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FORM 10-Q
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended May 25, 2002
Commission file number 1-11250
GTECH Holdings Corporation
- --------------------------------------------------------------------------------
(Exact name of registrant as specified in its charter)
Delaware 05-0450121
- --------------------------------- ------------------------------
(State or other jurisdiction of (I.R.S. Employer Identification
incorporation or organization) Number)
55 Technology Way, West Greenwich, Rhode Island 02817
- --------------------------------------------------------------------------------
(Address of principal executive offices) (Zip Code)
Registrant's telephone number, including area code: (401) 392-1000
Indicate by check mark whether the registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months (or for such shorter period that the registrant was
required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days.
Yes [_X_] No [___]
At June 21, 2002, there were 57,276,698 shares of the registrant's Common Stock
outstanding.
INDEX
GTECH HOLDINGS CORPORATION AND SUBSIDIARIES
Page
PART I. FINANCIAL INFORMATION Number
Item 1. Financial Statements
Consolidated Balance Sheets 3
Consolidated Income Statements 4
Consolidated Statements of Cash Flows 5
Consolidated Statements of Shareholders' Equity 6
Notes to Consolidated Financial Statements 7-19
Item 2. Management's Discussion and Analysis of Financial Condition 20-27
and Results of Operations
Item 3. Quantitative and Qualitative Disclosures about Market Risk 28
PART II. OTHER INFORMATION
Item 1. Legal Proceedings 28
Item 6. Exhibits and Reports on Form 8-K 28
SIGNATURES 29
EXHIBITS
PART 1. FINANCIAL INFORMATION
Item 1. FINANCIAL STATEMENTS
CONSOLIDATED BALANCE SHEETS
GTECH HOLDINGS CORPORATION AND SUBSIDIARIES (Unaudited)
May 25, February 23,
2002 2002
---------- ------------
(Dollars in thousands)
ASSETS
CURRENT ASSETS:
Cash and cash equivalents $ 49,876 $ 35,095
Trade accounts receivable 85,131 100,361
Sales-type lease receivables 4,674 4,894
Inventories 89,729 86,629
Deferred income taxes 28,321 28,321
Other current assets 18,107 22,730
--------- ---------
TOTAL CURRENT ASSETS 275,838 278,030
SYSTEMS, EQUIPMENT AND OTHER ASSETS RELATING TO CONTRACTS 391,207 369,595
GOODWILL 115,498 116,828
OTHER ASSETS 85,596 89,376
--------- ---------
TOTAL ASSETS $ 868,139 $ 853,829
========= =========
LIABILITIES AND SHAREHOLDERS' EQUITY
CURRENT LIABILITIES:
Short term borrowings $ 2,371 $ 2,358
Accounts payable 37,935 43,430
Accrued expenses 75,615 75,666
Employee compensation 23,085 37,941
Advance payments from customers 85,363 72,645
Income taxes payable 64,581 53,928
Current portion of long-term debt 3,370 3,510
--------- ---------
TOTAL CURRENT LIABILITIES 292,320 289,478
LONG-TERM DEBT, less current portion 329,065 329,715
OTHER LIABILITIES 32,830 27,986
DEFERRED INCOME TAXES 3,695 3,695
COMMITMENTS AND CONTINGENCIES --- ---
SHAREHOLDERS' EQUITY:
Preferred Stock, par value $.01 per share--20,000,000 shares authorized, none issued --- ---
Common Stock, par value $.01 per share--150,000,000 shares authorized,
92,296,404 and 92,297,404 shares issued; 57,245,514 and 57,491,256 shares
outstanding at May 25, 2002 and February 23, 2002, respectively (shares adjusted
to reflect May 2002 two-for-one stock split) 923 461
Additional paid-in capital 234,237 234,247
Equity carryover basis adjustment (7,008) (7,008)
Accumulated other comprehensive loss (99,021) (100,815)
Retained earnings 571,023 542,878
--------- ---------
700,154 669,763
Less cost of 35,050,890 and 34,806,148 shares in treasury at
May 25, 2002 and February 23, 2002, respectively (shares adjusted to reflect
May 2002 two-for-one stock split) (489,925) (466,808)
--------- ---------
210,229 202,955
--------- ---------
TOTAL LIABILITIES AND SHAREHOLDERS' EQUITY $ 868,139 $ 853,829
========= =========
See Notes to Consolidated Financial Statements
-3-
CONSOLIDATED INCOME STATEMENTS
GTECH HOLDINGS CORPORATION AND SUBSIDIARIES
(Unaudited)
Three Months Ended
---------------------
May 25, May 26,
2002 2001
------- -------
(Dollars in thousands,
except per share amounts)
Revenues:
Services $223,735 $210,551
Sales of products 7,677 24,414
-------- --------
231,412 234,965
Costs and expenses:
Costs of services 146,935 144,492
Costs of sales 6,247 19,937
-------- --------
153,182 164,429
-------- --------
Gross profit 78,230 70,536
Selling, general and administrative 22,909 29,570
Research and development 6,502 7,633
Goodwill amortization - 1,473
-------- --------
Operating expenses 29,411 38,676
-------- --------
Operating income 48,819 31,860
Other income (expense):
Interest income 842 2,030
Equity in earnings of unconsolidated affiliates 696 1,175
Other income (expense) (591) 2,178
Interest expense (2,925) (6,422)
-------- --------
Income before income taxes 46,841 30,821
Income taxes 17,800 11,712
-------- --------
Net income $ 29,041 $ 19,109
======== ========
Basic earnings per share $ .50 $ .31
======== ========
Diluted earnings per share $ .49 $ .30
======== ========
See Notes to Consolidated Financial Statements
-4-
CONSOLIDATED STATEMENTS OF CASH FLOWS
GTECH HOLDINGS CORPORATION AND SUBSIDIARIES
(Unaudited)
Three Months Ended
------------------
May 25, May 26,
2002 2001
------- -------
(Dollars in thousands)
OPERATING ACTIVITIES
Net income $ 29,041 $ 19,109
Adjustments to reconcile net income to net cash
provided by operating activities:
Depreciation 33,956 41,098
Intangibles amortization 1,685 2,343
Goodwill amortization - 1,473
Equity in earnings of unconsolidated affiliates, net of
dividends received 215 (9)
Other 1,250 (1,555)
Changes in operating assets and liabilities:
Trade accounts receivable 14,013 33,644
Inventories (3,100) 10,918
Special charge (347) (3,207)
Other assets and liabilities 14,684 (11,872)
-------- ---------
NET CASH PROVIDED BY OPERATING ACTIVITIES 91,397 91,942
INVESTING ACTIVITIES
Purchases of systems, equipment and other assets relating to contracts (53,023) (72,142)
Proceeds from sale of investments - 1,800
Other (662) (259)
-------- ---------
NET CASH USED FOR INVESTING ACTIVITIES (53,685) (70,601)
FINANCING ACTIVITIES
Net proceeds from issuance of long-term debt - 61,100
Principal payments on long-term debt (1,561) (1,145)
Purchases of treasury stock (37,686) (132,094)
Proceeds from stock options 12,549 13,648
Other 673 739
-------- ---------
NET CASH USED FOR FINANCING ACTIVITIES (26,025) (57,752)
Effect of exchange rate changes on cash 3,094 (217)
-------- ---------
INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS 14,781 (36,628)
Cash and cash equivalents at beginning of period 35,095 46,948
-------- ---------
CASH AND CASH EQUIVALENTS AT END OF PERIOD $ 49,876 $ 10,320
======== =========
See Notes to Consolidated Financial Statements
-5-
CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY - (Unaudited)
GTECH HOLDINGS CORPORATION AND SUBSIDIARIES
Accumulated
Equity Other
Additional Carryover Comprehensive
Outstanding Common Paid-in Basis Income Retained Treasury
Shares Stock Capital Adjustment (Loss) Earnings Stock Total
------ ----- ------- ---------- ------ -------- ----- -----
(Dollars in thousands)
Balance at
February 23, 2002 28,745,628 $461 $234,247 $(7,008) $(100,815) $542,878 $(466,808) $202,955
Comprehensive income:
Net income - - - - - 29,041 - 29,041
Other comprehensive
income (loss),
net of tax:
Foreign currency
translation - - - - 2,541 - - 2,541
Net loss on
derivative
instruments - - - - (675) - - (675)
Unrealized loss
on investments - - - - (72) - - (72)
--------
Comprehensive income 30,835
Treasury shares
purchased (656,900) - - - - - (37,686) (37,686)
Shares issued
under employee
stock purchase
and stock
award plans 57,154 - - - - 1 1,575 1,576
Shares issued
upon exercise
of stock options 476,875 - (10) - - (435) 12,994 12,549
Shares issued in
two-for-one
stock split 28,622,757 462 - - - (462) - -
---------- ---- -------- ------- --------- -------- --------- --------
Balance at
May 25, 2002 57,245,514 $923 $234,237 $(7,008) $ (99,021) $571,023 $(489,925) $210,229
========== ==== ======== ======= ========= ======== ========= ========
See Notes to Consolidated Financial Statements
-6-
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
GTECH HOLDINGS CORPORATION AND SUBSIDIARIES
NOTE A - BASIS OF PRESENTATION
The accompanying unaudited consolidated financial statements of GTECH Holdings
Corporation ("Holdings" or the "Company"), the parent of GTECH Corporation
("GTECH"), have been prepared in accordance with generally accepted accounting
principles ("GAAP") for interim financial information and with the instructions
to Form 10-Q and Article 10 of Regulation S-X. Accordingly, they do not include
all of the information and footnotes required by GAAP for complete financial
statements. In the opinion of management, all adjustments (consisting of normal
recurring accruals) considered necessary for a fair presentation have been
included. Operating results for the three-month period ended May 25, 2002 are
not necessarily indicative of the results that may be expected for the full
fiscal year ending February 22, 2003. The balance sheet at February 23, 2002 has
been derived from the audited financial statements at that date. For further
information refer to the Consolidated Financial Statements and footnotes thereto
included in the Company's fiscal 2002 Annual Report on Form 10-K.
Certain reclassifications have been made to the prior years' financial
statements to conform to the current year presentation.
NOTE B - COMMON STOCK SPLIT
In the first quarter of fiscal 2003, the Company's Board of Directors approved a
2-for-1 common stock split effected in the form of a stock dividend distributed
on May 23, 2002 to shareholders of record on May 16, 2002. All references to
common shares and per share amounts have been restated to reflect the stock
split for all periods presented.
NOTE C - INVENTORIES
May 25, February 23,
2002 2002
---- ----
(Dollars in thousands)
Inventories consist of:
Raw materials $ 6,786 $12,310
Work in progress 80,986 72,847
Finished goods 1,957 1,472
------- -------
$89,729 $86,629
======= =======
-7-
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)
NOTE D - LONG-TERM DEBT
May 25, February 23,
2002 2002
---- ----
(Dollars in thousands)
Long-term debt consists of:
1.75% Convertible Debentures due 2021 $175,000 $175,000
7.75% Series A Senior Notes due 2004 40,000 40,000
7.87% Series B Senior Notes due 2007 95,000 95,000
Interest rate swaps 10,795 12,089
Other 11,640 11,136
-------- --------
332,435 333,225
Less current portion 3,370 3,510
-------- --------
$329,065 $329,715
======== ========
The Company has an unsecured revolving credit facility of $300 million expiring
in June 2006 (the "Credit Facility"). There were no outstanding borrowings under
the Credit Facility at May 25, 2002 or February 23, 2002.
NOTE E - INCOME TAXES
The Company's effective income tax rate is greater than the statutory rate
primarily due to state income taxes and certain expenses that are not deductible
for income tax purposes.
NOTE F - COMMITMENTS AND CONTINGENCIES
See "Legal Proceedings" in Part II, Item 1 and "Management's Discussion and
Analysis of Financial Condition and Results of Operations" in Part I, Item 2
herein.
-8-
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)
NOTE G - EARNINGS PER SHARE
The following table sets forth the computation of basic and diluted earnings per
share:
May 25, May 26,
2002 2001
---- ----
(Dollars and shares in thousands,
except per share amounts)
Numerator:
Net income $29,041 $19,109
Denominator:
Weighted average shares-Basic 57,583 61,520
Effect of dilutive securities:
Employee stock options and unvested restricted shares 1,678 1,152
------- -------
Weighted average shares-Diluted 59,261 62,672
======= =======
Basic earnings per share $ .50 $ .31
======= =======
Diluted earnings per share $ .49 $ .30
======= =======
NOTE H -- COMPREHENSIVE INCOME
The following table sets forth the components of comprehensive income:
May 25, May 26,
2002 2001
---- ----
(Dollars in thousands)
Net income $29,041 $19,109
Other comprehensive income (loss), net of tax:
Foreign currency translation 2,541 (9,764)
Net loss on derivative instruments (675) (416)
Unrealized loss on investments (72) ---
------- -------
Comprehensive income $30,835 $ 8,929
======= =======
-9-
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)
NOTE I - SEGMENT INFORMATION
The Company presently has one reportable business segment, the Lottery segment,
which provides online, high speed, highly secure transaction processing systems
to the worldwide lottery industry. Executive management of the Company evaluates
segment performance based on net operating profit after income taxes. The "All
Other" category (as reported below) is comprised of the Company's Transactive
subsidiary, which provides electronic benefit transfer services over the
Company's dedicated network infrastructure. The composition of the "All Other"
category at May 26, 2001 has been revised to include the Company's IGI/Europrint
business unit in the Lottery segment because management considers it a component
of the Lottery segment.
The Company's business segment data is summarized below:
May 25, May 26,
2002 2001
------- -------
(Dollars in thousands)
Revenues from external sources:
Lottery $230,731 $231,090
All other 681 3,875
-------- --------
Consolidated $231,412 $234,965
======== ========
Net operating profit after income taxes:
Lottery $ 31,650 $ 24,317
All other (50) (252)
-------- --------
Consolidated $ 31,600 $ 24,065
======== ========
A reconciliation of net operating profit after income taxes to net income as
reported on the Consolidated Income Statements is as follows:
May 25, May 26,
2002 2001
------- -------
(Dollars in thousands)
Net operating profit after income taxes $31,600 $24,065
Reconciling items, net of tax:
Interest expense (1,814) (3,982)
Other (745) (974)
------- -------
Net income $29,041 $19,109
======= =======
-10-
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)
NOTE J - SPECIAL CHARGES
In fiscal 2001, the Company recorded special charges of $42.3 million in
connection with certain contractual obligations and a value assessment of the
Company's business operations. See Note P to the Consolidated Financial
Statements in the Company's fiscal 2002 Annual Report on Form 10-K for further
information.
A summary of the special charge activity, which is included in accrued expenses
in the Company's Consolidated Balance Sheets, is as follows:
Exit of Certain
Worldwide Executive Business
Workforce Contractual Strategies and
Reduction Obligations Product Lines Other Total
--------- ----------- ------------- ----- -----
(Dollars in thousands)
Special charges $13,958 $11,518 $ 8,536 $ 8,258 $ 42,270
Cash expenditures (6,032) (9,965) (4,140) (3,289) (23,426)
Noncash charges --- --- (4,396) (4,017) (8,413)
------- ------- ------- ------- --------
Balance at February 24, 2001 7,926 1,553 --- 952 10,431
Change in estimate (438) (71) --- 509 ---
Cash expenditures (5,880) (678) --- (1,437) (7,995)
------- ------- ------- ------- --------
Balance at February 23, 2002 1,608 804 --- 24 2,436
Cash expenditures (208) (152) --- 13 (347)
------- ------- ------- ------- --------
Balance at May 25, 2002 $ 1,400 $ 652 $ --- $ 37 $ 2,089
======= ======= ======= ======= ========
-11-
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)
NOTE K - GOODWILL AND OTHER INTANGIBLE ASSETS
On February 24, 2002, the Company adopted Statement of Financial Accounting
Standard No. 142 ("SFAS 142"), "Goodwill and Other Intangible Assets", which
requires companies to discontinue amortizing goodwill and certain intangible
assets with indefinite useful lives and requires an annual review for
impairment. Upon adoption, the Company discontinued the amortization of
goodwill. Amortization will continue to be recorded on other intangible assets
not classified as goodwill. The nonamortization provisions of SFAS 142 apply to
goodwill and intangible assets acquired after June 30, 2001. Since June 30,
2001, there have been no business acquisitions. Upon adoption, net goodwill of
$1.3 million was reclassified into intangible assets within the Lottery segment.
The pro forma impact of discontinuing the amortization of goodwill is presented
below:
Three Months Ended
------------------
May 25, May 26,
2002 2001
---- ----
(Dollars in thousands, except
per share data)
Net income as reported $29,041 $19,109
Add back amortization --- 1,427
------- -------
Adjusted net income $29,041 $20,536
======= =======
Basic earnings per share as reported $ .50 $ .31
Add back amortization --- .02
------- -------
Adjusted earnings per share - basic $ .50 $ .33
======= =======
Diluted earnings per share as reported $ .49 $ .30
Add back amortization --- .03
------- -------
Adjusted earnings per share - diluted $ .49 $ .33
======= =======
-12-
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)
NOTE K - GOODWILL AND OTHER INTANGIBLE ASSETS (continued)
Intangible assets, which are included in other assets in the Company's
Consolidated Balance Sheets, are comprised of the following:
As of May 25, 2002
--------------------------------------------------
Gross Carrying Accumulated Net Carrying
Amount Amortization Amount
-------------- ------------ ------------
(Dollars in thousands)
Contract based $22,038 $21,036 $1,002
Capitalized software 13,255 10,283 2,972
Other 1,853 589 1,264
------- ------- ------
Total intangible assets $37,146 $31,908 $5,238
======= ======= ======
As of February 23, 2002
------------------------------------------------
Gross Carrying Accumulated Net Carrying
Amount Amortization Amount
-------------- ------------ ------------
(Dollars in thousands)
Contract based $22,038 $20,034 $2,004
Capitalized software 13,255 9,667 3,588
Other 1,489 1,489 ---
------- ------- ------
Total intangible assets $36,782 $31,190 $5,592
======= ======= ======
A reconciliation of the net carrying amount of intangible assets as of February
23, 2002 to May 25, 2002 is as follows:
Net Carrying
Amount
------
Balance as of February 23, 2002 $ 5,592
Reclassification from goodwill, net 1,331
Amortization expense (1,685)
-------
Balance as of May 25, 2002 $ 5,238
=======
-13-
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)
NOTE K - GOODWILL AND OTHER INTANGIBLE ASSETS (continued)
Amortization expense for the three months ended May 25, 2002 and the fiscal year
ended February 23, 2002 is as follows:
Three Months Fiscal Year
Ended Ended
------------ -----------
May 25, February 23,
2002 2002
------------ ------------
(Dollars in thousands)
Contract based $1,002 $4,007
Capitalized software 616 4,223
Other 67 193
------ ------
Total amortization $1,685 $8,423
====== ======
Amortization expense for the next five fiscal years is expected to be as follows
(in thousands):
Fiscal Amortization
Year Expense
---- -------
2003 $4,733
2004 1,383
2005 262
2006 262
2007 262
NOTE L - SUPPLEMENTAL GUARANTOR/NON-GUARANTOR FINANCIAL INFORMATION
On December 18, 2001, Holdings (the "Parent Company") issued $175 million
principal amount of 1.75% Convertible Debentures due 2021 (the "Convertible
Debentures"). The Convertible Debentures are unsecured and unsubordinated
obligations of the Parent Company that are jointly and severally, fully and
unconditionally guaranteed by GTECH and two of its wholly-owned subsidiaries:
GTECH Rhode Island Corporation and GTECH Latin America Corporation (collectively
with GTECH, the "Guarantor Subsidiaries"). Condensed consolidating financial
information is presented below.
Selling, general and administrative costs and research and development costs are
allocated to each subsidiary based on the ratio of the subsidiaries combined
service revenue and sales of products to consolidated revenues.
The Parent Company conducts business through its consolidated subsidiaries and
unconsolidated affiliates and has, as its only asset, an investment in GTECH.
Equity in earnings of consolidated affiliates recorded by the Parent Company
includes the Parent Company's 100% share of the after-tax earnings of GTECH.
Taxes payable and deferred income taxes are obligations of the subsidiaries.
Income tax expense related to both current and deferred income taxes are
allocated to each subsidiary based on the Company's consolidated effective
income tax rates.
-14-
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)
NOTE L - SUPPLEMENTAL GUARANTOR/NON-GUARANTOR FINANCIAL INFORMATION
(continued)
Condensed Consolidating Balance Sheets
May 25, 2002
Parent Guarantor Non-Guarantor Eliminating
Company Subsidiaries Subsidiaries Entries Consolidated
------- ------------ ------------ ------- ------------
(Dollars in thousands)
Assets
Current Assets:
Cash and cash equivalents $ -- $ 37,985 $ 11,891 $ -- $ 49,876
Trade accounts receivable -- 59,100 26,031 -- 85,131
Due from subsidiaries and
affiliates -- 62,367 -- (62,367) --
Sales-type lease receivables -- 2,933 1,741 -- 4,674
Inventories -- 62,659 48,092 (21,022) 89,729
Deferred income taxes -- 25,264 3,057 -- 28,321
Other current assets -- 8,286 9,821 -- 18,107
-------- -------- -------- --------- --------
Total Current Assets -- 258,594 100,633 (83,389) 275,838
Systems, Equipment and Other
Assets Relating to Contracts -- 308,465 114,633 (31,891) 391,207
Investment in Subsidiaries and
Affiliates 210,229 91,586 -- (301,815) --
Goodwill -- 70,605 44,893 -- 115,498
Other Assets -- 69,027 16,569 -- 85,596
-------- -------- -------- --------- --------
Total Assets $210,229 $798,277 $276,728 $(417,095) $868,139
======== ======== ======== ========= ========
Liabilities and Shareholders' Equity
Current Liabilities:
Short term borrowings $ -- $ -- $ 2,371 $ -- $ 2,371
Accounts payable -- 30,947 6,988 -- 37,935
Due to subsidiaries and affiliates -- -- 62,367 (62,367) --
Accrued expenses -- 53,380 22,235 -- 75,615
Employee compensation -- 17,599 5,486 -- 23,085
Advance payments from
customers -- 36,706 48,657 -- 85,363
Income taxes payable -- 46,659 17,922 -- 64,581
Current portion of long-term debt -- 1,337 2,033 -- 3,370
-------- -------- -------- --------- --------
Total Current Liabilities -- 186,628 168,059 (62,367) 292,320
Long-Term Debt, less current
portion -- 319,457 9,608 -- 329,065
Other Liabilities -- 21,640 11,190 -- 32,830
Deferred Income Taxes -- 7,616 (3,921) -- 3,695
Shareholders' Equity 210,229 262,936 91,792 (354,728) 210,229
-------- -------- -------- --------- --------
Total Liabilities and
Shareholders' Equity $210,229 $798,277 $276,728 $(417,095) $868,139
======== ======== ======== ========= ========
-15-
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)
NOTE L - SUPPLEMENTAL GUARANTOR/NON-GUARANTOR FINANCIAL INFORMATION
(continued)
Condensed Consolidating Income Statements
Three Months Ended May 25, 2002
Parent Guarantor Non-Guarantor Eliminating
Company Subsidiaries Subsidiaries Entries Consolidated
------- ------------ ------------ ------- ------------
(Dollars in thousands)
Revenues:
Services $ -- $172,083 $51,652 $ -- $223,735
Sales of products -- 4,670 3,007 -- 7,677
Intercompany sales and fees -- 19,323 12,487 (31,810) --
------- -------- ------- -------- --------
-- 196,076 67,146 (31,810) 231,412
Costs and expenses:
Costs of services -- 104,223 44,859 (2,147) 146,935
Costs of sales -- 3,849 2,398 -- 6,247
Intercompany cost of sales
and fees -- 14,341 2,092 (16,433) --
------- -------- ------- -------- --------
-- 122,413 49,349 (18,580) 153,182
------- -------- ------- -------- --------
Gross profit -- 73,663 17,797 (13,230) 78,230
Selling, general & administrative -- 17,499 5,410 -- 22,909
Research and development -- 4,966 1,536 -- 6,502
------- -------- ------- -------- --------
Operating expenses -- 22,465 6,946 -- 29,411
------- -------- ------- -------- --------
Operating income -- 51,198 10,851 (13,230) 48,819
Other income (expense):
Interest income -- 354 488 -- 842
Equity in earnings of
unconsolidated affiliates -- 76 620 -- 696
Equity in earnings of
consolidated affiliates 29,041 7,086 -- (36,127) --
Other expense -- (505) (86) -- (591)
Interest expense -- (2,482) (443) -- (2,925)
------- -------- ------- -------- --------
Income before income taxes 29,041 55,727 11,430 (49,357) 46,841
Income taxes -- 21,176 4,343 (7,719) 17,800
------- -------- ------- -------- --------
Net income $29,041 $ 34,551 $ 7,087 $(41,638) $ 29,041
======= ======== ======= ======== ========
-16-
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)
NOTE L - SUPPLEMENTAL GUARANTOR/NON-GUARANTOR FINANCIAL INFORMATION
(continued)
Condensed Consolidating Income Statements
Three Months Ended May 26, 2001
Parent Guarantor Non-Guarantor Eliminating
Company Subsidiaries Subsidiaries Entries Consolidated
------- ------------ ------------ ------- ------------
(Dollars in thousands)
Revenues:
Services $ --- $155,994 $54,557 $ --- $210,551
Sales of products --- 14,341 10,073 --- 24,414
Intercompany sales and fees --- 45,546 12,470 (58,016) ---
------- -------- ------- -------- --------
--- 215,881 77,100 (58,016) 234,965
Costs and expenses:
Costs of services --- 100,283 46,361 (2,152) 144,492
Costs of sales --- 14,358 5,806 (227) 19,937
Intercompany cost of sales
and fees --- 25,869 7,870 (33,739) ---
------- -------- ------- -------- --------
--- 140,510 60,037 (36,118) 164,429
------- -------- ------- --------- --------
Gross profit --- 75,371 17,063 (21,898) 70,536
Selling, general & administrative --- 21,440 8,130 --- 29,570
Research and development --- 5,533 2,100 --- 7,633
Goodwill amortization --- 632 841 --- 1,473
------- -------- ------- -------- --------
Operating expenses --- 27,605 11,071 --- 38,676
------- -------- ------- -------- --------
Operating income --- 47,766 5,992 (21,898) 31,860
Other income (expense):
Interest income --- 1,147 883 --- 2,030
Equity in earnings of
unconsolidated affiliates --- 403 772 --- 1,175
Equity in earnings of
consolidated affiliates 19,109 6,036 --- (25,145) ---
Other income (expense) --- (531) 2,709 --- 2,178
Interest expense --- (5,802) (620) --- (6,422)
------- --------- -------- -------- --------
Income before income taxes 19,109 49,019 9,736 (47,043) 30,821
Income taxes --- 18,627 3,700 (10,615) 11,712
------- -------- ------- --------- --------
Net income $19,109 $ 30,392 $ 6,036 $(36,428) $ 19,109
======= ======== ======= ========= ========
-17-
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)
NOTE L - SUPPLEMENTAL GUARANTOR/NON-GUARANTOR FINANCIAL INFORMATION
(continued)
Condensed Consolidating Statements of Cash Flows
Three Months Ended May 25, 2002
Parent Guarantor Non-Guarantor Eliminating
Company Subsidiaries Subsidiaries Entries Consolidated
------- ------------ ------------ ------- ------------
(Dollars in thousands)
Net cash provided by operating
activities $ --- $ 88,440 $ 2,640 $ 317 $ 91,397
Investing Activities
Purchases of systems, equipment
and other assets relating to
contracts --- (49,848) (2,858) (317) (53,023)
Other --- (662) --- --- (662)
-------- -------- ------- ----- ---------
Net cash used for investing
activities --- (50,510) (2,858) (317) (53,685)
Financing Activities
Principal payments on long-term
debt --- (1,205) (356) --- (1,561)
Purchases of treasury stock (37,686) --- --- --- (37,686)
Proceeds from stock options 12,549 --- --- --- 12,549
Intercompany capital transactions 24,662 (24,662) --- --- ---
Other 475 --- 198 --- 673
-------- -------- -------- ----- --------
Net cash used for financing
activities --- (25,867) (158) --- (26,025)
Effect of exchange rate changes
on cash --- 57 3,037 --- 3,094
-------- --------- -------- ----- ---------
Increase in cash and
cash equivalents --- 12,120 2,661 --- 14,781
Cash and cash equivalents at
beginning of period --- 25,865 9,230 --- 35,095
-------- -------- ------- ----- --------
Cash and cash equivalents at end
of period $ --- $ 37,985 $11,891 $ --- $ 49,876
======== ======== ======= ===== ========
-18-
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)
NOTE L - SUPPLEMENTAL GUARANTOR/NON-GUARANTOR FINANCIAL INFORMATION
(continued)
Condensed Consolidating Statements of Cash Flows
Three Months Ended May 26, 2001
Parent Guarantor Non-Guarantor Eliminating
Company Subsidiaries Subsidiaries Entries Consolidated
------- ------------ ------------ ------- ------------
(Dollars in thousands)
Net cash provided by operating
activities $ -- $ 79,467 $ 22,947 $ (10,472) $ 91,942
Investing Activities
Purchases of systems, equipment
and other assets relating to
contracts -- (56,729) (25,885) 10,472 (72,142)
Proceeds from sale of investments -- -- 1,800 -- 1,800
Other -- (137) (122) -- (259)
--------- --------- --------- --------- ---------
Net cash used for investing
activities -- (56,866) (24,207) 10,472 (70,601)
Financing Activities
Net proceeds from issuance of
long-term debt -- 61,100 -- -- 61,100
Principal payments on long-term
debt -- (1,145) -- -- (1,145)
Purchases of treasury stock (132,094) -- -- -- (132,094)
Proceeds from stock options 13,648 -- -- -- 13,648
Intercompany capital transactions 117,614 (117,614) -- -- --
Other 832 -- (93) -- 739
--------- --------- --------- --------- ---------
Net cash used for financing
activities -- (57,659) (93) -- (57,752)
Effect of exchange rate changes
on cash -- 255 (472) -- (217)
--------- --------- --------- --------- ---------
Decrease in cash and cash
equivalents -- (34,803) (1,825) -- (36,628)
Cash and cash equivalents at
beginning of period -- 37,068 9,880 -- 46,948
--------- --------- --------- --------- ---------
Cash and cash equivalents at end
of period $ -- $ 2,265 $ 8,055 $ -- $ 10,320
========= ========= ========= ========= =========
-19-
Item 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
Certain statements contained in this section and elsewhere in this report are
forward-looking statements within the meaning of Section 27A of the Securities
Act and Section 21E of the Securities Exchange Act of 1934. Such statements may
include, without limitation, statements relating to (i) the future prospects for
and stability of the lottery industry and other businesses in which the Company
is engaged or expects to be engaged, (ii) the future operating and financial
performance of the Company, (iii) the ability of the Company to retain existing
business and to obtain and retain new business, and (iv) the results and effects
of legal proceedings and investigations. Such 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, but are not limited to, the
following: (i) governmental regulations and other actions affecting the online
lottery industry could have a negative effect on the Company's business, (ii)
the Company's lottery operations are dependent upon its continued ability to
retain and extend its existing contracts (including with respect to several of
the Company's significant online lottery service contracts which are the subject
of competitive procurement procedures over the next 9 months) and win new
contracts, (iii) slow growth or declines in sales of online lottery goods and
services could adversely affect the Company's future revenues and profitability,
(iv) the Company has significant foreign exchange exposure, (v) the Company is
subject to the economic, political and social instability risks of doing
business in foreign jurisdictions, (vi) the Company has a concentrated customer
base, and the loss of any of its larger customers could harm its results, (vii)
the Company's quarterly operating results may fluctuate significantly, (viii)
the Company operates in a highly competitive environment, (ix) the Company is
subject to substantial penalties for failure to perform under its contracts, (x)
the Company may not be able to respond to technological changes or satisfy
future technological demands of its customers, (xi) expansion of the gaming
industry faces opposition which may limit the legalization, or expansion, of
online gaming to the detriment of the Company's business, financial condition,
results and prospects, (xii) the Company's business prospects and future success
depend upon its ability to attract and retain qualified employees, (xiii) the
Company may be subject to adverse determinations in pending legal proceedings,
and (xiv) other risks and uncertainties set forth below and elsewhere in this
report, in the Company's fiscal 2002 Form 10-K, and in the Company's subsequent
press releases and Form 10-Q's and other reports and filings with the Securities
and Exchange Commission.
General
The Company operates on a 52- to 53-week fiscal year ending on the last Saturday
in February and fiscal 2003 ends on February 22, 2003.
The Company has derived substantially all of its revenues from the rendering of
services and the sale or supply of computerized online lottery systems and
components to government-authorized lotteries. Service revenues have been
derived primarily from lottery service contracts. These contracts are typically
at least five years in duration, and generally provide compensation to the
Company based upon a percentage of a lottery's gross online lottery sales. These
percentages vary depending on the size of the lottery and the scope of services
provided to the lottery. Product sale revenues have been derived primarily from
the installation of new online lottery systems, installation of new software and
sales of lottery terminals and equipment in connection with the expansion of
existing lottery systems. The Company's gross margins on product sales fluctuate
depending on the mix, volume and timing of product sales contracts. The size and
timing of these transactions have resulted in variability in product sale
revenues from period to period. The Company currently anticipates that product
sales during fiscal 2003 will be in a range of $90 million to $110 million.
-20-
The Company has taken steps to broaden its offerings of high-volume transaction
processing services outside of its core business of providing online lottery
services. For example, in May 2000 and December 2000, the Company entered into
agreements that permit bill payments over its Brazilian and Chilean lottery
networks, respectively.
The Company's business is highly regulated, and the competition to secure new
government contracts is often intense. Awards of contracts to the Company are,
from time to time, challenged by competitors. 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, the Company would not
necessarily know of the existence of an investigation that might involve the
Company. Because the Company's reputation for integrity is an important factor
in its business dealings with lottery and other government agencies, if
government authorities were to make an allegation of, or if there were to be a
finding of, improper conduct on the part of or attributable to the Company in
any matter, such an allegation or finding could have a material adverse effect
on the Company's business, including its ability to retain existing contracts
and to obtain new or renewal contracts. In addition, continuing adverse
publicity resulting from these investigations and related matters could have
such a material adverse effect. See "Legal Proceedings" in Part II, Item 1
herein; and Part I, Item 1 - "Certain Factors That May Affect Future Performance
- - Government regulations and other actions affecting the online lottery industry
could have a negative effect on the Company's business", Part I, Item 3 - "Legal
Proceedings" and Note F to the Consolidated Financial Statements in the
Company's fiscal 2002 Annual Report on Form 10-K, for further information
concerning these matters and other contingencies.
The Company is a global business and derives a substantial portion of its
revenues from operations outside of the United States. In particular, in fiscal
2002, the Company derived approximately 51% of its revenues from its
international operations and 11.5% of its revenues from its Brazilian operations
alone (including 10.7% of its revenues from the National Lottery of Brazil, one
of the Company's largest customers). In addition, a substantial portion of the
Company's assets are held outside of the United States.
Upcoming Significant Contract Rebids
A majority of the Company's revenues and cash flow is derived from its portfolio
of long-term online lottery services contracts, each of which in the ordinary
course of the Company's business periodically is the subject of competitive
procurement or renegotiation. Through fiscal 2003 (which ends in February 2003),
three of the Company's larger contracts, as measured by annual revenues, will be
the subject of competitive procurements to select contractors to supply lottery
goods and services upon the termination of the Company's current contracts.
Among these is the National Lottery of Brazil, one of the Company's largest
contracts, which accounted for 10.7% of the Company's consolidated revenues in
fiscal 2002. Upon the expiration of the Company's current contract, Caixa
Economica Federal ("Caixa"), the operator of Brazil's National Lottery, will
attempt to handle internally some non-lottery operations currently performed by
the Company under its contract and, with regard to the remaining lottery
operations, is seeking to proceed with a competitive procurement process
calculated to result in multiple vendors to administer Brazil's National
Lottery, which is presently administered solely by the Company. This procurement
process, which Caixa has indicated will result in several small procurements, is
intended to begin on June 28, 2002. Caixa has indicated further that GTECH will
be requested to provide lottery services in varying capacities through the end
of calendar 2003 due to the scope and complexity of the transition Caixa is
attempting. The Company intends to challenge the legality of Caixa's proposed
procurement process. Other large contracts that will be subject to competitive
procurement through fiscal 2003 include the California and Georgia lottery
contracts. See Part I, Item 1 -- "Certain Factors That May Affect Future
Performance" in the Company's fiscal 2002 Annual Report on Form 10-K, for
further information concerning these matters.
-21-
Critical Accounting Policies
In December 2001, the Securities and Exchange Commission issued new advice
regarding disclosure of critical accounting policies. In response to this
advice, the Company has identified the accounting policies listed below that it
believes are most critical to the Company's financial condition and results of
operations, and that require management's most difficult, subjective and complex
judgments in estimating the effect of inherent uncertainties. This section
should be read in conjunction with Note A to the Consolidated Financial
Statements in the Company's fiscal 2002 Annual Report on Form 10-K, which
includes other significant accounting policies.
REVENUE RECOGNITION
The Company recognizes service revenues as the services are performed.
Liquidated damages (which equaled 0.14%, 0.47% and 0.56% of the Company's total
revenues in fiscal 2002, 2001 and 2000, respectively) are recorded as a
reduction in revenue in the period in which it is determined that they are
probable and estimable. Revenues from product sales or sales-type leases are
recognized when installation is complete and the customer accepts the product
(when acceptance is a stipulated contractual term). In those instances where the
Company is not responsible for installation, revenue is recognized when the
product is shipped. Amounts received from customers in advance of revenue
recognition are deferred as liabilities.
Generally, product sales under long-term contracts are recorded over the
contractual period under the percentage of completion method of accounting.
Under the percentage of completion method of accounting, sales and estimated
gross profit are recognized as work is completed and accepted by the customer by
utilizing the most recent estimates of cost to complete. Sales and gross profit
are adjusted prospectively for revisions in estimated total contract costs
during the period in which the information necessary to make the adjustment
becomes available. If the current contract estimate indicates a loss, provision
is made for the estimated loss when it becomes known and quantifiable. The
completed contract method of accounting is used for long-term contracts in those
circumstances under which estimated costs to complete the delivery cannot be
reasonably estimated or when the contract stipulates the entire balance due
under the contract is refundable if the product is not accepted by the customer.
Under the completed contract method of accounting, product sales are recorded
when the Company has substantially completed its obligations under the contract.
At May 25, 2002, the Company had advance payments from customers of
approximately $85.4 million, including amounts received from two customers in
Europe whose lottery systems are online and selling lottery tickets. The Company
currently expects to record product sales related to these two customers in
fiscal 2003 upon receipt of final acceptance letters.
RECEIVABLES AND INVENTORY RESERVES
The Company evaluates the collectibility of trade accounts and sales-type lease
receivables on a customer-by-customer basis and believes its reserves are
adequate; however, if economic circumstances change significantly resulting in a
major customer's inability to meet its financial obligation to the Company,
original estimates of the recoverability of amounts due the Company could be
reduced by significant amounts requiring additional reserves.
Inventories include amounts related to the Company's long-term service contracts
and product sales contracts, including product sales under long-term contracts,
and are stated at the lower of cost (first-in, first-out method) or market.
Provision for potentially obsolete or slow-moving inventory is made based on
management's analysis of inventory levels and future sales forecasts. The
Company believes its
-22-
reserves are adequate; however, should future sales forecasts change, the
Company's original estimates of obsolescence could increase by a significant
amount requiring additional reserves.
IMPAIRMENT OF GOODWILL AND OTHER INTANGIBLE AND LONG-LIVED ASSETS
The Company periodically evaluates the recoverability of goodwill and other
intangible and long-lived assets whenever events or changes in circumstances,
such as declines in revenues, earnings or cash flows or material adverse changes
in the economic stability of a particular country indicate that the carrying
amount of an asset may not be recoverable. If facts and circumstances were to
indicate that the Company's long-lived assets might be impaired, the estimated
future undiscounted cash flows associated with the long-lived assets would be
compared to their carrying amounts to determine if a write-down to fair value is
necessary.
Effect of New Accounting Pronouncements
On February 24, 2002, the Company adopted Statement of Financial Accounting
Standard No. 142 ("SFAS 142"), "Goodwill and Other Intangible Assets", which
requires companies to discontinue amortizing goodwill and certain intangible
assets with indefinite useful lives and requires an annual review for
impairment. Upon adoption, the Company discontinued the amortization of
goodwill. Amortization will continue to be recorded on other intangible assets
not classified as goodwill. The nonamortization provisions of SFAS 142 apply to
goodwill and intangible assets acquired after June 30, 2001. Upon adoption, net
goodwill of $1.3 million was reclassified into intangible assets within the
Lottery segment. Prior year net income and diluted earnings per share, excluding
amortization of goodwill, was $20.5 million, or $0.33 per diluted share.
Recent Developments
In the first quarter of fiscal 2003, the Company's Board of Directors approved a
2-for-1 common stock split effected in the form of a stock dividend distributed
on May 23, 2002 to shareholders of record on May 16, 2002.
Results of Operations
Revenues for the first quarter of fiscal 2003 were $231.4 million, down $3.6
million, or 1.5%, from revenues of $235.0 million in the first quarter of fiscal
2002.
Service revenues, including lottery and other services, in the fiscal 2003 first
quarter were $223.7 million, up $13.1 million, or 6.3%, over service revenues of
$210.6 million in the first quarter of fiscal 2002. This increase was primarily
driven by a $9.8 million increase in international lottery service revenues and
a $6.6 million increase in domestic lottery services revenues, partially offset
by the expiration of certain electronic benefit transfer contracts.
The Company's international lottery service revenues in the first quarter of
fiscal 2003 were $97.1 million, up $9.8 million, or 11.2%, over the $87.3
million recorded in the first quarter of fiscal 2002, primarily driven by
several new international contracts, including Jamaica and Taiwan.
The Company's domestic lottery service revenues were $125.9 million in the first
quarter of fiscal 2003, up $6.6 million, or 5.5%, over the $119.3 million
recorded in the same quarter of fiscal 2002. This increase was primarily due to
higher sales in states offering multi-state games.
-23-
Product sales in the first quarter of fiscal 2003 were $7.7 million, down $16.7
million from the $24.4 million of product sales in the first quarter of fiscal
2002. Product sales in the first quarter of the prior year included the sale of
an instant-ticket system and online lottery system to the Company's customers in
Israel and West Australia, respectively.
Gross margins on service revenues were 34.3% in the first quarter of fiscal 2003
compared to 31.4% in the first quarter of fiscal 2002, primarily due to higher
domestic service revenues and new international contracts.
Gross margins on product sales of 18.6% in the first quarter of fiscal 2003 were
comparable to the 18.3% in the same quarter last year.
Operating expenses in the first quarter of fiscal 2003 were $29.4 million, down
$9.3 million, or 24%, when compared with the $38.7 million of operating expenses
incurred in the first quarter of fiscal 2002. This decrease was primarily driven
by the Company's continued focus on operating efficiency, along with the benefit
of the adoption of the new accounting rule on goodwill, which eliminated
approximately $1.5 million of goodwill amortization in the first quarter of the
current year. As a percentage of revenues, operating expenses were 12.7% and
16.5% (15.8% adjusted for the change in goodwill accounting) during the first
quarters of fiscal 2003 and 2002, respectively.
Interest expense in the first quarter of fiscal 2003 was $2.9 million, a
decrease of $3.5 million, or 55%, from interest expense of $6.4 million incurred
during the first quarter of the prior year. This decrease was primarily due to
lower debt balances along with lower interest rates resulting from the Company's
debt restructuring in the fourth quarter of fiscal 2002.
Weighted average diluted shares in the first quarter of fiscal 2003 declined 3.4
million shares to 59.3 million shares, adjusted for the two-for-one stock split,
as a result of the Company's share repurchase program. The impact on the first
quarter of fiscal 2003 diluted earnings per share of the lower level of weighted
average shares in the first quarter of fiscal 2003 as compared to the first
quarter of fiscal 2002 was approximately $0.03 per diluted share.
Changes in Financial Position, Liquidity and Capital Resources
During the first quarter of fiscal 2003, the Company generated $91.4 million of
cash from operations, which was primarily used to fund the purchase of $53.0
million of systems, equipment and other assets relating to contracts and to
repurchase $37.7 million of the Company's common stock.
Trade accounts receivable decreased by $15.3 million, from $100.4 million at
February 23, 2002 to $85.1 million at May 25, 2002, primarily due to collections
related to product sales recorded in the fourth quarter of fiscal 2002, along
with collection of certain domestic service receivables.
Accounts payable decreased by $5.5 million, from $43.4 million at February 23,
2002 to $37.9 million at May 25, 2002, primarily due to the timing of payments
to vendors.
Employee compensation decreased by $14.8 million, from $37.9 million at February
23, 2002 to $23.1 million at May 25, 2002, primarily due to the payment of
fiscal 2002 management incentive compensation and employee profit sharing.
-24-
Advance payments from customers increased by $12.8 million, from $72.6 million
at February 23, 2002 to $85.4 million at May 25, 2002, primarily due to advances
received from customers related to product sales expected to be delivered during
the second half of fiscal 2003 and the first half of fiscal 2004.
Income taxes payable increased by $10.7 million, from $53.9 million at February
23, 2002 to $64.6 million at May 25, 2002, primarily due to the timing of income
tax payments.
Other liabilities increased by $4.8 million, from $28.0 million at February 23,
2002 to $32.8 million at May 25, 2002, primarily due to the deferral of revenue
related to the Company's joint venture in Taiwan. See Note K to the Consolidated
Financial Statements in the Company's fiscal 2002 Annual Report on Form 10-K for
further information.
At May 25, 2002, the Company's current liabilities exceeded its current assets
by $16.5 million, principally due to the $85.4 million of advance payments from
customers.
The Company's business is capital-intensive. Although it is not possible to
estimate precisely, the Company currently anticipates that net cash used for
investing activities in fiscal 2003 will be in a range of $170 million to $180
million. The principal sources of liquidity for the Company are expected to be
cash generated from operations and borrowings under the Company's credit
facility. The Company's credit facility provides for an unsecured revolving line
of credit of $300 million and matures in June 2006. As of May 25, 2002, there
were no borrowings under the credit facility. The Company currently expects that
its cash flow from operations and available borrowings under its credit facility
will be sufficient for the foreseeable future to fund its anticipated working
capital and ordinary capital expenditure needs, to service its debt obligations,
to fund anticipated internal growth and to repurchase shares of the Company's
common stock, from time to time, under the Company's share repurchase programs.
Off-Balance Sheet Arrangements
The Company has a 50% limited partnership interest in West Greenwich Technology
Associates, L.P. (the "Partnership"), which owns the Company's World
Headquarters facilities. The Company accounts for the Partnership using the
equity method. See Note K to the Consolidated Financial Statements in the
Company's fiscal 2002 Annual Report on Form 10-K for further information.
Guarantees
The Company has guaranteed, at May 25, 2002, approximately $7.9 million, or 44%,
of $17.9 million of loans made by an unrelated commercial lender to Lottery
Technology Services Corporation ("LTSC"), an entity in which the Company has a
44% equity interest. LTSC provides equipment and services, supplied by the
Company, to the Bank of Taipei, which holds the license to operate the Taiwan
Public Welfare Lottery. The loans have a maturity date of January 2007 and the
Company's guarantee expires in July 2007. See Note K to the Consolidated
Financial Statements in the Company's fiscal 2002 Annual Report on Form 10-K for
further information.
At May 25, 2002, the Company has guaranteed $2.6 million of lease obligations of
Times Squared Incorporated. The guarantee expires in December 2013. See Note F
to the Consolidated Financial Statements in the Company's fiscal 2002 Annual
Report on Form 10-K for further information.
-25-
Market Risk Disclosures
The primary market risk inherent in the Company's financial instruments and
exposures is the potential loss arising from adverse changes in interest rates
and foreign currency rates. The Company's exposure to commodity price changes is
not considered material and is managed through its procurement and sales
practices. The Company did not own any marketable equity securities during the
first quarter of fiscal 2003.
Interest rates
Interest rate market risk is estimated as the potential change in the fair value
of the Company's total debt or current earnings resulting from a hypothetical
10% adverse change in interest rates. At May 25, 2002, after taking into
consideration $135 million of interest rate swaps, the estimated fair value of
the Company's $135 million of fixed rate Senior Notes approximated $138.6
million. A hypothetical 10% adverse or favorable change in interest rates
applied to the fixed rate Senior Notes would not have a material effect on
current earnings. An independent investment banker determined the estimated fair
value amounts.
At May 25, 2002, the estimated fair value of the Company's $175 million
principal amount of 1.75% Convertible Debentures approximated $221.6 million. At
May 25, 2002, a hypothetical 10% increase in interest rates would reduce the
estimated fair value of the Convertible Debentures to $220.0 million and a
hypothetical 10% decrease in interest rates would increase the estimated fair
value of the Convertible Debentures to $223.2 million. An independent investment
banker determined the estimated fair value amounts.
A hypothetical 10% adverse or favorable change in interest rates applied to
variable rate debt would not have a material effect on current earnings.
The Company uses various techniques to mitigate the risk associated with future
changes in interest rates, including entering into interest rate swaps. At May
25, 2002, the Company had interest rate swaps of $135 million, which effectively
entitles the Company to exchange fixed rate payments for variable rate payments
during the period June 2001 to May 2007.
Equity price risk
At May 25, 2002, the estimated fair value of the Company's $175 million
principal amount of 1.75% Convertible Debentures approximated $221.6 million. At
May 25, 2002, a hypothetical 10% increase in the market price of the Company's
common stock would increase the estimated fair value of the Convertible
Debentures to $236.9 million and a hypothetical 10% decrease in the market price
of the Company's common stock would reduce the estimated fair value of the
Convertible Debentures to $207.3 million. An independent investment banker
determined the estimated fair value amounts.
Foreign Currency Exchange Rates
Foreign exchange exposures arise from current and anticipated transactions
denominated in currencies other than the Company's functional currency (United
States dollars) and from the translation of foreign currency balance sheet
accounts into United States dollar balance sheet accounts.
The Company seeks to manage its foreign exchange risk by securing payment from
its customers in United States dollars, by sharing risk with its customers, by
utilizing foreign currency borrowings, by
-26-
leading and lagging receipts and payments and by entering into foreign currency
exchange and option contracts. In addition, a significant portion of the costs
attributable to the Company's foreign currency revenues are payable in the local
currencies. Whenever possible, the Company negotiates clauses into its contracts
that allow for price adjustments should a material change in foreign exchange
rates occur.
The Company, from time to time, enters into foreign currency exchange and option
contracts to reduce the exposure associated with current transactions and
anticipated transactions denominated in foreign currencies. However, the Company
does not engage in currency speculation. At May 25, 2002, a hypothetical 10%
adverse change in foreign exchange rates would result in a translation loss of
$9.9 million that would be recorded in the equity section of the Company's
balance sheet.
At May 25, 2002, a hypothetical 10% adverse change in foreign exchange rates
would result in a net transaction loss of $2.5 million that would be recorded in
current earnings after considering the effects of foreign exchange contracts
currently in place.
At May 25, 2002, a hypothetical 10% adverse change in foreign exchange rates
would result in a net reduction of cash flows from anticipatory transactions
during the remainder of fiscal 2003 of $9.9 million, after considering the
effects of foreign exchange contracts currently in place. The percentage of
fiscal 2003 anticipatory cash flows that were hedged varied throughout the first
quarter of fiscal 2003, but averaged 28%.
As of May 25, 2002, the Company had contracts for the sale of foreign currency
of approximately $63.9 million (primarily pounds sterling, Brazilian real, Czech
koruna, and Euro) and the purchase of foreign currency of approximately $23.4
million (primarily pounds sterling and Mexican pesos).
-27-
Item 3. Quantitative and Qualitative Disclosures about Market Risk
See "Market Risk Disclosures" above.
PART II. OTHER INFORMATION
Item 1. LEGAL PROCEEDINGS
As previously reported, in February 1999, the Company was sued by a Florida
corporation called EIG Gaming International, Inc. ("EIG"), in the Circuit Court
of the Eleventh Judicial Circuit of Florida. The Company removed the case to the
U.S. District Court for the Southern District of Florida, where it was captioned
EIG Gaming International, Inc. v. GTECH Corporation, Case No.
99-1808-Civ-Jordan. In its complaint, EIG alleged that it entered into a Letter
of Intent with the Company pursuant to which it would assist the Company to
obtain the lottery contract for Peru in return for a percentage of the lottery's
receipts. EIG further contended that it secured the Peruvian contract for the
Company but that the Company thereupon declined to pursue it. Plaintiff claimed
damages exceeding $80 million. In November 2000, the Company moved for summary
judgment. In May 2002, the court granted the Company's motion for summary
judgment and entered final judgment with respect to the matter in favor of the
Company.
The Company was declared the apparent successful vendor in a competitive
procurement to supply a new online and instant ticket central system to
Westdeutsche Gmbtt & Co. ("WestLotto") for the lottery in the German state of
Nordrhein-Westfalen. A competitor protested the award with the Public
Procurement Tribunal of the Regional Regulatory Authority of Munster, Germany.
The tribunal found in favor of the competitor's challenge that WestLotto's
procurement should have been conducted in accordance with European Union public
contracting law instead of provincial contracting law. The Company has decided
to appeal the tribunal's decision and is currently coordinating with WestLotto
on this process.
For information respecting this and other legal proceedings, refer to Part I,
Item 1 - "Certain Factors That May Affect Future Performance," Part I, Item 3 -
"Legal Proceedings" and Note F to the Consolidated Financial Statements in the
Company's fiscal 2002 Annual Report on Form 10-K.
Item 6. EXHIBITS AND REPORTS ON FORM 8-K
(a) Exhibits - The exhibits to this report are as follows:
12.1 Computation of Ratio of Earnings to Fixed Charges
(b) Reports on Form 8-K - The Company filed the following reports with the
Securities and Exchange Commission on Form 8-K during the quarter to
which this report relates:
(i) The Company filed a report on Form 8-K on February 27, 2002
concerning the issuance of $175 million of 1.75% Convertible
Debentures on December 18, 2001 and filed condensed
consolidating financial information as required by Rule 3-10
of Regulation S-X.
(ii) The Company filed a report on Form 8-K on April 4, 2002
incorporating by reference a press release issued by the
Company on April 4, 2002 announcing its fiscal year 2002
fourth quarter and year-end results and revising earnings
guidance upward for fiscal year 2003.
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SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
GTECH HOLDINGS CORPORATION
Date: July 1, 2002 By /s/ Jaymin B. Patel
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Jaymin B. Patel, Senior Vice President and Chief
Financial Officer (Principal Financial Officer)
Date: July 1, 2002 By /s/ Robert J. Plourde
-------------------------------------------------
Robert J. Plourde, Vice President and Corporate
Controller (Principal Accounting Officer)
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