1
EXHIBIT 13
SELECTED FINANCIAL DATA
Years Ended December 31, 1998 1997 1996 1995 1994
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Thousand of dollars except per share amounts
and non-monetary items
Statement of operations data
Revenue $13,172 $10,826 $ 16,594 $ 18,641 $ 24,089
Gross profit 4,599 1,179 648 (1,622) (12,917)
Operating loss (2,094) (6,700) (6,894) (14,221) (22,943)
Net loss (1,892) (5,938) (5,498) (13,869) (22,620)
Loss per share - basic and diluted(1) $ (0.31) $ (0.99) $ (0.92) $ (2.47) $ (4.04)
Balance sheet data
Total assets 5,078 8,662 13,883 21,352 31,888
Shareholders' equity 2,472 4,092 8,519 13,412 27,145
Key ratios and statistics
Gross profit 34.91% 10.89% 3.90% (8.70)% (53.62)%
Working capital $ 2,007 $ 3,290 $ 6,614 $ 8,679 $ 22,236
Book value per share 0.41 0.68 1.41(2) 2.40 4.86
Current ratio 1.77 1.70 2.23 2.12 5.69
Backlog $ 3,402 $ 4,988 $ 1,709 $ 9,214 $ 11,168
Employees 72 116 144 176 277
Shares outstanding(1) 6,009 6,009 6,005(2) 5,605 5,601
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(1) Adjusted to reflect a three-for-one reverse stock split on June 12,
1998.
(2) Includes 280 thousand shares (reflects the June 12, 1998 three-for-one
reverse stock split) issued in 1997 to the shareholder class in
settlement of a class action lawsuit. See note 13 to the consolidated
financial statements.
2
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF
OPERATIONS
FORWARD LOOKING STATEMENTS
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, 1998.
OVERVIEW
The Company has derived substantially all of its product sale revenues from the
sale of betting terminals to racing organizations and lotteries worldwide. The
size and timing of these transactions result in variability in product sales
revenues from period to period.
Service revenues have been derived primarily from providing betting
terminal maintenance services to New South Wales Lotteries (NSWL). NSWL is in
the process of changing its lottery system to a competitor's system. As a
result, substantially all of the Company's present service revenue will
contractually terminate in January 2000, although NSWL has the option to extend
the agreement for an additional six months.
RESULTS OF OPERATIONS
1998 Versus 1997
Revenues: Total revenues in fiscal 1998 increased 22%, or $2.3 million, versus
fiscal 1997. Product sales increased 32% in 1998 to $11.1 million from $8.4
million in 1997. This is primarily the result of a 61% increase in terminal
shipments in 1998 compared to 1997 shipments, which also included one central
system sale. Service revenues decreased 15% or $0.4 million from 1997. This
decrease is the result of fewer customer support projects and the impact of
lower Australian exchange rates in 1998.
Gross Profit: The gross profit on product sales was 37% in 1998 compared
to 7% in 1997. The increased gross profit percentage was due to the
manufacturing efficiencies achieved with the increased level of production,
lower production related expenses and sales of earlier model terminals which
previously had been fully reserved. Fiscal 1997 included a provision for the
closing of the Company's U.K. subsidiary and a $1.3 million charge related to
impairment of software capitalized in prior years. The gross profit percentage
on service revenues was approximately the same both years.
Engineering, Research & Development: Engineering, research and
development expenses decreased 13% to $1.5 million in 1998 compared to $1.7
million in 1997. Projects in 1998 included development of additional features
for the DataTrak lottery system and integration of an impact printer into the
Company's terminals. The 1997 expenditures were primarily directed towards Data
Trak lottery software and related features.
Selling, General and Administrative: Selling, general and administrative
expenses decreased 16% or $1.0 million in 1998 compared to 1997. This was
primarily the result of a lower level of staffing in 1998, partially offset by
expenses incurred for the proposed Prime Gaming acquisition described in Note 1.
Gain on Sales of Subsidiary and Lottery Service Agreement: In 1998 the
Company recognized a gain on the sale of its former Papua New Guinea lottery
service agreement of $105 thousand compared to a gain of $419 thousand in 1997.
Installment payments from the sale of the Papua New Guinea lottery were
suspended in late 1998 due to poor economic conditions in Papua New Guinea. In
addition, in 1997 the Company received final payment and recognized a gain of
$438 thousand from the 1993 sale of its McKinnie & Associates subsidiary.
Provision for Income Taxes: The provision for income taxes in 1998 and
1997 relates to income earned in the Company's Australian subsidiary.
3
1997 Versus 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 that
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.
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
DataTrak 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 DataTrak 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.
LIQUIDITY AND CAPITAL RESOURCES
During 1998, working capital decreased by $1.2 million. This was primarily due
to the completion of contracts that were started in 1997 and a reduction in
inventories, partially offset by a reduction in loss reserves against these same
contracts.
Although the Company's net loss from operations was $1.9 million, cash
on hand decreased only $0.1 million. The net loss was offset by the reduction in
working capital described above, of $1.2 million, depreciation of $0.3 million
and an exchange rate gain recognized upon the dissolution of the U.K.
subsidiary.
On November 20, 1998, the Company announced its plan to outsource the
manufacturing of its terminals. It has also taken steps to further reduce its
fixed costs by subleasing a portion of its facility and is actively looking for
a smaller facility.
The Company intends to strategically 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. Service contracts
require an up-front investment of capital which is repaid 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 or that the customer's gross
receipts from the system may be less than expected. The Company would have to
seek the funds necessary to implement such contracts from Berjaya or other
sources.
4
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 that would generate sufficient
resources to assure continuation of the Company's operations.
As of December 31, 1998 there were no material commitments for capital
expenditures.
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. Subsequent to December 31,
1998, the Company's largest shareholder, Berjaya Lottery Management (Berjaya),
agreed to provide a line of credit of up to $4.0 million to meet the Company's
cash needs through at least June 30, 2000. The Company has agreed with Berjaya
to pledge as security its current and future inventory and accounts receivable,
intellectual property, trademarks, contracts and all other tangible and
intangible assets upon the utilization of the credit facility.
FOREIGN EXCHANGE FLUCTUATION
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. 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 revenue and expense reported by the Company, and such
effect may be material in any individual reporting period. As the contracts are
predominantly denominated in the functional currency of the subsidiary
performing under the contract, the Company has historically incurred immaterial
amounts of transaction gains or losses.
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. The Company recognized a foreign exchange gain of $65 thousand
in 1998 primarily as a result of liquidating its United Kingdom subsidiary.
ASIA
Significant portions of the Company's revenues are derived from customers
located in Asia. In the last 24 months the currencies of the Asian countries in
which the Company's customer are located have declined significantly against the
U.S. dollar. Although the Company generally has been paid in U.S. dollars, this
decline has effectively increased the cost of the Company's products to its
customers. The Company does not believe that its on-going business has been
negatively impacted by the Asian currency exchange situation, however, one
current customer has asked and the Company has agreed, to delay to a later
undefined date the scheduled delivery of terminals which will result in the
delay of Company revenues and cash receipts of approximately $1.0 million.
5
YEAR 2000
During fiscal 1998, the Company developed a plan to address anticipated Year
2000 issues in connection with its data processing and other activities,
including non-information technology based systems. It is currently estimated
that the net cost to become Year 2000 compliant, including upgrades of its
personal computer hardware and software and its network, will total
approximately $30 thousand of which $5 thousand has been incurred to date. The
Company has completed its remediation portion of the Year 2000 project and will
be entering its testing phase during the first three-quarters of 1999.
Compliance status from key suppliers will be evaluated to determine whether the
Company will need to switch sources to ensure ongoing product/service
availability. This evaluation/conversion is expected to be completed by
September 1999. A contingency plan has not been developed, as the risk on
remaining items is considered low. Should any issues arise which cannot be
adequately addressed and remedied, management will develop a contingency plan at
that point. Although, based on a review of its data processing, operating, and
other computer based systems, the Company does not currently believe that it
will experience any significant adverse effect or material unbudgeted costs
resulting therefrom, there can be no assurance in that regard. In addition, the
Company has reviewed the software systems and hardware it has previously sold
and determined they are Year 2000 compliant.
The failure to correct a material Year 2000 problem could result in an
interruption in or a failure of certain normal activities or operations. Such
interruptions or failures could materially and adversely affect the Company's
results of operations, liquidity and financial conditions. Because there is
general uncertainty about the Year 2000 problem, including uncertainty about the
Year 2000 readiness of suppliers and customers, it is not possible to predict
whether Year 2000 problems will occur or what consequences such problems will
have on results of operation's, liquidity or financial condition. However, the
Company's plan to address Year 2000 issues is intended to minimize, to the
extent feasible, the possibility of interruptions of normal operations. There
can, however, be no assurance that the Company will be successful in doing so.
6
CONSOLIDATED STATEMENTS OF OPERATIONS AND COMPREHENSIVE LOSS
Years Ended December 31, 1998 1997 1996
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$ in thousands, except per share amounts
Revenues:
Sales of products $11,102 $ 8,392 $13,954
Services 2,070 2,434 2,640
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13,172 10,826 16,594
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Cost of revenues:
Cost of sales of products 7,040 7,804 11,342
Cost of services 1,533 1,843 1,811
Write-down of lottery service agreement -- -- 2,793
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8,573 9,647 15,946
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Gross profit 4,599 1,179 648
Engineering, research and development 1,464 1,684 1,662
Selling, general and administrative 5,229 6,195 5,880
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Loss from operations (2,094) (6,700) (6,894)
Other income:
Interest income, net 60 135 173
Exchange rate gain/(loss) 65 (150) --
Gain on sale of subsidiary and lottery service agreement 105 857 1,315
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Loss before provision for income taxes (1,864) (5,858) (5,406)
Provision for income taxes 28 80 92
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Net loss ($1,892) ($5,938) ($5,498)
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Other comprehensive income (loss):
Foreign currency translation adjustments 272 (185) (115)
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Comprehensive loss ($1,620) ($6,123) ($5,613)
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Net loss per share - Basic and diluted ($ 0.31) ($ 0.99) ($ 0.94)
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Shares used in determination of net loss per share -
Basic and diluted (1) 6,009 6,007 5,822
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See accompanying notes.
(1) Adjusted to reflect a three-for-one reverse stock split on June 12,
1998.
7
CONSOLIDATED BALANCE SHEETS
AS OF DECEMBER 31, 1998 1997
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$ in thousands, except share amounts
Assets
Current assets:
Cash and cash equivalents $ 2,270 $ 2,371
Accounts receivable, net of allowance for doubtful accounts of $93 ($173 in 1997) 1,338 1,040
Costs and estimated earnings in excess of billings on uncompleted contracts 45 1,716
Inventories, net 798 2,544
Other current assets 162 189
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Total current assets 4,613 7,860
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Equipment, furniture and fixtures at cost, less accumulated depreciation of $3,669
($4,078 in 1997) 465 802
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$ 5,078 $ 8,662
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Liabilities and Shareholders' Equity
Current liabilities:
Accounts payable $ 474 $ 575
Billings in excess of costs and estimated earnings on uncompleted contracts 9 386
Accrued payroll and related taxes 603 839
Related party liability 332 146
Other current liabilities 1,188 2,624
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Total current liabilities 2,606 4,570
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Commitments and contingencies
Shareholders' equity:
Common shares; no par value, 50,000,000 shares authorized; 6,009,183 shares issued
and outstanding in both years 51,103 51,103
Retained deficit (48,551) (46,659)
Foreign currency translation adjustment (80) (352)
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2,472 4,092
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$ 5,078 $ 8,662
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See accompanying notes.
8
CONSOLIDATED STATEMENTS OF CASH FLOWS
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Years Ended December 31, 1998 1997 1996
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$ in thousands
Cash flows from operating activities:
Net loss ($1,892) ($5,938) ($5,498)
Adjustments to reconcile net loss to net cash
provided by (used for) operating activities:
Depreciation and amortization 338 1,107 601
Gain on sale of subsidiaries and lottery service operations (105) (857) (1,315)
Adjustment in value of stock issued as settlement of litigation -- -- (1,200)
Write-down of lottery service agreement -- -- 2,793
Loss on impaired manufacturing assets 94 -- --
Changes in operating assets and liabilities:
Accounts receivable (298) (61) 609
Costs and estimated earnings in excess of billings
on uncompleted contracts 1,671 736 1,213
Inventories 1,746 474 3,802
Accounts payable (101) 85 260
Billings in excess of costs and estimated
earnings on uncompleted contracts (377) 225 46
Accrued payroll and related taxes (236) (54) (56)
Related party liability 186 -- 366
Accrued litigation settlement -- -- (600)
Other assets 27 42 463
Other liabilities (1,436) 687 (1,060)
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Net cash provided by (used for) operating activities (383) (3,554) 424
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Cash flows from investing activities:
Investment in lottery service agreements -- -- (34)
Lottery service agreement sale proceeds and repayment of advances 105 419 962
Additions to equipment (95) (150) (283)
Addition to computer software costs -- -- (211)
Proceeds from sale of subsidiary -- 438 740
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Net cash provided by investing activities 10 707 1,174
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Cash flows from financing activities:
Proceeds from issuance of common shares and warrants -- 16 --
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Net cash provided by financing activities -- 16 --
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Effect of exchange rate changes on cash 272 (185) (115)
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Increase (decrease) in cash and cash equivalents (101) (3,016) 1,483
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Cash and cash equivalents, beginning of year 2,371 5,387 3,904
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Cash and cash equivalents, end of year $ 2,270 $ 2,371 $ 5,387
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Supplemental cash flow information:
Cash paid during the year for interest 1 9 20
Cash paid during the year for income taxes 69 98 46
See accompanying notes.
9
CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY
Foreign
Common Stock currency
---------------------- Retained translation
Shares Amount deficit adjustment Total
- --------------------------------------------------------------------------------------------------------------------
Thousands of shares/dollars
Balance at December 31, 1995 5,605 $ 48,687 $(35,223) $(52) $ 13,412
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Issuance of shares in settlement
of shareholders' lawsuit 120 720 -- -- 720
Foreign currency translation
adjustment -- -- -- (115) (115)
Net loss - 1996 -- -- (5,498) -- (5,498)
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Balance at December 31, 1996 5,725 49,407 (40,721) (167) 8,519
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Proceeds from exercise of stock
options 4 16 -- -- 16
Issuance of shares in settlement
of shareholders' lawsuit 280 1,680 -- -- 1,680
Foreign currency translation
adjustment -- -- -- (185) (185)
Net loss - 1997 -- -- (5,938) -- (5,938)
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Balance at December 31, 1997 6,009 51,103 (46,659) (352) 4,092
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Foreign currency translation
adjustment -- -- -- 272 272
Net loss - 1998 -- -- (1,892) -- (1,892)
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Balance at December 31, 1998 6,009 $ 51,103 $(48,551) $(80) $ 2,472
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See accompanying notes.
10
Notes To Consolidated Financial Statements
1. Operations
The Company's consolidated financial statements for the year ended December 31,
1998 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 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. The
Company has incurred net losses of $5.5 million, $5.9 million and $1.9 million
in 1996, 1997 and 1998, respectively, while revenues have decreased from $16.6
million in 1996 to $13.2 million in 1998. As of December 31, 1998, the Company
had a backlog (unaudited) of $3.6 million compared to backlogs (unaudited) of
$5.0 million and $1.7 million in 1997 and 1996, respectively.
On June 1, 1998, the stockholders of the Company approved an amendment
to the Articles of Incorporation to effect a three-for-one reverse stock split.
Each share of stock owned by stockholders of record at the close of business on
June 12, 1998 was converted into 0.333 shares. All share and per share data
presented in the Consolidated Financial Statements and footnotes of this Annual
Report have been restated to reflect the three-for-one reverse stock split.
Historically, approximately 70% of the Company's annual service revenues
have been derived from a terminal maintenance agreement with an Australian
lottery customer that expires in January 2000. In October 1998, the Australian
lottery customer, as a result of a competitive bid, awarded this contract to a
competitor of the Company.
Early in 1998, NASDAQ adopted new requirements for continued listing on
NASDAQ Markets. On December 16, 1998, the Company was notified by the NASDAQ
that its shares did not meet the new criteria. On December 17, 1998, the
Company's shares began trading on the Over-the-Counter Bulletin Board (OTCBB).
In June 1998, the Company announced it had entered into negotiations to
acquire a controlling interest in Prime Gaming Philippines, Inc. ("Prime") from
Berjaya Lottery Management (H.K.) Limited and/or other Prime shareholders in
exchange for the issuance of ILTS common stock. One requirement to complete the
transaction was that ILTS common shares remain trading on NASDAQ markets. In
December 1998, NASDAQ notified the Company that it did not meet NASDAQ listing
criteria and that Company shares would begin trading OTCBB. In February 1999, as
a result of the Company's transfer from NASDAQ to OTCBB the Prime shareholders
terminated the proposed transaction.
At December 31, 1998, the Company had working capital of $2.0 million.
Management recognizes that the Company must recover its investment in existing
contracts (Note 4) 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 4) 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.
Subsequent to December 31, 1998, the Company's largest shareholder, Berjaya
Lottery Management (Berjaya), agreed to provide a line of credit up to $4.0
million to meet the Company's cash needs through at least June 30, 2000. The
Company has agreed with Berjaya to pledge as security its current and future
inventory and accounts receivable, intellectual property, trademarks, contracts
and all other tangible and intangible assets upon the utilization of the credit
facility. 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.
2. Summary of Significant Accounting Policies
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.
11
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 previously capitalized the costs
of computer software incurred in the development of specific products, after
technological feasibility had been established. The capitalized software costs
were 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 $0, $688 thousand, and $89 thousand for the years
ended December 31, 1998, 1997 and 1996, 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.
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.
Per Share Information - Net loss per share is based on the weighted
average number of shares outstanding during the year. The weighted average
number of shares outstanding were revised to reflect the three-for-one reverse
stock split implemented June 12, 1998. The 1996 computation includes 280
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.
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 have experienced 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, 1998 and 1997
are investments in commercial paper totaling $1.1 million and $1.0 million,
respectively, which mature in January 1999 and January 1998, respectively. The
estimated fair value of these investments approximates the carrying value;
therefore, there are no unrealized gains or losses as of December 31, 1998 or
1997.
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 1998 approximately $8.8 million or 67% of the
Company's revenues were derived from six customers. In 1997 and 1996 the amounts
were $7.4 million or 69% from 5 customers and $11.7 million or 70% from 5
customers, respectively.
Recent Accounting Pronouncements - On January 1, 1998, the Company
adopted SFAS No. 130, "Reporting Comprehensive Income." The effect of the
implementation was to show the change in the foreign currency translation
adjustment in shareholders' equity as a component of comprehensive income. In
June 1998, the Financial Accounting Standards Board issued SFAS No. 133,
"Accounting for Derivative Instruments and Hedging Activities" which is required
to be adopted for the fiscal quarter beginning after June 15, 1999. At this
time, the Company has not entered into any derivative instruments or hedging
activities. In March 1998, the Accounting Standards Executive Committee (AcSEC)
issued AICPA Statement of Position (SOP) 98-1, "Accounting for Costs of Computer
Software Developed or Obtained for Internal Use." This statement provides
guidance on accounting for the costs of computer software developed or obtained
for internal use and identifies characteristics of internal use software and
provides assistance in determining when computer software is for internal use.
SOP 98-1 is effective for fiscal years beginning after December 15, 1998, with
12
earlier application permitted. The Company has not yet determined what impact,
if any, the adoption of SOP 98-1 will have on the Company's consolidated
financial statements, results of operations, or related disclosures thereto. In
April 1998, the Accounting Standards Executive Committee (AcSEC) issued AICPA
Statement of Position (SOP) 98-5, "Reporting on the Costs of Start-Up
Activities." This statement provides guidance on financial reporting of start-up
costs and organization costs and requires that such costs of start-up activities
be expensed as incurred. SOP 98-5 is effective for fiscal years beginning after
December 15, 1998, with earlier application permitted. The Company has not yet
determined what impact, if any, the adoption of SOP 98-5 will have on the
Company's consolidated financial statements, results of operations, or related
disclosures thereto.
Reclassifications - Certain prior years balances have been reclassified
to conform with the 1998 presentation.
3. 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, has a
significant equity interest. Revenues related to these agreements totaled $2.5
million, $0.8 million and $2.0 million in 1998, 1997 and 1996, respectively.
Included in accounts receivable and costs and estimated earnings in excess of
billings on uncompleted contracts were $0.3 million and $0.2 million at December
31, 1998 and 1997 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 sheets for inventory purchased on their behalf.
Advances received in excess of inventory purchased aggregated approximately $332
thousand and $146 thousand and have been reflected as a related party liability
in the accompanying consolidated balance sheets as of December 31, 1998 and
1997, respectively.
4. 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, 1998 1997
- ------------------------ -------- --------
Costs incurred $ 1,273 $ 9,696
Estimated earnings 213 1,666
-------- --------
1,486 11,362
Less: billings (1,450) (10,032)
-------- --------
$ 36 $ 1,330
======== ========
Included in the accompanying consolidated balance sheets as follows:
Costs and estimated earnings in excess of billings on uncompleted contracts $ 45 $ 1,716
Billings in excess of costs and estimated earnings on uncompleted contracts (9) (386)
-------- --------
$ 36 $ 1,330
======== ========
13
5. Inventories
At December 31, 1998 and 1997, inventories were comprised of:
$ in thousands 1998 1997
- -----------------------------------------------
Raw materials $ 207 $1,393
Work in process 591 1,151
Finished goods -- --
----------------------
$ 798 $2,544
----------------------
6. 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 and
entered into a contract to provide lottery equipment in the United Kingdom in
1995.
In July 1995, the Company sold all interest in its Papua New Guinea
lottery operation to the principal shareholders of the licensee for a fixed
amount plus 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 recognized
approximately $105 thousand as a gain on the sale of the lottery service
agreement in 1998, before payments were suspended due to poor economic
conditions in Papua New Guinea. The Company recorded a gain of $419 thousand in
1997 and $624 thousand in 1996. The Company is reviewing its options to
recover the remaining amount due under the terms of the contract. At December
31, 1998, the Company has no investment remaining on its balance sheet as the
proceeds from the sale have exceeded the net book value.
The Company committed services and lottery equipment costing
approximately $2.8 million to its United Kingdom lottery service agreement in
1995. In September 1996, it became apparent that the customer was not able to
fund the lottery start-up and operations and the Company recorded a $2.8 million
charge to reflect a reserve for the project. The Company recovered part of its
U.K. investment in 1997 and 1998 through the sale of a system and terminals to
Olympic Gold, which aggregate $3.8 million.
7. 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. (a United Kingdom subsidiary ceased
operations in March 1998).
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 1998 1997 1996
- --------------------------------------------------------------------
Sweden $ 2,400 $ 1,400 $ 4,300
Philippines 2,300 400 900
Hong Kong 1,700 400 2,400
Australia 1,500 1,700 2,000
Malaysia 1,000 2,000 --
Ukraine 900 2,600 --
All other 3,400 2,300 7,000
------- ------- -------
Total $13,200 $10,800 $16,600
======= ======= =======
14
The following table summarizes information about the Company's
operations in different geographic areas for the years ended December 31, 1998,
1997 and 1996 (in thousands).
Year Ended December 31, 1998 1997
- --------------------------------------------------------------------------------------------------------------------------------
Eastern Eastern
Europe/ Consoli- Europe/ Consoli-
USA Pacific Europe dated USA Pacific Europe dated
- --------------------------------------------------------------------------------------------------------------------------------
Sales to unaffiliated customer:
Export $ 9,537 $ -- $ -- $ 9,537 $ 7,750 $ -- $ -- $ 7,750
Domestic 734 2,838 63 3,635 643 2,123 310 3,076
- --------------------------------------------------------------------------------------------------------------------------------
Sales to:
Australia subsidiary 1,209 -- -- 1,209 557 -- -- 557
- --------------------------------------------------------------------------------------------------------------------------------
11,480 2,838 63 14,381 8,950 2,123 310 11,383
- --------------------------------------------------------------------------------------------------------------------------------
Elimination of inter-company sales (1,209) -- -- (1,209) (557) -- -- (557)
- --------------------------------------------------------------------------------------------------------------------------------
Total Revenue 10,271 2,838 63 13,172 8,393 2,123 310 10,826
- --------------------------------------------------------------------------------------------------------------------------------
Write-down
of lottery service agreement -- -- -- -- -- -- -- --
- --------------------------------------------------------------------------------------------------------------------------------
Net income (loss) ($2,407) $ 115 $ 400 ($1,892) ($5,710) ($206) ($22) ($5,938)
- --------------------------------------------------------------------------------------------------------------------------------
Identifiable assets $ 4,331 $ 747 $ -- $ 5,078 $ 7,272 $ 1,356 $ 34 $ 8,662
- --------------------------------------------------------------------------------------------------------------------------------
Year Ended December 31, 1996
- ----------------------------------------------------------------------------------
Eastern
Europe/ Consoli-
USA Pacific Europe dated
- ----------------------------------------------------------------------------------
Sales to unaffiliated customer:
Export $ 11,313 $ -- $ -- $ 11,313
Domestic 293 4,482 506 5,281
- ----------------------------------------------------------------------------------
Sales to:
Australia subsidiary 1,738 -- -- 1,738
- ----------------------------------------------------------------------------------
13,344 4,482 506 18,332
- ----------------------------------------------------------------------------------
Elimination of inter-company sales (1,738) -- -- (1,738)
- ----------------------------------------------------------------------------------
Total Revenue 11,606 4,482 506 16,594
- ----------------------------------------------------------------------------------
Write-down
of lottery service agreement (2,793) -- -- (2,793)
- ----------------------------------------------------------------------------------
Net income (loss) ($5,865) $ 476 ($109) ($5,498)
- ----------------------------------------------------------------------------------
Identifiable assets $ 11,638 $ 2,096 $ 149 $ 13,883
- ----------------------------------------------------------------------------------
8. 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, 1998,
1997, and 1996 was $581 thousand, $595 thousand and $605 thousand, respectively.
Minimum future obligations for these leases are as follows (in
thousands): 1999-$586; 2000-$337; 2001-$65.
9. Income Taxes
The provision for income taxes of $28 thousand in 1998, $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, 1998 1997 1996
- ----------------------------------------------------------------------------------------------
Expected federal income tax benefit at statutory rate ($1,354) ($1,932) ($1,892)
U.S. and foreign net operating losses - no benefit 1,354 1,932 1,892
Other, net 28 80 92
Provision for income taxes 28 80 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.
15
The components of the Company's deferred tax liabilities and assets are
as follows (in thousands):
December 31, 1998 1997
Deferred tax liabilities:
Computer software costs $ -- $ 310
- ----------------------------------------------------------------------------------------
Total deferred tax liabilities -- 310
- ----------------------------------------------------------------------------------------
Deferred tax assets:
Installment sale PNG -- 1,152
Reserves against investment in lottery service agreements -- 1,203
Reserves and accruals 1,561 2,151
Net operating loss and credit carryforwards 20,253 19,120
Other 492 343
- ----------------------------------------------------------------------------------------
Total deferred tax assets 22,306 23,969
- ----------------------------------------------------------------------------------------
Net deferred tax assets 22,306 23,659
Valuation allowance (22,306) (23,659)
- ----------------------------------------------------------------------------------------
Net deferred taxes $ 0 $ 0
- ----------------------------------------------------------------------------------------
The Company has Federal and California net operating losses of
approximately $54 million and $23 million, respectively, which will begin to
expire in 2008 and 1999, 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 has provided a valuation allowance against its net deferred tax asset
due to uncertainty regarding its realization.
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.
10. 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 that does not exceed 5% of the annual compensation of all
participants in the Plan. Company contributions charged to operations were $0,
$82 thousand and $82 thousand in 1998, 1997 and 1996, respectively.
11. Stock Option Plans
The Company has three current employee stock option plans and a directors option
plan whereby options to purchase 901 thousand and 133 thousand shares,
respectively, of the Company's common stock may be granted. Options granted have
5 to 10 year terms that vest, become fully exercisable 2 to 4 years from the
date of grant and were granted at fair value on 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 1998, 1997 and 1996, respectively: risk-free interest rates of
4.58% - 4.95%, 5.3% - 5.9% and 5.4% - 6.0%, respectively; dividend yields of 0%
in 1998, 1997 and 1996; volatility factors of the expected market price of the
Company's common stock of 2.8 for 1998 and 1.2 for both 1997 and 1996,
respectively and a weighted-average life of the option of 7.2 years for
1998, 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
16
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):
- ------------------------------------------------------------------------------------
1998 1997 1996
Pro forma net loss ($2,093) ($6,204) ($5,645)
- ------------------------------------------------------------------------------------
Pro forma loss per share ($0.35) ($1.02) ($0.96)
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, 1998 1997 1996
Weighted Weighted Weighted
Average Average Average
Exercise Exercise Exercise
Options Price Options Price Options Price
--------------------------------------------------------------------------------------------------------------------------
Outstanding -beginning of year 493 $12.74 501 $17.22 442 $21.84
Granted 63 $ 1.48 160 $ 3.99 107 $ 3.66
Exercised -- $ -- (4) $ 4.14 -- $ --
Cancelled (120) $16.83 (164) $18.27 (48) $29.58
--------------------------------------------------------------------------------------------------------------------------
Outstanding -end of year 436 $ 9.92 493 $12.74 501 $17.22
--------------------------------------------------------------------------------------------------------------------------
Exercisable at end of year 263 $14.48 286 $18.66 336 $20.85
--------------------------------------------------------------------------------------------------------------------------
Weighted-average fair value of options
granted during the year $ 1.48 $ 3.99 $ 3.66
--------------------------------------------------------------------------------------------------------------------------
Exercise prices for options outstanding as of December 31, 1998 ranged from
$0.50 to $47.25. The weighted-average remaining contractual life of those
options is approximately 6 years.
At December 31, 1998, options for 465,167 shares were available for future
grant.
17
The following table summarizes information about stock options at December 31,
1998 (shares in thousands):
OUTSTANDING STOCK OPTIONS EXERCISABLE STOCK OPTIONS
- ---------------------------------------------------------------------------------------------------------------
Weighted
Average Weighted Weighted
Remaining Average Average
Contractual Exercise Exercise
Range of Exercise Prices Shares Life Price Shares Price
- ---------------------------------------------------------------------------------------------------------------
$ 0.5000 - $3.8439 180 8.37 $ 2.8338 49 $ 3.4218
$ 3.8445 - $6.6564 110 5.12 $ 4.6166 68 $ 4.8546
$ 8.2500 - $34.5000 115 3.55 $15.9041 115 $15.9047
$47.2500 - $47.2500 31 3.71 $47.2500 31 $47.2500
- ---------------------------------------------------------------------------------------------------------------
$0.5000 - $47.2500 436 5.95 $ 9.9248 263 $14.4812
12. 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.
13. Litigation
In 1994, shareholders of the Company filed a class action lawsuit against the
Company and several of its officers and directors. On June 17, 1996, the court
entered a judgment of a cash payment to the class shareholders and 400 thousand
shares of authorized but unissued common stock of the Company, of which, 120
thousand shares were issued in September 1996 and 280 thousand shares were
issued in 1997. Such shares were included in the calculation of loss 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 20, 1998, the
California Court of Appeal (Fourth District) substantially reversed the summary
judgement of the superior court awarded the Company on November 1, 1996 and the
appellate court returned the case to the superior court for trial. The Company
has filed a petition for review with the California Supreme 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.