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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 August 23, 2003
Commission file number 1-11250
GTECH Holdings Corporation
- --------------------------------------------------------------------------------
(Exact name of registrant as specified in its charter)
Delaware 05-0450121
- ------------------------------- -------------------------------
(State or other jurisdiction of (I.R.S. Employer Identification
incorporation or organization) Number)
55 Technology Way, West Greenwich, Rhode Island 02817
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(Address of principal executive offices) (Zip Code)
Registrant's telephone number, including area code: (401) 392-1000
Indicate by check mark whether the registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months (or for such shorter period that the registrant was
required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days.
Yes [X] No [ ]
At September 29, 2003, there were 58,952,267 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 8-25
Item 2. Management's Discussion and Analysis of Financial Condition 26-42
and Results of Operations
Item 3. Quantitative and Qualitative Disclosures about Market Risk 43
Item 4. Controls and Procedures 43
PART II. OTHER INFORMATION
Item 1. Legal Proceedings 44
Item 4. Submission of Matters to a Vote of Security Holders 45
Item 6. Exhibits and Reports on Form 8-K 46
SIGNATURES 47
EXHIBITS
PART 1. FINANCIAL INFORMATION
Item 1. FINANCIAL STATEMENTS
CONSOLIDATED BALANCE SHEETS
GTECH HOLDINGS CORPORATION AND SUBSIDIARIES
(Unaudited)
August 23, February 22,
2003 2003
----------- ------------
(Dollars in thousands)
ASSETS
CURRENT ASSETS:
Cash and cash equivalents $ 94,322 $ 116,174
Trade accounts receivable, net 106,564 107,666
Sales-type lease receivables 4,213 4,400
Inventories 57,448 72,287
Deferred income taxes 29,410 29,410
Other current assets 28,849 18,660
----------- -----------
TOTAL CURRENT ASSETS 320,806 348,597
SYSTEMS, EQUIPMENT AND OTHER ASSETS RELATING TO CONTRACTS, net 504,348 410,911
GOODWILL, net 146,995 115,498
OTHER ASSETS 97,862 79,189
----------- -----------
TOTAL ASSETS $ 1,070,011 $ 954,195
=========== ===========
LIABILITIES AND SHAREHOLDERS' EQUITY
CURRENT LIABILITIES:
Accounts payable $ 63,375 $ 74,042
Accrued expenses 53,565 51,200
Employee compensation 28,335 37,494
Advance payments from customers 62,508 52,442
Deferred revenue and advance billings 12,654 17,264
Income taxes payable 50,118 54,043
Taxes other than income taxes 25,262 16,020
Short term borrowings 2,219 2,616
Current portion of long-term debt 8,813 6,992
----------- -----------
TOTAL CURRENT LIABILITIES 306,849 312,113
LONG-TERM DEBT, less current portion 286,595 287,088
OTHER LIABILITIES 42,942 39,428
COMMITMENTS AND CONTINGENCIES - -
SHAREHOLDERS' EQUITY:
Preferred Stock, par value $.01 per share - 20,000,000 shares authorized, none issued - -
Common Stock, par value $.01 per share - 150,000,000 shares authorized,
92,296,404 and 92,296,404 shares issued; 58,235,704 and 56,638,331 shares
outstanding at August 23, 2003 and February 22, 2003, respectively 923 923
Additional paid-in capital 245,962 235,266
Accumulated other comprehensive loss (91,433) (95,488)
Retained earnings 765,230 684,653
----------- -----------
920,682 825,354
Less cost of 34,060,700 and 35,658,073 shares in treasury at
August 23, 2003 and February 22, 2003, respectively (487,057) (509,788)
----------- -----------
433,625 315,566
----------- -----------
TOTAL LIABILITIES AND SHAREHOLDERS' EQUITY $ 1,070,011 $ 954,195
=========== ===========
See Notes to Consolidated Financial Statements
-3-
CONSOLIDATED INCOME STATEMENTS
GTECH HOLDINGS CORPORATION AND SUBSIDIARIES
(Unaudited)
Three Months Ended
--------------------------
August 23, August 24,
2003 2002
----------- -----------
(Dollars in thousands,
except per share amounts)
Revenues:
Services $ 238,019 $ 211,600
Sales of products 39,228 9,358
----------- -----------
277,247 220,958
Costs and expenses:
Costs of services 132,805 126,942
Costs of sales 28,810 4,109
----------- -----------
161,615 131,051
----------- -----------
Gross profit 115,632 89,907
Selling, general and administrative 27,051 22,901
Research and development 14,106 7,170
----------- -----------
Operating expenses 41,157 30,071
----------- -----------
Operating income 74,475 59,836
Other income (expense):
Interest income 1,021 977
Equity in earnings of unconsolidated affiliates 2,691 1,261
Other income 465 2,269
Interest expense (1,705) (2,718)
----------- -----------
2,472 1,789
----------- -----------
Income before income taxes 76,947 61,625
Income taxes 28,471 23,418
----------- -----------
Net income $ 48,476 $ 38,207
=========== ===========
Basic earnings per share $ 0.84 $ 0.67
=========== ===========
Diluted earnings per share $ 0.74 $ 0.66
=========== ===========
Weighted average shares outstanding - basic 57,918 57,225
=========== ===========
Weighted average shares outstanding - diluted 65,908 58,299
=========== ===========
Dividends per share - common stock $ 0.17 $ -
=========== ===========
See Notes to Consolidated Financial Statements
-4-
CONSOLIDATED INCOME STATEMENTS
GTECH HOLDINGS CORPORATION AND SUBSIDIARIES
(Unaudited)
Six Months Ended
-------------------------
August 23, August 24,
2003 2002
---------- ------------
(Dollars in thousands,
except per share amounts)
Revenues:
Services $461,557 $ 435,335
Sales of products 55,275 17,035
-------- -----------
516,832 452,370
Costs and expenses:
Costs of services 259,602 273,877
Costs of sales 37,439 10,356
-------- -----------
297,041 284,233
-------- -----------
Gross profit 219,791 168,137
Selling, general and administrative 51,331 45,810
Research and development 28,496 13,672
-------- -----------
Operating expenses 79,827 59,482
-------- -----------
Operating income 139,964 108,655
Other income (expense):
Interest income 2,209 1,819
Equity in earnings of unconsolidated affiliates 4,620 1,957
Other income (expense) (715) 1,678
Interest expense (4,011) (5,643)
-------- -----------
2,103 (189)
-------- -----------
Income before income taxes 142,067 108,466
Income taxes 52,565 41,218
-------- -----------
Net income $ 89,502 $ 67,248
======== ===========
Basic earnings per share $ 1.56 $ 1.17
======== ===========
Diluted earnings per share $ 1.43 $ 1.14
======== ===========
Weighted average shares outstanding - basic 57,413 57,387
======== ===========
Weighted average shares outstanding - diluted 62,994 58,763
======== ===========
Dividends per share - common stock $ 0.17 $ -
======== ===========
See Notes to Consolidated Financial Statements
-5-
CONSOLIDATED STATEMENTS OF CASH FLOWS
GTECH HOLDINGS CORPORATION AND SUBSIDIARIES
(Unaudited)
Six Months Ended
-----------------------
August 23, August 24,
2003 2002
---------- ----------
(Dollars in thousands)
OPERATING ACTIVITIES
Net income $ 89,502 $ 67,248
Adjustments to reconcile net income to net cash provided by
operating activities:
Depreciation 51,924 66,619
Intangibles amortization 1,762 3,369
Tax benefit related to stock award plans 10,696 7,299
Equity in earnings of unconsolidated affiliates, net of dividends received (289) 653
Other 3,748 3,731
Changes in operating assets and liabilities:
Trade accounts receivable 9,769 8,490
Inventories 14,839 (12,780)
Other assets and liabilities (11,497) 55,024
--------- ---------
NET CASH PROVIDED BY OPERATING ACTIVITIES 170,454 199,653
INVESTING ACTIVITIES
Purchases of systems, equipment and other assets relating to contracts (143,774) (88,395)
Acquisitions (net of cash acquired) (41,023) -
License fee (12,500) -
Investments in and advances to unconsolidated subsidiaries (1,185) -
Other (6,285) (2,950)
--------- ---------
NET CASH USED FOR INVESTING ACTIVITIES (204,767) (91,345)
FINANCING ACTIVITIES
Net proceeds from issuance of long-term debt 1,409 -
Principal payments on long-term debt (2,146) (3,616)
Purchases of treasury stock - (42,453)
Proceeds from stock options 21,101 14,331
Dividends paid (9,883) -
Other (484) 1,504
--------- ---------
NET CASH PROVIDED BY (USED FOR) FINANCING ACTIVITIES 9,997 (30,234)
Effect of exchange rate changes on cash 2,464 1,737
--------- ---------
INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS (21,852) 79,811
Cash and cash equivalents at beginning of period 116,174 35,095
--------- ---------
CASH AND CASH EQUIVALENTS AT END OF PERIOD $ 94,322 $ 114,906
========= =========
See Notes to Consolidated Financial Statements
-6-
CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY - (Unaudited)
GTECH HOLDINGS CORPORATION AND SUBSIDIARIES
Accumulated
Additional Other
Outstanding Common Paid-in Comprehensive
Shares Stock Capital Income (Loss)
----------- --------- ----------- -------------
(Dollars in thousands)
Balance at February 22, 2003 56,638,331 $ 923 $ 235,266 $ (95,488)
Comprehensive income:
Net income - - - -
Other comprehensive income (loss), net of tax:
Foreign currency translation - - - 5,104
Unrecognized net loss on derivative instruments - - - (1,048)
Unrealized loss on investments - - - (1)
Comprehensive income
Cash dividends on common stock ($0.17 per share) - - - -
Shares issued under employee stock purchase
and stock award plans 139,197 - - -
Shares issued upon exercise of stock options 1,458,176 - - -
Tax benefits related to stock award plans - - 10,696 -
---------- --------- ----------- -----------
Balance at August 23, 2003 58,235,704 $ 923 $ 245,962 $ (91,433)
========== ========= =========== ===========
Retained Treasury
Earnings Stock Total
----------- ------------ ----------
(Dollars in thousands)
Balance at February 22, 2003 $ 684,653 $ (509,788) $ 315,566
Comprehensive income:
Net income 89,502 - 89,502
Other comprehensive income (loss), net of tax:
Foreign currency translation - - 5,104
Unrecognized net loss on derivative instruments - - (1,048)
Unrealized loss on investments - - (1)
----------
Comprehensive income 93,557
Cash dividends on common stock ($0.17 per share) (9,956) - (9,956)
Shares issued under employee stock purchase
and stock award plans 681 1,980 2,661
Shares issued upon exercise of stock options 350 20,751 21,101
Tax benefits related to stock award plans - - 10,696
----------- ------------ -----------
Balance at August 23, 2003 $ 765,230 $ (487,057) $ 433,625
=========== ============ ===========
See Notes to Consolidated Financial Statements
-7-
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
GTECH HOLDINGS CORPORATION AND SUBSIDIARIES
NOTE 1 - ORGANIZATION, BASIS OF PRESENTATION AND STOCK-BASED COMPENSATION PLANS
ORGANIZATION
GTECH Holdings Corporation ("Holdings") is a global information technology
company providing software, networks and professional services that power
high-performance, transaction processing solutions. When used in these notes,
the terms "Holdings", "the Company", "we", "our", and "us" refer to GTECH
Holdings Corporation and its consolidated subsidiaries, unless otherwise
specified. We have a single operating and reportable business segment, the
Transaction Processing segment. Our core market is the lottery industry, with a
growing presence in commercial services transaction processing. The accounting
policies of the Transaction Processing segment are the same as those described
in Note 1 - "Organization and Summary of Significant Accounting Policies" in our
Consolidated Financial Statements and footnotes included in our fiscal 2003
Annual Report on Form 10-K, as amended. Management evaluates the performance of
this segment based on operating income.
BASIS OF PRESENTATION
The accompanying unaudited consolidated financial statements of Holdings, the
parent of GTECH Corporation ("GTECH"), have been prepared in accordance with
generally accepted accounting principles ("GAAP") for interim financial
information and with the instructions to Form 10-Q and Article 10 of Regulation
S-X. They do not include all information and notes required by GAAP for complete
financial statements. In the opinion of management, all adjustments (consisting
of normal recurring accruals) considered necessary for a fair presentation have
been included. Operating results for the six-month period ended August 23, 2003
are not necessarily indicative of the results that may be expected for the full
fiscal year ending February 28, 2004. The balance sheet at February 22, 2003 has
been derived from the audited financial statements at that date. For further
information refer to the Consolidated Financial Statements and footnotes
included in our fiscal 2003 Annual Report on Form 10-K, as amended.
Certain amounts in our prior period financial statements have been reclassified
to conform to the current period presentation.
STOCK-BASED COMPENSATION PLANS
We follow Accounting Principles Board Opinion No. 25, "Accounting for Stock
Issued to Employees" and related Interpretations, in accounting for our
stock-based compensation plans and we have elected to continue to use the
intrinsic value-based method to account for stock option grants. We have adopted
the disclosure-only provisions of Statement of Financial Accounting Standards
No. 148, "Accounting for Stock-Based Compensation - Transition and Disclosure",
an amendment of Statement of Financial Accounting Standards No. 123.
Accordingly, no compensation expense has been recognized for our stock-based
compensation plans other than for restricted stock.
-8-
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)
NOTE 1 - ORGANIZATION, BASIS OF PRESENTATION AND STOCK-BASED COMPENSATION PLANS
(continued)
Had we elected to recognize compensation expense based upon the fair value at
the grant dates for awards under these plans, net income and earnings per share
would have been reduced to the pro forma amounts listed in the table below. The
fair value of each grant is estimated on the date of grant using the
Black-Scholes option pricing model.
Three Months Ended Six Months Ended
-------------------------- --------------------------
August 23, August 24, August 23, August 24,
2003 2002 2003 2002
------------ ------------ ------------ -----------
(Dollars and shares in thousands,
except per share amounts)
Net income, as reported $ 48,476 $ 38,207 $ 89,502 $ 67,248
Deduct: Total stock-based compensation expense
determined under the fair value method for all
awards, net of related tax effects (1,432) (1,752) (2,909) (3,431)
------------ ------------ ------------ -----------
Pro forma net income $ 47,044 $ 36,455 $ 86,593 $ 63,817
============ ============ ============ ===========
Basic earnings per share:
As reported $ .84 $ .67 $ 1.56 $ 1.17
Pro forma .81 .64 1.51 1.11
Diluted earnings per share:
As reported $ .74 $ .66 $ 1.43 $ 1.14
Pro forma .72 .63 1.39 1.09
NOTE 2 - BUSINESS ACQUISITIONS
POLCARD S.A.
On May 28, 2003, we completed the acquisition of a controlling equity position
in PolCard S.A. ("PolCard"), for a purchase price, net of cash acquired, of
$35.9 million. PolCard is the largest debit and credit card merchant transaction
acquirer and processor in Poland. At August 23, 2003, PolCard's outstanding
equity was owned 66.5% by us, 33.2% by two funds managed by Innova Capital Sp.
zo.o ("Innova"), a Warsaw-based private equity investment advisor, and 0.3% by
the Polish Bank Association, one of PolCard's previous owners. In September 2003
(after the close of our fiscal 2004 second quarter), Innova exercised its rights
under an option agreement to purchase from us, 3.7% of PolCard's equity for a
purchase price of $2.3 million. Following the exercise of this right, we now own
62.8% of PolCard's outstanding equity, while the two funds managed by Innova
own, in aggregate, 36.9% of PolCard's outstanding equity. The Polish Bank
Association continues to own 0.3% of the outstanding equity of PolCard. We have
a fair value option to purchase Innova's interest in PolCard, and Innova has the
reciprocal right to sell its interest in PolCard to us at fair value, during the
period commencing approximately four and ending approximately six years after
closing.
-9-
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)
NOTE 2 - BUSINESS ACQUISITIONS (continued)
EUROPRINT HOLDINGS LTD.
On June 24, 2003, we exercised our option to acquire the remaining 20% of the
equity of Europrint Holdings Ltd. ("Europrint") and its wholly owned
subsidiaries, including Interactive Games International ("IGI"), for
approximately $5.1 million. We acquired the initial 80% of the equity of
Europrint in fiscal 1999 for a net cash purchase price of $21.6 million,
including related acquisition costs. Europrint is a provider of media
promotional games and IGI has pioneered the development of interactive,
televised lottery games.
INTERLOTT TECHNOLOGIES, INC.
On September 18, 2003 (after the close of our fiscal 2004 second quarter), we
completed the acquisition of Interlott Technologies, Inc. ("Interlott"), a
provider of instant ticket vending machines for the worldwide lottery industry.
Interlott shareholders were given the opportunity to elect to receive either
$9.00 per share in cash or a number of shares of Holdings common stock having a
value of $9.00, or a combination of both, subject to adjustment so that the
aggregate consideration we paid was 48.5% in cash and 51.5% in Holdings common
stock. The final exchange ratio of 0.2156 shares of Holdings common stock for
every share of Interlott common stock was determined based on the average
closing price of $41.74 for Holdings common stock, for the 20 trading day period
commencing August 14, 2003 through September 11, 2003. The aggregate purchase
price, including assumed debt, was $86.4 million as follows:
Aggregate
purchase price
--------------
(in millions)
Cash ($9.00 per share of Interlott common stock) $ 28.2
Cash payment to cancel outstanding stock options relating to Interlott
common stock 5.7
---------------
Cash purchase price $ 33.9
Issuance of approximately 717,000 shares of Holdings common stock 30.0
---------------
Total aggregate purchase price $ 63.9
Cash payment to settle Interlott debt 22.5
---------------
$ 86.4
===============
All conditions to the closing of the acquisition were satisfied, including
obtaining the approval of the transaction by Interlott shareholders, securing
necessary regulatory consents, and satisfying certain other closing conditions.
Approval of this transaction by our shareholders was not required.
The PolCard, Europrint and Interlott acquisitions are individually and in the
aggregate, not material to our consolidated financial statements and
accordingly, pro forma financial information has not been presented.
-10-
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)
NOTE 3 - INVENTORIES
August 23, February 22,
2003 2003
------------------ -----------------
(Dollars in thousands)
Inventories consist of:
Raw materials $ 5,184 $ 14,133
Work in progress 47,479 54,855
Finished goods 4,785 3,299
------------------ -----------------
$ 57,448 $ 72,287
================== =================
Inventories include amounts we manufacture or assemble for our long-term service
contracts and amounts related to product sales contracts. Work in progress at
August 23, 2003 and February 22, 2003, includes approximately $42.1 million and
$51.3 million, respectively, related to product sale contracts.
Amounts received from customers in advance of revenue recognition (primarily
related to product sale contracts included in work in progress above) totaled
$62.5 million and $52.4 million at August 23, 2003 and February 22, 2003,
respectively.
NOTE 4 - LICENSE FEE
In May 2003, we entered into a Master Contract with the Rhode Island Lottery
(the "Lottery") that amends our existing contracts with the Lottery and grants
us the right to be the exclusive provider of online, instant ticket and video
lottery central systems and services for the Lottery during the 20-year term of
the Master Contract for a $12.5 million up-front license fee which we paid in
July 2003. This license fee has been capitalized, is included in Other Assets in
our Consolidated Balance Sheet at August 23, 2003, and will be amortized as a
reduction in service revenue on a straight-line basis over the 20-year term of
the Master Contract. The Master Contract is part of a comprehensive economic
development package that provides incentives for us to keep our world corporate
headquarters and manufacturing operations in Rhode Island. One such incentive is
a tax stabilization agreement that we entered into in July 2003 with the City of
Providence ("the City"), whereby the City agreed to stabilize the real estate
and personal property taxes payable in connection with our new world corporate
headquarters facility in the City and the personal property associated with such
facility for 20 years. We also agreed to complete and occupy the facility by
December 31, 2006, employ 500 employees at the facility by 2009, and we made
certain commitments regarding our employment, purchasing and education
activities in the City.
NOTE 5 - PRODUCT WARRANTIES
We offer a product warranty on all of our manufactured products (primarily
terminals and related peripherals) sold to our customers. Although we do not
have a standard product warranty, our typical warranty provides that we will
repair or replace defective products for a period of time (usually a minimum of
90 days) from the date revenue is recognized or from the date a product is
delivered and tested. We estimate product warranty costs that we expect to incur
during the warranty period and we record a charge to costs of sales for the
estimated warranty cost at the time the product sale is recorded. In determining
the appropriate warranty provision, consideration is given to historical
warranty cost information, the status of the terminal model in its life cycle
and current terminal performance. We periodically assess the adequacy of our
product warranty reserves and adjust them as necessary in the period when the
information necessary to make the adjustment becomes available.
We typically do not provide a product warranty on purchased products sold to our
customers but attempt to pass the manufacturer's warranty, if any, on to them.
-11-
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)
NOTE 5 - PRODUCT WARRANTIES (continued)
A summary of product warranty activity, which is included in Accrued Expenses in
our Consolidated Balance Sheets, is as follows:
August 23,
2003
------------------
(Dollars in thousands)
Balance at beginning of fiscal period $ 437
Additional reserves 291
Charges incurred (40)
------------------
Balance at end of fiscal period $ 688
==================
NOTE 6 - LONG-TERM DEBT
August 23, February 22,
2003 2003
------------------ -----------------
(Dollars in thousands)
Long-term debt consists of:
1.75% Convertible Debentures due 2021 $ 175,000 $ 175,000
7.87% Series B Senior Notes due 2007 95,000 95,000
Interest rate swaps 12,992 14,721
Other 12,416 9,359
------------------ -----------------
295,408 294,080
Less current portion 8,813 6,992
------------------ -----------------
$ 286,595 $ 287,088
================== =================
We have an unsecured revolving credit facility of $300 million expiring in June
2006 (the "Credit Facility"). There were no outstanding borrowings under the
Credit Facility at August 23, 2003 or February 22, 2003. Up to $100 million of
the Credit Facility may be used for the issuance of letters of credit. As of
August 23, 2003, there was $290.3 million available for borrowing under the
Credit Facility, after considering $9.7 million of letters of credit issued and
outstanding.
On August 7, 2003, we launched an offer to purchase up to $55 million of our
7.87% Series B Senior Notes due 2007 (the "Senior Notes"). The offer expired on
August 27, 2003. In September 2003, after the close of our fiscal 2004 second
quarter, we repurchased $5.0 million of the Senior Notes. The Senior Notes are
unsecured and are guaranteed by Holdings and certain of our subsidiaries and
interest on each series is payable semi-annually in arrears on May 15 and
November 15 of each year.
NOTE 7 - 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.
-12-
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)
NOTE 8 - GUARANTEES AND INDEMNIFICATIONS
PERFORMANCE AND OTHER BONDS
In connection with certain contracts and procurements, we have been required to
deliver performance bonds for the benefit of our customers and bid and
litigation bonds for the benefit of potential customers, respectively. These
bonds give the beneficiary the right to obtain payment and/or performance from
the issuer of the bond if the events set forth in the bond occur. In the case of
performance bonds, which generally have a term of one year, such events include
our failure to perform our obligations under the applicable contract. To obtain
these bonds, we are required to indemnify the issuers against the costs they
incur if a beneficiary exercises its rights under a bond. Historically, our
customers have not exercised their rights under these bonds and we do not
currently anticipate that they will do so. The following table provides
information related to potential commitments at August 23, 2003:
Total potential
commitments
---------------
(in thousands)
Performance bonds $ 176,672
Financial guarantees 7,571
All other bonds 8,285
---------------
$ 192,528
===============
LOTTERY TECHNOLOGY SERVICES INVESTMENT CORPORATION
We have a 44% interest in Lottery Technology Services Investment Corporation
("LTSIC"), which we account for using the equity method of accounting. LTSIC's
wholly owned subsidiary, Lottery Technology Services Corporation ("LTSC"),
provides equipment and services (which we supplied to LTSC), to the Bank of
Taipei. The Bank of Taipei holds the license to operate the Taiwan Public
Welfare Lottery.
In order to assist LTSC with the financing they required to enable them to
perform under their obligation to operate the Taiwan Public Welfare Lottery on
behalf of the Bank of Taipei, at August 23, 2003, we guaranteed $5.2 million
principal amount 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 did not receive any consideration in exchange for our guarantees on
behalf of LTSC. Rather, these guarantees were issued in connection with the
formation of LTSC and LTSIC.
We are recognizing 56% of our product sales to, and service revenue from, LTSC.
The remaining 44% of product sales (and related cost) and service revenue, has
been deferred as a result of our equity interest in LTSIC and related guarantee
of LTSC's debt, respectively, and is principally included in Other Liabilities
in our Consolidated Balance Sheets at August 23, 2003 and February 22, 2003.
Product sale deferrals are being recognized ratably over the life of our
contract with LTSC and service revenue deferrals are being recognized as the
guaranteed debt is repaid. At August 23, 2003, deferred product gross profit and
deferred service revenue totaled $4.1 million and $6.7 million, respectively.
-13-
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)
NOTE 8 - GUARANTEES AND INDEMNIFICATIONS (continued)
TIMES SQUARED INCORPORATED
We guaranteed outstanding lease obligations of Times Squared Incorporated
("Times Squared") for which we received no monetary consideration. The amount
outstanding under the lease at August 23, 2003, was $2.4 million. Our guarantee
expires in December 2013. Times Squared is a nonprofit corporation established
to provide, among other things, secondary and high school level educational
programs. Times Squared operates a Charter School for Engineering, Mathematics,
Science and Technology in Providence, Rhode Island that serves inner city
children who aspire to careers in the sciences and technology.
LOTTERY TECHNOLOGY ENTERPRISES
We have a 1% interest in Lottery Technology Enterprises ("LTE"), a joint venture
between us and District Enterprise for Lottery Technology Applications of
Washington, D.C. The joint venture agreement terminates on December 31, 2012.
LTE holds a 10-year contract (which expires in November 2009) with the District
of Columbia Lottery and Charitable Games Control Board. Under Washington, D.C.
law, by virtue of our 1% interest in LTE, we are jointly and severally liable,
with the other partner, for the acts of the joint venture.
GAMING ENTERTAINMENT (DELAWARE) L.L.C.
We have a 50% interest in Gaming Entertainment (Delaware) L.L.C. ("GED"). GED is
a joint venture between us and a subsidiary of Full House Resorts, Inc.
("FHRI"). Pursuant to a 1995 management agreement ("Agreement"), GED manages a
casino for Harrington Raceway, Inc. ("Harrington") and in return receives a
percentage of gross revenues and operating profits as defined in the Agreement.
Along with FHRI, we guarantee the payment of all amounts due Harrington under
the Agreement. Our guarantee expires on February 1, 2012 or upon expiration of
the Delaware Horse Racing Redevelopment Act. The consideration we receive in
exchange for the guarantee are the equity earnings from our joint venture with
FHRI.
NOTE 9 -- COMPREHENSIVE INCOME
The components of comprehensive income are as follows:
Three Months Ended Six Months Ended
-------------------------- -------------------------
August 23, August 24, August 23, August 24,
2003 2002 2003 2002
------------ ------------ ----------- -----------
(Dollars in thousands)
Net income $ 48,476 $ 38,207 $ 89,502 $ 67,248
Other comprehensive income (loss), net of tax
Foreign currency translation (4,113) (8,448) 5,104 (5,907)
Unrecognized net gain (loss) on derivative
instruments 4,000 (597) (1,048) (1,272)
Unrealized loss on investments (1) - (1) (72)
------------ ------------ ----------- -----------
Comprehensive income $ 48,362 $ 29,162 $ 93,557 $ 59,997
============ ============ =========== ===========
-14-
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)
NOTE 10 - EARNINGS PER SHARE
The following table shows the computation of basic and diluted earnings per
share:
Three Months Ended Six Months Ended
-------------------------- --------------------------
August 23, August 24, August 23, August 24,
2003 2002 2003 2002
------------ ------------ ------------ -----------
(Dollars and shares in thousands,
except per share amounts)
Numerator:
Net income (Numerator for basic earnings per share) $ 48,476 $ 38,207 $ 89,502 $ 67,248
Effect of dilutive securities:
Interest expense on 1.75% Convertible Debentures 517 - 662 -
------------ ------------ ------------ -----------
Numerator for diluted earnings per share $ 48,993 $ 38,207 $ 90,164 $ 67,248
============ ============ ============ ===========
Denominator:
Denominator for basic earnings per share - weighted-
average shares 57,918 57,225 57,413 57,387
Effect of dilutive securities:
1.75% Convertible Debentures 6,364 - 3,951 -
Employee stock options 1,484 981 1,526 1,269
Unvested restricted and stock bonus discount shares 142 93 104 107
------------ ------------ ------------ -----------
Dilutive potential common shares 7,990 1,074 5,581 1,376
Denominator for diluted earnings per share - adjusted
weighted-average shares and assumed conversions 65,908 58,299 62,994 58,763
============ ============ ============ ===========
Basic earnings per share $ .84 $ .67 $ 1.56 $ 1.17
============ ============ ============ ===========
Diluted earnings per share $ .74 $ .66 $ 1.43 $ 1.14
============ ============ ============ ===========
Our 1.75% Convertible Debentures ("Debentures") are convertible at the option of
the holder into shares of our common stock at an initial conversion rate of
36.3636 shares of common stock per $1,000 principal amount of Debentures, which
is equivalent to an initial conversion price of approximately $27.50 per share.
The Debentures become convertible when, among other circumstances, the closing
price of our common stock is more than 120% of the conversion price
(approximately $33 per share) for at least 20 out of 30 consecutive trading days
prior to the date of surrender for conversion. There are a total of 6.4 million
shares issuable upon the conversion of the Debentures.
The Debentures were convertible for all 63 trading days in the quarter ended
August 23, 2003, and all 6.4 million shares were included in the computation of
diluted earnings per share. For the quarter ended August 24, 2002, none of the
6.4 million shares were included in the computation of diluted earnings per
share because, in accordance with their terms, the Debentures had not yet become
convertible.
The Debentures were convertible for 80 out of 127 trading days during the six
month period ended August 23, 2003, and approximately 4 million shares were
included in the computation of diluted earnings per share. For the six months
ended August 24, 2002, none of the 6.4 million shares were included in the
computation of diluted earnings per share because, in accordance with their
terms, the Debentures had not yet become convertible.
-15-
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)
NOTE 11 - INCOME TAXES
Our effective income tax rate is greater than the statutory rate primarily due
to state income taxes and certain expenses that are not deductible for income
tax purposes.
NOTE 12 - RECENT ACCOUNTING PRONOUNCEMENTS
In January 2003, the Financial Accounting Standards Board ("FASB") issued
Interpretation No. 46, "Consolidation of Variable Interest Entities" ("FIN 46"),
which requires the consolidation of a variable interest entity (as defined) by
its primary beneficiary. Primary beneficiaries are those companies that are
subject to a majority of the risk of loss or entitled to receive a majority of
the variable interest entity's residual returns, or both. In determining whether
it is the primary beneficiary of a variable interest entity, a company with a
variable interest must also treat a variable interest held by the company's
related parties in that same entity as its own interests. FIN 46 applies
immediately to variable interest entities that are created after or for which
control is obtained after January 31, 2003. For variable interest entities
created prior to February 1, 2003, the provisions of FIN 46 would be applied in
the fiscal quarter beginning after June 15, 2003 (our third quarter of fiscal
2004). However, on September 19, 2003, the FASB issued proposed Staff Position
("FSP") No. FIN 46-e, "Effective Date of FASB Interpretation No. 46,
Consolidation of Variable Interest Entities, for Certain Interests Held by a
Public Entity", for public comment. Under the proposed FSP, we would not need to
apply the provisions of FIN 46 to interests held in a variable interest entity
("VIE"), or potential VIE, until our fiscal 2004 fourth quarter, if certain
conditions are met.
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 currently account for the Partnership using the equity
method of accounting. The FSP described above does not apply to the Partnership.
As a result, beginning in the third quarter of fiscal 2004, which began on
August 24, 2003, we will consolidate the Partnership in accordance with FIN 46.
Accordingly, we will record our world headquarters facilities owned by the
Partnership as an asset, and the Partnership's debt obligation as a liability in
our consolidated financial statements. We expect the adoption of this
interpretation to increase balance sheet assets and liabilities in the range of
$27 million to $30 million and to result in a one-time, non-cash, pre-tax gain
in the range of $4 million to $5 million, or $0.05 per diluted share, that will
be recorded in Other Income in our consolidated financial statements. The
pre-tax gain will be recorded in Other Income and not as a cumulative-effect
adjustment because the gain is not material to our consolidated financial
statements.
We have certain investments for which the applicability of FIN 46 has not yet
been determined. The adoption of FIN 46's provisions, if applicable to such
investments, is not expected to have a material impact on our financial
statements. Pursuant to the proposed FSP noted above, if applicable, we would
not be required to apply FIN 46 to these investments until our fiscal 2004
fourth quarter.
In April 2003, the FASB issued Statement of Financial Accounting Standards No.
149 ("SFAS 149"), "Amendment of Statement 133 on Derivative Instruments and
Hedging Activities". SFAS 149 amends Statement of Financial Accounting Standards
No. 133 to provide clarification on the financial accounting and reporting of
derivative instruments and hedging activities and requires that contracts with
similar characteristics be accounted for on a comparable basis. The provisions
of SFAS 149 are effective for contracts entered into or modified after June 30,
2003, and for hedging relationships designated after June 30, 2003. We do not
expect this statement to have a material impact on our consolidated financial
statements.
In May 2003, the FASB issued Statement of Financial Accounting Standards No. 150
("SFAS 150"), "Accounting for Certain Financial Instruments with Characteristics
of both Liabilities and Equity". SFAS 150 establishes standards on the
classification and measurement of certain financial instruments with
characteristics of both liabilities and equity. The provisions of SFAS 150 are
effective for financial instruments entered into or modified after May 31, 2003
and to all other instruments that exist as of the beginning of the first interim
financial reporting period beginning after June 15, 2003 (our third quarter of
fiscal 2004). We do not expect this statement to have a material impact on our
consolidated financial statements.
-16-
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)
NOTE 13 - SUPPLEMENTAL GUARANTOR/NON-GUARANTOR FINANCIAL INFORMATION
On December 18, 2001, Holdings (the "Parent Company") issued $175 million
principal amount of 1.75% Convertible Debentures due 2021 (the "Convertible
Debentures"). The Convertible Debentures are unsecured and unsubordinated
obligations of the Parent Company that are jointly and severally, fully and
unconditionally guaranteed by GTECH and two of its wholly-owned subsidiaries:
GTECH Rhode Island Corporation and GTECH Latin America Corporation (collectively
with GTECH, the "Guarantor Subsidiaries"). Condensed consolidating financial
information is presented below.
Selling, general and administrative costs and research and development costs are
allocated to each subsidiary based on the ratio of the subsidiaries combined
service revenue and sales of products to consolidated revenues.
The Parent Company conducts business through its consolidated subsidiaries and
unconsolidated affiliates and has, as its only material asset, an investment in
GTECH. Equity in earnings of consolidated affiliates recorded by the Parent
Company includes the Parent Company's share of the after-tax earnings of GTECH.
Taxes payable and deferred income taxes are obligations of the subsidiaries.
Income tax expense related to both current and deferred income taxes are
allocated to each subsidiary based on our consolidated effective income tax
rates.
-17-
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)
NOTE 13 - SUPPLEMENTAL GUARANTOR/NON-GUARANTOR FINANCIAL INFORMATION
(continued)
Condensed Consolidating Balance Sheets
August 23, 2003
Parent Guarantor Non-Guarantor Eliminating
Company Subsidiaries Subsidiaries Entries Consolidated
--------------- ------------- --------------- ------------- --------------
(Dollars in thousands)
Assets
Current Assets:
Cash and cash equivalents $ - $ 52,443 $ 41,879 $ - $ 94,322
Trade accounts receivable, net - 68,400 38,164 - 106,564
Due from subsidiaries and
affiliates - 48,005 - (48,005) -
Sales-type lease receivables - 1,074 3,139 - 4,213
Inventories - 43,144 19,665 (5,361) 57,448
Deferred income taxes - 25,599 3,811 - 29,410
Other current assets - 13,029 15,820 - 28,849
--------------- ------------- --------------- ------------- --------------
Total Current Assets - 251,694 122,478 (53,366) 320,806
Systems, Equipment and Other
Assets Relating to Contracts, net - 430,856 78,409 (4,917) 504,348
Investment in Subsidiaries and
Affiliates 433,625 134,981 - (568,606) -
Goodwill, net - 70,605 76,390 - 146,995
Other Assets - 65,321 32,541 - 97,862
--------------- ------------- --------------- ------------- --------------
Total Assets $ 433,625 $ 953,457 $ 309,818 $ (626,889) $ 1,070,011
=============== ============= =============== ============= ==============
Liabilities and Shareholders' Equity
Current Liabilities:
Accounts payable $ - $ 40,750 $ 22,625 $ - $ 63,375
Due to subsidiaries and affiliates - - 48,005 (48,005) -
Accrued expenses - 33,910 19,655 - 53,565
Employee compensation - 23,293 5,042 - 28,335
Advance payments from
customers - 36,534 25,974 - 62,508
Deferred revenue and advance
billings - 9,906 2,748 - 12,654
Income taxes payable - 45,874 4,244 - 50,118
Taxes other than income tax - 11,786 13,476 - 25,262
Short term borrowings - - 2,219 - 2,219
Current portion of long-term debt - 3,524 5,289 - 8,813
-------------- ------------- --------------- ------------- --------------
Total Current Liabilities - 205,577 149,277 (48,005) 306,849
Long-Term Debt, less current
portion - 279,468 7,127 - 286,595
Other Liabilities - 24,509 18,433 - 42,942
Shareholders' Equity 433,625 443,903 134,981 (578,884) 433,625
--------------- ------------- --------------- ------------- --------------
Total Liabilities and
Shareholders' Equity $ 433,625 $ 953,457 $ 309,818 $ (626,889) $ 1,070,011
=============== ============= =============== ============= ==============
-18-
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)
NOTE 13 - SUPPLEMENTAL GUARANTOR/NON-GUARANTOR FINANCIAL INFORMATION
(continued)
Condensed Consolidating Income Statements
Three Months Ended August 23, 2003
Parent Guarantor Non-Guarantor Eliminating
Company Subsidiaries Subsidiaries Entries Consolidated
--------------- ------------- --------------- ------------- --------------
(Dollars in thousands)
Revenues:
Services $ - $ 172,895 $ 65,124 $ - $ 238,019
Sales of products - 8,469 30,759 - 39,228
Intercompany sales and fees - 18,495 11,628 (30,123) -
--------------- ------------- --------------- ------------- --------------
- 199,859 107,511 (30,123) 277,247
Costs and expenses:
Costs of services - 92,010 41,796 (1,001) 132,805
Costs of sales - 3,694 25,150 (34) 28,810
Intercompany cost of sales
and fees - 38,634 3,906 (42,540) -
--------------- ------------- --------------- ------------- --------------
- 134,338 70,852 (43,575) 161,615
--------------- ------------- --------------- ------------- --------------
Gross profit - 65,521 36,659 13,452 115,632
Selling, general and administrative - 17,653 9,398 - 27,051
Research and development - 9,131 4,975 - 14,106
--------------- ------------- --------------- ------------- --------------
Operating expenses - 26,784 14,373 - 41,157
--------------- ------------- --------------- ------------- --------------
Operating income - 38,737 22,286 13,452 74,475
Other income (expense):
Interest income - 201 820 - 1,021
Equity in earnings of
unconsolidated affiliates - 1,381 1,310 - 2,691
Equity in earnings of
consolidated affiliates 48,476 15,035 - (63,511) -
Other income (expense) - 711 (246) - 465
Interest expense - (1,399) (306) - (1,705)
--------------- ------------- --------------- -------------- --------------
Income before income taxes 48,476 54,666 23,864 (50,059) 76,947
Income taxes - 20,226 8,829 (584) 28,471
--------------- ------------- --------------- ------------- --------------
Net income $ 48,476 $ 34,440 $ 15,035 $ (49,475) $ 48,476
=============== ============= =============== ============= ==============
-19-
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)
NOTE 13 - SUPPLEMENTAL GUARANTOR/NON-GUARANTOR FINANCIAL INFORMATION
(continued)
Condensed Consolidating Income Statements
Six Months Ended August 23, 2003
Parent Guarantor Non-Guarantor Eliminating
Company Subsidiaries Subsidiaries Entries Consolidated
-------------- ------------- --------------- ------------- ------------
(Dollars in thousands)
Revenues:
Services $ - $ 339,198 $ 122,359 $ - $ 461,557
Sales of products - 20,085 35,190 - 55,275
Intercompany sales and fees - 45,342 21,933 (67,275) -
-------------- ------------- --------------- ------------- --------------
- 404,625 179,482 (67,275) 516,832
Costs and expenses:
Costs of services - 182,031 79,618 (2,047) 259,602
Costs of sales - 9,981 27,512 (54) 37,439
Intercompany cost of sales
and fees - 54,604 8,552 (63,156) -
-------------- ------------- --------------- ------------- --------------
- 246,616 115,682 (65,257) 297,041
-------------- ------------- --------------- ------------- --------------
Gross profit - 158,009 63,800 (2,018) 219,791
Selling, general and administrative - 35,686 15,645 - 51,331
Research and development - 19,815 8,681 - 28,496
-------------- ------------- --------------- ------------- --------------
Operating expenses - 55,501 24,326 - 79,827
-------------- ------------- --------------- ------------- --------------
Operating income - 102,508 39,474 (2,018) 139,964
Other income (expense):
Interest income - 560 1,649 - 2,209
Equity in earnings of
unconsolidated affiliates - 2,571 2,049 - 4,620
Equity in earnings of
consolidated affiliates 89,502 24,513 - (114,015) -
Other income (expense) - 2,729 (3,444) - (715)
Interest expense - (3,192) (819) - (4,011)
-------------- ------------- --------------- ------------- --------------
Income before income taxes 89,502 129,689 38,909 (116,033) 142,067
Income taxes - 47,985 14,396 (9,816) 52,565
-------------- ------------- --------------- ------------- --------------
Net income $ 89,502 $ 81,704 $ 24,513 $ (106,217) $ 89,502
============== ============= =============== ============= ==============
-20-
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)
NOTE 13 - SUPPLEMENTAL GUARANTOR/NON-GUARANTOR FINANCIAL INFORMATION
(continued)
Condensed Consolidating Income Statements
Three Months Ended August 24, 2002
Parent Guarantor Non-Guarantor Eliminating
Company Subsidiaries Subsidiaries Entries Consolidated
-------------- ------------- --------------- ------------- --------------
(Dollars in thousands)
Revenues:
Services $ - $ 159,070 $ 52,530 $ - $ 211,600
Sales of products - 5,465 3,893 - 9,358
Intercompany sales and fees - 29,461 12,423 (41,884) -
-------------- ------------- --------------- ------------- --------------
- 193,996 68,846 (41,884) 220,958
Costs and expenses:
Costs of services - 90,031 40,180 (3,269) 126,942
Costs of sales - 2,007 2,417 (315) 4,109
Intercompany cost of sales
and fees - 14,443 5,195 (19,638) -
-------------- ------------- --------------- ------------- --------------
- 106,481 47,792 (23,222) 131,051
-------------- ------------- --------------- ------------- --------------
Gross profit - 87,515 21,054 (18,662) 89,907
Selling, general and administrative - 17,058 5,843 - 22,901
Research and development - 5,351 1,819 - 7,170
-------------- ------------- --------------- ------------- --------------
Operating expenses - 22,409 7,662 - 30,071
-------------- ------------- --------------- ------------- --------------
Operating income - 65,106 13,392 (18,662) 59,836
Other income (expense):
Interest income - 395 582 - 977
Equity in earnings of
unconsolidated affiliates - 220 1,041 - 1,261
Equity in earnings of
consolidated affiliates 38,207 11,144 - (49,351) -
Other income (expense) - (1,166) 3,435 - 2,269
Interest expense - (2,242) (476) - (2,718)
-------------- ------------- --------------- ------------- --------------
Income before income taxes 38,207 73,457 17,974 (68,013) 61,625
Income taxes - 27,914 6,831 (11,327) 23,418
-------------- ------------- --------------- ------------- --------------
Net income $ 38,207 $ 45,543 $ 11,143 $ (56,686) $ 38,207
============== ============= =============== ============= ==============
-21-
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)
NOTE 13 - SUPPLEMENTAL GUARANTOR/NON-GUARANTOR FINANCIAL INFORMATION
(continued)
Condensed Consolidating Income Statements
Six Months Ended August 24, 2002
Parent Guarantor Non-Guarantor Eliminating
Company Subsidiaries Subsidiaries Entries Consolidated
-------------- ------------- --------------- ------------- ------------
(Dollars in thousands)
Revenues:
Services $ - $ 331,153 $ 104,182 $ - $ 435,335
Sales of products - 10,135 6,900 - 17,035
Intercompany sales and fees - 48,784 24,910 (73,694) -
-------------- ------------- --------------- ------------- --------------
- 390,072 135,992 (73,694) 452,370
Costs and expenses:
Costs of services - 194,254 85,039 (5,416) 273,877
Costs of sales - 5,856 4,815 (315) 10,356
Intercompany cost of sales
and fees - 28,784 7,287 (36,071) -
-------------- ------------- --------------- ------------- --------------
- 228,894 97,141 (41,802) 284,233
-------------- ------------- --------------- ------------- --------------
Gross profit - 161,178 38,851 (31,892) 168,137
Selling, general and administrative - 34,557 11,253 - 45,810
Research and development - 10,317 3,355 - 13,672
-------------- ------------- --------------- ------------- --------------
Operating expenses - 44,874 14,608 - 59,482
-------------- ------------- --------------- ------------- --------------
Operating income - 116,304 24,243 (31,892) 108,655
Other income (expense):
Interest income - 749 1,070 - 1,819
Equity in earnings of
unconsolidated affiliates - 296 1,661 - 1,957
Equity in earnings of
consolidated affiliates 67,248 18,230 - (85,478) -
Other income (expense) - (1,671) 3,349 - 1,678
Interest expense - (4,724) (919) - (5,643)
-------------- ------------- --------------- ------------- --------------
Income before income taxes 67,248 129,184 29,404 (117,370) 108,466
Income taxes - 49,090 11,174 (19,046) 41,218
-------------- ------------- --------------- ------------- --------------
Net income $ 67,248 $ 80,094 $ 18,230 $ (98,324) $ 67,248
============== ============= =============== ============= ==============
-22-
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)
NOTE 13 - SUPPLEMENTAL GUARANTOR/NON-GUARANTOR FINANCIAL INFORMATION
(continued)
Condensed Consolidating Statements of Cash Flows
Six Months Ended August 23, 2003
Parent Guarantor Non-Guarantor Eliminating
Company Subsidiaries Subsidiaries Entries Consolidated
----------- ------------- --------------- ------------- --------------
(Dollars in thousands)
Net cash provided by operating
activities $ - $ 109,427 $ 61,340 $ (313) $ 170,454
Investing Activities
Purchases of systems, equipment
and other assets relating to
contracts - (137,541) (6,546) 313 (143,774)
Acquisitions (net of cash acquired) - - (41,023) - (41,023)
License fee - (12,500) - - (12,500)
Investments in and advances to
unconsolidated subsidiaries - (1,185) - - (1,185)
Other - (6,285) - - (6,285)
----------- ------------- --------------- ------------- --------------
Net cash used for investing
activities - (157,511) (47,569) 313 (204,767)
Financing Activities
Net proceeds from issuance
of long-term debt - - 1,409 - 1,409
Principal payments on long-term
debt - - (2,146) - (2,146)
Proceeds from stock options 21,101 - - - 21,101
Dividends paid (9,883) - - - (9,883)
Intercompany capital transactions (11,688) 11,688 - - -
Other 470 - (954) - (484)
----------- ------------- ---------------- ------------- --------------
Net cash provided by (used for)
financing activities - 11,688 (1,691) - 9,997
Effect of exchange rate changes
on cash - 100 2,364 - 2,464
----------- ------------- --------------- ------------- --------------
Increase (decrease) in cash and
cash equivalents - (36,296) 14,444 - (21,852)
Cash and cash equivalents at
beginning of period - 88,739 27,435 - 116,174
----------- ------------- --------------- ------------- --------------
Cash and cash equivalents at end
of period $ - $ 52,443 $ 41,879 $ - $ 94,322
=========== ============= =============== ============= ==============
-23-
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)
NOTE 13 - SUPPLEMENTAL GUARANTOR/NON-GUARANTOR FINANCIAL INFORMATION
(continued)
Condensed Consolidating Statements of Cash Flows
Six Months Ended August 24, 2002
Parent Guarantor Non-Guarantor Eliminating
Company Subsidiaries Subsidiaries Entries Consolidated
----------- ------------- --------------- ------------- --------------
(Dollars in thousands)
Net cash provided by operating
activities $ - $ 189,637 $ 9,849 $ 167 $ 199,653
Investing Activities
Purchases of systems, equipment
and other assets relating to
contracts - (82,259) (5,969) (167) (88,395)
Other - (2,950) - - (2,950)
----------- ------------- --------------- ------------- --------------
Net cash used for investing
activities - (85,209) (5,969) (167) (91,345)
Financing Activities
Principal payments on long-term
debt - (2,186) (1,430) - (3,616)
Purchases of treasury stock (42,453) - - - (42,453)
Proceeds from stock options 14,331 - - - 14,331
Intercompany capital transactions 27,647 (27,647) - - -
Other 475 (120) 1,149 - 1,504
----------- ------------- --------------- ------------- --------------
Net cash used for financing
activities - (29,953) (281) - (30,234)
Effect of exchange rate changes
on cash - (1,428) 3,165 - 1,737
----------- ------------- --------------- ------------- --------------
Increase in cash and
cash equivalents - 73,047 6,764 - 79,811
Cash and cash equivalents at
beginning of period - 25,865 9,230 - 35,095
----------- ------------- --------------- ------------- --------------
Cash and cash equivalents at end
of period $ - $ 98,912 $ 15,994 $ - $ 114,906
=========== ============= =============== ============= ==============
-24-
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)
NOTE 14 - SUBSEQUENT EVENTS
INTERLOTT TECHNOLOGIES, INC.
On September 18, 2003 (after the close of our fiscal 2004 second quarter), we
completed the acquisition of Interlott Technologies, Inc. ("Interlott"), a
provider of instant ticket vending machines for the worldwide lottery industry.
See Note 2 "Business Acquisitions" for detailed disclosures.
-25-
Item 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
The terms "Holdings", "the Company", "we", "our" and "us" refer to GTECH
Holdings Corporation and its consolidated subsidiaries, unless otherwise
specified.
Statements contained in this section and elsewhere in this report which are not
historical statements constitute "forward-looking statements" within the meaning
of Section 27A of the Securities Act and Section 21E of the Securities Exchange
Act of 1934. Generally, the words "believe", "expect", "estimate", "anticipate",
"will", "may", "could", "plan", "continue" and similar expressions identify
forward-looking statements. Such statements may include, without limitation,
statements relating to:
- the future prospects for and stability of the lottery industry and
other businesses in which we are engaged or expect to be engaged;
- our future operating and financial performance (including, without
limitation, expected future growth in revenues, profit margins and
earnings per share);
- our ability to retain existing contracts and to obtain and retain new
contracts;
- the future performance of comparable investment opportunities; and
- the results and effects of legal proceedings and investigations.
These forward-looking statements reflect management's assessment based on
information currently available, but are not guarantees and are subject to risks
and uncertainties that could cause actual results to differ materially from
those contemplated in the forward-looking statements. These risks and
uncertainties include the following:
- government regulations and other actions affecting the online lottery
industry could have a negative effect on our business and sales;
- our lottery operations are dependent upon our continued ability to
retain and extend our existing contracts and win new contracts;
- slow growth or declines in sales of online lottery goods and services
and other transaction processing services could lead to lower revenues
and net income;
- our results of operations are exposed to foreign currency exchange rate
fluctuations, which could result in lower revenues, net income and cash
flows when such results are translated into U.S. dollar accounts;
- we derive close to half of our revenues from foreign jurisdictions
(including over ten percent from Brazilian operations) and 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 these
customers (or lower sales from any of these customers) could lead to
lower revenues;
- our quarterly operating results may fluctuate significantly, including
as a result of variations in the amount and timing of product sales,
the occurrence of large jackpots in lotteries (which increase the
amount wagered and our revenue) and expenses incurred in connection
with lottery start-ups;
- we operate in a highly competitive environment and increased
competition may cause us to experience lower net income or to lose
contracts;
- we are subject to substantial penalties for failure to perform under
our contracts;
- we may not be able to respond in a timely manner to technological
changes or to satisfy future technology demands of our customers, in
which case we may fall behind our competitors;
- if we are unable to manage potential risks related to acquisitions, our
business and growth prospects could suffer;
- expansion of the gaming industry faces opposition which could limit our
access to new or existing markets to the detriment of our business;
- our business prospects and future success depend upon our ability to
attract and retain qualified employees;
-26-
- our business prospects and future success rely heavily upon the
integrity of our employees and executives and the security of our
systems;
- our dependence on certain suppliers creates a risk of implementation
delays if the supply contract is terminated or breached, and any delays
may result in substantial penalties;
- our non-lottery ventures, which are an increasingly important aspect of
our business, may fail;
- we may not be able to successfully integrate the operations of
companies that we acquire into our business, and may thereby fail to
realize the strategic and financial benefits that we had expected from
such acquisitions;
- we may be subject to adverse determinations in pending legal
proceedings, which could involve substantial monetary judgments or
reputational damage; and
- other risks and uncertainties set forth below and elsewhere in this
report, in our fiscal 2003 Form 10-K, as amended, and in our subsequent
press releases and Form 10-Q's and other reports and filings with the
Securities and Exchange Commission.
The foregoing list of important factors is not all-inclusive.
General
We operate on a 52 to 53-week fiscal year ending on the last Saturday in
February and fiscal 2004 ends on February 28, 2004. Fiscal 2004 is a 53-week
year and we will include the extra week in our fourth quarter ending February
28, 2004.
We have derived substantially all of our revenues from the rendering of services
and the sale or supply of computerized online lottery systems and components to
government-authorized lotteries. Our service revenues are derived primarily from
lottery service contracts, which are typically at least five years in duration,
and generally provide compensation to us based upon a percentage of a lottery's
gross online lottery sales. These percentages vary depending on the size of the
lottery and the scope of services provided to the lottery. We derive product
sale revenues primarily from the installation of new online lottery systems,
installation of new software and sales of lottery terminals and equipment in
connection with the expansion of existing lottery systems. Our product margins
fluctuate depending on the mix, volume and timing of product sale contracts. The
size and timing of these transactions have resulted in variability in product
sale revenues from period to period. Including the acquisition of Interlott
Technologies, Inc. described below, we currently anticipate that product sales
during fiscal 2004 will be in the range of $120 million to $130 million.
We continue to evaluate a variety of opportunities to broaden our offerings of
high-volume transaction processing services outside of our core market of
providing online lottery services, such as the processing and transmission of
commercial, non-lottery transactions including bill payments, electronic tax
payments, utility payments, prepaid cellular telephone recharges and
retail-based programs such as gift cards. Currently, our networks in Brazil,
Chile, the Czech Republic and Jamaica process bill payments and other commercial
service transactions. In addition, in May 2003 we acquired PolCard, the largest
debit and credit card merchant transaction acquirer and processor in Poland. In
the near term, we expect to concentrate our efforts to grow commercial service
revenues in Brazil, Poland and Mexico. While our goal is to leverage our
technology, infrastructure and relationships to drive growth in commercial
services, if, in the course of pursuing these opportunities, we see a chance to
gain access to certain markets through the acquisition of existing businesses,
we may consider making such acquisitions.
-27-
Our business is highly regulated, and the competition to secure new government
contracts is often intense. From time to time, competitors challenge our
contract awards and there have been, and may continue to be, investigations of
various types, including grand jury investigations conducted by governmental
authorities into possible improprieties and wrongdoing in connection with
efforts to obtain and/or the awarding of lottery contracts and related matters.
In light of the fact that such investigations frequently are conducted in
secret, we may not necessarily know of the existence of an investigation which
might involve us. Because our reputation for integrity is an important factor in
our business dealings with lottery and other governmental agencies, a
governmental allegation or a finding of improper conduct on our part or
attributable to us in any manner could have a material adverse effect on our
business, including our ability to retain existing contracts or to obtain new or
renewal contracts. In addition, continuing adverse publicity resulting from
these investigations and related matters could have a material adverse effect on
our reputation and business. See the following for further information
concerning these matters and other contingencies:
- "Legal Proceedings" in Part II, Item 1 in this report;
- "Legal Proceedings" in Part II, Item 1 in our Quarterly Report for the
quarterly period ended May 24, 2003;
- Part I, Item 1 - "Certain Factors That May Affect Future Performance -
Government regulations and other actions affecting the online lottery
industry could have a negative effect on our business" in our fiscal
2003 Annual Report on Form 10-K, as amended;
- Part I, Item 3 - "Legal Proceedings" in our fiscal 2003 Annual Report
on Form 10-K, as amended;
- Note 11 to the Consolidated Financial Statements in our fiscal 2003
Annual Report on Form 10-K, as amended
We are a global business and we derive a substantial portion of our revenues
from operations outside of the United States. In particular, in fiscal 2003, we
derived 49.2% of our revenues from international operations and 10.3% of our
revenues from our Brazilian operations alone (including 9.8% of our revenues
from Caixa Economica Federal, the operator of Brazil's National Lottery, which
was our largest customer in fiscal 2003 based on annual revenues). In addition,
substantial portions of our assets, primarily consisting of equipment we use to
operate online lottery systems for our customers, are held outside of the United
States. We are also exposed to more general risks of international operations,
including increased governmental regulation of the online lottery industry in
the markets where we operate; exchange controls or other currency restrictions;
and significant political instability.
Significant Contract Bids and Extensions
A majority of our revenues and cash flow is derived from our portfolio of
long-term online lottery service contracts, each of which in the ordinary course
of our business is periodically the subject of competitive procurement or
renegotiation. In the second quarter of fiscal 2004, we continued to execute
against our growth strategy by signing new contracts and contract extensions
both domestically and abroad.
As previously reported, in April 2003, we entered into an agreement with Caixa
Economica Federal ("CEF"), the operator of Brazil's National Lottery, pursuant
to which the term of our contract with CEF, which had been scheduled to expire
in April 2003, was extended for 25 months from April 2003 (with CEF having the
right to elect upon prior notice to terminate the contract early at any time
after 20 months), and fees payable under our contract are reduced by 15%. Our
previous contract with CEF, which as extended, expired in April 2003, was our
largest contract in fiscal 2003, as measured by annual revenues, accounting for
9.8% of our consolidated revenues. See Part I, Item 3 - "Legal Proceedings" and
Note 11 to the Consolidated Financial Statements in our fiscal 2003 Annual
Report on Form 10-K, as amended, for further information concerning this matter.
-28-
In May 2003, we entered into a Master Contract with the Rhode Island Lottery
(the "Lottery") that amends our existing contracts with the Lottery and grants
us the right to be the exclusive provider of online, instant ticket and video
lottery central systems and services for the Lottery during the 20-year term of
the Master Contract for a $12.5 million up-front license fee which we paid in
July 2003. This license fee has been capitalized, is included in Other Assets in
our Consolidated Balance Sheet at August 23, 2003, and will be amortized as a
reduction in service revenue on a straight-line basis over the 20-year term of
the Master Contract. The Master Contract is part of a comprehensive economic
development package that provides incentives for us to keep our world corporate
headquarters and manufacturing operations in Rhode Island. One such incentive is
a tax stabilization agreement that we entered into in July 2003 with the City of
Providence ("the City"), whereby the City agreed to stabilize the real estate
and personal property taxes payable in connection with our new world corporate
headquarters facility in the City and the personal property associated with such
facility for 20 years. We also agreed to complete and occupy the facility by
December 31, 2006, employ 500 employees at the facility by 2009, and we made
certain commitments regarding our employment, purchasing and education
activities in the City.
In June 2003, we were awarded a new five-year integrated services contract by
the Wisconsin Lottery to provide a fully integrated online and instant ticket
gaming system, and Internet Protocol-based wireless telecommunications network.
In July 2003, we signed a contract with The National Lotteries Control Board and
The Betting Levy Board of Trinidad and Tobago to provide a complete video
lottery solution, including a central system, video lottery terminals and
communications network, for a five-year period that is expected to commence in
April 2004 and includes a two-year extension option.
In September 2003 (after the close of our fiscal 2004 second quarter), following
a public, competitive procurement, we were selected by the Florida Lottery as
the apparent successful bidder to supply a new online lottery system, lottery
terminals, and related telecommunications network. The proposed six-year
integrated services contract is expected to commence on February 1, 2005 and
includes two, two-year extension options.
During the second quarter of fiscal 2004, the Michigan Lottery signed a
three-year contract extension with us and exercised an option in its existing
contract with us for Club Keno. Additionally, we extended our relationship with
lottery customers in Turkey, New Zealand, Sweden and the Idaho Department of
Fish and Game. In August 2003, following a competitive procurement, the Nebraska
lottery authority selected another vendor to provide equipment and services for
a new online lottery gaming system upon the scheduled expiration of our current
contract with the Nebraska Lottery in June 2004, however, we will remain as the
Nebraska Lottery's instant-ticket products and system supplier through June
2008.
Over the past several fiscal years, contract renewal and extension rates in the
United States have generally been lower than existing contract rates due to a
number of factors, including the substantial growth of lottery sales during the
latter part of the 1990's and calendar year 2002, reductions in the cost of
technology and telecommunications services, and general market and competitive
dynamics. In anticipation and response to these trends, beginning in fiscal
2001, we began the implementation of our new GTECH Enterprise Series-led
technology strategy combined with the implementation of a number of ongoing cost
savings initiatives and efficiency improvement programs designed to enable us to
maintain our market leadership in the lottery industry.
-29-
Recent Developments
POLCARD S.A.
On May 28, 2003, we completed the acquisition of a controlling equity position
in PolCard S.A. ("PolCard"), for a purchase price, net of cash acquired, of
$35.9 million. PolCard is the largest debit and credit card merchant transaction
acquirer and processor in Poland. At August 23, 2003, PolCard's outstanding
equity was owned 66.5% by us, 33.2% by two funds managed by Innova Capital Sp.
zo.o ("Innova"), a Warsaw-based private equity investment advisor, and 0.3% by
the Polish Bank Association, one of PolCard's previous owners. In September 2003
(after the close of our fiscal 2004 second quarter), Innova exercised its rights
under an option agreement to purchase from us, 3.7% of PolCard's equity for a
purchase price of $2.3 million. Following the exercise of this right, we now own
62.8% of PolCard's outstanding equity, while the two funds managed by Innova
own, in aggregate, 36.9% of PolCard's outstanding equity. The Polish Bank
Association continues to own 0.3% of the outstanding equity of PolCard. We have
a fair value option to purchase Innova's interest in PolCard, and Innova has the
reciprocal right to sell its interest in PolCard to us at fair value, during the
period commencing approximately four and ending approximately six years after
closing.
EUROPRINT HOLDINGS LTD.
On June 24, 2003, we exercised our option to acquire the remaining 20% of the
equity of Europrint Holdings Ltd. ("Europrint") and its wholly owned
subsidiaries, including Interactive Games International ("IGI"), for
approximately $5.1 million. We acquired the initial 80% of the equity of
Europrint during fiscal 1999 for a net cash purchase price of $21.6 million,
including related acquisition costs. Europrint is a provider of media
promotional games and IGI has pioneered the development of interactive,
televised lottery games.
DIVIDEND
On July 31, 2003, we paid our first quarterly cash dividend of $0.17 per share
to shareholders of record as of July 15, 2003, for a total of $9.9 million.
Subsequent Events
INTERLOTT TECHNOLOGIES, INC.
On September 18, 2003 (after the close of our fiscal 2004 second quarter), we
completed the acquisition of Interlott Technologies, Inc. ("Interlott"), a
provider of instant ticket vending machines for the worldwide lottery industry.
Interlott shareholders were given the opportunity to elect to receive either
$9.00 per share in cash or a number of shares of Holdings common stock having a
value of $9.00, or a combination of both, subject to adjustment so that the
aggregate consideration we paid was 48.5% in cash and 51.5% in Holdings common
stock. The final exchange ratio of 0.2156 shares of Holdings common stock for
every share of Interlott common stock was determined based on the average
closing price of $41.74 for Holdings common stock, for the 20 trading day
period commencing August 14, 2003 through September 11, 2003. The aggregate
purchase price, including assumed debt, was $86.4 million as follows:
Aggregate
purchase price
--------------
(in millions)
Cash ($9.00 per share of Interlott common stock) $ 28.2
Cash payment to cancel outstanding stock options relating to Interlott
common stock 5.7
--------------
Cash purchase price $ 33.9
Issuance of approximately 717,000 shares of Holdings common stock 30.0
--------------
Total aggregate purchase price $ 63.9
Cash payment to settle Interlott debt 22.5
--------------
$ 86.4
==============
-30-
All conditions to the closing of the acquisition were satisfied, including
obtaining the approval of the transaction by Interlott shareholders, securing
necessary regulatory consents, and satisfying certain other closing conditions.
Approval of this transaction by our shareholders was not required.
Critical Accounting Policies
We have identified the accounting policies listed below that we believe are most
critical to our financial condition and results of operations, and that require
management's most difficult, subjective and complex judgments in estimating the
effect of inherent uncertainties. This section should be read in conjunction
with Note 1 to our Consolidated Financial Statements included in our fiscal 2003
Annual Report on Form 10-K, as amended, which includes other significant
accounting policies.
REVENUE RECOGNITION
Amounts received from customers in advance of revenue recognition are recorded
in Advance Payments from Customers in our Consolidated Balance Sheets. We record
liquidated damages (which equaled 0.47%, 0.14% and 0.47% of our total revenues
in fiscal 2003, 2002 and 2001, respectively) as a reduction of revenue in the
period they become probable and estimable.
Service revenues from commercial transaction processing services are recorded
based on the net amount retained, which is the amount billed to our customer
less the amount paid to our suppliers, in accordance with Emerging Issues Task
Force Issue No. 99-19, "Reporting Revenue Gross as a Principal Versus Net as an
Agent".
We generally conduct business under one of three types of contractual
arrangements: Product Sales Contracts, Operating Contracts and Facilities
Management Contracts.
PRODUCT SALES CONTRACTS
Under Product Sales Contracts, we construct, sell, deliver and install a turnkey
online lottery system ("lottery system") or lottery equipment and license the
computer software for a fixed price, and the lottery authority subsequently
operates the lottery system.
Because Product Sales Contracts include significant customization and
modification and other services prior to customer acceptance that are considered
essential to the lottery software inherent in our lottery systems, revenue is
recognized using contract accounting. Under contract accounting, amounts due to
us, and costs incurred by us in constructing the lottery system, prior to
customer acceptance, are deferred. Revenue attributable to the lottery system is
recognized upon customer acceptance as long as there are no substantial doubts
regarding collectibility (the completed contract method of accounting).
In certain Product Sale Contracts (primarily the stand-alone sale of lottery
terminals), we are not responsible for installation. In these cases, we
recognize revenue when the four basic revenue recognition criteria of SEC Staff
Accounting Bulletin 101 have been met.
1. Persuasive evidence of an arrangement exists - Revenue is only recognized if
a signed contract or legally enforceable purchase order is obtained.
2. Delivery has occurred or services have been rendered - Revenue is only
recognized if appropriate evidence of delivery is obtained and once any
customer acceptance criteria have been met.
3. The seller's price to the buyer is fixed or determinable - Revenue is only
recognized if the sales price is fixed and determinable in the signed
contract or legally enforceable purchase order.
-31-
4. Collectibility is reasonably assured - Revenue is only recognized when there
are no significant doubts regarding the collectibility of the amounts due
from the customer.
Revenues received under Product Sale Contracts are classified as Sales of
Products in our Consolidated Income Statements.
OPERATING CONTRACTS
Under Operating Contracts, we generally construct, install and operate the
lottery system, but sell and transfer full title and interest in the lottery
system to the customer for a fixed fee. Fees paid to us for ongoing services and
the licensing of the computer software are generally variable and are based on a
percentage of a lottery's gross online and instant lottery sales.
Because Operating Contracts include significant customization and modification
and other services prior to customer acceptance that are considered essential to
the lottery software inherent in our lottery systems, revenue is recognized
using contract accounting. Under contract accounting, amounts due to us, and
costs incurred by us in constructing the lottery system, prior to customer
acceptance, are deferred. Revenue attributable to the lottery system is
recognized upon customer acceptance as long as there are no substantial doubts
regarding collectibility (the completed contract method of accounting) and are
classified as Sales of Products in our Consolidated Income Statements. Ongoing
service and license fees are recognized as revenue in the period earned and are
classified as Service Revenue in our Consolidated Income Statements.
We have not entered into any new Operating Contracts in the last three fiscal
years. Additionally, Operating Contract revenue accounted for less than 2% of
our consolidated revenue during fiscal 2003. These types of contractual
arrangements have diminished in importance and we expect similar levels of
revenue in the future.
FACILITIES MANAGEMENT CONTRACTS
Under typical Facilities Management Contracts, we construct, install and operate
the lottery system, and retain ownership of the lottery system. These contracts
generally provide for a variable amount of monthly or weekly service fees paid
to us directly from the lottery authority based on a percentage of a lottery's
gross online and instant lottery sales. These fees are recognized as revenue in
the period earned and are classified as Service Revenue in our Consolidated
Income Statements.
RECEIVABLES AND INVENTORY RESERVES
We evaluate the collectibility of trade accounts and sales-type lease
receivables on a customer-by-customer basis and we believe our reserves are
adequate; however, if economic circumstances change significantly resulting in a
major customer's inability or unwillingness to meet its financial obligations to
us, original estimates of the recoverability of amounts due to us could be
reduced by significant amounts requiring additional reserves.
Inventories are stated at the lower of cost (first-in, first-out method) or
market. Inventories include amounts related to products we manufacture or
assemble for our long-term service contracts, which are transferred to Systems,
Equipment and Other Assets Relating to Contracts in our Consolidated Balance
Sheets upon shipment. Inventories also include amounts related to product sales
contracts, including product sales under long-term contracts. We regularly
review inventory quantities on hand and record provisions for potentially
obsolete or slow-moving inventory based primarily on our estimated forecast of
product demand and production requirements. We believe our reserves are
adequate; however, should future sales forecasts change, our original estimates
of obsolescence could increase by a significant amount requiring additional
reserves.
-32-
IMPAIRMENT OF GOODWILL
We perform a test for the impairment of goodwill annually, or more frequently if
events or circumstances indicate that goodwill may be impaired. Because we have
a single operating and reportable business segment (the Transaction Processing
Segment), we perform this test by comparing the fair value of the Transaction
Processing Segment with its book value, including goodwill. If the fair value of
the Transaction Processing Segment exceeds its book value, goodwill is not
impaired. If the book value exceeds the fair value, we would calculate the
potential impairment loss by comparing the implied fair value of goodwill with
the book value. If the implied goodwill is less than the book value, a
write-down would be recorded.
IMPAIRMENT OF LONG-LIVED ASSETS
We periodically evaluate the recoverability of long-lived assets whenever
indicators of impairment are present. Indicators of impairment include such
items as declines in revenues and earnings or cash flows or material adverse
changes in the economic or political stability of a particular country, which
may indicate that the carrying amount of an asset is not recoverable. If facts
and circumstances indicate that our long-lived assets may be impaired, the
estimated future undiscounted cash flows associated with these long-lived assets
would be compared to their carrying amounts to determine if a write-down to fair
value is necessary.
Effect of Recent Accounting Pronouncements
In January 2003, the Financial Accounting Standards Board ("FASB") issued
Interpretation No. 46, "Consolidation of Variable Interest Entities" ("FIN 46"),
which requires the consolidation of a variable interest entity (as defined) by
its primary beneficiary. Primary beneficiaries are those companies that are
subject to a majority of the risk of loss or entitled to receive a majority of
the variable interest entity's residual returns, or both. In determining whether
it is the primary beneficiary of a variable interest entity, a company with a
variable interest must also treat a variable interest held by the company's
related parties in that same entity as its own interests. FIN 46 applies
immediately to variable interest entities that are created after or for which
control is obtained after January 31, 2003. For variable interest entities
created prior to February 1, 2003, the provisions of FIN 46 would be applied in
the fiscal quarter beginning after June 15, 2003 (our third quarter of fiscal
2004). However, on September 19, 2003, the FASB issued proposed Staff Position
("FSP") No. FIN 46-e, "Effective Date of FASB Interpretation No. 46,
Consolidation of Variable Interest Entities, for Certain Interests Held by a
Public Entity", for public comment. Under the proposed FSP, we would not need to
apply the provisions of FIN 46 to interests held in a variable interest entity
("VIE"), or potential VIE, until our fiscal 2004 fourth quarter, if certain
conditions are met.
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 currently account for the Partnership using the equity
method of accounting. The FSP described above does not apply to the Partnership.
As a result, beginning in the third quarter of fiscal 2004, which began on
August 24, 2003, we will consolidate the Partnership in accordance with FIN 46.
Accordingly, we will record our world headquarters facilities owned by the
Partnership as an asset, and the Partnership's debt obligation as a liability in
our consolidated financial statements. We expect the adoption of this
interpretation to increase balance sheet assets and liabilities in the range of
$27 million to $30 million and to result in a one-time, non-cash, pre-tax gain
in the range of $4 million to $5 million, or $0.05 per diluted share, that will
be recorded in Other Income in our consolidated financial statements. The
pre-tax gain will be recorded in Other Income and not as a cumulative-effect
adjustment because the gain is not material to our consolidated financial
statements.
We have certain investments for which the applicability of FIN 46 has not yet
been determined. The adoption of FIN 46's provisions, if applicable to such
investments, is not expected to have a material impact on our financial
statements. Pursuant to the proposed FSP noted above, if applicable, we would
not be required to apply FIN 46 to these investments until our fiscal 2004
fourth quarter.
-33-
In April 2003, the FASB issued Statement of Financial Accounting Standards No.
149 ("SFAS 149"), "Amendment of Statement 133 on Derivative Instruments and
Hedging Activities". SFAS 149 amends Statement of Financial Accounting Standards
No. 133 to provide clarification on the financial accounting and reporting of
derivative instruments and hedging activities and requires that contracts with
similar characteristics be accounted for on a comparable basis. The provisions
of SFAS 149 are effective for contracts entered into or modified after June 30,
2003, and for hedging relationships designated after June 30, 2003. We do not
expect this statement to have a material impact on our consolidated financial
statements.
In May 2003, the FASB issued Statement of Financial Accounting Standards No. 150
("SFAS 150"), "Accounting for Certain Financial Instruments with Characteristics
of both Liabilities and Equity". SFAS 150 establishes standards on the
classification and measurement of certain financial instruments with
characteristics of both liabilities and equity. The provisions of SFAS 150 are
effective for financial instruments entered into or modified after May 31, 2003
and to all other instruments that exist as of the beginning of the first interim
financial reporting period beginning after June 15, 2003 (our third quarter of
fiscal 2004). We do not expect this statement to have a material impact on our
consolidated financial statements.
Results of Operations
THREE MONTHS ENDED AUGUST 23, 2003 VERSUS THREE MONTHS ENDED AUGUST 24, 2002
Revenues were $277.2 million in the second quarter of fiscal 2004, compared to
$221.0 million in the second quarter of fiscal 2003, up $56.2 million, or 25.5%.
The following discussion on service revenues should be read in conjunction with
the table below (in millions):
Three Months Ended
-------------------------------------------------------
Change
August 23, August 24, -------------------
Service revenues 2003 2002 $ %
- ---------------- ------------ ------------ --------- ------
Domestic lottery $ 130.1 $ 121.0 $ 9.1 7.5
International lottery 87.7 77.5 10.2 13.2
Commercial services 19.5 12.5 7.0 56.7
All other 0.7 0.6 0.1 5.5
------------ ------------ --------- ------
$ 238.0 $ 211.6 $ 26.4 12.5
============ ============ ========= ======
Our domestic lottery service revenues were $130.1 million in the second quarter
of fiscal 2004, compared to $121.0 million in the second quarter of fiscal 2003,
up $9.1 million, or 7.5%. This 7.5% increase was primarily due to higher service
revenues of approximately 5% from an increase in sales by our domestic lottery
customers, with the balance of the increase due to the combined effect of higher
jackpot activity and new contracts, net of contractual rate changes and
penalties. While we are not able to quantify precisely the reasons for increases
in sales by our domestic lottery customers, we believe that in general, such
increases are attributable to enhanced marketing efforts by state lottery
authorities seeking to offset declining tax revenues and the successful
introduction by state lottery authorities of new games and products,
modifications to existing games (such as matrix changes and more frequent
drawings) and expanded distribution channels.
Our international lottery service revenues grew to $87.7 million in the second
quarter of fiscal 2004, from $77.5 million in the second quarter of fiscal 2003,
up $10.2 million, or 13.2%. This 13.2% increase includes higher service revenues
of approximately 11% from an increase in sales by our international lottery
customers and approximately 2% from the strengthening of most major currencies
against the U.S. dollar, particularly the Brazilian real, British pound, Czech
koruna and the South African rand.
-34-
While we are not able to quantify precisely the reasons for increases in sales
by our international lottery customers, we believe that in general, such
increases are attributable to more rapid growth rates typical of newer lottery
jurisdictions and the successful introduction of new games.
Service revenues from commercial transaction processing services were $19.5
million in the second quarter of fiscal 2004, compared to $12.5 million in the
second quarter of fiscal 2003, up $7.0 million, or 56.7%, primarily due to the
acquisition of PolCard.
Product sales were $39.2 million in the second quarter of fiscal 2004, compared
to $9.4 million in the second quarter of fiscal 2003. This $29.8 million
increase was primarily driven by the sale of our new interactive, web-based
software application, ES Interactive, to our customer in the United Kingdom.
Our service margins improved from 40.0% in the second quarter of fiscal 2003 to
44.2% in the second quarter of fiscal 2004, primarily due to lower depreciation
of approximately 3 percentage points, principally related to fully depreciated
assets associated with our contract with Caixa Economica Federal in Brazil.
Our product margins fluctuate depending on the mix, volume and timing of product
sales contracts. Our product margins were 26.6% in the second quarter of fiscal
2004 compared to 56.1% in the second quarter of fiscal 2003. This change was
primarily due to the different mix of sales, with a high volume of higher margin
equipment sales recorded in the second quarter of fiscal 2003.
Operating expenses were $41.2 million in the second quarter of fiscal 2004,
compared to $30.1 million in the second quarter of fiscal 2003, up $11.1
million, or 36.9%. This increase was driven by $6.9 million of increased
spending on research and development as we continue our efforts to accelerate
the development and deployment of industry-leading products into the marketplace
and to execute against our commercial services strategy. In addition, selling,
general and administrative expense was up $4.2 million, primarily driven by
business development activities in Poland and Mexico, increased marketing
expenses primarily associated with trade shows and conferences, and the
acquisition of PolCard. As a percentage of revenues, operating expenses were
14.8% and 13.6% during the second quarters of fiscal 2004 and 2003,
respectively.
Weighted average diluted shares in the second quarter of fiscal 2004 increased
by 7.6 million shares to 65.9 million shares, primarily due to the
convertibility during the second quarter of our $175 million principal amount of
1.75% Convertible Debentures into shares of our common stock, resulting in a
decrease to diluted earnings per share of approximately $0.07. These Debentures
are convertible at the option of the holder into shares of our common stock at a
conversion price of approximately $27.50 per share when, among other
circumstances, our stock closes above $33 per share for at least 20 out of 30
consecutive trading days prior to the date of surrender for conversion. There
are a total of 6.4 million shares issuable upon the conversion of the
Debentures. The Debentures were convertible for all 63 trading days in the
second quarter of fiscal 2004, and accordingly, all 6.4 million shares were
included in the computation of diluted earnings per share.
Our effective income tax rate decreased from 38% in the second quarter of fiscal
2003 to 37% in the second quarter of fiscal 2004 principally due to a larger
percentage of international profits taxed at rates that are lower than the U.S.
statutory tax rate and the increased recognition of research and development tax
credits.
-35-
SIX MONTHS ENDED AUGUST 23, 2003 VERSUS SIX MONTHS ENDED AUGUST 24, 2002
Revenues were $516.8 million in the first six months of fiscal 2004, compared to
$452.4 million in the first six months of fiscal 2003, up $64.5 million, or
14.2%.
The following discussion on service revenues should be read in conjunction with
the table below (in millions):
Six Months Ended
-------------------------------------------------------
Change
August 23, August 24, -------------------
Service revenues 2003 2002 $ %
- ---------------- ------------ ------------ --------- ------
Domestic lottery $ 254.9 $ 246.9 $ 8.0 3.2
International lottery 173.8 159.9 13.9 8.7
Commercial services 31.5 27.2 4.3 16.0
All other 1.4 1.3 0.1 0.8
------------ ------------ --------- ------
$ 461.6 $ 435.3 $ 26.3 6.0
============ ============ ========= ======
Our domestic lottery service revenues were $254.9 million in the first six
months of fiscal 2004, compared to $246.9 million in the first six months of
fiscal 2003, up $8.0 million, or 3.2%, primarily due to higher service revenues
from an increase in sales by our domestic lottery customers. While we are not
able to quantify precisely the reasons for increases in sales by our domestic
lottery customers, we believe that in general, such increases are attributable
to enhanced marketing efforts by state lottery authorities seeking to offset
declining tax revenues and the successful introduction by state lottery
authorities of new games and products, modifications to existing games (such as
matrix changes and more frequent drawings) and expanded distribution channels.
Our international lottery service revenues were $173.8 million in the first six
months of fiscal 2004, compared to $159.9 million in the first six months of
fiscal 2003, up $13.9 million, or 8.7%. This 8.7% increase includes higher
service revenues of approximately 11% from an increase in sales by our
international lottery customers and the effect of higher jackpot activity
(primarily in Brazil) of approximately 2%, partially offset by the combined
impact of net contract losses and contractual rate changes of approximately 4%.
While we are not able to quantify precisely the reasons for increases in sales
by our international lottery customers, we believe that in general, such
increases are attributable to more rapid growth rates typical of newer lottery
jurisdictions and the successful introduction of new games.
Service revenues from commercial transaction processing services were $31.5
million in the first six months of fiscal 2004, compared to $27.2 million in the
first six months of fiscal 2003, up $4.3 million, or 16.0%. The acquisition of
PolCard accounted for approximately 28% of this increase, which was partially
offset by the overall weakening of the Brazilian real against the U.S. dollar on
a year to date basis of approximately 10%.
Product sales were $55.3 million in the first six months of fiscal 2004,
compared to $17.0 million in the first six months of fiscal 2003, up $38.2
million. This increase was primarily driven by the sale of our new interactive,
web-based software application, ES Interactive, to our customer in the United
Kingdom.
Our service margins improved from 37.1% in the first six months of fiscal 2003
to 43.8% in the first six months of fiscal 2004. This 6.7 percentage point
increase was primarily due to lower depreciation of 3.4 percentage points
(principally related to fully depreciated assets associated with our contract
with Caixa Economica Federal in Brazil), 1.6 percentage points from the absence
of certain consulting costs incurred during the first six months of the prior
year, and the balance of the increase due to the combined impact of higher
services revenues and our ongoing efforts to improve cost efficiencies.
-36-
Our product margins fluctuate depending on the mix, volume and timing of product
sales contracts. Our product margins were to 32.3% in the first six months of
fiscal 2004 compared to 39.2% in the first six months of fiscal 2003. Fiscal
2004 product margins are returning to historical levels when compared to the
higher margin product sales which we recorded in the first half of fiscal 2003,
primarily reflecting a high volume of higher margin equipment sales.
Operating expenses were $79.8 million in the first six months of fiscal 2004,
compared to $59.5 million in the first six months of fiscal 2003, up $20.3
million, or 34.2%. This increase was driven by $14.8 million of increased
spending on research and development as we continue our efforts to accelerate
the development and deployment of industry-leading products into the marketplace
and to execute against our commercial services strategy. In addition, selling,
general and administrative expense was up $5.5 million, primarily driven by
business development activities in Poland and Mexico, increased marketing
expenses primarily associated with trade shows and conferences, and the
acquisition of PolCard. As a percentage of revenues, operating expenses were
15.4% and 13.1% during the first six months of fiscal 2004 and 2003,
respectively.
Weighted average diluted shares in the first six months of fiscal 2004 increased
by 4.2 million shares to 63.0 million shares, primarily due to the
convertibility during the first six months of this fiscal year of our $175
million principal amount of 1.75% Convertible Debentures into shares of our
common stock, resulting in a decrease to diluted earnings per share of
approximately $0.09. These Debentures are convertible at the option of the
holder into shares of our common stock at a conversion price of approximately
$27.50 per share when, among other circumstances, our stock closes above $33 per
share for at least 20 out of 30 consecutive trading days prior to the date of
surrender for conversion. There are a total of 6.4 million shares issuable upon
the conversion of the Debentures. The Debentures were convertible for 80 out of
127 trading days in the first six months of fiscal 2004, and approximately 4
million shares were included in the computation of diluted earnings per share.
Our effective income tax rate decreased from 38% in the first six months of
fiscal 2003 to 37% in the second quarter of fiscal 2004 principally due to a
larger percentage of international profits taxed at rates that are lower than
the U.S. statutory tax rate and the increased recognition of research and
development tax credits.
Changes in Financial Position, Liquidity and Capital Resources
During the first six months of fiscal 2004, we generated $170.5 million of cash
from operations, which, along with cash on hand, was principally used to
purchase $143.8 million of systems, equipment and other assets relating to
contracts and to fund acquisitions of $41.0 million. At August 23, 2003, we had
$94.3 million of cash and cash equivalents on hand, of which approximately $36
million was invested at a major U.S. financial institution and approximately $30
million was invested in tax-exempt money market funds. At the end of the fiscal
2004 second quarter, there was $290.3 million available for borrowing under our
$300 million credit facility after considering $9.7 million of letters of credit
issued and outstanding under the credit facility.
Inventories decreased by $14.9 million, from $72.3 million at February 22, 2003
to $57.4 million at August 23, 2003, primarily due to the sale of ES Interactive
to our customer in the United Kingdom, partially offset by a build up of
inventory associated with product sales expected to be recorded during fiscal
2005.
Other current assets increased by $10.1 million, from $18.7 million at February
22, 2003 to $28.8 million at August 23, 2003, primarily due to $5.8 million of
prepayments and $3.3 million of value-added tax receivables, both related to
ongoing lottery system installations, primarily in Europe.
-37-
Systems, equipment and other assets relating to contracts, net, increased by
$93.4 million, from $410.9 million at February 22, 2003 to $504.3 million at
August 23, 2003, primarily due to the purchase of $143.8 million of systems,
equipment and other assets relating to contracts (principally related to lottery
system implementations in California and Georgia), partially offset by
depreciation expense.
Goodwill, net, increased by $31.5 million, from $115.5 million at February 22,
2003 to $147.0 million at August 23, 2003, due to the acquisition of PolCard,
the largest debit and credit card merchant transaction acquirer and processor in
Poland, along with the acquisition of the remaining 20% of the equity of
Europrint.
Other assets increased by $18.7 million, from $79.2 million at February 22, 2003
to $97.9 million at August 23, 2003, primarily due to a $12.5 million up-front
license fee we paid to the Rhode Island Lottery and $5.2 million of intangible
assets recorded as a result of our acquisition of PolCard.
Accounts payable decreased by $10.6 million, from $74.0 million at February 22,
2003 to $63.4 million at August 23, 2003, primarily due to the timing of
payments related to ongoing lottery system installations.
Employee compensation decreased by $9.2 million, from $37.5 million at February
22, 2003 to $28.3 million at August 23, 2003, primarily due to the payment, in
the first quarter of fiscal 2004, of fiscal 2003 management incentive
compensation and employee profit sharing.
Advance payments from customers increased by $10.1 million, from $52.4 million
at February 22, 2003 to $62.5 million at August 23, 2003, primarily due to
advances received from customers related to product sales that are expected to
be recorded during the second half of fiscal 2004 and during fiscal 2005,
partially offset by the sale of ES Interactive to our customer in the United
Kingdom.
Taxes other than income taxes increased by $9.3 million, from $16.0 million at
February 22, 2003 to $25.3 million at August 23, 2003, primarily due to $3.8
million of value-added tax payables related to ongoing lottery system
installations and $4.1 million due to the acquisition of PolCard.
Our business is capital-intensive. We currently estimate that net cash to be
used for investing activities in fiscal 2004 will be in the range of $370
million to $380 million, including investments we made in September 2003 to
acquire Interlott. We currently estimate that net cash to be used for investing
activities in fiscal 2004 for the purchase of Interlott (which was consummated
in September 2003) and investing activities subsequent to acquisition, will be
in the range of $45 million to $50 million, of which $33.9 million is the cash
portion of the purchase price for the acquisition. In addition, to complete the
acquisition of Interlott, we issued common shares held in treasury having a
market value of approximately $30 million and we also assumed approximately
$22.5 million of Interlott debt.
We expect our principal sources of liquidity to be existing cash balances, along
with cash we generate 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 August 23, 2003, there were no
borrowings under the credit facility. Up to $100 million of the Credit Facility
may be used for the issuance of letters of credit. As of August 23, 2003, there
was $290.3 million available for borrowing under the Credit Facility, after
considering $9.7 million of letters of credit issued and outstanding. We
currently expect that our cash flow from operations, existing cash balances and
available borrowings under our credit facility will be sufficient for the
foreseeable future to fund our anticipated working capital and ordinary capital
expenditure needs, to service our debt obligations, to fund anticipated internal
growth, to fund the cash portion of the Interlott acquisition, to fund all or a
portion of the cash needed for potential acquisitions, to pay dividends, to fund
the capital requirements under our Master Contract with the Rhode Island
Lottery, and to repurchase shares of our common stock, from time to time, under
our share repurchase programs. Notwithstanding the foregoing, we may seek
alternative
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sources of financing to fund certain of our obligations under our Master
Contract with the Rhode Island Lottery and to fund future potential acquisitions
and growth opportunities that are not currently contemplated in the $370 million
to $380 million range of fiscal 2004 investing activities disclosed above.
Details of our contractual obligations for long-term debt and operating leases
as of February 22, 2003 are as follows (in millions):
Fiscal
----------------------------------------------------------------------------
2004 2005 2006 2007 2008 Thereafter Total
-------- -------- -------- -------- -------- ---------- --------
Long-term debt $ 7.0 $ 5.6 $ 5.1 $ 5.8 $ 95.6 $ 175.0 $ 294.1
Operating leases 18.7 14.8 7.3 33.4 3.1 6.1 83.4
-------- -------- -------- -------- -------- ---------- --------
Total $ 25.7 $ 20.4 $ 12.4 $ 39.2 $ 98.7 $ 181.1 $ 377.5
======== ======== ======== ======== ======== ========== ========
Operating lease payments include a $28 million residual value payment that we
may be required to pay in fiscal 2007, or earlier under certain limited
circumstances, related to the lease of our world headquarters facilities.
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 currently account for the Partnership using the equity
method of accounting. The following is a summary of certain unaudited financial
information of the Partnership, at and for the period ended August 23, 2003,
used as the basis for applying the equity method of accounting (in millions):
August 23, 2003 (Unaudited)
--------------- ----------
Earnings data:
Net loss $ (0.4)
Balance sheet data:
Assets $ 17.7
Liabilities 27.8
Partners' deficit (10.1)
Beginning in the third quarter of fiscal 2004, which began on August 24, 2003,
we will consolidate the Partnership in accordance with Financial Accounting
Standards Board Interpretation No. 46, "Consolidation of Variable Interest
Entities" ("FIN 46"), which requires the consolidation of a variable interest
entity (as defined) by its primary beneficiary. As a result, we will record our
world headquarters facilities owned by the Partnership as an asset, and the
Partnership's debt obligation as a liability in our consolidated financial
statements. We expect the adoption of this interpretation to increase balance
sheet assets and liabilities in the range of $27 million to $30 million and to
result in a one-time, non-cash, pre-tax gain in the range of $4 million to $5
million, or $0.05 per diluted share, that will be recorded in Other Income in
our consolidated financial statements. The pre-tax gain will be recorded in
Other Income and not as a cumulative-effect adjustment because the gain is not
material to our consolidated financial statements.
-39-
Guarantees and Indemnifications
PERFORMANCE AND OTHER BONDS
In connection with certain contracts and procurements, we have been required to
deliver performance bonds for the benefit of our customers and bid and
litigation bonds for the benefit of potential customers, respectively. These
bonds give the beneficiary the right to obtain payment and/or performance from
the issuer of the bond if the events set forth in the bond occur. In the case of
performance bonds, which generally have a term of one year, such events include
our failure to perform our obligations under the applicable contract. To obtain
these bonds, we are required to indemnify the issuers against the costs they
incur if a beneficiary exercises its rights under a bond. Historically, our
customers have not exercised their rights under these bonds and we do not
currently anticipate that they will do so. The following table provides
information related to potential commitments at August 23, 2003:
Total potential
commitments
---------------
(in millions)
Performance bonds $ 176.7
Financial guarantees 7.5
All other bonds 8.3
---------------
$ 192.5
===============
LOTTERY TECHNOLOGY SERVICES INVESTMENT CORPORATION
We have a 44% interest in Lottery Technology Services Investment Corporation
("LTSIC"), which we account for using the equity method of accounting. LTSIC's
wholly owned subsidiary, Lottery Technology Services Corporation ("LTSC"),
provides equipment and services (which we supplied to LTSC), to the Bank of
Taipei. The Bank of Taipei holds the license to operate the Taiwan Public
Welfare Lottery.
In order to assist LTSC with the financing they required to enable them to
perform under their obligation to operate the Taiwan Public Welfare Lottery on
behalf of the Bank of Taipei, at August 23, 2003, we guaranteed $5.2 million
principal amount 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 did not receive any consideration in exchange for our guarantees on
behalf of LTSC. Rather, these guarantees were issued in connection with the
formation of LTSC and LTSIC.
We are recognizing 56% of our product sales to, and service revenue from, LTSC.
The remaining 44% of product sales (and related cost) and service revenue has
been deferred as a result of our equity interest in LTSIC and related guarantee
of LTSC's debt, respectively, and is principally included in Other Liabilities
in our Consolidated Balance Sheets at August 23, 2003 and February 22, 2003.
Product sale deferrals are being recognized ratably over the life of our
contract with LTSC and service revenue deferrals are being recognized as the
guaranteed debt is repaid. At August 23, 2003, deferred product gross profit and
deferred service revenue totaled $4.1 million and $6.7 million, respectively.
TIMES SQUARED INCORPORATED
We guaranteed outstanding lease obligations of Times Squared Incorporated
("Times Squared") for which we received no monetary consideration. The amount
outstanding under the lease at August 23, 2003, was $2.4 million. Our guarantee
expires in December 2013. Times Squared is a nonprofit corporation established
to provide, among other things, secondary and high school level educational
programs. Times Squared operates a Charter School for Engineering, Mathematics,
Science and Technology in Providence, Rhode Island that serves inner city
children who aspire to careers in the sciences and technology.
-40-
LOTTERY TECHNOLOGY ENTERPRISES
We have a 1% interest in Lottery Technology Enterprises ("LTE"), a joint venture
between us and District Enterprise for Lottery Technology Applications of
Washington, D.C. The joint venture agreement terminates on December 31, 2012.
LTE holds a 10-year contract (which expires in November 2009) with the District
of Columbia Lottery and Charitable Games Control Board. Under Washington, D.C.
law, by virtue of our 1% interest in LTE, we are jointly and severally liable,
with the other partner, for the acts of the joint venture.
GAMING ENTERTAINMENT (DELAWARE) L.L.C.
We have a 50% interest in Gaming Entertainment (Delaware) L.L.C. ("GED"). GED is
a joint venture between us and a subsidiary of Full House Resorts, Inc.
("FHRI"). Pursuant to a 1995 management agreement ("Agreement"), GED manages a
casino for Harrington Raceway, Inc. ("Harrington") and in return receives a
percentage of gross revenues and operating profits as defined in the Agreement.
Along with FHRI, we guarantee the payment of all amounts due Harrington under
the Agreement. Our guarantee expires on February 1, 2012 or upon expiration of
the Delaware Horse Racing Redevelopment Act. The consideration we receive in
exchange for the guarantee are the equity earnings from our joint venture with
FHRI.
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 six months of fiscal 2004.
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 August 23, 2003, the estimated fair value of our
$95 million of fixed rate Senior Notes approximated $105.2 million (as
determined by an independent investment banker). At August 23, 2003, a
hypothetical 10% increase in interest rates would reduce the estimated fair
value of the fixed rate Senior Notes to $104.2 million and a hypothetical 10%
decrease in interest rates would increase the estimated fair value of the fixed
rate Senior Notes to $106.2 million.
At August 23, 2003, the estimated fair value of our $175 million principal
amount of 1.75% Convertible Debentures was $268.6 million (based on a quoted
market price of $153.50 per Debenture). At August 23, 2003, a hypothetical 10%
increase in interest rates would reduce the estimated fair value of the
Convertible Debentures to $267.7 million and a hypothetical 10% decrease in
interest rates would increase the estimated fair value of the Convertible
Debentures to $269.6 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.
We use various techniques to mitigate the risk associated with future changes in
interest rates, including entering into interest rate swaps. During the first
six months of fiscal 2004, we did not have any interest rate swap agreements in
place.
-41-
Equity price risk
At August 23, 2003, the estimated fair value of our $175 million principal
amount of 1.75% Convertible Debentures was $268.6 million (based on a quoted
market price of $153.50 per Debenture). At August 23, 2003, a hypothetical 10%
increase in the market price of our common stock would increase the estimated
fair value of the Convertible Debentures to $291.7 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 $246.7 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. In limited circumstances,
but whenever possible, we negotiate clauses into our contracts that allow for
price adjustments should a material change in foreign exchange rates occur.
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
foreign currency speculation. At August 23, 2003, a hypothetical 10% adverse
change in foreign exchange rates would result in a translation loss of $15.4
million that would be recorded in the equity section of our balance sheet.
At August 23, 2003, a hypothetical 10% adverse change in foreign exchange rates
would result in a net pre-tax transaction loss of $1.6 million that would be
recorded in current earnings after considering the effects of foreign exchange
contracts currently in place.
At August 23, 2003, 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 2004 of $4.3 million, after considering the
effects of foreign exchange contracts currently in place. The percentage of
fiscal 2004 anticipatory cash flows that were hedged varied throughout the first
six months of fiscal 2004, but averaged 51%.
As of August 23, 2003, we had contracts for the sale of foreign currency of
approximately $96.8 million (primarily Euro, pounds sterling and Czech koruna)
and the purchase of foreign currency of approximately $73.6 million (primarily
Euro, pounds sterling, Singapore dollars and Brazilian real).
-42-
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. Our controls and procedures are designed to provide a reasonable
level of assurance in reaching our desired controls and procedures objectives.
As of the end of the quarterly period covered by 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-15(e) under
the Securities Exchange Act of 1934), and of any changes in our internal control
over financial reporting (as defined in Rule 13a-15(f) under the Securities
Exchange Act of 1934) that occurred during the quarterly period covered by this
report. Based upon that evaluation, the CEO and CFO concluded that the Company's
disclosure controls and procedures were effective in reaching a reasonable level
of assurance of achieving management's desired controls and procedures
objectives, and that no change in our internal control over financial reporting
occurred during the quarterly period covered by this report that has materially
affected, or is reasonably likely to materially affect, our internal control
over financial reporting. 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.
-43-
PART II. OTHER INFORMATION
Item 1. LEGAL PROCEEDINGS
For information respecting certain legal proceedings, refer to Part I, Item 3 -
"Legal Proceedings" and Note 11 to the Consolidated Financial Statements in our
fiscal 2003 Annual Report on Form 10-K, as amended, and Part II, Item 1 - "Legal
Proceedings" in our Quarterly Report for the quarterly period ended May 24,
2003.
-44-
Item 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
(a) and (c)
The Company's Annual Meeting of Shareholders was held on August 4, 2003 and in
connection therewith, proxies were solicited by management pursuant to
Regulation 14A under the Securities Exchange Act of 1934. An aggregate of
57,845,928 shares of the Company's common stock ("Shares") were issued and
eligible to vote at the meeting. At the meeting, the following matters (not
including ordinary procedural matters) were submitted to a vote of the holders
of Shares, with the results indicated below:
1. Election of three directors to serve until the 2006 Annual Meeting
The following incumbent directors were reelected. The tabulation of
votes was as follows:
Nominee For Withheld
- ----------------- ----------------- ----------------
Burnett W. Donoho 49,996,946 Shares 2,440,707 Shares
James F. McCann 51,840,268 Shares 597,385 Shares
W. Bruce Turner 43,543,121 Shares 8,894,532 Shares
2. Approval of the Company's Corporate Financials Management Incentive
Plan
The tabulation of votes was as follows:
Abstentions
For Against (including broker non-votes)
- ----------------- ---------------- ----------------------------
44,590,155 Shares 2,774,230 Shares 5,073,268 Shares
3. Ratification of Ernst & Young LLP, Independent Certified Public
Accountants, as auditors for the fiscal year ending February 28, 2004
The tabulation of votes was as follows:
For Against Abstentions
- ----------------- ---------------- ------------
48,779,770 Shares 3,649,253 Shares 8,630 Shares
-45-
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
31.1 Certification Pursuant to Section 302 of the Sarbanes-Oxley
Act of 2002, of W. Bruce Turner, President and Chief Executive
Officer of the Company
31.2 Certification Pursuant to Section 302 of the Sarbanes-Oxley
Act of 2002, of Jaymin B. Patel, Senior Vice President and
Chief Financial Officer of the Company
32.1 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
32.2 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 June 18, 2003 describing an
administrative legal proceeding in its initial stages that was
commenced against us in Brazil.
(ii) We filed a report on Form 8-K on June 19, 2003 incorporating
by reference a press release we issued on June 19, 2003
announcing our fiscal 2004 first quarter results. In addition,
we incorporated by reference the transcripts from our fiscal
2004 first quarter earnings conference call held on June 19,
2003.
(iii) We filed a report on Form 8-K on August 11, 2003 incorporating
by reference a press release we issued on August 7, 2003
describing that we launched an offer to purchase existing
indebtedness.
-46-
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: October 1, 2003 By /s/ Jaymin B. Patel
-----------------------------------------------------
Jaymin B. Patel, Senior Vice President and Chief
Financial Officer (Principal Financial Officer)
Date: October 1, 2003 By /s/ Robert J. Plourde
-----------------------------------------------------
Robert J. Plourde, Vice President and Corporate
Controller (Principal Accounting Officer)
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