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EXHIBIT 13
1997 ANNUAL REPORT
[GRAPHIC]
[ILTS(R) LOGO]
INTERNATIONAL LOTTERY & TOTALIZATOR SYSTEMS, INC.
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MISSION STATEMENT
International Lottery & Totalizator Systems provides computerized wagering
equipment and systems to racing organizations and lotteries worldwide.
We are committed to providing innovative gaming solutions through quality
products and service to maximize the revenue of our customers and bring a fair
return to our shareholders.
ILTS is an ISO 9001 registered company.
[PHOTO]
COMPANY PROFILE
In 1994, International Totalizator Systems, changed its name to
International Lottery & Totalizator Systems (ILTS) to more accurately reflect
the primary business activities of the Company.
As supplier to more than 200 race tracks worldwide, ILTS has long been
recognized as an industry leader in pari-mutuel wagering. In recent years ILTS
has become a major supplier to state lotteries, and in the last decade has grown
to serve customers in 18 countries, providing advanced on-line wagering systems
and facilities management.
BACKGROUND & EXPERIENCE
International Totalizator Systems was incorporated in California in 1978
and began operations in 1979. ITS became a public company in 1981, with its
stock traded on the NASDAQ System (symbol: ITSI). In 1993 Berjaya Lottery
Management became a major shareholder of ILTS, providing substantial resources
for continued growth and expansion.
ILTS management, engineering staff, customer support groups and wagering
specialists represent a unique blend of experience in mechanical design,
software and applied systems technology. The Company's technical expertise in
partnership with its customers and suppliers has resulted in innovative
solutions that have put ILTS systems at the leading edge of automated wagering
technology.
RESEARCH & DEVELOPMENT
ILTS is committed to maintaining technological leadership through continued
research and development to provide innovative features and enhancements to the
entire product line. Over the past five years the Company has invested heavily
in research and development, and will continue to devote a significant portion
of revenues to explore new bet-processing technologies, software and data
management systems to maintain a competitive level of excellence.
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QUALITY ASSURANCE
At ILTS the quality goal is to provide the best products and service
possible, by not only meeting customer requirements, but by exceeding customer
expectations. To achieve this ILTS has established a formal quality assurance
program that includes product design and development, and all manufacturing and
assembly operations, in compliance with ISO 9000 guidelines.
ILTS received a certificate of compliance to ISO 9001 in February of 1996.
The audit demonstrated ongoing conformance to ISO 9001 and continuous
improvement in the ILTS quality program. Registration to ISO 9001 puts ILTS in
an elite group of companies worldwide who have met the most stringent
requirements of the International Organization for Standardization.
At ILTS, quality is more than inspection guidelines and standards. Quality
is an integral part of the Company's management and work philosophy.
MANAGEMENT ORGANIZATION
The collective knowledge and experience of ILTS' people is the Company's
most important asset and the cornerstone of an effective work environment. ILTS
has an experienced management team, well trained staff and established
management systems, procedures and controls. The effectiveness of the ILTS
management approach has been demonstrated in the successful installation of
numerous automated wagering systems since 1981. The Company has designed and
installed a variety of wagering systems within budget and on schedule.
Subcontractor, vendor management and after sales support are also
well-established disciplines within the organization.
MARKET-DRIVEN
ILTS delivers more than advanced technology and innovative solutions. As a
company and as individuals, ILTS is committed to customer satisfaction. By
combining technical expertise with dedicated service, the Company endeavors to
do it right, on time, the first time, every time!
Extensive experience combined with the efforts of a talented and dedicated
staff have helped ILTS become one of the most respected names in
state-of-the-art computerized wagering systems.
STRATEGIES & OBJECTIVES
CONDUCT our business in an ethical and forthright manner and to be a responsible
member of our community.
REALIZE increased value to our shareholders through revenue growth and
consistent profitability.
ESTABLISH an industry benchmark for leadership in customer service and quality.
DEFINE primary market segments within the lottery and pari-mutuel wagering
industries.
DEVELOP quality products and solutions to meet the current and future needs of
customers in our primary markets.
ACHIEVE operational excellence and quality management throughout the Company to
maximize the effect of product development and reduce costs through improved
planning and control.
INITIATE strategic alliances with companies whose technology and products
complement and expand our product offering.
PROVIDE an environment for employees that encourages teamwork and creativity to
maximize job satisfaction, personal development and career growth opportunities.
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YEAR IN REVIEW
Over the past year, management has aggressively initiated steps to
transform the Company from an engineering-driven organization to a market-driven
organization. An integral part of this transformation has been to ensure that we
have the requisite products to serve our target markets. This convergence of
product development with market opportunity has resulted in the launch of
several new products that have helped position ILTS to strongly compete for
business in our targeted markets.
PRODUCTS & MARKETS
ILTS provides on-line lottery products to the worldwide market. To meet the
requirements of lottery customers in search of total system solutions, the
Company developed the DataTrak(TM) on-line gaming system, a client/server
distributed processing system built around an open architecture. The system
incorporates a proven high-performance bet engine, and can be scaled to meet
specific customer
[PHOTO]
[DATATRAK INSTANT LOGO]
TO OUR SHAREHOLDERS
[PHOTO]
Nineteen ninety-seven was a productive year for ILTS. We improved our
performance in many facets of our business, and laid the foundation for future
improvements in others. We made several fundamental changes that have already
borne fruit, and which will position the Company for future growth and sustained
profitability.
From its inception, ILTS has been an engineering-driven company. Emphasis
was on product innovation and development, and justifiably so, as the Company
won much of its early business based on precisely these factors.
As we move toward a new century, market dynamics demand more than technical
competence. We must become a market-driven organization, and we have taken
aggressive steps to effect this transformation.
In the short time since the management change last summer, we have
implemented a broad range of strategic initiatives. We carefully and critically
analyzed the way ILTS historically has done business, retained that which has
produced positive results, and changed those areas where there was room for
improvement.
First and foremost, we sharpened the Company's focus to concentrate on the
industry in which we historically have been most successful -- gaming. And
within the broader gaming market, we have identified three distinct target
markets: [i] long-standing customers, [ii] new customers in established markets,
and [iii] new customers in emerging markets.
Most importantly, we have strategically developed products to competitively
address the unique requirements of each market segment.
To pursue business in these target markets, we redeployed our sales force
to form task-oriented teams, and retained experienced consultants to augment our
internal capabilities. And we are concentrating on those opportunities where we
can create a specific competitive advantage.
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We have also formed strategic alliances with world-class partners to
strengthen our product offerings.
Recognizing that the cornerstone of any growth strategy is retention of
existing business, virtually my first official action was to visit all of our
long-standing customers to ascertain how we can strengthen and improve our
relationship with them. I am pleased to report that several new product
contracts were obtained with such long-standing customers as ATG of Sweden,
South Australia TAB and Leisure Management of Malaysia. We have also paved the
way for future business by introducing the DATAMARK NXT, a technology upgrade
which cost-effectively extends the serviceability of customers' existing
terminals.
In the area of new business, we are pleased to add the Singapore Turf Club
and Olympic Gold Holdings to our growing customer list. As of this writing, we
have several bids pending for new business from both our long-standing customers
and new prospects as well.
In terms of product offerings, we completed development of DataTrak, our
leading-edge lottery software product for lotteries in developed markets. For
emerging markets, in conjunction with a strategic partner, we have developed a
unique terminal which can expand sales into areas where marginal electrical
power or telecommunications service would preclude traditional on-line systems.
On the totalizator side of the business, through another strategic
alliance, we now can offer racing prospects a scalable, field-proven software
system known as InterTote.
We will always be subject to the vagaries of contract timing, and 1997 was
no exception. Several excellent opportunities were pushed forward into 1998.
However, our task is to ensure that ILTS is well-positioned to win new business
whenever the opportunities arise. We believe we have done precisely that.
In evaluating our performance, we acknowledge that there is still much to
be done. Financially, we must further improve our performance and achieve
consistent profitability. To that end, we must continue to succeed in our
traditional market, while we hone our product offerings and sales strategies to
be even more competitive in new markets.
As we continue to implement these new strategies and tactics, I am
confident that we will complete ILTS' transformation into a more vibrant,
stronger, and consistently profitable Company for years to come.
/s/M. Mark Michalko
M. Mark Michalko
President / Director
YEAR IN REVIEW (CONTINUED)
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[PHOTO]
requirements, large or small. The first release of this system was in October of
1996.
In 1997 two new DataTrak modules were developed: DataTrak Instant and
Player Registration, demonstrating the flexibility and upward compatible path of
the system.
DataTrak Instant is a fully integrated, on-line instant ticket validation
and management system that provides real-time validation of instant lottery
tickets together with a host of accounting, distribution and inventory control
functions. It is designed to operate seamlessly with the ILTS DataTrak gaming
system and shares the same client/server architecture and security features.
The Player Registration application allows players to be registered with a
lottery and to maintain a betting account. The application is used to create and
update a player's account, request payment of a player's winnings, display a
history of player's winnings and activities, and a host of other data.
DataTrak is a dynamic system and it will continue to expand to meet the
future needs of lotteries.
Two new terminal products have been tailored for the targeted lottery
markets. The DATAMARK XClaim was introduced in 1996 to meet the general
requirements of lotteries and facilities management contracts. The XClaim is
robust, affordable and provides all features and functions required for lottery
operations.
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Year in Review (Continued)
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[PHOTO]
In late 1997 ILTS introduced the DATAMARK NXT, the next generation of the
DATAMARK Flipper. This terminal provides a number of high-end features for
technically sophisticated lotteries that typically purchase and operate their
own systems.
The DATAMARK NXT also provides an upgrade path for earlier DATAMARK
terminals. This new option allows ILTS customers to integrate their existing
reader/printer mechanisms with new PC electronics, a higher resolution printhead
and an attractive, ergonomic enclosure. Benefits include expanded memory, use of
high-level programming language, improved speed, better print quality, and
continuity in appearance of bet slips and tickets.
In addition to providing lottery systems, ILTS remains a leading provider
of computerized on-line wagering systems to the racing industry. In 1996, the
Company introduced the ILTS InterTote System, an open systems totalizator with
broad application. The system encompasses both on-track and off-track betting,
and can provide multi-track operation. It handles numerous wagering options
including standard bet types and special features, which can easily be adapted
to local rules and regulations. InterTote is designed to run on the UNIX
operating system, which permits the use of virtually any hardware platform
including IBM, Digital and Intel-based PCs. It is extremely flexible, with
well-defined technology upgrade paths.
[PHOTO]
STRATEGIC ALLIANCES
Management's critical analysis has determined that in the development of
new products for the Company's target markets, in certain cases it is more
efficient to form strategic alliances with synergistic partners than to develop
and manufacture internally. Such relationships bring higher expertise, lower
costs and expedite delivery to market.
To strengthen the ILTS product offering, the Company has formed strategic
alliances with several world-class organizations, including:
[PHOTO]
Racecourse Totalizators, a leading designer and operator of scalable
pari-mutuel wagering systems. ILTS has licensed this software system, and is
marketing it worldwide under the name ILTS InterTote as a feature-rich,
cost-effective wagering system for race tracks.
Symbol Technologies, a world leader in bar-code technology, spread spectrum
radio technology and battery-powered hand-held computers. ILTS is partnering
with Symbol to develop 1D and 2D bar-code reading solutions for instant ticket
validation and player registration products. Symbol is also providing radio
equipment for our wireless terminal product.
ICL/Natech South Africa, a leader in the computer service sector and point
of sale industry. ICL/Natech is working with ILTS to provide installation and
maintenance repair service for certain customers and prospects. The companies
have also jointly developed a portable hand-held off-line betting terminal, the
DATAMARK Passport, for use in emerging markets where power and
telecommunications are problematic.
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SELECTED FINANCIAL DATA
YEARS ENDED DECEMBER 31, 1997 1996 1995 1994 1993
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Thousands of dollars except per
share amounts and non-monetary items
Statement of operations data
Revenue $ 10,826 $ 16,594 $ 18,641 $ 24,089 $25,017
Gross profit(1) 1,179 3,441 1,185 4,527 9,038
Operating income (loss) (6,700) (6,894) (14,221) (22,943) 302
Net income (loss) (5,938) (5,498) (13,869) (22,620) 605
Earnings (loss) per share - basic (0.33) (0.31) (0.83) (1.35) 0.05
Earnings (loss) per share - diluted (0.33) (0.31) (0.83) (1.35) 0.04
Balance sheet data
Total assets 8,662 13,883 21,352 31,888 54,924
Shareholders' equity 4,092 8,519 13,412 27,145 48,855
Key ratios and statistics
Gross profit(1) 10.9% 20.7% 6.4% 18.8% 36.1%
Working capital 3,212 6,614 8,679 22,236 31,670
Book value per share 0.23 (2) 0.47 0.80 1.62 2.94
Current ratio 1.70 2.23 2.12 5.69 6.22
Backlog 4,988 1,709 9,214 11,168 15,250
Employees 116 144 176 277 249
Shares outstanding 18,028 (2) 18,016 16,816 16,804 16,574
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(1) Amounts are before lottery service agreement write-offs and write downs of
$2,793, $2,807 and $17,444 for 1996, 1995 and 1994, respectively.
(2) Includes 840 thousand shares issued in 1997 to the shareholder class in
settlement of a class action lawsuit. See note 11 to the consolidated financial
statements.
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MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF
OPERATIONS
1997 VS. 1996
REVENUES: Revenue from the sale of products decreased by 40% to $8.4 million in
1997 from $14.0 million in 1996. The decrease was primarily the result of the
low backlog of contracts at the end of 1996 and the level of new contracts which
were delivered in 1997. Service related revenues, which include terminal
maintenance and software service agreements, decreased 8% to $2.4 million in
1997 from $2.6 million in 1996. This decrease was due to a lower level of
customer support contract requirements. New orders received in 1997 were $8.0
million compared to $3.0 million in 1996.
GROSS PROFIT: During 1997 the Company recognized a gross profit of 7% on
sales of products compared to a gross profit of 21% (before write offs and
write-downs of lottery service agreements) in 1996. The decrease in gross profit
is due to unfavorable manufacturing variances related to the decrease in sales,
charges of approximately $1.3 million taken to recognize impairment in the value
of software capitalized in previous years, for which sales orders have not yet
been received, additional reserves for inventory obsolescence, to record
provisions for certain development contracts and costs related to the closing of
the Company's United Kingdom subsidiary. The Company recognized a gross profit
of 24% on services in 1997 compared to 31% (before write offs of lottery service
agreements) in 1996. This decrease was the result of the mix of services
provided and the increase in the foreign exchange rate of the U.S. dollar versus
the Australian dollar in 1997.
ENGINEERING, RESEARCH & DEVELOPMENT: Engineering, research and development
expenses of $1.7 million in 1997 were equal to those of 1996. Of the $1.7
million expended in 1997, $1.3 million was for additional development of Data
Trak lottery software and the related instant ticket validation and player
registration modules. Additional funds were expended to reduce the manufactured
cost of the Company's terminals. The 1996 expenditures related primarily to
development of the Data Trak software. Selling, General and Administrative:
Selling, general and administrative expenses increased $0.3 million in 1997
compared to 1996. The 1997 selling, general and administrative costs were
actually less than 1996 costs if the 1996 benefit from the $1.2 million
reduction to the June 1996 judgment to settle the shareholders class action
lawsuit was omitted.
GAIN ON SALES OF SUBSIDIARY AND LOTTERY SERVICE AGREEMENT: In 1993 the
Company sold its subsidiary McKinnie & Associates. In the fourth quarter of
1997, the Company negotiated and received a final settlement on this agreement.
The Company recognized a gain on the sale of $438 thousand and $691 thousand in
1997 and 1996 respectively. In 1995, the Company sold its Papua New Guinea
lottery service agreement. The Company recognized a gain on the sale of $419
thousand and $624 thousand in 1997 and 1996 respectively. Both of these sales
have been recorded under the cost recovery method and, as such, no income was
recognized until 1996, when the basis of these investments had been recovered.
Provision for Income Taxes: The provision of income taxes in 1997 and 1996
relates to income earned in the Company's Australian subsidiary.
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1996 VS. 1995
REVENUES: Revenue decreased by 11% to $16.6 million in 1996 from $18.6 million
in 1995. The decrease is a result of lower levels of contract revenues caused by
the booking by the Company of $3.0 million in new orders in 1996 compared to
$12.6 million of new orders in 1995. Spares sales in 1996 increased 103% or
$1,087 over 1995 sales. This increase in spares was due to the increased number
of ILTS terminals in service and the timing of customer orders.
GROSS PROFIT: During 1996 the Company had gross profits of 21% (before write
offs and write-downs of Lottery Service Agreements) compared to a gross profit
of 6% (before write offs and write-downs of Lottery Service Agreements) in 1995.
The increase in gross profit is due to more favorable sales mix in 1996, the
accrual of $660 thousand as a loss on a contract in 1995, costs related to the
winding down of the Russian lottery project in 1995 and the effect of
cost-saving measures which were implemented in late 1995.
WRITE-OFFS AND WRITE-DOWNS OF LOTTERY SERVICE AGREEMENTS: During 1996, the
charge of $2.8 million relates entirely to the U.K. lottery. The reserve was
established after an affiliate of the customer was unable to obtain the
additional funding necessary for the project start-up and ongoing operations. At
this time, the customer has not indicated when a start-up may occur. The amount
of the charge approximates the Company's tangible investment, previously carried
on the balance sheet as "Investment in Lottery Service Contracts." In 1997 the
Company was able to recover $2.6 million of its investment through the sale of
the system and terminals. The 1995 charge relates to the withdrawal by the
Company from its Russian Lottery project. At December 31, 1996, the Company's
net book value of its investment in Lottery Service agreements was zero.
ENGINEERING, RESEARCH & DEVELOPMENT: Engineering, research and development
expenses in 1996 increased $302 thousand, or 22%, compared to 1995. Of the $1.7
million expended in 1996, $1.0 million went toward development of DataTrak
lottery software. The DataTrak software was completed for release in October
1996 and future research and development costs will be expended to provide
additional features. The 1995 expenditures related to development of the Flipper
terminal and the DataTrak software.
SELLING, GENERAL AND ADMINISTRATIVE: Selling, general and administrative
expenses decreased $5.4 million in 1996 compared to 1995. The decrease was due
to a $4.2 million accrual in 1995 for the estimated cost to settle the
shareholders class action litigation. The June 1996 judgment fixed the cost at
an amount approximately $1.2 million less than the 1995 estimate. This $1.2
million was recorded as a reduction to the 1996 second quarter selling, general
and administrative costs.
GAIN ON SALES OF SUBSIDIARY AND LOTTERY SERVICE AGREEMENT: During 1996, the
Company recognized gains of $691 thousand and $624 thousand on the sales of its
subsidiary McKinnie & Associates, and the Papua New Guinea lottery service
agreement, respectively. These sales which occurred in 1993 and 1995,
respectively, have been recorded under the cost recovery method and, as such, no
income was recognized until the basis of these investments had been recovered.
This occurred in 1996. No related gains were recognized prior to 1996.
PROVISION FOR INCOME TAXES: The provision for income taxes in 1996 relates
to income earned in the Company's Australia subsidiary.
LIQUIDITY AND CAPITAL RESOURCES
During 1997, the Company's working capital decreased approximately $3.4 million,
primarily due to the Company's net loss of $5.9 million. The accrued litigation
settlement of $1.7 million was extinguished through the issuance in 1997 of 840
thousand shares of common stock of the Company. During 1997 the Company
generated cashflows of $857 thousand primarily as a result of proceeds of $438
thousand and $419 thousand relating to the sale, in previous years, of McKinnie
& Associates and of the Papua New Guinea lottery, respectively. During 1997
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MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF
OPERATIONS (CONTINUED)
the Company invested $150 thousand in additional equipment.
As part of its strategic plan, the Company intends to pursue long-term
service contracts as a source of revenue. Service contracts pose new capital
investment risks for the Company that do not exist in its product sale business.
Payments are received only after a system becomes operational, based upon a
percentage of the customer's gross receipts from the system. The Company
therefore bears the risk that scheduling delays may occur and that a system may
not become operational.
The Company's consolidated financial statements have been prepared on a
continuing operations basis which contemplates the realization of assets and the
settlement of liabilities and commitments in the normal course of business.
Management recognizes that the Company must generate additional contract sales
to maintain its current level of operations. Additionally, management is
currently seeking additional sources of funding through debt or equity financing
and consideration of other business transactions which would generate sufficient
resources to assure continuation of the Company's operations.
Management anticipates that it will be successful in obtaining sufficient
contracts to enable the Company to continue normal operations; however, no
assurances can be given that the Company will be successful in realizing
sufficient contract revenue or obtaining additional funding. If the Company is
unable to obtain sufficient contract revenue or funding, management will be
required to sharply curtail the Company's operations. On February 27, 1998, the
Company's largest shareholder, Berjaya Lottery Management (Berjaya), agreed to
provide financial support if and when necessary to ensure that the Company's
operations continue for at least one year from December 31, 1997.
The Company's reporting currency is the U.S. dollar. Historically, a majority
of the Company's sales have been denominated in U.S. dollars, with the balance
denominated in foreign currencies. These foreign currency sales have been
effected principally by the Company's international subsidiaries. In accordance
with U.S. accounting requirements, sales denominated in foreign currencies are
translated into the local functional currency and then into U.S. dollars, at an
average exchange rate in effect during the period. In addition, the Company
incurs operating and technical support related expenses in Australian dollars in
connection with its Australian operations and also incurred operating expenses
in local currency at its United Kingdom location through 1998. Thus, changes
from reporting period to reporting period in the exchange rates between various
foreign currencies and the U.S. dollar have had, and will in the future continue
to have, an impact on revenues and expenses reported by the Company, and such
effect may be material in any individual reporting period. To the extent that
the Company incurs operating expenses in local currencies at its foreign
subsidiaries, the Company has a natural hedge against a portion of the possible
fluctuation in foreign currency exchange rates of revenues in such currencies.
As the contracts are predominantly denominated in the functional currency
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of the subsidiary performing under the contract, the Company has historically
incurred immaterial amounts of transaction gains or losses.
The majority of the Company's sales are denominated in U.S. dollars and thus
not subject to foreign currency fluctuations. However, the ultimate cost of the
Company's products to its customers have increased due to recent fluctuations in
the foreign exchange rates of many southeast Asian countries. At this point the
Company does not believe that these fluctuations in exchange rates has had an
impact on any potential sales. However, any further significant decline in the
economy of such Asian countries or in the value of their currencies could have a
material adverse impact on the Company.
The balance sheets of the Company's international subsidiaries are translated
into U.S. dollars and consolidated with the balance sheets of the Company's
domestic subsidiary in accordance with U.S. accounting requirements. Changes in
the U.S. dollar value of the foreign currency denominated assets are accounted
for as an adjustment to stockholders' equity. Therefore, changes from reporting
period to reporting period in the exchange rates between various foreign
currencies and the U.S. dollar have had, and will continue to have, an impact on
the foreign currency translation component of stockholders' equity reported by
the Company, and such effect may be material in any individual reporting period.
Within the 1997 calendar year the Australian dollar decreased 17% against the
U.S. dollar, which increased the foreign currency translation adjustment
component of the equity section.
YEAR 2000
Management has initiated an enterprise-wide program to prepare the Company's
computer systems and applications for the Year 2000. The Company expects to
incur internal staff costs as well as other expenses related to infrastructure
and facilities enhancements necessary to prepare the systems for the Year 2000.
The Company is still evaluating the effort required, and the related costs will
be expensed as incurred.
FORWARD LOOKING STATEMENT
The statements in this filing which are not historical facts are
forward-looking statements that are subject to risks and uncertainties that
could cause actual results to differ materially from those set forth or implied
by forward-looking statements. These risks and uncertainties include the absence
of significant contract backlog, the dependence on business from foreign
customers sometimes in politically unstable regions, political and governmental
decisions as to the establishment of lotteries and other wagering industries in
which the Company's products are marketed, fluctuations in quarter-by-quarter
operating results and other factors described in the Company's Annual Report on
Form 10-K for the year ended December 31, 1997.
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CONSOLIDATED STATEMENTS OF OPERATIONS
YEARS ENDED DECEMBER 31, 1997 1996 1995
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Thousands of dollars, except per share amounts
Revenues:
Sales of products $ 8,392 $ 13,954 $ 16,195
Services 2,434 2,640 2,446
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Total revenues 10,826 16,594 18,641
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Costs of revenues:
Cost of sales of products 7,804 11,342 15,705
Cost of services 1,843 1,811 1,751
Write-offs and write-downs of lottery service agreements -- 2,793 2,807
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Total costs of revenues 9,647 15,946 20,263
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Gross profit 1,179 648 (1,622)
Engineering, research and development 1,684 1,662 1,360
Selling, general and administrative 6,195 5,880 11,239
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Loss from operations (6,700) (6,894) (14,221)
Other income:
Interest income, net 135 173 352
Exchange rate loss (150) -- --
Gain on sale of subsidiary and lottery service agreement 857 1,315 --
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Loss before provision for income taxes (5,858) (5,406) (13,869)
Provision for income taxes 80 92 --
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Net loss $ (5,938) $ (5,498) $(13,869)
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Net loss per share - Basic and diluted $ (0.33) $ (0.31) $ (0.83)
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Shares used in determination of net loss per share -
Basic and diluted 18,021 17,465 16,812
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See accompanying notes.
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CONSOLIDATED BALANCE SHEETS
AS OF DECEMBER 31, 1997 1996
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Thousands of dollars, except share amounts
Assets
Current Assets:
Cash and cash equivalents $ 2,371 $ 5,387
Accounts receivable, net of allowance for doubtful accounts of $173 ($111 in 1996) 1,040 979
Costs and estimated earnings in excess of billings on uncompleted contracts 1,716 2,452
Inventories, at lower of cost (first-in, first-out method) or market:
Finished goods -- --
Work in process 1,151 283
Raw materials 1,393 2,735
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Total inventories 2,544 3,018
Other current assets 111 142
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Total current assets 7,782 11,978
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Equipment, furniture and fixtures at cost, less accumulated depreciation of
$4,078 ($3,737 in 1996) 802 1,128
Computer software costs, less accumulated amortization of $1,983
($1,420 in 1996) -- 688
Other 78 89
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Total assets $ 8,662 $ 13,883
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Liabilities and Shareholders' Equity
Current Liabilities:
Accounts payable $ 575 $ 491
Billings in excess of costs and estimated earnings on uncompleted contracts 386 161
Accrued payroll and related taxes 839 893
Accrued litigation settlement -- 1,680
Related party liability 146 366
Other current liabilities 2,624 1,773
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Total current liabilities 4,570 5,364
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Commitments and contingencies
Shareholders' equity:
Common shares; no par value, 50,000,000 shares authorized; 18,027,548
shares issued and outstanding (17,176,211 in 1996) 51,103 49,407
Retained deficit (46,659) (40,721)
Foreign currency translation adjustment (352) (167)
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Total shareholders' equity 4,092 8,519
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Total liabilities and shareholders' equity $ 8,662 $ 13,883
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See accompanying notes.
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CONSOLIDATED STATEMENTS OF CASH FLOWS
THOUSANDS OF DOLLARS 1997 1996 1995
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Years Ended December 31,
Cash flows from operating activities:
Net loss $(5,938) $(5,498) $(13,869)
Adjustments to reconcile net loss to net cash provided by (used for)
operating activities:
Depreciation and amortization 1,107 601 1,061
Gain on sale of subsidiaries and lottery service operations 857 (1,315) --
Adjustment in value of stock issued as settlement of litigation -- (1,200) --
Write-offs and write-downs of lottery service agreements -- 2,793 2,807
Changes in operating assets and liabilities:
Accounts receivable (61) 609 810
Costs and estimated earnings in excess of billings on uncompleted contracts 736 1,213 (283)
Inventories 474 3,802 3,679
Accounts payable 85 260 (678)
Billings in excess of costs and estimated earnings on uncompleted contracts 225 46 (853)
Accrued payroll and related taxes (54) (56) 354
Related party liability -- 366 --
Accrued litigation settlement -- (600) 4,200
Other (139) (560) 572
- ---------------------------------------------------------------------------------------------------------------------------------
Net cash provided by (used for) operating activities (2,708) 461 (2,200)
- ---------------------------------------------------------------------------------------------------------------------------------
Cash flows from investing activities:
Investment in lottery service agreements -- (34) (4,044)
Lottery service agreement sale proceeds and repayment of advances -- 962 651
Other non-current assets 11 (37) --
Additions to equipment (150) (283) (250)
Additions to computer software costs -- (211) (67)
Proceeds from sale of subsidiary -- 740 525
- ---------------------------------------------------------------------------------------------------------------------------------
Net cash provided by (used for) investing activities (139) 1,137 (3,185)
- ---------------------------------------------------------------------------------------------------------------------------------
Cash flows from financing activities:
Payments on notes payable -- -- (300)
Proceeds from issuance of common shares and warrants 16 -- 23
- ---------------------------------------------------------------------------------------------------------------------------------
Net cash provided by (used for) financing activities 16 -- (277)
- ---------------------------------------------------------------------------------------------------------------------------------
Effect of exchange rate changes on cash (185) (115) 99
- ---------------------------------------------------------------------------------------------------------------------------------
Increase (decrease) in cash and cash equivalents (3,016) 1,483 (5,563)
- ---------------------------------------------------------------------------------------------------------------------------------
Cash and cash equivalents, beginning of year 5,387 3,904 9,467
- ---------------------------------------------------------------------------------------------------------------------------------
Cash and cash equivalents, end of year $ 2,371 $ 5,387 $ 3,904
- ---------------------------------------------------------------------------------------------------------------------------------
Supplemental cash flow information:
Cash paid during the year for interest $ 9 $ 20 $ 46
- ---------------------------------------------------------------------------------------------------------------------------------
Cash paid during the year for income taxes $ 98 $ 46 $ 7
- ---------------------------------------------------------------------------------------------------------------------------------
See accompanying notes.
13
15
CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY
FOREIGN
COMMON STOCK CURRENCY
---------------------- RETAINED TRANSLATION
SHARES AMOUNT DEFICIT ADJUSTMENT TOTAL
- ------------------------------------------------------------------------------------------------------------------------------------
Thousands of shares/dollars
Balance at December 31, 1994 16,804 $48,650 $(21,354) $(151) $ 27,145
- ------------------------------------------------------------------------------------------------------------------------------------
Proceeds from exercise of stock options 12 23 -- -- 23
Accelerated vesting of stock options for
terminated employees -- 14 -- -- 14
Foreign currency translation adjustment -- -- -- 99 99
Net loss - 1995 -- -- (13,869) -- (13,869)
- ------------------------------------------------------------------------------------------------------------------------------------
Balance at December 31, 1995 16,816 48,687 (35,223) (52) 13,412
- ------------------------------------------------------------------------------------------------------------------------------------
Issuance of shares in settlement of shareholders' lawsuit 360 720 -- -- 720
Foreign currency translation adjustment -- -- -- (115) (115)
Net loss - 1996 -- -- (5,498) -- (5,498)
- ------------------------------------------------------------------------------------------------------------------------------------
Balance at December 31, 1996 17,176 49,407 (40,721) (167) 8,519
- ------------------------------------------------------------------------------------------------------------------------------------
Proceeds from exercise of stock options 12 16 -- -- 16
Issuance of shares in settlement of shareholders' lawsuit 840 1,680 -- -- 1,680
Foreign currency translation adjustment -- -- -- (185) (185)
Net loss - 1997 -- -- (5,938) -- (5,938)
- ------------------------------------------------------------------------------------------------------------------------------------
Balance at December 31, 1997 18,028 $51,103 ($46,659) ($352) $ 4,092
- ------------------------------------------------------------------------------------------------------------------------------------
See accompanying notes.
14
16
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
1. OPERATIONS AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
International Lottery & Totalizator Systems, Inc. ("the Company") provides
computerized, on-line wagering systems including system software, betting
terminals, data communications, consulting, training, facilities management and
maintenance support to the worldwide wagering market. The principle applications
for the Company's products are in the automated pari-mutuel (horse racing)
wagering and on-line government sponsored lotteries.
The Company has developed several models of DATAMARK(R) terminals for
specific wagering applications. All are microprocessor based and have a
lightweight, compact design. The most recent models, the DATAMARK(R) Flipper and
DATAMARK XClaim feature PC compatible architecture which provides greater
flexibility for future enhancements such as smart card readers and POS displays.
Many models offer industry unique features such as reading two-sided bet slips,
printing on the back of a bet slip and batch feeding of up to 50 customer marked
bet slips.
ILTS is recognized as a world leader in providing computerized, on-line
wagering systems to the racing industry. The Company's pari-mutual wagering
system, ILTS InterTote, is designed to run on the Unix operating system, an open
systems architecture which permits the use of virtually any Unix hardware
platform. The system can be scaled to efficiently serve either small tracks with
just a few betting stations, or large installations of more than a thousand
terminals. This open approach provides a system that can be cost configured to
meet specific current needs while providing a built-in expansion path to meet
future requirements.
The ILTS DataTrak on-line gaming system is the product of more than a
decade of development and refinement of on-line lottery transaction processing
experience. It was designed to support a large terminal base and to handle
virtually any required transaction volume with ease. It retains all the speed,
security and reliability of a proven transaction processing system and extensive
game library, while offering the increased flexibility of interfacing with a
variety of information management solutions and standard software development
tools in one fully integrated system.
The Company's consolidated financial statements for the year ended December
31, 1997 have been prepared on a continuing operations basis which contemplates
the realization of assets and the settlement of liabilities and commitments in
the normal course of business. The Company has incurred net losses of $13.9
million, $5.5 million and $5.9 million in 1995, 1996 and 1997, respectively,
while revenues have decreased from $18.6 in 1995 to $10.8 million in 1997. The
Company is largely dependent upon significant contracts for its revenue, which
typically include a deposit upon contract signing and up to 3 months lead-time
before delivery of hardware begins. As of December 31, 1997, the Company had a
backlog (unaudited) of $5.0 million compared to backlogs (unaudited) of $1.7
million and $9.2 million in 1996 and 1995, respectively.
At December 31, 1997, the Company had working capital of $3.2 million.
Management recognizes that the Company must recover its investment in existing
contracts (Note 3) and generate additional contract sales to maintain its
current level of operations. Additionally, management is currently seeking
additional sources of funding through debt or equity financing and consideration
of other business transactions which would generate sufficient resources to
assure continuation of the Company's operations.
Management anticipates that it will be successful in recovering its
investment in existing contracts (Note 3) and obtaining sufficient contracts to
enable the Company to continue normal operations; however, no assurances can be
given that the Company will be successful in realizing sufficient new contract
revenues or obtaining additional financing. If the Company is unable to recover
its investment in existing contracts, obtain sufficient new contract revenue or
financing, management will be required to reduce the Company's operations. On
February 27, 1998, the Company's largest shareholder, Berjaya Lottery Management
(Berjaya), agreed to provide financial support, if and when necessary, to ensure
the Company's operations continue for at least one year from December 31, 1997.
The Company's ability to continue its ongoing operations on a long-term basis is
dependent upon its ability to recover its investment in existing contracts, to
obtain additional financing, secure additional new contracts and ultimately
achieve a sustainable level of profit from operations.
PRINCIPLES OF CONSOLIDATION - The accompanying consolidating financial
statements include the accounts of the Company and its subsidiaries, all of
which are wholly-owned. All significant intercompany accounts and transactions
are eliminated in consolidation.
REVENUE RECOGNITION - The Company recognizes long-term contract revenue on
the percentage-of-completion method, based on contract costs incurred to date
compared to total estimated contract costs. The effects of changes in contract
cost estimates are recognized in the period they are determined. Estimated
contract losses are fully charged to operations when identified. Revenues
relating to the sale of certain assets, when the ultimate total collection is
not reasonably assured, are being recorded under the cost recovery method. All
other revenue is recorded on the basis of shipments of products or performance
of services.
USE OF ESTIMATES - The preparation of financial statements in conformity
with generally accepted accounting principles requires management to make
estimates and assumptions that affect the reported amounts of assets and
liabilities and disclosure of contingent assets and liabilities at the date of
the financial statements and the reported amounts of revenues and expenses
during the reporting period. Actual results could differ from those estimates.
DEPRECIATION - Depreciation of equipment, furniture and fixtures is
provided principally using the straight-line method over estimated useful lives
of 3 - 7 years.
COMPUTER SOFTWARE COSTS - The Company has capitalized the costs of computer
software incurred in the development of specific products, after technological
feasibility has been established. The capitalized software costs are amortized
using the greater of the amount computed using the ratio of current product
revenue to estimated total product revenue or the straight-line method over the
remaining estimated economic lives of the products (3 years). Amortization
expense totaled $688 thousand, $89 thousand and $510 thousand for the years
ended December 31, 1997, 1996 and 1995, respectively. In 1997, the Company
determined that software which had been capitalized in prior years had become
impaired, and accordingly, took a charge for the remaining asset value of $457
thousand.
RECENT ACCOUNTING PRONOUNCEMENTS - In June 1997, the Financial
Accounting Standards Board issued SFAS No. 130, "Reporting Comprehensive
Income," and SFAS No. 131, "Disclosure about Segments of an Enterprise and
Related Information." SFAS No. 130 establishes
15
17
standards for reporting of comprehensive income and its components in a full set
of general-purpose financial statements. SFAS No. 131 requires reporting certain
information about operating segments in annual and interim period financial
statements. Both standards were required to be adopted beginning January 1,
1998. The adoption of these standards is not expected to have a material effect
on the Company's financial position or results of operations.
WARRANTY RESERVES - Estimated expenses for warranty obligations are accrued
as income is recognized on related contracts. The reserves are adjusted
periodically to reflect actual experience.
FOREIGN CURRENCY - The Company has contracts with certain customers that
are denominated in foreign currencies, and related transaction gains and losses
are recognized as a component of current operations. The consolidated accounts
of the Company's Australian subsidiary have been translated from its functional
currency, the Australian dollar. The effect of the exchange rate fluctuations
between the U.S. dollar and the Australian dollar is recorded as a separate
component of shareholders' equity. The Company's other foreign subsidiary uses
the U.S. dollar as its functional currency and, accordingly, related translation
gains and losses are recognized in current operations.
PER SHARE INFORMATION - Net loss per share is based on the weighted average
number of shares outstanding during the year. The 1996 computation includes 840
thousand shares of common stock which were issued in 1997, pursuant to a class
action lawsuit settlement rendered by the court on June 17, 1996. In 1997, the
Company adopted SFAS No. 128 "Earnings Per Share," which requires companies to
present basic and diluted earnings per share. There was no impact to earnings
per share from the adoption of SFAS No.128 due to the Company's net loss
position.
RESEARCH AND DEVELOPMENT - Engineering, research and development costs are
expensed as incurred. Substantially all engineering, research and development
expenses are related to new product development and designing significant
improvements.
CONCENTRATION OF CREDIT RISK - Accounts receivable and costs and estimated
earnings in excess of billings on uncompleted contracts are primarily related to
contracts with a few major customers. These amounts are payable in accordance
with the terms of individual contracts and generally collateral is not required.
Estimated credit losses are provided for in the financial statements. The
Company conducts business in the Asia/Pacific region. Certain Asian countries
are currently experiencing severe economic turmoil represented by depressed
business conditions and volatility in local currencies. Any significant further
decline in these economies and in the value of their currencies could have a
material adverse effect on the Company.
CASH AND CASH EQUIVALENTS - The Company considers all highly liquid
investments with a maturity of three months or less when purchased to be cash
equivalents. Included in cash and cash equivalents at December 31, 1997 and 1996
are investments in commercial paper totaling $1.0 and $2.3 million,
respectively, which mature in January 1998 and January 1997, respectively. The
estimated fair value of these investments approximate the amortized cost;
therefore, there are no unrealized gains or losses as of December 31, 1997 or
1996.
STOCK OPTIONS - As permitted, the Company has elected the disclosure only
provisions of SFAS No. 123. Accordingly, the Company continues to follow
Accounting Principles Board Opinion No. 25 "Accounting for Stock Issued to
Employees" (APB 25) and related interpretations in accounting for its employee
stock options. Under APB 25, because the exercise price of the Company's stock
options equals the market price of the underlying stock on the date of grant, no
compensation expense is recognized.
MAJOR CUSTOMERS - During 1997 approximately $7.4 million or 69% of the
Company's revenues were derived from five customers. In 1996 and 1995 the
amounts were $11.7 million or 70% from 5 customers and $13.1 million or 70% from
6 customers, respectively.
RECLASSIFICATIONS - Certain prior year balances have been reclassified to
conform with the 1997 presentation.
2. RELATED PARTY TRANSACTIONS
The Company has entered into sales agreements to supply terminals, spares and
services to entities in which the Company's largest shareholder, Berjaya Lottery
Management (Berjaya), has a significant equity interest. Revenues related to
these agreements totaled $0.8 million, $2.0 million and $3.5 million in 1997,
1996 and 1995, respectively. Included in accounts receivable and costs and
estimated earnings in excess of billings on uncompleted contracts were $0.2
million and $0.5 million at December 31, 1997 and 1996 respectively, relating to
these customers.
During 1996 the Company entered into an agreement with Berjaya to purchase
specific inventory on behalf of Berjaya to enable the Company to satisfy certain
future potential orders in a timely manner. Title to the inventory purchased
resides with Berjaya; therefore, no amounts are reflected in the consolidated
balance sheet for inventory purchased on their behalf. Advances received in
excess of inventory purchased aggregated approximately $146 thousand and $366
thousand and have been reflected as a related party liability in the
accompanying consolidated balance sheet as of December 31, 1997 and 1996,
respectively.
3. CONTRACTS IN PROCESS
The amounts by which total costs and estimated earnings exceeded or were less
than billings on uncompleted contracts are as follows (in thousands):
YEARS ENDED DECEMBER 31, 1997 1996
- -----------------------------------------------------------------------------------------------------------------
Costs incurred $9,696 $13,449
Estimated earnings 1,666 1,745
----- -----
11,362 15,194
Less: billings (10,032) (12,903)
------- -------
$1,330 $2,291
====== ======
Included in the accompanying consolidated balance sheets as follows:
Costs and estimated earnings in excess of billings on uncompleted contracts $1,716 $2,452
Billings in excess of costs and estimated earnings on uncompleted contracts (386) (161)
---- ----
$1,330 $2,291
====== ======
16
18
4. LOTTERY SERVICE AGREEMENTS
The Company entered into contracts to provide lottery equipment and management
of on-line lottery systems on a long-term basis in Papua New Guinea in 1992, the
Russian Federation in 1993 and entered into a contract to provide lottery
equipment in the United Kingdom in 1995.
The Company committed lottery equipment costing approximately $2.8 million
to its United Kingdom lottery service agreement in 1995. The Company agreed to
provide a complete lottery system for a percentage of lottery revenues. In
September 1996, it became apparent that an affiliate of the customer was unable
to obtain the additional funding necessary for the project start-up and ongoing
operations, and the Company recorded a $2.8 million charge to reflect a reserve
for the project. The amount of the charge approximates the Company's tangible
investment, previously carried on the balance sheet as "Investment in Lottery
Service Contracts." The Company recovered part of its U.K. investment in 1997
through a sale of a system and terminals to Olympic Gold for $2.6 million.
The Papua New Guinea lottery commenced operation in March 1993. In July
1995, the Company sold all interests in the Papua New Guinea lottery operation
to the principal shareholders of the lottery licensee, for $175 thousand in cash
and a note of $1.3 million to be paid in monthly installments of approximately
$79 thousand per month for a period of 17 months commencing in September 1995.
Additionally, the Company will receive a percentage of the annual gross lottery
sales or an annual sum of $260 thousand, whichever is greater, for a period of
five years, provided that the additional sums shall not exceed $3.0 million. The
Company is accounting for the sale under the cost recovery method. The
installment payments and the minimum percentage payments are secured by all
lottery assets and certain personal guarantees. During 1997, the Company
recognized approximately $419 thousand as a gain on the sale of the lottery
service agreement. The amount reflects the aggregate amount of payments received
under the sale agreement in excess of the Company's carrying amount of its
investment in the lottery service agreement on the date of the sale. Under the
cost recovery method, no amount of gain on the sale was recognized until the net
investment in the lottery service agreement on the date of sale was recovered in
1996. At December 31, 1997, the Company has no investment remaining on its
balance sheet as the proceeds from the sale have exceeded the net book value.
Due to uncertainties which arose in November 1994 regarding the Russian
lottery license process and the continued economic, political and legal
instability in Russia, the Company recorded a provision of $7.6 million to write
down the assets to estimated net realizable value with respect to the Russian
lottery investment. Subsequently, the Company terminated its Russian lottery
project in November 1995. In 1995, the Company incurred $2.8 million in costs
toward its Russian lottery project, including the write-off of costs related to
a reduction in its Russian work force and future costs to liquidate the
operation.
5. INDUSTRY SEGMENT AND GEOGRAPHICAL DATA
The Company operates in one industry segment which includes totalizator and
lottery systems. The Company has an Australian subsidiary, International Lottery
& Totalizator Systems Australia Pty., Ltd., and a United Kingdom subsidiary,
International Lottery & Totalizator Systems (U.K.) Ltd.
Sales between geographic areas are generally priced to recover material
costs plus an appropriate markup. Revenue by major customers is as follows (in
thousands):
CUSTOMER LOCATION 1997 1996 1995
- -----------------------------------------------------------
Ukraine $ 2,600 $ -- $ --
Malaysia 2,000 -- 2,300
Australia* 1,700 2,000 4,400
Sweden 1,400 4,300 2,700
Hong Kong 400 2,400 600
Philippines 400 900 2,900
All other 2,300 7,000 5,700
------- ------- -------
Total $10,800 $16,600 $18,600
======= ======= =======
* Different customer in 1995 as compared to 1997 and 1996.
17
19
The following table summarizes information about the Company's operations in
different geographic areas for the years ended December 31, 1997, 1996 and 1995
(in thousands).
YEARS ENDED DECEMBER 31, 1997 1996
--------------------------------------------------------------------------------------------------------
EASTERN EASTERN
EUROPE/ CONSOLI- EUROPE/ CONSOLI-
USA PACIFIC EUROPE DATED USA PACIFIC EUROPE DATED
- ------------------------------------------------------------------------------------------------------------------------------------
Sales to unaffiliated
customers:
Export $ 7,750 -- -- $ 7,750 $ 11,313 -- -- $ 11,313
Domestic 643 2,123 310 3,076 293 4,482 506 5,281
- ------------------------------------------------------------------------------------------------------------------------------------
Sales to:
Australia subsidiary 557 -- -- 557 1,738 -- -- 1,738
- ------------------------------------------------------------------------------------------------------------------------------------
8,950 2,123 310 11,383 13,344 4,482 506 18,332
- ------------------------------------------------------------------------------------------------------------------------------------
Elimination of inter-
company sales (557) -- -- (557) (1,738) -- -- (1,738)
- ------------------------------------------------------------------------------------------------------------------------------------
Total revenue 8,393 2,123 310 10,826 11,606 4,482 506 16,594
- ------------------------------------------------------------------------------------------------------------------------------------
Write-offs and write-
downs of lottery
service agreements -- -- -- -- (2,793) -- -- (2,793)
- ------------------------------------------------------------------------------------------------------------------------------------
Net income (loss) $(5,709) $ (206) $ (22) $ (5,938) $ (5,865) $ 476 $ (109) $ (5,498)
- ------------------------------------------------------------------------------------------------------------------------------------
Identifiable assets $ 7,272 $ 1,356 $ 34 $ 8,662 $ 11,638 $2,096 $ 149 $ 13,883
- ------------------------------------------------------------------------------------------------------------------------------------
YEARS ENDED DECEMBER 31, 1995
-----------------------------------------------------
EASTERN
EUROPE/ CONSOLI-
USA PACIFIC EUROPE DATED
- ---------------------------------------------------------------------------------
Sales to unaffiliated
customers:
Export $ 15,006 -- -- $ 15,006
Domestic 513 2,614 508 3,635
- ---------------------------------------------------------------------------------
Sales to:
Australia subsidiary 508 -- -- 508
- ---------------------------------------------------------------------------------
16,027 2,614 508 19,149
- ---------------------------------------------------------------------------------
Elimination of inter-
company sales (508) -- -- (508)
- ---------------------------------------------------------------------------------
Total revenue 15,519 2,614 508 18,641
- ---------------------------------------------------------------------------------
Write-offs and write-
downs of lottery
service agreements -- -- (2,807) (2,807)
- ---------------------------------------------------------------------------------
Net income (loss) $(13,561) $ (76) $ (232) $(13,869)
- ---------------------------------------------------------------------------------
Identifiable assets $ 19,572 $ 1,478 $ 302 $ 21,352
- ---------------------------------------------------------------------------------
6. LEASES
The Company leases its facilities under operating lease agreements which expire
at various dates through October 2001. Certain lease agreements provide for
increases in minimum annual rent based on increases in various market indices.
Also, the Company has the option to renew the lease on its U.S. facility for one
additional ten-year term. Rent expense for the years ended December 31, 1997,
1996, and 1995 was $595 thousand, $605 thousand and $674 thousand, respectively.
Minimum future obligations for these leases are as follows (in thousands):
1998 - $634; 1999 - $606; 2000 - $365; 2001 - $79.
7. INCOME TAXES
The provision for income taxes of $80 thousand in 1997 and $92 thousand in 1996
primarily relates to income earned by the Company's Australian subsidiary.
The following is a reconciliation of the actual tax provision to the
expected tax benefit computed by applying the statutory federal income tax rate
to the loss before provision for income taxes (in thousands):
YEARS ENDED DECEMBER 31, 1997 1996 1995
- -------------------------------------------------------------------------------------------------
Expected federal income tax benefit at statutory rate $(1,932) $(1,892) $(4,715)
U.S. and foreign net operating losses - no benefit 1,932 1,892 4,715
Other, net 79 92 --
Provision for income taxes $ 79 $ 92 --
- -------------------------------------------------------------------------------------------------
Deferred income taxes reflect the net tax effects of temporary differences
between the carrying amounts of assets and liabilities for financial reporting
purposes and amounts used for income tax purposes. The components of the
Company's deferred tax liabilities and assets are as follows (in thousands):
DECEMBER 31, 1997 1996
- ----------------------------------------------------------------------------------------
Deferred tax liabilities:
Computer software costs $ 310 $ 310
- ----------------------------------------------------------------------------------------
Total deferred tax liabilities 310 310
- ----------------------------------------------------------------------------------------
Deferred tax assets:
Installment sale PNG 1,152 1,209
Reserves against investment in lottery service agreements 1,203 1,401
Reserves and accruals 2,151 1,514
Rent expense 115 177
Employee benefits 69 88
Patent expense 28 31
Net operating loss and credit carryforwards 19,120 17,589
Other 131 29
- ----------------------------------------------------------------------------------------
Total deferred tax assets 23,969 22,038
- ----------------------------------------------------------------------------------------
Net deferred tax assets 23,660 21,728
Valuation allowance (23,660) (21,728)
- ----------------------------------------------------------------------------------------
Net deferred taxes $ 0 $ 0
- ----------------------------------------------------------------------------------------
18
20
The Company has Federal and California net operating losses of
approximately $51 million and $22 million, respectively, which will begin to
expire in 2008 and 1998, respectively, unless previously utilized. The
difference between the Federal and California net operating loss carryforwards
relates primarily to California's statutory 50% annual reduction rule.
The Company also has Federal general business credit carryforwards of
approximately of $588 thousand, which begin to expire in 2002. Pursuant to the
Tax Reform Act of 1986, use of the Company's business credit and net operating
loss carryforwards may be limited if a cumulative change in ownership of more
than 50% occurs within any three-year period.
8. EMPLOYEE STOCK BONUS PLAN
The Company has an employee stock bonus plan, commonly referred to as a 401(k)
plan, qualified under the Internal Revenue Code, in which all eligible
employees, as defined in the Internal Revenue Code, may elect to participate.
Under the Plan, employees may voluntarily make tax-deferred contributions of up
to 15% of their compensation to a trust which provides the participant with
various investment alternatives. In addition, the Company, at the discretion of
the Board of Directors, may contribute an amount of Company stock for each
fiscal year which does not exceed 5% of the annual compensation of all
participants in the Plan. Company contributions charged to operations were $82
thousand, $82 thousand and $198 thousand in 1997, 1996 and 1995, respectively.
9. STOCK OPTION PLANS
The Company has three current employee stock option plans and a directors option
plan whereby options to purchase 2.7 million and 400 thousand shares,
respectively, of the Company's common stock may be granted. Options granted have
5-to-10 year terms that vest and become fully exercisable 4 to 5 years from the
date of grant.
Pro forma information regarding net loss and net loss per share is required
by SFAS No. 123, and has been determined as if the Company has accounted for its
employee stock options under the fair value method of SFAS No. 123. The fair
value of these options was estimated at the date of grant using the
Black-Scholes option pricing model with the following weighted average
assumptions for 1997 and 1996, respectively: risk-free interest rates of 5.3% -
5.9% and 5.4% - 6.0%, respectively; dividend yields of 0% in both 1997 and 1996;
volatility factors of the expected market price of the Company's common stock of
1.2 for both 1997 and 1996; and a weighted-average life of the option of 7.21
years for both 1997 and 1996.
The Black-Scholes option valuation model was developed for use in
estimating the fair value of traded options which have no vesting restrictions
and are fully transferable. In addition, option valuation models require the
input of highly subjective assumptions including the expected stock price
volatility. Because the Company's employee stock options have characteristics
significantly different from those of traded options, and because changes in the
subjective input assumptions can materially affect the fair value estimate, in
management's opinion, the existing models do not necessarily provide a reliable
single measure of the fair value of its employee stock options.
For purposes of pro forma disclosures, the estimated fair value of the
options is amortized to expense over the options' vesting period. The effects of
applying SFAS No. 123 for pro forma disclosure purposes are not likely to be
representative of the effects on pro forma net loss in future years because it
does not take into consideration pro forma compensation expense related to
grants made prior to 1995. The Company's pro forma information follows (in
thousands, except per share amounts):
1997 1996
Pro forma net loss $ (6,204) $ (5,645)
- --------------------------------------------------------
Pro forma loss per share $ (0.34) $ (0.32)
A summary of the Company's stock option activity, and related
information for the years ended December 31 follows (options in thousands):
- -----------------------------------------------------------------------------------------------------------------------
YEARS ENDED DECEMBER 31, 1997 1996 1995
Weighted- Weighted- Weighted-
Average Average Average
Exercise Exercise Exercise
Options Price Options Price Options Price
- -----------------------------------------------------------------------------------------------------------------------
Outstanding - beginning of year 1,501 $ 5.74 1,325 $ 7.28 1,351 $ 7.50
Granted 480 $ 1.33 320 $ 1.22 75 $ 2.28
Exercised (11) $ 1.38 -- -- (12) $ 1.87
Cancelled (491) $ 6.09 (144) $ 9.86 (89) $ 7.16
- -----------------------------------------------------------------------------------------------------------------------
Outstanding - end of year 1,479 $ 4.13 1,501 $ 5.74 1,325 $ 7.28
- -----------------------------------------------------------------------------------------------------------------------
Exercisable at end of year 857 $ 6.22 1,007 $ 6.95 931 $ 7.35
- -----------------------------------------------------------------------------------------------------------------------
Weighted-average fair value of options
granted during the year $ 1.33 $ 1.22 $ 2.28
- -----------------------------------------------------------------------------------------------------------------------
Exercise prices for options outstanding as of December 31, 1997 ranged from
$1.03 to $15.75. The weighted-average remaining contractual life of those
options is approximately 6 years.
19
21
At December 31, 1997, options for 1,225,332 shares were available for future
grant. The following table summarizes information about stock options at
December 31, 1997 (shares in thousands):
OUTSTANDING STOCK OPTIONS EXERCISABLE STOCK OPTIONS
- -----------------------------------------------------------------------------------------------------------------
WEIGHTED- WEIGHTED- WEIGHTED-
AVERAGE AVERAGE AVERAGE
REMAINING EXERCISE EXERCISE
SHARES CONTRACTUAL LIFE PRICE SHARES PRICE
RANGE OF EXERCISE PRICES
$1.0310 to $1.2813 398 8.50 years $1.1857 58 $1.0311
$1.2815 to $1.5620 320 6.79 years $1.4218 69 $1.4141
$2.2188 to $3.0000 357 3.07 years $2.6591 336 $2.6383
$3.6250 to $11.500 249 3.55 years $7.7494 239 $7.7076
$15.7500 to $15.7500 155 3.12 years $15.7500 155 $15.7500
- -----------------------------------------------------------------------------------------------------------------
10. SALE OF SUBSIDIARY
On March 31, 1993, the Company sold its subsidiary, McKinnie & Associates, Inc.
to Shreveport Acquisition for cash and a note. During 1997, the Company
negotiated and received a final settlement of the remaining balance due on the
note and recorded a gain of $438 thousand from receipts during the year.
11. LITIGATION
In 1994, shareholders of the Company filed class action lawsuits against the
Company and several of its officers and directors. Those actions were
consolidated in the United States District Court for the Southern District of
California. Plaintiffs contended that during the class period (June 22, 1993
through June 21, 1994) the Company and the individual defendants made a series
of public statements that failed to disclose adverse information about the
Company's lottery service contracts, that these purported nondisclosures
artificially inflated the price of the Company's stock, and that those
purchasers who acquired their shares in reliance on the integrity of the market
suffered damages as a result. On June 17, 1996, the court entered a judgment of
a cash payment to the class shareholders and 1.2 million shares of authorized
but unissued common stock of the Company, of which, 360 thousand shares were
issued in September 1996 and 840 thousand shares were issued in 1997. Such
shares were included in the calculation of earnings per share for the year ended
December 31, 1996. The estimated settlement was accrued as of September 30, 1995
and an adjustment of approximately $1.2 million was recorded during the three
months ended June 30, 1996 to reduce the accrual to the actual settlement
amount, valued as of the judgment date.
In November, 1995, Mr. James Walters, the former chairman and president of
the Company, filed an action in the San Diego County Superior Court against the
Company, its then current president, Frederick A. Brunn, a publishing company
and an author alleging that certain statements in a magazine article were
slander per se by ILTS and Brunn and libel by the publishing company and the
author, and that Mr. Walters suffered an invasion of privacy by all defendants.
In addition, Walters alleged that erroneous information in the Company's 1995
Proxy Statement resulted in two other magazine articles publishing allegedly
incorrect information. Mr. Walters seeks general and special damages of $9
million and punitive damages. On November 1, 1996, the San Diego County Superior
Court entered a summary judgment in favor of the Company. Mr. Walters has filed
an appeal with the California appellate court. Management, based on the advice
of counsel, believes that the outcome of this case will not result in any
liability to the Company. Accordingly, no provision for any liability that may
result has been included in the consolidated financial statements. The Company
is also subject to other legal proceedings and claims that arise in the normal
course of business. While the outcome of these proceedings and claims cannot be
predicted with certainty, management does not believe that the outcome of any of
these matters will have a material adverse effect on the Company's consolidated
financial position or results of operations.
20
22
REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS
TO THE BOARD OF DIRECTORS AND SHAREHOLDERS OF INTERNATIONAL LOTTERY &
TOTALIZATOR SYSTEMS, INC.
We have audited the accompanying consolidated balance sheet of International
Lottery & Totalizator Systems, Inc. (a California corporation) and subsidiaries
as of December 31, 1997 and the related consolidated statements of operations,
shareholders' equity and cash flows for the year then ended. These financial
statements are the responsibility of the Company's management. Our
responsibility is to express an opinion on these financial statements based on
our audit. The consolidated balance sheet as of December 31, 1996, and the
related consolidated statements of operations, shareholders' equity and cash
flows for each of the two years in the period ended December 31, 1996, were
audited by other accountants whose report, dated February 21, 1997, expressed an
unqualified opinion on those statements.
We conducted our audit in accordance with generally accepted auditing standards.
Those standards require that we plan and perform the audit to obtain reasonable
assurance about whether the financial statements are free of material
misstatements. 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, the consolidated financial statements referred to above present
fairly, in all material respects, the financial position of International
Lottery & Totalizator Systems, Inc. and subsidiaries as of December 31, 1997,
and the results of their operations and their cash flows for the year then
ended, in conformity with generally accepted accounting principles.
ARTHUR ANDERSEN LLP
San Diego, California
February 18, 1998
21
23
CORPORATE AND COMMON SHARE INFORMATION
DIRECTORS
Theodore A. Johnson
Chairman of the Board
Frederick A. Brunn
Chan Kien Sing
Group Executive Director
Berjaya Group Berhad
M. Mark Michalko
President
Ng Aik Chin
Executive Assistant to the President
Ng Foo Leong
Executive Director,
Sports Toto Malaysia
Martin J. O'Meara Jr.
President,
The Budget Plan, Inc.
Lord Michael G.R. Sandberg
Private Investor
OFFICERS
[PHOTO]
M. Mark Michalko
President
[PHOTO]
Timothy R. Groth
Vice President
Technical Operations
[PHOTO]
Dennis D. Klahn
Chief Financial Officer
[PHOTO]
Ng Aik Chin
Executive Assistant to the President
[PHOTO]
Robert F. McPhail
Vice President
International Marketing
MARKET FOR COMMON STOCK
The Company's Common Stock is traded under the symbol ITSI on the NASDAQ
National Market system. As of December 31, 1997, there were 18,027,548 common
shares outstanding and 2,385 shareholders of record. Berjaya Lottery Management
owned 36.6% of the total outstanding shares and the Company's management owned
1%.
1997 HIGH LOW
First Quarter 1 38/64 5/8
Second Quarter 2 5/16 25/32
Third Quarter 2 1/4 1 3/16
Fourth Quarter 1 15/16 13/16
Average Daily Volume 60,836
Total Annual Trading Volume 16,060,597
1996 HIGH LOW
First Quarter 1 25/32 1 1/16
Second Quarter 3 3/16 1 1/16
Third Quarter 2 1/2 1 1/8
Fourth Quarter 1 5/16 25/32
Average Daily Volume 42,045
Total Annual Trading Volume 10,679,305
DIVIDEND POLICY
The Company retains earnings to support operations.
FORM 10-K
A Copy of Form 10-K as filed with the Securities and Exchange Commission can be
obtained by contacting:
Investor Relations
ILTS
2131 Faraday Avenue
Carlsbad, CA 92008-7297 USA
(760) 931-4000
ANNUAL MEETING OF SHAREHOLDERS
The 1998 Annual Meeting will be held at 3:00 p.m. PDT on Monday, May 18, 1998,
at La Costa Resort and Spa, Costa Del Mar Road, Carlsbad, California, (760)
438-9111. Shareholders and interested parties are invited to attend.
TRANSFER AGENT AND REGISTRAR
ChaseMellon Shareholder Services
85 Challenger Road
Ridgefield Park, New Jersey USA
1-800-522-6645
(231) 553-9719
(213) 553-9735 Fax
LEGAL COUNSEL
Lawrence E. Logue
General Counsel
ILTS
2131 Faraday Avenue
Carlsbad, CA 92008-7297 USA
(760) 931-4000
INDEPENDENT AUDITORS
Arthur Andersen LLP
701 West Broadway, Suite 1600
San Diego, CA 92101-8195 USA
(619) 699-6600
INVESTOR RELATIONS
ILTS
2131 Faraday Avenue
Carlsbad, CA 92008-7297 USA
(760) 931-4000
To receive Company information via facsimile, call the Investor Relations
Hotline: 1-800-859-5903.
24
HEADQUARTERS
International Lottery & Totalizator Systems, Inc.
2131 Faraday Avenue
Carlsbad, CA 92008-7297 USA
(760) 931-4000
(760) 931-1789 Fax
TECHNICAL AND MARKETING/SALES SUPPORT FACILITIES
AUSTRALIA
International Lottery & Totalizator Systems Australia Pty. Ltd.
Unit 1A, 167 Prospect Highway
Seven Hills, New South Wales 2147
Australia
(61) (2) 9624-4300
(61) (2) 9674-6832 Fax
[GRAPHIC]
SALES OFFICES
Asia/Pacific
Sales Office
Christina Bldg. Unit 304
Herrera Corner Legaspi Sts.
Legaspi Village, Makati, Philippines
(63) (2) 816-6989
(63) (2) 815-3270
Europe
ILTS Europe
Vollsveien 168
N-1343 Eiksmarka
Norway
(47) (67) 14 73 76
(47) (67) 14 80 68
South Africa
ILTS South Africa
c/o First Floor, Export House
Corner West & Maude Streets
Sandown
P.O. Box 651525
Benmore 2010
Johannesburg
Republic of South Africa
(27) (11) 320-6971
(27) (11) 320-6873 Fax
[ILTS(R) LOGO]
INTERNATIONAL LOTTERY & TOTALIZATOR SYSTEMS, INC.
Visit the ILTS Home Page: http://www.ilts.com
Registered to ISO 9001 Certificate No. A3960
International Lottery & Totalizator Systems, Inc.(R), ILTS(R), DataTrak(R) and
DATAMARK XClaim(TM) are registered trademarks of International Lottery &
Totalizator Systems, Inc.