Back to GetFilings.com
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
------------------------------
FORM 10-Q
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the quarterly period ended May 28, 2005
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
Commission file number 1-11250
------------------------------
GTECH Holdings Corporation
(Exact name of Registrant as specified in its charter)
Delaware 05-0450121
(State or other Jurisdiction of (I.R.S. Employer Identification
Incorporation or Organization) Number)
55 Technology Way, West Greenwich, Rhode Island 02817
(Address of Principal Executive Offices) (Zip Code)
(401) 392-1000
(Registrant's telephone number, including area code)
------------------------------
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 [ ]
Indicate by check mark whether the Registrant is an accelerated filer (as
defined in Rule 12b-2 of the Securities Exchange Act of 1934)
Yes [X] No [ ]
Number of shares of Registrant's Common Stock outstanding as of June 23, 2005:
115,787,545
INDEX
GTECH HOLDINGS CORPORATION AND SUBSIDIARIES
Page
Number
-------
PART I. FINANCIAL INFORMATION
Item 1. Financial Statements
Consolidated Balance Sheets 3
Consolidated Income Statements 4
Consolidated Statements of Cash Flows 5
Consolidated Statement of Shareholders' Equity 6
Notes to Consolidated Financial Statements 7-22
Item 2. Management's Discussion and Analysis of Financial Condition 23-35
and Results of Operations
Item 3. Quantitative and Qualitative Disclosures about Market Risk 36
Item 4. Controls and Procedures 36
PART II. OTHER INFORMATION
Item 1. Legal Proceedings 36
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds 37
Item 5. Other Information 38
Item 6. Exhibits 39
SIGNATURES 40
EXHIBITS
PART I. FINANCIAL INFORMATION
Item 1. FINANCIAL STATEMENTS
GTECH HOLDINGS CORPORATION AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
(Unaudited)
May 28, February 26,
2005 2005
----------- ------------
(Dollars in thousands)
ASSETS
CURRENT ASSETS
Cash and cash equivalents $ 125,634 $ 94,446
Investment securities available-for-sale 209,500 196,825
Trade accounts receivable, net 148,509 168,706
Sales-type lease receivables 3,271 3,461
Refundable performance deposit 8,000 8,000
Inventories 47,638 61,135
Deferred income taxes 24,538 31,435
Other current assets 31,286 26,646
----------- ------------
TOTAL CURRENT ASSETS 598,376 590,654
SYSTEMS, EQUIPMENT AND OTHER ASSETS RELATING TO CONTRACTS, net 714,085 720,438
GOODWILL, net 330,726 331,022
PROPERTY, PLANT AND EQUIPMENT, net 77,595 74,558
INTANGIBLE ASSETS, net 68,190 70,839
REFUNDABLE PERFORMANCE DEPOSIT 12,000 12,000
SALES-TYPE LEASE RECEIVABLES 3,942 4,756
OTHER ASSETS 49,975 50,874
----------- ------------
TOTAL ASSETS $ 1,854,889 $ 1,855,141
=========== ============
LIABILITIES AND SHAREHOLDERS' EQUITY
CURRENT LIABILITIES
Accounts payable $ 62,424 $ 99,234
Accrued expenses 57,852 54,227
Employee compensation 26,240 21,862
Advance payments from customers 42,673 42,865
Deferred revenue and advance billings 24,604 29,705
Income taxes payable 28,057 16,499
Taxes other than income taxes 17,012 16,572
Short term borrowings 20 334
Current portion of long-term debt 3,567 2,476
----------- ------------
TOTAL CURRENT LIABILITIES 262,449 283,774
LONG-TERM DEBT, less current portion 721,425 726,329
OTHER LIABILITIES 89,696 83,260
DEFERRED INCOME TAXES 103,485 106,010
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 - 200,000,000 shares
authorized, 116,551,144 shares issued; 114,491,856 and 115,006,751
shares outstanding at May 28, 2005 and February 26, 2005,
respectively 1,166 1,166
Additional paid-in capital 281,248 278,204
Accumulated other comprehensive loss (47,435) (43,227)
Retained earnings 492,438 455,537
----------- ------------
727,417 691,680
Less cost of 2,059,288 and 1,544,393 shares in treasury at
May 28, 2005 and February 26, 2005, respectively (49,583) (35,912)
----------- ------------
677,834 655,768
----------- ------------
TOTAL LIABILITIES AND SHAREHOLDERS' EQUITY $ 1,854,889 $ 1,855,141
=========== ============
See Notes to Consolidated Financial Statements
-3-
GTECH HOLDINGS CORPORATION AND SUBSIDIARIES
CONSOLIDATED INCOME STATEMENTS
(Unaudited)
Three Months Ended
------------------------------
May 28, May 29,
2005 2004
------------ ------------
(Dollars in thousands,
except per share amounts)
Revenues:
Services $ 291,364 $ 253,326
Sales of products 35,035 26,879
------------ ------------
326,399 280,205
Costs and expenses:
Costs of services 168,917 147,293
Costs of sales 21,604 15,917
------------ ------------
190,521 163,210
------------ ------------
Gross profit 135,878 116,995
Selling, general and administrative 32,019 27,635
Research and development 12,938 13,087
------------ ------------
Operating expenses 44,957 40,722
------------ ------------
Operating income 90,921 76,273
Other income (expense):
Interest income 2,045 1,335
Equity in earnings of unconsolidated affiliates 1,787 1,306
Other income (expense) (1,794) 10,525
Interest expense (7,265) (4,336)
------------ ------------
(5,227) 8,830
------------ ------------
Income before income taxes 85,694 85,103
Income taxes 30,850 31,488
------------ ------------
Net income $ 54,844 $ 53,615
============ ============
Basic earnings per share $ 0.48 $ 0.45
============ ============
Diluted earnings per share $ 0.43 $ 0.40
============ ============
Weighted average shares outstanding - basic 114,646 118,624
============ ============
Weighted average shares outstanding - diluted 129,707 134,977
============ ============
Cash dividends declared per common share $ 0.085 $ 0.085
============ ============
See Notes to Consolidated Financial Statements
-4-
GTECH HOLDINGS CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(Unaudited)
Three Months Ended
----------------------------
May 28, May 29,
2005 2004
----------- -----------
(Dollars in thousands)
OPERATING ACTIVITIES
Net income $ 54,844 $ 53,615
Adjustments to reconcile net income to net cash provided by
operating activities:
Depreciation 42,023 33,379
Intangibles amortization 2,641 1,633
Deferred income taxes 4,372 7,237
Tax benefit related to stock award plans 3,044 5,250
Minority interest 1,309 353
Equity in earnings of unconsolidated affiliates, net of dividends received (1,787) (494)
Gain on sale of investment - (10,924)
Other 7,706 3,123
Changes in operating assets and liabilities:
Trade accounts receivable 16,924 (6,417)
Inventories 13,486 (10,340)
Accounts payable (32,448) (7,020)
Employee compensation 3,188 (13,802)
Advance payments from customers (192) 22,610
Deferred revenue and advance billings (5,101) 16,169
Income taxes payable 11,558 9,899
Other assets and liabilities 9 (7,823)
----------- -----------
NET CASH PROVIDED BY OPERATING ACTIVITIES 121,576 96,448
INVESTING ACTIVITIES
Acquisitions (net of cash acquired) 296 (193,018)
Purchases of systems, equipment and other assets relating to contracts (40,562) (53,932)
Purchases of available-for-sale investment securities (85,000) (49,895)
Maturities and sales of available-for-sale investment securities 72,325 259,600
Purchases of property, plant and equipment (2,394) (1,973)
Decrease in restricted cash 5,080 -
Proceeds from sale of investment - 11,773
Investments in and advances to unconsolidated subsidiaries - (775)
----------- -----------
NET CASH USED FOR INVESTING ACTIVITIES (50,255) (28,220)
FINANCING ACTIVITIES
Principal payments on long-term debt (1,317) (91,239)
Purchases of treasury stock (32,051) (28,275)
Dividends paid (9,770) (10,103)
Premiums and fees paid in connection with the early retirement of debt - (10,610)
Proceeds from stock options 3,322 3,508
Other 863 769
----------- -----------
NET CASH USED FOR FINANCING ACTIVITIES (38,953) (135,950)
Effect of exchange rate changes on cash (1,180) (1,376)
----------- -----------
INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS 31,188 (69,098)
Cash and cash equivalents at beginning of period 94,446 129,339
----------- -----------
CASH AND CASH EQUIVALENTS AT END OF PERIOD $ 125,634 $ 60,241
=========== ===========
See Notes to Consolidated Financial Statements
-5-
GTECH HOLDINGS CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENT OF SHAREHOLDERS' EQUITY - (Unaudited)
Accumulated
Additional Other
Outstanding Common Paid-in Comprehensive Retained Treasury
Shares Stock Capital Loss Earnings Stock Total
----------- ------- ---------- ------------- --------- --------- ---------
(Dollars in thousands)
Balance at February 26, 2005 115,006,751 $ 1,166 $ 278,204 $ (43,227) $ 455,537 $ (35,912) $ 655,768
Comprehensive income:
Net income - - - - 54,844 - 54,844
Other comprehensive income (loss), net of tax:
Foreign currency translation - - - (5,088) - - (5,088)
Unrecognized loss on interest rate locks - - - (83) - - (83)
Unrecognized net gain on derivative instruments - - - 963 - - 963
---------
Comprehensive income 50,636
Treasury shares purchased (1,326,100) - - - - (32,051) (32,051)
Cash dividends on common stock ($0.085 per share) - - - - (9,848) - (9,848)
Shares issued under employee stock purchase
and stock award plans 198,887 - - - (1,234) 4,509 3,275
Shares issued upon exercise of stock options 344,100 - - - (4,484) 7,806 3,322
Shares issued upon conversion of debentures 268,218 - - - (2,377) 6,065 3,688
Tax benefits related to stock award plans - - 3,044 - - - 3,044
----------- ------- --------- ------------- --------- --------- ---------
Balance at May 28, 2005 114,491,856 $ 1,166 $ 281,248 $ (47,435) $ 492,438 $ (49,583) $ 677,834
=========== ======= ========= ============= ========= ========= =========
See Notes to Consolidated Financial Statements
-6-
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 gaming and technology
company providing software, networks and professional services that power
high-performance, transaction processing systems. We are the world's leading
operator of highly-secure online lottery transaction processing systems, doing
business in 53 countries worldwide and we have a growing presence in commercial
gaming technology and financial services transaction processing. We have a
single operating and reportable business segment, the Transaction Processing
segment. In these notes, the terms "Holdings," "Company," "we," "our," and "us"
refer to GTECH Holdings Corporation and all subsidiaries included in the
consolidated financial statements, unless otherwise specified. 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 2005
Annual Report on Form 10-K. 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 three-month period ended May 28, 2005
are not necessarily indicative of the results that may be expected for the full
fiscal year ending February 25, 2006. The balance sheet at February 26, 2005 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 2005 Annual Report on Form 10-K.
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.
-7-
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. In
the first quarter of fiscal 2005, the fair value of each grant was estimated on
the date of grant using the Black-Scholes option pricing model. In the first
quarter of fiscal 2006, the fair value of each grant was estimated on the date
of grant using a binomial option pricing model. We changed our option pricing
model to a binomial model as we believe the binomial model provides a better
estimate of fair value.
Three Months Ended
--------------------------------------
May 28, May 29,
2005 2004
---------------- -------------------
(Dollars in thousands,
except per share amounts)
Net income, as reported $ 54,844 $ 53,615
Add: Stock-based compensation expense included in reported
net income, net of related tax effects 1,615 598
Deduct: Total stock-based compensation expense determined under
the fair value method for all awards, net of related tax effects (2,753) (2,012)
---------------- -------------------
Pro forma net income $ 53,706 $ 52,201
================ ===================
Basic earnings per share:
As reported $ .48 $ .45
Pro forma .47 .44
Diluted earnings per share:
As reported $ .43 $ .40
Pro forma .42 .39
NOTE 2 - COMMON STOCK SPLIT
In the second quarter of fiscal 2005, our Board of Directors approved a 2-for-1
common stock split, payable in the form of a stock dividend, which entitled each
shareholder of record on July 1, 2004 to receive one share of common stock for
each outstanding share of common stock held on that date. The stock dividend was
distributed on July 30, 2004. All references to common shares and per share
amounts herein have been restated to reflect the stock splits for all periods
presented.
-8-
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)
NOTE 3 - INVENTORIES
Inventories consist of the following:
May 28, February 26,
2005 2005
------------ ------------
(Dollars in thousands)
Raw materials $ 18,223 $ 29,622
Work in progress 16,298 15,492
Finished goods 13,117 16,021
------------ ------------
$ 47,638 $ 61,135
============ ============
Inventories include amounts we manufacture or assemble for our long-term service
contracts and amounts related to product sales contracts, including product
sales which are accounted for using contract accounting. Work in progress at May
28, 2005 and February 26, 2005 includes approximately $13.3 million and $12.0
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
$42.7 million and $42.9 million at May 28, 2005 and February 26, 2005,
respectively.
NOTE 4 - RESTRICTED ASSETS
Pursuant to a June 2004 ruling (the "Ruling") in a civil action initiated by
federal attorneys with Brazil's Public Ministry, certain of our Brazilian assets
totaling approximately $10.7 million (including $5.1 million of cash that was
included in Other Assets in our Consolidated Balance Sheet at February 26,
2005), was restricted from transfer or sale. In July 2004, we filed an appeal of
the Ruling and in March 2005, an appellate court decision ordered that the
restrictions on the transfer or sale of our Brazilian assets be removed.
Accordingly, there were no restricted assets as of May 28, 2005.
-9-
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)
NOTE 5 - PRODUCT WARRANTY
We offer a product warranty on all of our manufactured products (primarily
terminals and related peripherals) sold to our customers. Although we do not
have a standard product warranty, our typical warranty provides that we will
repair or replace defective products for a period of time (usually a minimum of
90 days) from the date revenue is recognized or from the date a product is
delivered and tested. We estimate product warranty costs that we expect to incur
during the warranty period and we record a charge to costs of sales for the
estimated warranty cost at the time the product sale is recorded. In determining
the appropriate warranty provision, consideration is given to historical
warranty cost information, the status of the terminal model in its life cycle
and current terminal performance. We periodically assess the adequacy of our
product warranty reserves and adjust them as necessary in the period when the
information necessary to make the adjustment becomes available.
We typically do not provide a product warranty on purchased products sold to our
customers but attempt to pass the manufacturer's warranty, if any, on to them.
A summary of product warranty activity for the three months ended May 28, 2005
and May 29, 2004 is as follows:
May 28, May 29,
2005 2004
--------------------- -------------------
(Dollars in thousands)
Balance at beginning of period $ 1,634 $ 749
Additional reserves 84 81
Charges incurred (411) (161)
Change in estimate - (300)
Opening reserve balance associated with acquisitions - 1,126
Other (16) 10
--------------------- -------------------
Balance at end of period $ 1,291 $ 1,505
===================== ===================
Our reserves for product warranty are included in Accrued Expenses in our
Consolidated Balance Sheets.
-10-
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)
NOTE 6 - LONG-TERM DEBT
Long-term debt consists of the following:
May 28, February 26,
2005 2005
--------------------- -------------------
(Dollars in thousands)
4.75% Senior Notes due October 2010 $ 249,704 $ 249,690
1.75% Convertible Debentures due December 2021 171,312 175,000
4.50% Senior Notes due December 2009 149,625 149,604
5.25% Senior Notes due December 2014 148,737 148,704
Fair value of interest rate swaps 1,914 541
Other, due through October 2007 3,700 5,266
--------------------- -------------------
724,992 728,805
Less current portion 3,567 2,476
--------------------- -------------------
$ 721,425 $ 726,329
===================== ===================
1.75% CONVERTIBLE DEBENTURES
Our 1.75% Convertible Debentures due December 2021 (the "Debentures") are
convertible at the option of the holder into shares of our common stock in
certain specified circumstances. The Debentures became convertible on May 1,
2003 and remained convertible through the end of the first quarter of fiscal
2006 (May 28, 2005) because the sale price of our common stock was more than
120% of the conversion price (approximately $16.50 per share) for at least 20
trading days in a 30 trading-day period.
On April 14, 2005, approximately $3.7 million principal amount of the Debentures
were converted by holders of the Debentures, resulting in the issuance of
268,218 shares of our common stock.
CREDIT FACILITY
We have a $500 million unsecured senior revolving credit facility expiring in
October 2009 (the "Credit Facility"). There were no outstanding borrowings under
the Credit Facility at May 28, 2005 or February 26, 2005. Up to $100 million of
the Credit Facility may be used for the issuance of letters of credit. At May
28, 2005 there was $492.4 million available for borrowing under the Credit
Facility, after considering $7.6 million of letters of credit issued and
outstanding.
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.
-11-
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 certain specified events 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 May 28, 2005:
Total potential
commitments
------------------
(in thousands)
Performance bonds $ 204,505
Financial guarantees 31,280
Litigation bonds 6,370
All other bonds 4,063
------------------
$ 246,218
==================
LOTTERY TECHNOLOGY SERVICES INVESTMENT CORPORATION
We have a 44% interest in Lottery Technology Services Corporation ("LTSC"),
which we account for using the equity method of accounting. LTSC provides
equipment and services (which we supplied to LTSC), to the Taipei Fubon Bank.
The Taipei Fubon Bank holds the license to operate the Taiwan Public Welfare
Lottery.
In fiscal 2002, we signed an agreement with Acer, Inc. ("Acer"), the partner
that holds the remaining 56% interest in LTSC, which provides that in the event
a third party lender to LTSC requires the guarantee of GTECH or Acer as a
condition of making a loan to LTSC, we, along with Acer, will provide such a
guarantee on reasonable terms. This potential guarantee is limited to 44% of any
such third-party loan and would expire on December 31, 2006.
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. ("DELTA"). 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 may be jointly and
severally liable, with DELTA, for the obligations of the joint venture.
-12-
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)
NOTE 8 - GUARANTEES AND INDEMNIFICATIONS (continued)
ATRONIC
In December 2004, we entered into an agreement to acquire a 50% controlling
equity position in the Atronic group of companies ("Atronic") privately held by
the Gauselmann Group ("Gauselmann"). The remaining 50% of Atronic will be
retained by the owners of Gauselmann. Atronic is a video slot machine
manufacturer and also develops slot machine games and customized solutions for
dynamic gaming operations. This transaction is contingent upon regulatory and
gaming license approvals and other closing conditions, and is expected to be
completed on December 31, 2006.
On March 24, 2005, we guaranteed 50% of Atronic's obligations due under a Euro
50 million (approximately $63 million at the May 28, 2005 exchange rate) loan
made by a commercial lender to Atronic (the "Agreement"). Our maximum liability
under this guaranty is equal to the lesser of Euro 25 million (approximately $31
million at the May 28, 2005 exchange rate) or 50% of Atronic's outstanding
obligations under the Agreement. The guarantee arose in connection with our
planned acquisition of Atronic on December 31, 2006. We would be required to
perform under the guaranty should Atronic fail to make any interest or principal
payments in accordance with the terms and conditions of the Agreement. Our
guarantee expires on April 26, 2010. As of May 28, 2005, the carrying amount of
the liability for our obligations under this guarantee is $2.0 million, which is
included in Other Liabilities in our Consolidated Balance Sheets.
The Agreement stipulates that if any event of default should occur and be
continuing under our Credit Facility, we would be required to deposit in an
account with the commercial lender, Euro 25 million, which would be held by the
commercial lender as collateral for the payment and performance of our
obligations under the guaranty. The commercial lender would have control over
this account. The cash deposit would be released to us three business days after
all the events of default have been cured or waived.
LOXLEY GTECH PRIVATE LIMITED
We have a 49% interest in Loxley GTECH Private Limited Co. ("LGT"), which is
accounted for using the equity method of accounting. LGT is a corporate joint
venture that is expected to provide the online lottery system in Thailand. On
March 29, 2005, in order to assist LGT with obtaining the financing they require
to enable them to perform under their anticipated obligation to operate the
online lottery system in Thailand, we guaranteed, along with the 51% shareholder
in LGT, Baht 1.925 billion (approximately $48 million at the May 28, 2005
exchange rate) principal amount in loans and Baht 455 million (approximately $11
million at the May 28, 2005 exchange rate) in performance bonds and trade
finance facilities made to LGT by an unrelated commercial lender (collectively,
the "Facilities"). We are jointly and severally liable with the other
shareholder in LGT for this guarantee. We would be required to perform under the
guaranty should LGT fail to make interest or principal payments in accordance
with the terms and conditions of the Facilities. Our guarantee obligations will
not commence until LGT enters into a definitive agreement with the government,
which we currently expect will take place in the second quarter of fiscal 2006,
and will terminate upon the start-up of the online lottery system in Thailand,
which is currently expected to occur in the fourth quarter of fiscal 2006.
-13-
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)
NOTE 8 - GUARANTEES AND INDEMNIFICATIONS (continued)
WORLD HEADQUARTERS FACILITY
Under our Master Contract with the State of Rhode Island, we are to invest (or
cause to be invested) at least $100 million in the State of Rhode Island, in the
aggregate, by December 31, 2008. This investment commitment includes the
development of a new world headquarters facility in Providence, Rhode Island by
December 31, 2006. We have entered into (i) a development agreement with US Real
Estate Limited Partnership (the "Developer"), whereby the Developer will develop
and own the facility; and (ii) an office lease with the Developer, whereby we
will lease a portion of the facility from the Developer for 20 years. We also
entered into (i) a 149 year ground lease with Capital Properties, Inc. (the
"Ground Landlord") with respect to the land upon which the facility will be
constructed; and (ii) a completion guarantee in favor of the Ground Landlord
whereby we guaranteed the completion of the facility and the payment of the rent
and real estate taxes under the ground lease until the completion of the
facility. We have assigned the ground lease to the Developer but remain liable
under the ground lease and the completion guarantee. Rent payable under the
ground lease is currently $0.1 million per year. It is our position that our
liability under the ground lease will expire upon completion of the facility.
Upon completion of the facility, the Ground Landlord's recourse in the event of
a default by the Developer under the ground lease is limited to the facility.
NOTE 9 - COMPREHENSIVE INCOME
The components of comprehensive income are as follows:
Three Months Ended
-------------------------------------------
May 28, May 29,
2005 2004
--------------------- -------------------
(Dollars in thousands)
Net income $ 54,844 $ 53,615
Other comprehensive income (loss), net of tax
Foreign currency translation (5,088) (2,220)
Unrecognized loss on interest rate locks (83) -
Unrecognized net gain on derivative instruments 963 894
Unrealized loss on investments - (2)
--------------------- -------------------
Comprehensive income $ 50,636 $ 52,287
===================== ===================
-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
-------------------------------------------
May 28, May 29,
2005 2004
--------------------- -------------------
(In thousands, except per
share amounts)
Numerator:
Net income (Numerator for basic earnings per share) $ 54,844 $ 53,615
Effect of dilutive securities:
Interest expense on 1.75% Convertible Debentures, net of tax 523 529
--------------------- -------------------
Numerator for diluted earnings per share $ 55,367 $ 54,144
===================== ===================
Denominator:
Denominator for basic earnings per share - weighted average shares 114,646 118,624
Effect of dilutive securities:
1.75% Convertible Debentures 12,459 12,727
Employee stock options 2,463 3,380
Unvested stock awards and employee stock purchase plan shares 139 246
--------------------- -------------------
Dilutive potential common shares 15,061 16,353
Denominator for diluted earnings per share - adjusted weighted
average shares and assumed conversions 129,707 134,977
===================== ===================
Basic earnings per share $ .48 $ .45
===================== ===================
Diluted earnings per share $ .43 $ .40
===================== ===================
NOTE 11 - INCOME TAXES
Our effective income tax rate is greater than the statutory rate primarily due
to state income taxes. The effective income tax rate is based upon expected
income for the year, the composition of income or loss in different
jurisdictions and related statutory tax rates, accruals for tax contingencies
and the tax consequences or benefits from audits or the resolution of tax
contingencies.
In October 2004, the American Jobs Creation Act of 2004 (the "Act") was signed
into law. Among its provisions, the Act provides for a one-time special
deduction for certain qualifying dividends from foreign subsidiaries. We have
made the determination that it is not economical to repatriate foreign dividends
at this time.
-15-
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)
NOTE 12 - SUPPLEMENTAL GUARANTOR/NON-GUARANTOR FINANCIAL INFORMATION
On December 18, 2001, Holdings (the "Parent Company") issued, in a private
placement, $175 million principal amount of 1.75% Convertible Debentures due
December 15, 2021 (the "Debentures"). On October 9, 2003, the Parent Company
issued, in a private placement, $250 million principal amount of 4.75% Senior
Notes due October 15, 2010, and on November 16, 2004, issued $150 million
principal amount of 4.75% Senior Notes due December 1, 2009 and $150 million
principal amount of 5.25% Senior Notes due December 1, 2014 (collectively, the
"Senior Notes"). All of the Senior Notes were subsequently exchanged for Senior
Notes registered under the Securities Act of 1933. The Debentures and Senior
Notes 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 revenues 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.
-16-
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)
NOTE 12 - SUPPLEMENTAL GUARANTOR/NON-GUARANTOR FINANCIAL INFORMATION(continued)
Condensed Consolidating Balance Sheets
May 28, 2005
Parent Guarantor Non-Guarantor Eliminating
Company Subsidiaries Subsidiaries Entries Consolidated
----------- ---------------- ------------------ --------------- ---------------
(Dollars in thousands)
Assets
Current Assets:
Cash and cash equivalents $ - $ 50,985 $ 74,649 $ - $ 125,634
Investment securities
available-for-sale - 209,500 - - 209,500
Trade accounts receivable, net - 75,776 72,733 - 148,509
Due from subsidiaries and affiliates - 65,286 - (65,286) -
Sales-type lease receivables - 3,077 194 - 3,271
Refundable performance deposit - - 8,000 - 8,000
Inventories - 20,593 31,529 (4,484) 47,638
Deferred income taxes - 10,756 13,782 - 24,538
Other current assets - 10,382 20,904 - 31,286
----------- ---------------- ------------------ --------------- ---------------
Total Current Assets - 446,355 221,791 (69,770) 598,376
Systems, Equipment and Other
Assets Relating to Contracts, net - 617,762 110,018 (13,695) 714,085
Investment in Subsidiaries and
Affiliates 677,834 443,866 - (1,121,700) -
Goodwill, net - 115,981 214,745 - 330,726
Property, Plant and Equipment, net - 43,178 34,417 - 77,595
Intangible Assets, net - 21,436 46,754 - 68,190
Refundable Performance Deposit - - 12,000 - 12,000
Sales-Type Lease Receivables - 3,900 42 - 3,942
Other Assets - 20,140 29,835 - 49,975
----------- ---------------- ------------------ --------------- ---------------
Total Assets $ 677,834 $ 1,712,618 $ 669,602 $ (1,205,165) $ 1,854,889
=========== ================ ================== =============== ===============
Liabilities and Shareholders' Equity
Current Liabilities:
Accounts payable $ - $ 30,419 $ 32,005 $ - $ 62,424
Due to subsidiaries and affiliates - - 65,286 (65,286) -
Accrued expenses - 31,789 26,063 - 57,852
Employee compensation - 16,616 9,624 - 26,240
Advance payments from customers - 10,029 32,644 - 42,673
Deferred revenue and advance billings - 11,013 13,591 - 24,604
Income taxes payable - 20,349 7,708 - 28,057
Taxes other than income taxes - 8,832 8,180 - 17,012
Short term borrowings - - 20 - 20
Current portion of long-term debt - - 3,567 - 3,567
----------- ---------------- ------------------ --------------- ---------------
Total Current Liabilities - 129,047 198,688 (65,286) 262,449
Long-Term Debt, less current
portion - 721,292 133 - 721,425
Other Liabilities - 67,196 22,500 - 89,696
Deferred Income Taxes - 99,070 4,415 - 103,485
Shareholders' Equity 677,834 696,013 443,866 (1,139,879) 677,834
----------- ---------------- ------------------ --------------- ---------------
Total Liabilities and
Shareholders' Equity $ 677,834 $ 1,712,618 $ 669,602 $ (1,205,165) $ 1,854,889
=========== ================ ================== =============== ===============
-17-
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)
NOTE 12 - SUPPLEMENTAL GUARANTOR/NON-GUARANTOR FINANCIAL INFORMATION(continued)
Condensed Consolidating Balance Sheets
February 26, 2005
Parent Guarantor Non-Guarantor Eliminating
Company Subsidiaries Subsidiaries Entries Consolidated
--------------- ------------- --------------- ------------- --------------
(Dollars in thousands)
Assets
Current Assets:
Cash and cash equivalents $ - $ 23,020 $ 71,426 $ - $ 94,446
Investment securities
available-for-sale - 196,825 - - 196,825
Trade accounts receivable, net - 82,212 86,494 - 168,706
Due from subsidiaries and affiliates - 53,345 - (53,345) -
Sales-type lease receivables - 3,215 246 - 3,461
Refundable performance deposit - - 8,000 - 8,000
Inventories - 30,387 34,366 (3,618) 61,135
Deferred income taxes - 14,030 17,405 - 31,435
Other current assets - 6,669 19,977 - 26,646
--------------- ------------- --------------- ------------- --------------
Total Current Assets - 409,703 237,914 (56,963) 590,654
Systems, Equipment and Other
Assets Relating to Contracts, net - 616,204 118,436 (14,202) 720,438
Investment in Subsidiaries and
Affiliates 655,768 448,499 - (1,104,267) -
Goodwill, net - 115,981 215,041 - 331,022
Property, Plant and Equipment, net - 40,120 34,438 - 74,558
Intangible Assets, net - 22,157 48,682 - 70,839
Refundable Performance Deposit - - 12,000 - 12,000
Sales-Type Lease Receivables - 4,681 75 - 4,756
Other Assets - 28,209 22,665 - 50,874
--------------- ------------- --------------- ------------- --------------
Total Assets $ 655,768 $ 1,685,554 $ 689,251 $ (1,175,432) $ 1,855,141
=============== ============= =============== ============= ==============
Liabilities and Shareholders' Equity
Current Liabilities:
Accounts payable $ - $ 41,525 $ 57,709 $ - $ 99,234
Due to subsidiaries and affiliates - - 53,345 (53,345) -
Accrued expenses - 29,277 24,950 - 54,227
Employee compensation - 13,252 8,610 - 21,862
Advance payments from customers - 8,113 34,752 - 42,865
Deferred revenue and advance billings - 11,369 18,336 - 29,705
Income taxes payable - 11,902 4,597 - 16,499
Taxes other than income taxes - 7,688 8,884 - 16,572
Short term borrowings - - 334 - 334
Current portion of long-term debt - - 2,476 - 2,476
--------------- ------------- --------------- ------------- --------------
Total Current Liabilities - 123,126 213,993 (53,345) 283,774
Long-Term Debt, less current
portion - 723,539 2,790 - 726,329
Other Liabilities - 64,035 19,225 - 83,260
Deferred Income Taxes - 101,266 4,744 - 106,010
Shareholders' Equity 655,768 673,588 448,499 (1,122,087) 655,768
--------------- ------------- --------------- ------------- --------------
Total Liabilities and
Shareholders' Equity $ 655,768 $ 1,685,554 $ 689,251 $ (1,175,432) $ 1,855,141
=============== ============= =============== ============= ==============
-18-
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)
NOTE 12 - SUPPLEMENTAL GUARANTOR/NON-GUARANTOR FINANCIAL INFORMATION (continued)
Condensed Consolidating Income Statements
Three Months Ended May 28, 2005
Parent Guarantor Non-Guarantor Eliminating
Company Subsidiaries Subsidiaries Entries Consolidated
--------------- ------------- --------------- ------------- --------------
(Dollars in thousands)
Revenues:
Services $ - $ 189,638 $ 101,726 $ - $ 291,364
Sales of products - 9,097 25,938 - 35,035
Intercompany sales and fees - 48,477 12,616 (61,093) -
--------------- ------------- --------------- ------------- --------------
- 247,212 140,280 (61,093) 326,399
Costs and expenses:
Costs of services - 114,184 55,903 (1,170) 168,917
Costs of sales - 4,738 16,866 - 21,604
Intercompany cost of sales
and fees - 28,156 7,833 (35,989) -
--------------- ------------- --------------- ------------- --------------
- 147,078 80,602 (37,159) 190,521
--------------- ------------- --------------- ------------- --------------
Gross profit - 100,134 59,678 (23,934) 135,878
Selling, general & administrative - 19,495 12,524 - 32,019
Research and development - 7,883 5,055 - 12,938
--------------- ------------- --------------- ------------- --------------
Operating expenses - 27,378 17,579 - 44,957
--------------- ------------- --------------- ------------- --------------
Operating income - 72,756 42,099 (23,934) 90,921
Other income (expense):
Interest income - 1,395 650 - 2,045
Equity in earnings of
unconsolidated affiliates - 1,289 498 - 1,787
Equity in earnings of
consolidated affiliates 54,844 26,126 - (80,970) -
Other income (expense) - 548 (2,342) - (1,794)
Interest expense - (7,182) (83) - (7,265)
--------------- ------------- --------------- ------------- --------------
Income before income taxes 54,844 94,932 40,822 (104,904) 85,694
Income taxes - 34,176 14,696 (18,022) 30,850
--------------- ------------- --------------- ------------- --------------
Net income $ 54,844 $ 60,756 $ 26,126 $ (86,882) $ 54,844
=============== ============= =============== ============= ==============
-19-
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)
NOTE 12 - SUPPLEMENTAL GUARANTOR/NON-GUARANTOR FINANCIAL INFORMATION (continued)
Condensed Consolidating Income Statements
Three Months Ended May 29, 2004
Parent Guarantor Non-Guarantor Eliminating
Company Subsidiaries Subsidiaries Entries Consolidated
--------------- ------------- --------------- ------------- --------------
(Dollars in thousands)
Revenues:
Services $ - $ 178,663 $ 74,663 $ - $ 253,326
Sales of products - 18,444 8,435 - 26,879
Intercompany sales and fees - 31,906 14,191 (46,097) -
--------------- ------------- --------------- ------------- --------------
- 229,013 97,289 (46,097) 280,205
Costs and expenses:
Costs of services - 104,074 43,737 (518) 147,293
Costs of sales - 11,368 4,562 (13) 15,917
Intercompany cost of sales
and fees - 23,696 4,291 (27,987) -
--------------- ------------- --------------- ------------- --------------
- 139,138 52,590 (28,518) 163,210
--------------- ------------- --------------- ------------- --------------
Gross profit - 89,875 44,699 (17,579) 116,995
Selling, general & administrative - 19,442 8,193 - 27,635
Research and development - 9,206 3,881 - 13,087
--------------- ------------- --------------- ------------- --------------
Operating expenses - 28,648 12,074 - 40,722
--------------- ------------- --------------- ------------- --------------
Operating income - 61,227 32,625 (17,579) 76,273
Other income (expense):
Interest income - 613 722 - 1,335
Equity in earnings of
unconsolidated affiliates - 1,341 (35) - 1,306
Equity in earnings of
consolidated affiliates 53,615 28,241 - (81,856) -
Other income (expense) - (1,429) 11,954 - 10,525
Interest expense - (3,897) (439) - (4,336)
--------------- ------------- --------------- ------------- --------------
Income before income taxes 53,615 86,096 44,827 (99,435) 85,103
Income taxes - 31,856 16,586 (16,954) 31,488
--------------- ------------- --------------- ------------- --------------
Net income $ 53,615 $ 54,240 $ 28,241 $ (82,481) $ 53,615
=============== ============= =============== ============= ==============
-20-
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)
NOTE 12 - SUPPLEMENTAL GUARANTOR/NON-GUARANTOR FINANCIAL INFORMATION (continued)
Condensed Consolidating Statements of Cash Flows
Three Months Ended May 28, 2005
Parent Guarantor Non-Guarantor Eliminating
Company Subsidiaries Subsidiaries Entries Consolidated
------------- ------------- ------------- ------------- -------------
(Dollars in thousands)
Net cash provided by operating
activities $ - $ 68,638 $ 53,877 $ (939) $ 121,576
Investing Activities
Acquisitions (net of cash acquired) - - 296 - 296
Purchases of systems, equipment
and other assets relating to
contracts - (34,766) (6,735) 939 (40,562)
Purchases of available-for-sale
investment securities - (85,000) - - (85,000)
Maturities and sales of
available-for-sale investment
securities - 72,325 - - 72,325
Purchases of property, plant and
equipment - (1,841) (553) - (2,394)
Decrease in restricted cash - - 5,080 - 5,080
------------- ------------- ------------- ------------- -------------
Net cash used for investing
activities - (49,282) (1,912) 939 (50,255)
Financing Activities
Principal payments on long-term
debt - - (1,317) - (1,317)
Purchases of treasury stock (32,051) - - - (32,051)
Dividends paid (9,770) - - - (9,770)
Proceeds from stock options 3,322 - - - 3,322
Intercompany capital transactions 37,264 (37,264) - - -
Other 1,235 (68) (304) - 863
------------- ------------- ------------- ------------- -------------
Net cash used for financing
activities - (37,332) (1,621) - (38,953)
Effect of exchange rate changes
on cash - 5 (1,185) - (1,180)
------------- ------------- ------------- ------------- -------------
Increase (decrease) in cash and
cash equivalents - (17,971) 49,159 - 31,188
Cash and cash equivalents at
beginning of period - 68,956 25,490 - 94,446
------------- ------------- ------------- ------------- -------------
Cash and cash equivalents at end
of period $ - $ 50,985 $ 74,649 $ - $ 125,634
============= ============= ============= ============= =============
-21-
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)
NOTE 12 - SUPPLEMENTAL GUARANTOR/NON-GUARANTOR FINANCIAL INFORMATION(continued)
Condensed Consolidating Statements of Cash Flows
Three Months Ended May 29, 2004
Parent Guarantor Non-Guarantor Eliminating
Company Subsidiaries Subsidiaries Entries Consolidated
------------- ------------- ------------- ------------- -------------
(Dollars in thousands)
Net cash provided by operating
activities $ - $ 88,705 $ 8,064 $ (321) $ 96,448
Investing Activities
Acquisitions (net of cash acquired) - - (193,018) - (193,018)
Purchases of systems, equipment
and other assets relating to
contracts - (46,887) (7,366) 321 (53,932)
Purchases of available-for-sale
investment securities - (49,895) - - (49,895)
Maturities and sales of
available-for-sale investment
securities - 259,600 - - 259,600
Purchases of property, plant and
equipment - (1,957) (16) - (1,973)
Proceeds from sale of investment - - 11,773 - 11,773
Investments in and advances to
unconsolidated subsidiaries - - (775) - (775)
------------- ------------- ------------- ------------- -------------
Net cash provided by (used for)
investing activities - 160,861 (189,402) 321 (28,220)
Financing Activities
Principal payments on long-term
debt - (90,000) (1,239) - (91,239)
Purchases of treasury stock (28,275) - - - (28,275)
Dividends paid (10,103) - - - (10,103)
Premiums and fees paid in
connection with the early
retirement of debt - (10,610) - - (10,610)
Proceeds from stock options 3,508 - - - 3,508
Intercompany capital transactions 34,055 (202,055) 168,000 - -
Other 815 (46) - - 769
------------- ------------- ------------- ------------- -------------
Net cash provided by (used for)
financing activities - (302,711) 166,761 - (135,950)
Effect of exchange rate changes
on cash - (7) (1,369) - (1,376)
------------- ------------- ------------- ------------- -------------
Decrease in cash and
cash equivalents - (53,152) (15,946) - (69,098)
Cash and cash equivalents at
beginning of period - 68,956 60,383 - 129,339
------------- ------------- ------------- ------------- -------------
Cash and cash equivalents at end
of period $ - $ 15,804 $ 44,437 $ - $ 60,241
============= ============= ============= ============= =============
-22-
Item 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
OVERVIEW
The following Management's Discussion and Analysis ("MD&A") is intended to help
the reader understand the financial results of GTECH Holdings Corporation. MD&A
is provided as a supplement to, and should be read in conjunction with, our
financial statements and the accompanying notes. This overview provides guidance
on the individual sections of MD&A as follows:
- - FORWARD-LOOKING STATEMENTS - cautionary information about forward-looking
statements.
- - OUR BUSINESS - a general description of our business; our growth strategy;
and Brazil matters.
- - COMMON STOCK SPLIT - information about our prior year common stock split.
- - OPERATIONS REVIEW - an analysis of our consolidated results of operations
for the three month periods ended May 28, 2005 and May 29, 2004 presented
in our financial statements. We operate in one business - Transaction
Processing, and we have a single operating and reportable business
segment. Therefore, our discussions are not quantified by segment results.
- - LIQUIDITY, CAPITAL RESOURCES AND FINANCIAL POSITION - an analysis of cash
flows; financial position; and commitments.
- - FINANCIAL RISK MANAGEMENT AND DIVIDEND POLICY - information about
financial risk management; interest rate market risk; equity price risk;
foreign currency exchange rate risk; and our dividend policy.
Unless specified otherwise, we use the terms "Holdings," "the Company," "we,"
"our," and "us" in MD&A to refer to GTECH Holdings Corporation and its
consolidated subsidiaries included in the consolidated financial statements.
FORWARD-LOOKING STATEMENTS
Certain statements contained or incorporated by reference in this report are
forward-looking statements within the meaning of the United States Private
Litigation Reform Act of 1995. We identify forward-looking statements by words
such as "may", "will", "should", "could", "expect", "plan", "anticipate",
"intend", "believe", "estimate", "continue", "project" or similar terms that
refer to the future. Such statements include, without limitation, statements
relating to:
- - the future prospects for and stability of the lottery industry and other
businesses in which we are engaged or expect to be engaged;
- - our future operating and financial performance (including, without
limitation, expected future growth in revenues, profit margins and
earnings per share);
- - our ability to secure and protect trademarks and other intellectual
property rights;
- - our ability to retain existing contracts and to obtain and retain new
contracts;
- - competition in the online lottery industry and other businesses in which
we are engaged or may engage and the impact of competition on our revenues
and profitability;
- - our ability to realize the anticipated benefits of our acquisitions; and
- - the results and effects of legal proceedings and investigations.
-23-
These forward-looking statements reflect management's assessment based on
information currently available, but are not guarantees and are subject to risks
and uncertainties that could cause actual results to differ materially from
those contemplated in the forward-looking statements. These risks and
uncertainties include, among other things, the following:
- - government regulations and other actions affecting the online lottery
industry could have a negative effect on our business and sales;
- - we may be subject to adverse determinations in legal proceedings
(including previously announced legal proceedings in Brazil) which could
result in substantial monetary judgments or reputational damage;
- - 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
could lead to lower revenues and cash flows;
- - we derive over half of our revenues from foreign jurisdictions (including
over 7.4% in fiscal 2005 from Brazilian operations) and are subject to the
economic, political and social instability risks of doing business in
foreign jurisdictions;
- - 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 have a concentrated customer base and the loss of any of our larger
customers (or lower sales from any of these customers) could lead to lower
revenue;
- - 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 cash flows or to lose contracts;
- - we are subject to substantial penalties for failure to perform under our
contracts;
- - we may not be able to respond to technological changes or to satisfy
future technology demands of our customers in which case we could fall
behind our competitors;
- - 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 some markets;
- - our business prospects and future success depend upon our ability to
attract and retain qualified employees;
- - 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; and
- - other risks and uncertainties set forth below and elsewhere in this
report, in our fiscal 2005 Annual Report on Form 10-K, and in our
subsequent press releases and Forms 10-Qs and other reports and filings
with the Securities and Exchange Commission.
The foregoing list of important factors is not all-inclusive.
-24-
OUR BUSINESS
GENERAL
We operate on a 52-week or 53-week fiscal year ending on the last Saturday in
February and fiscal 2006 is a 52-week year that ends on February 25, 2006.
We are a global gaming and technology company providing software, networks and
professional services that power high-performance, transaction processing
systems. We are the world's leading operator of highly-secure online lottery
transaction processing systems, doing business in 53 countries worldwide and we
have a growing presence in commercial gaming technology ("Gaming Solutions") and
financial services transaction processing ("Commercial Services"). A comparison
of our revenue concentration is as follows:
Three Months
Ended
May 28, Fiscal Fiscal
Consolidated Revenues 2005 2005 2004
- --------------------- ------------ ------------ ------------
Lottery 85% 87% 91%
Commercial Services 10% 7% 7%
Gaming Solutions 5% 6% 2%
------------ ------------ ------------
100% 100% 100%
============ ============ ============
Being a global business, we derive a substantial portion of our revenue from our
operations outside of the United States. In particular, in fiscal 2005, we
derived 52.2% of our revenues from international operations, including 7.4% of
our revenues from our Brazilian operations alone (including 7.2% of our revenues
from Caixa Economica Federal, the operator of Brazil's National Lottery, our
second largest customer in fiscal 2005 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.
Our service revenues are derived primarily from lottery service contracts, which
are typically at least five to seven years in duration, and generally provide
compensation to us based upon a percentage of a lottery's gross online and
instant ticket sales. These percentages vary depending on the size of the
lottery and the scope of services provided to the lottery. We primarily derive
product sale revenues 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. Our
product sale revenues from period to period may not be comparable due to the
size and timing of product sale transactions. During fiscal 2006, we currently
anticipate that product sales will be in the range of $180 million to $210
million.
Our compensation under lottery service contracts is typically based upon a
percentage of a lottery's gross online and instant ticket sales. Over the past
several fiscal years, we have experienced and may continue to experience a
reduction in the percentage of lottery ticket sales we receive from certain
customers resulting from contract rebids, extensions and renewals due to a
number of factors, including the substantial growth of lottery sales over the
last decade, 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 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. In addition, we are developing a suite of new lottery
games designed to maintain a strong level of same store sales growth for our
customers.
-25-
Our business is highly regulated, and the competition to secure new government
contracts is often intense. In addition, our ability to consummate the
acquisition, which we announced in December 2004, of a 50% controlling equity
interest in the Atronic group of companies, one of the world's five largest
manufacturers of slot machines, and to otherwise expand our business in
non-lottery gaming markets, is contingent upon obtaining required gaming
licenses. 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 government authorities into possible
improprieties and wrongdoing in connection with efforts to obtain and/or the
awarding of lottery contracts and related matters. Because 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, gaming licensing,
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, obtain new or renewal contracts and to expand our business
in non-lottery gaming markets. 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:
- 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 and
sales" in our fiscal 2005 Annual Report on Form 10-K;
- Part I, Item 3 - "Legal Proceedings" in our fiscal 2005 Annual
Report on Form 10-K; and
- Note 14 to the Consolidated Financial Statements in our fiscal 2005
Annual Report on Form 10-K.
GROWTH STRATEGY
Fiscal 2005 was a year of significant strategic progress for us with the
acquisition of three privately-held companies that strengthened our growth
strategy in Commercial Services and Gaming Solutions. In addition, our growth
strategy in Gaming Solutions was significantly advanced when in December 2004,
we signed an agreement to acquire a 50% controlling equity position in the
Atronic group of companies, a video slot machine manufacturer that also develops
slot machine games and customized solutions for dynamic gaming operations.
Our Commercial Services market includes 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,
Poland, Chile, the Czech Republic and Jamaica process bill payments and other
commercial service transactions. In the near term, we expect to concentrate our
efforts to grow commercial service revenues principally in Central and Eastern
Europe and other selected emerging economies, with the goal of leveraging our
technology, infrastructure and relationships to drive growth in Commercial
Services.
In addition, we will continue to identify and evaluate a variety of selective
opportunities for acquisitions in the Lottery, Commercial Services, and Gaming
Solutions markets, as well as investing in growth through licensing when the
right opportunities present themselves.
-26-
BRAZIL MATTERS
GTECH Brasil Ltda., our Brazilian subsidiary ("GTECH Brazil"), has provided
online lottery services and technology to Caixa Economica Federal ("CEF"), the
Brazilian bank and operator of Brazil's National Lottery since 1997. Revenues
from our lottery contract with CEF accounted for 7.2% of our total fiscal 2005
revenues, making CEF our second largest customer in fiscal 2005 based upon
annual revenues.
In June 2004, a ruling (the "Ruling") in a civil action initiated by federal
attorneys with Brazil's Public Ministry had the effect in fiscal 2005 of
materially reducing payments that we otherwise would have received from our
lottery contract with CEF. The Ruling ordered that 30% of payments subsequent to
the date of the Ruling due to GTECH Brazil by CEF, be withheld and deposited in
an account maintained by the Court. As of February 26, 2005, the total amount
withheld and deposited pursuant to the Ruling was approximately 68 million
Brazilian reals, or $26 million. In fiscal 2005, we did not recognize service
revenues for the payments that were withheld from GTECH Brazil, as realization
of these amounts was not reasonably assured.
In July 2004, we filed an appeal of the Ruling and in March 2005, an appellate
court decision ordered that the withholding be discontinued and that all funds
currently held in escrow in excess of 40 million Brazilian reals be returned to
us, which amounts to $11 million of the $26 million withheld as of February 26,
2005. We received and recognized these funds as service revenue on April 13,
2005. In addition, the Ruling's restrictions on the transfer or sale of our
Brazilian assets was removed and accordingly, there were no restricted cash
balances as of May 28, 2005.
The Ruling also put in place certain restrictions on the transfer or sale of
certain of our Brazilian assets. Such restrictions were lifted in March 2005.
See Note 4 of this report for further information.
In May 2005, GTECH Brazil entered into a new one-year contract with CEF, which
expires in May 2006. Foreign currency translation related to our operations in
Brazil of $56.4 million (which is recorded in Accumulated Other Comprehensive
Loss in our Consolidated Balance Sheet at May 28, 2005), would be recorded as a
charge to our consolidated income statement upon the expiration of our contract
with CEF should we determine that the expiration of the CEF contract results in
a substantial liquidation of our investment in Brazil.
Refer to Note 14 to the Consolidated Financial Statements in our fiscal 2005
Annual Report on Form 10-K for detailed disclosures regarding Brazil matters.
COMMON STOCK SPLIT
In the second quarter of fiscal 2005, our Board of Directors approved a 2-for-1
common stock split, payable in the form of a stock dividend, which entitled each
shareholder of record on July 1, 2004 to receive one share of common stock for
each outstanding share of common stock held on that date. The stock dividend was
distributed on July 30, 2004. All references to common shares and per share
amounts herein have been restated to reflect the stock splits for all periods
presented.
-27-
OPERATIONS REVIEW
COMPARISON OF THE THREE MONTH PERIODS ENDED MAY 28, 2005 AND MAY 29, 2004
REVENUES AND GROSS MARGIN
Three Months Ended
--------------------------------------------------------------
Change
May 28, May 29, ----------------------------
2005 2004 $ %
----------- ----------- ------------ -----------
(Dollars in millions)
Domestic lottery $ 143.1 $ 128.1 $ 15.0 11.7
International lottery 108.4 98.5 9.9 10.1
Commercial services 31.9 20.4 11.5 56.4
Gaming solutions 8.0 5.6 2.4 42.9
All other - 0.7 (0.7) (100.0)
----------- ----------- ------------ -----------
Services $ 291.4 $ 253.3 $ 38.1 15.0
Sales of products 35.0 26.9 8.1 30.1
----------- ----------- ------------ -----------
Total revenues $ 326.4 $ 280.2 $ 46.2 16.5
=========== =========== ============ ===========
Three Months Ended
--------------------------------------------------------------
Change
May 28, May 29, ------------------
2005 2004 Percentage Points
------- ------- ------------------
Service gross margin 42.0% 41.9% 0.1
Product gross margin 38.3% 40.8% (2.5)
The 11.7% increase in domestic lottery service revenues was primarily due to
higher service revenues from an increase in sales by our domestic lottery
customers of approximately 6%, combined with net contract wins of approximately
3% (including the impact of our new service contract in Florida), the benefit of
the new instant ticket vending machine contract in Illinois, and strong jackpot
activity. We believe that in general, increases in sales by our domestic lottery
customers 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, such as Keno.
International lottery service revenues increased by 10.1%. Approximately 7% of
this increase was due to higher revenues from Brazil related to the court
ordered return of funds previously held in escrow, approximately 7% was due to
favorable foreign exchange rates, and approximately 3% was due to higher service
revenues from an increase in sales by our international lottery customers. These
increases were partially offset by the combined impact of contractual rate
changes and lower revenues from the loss of the Puerto Rico contract. We believe
that in general, increases in sales by our international lottery customers are
attributable to more rapid growth rates typical of newer lottery jurisdictions,
the successful introduction of new games and modifications to existing games
(such as matrix changes and more frequent drawings).
Commercial transaction processing service revenues increased by 56.4%.
Approximately 22% of this increase was due to favorable foreign exchange rates,
approximately 15% was due to higher revenues from Brazil related to the court
ordered return of funds previously held in escrow, approximately 8% was due to
higher service revenues from an increase in sales by our commercial transaction
processing customers, and the balance was primarily due to a full quarter of
service revenues from BillBird, which we acquired in the third quarter of last
year.
-28-
The 42.9% increase in gaming solutions service revenues was primarily due to a
full quarter of service revenues from Spielo (versus two months of service
revenue in the first quarter of the prior year) and the installation of
additional video lottery terminals in the state of Rhode Island, along with
higher service revenues from an increase in sales by our gaming solutions
customers of approximately 10%.
Our service margins were comparable to last year. Current year service margins
include higher margins from Brazil related to higher service revenues resulting
from the court ordered return of funds previously held in escrow, partially
offset by the current year impact of higher depreciation and amortization
related to the implementation of new contracts.
Product sales were up principally due to a full quarter of revenues from Spielo.
Our product margins fluctuate depending on the mix, volume and timing of product
sales contracts and were down 2.5 percentage points from last year, primarily
due to the mix of sales.
OPERATING EXPENSES
Operating expenses are comprised of selling, general and administrative (SG&A)
expenses and research and development (R&D) expenses.
Three Months Ended
---------------------------------------------------------
Change
May 28, May 29, ---------------------
2005 2004 $ %
-------------- -------------- --------- --------
(Dollars in millions)
SG&A expenses $ 32.0 $ 27.6 $ 4.4 15.9
R&D expenses 12.9 13.1 (0.2) (1.5)
-------------- -------------- --------- --------
$ 44.9 $ 40.7 $ 4.2 10.3
============== ============== ========= ========
PERCENTAGE OF TOTAL REVENUE
SG&A expenses 9.8% 9.9%
R&D expenses 4.0% 4.7%
The $4.4 million increase in SG&A expenses was principally due to increased
activities in new business development and a full quarter of spending by Spielo.
OTHER INCOME (EXPENSE)
The components of other income (expense) in the first quarters of fiscal 2006
and fiscal 2005 are as follows:
Three Months Ended
---------------------------------------------------------
Change
May 28, May 29, ---------------------
2005 2004 $ %
-------------- -------------- --------- --------
(Dollars in millions)
Minority interest in
consolidated subsidiaries $ (1.3) $ (0.4) $ (0.9) (>100.0)
Foreign exchange gain (loss) (0.5) 0.5 (1.0) (>100.0)
Gain on sale of investment - 10.9 (10.9) ( 100.0)
Net charge associated with
the early retirement of debt - (0.8) 0.8 100.0
Other - 0.3 (0.3) ( 100.0)
-------------- -------------- --------- -------
$ (1.8) $ 10.5 $ (12.3) (>100.0)
============== ============== ========= =======
Minority interest in consolidated subsidiaries principally relates to our
controlling interests in PolCard S.A. ("PolCard") and Wireless Business
Solutions (Proprietary) Limited ("WBS"). PolCard is the leading debit and credit
card merchant transaction acquirer and processor in Poland. WBS is a
telecommunications provider in South Africa.
-29-
The prior year $10.9 million gain on sale of investment resulted from the sale
of our 50% interest in Gaming Entertainment (Delaware) L.L.C. to Harrington
Raceway, Inc.
INTEREST EXPENSE Three Months Ended
---------------------------------------------------------
Change
May 28, May 29, ---------------------
2005 2004 $ %
-------------- -------------- --------- --------
(Dollars in millions)
Interest expense $ 7.3 $ 4.3 $ 3.0 69.8
Interest expense was up over last year primarily due to higher average debt
balances resulting from the issuance of $300 million of Senior Notes in November
2004.
INCOME TAXES
Our effective income tax rate of 36% in the first quarter of fiscal 2006 was
down from 37% in the first quarter of fiscal 2005 primarily due to a larger
percentage of international profits taxed at rates that are lower than the U.S.
statutory income tax rate. Our aggregate income tax rate in foreign
jurisdictions is lower than our income tax rate in the United States. Our income
tax rate may vary, however, depending on the composition of income or loss in
different countries and the resolution of audits and tax contingencies.
In October 2004, the American Jobs Creation Act of 2004 (the "Act") was signed
into law. Among its provisions, the Act provides for a one-time special
deduction for certain qualifying dividends from foreign subsidiaries. We have
made the determination that it is not economical to repatriate foreign dividends
at this time.
WEIGHTED AVERAGE DILUTED SHARES
Weighted average diluted shares in the first quarter of fiscal 2006 decreased by
5.3 million shares to 129.7 million shares, primarily due to treasury share
repurchases made under our share buyback program.
LIQUIDITY, CAPITAL RESOURCES AND FINANCIAL POSITION
We believe our ability to generate cash from operations to reinvest in our
business is one of our fundamental financial strengths and we expect to meet our
financial commitments and operating needs in the foreseeable future. We expect
to use cash generated from operating activities primarily for contractual
obligations and to pay dividends. We expect our growth to be financed through a
combination of cash generated from operating activities, existing sources of
liquidity, access to capital markets and other sources of capital. Our debt
ratings of Baa1 (stable outlook) from Moody's and BBB (stable outlook) from
Standard and Poor's contribute to our ability to access capital markets at
attractive prices.
ANALYSIS OF CASH FLOWS
During the first quarter of fiscal 2006, we generated $121.6 million of cash
from operations. This cash was principally used to fund $40.6 million of
systems, equipment and other assets relating to contracts; to repurchase $32.1
million, or 1,326,100 shares of our common stock; and to pay cash dividends of
$9.8 million. At May 28, 2005, we had $125.6 million of cash and cash
equivalents and $209.5 million of short-term investment securities on hand.
-30-
Our business is capital-intensive. We currently estimate that net cash to be
used for investing activities in fiscal 2006 will be in the range of $230
million to $240 million. We expect our principal sources of liquidity to be
existing cash and short-term investment securities balances, along with cash we
generate from operations and borrowings under our revolving credit facility. Our
credit facility provides for an unsecured revolving line of credit of $500
million and matures in October 2009. There were no borrowings under the credit
facility as of May 28, 2005. Up to $100 million of the Credit Facility may be
used for the issuance of letters of credit. As of May 28, 2005, after
considering $7.6 million of letters of credit issued and outstanding, there was
$492.4 million available for borrowing under the credit facility. The credit
facility contains various covenants, including among other things, requirements
relating to the maintenance of certain financial ratios. None of these covenants
are expected to impact our liquidity or capital resources. There are no
covenants in our credit facility that restrict our ability to pay dividends. At
May 28, 2005, we were in compliance with all applicable covenants.
We currently expect that our cash flow from operations, existing cash, available
borrowings under our credit facility and access to additional sources of capital
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 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 program. We
may also seek alternative 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 our planned investing activities in fiscal 2006.
FINANCIAL POSITION
Our consolidated balance sheet as of May 28, 2005 as compared to our
consolidated balance sheet as of February 26, 2005 was impacted by the material
changes described below.
As of
------------------------------ Change
May 28, February 26, ---------------------
2005 2005 $ %
------------ ------------ --------- --------
(Dollars in millions)
Trade accounts receivable, net $ 148.5 $ 168.7 $ (20.2) (12.0)
Inventories 47.6 61.1 (13.5) (22.1)
Accounts payable 62.4 99.2 (36.8) (37.1)
Income taxes payable 28.1 16.5 11.6 70.3
Cost of treasury shares 49.6 35.9 13.7 38.2
The decrease in trade accounts receivable, net was primarily due to collections
of prior year receivables from product sales to our customers in Spain and
California.
The decrease in inventories was primarily due to shipments of finished lottery
terminals to our domestic lottery customers in Florida and Missouri, along with
lower inventory related to the sale of handheld lottery terminals to our
customer in Spain.
The decrease in accounts payable was primarily due to the timing of PolCard's
settlement of card related transactions, along with payments to the vendor that
supplied the handheld lottery terminals for our product sale to our customer in
Spain.
The increase in income taxes payable was primarily due to the timing of income
tax payments.
-31-
The increase in the cost of treasury shares was primarily due to $32.1 million
of treasury share repurchases, partially offset by shares reissued under our
stock award plans.
COMMITMENTS
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 certain specified events 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 they will do so. The following table provides information
related to potential commitments at May 28, 2005:
Total Potential
Commitments
---------------
(in millions)
Performance bonds $ 204.5
Financial guarantees 31.3
Litigation bonds 6.4
All other bonds 4.0
---------
$ 246.2
=========
MASTER CONTRACT WITH THE RHODE ISLAND LOTTERY
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. Under the terms of the Master Contract, we are to invest (or cause to
be invested) at least $100 million in the State of Rhode Island, in the
aggregate, by December 31, 2008. We currently plan to satisfy our obligation to
invest (or cause to be invested) at least $100 million in the State of Rhode
Island by December 31, 2008 as follows: (i) approximately $24 million was
invested during fiscal 2004; (ii) approximately $15 million was invested during
fiscal 2005; (iii) approximately $45 million will be invested during fiscal
2006; and (iv) the balance will be invested during fiscal 2007. The Lottery may
terminate the Master Contract in the event that we fail to meet our obligations
as stated above.
In addition, in July 2003 we entered into a tax stabilization agreement 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
headquarters facility in the City 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.
ACQUISITION OF ATRONIC
In the fourth quarter of fiscal 2005, we entered into an agreement to acquire a
50% controlling equity position in the Atronic group of companies ("Atronic")
privately held by the Gauselmann Group ("Gauselmann"). The remaining 50% of
Atronic will be retained by the owners of Gauselmann. Atronic is a video slot
machine manufacturer and develops slot machine games and customized solutions
for dynamic gaming operations.
-32-
The final purchase price for Atronic will be calculated through a
performance-based formula equal to eight times Atronic's EBITDA (earnings before
interest, taxes, depreciation and amortization) for its fiscal year ending
December 31, 2006. In addition, in the 12 months after the closing, Atronic will
also have the potential to receive an earn-out amount based on its 2007
performance above specified thresholds. We currently expect the all-cash
transaction will have a total value of approximately $100 million to $150
million, for our 50% share, including the assumption of debt.
Beginning in 2012, we have the option to purchase Gauselmann's interest in
Atronic and Gauselmann has a reciprocal right to sell its interest to us at a
value determined by independent appraisers. There are also mutual put/call
rights that may become effective before 2012, under certain circumstances. The
exercise price under these circumstances will be calculated through a
performance based formula. This transaction is contingent upon regulatory and
gaming license approvals and other closing conditions, and is expected to be
completed on December 31, 2006.
OPTION TO PURCHASE POLCARD OUTSTANDING EQUITY
In May 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 leading debit and credit card merchant transaction
acquirer and processor in Poland. At February 26, 2005, PolCard's outstanding
equity was owned 62.8% by us, 36.9% by two funds managed by Innova Capital Sp.
z o.o. ("Innova"), a Warsaw-based private equity investment advisor, and 0.3% by
the Polish Bank Association, one of PolCard's previous owners.
We have three fair value options to purchase Innova's interest in PolCard, and
Innova has the reciprocal right to sell its interest in PolCard to us at fair
value. Each fair value option has a duration of 90 days and is to be based on an
appraised value from at least two investment banks at the date of each option
period. We estimate that the buyout prices of each fair value option, based on
discounted cash flows, could be as follows:
Buyout Percentage
of the PolCard Range of
Exercise Date Commencing In Outstanding Equity Buyout Price
- --------------------------- ------------------ ------------------
May 2007 18.5% $29 to $44 million
May 2008 9.2% $16 to $25 million
May 2009 9.2% $18 to $28 million
FINANCIAL RISK MANAGEMENT AND DIVIDEND POLICY
FINANCIAL RISK MANAGEMENT
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 exchange rates. Our exposure to commodity price changes is not
considered material and is managed through our procurement and sales practices.
We use various techniques to manage our market risks, including from time to
time, the use of derivative instruments. We manage our exposure to counterparty
credit risk by entering into financial instruments with major, financially sound
counterparties with high-grade credit ratings and by limiting exposure to any
one counterparty. We do not engage in currency or interest rate speculation.
-33-
INTEREST RATE MARKET RISK
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.
The estimated fair value of our long-term debt and change in the estimated fair
value due to hypothetical changes in interest rates are as follows (dollars in
millions):
Estimated Fair Value
------------------------------------------------------------
At May 28, 10% Increase in 10% Decrease in
2005 Interest Rates Interest Rates
---------------- -------------------- ---------------
$250 million of 4.75% Senior Notes $ 246.2 $ 245.1 $ 247.3
$150 million of 4.50% Senior Notes 147.8 145.8 149.9
$150 million of 5.25% Senior Notes 148.5 144.3 152.9
$171 million of 1.75% Convertible
Debentures 352.0 351.9 352.2
The estimated fair values above were determined by an independent investment
banker. The values of the Senior Notes were determined after taking into
consideration $225 million of interest rate swaps as follows:
Estimated Fair Value
-----------------------------------------
Debt Fair Interest Rate
Value Swaps Outstanding
----------------- -----------------
$250 million of 4.75% Senior Notes $ 246.2 $ 150.0
$150 million of 4.50% Senior Notes 147.8 50.0
$150 million of 5.25% Senior Notes 148.5 25.0
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 swap and treasury rate
lock agreements.
EQUITY PRICE RISK
The estimated fair value of our $171 million of 1.75% Convertible Debentures and
change in the estimated fair value due to hypothetical changes in the market
price of our common stock is as follows (dollars in millions):
Estimated Fair Value
--------------------------------------------------------------
10% Increase in 10% Decrease in
At May 28, Market Price of Market Price of
2005 Common Stock Common Stock
------------------ ----------------- ---------------
$171 million of 1.75% Convertible
Debentures $ 352.0 $ 387.5 $ 320.5
The estimated fair value above was determined by an independent investment
banker and was based on a quoted market price of $2,055.00 per Debenture.
-34-
FOREIGN CURRENCY EXCHANGE RATE RISK
We are subject to foreign exchange exposures arising from current and
anticipated transactions denominated in currencies other than our functional
currency, which is 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 certain firm commitments, variable
service revenues and certain assets and liabilities denominated in foreign
currencies, but we do not engage in foreign currency speculation. These
contracts generally have maturities of 12 months or less and are regularly
renewed to provide continuing coverage throughout the year.
As of May 28, 2005, we had contracts for the sale of approximately $41.8 million
of foreign currency (primarily Euro and Brazilian real) and the purchase of
approximately $49.9 million of foreign currency (primarily New Taiwan dollars,
Brazilian real, Canadian dollars and pounds sterling).
At May 28, 2005, a hypothetical 10% adverse change in foreign exchange rates
would result in a translation loss of $17.8 million that would be recorded in
the equity section of our balance sheet.
At May 28, 2005, a hypothetical 10% adverse change in foreign exchange rates
would result in a net pre-tax transaction loss of $3.7 million that would be
recorded in current earnings after considering the effects of foreign exchange
contracts currently in place.
At May 28, 2005, 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 2006 of $18.5 million, after considering the
effects of foreign exchange contracts currently in place. The percentage of
fiscal 2006 first quarter anticipatory cash flows that were hedged varied
throughout the quarter, but averaged 11%.
DIVIDEND POLICY
We are committed to returning value to our shareholders. Beginning in the second
quarter of fiscal 2004, we commenced paying cash dividends on our common stock
of $0.085 per share, equivalent to a full-year dividend of $0.34 per share. We
currently plan to continue paying dividends in the foreseeable future.
-35-
Item 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
See "Financial Risk Management and Dividend Policy" above.
Item 4. CONTROLS AND PROCEDURES
We carried out an evaluation, under the supervision and with the participation
of our management, including our Chief Executive Officer ("CEO") and our Senior
Vice President and Chief Financial Officer ("CFO"), of the effectiveness of our
disclosure controls and procedures (as defined in Exchange Act Rule 13a-15 (e))
as of the end of the period covered by this report. Based upon that evaluation,
our CEO and CFO concluded that our disclosure controls and procedures were
effective as of the end of the period covered by this report.
PART II. OTHER INFORMATION
Item 1. LEGAL PROCEEDINGS
For information respecting certain legal proceedings, see Item 1, "Certain
Factors That May Affect Future Performance," Item 7, "Management's Discussion
and Analysis of Financial Condition and Results of Operations," and Item 8, Note
14 to Notes to Consolidated Financial Statements of our fiscal 2005 Annual
Report on Form 10-K.
-36-
Item 2. UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS
The following table presents information regarding purchases by GTECH of shares
of its Common Stock, par value $.01 per share (the "Shares") made during the
three months ended May 28, 2005.
(a) (b) (c) (d)
Total Number of Approximate Dollar
Total Shares Purchased Value of Shares
Number Average as Part of Publicly That May Yet Be
of Shares Price Paid Announced Plans Purchased Under the
Period Purchased Per Share or Programs Plans or Programs
- ----------------- --------- ---------- ------------------- -------------------
February 27, 2005
to April 2, 2005
("March 2005") 556,300 $ 23.66 556,300 $ 66,180,769
April 3, 2005 to
April 30, 2005
("April 2005") 392,500 $ 24.54 392,500 $ 56,547,375
May 1, 2005 to
May 28, 2005
("May 2005") 377,300 $ 24.53 377,300 $ 47,291,272
--------- ---------
Total 1,326,100 1,326,100
========= =========
On November 2, 2004, we publicly announced that our Board of Directors
authorized a program for the Company to purchase up to an aggregate of $100
million of our outstanding Common Stock through February 25, 2006, pursuant to
which these shares were purchased.
-37-
Item 5. OTHER INFORMATION
The following information was reportable by us in Current Reports on Form 8-K
during the quarterly period ended May 28, 2005 as events falling under Item 1.01
of Form 8-K ("Entry into a Material Definitive Agreement"), but was not so
reported:
(a) We entered into a Separation Agreement and Release with David J.
Calabro, our former Executive Vice President and Chief Operating
Officer, as of April 15, 2005. This agreement provided: (i) that Mr.
Calabro's employment would terminate effective May 15, 2005 (the
"Termination Date"); (ii) that Mr. Calabro would continue to receive
his base salary as of the Termination Date (i.e., $490,000 per
annum) through May 14, 2007; (iii) for Mr. Calabro to receive a
one-time lump sum payment of $250,000; and (iv) for Mr. Calabro to
receive through May 14, 2007 continued life and health insurance
coverage at levels equal to those existing as of the Termination
Date, subject to continued contribution by Mr. Calabro and
discontinuance and offset in certain circumstances. Our agreement
with Mr. Calabro contains certain other terms and conditions and is
set forth in full as Exhibit 10.2 to the report.
(b) We entered into a separation agreement and release with Barbara A.
Burns, our former Senior Vice President of Human Resources, on April
22, 2005. This agreement provided that Ms. Burns' employment
terminated on April 22, 2005, and that Ms. Burns would receive a
continuation of her base salary at the time of the termination of
employment for thirty-two weeks, or $138,461 in aggregate. Our
agreement with Ms. Burns contains certain other terms and conditions
and is set forth in full as Exhibit 10.3 to this report.
-38-
Item 6. EXHIBITS
The exhibits to this report are as follows:
10.1 Service Agreement, dated May 12, 2005, between Caixa Economica
Federal, and GTECH Brasil Ltda
10.2 Separation Agreement and Release, dated as of April 15, 2005, by and
between Holdings and David J. Calabro
10.3 Separation Agreement and Release, dated April 22, 2005, by and
between Holdings and Barbara A. Burns
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
-39-
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: June 30, 2005 By /s/ Jaymin B. Patel
------------------------------------------------
Jaymin B. Patel, Senior Vice President and Chief
Financial Officer (Principal Financial Officer)
Date: June 30, 2005 By /s/ Robert J. Plourde
------------------------------------------------
Robert J. Plourde, Vice President, Corporate
Controller and Chief Accounting Officer
(Principal Accounting Officer)
-40-