 11% as a
result of the full amortization of certain intangible assets and lower
depreciation on North American pari-mutuel assets and lottery assets in fiscal
1998. These decreases were partially offset by the accelerated amortization of
deferred transponder costs as a result of the Galaxy satellite failure and
accelerated amortization of goodwill in the French operations resulting from the
loss of a major service contract. Due to the large number of service contract
renewals in fiscal 1998 and the realized durability of the equipment, the
Company is lengthening the depreciable lives of its pari-mutuel terminals from
seven to ten years in future reporting periods. Additionally, in fiscal 1998,
the Company completed the installation of new lottery terminals for the
Connecticut State Lottery under a contract with an initial five-year term plus
five one-year options to extend the contract through May 2008. Based on industry
practice of lottery contracts and the Company's historical relationship with the
Connecticut State Lottery for the past ten years, the Company expects to
depreciate the terminals and installation costs on a straight-line method over
their estimated useful lives of 10 years.
24
Interest expense was $15.5 million in fiscal 1998, compared to $14.4
million in fiscal 1997. The $1.1 million increase reflects higher borrowing
levels to finance the installation of the new Connecticut lottery terminals and
higher interest rates.
Income Taxes
Income tax expense was $0.3 million in fisca1 1998 compared to $0.9 million
in fiscal 1997. Income tax expense principally reflects foreign tax expense,
since no U.S. Federal tax benefit has been recognized on domestic operating
losses. The decrease in income tax expense principally reflects the sale of the
European lottery business.
Fiscal 1997 Compared to Fiscal 1996
Revenue Analysis
Revenues decreased 10.7% or $18.9 million to $157.3 million in fiscal 1997
from $176.2 million in the fiscal year ended October 31, 1996 ("fiscal 1996").
Pari-mutuel Operations service revenues of $119.4 million for fiscal 1997
improved $1.1 million or 1% from $118.3 million in the prior year. This
improvement reflects revenue increases of $4.6 million as a result of growth in
Handle in the Company's North American pari-mutuel and Connecticut OTB
operations, and the addition of new customers in the simulcasting business.
These increases were partially offset by the absence of $2.4 million in revenue
provided in fiscal 1996 by the casino/sports wagering business which was sold in
October 1996 and a loss of $1.5 million in sales of excess transponder time due
to the unanticipated shutdown of one of the satellites leased by the Company.
The growth in Handle during fiscal 1997 compared to fiscal 1996 is attributable
to the addition of six new North American racetrack and OTB sites, full card
simulcasting at three North American racetrack customers, the increase in the
number of VGM machines, and the expansion of OTB operations in Connecticut to
seven days a week in the first quarter of fiscal 1997. Sales revenue in fiscal
1997 of $14.9 million increased $4.7 million from $10.2 million in the prior
year, due to a $5.5 million export sale of a totalisator system to the Jockey
Club of Peru.
Lottery Operations service revenues decreased $5.9 million to $13.6 million
in fiscal 1997 from $19.5 million in fiscal 1996 primarily because of the sale
of the European lottery business in April 1997. Sales revenues decreased
significantly in fiscal 1997 to $9.5 million from $28.3 million in fiscal 1996.
This decrease is primarily attributable to the absence of fiscal 1996 sales of
systems by the European lottery business to several German lottery contract
sites and the absence of sales of terminals and parts for use in the SISAL Sport
Italia SpA lottery operations, partially offset by the fiscal 1997 sales of
approximately 450 terminals to the Israel lottery.
Gross Profit Analysis
Gross profits earned by the Pari-mutuel Operations of $51.7 million in
fiscal 1997 increased $3.0 million from $48.7 million in fiscal 1996,
principally due to increased North American pari-mutuel revenues and improved
simulcasting margins resulting from lower equipment costs. These increases were
partially offset by $0.4 million lower margins from the loss of sales of excess
transponder time, the absence of margin provided in the prior year by the
casino/sports wagering business which was sold in October 1996, and lower profit
on the Company's European pari-mutuel operations as the result of the
strengthening of the U.S. dollar early in the year.
Gross profits earned by the Lottery Operations totaled $9.7 million for
fiscal 1997, a decrease of $5.3 million from the fiscal 1996 level of $15.0
million. This decline is attributable to the non-recurring delivery of computer
systems to the German Lottery in fiscal 1996, coupled with lower European
lottery service revenues due to the sale of the business unit in April 1997 and
a decrease in the number of terminals delivered to Italy's TOTIP pari-mutuel
lottery. Partly offsetting these declines were margins earned on equipment
delivered to the Company's customer in Israel.
Total gross profits on equipment sales were 37% for fiscal 1997, compared
to gross profits on such sales of 33% in fiscal 1996 as a result of a change in
product mix. Gross profits on services were approximately 40% for
25
fiscal 1997, a 2% improvement over margins earned in fiscal 1996, reflecting
higher revenues and improved operating efficiencies in the North American
pari-mutuel, OTB and simulcasting operations.
Expense Analysis
Selling, general and administrative expenses decreased $3.5 million or 11%
to $28.4 million in fiscal 1997 from $31.9 million in fiscal 1996, primarily
reflecting the absence of expenses for businesses sold in fiscal years 1996 and
1997. Excluding businesses sold, selling general and administrative expenses
increased $0.3 million, reflecting higher compensation costs, partially offset
by lower litigation expenses.
Depreciation and amortization expenses decreased $4.1 million or 10% to
$36.7 million in fiscal 1997 from $40.9 million in fiscal 1996. The decrease
resulted primarily from the absence of expenses related to the businesses sold
in fiscal 1996 and fiscal 1997. Excluding businesses sold, depreciation and
amortization expenses decreased $1.3 million or 4% as a result of the
non-recurring effect of depreciation on certain assets in fiscal 1996, partially
offset by higher depreciation on fiscal 1996 and fiscal 1997 capital additions
for North America's pari-mutuel and video gaming operations.
Interest expense was $14.4 million in fiscal 1997, compared to $14.8
million in fiscal 1996. The $0.4 million decrease reflects lower borrowing
levels as a result of asset sales, partially offset by higher interest rates.
Income Taxes
Income tax expense was $0.9 million in fisca1 1997 compared to $2.4 million
in fiscal 1996. Income tax expense principally reflects foreign tax expense,
since no U.S. Federal tax benefit has been recognized on domestic operating
losses. The decrease in income tax expense principally reflects the sale of the
European lottery business.
Liquidity and Capital Resources
On May 22, 1998, Company and Autotote Lottery Corporation entered into a
$12.0 million, three-year term loan arrangement (the "Term Loan") to finance the
development and installation of the lottery system for the Connecticut State
Lottery, including the manufacture of approximately three thousand new lottery
terminals. The Term Loan bears interest at a fixed rate of 8.87% payable
quarterly and at maturity on February 15, 2001, with principal payments of $0.6
million due quarterly through January 31, 2001 with a final principal payment of
$6.0 million due at maturity. In addition to scheduled principal payments, the
Term Loan requires mandatory principal prepayments upon the occurrence of
certain events, including asset sales, the incurrence of certain indebtedness,
Recovery Events (as defined), and Autotote Lottery Corporation Excess Cash Flow
(as defined), in each case, in excess of specified thresholds. The Term Loan was
extended in conjunction with the July 28, 1997 revolving credit facility (the
"Facility") and is subject to certain restrictive and financial covenants
contained in the Facility. Obligations under the Facility and Term Loan are
jointly and severally guaranteed by substantially all of the Company's U.S.
subsidiaries and are secured by (i) first priority security interests in
substantially all tangible and intangible assets of the Company and its U.S.
subsidiaries, and (ii) a first priority lien on all of the capital stock of the
Company's U.S. subsidiaries and on 65% of the capital stock of the Company's
non-U.S. subsidiaries. In addition, the Term Loan is secured by a first priority
security interest in substantially all of the Company's Connecticut lottery
assets now owned or hereafter acquired. Also, under the terms of the Request for
Proposal for the development and installation of the lottery system for the
Connecticut State Lottery, the Company provided a Performance Bond in the
initial amount $8 million, which was automatically increased to $10 million upon
the effective date of the agreement, May 9, 1998.
On July 28, 1997, the Company issued $110 million of 10 7/8% Senior Notes
due August 1, 2004 (see Note 7 to Consolidated Financial Statements), which were
exchanged for $110 million of 10 7/8% Series B Notes due 2004 (the "Notes") in
connection with the Company's exchange offer in October 1997. The Notes bear
interest at a rate of 10 7/8% per annum payable semi-ann