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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 November 23, 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 December 28, 2002, there were 56,522,801 shares of the registrant's Common
Stock outstanding.
INDEX
GTECH HOLDINGS CORPORATION AND SUBSIDIARIES
Page
Number
------
PART I. FINANCIAL INFORMATION
Item 1. Financial Statements
Consolidated Balance Sheets 3
Consolidated Income Statements 4-5
Consolidated Statements of Cash Flows 6
Consolidated Statements of Shareholders' Equity 7
Notes to Consolidated Financial Statements 8-23
Item 2. Management's Discussion and Analysis of Financial Condition 24-37
and Results of Operations
Item 3. Quantitative and Qualitative Disclosures about Market Risk 38
Item 4. Controls and Procedures 38
PART II. OTHER INFORMATION
Item 1. Legal Proceedings 38
Item 6. Exhibits and Reports on Form 8-K 39
SIGNATURES 40
CERTIFICATIONS 41-42
EXHIBITS
PART 1. FINANCIAL INFORMATION
Item 1. FINANCIAL STATEMENTS
CONSOLIDATED BALANCE SHEETS
GTECH HOLDINGS CORPORATION AND SUBSIDIARIES
(Unaudited)
November 23, February 23,
2002 2002
------------- -------------
(Dollars in thousands)
ASSETS
CURRENT ASSETS:
Cash and cash equivalents $ 97,509 $ 35,095
Trade accounts receivable 82,815 100,361
Sales-type lease receivables 4,454 4,894
Inventories 71,685 86,629
Deferred income taxes 28,321 28,321
Other current assets 18,369 22,730
------------- -------------
TOTAL CURRENT ASSETS 303,153 278,030
SYSTEMS, EQUIPMENT AND OTHER ASSETS RELATING TO CONTRACTS 398,157 369,595
GOODWILL 115,498 116,828
OTHER ASSETS 74,716 89,376
------------- -------------
TOTAL ASSETS $ 891,524 $ 853,829
============= =============
LIABILITIES AND SHAREHOLDERS' EQUITY
CURRENT LIABILITIES:
Short term borrowings $ 3,624 $ 2,358
Accounts payable 51,905 43,430
Accrued expenses 68,947 75,666
Employee compensation 29,911 37,941
Advance payments from customers 74,665 72,645
Income taxes payable 47,306 53,928
Current portion of long-term debt 6,600 3,510
------------- -------------
TOTAL CURRENT LIABILITIES 282,958 289,478
LONG-TERM DEBT, less current portion 287,974 329,715
OTHER LIABILITIES 41,255 27,986
DEFERRED INCOME TAXES 4,825 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; 56,739,848 and 57,491,256 shares
outstanding at November 23, 2002 and February 23, 2002, respectively (shares adjusted
to reflect May 2002 two-for-one stock split) 923 461
Additional paid-in capital 241,536 234,247
Equity carryover basis adjustment (7,008) (7,008)
Accumulated other comprehensive loss (97,155) (100,815)
Retained earnings 641,934 542,878
------------- -------------
780,230 669,763
Less cost of 35,556,556 and 34,806,148 shares in treasury at
November 23, 2002 and February 23, 2002, respectively (shares adjusted to reflect
May 2002 two-for-one stock split) (505,718) (466,808)
------------- -------------
274,512 202,955
------------- -------------
TOTAL LIABILITIES AND SHAREHOLDERS' EQUITY $ 891,524 $ 853,829
============= =============
See Notes to Consolidated Financial Statements
-3-
CONSOLIDATED INCOME STATEMENTS
GTECH HOLDINGS CORPORATION AND SUBSIDIARIES
(Unaudited)
Three Months Ended
-----------------------------
November 23, November 24,
2002 2001
------------ ------------
(Dollars in thousands,
except per share amounts)
Revenues:
Services $ 207,784 $ 196,427
Sales of products 48,682 67,152
------------ ------------
256,466 263,579
Costs and expenses:
Costs of services 129,122 138,346
Costs of sales 39,070 51,147
------------ ------------
168,192 189,493
------------ ------------
Gross profit 88,274 74,086
Selling, general and administrative 24,358 26,692
Research and development 10,903 7,980
Goodwill amortization - 1,493
------------ ------------
Operating expenses 35,261 36,165
------------ ------------
Operating income 53,013 37,921
Other income (expense):
Interest income 1,028 1,070
Equity in earnings of unconsolidated affiliates 1,406 1,255
Other income 234 250
Interest expense (2,728) (5,624)
------------ ------------
(60) (3,049)
------------ ------------
Income before income taxes 52,953 34,872
Income taxes 20,122 13,251
------------ ------------
Net income $ 32,831 $ 21,621
============ ============
Basic earnings per share $ 0.58 $ 0.37
============ ============
Diluted earnings per share $ 0.57 $ 0.37
============ ============
See Notes to Consolidated Financial Statements
-4-
CONSOLIDATED INCOME STATEMENTS
GTECH HOLDINGS CORPORATION AND SUBSIDIARIES
(Unaudited)
Nine Months Ended
-----------------------------
November 23, November 24,
2002 2001
------------ ------------
(Dollars in thousands,
except per share amounts)
Revenues:
Services $ 643,119 $ 616,597
Sales of products 65,717 118,531
------------ ------------
708,836 735,128
Costs and expenses:
Costs of services 402,999 426,430
Costs of sales 49,426 94,747
------------ ------------
452,425 521,177
------------ ------------
Gross profit 256,411 213,951
Selling, general and administrative 70,168 83,343
Research and development 24,575 23,949
Goodwill amortization - 4,556
------------ ------------
Operating expenses 94,743 111,848
------------ ------------
Operating income 161,668 102,103
Other income (expense):
Interest income 2,847 4,324
Equity in earnings of unconsolidated affiliates 3,363 3,830
Other income 1,912 743
Interest expense (8,371) (18,475)
------------ ------------
(249) (9,578)
------------ ------------
Income before income taxes 161,419 92,525
Income taxes 61,340 35,159
------------ ------------
Net income $ 100,079 $ 57,366
============ ============
Basic earnings per share $ 1.75 $ 0.96
============ ============
Diluted earnings per share $ 1.71 $ 0.94
============ ============
See Notes to Consolidated Financial Statements
-5-
CONSOLIDATED STATEMENTS OF CASH FLOWS
GTECH HOLDINGS CORPORATION AND SUBSIDIARIES
(Unaudited)
Nine Months Ended
-----------------------------
November 23, November 24,
2002 2001
------------ ------------
(Dollars in thousands)
OPERATING ACTIVITIES
Net income $ 100,079 $ 57,366
Adjustments to reconcile net income to net cash provided by
operating activities:
Depreciation 101,858 118,483
Intangibles amortization 4,051 6,356
Goodwill amortization - 4,556
Termination of interest rate swaps 11,357 -
Tax benefit related to stock award plans 7,299 -
Deferred income taxes provision 1,130 -
Asset impairment charges - 9,313
Equity in earnings of unconsolidated affiliates, net of dividends received 559 (588)
Other 4,568 (2,145)
Changes in operating assets and liabilities:
Trade accounts receivable 11,723 27,332
Inventories 14,944 12,055
Special charge (364) (6,272)
Other assets and liabilities 23,760 26,865
------------ ------------
NET CASH PROVIDED BY OPERATING ACTIVITIES 280,964 253,321
INVESTING ACTIVITIES
Purchases of systems, equipment and other assets relating to contracts (131,221) (146,117)
Investments in and advances to unconsolidated subsidiaries - 3,786
Proceeds from the sale of majority interest in a subsidiary - 10,000
Proceeds from sale of investments - 2,098
Other (1,350) (3,556)
------------ ------------
NET CASH USED FOR INVESTING ACTIVITIES (132,571) (133,789)
FINANCING ACTIVITIES
Net proceeds from issuance of long-term debt - 186,000
Principal payments on long-term debt (46,408) (182,298)
Purchases of treasury stock (57,424) (194,389)
Proceeds from stock options 15,842 40,968
Tender premiums and fees (3,434) -
Other 2,926 (1,056)
------------ ------------
NET CASH USED FOR FINANCING ACTIVITIES (88,498) (150,775)
Effect of exchange rate changes on cash 2,519 (4,272)
------------ ------------
INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS 62,414 (35,515)
Cash and cash equivalents at beginning of period 35,095 46,948
------------ ------------
CASH AND CASH EQUIVALENTS AT END OF PERIOD $ 97,509 $ 11,433
============ ============
See Notes to Consolidated Financial Statements
-6-
CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY - (Unaudited)
GTECH HOLDINGS CORPORATION AND SUBSIDIARIES
Equity Accumulated
Additional Carryover Other
Outstanding Common Paid-in Basis Comprehensive Retained Treasury
Shares Stock Capital Adjustment Income (Loss) Earnings Stock Total
----------- ------ ---------- ---------- ------------- --------- ---------- ---------
(Dollars in thousands)
Balance at February 23, 2002 57,491,256 $ 461 $ 234,247 $ (7,008) $ (100,815) $ 542,878 $ (466,808) $ 202,955
Comprehensive income:
Net income - - - - - 100,079 - 100,079
Other comprehensive income
(loss), net of tax:
Foreign currency translation,
net of tax benefits of
$13 million - - - - 4,907 - - 4,907
Net loss on derivative
instruments - - - - (1,143) - - (1,143)
Unrealized loss on
investments - - - - (104) - - (104)
---------
Comprehensive income 103,739
Treasury shares purchased (2,101,100) - - - - - (57,424) (57,424)
Shares issued under employee
stock purchase and stock
award plans 144,992 - - - - 104 1,997 2,101
Shares issued upon exercise
of stock options 1,204,700 - (10) - - (665) 16,517 15,842
Tax benefits related to stock
award plans - - 7,299 - - - - 7,299
May 2002 two-for-one stock
split - 462 - - - (462) - -
----------- ------ ---------- ---------- ------------- --------- ---------- ---------
Balance at November 23, 2002 56,739,848 $ 923 $ 241,536 $ (7,008) $ (97,155) $ 641,934 $ (505,718) $ 274,512
=========== ====== ========== ========== ============= ========= ========== =========
See Notes to Consolidated Financial Statements
-7-
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, the parent of GTECH Corporation ("GTECH"), have been prepared in
accordance with generally accepted accounting principles ("GAAP") for interim
financial information and with the instructions to Form 10-Q and Article 10 of
Regulation S-X. They do not include all of the information and notes required by
GAAP for complete financial statements. In the opinion of management, all
adjustments (consisting of normal recurring accruals) considered necessary for a
fair presentation have been included. Operating results for the three and nine
month periods ended November 23, 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 included in our fiscal 2002
Annual Report on Form 10-K.
The terms "Holdings", "the Company", "we", "our", and "us" refer to GTECH
Holdings Corporation and its consolidated subsidiaries, unless otherwise
specified.
Certain amounts in our prior period financial statements have been reclassified
to conform to the current period presentation.
NOTE B - COMMON STOCK SPLIT
In the first quarter of this fiscal year, our Board of Directors approved a
2-for-1 common stock split that was distributed in the form of a stock dividend
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
November 23, February 23,
2002 2002
------------ ------------
(Dollars in thousands)
Inventories consist of:
Raw materials $ 9,991 $ 12,310
Work in progress 56,512 72,847
Finished goods 5,182 1,472
------------ ------------
$ 71,685 $ 86,629
============ ============
Inventories include amounts related to our long-term service contracts and
product sales contracts and are stated at the lower of cost (first-in, first-out
method) or market. Work in progress is primarily comprised of inventory related
to product sales contracts, certain of which we are awaiting final customer
acceptance.
-8-
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)
NOTE D - LONG-TERM DEBT
November 23, 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
7.87% Series B Senior Notes due 2007 95,000 95,000
Interest rate swaps 15,602 12,089
Other 8,972 11,136
-------------- --------------
294,574 333,225
Less current portion 6,600 3,510
-------------- --------------
$ 287,974 $ 329,715
============== ==============
During the third quarter of fiscal 2003, we used cash on hand to repurchase $40
million of our 2004 Series A Senior Notes. In connection with this repurchase,
we paid tender premiums to the holders of the notes and incurred associated fees
totaling $3.4 million. This amount, along with the write-off of $0.1 million of
debt issuance costs, net of $1.2 million in proceeds from the sale, as noted
below, of certain interest rate swaps associated with these notes, are netted
against other income in our Consolidated Income Statements.
During the third quarter of fiscal 2003, we sold $135 million of interest rate
swaps for $13.1 million, the proceeds of which were applied as follows:
Sale of interest rate swaps related to:
---------------------------------------------
2004 Senior 2007 Senior
Notes Notes Total
------------- ------------- -------------
(Dollars in thousands)
Long-term debt $ --- $10,023 $10,023
Accounts receivable 364 1,413 1,777
Other income 1,264 --- 1,264
Interest expense 70 --- 70
------ ------- -------
$1,698 $11,436 $13,134
====== ======= =======
In accordance with Financial Accounting Standards Board Statement 133, the $10.0
million addition to long-term debt will be amortized as a reduction of interest
expense through the due date of the Series B Senior Notes (May 2007). The $1.8
million applied to accounts receivable represents receivables from banks for
interest rate resets that were effective on May 15, 2002 and August 15, 2002.
We have an unsecured revolving credit facility of $300 million expiring in June
2006 (the "Credit Facility"). There were no outstanding borrowings under the
Credit Facility at November 23, 2002 or February 23, 2002.
NOTE E - INCOME TAXES
Our effective income tax rate is greater than the statutory rate primarily due
to state income taxes and certain expenses that are not deductible for income
tax purposes.
-9-
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)
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 of
this report.
NOTE G - EARNINGS PER SHARE
The computation of basic and diluted earnings per share is as follows:
Three Months Ended Nine Months Ended
----------------------------- -----------------------------
November 23, November 24, November 23, November 24,
2002 2001 2002 2001
------------ ------------ ------------ ------------
(Dollars and shares in thousands, except per share amounts)
Numerator:
Net income $ 32,831 $ 21,621 $ 100,079 $ 57,366
============ ============ ============ ============
Denominator:
Weighted average shares-Basic 56,981 57,790 57,252 59,462
Effect of dilutive securities:
Employee stock options and
unvested restricted shares 1,081 1,398 1,277 1,266
------------ ------------ ------------ ------------
Weighted average shares-Diluted 58,062 59,188 58,529 60,728
============ ============ ============ ============
Basic earnings per share $ .58 $ .37 $ 1.75 $ .96
============ ============ ============ ============
Diluted earnings per share $ .57 $ .37 $ 1.71 $ .94
============ ============ ============ ============
NOTE H - COMPREHENSIVE INCOME
The components of comprehensive income are as follows:
Three Months Ended Nine Months Ended
----------------------------- -----------------------------
November 23, November 24, November 23, November 24,
2002 2001 2002 2001
------------ ------------ ------------ ------------
(Dollars in thousands)
Net income $ 32,831 $ 21,621 $ 100,079 $ 57,366
Other comprehensive income (loss),
net of tax
Foreign currency translation 10,814 (1,598) 4,907 (14,929)
Net gain (loss) on derivative instruments 129 2,413 (1,143) 281
Unrealized loss on investments (32) (6) (104) (42)
------------ ------------ ------------ ------------
Comprehensive income $ 43,742 $ 22,430 $ 103,739 $ 42,676
============ ============ ============ ============
-10-
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)
NOTE I - SEGMENT INFORMATION
We presently have 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 our Transactive subsidiary,
which provides electronic benefit transfer services over our dedicated network
infrastructure. The composition of the "All Other" category for the three months
and nine months ended November 24, 2001 has been revised to include our
IGI/Europrint business unit in the Lottery segment because management considers
it a component of the Lottery segment.
Our business segment data is summarized below:
Three Months Ended Nine Months Ended
---------------------------------- ---------------------------------
November 23, November 24, November 23, November 24,
2002 2001 2002 2001
--------------- -------------- -------------- --------------
(Dollars in thousands)
Revenues from external sources:
Lottery $ 255,624 $ 261,497 $ 706,549 $ 726,172
All other 842 2,082 2,287 8,956
--------------- -------------- -------------- --------------
Consolidated $ 256,466 $ 263,579 $ 708,836 $ 735,128
=============== ============== ============== ==============
Net operating profit after income taxes:
Lottery $ 34,730 $ 25,594 $ 105,755 $ 71,032
All other 139 431 167 65
--------------- -------------- -------------- --------------
Consolidated $ 34,869 $ 26,025 $ 105,922 $ 71,097
=============== ============== ============== ==============
A reconciliation of net operating profit after income taxes to net income as
reported on the Consolidated Income Statements is as follows:
Three Months Ended Nine Months Ended
---------------------------------- ---------------------------------
November 23, November 24, November 23, November 24,
2002 2001 2002 2001
--------------- -------------- -------------- --------------
(Dollars in thousands)
Net operating profit after income taxes $ 34,869 $ 26,025 $ 105,922 $ 71,097
Reconciling items, net of tax:
Interest expense (1,691) (3,486) (5,190) (11,454)
Other (347) (918) (653) (2,277)
--------------- -------------- -------------- --------------
Net income $ 32,831 $ 21,621 $ 100,079 $ 57,366
=============== ============== ============== ==============
November 23, February 23,
2002 2002
--------------- --------------
(Dollars in thousands)
Segment assets:
Lottery $ 887,544 $ 848,162
All other 3,980 5,667
--------------- --------------
Consolidated $ 891,524 $ 853,829
=============== ==============
-11-
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)
NOTE J - SPECIAL CHARGES
In fiscal 2001, we recorded special charges of $42.3 million in connection with
certain contractual obligations and a value assessment of our business
operations. See Note P to the Consolidated Financial Statements in our 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 our 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 (140) (279) - 55 (364)
------------- ------------- --------------- ----------- -----------
Balance at November 23, 2002 $ 1,468 $ 525 $ - $ 79 $ 2,072
============= ============= =============== =========== ===========
NOTE K - GOODWILL AND OTHER INTANGIBLE ASSETS
During the first quarter of this fiscal year, we adopted Statement of Financial
Accounting Standards No. 142 ("SFAS 142"), "Goodwill and Other Intangible
Assets", which requires, among other things, that we no longer amortize goodwill
and certain other indefinite-lived intangible assets, but instead test them at
least annually for impairment. In connection with the adoption of the new
standard, we determined that goodwill with a net book value of $1.3 million
(within the Lottery segment) met the standards' intangible asset recognition
criteria. Accordingly, we reclassified this amount into intangible assets and we
will continue to amortize it over its remaining useful life.
-12-
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)
NOTE K - GOODWILL AND OTHER INTANGIBLE ASSETS (continued)
The following table presents the impact of SFAS 142 on net income and earnings
per share had the standard been in effect for the three and nine month periods
ended November 24, 2001:
Three Nine
Months Ended Months Ended
November 24, November 24,
2001 2001
---------------- ----------------
(Dollars in thousands, except per share data)
Net income as reported $ 21,621 $ 57,366
Add back amortization 1,427 4,282
---------------- ----------------
Adjusted net income $ 23,048 $ 61,648
================ ================
Basic earnings per share as reported $ .37 $ .96
Add back amortization .03 .08
---------------- ----------------
Adjusted earnings per share - basic $ .40 $ 1.04
================ ================
Diluted earnings per share as reported $ .37 $ .94
Add back amortization .02 .08
---------------- ----------------
Adjusted earnings per share - diluted $ .39 $ 1.02
================ ================
Intangible assets, which are included in other assets in our Consolidated
Balance Sheets, are comprised of the following:
As of November 23, 2002
--------------------------------------------------------------
Gross Carrying Accumulated Net Carrying
Amount Amortization Amount
----------------- ------------ --------------
(Dollars in thousands)
Capitalized software $ 13,255 $ 11,517 $ 1,738
Other 1,853 719 1,134
----------------- -------------- --------------
Total intangible assets $ 15,108 $ 12,236 $ 2,872
================= =============== ==============
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
================= ============== ==============
-13-
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)
NOTE K - GOODWILL AND OTHER INTANGIBLE ASSETS (continued)
A reconciliation of the net carrying amount of intangible assets as of February
23, 2002 to November 23, 2002 is as follows (in thousands):
Net Carrying
Amount
--------------
Balance as of February 23, 2002 $ 5,592
Reclassification from goodwill, net 1,331
Amortization expense (4,051)
--------------
Balance as of November 23, 2002 $ 2,872
==============
Amortization expense for the nine months ended November 23, 2002 and the fiscal
year ended February 23, 2002 is as follows:
Nine Months Ended Fiscal Year Ended
November 23, February 23,
2002 2002
---------------- ----------------
(Dollars in thousands)
Contract based $ 2,004 $ 4,007
Capitalized software 1,850 4,223
Other 197 193
---------------- ----------------
Total amortization $ 4,051 $ 8,423
================ ================
Amortization expense for the next five fiscal years is estimated to be as
follows (in thousands):
Fiscal Amortization
Year Expense
- ---------- --------------
2003 $ 4,733
2004 1,383
2005 262
2006 262
2007 262
-14-
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)
NOTE L - NEW ACCOUNTING PRONOUNCEMENTS
In April 2002, the Financial Accounting Standards Board ("FASB") issued
Statement of Financial Accounting Standards No. 145 ("SFAS 145"), "Rescission of
FASB Statements No. 4, 44, and 64, Amendment of FASB Statement No. 13, and
Technical Corrections". Among other things, SFAS 145 rescinds Statement of
Financial Accounting Standards No. 4 ("SFAS 4"), "Reporting Gains and Losses
from Extinguishment of Debt" and eliminates the requirement that gains and
losses from the extinguishment of debt be classified as an extraordinary item,
net of related income tax effects, unless the criteria in Accounting Principles
Board Opinion No. 30, "Reporting the Results of Operations - Reporting the
Effects of Disposal of a Segment of a Business, and Extraordinary, Unusual and
Infrequently Occurring Events and Transactions" are met. We are required to
adopt the standard beginning on February 23, 2003 (the first day of fiscal
2004). We early adopted SFAS 145 on August 25, 2002 (the first day of our fiscal
2003 third quarter) and will reclassify, in the fourth quarter of fiscal 2003,
the $12.5 million ($7.8 million after-tax) extraordinary charge we recorded in
the fourth quarter of the prior fiscal year into other expense in our
Consolidated Income Statements.
In June 2002, the FASB issued Statement of Financial Accounting Standards
No. 146 ("SFAS 146"), "Accounting for Costs Associated With Exit or Disposal
Activities". SFAS 146 nullifies Emerging Issues Task Force Issue No. 94-3 ("EITF
94-3"), "Liability Recognition for Certain Employee Termination Benefits and
Other Costs to Exit an Activity (Including Certain Costs Incurred in a
Restructuring)". SFAS 146 requires that a liability for a cost associated with
an exit or disposal activity be recognized when the liability is incurred.
Therefore, SFAS 146 eliminates the definition and requirements for recognition
of exit costs in EITF 94-3. The provisions of SFAS 146 are effective for exit or
disposal activities that are initiated after December 31, 2002. We do not expect
the adoption of this statement to have a material impact on our consolidated
financial statements.
In November 2002, the FASB issued Interpretation No. 45, "Guarantor's Accounting
and Disclosure Requirements for Guarantees, Including Indirect Guarantees of
Indebtedness of Others", which requires certain guarantees to be recorded at
fair value as opposed to the current practice of recording a liability only when
a loss is probable and reasonably estimable and also requires a guarantor to
make significant new guaranty disclosures, even when the likelihood of making
any payments under the guarantee is remote. The Interpretation's initial
recognition and initial measurement provisions are applicable on a prospective
basis to guarantees issued or modified after December 31, 2002. We are required
to adopt the disclosure requirements beginning on November 24, 2002 (the first
day of our fiscal 2003 fourth quarter). We are currently evaluating the effects
this Interpretation may have on our consolidated financial statements.
In November 2002, the Emerging Issues Task Force ("EITF") reached a consensus on
EITF Issue No. 00-21, "Multiple-Deliverable Revenue Arrangements", which
provides guidance on how to account for arrangements that may involve the
delivery or performance of multiple products, services, and/or rights to use
assets. The final consensus is applicable to agreements entered into in fiscal
periods beginning after June 15, 2003 with early adoption permitted.
Additionally, companies will be allowed to apply the guidance to all existing
arrangements as the cumulative effect of a change in accounting principle in
accordance with Accounting Principles Board Opinion No. 20, "Accounting
Changes". We are required to adopt the provisions of this EITF beginning on
September 27, 2003 (the first day of our fiscal 2004 third quarter). We are
currently evaluating the effects this EITF may have on our consolidated
financial statements.
-15-
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)
NOTE M - 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 our consolidated effective income tax
rates.
-16-
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)
NOTE M - SUPPLEMENTAL GUARANTOR/NON-GUARANTOR FINANCIAL INFORMATION
(continued)
Condensed Consolidating Balance Sheets
November 23, 2002
Parent Guarantor Non-Guarantor Eliminating
Company Subsidiaries Subsidiaries Entries Consolidated
------------- -------------- ------------- ------------- --------------
(Dollars in thousands)
Assets
Current Assets:
Cash and cash equivalents $ - $ 80,067 $ 17,442 $ - $ 97,509
Trade accounts receivable - 62,711 20,104 - 82,815
Due from subsidiaries and
affiliates - 42,879 - (42,879) -
Sales-type lease receivables - 2,334 2,120 - 4,454
Inventories - 46,705 52,813 (27,833) 71,685
Deferred income taxes - 25,264 3,057 - 28,321
Other current assets - 7,032 11,337 - 18,369
------------- ------------- ------------- ------------ --------------
Total Current Assets - 266,992 106,873 (70,712) 303,153
Systems, Equipment and Other
Assets Relating to Contracts - 335,985 87,706 (25,534) 398,157
Investment in Subsidiaries and
Affiliates 274,512 89,660 - (364,172) -
Goodwill - 70,605 44,893 - 115,498
Other Assets - 58,395 16,321 - 74,716
------------- ------------- ------------- ------------- --------------
Total Assets $ 274,512 $ 821,637 $ 255,793 $ (460,418) $ 891,524
============= ============= ============= ============= ==============
Liabilities and Shareholders' Equity
Current Liabilities:
Short term borrowings $ - $ - $ 3,624 $ - $ 3,624
Accounts payable - 41,781 10,124 - 51,905
Due to subsidiaries and affiliates - - 42,879 (42,879) -
Accrued expenses - 51,894 17,053 - 68,947
Employee compensation - 24,453 5,458 - 29,911
Advance payments from
customers - 12,876 61,789 - 74,665
Income taxes payable - 42,353 4,953 - 47,306
Current portion of long-term debt - 3,524 3,076 - 6,600
------------- ------------- ------------- ------------- --------------
Total Current Liabilities - 176,881 148,956 (42,879) 282,958
Long-Term Debt, less current
portion - 282,078 5,896 - 287,974
Other Liabilities - 26,052 15,203 - 41,255
Deferred Income Taxes - 8,747 (3,922) - 4,825
Shareholders' Equity 274,512 327,879 89,660 (417,539) 274,512
------------- ------------- ------------- ------------- --------------
Total Liabilities and
Shareholders' Equity $ 274,512 $ 821,637 $ 255,793 $ (460,418) $ 891,524
============= ============= ============= ============= ==============
-17-
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)
NOTE M - SUPPLEMENTAL GUARANTOR/NON-GUARANTOR FINANCIAL INFORMATION
(continued)
Condensed Consolidating Income Statements
Three Months Ended November 23, 2002
Parent Guarantor Non-Guarantor Eliminating
Company Subsidiaries Subsidiaries Entries Consolidated
------------- -------------- ------------- ------------- --------------
(Dollars in thousands)
Revenues:
Services $ - $ 156,069 $ 51,715 $ - $ 207,784
Sales of products - 43,266 5,416 - 48,682
Intercompany sales and fees - 19,858 11,956 (31,814) -
------------- ------------- ------------- ------------- --------------
- 219,193 69,087 (31,814) 256,466
Costs and expenses:
Costs of services - 93,275 38,846 (2,999) 129,122
Costs of sales - 35,222 3,968 (120) 39,070
Intercompany cost of sales
and fees - 14,835 5,739 (20,574) -
------------- ------------- ------------- ------------- --------------
- 143,332 48,553 (23,693) 168,192
------------- ------------- ------------- ------------- --------------
Gross profit - 75,861 20,534 (8,121) 88,274
Selling, general & administrative - 18,958 5,400 - 24,358
Research and development - 8,421 2,482 - 10,903
------------- ------------- ------------- ------------- --------------
Operating expenses - 27,379 7,882 - 35,261
------------- ------------- ------------- ------------- --------------
Operating income - 48,482 12,652 (8,121) 53,013
Other income (expense):
Interest income - 514 514 - 1,028
Equity in earnings of
unconsolidated affiliates - 289 1,117 - 1,406
Equity in earnings of
consolidated affiliates 32,831 10,976 - (43,807) -
Other income (expense) - (3,562) 3,796 - 234
Interest expense - (2,351) (377) - (2,728)
------------- ------------- ------------- ------------- --------------
32,831 5,866 5,050 (43,807) (60)
------------- ------------- ------------- ------------- --------------
Income before income taxes 32,831 54,348 17,702 (51,928) 52,953
Income taxes - 20,652 6,726 (7,256) 20,122
------------- ------------- ------------- ------------- --------------
Net income $ 32,831 $ 33,696 $ 10,976 $ (44,672) $ 32,831
============= ============= ============= ============= ==============
-18-
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)
NOTE M - SUPPLEMENTAL GUARANTOR/NON-GUARANTOR FINANCIAL INFORMATION
(continued)
Condensed Consolidating Income Statements
Nine Months Ended November 23, 2002
Parent Guarantor Non-Guarantor Eliminating
Company Subsidiaries Subsidiaries Entries Consolidated
------------- -------------- ------------- ------------- --------------
(Dollars in thousands)
Revenues:
Services $ - $ 487,222 $ 155,897 $ - $ 643,119
Sales of products - 53,401 12,316 - 65,717
Intercompany sales and fees - 68,642 36,866 (105,508) -
------------- ------------- ------------- ------------- --------------
- 609,265 205,079 (105,508) 708,836
Costs and expenses:
Costs of services - 287,529 123,885 (8,415) 402,999
Costs of sales - 41,078 8,783 (435) 49,426
Intercompany cost of sales
and fees - 43,619 13,026 (56,645) -
------------- ------------- ------------- ------------- --------------
- 372,226 145,694 (65,495) 452,425
------------- ------------- ------------- ------------- --------------
Gross profit - 237,039 59,385 (40,013) 256,411
Selling, general & administrative - 53,515 16,653 - 70,168
Research and development - 18,738 5,837 - 24,575
------------- ------------- ------------- ------------- --------------
Operating expenses - 72,253 22,490 - 94,743
------------- ------------- ------------- ------------- --------------
Operating income - 164,786 36,895 (40,013) 161,668
Other income (expense):
Interest income - 1,263 1,584 - 2,847
Equity in earnings of
unconsolidated affiliates - 585 2,778 - 3,363
Equity in earnings of
consolidated affiliates 100,079 29,206 - (129,285) -
Other income (expense) - (5,233) 7,145 - 1,912
Interest expense - (7,075) (1,296) - (8,371)
------------- ------------- ------------- ------------- --------------
100,079 18,746 10,211 (129,285) (249)
------------- ------------- ------------- ------------- --------------
Income before income taxes 100,079 183,532 47,106 (169,298) 161,419
Income taxes - 69,742 17,900 (26,302) 61,340
------------- ------------- ------------- ------------- --------------
Net income $ 100,079 $ 113,790 $ 29,206 $ (142,996) $ 100,079
============= ============= ============= ============= ==============
-19-
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)
NOTE M - SUPPLEMENTAL GUARANTOR/NON-GUARANTOR FINANCIAL INFORMATION
(continued)
Condensed Consolidating Income Statements
Three Months Ended November 24, 2001
Parent Guarantor Non-Guarantor Eliminating
Company Subsidiaries Subsidiaries Entries Consolidated
------------- -------------- ------------- ------------- --------------
(Dollars in thousands)
Revenues:
Services $ - $ 153,573 $ 42,854 $ - $ 196,427
Sales of products - 53,391 13,735 26 67,152
Intercompany sales and fees - 38,283 33,938 (72,221) -
------------- ------------- ------------- ------------- --------------
- 245,247 90,527 (72,195) 263,579
Costs and expenses:
Costs of services - 96,676 44,164 (2,494) 138,346
Costs of sales - 44,529 6,613 5 51,147
Intercompany cost of sales
and fees - 35,486 16,872 (52,358) -
------------- ------------- ------------- ------------- --------------
- 176,691 67,649 (54,847) 189,493
------------- ------------- ------------- ------------- --------------
Gross profit - 68,556 22,878 (17,348) 74,086
Selling, general & administrative - 21,065 5,627 - 26,692
Research and development - 6,289 1,691 - 7,980
Goodwill amortization - 632 861 - 1,493
------------- ------------- ------------- ------------- --------------
Operating expenses - 27,986 8,179 - 36,165
------------- ------------- ------------- ------------- --------------
Operating income - 40,570 14,699 (17,348) 37,921
Other income (expense):
Interest income - 279 791 - 1,070
Equity in earnings of
unconsolidated affiliates - 311 944 - 1,255
Equity in earnings of
consolidated affiliates 21,621 10,546 - (32,167) -
Other income (expense) - (723) 973 - 250
Interest expense - (5,226) (398) - (5,624)
------------- ------------- ------------- ------------- --------------
21,621 5,187 2,310 (32,167) (3,049)
------------- ------------- ------------- ------------- --------------
Income before income taxes 21,621 45,757 17,009 (49,515) 34,872
Income taxes - 17,388 6,463 (10,600) 13,251
------------- ------------- ------------- ------------- --------------
Net income $ 21,621 $ 28,369 $ 10,546 $ (38,915) $ 21,621
============= ============= ============= ============= ==============
-20-
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)
NOTE M - SUPPLEMENTAL GUARANTOR/NON-GUARANTOR FINANCIAL INFORMATION
(continued)
Condensed Consolidating Income Statements
Nine Months Ended November 24, 2001
Parent Guarantor Non-Guarantor Eliminating
Company Subsidiaries Subsidiaries Entries Consolidated
------------- -------------- ------------- ------------- --------------
(Dollars in thousands)
Revenues:
Services $ - $ 469,721 $ 146,876 $ - $ 616,597
Sales of products - 90,985 27,546 118,531
Intercompany sales and fees - 100,770 69,408 (170,178) -
------------- ------------- ------------- ------------- --------------
- 661,476 243,830 (170,178) 735,128
Costs and expenses:
Costs of services - 299,052 134,704 (7,326) 426,430
Costs of sales - 79,895 15,158 (306) 94,747
Intercompany cost of sales
and fees - 81,609 35,087 (116,696) -
------------- ------------- ------------- -------------- --------------
- 460,556 184,949 (124,328) 521,177
------------- ------------- ------------- ------------- --------------
Gross profit - 200,920 58,881 (45,850) 213,951
Selling, general & administrative - 63,564 19,779 - 83,343
Research and development - 18,263 5,686 - 23,949
Goodwill amortization - 1,897 2,659 - 4,556
------------- ------------- ------------- ------------- --------------
Operating expenses - 83,724 28,124 - 111,848
------------- ------------- ------------- ------------- --------------
Operating income - 117,196 30,757 (45,850) 102,103
Other income (expense):
Interest income - 1,707 2,617 - 4,324
Equity in earnings of
unconsolidated affiliates - 850 2,980 - 3,830
Equity in earnings of
consolidated affiliates 57,366 25,924 - (83,290) -
Other income (expense) - (6,350) 7,093 - 743
Interest expense - (16,841) (1,634) - (18,475)
------------- ------------- ------------- ------------- --------------
57,366 5,290 11,056 (83,290) (9,578)
------------- ------------- ------------- ------------- --------------
Income before income taxes 57,366 122,486 41,813 (129,140) 92,525
Income taxes - 46,545 15,889 (27,275) 35,159
------------- ------------- ------------- ------------- --------------
Net income $ 57,366 $ 75,941 $ 25,924 $ (101,865) $ 57,366
============= ============= ============= ============= ==============
-21-
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)
NOTE M - SUPPLEMENTAL GUARANTOR/NON-GUARANTOR FINANCIAL INFORMATION
(continued)
Condensed Consolidating Statements of Cash Flows
Nine Months Ended November 23, 2002
Parent Guarantor Non-Guarantor Eliminating
Company Subsidiaries Subsidiaries Entries Consolidated
------------- -------------- ------------- ------------- --------------
(Dollars in thousands)
Net cash provided by operating
activities $ - $ 252,905 $ 27,973 $ 86 $ 280,964
Investing Activities
Purchases of systems, equipment
and other assets relating to
contracts - (121,396) (9,739) (86) (131,221)
Other - (1,350) - - (1,350)
------------- ------------- ------------- ------------- --------------
Net cash used for investing
activities - (122,746) (9,739) (86) (132,571)
Financing Activities
Principal payments on long-term
debt - (42,989) (3,419) - (46,408)
Purchases of treasury stock (57,424) - - - (57,424)
Proceeds from stock options 15,842 - - - 15,842
Tender premiums and fees - (3,434) - - (3,434)
Intercompany capital transactions 40,698 (27,647) (13,051) - -
Other 884 (120) 2,162 - 2,926
------------- ------------- ------------- ------------- --------------
Net cash used for financing
activities - (74,190) (14,308) - (88,498)
Effect of exchange rate changes
on cash - (1,767) 4,286 - 2,519
------------- ------------- ------------- ------------- --------------
Increase in cash and
cash equivalents - 54,202 8,212 - 62,414
Cash and cash equivalents at
beginning of period - 25,865 9,230 - 35,095
------------- ------------- ------------- ------------- --------------
Cash and cash equivalents at end
of period $ - $ 80,067 $ 17,442 $ - $ 97,509
============= ============= ============= ============= ==============
-22-
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)
NOTE M - SUPPLEMENTAL GUARANTOR/NON-GUARANTOR FINANCIAL INFORMATION
(continued)
Condensed Consolidating Statements of Cash Flows
Nine Months Ended November 24, 2001
Parent Guarantor Non-Guarantor Eliminating
Company Subsidiaries Subsidiaries Entries Consolidated
------------- -------------- ------------- ------------- --------------
(Dollars in thousands)
Net cash provided by operating
activities $ - $ 210,127 $ 53,935 $ (10,741) $ 253,321
Investing Activities
Purchases of systems, equipment
and other assets relating to
contracts - (111,900) (44,958) 10,741 (146,117)
Investments in and advances to
unconsolidated subsidiaries - - 3,786 - 3,786
Proceeds from the sale of majority
interest in subsidiary - 10,000 - - 10,000
Proceeds from sale of investments - - 2,098 - 2,098
Other - (2,919) (637) - (3,556)
------------- ------------- ------------- ------------- --------------
Net cash used for investing
activities - (101,033) (43,497) 10,741 (133,789)
Financing Activities
Net proceeds from issuance of
long-term debt - 186,000 - - 186,000
Principal payments on long-term
debt - (178,003) (4,295) - (182,298)
Purchases of treasury stock (194,389) - - - (194,389)
Proceeds from stock options 40,968 - - - 40,968
Intercompany capital transactions 151,701 (151,701) - - -
Other 1,720 (1,428) (1,348) - (1,056)
------------- ------------- ------------- ------------- --------------
Net cash used for financing
activities - (145,132) (5,643) - (150,775)
Effect of exchange rate changes
on cash - (124) (4,148) - (4,272)
------------- ------------- ------------- ------------- --------------
(Decrease) increase in cash and
cash equivalents - (36,162) 647 - (35,515)
Cash and cash equivalents at
beginning of period - 37,068 9,880 - 46,948
------------- ------------- ------------- ------------- --------------
Cash and cash equivalents at end
of period $ - $ 906 $ 10,527 $ - $ 11,433
============= ============= ============= ============= ==============
-23-
Item 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS
The terms "Holdings", "the Company", "we", "our" and "us" refer to GTECH
Holdings Corporation and its consolidated subsidiaries, unless otherwise
specified.
Statements contained in this section and elsewhere in this report which are not
historical statements constitute "forward-looking statements" within the meaning
of Section 27A of the Securities Act and Section 21E of the Securities Exchange
Act of 1934. Generally, the words "believe", "expect", "intend", "estimate",
"anticipate", "project", "will" and similar expressions identify forward-looking
statements. Such statements may include, without limitation, statements relating
to:
- the future prospects for and stability of the lottery industry and
other businesses in which we are engaged or expect to be engaged;
- our future operating and financial performance (including, without
limitation, expected future growth in revenues, profit margins and
earnings per share);
- our ability to retain existing business and to obtain and retain new
business;
- the future performance of comparable investment opportunities; and
- 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
results contemplated in the forward-looking statements. These risks and
uncertainties include the following:
- governmental regulations and other actions affecting the online
lottery industry could have a negative effect on our business;
- our lottery operations are dependent upon our continued ability to
retain and extend our existing contracts (including with respect to
several of our significant online lottery service contracts which are
the subject of competitive procurement procedures over the next
several months) and win new contracts;
- slow growth or declines in sales of online lottery goods and services
could adversely affect our future revenues and profitability;
- we have significant foreign exchange exposure;
- we are subject to the economic, political and social instability risks
of doing business in foreign jurisdictions;
- we have a concentrated customer base, and the loss of any of our
larger customers could harm our results;
- our quarterly operating results may fluctuate significantly;
- we operate in a highly competitive environment;
- we are subject to substantial penalties for failure to perform under
our contracts;
- we may not be able to respond to technological changes or satisfy
future technological demands of our customers;
- expansion of the gaming industry faces opposition which may limit the
legalization, or expansion, of online gaming to the detriment of our
business, financial condition, results and prospects;
- our business prospects and future success depend upon our ability to
attract and retain qualified employees;
- we may be subject to adverse determinations in pending legal
proceedings; and
-24-
- other risks and uncertainties set forth below and elsewhere in this
report, in our fiscal 2002 Form 10-K, and in our subsequent press
releases and Form 10-Q's and other reports and filings with the
Securities and Exchange Commission.
The foregoing list of important factors is not all-inclusive.
General
We operate on a 52- to 53-week fiscal year ending on the last Saturday in
February and fiscal 2003 ends on February 22, 2003. Fiscal 2004 is a 53-week
year and we will include the extra week in our fourth quarter ending February
28, 2004.
We have derived substantially all of our revenues from the rendering of services
and the sale or supply of computerized online lottery systems and components to
government-authorized lotteries. Our service revenues are derived primarily from
lottery service contracts which are typically at least five years in duration,
and generally provide compensation to us based upon a percentage of a lottery's
gross online lottery sales. These percentages vary depending on the size of the
lottery and the scope of services provided to the lottery. We derive product
sale revenues primarily from the installation of new online lottery systems,
installation of new software and sales of lottery terminals and equipment in
connection with the expansion of existing lottery systems. Our product margins
fluctuate depending on the mix, volume and timing of product sales contracts.
The size and timing of these transactions have resulted in variability in
product sale revenues from period to period. We currently anticipate that
product sales during fiscal 2003 will be in a range of $100 million to $110
million.
We continue to evaluate a variety of opportunities to broaden our offerings of
high-volume transaction processing services outside of our core business of
providing online lottery services, such as the processing and transmitting of
commercial, non-lottery transactions including bill payments, electronic tax
payments, utility payments and retail-based programs such as gift cards.
Currently, our networks in Brazil and Chile process bill payments and other
commercial service transactions. In the near term, we expect to concentrate our
efforts to grow commercial services revenues in Brazil, Poland and Mexico. While
our goal is to leverage our technology, infrastructure and relationships to
drive growth in our commercial services, if, in the course of pursuing these
opportunities, we see a chance to gain access to certain markets through the
acquisition of existing infrastructure, we may consider making such
acquisitions.
Our business is highly regulated, and the competition to secure new government
contracts is often intense. From time to time, competitors challenge our
contract awards and there have been and may continue to be investigations of
various types, including grand jury investigations, conducted by governmental
authorities into possible improprieties and wrongdoing in connection with
efforts to obtain and/or the awarding of lottery contracts and related matters.
In light of the fact that such investigations frequently are conducted in
secret, we would not necessarily know of the existence of an investigation that
might involve us. Because our reputation for integrity is an important factor in
our business dealings with lottery and other government agencies, if government
authorities made an allegation of, or if there was a finding of improper conduct
on our part in any matter, such an allegation or finding could have a material
adverse effect on our business, including our 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
in this report; and Part I, Item 1 - "Certain Factors That May Affect Future
Performance - Government regulations and other actions affecting the online
lottery industry could have a negative effect on the Company's business", Part
I, Item 3 - "Legal Proceedings" and Note F to the Consolidated Financial
Statements in our fiscal 2002 Annual Report on Form 10-K, for further
information concerning these matters and other contingencies.
-25-
We are a global business and we derive a substantial portion of our revenues
from operations outside of the United States. In particular, in fiscal 2002, we
derived approximately 51% of our revenues from international operations and
11.5% of our revenues from our Brazilian operations alone (including 10.7% of
our revenues from the National Lottery of Brazil, one of our largest customers).
In addition, a substantial portion of our assets, primarily consisting of
equipment we use to operate online lottery systems for our customers, are held
outside of the United States.
Significant Contract Rebids
A majority of our revenues and cash flow is derived from our portfolio of
long-term online lottery services contracts, each of which in the ordinary
course of our business is periodically the subject of competitive procurement or
renegotiation. Through fiscal 2003 (which ends in February 2003), the National
Lottery of Brazil, our second largest contract in fiscal 2002 (based on annual
revenues), will be the subject of a competitive procurement to select
contractors to supply lottery goods and services upon the termination of our
current contract.
Upon the expiration of our current contract, Caixa Economica Federal ("CEF"),
the operator of Brazil's National Lottery, will attempt to handle internally
some non-lottery operations that we currently perform under our 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
us. On July 24, 2002, CEF published four Requests for Proposals in connection
with this procurement process, the validity of which we are challenging in
court. See Part II, Item 1 - "Legal Proceedings". CEF has indicated that it
plans to request that we extend the term of our current contract with CEF, which
is scheduled to end in January 2003, for an additional six months.
The California lottery contract, which was our fourth largest contract in fiscal
2002 (based on annual revenues), expires in October 2003. On October 4, 2002,
following a competitive procurement process, we entered into a facilities
management agreement to provide online lottery technology, equipment and
services to the California Lottery for a period of six years beginning on
October 14, 2003, with four additional one year options to extend the agreement
at the discretion of the California Lottery. After the exercise of any extension
options, the agreement will remain in effect until either party gives notice of
termination at least two years in advance.
In addition, the Georgia lottery contract, which was our fifth largest contract
in fiscal 2002 (based on annual revenues), expires in September 2003. On
November 15, 2002, following a competitive bidding process, we were awarded a
contract by the Georgia Lottery Corporation to provide equipment for an online
gaming system and related services, including a new wireless telecommunications
network, for a seven-year period which is expected to commence on September 10,
2003.
Critical Accounting Policies
In December 2001, the Securities and Exchange Commission issued advice regarding
disclosure of critical accounting policies. In response to this advice, we have
identified the accounting policies listed below that we believe are most
critical to our financial condition and results of operations, and that require
management's most difficult, subjective and complex judgments in estimating the
effect of inherent uncertainties. This section should be read in conjunction
with Note A to the Consolidated Financial Statements in our fiscal 2002 Annual
Report on Form 10-K, which includes other significant accounting policies.
-26-
REVENUE RECOGNITION
We recognize service revenues as the services are performed. Liquidated damages
(which equaled 0.40% of our total revenues in the first nine months of fiscal
2003 and 0.14%, 0.47% and 0.56% of our total revenues in fiscal 2002, 2001 and
2000, respectively) are recorded as a reduction in revenue in the period when
they are determined to be 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 we are not responsible for installation, revenue is recognized
when the product is shipped. Amounts received from customers in advance of
revenue recognition are recorded in advance payments from customers in our
Consolidated Balance Sheets.
Generally, we record product sales under long-term contracts 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
and are adjusted prospectively for revisions in estimated total contract costs
in the period when the information necessary to make the adjustment becomes
available. Provision for contract losses are made when the loss is known and
quantifiable. The completed contract method of accounting is used for long-term
contracts whenever we cannot estimate the costs to complete the delivery or when
the contract stipulates the entire balance due under the contract is refundable
if the customer does not accept the product. Under the completed contract method
of accounting, product sales are recorded when we have substantially completed
our obligations under the contract.
RECEIVABLES AND INVENTORY RESERVES
We evaluate the collectibility of trade accounts and sales-type lease
receivables on a customer-by-customer basis and we believe our reserves are
adequate; however, if economic circumstances change significantly resulting in a
major customer's inability to meet its financial obligations to us, original
estimates of the recoverability of amounts due to us could be reduced by
significant amounts requiring additional reserves.
Inventories include amounts related to our 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. We make
provisions for potentially obsolete or slow-moving inventory based on
management's analysis of inventory levels and future sales forecasts. We believe
our reserves are adequate; however, should future sales forecasts change, our
original estimates of obsolescence could increase by a significant amount
requiring additional reserves.
IMPAIRMENT OF GOODWILL AND OTHER INTANGIBLE AND LONG-LIVED ASSETS
We periodically evaluate 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. We would write-down our long-lived assets to fair value,
calculated using future undiscounted cash flows, if facts and circumstances
indicated that they were impaired.
-27-
Effect of New Accounting Pronouncements
During the first quarter of this fiscal year, we adopted Statement of Financial
Accounting Standards No. 142 ("SFAS 142"), "Goodwill and Other Intangible
Assets", which requires, among other things, that we no longer amortize goodwill
and certain other indefinite-lived intangible assets, but instead test them at
least annually for impairment. In connection with the adoption of the new
standard, we determined that goodwill with a net book value of $1.3 million
(within the Lottery segment) met the standards' intangible asset recognition
criteria. Accordingly, we reclassified this amount into intangible assets and we
will continue to amortize it over its remaining useful life. Prior year net
income and diluted earnings per share for the nine-months ended November 24,
2001, excluding amortization of goodwill, was $61.6 million, or $1.02 per
diluted share.
In April 2002, the Financial Accounting Standards Board ("FASB") issued
Statement of Financial Accounting Standards No. 145 ("SFAS 145"), "Rescission of
FASB Statements No. 4, 44, and 64, Amendment of FASB Statement No. 13, and
Technical Corrections". Among other things, SFAS 145 rescinds Statement of
Financial Accounting Standards No. 4 ("SFAS 4"), "Reporting Gains and Losses
from Extinguishment of Debt" and eliminates the requirement that gains and
losses from the extinguishment of debt be classified as an extraordinary item,
net of related income tax effects, unless the criteria in Accounting Principles
Board Opinion No. 30, "Reporting the Results of Operations - Reporting the
Effects of Disposal of a Segment of a Business, and Extraordinary, Unusual and
Infrequently Occurring Events and Transactions" are met. We are required to
adopt the standard beginning on February 23, 2003 (the first day of fiscal
2004). We early adopted SFAS 145 on August 25, 2002 (the first day of our fiscal
2003 third quarter) and will reclassify, in the fourth quarter of fiscal 2003,
the $12.5 million ($7.8 million after-tax) extraordinary charge we recorded in
the fourth quarter of the prior fiscal year into other expense in our
Consolidated Income Statements.
In June 2002, the FASB issued Statement of Financial Accounting Standards No.
146 ("SFAS 146"), "Accounting for Costs Associated With Exit or Disposal
Activities". SFAS 146 nullifies Emerging Issues Task Force Issue No. 94-3 ("EITF
94-3"), "Liability Recognition for Certain Employee Termination Benefits and
Other Costs to Exit an Activity (Including Certain Costs Incurred in a
Restructuring)". SFAS 146 requires that a liability for a cost associated with
an exit or disposal activity be recognized when the liability is incurred.
Therefore, SFAS 146 eliminates the definition and requirements for recognition
of exit costs in EITF 94-3. The provisions of SFAS 146 are effective for exit or
disposal activities that are initiated after December 31, 2002. We do not expect
the adoption of this statement to have a material impact on our consolidated
financial statements.
In November 2002, the FASB issued Interpretation No. 45, "Guarantor's Accounting
and Disclosure Requirements for Guarantees, Including Indirect Guarantees of
Indebtedness of Others", which requires certain guarantees to be recorded at
fair value as opposed to the current practice of recording a liability only when
a loss is probable and reasonably estimable and also requires a guarantor to
make significant new guaranty disclosures, even when the likelihood of making
any payments under the guarantee is remote. The Interpretation's initial
recognition and initial measurement provisions are applicable on a prospective
basis to guarantees issued or modified after December 31, 2002. We are required
to adopt the disclosure requirements beginning on November 24, 2002 (the first
day of our fiscal 2003 fourth quarter). We are currently evaluating the effects
this Interpretation may have on our consolidated financial statements.
In November 2002, the Emerging Issues Task Force ("EITF") reached a consensus on
EITF Issue No. 00-21, "Multiple-Deliverable Revenue Arrangements", which
provides guidance on how to account for arrangements that may involve the
delivery or performance of multiple products, services, and/or rights to use
assets. The final consensus is applicable to agreements entered into in fiscal
periods beginning after June 15, 2003 with early adoption permitted.
Additionally, companies will be allowed to apply the
-28-
guidance to all existing arrangements as the cumulative effect of a change in
accounting principle in accordance with Accounting Principles Board Opinion No.
20, "Accounting Changes". We are required to adopt the provisions of this EITF
beginning on September 27, 2003 (the first day of our fiscal 2004 third
quarter). We are currently evaluating the effects this EITF may have on our
consolidated financial statements.
Results of Operations
Three months ended November 23, 2002 versus Three months ended November 24, 2001
Revenues were $256.5 million in the third quarter of fiscal 2003, compared to
$263.6 million in the third quarter of fiscal 2002, down $7.1 million, or 2.7%.
The following discussion on service revenues should be read in conjunction with
the table below:
Three Months Ended
---------------------------------------------
Change
November 23, November 24, ----------------
Service revenues 2002 2001 $ %
- ---------------- ----------- ---------- ------- -----
Domestic $ 116.2 $ 112.0 $ 4.2 3.8
International 90.8 82.3 8.5 10.4
Other 0.8 2.1 (1.3) (65.9)
----------- ---------- ------- -----
$ 207.8 $ 196.4 $ 11.4 5.8
=========== ========== ======= =====
Service revenues, including lottery and other services, were $207.8 million in
the third quarter of fiscal 2003, compared to $196.4 million in the third
quarter of fiscal 2002, up $11.4 million, or 5.8%. This increase was primarily
driven by an $8.5 million increase in international lottery service revenues and
a $4.2 million increase in domestic lottery services revenues, partially offset
by the expiration of certain electronic benefit transfer contracts. Had last
year's average exchange rates prevailed throughout the most recent quarter, we
estimate that service revenues would have increased by approximately 10%
compared to the third quarter of last year.
Our international lottery service revenues were $90.8 million in the third
quarter of fiscal 2003, compared to $82.3 million in the third quarter of fiscal
2002, up $8.5 million, or 10.4%. This increase was primarily driven by several
new international contracts, along with higher service revenues from Colombia.
These positive factors were partially offset by lower service revenues from the
weakening of the Brazilian real against the U.S. dollar. International lottery
service revenues in the third quarter of fiscal 2003 include approximately $10.2
million from commercial transaction processing services, (primarily in Brazil),
which on a constant currency basis increased approximately 19% over the third
quarter of the prior year.
Our domestic lottery service revenues were $116.2 million in the third quarter
of fiscal 2003, compared to $112.0 million in the third quarter of fiscal 2002,
up $4.2 million, or 3.8%. This increase was primarily due to same store sales
growth of approximately 7% and the impact of new contract wins, partially offset
by contractual rate changes.
Product sales were $48.7 million in the third quarter of fiscal 2003, compared
to $67.2 million in the third quarter of fiscal 2002, down $18.5 million, or
27.5%. Product sales in the third quarter of the prior year included sales of
terminals and software to our customer in the United Kingdom, which were
partially offset by sales in the third quarter of the current fiscal year of a
turnkey system to our customer in France and terminals to our customer in Spain.
-29-
Our service margins improved from 29.6% in the third quarter of fiscal 2002 to
37.9% in the third quarter of fiscal 2003, primarily driven by new contracts
that generated incrementally higher gross margins, lower depreciation
(principally related to contract extensions and fully depreciated assets
associated with existing contracts), and improved operational and service
delivery efficiencies.
Our product margins fluctuate depending on the mix, volume and timing of product
sales contracts. Product sale margins declined to 19.7% in the third quarter of
fiscal 2003 compared to 23.8% in the third quarter of last year, reflecting
sales of a turnkey system to our customer in France and terminals to our
customer in Spain, partially offset by the absence of inventory reserves
recorded in the prior fiscal year in connection with a product sale contract
with a customer in Italy.
Operating expenses were $35.3 million in the third quarter of fiscal 2003,
compared to $36.2 million in the third quarter of fiscal 2002, down $0.9
million, or 2.5%. This decrease was primarily driven by our continued execution
of cost savings initiatives and emphasis on improving operating efficiencies,
along with the benefit of the adoption of the new accounting standard on
goodwill, which eliminated approximately $1.4 million of goodwill amortization
in the third quarter of the current year. These declines in operating expenses
were partially offset by increased spending on research and development in an
effort to accelerate deployment of Enterprise Series (our open platform based
lottery management system) in the marketplace. As a percentage of revenues,
operating expenses were 13.7% and 13.7% (13.2% in the third quarter of the prior
year adjusted for the change in goodwill accounting) during the third quarters
of fiscal 2003 and 2002, respectively.
Other income was $0.2 million and $0.3 million in the third quarters of fiscal
2003 and fiscal 2002, respectively. The components of other income are as
follows (in millions):
Three Months Ended
---------------------------
November 23, November 24,
2002 2001
------------ ------------
Foreign exchange gains (losses) $ 2.8 $ (0.7)
Tender premiums and fees associated with the early retirement
of our 2004 Senior Notes, net of $1.2 million in proceeds from the
sale of certain interest rate swaps associated with these notes (2.3) -
Amortization of the gain on the 1998 sale of our 22.5% equity
interest in Camelot Group plc - 0.7
Other (0.3) 0.3
----------- ------------
Total other income $ 0.2 $ 0.3
=========== ============
Interest expense was $2.7 million in the third quarter of fiscal 2003, compared
to $5.6 million in the third quarter of fiscal 2002, down $2.9 million, or
51.5%. This decrease was primarily due to our debt restructuring in the fourth
quarter of last fiscal year and the third quarter of this fiscal year, resulting
in lower debt balances and lower interest rates. In the fourth quarter of the
prior fiscal year, we issued $175 million principal amount of 1.75% Convertible
Debentures. We used a portion of the proceeds from the Convertible Debentures to
retire $55 million of 7.87% Senior Notes and $110 million of 7.75% Senior Notes
in the fourth quarter of fiscal 2002 and we used cash on hand to retire $40
million of 7.75% Senior Notes in the third quarter of fiscal 2003.
Weighted average diluted shares in the third quarter of fiscal 2003 declined 1.1
million shares to 58.1 million shares as a result of our share repurchase
programs, resulting in an improvement to diluted earnings per share of $0.02.
-30-
Nine months ended November 23, 2002 versus Nine months ended November 24, 2001
Revenues were $708.8 million in the first nine months of fiscal 2003, compared
to $735.1 million in the first nine months of fiscal 2002, down $26.3 million,
or 3.6%.
The following discussion on service revenues should be read in conjunction with
the table below:
Nine Months Ended
---------------------------------------------------
Change
November 23, November 24, ------------------
Service revenues 2002 2001 $ %
- ---------------- ------------ ------------ -------- -----
Domestic $ 363.1 $ 357.4 $ 5.7 1.6
International 277.9 250.4 27.5 11.0
Other 2.1 8.8 (6.7) (76.1)
------------ ------------ -------- -----
$ 643.1 $ 616.6 $ 26.5 4.3
============ ============ ======== =====
Service revenues, including lottery and other services, were $643.1 million in
the first nine months of fiscal 2003, compared to $616.6 million in the first
nine months of fiscal 2002, up $26.5 million, or 4.3%. This increase was
primarily driven by a $27.5 million increase in international lottery service
revenues and a $5.7 million increase in domestic lottery services revenues,
partially offset by the expiration of certain electronic benefit transfer
contracts. Had last year's average exchange rates prevailed throughout the first
nine months of this fiscal year, we estimate that service revenues would have
increased by approximately 6.6% compared to the same period last year.
Our international lottery service revenues were $277.9 million in the first nine
months of fiscal 2003, compared to $250.4 million in the first nine months of
fiscal 2002, up $27.5 million, or 11.0%. This increase was primarily driven by
several new international contracts, along with higher service revenues from
Colombia. These positive factors were partially offset by lower service revenues
from the weakening of the Brazilian real against the U.S. dollar.
Our domestic lottery service revenues were $363.1 million in the first nine
months of fiscal 2003, compared to $357.4 million in the first nine months of
fiscal 2002, up $5.7 million, or 1.6%. This increase was primarily due to higher
lottery sales generated by a number of our existing domestic customers,
including Texas and New York, partially offset by lower jackpot activity in the
Powerball states and contractual rate changes.
Product sales were $65.7 million in the first nine months of fiscal 2003,
compared to $118.5 million in the first nine months of fiscal 2002, down $52.8
million, or 44.6%. Prior year product sales included one-time sales of terminals
and software to our customer in the United Kingdom, which were partially offset
by sales in the third quarter of the current fiscal year of a turnkey system to
our customer in France and terminals to our customer in Spain.
Our service margins improved from 30.8% in the first nine months of fiscal 2002
to 37.3% in the first nine months of fiscal 2003, primarily driven by new
contracts that generated incrementally higher gross margins, lower depreciation
(principally related to contract extensions and fully depreciated assets
associated with existing contracts), and improved operational and service
delivery efficiencies.
Product margins improved to 24.8% in the first nine months of fiscal 2003
compared to 20.1% in the first nine months of last year, primarily due to the
absence of prior year inventory reserves recorded in connection with a product
sale contract with a customer in Italy, partially offset by lower margins
associated with sales of a turnkey system to our customer in France and
terminals to our customer in Spain, which were recorded in the current fiscal
year.
-31-
Operating expenses were $94.7 million in the first nine months of fiscal 2003,
compared to $111.8 million in the first nine months of fiscal 2002, down $17.1
million, or 15.3%. This decrease was primarily driven by our continued execution
of cost savings initiatives and emphasis on improving operating efficiencies. We
also benefited from the adoption of the new accounting standard on goodwill,
which eliminated approximately $4.3 million of goodwill amortization in the
first nine months of the current year. These declines in operating expenses were
partially offset by the cost of contractual obligations associated with the
departure in August 2002 of our former President and Chief Executive Officer. As
a percentage of revenues, operating expenses were 13.4% and 15.2% (14.6%
adjusted for the change in goodwill accounting) during the first nine months of
fiscal 2003 and 2002, respectively.
Other income was $1.9 million and $0.7 million in the first nine months of
fiscal 2003 and fiscal 2002, respectively. The components of other income are as
follows (in millions):
Nine Months Ended
--------------------------------
November 23, November 24,
2002 2001
------------ ------------
Foreign exchange gains $ 5.4 $ 1.1
Tender premiums and fees associated with the early retirement
of our 2004 Senior Notes, net of $1.2 million in proceeds from the
sale of certain interest rate swaps associated with these notes (2.3) -
Gain on the sale of a majority interest in our subsidiary in the
Czech Republic - 3.9
Amortization of the gain on the 1998 sale of our 22.5% equity
interest in Camelot Group plc - 5.0
Write-off of our cost method investment in the common stock of an
Internet security developer - (9.3)
Other (1.2) -
------------ ------------
Total other income $ 1.9 $ 0.7
============ ============
Interest expense was $8.4 million in the first nine months of fiscal 2003,
compared to $18.5 million in the first nine months of fiscal 2002, down $10.1
million, or 54.7%. This decrease was primarily due to our debt restructuring in
the fourth quarter of last fiscal year and the third quarter of this fiscal
year, resulting in lower debt balances and lower interest rates. In the fourth
quarter of the prior fiscal year, we issued $175 million principal amount of
1.75% Convertible Debentures. We used a portion of the proceeds from the
Convertible Debentures to retire $55 million of 7.87% Senior Notes and $110
million of 7.75% Senior Notes in the fourth quarter of fiscal 2002 and we used
cash on hand to retire $40 million of 7.75% Senior Notes in the third quarter of
fiscal 2003.
Weighted average diluted shares in the first nine months of fiscal 2003 declined
1.1 million shares to 58.1 million shares as a result of our share repurchase
programs, resulting in an improvement to diluted earnings per share of $0.06.
-32-
Third Quarter and Recent Developments
We have a 44% interest in Lottery Technology Services Investment Corporation
("LTSIC"), which is accounted for using the equity method. LTSIC's wholly owned
subsidiary, Lottery Technology Services Corporation ("LTSC"), provides equipment
and services, (which we supplied to LTSC), to the Bank of Taipei, who holds the
license to operate the Taiwan Public Welfare Lottery (the "Lottery").
In November 2002, the Lottery announced a voluntary recall of previously issued
instant tickets distributed by LTSC, in response to concerns about potential
operational and technical issues related to the instant ticket games. A small
portion of the tickets in the field were returned by the retail agents before
new tickets were issued and made available for play on November 22, 2002. We
have conducted a thorough review of all instant ticket game design, distribution
and sales techniques across the jurisdictions we serve. We believe the issues
addressed in Taiwan were the product of unique circumstances that are not
present in other jurisdictions.
On December 5, 2002, after the close of our fiscal 2003 third quarter, we
announced that our Board of Directors authorized a new open market share
repurchase program for up to an aggregate of $100 million of our outstanding
common stock through March 31, 2004. This new program is in addition to the
unused capacity of approximately $2 million remaining in our existing program,
which is scheduled to expire in February 2003. We plan to periodically
repurchase the shares in the open market based on market conditions and
corporate considerations.
Changes in Financial Position, Liquidity and Capital Resources
During the first nine months of fiscal 2003, we generated $281 million of cash
from operations, which we used to purchase $131.2 million of systems, equipment
and other assets relating to contracts, to repurchase $57.4 million of our
common stock and to early retire $40 million of Senior Notes. At November 23,
2002, we had $97.5 million of cash and cash equivalents on hand, of which
approximately 84% was invested with two financial institutions. At the end of
the fiscal 2003 third quarter, we had no borrowings under our $300 million
credit facility.
Trade accounts receivable decreased by $17.6 million, from $100.4 million at
February 23, 2002 to $82.8 million at November 23, 2002, primarily due to
collections related to product sales we recorded in the prior fiscal year, along
with the collection of certain domestic service receivables.
Inventories decreased by $14.9 million, from $86.6 million at February 23, 2002
to $71.7 million at November 23, 2002, primarily due to the recording of product
sales in the third quarter of this fiscal year of a turnkey system to our
customer in France and terminals to our customer in Spain, partially offset by
spending related to product sales expected to be delivered during fiscal 2004.
Other current assets decreased by $4.3 million, from $22.7 million at February
23, 2002 to $18.4 million at November 23, 2002. The February 23, 2002 balance
included $5.9 million of prepaid inventory that was shipped to us during the
first half of this fiscal year.
Other assets decreased by $14.7 million, from $89.4 million at February 23, 2002
to $74.7 million at November 23, 2002, primarily due to the sale of interest
rate swaps in the third quarter of this fiscal year.
Accounts payable increased by $8.5 million, from $43.4 million at February 23,
2002 to $51.9 million at November 23, 2002, primarily due to the timing of
payments related to ongoing lottery system installations.
-33-
Accrued expenses decreased by $6.8 million, from $75.7 million at February 23,
2002 to $68.9 million at November 23, 2002, primarily due to the payment of
costs accrued in connection with cost savings initiatives and operating
efficiency programs.
Employee compensation decreased by $8.0 million, from $37.9 million at February
23, 2002 to $29.9 million at November 23, 2002, primarily due to the payment of
fiscal 2002 management incentive compensation and employee profit sharing.
Income taxes payable decreased by $6.6 million, from $53.9 million at February
23, 2002 to $47.3 million at November 23, 2002, primarily due to tax benefits
related to foreign currency translation and stock award plans which were
recorded through other comprehensive income, partially offset by the timing of
income tax payments.
Other liabilities increased by $13.3 million, from $28.0 million at February 23,
2002 to $41.3 million at November 23, 2002, primarily due to the deferral of
revenue related to our joint venture in Taiwan. See "Guarantees" below and Note
K to the Consolidated Financial Statements in our fiscal 2002 Annual Report on
Form 10-K for further information.
Our business is capital-intensive. Although it is not possible to estimate
precisely, we currently anticipate that net cash used for investing activities
in fiscal 2003 will be in a range of $170 million to $180 million. We expect our
principal sources of liquidity to be existing cash balances, along with cash
generated from operations and borrowings under our credit facility. Our credit
facility provides for an unsecured revolving line of credit of $300 million and
matures in June 2006. As of November 23, 2002, there were no borrowings under
the credit facility. We currently expect that our cash flow from operations and
available borrowings under our credit facility will be sufficient for the
foreseeable future to fund our anticipated working capital and ordinary capital
expenditure needs, to service our debt obligations, to fund anticipated internal
growth, to fund potential acquisitions and to repurchase shares of our common
stock, from time to time, under our share repurchase programs.
Off-Balance Sheet Arrangements
We have a 50% limited partnership interest in West Greenwich Technology
Associates, L.P. (the "Partnership"), which owns our World Headquarters
facilities and leases them to us. The general partner of the Partnership is an
unrelated third party. We account for the Partnership using the equity method.
The following is a summary of certain unaudited financial information of the
Partnership, along with the results of operations at November 23, 2002, used as
the basis for applying the equity method of accounting (in thousands):
(Unaudited)
-----------
NOVEMBER 23, 2002
EARNINGS DATA:
Net loss $ (639)
BALANCE SHEET DATA:
Assets $ 17,162
Liabilities 27,266
In the first nine months of fiscal 2003, we made lease payments of $0.3 million
to the Partnership, which is included in selling, general and administrative
expense in our Consolidated Income Statements. See Note K to the Consolidated
Financial Statements in our fiscal 2002 Annual Report on Form 10-K for further
information.
-34-
Guarantees
Taiwan
We have a 44% interest in Lottery Technology Services Investment Corporation
("LTSIC"), which is accounted for using the equity method. LTSIC's wholly owned
subsidiary, Lottery Technology Services Corporation ("LTSC"), provides equipment
and services, (which we supplied to LTSC), to the Bank of Taipei, who holds the
license to operate the Taiwan Public Welfare Lottery.
At November 23, 2002, we have guaranteed approximately $4.4 million, or 44%, of
$10.1 million of loans made by an unrelated commercial lender to LTSC. The loans
have a maturity date of January 2007 and our guarantee expires in July 2007.
We are recognizing 56% of product sales and service revenue from LTSC. The
remaining 44% of product sales and service revenue has been deferred and is
included in other liabilities in our Consolidated Balance Sheets at November 23,
2002 and February 23, 2002. Sales of products and services to LTSC were $5.6
million during the first nine months of fiscal 2003. See Notes F and K to the
Consolidated Financial Statements in our fiscal 2002 Annual Report on Form 10-K
for further information.
Times Squared
At November 23, 2002, we have 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 our fiscal 2002 Annual Report on
Form 10-K for further information.
Market Risk Disclosures
The primary market risk inherent in our financial instruments and exposures is
the potential loss arising from adverse changes in interest rates and foreign
currency rates. Our exposure to commodity price changes is not considered
material and is managed through our procurement and sales practices. We did not
own any marketable equity securities during the first nine months of fiscal
2003.
Interest rates
Interest rate market risk is estimated as the potential change in the fair value
of our total debt or current earnings resulting from a hypothetical 10% adverse
change in interest rates. At November 23, 2002, the estimated fair value of our
$95 million of fixed rate Senior Notes approximated $104.1 million (as
determined by an independent investment banker). 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.
At November 23, 2002, the estimated fair value of our $175 million principal
amount of 1.75% Convertible Debentures was $205.4 million (as determined by an
independent investment banker). At November 23, 2002, a hypothetical 10%
increase in interest rates would reduce the estimated fair value of the
Convertible Debentures to $203.7 million and a hypothetical 10% decrease in
interest rates would increase the estimated fair value of the Convertible
Debentures to $207.2 million.
A hypothetical 10% adverse or favorable change in interest rates applied to
variable rate debt would not have a material effect on current earnings.
-35-
We use various techniques to mitigate the risk associated with future changes in
interest rates, including entering into interest rate swaps. As of the second
quarter of this fiscal year, we had $135 million of interest rate swap
agreements in place on our fixed rate Series A and Series B Senior Notes, which
effectively entitled us to exchange fixed rate payments for variable rate
payments until May 2007. During the third quarter of fiscal 2003, we sold these
interest rate swaps for $13.1 million, the proceeds of which were applied as
follows:
Sale of interest rate swaps related to:
---------------------------------------------
2004 Senior 2007 Senior
Notes Notes Total
------------- ------------- -------------
Long-term debt $ - $ 10.0 $ 10.0
Accounts receivable 0.4 1.4 1.8
Other income 1.2 - 1.2
Interest expense 0.1 - 0.1
------------- ------------- -------------
$ 1.7 $ 11.4 $ 13.1
============= ============= =============
In accordance with Financial Accounting Standards Board Statement 133, the $10.0
million addition to long-term debt will be amortized as a reduction of interest
expense through the due date of the Series B Senior Notes (May 2007). The $1.8
million applied to accounts receivable represents receivables from banks for
interest rate resets that were effective on May 15, 2002 and August 15, 2002.
In addition, we used cash on hand to repurchase, during the third quarter of
fiscal 2003, $40 million of our 2004 Series A Senior Notes. In connection with
this repurchase, we paid tender premiums to the holders of the notes and
incurred associated fees totaling $3.4 million. This amount, along with the
write-off of debt issuance costs of $0.1 million, net of $1.2 million in
proceeds from the sale, as noted above, of certain interest rate swaps
associated with these notes, are included in other income in our Consolidated
Income Statements.
Equity price risk
At November 23, 2002, the estimated fair value of our $175 million principal
amount of 1.75% Convertible Debentures was $205.4 million (as determined by an
independent investment banker). At November 23, 2002, a hypothetical 10%
increase in the market price of our common stock would increase the estimated
fair value of the Convertible Debentures to $214.7 million and a hypothetical
10% decrease in the market price of our common stock would reduce the estimated
fair value of the Convertible Debentures to $196.7 million.
Foreign Currency Exchange Rates
We are subject to foreign exchange exposures arising from current and
anticipated transactions denominated in currencies other than our functional
currency (United States dollars) and from the translation of foreign currency
balance sheet accounts into United States dollar balance sheet accounts.
We seek to manage our foreign exchange risk by securing payment from our
customers in United States dollars, by sharing risk with our customers, by
utilizing foreign currency borrowings, by 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 our foreign
currency revenues are payable in the local currencies. Whenever possible, we
negotiate clauses into our contracts that allow for price adjustments should a
material change in foreign exchange rates occur.
-36-
From time to time, we enter into foreign currency exchange and option contracts
to reduce the exposure associated with current transactions and anticipated
transactions denominated in foreign currencies. However, we do not engage in
currency speculation. At November 23, 2002, a hypothetical 10% adverse change in
foreign exchange rates would result in a translation loss of $7.7 million that
would be recorded in the equity section of our balance sheet.
At November 23, 2002, a hypothetical 10% adverse change in foreign exchange
rates would result in a net transaction loss of $2.7 million that would be
recorded in current earnings after considering the effects of foreign exchange
contracts currently in place.
At November 23, 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 $1.9 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 nine months of fiscal 2003, but averaged 54%.
As of November 23, 2002, we had contracts for the sale of foreign currency of
approximately $46.5 million (primarily euro, pounds sterling and Brazilian real)
and the purchase of foreign currency of approximately $34.4 million (primarily
pounds sterling, Brazilian real and Swedish Krona).
-37-
Item 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
See "Market Risk Disclosures" above.
Item 4. CONTROLS AND PROCEDURES
We maintain disclosure controls and procedures that are designed to ensure that
information required to be disclosed in our Securities Exchange Act reports is
recorded, processed, summarized and reported within the time periods specified
in the Securities and Exchange Commission's rules and forms, and that such
information is accumulated and communicated to our management, including our
President and Chief Executive Officer ("CEO") and our Senior Vice President and
Chief Financial Officer ("CFO"), as appropriate, to allow timely decisions
regarding required disclosure. In designing and evaluating the disclosure
controls and procedures, management recognized that any controls and procedures,
no matter how well designed and operated, can provide only reasonable assurance
of achieving the desired control objectives and management was required to apply
its judgment in evaluating the cost-benefit relationship of possible controls
and procedures.
During the 90-day period prior to the date of this report, we carried out an
evaluation under the supervision and with the participation of our management,
including our CEO and our CFO, of the effectiveness of the design and operation
of our disclosure controls and procedures (as defined in Rule 13a-14(c) under
the Securities Exchange Act of 1934). Based upon that evaluation, the CEO and
CFO concluded that the Company's disclosure controls and procedures were
effective. Subsequent to the date of this evaluation, there have been no
significant changes in our internal controls or in other factors that could
significantly affect these controls, and no corrective actions have been taken
with regard to significant deficiencies or material weaknesses in such controls.
PART II. OTHER INFORMATION
Item 1. LEGAL PROCEEDINGS
As previously reported, on October 2, 2002, the Regional Appeals Court of
Dusseldorf, Public Procurement Division, ruled that the decision of Westdeutsche
Lotterie GmbH & Co. OHG ("WestLotto") to award its new online lottery system
contract to us was lawful and consistent with applicable legal authorities. This
ruling overturned the determination of the Public Procurement Tribunal of
Munster, announced on June 24, 2002 and served on June 26, 2002, which granted
the bid protest of Scientific Games Corporation under the aforementioned online
lottery procurement. On October 10, 2002, WestLotto announced that it would
award the new online lottery systems contract to us.
As previously reported, upon the expiration of our current contract, Caixa
Economica Federal ("CEF"), the operator of Brazil's National Lottery, will
attempt to handle internally some non-lottery operations that we currently
perform under our 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 us. See Part 1, Item 2 - "Significant Contract
Rebids". We continue to press in Brazilian courts our contention, which we
believe to have merit, that the CEF procurement process (detailed in previous
reports) violates a prior Brazilian judicial decision as well as other
applicable Brazilian law. We remain unable to predict the outcome of our legal
challenges to the CEF's procurement process. During our 2003 third quarter, CEF
indicated that it plans to request that we extend the term of our contract with
CEF, which is scheduled to end in January 2003, for an additional six months.
For information respecting these and certain other legal proceedings, refer to
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 Consolidated Financial Statements, in our fiscal 2002
Annual Report on Form 10-K, and Part II, Item 1 - "Legal Proceedings" in our
Quarterly Report for the quarterly periods ended respectively, May 25, 2002 and
August 24, 2002.
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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
99.1 Certification Pursuant to 18 United States Code Section 1350, as
Adopted Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002,
of W. Bruce Turner, President and Chief Executive Officer of the
Company
99.2 Certification Pursuant to 18 United States Code Section 1350, as
Adopted Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002,
of Jaymin B. Patel, Senior Vice President and Chief Financial
Officer of the Company
(b) Reports on Form 8-K - We filed the following reports with the Securities
and Exchange Commission on Form 8-K during the quarter to which this report
relates:
(i) We filed a report on Form 8-K on September 13, 2002 incorporating
by reference a press release we issued on September 13, 2002
announcing our fiscal 2003 second quarter and year to date results.
In addition, we revised our earnings guidance upward for the fiscal
year ending February 22, 2003.
(ii) We filed a report on Form 8-K on October 2, 2002 incorporating by
reference a press release we issued on October 2, 2002 announcing
that we launched an offer to purchase up to $50 million of our
7.75% Series A Guaranteed Senior Notes due 2004 and our 7.87%
Series B Guaranteed Senior Notes due 2007.
(iii) We filed a report on Form 8-K on November 6, 2002 incorporating by
reference a press release we issued on November 6, 2002 announcing
that the Taiwan National Lottery recalled previously issued instant
tickets distributed by a partnership in which we own a 44%
interest.
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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: January 2, 2003 By /s/ Jaymin B. Patel
------------------------------------------------
Jaymin B. Patel, Senior Vice President and Chief
Financial Officer (Principal Financial Officer)
Date: January 2, 2003 By /s/ Robert J. Plourde
------------------------------------------------
Robert J. Plourde, Vice President and Corporate
Controller (Principal Accounting Officer)
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CERTIFICATIONS
I, W. Bruce Turner, President and Chief Executive Officer of GTECH Holdings
Corporation (the "Company"), certify that:
(1) I have reviewed this quarterly report on Form 10-Q of the Company;
(2) Based on my knowledge, this quarterly report does not contain any
untrue statement of a material fact or omit to state a material fact
necessary to make the statements made, in light of the circumstances
under which such statements were made, not misleading with respect to
the period covered by this quarterly report;
(3) Based on my knowledge, the financial statements, and other financial
information included in this quarterly report, fairly present in all
material respects the financial condition, results of operations and
cash flows of the Company as of, and for, the periods presented in this
quarterly report;
(4) The Company's other certifying officer and I are responsible for
establishing and maintaining disclosure controls and procedures (as
defined in Exchange Act Rules 13a-14 and 15d-14) for the Company and we
have:
(a) designed such disclosure controls and procedures to ensure that
material information relating to the Company, including its
consolidated subsidiaries, is made known to us by others within
those entities, particularly during the period in which this
quarterly report was being prepared;
(b) evaluated the effectiveness of the Company's disclosure controls
and procedures as of a date within 90 days prior to the filing
date of this quarterly report (the "Evaluation Date"); and
(c) presented in this quarterly report our conclusions about the
effectiveness of the disclosure controls and procedures based on
our evaluation as of the Evaluation Date;
(5) The Company's other certifying officer and I have disclosed, based on
our most recent evaluation, to the Company's auditors and the audit
committee of the Company's board of directors:
(a) all significant deficiencies in the design or operation of
internal controls which could adversely affect the Company's
ability to record, process, summarize and report financial data
and have identified for the Company's auditors any material
weaknesses in internal controls; and
(b) any fraud, whether or not material, that involves management or
other employees who have a significant role in the Company's
internal controls; and
(6) The Company's other certifying officer and I have indicated in this
quarterly report whether or not there were any significant changes in
internal controls or in other factors that could significantly affect
internal controls subsequent to the date of our most recent evaluation,
including any corrective actions with regard to significant
deficiencies and material weaknesses.
GTECH HOLDINGS CORPORATION
Date: January 2, 2003 By /s/ W. Bruce Turner
-------------------------------------
W. Bruce Turner
President and Chief Executive Officer
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I, Jaymin B. Patel, Senior Vice President and Chief Financial Officer of GTECH
Holdings Corporation (the "Company"), certify that:
(1) I have reviewed this quarterly report on Form 10-Q of the Company;
(2) Based on my knowledge, this quarterly report does not contain any
untrue statement of a material fact or omit to state a material fact
necessary to make the statements made, in light of the circumstances
under which such statements were made, not misleading with respect to
the period covered by this quarterly report;
(3) Based on my knowledge, the financial statements, and other financial
information included in this quarterly report, fairly present in all
material respects the financial condition, results of operations and
cash flows of the Company as of, and for, the periods presented in this
quarterly report;
(4) The Company's other certifying officer and I are responsible for
establishing and maintaining disclosure controls and procedures (as
defined in Exchange Act Rules 13a-14 and 15d-14) for the Company and we
have:
(a) designed such disclosure controls and procedures to ensure that
material information relating to the Company, including its
consolidated subsidiaries, is made known to us by others within
those entities, particularly during the period in which this
quarterly report was being prepared;
(b) evaluated the effectiveness of the Company's disclosure controls
and procedures as of a date within 90 days prior to the filing
date of this quarterly report (the "Evaluation Date"); and
(c) presented in this quarterly report our conclusions about the
effectiveness of the disclosure controls and procedures based on
our evaluation as of the Evaluation Date;
(5) The Company's other certifying officer and I have disclosed, based on
our most recent evaluation, to the Company's auditors and the audit
committee of the Company's board of directors:
(a) all significant deficiencies in the design or operation of
internal controls which could adversely affect the Company's
ability to record, process, summarize and report financial data
and have identified for the Company's auditors any material
weaknesses in internal controls; and
(b) any fraud, whether or not material, that involves management or
other employees who have a significant role in the Company's
internal controls; and
(6) The Company's other certifying officer and I have indicated in this
quarterly report whether or not there were any significant changes in
internal controls or in other factors that could significantly affect
internal controls subsequent to the date of our most recent evaluation,
including any corrective actions with regard to significant
deficiencies and material weaknesses.
GTECH HOLDINGS CORPORATION
Date: January 2, 2003 By /s/ Jaymin B. Patel
------------------------------------------
Jaymin B. Patel, Senior Vice President and
Chief Financial Officer
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