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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, DC 20549
--------------------
FORM 10-K
(MARK ONE)
[X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE SECURITIES EXCHANGE
ACT OF 1934
FOR THE FISCAL YEAR ENDED: FEBRUARY 28, 2004
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 1-11250
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GTECH HOLDINGS CORPORATION
(Exact Name of Registrant as Specified in Its Charter)
DELAWARE 05-0450121
(State or other jurisdiction (I.R.S. Employer Identification Number)
of incorporation or organization)
55 TECHNOLOGY WAY, WEST GREENWICH, RHODE ISLAND 02817
(Address of Principal Executive Offices)
Registrant's telephone number, including area code: (401) 392-1000
Securities registered pursuant to Section 12(b) of the Act:
Title of Each Class: Name of Each Exchange on which Registered:
- ------------------- -----------------------------------------
Common Stock $.01 par value New York Stock Exchange
Securities registered pursuant to Section 12(g) of the Act: None
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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 twelve 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 registrant's knowledge, in definitive proxy or information statements
incorporated by reference in Part III of this Form 10-K or any amendments to
this Form 10-K. [ ]
Indicate by check mark whether the registrant is an accelerated filer (as
defined in Exchange Act Rule 12b-2
YES [X] NO [ ]
The aggregate market value of the voting and non-voting common equity held by
non-affiliates of the registrant as of August 23, 2003 was approximately $2.27
billion.
On April 6, 2004, there were 59,325,280 outstanding shares of the registrant's
Common Stock.
DOCUMENTS INCORPORATED BY REFERENCE
Document Location in Form 10-K
-------- ---------------------
Portions of Registrant's Proxy Statement Part III
For its 2004 Annual Meeting of Shareholders
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GTECH HOLDINGS CORPORATION
FORM 10-K
FOR THE FISCAL YEAR ENDED FEBRUARY 28, 2004
INDEX
Page
PART I
Item 1. Business 4
Item 2. Properties 37
Item 3. Legal Proceedings 39
Item 4. Submission of Matters to a Vote of Security Holders 43
Additional Information -- Executive Officers 43
PART II
Item 5. Market For Registrant's Common Equity, Related Stockholder Matters and Issuer Purchases of
Equity Securities 45
Item 6. Selected Consolidated Financial Data 46
Item 7. Management's Discussion and Analysis of Financial Condition
and Results of Operations 47
Item 7A. Quantitative and Qualitative Disclosures About Market Risk 69
Item 8. Financial Statements and Supplementary Data 70
Item 9. Changes in and Disagreements With Accountants on Accounting
and Financial Disclosures 126
Item 9A. Controls and Procedures 127
PART III
Item 10. Directors and Executive Officers of the Registrant 128
Item 11. Executive Compensation 128
Item 12. Security Ownership of Certain Beneficial Owners and Management 128
Item 13. Certain Relationships and Related Transactions 128
Item 14. Principal Accountant Fees and Services 128
PART IV
Item 15. Exhibits, Financial Statement Schedules, and Reports on Form 8-K 129
PART I
When used in this report, the terms "Company", "we", "our" and "us"
refer to GTECH Holdings Corporation ("Holdings") and its consolidated
subsidiaries, including GTECH Corporation ("GTECH").
ITEM 1. BUSINESS
GENERAL
We are a global technology services company providing software, networks and
professional services that power high-performance solutions. We are the world's
leading operator of highly-secure online lottery transaction processing systems,
operating in 44 countries worldwide, and we have a growing presence in
commercial services transaction processing. Our core market is the lottery
industry, for which we design, sell and operate a complete suite of
lottery-enabled point-of-sale terminals that are electronically linked with a
centralized transaction processing system which mediates lottery funds between
the retailer, where a transaction is enabled, and the lottery authority. We
currently operate, provide equipment and services to, or have entered into
contracts to operate or provide equipment and services in the future to, 27 of
the 41 online lottery authorities in the United States, and currently operate,
provide equipment and services to, or have entered into contracts to operate or
provide equipment and services in the future to, online lottery systems for 57
of the 113 international online lottery authorities.
We provide integrated online lottery transaction processing solutions, services
and products to governmental lottery authorities and governmental licensees
worldwide. We offer our customers a full range of lottery technology services,
including the design, assembly, installation, operation, maintenance and
marketing of online lottery systems and instant-ticket support systems. Our
lottery systems consist of numerous lottery terminals located in retail outlets,
central computer systems, systems software and game software, and communications
equipment which connects the terminals and the central computer systems.
Historically, the majority of our lottery customers in the United States have
entered into long-term service contracts (typically at least five years in
duration) pursuant to which we provide, operate and maintain the customers'
online lottery systems in return for a transaction processing fee typically
expressed as an agreed percentage of the gross lottery sales. Many of our
international lottery customers have purchased their online lottery systems,
although some, especially lottery authorities in Eastern Europe and Latin
America, have entered into long-term service contracts with us.
In recent years, lottery authorities have recognized that by offering new games
or products, they often are able to generate significant additional revenues. An
important
part of our strategy is to develop new products and services for our customers
in order to increase their lottery revenues. Indicative online products and
services introduced recently to increase lottery revenues for our customers
include Aladdin(TM), the Doubletake(TM) game, e-scratch(TM) and our family of
self-service terminals, including Instant Ticket Vending Machines (also known as
Lottery Product Vending Machines or Instant Ticket Dispensing Machines; "ITVMs")
designed, manufactured and marketed by Interlott Technologies, Inc.
("Interlott"), which we acquired during fiscal 2004, and, from our Altura(R)
family of terminals, the Altura Self-Service Terminal or Altura SST(TM). Aladdin
is a credit-card sized lottery ticket, that, through the use of magnetic strip
and thermal printing technology, can be reused up to 500 times, and which also
can be employed in various non-lottery commercial contexts. The Doubletake game
is an online lottery game that permits players to purchase an additional game
with instant-ticket features, thus enhancing wagering interest. Our e-scratch
product is a web-based interactive suite of scratch and reveal games that
combines the security and convenience of online play with the entertainment,
branded content and immediate gratification of instant-tickets. Interlott's
EDS-Q family of ITVMs offers flexibility and expandability (from a four to 24
game capacity) as well as the industry's first transaction processing
connectivity to in-store lottery terminals and lottery authority central
systems. Our Altura SST combines the functionality of ITVMs with the capability
of selling online lottery products through a touch screen interface. In recent
years, we have also introduced various instant-ticket support services, products
and systems to assist our lottery customers in increasing revenue.
In appropriate circumstances, we have extended our online and video lottery
product offerings through acquisitions. During fiscal 2004 we completed the
acquisition of Interlott, a leading provider of instant ticket vending machines
for the worldwide lottery industry, and entered into an agreement to acquire
Spielo Manufacturing Incorporated, a leading provider of video lottery terminals
and related products and services to the global gaming industry ("Spielo"). In
April 2004 (after the close of fiscal 2004) we completed the acquisition of
Spielo. See "Significant Developments Since The Start of Fiscal 2004", and Item
7, "Management's Discussion and Analysis of Financial Condition and Results of
Operations", below.
In recent years, we have taken steps to broaden our offerings of high-volume
transaction processing services outside of our core market of providing online
lottery services. During fiscal 2004, we completed our acquisition of a
controlling equity position of PolCard S.A., a leading debit and credit card
merchant transaction acquiror and processor in Poland. See "Significant
Developments Since The Start of Fiscal 2004", and Item 7, "Management's
Discussion and Analysis of Financial Condition and Results of Operations",
below.
GTECH Corporation was founded in 1980. GTECH Holdings Corporation acquired GTECH
Corporation in a leveraged buy-out in February 1990.
Our World Headquarters is located at 55 Technology Way, West Greenwich, Rhode
Island 02817, and our telephone number is (401) 392-1000.
Our Internet address is www.gtech.com. We make available free of charge through
our Internet address our annual report on Form 10-K, quarterly reports on Form
10-Q, current reports on Form 8-K, and amendments to those reports filed or
furnished pursuant to Section 13(a) or 15(d) of the Exchange Act, as soon as
reasonably practicable after we electronically file such material with, or
furnish it to, the SEC. In addition, we review our financial results and
business prospects on quarterly earnings conference calls, and from time-to-time
on other conference call presentations, to which we invite the public to listen.
We typically announce by press release the date and time of, and dial-in and
Internet-access information respecting, such conference calls several days in
advance, and make materials respecting matters discussed on such conference
calls available free of charge through our Internet address.
FORWARD-LOOKING STATEMENTS
Statements contained or incorporated by reference 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 "may", "will", "should", "could", "expect",
"plan", "anticipate", "intend", "believe", "estimate", "continue", "project" and
similar expressions identify forward-looking statements. Such statements
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;
- our ability to retain existing contracts and to obtain and retain new
contracts; 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, among other things, the matters described in this report
under "Certain Factors That May Affect Future Performance" below.
CERTAIN FACTORS THAT MAY AFFECT FUTURE PERFORMANCE
The future performance of our business is subject to the factors set forth
below, as well as the other considerations described elsewhere herein.
GOVERNMENT REGULATIONS AND OTHER ACTIONS AFFECTING THE ONLINE LOTTERY INDUSTRY
COULD HAVE A NEGATIVE EFFECT ON OUR BUSINESS AND SALES.
In the United States and in many international jurisdictions where we currently
operate or seek to do business, online lotteries are not permitted unless
expressly authorized by law. The successful implementation of our growth
strategy and our business could be materially adversely affected if
jurisdictions that do not currently authorize lotteries do not approve online
lotteries or if those jurisdictions that currently authorize lotteries do not
continue to permit such activities.
Once authorized, the ongoing operations of lotteries and lottery operators are
typically subject to extensive and evolving regulation. Lottery authorities
generally conduct an intensive investigation of the winning vendor and its
employees prior to and after the award of a lottery contract. Lottery
authorities with which we do business may require the removal of any of our
employees deemed to be unsuitable and are generally empowered to disqualify us
from receiving a lottery contract or operating a lottery system
as a result of any such investigation. Some 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 our securities. The failure of these beneficial owners to submit to
such background checks and provide required disclosure could jeopardize the
award of a lottery contract to us or provide grounds for termination of an
existing lottery contract. Additional restrictions are often imposed by
international jurisdictions in which we market our lottery systems upon foreign
corporations, such as us, seeking to do business there.
Further, 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
Item 3, "Legal Proceedings --Brazilian Legal Proceedings, The CEF Contract
Proceedings," and Item 8, Note 13 to Notes to Consolidated Financial Statements,
below, for a discussion of the late March 2004 recommendation by federal
attorneys with Brazil's Public Ministry that criminal charges be brought against
nine individuals, including four senior officers of Caixa Economica Federal, our
customer and the operator of Brazil's National Lottery, Antonio Carlos Rocha,
the former Senior Vice President of GTECH Holdings Corporation and President of
GTECH Brasil Ltda., our Brazilian subsidiary ("GTECH Brazil") and Marcelo Rovai,
GTECH Brazil's marketing director.
Finally, sales generated by online lottery games are dependent upon decisions
over which we have no control made by lottery authorities with respect to the
operation of these games, such as matters relating to the marketing and prize
payout features of online lottery games. Because we are typically compensated in
whole or in part based on a jurisdiction's gross online lottery sales, lower
than anticipated sales due to these factors could have a material adverse effect
on our revenues.
WE MAY BE SUBJECT TO ADVERSE DETERMINATIONS IN LEGAL PROCEEDINGS (INCLUDING
RECENTLY ANNOUNCED LEGAL PROCEEDINGS IN BRAZIL) WHICH COULD RESULT IN
SUBSTANTIAL MONETARY JUDGMENTS OR REPUTATIONAL DAMAGE.
We refer you to Item 3, "Legal Proceedings -- Brazilian Legal Proceedings, The
CEF Contract Proceedings," below for a discussion of a civil action recently
announced by federal attorneys with Brazil's Public Ministry against GTECH
Brasil Ltda, our Brazilian subsidiary, and two of our former employees, among
others, and other legal proceedings involving our contractual relationship with
Caixa Economica Federal, the Brazilian bank and operator of Brazil's National
Lottery. We are also subject to a securities class action lawsuit and to other
legal proceedings described more fully in this report in Item 3 under "Legal
Proceedings." We may not prevail in any of these legal proceedings. If we are
not successful in defending these legal proceedings, we could incur substantial
monetary judgments or penalties or damage to our reputation, and whether or not
we are successful, the proceedings may occupy the time and attention of our
senior management.
OUR LOTTERY OPERATIONS ARE DEPENDENT UPON OUR CONTINUED ABILITY TO RETAIN AND
EXTEND OUR EXISTING CONTRACTS AND WIN NEW CONTRACTS.
We derive the majority of our revenues and cash flow from our portfolio of
long-term facilities management contracts. Upon the expiration of a contract,
lottery authorities may award new contracts through a competitive procurement
process. In addition, our lottery contracts typically permit a lottery authority
to terminate the contract at any time for failure to perform and for other
specified reasons, and many of our contracts permit the lottery authority to
terminate the contract at will with limited notice and do not
specify the compensation, if any, to which we would be entitled were such
termination to occur.
In addition, some of our lottery contracts permit the lottery authority to
acquire title to our system-related equipment and software during the term of
the contract or upon the expiration or earlier termination of the contract, in
some cases without paying us any compensation related to the transfer of that
equipment and software to the lottery authority.
The termination of or failure to renew or extend one or more lottery contracts,
the renewal or extension of one or more lottery contracts on materially altered
terms or the loss of our assets without compensation could, depending upon the
circumstances, have a material adverse effect on our business, financial
condition, results and prospects. See Item 3, "Legal Proceedings - Brazilian
Legal Proceedings: The CEF Contract Proceedings," Item 7, "Management's
Discussion and Analysis of Financial Condition and Results of Operation," below.
SLOW GROWTH OR DECLINES IN SALES OF ONLINE LOTTERY GOODS AND SERVICES COULD LEAD
TO LOWER REVENUES AND CASH FLOWS.
In recent years, as the United States lottery industry has matured, the rate of
lottery sales growth has slowed and certain of our customers have from
time-to-time experienced a downward trend in sales. These developments may in
part reflect increased competition that the lottery industry has experienced in
recent years for the consumers' entertainment dollar, including by virtue of a
proliferation of destination gaming venues, and an increased availability of
Internet gaming opportunities, as well as the relative difficulty of attracting
younger consumers to playing online lottery games. Our future success will
depend, in part, on the success of the lottery industry, as a whole, in
attracting and retaining players in the face of such increased competition for
the consumers' entertainment dollar (which competition may well increase further
in the future), as well as our own success in developing innovative products and
systems to achieve this goal. Our future success also will depend, in part, on
our ability to develop innovative products and services to permit us to
successfully market transaction processing goods and services outside of the
lottery industry. Our failure to achieve these goals could have a material
adverse effect on our business, financial condition and results and prospects.
See Item 7, "Management's Discussion and Analysis of Financial Condition and
Results of Operation," below.
WE DERIVE CLOSE TO HALF OF OUR REVENUES FROM FOREIGN JURISDICTIONS (INCLUDING
OVER 10% FROM BRAZILIAN OPERATIONS) AND ARE SUBJECT TO THE ECONOMIC, POLITICAL
AND SOCIAL INSTABILITY RISKS OF DOING BUSINESS IN FOREIGN JURISDICTIONS.
We are a global business and derive a substantial portion of our revenue from
our operations outside the United States. In particular, in fiscal 2004, we
derived approximately 49% of our revenues from our international operations and
approximately
10.2% of our revenues from our Brazilian operations alone (including 9.7% of our
revenues from the National Lottery of Brazil, our largest customer in fiscal
2004 based on annual revenues). In addition, a substantial portion of our assets
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. Other
economic risks that our international activity subjects us to might include
inflation, foreign exchange risks (both depreciation and devaluation), illiquid
foreign exchange markets, high interest rates, debt default, unstable capital
markets and foreign direct investment restrictions. Political risks include
change of leadership, change of governmental policies, new foreign exchange
controls regulating the flow of money into or out of a country, failure of a
government to honor existing contracts, changes in tax laws and corruption, as
well as global risk aversion driven by political unrest," war and terrorism. See
Item 3, "Legal Proceedings - Brazilian Legal Proceedings and Item 8, Note 13 to
Notes to Consolidated Financial Statements, below for a discussion of various
legal matters, including allegations of employee misconduct and challenges to
our contract that may materially adversely affect our business in Brazil.
Finally, social instability risks include high crime in the countries in which
we operate due to poor economic and political conditions, riots, unemployment
and poor health conditions. These factors may affect our work force as well as
the general business environment in a country. See Item 8, Note 24 to Notes to
Consolidated Financial Statements included in this report, for additional
financial information respecting geographic areas where we conduct business.
The occurrence of any of these events in the markets where we operate could
jeopardize or limit our ability to transact business in those markets in the
manner we expect and could have a material adverse effect on our business,
financial condition, results and prospects.
OUR RESULTS OF OPERATIONS ARE EXPOSED TO FOREIGN CURRENCY EXCHANGE RATE
FLUCTUATIONS WHICH COULD RESULT IN LOWER REVENUES, NET INCOME AND CASH FLOWS
WHEN SUCH RESULTS ARE TRANSLATED INTO U.S. DOLLAR ACCOUNTS.
Our consolidated financial results are significantly affected by foreign
currency exchange rate fluctuations. Foreign currency exchange rate exposures
arise from current transactions and anticipated transactions denominated in
currencies other than United States dollars and from the translation of foreign
currency balance sheet accounts into United States dollar balance sheet
accounts. We are exposed to currency exchange rate fluctuations because a
significant portion of our revenues is denominated in currencies other than the
United States dollar. These exchange rate fluctuations have during certain
periods in our past adversely affected our operating results and may continue to
adversely affect our results of operations and the value of our assets outside
the United States. See Item 7, "Management's Discussion and Analysis of
Financial Condition and Results of Operation," below.
WE HAVE A CONCENTRATED CUSTOMER BASE AND THE LOSS OF ANY OF OUR LARGER CUSTOMERS
(OR LOWER SALES FROM ANY OF THESE CUSTOMERS) COULD LEAD TO LOWER REVENUE.
Revenue from our top ten customers accounted for approximately 51% of our total
revenues in fiscal 2004. If we were to lose any of these larger customers, or if
these larger customers experience slow lottery ticket sales and consequently
reduced lottery revenue, our business, financial condition, results and
prospects could suffer.
OUR QUARTERLY OPERATING RESULTS MAY FLUCTUATE SIGNIFICANTLY.
We have experienced and may continue to experience significant fluctuations in
our operating results from quarter to quarter due to such factors as the amount
and timing of product sales, the occurrence of large jackpots in lotteries
(which increase the amount wagered and our revenue) and expenses incurred in
connection with lottery start-ups. Fluctuations in our operating results from
quarter to quarter may cause our operating results to be below the expectations
of securities analysts and investors.
WE OPERATE IN A HIGHLY COMPETITIVE ENVIRONMENT AND INCREASED COMPETITION MAY
CAUSE US TO EXPERIENCE LOWER CASH FLOWS OR TO LOSE CONTRACTS.
The online lottery industry has faced increased competition in recent years for
the consumers' entertainment dollar, including from a proliferation of
destination gaming venues, and an increased availability of Internet gaming
opportunities. In addition, in recent years there has been increased competition
among domestic and international participants in the online lottery industry,
which could adversely affect our ability to win renewals of contracts from our
existing customers or to win contract awards from other lottery authorities. In
addition, awards of contracts to us are, from time to time, challenged by our
competitors. Increased competition also may have a material adverse effect on
the profitability of contracts which we do obtain. See "Competition" below. Over
the past several fiscal years, we have experienced and may continue to
experience a reduction in the percentage of lottery ticket sales that we receive
from certain customers resulting from contract rebids, extensions and renewals
due to a number of factors, including the substantial growth of lottery sales,
reductions in the cost of technology and telecommunications services and general
and competitive dynamics. We are unable to determine at this time the likely
effect of this trend on our business. See Item 7, "Management's Discussion and
Analysis of Financial Condition and Result of Operations" below.
WE ARE SUBJECT TO SUBSTANTIAL PENALTIES FOR FAILURE TO PERFORM UNDER OUR
CONTRACTS.
Our lottery contracts typically permit termination of the contract at any time
for failure by us to perform and for other specified reasons and generally
contain demanding implementation and performance schedules. Failure to perform
under these contracts may result in substantial monetary liquidated damages, as
well as contract termination. These provisions in our lottery contracts present
an ongoing potential for substantial expense.
Lottery contracts also generally require us to post a performance bond, which in
some cases may be substantial, to secure our performance under such contracts.
We paid or incurred liquidated damages with respect to our contracts in an
amount equal to 0.50%, 0.47%, 0.14%, 0.47%, and 0.56% of our annual revenues in
fiscal 2004, 2003, 2002, 2001 and 2000, respectively. If we incur substantial
liquidated damages in the future, it could significantly reduce the amount of
funds that we have available for other uses in our business and may delay or
prevent us from pursuing and achieving our growth strategy, which could have a
material adverse effect on our business, financial condition, results and
prospects.
WE MAY NOT BE ABLE TO RESPOND TO TECHNOLOGICAL CHANGES OR TO SATISFY FUTURE
TECHNOLOGY DEMANDS OF OUR CUSTOMERS IN WHICH CASE WE COULD FALL BEHIND OUR
COMPETITORS.
Most of our software and hardware products are based on proprietary
technologies. While we believe that certain of our technologies, such as our
Enterprise Series(TM) open-architecture software platform, provides an industry
standard, if we were to fail to develop our product and service offerings to
take advantage of technological developments, we may fall behind our competitors
and our business, financial condition, results and prospects could suffer.
IF WE ARE UNABLE TO MANAGE POTENTIAL RISKS RELATED TO ACQUISITIONS, OUR BUSINESS
AND GROWTH PROSPECTS COULD SUFFER.
Part of our growth strategy involves acquisitions designed to extend our product
offerings and customer base. Since the start of fiscal 2004 (which ended on
February 28, 2004) we completed our acquisitions of Interlott Technologies,
Inc., a leading provider of instant ticket vending machines for the worldwide
lottery industry, and a controlling equity position in PolCard S.A., a leading
debit and credit card merchant transaction acquiror and processor in Poland, and
entered into agreements to acquire Spielo Manufacturing Incorporated ("Spielo"),
a leading provider of video lottery terminals and related products and services
to the global gaming industry, and Leeward Islands Lottery Holding Company, Inc.
("LILHCo"), a lottery holding company headquartered on the Caribbean islands of
Antigua and St. Croix. The acquisitions of Spielo and LILHCo closed during the
first quarter of fiscal 2005. See "Significant Developments Since Start of
Fiscal 2004" and Item 7, "Management's Discussion and Analysis of Financial
Condition and Results of Operation," below. Our ability to continue to expand
successfully through acquisitions depends on many factors, including our ability
to identify acquisition prospects and negotiate and close transactions. Even if
we complete an acquisition, the integration of an acquired business into our
operations involves numerous risks, including difficulties in integrating an
acquired company's hardware and software products and services with our own; the
diversion of our resources and management's attention from other business
concerns; the potential loss of key employees; risks associated with entering
markets in which we may have little experience; and the day-to-day management of
a substantially larger and more geographically diverse combined company.
We may not realize the synergies, operating efficiencies, market position or
revenue growth we anticipate from acquisitions and our failure to effectively
manage the above risks and other problems associated with acquisitions could
have a material adverse effect on our business, growth prospects and financial
performance.
Acquisitions outside of our core lottery market may subject us to enhanced
competition. For example, with the completion of our acquisition of Spielo, we
have entered the broader gaming technology and services industry, where we
expect to encounter significant competition.
Acquisitions also pose the risk that we may be exposed to successor liability
relating to actions by an acquired company and its management before the
acquisition. The due diligence we conduct in connection with an acquisition, and
any contractual indemnities we may receive from sellers of acquired companies,
may not be sufficient to protect us from, or compensate us for, actual
liabilities. A material liability associated with an acquisition could also
adversely affect our financial position and reduce the anticipated benefits of
the acquisition.
EXPANSION OF THE GAMING INDUSTRY FACES OPPOSITION WHICH COULD LIMIT OUR ACCESS
TO SOME MARKETS.
Gaming opponents continue to persist in efforts to curtail the expansion of
legalized gaming. We can give no assurance that this opposition will not be
successful in preventing the legalization of online gaming in jurisdictions
where these activities are presently prohibited or prohibiting or limiting the
expansion of online gaming where it is currently permitted, in either case 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 depend, in part, upon our ability to
attract and to retain qualified managerial, marketing and technical employees.
Competition for such employees is sometimes intense, and we may not succeed in
hiring and retaining the executives and other employees that we need. Our loss
of or inability to hire key employees could have a material adverse effect on
our business, financial condition, results and prospects.
OUR BUSINESS PROSPECTS AND FUTURE SUCCESS RELY HEAVILY UPON THE INTEGRITY OF OUR
EMPLOYEES AND EXECUTIVES AND THE SECURITY OF OUR SYSTEMS.
The real and perceived integrity and security of a lottery is critical to its
ability to attract players. We strive to set exacting standards of personal
integrity for our employees and system security for the systems that we provide
to our customers, and our reputation in this regard is an important factor in
our business dealings with lottery and other governmental agencies. For this
reason, an allegation or a finding of improper conduct on
our part, or on the part of one or more of our employees that is attributable to
us, or an actual or alleged system security defect or failure attributable to
us, could have a material adverse effect upon our business, financial condition,
results and prospects, including our ability to retain existing contracts or
obtain new or renewal contracts. See Item 3, "Legal Proceedings - "Brazilian
Legal Proceedings: The CEF Contract Proceedings".
OUR DEPENDENCE ON CERTAIN SUPPLIERS CREATES A RISK OF IMPLEMENTATION DELAYS IF
THE SUPPLY CONTRACT IS TERMINATED OR BREACHED, AND ANY DELAYS MAY RESULT IN
SUBSTANTIAL PENALTIES.
We purchase most of the parts, components and subassemblies necessary for our
terminals from outside sources. We assemble these parts, components and
subassemblies into finished products in our manufacturing facility. While most
of the parts, components and subassemblies can be purchased through more than
one supplier, we currently have approximately three material sole source
vendors. We believe that if a supply contract with one of these vendors were to
be terminated or breached, we would be able to replace the vendor. However, it
may take time to replace the vendor under some circumstances and any replacement
parts, components or subassemblies may be more expensive, which could reduce our
margins. Depending on a number of factors, including the level of the related
part, component or subassembly in our inventory, the time it takes to replace a
vendor may result in a delay in our implementation of a lottery system for a
customer. Generally, if we fail to meet our performance schedules under our
contracts, we may be subject to substantial penalties or liquidated damages, or
even contract termination.
OUR NON-LOTTERY VENTURES, WHICH ARE AN INCREASINGLY IMPORTANT ASPECT OF OUR
BUSINESS, MAY FAIL.
Our business prospects and future success depend, in part, upon our ability to
expand our transaction processing services into complementary and parallel
markets outside of our core lottery market. In fiscal 2004 (which ended on
February 28, 2004), commercial services transaction processing represented
approximately 7% of our total revenues. By way of comparison, in fiscal 2003,
approximately 5% of our total revenues were derived from commercial services
transaction processing. With our acquisition in May 2003 of a controlling equity
interest in PolCard, S.A., a leading debit and credit card merchant transaction
acquirer and processor company in Poland, we expect non-lottery ventures to
become increasingly significant to our overall financial performance. Because we
have less experience in non-lottery markets than we have in our core lottery
market, our non-lottery ventures present an enhanced element of risk for us. In
the near term, we expect to concentrate our efforts to grow commercial service
revenues principally in the United States, Latin America and Eastern Europe,
where we have significant operational experience and where we see opportunities
for growth. Our non-lottery ventures outside the United States are particularly
sensitive to the economic and political risks of doing business in these
countries, including foreign currency exchange risks. As non-lottery services
start to represent a more significant portion of our operations, the failure of
one or more of our non-lottery ventures could have a material effect on our
business, financial condition, results and prospects.
SIGNIFICANT DEVELOPMENTS SINCE THE START OF FISCAL 2004
LOTTERY CONTACT AWARDS
Since the start of fiscal 2004 (which ended on February 28, 2004) we have
received a number of contract awards and extensions from lottery authorities.
NEW ONLINE CUSTOMERS. During fiscal 2004, we received awards to install online
systems from three new online customers.
In September 2003, following a competitive procurement, we entered into a
six-year contract with the Florida lottery authority to supply a new online and
instant ticket lottery system, lottery terminals, telecommunications network and
related services. Sales are expected to commence under our contract with the
Florida lottery authority in February 2005.
In November 2003, following a competitive procurement, we entered into a
ten-year contract with Mahapola Higher Education Scholarship Trust Fund
("Mahapola") to provide online, instant and passive lottery technology and
management services in Sri Lanka. Online sales had been expected to commence
under our Sri Lanka lottery contract in September 2004, but in March 2004,
lawsuits were filed by competitors challenging Mahapola's award to us of a
lottery contract. These legal challenges have delayed and may prevent
implementation of our contract with Mahapola.
Finally, in January 2004, following a competitive procurement, we entered into a
seven-year contract with the Tennessee lottery authority to provide an online
lottery system, lottery terminals, related communications network and related
services. Sales commenced under our contract with the Tennessee lottery
authority in January 2004.
With respect to each of these three new contracts, we have provided or will
provide a lottery system featuring our Enterprise Series((TM)) architecture
(including Internet Protocol (IP) web-component technology) and our Altura
terminals.
NEW CONTRACTS AND EXTENSIONS WITH EXISTING CUSTOMERS. Since the start of fiscal
2004, we also have been awarded new contracts by, or have received contract
extensions from, a number of our existing customers.
In April 2003, we entered into an agreement with Caixa Economica Federal
("CEF"), the operator of Brazil's National Lottery and our largest customer in
fiscal 2004 based on annual revenues, pursuant to which the term of our contract
with CEF, which had been scheduled to expire in April 2003, was extended through
May 2005 (with CEF having the right to elect upon prior notice to terminate the
contract early at any time after December 2004), and fees payable under our
contract were reduced by 15%. See Item 3, "Legal Proceedings", Item 7,
"Management's Discussion and Analysis of Financial Condition and Results of
Operations" and Note 13 to Notes to Consolidated Financial Statements, below.
In May 2003, we entered into a Master Contract with the Rhode Island lottery
authority that amended our existing contracts with the Rhode Island lottery
authority and grants us the right to be the exclusive provider of online,
instant ticket and video lottery central systems and services for the Rhode
Island lottery authority during the 20-year term of the Master Contract for a
$12.5 million up-front license fee, which we paid in July 2003. The Master
Contract is part of a comprehensive economic development package that provides
incentives for us to keep our world headquarters and manufacturing operations in
Rhode Island. See Item 7, "Management's Discussion and Analysis of Financial
Condition and Results of Operation" and Note 8 to the "Notes to Consolidated
Financial Statements," below. The Master Contract provides for us to replace the
Rhode Island lottery authority's existing central system with our Enterprise
Series((TM)) central system, install a new state-of-the-art communications
network, and replace all of the lottery authority's online terminals with new
PC-based terminals by 2007. By 2015, the Master Contract provides for us to
again replace the Rhode Island lottery's then-existing central system hardware
with new state of the art hardware, and its then-existing terminals with new
online lottery terminals in accordance with performance ratings outlined in the
contract.
In June 2003, we entered into a new five-year contract with the Wisconsin
lottery authority to supply a new online and instant tickets lottery system, and
related telecommunications network. In January 2004, we signed a product sale
agreement with Sistemas Tecnicos de Loterias del Estado ("STL"), the operator of
the online system for Spain's National Lottery, to replace 2,500 existing
terminals with 2,500 Altura terminals and to provide STL with terminal
maintenance and repair services. In February 2004, we entered into a contract to
supply Beijing Welfare Lottery Center ("BWLC") with equipment, software, and
technical services to operate a computerized keno game in Beijing. In connection
with the contract, BWLC extended our original online lottery services contract
for an
additional three years, such that the contract, as extended, is scheduled to
terminate in December 2012, and entered into an alliance agreement with us under
which we agreed to provide BWLC with lottery central system hardware, network
connectivity, software licenses and ongoing software services in support of
BWLC's efforts to become a hub operator of lotteries implemented in neighboring
jurisdictions in China.
During fiscal 2004, the lottery authorities of Michigan, New Zealand, Denmark
and AB Svenska Spel, our lottery customer in Sweden, exercised options to extend
the terms of their online contracts with us. In addition, in October 2003 we
entered into a 12-year contract extension with Sazka, a.s., the operator of
lottery and betting games in the Czech Republic.
In August 2003, following a competitive procurement, the Nebraska lottery
authority announced that it had selected another vendor to provide equipment and
services for a new online lottery gaming system, and associated
telecommunications network, upon the scheduled expiration in June 2004 of our
current contract with the Nebraska lottery authority.
In February 2004, following a competitive procurement, we were selected by the
Mexican lottery authority Pronosticos para la Asistencia Publica to enter into a
six year agreement to provide equipment and services for a new online lottery
system and associated telecommunications network. In late April 2004, we were
notified that this award has been revoked. This revocation follows a ruling by
the Mexican Comptroller Ministry on a protest filed by unsuccessful competitors
that declared our bid non-compliant and disqualified us from the competitive
procurement. The Mexican lottery authority subsequently announced that it has
disqualified the sole remaining bidder as also being non-compliant and has
formally ended the procurement. We intend to pursue all appropriate avenues to
contest the Comptroller's decision.
OTHER PRODUCTS AND SERVICES
During fiscal 2004, we entered into a number of agreements, and announced a
number of other developments, respecting products and services outside of our
traditional online lottery product offerings.
VIDEO LOTTERY. In November 2003, we entered into an agreement to acquire all of
the shares of privately-held Spielo Manufacturing Incorporated, ("Spielo") a
leading provider of video lottery terminals ("VLTs") and related products and
services to the global gaming industry. This agreement provided for us to pay a
potential aggregate cash purchase price of approximately $185 million,
consisting of a $150 million payment due at the closing and an earn-out amount
of up to $35 million payable in the eighteen (18) months thereafter, which
earn-out amount Spielo shareholders are entitled to received based upon Spielo's
success in achieving certain VLT installation objectives in New York. In April
2004 (after the close of fiscal 2004) we completed the acquisition of Spielo. We
believe that by acquiring Spielo, we will be better able to deliver a complete,
integrated, VLT solution to our existing and potential customers with a single
point of contact and accountability.
The Master Contract that we entered into in May 2003 with the Rhode Island
lottery authority, described generally above, also provides for us to replace
the Rhode Island video lottery central system by 2010, to replace our
then-existing installed VLT base by July 2004, and to provide 1,000 of the 1,825
recently-approved additional VLTs to be installed at Lincoln Park and Newport
Grand (subject to satisfying certain performance standards). In addition, the
Master Contract gives us the right to provide up to 50 percent of any additional
gaming machines approved by the State of Rhode Island (subject to the
satisfaction of certain performance standards after 2008). See Note 8 to the
Notes to
Consolidated Financial Statements. Following consummation of the Spielo
acquisition, we will have an installed base of over 2,000 participation based
gaming machines in Rhode Island.
In June 2003, we entered into a contract with AB Svenska Spel, our lottery
customer in Sweden, to replace Svenska Spel's then-existing video lottery
central system, with our Enterprise Series(TM) video central system, to
provide Svenska Spel with approximately 2,200 internet protocol (IP)-ready video
site controllers, and to provide certain software licensing and support services
through September 2008. Sales commenced under the Svenska Spel system in
November 2003.
Finally, in July 2003, we entered into a five-year contract with the National
Lotteries Control Board and The Betting Levy Board ("NLCB/BLB") to provide a
complete video lottery solution, including a control system, VLTs and
communications network in Trinidad and Tobago. Sales are expected to commence
under the NLCB/BLB contract in November 2004.
COMMERCIAL SERVICES. In May 2003, we completed our acquisition of a controlling
equity position in PolCard S.A. ("PolCard"), for a purchase price, net of cash
acquired, of $35.9 million. PolCard is a leading debit and credit card merchant
transaction acquiror and processor in Poland. Upon the completion of this
acquisition, PolCard's outstanding equity was owned 66.5% by us, 33.2% by two
funds managed by Innova Capital Sp.Z.o.o ("Innova"), a Warsaw-based private
equity investment advisor, and 0.3% by the Polish Bank Association, one of
PolCard's previous owners. In September 2003, Innova exercised its right under
an option agreement to purchase from us 3.7% of PolCard's equity. Following the
exercise of this option, we now own 62.8% of PolCard's outstanding equity, while
the two funds managed by Innova own, in aggregate, 36.9% of PolCard's
outstanding equity. The Polish Bank Association continues to own 0.3% of the
outstanding equity of PolCard. We have the option to purchase Innova's interest
in PolCard, and Innova has the reciprocal right to sell its interest in PolCard
to us, during the period commencing approximately four and ending approximately
six years after the closing of this transaction. We believe that our acquisition
of a controlling equity position in PolCard will permit us to leverage our
extensive infrastructure in Poland in the development of our commercial services
product offerings.
In addition, in July 2003 we entered into a two-year contract extension with the
Idaho Department of Fish and Game to continue to provide products and services
to operate Idaho's fish and game licensing system through December 2006.
NEW PRODUCT OFFERINGS AND DEVELOPMENTS. In September 2003, we completed the
acquisition of Interlott Technologies, Inc. ("Interlott"), a leading provider of
instant ticket vending machines for the worldwide lottery industry, for an
aggregate purchase price, including assumed debt, of $87.5 million. We believe
that our acquisition of Interlott will expand our presence in the instant-ticket
distribution business, thus anchoring our self-service strategy and allowing us
to grow our core lottery market.
In March 2003, we announced a program whereby third party vendors of technology
that has been successfully tested for conformance with our technological and
security standards, can be approved for use with our GTECH Enterprise Series
lottery solution. Our Enterprise Series solution offers a unique open-system
architecture which allows lotteries the flexibility to continuously upgrade
their lottery systems by integrating a broad spectrum of third-party software
and hardware solutions to achieve greater performance. Our certification
process, and resulting ES Approved(TM) designation for qualifying third-party
products, supports the open system lottery architectural philosophy of our
Enterprise Series by facilitating the development of `best of class' technology
solutions.
In April 2003, we announced the development of our e-scratch product, a
web-based interactive suite of scratch and reveal games that combines the
security and convenience of online play with the entertainment, branded content
and immediate gratification of instant tickets. We believe that our e-scratch
product supports our strategy to expand the core lottery business by attracting
new players through traditional and emerging-content venues such as interactive
environments.
In July 2003, we entered into an agreement with 7-Eleven, Inc., the world's
largest convenience retailer, to add lottery sales capabilities to the chain's
Vcom(TM) electronic commerce kiosks in selected 7-Eleven, Inc. stores in the
United States. Subject to the approval of applicable state lottery authorities,
customers will be able to purchase lottery tickets through Vcom kiosks using our
proprietary "Lottery Inside" technology.
DEVELOPMENTS SINCE THE CLOSE OF FISCAL 2004
We have reported several developments since the close of fiscal 2004 (which
ended on February 28, 2004).
In April 2004, we entered into an agreement to acquire all of the shares of
privately-held Leeward Islands Lottery Holding Company, Inc. ("LILHCo"), a
lottery operating company headquartered on the Caribbean islands of Antigua and
St. Croix. The enterprise purchase price for LILHCo payable in cash at closing
will be approximately $40 million. LILHCo holds long-term licenses to operate
lotteries in Antigua/Barbuda, Anguilla, St. Kitts & Nevis, St. Maarten/Saba/St.
Eustatius and Turks & Caicos, and operates lotteries in Barbados, Bermuda and
the U.S. Virgin Islands. In addition, LILHCo recently obtained a new 10-year
video lottery terminal license in Turks & Caicos, and has received confirmation
that its existing license in St. Kitts & Nevis allows for the installation of
video lottery games. In May 2004 we completed the acquisition of LILHCo. We
expect to replace LILHCo's current systems and equipment with our Enterprise
Series(TM) architecture and Altura (TM) terminals. We believe that the
acquisition of LILHCo broadens our strategic foothold in the Caribbean lottery
market as well as offers significant growth opportunities in additional
jurisdictions within the Caribbean.
In March 2004, we received notice that, following a competitive procurement, the
Illinois lottery authority intends to award us a five-year contract to provide
the Illinois lottery authority with up to 2,000 instant ticket vending machines.
In March 2004, we also were named by the Washington lottery authority, following
a competitive procurement, as the apparent successful bidder to receive a
three-year contract to provide the Washington lottery with up to 1,000 lottery
product vending machines. These awards are subject to the successful completion
of contract negotiations with, respectively, the Illinois and Washington lottery
authorities.
In April 2004, we entered into a five-year contract extension with Oeuvre
Nationale Secours Grande-Duchesse Charlotte, the operator of Loterie Nationale
of Luxembourg, to provide new lottery terminals, products and services through
October 2012.
In May 2004, we were notified by our customer, Loteria Electronica de Puerto
Rico, of its intent to negotiate a contract to provide a new online lottery
system and an associated telecommunications network with another vendor to take
effect upon the expiration of our current contract in March 2005.
LOTTERY INDUSTRY
Statements relating to the lottery industry contained in this report are based
on information compiled by us, or derived from independent public sources which
we believe to be reliable. No assurance can be given, however, regarding the
accuracy of such statements. In general, there is less publicly-available
information concerning the international lottery industry than the lottery
industry in the United States.
Lotteries are operated by state and foreign governmental authorities and their
licensees in over 200 jurisdictions worldwide. Governments have authorized
lotteries primarily as a means of generating non-tax revenues. In the United
States, lottery revenues are frequently designated for particular purposes, such
as education, economic development, conservation, transportation and aid to the
elderly. Many states have become increasingly dependent on their lotteries as
revenues from lottery ticket sales are often a significant source of funding for
these programs.
Although there are many types of lotteries in the world, it is possible to
categorize government authorized lotteries into two principal groups: online
lotteries and off-line lotteries. An online lottery is conducted through a
computerized lottery system in which lottery terminals are connected to a
central computer system. An online lottery system is generally utilized for
conducting games such as lotto, sports pools, keno and numbers, in which players
make their own selections. Off-line lotteries feature lottery games which are
not computerized, including traditional off-line lottery games and
instant-ticket games. Traditional off-line lottery games, in which players
purchase tickets which are manually processed for a future drawing, generally
are conducted only in international jurisdictions. Instant-ticket games, in
which players scratch off a coating from a pre-printed ticket to determine if it
is a winning ticket, are conducted both internationally and in the United
States.
In general, online lotteries generate significantly greater revenues than both
traditional off-line lottery games and instant-ticket games. In addition, there
are several other advantages to online lotteries as compared to traditional
off-line lotteries. Unlike
traditional off-line lottery games, wagers can be accepted and processed by an
online lottery system until minutes before a drawing, thereby significantly
increasing the lottery's revenue in cases in which a large prize has attracted
substantial wagering interest. Online lottery systems also provide greater
reliability and security, allow a wider variety of games to be offered and
automate accounting and administrative procedures which are otherwise manually
performed.
Typically, approximately 50% of the gross revenues of an online lottery in the
United States is returned to the public in the form of prizes. Approximately 35%
is used by the state to support specific public programs or as a contribution to
the state's general funds. The remaining 15% is generally used to fund the
operations of the lottery, including the cost of advertising, sales commissions
to point-of-purchase retailers and service fees to vendors such as us.
According to La Fleur's 2003 World Lottery Almanac, from 1972 through 2003,
total annual lottery ticket sales in the United States grew from approximately
$295.0 million to approximately $44.8 billion, although, in recent years, as the
United States lottery industry has matured, the rate of lottery sales growth has
slowed and certain of our customers have from time-to-time experienced a
downward trend in sales. See "Certain Factors That May Affect Future Performance
- - Slow growth or declines in sales of online lottery goods and services could
lead to lower revenues and net income," above.
There are currently 41 jurisdictions operating online lotteries in the United
States. Implementation of lotteries in other jurisdictions will depend upon
successful completion of legislative, regulatory and administrative processes.
Outside the United States, government operated or licensed lotteries, many of
which are off-line, have a long history. The international online lottery
industry has experienced significant growth. Since 1977, when there were no
online lotteries operating outside of the United States, 113 international
jurisdictions have implemented online lottery systems. A number of other
international jurisdictions, principally in Europe, Asia-Pacific, and Latin
America, are currently considering the implementation of online lotteries.
ONLINE LOTTERY BUSINESS
ONLINE LOTTERY CONTRACTS
OVERVIEW. We generally conduct business under one of two types of contractual
arrangements which are described in more detail below: Facilities Management
Contracts and Product Sales Contracts. Under a typical Facilities Management
Contract, we construct, install and operate the lottery system and retain
ownership of the lottery system. These contracts generally provide for a
variable amount of monthly or weekly service fees to be paid to us directly from
the lottery authority based on a percentage of a lottery's gross online and
instant ticket sales. Under Product Sales Contracts, we
construct, sell, deliver and install a turnkey online lottery system or lottery
equipment and license the computer software for a fixed price, and the lottery
authority subsequently operates the lottery system.
The collection of lottery monies, the selection of winners, the financial
responsibility for the payment of prizes and the qualification of retail sales
agents are usually the sole responsibility of the lottery authority in each
jurisdiction in which we operate a lottery. The United Kingdom's National
Lottery, Taiwan's Public Welfare Lottery and the South African National Lottery
provide important exceptions to the general rule, in that in each case a
licensee to whom we supply goods and services (rather than the lottery
authority) operates all aspects of the respective lottery with the exception of
proceeds allocation.
With respect to fiscal 2004, approximately 83.8% of our revenues were service
revenues earned under our Facilities Management Contracts; approximately 8.9% of
our revenues were product sales revenues earned under Product Sales Contracts;
and approximately 7.3% of our revenues were attributable to the provision of
nonlottery goods and services.
FACILITIES MANAGEMENT CONTRACTS. Our Facilities Management Contracts typically
require us to construct, install and operate the lottery system for an initial
term, which is typically at least five years, and usually contain options
permitting the lottery authority to extend the contract under the same terms and
conditions for one or more additional periods, generally ranging from one to
five years. In addition, our customers occasionally renegotiate extensions on
different terms and conditions.
Our revenues under Facilities Management Contracts are generally a variable
amount of monthly or weekly service fees which are paid to us directly from the
lottery authority based on a percentage of such lottery's gross online and
instant ticket sales. The level of lottery ticket sales within a given
jurisdiction is determined by many factors, including population density, the
types of games played and the games' design, the number of terminals, the size
and frequency of prizes, the nature of the lottery's marketing efforts and the
length of time the online lottery system has been in operation.
Under our Facilities Management Contracts, we typically retain title to the
lottery system and typically provide our customers with the services necessary
to operate and manage the lottery system. We install and commence operations of
a lottery system after being awarded a Facilities Management Contract and,
following the start-up of the lottery system, we are responsible for all aspects
of the system's operations. We typically operate lottery systems in each
jurisdiction on a stand-alone basis through the installation of two or more
dedicated central computer systems, although in a few instances several
jurisdictions have shared the same central system. In addition, in most
jurisdictions we employ a dedicated work force, consisting of a site director,
marketing personnel, computer operators, communications specialists and customer
service representatives who service and maintain most aspects of the system.
Under certain of our Facilities Management Contracts the lottery authority has
the right to purchase our lottery system during the contract term at a
predetermined price, which is calculated so that it exceeds the net book value
of the system at the time the right is exercisable. In addition, some of our
lottery contracts permit the lottery authority to acquire title to our
system-related equipment and software during the term of the contract or upon
the expiration or earlier termination of the contract, in some cases (i.e., were
we to materially breach or be unable to perform under certain circumstances)
without paying us any compensation related to the transfer of that equipment and
software to the lottery authority. Our role, if any, with respect to the
continued operation of a lottery system in the event of the exercise of such a
purchase option generally is not specified in such contracts and thus would be
subject to negotiation. Under many of our Facilities Management Contracts, the
lottery authority also has the option to require us to install additional
terminals and/or add new lottery games. Such installations may require
significant expenditures by us. However, since our revenues under such contracts
generally depend on the level of lottery ticket sales, such expenditures have
generally been recovered through the revenues generated by the additional
equipment or games and revenues from existing equipment.
Under a number of our lottery contracts, in addition to constructing, installing
and operating the online lottery systems in these jurisdictions, we are
providing a wide range of support services and equipment for the lottery's
instant-ticket games, such as marketing, distribution and automation of
validation, inventory and accounting systems, for which we receive fees based
upon a percentage of the sales of the instant-ticket games.
Revenues from Facilities Management Contracts are accounted for as Service
Revenue in our Consolidated Income Statements.
Unless otherwise indicated, the table below sets forth the lottery authorities
with which we had Facilities Management Contracts and fully installed,
operational lottery systems as of February 28, 2004, and as to which we are the
sole supplier of central computers and terminals and material services. The
table also sets forth information regarding the term of each contract and, as of
February 28, 2004, the approximate number of terminals installed in each
jurisdiction.
APPROXIMATE CURRENT
NUMBER OF LOTTERY DATE OF COMMENCEMENT OF DATE OF EXPIRATION OF EXTENSION
JURISDICTION TERMINALS INSTALLED(1) CURRENT CONTRACT CURRENT CONTRACT TERM OPTIONS*
------------ ---------------------- ----------------------- --------------------- ----------
UNITED STATES:
Arizona 2,500 9/99 9/06 ---
California 18,540 10/03 10/09 4 one-year
Colorado (2) 2,440 3/95 10/04 ---
D.C. (3) 580 6/99 11/09 ---
Florida (4) -- 1/05 3/11 2 two-year
Georgia 8,045 9/03 9/10 ---
Idaho (5) 740 2/99 2/07 ---
Illinois 6,860 4/00 10/07 1 one-year
Kansas 1,850 7/02 6/08 ---
Kentucky 2,813 4/97 6/08 ---
Louisiana 2,790 6/97 6/10 ---
Michigan 8,460 1/98 1/09 ---
Minnesota 3,000 2/03 2/08 5 one-year
Missouri 2,950 7/96 6/05 ---
Nebraska (6) 935 4/94 6/04 ---
New Jersey 6,000 6/96 6/06 ---
New Mexico 1,160 6/96 11/08 ---
New York 15,600 11/00 3/07 3 one-year
Ohio 7,230 8/00 6/05 2 two-year
Oregon 3,000 12/96 6/05 3 one-year
Rhode Island 1,030 7/03 6/23 ---
Tennessee 3,800 1/04 4/11 ---
Texas 16,350 8/02 8/11 ---
Washington 2,700 9/95 6/06 ---
APPROXIMATE CURRENT
NUMBER OF LOTTERY DATE OF COMMENCEMENT OF DATE OF EXPIRATION OF EXTENSION
JURISDICTION TERMINALS INSTALLED(1) CURRENT CONTRACT CURRENT CONTRACT TERM OPTIONS*
------------ ---------------------- ----------------------- --------------------- ----------
Wisconsin 3,070 11/03 6/11 2 one-year
INTERNATIONAL:
Argentina
- -Loteria National 800 11/93 1/05 ---
Sociedad del
Estado (5, 7)
- -Boldt IPLC (5) 3,000 11/99 11/09 ---
Barbados
- -T.L. Lotteries 200 10/94 11/04 ---
Brazil
- -National
Lottery (8) 21,800 5/00 5/05 ---
- -Minas Gerais 800 10/94 11/06 ---
- -Santa Catarina 105 4/02 4/06 1 one-year
Colombia
- -ETESA (9) 2,400 12/99 1/11 5 years
Czech Republic
- -SAZKA 8,250 10/92 12/17 ---
Ireland
- -An Post Nat'l
Lottery Company 2,060 6/02 12/08 (10)
Jamaica
- -Supreme
Ventures Limited 700 11/00 01/11 1 ten-year
Luxembourg (11)
- -Loterie Nationale 150 6/01 10/07 4 one-year
Mexico
- -Pronosticos Para
La Assistencia
Publica 6,800 (12) (12) (12)
Morocco
- -La Societe de 1,600 8/99 4/09 1 one-year
Gestion de la
Loterie Nationale
and La Marocaine
des Jeux et Les
Sports
APPROXIMATE CURRENT
NUMBER OF LOTTERY DATE OF COMMENCEMENT OF DATE OF EXPIRATION OF EXTENSION
JURISDICTION TERMINALS INSTALLED(1) CURRENT CONTRACT CURRENT CONTRACT TERM OPTIONS*
------------ ---------------------- ----------------------- --------------------- ----------
Poland
- -Totalizator 9,200 5/01 5/11 1 six-month
Sportowy
Puerto Rico
- -Loteria 2,290 3/99 3/05 (6)
Electronica de
Puerto Rico
Slovak Republic
- -TIPOS a.s. 1,550 3/96 12/11 ---
South Africa (13)
- -National Lottery 8,235 7/99 4/07 1 one-year
Spain
- -L'Entitat 2,445 10/97 4/04 1 six-month
Autonoma de Jocs
I Apostes de la
Generalitat de
Catalunya (14)
Sri Lanka
- -Mahapola Higher -- 11/03 (14) 1 five-year
Education
Scholarship Trust
Fund (15)
Taiwan
- -Taipei Bank (16) 7,000 11/01 12/06 ---
Trinidad & Tobago
- -National Lotteries 600 12/93 7/06 1 three-year
Control Board
Turkey
- -Turkish National 4,000 2/96 11/04 (17)
Lottery (5)
United Kingdom
- -The National 25,440 1/02 1/09 ---
Lottery (18)
Ukraine
- -Ukrainian
National Lottery 2,430 8/00 12/10 ---
*Reflects extensions available to the lottery authority under the same terms as
the current contract. Lottery authorities occasionally negotiate extensions on
different terms and conditions.
(1) Total does not include instant-ticket validation terminals or instant
ticket vending machines.
(2) The Colorado lottery authority has selected another vendor to provide
equipment and services after the Colorado lottery authority's contract
with us expires in October 2004.
(3) Operated by Lottery Technology Enterprises, a joint venture in which we
have a 1% interest, and to which we supply lottery goods and services.
(4) The lottery system that we are implementing for the Florida lottery
authority under the contract that we entered into during fiscal 2004 is
scheduled to become operational in February 2005.
(5) Under these contractual arrangements (which we formerly referred to as
"Operating Contracts"), the lottery authorities purchased the lottery
system and related software license from us at the respective start of
the contracts.
(6) The Nebraska lottery authority has selected another vendor to provide
equipment and services after the Nebraska lottery authority's contract
with us expires in June 2004. The Puerto Rico lottery authority has
selected another vendor to provide equipment and services after the
Puerto Rico lottery authority's contract with us terminates in March
2005.
(7) We are the service provider only with respect to one-half of this
network.
(8) Operated by GTECH Brasil Holdings, S.A., a Brazilian company in which
we own all voting stock. The term of our contract runs until May 2005,
with Caixa Economica Federal, the operator of the National Lottery,
having the right to elect upon prior notice to terminate the contract
as early as December 2004. See "Item 3, "Legal Proceedings" and Note 13
to Notes to Consolidated Financial Statements below.
(9) Our contract with the Colombia lottery authority is not a true
facilities management contract in that title to the equipment vests in
the Colombia lottery authority at the end of the term.
(10) Our contract with the Ireland lottery authority may be extended for any
period mutually acceptable to us and the Ireland lottery authority.
(11) The Luxembourg lottery authority can extend the software license
granted by us for up to 10 years after the end of the initial term and
any extensions of the contract.
(12) Our contract with the Mexico lottery authority is not a true facilities
management contract. Title to all equipment, which initially had been
supplied under lease, has passed to the lottery authority pursuant to
the terms of our agreement. We provide maintenance and other services,
if requested by the lottery authority. In February 2004, the Mexico
lottery authority selected the Company, after a competitive
procurement, as the apparent successful vendor to provide equipment and
services for a new online lottery system under a proposed six-year
contract. In late April 2004, we were notified that this award has been
revoked. This revocation follows a ruling by the Mexican Comptroller
Ministry on a protest filed by unsuccessful competitors that declared
our bid non-compliant and disqualified us from the competitive
procurement. The Mexican lottery authority subsequently announced that
it has disqualified the sole remaining bidder as also being
non-compliant and has formally ended the procurement. We intend to
pursue all appropriate avenues to contest the Comptroller's decision.
(13) Operated by Uthingo consortium, in which we are a 10 percent equity
owner.
(14) We are in the process of negotiating a one-year extension of our
contract with this lottery authority.
(15) The lottery system that we are implementing for the Mahapola Higher
Education Scholarship Trust Fund ("Mahapola") under the contract that
we entered into during fiscal 2004 is scheduled to become operational
in September 2004, although lawsuits filed by competitors challenging
the award have delayed and may prevent implementation of this lottery
system. See "Significant Developments Since the Start of Fiscal 2004,"
above. Our contract with Mahapola runs from the tenth anniversary of
the first date on which lottery tickets are processed or September
2014, whichever is earlier.
(16) Lottery Technology Services Corporation ("LTSC"), a consortium in which
we own a 44% indirect interest, entered into a Commission Agreement
with the Bank of Taipei to operate the Taiwan Public Welfare Lottery.
ACER, Inc. indirectly owns the other 56% of LTSC. We supply terminals
to LTSC and provide to LTSC central system maintenance, software
support and consulting services pursuant to service and supply
agreements.
(17) The term of the contract with the Turkey lottery authority renews for
successive one-year extension terms unless either party gives timely
notice of non-renewal. In addition, the Turkey lottery authority has
the option to assume responsibility for the provision of certain
lottery services at any time after the second anniversary of system
start-up.
(18) Operated by Camelot Group plc, a consortium, on a facilities management
basis.
PRODUCT SALES CONTRACTS. Under Product Sale Contracts, we construct, sell,
deliver and install turnkey lottery systems or lottery equipment and license the
computer software for a fixed price, and the lottery authority subsequently
operates the lottery system. We also sell additional terminals and central
computers to expand existing systems and/or replace existing equipment under
Product Sales Contracts.
In connection with our Product Sales Contracts, we generally design the lottery
system, train the lottery authority's personnel and provide other services
required to make and
keep the system operational. We also generally license our software to our
customers for a fixed additional fee.
Historically, product sales revenues have been derived from the installation of
new online lottery systems, installation of new software and the sales of
lottery terminals and equipment in connection with the expansion of existing
lottery systems. The size and timing of these transactions at times has resulted
in variability in product sales revenues from quarter to quarter. See Item 7,
"Management's Discussion and Analysis of Financial Condition and Results of
Operations."
The table below lists certain of our direct and indirect customers that since
March 1, 1999 have purchased (or have agreed to purchase) from us new online or
video lottery systems, software and/or terminals and equipment in connection
with the expansion of existing lottery systems.
Argentina --Boldt IPLC
Australia --Lotteries Commission of New South Wales
Australia --Lotteries Commission of South Australia
Australia --Western Australia Lotteries Commission
Belgium --Loterie Nationale de Belgique
Canada --British Columbia Lottery Corporation
--Western Canada Lottery Corporation
China --Beijing Welfare Lottery Center
France --La Francaise des Jeux
Germany --WestLotto
--Sachsische Lotto - Gmbh
Israel --Mifal Hapayis
Luxembourg --Loterie Nationale
Massachusetts --Massachusetts State Lottery Commission
Netherlands --Stichting de Nationale Sport Totalisator
Poland --Totalizator Sportowy Sp. Zo.o
Portugal --Santa Casa de Misericordia de Lisboa
Singapore --Singapore Pools (Pte) Ltd.
South Africa --Uthingo
Spain --Sistemas Tecnicos de Loterias del Estado
--Organizacion Nacional de Ciegos Espanoles
Sweden --AB Svenska Spel
Switzerland --Loterie de la Suisse Romande
Taiwan --Lottery Technology Services Corporation
United Kingdom --The National Lottery
Virginia --Virginia Lottery
INSTANT TICKET VENDING MACHINE LOTTERY CONTRACTS
OVERVIEW: As described above, during fiscal 2004 we completed the acquisition of
Interlott Technologies, Inc. ("Interlott"), a leading provider of instant ticket
vending machines ("ITVMs") for the lottery industry worldwide. Like GTECH,
Interlott generally conducts business under one of two types of contractual
arrangements which are described in more detail below: Facilities Management
Contracts and Product Sales Contracts.
FACILITIES MANAGEMENT CONTRACTS: Under a typical Facilities Management Contract
with a lottery authority, Interlott builds to specification, installs, and
services ITVMs for an initial term which typically is four years. These
contracts usually contain options permitting the relevant lottery authority to
extend the contract under the same terms and conditions for additional periods,
generally ranging from one to three years. In addition, Interlott's customers
occasionally renegotiate extensions on different terms and conditions.
Historically, the majority of Interlott's Facilities Management Contracts have
been based on a compensation structure involving fixed monthly lease payments
paid directly by the lottery authorities. However, recent Interlott Facilities
Management Contracts feature a compensation structure based upon a negotiated
percentage of the ITVM instant tickets sales revenues. Under Interlott's
Facilities Management Contracts, Interlott retains title to the ITVMs, while
providing its customers with necessary support services. In most jurisdictions
Interlott employs a dedicated work force, consisting of a Regional Service
Manager, marketing personnel, and customer service representatives who help
service and maintain most aspects of the ITVM program.
PRODUCT SALES CONTRACTS: Under a typical Product Sales Contract, for a fixed
price Interlott constructs, sells, delivers and installs a turnkey ITVM system
that the lottery jurisdiction subsequently operates.
The table below sets forth the lottery authorities with which Interlott
currently has Facilities Management Contracts ("FMCs"). This table also provides
(except where noted by footnote) historical information respecting the number of
ITVMs that are currently in service that were sold by Interlott prior to the
completion of our acquisition of Interlott under its various Product Sales
Contracts ("PSCs"). The table also sets forth information regarding the term of
each FMC, as well as the approximate number of ITVMs installed in each FMC
jurisdiction as of the date hereof.
DATE OF
FMC APPROXIMATE DATE OF EXPIRATION OF CURRENT
OR NUMBER OF COMMENCEMENT OF CURRENT EXTENSION
JURISDICTION PSC ITVMS IN SERVICE CURRENT CONTRACT CONTRACT TERM OPTIONS
- ------------ --- ---------------- ---------------- ------------- ----------
Arizona FMC 325 7/03 7/05 3 one-year
California PSC 4,190
Colorado FMC 530 7/00 10/04 --
D.C. FMC 90 12/01 12/04 1 one-year
Idaho PSC 170
Illinois FMC 2,730(2) 6/97(2) (2) (2)
Indiana FMC 685 1/01 12/04 --
Iowa FMC 430 1/01 12/04 2 one-year
Kentucky FMC 530 8/99 8/04 --
Maine FMC 165 7/99 7/04 --
Maryland FMC 955 2/00 2/05 --
Massachusetts PSC 1,575
Minnesota FMC 15 12/01 11/04 2 one-year
Missouri FMC 630 6/01 6/04 4 one-year
New Hampshire FMC 220 7/00 6/05 --
New Jersey(1) 210
New Mexico FMC 160 5/97 5/04 3 one-year
New York FMC 4,380 5/02 5/05 2 one-year
Ohio FMC 1,500 7/03 6/05 2 two-year
Oregon PSC 520
Pennsylvania PSC 3,050(3)
Rhode Island(1) 100
Texas FMC 1,200 10/03 10/06 2 one-year
Virginia PSC 1,650
Washington FMC 1,010 12/98(4) 11/04(4) --
West Virginia PSC 110
Wisconsin(1) 500
- -------------
(1) Represents ITVMs installed under a GTECH Facilities Management Contract. See
Facilities Management Contracts table above for additional information.
- -------------------
(2) The contract term with the Illinois lottery authority runs in tranches,
based upon the corresponding dates of installation for ITVMs. Upon expiration of
their respective contract terms, ITVMs may be purchased by the lottery
authority, with post-purchase service to be provided by our Interlott business
unit under a service contract. Installed ITVM base includes both ITVMs that are
leased to, and ITVMs that are owned by, the lottery authority. The contract term
with regards to the last tranche of ITVMs installed in Illinois expires in
August 2008. In March 2004, after the close of fiscal 2004, we received notice
that, following a competitive procurement, the Illinois lottery authority
intends to award us a five-year contract to provide up to 2,000 ITVMs. This
award is subject to the successful completion of negotiations with the Illinois
lottery authority.
(3) Of this number, 650 ITVMs were purchased by a company providing facilities
management services to the Pennsylvania lottery authority after the completion
of our acquisition of Interlott in fiscal 2004.
(4) In March 2004, after the close of fiscal 2004, we received notice that we
were named by the Washington lottery authority, following a competitive
procurement, as the approved successful bidder to receive a three-year contract
to provide the Washington lottery authority with up to 1,000 ITVMs. This award
is subject to the successful completion of negotiations with the Washington
lottery authority.
CONTRACT AWARD PROCESS
In the United States, lottery authorities generally commence the contract award
process by issuing a request inviting proposals from various lottery vendors.
The request for proposals usually indicates certain requirements specific to the
jurisdiction, such as the number of terminals and breadth of services desired,
the particular games which will be required, particular pricing mechanisms, the
experience required of the vendor and the amount of any performance bonds that
must be furnished. After the bids have been evaluated and a particular vendor's
bid has been accepted, the lottery authority and the vendor generally negotiate
a contract in more detailed terms. Once the contract has been finalized, the
vendor begins to install the lottery system.
Our marketing efforts for our lottery products and services frequently involve
top management in addition to our professional marketing staff. These efforts
consist primarily of marketing presentations to the lottery authorities of
jurisdictions in which requests for proposals have been issued.
Marketing of our lottery products and services to lottery authorities outside of
the United States is often performed in conjunction with licensees and
consultants with whom we contract for representation in specific market areas.
Although generally neither a condition of their contracts with us nor a
condition of their contracts with lottery authorities, such licensees and
consultants often agree with us to provide on-site services after installation
of the online lottery system.
After the expiration of the initial or extended contract term, a lottery
authority in the United States generally may either seek to negotiate further
extensions or commence a new competitive bidding process. Internationally,
lottery authorities do not typically utilize as formal a bidding process, but
rather negotiate proposals with one or more potential vendors.
From time to time, there are challenges or other proceedings relating to the
awarding of lottery contracts.
ONLINE PRODUCTS AND SERVICES
A significant portion 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 periodically is the subject of competitive
procurement or renegotiation. Our lottery operations are dependent upon our
continued ability to retain and extend our existing contracts and win new
contracts.
Our lottery systems consist of lottery terminals, central computer systems,
systems and communications software and game software, and communications
equipment which connects the terminals and the central computer systems. The
systems' terminals are typically located in high-traffic retail outlets, such as
newsstands, convenience stores, food stores, tobacco shops and liquor stores.
Our online lottery systems control and perform the following functions: entry of
wagers using a terminal's keyboard or a fully-integrated optical mark
recognition reader; automatic auditing of each wager for correctness by the
originating terminal; encryption and transmission of the wager and related data
to the central computer installation(s); processing of each wager by the central
computers, including entry of the wager on redundant systems; transmission of
authorization for the originating terminal to accept the wager and print a
receipt or ticket, winning ticket identification and validation; and
administrative functions, including determination of prize pools and generation
of management information reports.
The basic functions of our systems, which are listed above, as well as various
optional or custom-designed functions, are performed under internal controls
designed for maximum security and minimum processing time. Security is provided
through an integrated system of techniques, procedures and controls supported by
hardware, software and human resources. Individual systems generally have
redundant capacity at multiple levels and sophisticated software to ensure
continuous service to the customer.
TERMINALS
We design, manufacture and provide the point-of-sale terminals used in our
online lottery systems. Our model GT-101TF terminals, introduced in 1985, and
our model GT-401/OI terminals, introduced in 1989, are installed in numerous
jurisdictions. Our Spectra(R) terminal series (GT-401/0M, 402/0M and 403/OM),
first introduced in 1989, is distinguished by its modular internal and external
architecture.
Our ISYS terminal series (GT-501, 502 and 503), introduced during fiscal 1996,
is an integral, single-unit terminal which features modular subassemblies, high
performance ticket printer and playslip reader subassemblies, an easy-to-use
design, and a host of new features and technologies.
During fiscal 1999, we announced the introduction of the PlayerExpress(TM)
terminal, which was designed specifically for large retail environments, such as
grocery stores, with numerous checkout lanes.
During fiscal 1999, we also announced the launch of our Altura family of
terminals. Altura, which represents the initial offering of our ninth generation
of online lottery terminal, permits applications to be written in the Java
programming language, enabling the rapid development of a wide variety of games
that are compatible with numerous software environments. We have supplied Altura
terminals to a number of our customers.
The Altura LVT and Altura SST terminals are the newest additions to our Altura
family of terminals. The Altura LVT, which features a compact platform, touch
screen interface and expandable configuration, is designed to meet the needs of
retailers with low volumes of transactions. The Altura SST, a self-service
terminal, combines the functionality of instant ticket vending machines
("ITVMs") with the capability of selling online lottery products through a touch
screen interface.
During fiscal 2004, we expanded our self-service terminal offerings with the
completion of our acquisition of Interlott Technologies, Inc. ("Interlott"), a
leading provider of ITVMs for the worldwide lottery industry. Interlott's EDS-Q
family of ITVMs offers flexibility and expandability (from a four to 24 game
capacity) as well as the industry's first transaction processing connectivity to
in-store lottery terminals and lottery authority central systems. We recently
accepted our first order for a hybrid self-service product that we have
developed which we believe will combine the functionality of the ITVM and Altura
SST, enabling the sale of both instant tickets and online games.
During fiscal 2004, we entered into an agreement to acquire Spielo
Manufacturing, Incorporated ("Spielo"), a leading provider of video lottery
terminals and related products and services to the global gaming industry. In
April 2004 (after the close of fiscal 2004) we completed the acquisition of
Spielo. We believe that this acquisition will further expand our terminal
offerings. The Spielo family of terminals includes the Aura,(TM) a video lottery
terminal that features a high-resolution 18" flat screen color monitor, 16-bit
digital stereo sound, ergonomic design and powerful processor, and the Power
Station 5,(TM) a video lottery terminal that is designed to meet the needs of
bar and restaurant venues.
We are not dependent upon the use of our proprietary terminals and have the
ability to integrate into our online lottery systems qualified third party
terminals.
SOFTWARE. We design and provide, or license from third parties, all applications
solutions for our lottery systems. Our highly sophisticated and specialized
software is designed to provide the following system characteristics: rapid
processing, storage and retrieval of transaction data in high volumes and in
multiple applications; the ability to down-line load (i.e., to reprogram the
lottery terminals from the central computer installation via the communications
system to add new games); a high degree of security and redundancy to guard
against unauthorized access and tampering and to ensure continued operations
without data loss; and a comprehensive management information and control
system. Our ProSys(R) software system is based on client server architecture and
provides open interfaces which allow for the integration and support of
third-party and commercial modules and applications.
Our latest generation software system, the Enterprise Series(TM), is a unique,
fully-open architecture that we believe provides a new industry standard for the
development, deployment, integration and support of next-generation online
lottery solutions, including those which permit sales of lottery products via a
secure infrastructure over the Internet, without compromising the integrity of
the games. The open system architecture of the Enterprise Series(TM) allows
lotteries the flexibility to continuously upgrade their lottery systems, and
integrate a broad spectrum of third party hardware and software solutions to
achieve greater performance. In March 2003 we announced the launch of a
certification process whereby third party technology vendors can be approved for
integration with the Enterprise Series
platform. Under our Enterprise Series certification process we have certified 4
third party vendors and 3 third party vendors are pending review.
CENTRAL COMPUTERS. Each of our lottery systems contains one or more central
computer sites to which the lottery terminals are connected. Our central
computer systems are manufactured by Hewlett-Packard Company, Stratus Computer,
Inc. and IBM Corporation. The specifications for the configuration of our
central computer installations are designed to provide continuous availability,
a high throughput rate and maximum security. Central computer installations
typically include: redundant mainframe computers, various peripheral devices
(such as magnetic storage devices, management terminals and hard copy printers),
and various safety, environmental control and security subsystems (including
back-up power suppliers), which are all manufactured by third parties, and a
microcomputer-based communication and switching subsystem. In addition, we
supply management information systems that provide lottery personnel access to
important financial and operational data without compromising the security of
the online system. Based upon our development of our Enterprise Series(TM), we
will be able to integrate qualified third party software applications.
COMMUNICATIONS. Our lottery terminals are typically connected to the central
computer installations by dedicated telephone lines owned or leased by the
jurisdiction in which the system is located. Due to the varying nature of
telecommunications services available in lottery jurisdictions, we have
developed the capability to utilize and interface with a wide range of
communications technologies to provide a data communications pathway between the
lottery terminals and the central computers, including UHF Radio capability
(narrow-band and Spread Spectrum), GSAT/VSAT, Microwave, Integrated Services
Digital Networking (ISDN), Data Over Voice (DOV), fiber optic and cellular
telephone.
According to industry sources that we regard as reliable, we are the largest
global provider of wireless point-of-sale devices.
GAMES. An important factor in maintaining and increasing public interest in
lottery games is innovation in game design that aims to catch the eye and
interest of potential players. In conjunction with lottery authorities, we
utilize principles of demographics, sociology, psychology, mathematics and
computer technology to design customized lottery games which are intended to
appeal to the populations served by our lottery systems. The principal
characteristics of game design include: frequency of drawing, size of pool, cost
per play and setting of appropriate odds. We believe that our expertise in game
design has enhanced the marketing of our lottery systems and has contributed to
increases in the revenues of some of our customers.
Keno(TM), an online game which we, together with the Lotteries Commission of
South Australia, first introduced in 1990, exemplifies how innovative lottery
games can help our lottery customers maintain or increase public interest in
lottery games and thereby generate additional revenues. Keno(TM), features
online drawings as often as every four minutes and is currently offered by 20 of
our customers.
We currently have a substantial number of variations of lottery games in our
software library and new games under development. We believe that this game
library and the "know how" and experience accumulated by our professionals since
our inception make it possible for us to meet the requirements of our customers
for specifically tailored games on a timely and comprehensive basis.
In March 2004, after the close of fiscal 2004, we announced that we had entered
into agreements with Hasbro Properties Group, the intellectual property
development arm of Hasbro, Inc. ("Hasbro"), and New Vision Gaming, a company
with extensive casino game development experience ("New Vision"), that we
believe will further strengthen our lottery game content library. Under the
Hasbro agreement, Hasbro grants to us a license to develop and distribute select
lottery products featuring Hasbro's Monopoly(TM) and Battleship(TM) brands in
the United States, Canada and Mexico, while our agreement with New Vision
permits us to offer on an exclusive basis two of New Vision's flagship games
through a variety of lottery distribution channels.
MARKETING. In United States jurisdictions in which we have been awarded a
lottery contract, we are frequently asked to assist the lottery authority in the
marketing of lottery games to the public. Such assistance generally includes
advice with respect to game design, and promotion and development and
distribution of terminals and advertising programs. As part of such assistance,
we developed "GMark," a computerized marketing analysis system used to determine
favorable locations for new lottery terminals. The lottery authorities of
California, Florida, Georgia, Illinois, Kansas, Missouri, New York, Ohio, Rhode
Island, Texas and Washington currently utilize GMark systems, and many customers
contact the Market Research Group from time to time to obtain GMark services.
WARRANTY. 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 ninety
days) from the date revenue is recognized or from the date a product is
delivered and tested. We estimate product warranty costs 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.
NON-LOTTERY COMMERCIAL SERVICES
While transaction processing services for the online lottery industry remains
our core service offering, we have in recent years undertaken to capitalize on
the investments that we have made in secure, high-volume transaction processing
technology through development of additional applications, such as financial or
retail transaction processing. During fiscal 2004, revenues from non-lottery
commercial services accounted for approximately 7% of our consolidated revenues.
In May 2000, we signed a contract with Caixa Economica Federal, the operator of
Brazil's National Lottery, to include additional financial transaction services
(including bill and tax payment, social security contribution and traditional
banking transaction services) over our dedicated network infrastructure. We are
party to agreements with more than 700 retailers in Chile to provide electronic
bill payment services at retail outlets throughout the country. See Item 3,
"Legal Proceedings - Brazilian Legal Proceedings," below.
During fiscal 2003, we entered into an agreement with Supreme Ventures Limited,
a licensee operating certain online games in Jamaica, and Mossel Jamaica
Limited, a cellular telephone service provider in Jamaica ("Digicel") to provide
Digicel with a non-exclusive distribution network for the electronic sale of
personal identification numbers for cellular phone usage in Jamaica, thus
providing customers in Jamaica with the ability to place cellular telephone
calls using purchased minutes. During fiscal 2004, we acquired a controlling
equity position in PolCard S.A., a leading debit and credit card merchant
transaction acquirer and processor in Poland, and were awarded a two-year
contract extension by the Idaho Department of Fish and Game to continue to
provide products and services to operate Idaho's fish and game licensing system
through December 31, 2006. See "Significant Developments Since the Start of
Fiscal 2004" above.
PRODUCT DEVELOPMENT
We devote substantial resources in order to enhance our present products and
systems and develop new products. In fiscal 2004, we spent approximately $57.3
million on research and development, as compared to $42.9 million in fiscal
2003, and $33.8 million in fiscal 2002.
INTELLECTUAL PROPERTY
Historically, we generally have not sought to obtain patents on our products,
believing that our technical "know-how," trade secrets and the creative skills
of our personnel would be of substantially more importance to our success than
the benefit which patent protection ordinarily would afford. As we continue to
advance the development of new technological solutions, we have decided to
pursue comprehensive intellectual property protection, including patents where
appropriate, for these solutions. We are currently pursuing protection of some
of our newest advances in technology and gaming, including our Enterprise
Series(TM), a unique, fully-open, integrated solution which includes the ability
to distribute lottery games via a secure infrastructure over the Internet,
without compromising the integrity of the games. We have obtained patent
protection in certain of our key business methods in the areas of infrastructure
systems, terminal improvements and creative game design. These use-related
patents will provide legal protection in the U.S. for the next 18 to 20 years.
PRODUCTION, ASSEMBLY AND COMPONENTS
We purchase most of the parts, components and subassemblies necessary for our
terminals and other products from outside sources. We assemble these parts,
components and subassemblies into finished products in our manufacturing
facility where we also conduct all of our quality testing. We offer central
systems manufactured by Hewlett-Packard Company, Stratus Computer, Inc. and IBM
Corporation for our lottery systems. We do not manufacture any central system
components. We have approximately three material sole source vendors. The loss
of any of those vendors might result in material additional costs and/or
manufacturing delays.
BACKLOG
The backlog of our orders for sales of our products, which are supported by
signed contracts with our customers and which are believed by us to be firm,
amounted to approximately $166.7 million as of
February 28, 2004, as compared to a backlog of approximately $141.2 million as
of February 22, 2003. The increase in the backlog is due to a higher level of
product sales expected to be consummated in fiscal year 2005. Approximately
$112.8 million, or 67.7% of the backlog at February 28, 2004, is expected to be
filled during fiscal 2005.
COMPETITION
The online lottery industry has faced increased competition in recent years for
the consumers' entertainment dollar, including from a proliferation of
destination gaming venues, and an increased availability of Internet gaming
opportunities. In addition, in recent years, there has been increased
competition among domestic and international participants in the online lottery
industry. The online lottery business is highly competitive in the United States
and internationally. Both in the United States and internationally, price is an
increasingly important, but usually not the sole, criterion for selection. Other
significant factors that influence the award of lottery contracts are: the
ability to optimize lottery revenues through technical capability and
applications knowledge; the quality, dependability and upgrade capability of the
system; the marketing and gaming experience, financial condition and reputation
of the vendor; and the satisfaction of other requirements and qualifications
that the lottery authority may impose.
During fiscal 2004, our principal competitors in the online lottery business
(and the number of online lottery jurisdictions currently serviced or under
contract worldwide by such competitors) were as follows: Scientific Games
Corporation (including the business formerly known as Automated Wagering
International, Inc., and IGT Online Entertainment Systems, Inc.) (32); Essnet
(11); and Intralot S.A. (5).
PERSONNEL
As of April 1, 2004, we had approximately 4,900 full-time employees worldwide.
The vast majority of our domestic employees is not represented by any labor
union. We believe that our relationship with our employees is satisfactory.
ITEM 2. PROPERTIES
Our world headquarters and research and development and main production facility
are located in our approximately 260,000 square foot building on approximately
26 acres in West Greenwich, Rhode Island, which we lease from West Greenwich
Technology Associates, L.P. We are a limited partner in, and own 50% of, this
partnership. As amended during fiscal 2002, our lease term runs until January 1,
2007 and we have an option to purchase the remaining 50% interest in West
Greenwich Technology Associates, L.P. on or before the termination of the lease
term. We own approximately 24 acres adjoining our headquarters in West
Greenwich, Rhode Island. In May 2003, we entered into a master contract with the
Rhode Island Lottery that, among other matters, relates to the development of a
new world headquarters facility containing at least 210,000 square feet in
Providence, Rhode Island by December 31, 2006. See Note 8 to Notes to
Consolidated Financial Statements for further information respecting the planned
relocation of our World Headquarters to Providence, Rhode Island, and certain
related matters.
We also own an approximately 140,000 square foot manufacturing and central
storage facility in Coventry, Rhode Island.
In addition, except in New York State, where we own our back-up data center
facility, we lease, or are supplied by the relevant state authorities with, our
data center facilities in the various jurisdictions. We also lease office, depot
maintenance and warehouse space in a number of other locations.
Our facilities are in good condition and are adequate for our present needs.
ITEM 3. LEGAL PROCEEDINGS
BRAZILIAN LEGAL PROCEEDINGS
THE CEF CONTRACT PROCEEDINGS
BACKGROUND. In September 1993, we purchased 41.5% of the voting common and
non-voting preferred stock of Racimec Informatica Brasileira S.A. ("Racimec"), a
Brazilian company engaged in the lottery business and the predecessor of our
present Brazilian subsidiary, GTECH Brasil Ltda. In January 1996, we purchased
the remaining voting common stock, and 37.7% of the non-voting preferred stock,
of Racimec. Subsequent to January 1996, Racimec's accounts were consolidated
with our own. In December 1997, we purchased the remaining non-voting preferred
stock of Racimec. Racimec was reorganized in December 1998, and was eventually
renamed GTECH Brasil Ltda. ("GTECH Brazil").
In January 1997, Caixa Economica Federal ("CEF"), the Brazilian bank and
operator of Brazil's National Lottery, and Racimec entered into a four-year
contract pursuant to which Racimec agreed to provide online lottery services and
technology to CEF (the "1997 Contract"). This award was made by CEF with respect
to a competitive bid that CEF had issued in 1994. Online lottery sales by
Brazil's National Lottery commenced in May 1997.
In May 2000, CEF and GTECH Brazil terminated the 1997 Contract and entered into
a new agreement obliging GTECH Brazil to provide lottery goods and services and
additional financial transaction services (including bill and tax payment,
social security contribution and traditional banking transaction services) to
CEF for a contract term that, as subsequently extended, was scheduled to expire
in April 2003 (the "2000 Contract"). In April 2003, GTECH Brazil entered into an
agreement with CEF (the "2003 Contract Extension") pursuant to which: (a) the
term of the 2000 Contract was extended through May 2005, with CEF having the
right to elect upon prior notice to terminate the 2000 Contract early at any
time after December 2004, and (b) fees payable to GTECH Brazil under the 2000
Contract were reduced by 15%.
As part of sworn testimony before the Brazilian Congress, in April 2004 CEF's
President indicated that it is his intent to enter into negotiations with GTECH
Brazil to accommodate an as-of-yet undisclosed procurement process, pursuant to
which he would seek to negotiate certain concessions from GTECH Brazil relating
to pending court actions respecting CEF procurement matters, and CEF would agree
to extend the 2000 Contract beyond its current term. See -- "CEF Procurement,"
below. In addition, CEF and GTECH Brazil continue to work closely. For example,
CEF recently notified us that GTECH Brazil has been pre-qualified for an
upcoming bid to provide services and equipment for the Caixa Aqui, a
correspondent banking system comprised of free-standing kiosks operated by CEF.
GTECH Brazil and pre-qualified companies have been invited to present proposals
to CEF regarding the expansion of the service offering and network territory of
Caixa Aqui.
Revenues from the 2000 Contract accounted for approximately 9.7% of our total
revenues for fiscal 2004, making CEF our largest customer for fiscal 2004 based
on revenues.
CRIMINAL ALLEGATIONS AGAINST CERTAIN EMPLOYEES. In late March 2004, federal
attorneys with Brazil's Public Ministry (the "Public Ministry Attorneys")
recommended that criminal charges be brought against nine individuals, including
four senior officers of CEF; Antonio Carlos Rocha, the former Senior Vice
President of GTECH Holdings Corporation and President of GTECH Brazil; and
Marcelo Rovai, GTECH Brazil's marketing director. No other present or former
employee of the Company has been implicated by the Public Ministry Attorneys,
and under Brazilian law (which provides that criminal charges may not be brought
against corporations and other entities), we cannot be subject to criminal
charges in connection with this matter. We understand that Messrs. Rocha and
Rovai will likely be charged with offering an improper inducement in connection
with the negotiation of the 2003 Contract Extension. We further understand that
Messrs. Rocha and Rovai will likely be charged with effectively co-authoring or
aiding and abetting certain allegedly fraudulent or inappropriate management
practices of the CEF management who agreed to enter into the 2003 Contract
Extension. An investigation is being conducted on our behalf to ascertain the
facts regarding this matter. The Company has encouraged Messrs. Rocha and Rovai
to cooperate fully with the Brazilian authorities investigating this matter. In
addition, the United States Securities and Exchange Commission has made an
informal inquiry as to this matter, and we are cooperating fully with this
inquiry. Brazilian news accounts have quoted CEF's President as denying that
there had been any external pressure applied in connection with the negotiation
of the 2003 CEF Contract Extension.
In light of the fact that our reputation for integrity is an important factor in
our business dealings with lottery and other governmental agencies, an
allegation or finding of improper conduct that is attributable to us could have
a material adverse effect on