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FORM 10-Q
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended May 24, 2003
Commission file number 1-11250
GTECH Holdings Corporation
- --------------------------------------------------------------------------------
(Exact name of registrant as specified in its charter)
Delaware 05-0450121
- --------------------------------- --------------------------------
(State or other jurisdiction of (I.R.S. Employer Identification
incorporation or organization) Number)
55 Technology Way, West Greenwich, Rhode Island 02817
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(Address of principal executive offices) (Zip Code)
Registrant's telephone number, including area code: (401) 392-1000
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 [ ]
At June 30, 2003, there were 58,013,801 shares of the registrant's Common Stock
outstanding.
INDEX
GTECH HOLDINGS CORPORATION AND SUBSIDIARIES
Page
PART I. FINANCIAL INFORMATION Number
- ------------------------------ ------
Item 1. Financial Statements
Consolidated Balance Sheets 3
Consolidated Income Statements 4
Consolidated Statements of Cash Flows 5
Consolidated Statements of Shareholders' Equity 6
Notes to Consolidated Financial Statements 7-20
Item 2. Management's Discussion and Analysis of Financial Condition 21-34
and Results of Operations
Item 3. Quantitative and Qualitative Disclosures about Market Risk 35
Item 4. Controls and Procedures 35
PART II. OTHER INFORMATION
Item 1. Legal Proceedings 36-38
Item 6. Exhibits and Reports on Form 8-K 39
SIGNATURES 40
CERTIFICATIONS 41-42
EXHIBITS
PART 1. FINANCIAL INFORMATION
Item 1. FINANCIAL STATEMENTS
CONSOLIDATED BALANCE SHEETS
GTECH HOLDINGS CORPORATION AND SUBSIDIARIES
(Unaudited)
May 24, February 22,
2003 2003
---------- ------------
(Dollars in thousands)
ASSETS
CURRENT ASSETS:
Cash and cash equivalents $ 131,476 $ 116,174
Trade accounts receivable, net 95,738 107,666
Sales-type lease receivables 4,303 4,400
Inventories 84,713 72,287
Deferred income taxes 29,410 29,410
Other current assets 26,342 18,660
---------- ------------
TOTAL CURRENT ASSETS 371,982 348,597
SYSTEMS, EQUIPMENT AND OTHER ASSETS RELATING TO CONTRACTS, net 432,133 410,911
GOODWILL, net 115,498 115,498
OTHER ASSETS 80,272 79,189
---------- ------------
TOTAL ASSETS $ 999,885 $ 954,195
========== ============
LIABILITIES AND SHAREHOLDERS' EQUITY
CURRENT LIABILITIES:
Accounts payable $ 60,055 $ 74,042
Accrued expenses 71,599 67,220
Employee compensation 18,945 37,494
Advance payments from customers 83,567 69,706
Income taxes payable 51,244 54,043
Short term borrowings 2,475 2,616
Current portion of long-term debt 7,161 6,992
---------- ------------
TOTAL CURRENT LIABILITIES 295,046 312,113
LONG-TERM DEBT, less current portion 287,218 287,088
OTHER LIABILITIES 41,489 39,428
COMMITMENTS AND CONTINGENCIES - -
SHAREHOLDERS' EQUITY:
Preferred Stock, par value $.01 per share - 20,000,000 shares authorized, none issued - -
Common Stock, par value $.01 per share - 150,000,000 shares authorized,
92,296,404 and 92,296,404 shares issued; 57,367,876 and 56,638,331 shares
outstanding at May 24, 2003 and February 22, 2003, respectively 923 923
Additional paid-in capital 246,689 242,274
Equity carryover basis adjustment (7,008) (7,008)
Accumulated other comprehensive loss (91,319) (95,488)
Retained earnings 726,254 684,653
---------- ------------
875,539 825,354
Less cost of 34,928,528 and 35,658,073 shares in treasury at
May 24, 2003 and February 22, 2003, respectively (499,407) (509,788)
---------- ------------
376,132 315,566
---------- ------------
TOTAL LIABILITIES AND SHAREHOLDERS' EQUITY $ 999,885 $ 954,195
========== ============
See Notes to Consolidated Financial Statements
-3-
CONSOLIDATED INCOME STATEMENTS
GTECH HOLDINGS CORPORATION AND SUBSIDIARIES
(Unaudited)
Three Months Ended
-----------------------
May 24, May 25,
2003 2002
--------- ---------
(Dollars in thousands,
except per share amounts)
Revenues:
Services $ 223,538 $ 223,735
Sales of products 16,047 7,677
--------- ---------
239,585 231,412
Costs and expenses:
Costs of services 126,797 146,935
Costs of sales 8,629 6,247
--------- ---------
135,426 153,182
--------- ---------
Gross profit 104,159 78,230
Selling, general and administrative 24,280 22,909
Research and development 14,390 6,502
--------- ---------
Operating expenses 38,670 29,411
--------- ---------
Operating income 65,489 48,819
Other income (expense):
Interest income 1,188 842
Equity in earnings of unconsolidated affiliates 1,929 696
Other expense (1,180) (591)
Interest expense (2,306) (2,925)
--------- ---------
(369) (1,978)
--------- ---------
Income before income taxes 65,120 46,841
Income taxes 24,094 17,800
--------- ---------
Net income $ 41,026 $ 29,041
========= =========
Basic earnings per share $ 0.72 $ 0.50
========= =========
Diluted earnings per share $ 0.68 $ 0.49
========= =========
Weighted average shares outstanding - basic 56,904 57,583
========= =========
Weighted average shares outstanding - diluted 60,228 59,261
========= =========
See Notes to Consolidated Financial Statements
-4-
CONSOLIDATED STATEMENTS OF CASH FLOWS
GTECH HOLDINGS CORPORATION AND SUBSIDIARIES
(Unaudited)
Three Months Ended
----------------------
May 24, May 25,
2003 2002
--------- ---------
(Dollars in thousands)
OPERATING ACTIVITIES
Net income $ 41,026 $ 29,041
Adjustments to reconcile net income to net cash provided by
operating activities:
Depreciation 25,692 33,956
Intangibles amortization 447 1,685
Tax benefit related to stock award plans 4,415 6,462
Equity in earnings of unconsolidated affiliates, net of dividends received (959) 215
Other 3,284 1,844
Changes in operating assets and liabilities:
Trade accounts receivable 11,447 14,013
Inventories (12,426) (3,100)
Other assets and liabilities (9,957) 7,281
--------- ---------
NET CASH PROVIDED BY OPERATING ACTIVITIES 62,969 91,397
INVESTING ACTIVITIES
Purchases of systems, equipment and other assets relating to contracts (58,663) (53,023)
Other (1,186) (662)
--------- ---------
NET CASH USED FOR INVESTING ACTIVITIES (59,849) (53,685)
FINANCING ACTIVITIES
Net proceeds from issuance of long-term debt 1,409 -
Principal payments on long-term debt (866) (1,561)
Purchases of treasury stock - (37,686)
Proceeds from stock options 8,406 12,549
Other (52) 673
--------- ---------
NET CASH PROVIDED BY (USED FOR) FINANCING ACTIVITIES 8,897 (26,025)
Effect of exchange rate changes on cash 3,285 3,094
--------- ---------
INCREASE IN CASH AND CASH EQUIVALENTS 15,302 14,781
Cash and cash equivalents at beginning of period 116,174 35,095
--------- ---------
CASH AND CASH EQUIVALENTS AT END OF PERIOD $ 131,476 $ 49,876
========= =========
See Notes to Consolidated Financial Statements
-5-
CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY - (Unaudited)
GTECH HOLDINGS CORPORATION AND SUBSIDIARIES
Equity
Additional Carryover
Outstanding Common Paid-in Basis
Shares Stock Capital Adjustment
----------- ----------- ---------- -----------
(Dollars in thousands)
Balance at February 22, 2003 56,638,331 $ 923 $ 242,274 $ (7,008)
Comprehensive income:
Net income - - - -
Other comprehensive income (loss), net of tax:
Foreign currency translation - - - -
Unrecognized net loss on derivative instruments - - - -
Comprehensive income
Shares issued under employee stock purchase
and stock award plans 123,519 - - -
Shares issued upon exercise of stock options 606,026 - - -
Tax benefits related to stock award plans - - 4,415 -
----------- ----------- ---------- ----------
Balance at May 24, 2003 57,367,876 $ 923 $ 246,689 $ (7,008)
=========== =========== ========== ==========
Accumulated
Other
Comprehensive Retained Treasury
Income (Loss) Earnings Stock Total
------------- ---------- ---------- ----------
(Dollars in thousands)
Balance at February 22, 2003 $ (95,488) $ 684,653 $ (509,788) $ 315,566
Comprehensive income:
Net income - 41,026 - 41,026
Other comprehensive income (loss), net of tax:
Foreign currency translation 9,217 - - 9,217
Unrecognized net loss on derivative instruments (5,048) - - (5,048)
----------
Comprehensive income 45,195
Shares issued under employee stock purchase
and stock award plans - 793 1,757 2,550
Shares issued upon exercise of stock options - (218) 8,624 8,406
Tax benefits related to stock award plans - - - 4,415
------------- ---------- ---------- ----------
Balance at May 24, 2003 $ (91,319) $ 726,254 $ (499,407) $ 376,132
============= ========== ========== ==========
See Notes to Consolidated Financial Statements
-6-
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
GTECH HOLDINGS CORPORATION AND SUBSIDIARIES
NOTE 1 - ORGANIZATION, BASIS OF PRESENTATION AND STOCK-BASED COMPENSATION PLANS
ORGANIZATION
GTECH Holdings Corporation ("Holdings") is a global information technology
company providing software, networks and professional services that power
high-performance, transaction processing solutions. When used in these notes,
the terms "Holdings", "the Company", "we", "our", and "us" refer to GTECH
Holdings Corporation and its consolidated subsidiaries, unless otherwise
specified. We have a single operating and reportable business segment, the
Transaction Processing segment. Our core market is the lottery industry, with a
growing presence in commercial services transaction processing. The accounting
policies of the Transaction Processing segment are the same as those described
in Note 1 - "Organization and Summary of Significant Accounting Policies" in our
Consolidated Financial Statements and footnotes included in our fiscal 2003
Annual Report on Form 10-K, as amended. Management evaluates the performance of
this segment based on operating income.
BASIS OF PRESENTATION
The accompanying unaudited consolidated financial statements of Holdings, the
parent of GTECH Corporation ("GTECH"), have been prepared in accordance with
generally accepted accounting principles ("GAAP") for interim financial
information and with the instructions to Form 10-Q and Article 10 of Regulation
S-X. They do not include all information and notes required by GAAP for complete
financial statements. In the opinion of management, all adjustments (consisting
of normal recurring accruals) considered necessary for a fair presentation have
been included. Operating results for the three-month period ended May 24, 2003
are not necessarily indicative of the results that may be expected for the full
fiscal year ending February 28, 2004. The balance sheet at February 22, 2003 has
been derived from the audited financial statements at that date. For further
information refer to the Consolidated Financial Statements and footnotes
included in our fiscal 2003 Annual Report on Form 10-K, as amended.
Certain amounts in our prior period financial statements have been reclassified
to conform to the current period presentation.
STOCK-BASED COMPENSATION PLANS
We follow Accounting Principles Board Opinion No. 25, "Accounting for Stock
Issued to Employees" and related Interpretations, in accounting for our
stock-based compensation plans and we have elected to continue to use the
intrinsic value-based method to account for stock option grants. We have adopted
the disclosure-only provisions of Statement of Financial Accounting Standards
No. 148 ("SFAS 148"), "Accounting for Stock-Based Compensation - Transition and
Disclosure", an amendment of Statement of Financial Accounting Standards No. 123
("SFAS 123"). Accordingly, no compensation expense has been recognized for our
stock-based compensation plans other than for restricted stock.
-7-
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)
NOTE 1 - ORGANIZATION, BASIS OF PRESENTATION AND STOCK-BASED COMPENSATION PLANS
(continued)
Had we elected to recognize compensation expense based upon the fair value at
the grant dates for awards under these plans, net income and earnings per share
would have been reduced to the pro forma amounts listed in the table below. The
fair value of each grant is estimated on the date of grant using the
Black-Scholes option pricing model.
Three Months Ended
--------------------------
May 24, May 25,
2003 2002
----------- ----------
(Dollars in thousands,
except per share amounts)
Net income, as reported $ 41,026 $ 29,041
Deduct: Total stock-based compensation expense determined under
the fair value method for all awards, net of related tax effects (5,910) (6,715)
--------- --------
Pro forma net income $ 35,116 $ 22,326
========= ========
Basic earnings per share:
As reported $ .72 $ .50
Pro forma .62 .39
Diluted earnings per share:
As reported $ .68 $ .49
Pro forma .59 .38
NOTE 2 - PROPOSED ACQUISITION
In March 2003, we entered into an agreement to acquire Interlott Technologies,
Inc. ("Interlott"), a provider of instant ticket vending machines for the
worldwide lottery industry. This agreement provides for us to pay $9.00 per
share of Interlott in cash (48.5%) or Holdings common stock (51.5%), and to
assume debt of approximately $21 million. The aggregate purchase price, together
with the assumed debt, is approximately $85 million. Our obligation to complete
this acquisition is subject to obtaining approval of the transaction by
Interlott shareholders, securing necessary regulatory consents, and satisfying
certain other closing conditions. Approval of this transaction by our
shareholders is not required. We expect the closing of the Interlott acquisition
to occur by late August 2003.
-8-
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)
NOTE 3 - INVENTORIES
May 24, February 22,
2003 2003
---------- ------------
(Dollars in thousands)
Inventories consist of:
Raw materials $ 11,044 $ 14,133
Work in progress 69,457 54,855
Finished goods 4,212 3,299
---------- ----------
$ 84,713 $ 72,287
========== ==========
Inventories include amounts we manufacture or assemble for our long-term service
contracts and amounts related to product sales contracts. Work in progress at
May 24, 2003 and February 22, 2003, includes approximately $63.6 million and
$51.3 million, respectively, related to product sale contracts.
Amounts received from customers in advance of revenue recognition (primarily
related to product sale contracts included in work in progress above) totaled
$63.4 million and $52.4 million at May 24, 2003 and February 22, 2003,
respectively. These amounts are included in Advance Payments from Customers in
our Consolidated Balance Sheets.
NOTE 4 - PRODUCT WARRANTIES
We offer a product warranty on all of our manufactured products (primarily
terminals and related peripherals) sold to third parties. Although we do not
have a standard product warranty, our typical warranty provides that we will
repair or replace defective products for a period of time (usually 90 days) from
the date revenue is recognized or from the date a product is delivered and
tested. We estimate product warranty costs that we expect to incur during the
warranty period and we record a charge to costs of sales for the estimated
warranty cost at the time the product sale is recorded. In determining the
appropriate warranty provision, consideration is given to historical warranty
cost information, the status of the terminal model in its life cycle and current
terminal performance. We periodically assess the adequacy of our product
warranty reserves and adjust them as necessary in the period when the
information necessary to make the adjustment becomes available.
We typically do not provide a product warranty on purchased products sold to
third parties but attempt to pass the manufacturer's warranty, if any, on to our
customers.
A summary of product warranty activity, which is included in Accrued Expenses in
our Consolidated Balance Sheets, is as follows (in thousands):
May 24,
2003
---------
Balance at beginning of fiscal period $ 437
Additional reserves 270
Charges incurred (15)
---------
Balance at end of fiscal period $ 692
=========
-9-
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)
NOTE 5 - LONG-TERM DEBT
May 24, February 22,
2003 2003
------------- ------------
(Dollars in thousands)
Long-term debt consists of:
1.75% Convertible Debentures due 2021 $ 175,000 $ 175,000
7.87% Series B Senior Notes due 2007 95,000 95,000
Interest rate swaps 13,857 14,721
Other 10,522 9,359
------------- ------------
294,379 294,080
Less current portion 7,161 6,992
------------- ------------
$ 287,218 $ 287,088
============= ============
We have an unsecured revolving credit facility of $300 million expiring in June
2006 (the "Credit Facility"). There were no outstanding borrowings under the
Credit Facility at May 24, 2003 or February 22, 2003.
NOTE 6 - COMMITMENTS AND CONTINGENCIES
See "Legal Proceedings" in Part II, Item 1 and "Management's Discussion and
Analysis of Financial Condition and Results of Operations" in Part I, Item 2 of
this report.
NOTE 7 - GUARANTEES AND INDEMNIFICATIONS
We enter into performance and other bonds related to various contracts, which
generally have terms of one year. Potential payments due under these bonds are
related to performance under the applicable contract. Historically, we have
never made any payments under these types of bonds and we do not currently
anticipate that payments will be required under the current bonds. The following
table provides information related to potential commitments at May 24, 2003 (in
thousands):
Total potential
commitments
---------------
Performance bonds $ 171,235
Financial guarantees 8,081
All other bonds 9,318
---------------
$ 188,634
===============
LOTTERY TECHNOLOGY SERVICES INVESTMENT CORPORATION
We have a 44% interest in Lottery Technology Services Investment Corporation
("LTSIC"), which we account for using the equity method of accounting. LTSIC's
wholly owned subsidiary, Lottery Technology Services Corporation ("LTSC"),
provides equipment and services (which we supplied to LTSC), to the Bank of
Taipei. The Bank of Taipei holds the license to operate the Taiwan Public
Welfare Lottery.
-10-
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)
NOTE 7 - GUARANTEES AND INDEMNIFICATIONS (continued)
At May 24, 2003, in order to assist LTSC with the financing they required to
enable them to perform under their obligation to operate the Taiwan Public
Welfare Lottery on behalf of the Bank of Taipei, we guaranteed loans made by an
unrelated commercial lender to LTSC of $5.6 million. The loans have a maturity
date of January 2007 and our guarantee expires in July 2007. We did not receive
any consideration in exchange for our guarantees on behalf of LTSC. Rather,
these guarantees were issued in connection with the formation of LTSC and LTSIC.
We are recognizing 56% of product sales to, and service revenue from, LTSC. The
remaining 44% of product sales (and related cost) and service revenue, has been
deferred as a result of our equity interest in LTSIC and related guarantee of
LTSC's debt, respectively, and is principally included in Other Liabilities in
our Consolidated Balance Sheets at May 24, 2003 and February 22, 2003. Product
sale deferrals are being recognized ratably over the life of our contract with
LTSC and service revenue deferrals are being recognized as the guaranteed debt
is repaid. At May 24, 2003, deferred product gross profit and deferred service
revenue totaled $4.4 million and $8.0 million, respectively.
TIMES SQUARED INCORPORATED
At May 24, 2003, we guaranteed outstanding lease obligations of Times Squared
Incorporated ("Times Squared") of $2.4 million for which we received no monetary
consideration. The guarantee expires in December 2013. Times Squared is a
nonprofit corporation established for, among other things, providing secondary
and high school level educational programs. Times Squared operates a Charter
School for Engineering, Mathematics, Science and Technology in Providence, Rhode
Island that serves inner city children who aspire to careers in the sciences and
technology.
LOTTERY TECHNOLOGY ENTERPRISES
We have a 1% interest in Lottery Technology Enterprises ("LTE"), which is a
joint venture between us and District Enterprise for Lottery Technology
Applications of Washington, D.C. The joint venture agreement terminates on
December 31, 2012. LTE holds a 10-year contract with the District of Columbia
Lottery and Charitable Games Control Board (which expires in November 2009).
Under Washington, D.C. law, by virtue of our 1% interest in LTE, we are jointly
and severally liable, with the other partner, for the acts of the joint venture.
GAMING ENTERTAINMENT (DELAWARE) L.L.C.
We have a 50% interest in Gaming Entertainment (Delaware) L.L.C. ("GED"). GED is
a joint venture between us and Full House Resorts, Inc. ("FHRI"), which was
formed to conduct gaming development activities with Harrington Raceway, Inc.
("Harrington"). Pursuant to a 1995 management agreement ("Agreement"), GED
manages a casino for Harrington and in return receives a percentage of gross
revenues and operating profits as defined in the Agreement. Along with FHRI, we
guarantee the payment of all amounts due Harrington under the Agreement. Our
guarantee expires on February 1, 2012 or upon expiration of the Delaware Horse
Racing Redevelopment Act. The consideration we receive in exchange for the
guarantee are the equity earnings from our joint venture with FHRI.
EUROPRINT HOLDINGS LTD.
On July 1, 1998, we acquired 80% of the equity of Europrint Holdings Ltd.
("Europrint") and its wholly owned subsidiaries, including Interactive Games
International ("IGI"), for a net cash purchase price of $21.6 million, including
related acquisition costs. Europrint is a provider of media promotional games
and IGI has pioneered the development of interactive, televised lottery games.
On June 24, 2003 (after the close of our fiscal 2004 first quarter), we
exercised our option to acquire the remaining 20% of the equity of Europrint for
approximately $5.1 million.
-11-
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)
NOTE 8-- COMPREHENSIVE INCOME
The components of comprehensive income are as follows:
Three Months Ended
----------------------------
May 24, May 25,
2003 2002
----------- -----------
(Dollars in thousands)
Net income $ 41,026 $ 29,041
Other comprehensive income (loss), net of tax
Foreign currency translation 9,217 2,541
Unrecognized net loss on derivative instruments (5,048) (675)
Unrealized loss on investments - (72)
----------- -----------
Comprehensive income $ 45,195 $ 30,835
=========== ===========
NOTE 9 - EARNINGS PER SHARE
The following table shows the computation of basic and diluted earnings per
share:
Three Months Ended
---------------------------------
May 24, May 25,
2003 2002
-------------- -------------
(Dollars and shares in thousands,
except per share amounts)
Numerator:
Net income (Numerator for basic earnings per share) $ 41,026 $ 29,041
Effect of dilutive securities:
Interest expense on 1.75% Convertible Debentures 142 -
-------------- -------------
Numerator for diluted earnings per share $ 41,168 $ 29,041
============== =============
Denominator:
Denominator for basic earnings per share - weighted-average shares 56,904 57,583
Effect of dilutive securities:
1.75% Convertible Debentures 1,690 -
Employee stock options 1,567 1,557
Unvested restricted and stock bonus discount shares 67 121
-------------- -------------
Dilutive potential common shares 3,324 1,678
Denominator for diluted earnings per share - adjusted
weighted-average shares and assumed conversions 60,228 59,261
============== =============
Basic earnings per share $ .72 $ .50
============== =============
Diluted earnings per share $ .68 $ .49
============== =============
-12-
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)
NOTE 9 - EARNINGS PER SHARE (continued)
Our 1.75% Convertible Debentures ("Debentures") are convertible at the option of
the holder into shares of our common stock at an initial conversion rate of
36.3636 shares of common stock per $1,000 principal amount of Debentures, which
is equivalent to an initial conversion price of approximately $27.50 per share.
The Debentures become convertible when, among other circumstances, the closing
price of our common stock is more than 120% of the conversion price
(approximately $33 per share) for at least 20 out of 30 consecutive trading days
prior to the date of surrender for conversion. The total amount of shares
issuable upon the conversion of the Debentures is 6.4 million.
For the quarter ended May 24, 2003, the Debentures were convertible for 17 out
of 64 trading days in the quarter, resulting in 1.7 million shares included in
the computation of diluted earnings per share. For the quarter ended May 25,
2002, the 6.4 million shares issuable upon the conversion of our Debentures were
not included in the computation of diluted earnings per share because, in
accordance with their terms, the Debentures had not yet become convertible.
NOTE 10 - INCOME TAXES
Our effective income tax rate is greater than the statutory rate primarily due
to state income taxes and certain expenses that are not deductible for income
tax purposes.
NOTE 11 - NEW ACCOUNTING PRONOUNCEMENTS
In April 2003, the Financial Accounting Standards Board ("FASB") issued
Statement of Financial Accounting Standards No. 149 ("SFAS 149"), "Amendment of
Statement 133 on Derivative Instruments and Hedging Activities". SFAS 149 amends
Statement of Financial Accounting Standards No. 133 to provide clarification on
the financial accounting and reporting of derivative instruments and hedging
activities and requires that contracts with similar characteristics be accounted
for on a comparable basis. The provisions of SFAS 149 are effective for
contracts entered into or modified after June 30, 2003, and for hedging
relationships designated after June 30, 2003. We are currently evaluating the
effects this statement may have on our consolidated financial statements.
In May 2003, the FASB issued Statement of Financial Accounting Standards No. 150
("SFAS 150"), "Accounting for Certain Financial Instruments with Characteristics
of both Liabilities and Equity". SFAS 150 establishes standards on the
classification and measurement of certain financial instruments with
characteristics of both liabilities and equity. The provisions of SFAS 150 are
effective for financial instruments entered into or modified after May 31, 2003
and to all other instruments that exist as of the beginning of the first interim
financial reporting period beginning after June 15, 2003 (our third quarter of
fiscal 2004). We are currently evaluating the effects this statement may have on
our consolidated financial statements.
-13-
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)
NOTE 12 - SUPPLEMENTAL GUARANTOR/NON-GUARANTOR FINANCIAL INFORMATION
On December 18, 2001, Holdings (the "Parent Company") issued $175 million
principal amount of 1.75% Convertible Debentures due 2021 (the "Convertible
Debentures"). The Convertible Debentures are unsecured and unsubordinated
obligations of the Parent Company that are jointly and severally, fully and
unconditionally guaranteed by GTECH and two of its wholly-owned subsidiaries:
GTECH Rhode Island Corporation and GTECH Latin America Corporation (collectively
with GTECH, the "Guarantor Subsidiaries"). Condensed consolidating financial
information is presented below.
Selling, general and administrative costs and research and development costs are
allocated to each subsidiary based on the ratio of the subsidiaries combined
service revenue and sales of products to consolidated revenues.
The Parent Company conducts business through its consolidated subsidiaries and
unconsolidated affiliates and has, as its only material asset, an investment in
GTECH. Equity in earnings of consolidated affiliates recorded by the Parent
Company includes the Parent Company's share of the after-tax earnings of GTECH.
Taxes payable and deferred income taxes are obligations of the subsidiaries.
Income tax expense related to both current and deferred income taxes are
allocated to each subsidiary based on our consolidated effective income tax
rates.
-14-
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)
NOTE 12 - SUPPLEMENTAL GUARANTOR/NON-GUARANTOR FINANCIAL INFORMATION
(continued)
Condensed Consolidating Balance Sheets
May 24, 2003
Parent Guarantor Non-Guarantor Eliminating
Company Subsidiaries Subsidiaries Entries Consolidated
--------- ------------ ------------- ----------- ------------
(Dollars in thousands)
Assets
Current Assets:
Cash and cash equivalents $ - $ 98,005 $ 33,471 $ - $ 131,476
Trade accounts receivable, net - 74,130 21,608 - 95,738
Due from subsidiaries and
affiliates - 48,775 - (48,775) -
Sales-type lease receivables - 1,522 2,781 - 4,303
Inventories - 69,450 42,757 (27,494) 84,713
Deferred income taxes - 25,097 4,313 - 29,410
Other current assets - 11,680 14,662 - 26,342
--------- --------- --------- --------- ---------
Total Current Assets - 328,659 119,592 (76,269) 371,982
Systems, Equipment and Other
Assets Relating to Contracts, net - 367,374 73,991 (9,232) 432,133
Investment in Subsidiaries and
Affiliates 376,132 87,487 - (463,619) -
Goodwill, net - 70,605 44,893 - 115,498
Other Assets - 50,971 29,301 - 80,272
--------- --------- --------- --------- ---------
Total Assets $ 376,132 $ 905,096 $ 267,777 $(549,120) $ 999,885
========= ========= ========= ========= =========
Liabilities and Shareholders' Equity
Current Liabilities:
Accounts payable $ - $ 51,055 $ 9,000 $ - $ 60,055
Due to subsidiaries and affiliates - - 48,775 (48,775) -
Accrued expenses - 42,470 29,129 - 71,599
Employee compensation - 13,739 5,206 - 18,945
Advance payments from
customers - 31,372 52,195 - 83,567
Income taxes payable - 42,983 8,261 - 51,244
Short term borrowings - - 2,475 - 2,475
Current portion of long-term debt - 3,524 3,637 - 7,161
--------- --------- --------- --------- ---------
Total Current Liabilities - 185,143 158,678 (48,775) 295,046
Long-Term Debt, less current
portion - 280,333 6,885 - 287,218
Other Liabilities - 26,762 14,727 - 41,489
Shareholders' Equity 376,132 412,858 87,487 (500,345) 376,132
--------- --------- --------- --------- ---------
Total Liabilities and
Shareholders' Equity $ 376,132 $ 905,096 $ 267,777 $(549,120) $ 999,885
========= ========= ========= ========= =========
-15-
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)
NOTE 12 - SUPPLEMENTAL GUARANTOR/NON-GUARANTOR FINANCIAL INFORMATION
(continued)
Condensed Consolidating Income Statements
Three Months Ended May 24, 2003
Parent Guarantor Non-Guarantor Eliminating
Company Subsidiaries Subsidiaries Entries Consolidated
--------- ------------ ------------- ----------- ------------
(Dollars in thousands)
Revenues:
Services $ - $ 166,303 $ 57,235 $ - $ 223,538
Sales of products - 11,616 4,431 - 16,047
Intercompany sales and fees - 26,847 10,305 (37,152) -
--------- --------- --------- --------- ---------
- 204,766 71,971 (37,152) 239,585
Costs and expenses:
Costs of services - 90,021 37,822 (1,046) 126,797
Costs of sales - 6,287 2,362 (20) 8,629
Intercompany cost of sales
and fees - 15,970 4,646 (20,616) -
--------- --------- --------- --------- ---------
- 112,278 44,830 (21,682) 135,426
--------- --------- --------- --------- ---------
Gross profit - 92,488 27,141 (15,470) 104,159
Selling, general & administrative - 18,033 6,247 - 24,280
Research and development - 10,684 3,706 - 14,390
--------- --------- --------- --------- ---------
Operating expenses - 28,717 9,953 - 38,670
--------- --------- --------- --------- ---------
Operating income - 63,771 17,188 (15,470) 65,489
Other income (expense):
Interest income - 359 829 - 1,188
Equity in earnings of
unconsolidated affiliates - 1,190 739 - 1,929
Equity in earnings of
consolidated affiliates 41,026 9,478 - (50,504) -
Other income (expense) - 2,018 (3,198) - (1,180)
Interest expense - (1,793) (513) - (2,306)
--------- --------- --------- --------- ---------
Income before income taxes 41,026 75,023 15,045 (65,974) 65,120
Income taxes - 27,759 5,567 (9,232) 24,094
--------- --------- --------- --------- ---------
Net income $ 41,026 $ 47,264 $ 9,478 $ (56,742) $ 41,026
========= ========= ========= ========= =========
-16-
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)
NOTE 12 - SUPPLEMENTAL GUARANTOR/NON-GUARANTOR FINANCIAL INFORMATION
(continued)
Condensed Consolidating Income Statements
Three Months Ended May 25, 2002
Parent Guarantor Non-Guarantor Eliminating
Company Subsidiaries Subsidiaries Entries Consolidated
--------- ------------ ------------- ----------- ------------
(Dollars in thousands)
Revenues:
Services $ - $ 172,083 $ 51,652 $ - $ 223,735
Sales of products - 4,670 3,007 - 7,677
Intercompany sales and fees - 19,323 12,487 (31,810) -
--------- --------- --------- --------- ---------
- 196,076 67,146 (31,810) 231,412
Costs and expenses:
Costs of services - 104,223 44,860 (2,148) 146,935
Costs of sales - 3,849 2,398 - 6,247
Intercompany cost of sales
and fees - 14,341 2,092 (16,433) -
--------- --------- --------- --------- ---------
- 122,413 49,350 (18,581) 153,182
--------- --------- --------- --------- ---------
Gross profit - 73,663 17,796 (13,229) 78,230
Selling, general & administrative - 17,499 5,410 - 22,909
Research and development - 4,966 1,536 - 6,502
--------- --------- --------- --------- ---------
Operating expenses - 22,465 6,946 - 29,411
--------- --------- --------- --------- ---------
Operating income - 51,198 10,850 (13,229) 48,819
Other income (expense):
Interest income - 354 488 - 842
Equity in earnings of
unconsolidated affiliates - 76 620 - 696
Equity in earnings of
consolidated affiliates 29,041 7,086 - (36,127) -
Other expense - (505) (86) - (591)
Interest expense - (2,482) (443) - (2,925)
--------- --------- --------- --------- ---------
Income before income taxes 29,041 55,727 11,429 (49,356) 46,841
Income taxes - 21,176 4,343 (7,719) 17,800
--------- --------- --------- --------- ---------
Net income $ 29,041 $ 34,551 $ 7,086 $ (41,637) $ 29,041
========= ========= ========= ========= =========
-17-
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)
NOTE 12 - SUPPLEMENTAL GUARANTOR/NON-GUARANTOR FINANCIAL INFORMATION
(continued)
Condensed Consolidating Statements of Cash Flows
Three Months Ended May 24, 2003
Parent Guarantor Non-Guarantor Eliminating
Company Subsidiaries Subsidiaries Entries Consolidated
--------- ------------ ------------- ----------- ------------
(Dollars in thousands)
Net cash provided by operating
activities $ - $ 58,331 $ 4,675 $ (37) $ 62,969
Investing Activities
Purchases of systems, equipment
and other assets relating to
contracts - (56,750) (1,950) 37 (58,663)
Other - (1,186) - - (1,186)
------- --------- --------- ----- ---------
Net cash used for investing
activities - (57,936) (1,950) 37 (59,849)
Financing Activities
Net proceeds from issuance
of long-term debt - - 1,409 - 1,409
Principal payments on long-term
debt - - (866) - (866)
Proceeds from stock options 8,406 - - - 8,406
Intercompany capital transactions (8,876) 8,876 - - -
Other 470 - (522) - (52)
------- --------- --------- ----- ---------
Net cash provided by financing
activities - 8,876 21 - 8,897
Effect of exchange rate changes
on cash - (5) 3,290 - 3,285
------- --------- --------- ----- ---------
Increase in cash and
cash equivalents - 9,266 6,036 - 15,302
Cash and cash equivalents at
beginning of period - 88,739 27,435 - 116,174
------- --------- --------- ----- ---------
Cash and cash equivalents at end
of period $ - $ 98,005 $ 33,471 $ - $ 131,476
======= ========= ========= ===== =========
-18-
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)
NOTE 12 - SUPPLEMENTAL GUARANTOR/NON-GUARANTOR FINANCIAL INFORMATION
(continued)
Condensed Consolidating Statements of Cash Flows
Three Months Ended May 25, 2002
Parent Guarantor Non-Guarantor Eliminating
Company Subsidiaries Subsidiaries Entries Consolidated
--------- ------------ ------------- ----------- ------------
(Dollars in thousands)
Net cash provided by operating
activities $ - $ 88,440 $ 2,640 $ 317 $ 91,397
Investing Activities
Purchases of systems, equipment
and other assets relating to
contracts - (49,848) (2,858) (317) (53,023)
Other - (662) - - (662)
-------- -------- -------- -------- --------
Net cash used for investing
activities - (50,510) (2,858) (317) (53,685)
Financing Activities
Principal payments on long-term
debt - (1,205) (356) - (1,561)
Purchases of treasury stock (37,686) - - - (37,686)
Proceeds from stock options 12,549 - - - 12,549
Intercompany capital transactions 24,662 (24,662) - - -
Other 475 - 198 - 673
-------- -------- -------- -------- --------
Net cash used for financing
activities - (25,867) (158) - (26,025)
Effect of exchange rate changes
on cash - 57 3,037 - 3,094
-------- -------- -------- -------- --------
Increase in cash and
cash equivalents - 12,120 2,661 - 14,781
Cash and cash equivalents at
beginning of period - 25,865 9,230 - 35,095
-------- -------- -------- -------- --------
Cash and cash equivalents at end
of period $ - $ 37,985 $ 11,891 $ - $ 49,876
======== ======== ======== ======== ========
-19-
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)
NOTE 13 - SUBSEQUENT EVENTS
PolCard S.A.
On May 28, 2003 (after the close of our fiscal 2004 first quarter), we completed
the acquisition of a controlling equity position in PolCard S.A. ("PolCard"), a
debit and credit card merchant transaction acquirer and processor in Poland.
Upon the exercise of rights under an option agreement we entered into with
Innova Capital Sp. zo.o ("Innova"), a Warsaw-based private equity investment
advisor, to accommodate the timing of funding the acquisition, we will own 62.8%
of PolCard's outstanding equity, while two funds managed by Innova will own
36.9% of PolCard's outstanding equity, and the Polish Bank Association, one of
PolCard's existing owners, will continue to own 0.3% of the outstanding equity
of PolCard. We expect the exercise of these rights to occur by the end of July
2003. PolCard's outstanding equity is now owned 66.5% by us, 33.2% by Innova
and 0.3% by the Polish Bank Association. The aggregate purchase price paid by
us and Innova for the PolCard equity, together with approximately $2 million in
long-term debt assumed as part of the transaction, was approximately $62
million. All conditions to the closing of the acquisition were satisfied,
including the approvals of the Polish Competition and Consumer Protection Office
and the Polish Bank Association, and the acquisition closed in accordance with
the terms of the February 2003 purchase agreement. We have a fair value option
to purchase Innova's interest in PolCard, and Innova has the reciprocal right to
sell its interest in PolCard to us at fair value, during the period commencing
approximately four and ending approximately six years after closing.
TCU Audit
As previously reported, on June 5, 2003, the Federal Court of Accounts ("TCU"),
the court charged with auditing agencies of the Brazilian federal government and
its subdivisions, summoned us, together with several current and former
employees of Caixa Economica Federal ("CEF"), the operator of Brazil's National
Lottery, to appear before TCU's Brasilia court. The summons required the
defendants to show cause why they should not be required to jointly pay a base
amount determined by the TCU to be due of R$91,974,625.10, duly indexed for
inflation and interest as of May 26, 2000 (Decision No. 692/2003). We estimate
that this claim, in aggregate, is for the local currency equivalent of
approximately US$57,343,359.00 at current exchange rates. The allegations
underlying this summons are set forth in a report (the "Audit Report") issued by
the TCU in May 2003 respecting an audit conducted by the TCU of our January 1997
contract to provide lottery goods and services to CEF (the "1997 Contract").
The 1997 Contract expired on May 26, 2000 and was replaced on the same date by a
new contract which, as extended, is scheduled to terminate in May 2005 (the
"2000 Contract").
The central allegation of the Audit Report is that under the 1997 Contract we
were accorded certain payment increases, and we contracted to supply to CEF
certain services, that were not contemplated by the procurement process
respecting the 1997 Contract and that are not otherwise permitted under
applicable Brazilian law. The Audit Report alleges that as a result of this,
CEF overpaid us under the 1997 Contract for the period commencing in January
1997 through May 26, 2000, and that we are liable with respect to such alleged
overpayments as specified above. The Audit Report further determines that TCU
shall audit the 2000 Contract and any other contract between us and CEF in
effect after May 26, 2000 respecting the provision by us of lottery services.
Moreover, the Audit Report states that the TCU will refer the Audit Report to,
among others, the Brazil Public Prosecutor's Office and the Brazil Federal
Police (who, we have been advised, are conducting an investigation of CEF's
public procurement activities in general).
The Audit Report does not allege that we have acted improperly, and we do not
believe that we have done anything improper in connection with the 1997
Contract, 2000 Contract or any other contract with CEF.
We plan to vigorously defend ourselves against the allegations made by TCU in
the Audit Report and the proceedings initiated by the TCU with respect thereto.
This includes raising a preliminary defense based on the absence of due process
of law, since we believe that we should have been accorded a fair chance to
defend ourselves before the TCU determination was made. Because these
proceedings are in their initial stages, however, it is impossible at this time
for us to assess the merit of the TCU's claims, predict the outcome of the TCU
proceedings, or provide an estimate of losses likely to be incurred in
connection with the resolution of this matter, or its financial statement
impact, if any.
Dividend
On June 17, 2003, our Board of Directors approved an annual cash dividend in the
amount of $0.68 per share, payable quarterly beginning in the second quarter of
this fiscal year (our second quarter began on May 25, 2003). We will pay $0.17
per share on July 31, 2003, to shareholders of record as of July 15, 2003.
Europrint
As discussed in Note 7, on June 24, 2003, we exercised our option to acquire the
remaining 20% of the equity of Europrint for approximately $5.1 million.
-20-
Item 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS
The terms "Holdings", "the Company", "we", "our" and "us" refer to GTECH
Holdings Corporation and its consolidated subsidiaries, unless otherwise
specified.
Statements contained in this section and elsewhere in this report which are not
historical statements constitute "forward-looking statements" within the meaning
of Section 27A of the Securities Act and Section 21E of the Securities Exchange
Act of 1934. Generally, the words "believe", "expect", "estimate", "anticipate",
"will", "may", "could", "plan", "continue" and similar expressions identify
forward-looking statements. Such statements may include, without limitation,
statements relating to:
- the future prospects for and stability of the lottery industry and
other businesses in which we are engaged or expect to be engaged;
- our future operating and financial performance (including, without
limitation, expected future growth in revenues, profit margins and
earnings per share);
- our ability to retain existing contracts and to obtain and retain new
contracts;
- the future performance of comparable investment opportunities; and
- the results and effects of legal proceedings and investigations.
These forward-looking statements reflect management's assessment based on
information currently available, but are not guarantees and are subject to risks
and uncertainties that could cause actual results to differ materially from
those contemplated in the forward-looking statements. These risks and
uncertainties include the following:
- government regulations and other actions affecting the online lottery
industry could have a negative effect on our business;
- our operations are dependent upon our continued ability to retain and
extend our existing contracts and win new contracts;
- slow growth or declines in sales of online lottery goods and services
could adversely affect our future revenues and profitability;
- we have significant foreign currency exposure;
- we are subject to the economic, political and social instability risks
of doing business in foreign jurisdictions;
- we have a concentrated customer base and the loss of any of our larger
customers could harm our results;
- our quarterly operating results may fluctuate significantly;
- we operate in a highly competitive environment;
- we are subject to substantial penalties for failure to perform under
our contracts;
- we may not be able to respond to technological changes or satisfy
future technological demands of our customers;
- expansion of the gaming industry faces opposition which may limit the
legalization, or expansion, of online gaming to the detriment of our
business, financial condition, results and prospects;
- our business prospects and future success depend upon our ability to
attract and retain qualified employees;
- our business prospects and future success rely heavily upon the
integrity of our employees and executives and the security of our
systems;
- our non-lottery ventures may fail;
- we may be subject to adverse determinations in pending legal
proceedings; and
- other risks and uncertainties set forth below and elsewhere in this
report, in our fiscal 2003 Form 10-K, as amended, and in our subsequent
press releases and Form 10-Q's and other reports and filings with the
Securities and Exchange Commission.
The foregoing list of important factors is not all-inclusive.
-21-
General
We operate on a 52 to 53-week fiscal year ending on the last Saturday in
February and fiscal 2004 ends on February 28, 2004. Fiscal 2004 is a 53-week
year and we will include the extra week in our fourth quarter ending February
28, 2004.
We have derived substantially all of our revenues from the rendering of services
and the sale or supply of computerized online lottery systems and components to
government-authorized lotteries. Our service revenues are derived primarily from
lottery service contracts, which are typically at least five years in duration,
and generally provide compensation to us based upon a percentage of a lottery's
gross online lottery sales. These percentages vary depending on the size of the
lottery and the scope of services provided to the lottery. We derive product
sale revenues primarily from the installation of new online lottery systems,
installation of new software and sales of lottery terminals and equipment in
connection with the expansion of existing lottery systems. Our product margins
fluctuate depending on the mix, volume and timing of product sale contracts. The
size and timing of these transactions have resulted in variability in product
sale revenues from period to period. Excluding the proposed acquisition of
Interlott Technologies, Inc. described below, we currently anticipate that
product sales during fiscal 2004 will be in the range of $80 million to $90
million.
We continue to evaluate a variety of opportunities to broaden our offerings of
high-volume transaction processing services outside of our core market of
providing online lottery services, such as the processing and transmitting of
commercial, non-lottery transactions including bill payments, electronic tax
payments, utility payments and retail-based programs such as gift cards.
Currently, our networks in Brazil, Chile, the Czech Republic and Jamaica process
bill payments and other commercial service transactions. In the near term, we
expect to concentrate our efforts to grow commercial service revenues in Brazil,
Poland and Mexico. While our goal is to leverage our technology, infrastructure
and relationships to drive growth in commercial services, if, in the course of
pursuing these opportunities, we see a chance to gain access to certain markets
through the acquisition of existing infrastructure, we may consider making such
acquisitions.
Our business is highly regulated, and the competition to secure new government
contracts is often intense. From time to time, competitors challenge our
contract awards and there have been, and may continue to be, investigations of
various types, including grand jury investigations conducted by governmental
authorities into possible improprieties and wrongdoing in connection with
efforts to obtain and/or the awarding of lottery contracts and related matters.
In light of the fact that such investigations frequently are conducted in
secret, we may not necessarily know of the existence of an investigation which
might involve us. Because our reputation for integrity is an important factor in
our business dealings with lottery and other governmental agencies, a
governmental allegation or a finding of improper conduct on our part or
attributable to us in any manner could have a material adverse effect on our
business, including our ability to retain existing contracts or to obtain new or
renewal contracts. In addition, continuing adverse publicity resulting from
these investigations and related matters could have a material adverse effect on
our reputation and business. See "Legal Proceedings" in Part II, Item 1 in this
report; and Part I, Item 1 - "Certain Factors That May Affect Future Performance
- - Government regulations and other actions affecting the online lottery industry
could have a negative effect on our business", Part I, Item 3 - "Legal
Proceedings" and Note 11 to the Consolidated Financial Statements in our fiscal
2003 Annual Report on Form 10-K, as amended, for further information concerning
these matters and other contingencies.
-22-
We are a global business and we derive a substantial portion of our revenues
from operations outside of the United States. In particular, in fiscal 2003, we
derived 49.2% of our revenues from international operations and 10.3% of our
revenues from our Brazilian operations alone (including 9.8% of our revenues
from Caixa Economica Federal, the operator of Brazil's National Lottery, which
was our largest customer in fiscal 2003 based on annual revenues). In addition,
substantial portions of our assets, primarily consisting of equipment we use to
operate online lottery systems for our customers, are held outside of the United
States. We are also exposed to more general risks of international operations,
including increased governmental regulation of the online lottery industry in
the markets where we operate; exchange controls or other currency restrictions;
and significant political instability.
Significant Contract Extensions and Renegotiations
A majority of our revenues and cash flow is derived from our portfolio of
long-term online lottery service contracts, each of which in the ordinary course
of our business is periodically the subject of competitive procurement or
renegotiation.
As previously reported, in April 2003, we entered into an agreement with Caixa
Economica Federal ("CEF"), the operator of Brazil's National Lottery, pursuant
to which the term of our contract with CEF, which had been scheduled to expire
in April 2003, was extended for 25 months from April 2003 (with CEF having the
right to elect upon prior notice to terminate the contract early at any time
after 20 months), and fees payable under our contract are reduced by 15%. Our
previous contract with CEF, which as extended, expired in April 2003, was our
largest contract in fiscal 2003, as measured by annual revenues, accounting for
9.8% of our consolidated revenues. See Part I, Item 3 - "Legal Proceedings" and
Note 11 to the Consolidated Financial Statements in our fiscal 2003 Annual
Report on Form 10-K, as amended, for further information concerning this matter.
In May 2003, we entered into a Master Contract with the Rhode Island Lottery
(the "Lottery") that amends our existing contracts with the Lottery and grants
us the right to be the exclusive provider of online, instant ticket and video
lottery central systems and services for the Lottery during the 20-year term of
the Master Contract for an up-front payment by us in the amount of $12.5
million. The Master Contract is part of a comprehensive economic development
package that provides incentives for us to keep our world corporate headquarters
and manufacturing operations in Rhode Island. Under the terms of the Master
Contract, we are to invest (or cause to be invested) at least $100 million in
the State of Rhode Island, in the aggregate, by December 31, 2008. This
investment commitment includes the $12.5 million up-front payment; new online
and video lottery related hardware, software and services; the development of a
new world corporate headquarters facility of at least 210,000 square feet in
Providence, Rhode Island by December 31, 2006; and improvements to our existing
manufacturing facility in West Greenwich, Rhode Island. We have agreed to employ
at least 1,000 people full-time in Rhode Island by the end of calendar year 2005
and maintain that level of employment thereafter. In the event the State of
Rhode Island takes certain actions which affect our financial performance, we
shall be automatically released from the in-state employment obligation. We
currently plan to satisfy our obligation to invest at least $100 million in the
State of Rhode Island by December 31, 2008 by investing: (i) approximately $31
million during fiscal 2004; and (ii) approximately $91 million during fiscal
2005 through fiscal 2006.
In addition, in July 2003 (after the close of our fiscal 2004 first quarter), we
entered into a tax stabilization agreement (the "Agreement") with the City of
Providence ("the City"), subject to final passage by the Providence City Council
and execution by the Mayor of the City, all of which we expect to occur in July
2003. Under the terms of the Agreement, the City agreed to stabilize the real
estate and personal property taxes payable in connection with the new world
corporate headquarters facility and the personal property associated with such
facility for 20 years. We also agreed to complete and occupy the facility by
December 31, 2006, employ 500 employees at the facility by 2009, and we made
certain commitments regarding our employment, purchasing and education
activities in the City.
-23-
During the first quarter of fiscal 2004, the lottery authorities of Michigan and
Sweden exercised options to extend the terms of their online contracts with us,
and the lottery authority of Wisconsin selected us to negotiate a new five-year
contract with them to supply a new online and instant-ticket lottery system.
Recent Developments
In March 2003, we entered into an agreement to acquire Interlott Technologies,
Inc. ("Interlott"), a provider of instant ticket vending machines for the
worldwide lottery industry. This agreement provides for us to pay $9.00 per
share of Interlott in cash (48.5%) or Holdings common stock (51.5%), and to
assume debt of approximately $21 million. The aggregate purchase price, together
with the assumed debt, is approximately $85 million. Our obligation to complete
this acquisition is subject to obtaining approval of the transaction by
Interlott shareholders, securing necessary regulatory consents, and satisfying
certain other closing conditions. Approval of this transaction by our
shareholders is not required. We expect the closing of the Interlott acquisition
to occur by late August 2003.
Subsequent Events
PolCard S.A.
On May 28, 2003 (after the close of our fiscal 2004 first quarter), we completed
the acquisition of a controlling equity position in PolCard S.A. ("PolCard"), a
debit and credit card merchant transaction acquirer and processor in Poland.
Upon the exercise of rights under an option agreement we entered into with
Innova Capital Sp. zo.o ("Innova"), a Warsaw-based private equity investment
advisor, to accommodate the timing of funding the acquisition, we will own 62.8%
of PolCard's outstanding equity, while two funds managed by Innova will own
36.9% of PolCard's outstanding equity, and the Polish Bank Association, one of
PolCard's existing owners, will continue to own 0.3% of the outstanding equity
of PolCard. We expect the exercise of these rights to occur by the end of July
2003. PolCard's outstanding equity is now owned 66.5% by us, 33.2% by Innova
and 0.3% by the Polish Bank Association. The aggregate purchase price paid by
us and Innova for the PolCard equity, together with approximately $2 million in
long-term debt assumed as part of the transaction, was approximately $62
million. All conditions to the closing of the acquisition were satisfied,
including the approvals of the Polish Competition and Consumer Protection Office
and the Polish Bank Association, and the acquisition closed in accordance with
the terms of the February 2003 purchase agreement. We have a fair value option
to purchase Innova's interest in PolCard, and Innova has the reciprocal right to
sell its interest in PolCard to us at fair value, during the period commencing
approximately four and ending approximately six years after closing.
TCU Audit
As previously reported, on June 5, 2003, the Federal Court of Accounts ("TCU"),
the court charged with auditing agencies of the Brazilian federal government and
its subdivisions, summoned us, together with several current and former
employees of Caixa Economica Federal ("CEF"), the operator of Brazil's National
Lottery, to appear before TCU's Brasilia court. The summons required the
defendants to show cause why they should not be required to jointly pay a base
amount determined by the TCU to be due of R$91,974,625.10, duly indexed for
inflation and interest as of May 26, 2000 (Decision No. 692/2003). We estimate
that this claim, in aggregate, is for the local currency equivalent of
approximately US$57,343,359.00 at current exchange rates. The allegations
underlying this summons are set forth in a report (the "Audit Report") issued by
the TCU in May 2003 respecting an audit conducted by the TCU of our January 1997
contract to provide lottery goods and services to CEF (the "1997 Contract").
The 1997 Contract expired on May 26, 2000 and was replaced on the same date by a
new contract which, as extended, is scheduled to terminate in May 2005 (the
"2000 Contract").
The central allegation of the Audit Report is that under the 1997 Contract we
were accorded certain payment increases, and we contracted to supply to CEF
certain services, that were not contemplated by the procurement process
respecting the 1997 Contract and that are not otherwise permitted under
applicable Brazilian law. The Audit Report alleges that as a result of this,
CEF overpaid us under the 1997 Contract for the period commencing in January
1997 through May 26, 2000, and that we are liable with respect to such alleged
overpayments as specified above. The Audit Report further determines that TCU
shall audit the 2000 Contract and any other contract between us and CEF in
effect after May 26, 2000 respecting the provision by us of lottery services.
Moreover, the Audit Report states that the TCU will refer the Audit Report to,
among others, the Brazil Public Prosecutor's Office and the Brazil Federal
Police (who, we have been advised, are conducting an investigation of CEF's
public procurement activities in general).
The Audit Report does not allege that we have acted improperly, and we do not
believe that we have done anything improper in connection with the 1997
Contract, 2000 Contract or any other contract with CEF.
We plan to vigorously defend ourselves against the allegations made by TCU in
the Audit Report and the proceedings initiated by the TCU with respect thereto.
This includes raising a preliminary defense based on the absence of due process
of law, since we believe that we should have been accorded a fair chance to
defend ourselves before the TCU determination was made. Because these
proceedings are in their initial stages, however, it is impossible at this time
for us to assess the merit of the TCU's claims, predict the outcome of the TCU
proceedings, or provide an estimate of losses likely to be incurred in
connection with the resolution of this matter, or its financial statement
impact, if any.
Dividend
On June 17, 2003, our Board of Directors approved an annual cash dividend in the
amount of $0.68 per share, payable quarterly beginning in the second quarter of
this fiscal year (our second quarter began on May 25, 2003). We will pay $0.17
per share on July 31, 2003, to shareholders of record as of July 15, 2003.
Europrint
As discussed in Note 7 to the consolidated financial statements, on June 24,
2003, we exercised our option to acquire the remaining 20% of the equity of
Europrint for approximately $5.1 million.
-24-
Critical Accounting Policies
We have identified the accounting policies listed below that we believe are most
critical to our financial condition and results of operations, and that require
management's most difficult, subjective and complex judgments in estimating the
effect of inherent uncertainties. This section should be read in conjunction
with Note 1 to the Consolidated Financial Statements in our fiscal 2003 Annual
Report on Form 10-K, as amended, which includes other significant accounting
policies.
REVENUE RECOGNITION
We generally conduct business under one of three types of contractual
arrangements: Product Sales Contracts, Operating Contracts and Facilities
Management Contracts.
PRODUCT SALES CONTRACTS
Under Product Sales Contracts, we construct, sell, deliver and install a turnkey
online lottery system ("lottery system") or lottery equipment and license the
computer software for a fixed price, and the lottery authority subsequently
operates the lottery system.
Because Product Sales Contracts include significant customization and
modification and other services prior to customer acceptance that are considered
essential to the lottery software inherent in our lottery systems, revenue is
recognized using contract accounting. Under contract accounting, amounts due to
us, and costs incurred by us in constructing the lottery system, prior to
customer acceptance, are deferred. Revenue attributable to the lottery system is
recognized upon customer acceptance as long as there are no substantial doubts
regarding collectibility (the completed contract method of accounting).
In certain Product Sale Contracts (primarily the stand alone sale of lottery
terminals), we are not responsible for installation. In these cases, we
recognize revenue when the four basic revenue recognition criteria of SEC Staff
Accounting Bulletin 101 have been met.
1. Persuasive evidence of an arrangement exists - Revenue is only
recognized if a signed contract or legally enforceable purchase order
is obtained.
2. Delivery has occurred or services have been rendered - Revenue is only
recognized if appropriate evidence of delivery is obtained and once any
customer acceptance criteria have been met.
3. The seller's price to the buyer is fixed or determinable - Revenue is
only recognized if the sales price is fixed and determinable in the
signed contract or legally enforceable purchase order.
4. Collectibility is reasonably assured - Revenue is only recognized when
there are no significant doubts regarding the collectibility of the
amounts due from the customer.
Revenues received under Product Sale Contracts are classified as Sales of
Products in our Consolidated Income Statements.
OPERATING CONTRACTS
Under Operating Contracts, we generally construct, install and operate the
lottery system, but sell and transfer full title and interest in the lottery
system to the customer for a fixed fee. Fees paid to us for ongoing services and
the licensing of the computer software are generally variable and are based on a
percentage of a lottery's gross online lottery sales.
Because Operating Contracts include significant customization and modification
and other services prior to customer acceptance that are considered essential to
the lottery software inherent in our lottery systems, revenue is recognized
using contract accounting. Under contract accounting, amounts due to us, and
costs incurred by us in constructing the lottery system, prior to customer
acceptance, are deferred.
-25-
Revenue attributable to the lottery system is recognized upon customer
acceptance as long as there are no substantial doubts regarding collectibility
(the completed contract method of accounting) and are classified as Sales of
Products in our Consolidated Income Statements. Ongoing service and license fees
are recognized as revenue in the period earned and are classified as Service
Revenue in our Consolidated Income Statements.
FACILITIES MANAGEMENT CONTRACTS
Under typical Facilities Management Contracts, we construct, install and operate
the lottery system, while retaining ownership of the lottery system. These
contracts generally provide for a variable amount of monthly or weekly service
fees paid to us directly from the lottery authority based on a percentage of a
lottery's gross online lottery sales. These fees are recognized as revenue in
the period earned and are classified as Service Revenue in our Consolidated
Income Statements.
Amounts invoiced or received from customers in advance of revenue recognition
are recorded in Advance Payments from Customers in our Consolidated Balance
Sheets. We record liquidated damages (which equaled 0.47%, 0.14% and 0.47% of
our total revenues in fiscal 2003, 2002 and 2001, respectively) as a reduction
of revenue in the period they become probable and estimable.
RECEIVABLES AND INVENTORY RESERVES
We evaluate the collectibility of trade accounts and sales-type lease
receivables on a customer-by-customer basis and we believe our reserves are
adequate; however, if economic circumstances change significantly resulting in a
major customer's inability or unwillingness to meet its financial obligations to
us, original estimates of the recoverability of amounts due to us could be
reduced by significant amounts requiring additional reserves. We have not
experienced any collectibility or billing problems with any major customers or
geographic localities for which revenue has been recognized, with the exception
of a sales-type lease receivable from a customer in Argentina, which was fully
reserved in fiscal 2002 due to the economic instability in that country.
Inventories are stated at the lower of cost (first-in, first-out method) or
market. Inventories include amounts we manufacture or assemble for our long-term
service contracts, which are transferred to Systems, Equipment and Other Assets
Relating to Contracts upon shipment. Inventories also include amounts related to
product sales contracts, including product sales under long-term contracts. We
regularly review inventory quantities on hand and record provisions for
potentially obsolete or slow-moving inventory based primarily on our estimated
forecast of product demand and production requirements. We believe our reserves
are adequate; however, should future sales forecasts change, our original
estimates of obsolescence could increase by a significant amount requiring
additional reserves.
IMPAIRMENT OF GOODWILL
We perform a test for the impairment of goodwill annually, or more frequently if
events or circumstances indicate that goodwill may be impaired. Because we have
a single operating and reportable business segment (the Transaction Processing
Segment), we perform this test by comparing the fair value of the Transaction
Processing segment with its book value, including goodwill. If the fair value of
the Transaction Processing segment exceeds the book value, goodwill is not
impaired. If the book value exceeds the fair value, we would calculate the
potential impairment loss by comparing the implied fair value of goodwill with
the book value. If the implied goodwill is less than the book value, a
write-down would be recorded.
-26-
IMPAIRMENT OF LONG-LIVED ASSETS
We periodically evaluate the recoverability of long-lived assets whenever
indicators of impairment are present. Indicators of impairment include such
items as declines in revenues and earnings or cash flows or material adverse
changes in the economic or political stability of a particular country, which
may indicate that the carrying amount of an asset is not recoverable. If facts
and circumstances indicate that our long-lived assets may be impaired, the
estimated future undiscounted cash flows associated with these long-lived assets
would be compared to their carrying amounts to determine if a write-down to fair
value is necessary.
Effect of New Accounting Pronouncements
In April 2003, the Financial Accounting Standards Board ("FASB") issued
Statement of Financial Accounting Standards No. 149 ("SFAS 149"), "Amendment of
Statement 133 on Derivative Instruments and Hedging Activities". SFAS 149 amends
Statement of Financial Accounting Standards No. 133 to provide clarification on
the financial accounting and reporting of derivative instruments and hedging
activities and requires that contracts with similar characteristics be accounted
for on a comparable basis. The provisions of SFAS 149 are effective for
contracts entered into or modified after June 30, 2003, and for hedging
relationships designated after June 30, 2003. We are currently evaluating the
effects this statement may have on our consolidated financial statements.
In May 2003, the FASB issued Statement of Financial Accounting Standards No. 150
("SFAS 150"), "Accounting for Certain Financial Instruments with Characteristics
of both Liabilities and Equity". SFAS 150 establishes standards on the
classification and measurement of certain financial instruments with
characteristics of both liabilities and equity. The provisions of SFAS 150 are
effective for financial instruments entered into or modified after May 31, 2003
and to all other instruments that exist as of the beginning of the first interim
financial reporting period beginning after June 15, 2003 (our third quarter of
fiscal 2004). We are currently evaluating the effects this statement may have on
our consolidated financial statements.
Results of Operations
THREE MONTHS ENDED MAY 24, 2003 VERSUS THREE MONTHS ENDED MAY 25, 2002
Revenues were $239.6 million in the first quarter of fiscal 2004, compared to
$231.4 million in the first quarter of fiscal 2003, up $8.2 million, or 3.5%.
The following discussion on service revenues should be read in conjunction with
the table below (in millions):
Three Months Ended
------------------------------------------------------
Change
May 24, May 25, ------------------
Service revenues 2003 2002 $ %
---------------- ------------ ------------ -------- -----
Domestic lottery $ 124.8 $ 125.9 $ (1.1) (0.9)
International lottery 86.5 82.4 4.1 5.0
Commercial services 11.6 14.7 (3.1) (21.4)
All other 0.6 0.7 (0.1) (6.7)
------------ ------------ -------- -----
$ 223.5 $ 223.7 $ (0.2) (0.1)
============ ============ ======== =====
-27-
Service revenues, including lottery and other services, were $223.5 million in
the first quarter of fiscal 2004, comparable to service revenues of $223.7
million in the first quarter of fiscal 2003. Had last year's average exchange
rates prevailed throughout the most recent quarter, we estimate that service
revenues would have increased by approximately 2% compared to the first quarter
of last year.
Our domestic lottery service revenues were $124.8 million in the first quarter
of fiscal 2004, compared to $125.9 million in the first quarter of fiscal 2003,
down $1.1 million, or 0.9%. This 0.9% decrease was primarily due to lower
jackpot activity of approximately 6%, partially offset by the combined impact of
net new contracts and contractual rate changes of approximately 2% and higher
service revenues from an increase in sales by our domestic lottery customers of
approximately 3%. While we are not able to quantify precisely the reasons for
increases in sales by our domestic lottery customers, we believe that in
general, such increases are attributable to enhanced marketing efforts by state
lottery authorities seeking to offset declining tax revenues and the successful
introduction by state lottery authorities of new games and products.
Our international lottery service revenues were $86.5 million in the first
quarter of fiscal 2004, compared to $82.4 million in the first quarter of fiscal
2003, up $4.1 million, or 5.0%. This 5.0% increase includes higher service
revenues from an increase in sales by our international lottery customers of
approximately 10%, partially offset by the combined impact of contract losses
and contractual rate changes of approximately 5%.
Service revenues from commercial transaction processing services (primarily in
Brazil) were $11.6 million in the first quarter of fiscal 2004, compared to
$14.7 million in the first quarter of fiscal 2003, down $3.1 million, or 21.4%.
This 21.4% decrease was primarily due to the weakening of the Brazilian real
against the U.S. dollar.
Over the past several fiscal years, contract renewal and extension rates in the
United States have generally been lower than existing contract rates due to a
number of factors, including the substantial growth of lottery sales during the
latter part of the 1990's and calendar year 2002, reductions in the cost of
technology and telecommunications services, and general market and competitive
dynamics. In anticipation and response to these trends, beginning in fiscal
2001, we began the implementation of our new Enterprise Series led technology
strategy combined with the implementation of a number of ongoing cost savings
initiatives and efficiency improvement programs designed to enable us to
maintain our market leadership in the lottery industry.
Product sales were $16.0 million in the first quarter of fiscal 2004, compared
to $7.7 million in the first quarter of fiscal 2003, up $8.3 million. This
increase was primarily driven by sales of terminals to our joint venture in
Taiwan and our customers in Poland and China.
Our service margins improved from 34.3% in the first quarter of fiscal 2003 to
43.3% in the first quarter of fiscal 2004. Service margins in the first quarter
of fiscal 2004 benefited by 4.2 percentage points from lower depreciation
(principally related to fully depreciated assets associated with our contract
with Caixa Economica Federal in Brazil) and 3.4 percentage points from the
absence of certain consulting costs incurred during the prior year first
quarter.
Our product margins fluctuate depending on the mix, volume and timing of product
sales contracts. Our product margins improved to 46.2% in the first quarter of
fiscal 2004 compared to 18.6% in the first quarter of fiscal 2003. This
improvement was primarily due to the mix of sales in the first quarter of fiscal
2004, which included higher margin terminal sales to our joint venture in Taiwan
and our customers in China and Poland, driven by improved efficiencies in our
manufacturing process.
-28-
Operating expenses were $38.7 million in the first quarter of fiscal 2004,
compared to $29.4 million in the first quarter of fiscal 2003, up $9.3 million,
or 31.5%. This increase was driven by $7.9 million of increased spending on
research and development as we continue our efforts to accelerate the
development and deployment of industry-leading products into the marketplace and
to execute against our commercial services strategy. In addition, selling,
general and administrative expense was up $1.4 million, driven by expenses
associated with our bi-annual World Leaders Forum. As a percentage of revenues,
operating expenses were 16.2% and 12.7% during the first quarters of fiscal 2004
and 2003, respectively.
Equity income was $1.9 million in the first quarter of fiscal 2004, compared to
$0.7 million in the first quarter of fiscal 2003, up $1.2 million, primarily due
to higher equity income from our joint venture in Taiwan.
Weighted average diluted shares in the first quarter of fiscal 2004 increased by
1.0 million shares to 60.2 million shares, primarily due to the convertibility
during a portion of the first quarter of our $175 million principal amount of
1.75% Convertible Debentures into shares of our common stock, resulting in a
decrease to diluted earnings per share of approximately $0.02. These Debentures
are convertible at the option of the holder into shares of our common stock at a
conversion price of approximately $27.50 per share when, among other
circumstances, our stock closes above $33 per share for at least 20 out of 30
consecutive trading days prior to the date of surrender for conversion. The
total amount of shares issuable upon the conversion of the Debentures is 6.4
million. For the first quarter of fiscal 2004, the Debentures were convertible
for 17 out of 64 trading days, resulting in 1.7 million shares included in the
computation of diluted earnings per share.
Our effective income tax rate decreased from 38% in the first quarter of fiscal
2003 to 37% in the first quarter of fiscal 2004 principally due to a larger
percentage of international profits taxed at rates that are lower than the U.S.
statutory tax rate and the increased recognition of research and development tax
credits.
Changes in Financial Position, Liquidity and Capital Resources
During the first three months of fiscal 2004, we generated $63.0 million of cash
from operations, which was principally used to purchase $58.7 million of
systems, equipment and other assets relating to contracts. At May 24, 2003, we
had $131.5 million of cash and cash equivalents on hand, of which approximately
86% was concentrated with three financial institutions. At the end of the fiscal
2004 first quarter, we had no borrowings under our $300 million credit facility.
Trade accounts receivable decreased by $12.0 million, from $107.7 million at
February 22, 2003 to $95.7 million at May 24, 2003, primarily due to collection
of amounts related to product sales we recorded in the fourth quarter of fiscal
2003, along with the collection of certain domestic service receivables.
Inventories increased by $12.4 million, from $72.3 million at February 22, 2003
to $84.7 million at May 24, 2003, primarily due to increases to inventory
associated with product sales expected to be recorded during fiscal 2005.
Other current assets increased by $7.6 million, from $18.7 million at February
22, 2003 to $26.3 million at May 24, 2003, primarily due to $2.9 million of
value-added tax receivables and $2.9 million of prepayments, both related to
ongoing lottery system installations.
-29-
Systems, equipment and other assets relating to contracts, net, increased by
$21.2 million, from $410.9 million at February 22, 2003 to $432.1 million at May
24, 2003, primarily due to the purchase of $58.7 million of systems, equipment
and other assets relating to contracts, partially offset by depreciation
expense.
Accounts payable decreased by $13.9 million, from $74.0 million at February 22,
2003 to $60.1 million at May 24, 2003, primarily due to the timing of payments
related to ongoing lottery system installations.
Employee compensation decreased by $18.6 million, from $37.5 million at February
22, 2003 to $18.9 million at May 24, 2003, primarily due to the payment of
fiscal 2003 management incentive compensation and employee profit sharing.
Advance payments from customers increased by $13.9 million, from $69.7 million
at February 22, 2003 to $83.6 million at May 24, 2003, primarily due to advances
received from customers related to product sales that are expected to be
recorded during fiscal 2004.
Our business is capital-intensive. We currently estimate that net cash to be
used for investing activities in fiscal 2004 will be in the range of $335
million to $345 million, excluding investments that will be required under the
proposed acquisition of Interlott. Assuming that the Interlott acquisition is
consummated in August 2003, we currently estimate that net cash to be used for
investing activities in fiscal 2004 for the purchase of this business and
investing activities subsequent to acquisition, will be in the range of $45
million to $50 million. In addition, to complete the acquisition of Interlott,
we plan to issue common shares held in treasury with an aggregate value of
approximately $30 million based upon our per share price before the closing. We
will also assume approximately $21 million of Interlott debt.
We expect our principal sources of liquidity to be existing cash balances, along
with cash generated from operations and borrowings under our credit facility.
Our credit facility provides for an unsecured revolving line of credit of $300
million and matures in June 2006. As of May 24, 2003, there were no borrowings
under the credit facility. We currently expect that our cash flow from
operations, existing cash balances and available borrowings under our credit
facility will be sufficient for the foreseeable future to fund our anticipated
working capital and ordinary capital expenditure needs, to service our debt
obligations, to fund anticipated internal growth, to fund potential
acquisitions, to pay dividends, to fund the capital requirements under our
Master Contract with the Rhode Island Lottery (the "Lottery), and to repurchase
shares of our common stock, from time to time, under our share repurchase
programs. Not withstanding the foregoing, we may seek alternative sources of
financing to fund certain of our obligations under our Master Contract with the
Lottery.
Details of our contractual obligations for long-term debt and operating leases
as of February 22, 2003 are as follows (in millions):
Fiscal
----------------------------------------------------------------------------
2004 2005 2006 2007 2008 Thereafter Total
-------- -------- --------- -------- -------- ----------- -------
Long-term debt $ 7.0 $ 5.6 $ 5.1 $ 5.8 $ 95.6 $ 175.0 $ 294.1
Operating leases 18.7 14.8 7.3 33.4 3.1 6.1 83.4
-------- -------- --------- -------- -------- ----------- -------
Total $ 25.7 $ 20.4 $ 12.4 $ 39.2 $ 98.7 $ 181.1 $ 377.5
======== ======== ========= ======== ======== =========== =======
Operating lease payments include a $28 million residual value payment that we
may be required to pay in fiscal 2007, or earlier under certain limited
circumstances, related to the lease of our World Headquarters facilities.
-30-
Off-Balance Sheet Arrangements
We have a 50% limited partnership interest in West Greenwich Technology
Associates, L.P. (the "Partnership"), which owns our World Headquarters
facilities and leases them to us. The general partner of the Partnership is an
unrelated third party. We account for the Partnership using the equity method of
accounting. The following is a summary of certain unaudited financial
information of the Partnership, at and for the period ended May 24, 2003, used
as the basis for applying the equity method of accounting (in millions):
May 24, 2003 (Unaudited)
- ------------------- ----------
Earnings data:
Net loss $ (0.2)
Balance sheet data:
Assets $ 17.7
Liabilities 27.6
Partners' deficit (9.9)
We are currently assessing the requirements to consolidate the Partnership in
accordance with Financial Accounting Standards Board Interpretation No. 46,
"Consolidation of Variable Interest Entities", which requires the consolidation
of a variable interest entity (as defined) by its primary beneficiary. Should
the Partnership require consolidation, we would be required to initially measure
and record the assets, liabilities and noncontrolling interest of the
Partnership at their carrying values in our consolidated financial statements.
Accordingly, we would record our World Headquarters facilities owned by the
Partnership as an asset, and the Partnership's debt obligation as a liability in
our consolidated financial statements. We do not expect the adoption of this
interpretation to have a material impact on our consolidated financial
statements.
Guarantees and Indemnifications
PERFORMANCE AND OTHER BONDS
We enter into performance and other bonds related to various contracts, which
generally have terms of one year. Potential payments due under these bonds are
related to performance under the applicable contract. Historically, we have
never made any payments under these types of bonds and we do not currently
anticipate that payments will be required under the current bonds. The following
table provides information related to potential commitments at May 24, 2003 (in
millions):
Total potential
commitments
---------------
Performance bonds $ 171.2
Financial guarantees 8.1
All other bonds 9.3
---------------
$ 188.6
===============
LOTTERY TECHNOLOGY SERVICES INVESTMENT CORPORATION
We have a 44% interest in Lottery Technology Services Investment Corporation
("LTSIC"), which we account for using the equity method of accounting. LTSIC's
wholly owned subsidiary, Lottery Technology Services Corporation ("LTSC"),
provides equipment and services (which we supplied to LTSC), to the Bank of
Taipei. The Bank of Taipei holds the license to operate the Taiwan Public
Welfare Lottery.
-31-
At May 24, 2003, in order to assist LTSC with the financing they required to
enable them to perform under their obligation to operate the Taiwan Public
Welfare Lottery on behalf of the Bank of Taipei, we guaranteed loans made by an
unrelated commercial lender to LTSC of $5.6 million. The loans have a maturity
date of January 2007 and our guarantee expires in July 2007. We did not receive
any consideration in exchange for our guarant