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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 26, 2005
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
=====================
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:
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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 28, 2004 was approximately $2.6
billion.
On April 15, 2005, there were 114,911,459 outstanding shares of the registrant's
Common Stock.
DOCUMENTS INCORPORATED BY REFERENCE
Document Location in Form 10-K
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Portions of Registrant's Proxy Statement
For its 2005 Annual Meeting of Shareholders Part III
================================================================================
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GTECH HOLDINGS CORPORATION
FORM 10-K
FOR THE FISCAL YEAR ENDED FEBRUARY 26, 2005
INDEX
Page
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PART I
Item 1. Business 4
Item 2. Properties 40
Item 3. Legal Proceedings 41
Item 4. Submission of Matters to a Vote of Security Holders 48
Additional Information - Executive Officers 48
PART II
Item 5. Market For Registrant's Common Equity, Related Stockholder
Matters and Issuer Purchases of Equity Securities 51
Item 6. Selected Financial Data 53
Item 7. Management's Discussion and Analysis of Financial
Condition and Results of Operations 54
Item 7A. Quantitative and Qualitative Disclosures About Market Risk 83
Page
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Item 8. Financial Statements and Supplementary Data 84
Item 9. Changes in and Disagreements with Accountants on
Accounting and Financial Disclosures 150
Item 9A. Controls and Procedures 151
Item 9B. Other Information 153
PART III
Item 10. Directors and Executive Officers of the Registrant 154
Item 11. Executive Compensation 154
Item 12. Security Ownership of Certain Beneficial Owners and
Management and Related Stockholder Matters 154
Item 13. Certain Relationships and Related Transactions 154
Item 14. Principal Accountant Fees and Services 154
PART IV
Item 15. Exhibits and Financial Statement Schedules 155
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 leading provider of gaming and technology solutions worldwide with over
$1.25 billion in revenues and more than 5,300 employees on six continents. We
leverage our global lottery experience and capabilities to offer a full range of
game content and solutions and financial transaction processing services.
We are the world's leading operator of highly-secure online lottery transaction
processing systems, doing business in 53 countries worldwide, and we have a
growing presence in commercial gaming technology and financial 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, 26 of the 41 online lottery authorities
in the United States, and 65 of the 121 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 to seven 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, Latin America
and Asia, 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. For example, during
fiscal 2005, we expanded our lottery game offerings by entering into licensing
agreements with Hasbro Properties, Inc. (granting us rights to develop and
distribute select lottery products featuring Hasbro Inc.'s Monopoly(R) and
Battleship(R) brands), and New Vision Gaming (granting us exclusive rights to
offer the flagship games Players Choice(R) and Worldwide Poker(R)). During
fiscal 2005, we also developed and introduced HotTrax,(R) an exciting new
lottery monitor game that creates the illusion of an auto race that is taking
place in three dimensions; received an award, following a competitive
procurement, from the Multi-State Lottery Association to support the development
of the first ever system that permits the sale of video lottery products across
jurisdictions and over equipment supplied by numerous vendors; and announced the
development of GamePoint,(TM), our lottery vending machine that permits the sale
both of online and instant tickets.
Other indicative online products and services introduced in recent years 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, 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 2005, we completed the
acquisition of Spielo Manufacturing, Inc. ("Spielo"), a leading provider of
video lottery terminals and related products and services to the global gaming
industry. See "Significant Developments Since The Start of Fiscal 2005", 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 transaction
processing services outside of our core market of providing online lottery
services into the gaming
technology and financial services markets. During fiscal 2005, we entered into
an agreement with the owners of the privately-held Gauselmann Group
("Gauselmann") to acquire a 50 percent controlling equity interest in the
Atronic group of companies ("Atronic") owned by Gauselmann. Atronic, the leading
video slot provider in Europe, Russia and Latin America, has a growing presence
in the United States and is licensed in 196 worldwide gaming jurisdictions.
Subject to obtaining required regulatory and gaming license approvals and the
satisfaction of other closing conditions, we expect that the closing of this
acquisition will take place in December 2006. In addition, during fiscal 2005,
our majority-owned commercial services subsidiary, PolCard S.A., completed the
acquisition of BillBird S.A., the leading provider of electronic bill payment
services in Poland. See "Significant Developments Since The Start of Fiscal
2005", 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 INFORMATION
Certain statements contained or incorporated by reference in this report are
forward-looking statements within the meaning of the United States Private
Litigation Reform Act of 1995. We identify forward-looking statements by words
such as "may", "will", "should", "could", "expect", "plan", "anticipate",
"intend", "believe", "estimate", "continue", "project" or similar terms that
refer to the future. 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 (including, without
limitation, expected future growth in revenues, profit margins and
earnings per share);
- our ability to secure and protect trademarks and other intellectual
property rights;
- our ability to retain existing contracts and to obtain and retain
new contracts;
- competition in the online lottery industry and other businesses in
which we are engaged or may engage and the impact of competition on
our revenues and profitability;
- our ability to realize the anticipated benefits of our acquisitions;
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 14 to Notes to Consolidated Financial Statements,
below, for a discussion of a civil action initiated by federal attorneys with
Brazil's Public Ministry against GTECH Brasil Ltda., our Brazilian subsidiary,
("GTECH Brazil"), and two of our former employees, among others; a criminal
action recommended by federal attorneys with Brazil's Public Ministry alleging
employee misconduct against one of our current and one of our former employees,
among others, and a related SEC investigation; and other legal proceedings
involving our contractual relationship with Caixa Economica Federal, the
Brazilian bank and operator of Brazil's National Lottery ("CEF").
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
PREVIOUSLY ANNOUNCED LEGAL PROCEEDINGS IN BRAZIL) WHICH COULD RESULT IN
SUBSTANTIAL MONETARY JUDGMENTS OR REPUTATIONAL DAMAGE.
We are presently involved in a civil action that was initiated by federal
attorneys with Brazil's Public Ministry against our subsidiary, GTECH Brazil,
and two of our former employees, among others; a criminal action recommended by
federal attorneys with Brazil's Public Ministry alleging employee misconduct by
one of our current and one of our former employees, among others, and a related
SEC investigation; and other legal proceedings involving our contractual
relationship with CEF. We refer you to Item 3, "Legal Proceedings - Brazilian
Legal Proceedings - the CEF Contract Proceedings," below for a more detailed
discussion of these matters. We are also subject to other legal proceedings
which are 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. If we are not successful in defending these
proceedings, we may also suffer 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, in the event that we are unable or unwilling to perform, 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.
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 moderated 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.
WE DERIVE OVER HALF OF OUR REVENUES FROM FOREIGN JURISDICTIONS (INCLUDING OVER
7.4% IN FISCAL 2005 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 2005, we
derived approximately 52% of our revenues from our international operations and
approximately 7.4% of our revenues from our Brazilian operations alone
(including 7.2% of our revenues from the National Lottery of Brazil, our second
largest customer in fiscal 2005 based on annual revenues). In addition, a
substantial portion of our assets are held outside of the United States and
could be prevented by a foreign jurisdiction from leaving that country. On June
25, 2004 the judge hearing the civil action initiated by the public ministry
attorneys in the Federal Court of Brasilia against GTECH Brazil and two of our
former employees, among others, granted a procedural injunction ordering that
30% of payments due to GTECH Brazil from CEF under its current contract be
withheld and deposited into an account maintained by the court. The court also
ordered that assets of GTECH Brazil, with certain exceptions, be identified to
the court so as to prevent their transfer or disposition. We filed an appeal of
this procedural injunction, and on March 22, 2005, a panel of judges of the
Brazilian Federal Court of Appeals issued an order discontinuing the withholding
of payments due to GTECH Brazil from CEF, removing the restrictions on the
transfer or sale of our Brazilian assets, and requiring the return to us of
amounts in excess of 40 million Brazilian reals that had been held in escrow
pursuant to the procedural injunction, thereby permitting the return to us of
approximately $11 million of the approximately $26 million held in escrow as of
February 26, 2005. This order of the Brazilian Federal Court of Appeals may be
appealed by the Brazilian Public Attorneys. See Item 3, "Legal Proceedings -
Brazilian Legal
Proceedings - The CEF Contract Proceedings" for a more detailed discussion of
this matter.
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. 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 25 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 in the 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 Operations," 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 46% of our total
revenues in fiscal 2005. 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. Revenue under our contract with CEF attributable to the
National Lottery of Brazil accounted for 7.2% of our revenues in fiscal 2005. We
are currently involved in negotiations with CEF respecting the possible
extension of the term of our contract beyond its May 2005 scheduled termination
date, or the execution of a new contract with CEF for the provision of goods and
services by us after this date.
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 NET 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 0.18%, 0.50%, 0.47%, 0.14%, and 0.47% of our annual revenues in
fiscal 2005, 2004, 2003, 2002 and 2001, 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. During fiscal 2004, we acquired 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 acquirer and
processor in Poland ("PolCard"). During fiscal 2005, we acquired Spielo
Manufacturing Incorporated, 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. In September
2004, PolCard acquired privately-held BillBird S.A., a leading provider of
electronic bill payment services in Poland. Finally, in December 2004 we
announced that we had signed an agreement to acquire a 50% controlling equity
position in the Atronic group of companies ("Atronic") from the owners of the
Gauselmann Group, in a transaction which we expect to close in December 2006.
Atronic is a video slot manufacturer that is a market leader in Europe, Russia,
and Latin America, with a presence in the United States. See "Significant
Developments Since Start of Fiscal 2005" 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 and
our announced acquisition of a 50% controlling equity interest in Atronic, 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" for a discussion of a civil action initiated by
federal attorneys with Brazil's Public Ministry against GTECH Brazil and two of
our former employees, among others; a criminal action recommended by federal
attorneys with Brazil's Public Ministry alleging employee misconduct by two of
our former employees, among others, and a related SEC investigation; and other
legal proceedings involving our contractual relationship with CEF.
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 2005, commercial services
transaction processing represented approximately 7% of our total revenues and
non-lottery gaming represented approximately 6% of our total revenues. By way of
comparison, in fiscal 2003, approximately 5% of our total revenues were derived
from commercial services transaction processing, and approximately 2% of our
total revenues were derived from non-lottery gaming. With our acquisition in May
2003 of a controlling equity interest in PolCard, S.A. ("PolCard"), a leading
debit and credit card merchant transaction acquirer and processor company in
Poland; our acquisition in September 2004 by PolCard of BillBird S.A., a leading
provider of electronic bill payment services in Poland; and our December 2004
agreement to acquire a 50% controlling equity position in Atronic, a video slot
manufacturer that is a market lender in Europe, Russia, and Latin America, with
a presence in the United States, 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. 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. In addition, our ability to complete the
acquisition of a 50% controlling equity interest in Atronic, and otherwise to
expand into non-lottery gaming markets, is dependent upon our success in
obtaining required non-lottery gaming licenses in numerous jurisdictions. 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 DEVELOPMENT SINCE THE START OF FISCAL 2005
LOTTERY CONTRACT AWARDS
Since the start of fiscal 2005 (which ended on February 26, 2005), we received a
number of contract awards and extensions from lottery authorities.
NEW ONLINE CUSTOMERS. During fiscal 2005, we acquired nine new online customers.
In May 2004, we acquired eight new online lottery customers upon completion of
our acquisition of 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
that we paid in cash for LILHCo was approximately $40 million. LILHCo holds
long-term licenses to operate
lotteries in Antigua and Barbuda; Anguilla; St. Kitts/Nevis; St. Maarten, Saba
and St. Eustatius; and Turks and Caicos, and operates lotteries in Barbados,
Bermuda and the U.S. Virgin Islands. In addition, LILHCo holds a video lottery
terminal ("VLT") license in Turks and Caicos, and has received confirmation that
its existing license in St. Kitts/Nevis allows for the installation of video
lottery gaming. See Item 7, "Management's Discussion and Analysis of Financial
Condition and Results of Operations."
In September 2004 the Government Lottery Office of Thailand announced that
Loxley GTECH Technology Co. Ltd. ("LGT") had been chosen, following a
competitive procurement, as the preferred bidder to provide equipment and
services for a national online lottery in Thailand. LGT is a company that we
formed in joint venture with Loxley Public Company Limited, a leading trading
and telecommunications conglomerate in Thailand. We own a 49 percent equity
interest in LGT and Loxley Public Company Limited owns the remaining 51 percent
equity interest in LGT. We will be the principal provider of technology and
services to LGT. The Thailand lottery authority and LGT remain in contract
negotiations to finalize the terms and conditions of this award.
NEW CONTRACTS WITH, AND EXTENSIONS AND ORDERS BY, EXISTING CUSTOMERS. Since the
start of fiscal 2005, we have also been awarded new contracts by, or have
received contract extensions or orders from, a number of our existing customers.
In September 2004, following a competitive procurement, we entered into a
six-year integrated services contract with Pronosticos para la Asistencia
Publica ("Pronosticos"), the Mexican lottery authority, to provide equipment and
services for a new online lottery system and an associated telecommunications
network. Under the terms of the new contract, we will replace Pronosticos's
existing lottery system with new central system hardware and add our ES
Connect(TM) software, which provides IP message routing, translation and
terminal management. We will also provide Pronosticos with approximately 4,800
Altura(R) terminals, 3,200 Altura(R) LVT Plus Terminals, and ongoing services.
Implementation of this contract has been suspended pending resolution of
administrative and legal challenges by two of our competitors to Pronosticos'
award of this contract.
In December 2004, following a competitive procurement, we entered into a
seven-year facilities management agreement with the Missouri lottery authority
to provide a new online lottery central system and ongoing services. Under the
terms of this contract, we will provide the Missouri lottery authority with our
Enterprise Series(TM) architecture, and approximately 6,000 Altura(R) terminals,
a communications network and comprehensive services. We expect sales to commence
under the Missouri lottery authority's new system in July 2005.
Several of our fiscal 2005 contract developments were in respect to product
sales. In June and July 2004, we announced that Organizaciun Nacional de Ciegos
Espanoles ("ONCE") had exercised options under its existing agreement with us to
purchase a total of 12,000 additional handheld lottery terminals. ONCE, also
known as the Spanish
National Organization for the Blind, is authorized by the Spanish government to
administer lottery and wagering games in Spain.
In November 2004, following a competitive procurement, we were selected as the
preferred bidder by Societe de la Loterie de la Suisse Romande, the Swiss
lottery authority, to provide a new integrated online and instant-ticket lottery
system, terminals, and communications network. We are currently finalizing the
terms of the product sale agreement documenting this award.
In December 2004, we entered into a product sale agreement with the German
lottery authority Lotterie-Treuhandgesellschaft mbH Thuringen ("Thuringen
Lottery") pursuant to which we will provide a new online and instant-ticket
lottery central system, and terminals. We have also agreed to provide to
Thuringen Lottery ongoing services (including central system and terminal
maintenance, retailer training and field services) as part of these
arrangements.
In December 2004 we also entered into a five year product sale agreement with
Veikkaus Oy, the operator of the Finnish national lottery, to replace the
Finnish lottery authority's existing gaming system with an integrated system
featuring our Enterprise Series(TM) architecture and Altura(R) terminals. The
new integrated system that we are providing will include an interactive gaming
solution as well as online and instant ticket lottery systems. We will provide
ongoing services to the Finnish lottery authority over the term of the
agreement. This contract award followed a competitive procurement.
In February 2005, following a competitive procurement, we were selected as the
lead bidder by the New Zealand Lotteries Commission to begin negotiations of the
terms of a product sale agreement under which we would provide the New Zealand
lottery authority with a new integrated online and instant lottery system,
including new terminals. We expect to finalize this agreement with the New
Zealand lottery authority by June 2005.
During fiscal 2005, we received several awards to provide instant-ticket vending
machines, which are also known as instant ticket dispensing machines and lottery
product vending machines ("ITVMs"), to our existing customers. In June 2004, we
entered into a three-year contract to provide the Washington State lottery
authority with ITVMs and ongoing maintenance and support services. In June 2004,
the Virginia lottery authority awarded a seven-year contract to Oberthur Gaming
Technologies Corporation ("OGT") to provide lottery goods and services to the
Virginia lottery authority commencing in June 2005. We have subcontracted with
OGT to provide to the Virginia lottery authority new ITVMs and to manage the
warehousing and distribution of instant tickets. In July 2004 we entered into a
five-year contract to provide to the Illinois lottery authority new ITVMs and
ongoing maintenance and support services. Finally, in September 2004, we entered
into a three-year contract to provide the Maine lottery authority with ITVMs.
Each of these awards followed a competitive procurement.
During fiscal 2005, the lottery authorities of Oregon, Minnesota and South
Australia and Milli Piyango and Oeuvre Nationale de Secours Grande-Duchesse
Charlotte, our lottery customers in Turkey and Luxembourg, respectively,
exercised options to extend the terms
of their online contracts with us. Moreover, the Colorado lottery authority,
which, following a competitive procurement, had selected another vendor in
October 2002 to provide equipment and services for a new lottery system to
become operational upon the termination of our online contract in October 2004,
twice exercised its right to extend our contract for a total of 180 days in
order to provide the other vendor additional time beyond the previously
established deadline to convert the system. In addition, we entered into
contract extensions with the lottery authorities of Arizona and New Mexico to
provide new products and continued services for the lotteries' ITVMs.
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 contract in March 2005.
OTHER PRODUCTS AND SERVICES
Since the start of fiscal 2005, 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 AND GAMING. In April 2004, we completed the acquisition of
privately-held Spielo Manufacturing, Inc. ("Spielo"), a leading provider of
video lottery terminals ("VLTs") and related products and services to the global
gaming industry for an all-cash purchase price of approximately $150 million. In
addition, we paid Spielo shareholders approximately $10.7 million out of a
potential maximum earn-out of up to $35 million which the former Spielo
shareholders are entitled to receive in the 18 months following the closing,
based upon Spielo achieving certain VLT installation objectives in New York, and
separately, a working capital adjustment of approximately $1.5 million. 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.
In July 2004, we signed a new integrated services contract to provide a complete
video lottery solution, including a central system, VLTs, and a communications
network, and related services to Supreme Ventures Limited in Jamaica. Under the
term of this new contract, we will provide Supreme Ventures with our Enterprise
Series(TM) video lottery central system solution, an initial installation of
approximately 125 VLTs, and such additional terminals as Supreme Ventures may
elect to order over the life of the contract. This contract is coterminous with
our existing online lottery contract with Supreme Ventures, which is scheduled
to expire in January 2011.
In October 2004, following a competitive procurement, and subject to the
negotiation and execution of a definitive product sale agreement, we were
selected by Atlantic Lottery, the Canadian lottery authority ("ALC") to replace
ALC's existing video lottery central system, currently provided by another
vendor, with our Enterprise Series(TM) video central
system. The new system will monitor the integrity and security of over 9,000
VLTs currently installed in age-controlled establishments throughout New
Brunswick, Prince Edward Island, Nova Scotia, Newfoundland and Labrador. We
continue to negotiate with the ALC the terms and conditions of the definitive
product sale agreement reflecting the ALC award.
In December 2004, we entered into an agreement with the owners of the
privately-held Gauselmann Group ("Gauselmann"), to acquire a 50 percent
controlling equity interest in the Atronic group of companies ("Atronic") owned
by Gauselmann. Atronic is a video slot manufacturer that is a market leader in
Europe, Russia and Latin America with a presence in the United States.
Completion of this transaction, which is contingent upon obtaining required
regulatory and gaming license approvals and the satisfaction of other closing
conditions, is expected to take place in December 2006. The acquisition
agreement provides that the purchase price payable by us at the closing shall be
equal to eight times Atronic's earnings before interest, tax, depreciation, and
amortization for its fiscal year ending December 31, 2006. In addition, during
the twelve months following the closing, we may be obligated to pay additional
amounts with respect to our acquisition of a 50 percent controlling interest in
Atronic if Atronic's performance during calendar 2007 exceeds specified
thresholds. The acquisition agreement also provides that we have the option to
purchase from Gauselmann and Gauselmann has the right to sell to us, its
remaining 50 percent interest in Atronic commencing in 2012, and under certain
circumstances prior to 2012. We believe that our alliance with Gauselmann will
create a strong new competitor in world gaming markets, and will, in addition,
broaden our government-sponsored game and systems offerings and strengthen our
Spielo subsidiary. We believe that the Atronic transaction represents the next
logical step for us towards achieving our long-term strategic objectives within
the gaming markets that we have targeted.
In February 2005, AB Svenska Spel, the Swedish lottery authority, agreed to
purchase from Spielo 2,000 next generation wide area VLTs to be deployed
commencing in September 2005.
During fiscal 2005, Spielo was also selected to provide the Oregon lottery
authority with approximately 2,000 PowerStation5(TM) VLTs.
COMMERCIAL SERVICES. In September 2004, our majority-owned commercial services
subsidiary, PolCard S.A., completed the acquisition of all of the shares of
privately-held BillBird S.A., the leading provider of electronic bill payment
services in Poland, for a total purchase price of approximately $6 million. This
acquisition advances our commercial services market objective of offering a full
product suite, including debit and credit transaction processing, card services,
electronic bill payments, and prepaid mobile phone top-ups.
In addition, during fiscal 2005 we commenced the sale of mobile phone top-ups
through lottery terminals in Barbados, Trinidad and Tobago and Lithuania.
Lottery terminals that
went into service during fiscal 2005 in Trinidad and Tobago permit bill payment
transactions, as well as the sale of mobile phone top-ups.
NEW PRODUCT OFFERINGS AND DEVELOPMENTS. In March 2004, we expanded our lottery
game offerings by entering into separate licensing agreements with Hasbro
Properties Group, the intellectual property arm of Hasbro, Inc. (granting us
rights to develop and distribute in the United States, Canada and Mexico, select
lottery products featuring Hasbro's Monopoly(R) and Battleship(R) brands), and
New Vision Gaming (granting us exclusive rights to offer the flagship games
Players Choice Poker(R) and Worldwide Poker.(R)) Both agreements permit the
development and distribution of the licensed games through various sales
channels in addition to traditional online and instant ticket lottery.
In May 2004, HotTrax,(R) a new three dimensional lottery game that we developed,
debuted in Rhode Island. This race-based monitor game provides players with an
opportunity to place every four or five minutes a variety of wagers on the
finishing order of racecars. In February 2005, we obtained a five-year exclusive
licensing agreement giving us the right to utilize the names, likenesses, and
signatures of premier racecar drivers in connection with our HotTrax(R) game.
In July 2004, we announced the development of GamePoint,(TM) our all-in-one
instant and online lottery terminal solution. The GamePoint terminal, which
dispenses both instant and online tickets, is completely self-contained and
provides a secure and player-friendly opportunity for the sale of instant and
online lottery products.
In September 2004, Spielo introduced new multi-denomination and low-denomination
games for its Aura(R) upright and slant top VLTs.
In December 2004, the Multi-State Lottery Association ("MUSL") selected us,
following a competitive procurement involving four other bidders, to supply
equipment, software, services and a communications network for the first ever
multi-vendor, multi-state video lottery wide area progressive solution. Our
unique and patent-pending multi-vendor concept allows VLTs from multiple vendors
to be linked in a single progressive game, and affords MUSL great flexibility in
providing players with their favorite games within a professional environment.
We anticipate that the MUSL wide area progressive solution will commence
operations in nine facilities in Rhode Island, Delaware and West Virginia. MUSL
is a non-profit, government-benefit association owned and operated by its member
lotteries and has responsibility for PowerBall(R).
LOTTERY INDUSTRY
We base statements relating to the lottery industry contained in this report 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 percent of the gross revenues of an online lottery
in the United States is returned to the public in the form of prizes.
Approximately 35 percent is used by the state to support specific public
programs or as a contribution to the state's general funds. The remaining 15
percent 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 and 2005 World Lottery Almanacs, from 1972 through
2004, total annual lottery ticket sales in the United States grew from
approximately $295.0 million to approximately $44.9 billion, although, in recent
years, as the United States lottery industry has matured, the rate of lottery
sales growth has moderated 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 cash
flow," 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, 122 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 2005, approximately 72% of our revenues were service
revenues earned under our Facilities Management Contracts; approximately 15% of
our revenues were product sales revenues earned under Product Sales Contracts;
and approximately 13% 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 to seven 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 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 26, 2005, 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 26, 2005, the approximate number of terminals installed in each
jurisdiction.
Approximate Date of Current
Number of Lottery 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 19,800 10/03 10/09 4 one-year
Colorado (2) 2,450 3/95 4/05 -
D.C. (3) 600 6/99 11/09 -
Florida 11,250 1/05 3/11 2 two-year
Georgia 8,150 9/03 9/10 -
Idaho 750 2/99 2/07 -
Illinois 7,100 4/00 10/07 1 one-year
Kansas 1,950 7/02 6/08 -
Kentucky 2,800 4/97 6/08 -
Louisiana 2,750 6/97 6/10 -
Michigan 9,250 1/98 1/09 -
Minnesota 3,150 2/03 2/11 2 one-year
Missouri 3,900 12/04 6/05 (5)
New Jersey 6,050 6/96 6/06 -
New Mexico 1,100 6/96 11/08 -
New York 15,950 3/02 3/07 3 one-year
Ohio 7,350 6/01 6/05 2 two-year
Oregon 2,750 6/98 6/08 -
Rhode Island 1,050 7/03 6/23 -
Tennessee 4,400 1/04 4/11 -
Texas 16,750 8/02 8/11 -
Washington 2,800 9/95 6/06 -
Approximate Date of Current
Number of Lottery Commencement of Date of Expiration of Extension
Jurisdiction Terminals Installed (1) Current Contract Current Contract Term Options*
- -------------- ----------------------- ---------------- --------------------- ---------
Wisconsin 3,100 6/04 6/11 2 one-year
International:
Anguilla
- -LILHCo 9 10/97 10/07 1 ten-year
Antigua/Barbuda
- -LILHCo 54 1/00 1/10 1 ten-year
Argentina
- -Loteria National Sociedad del Estado(4) 800 11/93 1/07 -
- -Boldt IPLC (4) 2,950 11/99 11/09 -
Barbados
- -T.L. Lotteries (6) 200 10/94 5/05 -
- -LILHCo (6) 103 12/01 12/11 1 ten-year
Bermuda automatic
- -LILHCo 1 - - annual renewal
Brazil
- -National
Lottery (7) 21,600 5/00 5/05 -
- -Minas Gerais 800 10/94 11/06 -
- -Santa Catarina 100 4/02 4/06 1 one-year
China
- -Beijing Welfare Lottery 1,650 4/04 12/12 -
Colombia
- -ETESA (8) 4,100 12/99 1/11 1 five-year
Czech Republic
- -SAZKA 6,900 10/92 12/17 -
Ireland
- -An Post Nat'l Lottery Company 2,050 6/02 12/08 (9)
Jamaica
- -Supreme Ventures Limited 900 11/00 01/11 1 ten-year
Luxembourg (10)
- -Loterie Nationale 350 6/01 10/12 -
Approximate Date of Current
Number of Lottery Commencement of Date of Expiration of Extension
Jurisdiction Terminals Installed (1) Current Contract Current Contract Term Options*
- -------------- ----------------------- ---------------- --------------------- ---------
Mexico
- -Pronosticos Para La Assistencia Publica 7,450 (11) (11) (11)
Morocco
- -La Societe de Gestion de la Loterie
Nationale and La Marocaine des Jeux et
Les Sports 1,400 8/99 4/09 1 one-year
Poland
- -Totalizator Sportowy 10,800 5/01 5/11 1 six-month
Puerto Rico
- -Loteria Electronica de Puerto Rico 1,850 3/99 3/05 (12)
Slovak Republic
- -TIPOS a.s. 1,500 3/96 12/11 -
South Africa (13)
- -National Lottery 7,850 7/99 4/07 1 one-year
Spain
- -L'Entitat Autonoma de Jocs I Apostes
de la Generalitat de Catalunya 2,500 4/04 10/05 (14) -
Sri Lanka
- -Mahapola Higher Education Scholarship
Trust Fund 300 6/04 6/14 1 five-year
St. Kitts/Nevis
- -LILHCo 50 4/96 4/06 1 ten-year
St. Maarten/Saba/St. Eustatius
- -LILHCo 40 1/97 1/07 1 ten-year
Taiwan
- -Taipei Bank (15) 6,800 11/01 12/06 -
Approximate Date of Current
Number of Lottery Commencement of Date of Expiration of Extension
Jurisdiction Terminals Installed (1) Current Contract Current Contract Term Options*
- -------------- ----------------------- ---------------- --------------------- ---------
Trinidad & Tobago
- -National Lotteries Control Board 550 12/93 7/06 1 three-year
Turkey
- -Turkish National Lottery (4) 3,900 2/96 11/05 (16)
Turks & Caicos
- -LILHCo - 10/04 10/14 1 ten-year
United Kingdom
- -The National Lottery (17) 26,850 1/02 1/09 -
Ukraine
- -Ukrainian National Lottery 2,600 8/00 12/10 -
U.S. Virgin Islands
- -LILHCo 81 1/02 1/12 2 five-year
- ---------------------------------------------------
*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 selected another vendor to provide
equipment and services after the Colorado lottery authority's contract
expired in October 2004. Two extensions to the contract have extended the
term through April 2005.
(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) 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.
(5) A seven year contract extension has been signed that will, upon
termination of the current term, extend the term of the contract through
June 2012.
(6) The entities operating the Barbados lotteries are in the process of
consolidation. Upon completion of the consolidation, GTECH will enter into
a contract to provide lottery services with the consolidated entity which
is expected to occur in May 2005.
(7) Operated by GTECH Brasil Ltda. 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 extend the term until May 2006 upon its existing terms
and conditions. We are currently negotiating an extension to the contract.
See "Item 3, "Legal Proceedings" below.
(8) 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.
(9) Our contract with the Ireland lottery authority may be extended for any
period mutually acceptable to us and the Ireland lottery authority.
(10) 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.
(11) 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 September 2004, GTECH signed a
contract with Pronosticos para la Asistencia Publica to provide equipment
and services to a new online lottery system and associated
telecommunications network in Mexico. Implementation of this contract has
been suspended pending resolution of administrative and legal challenges
by two of our competitors to Pronosticos's award to us of this contract.
(12) The Puerto Rico lottery authority selected another vendor to provide
equipment and services after the Puerto Rico lottery authority's contract
with us terminates in March 2005.
(13) Operated by Uthingo consortium, in which we are a 10 percent equity owner.
(14) We have been advised that this lottery authority has selected another
vendor to supply lottery goods and services upon the termination of our
contract in October 2005.
(15) 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.
(16) 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.
(17) 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, 2000 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 or replacement of existing lottery systems.
Australia --Lotteries Commission of New South Wales
Australia --Western Australia Lotteries Commission
Belgium --Loterie Nationale de Belgique
California --California State Lottery
Canada --Alberta Gaming & Liquor Commission
--British Columbia Lottery Corporation
--Western Canada Lottery Corporation
China --Beijing Welfare Lottery Center
Finland --Veikkus Oy
France --La Francaise des Jeux
Germany --WestLotto
--Sachsische Lotto - Gmbh
--Lotterie Treuhandgesellschaft mbH Thuringen
Israel --Mifal Hapayis
Luxembourg --Loterie Nationale
Massachusetts --Massachusetts State Lottery Commission
Netherlands --Stichting de Nationale Sport Totalisator
Pennsylvania --IGT OES Online Entertainment Systems, Inc.
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
VIDEO LOTTERY CONTRACTS. On April 30, 2004, we acquired Spielo Manufacturing
Incorporated ("Spielo"), a leading provider of video lottery terminals ("VLTs")
and related products and services to the global gaming industry. Spielo supplies
video lottery terminals on a product sales basis to various lottery authorities
and gaming establishments throughout the world.
INSTANT TICKET VENDING MACHINE LOTTERY CONTRACTS
OVERVIEW: During fiscal 2004 we acquired Interlott Technologies, Inc.
("Interlott"), a leading provider of instant ticket vending machines ("ITVMs")
for the lottery industry worldwide. Similar to our online business, our ITVM
business is generally conducted 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 ITVM Facilities Management
Contract with a lottery authority, we build to specification, install, and
service 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, our ITVM 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, our recent ITVM Facilities
Management Contracts feature a compensation structure based upon a negotiated
percentage of the ITVM instant tickets sales revenues. Under our ITVM Facilities
Management Contracts, we retain title to the ITVMs, while providing our
customers with necessary support services. In most of our ITVM jurisdictions we
employ 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 ITVM Product Sales Contract, for a
fixed price we construct, sell, deliver and install a turnkey ITVM system that
the lottery jurisdiction subsequently operates.
The table below sets forth the lottery authorities with which we currently have
ITVM 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, under various ITVM Product Sales Contracts
("PSCs"). Finally, the table below 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 DATE OF
FMC APPROXIMATE COMMENCEMENT OF EXPIRATION OF CURRENT
OR NUMBER OF CURRENT FMC CURRENT FMC EXTENSION
JURISDICTION PSC ITVMS IN SERVICE CONTRACT CONTRACT TERM OPTIONS
- ------------ --- ---------------- --------------- ------------- -------------
Arizona FMC 420 7/03 7/08 --
California PSC 3,900 N/A N/A N/A
D.C. FMC 100 12/01 12/05 1 one-year
Idaho PSC 195 N/A N/A N/A
Illinois FMC 3,245 6/04 9/10 1 three-year
Indiana FMC 1,385 1/01 3/05 --
Iowa FMC 400 1/01 3/05 --
Kentucky PSC 1,250 N/A N/A N/A
Maine FMC 150 9/04 8/07 --
Maryland PSC 910 N/A N/A --
Massachusetts PSC 1,575 N/A N/A N/A
Minnesota (2) 110 N/A N/A N/A
Missouri FMC 630 6/01 6/08 4 one-year
New Hampshire FMC 220 7/00 6/05 --
New Jersey (2) 210 N/A N/A N/A
New Mexico FMC 160 5/97 6/07 --
New York FMC 4,380 5/02 7/05 --
Ohio FMC 1,500 7/03 6/05 2 two-year
Oregon PSC 500 N/A N/A N/A
Pennsylvania PSC 3,050 N/A N/A N/A
Rhode Island (2) 100 N/A N/A N/A
Texas FMC 1,400 9/03 9/06 2 one-year
Virginia (1) PSC 1,600 N/A N/A N/A
Washington FMC 1,010 11/04 11/07 1 three-year
West Virginia PSC 110 N/A N/A N/A
Wisconsin PSC 500 N/A N/A N/A
- ----------
(1) The Virginia Lottery entered into a seven-year contract with Oberthur
Gaming Technologies Corporation (OGT) under which GTECH has subcontracted
to provide new ITVMs and management of warehousing and distribution of
instant tickets.
(2) Represents ITVMs installed under a GTECH Facilities Management Contract.
See Facilities Management Contracts table above for additional
information.
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 have
received 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 2005, we completed the acquisition of Spielo Manufacturing
Incorporated ("Spielo"), a leading provider of video lottery terminals and
related products and services to the global gaming industry. 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.
During fiscal 2005, we announced the development of GamePoint,(TM) our
all-in-one instant and online lottery terminal solution. The GamePoint terminal,
which dispenses both instant and online tickets, is completely self-contained
and provides a secure and player-friendly opportunity for the sale of instant
and online lottery products.
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 24 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.
During fiscal 2005, we 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.
In February 2005, we obtained a five-year exclusive licensing agreement giving
us the right to utilize the names, likenesses, and signatures of premium racecar
drivers in connection with the HotTrax game.
During fiscal 2005, we introduced HotTrax,(R) a new three dimensional lottery
game that we developed, in Rhode Island. This race-based monitor game provides
players with an exciting opportunity to place every four or five minutes a
variety of wagers on the finishing order of racecars.
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 our customers. 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 a
minimum of 90 days) from the date revenue is recognized or from the date a
product is delivered and tested. We estimate product warranty costs that we
expect to incur during the warranty period and we record a charge to costs of
sales for the estimated warranty cost at the time the product sale is recorded.
In determining the appropriate warranty provision, consideration is given to
historical warranty cost information, the status of the terminal model in its
life cycle and current terminal performance. We periodically assess the adequacy
of our product warranty reserves and adjust them as necessary in the period when
the information necessary to make the adjustment becomes available.
We typically do not provide a product warranty on purchased products sold to our
customers but attempt to pass the manufacturer's warranty, if any, on to them.
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 2005, 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. See
Item 3, "Legal Proceedings - Brazilian Legal Proceedings," below. We are party
to
agreements with more than 700 retailers in Chile to provide electronic bill
payment services at retail outlets throughout the country.
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. During fiscal 2005, PolCard completed the acquisition
of BillBird S.A., a leading provider of electronic bill payment services in
Poland.
PRODUCT DEVELOPMENT
We devote substantial resources in order to enhance our present products and
systems and develop new products. In fiscal 2005, we spent approximately $52.6
million on research and development, as compared to $57.3 million in fiscal
2004, and $42.9 million in fiscal 2003.
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 $143.7 million as of February 26, 2005, as compared to
a backlog of approximately $166.7 million as of February 28, 2004. The decrease
in the backlog is due to a lower level of product sales expected to be
consummated in fiscal year 2006. Approximately $79.5 million, or 55.3% of the
backlog at February 26, 2005, is expected to be filled during fiscal 2006.
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 2005, our principal competitors in the online lottery business
(and the number of online lottery contracts serviced 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.) (33); Essnet (22); and Intralot S.A. (20).
PERSONNEL
As of April 1, 2005, we had approximately 5,300 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. Prior to February 1, 2005 we had a 50% limited
partnership interest in this partnership. On February 1, 2005, we acquired the
remaining 50% interest in, and presently own 100% of, West Greenwich Technology
Associates, L.P. We also 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.
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.
In addition, our subsidiary, Spielo Manufacturing, Inc., owns an approximately
113,000 square foot office building in Moncton, Canada, and leases an
approximately 31,000 square foot manufacturing and warehouse facility in
Saint-Anne-des-Monts, Canada.
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 January 1997, Caixa Economica Federal ("CEF"), the Brazilian bank
and operator of Brazil's National Lottery, and Racimec Information Brasileira
S.A. ("Racimec"), the predecessor of the Company's subsidiary GTECH Brasil Ltda.
("GTECH Brazil"), entered into a four-year contract pursuant to which GTECH
Brazil agreed to provide online lottery services and technology to CEF (the
"1997 Contract"). In May 2000, CEF and GTECH Brazil terminated the 1997 Contract
and entered into a new agreement (the "2000 Contract") obliging GTECH Brazil to
provide lottery goods and services and additional financial transaction services
to CEF for a contract term that, as subsequently extended, was scheduled to
expire in April 2003. 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 into May 2005, and (b) fees payable to GTECH Brazil under
the 2000 Contract were reduced by 15%.
CEF recently completed a procurement process for products and services to
replace those that we currently provide under the 2000 Contract. Based upon the
commodity auction nature of the p