Exhibit 99.1
OnLine Entertainment Systems
Financial Statements for the
Nine Months Ended September 28, 2002
and June 28, 2003
and Independent Auditors' Report
To the Board of Directors of
International Game Technology
Reno, Nevada
We have audited the accompanying combined balance sheet of IGT OnLine Entertainment Systems, Inc. and the systems business of VLC, Inc. (collectively referred to as "OnLine Entertainment Systems") as of September 28, 2002, and the related combined statements of income, equity, and cash flows for the period from December 30, 2001 to September 28, 2002. These financial statements are the responsibility of OnLine Entertainment Systems management. Our responsibility is to express an opinion on these financial statements based on our audit.
We conducted our audit in accordance with auditing standards generally accepted in the United States of America. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audit provides a reasonable basis for our opinion.
In our opinion, such combined financial statements present fairly, in all material respects, the combined financial position of OnLine Entertainment Systems as of September 28, 2002, and the results of its combined operations and its combined cash flows for the period from December 30, 2001 to September 28, 2002 in conformity with accounting principles generally accepted in the United States of America.
October 31, 2003
Reno, Nevada
OnLine Entertainment Systems
Combined Balance Sheets
| | September 28, 2002 | June 28, 2003 | ||||||
|---|---|---|---|---|---|---|---|---|
| | | (unaudited) | ||||||
| | (Amounts in thousands) | |||||||
| Assets | ||||||||
| Current assets | ||||||||
| Cash | $ | 4,697 | $ | 5,470 | ||||
| Accounts receivable, net | 11,129 | 14,837 | ||||||
| Inventory | 569 | 230 | ||||||
| Deferred income taxes | 4,859 | 4,761 | ||||||
| Other assets | 3,391 | 620 | ||||||
| Total current assets | 24,645 | 25,918 | ||||||
Receivable from affiliates | 11,020 | 25,243 | ||||||
Property and equipment, net | 32,096 | 30,042 | ||||||
Intangible assets, net | 26,040 | 21,264 | ||||||
Other assets | 139 | 152 | ||||||
| Total assets | $ | 93,940 | $ | 102,619 | ||||
| Liabilities and Combined Equity | ||||||||
| Current liabilities | ||||||||
| Current portion of long-term capital lease obligations | $ | 5,656 | $ | 3,148 | ||||
| Accounts payable | 1,455 | 1,496 | ||||||
| Accrued employee compensation and benefits | 3,737 | 6,917 | ||||||
| Accrued taxes | 1,300 | 1,724 | ||||||
| Accrued liquidated damages | 2,736 | 1,517 | ||||||
| Other accrued liabilities | 8,914 | 7,951 | ||||||
| Total current liabilities | 23,798 | 22,753 | ||||||
Long-term capital lease obligations, net of current maturities | 2,237 | 10 | ||||||
Deferred income taxes | 14,138 | 18,193 | ||||||
Other long-term liabilities | 27 | 18 | ||||||
| Total liabilities | 40,200 | 40,974 | ||||||
| Commitments and contingencies | ||||||||
Combined equity | ||||||||
| Contributed capital | 47,050 | 47,050 | ||||||
| Retained earnings | 6,690 | 14,595 | ||||||
| Total combined equity | 53,740 | 61,645 | ||||||
| Total liabilities and combined equity | $ | 93,940 | $ | 102,619 | ||||
See notes to combined financial statements.
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OnLine Entertainment Systems
Combined Statements of Income
| | Nine Months Ended | |||||||
|---|---|---|---|---|---|---|---|---|
| | September 28, 2002 | June 28, 2003 | ||||||
| | | (unaudited) | ||||||
| | (Amounts in thousands) | |||||||
| Revenues | $ | 105,510 | $ | 112,106 | ||||
| Costs and expenses | ||||||||
| Cost of revenues (including depreciation expense of $7,274 and $9,884) | 68,197 | 74,577 | ||||||
| Selling, general and administrative | 16,319 | 17,674 | ||||||
| Research and development | 3,410 | 892 | ||||||
| Depreciation and amortization | 5,651 | 5,371 | ||||||
| Total costs and expenses | 93,577 | 98,514 | ||||||
| Income from operations | 11,933 | 13,592 | ||||||
Other expense, net | 783 | 418 | ||||||
| Income before income taxes | 11,150 | 13,174 | ||||||
Provision for income taxes | 4,460 | 5,269 | ||||||
| Net income | $ | 6,690 | $ | 7,905 | ||||
See notes to combined financial statements.
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OnLine Entertainment Systems
Statements of Combined Equity
| | Contributed Capital | Retained Earnings | Total | ||||||
|---|---|---|---|---|---|---|---|---|---|
| | (Amounts in thousands) | ||||||||
| Balances, December 30, 2001 | $ | 47,050 | $ | — | $ | 47,050 | |||
Net income | — | 6,690 | 6,690 | ||||||
| Balances, September 28, 2002 | 47,050 | 6,690 | 53,740 | ||||||
Net income (unaudited) | — | 7,905 | 7,905 | ||||||
| Balances, June 28, 2003 (unaudited) | $ | 47,050 | $ | 14,595 | $ | 61,645 | |||
See notes to combined financial statements.
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OnLine Entertainment Systems
Combined Statements of Cash Flows
| | Nine Months Ended | |||||||||
|---|---|---|---|---|---|---|---|---|---|---|
| | September 28, 2002 | June 28, 2003 | ||||||||
| | | (unaudited) | ||||||||
| | (Amounts in thousands) | |||||||||
| Cash flows from operating activities | ||||||||||
| Net income | $ | 6,690 | $ | 7,905 | ||||||
| Adjustments to reconcile net income to net cash provided by operating activities: | ||||||||||
| Depreciation and amortization | 12,925 | 15,255 | ||||||||
| Gain on disposal of assets | — | (11 | ) | |||||||
| Provision for bad debts | 6 | — | ||||||||
| Provision for inventory obsolescence | 231 | 104 | ||||||||
| (Increase) decrease in operating assets: | ||||||||||
| Accounts receivable | 1,479 | (3,708 | ) | |||||||
| Inventory | (218 | ) | 235 | |||||||
| Other assets | (1,838 | ) | 2,606 | |||||||
| Net accrued and deferred income taxes | 3,944 | 4,648 | ||||||||
| Increase in accounts payable and accrued liabilities | 1,220 | 959 | ||||||||
| Net cash provided by operating activities | 24,439 | 27,993 | ||||||||
| Cash flows from investing activities | ||||||||||
| Investment in property and equipment | (2,156 | ) | (8,263 | ) | ||||||
| Net cash used in investing activities | (2,156 | ) | (8,263 | ) | ||||||
| Cash flows from financing activities | ||||||||||
| Principal payments on long-term capital lease obligations | (5,025 | ) | (4,734 | ) | ||||||
| Receivable from affiliates | (13,997 | ) | (14,223 | ) | ||||||
| Net cash used in financing activities | (19,022 | ) | (18,957 | ) | ||||||
| Net increase in cash | 3,261 | 773 | ||||||||
Cash at beginning of period | 1,436 | 4,697 | ||||||||
| Cash at end of period | $ | 4,697 | $ | 5,470 | ||||||
| Supplemental Cash Flow Information | ||||||||||
| Interest paid | $ | 648 | $ | 310 | ||||||
See notes to combined financial statements.
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OnLine Entertainment Systems
Notes to Combined Financial Statements
for the Nine Months Ended September 28, 2002 and June 28, 2003 (unaudited)
1. BASIS OF PRESENTATION AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
The accompanying financial statements include the combined assets and liabilities and the related operations of IGT OnLine Entertainment Systems, Inc. and the systems business of VLC, Inc., collectively referred to as OnLine Entertainment Systems (OES), which are wholly-owned subsidiaries of International Game Technology (Parent). The Parent acquired OES in connection with the acquisition of Anchor Gaming (Anchor) on December 30, 2001 (see Note 2).
The period ended September 28, 2002 represents the results of operations for OES for the nine months from the acquisition date to the end of the Parents' fiscal year. Our combined financial statements for the nine months ended June 28, 2003 are unaudited and include all adjustments necessary to fairly present our combined results of operations, financial position and cash flows for the period, on a basis consistent with the audited financial statements. Results are not necessarily indicative of results for the full year.
The Parent incurs certain expenses on behalf of OES, which have been allocated for purposes of these financial statements (see Note 8).
OES provides online lottery system solutions to various domestic and international lotteries in North America, Europe, Asia and South Australia.
Cash—Cash consists primarily of cash on deposit at various financial institutions.
Fair Value of Financial Instruments—The carrying values of OES's accounts receivable and accounts payable approximate fair value primarily because of the short maturities of these instruments. The estimated fair values of the capital lease obligations closely approximated the carrying values at September 28, 2002 and June 28, 2003.
Receivables and Allowance for Doubtful Accounts—We maintain an allowance for doubtful accounts on our accounts receivable that we have deemed to have a high risk of collectibility. We analyze historical collection trends, customer concentrations, customer creditworthiness, current economic trends and changes in our customer payment terms when evaluating the adequacy of our allowance for doubtful accounts.
Inventories and Obsolescence—Inventories are stated at the lower of cost (first-in, first-out method) or market value. We regularly review inventory quantities on hand and record provisions for excess and obsolete inventory based primarily on our estimated forecast of product demand and production requirements.
Concentrations of Credit Risk—The financial instruments that potentially subject OES to concentrations of credit risk consist principally of accounts receivable. Accounts receivable from Pennsylvania, Florida and Indiana represent 40%, 10% and 11% of total accounts receivable, as of September 28, 2002. Accounts receivable from state lotteries in Pennsylvania and Florida and the Quebec lottery in Canada represent 35%, 13% and 20% of total accounts receivable, as of June 28, 2003. We maintain cash balances in amounts, which at times, may be in excess of the Federal Deposit Insurance Corporation insurance limits.
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Property and Equipment—Assets acquired in business combinations are accounted for using the purchase method of accounting and are recorded at their estimated fair value at the acquisition date. Property and equipment additions are recorded at cost. Assets that have been placed in service are depreciated on a straight-line basis over their estimated useful lives. Depreciation expense related to assets at lottery locations is recorded as cost of revenues. Costs that materially increase the life or value of existing assets are capitalized. Ordinary maintenance and repairs are charged to expense as incurred.
Long-Lived Assets—In accordance with the provisions of Statement of Financial Accounting Standards (SFAS) 144,Accounting for the Impairment and Disposal of Long-Lived Assets, we evaluate the potential impairment of long-lived assets when events or changes in circumstances indicate that the carrying amount of a long-lived asset may not be recoverable based upon the relevant facts and circumstances. If the facts indicate the fair value is less than the carrying value of the asset, we will recognize an impairment loss for the difference between the carrying value of the asset and its fair value.
Intangible Assets—Intangible assets are comprised of online lottery and maintenance contracts, business and product trademarks, and developed technology. Amortization of finite lived intangible assets is recorded to reflect the pattern of economic benefit based on projected revenues over their estimated useful lives.
Revenue Recognition—We recognize revenue when persuasive evidence of an arrangement exists, the price to the buyer is fixed or determinable, collectibility is reasonably assured and delivery has occurred. Revenue from the sales of online lottery and video gaming central site systems is recognized using the percentage of completion method of accounting for long-term construction type contracts. If estimates of total costs indicate a loss on the contract, the entire amount of the estimated loss would be charged to operations immediately. Revenue related to systems contract services is recognized as the services are performed. These long-term service contracts require operation of lottery systems and related revenue is based on a percentage of sales volume. System maintenance revenue is recognized ratably over the period.
Stock-Based Compensation—We adopted SFAS 123,Accounting for Stock-Based Compensation, which establishes a fair value based method of accounting for stock compensation plans with employees and others. As permitted by SFAS 123, we continue to account for stock-based compensation plans in accordance with the Accounting Principles Board (APB) Opinion 25 intrinsic value method, which determines the compensation cost of stock options issued for non-variable plans such as ours as the difference between the quoted market value at the measurement date and the amount, if any, required to be paid by employees. Our stock-based compensation plans are predominantly non-compensatory plans where the option price is equal to or greater than the trading price of our stock on the date of the option grant and therefore, no compensation cost is recorded. See Note 10 for pro forma stock-based compensation costs that would have been charged to operations had the SFAS 123 fair value method been applied.
Income Taxes—Income taxes are allocated to OES on a stand-alone basis using effective tax rates as if on a separate return basis. Deferred income taxes result from temporary differences between financial and tax reporting.
Estimates and Assumptions—The preparation of financial statements in conformity with accounting principles generally accepted in the United States of America requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent
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assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the period. Actual results could differ from those estimates.
Recently Issued Accounting Standards—In June 2002, the FASB issued SFAS 146,Accounting for Costs Associated with Exit or Disposal Activities. SFAS 146 addresses financial accounting and reporting for costs associated with exit or disposal activities and nullifies Emerging Issues Task Force Issue No. 94-3,Liability Recognition for Certain Employee Termination Benefits and Other Costs to Exit an Activity (including Certain Costs Incurred in a Restructuring). SFAS 146 requires that a liability for a cost associated with an exit or disposal activity be recognized when the liability is incurred. The provisions of this statement are effective for exit or disposal activities that are initiated after December 31, 2002, with early adoption encouraged. The adoption of these requirements did not have a material impact on the results of operations or financial position.
In November 2002, the FASB issued FASB Interpretation (FIN) 45,Guarantor's Accounting and Disclosure Requirements for Guarantees, Including Indirect Guarantees of Indebtedness of Others. FIN 45 expands the disclosures required by guarantors for obligations under certain types of guarantees. It also requires initial recognition at fair value of a liability for such guarantees. We adopted the disclosure requirements of FIN 45 for the quarter ended December 28, 2002 and the liability recognition requirements to all guarantees issued or modified after December 31, 2002. The adoption of these requirements did not have a material impact on our results of operations or financial position.
In December 2002, the FASB issued SFAS 148,Accounting for Stock-Based Compensation-Transition and Disclosure. This Statement amends SFAS 123, Accounting for Stock-Based Compensation, to provide alternative methods of transition for a voluntary change to the fair value based method of accounting for stock-based employee compensation. In addition, this Statement amends the disclosure requirements of Statement 123 to require prominent disclosures in both annual and interim financial statements about the method of accounting for stock-based employee compensation and the effect of the method used on reported results. We have adopted the disclosure requirements of this statement. See Note 10.
2. ACQUISITION BY THE PARENT
On December 30, 2001, the Parent acquired OES in connection with the acquisition of Anchor. The acquisition of Anchor was an opportunity to use our complementary resources to develop new games more effectively for the benefit of our customers. Upon acquisition, Anchor became a wholly-owned subsidiary of the Parent in a stock-for-stock exchange. This acquisition was accounted for as a purchase for financial accounting and reporting purposes in accordance with SFAS 141,Business Combinations. With the assistance of valuation consultants, the purchase price was allocated to assets and liabilities based upon estimates of the fair values of the assets acquired and liabilities assumed, including identifiable intangible assets. The Parent applied push down accounting for the period subsequent to December 30, 2001.
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The accompanying financial statements reflect the allocation of the purchase price to the assets acquired and liabilities assumed of OES, as follows (in thousands):
| Current assets | $ | 19,121 | ||
| Property and equipment | 37,903 | |||
| Intangible assets | 31,402 | |||
| Other assets | 585 | |||
| Deferred income taxes | (8,784 | ) | ||
| Liabilities assumed | (33,177 | ) | ||
| Initial capitalization | $ | 47,050 | ||
3. ACCOUNTS RECEIVABLE
Accounts receivable consisted primarily of amounts due from online lottery contracts in 12 jurisdictions. Accounts receivable consisted of the following:
| | September 2002 | June 2003 | |||||
|---|---|---|---|---|---|---|---|
| | | (unaudited) | |||||
| | (Amounts in thousands) | ||||||
| Accounts receivable | $ | 11,135 | $ | 14,843 | |||
| Less allowance for doubtful accounts | (6 | ) | (6 | ) | |||
| Accounts receivable, net | $ | 11,129 | $ | 14,837 | |||
4. INVENTORY
Inventory consisted of the following:
| | September 2002 | June 2003 | |||||
|---|---|---|---|---|---|---|---|
| | | (unaudited) | |||||
| | (Amounts in thousands) | ||||||
| Consumables | $ | 1,377 | $ | 1,151 | |||
| Parts | 2,760 | 2,751 | |||||
| 4,137 | 3,902 | ||||||
| Less reserve for obsolescence | (3,568 | ) | (3,672 | ) | |||
| Inventory | $ | 569 | $ | 230 | |||
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5. PROPERTY AND EQUIPMENT
Property and equipment consisted of the following:
| | Estimated Life in Years | September 2002 | June 2003 | ||||||
|---|---|---|---|---|---|---|---|---|---|
| | | | (unaudited) | ||||||
| | | (Amounts in thousands) | |||||||
| Lottery equipment | 7 | $ | 25,698 | $ | 30,459 | ||||
| Furniture, fixtures and equipment | 3-7 | 11,998 | 12,679 | ||||||
| Leasehold improvements | 7 | 2,364 | 2,945 | ||||||
| 40,060 | 46,083 | ||||||||
| Less accumulated depreciation | (7,964 | ) | (16,041 | ) | |||||
| Property and equipment, net | $ | 32,096 | $ | 30,042 | |||||
Total depreciation expense, including amounts recorded as cost of revenues, for the nine months ended September 28, 2002 and June 28, 2003 was $8.0 million and $10.5 million.
6. INTANGIBLE ASSETS
As a result of the acquisition (see Note 2), our intangible assets were recorded at fair value and became immediately subject to SFAS 142,Goodwill and Other Intangible Assets, which established new accounting and reporting requirements for goodwill and other intangible assets.
Intangible assets consisted of the following:
| | | September 2002 | June 2003 | ||||||||||||||||||
|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
| | Estimated Life In Years | Carrying Amount | Accumulated Amortization | Net | Carrying Amount | Accumulated Amortization | Net | ||||||||||||||
| | | | | | | (unaudited) | | ||||||||||||||
| | | (Amounts in thousands) | |||||||||||||||||||
| Finite Lived Intangible Assets | |||||||||||||||||||||
| Contracts | 9 | $ | 23,460 | $ | 3,994 | $ | 19,466 | $ | 23,460 | $ | 7,627 | $ | 15,833 | ||||||||
| Developed technology | 12 | 4,817 | 586 | 4,231 | 4,817 | 1,227 | 3,590 | ||||||||||||||
| Product trademarks | 5-9 | 468 | 19 | 449 | 468 | 300 | 168 | ||||||||||||||
| Business trademarks | 9-12 | 2,257 | 363 | 1,894 | 2,257 | 584 | 1,673 | ||||||||||||||
| Net carrying amount | $ | 31,002 | $ | 4,962 | $ | 26,040 | $ | 31,002 | $ | 9,738 | $ | 21,264 | |||||||||
F-10
Total amortization expense for the nine month periods ended September 28, 2002 and June 28, 2003 was $4.9 million and $4.7 million. Estimated remaining amortization expense for fiscal 2003 and for each of the four succeeding fiscal years is as follows:
| Fiscal Year | Amount | ||
|---|---|---|---|
| | (Amounts in thousands) | ||
| 2003 | $ | 1,692 | |
| 2004 | 6,322 | ||
| 2005 | 5,556 | ||
| 2006 | 2,718 | ||
| 2007 | 1,511 | ||
7. REVENUES DERIVED FROM MAJOR LOCATIONS
Our operations for the Florida State Lottery and the Pennsylvania State Lottery accounted for $26.8 million and $31.6 million of revenues for the nine months ended September 28, 2002 and $27.3 million and $33.9 million of revenues for the nine months ended June 28, 2003. No other customer contributed more than 10% of total revenues.
8. RELATED PARTY TRANSACTIONS
Receivable from Affiliates—This balance is made up primarily of the net cash transfers to the Parent.
Intercompany Allocations—Certain costs charged to OES by the Parent were provided through intercompany allocations and included general and administrative costs such as corporate overhead, information systems support, human resources, finance and accounting. These costs, which were allocated primarily on revenues and assets, were included in the accompanying statement of income as selling, general and administrative in the amount of $2.5 million for both nine month periods ended September 28, 2002 and June 28, 2003. Management believes the allocation method used reflected a reasonable estimate of services provided and benefits received. It is not practical to estimate the cost that would have been incurred if we had operated as a stand-alone company.
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9. INCOME TAXES
Components of our provision for income taxes were as follows:
| | September 2002 | June 2003 | ||||||
|---|---|---|---|---|---|---|---|---|
| | | (unaudited) | ||||||
| | (Amounts in thousands) | |||||||
| Current | ||||||||
| Federal | $ | 465 | $ | 899 | ||||
| State | 67 | 129 | ||||||
| Total current | 532 | 1,028 | ||||||
| Deferred | ||||||||
| Federal | 3,437 | 3,712 | ||||||
| State | 491 | 529 | ||||||
| Total deferred | 3,928 | 4,241 | ||||||
| Provision for income taxes | $ | 4,460 | $ | 5,269 | ||||
The combined state and US federal income tax rate of 40.0% represents the estimated rate as if OES filed separate returns.
SFAS 109,Accounting for Income Taxes, requires the recognition of deferred tax assets and liabilities for the expected future tax consequences of events that have been included in the financial statements or income tax returns. Deferred income taxes on the balance sheet reflects the net tax effects of temporary differences between the carrying amounts of assets and liabilities for financial reporting purposes and the amounts used for income tax purposes.
Significant components of our deferred tax assets and liabilities were as follows:
| | September 2002 | June 2003 | |||||||
|---|---|---|---|---|---|---|---|---|---|
| | | (unaudited) | |||||||
| | (Amounts in thousands) | ||||||||
| Current | |||||||||
| Deferred tax assets—accrued reserves and allowances | $ | 4,859 | $ | 4,761 | |||||
| Long term | |||||||||
| Deferred tax liability | |||||||||
| Difference between book and tax basis of property | (14,138 | ) | (18,193 | ) | |||||
| Net deferred tax liability | $ | (9,279 | ) | $ | (13,432 | ) | |||
F-12
Employee Incentive Plans
From December 30, 2001 to March 31, 2002, we participated in a defined contribution benefit plan, 401(k) plan, administered by Anchor. Our matching contributions to this 401(k) plan were based on a percentage of the employees' contributions to the 401(k) plan.
Effective April 1, 2002, our employees participated in a profit sharing and 401(k) plan sponsored by the Parent. The Parent 401(k) plan matches 100% of an employee's contributions up to $750. This allows for maximum annual matching contributions of $750 to each employee's account. Our contributions to the plans are expensed as incurred.
We contributed approximately $1.4 million to these plans for both nine months ended September 28, 2002 and June 28, 2003. The Parent has the right under the Parent 401(k) plan to discontinue matching contributions at any time and to terminate the Parent 401(k) plan subject to the provisions of ERISA.
Employee Stock Purchase Plan
Our employees who have completed 90 days of service are eligible to participate in the Parent's Qualified Employee Stock Purchase Plan (Plan). Under this Plan, each eligible employee may purchase common stock of the Parent at 85% of the lower of the closing price of the Parent's common stock on the first or last day of the 12 month purchase period. Employees may participate in this plan through payroll deductions up to a maximum of 10% of their base pay.
Stock Options
At the date of the acquisition, all outstanding stock options under Anchor's stock option plans were converted into options for IGT's common stock at the same terms and conditions as originally granted. No options for additional shares were granted under the Anchor plan subsequent to the acquisition.
Certain eligible employees may be granted non-qualified and incentive options to purchase shares of common stock under the Parent's Stock Incentive Plan (SIP).
The following table summarizes the activity of the employees' participation in the SIP:
| | Number of Option Shares Outstanding | Weighted Average Exercise Price | ||||
|---|---|---|---|---|---|---|
| Outstanding at December 30, 2001 | 1,033,200 | $ | 11.75 | |||
| Granted | 40,000 | 15.06 | ||||
| Forfeited | — | — | ||||
| Exercised | (369,600 | ) | 9.79 | |||
| Outstanding at September 28, 2002 | 703,600 | 13.22 | ||||
| Granted (unaudited) | 194,000 | 18.98 | ||||
| Forfeited (unaudited) | (14,000 | ) | 15.33 | |||
| Exercised (unaudited) | (176,800 | ) | 11.31 | |||
| Outstanding at June 28, 2003 (unaudited) | 706,800 | 15.14 | ||||
At June 28, 2003, exercise prices for outstanding options ranged from $6.19 to $17.50 with a weighted average remaining life of 7.3 years.
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At September 28, 2002 and June 28, 2003, a total of 46,000 and 38,800 options were exercisable at a weighted-average exercise price of $6.19 and $8.02.
Pro Forma Stock-Based Compensation Expense
The stock option plan is accounted for under the intrinsic value recognition and measurement principles of Accounting Principles Board Opinion (APB) 25,Accounting for Stock Issued to Employees. As the exercise price of all options granted under these plans was equal to or greater than the market price of the common stock on the grant date, no stock-based employee compensation cost is recognized in net income. The following pro forma financial information reflects the difference between compensation cost charged to operations pursuant to APB 25 and compensation cost that would have been charged to operations if we had applied the fair value recognition provisions of SFAS 123,Accounting for Stock-Based Compensation.
| | September 2002 | June 2003 | ||||||
|---|---|---|---|---|---|---|---|---|
| | | (unaudited) | ||||||
| | (Amounts in thousands, except assumptions) | |||||||
| Reported net income | $ | 6,690 | $ | 7,905 | ||||
| Pro forma stock compensation, net of tax | (435 | ) | (483 | ) | ||||
| Pro forma net income | $ | 6,255 | $ | 7,422 | ||||
| Weighted average fair value of options granted during period | 5.05 | 5.69 | ||||||
| Weighted average assumptions: | ||||||||
| Interest rates | 2.98 | % | 1.41 | % | ||||
| Dividend yield | — | 1.18 | ||||||
| Volatility factor of the expected market price of common stock | 0.42 | 0.32 | ||||||
| Weighted average expected life | 3.54 | 3.18 | ||||||
11. COMMITMENTS AND CONTINGENCIES
Lease—We lease certain of our facilities and equipment under various agreements for periods through the year 2009. The following table shows future minimum payments required under these leases that have initial or remaining non-cancelable lease terms in excess of one year as of September 28, 2002. Certain of the facility leases provide that we pay utilities, maintenance, property taxes, and certain other operating expenses applicable to the leased property, including liability and property damage insurance. The cost and accumulated depreciation of equipment under capital leases
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totaled $11.3 million and $2.9 million as of September 28, 2002 and $11.3 million and $5.0 million at June 28, 2003.
| Fiscal Year | Operating Leases | Capital Leases | Total | ||||||
|---|---|---|---|---|---|---|---|---|---|
| | (Amounts in thousands) | ||||||||
| 2003 | $ | 2,150 | $ | 5,995 | $ | 8,145 | |||
| 2004 | 1,959 | 2,248 | 4,207 | ||||||
| 2005 | 1,435 | — | 1,435 | ||||||
| 2006 | 1,059 | — | 1,059 | ||||||
| 2007 | 431 | — | 431 | ||||||
| Thereafter | 414 | — | 414 | ||||||
| Total minimum payments | $ | 7,448 | 8,243 | $ | 15,691 | ||||
| Less amount representing interest | (350 | ) | |||||||
| Capital lease obligations | 7,893 | ||||||||
| Less current portion | (5,656 | ) | |||||||
| Long-term capital lease obligations | $ | 2,237 | |||||||
Our total rental expense was approximately $2.7 million and $2.6 for the nine month periods ended September 28, 2002 and June 28, 2003.
Off-Balance Sheet Financial Instruments—In the normal course of business, we are party to financial instruments with off-balance sheet risks such as performance bonds. We have performance bonds outstanding of $75.0 million and $50.0 million at September 28, 2002 and June 28, 2003 related to our lottery systems. We are liable to reimburse the bond issuer in the event the bond is exercised as a result of our non-performance. We accrue the estimated fair value of liquidated damages.
Liquidated Damages—Our online lottery contracts typically permit termination of the contract by the lottery authority at any time for material breach or for other specified reasons and generally contain demanding implementation and performance schedules. Failure to perform under such contracts may result in substantial monetary damages. Some of our US lottery contracts contain provisions for significant liquidated damages related to various incidents such as implementation delays, system downtime, supply downtime, supply shortages, or degraded systems performance. Many of our lottery contracts also permit the lottery authority to terminate the contract upon notice "for convenience" or upon a State's cessation, in whole or in part, of lottery operations and do not specify the compensation, if any, to which we would be entitled should such termination occur. Some of our international customers similarly reserve the right to assess monetary damages in the event of contract termination or breach. Although such liquidated damages provisions are customary in the lottery industry and the actual liquidated damages imposed are sometimes subject to negotiation, such provisions in our lottery contracts present an ongoing potential for additional expense.
Lottery Regulations—We operate each of our lottery systems under the legislative authority of each respective state.
Litigation—We have been named in and have brought lawsuits in the normal course of business. We do not expect the outcome of these suits to have a material adverse effect on our financial position, cash flows or results of future operations.
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12. SUBSEQUENT EVENTS
In January 2003, all assets and liabilities of the systems business of VLC, Inc., were transferred to IGT OnLine Entertainments Systems, Inc.
In September 2003 the Parent entered into a definitive agreement to sell 100% of the stock of IGT OnLine Entertainment Systems, Inc. for approximately $143.0 million.
In connection with the consummation of the sale, OES will reclassify the long-term receivable from the Parent to the equity section in the balance sheet as a capital distribution.
13. SELECTED FINANCIAL DATA (UNAUDITED)
| | Quarters Ended | |||||||||||||||||
|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
| | March 2002 | June 2002 | September 2002 | December 2002 | March 2003 | June 2003 | ||||||||||||
| | (amounts in thousands) | |||||||||||||||||
| Total Revenues | $ | 35,787 | $ | 33,874 | $ | 35,849 | $ | 37,796 | $ | 38,561 | $ | 35,749 | ||||||
| Gross profit | 11,071 | 12,467 | 13,775 | 12,341 | 12,578 | 12,610 | ||||||||||||
| Income from operations | 2,701 | 2,523 | 6,709 | 4,417 | 4,307 | 4,868 | ||||||||||||
| Net income | 1,446 | 1,334 | 3,910 | 2,541 | 2,498 | 2,866 | ||||||||||||
* * * * * *
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