FORM 10-Q
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended November 22, 2003
Commission file number 1-11250
GTECH Holdings Corporation
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(Exact name of registrant as specified in its charter)
Delaware 05-0450121
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(State or other jurisdiction of (I.R.S. Employer Identification
incorporation or organization) Number)
55 Technology Way, West Greenwich, Rhode Island 02817
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(Address of principal executive offices) (Zip Code)
Registrant's telephone number, including area code: (401)392-1000
Indicate by check mark whether the registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months (or for such shorter period that the registrant was
required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days.
Yes [X] No [ ]
Indicate by check mark whether the registrant is an accelerated filer (as
defined in Rule 12b-2 of the Securities Exchange Act of 1934)
Yes [X] No [ ]
At December 27, 2003, there were 59,083,106 shares of the registrant's Common
Stock outstanding.
INDEX
GTECH HOLDINGS CORPORATION AND SUBSIDIARIES
Page
Number
------
PART I. FINANCIAL INFORMATION
Item 1. Financial Statements
Consolidated Balance Sheets 3
Consolidated Income Statements 4-5
Consolidated Statements of Cash Flows 6
Consolidated Statements of Shareholders' Equity 7
Notes to Consolidated Financial Statements 8-25
Item 2. Management's Discussion and Analysis of Financial Condition
and Results of Operations 26-42
Item 3. Quantitative and Qualitative Disclosures about Market Risk 43
Item 4. Controls and Procedures 43
PART II. OTHER INFORMATION
Item 1. Legal Proceedings 43
Item 6. Exhibits and Reports on Form 8-K 44
SIGNATURES 45
EXHIBITS
PART 1. FINANCIAL INFORMATION
Item 1. FINANCIAL STATEMENTS
CONSOLIDATED BALANCE SHEETS
GTECH HOLDINGS CORPORATION AND SUBSIDIARIES
(Unaudited)
November 22, February 22,
2003 2003
------------ ------------
(Dollars in thousands)
ASSETS
CURRENT ASSETS:
Cash and cash equivalents $ 320,536 $ 116,174
Trade accounts receivable, net 122,718 107,666
Sales-type lease receivables 7,288 4,400
Inventories 58,852 72,287
Deferred income taxes 29,410 29,410
Other current assets 27,202 18,660
----------- -----------
TOTAL CURRENT ASSETS 566,006 348,597
SYSTEMS, EQUIPMENT AND OTHER ASSETS RELATING TO CONTRACTS, net 561,930 410,911
GOODWILL, net 188,809 115,498
OTHER ASSETS 169,232 79,189
----------- -----------
TOTAL ASSETS $ 1,485,977 $ 954,195
=========== ===========
LIABILITIES AND SHAREHOLDERS' EQUITY
CURRENT LIABILITIES:
Accounts payable $ 74,171 $ 74,042
Accrued expenses 52,903 51,200
Employee compensation 32,170 37,494
Advance payments from customers 95,856 52,442
Deferred revenue and advance billings 10,075 17,264
Income taxes payable 56,072 54,043
Taxes other than income taxes 28,017 16,020
Short term borrowings 2,379 2,616
Current portion of long-term debt 9,012 6,992
----------- -----------
TOTAL CURRENT LIABILITIES 360,655 312,113
LONG-TERM DEBT, less current portion 557,912 287,088
OTHER LIABILITIES 51,716 39,428
COMMITMENTS AND CONTINGENCIES - -
SHAREHOLDERS' EQUITY:
Preferred Stock, par value $.01 per share - 20,000,000 shares authorized, none issued - -
Common Stock, par value $.01 per share - 150,000,000 shares authorized,
92,296,404 and 92,296,404 shares issued; 59,065,006 and 56,638,331 shares
outstanding at November 22, 2003 and February 22, 2003, respectively 923 923
Additional paid-in capital 267,759 235,266
Accumulated other comprehensive loss (78,937) (95,488)
Retained earnings 801,204 684,653
----------- -----------
990,949 825,354
Less cost of 33,231,398 and 35,658,073 shares in treasury at
November 22, 2003 and February 22, 2003, respectively (475,255) (509,788)
----------- -----------
515,694 315,566
----------- -----------
TOTAL LIABILITIES AND SHAREHOLDERS' EQUITY $ 1,485,977 $ 954,195
=========== ===========
See Notes to Consolidated Financial Statements
-3-
CONSOLIDATED INCOME STATEMENTS
GTECH HOLDINGS CORPORATION AND SUBSIDIARIES
(Unaudited)
Three Months Ended
-------------------------
November 22, November 23,
2003 2002
------------ ------------
(Dollars in thousands,
except per share amounts)
Revenues:
Services $ 231,225 $ 207,784
Sales of products 23,697 48,682
--------- ---------
254,922 256,466
Costs and expenses:
Costs of services 131,991 129,122
Costs of sales 13,094 39,070
--------- ---------
145,085 168,192
--------- ---------
Gross profit 109,837 88,274
Selling, general and administrative 28,167 24,358
Research and development 12,926 10,903
--------- ---------
Operating expenses 41,093 35,261
--------- ---------
Operating income 68,744 53,013
Other income (expense):
Interest income 1,494 1,028
Equity in earnings of unconsolidated affiliates 1,500 1,406
Other income 4,052 234
Interest expense (2,986) (2,728)
--------- ---------
4,060 (60)
--------- ---------
Income before income taxes 72,804 52,953
Income taxes 26,937 20,122
--------- ---------
Net income $ 45,867 $ 32,831
========= =========
Basic earnings per share $ 0.78 $ 0.58
========= =========
Diluted earnings per share $ 0.69 $ 0.57
========= =========
Weighted average shares outstanding - basic 58,820 56,981
========= =========
Weighted average shares outstanding - diluted 66,927 58,062
========= =========
Dividends per share - common stock $ 0.17 $ -
========= =========
See Notes to Consolidated Financial Statements
-4-
CONSOLIDATED INCOME STATEMENTS
GTECH HOLDINGS CORPORATION AND SUBSIDIARIES
(Unaudited)
Nine Months Ended
-------------------------
November 22, November 23,
2003 2002
------------ ------------
(Dollars in thousands,
except per share amounts)
Revenues:
Services $ 692,782 $ 643,119
Sales of products 78,972 65,717
--------- ---------
771,754 708,836
Costs and expenses:
Costs of services 391,593 402,999
Costs of sales 50,533 49,426
--------- ---------
442,126 452,425
--------- ---------
Gross profit 329,628 256,411
Selling, general and administrative 79,498 70,168
Research and development 41,422 24,575
--------- ---------
Operating expenses 120,920 94,743
--------- ---------
Operating income 208,708 161,668
Other income (expense):
Interest income 3,703 2,847
Equity in earnings of unconsolidated affiliates 6,120 3,363
Other income 3,337 1,912
Interest expense (6,997) (8,371)
--------- ---------
6,163 (249)
--------- ---------
Income before income taxes 214,871 161,419
Income taxes 79,502 61,340
--------- ---------
Net income $ 135,369 $ 100,079
========= =========
Basic earnings per share $ 2.34 $ 1.75
========= =========
Diluted earnings per share $ 2.12 $ 1.71
========= =========
Weighted average shares outstanding - basic 57,882 57,252
========= =========
Weighted average shares outstanding - diluted 64,356 58,529
========= =========
Dividends per share - common stock $ 0.34 $ -
========= =========
See Notes to Consolidated Financial Statements
-5-
CONSOLIDATED STATEMENTS OF CASH FLOWS
GTECH HOLDINGS CORPORATION AND SUBSIDIARIES
(Unaudited)
Nine Months Ended
---------------------------
November 22, November 23,
2003 2002
------------ ------------
(Dollars in thousands)
OPERATING ACTIVITIES
Net income $ 135,369 $ 100,079
Adjustments to reconcile net income to net cash provided by
operating activities:
Depreciation 81,449 101,858
Intangibles amortization 2,908 4,051
Tax benefit related to stock award plans 11,871 7,299
Non-cash gain from consolidation of West Greenwich Technology
Associates, L.P. (5,292) -
Termination of interest rate swaps - 11,357
Deferred income taxes provision - 1,130
Equity in earnings of unconsolidated affiliates, net of dividends received (263) 559
Other 6,943 5,351
Changes in operating assets and liabilities:
Trade accounts receivable 2,358 11,723
Inventories 22,879 14,944
Advance payments from customers 43,414 5,211
Other assets and liabilities 8,300 17,402
------------ ------------
NET CASH PROVIDED BY OPERATING ACTIVITIES 309,936 280,964
INVESTING ACTIVITIES
Purchases of systems, equipment and other assets relating to contracts (211,867) (131,221)
Acquisitions (net of cash acquired) (74,174) -
Refundable performance deposit (20,000) -
License fee (12,500) -
Other (9,691) (1,350)
------------ ------------
NET CASH USED FOR INVESTING ACTIVITIES (328,232) (132,571)
FINANCING ACTIVITIES
Net proceeds from issuance of long-term debt 252,527 -
Principal payments on long-term debt (31,688) (46,408)
Proceeds from stock options 22,068 15,842
Dividends paid (19,928) -
Purchases of treasury stock - (57,424)
Tender premiums and fees - (3,434)
Other (3,583) 2,926
------------ ------------
NET CASH PROVIDED BY (USED FOR) FINANCING ACTIVITIES 219,396 (88,498)
Effect of exchange rate changes on cash 3,262 2,519
------------ ------------
INCREASE IN CASH AND CASH EQUIVALENTS 204,362 62,414
Cash and cash equivalents at beginning of period 116,174 35,095
------------ ------------
CASH AND CASH EQUIVALENTS AT END OF PERIOD $ 320,536 $ 97,509
============ ============
See Notes to Consolidated Financial Statements
-6-
CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY - (Unaudited)
GTECH HOLDINGS CORPORATION AND SUBSIDIARIES
Accumulated
Additional Other
Outstanding Common Paid-in Comprehensive
Shares Stock Capital Income (Loss)
----------- -------- ----------- -------------
(Dollars in thousands)
Balance at February 22, 2003 56,638,331 $ 923 $ 235,266 $ (95,488)
Comprehensive income:
Net income - - - -
Other comprehensive income (loss), net of tax:
Foreign currency translation - - - 19,190
Unrecognized net loss on derivative instruments - - - (2,624)
Unrealized loss on investments - - - (15)
Comprehensive income
Cash dividends on common stock ($0.17 per share) - - - -
Shares issued to acquire Interlott Technologies, Inc. 717,565 - 20,622 -
Shares issued under employee stock purchase
and stock award plans 185,484 - - -
Shares issued upon exercise of stock options 1,523,626 - - -
Tax benefits related to stock award plans - - 11,871 -
---------- -------- ----------- -------------
Balance at November 22, 2003 59,065,006 $ 923 $ 267,759 $ (78,937)
========== ======== =========== =============
Retained Treasury
Earnings Stock Total
----------- ------------ ----------
(Dollars in thousands)
Balance at February 22, 2003 $ 684,653 $ (509,788) $ 315,566
Comprehensive income:
Net income 135,369 - 135,369
Other comprehensive income (loss), net of tax:
Foreign currency translation - - 19,190
Unrecognized net loss on derivative instruments - - (2,624)
Unrealized loss on investments - - (15)
----------
Comprehensive income 151,920
Cash dividends on common stock ($0.17 per share) (20,069) - (20,069)
Shares issued to acquire Interlott Technologies, Inc. - 10,212 30,834
Shares issued under employee stock purchase
and stock award plans 865 2,639 3,504
Shares issued upon exercise of stock options 386 21,682 22,068
Tax benefits related to stock award plans - - 11,871
----------- ------------ ----------
Balance at November 22, 2003 $ 801,204 $ (475,255) $ 515,694
=========== ============ ==========
See Notes to Consolidated Financial Statements
-7-
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
GTECH HOLDINGS CORPORATION AND SUBSIDIARIES
NOTE 1 - ORGANIZATION, BASIS OF PRESENTATION AND STOCK-BASED COMPENSATION PLANS
ORGANIZATION
GTECH Holdings Corporation ("Holdings") is a global information technology
company providing software, networks and professional services that power
high-performance, transaction processing solutions. When used in these notes,
the terms "Holdings", "the Company", "we", "our", and "us" refer to GTECH
Holdings Corporation and its consolidated subsidiaries, unless otherwise
specified. We have a single operating and reportable business segment, the
Transaction Processing segment. Our core market is the lottery industry, with a
growing presence in commercial services transaction processing. The accounting
policies of the Transaction Processing segment are the same as those described
in Note 1 - "Organization and Summary of Significant Accounting Policies" in our
Consolidated Financial Statements and footnotes included in our fiscal 2003
Annual Report on Form 10-K, as amended. Management evaluates the performance of
this segment based on operating income.
BASIS OF PRESENTATION
The accompanying unaudited consolidated financial statements of Holdings, the
parent of GTECH Corporation ("GTECH"), have been prepared in accordance with
generally accepted accounting principles ("GAAP") for interim financial
information and with the instructions to Form 10-Q and Article 10 of Regulation
S-X. They do not include all information and notes required by GAAP for complete
financial statements. In the opinion of management, all adjustments (consisting
of normal recurring accruals) considered necessary for a fair presentation have
been included. Operating results for the nine-month period ended November 22,
2003 are not necessarily indicative of the results that may be expected for the
full fiscal year ending February 28, 2004. The balance sheet at February 22,
2003 has been derived from the audited financial statements at that date. For
further information refer to the Consolidated Financial Statements and footnotes
included in our fiscal 2003 Annual Report on Form 10-K, as amended.
Certain amounts in our prior period financial statements have been reclassified
to conform to the current period presentation.
STOCK-BASED COMPENSATION PLANS
We follow Accounting Principles Board Opinion No. 25, "Accounting for Stock
Issued to Employees" and related Interpretations, in accounting for our
stock-based compensation plans and we have elected to continue to use the
intrinsic value-based method to account for stock option grants. We have adopted
the disclosure-only provisions of Statement of Financial Accounting Standards
No. 148, "Accounting for Stock-Based Compensation - Transition and Disclosure",
an amendment of Statement of Financial Accounting Standards No. 123.
Accordingly, no compensation expense has been recognized for our stock-based
compensation plans other than for restricted stock.
-8-
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)
NOTE 1 - ORGANIZATION, BASIS OF PRESENTATION AND STOCK-BASED COMPENSATION PLANS
(continued)
Had we elected to recognize compensation expense based upon the fair value at
the grant dates for awards under these plans, net income and earnings per share
would have been reduced to the pro forma amounts listed in the table below. The
fair value of each grant is estimated on the date of grant using the
Black-Scholes option pricing model.
Three Months Ended Nine Months Ended
---------------------------- ---------------------------
November 22, November 23, November 22, November 23,
2003 2002 2003 2002
------------ ------------ ------------ ------------
(Dollars and shares in thousands, except per share amounts)
Net income, as reported $ 45,867 $ 32,831 $ 135,369 $ 100,079
Deduct: Total stock-based compensation
expense determined under the fair value
method for all awards, net of related
tax effects (893) (1,862) (3,803) (5,293)
------------ ------------ ------------ ------------
Pro forma net income $ 44,974 $ 30,969 $ 131,566 $ 94,786
============ ============ ============ ============
Basic earnings per share:
As reported $ .78 $ .58 $ 2.34 $ 1.75
Pro forma .76 .54 2.27 1.66
Diluted earnings per share:
As reported $ .69 $ .57 $ 2.12 $ 1.71
Pro forma .68 .53 2.06 1.62
NOTE 2 - BUSINESS ACQUISITIONS
POLCARD S.A.
On May 28, 2003, we completed the acquisition of a controlling equity position
in PolCard S.A. ("PolCard"), for a purchase price, net of cash acquired, of
$35.9 million. PolCard is the largest debit and credit card merchant transaction
acquirer and processor in Poland. At August 23, 2003, PolCard's outstanding
equity was owned 66.5% by us, 33.2% by two funds managed by Innova Capital Sp. z
o.o. ("Innova"), a Warsaw-based private equity investment advisor, and 0.3% by
the Polish Bank Association, one of PolCard's previous owners. In September
2003, Innova exercised its rights under an option agreement to purchase from us,
3.7% of PolCard's equity for a purchase price of $2.3 million. Following the
exercise of this right, we now own 62.8% of PolCard's outstanding equity, while
the two funds managed by Innova own, in aggregate, 36.9% of PolCard's
outstanding equity, the fair value of which approximated $22.2 million. The
Polish Bank Association continues to own 0.3% of the outstanding equity of
PolCard. We have a fair value option to purchase Innova's interest in PolCard,
and Innova has the reciprocal right to sell its interest in PolCard to us at
fair value, during the period commencing approximately four and ending
approximately six years after closing.
-9-
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)
NOTE 2 - BUSINESS ACQUISITIONS (continued)
INTERLOTT TECHNOLOGIES, INC.
On September 18, 2003, we completed the acquisition of Interlott Technologies,
Inc. ("Interlott"), a leading provider of instant ticket vending machines for
the worldwide lottery industry. Interlott shareholders were given the
opportunity to elect to receive either $9.00 per share in cash or a number of
shares of Holdings common stock having a value of $9.00, or a combination of
both, subject to adjustment so that the aggregate consideration we paid was
48.5% in cash and 51.5% in Holdings common stock. The final exchange ratio of
0.2156 shares of Holdings common stock for every share of Interlott common stock
was determined based on the average closing price of $41.74 for Holdings common
stock for the 20 trading day period commencing August 14, 2003 through September
11, 2003. For purposes of purchase accounting, Holdings common stock was valued
at $42.97 per share using the average price of Holdings common stock two days
prior to the acquisition date in accordance with Emerging Issues Task Force
Issue No. 99-12, "Determination of the Measurement Date for the Market Price of
Acquirer Securities issued in a Purchase Business Combination". The aggregate
purchase price, including assumed debt, was as follows:
Aggregate
purchase price
--------------
(in millions)
Cash ($9.00 per share of Interlott common stock) $ 28.2
Cash payment to cancel outstanding stock options relating to Interlott
common stock 5.7
--------------
Cash purchase price 33.9
Issuance of 717,565 shares of Holdings common stock 30.8
--------------
Total aggregate purchase price 64.7
Cash payment to settle Interlott debt 22.5
--------------
$ 87.2
==============
The PolCard and Interlott acquisitions are individually and in the aggregate,
not material to our consolidated financial statements and accordingly, pro forma
financial information has not been presented. Neither acquisition required the
approval of our shareholders.
SPIELO MANUFACTURING INC.
On November 7, 2003, we entered into an agreement to acquire all of the shares
of privately-held Spielo Manufacturing Inc. ("Spielo"), a leading provider of
video lottery terminals and related products and services to the global gaming
industry. This agreement provides for us to pay a potential aggregate cash
purchase price of approximately $185 million, which includes a $150 million cash
payment at the closing and an earn-out amount of up to $35 million in the 18
months following the closing, which Spielo shareholders are entitled to receive
based upon Spielo achieving certain video lottery terminal installation
objectives in New York. Our obligation to complete this acquisition is subject
to securing regulatory and gaming license approvals, and satisfying certain
other closing conditions. Approval of this transaction by our shareholders is
not required. We expect the closing of the Spielo acquisition to be completed in
the second quarter of fiscal year 2005.
-10-
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)
NOTE 3 - INVENTORIES
November 22, February 22,
2003 2003
------------ ------------
(Dollars in thousands)
Inventories consist of:
Raw materials $ 7,328 $ 14,133
Work in progress 49,509 54,855
Finished goods 2,015 3,299
------------ ------------
$ 58,852 $ 72,287
============ ============
Inventories include amounts we manufacture or assemble for our long-term service
contracts and amounts related to product sales contracts. Work in progress at
November 22, 2003 and February 22, 2003, includes approximately $46.2 million
and $51.3 million, respectively, related to product sale contracts.
Amounts received from customers in advance of revenue recognition (primarily
related to product sale contracts included in work in progress above) totaled
$95.9 million and $52.4 million at November 22, 2003 and February 22, 2003,
respectively.
NOTE 4 - LICENSE FEE
In the first quarter of this fiscal year, we entered into a Master Contract with
the Rhode Island Lottery (the "Lottery") that amends our existing contracts with
the Lottery and grants us the right to be the exclusive provider of online,
instant ticket and video lottery central systems and services for the Lottery
during the 20-year term of the Master Contract for a $12.5 million up-front
license fee which we paid in July 2003. This license fee is included in Other
Assets in our Consolidated Balance Sheet at November 22, 2003 and will be
amortized as a reduction in service revenue on a straight-line basis over the
20-year term of the Master Contract.
The Master Contract is part of a comprehensive economic development package that
provides incentives for us to keep our world corporate headquarters and
manufacturing operations in Rhode Island. Under the terms of the Master
Contract, we are to invest (or cause to be invested) at least $100 million in
the State of Rhode Island, in the aggregate, by December 31, 2008. This
investment commitment includes the $12.5 million up-front license fee; new
online and video lottery related hardware, software and services; the
development of a new world corporate headquarters facility of at least 210,000
square feet in Providence, Rhode Island by December 31, 2006; and improvements
to our existing manufacturing facility in West Greenwich, Rhode Island. We have
agreed to employ at least 1,000 people full-time in Rhode Island by the end of
calendar year 2005 and maintain that level of employment thereafter. In the
event the State of Rhode Island takes certain actions which affect our financial
performance, we will be automatically released from the in-state employment
obligation. We currently plan to satisfy our obligation to invest (or cause to
be invested) at least $100 million in the State of Rhode Island by December 31,
2008 by investing: (i) approximately $23 million during fiscal 2004; (ii)
approximately $24 million during fiscal 2005; (iii) approximately $51 million
during fiscal 2006; and (iv) the balance during fiscal 2007. In addition,
in July 2003 we entered into a tax stabilization agreement (the "Agreement")
with the City of Providence (the "City"), whereby the City agreed to stabilize
the real estate and personal property taxes payable in connection with our new
world corporate headquarters facility in the City and the personal property
associated with such facility for 20 years. We also agreed to complete and
occupy the facility by December 31, 2006, employ 500 employees at the facility
by 2009, and we made certain commitments regarding our employment, purchasing
and education activities in the City. The Lottery may terminate the Master
Contract in the event that we fail to meet our obligations as stated above.
-11-
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)
NOTE 5- REFUNDABLE PERFORMANCE DEPOSIT
On September 23, 2003, we entered into a 12-year contract extension to provide
online lottery products and services to SAZKA, a.s. ("SAZKA"), the operator of
lottery and betting games in the Czech Republic. The contract extension will
commence on January 1, 2006 and expire on December 31, 2017. As part of the
agreement with SAZKA, we paid SAZKA a $20 million performance deposit that SAZKA
will repay upon achievement of certain milestones beginning in 2006, and is
scheduled to be fully repaid by 2010. This performance deposit is included in
Other Assets in our Consolidated Balance Sheet at November 22, 2003.
NOTE 6 - PRODUCT WARRANTIES
We offer a product warranty on all of our manufactured products (primarily
terminals and related peripherals) sold to our customers. Although we do not
have a standard product warranty, our typical warranty provides that we will
repair or replace defective products for a period of time (usually a minimum of
90 days) from the date revenue is recognized or from the date a product is
delivered and tested. We estimate product warranty costs that we expect to incur
during the warranty period and we record a charge to costs of sales for the
estimated warranty cost at the time the product sale is recorded. In determining
the appropriate warranty provision, consideration is given to historical
warranty cost information, the status of the terminal model in its life cycle
and current terminal performance. We periodically assess the adequacy of our
product warranty reserves and adjust them as necessary in the period when the
information necessary to make the adjustment becomes available.
We typically do not provide a product warranty on purchased products sold to our
customers but attempt to pass the manufacturer's warranty, if any, on to them.
A summary of product warranty activity, which is included in Accrued Expenses in
our Consolidated Balance Sheets, is as follows (dollars in thousands):
Balance at February 23, 2003 $ 437
Additional reserves 519
Charges incurred (40)
-----------
Balance at November 22, 2003 $ 916
===========
-12-
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)
NOTE 7 - LONG-TERM DEBT
November 22, February 22,
2003 2003
------------ ------------
(Dollars in thousands)
Long-term debt consists of:
4.75% Senior Notes due 2010 $ 249,622 $ -
1.75% Convertible Debentures due 2021 175,000 175,000
7.87% Series B Senior Notes due 2007 90,000 95,000
Loan on World Headquarters due 2007 27,933 -
Other 24,369 24,080
------------ ------------
566,924 294,080
Less current portion 9,012 6,992
------------ ------------
$ 557,912 $ 287,088
============ ============
We have an unsecured revolving credit facility of $300 million expiring in June
2006 (the "Credit Facility"). There were no outstanding borrowings under the
Credit Facility at November 22, 2003 or February 22, 2003. Up to $100 million of
the Credit Facility may be used for the issuance of letters of credit. As of
November 22, 2003, there was $290.0 million available for borrowing under the
Credit Facility, after considering $10.0 million of letters of credit issued and
outstanding.
In September 2003, we repurchased $5.0 million of our 7.87% Series B Senior
Notes due 2007 (the "Series B Senior Notes"). The Series B Senior Notes are
unsecured and are guaranteed by Holdings and certain of our subsidiaries and
interest on each series is payable semi-annually in arrears on May 15 and
November 15 of each year.
In October 2003, we issued in a private placement, $250 million of 4.75% Senior
Notes due 2010 (the "Senior Notes"). The Senior Notes are unsecured and are
guaranteed by certain of our subsidiaries and interest is payable semi-annually
in arrears on April 15 and October 15 of each year, beginning in April 2004. We
intend to use the proceeds from the offering for general corporate purposes,
which may include funding future acquisitions. In conjunction with this Senior
Note offering, in October 2003, we entered into three interest rate swaps for an
aggregate amount of $150 million, which effectively entitle us to exchange fixed
rate payments for variable rate payments for the period October 15, 2003 to
October 15, 2010.
NOTE 8 - COMMITMENTS AND CONTINGENCIES
See "Legal Proceedings" in Part II, Item 1 and "Management's Discussion and
Analysis of Financial Condition and Results of Operations" in Part I, Item 2 of
this report.
-13-
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)
NOTE 9 - GUARANTEES AND INDEMNIFICATIONS
PERFORMANCE AND OTHER BONDS
In connection with certain contracts and procurements, we have been required to
deliver performance bonds for the benefit of our customers and bid and
litigation bonds for the benefit of potential customers, respectively. These
bonds give the beneficiary the right to obtain payment and/or performance from
the issuer of the bond if the events set forth in the bond occur. In the case of
performance bonds, which generally have a term of one year, such events include
our failure to perform our obligations under the applicable contract. To obtain
these bonds, we are required to indemnify the issuers against the costs they
incur if a beneficiary exercises its rights under a bond. Historically, our
customers have not exercised their rights under these bonds and we do not
currently anticipate that they will do so. The following table provides
information related to potential commitments at November 22, 2003:
Total potential
commitments
---------------
(in thousands)
Performance bonds $ 164,813
Financial guarantees 7,294
All other bonds 9,137
---------------
$ 181,244
===============
LOTTERY TECHNOLOGY SERVICES INVESTMENT CORPORATION
We have a 44% interest in Lottery Technology Services Investment Corporation
("LTSIC"), which we account for using the equity method of accounting. LTSIC's
wholly owned subsidiary, Lottery Technology Services Corporation ("LTSC"),
provides equipment and services (which we supplied to LTSC), to the Bank of
Taipei. The Bank of Taipei holds the license to operate the Taiwan Public
Welfare Lottery.
In order to assist LTSC with the financing they required to enable them to
perform under their obligation to operate the Taiwan Public Welfare Lottery on
behalf of the Bank of Taipei, at November 22, 2003, we guaranteed $4.9 million
principal amount of loans made by an unrelated commercial lender to LTSC. The
loans have a maturity date of January 2007 and our guarantee expires in July
2007. We did not receive any consideration in exchange for our guarantees on
behalf of LTSC. Rather, these guarantees were issued in connection with the
formation of LTSC and LTSIC.
We are recognizing 56% of our product sales to, and service revenue from, LTSC.
The remaining 44% of product sales (and related cost) and service revenue, has
been deferred as a result of our equity interest in LTSIC and related guarantee
of LTSC's debt, respectively, and is principally included in Other Liabilities
in our Consolidated Balance Sheets at November 22, 2003 and February 22, 2003.
Product sale deferrals are being recognized ratably over the life of our
contract with LTSC and service revenue deferrals are being recognized as the
guaranteed debt is repaid. At November 22, 2003, deferred product gross profit
and deferred service revenue totaled $3.8 million and $6.7 million,
respectively.
TIMES SQUARED INCORPORATED
We guaranteed outstanding lease obligations of Times Squared Incorporated
("Times Squared") for which we received no monetary consideration. The amount
outstanding under the lease at November 22, 2003, was $2.4 million. Our
guarantee expires in December 2013. Times Squared is a nonprofit corporation
established to provide, among other things, secondary and high school level
educational programs. Times Squared operates a Charter School for Engineering,
Mathematics, Science and Technology in Providence, Rhode Island that serves
inner city children who aspire to careers in the sciences and technology.
-14-
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)
NOTE 9 - GUARANTEES AND INDEMNIFICATIONS (continued)
LOTTERY TECHNOLOGY ENTERPRISES
We have a 1% interest in Lottery Technology Enterprises ("LTE"), a joint venture
between us and District Enterprise for Lottery Technology Applications of
Washington, D.C. The joint venture agreement terminates on December 31, 2012.
LTE holds a 10-year contract (which expires in November 2009) with the District
of Columbia Lottery and Charitable Games Control Board. Under Washington, D.C.
law, by virtue of our 1% interest in LTE, we are jointly and severally liable,
with the other partner, for the acts of the joint venture.
GAMING ENTERTAINMENT (DELAWARE) L.L.C.
We have a 50% interest in Gaming Entertainment (Delaware) L.L.C. ("GED"). GED is
also owned 50% by a subsidiary of Full House Resorts, Inc. ("FHRI"). Pursuant to
a 1995 management agreement ("Agreement"), GED manages a casino for Harrington
Raceway, Inc. ("Harrington") and in return receives a percentage of gross
revenues and operating profits as defined in the Agreement. Along with FHRI, we
guarantee the payment of all amounts due Harrington under the Agreement. Our
guarantee expires on February 1, 2012 or upon expiration of the Delaware Horse
Racing Redevelopment Act. The consideration we receive in exchange for the
guarantee are the equity earnings from our ownership in GED.
NOTE 10 -- COMPREHENSIVE INCOME
The components of comprehensive income are as follows:
Three Months Ended Nine Months Ended
-------------------------- --------------------------
November 22, November 23, November 22, November 23,
2003 2002 2003 2002
------------ ------------ ------------ ------------
(Dollars in thousands)
Net income $ 45,867 $ 32,831 $ 135,369 $ 100,079
Other comprehensive income (loss),
net of tax
Foreign currency translation 14,086 10,814 19,190 4,907
Unrecognized net gain (loss) on
derivative instruments (1,576) 129 (2,624) (1,143)
Unrealized loss on investments (14) (32) (15) (104)
---------- --------- ---------- ----------
Comprehensive income $ 58,363 $ 43,742 $ 151,920 $ 103,739
========== ========= ========== ==========
-15-
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)
NOTE 11 - EARNINGS PER SHARE
The following table shows the computation of basic and diluted earnings per
share:
Three Months Ended Nine Months Ended
------------------------------- -------------------------------
November 22, November 23, November 22, November 23,
2003 2002 2003 2002
-------------- --------------- -------------- ---------------
(Dollars and shares in thousands, except per share amounts)
Numerator:
Net income (Numerator for basic earnings
per share) $ 45,867 $ 32,831 $ 135,369 $ 100,079
Effect of dilutive securities:
Interest expense on 1.75% Convertible
Debentures, net of tax 517 - 1,182 -
-------------- --------------- -------------- ---------------
Numerator for diluted earnings per share $ 46,384 $ 32,831 $ 136,551 $ 100,079
============== =============== ============== ===============
Denominator:
Denominator for basic earnings per share-
weighted-average shares 58,820 56,981 57,882 57,252
Effect of dilutive securities:
1.75% Convertible Debentures 6,364 - 4,806 -
Employee stock options 1,559 1,025 1,537 1,187
Unvested restricted and stock bonus
discount shares 184 56 131 90
-------------- --------------- -------------- ---------------
Dilutive potential common shares 8,107 1,081 6,474 1,277
Denominator for diluted earnings per
share-adjusted weighted-average shares
and assumed conversions 66,927 58,062 64,356 58,529
============== =============== ============== ===============
Basic earnings per share $ .78 $ .58 $ 2.34 $ 1.75
============== =============== ============== ===============
Diluted earnings per share $ .69 $ .57 $ 2.12 $ 1.71
============== =============== ============== ===============
Our 1.75% Convertible Debentures ("Debentures") are convertible at the option of
the holder into shares of our common stock at an initial conversion rate of
36.3636 shares of common stock per $1,000 principal amount of Debentures, which
is equivalent to an initial conversion price of approximately $27.50 per share.
The Debentures become convertible when, among other circumstances, the closing
price of our common stock is more than 120% of the conversion price
(approximately $33 per share) for at least 20 out of 30 consecutive trading days
prior to the date of surrender for conversion. There are a total of 6.4 million
shares issuable upon the conversion of the Debentures.
The Debentures were convertible for all 64 trading days in the quarter ended
November 22, 2003, and all 6.4 million shares were included in the computation
of diluted earnings per share. For the quarter ended November 23, 2002, none of
the 6.4 million shares were included in the computation of diluted earnings per
share because, in accordance with their terms, the Debentures had not yet become
convertible.
-16-
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)
NOTE 11 - EARNINGS PER SHARE (continued)
The Debentures were convertible for 144 out of 191 trading days during the nine
month period ended November 22, 2003, and approximately 4.8 million shares were
included in the computation of diluted earnings per share. For the nine months
ended November 23, 2002, none of the 6.4 million shares were included in the
computation of diluted earnings per share because, in accordance with their
terms, the Debentures had not yet become convertible.
NOTE 12 - CONSOLIDATION OF WEST GREENWICH TECHNOLOGY ASSOCIATES, L.P.
We have a 50% limited partnership interest in West Greenwich Technology
Associates, L.P. (the "Partnership"), which owns our world headquarters
facilities and leases them to us. The general partner of the Partnership is an
unrelated third party. Prior to the third quarter of fiscal 2004, we accounted
for the Partnership using the equity method of accounting. Beginning in the
third quarter of fiscal 2004, we consolidate the Partnership in accordance with
Financial Accounting Standards Board Interpretation No. 46, "Consolidation of
Variable Interest Entities", which requires the consolidation of a variable
interest entity (as defined) by its primary beneficiary. As a result, we
recorded our world headquarters facilities owned by the Partnership as an asset,
and the Partnership's debt obligation as a liability in our consolidated
financial statements. The adoption of this interpretation increased balance
sheet assets and liabilities by $30.0 million and $26.7 million, respectively,
and resulted in a one-time, non-cash, after-tax gain of $3.3 million. The
pre-tax gain of $5.3 million is recorded in Other Income in our consolidated
financial statements and not as a cumulative-effect adjustment because the gain
is not material to our consolidated financial statements.
NOTE 13 - INCOME TAXES
Our effective income tax rate is greater than the statutory rate primarily due
to state income taxes and certain expenses that are not deductible for income
tax purposes.
NOTE 14 - RECENT ACCOUNTING PRONOUNCEMENTS
In January 2003, the Financial Accounting Standards Board ("FASB") issued
Interpretation No. 46, "Consolidation of Variable Interest Entities" ("FIN 46"),
which requires the consolidation of a variable interest entity (as defined) by
its primary beneficiary. Primary beneficiaries are those companies that are
subject to a majority of the risk of loss or entitled to receive a majority of
the variable interest entity's residual returns, or both. In determining
whether it is the primary beneficiary of a variable interest entity, a company
with a variable interest must also treat a variable interest held by the
company's related parties in that same entity as its own interests. In December
2003, the FASB published a revision to FIN 46 to clarify some of the provisions
of FIN 46 and to exempt certain entities from its requirements. FIN 46, as
revised, applies to variable interest entities that are commonly referred to as
special-purpose entities for periods ending after December 15, 2003 (our fiscal
2004 fourth quarter) and for all other types of variable interest entities for
periods ending after March 15, 2004 (our fiscal 2005 first quarter). Earlier
application is permitted.
-17-
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)
NOTE 14 - RECENT ACCOUNTING PRONOUNCEMENTS (continued)
We have applied the provisions of FIN 46 to our 50% limited partnership interest
in West Greenwich Technology Associates, L.P. (the "Partnership"), which owns
our world headquarters facilities and leases them to us, resulting in the
consolidation of the Partnership in the third quarter of fiscal 2004. Refer to
Note 12 for detailed disclosures.
Our evaluation of the impact of FIN 46 on certain of our investments created
prior to February 1, 2003 is ongoing and is not expected to have a material
impact on our financial statements. If applicable, we would not be required to
apply FIN 46 to these investments until our fiscal 2005 first quarter.
NOTE 15 - SUPPLEMENTAL GUARANTOR/NON-GUARANTOR FINANCIAL INFORMATION
On December 18, 2001, Holdings (the "Parent Company") issued $175 million
principal amount of 1.75% Convertible Debentures due 2021 (the "Convertible
Debentures"). On October 9, 2003, the Parent Company issued $250 million
principal amount of 4.75% Senior Notes due 2010 (the "Senior Notes"). The
Convertible Debentures and Senior Notes are unsecured and unsubordinated
obligations of the Parent Company that are jointly and severally, fully and
unconditionally guaranteed by GTECH and three of its wholly-owned subsidiaries:
GTECH Rhode Island Corporation, GTECH Latin America Corporation and Interlott
Technologies, Inc. (collectively with GTECH, the "Guarantor Subsidiaries").
Condensed consolidating financial information is presented below.
Selling, general and administrative costs and research and development costs are
allocated to each subsidiary based on the ratio of the subsidiaries combined
service revenue and sales of products to consolidated revenues.
The Parent Company conducts business through its consolidated subsidiaries and
unconsolidated affiliates and has, as its only material asset, an investment in
GTECH. Equity in earnings of consolidated affiliates recorded by the Parent
Company includes the Parent Company's share of the after-tax earnings of GTECH.
Taxes payable and deferred income taxes are obligations of the subsidiaries.
Income tax expense related to both current and deferred income taxes are
allocated to each subsidiary based on our consolidated effective income tax
rates.
-18-
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)
NOTE 15 - SUPPLEMENTAL GUARANTOR/NON-GUARANTOR FINANCIAL INFORMATION (continued)
Condensed Consolidating Balance Sheets
November 22, 2003
Parent Guarantor Non-Guarantor Eliminating
Company Subsidiaries Subsidiaries Entries Consolidated
--------------- ------------- --------------- ------------- --------------
(Dollars in thousands)
Assets
Current Assets:
Cash and cash equivalents $ - $ 270,568 $ 49,968 $ - $ 320,536
Trade accounts receivable, net - 78,282 44,436 - 122,718
Due from subsidiaries and
affiliates - 38,706 - (38,706) -
Sales-type lease receivables - 3,591 3,697 - 7,288
Inventories - 45,344 18,449 (4,941) 58,852
Deferred income taxes - 24,700 4,710 - 29,410
Other current assets - 10,980 16,222 - 27,202
--------------- ------------- --------------- ------------- --------------
Total Current Assets - 472,171 137,482 (43,647) 566,006
Systems, Equipment and Other
Assets Relating to Contracts, net - 488,007 81,791 (7,868) 561,930
Investment in Subsidiaries and
Affiliates 515,694 151,833 - (667,527) -
Goodwill, net - 114,807 74,002 - 188,809
Other Assets - 89,841 79,391 - 169,232
--------------- ------------- --------------- ------------- --------------
Total Assets $ 515,694 $ 1,316,659 $ 372,666 $ (719,042) $ 1,485,977
=============== ============= =============== ============= ==============
Liabilities and Shareholders' Equity
Current Liabilities:
Accounts payable $ - $ 49,614 $ 24,557 $ - $ 74,171
Due to subsidiaries and affiliates - - 38,706 (38,706) -
Accrued expenses - 34,670 18,233 - 52,903
Employee compensation - 25,036 7,134 - 32,170
Advance payments from
customers - 43,138 52,718 - 95,856
Deferred revenue and advance
billings - 7,202 2,873 - 10,075
Income taxes payable - 51,690 4,382 - 56,072
Taxes other than income taxes - 14,522 13,495 - 28,017
Short term borrowings - - 2,379 - 2,379
Current portion of long-term debt - 3,537 5,475 - 9,012
-------------- ------------- --------------- ------------- --------------
Total Current Liabilities - 229,409 169,952 (38,706) 360,655
Long-Term Debt, less current
portion - 524,038 33,874 - 557,912
Other Liabilities - 34,709 17,007 - 51,716
Shareholders' Equity 515,694 528,503 151,833 (680,336) 515,694
--------------- ------------- --------------- ------------- --------------
Total Liabilities and
Shareholders' Equity $ 515,694 $ 1,316,659 $ 372,666 $ (719,042) $ 1,485,977
=============== ============= =============== ============= ==============
-19-
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)
NOTE 15 - SUPPLEMENTAL GUARANTOR/NON-GUARANTOR FINANCIAL INFORMATION (continued)
Condensed Consolidating Income Statements
Three Months Ended November 22, 2003
Parent Guarantor Non-Guarantor Eliminating
Company Subsidiaries Subsidiaries Entries Consolidated
--------------- ------------- --------------- ------------- --------------
(Dollars in thousands)
Revenues:
Services $ - $ 164,238 $ 66,987 $ - $ 231,225
Sales of products - 14,308 9,389 - 23,697
Intercompany sales and fees - 21,582 12,050 (33,632) -
--------------- ------------- --------------- ------------- --------------
- 200,128 88,426 (33,632) 254,922
Costs and expenses:
Costs of services - 93,176 39,667 (852) 131,991
Costs of sales - 8,851 4,252 (9) 13,094
Intercompany cost of sales
and fees - 16,285 5,796 (22,081) -
--------------- ------------- --------------- ------------- --------------
- 118,312 49,715 (22,942) 145,085
--------------- ------------- --------------- ------------- --------------
Gross profit - 81,816 38,711 (10,690) 109,837
Selling, general and administrative - 19,718 8,449 - 28,167
Research and development - 9,045 3,881 - 12,926
--------------- ------------- --------------- ------------- --------------
Operating expenses - 28,763 12,330 - 41,093
--------------- ------------- --------------- ------------- --------------
Operating income - 53,053 26,381 (10,690) 68,744
Other income (expense):
Interest income - 510 984 - 1,494
Equity in earnings of
unconsolidated affiliates - 430 1,070 - 1,500
Equity in earnings of
consolidated affiliates 45,867 18,038 - (63,905) -
Other income - 3,574 478 - 4,052
Interest expense - (2,705) (281) - (2,986)
--------------- ------------- --------------- ------------- --------------
45,867 19,847 2,251 (63,905) 4,060
--------------- ------------- --------------- ------------- --------------
Income before income taxes 45,867 72,900 28,632 (74,595) 72,804
Income taxes - 26,973 10,594 (10,630) 26,937
--------------- ------------- --------------- -------------- --------------
Net income $ 45,867 $ 45,927 $ 18,038 $ (63,965) $ 45,867
=============== ============= =============== ============= ==============
-20-
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)
NOTE 15 - SUPPLEMENTAL GUARANTOR/NON-GUARANTOR FINANCIAL INFORMATION (continued)
Condensed Consolidating Income Statements
Nine Months Ended November 22, 2003
Parent Guarantor Non-Guarantor Eliminating
Company Subsidiaries Subsidiaries Entries Consolidated
--------------- ------------- --------------- ------------- --------------
(Dollars in thousands)
Revenues:
Services $ - $ 503,436 $ 189,346 $ - $ 692,782
Sales of products - 34,393 44,579 - 78,972
Intercompany sales and fees - 66,924 33,983 (100,907) -
--------------- ------------- --------------- ------------- --------------
- 604,753 267,908 (100,907) 771,754
Costs and expenses:
Costs of services - 275,207 119,285 (2,899) 391,593
Costs of sales - 18,832 31,764 (63) 50,533
Intercompany cost of sales
and fees - 70,889 14,348 (85,237) -
--------------- ------------- --------------- ------------- --------------
- 364,928 165,397 (88,199) 442,126
--------------- ------------- --------------- ------------- --------------
Gross profit - 239,825 102,511 (12,708) 329,628
Selling, general and administrative - 55,404 24,094 - 79,498
Research and development - 28,860 12,562 - 41,422
--------------- ------------- --------------- ------------- --------------
Operating expenses - 84,264 36,656 - 120,920
--------------- ------------- --------------- ------------- --------------
Operating income - 155,561 65,855 (12,708) 208,708
Other income (expense):
Interest income - 1,070 2,633 - 3,703
Equity in earnings of
unconsolidated affiliates - 3,001 3,119 - 6,120
Equity in earnings of
consolidated affiliates 135,369 42,551 - (177,920) -
Other income (expense) - 6,303 (2,966) - 3,337
Interest expense - (5,897) (1,100) - (6,997)
--------------- ------------- --------------- ------------- --------------
135,369 47,028 1,686 (177,920) 6,163
--------------- ------------- --------------- ------------- --------------
Income before income taxes 135,369 202,589 67,541 (190,628) 214,871
Income taxes - 74,958 24,990 (20,446) 79,502
--------------- ------------- --------------- ------------- --------------
Net income $ 135,369 $ 127,631 $ 42,551 $ (170,182) $ 135,369
=============== ============= =============== ============= ==============
-21-
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)
NOTE 15 - SUPPLEMENTAL GUARANTOR/NON-GUARANTOR FINANCIAL INFORMATION (continued)
Condensed Consolidating Income Statements
Three Months Ended November 23, 2002
Parent Guarantor Non-Guarantor Eliminating
Company Subsidiaries Subsidiaries Entries Consolidated
--------------- ------------- --------------- ------------- --------------
(Dollars in thousands)
Revenues:
Services $ - $ 156,069 $ 51,715 $ - $ 207,784
Sales of products - 43,266 5,416 - 48,682
Intercompany sales and fees - 19,858 11,956 (31,814) -
--------------- ------------- --------------- ------------- --------------
- 219,193 69,087 (31,814) 256,466
Costs and expenses:
Costs of services - 93,275 38,846 (2,999) 129,122
Costs of sales - 35,222 3,968 (120) 39,070
Intercompany cost of sales
and fees - 14,835 5,739 (20,574) -
--------------- ------------- --------------- ------------- --------------
- 143,332 48,553 (23,693) 168,192
--------------- ------------- --------------- ------------- --------------
Gross profit - 75,861 20,534 (8,121) 88,274
Selling, general and administrative - 18,958 5,400 - 24,358
Research and development - 8,421 2,482 - 10,903
--------------- ------------- --------------- ------------- --------------
Operating expenses - 27,379 7,882 - 35,261
--------------- ------------- --------------- ------------- --------------
Operating income - 48,482 12,652 (8,121) 53,013
Other income (expense):
Interest income - 514 514 - 1,028
Equity in earnings of
unconsolidated affiliates - 289 1,117 - 1,406
Equity in earnings of
consolidated affiliates 32,831 10,976 - (43,807) -
Other income (expense) - (3,562) 3,796 - 234
Interest expense - (2,351) (377) - (2,728)
--------------- ------------- --------------- ------------- --------------
32,831 5,866 5,050 (43,807) (60)
--------------- ------------- --------------- ------------- --------------
Income before income taxes 32,831 54,348 17,702 (51,928) 52,953
Income taxes - 20,652 6,726 (7,256) 20,122
--------------- ------------- --------------- ------------- --------------
Net income $ 32,831 $ 33,696 $ 10,976 $ (44,672) $ 32,831
=============== ============= =============== ============= ==============
-22-
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)
NOTE 15 - SUPPLEMENTAL GUARANTOR/NON-GUARANTOR FINANCIAL INFORMATION\
(continued)
Condensed Consolidating Income Statements
Nine Months Ended November 23, 2002
Parent Guarantor Non-Guarantor Eliminating
Company Subsidiaries Subsidiaries Entries Consolidated
-------------- ------------ --------------- ------------- -------------
(Dollars in thousands)
Revenues:
Services $ - $ 487,222 $ 155,897 $ - $ 643,119
Sales of products - 53,401 12,316 - 65,717
Intercompany sales and fees - 68,642 36,866 (105,508) -
------------- ------------ --------------- -------------- -------------
- 609,265 205,079 (105,508) 708,836
Costs and expenses:
Costs of services - 287,529 123,885 (8,415) 402,999
Costs of sales - 41,078 8,783 (435) 49,426
Intercompany cost of sales
and fees - 43,619 13,026 (56,645) -
------------- ----------- --------------- -------------- -------------
- 372,226 145,694 (65,495) 452,425
------------- ----------- --------------- -------------- -------------
Gross profit - 237,039 59,385 (40,013) 256,411
Selling, general and administrative - 53,515 16,653 - 70,168
Research and development - 18,738 5,837 - 24,575
------------- ----------- --------------- -------------- -------------
Operating expenses - 72,253 22,490 - 94,743
------------- ----------- --------------- -------------- -------------
Operating income - 164,786 36,895 (40,013) 161,668
Other income (expense):
Interest income - 1,263 1,584 - 2,847
Equity in earnings of
unconsolidated affiliates - 585 2,778 - 3,363
Equity in earnings of
consolidated affiliates 100,079 29,206 - (129,285) -
Other income (expense) - (5,233) 7,145 - 1,912
Interest expense - (7,075) (1,296) - (8,371)
------------- ----------- --------------- -------------- -------------
100,079 18,746 10,211 (129,285) (249)
------------- ----------- --------------- -------------- -------------
Income before income taxes 100,079 183,532 47,106 (169,298) 161,419
Income taxes - 69,742 17,900 (26,302) 61,340
------------- ----------- --------------- -------------- -------------
Net income $ 100,079 $ 113,790 $ 29,206 $ (142,996) $ 100,079
============= =========== =============== ============== =============
-23-
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)
NOTE 15 - SUPPLEMENTAL GUARANTOR/NON-GUARANTOR FINANCIAL INFORMATION
(continued)
Condensed Consolidating Statements of Cash Flows
Nine Months Ended November 22, 2003
Parent Guarantor Non-Guarantor Eliminating
Company Subsidiaries Subsidiaries Entries Consolidated
--------------- ------------- --------------- ------------- --------------
(Dollars in thousands)
Net cash provided by operating
activities $ - $ 253,810 $ 56,508 $ (382) $ 309,936
Investing Activities
Purchases of systems, equipment
and other assets relating to
contracts - (200,454) (11,795) 382 (211,867)
Acquisitions (net of cash acquired) - (40,426) (33,748) - (74,174)
Refundable performance deposit - - (20,000) - (20,000)
License fee - (12,500) - - (12,500)
Other - (9,691) - - (9,691)
--------------- ------------- --------------- ------------- --------------
Net cash used for investing
activities - (263,071) (65,543) 382 (328,232)
Financing Activities
Net proceeds from issuance
of long-term debt - 251,006 1,521 - 252,527
Principal payments on long-term
debt - (27,759) (3,929) - (31,688)
Proceeds from stock options 22,068 - - - 22,068
Dividends paid (19,928) - - - (19,928)
Intercompany capital transactions (3,222) (30,526) 33,748 - -
Other 1,082 (1,819) (2,846) - (3,583)
--------------- ------------- --------------- ------------- --------------
Net cash provided by (used for)
financing activities - 190,902 28,494 - 219,396
Effect of exchange rate changes
on cash - 188 3,074 - 3,262
--------------- ------------- --------------- ------------- --------------
Increase in cash and cash
equivalents - 181,829 22,533 - 204,362
Cash and cash equivalents at
beginning of period - 88,739 27,435 - 116,174
--------------- ------------- --------------- ------------- --------------
Cash and cash equivalents at end
of period $ - $ 270,568 $ 49,968 $ - $ 320,536
=============== ============= =============== ============= ==============
-24-
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)
NOTE 15 - SUPPLEMENTAL GUARANTOR/NON-GUARANTOR FINANCIAL INFORMATION
(continued)
Condensed Consolidating Statements of Cash Flows
Nine Months Ended November 22, 2003
Parent Guarantor Non-Guarantor Eliminating
Company Subsidiaries Subsidiaries Entries Consolidated
--------------- ------------- --------------- ------------- --------------
(Dollars in thousands)
Net cash provided by operating
activities $ - $ 265,956 $ 14,922 $ 86 $ 280,964
Investing Activities
Purchases of systems, equipment
and other assets relating to
contracts - (121,396) (9,739) (86) (131,221)
Other - (1,350) - - (1,350)
--------------- ------------- --------------- ------------- --------------
Net cash used for investing
activities - (122,746) (9,739) (86) (132,571)
Financing Activities
Principal payments on long-term
debt - (42,989) (3,419) - (46,408)
Purchases of treasury stock (57,424) - - - (57,424)
Proceeds from stock options 15,842 - - - 15,842
Tender premiums and fees - (3,434) - - (3,434)
Intercompany capital transactions 40,698 (40,698) - - -
Other 884 (120) 2,162 - 2,926
--------------- ------------- --------------- ------------- --------------
Net cash used for financing
activities - (87,241) (1,257) - (88,498)
Effect of exchange rate changes
on cash - (1,767) 4,286 - 2,519
--------------- ------------- --------------- ------------- --------------
Increase in cash and
cash equivalents - 54,202 8,212 - 62,414
Cash and cash equivalents at
beginning of period - 25,865 9,230 - 35,095
--------------- ------------- --------------- ------------- --------------
Cash and cash equivalents at end
of period $ - $ 80,067 $ 17,442 $ - $ 97,509
=============== ============= =============== ============= ==============
-25-
Item 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
The terms "Holdings", "the Company", "we", "our" and "us" refer to GTECH
Holdings Corporation and its consolidated subsidiaries, unless otherwise
specified.
Statements contained in this section and elsewhere in this report which are not
historical statements constitute "forward-looking statements" within the meaning
of Section 27A of the Securities Act and Section 21E of the Securities Exchange
Act of 1934. Generally, the words "believe", "expect", "estimate", "anticipate",
"will", "may", "could", "plan", "continue" and similar expressions identify
forward-looking statements. Such statements may include, without limitation,
statements relating to:
- the future prospects for and stability of the lottery industry and
other businesses in which we are engaged or expect to be engaged;
- our future operating and financial performance (including, without
limitation, expected future growth in revenues, profit margins and
earnings per share);
- our ability to retain existing contracts and to obtain and retain new
contracts;
- the future performance of comparable investment opportunities; and
- the results and effects of legal proceedings and investigations.
These forward-looking statements reflect management's assessment based on
information currently available, but are not guarantees and are subject to risks
and uncertainties that could cause actual results to differ materially from
those contemplated in the forward-looking statements. These risks and
uncertainties include the following:
- government regulations and other actions affecting the online lottery
industry could have a negative effect on our business and sales;
- our lottery operations are dependent upon our continued ability to
retain and extend our existing contracts and win new contracts;
- slow growth or declines in sales of online lottery goods and services
and other transaction processing services could lead to lower revenues
and net income;
- our results of operations are exposed to foreign currency exchange
rate fluctuations, which could result in lower revenues, net income
and cash flows when such results are translated into U.S. dollar
accounts;
- we derive close to half of our revenues from foreign jurisdictions
(including over ten percent from our Brazilian operations) and are
subject to the economic, political and social instability risks of
doing business in foreign jurisdictions;
- we have a concentrated customer base and the loss of any of these
customers (or lower sales from any of these customers) could lead to
lower revenues;
- our quarterly operating results may fluctuate significantly, including
as a result of variations in the amount and timing of product sales,
the occurrence of large jackpots in lotteries (which increase the
amount wagered and our revenue) and expenses incurred in connection
with lottery start-ups;
- we operate in a highly competitive environment and increased
competition may cause us to experience lower net income or to lose
contracts;
- we are subject to substantial penalties for failure to perform under
our contracts;
- we may not be able to respond in a timely manner to technological
changes or to satisfy future technology demands of our customers, in
which case we may fall behind our competitors;
- if we are unable to manage potential risks related to acquisitions,
our business and growth prospects could suffer;
- expansion of the gaming industry faces opposition which could limit
our access to new or existing markets to the detriment of our
business;
- our business prospects and future success depend upon our ability to
attract and retain qualified employees;
-26-
- our business prospects and future success rely heavily upon the
integrity of our employees and executives and the security of our
systems;
- our dependence on certain suppliers creates a risk of implementation
delays if the supply contract is terminated or breached, and any
delays may result in substantial penalties;
- our non-lottery ventures, which are an increasingly important aspect
of our business, may fail;
- we may not be able to successfully integrate the operations of
companies that we acquire into our business, and may thereby fail to
realize the strategic and financial benefits that we had expected from
such acquisitions;
- we may be subject to adverse determinations in pending legal
proceedings, which could involve substantial monetary judgments or
reputational damage; and
- other risks and uncertainties set forth below and elsewhere in this
report, in our fiscal 2003 Form 10-K, as amended, and in our
subsequent press releases and Form 10-Q's and other reports and
filings with the Securities and Exchange Commission.
The foregoing list of important factors is not all-inclusive.
General
We operate on a 52 or 53-week fiscal year ending on the last Saturday in
February and fiscal 2004 ends on February 28, 2004. Fiscal 2004 is a 53-week
year and we will include the extra week in our fourth quarter ending February
28, 2004.
We have derived substantially all of our revenues from the rendering of services
and the sale or supply of computerized online lottery systems and components to
government-authorized lotteries. Our service revenues are derived primarily from
lottery service contracts, which are typically at least five years in duration,
and generally provide compensation to us based upon a percentage of a lottery's
gross online lottery sales. These percentages vary depending on the size of the
lottery and the scope of services provided to the lottery. We derive product
sale revenues primarily from the installation of new online lottery systems,
installation of new software and sales of lottery terminals and equipment in
connection with the expansion of existing lottery systems. Our product margins
fluctuate depending on the mix, volume and timing of product sale contracts. The
size and timing of these transactions have resulted in variability in product
sale revenues from period to period. We currently anticipate that product sales
during fiscal 2004 will be in the range of $105 million to $110 million.
We continue to evaluate a variety of opportunities to broaden our offerings of
high-volume transaction processing services outside of our core market of
providing online lottery services, such as the processing and transmission of
commercial, non-lottery transactions including bill payments, electronic tax
payments, utility payments, prepaid cellular telephone recharges and
retail-based programs such as gift cards. Currently, our networks in Brazil,
Chile, the Czech Republic and Jamaica process bill payments and other commercial
service transactions. In addition, in May 2003 we acquired PolCard, the largest
debit and credit card merchant transaction acquirer and processor in Poland. In
the near term, we expect to concentrate our efforts to grow commercial service
revenues in Brazil, Poland, the United Kingdom and Turkey. While our goal is to
leverage our technology, infrastructure and relationships to drive growth in
commercial services, if, in the course of pursuing these opportunities, we see a
chance to gain access to certain markets through the acquisition of existing
businesses, we may consider making such acquisitions.
-27-
Our business is highly regulated, and the competition to secure new government
contracts is often intense. From time to time, competitors challenge our
contract awards and there have been, and may continue to be, investigations of
various types, including grand jury investigations conducted by governmental
authorities into possible improprieties and wrongdoing in connection with
efforts to obtain and/or the awarding of lottery contracts and related matters.
In light of the fact that such investigations frequently are conducted in
secret, we may not necessarily know of the existence of an investigation which
might involve us. Because our reputation for integrity is an important factor in
our business dealings with lottery and other governmental agencies, a
governmental allegation or a finding of improper conduct on our part or
attributable to us in any manner could have a material adverse effect on our
business, including our ability to retain existing contracts or to obtain new or
renewal contracts. In addition, continuing adverse publicity resulting from
these investigations and related matters could have a material adverse effect on
our reputation and business. See the following for further information
concerning these matters and other contingencies:
- "Legal Proceedings" in Part II, Item 1 in this report;
- "Legal Proceedings" in Part II, Item 1 in our Quarterly Report for the
quarterly period ended May 24, 2003;
- Part I, Item 1 - "Certain Factors That May Affect Future Performance -
Government regulations and other actions affecting the online lottery
industry could have a negative effect on our business" in our fiscal
2003 Annual Report on Form 10-K, as amended;
- Part I, Item 3 - "Legal Proceedings" in our fiscal 2003 Annual Report
on Form 10-K, as amended;
- Note 11 to the Consolidated Financial Statements in our fiscal 2003
Annual Report on Form 10-K, as amended
We are a global business and we derive a substantial portion of our revenue from
our operations outside the United States. In particular, in fiscal 2003, we
derived 49.2% of our revenues from international operations and 10.3% of our
revenues from our Brazilian operations alone (including 9.8% of our revenues
from Caixa Economica Federal, the operator of Brazil's National Lottery, our
largest customer in fiscal 2003 based on annual revenues). In addition, a
substantial portion of our assets, primarily consisting of equipment we use to
operate online lottery systems for our customers, are held outside of the United
States. We are also exposed to more general risks of international operations,
including increased governmental regulation of the online lottery industry in
the markets where we operate; exchange controls or other currency restrictions;
and significant political instability.
Significant Contract Bids and Extensions
A majority of our revenues and cash flow is derived from our portfolio of
long-term online lottery service contracts, each of which in the ordinary course
of our business is periodically the subject of competitive procurement or
renegotiation. In the third quarter of fiscal 2004, we continued to execute
against our growth strategy by signing new contracts and contract extensions
both domestically and abroad.
During the third quarter of fiscal 2004, following public, competitive
procurements, we were selected by both the Florida Lottery and Tennessee
Education Lottery Corporation to supply new online lottery systems, lottery
terminals, and related telecommunications networks in each of those respective
states. On November 26, 2003 (after the close of the third quarter of this
fiscal year), we signed a six-year integrated services contract with the Florida
Lottery which is expected to commence on February 1, 2005 and includes two,
two-year extension options. In Tennessee, the proposed seven-year integrated
services contract is expected to commence on February 10, 2004 and does not
include any extension options. In addition, during the third quarter of fiscal
2004, we signed a 12-year contract extension to provide online lottery products
and services to SAZKA a.s., the operator of lottery and betting games in the
Czech Republic and we also extended our relationship with lottery customers in
Denmark and Portugal.
-28-
In December 2003 (after the close of our fiscal 2004 third quarter), following a
public, competitive procurement, we signed a 10-year integrated services
contract to provide online, instant and passive lottery technology and
management services in Sri Lanka, which includes a five-year extension option.
We anticipate launching the new system in mid-2004.
Over the past several fiscal years, contract renewal and extension rates in the
United States have generally been lower than existing contract rates due to a
number of factors, including the substantial growth of lottery sales during the
latter part of the 1990's and calendar year 2002, reductions in the cost of
technology and telecommunications services, and general market and competitive
dynamics. In anticipation and response to these trends, beginning in fiscal
2001, we began the implementation of our new Enterprise Series-led technology
strategy combined with the implementation of a number of ongoing cost savings
initiatives and efficiency improvement programs designed to enable us to
maintain our market leadership in the lottery industry.
Recent Developments
POLCARD S.A.
On May 28, 2003, we completed the acquisition of a controlling equity position
in PolCard S.A. ("PolCard"), for a purchase price, net of cash acquired, of
$35.9 million. PolCard is the largest debit and credit card merchant transaction
acquirer and processor in Poland. At August 23, 2003, PolCard's outstanding
equity was owned 66.5% by us, 33.2% by two funds managed by Innova Capital Sp. z
o.o. ("Innova"), a Warsaw-based private equity investment advisor, and 0.3% by
the Polish Bank Association, one of PolCard's previous owners. In September
2003, Innova exercised its rights under an option agreement to purchase from us,
3.7% of PolCard's equity for a purchase price of $2.3 million. Following the
exercise of this right, we now own 62.8% of PolCard's outstanding equity, while
the two funds managed by Innova own, in aggregate, 36.9% of PolCard's
outstanding equity, the fair value of which approximated $22.2 million. The
Polish Bank Association continues to own 0.3% of the outstanding equity of
PolCard. We have a fair value option to purchase Innova's interest in PolCard,
and Innova has the reciprocal right to sell its interest in PolCard to us at
fair value, during the period commencing approximately four and ending
approximately six years after closing.
INTERLOTT TECHNOLOGIES, INC.
On September 18, 2003, we completed the acquisition of Interlott Technologies,
Inc. ("Interlott"), a leading provider of instant ticket vending machines for
the worldwide lottery industry. Interlott shareholders were given the
opportunity to elect to receive either $9.00 per share in cash or a number of
shares of Holdings common stock having a value of $9.00, or a combination of
both, subject to adjustment so that the aggregate consideration we paid was
48.5% in cash and 51.5% in Holdings common stock. The final exchange ratio of
0.2156 shares of Holdings common stock for every share of Interlott common stock
was determined based on the average closing price of $41.74 for Holdings common
stock for the 20 trading day period commencing August 14, 2003 through September
11, 2003. For purposes of purchase accounting, Holdings common stock was valued
at $42.97 per share using the average price of Holdings common stock two days
prior to the acquisition date in accordance with Emerging Issues Task Force
Issue No. 99-12, "Determination of the Measurement Date for the Market Price of
Acquirer Securities issued in a Purchase Business Combination". The aggregate
purchase price, including assumed debt, was as follows:
-29-
Aggregate
purchase price
--------------
(in millions)
Cash ($9.00 per share of Interlott common stock) $ 28.2
Cash payment to cancel outstanding stock options relating to Interlott
common stock 5.7
--------------
Cash purchase price 33.9
Issuance of 717,565 shares of Holdings common stock 30.8
--------------
Total aggregate purchase price 64.7
Cash payment to settle Interlott debt 22.5
--------------
$ 87.2
==============
The PolCard and Interlott acquisitions did not require the approval of our
shareholders.
SPIELO MANUFACTURING INC.
On November 7, 2003, we entered into an agreement to acquire all of the shares
of privately-held Spielo Manufacturing Inc. ("Spielo"), a leading provider of
video lottery terminals and related products and services to the global gaming
industry. This agreement provides for us to pay a potential aggregate cash
purchase price of approximately $185 million, which includes a $150 million cash
payment at the closing and an earn-out amount of up to $35 million in the 18
months following the closing, which Spielo shareholders are entitled to receive
based upon Spielo achieving certain video lottery terminal installation
objectives in New York. Our obligation to complete this acquisition is subject
to securing regulatory and gaming license approvals, and satisfying certain
other closing conditions. Approval of this transaction by our shareholders is
not required. We expect the closing of the Spielo acquisition to be completed in
the second quarter of fiscal year 2005.
DIVIDEND
On October 31, 2003, we paid our second quarterly cash dividend of $0.17 per
share to shareholders of record as of October 15, 2003, for a total of $10.0
million.
Critical Accounting Policies
We have identified the accounting policies listed below that we believe are most
critical to our financial condition and results of operations, and that require
management's most difficult, subjective and complex judgments in estimating the
effect of inherent uncertainties. This section should be read in conjunction
with Note 1 to our Consolidated Financial Statements included in our fiscal 2003
Annual Report on Form 10-K, as amended, which includes other significant
accounting policies.
REVENUE RECOGNITION
Amounts received from customers in advance of revenue recognition are recorded
in Advance Payments from Customers in our Consolidated Balance Sheets. We record
liquidated damages (which equaled 0.47%, 0.14% and 0.47% of our total revenues
in fiscal 2003, 2002 and 2001, respectively) as a reduction of revenue in the
period they become probable and estimable.
Service revenues from commercial transaction processing services are recorded
based on the net amount retained, which is the amount billed to our customer
less the amount paid to our suppliers, in accordance with Emerging Issues Task
Force Issue No. 99-19, "Reporting Revenue Gross as a Principal Versus Net as an
Agent".
-30-
We generally conduct business under one of three types of contractual
arrangements: Product Sales Contracts, Operating Contracts and Facilities
Management Contracts.
PRODUCT SALES CONTRACTS
Under Product Sales Contracts, we construct, sell, deliver and install a turnkey
online lottery system ("lottery system") or lottery equipment and license the
computer software for a fixed price, and the lottery authority subsequently
operates the lottery system.
Because Product Sales Contracts include significant customization and
modification and other services prior to customer acceptance that are considered
essential to the lottery software inherent in our lottery systems, revenue is
recognized using contract accounting. Under contract accounting, amounts due to
us, and costs incurred by us in constructing the lottery system, prior to
customer acceptance, are deferred. Revenue attributable to the lottery system is
recognized upon customer acceptance as long as there are no substantial doubts
regarding collectibility (the completed contract method of accounting).
In certain Product Sale Contracts (primarily the sale of lottery terminals), we
are not responsible for installation. In these cases, we recognize revenue when
the four basic revenue recognition criteria of SEC Staff Accounting Bulletin 101
have been met.
1. Persuasive evidence of an arrangement exists - Revenue is only
recognized if a signed contract or legally enforceable purchase order
is obtained.
2. Delivery has occurred or services have been rendered - Revenue is only
recognized if appropriate evidence of delivery is obtained and once any
customer acceptance criteria have been met.
3. The seller's price to the buyer is fixed or determinable - Revenue is
only recognized if the sales price is fixed and determinable in the
signed contract or legally enforceable purchase order.
4. Collectibility is reasonably assured - Revenue is only recognized when
there are no significant doubts regarding the collectibility of the
amounts due from the customer.
Revenues received under Product Sale Contracts are classified as Sales of
Products in our Consolidated Income Statements.
OPERATING CONTRACTS
Under Operating Contracts, we generally construct, install and operate the
lottery system, but sell and transfer full title and interest in the lottery
system to the customer for a fixed fee. Fees paid to us for ongoing services and
the licensing of the computer software are generally variable and are based on a
percentage of a lottery's gross online and instant lottery sales.
Because Operating Contracts include significant customization and modification
and other services prior to customer acceptance that are considered essential to
the lottery software inherent in our lottery systems, revenue is recognized
using contract accounting. Under contract accounting, amounts due to us, and
costs incurred by us in constructing the lottery system, prior to customer
acceptance, are deferred. Revenue attributable to the lottery system is
recognized upon customer acceptance as long as there are no substantial doubts
regarding collectibility (the completed contract method of accounting) and are
classified as Sales of Products in our Consolidated Income Statements. Ongoing
service and license fees are recognized as revenue in the period earned and are
classified as Service Revenue in our Consolidated Income Statements.
We have not entered into any new Operating Contracts in the last three fiscal
years. Additionally, Operating Contract revenue accounted for less than 2% of
our consolidated revenue during fiscal 2003. These types of contractual
arrangements have diminished in importance and we expect similar levels of
revenue in the future.
-31-
FACILITIES MANAGEMENT CONTRACTS
Under typical Facilities Management Contracts, we construct, install and operate
the lottery system, and retain ownership of the lottery system. These contracts
generally provide for a variable amount of monthly or weekly service fees paid
to us directly from the lottery authority based on a percentage of a lottery's
gross online and instant lottery sales. These fees are recognized as revenue in
the period earned and are classified as Service Revenue in our Consolidated
Income Statements.
RECEIVABLES AND INVENTORY RESERVES
We evaluate the collectibility of trade accounts and sales-type lease
receivables on a customer-by-customer basis and we believe our reserves are
adequate; however, if economic circumstances change significantly resulting in a
major customer's inability or unwillingness to meet its financial obligations to
us, original estimates of the recoverability of amounts due to us could be
reduced by significant amounts requiring additional reserves.
Inventories are stated at the lower of cost (first-in, first-out method) or
market. Inventories include amounts related to products we manufacture or
assemble for our long-term service contracts, which are transferred to Systems,
Equipment and Other Assets Relating to Contracts in our Consolidated Balance
Sheets upon shipment. Inventories also include amounts related to product sales
contracts, including product sales under long-term contracts. We regularly
review inventory quantities on hand and record provisions for potentially
obsolete or slow-moving inventory based primarily on our estimated forecast of
product demand and production requirements. We believe our reserves are
adequate; however, should future sales forecasts change, our original estimates
of obsolescence could increase by a significant amount requiring additional
reserves.
IMPAIRMENT OF GOODWILL
We perform a test for the impairment of goodwill annually, during our fiscal
third quarter, or more frequently if events or circumstances indicate that
goodwill may be impaired. Because we have a single operating and reportable
business segment (the Transaction Processing Segment), we perform this test by
comparing the fair value of the Transaction Processing Segment with its book
value, including goodwill. If the fair value of the Transaction Processing
Segment exceeds its book value, goodwill is not impaired. If the book value
exceeds the fair value, we would calculate the potential impairment loss by
comparing the implied fair value of goodwill with the book value. If the implied
goodwill is less than the book value, a write-down would be recorded.
IMPAIRMENT OF LONG-LIVED ASSETS
We periodically evaluate the recoverability of long-lived assets whenever
indicators of impairment are present. Indicators of impairment include such
items as declines in revenues and earnings or cash flows or material adverse
changes in the economic or political stability of a particular country, which
may indicate that the carrying amount of an asset is not recoverable. If facts
and circumstances indicate that our long-lived assets may be impaired, the
estimated future undiscounted cash flows associated with these long-lived assets
would be compared to their carrying amounts to determine if a write-down to fair
value is necessary.
-32-
Consolidation of West Greenwich Technology Associates, L.P.
We have a 50% limited partnership interest in West Greenwich Technology
Associates, L.P. (the "Partnership"), which owns our world headquarters
facilities and leases them to us. The general partner of the Partnership is an
unrelated third party. Prior to the third quarter of fiscal 2004, we accounted
for the Partnership using the equity method of accounting. Beginning in the
third quarter of fiscal 2004, we consolidate the Partnership in accordance with
Financial Accounting Standards Board Interpretation No. 46, "Consolidation of
Variable Interest Entities", which requires the consolidation of a variable
interest entity (as defined) by its primary beneficiary. As a result, we
recorded our world headquarters facilities owned by the Partnership as an asset,
and the Partnership's debt obligation as a liability in our consolidated
financial statements. The adoption of this interpretation increased balance
sheet assets and liabilities by $30.0 million and $26.7 million, respectively,
and resulted in a one-time, non-cash, after-tax gain of $3.3. The pre-tax gain
of $5.3 million is recorded in Other Income in our consolidated financial
statements and not as a cumulative-effect adjustment because the gain is not
material to our consolidated financial statements.
Effect of Recent Accounting Pronouncements
In January 2003, the Financial Accounting Standards Board ("FASB") issued
Interpretation No. 46, "Consolidation of Variable Interest Entities" ("FIN 46"),
which requires the consolidation of a variable interest entity (as defined) by
its primary beneficiary. Primary beneficiaries are those companies that are
subject to a majority of the risk of loss or entitled to receive a majority of
the variable interest entity's residual returns, or both. In determining
whether it is the primary beneficiary of a variable interest entity, a company
with a variable interest must also treat a variable interest held by the
company's related parties in that same entity as its own interests. In December
2003, the FASB published a revision to FIN 46 to clarify some of the provisions
of FIN 46 and to exempt certain entities from its requirements. FIN 46, as
revised, applies to variable interest entities that are commonly referred to as
special-purpose entities for periods ending after December 15, 2003 (our fiscal
2004 fourth quarter) and for all other types of variable interest entities for
periods ending after March 15, 2004 (our fiscal 2005 first quarter). Earlier
application is permitted.
We have applied the provisions of FIN 46 to our 50% limited partnership interest
in West Greenwich Technology Associates, L.P. (the "Partnership"), which owns
our world headquarters facilities and leases them to us, resulting in the
consolidation of the Partnership in the third quarter of fiscal 2004. Refer to
"Consolidation of West Greenwich Technology Associates, L.P." above for detailed
disclosures.
Our evaluation of the impact of FIN 46 on certain of our investments created
prior to February 1, 2003 is ongoing and is not expected to have a material
impact on our financial statements. If applicable, we would not be required to
apply FIN 46 to these investments until our fiscal 2005 first quarter.
-33-
Results of Operations
THREE MONTHS ENDED NOVEMBER 22, 2003 VERSUS THREE MONTHS ENDED NOVEMBER 23, 2002
Revenues were $254.9 million in the third quarter of fiscal 2004, compared to
$256.5 million in the third quarter of fiscal 2003, down $1.5 million, or 0.6%.
The following discussion on service revenues should be read in conjunction with
the table below (in millions):
Three Months Ended
-------------------------------------------------------
Change
November 22, November 23, -------------------
Service revenues 2003 2002 $ %
- ---------------------- -------------- -------------- --------- -----
Domestic lottery $ 123.5 $ 116.2 $ 7.3 6.2
International lottery 86.4 79.7 6.7 8.5
Commercial services 20.7 11.2 9.5 85.8
All other 0.6 0.7 (0.1) (21.0)
-------------- -------------- --------- -----
$ 231.2 $ 207.8 $ 23.4 11.3
============== ============== ========= =====
Our domestic lottery service revenues were $123.5 million in the third quarter
of fiscal 2004, compared to $116.2 million in the third quarter of fiscal 2003,
up $7.3 million, or 6.2%. This 6.2% increase was primarily due to higher service
revenues of approximately 3% from an increase in sales by our domestic lottery
customers, with the balance of the increase due to the combined effect of higher
jackpot activity and new contracts, including the impact of the Interlott
acquisition, net of contractual rate changes. While we are not able to quantify
precisely the reasons for increases in sales by our domestic lottery customers,
we believe that in general, such increases are attributable to enhanced
marketing efforts by state lottery authorities seeking to offset declining tax
revenues and the successful introduction by state lottery authorities of new
games and products, modifications to existing games (such as matrix changes and
more frequent drawings) and expanded distribution channels, such as Keno.
Our international lottery service revenues grew to $86.4 million in the third
quarter of fiscal 2004, from $79.7 million in the third quarter of fiscal 2003,
up $6.7 million, or 8.5%. This 8.5% increase includes higher service revenues of
approximately 7% from an increase in sales by our international lottery
customers, with the balance of the increase due to the impact of favorable
foreign exchange rates, net of the combined effect of lower jackpot activity and
contractual rate changes. While we are not able to quantify precisely the
reasons for increases in sales by our international lottery customers, we
believe that in general, such increases are attributable to more rapid growth
rates typical of newer lottery jurisdictions and the successful introduction of
new games.
Service revenues from commercial transaction processing services were $20.7
million in the third quarter of fiscal 2004, compared to $11.2 million in the
third quarter of fiscal 2003, up $9.5 million, or 85.8%, primarily due to the
acquisition of PolCard, which contributed $6.8 million of service revenues in
the third quarter of this fiscal year.
Product sales were $23.7 million in the third quarter of fiscal 2004, compared
to $48.7 million in the third quarter of fiscal 2003, down $25.0 million or
51.3%. Product sales in the third quarter of the prior year included a one-time
sale of a turnkey system to our customer in France.
Our service margins improved from 37.9% in the third quarter of fiscal 2003 to
42.9% in the third quarter of fiscal 2004, primarily due to lower depreciation
of approximately 2 percentage points, principally related to fully depreciated
assets associated with our contract with Caixa Economica Federal in Brazil, with
the balance of the increase primarily due to the impact of higher service
revenues.
-34-
Our product margins fluctuate depending on the mix, volume and timing of product
sales contracts. Our product margins were 44.7% in the third quarter of fiscal
2004 compared to 19.7% in the third quarter of fiscal 2003. This change was
primarily due to the different mix of sales, with higher margin software and
equipment sales recorded in the third quarter of fiscal 2004.
Operating expenses were $41.1 million in the third quarter of fiscal 2004,
compared to $35.3 million in the third quarter of fiscal 2003, up $5.8 million,
or 16.5%. This increase was driven by $3.8 million of increased spending on
selling, general and administrative expenses, primarily driven by increased
business development activities and the consolidation of PolCard and Interlott.
In addition, our investment in research and development increased by $2.0
million as we continue our efforts to accelerate the development and deployment
of Enterprise Series into the marketplace. As a percentage of revenues,
operating expenses were 16.1% and 13.7% during the third quarters of fiscal 2004
and 2003, respectively.
Other income was $4.1 million in the third quarter of fiscal 2004, compared to
$0.2 million in the third quarter of fiscal 2003. This $3.9 million increase was
primarily due to a one-time, non-cash, pre-tax gain of $5.3 million resulting
from the consolidation of the partnership that owns our world headquarters
facilities, in compliance with Financial Accounting Standards Board
Interpretation No. 46, "Consolidation of Variable Interest Entities".
Weighted average diluted shares in the third quarter of fiscal 2004 increased by
8.9 million shares to 66.9 million shares, primarily due to the convertibility
during the third quarter of our $175 million principal amount of 1.75%
Convertible Debentures (the "Debentures") into shares of our common stock,
resulting in a decrease to diluted earnings per share of approximately $0.07.
These Debentures are convertible at the option of the holder into shares of our
common stock at a conversion price of approximately $27.50 per share when, among
other circumstances, our stock closes above $33 per share for at least 20 out of
30 consecutive trading days prior to the date of surrender for conversion. There
are a total of 6.4 million shares issuable upon the conversion of the
Debentures. The Debentures were convertible for all 64 trading days in the third
quarter of fiscal 2004, and accordingly, all 6.4 million shares were included in
the computation of diluted earnings per share.
Our effective income tax rate decreased from 38% in the third quarter of fiscal
2003 to 37% in the third quarter of fiscal 2004 principally due to a larger
percentage of international profits taxed at rates that are lower than the U.S.
statutory tax rate and the increased recognition of research and development tax
credits.
NINE MONTHS ENDED NOVEMBER 22, 2003 VERSUS NINE MONTHS ENDED NOVEMBER 23, 2002
Revenues were $771.8 million in the first nine months of fiscal 2004, compared
to $708.8 million in the first nine months of fiscal 2003, up $63.0 million, or
8.9%.
The following discussion on service revenues should be read in conjunction with
the table below (in millions):
Nine Months Ended
-------------------------------------------------------
Change
November 22, November 23, -------------------
Service revenues 2003 2002 $ %
- ---------------- -------------- -------------- --------- ----
Domestic lottery $ 378.4 $ 363.2 $ 15.2 4.2
International lottery 260.2 239.6 20.6 8.6
Commercial services 52.3 38.3 14.0 36.3
All other 1.9 2.0 (0.1) (8.0)
-------------- -------------- --------- ----
$ 692.8 $ 643.1 $ 49.7 7.7
============== ============== ========= ====
-35-
Our domestic lottery service revenues were $378.4 million in the first nine
months of fiscal 2004, compared to $363.2 million in the first nine months of
fiscal 2003, up $15.2 million, or 4.2%. This 4.2% increase includes higher
service revenues of approximately 4% from an increase in sales by our domestic
lottery customers, with the balance of the increase due to the combined effect
of new contracts and the impact of the PolCard and Interlott acquisitions, net
of contractual rate changes. While we are not able to quantify precisely the
reasons for increases in sales by our domestic lottery customers, we believe
that in general, such increases are attributable to enhanced marketing efforts
by state lottery authorities seeking to offset declining tax revenues and the
successful introduction by state lottery authorities of new games and products,
modifications to existing games (such as matrix changes and more frequent
drawings) and expanded distribution channels, such as Keno.
Our international lottery service revenues were $260.2 million in the first nine
months of fiscal 2004, compared to $239.6 million in the first nine months of
fiscal 2003, up $20.6 million, or 8.6%. This 8.6% increase includes higher
service revenues of approximately 10% from an increase in sales by our
international lottery customers, along with the impact of favorable foreign
exchange rates, partially offset by the impact of contractual rate changes.
While we are not able to quantify precisely the reasons for increases in sales
by our international lottery customers, we believe that in general, such
increases are attributable to more rapid growth rates typical of newer lottery
jurisdictions and the successful introduction of new games.
Service revenues from commercial transaction processing services were $52.3
million in the first nine months of fiscal 2004, compared to $38.3 million in
the first nine months of fiscal 2003, up $14.0 million, or 36.3%, primarily due
to the consolidation of PolCard, which contributed $13.9 million of service
revenues in the first nine months of this fiscal year.
Product sales were $79.0 million in the first nine months of fiscal 2004,
compared to $65.7 million in the first nine months of fiscal 2003, up $13.3
million. This increase was primarily driven by the sale of our new interactive,
web-based software application, ES Interactive, to our customer in the United
Kingdom.
Our service margins improved from 37.3% in the first nine months of fiscal 2003
to 43.5% in the first nine months of fiscal 2004. This 6.2 percentage point
increase was primarily due to lower depreciation of 3.0 percentage points
(principally related to fully depreciated assets associated with our contract
with Caixa Economica Federal in Brazil), 1.4 percentage points from the absence
of certain consulting costs incurred during the first nine months of the prior
year, and the balance of the increase primarily due to the impact of higher
service revenues.
Our product margins fluctuate depending on the mix, volume and timing of product
sales contracts. Our product margins were 36.0% in the first nine months of
fiscal 2004 compared to 24.8% in the first nine months of fiscal 2003, primarily
due to the different mix of sales during the two periods.
Operating expenses were $120.9 million in the first nine months of fiscal 2004,
compared to $94.7 million in the first nine months of fiscal 2003, up $26.2
million, or 27.6%. This increase was driven by $16.9 million of increased
spending on research and development as we continue our efforts to accelerate
the development and deployment of Enterprise Series into the marketplace. In
addition, selling, general and administrative expense was up $9.3 million,
primarily driven by an increase in business development and related bidding
activity, along with expenses of PolCard and Interlott. As a percentage of
revenues, operating expenses were 15.7% and 13.4% during the first nine months
of fiscal 2004 and 2003, respectively.
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The components of other income in the first nine months of fiscal 2004 and 2003
are as follows (in millions):
Nine Months Ended
---------------------------------
November 22, November 23,
2003 2002
-------------- ---------------
Non-cash gain resulting from the consolidation of the partnership that $ 5.3 $ -
owns our world headquarters facilities
Foreign exchange gains 0.3 5.4
Tender premiums and fees associated with the early retirement of our - (2.1)
7.75% Series A Senior Notes due 2004, net of proceeds from the sale
of certain interest rate swaps associated with these notes
Other (2.3) (1.4)
-------------- ---------------
Total other income $ 3.3 $ 1.9
============== ===============
Weighted average diluted shares in the first nine months of fiscal 2004
increased by 5.8 million shares to 64.4 million shares, primarily due to the
convertibility during the first nine months of this fiscal year of our $175
million principal amount of 1.75% Convertible Debentures (the "Debentures") into
shares of our common stock, resulting in a decrease to diluted earnings per
share of approximately $0.15. These Debentures are convertible at the option of
the holder into shares of our common stock at a conversion price of
approximately $27.50 per share when, among other circumstances, our stock closes
above $33 per share for at least 20 out of 30 consecutive trading days prior to
the date of surrender for conversion. There are a total of 6.4 million shares
issuable upon the conversion of the Debentures. The Debentures were convertible
for 144 out of 191 trading days in the first nine months of fiscal 2004, and
approximately 4.8 million shares were included in the computation of diluted
earnings per share.
Our effective income tax rate decreased from 38% in the first nine months of
fiscal 2003 to 37% in the first nine months of fiscal 2004 principally due to a
larger percentage of international profits taxed at rates that are lower than
the U.S. statutory tax rate and the increased recognition of research and
development tax credits.
Changes in Financial Position, Liquidity and Capital Resources
During the first nine months of fiscal 2004, we generated $309.9 million of cash
from operations which, along with cash on hand, was principally used to purchase
$211.9 million of systems, equipment and other assets relating to contracts and
to fund acquisitions of $74.2 million. In addition, during the third quarter of
this fiscal year, we issued $250 million of 4.75% Senior Notes. At November 22,
2003, we had $320.5 million of cash and cash equivalents on hand, of which
approximately $96.4 million was invested in a savings account at a major U.S.
financial institution with a credit rating of AA- and Aa2 from Standard and
Poor's and Moody's Investor Service, respectively, and approximately $196.1
million was invested in tax-exempt municipal and auction rate securities that
typically have a minimal credit rating of A- or A3 from Standard and Poor's and
Moody's Investor Service, respectively. At November 22, 2003, the weighted
average duration and weighted average taxable equivalent yield of the portfolio
was approximately eight days and 1.6%, respectively. At the end of the fiscal
2004 third quarter, there was $290.0 million available for borrowing under our
$300 million credit facility after considering $10.0 million of letters of
credit issued and outstanding under the credit facility.
Trade accounts receivable, net increased by $15.0 million, from $107.7 million
at February 22, 2003 to $122.7 million at November 22, 2003, primarily due to
$29.4 million related to the consolidation of PolCard and Interlott, partially
offset by collections related to product sales we recorded in the prior fiscal
year.
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Inventories decreased by $13.4 million, from $72.3 million at February 22, 2003
to $58.9 million at November 22, 2003, primarily due to the sale of ES
Interactive to our customer in the United Kingdom, partially offset by an
increase of inventory associated with product sales expected to be recorded
during fiscal 2005 and inventory associated with the acquisition of Interlott.
Other current assets increased by $8.5 million, from $18.7 million at February
22, 2003 to $27.2 million at November 22, 2003, primarily due to $6.1 million of
prepayments and $3.9 million of value-added tax receivables, both related to
ongoing lottery system installations, primarily in Europe.
Systems, equipment and other assets relating to contracts, net, increased by
$151.0 million, from $410.9 million at February 22, 2003 to $561.9 million at
November 22, 2003, primarily due to the purchase of $211.9 million of systems,
equipment and other assets relating to contracts (principally related to lottery
system implementations in California and Georgia and the consolidation of
Interlott and PolCard), partially offset by depreciation expense.
Goodwill, net, increased by $73.3 million, from $115.5 million at February 22,
2003 to $188.8 million at November 22, 2003, primarily due to the acquisition of
PolCard, the largest debit and credit card merchant transaction acquirer and
processor in Poland, along with the acquisition of Interlott, a leading provider
of instant ticket vending machines for the worldwide lottery industry.
Other assets increased by $90.0 million, from $79.2 million at February 22, 2003
to $169.2 million at November 22, 2003, primarily due to the consolidation of
the partnership that owns our world headquarters facilities, a $20.0 million
refundable performance deposit we paid to our customer in the Czech Republic, a
$12.5 million up-front license fee we paid to the Rhode Island Lottery, with the
balance related to intangible assets recorded as a result of our acquisitions of
PolCard and Interlott.
Advance payments from customers increased by $43.5 million, from $52.4 million
at February 22, 2003 to $95.9 million at November 22, 2003, primarily due to
advances received from customers related to product sales that are expected to
be recorded during fiscal 2005 and 2006, partially offset by the sale of ES
Interactive to our customer in the United Kingdom.
Taxes other than income taxes increased by $12.0 million, from $16.0 million at
February 22, 2003 to $28.0 million at November 22, 2003, primarily due to $9.0
million of value-added tax payables related to ongoing lottery system
installations, primarily in Europe.
Long-term debt, less current portion, increased by $270.8 million, from $287.1
million at February 22, 2003 to $557.9 million at November 22, 2003, primarily
due to proceeds from the issuance of $250 million of 4.75% Senior Notes during
the third quarter of fiscal 2004 and the consolidation of the partnership that
owns our world headquarters facilities.
Other liabilities increased by $12.3 million, from $39.4 million at February 22,
2003 to $51.7 million at November 22, 2003 due to an advance payment we received
from a lottery customer that will be amortized to service revenue ratably over
the base contract term.
Our business is capital-intensive. We currently estimate that net cash to be
used for investing activities in fiscal 2004 will be in the range of $400
million to $410 million, including investments we made to acquire PolCard and
Interlott, and spending on new contract assets necessary for the recently
announced contracts in Tennessee and Sri Lanka. We expect our principal sources
of liquidity to be existing cash balances, along with cash we generate from
operations. Our credit facility provides for an unsecured revolving line of
credit of $300 million and matures in June 2006. As of November 22, 2003, there
were no borrowings under the credit facility. Up to $100 million of the Credit
Facility may be used for the issuance of letters of credit. As of November 22,
2003, there was $290.0 million available for borrowing under the Credit
Facility, after considering $10.0 million of letters of credit issued and
outstanding. We
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currently expect that our cash flow from operations, existing cash balances and
available borrowings under our credit facility will be sufficient for the
foreseeable future to fund our anticipated working capital and ordinary capital
expenditure needs, to service our debt obligations, to fund anticipated internal
growth, to fund all or a portion of the cash needed for potential acquisitions,
to pay dividends, to fund the capital requirements under our Master Contract
with the Rhode Island Lottery, and to repurchase shares of our common stock,
from time to time, under our share repurchase programs. Notwithstanding the
foregoing, we may seek alternative sources of financing to fund certain of our
obligations under our Master Contract with the Rhode Island Lottery and to fund
future potential acquisitions and growth opportunities that are not currently
contemplated in the $400 million to $410 million range of fiscal 2004 investing
activities disclosed above.
Details of our contractual obligations for long-term debt and operating leases
as of February 22, 2003 are as follows (in millions):
Fiscal
----------------------------------------------------------------------------
2004 2005 2006 2007 2008 Thereafter Total
-------- -------- -------- -------- -------- ---------- --------
Long-term debt $ 7.0 $ 5.6 $ 5.1 $ 5.8 $ 95.6 $ 175.0 $ 294.1
Operating leases 18.7 14.8 7.3 33.4 3.1 6.1 83.4
-------- ------- -------- ------- -------- ---------- --------
Total $ 25.7 $ 20.4 $ 12.4 $ 39.2 $ 98.7 $ 181.1 $ 377.5
======== ======= ======== ======= ======== ========== ========
Operating lease payments include a $28 million residual value payment that we
may be required to pay in fiscal 2007, or earlier under certain limited
circumstances, related to the lease of our world headquarters facilities.
Guarantees and Indemnifications
PERFORMANCE AND OTHER BONDS
In connection with certain contracts and procurements, we have been required to
deliver performance bonds for the benefit of our customers and bid and
litigation bonds for the benefit of potential customers, respectively. These
bonds give the beneficiary the right to obtain payment and/or performance from
the issuer of the bond if the events set forth in the bond occur. In the case of
performance bonds, which generally have a term of one year, such events include
our failure to perform our obligations under the applicable contract. To obtain
these bonds, we are required to indemnify the issuers against the costs they
incur if a beneficiary exercises its rights under a bond. Historically, our
customers have not exercised their rights under these bonds and we do not
currently anticipate that they will do so. The following table provides
information related to potential commitments at November 22, 2003:
Total potential
commitments
---------------
(in millions)
Performance bonds $ 164.8
Financial guarantees 7.3
All other bonds 9.1
---------------
$ 181.2
===============
LOTTERY TECHNOLOGY SERVICES INVESTMENT CORPORATION
We have a 44% interest in Lottery Technology Services Investment Corporation
("LTSIC"), which we account for using the equity method of accounting. LTSIC's
wholly owned subsidiary, Lottery Technology Services Corporation ("LTSC"),
provides equipment and services (which we supplied to LTSC), to the Bank of
Taipei. The Bank of Taipei holds the license to operate the Taiwan Public
Welfare Lottery.
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In order to assist LTSC with the financing they required to enable them to
perform under their obligation to operate the Taiwan Public Welfare Lottery on
behalf of the Bank of Taipei, at November 22, 2003, we guaranteed $4.9 million
principal amount of loans made by an unrelated commercial lender to LTSC. The
loans have a maturity date of January 2007 and our guarantee expires in July
2007. We did not receive any consideration in exchange for our guarantees on
behalf of LTSC. Rather, these guarantees were issued in connection with the
formation of LTSC and LTSIC.
We are recognizing 56% of our product sales to, and service revenue from, LTSC.
The remaining 44% of product sales (and related cost) and service revenue, has
been deferred as a result of our equity interest in LTSIC and related guarantee
of LTSC's debt, respectively, and is principally included in Other Liabilities
in our Consolidated Balance Sheets at November 22, 2003 and February 22, 2003.
Product sale deferrals are being recognized ratably over the life of our
contract with LTSC and service revenue deferrals are being recognized as the
guaranteed debt is repaid. At November 22, 2003, deferred product gross profit
and deferred service revenue totaled $3.8 million and $6.7 million,
respectively.
TIMES SQUARED INCORPORATED
We guaranteed outstanding lease obligations of Times Squared Incorporated
("Times Squared") for which we received no monetary consideration. The amount
outstanding under the lease at November 22, 2003, was $2.4 million. Our
guarantee expires in December 2013. Times Squared is a nonprofit corporation
established to provide, among other things, secondary and high school level
educational programs. Times Squared operates a Charter School for Engineering,
Mathematics, Science and Technology in Providence, Rhode Island that serves
inner city children who aspire to careers in the sciences and technology.
LOTTERY TECHNOLOGY ENTERPRISES
We have a 1% interest in Lottery Technology Enterprises ("LTE"), a joint venture
between us and District Enterprise for Lottery Technology Applications of
Washington, D.C. The joint venture agreement terminates on December 31, 2012.
LTE holds a 10-year contract (which expires in November 2009) with the District
of Columbia Lottery and Charitable Games Control Board. Under Washington, D.C.
law, by virtue of our 1% interest in LTE, we are jointly and severally liable,
with the other partner, for the acts of the joint venture.
GAMING ENTERTAINMENT (DELAWARE) L.L.C.
We have a 50% interest in Gaming Entertainment (Delaware) L.L.C. ("GED"). GED is
also owned 50% by a subsidiary of Full House Resorts, Inc. ("FHRI"). Pursuant to
a 1995 management agreement ("Agreement"), GED manages a casino for Harrington
Raceway, Inc. ("Harrington") and in return receives a percentage of gross
revenues and operating profits as defined in the Agreement. Along with FHRI, we
guarantee the payment of all amounts due Harrington under the Agreement. Our
guarantee expires on February 1, 2012 or upon expiration of the Delaware Horse
Racing Redevelopment Act. The consideration we receive in exchange for the
guarantee are the equity earnings from our ownership in GED.
Market Risk Disclosures
The primary market risk inherent in our financial instruments and exposures is
the potential loss arising from adverse changes in interest rates and foreign
currency rates. Our exposure to commodity price changes is not considered
material and is managed through our procurement and sales practices. We did not
own any marketable equity securities during the first nine months of fiscal
2004.
-40-
Interest rates
Interest rate market risk is estimated as the potential change in the fair value
of our total debt or current earnings resulting from a hypothetical 10% adverse
change in interest rates. At November 22, 2003, after taking into consideration
$150 million of interest rate swaps, the estimated fair value of our $250
million of 4.75% Senior Notes due 2010 and $90 million of 7.87% Series B Senior
Notes due 2007 approximated $351.3 million (as determined by an independent
investment banker). At November 22, 2003, after taking into consideration the
interest rate swaps, a hypothetical 10% increase in interest rates would
decrease the estimated fair value of these Senior Notes to $349.1 million and a
hypothetical 10% decrease in interest rates would increase the estimated fair
value of these Senior Notes to $353.6 million.
At November 22, 2003, the estimated fair value of our $175 million principal
amount of 1.75% Convertible Debentures was $312.4 million (based on a quoted
market price of $178.50 per Debenture). At November 22, 2003, a hypothetical 10%
increase in interest rates would reduce the estimated fair value of the
Convertible Debentures to $311.8 million and a hypothetical 10% decrease in
interest rates would increase the estimated fair value of the Convertible
Debentures to $313.0 million.
A hypothetical 10% adverse or favorable change in interest rates applied to
variable rate debt would not have a material effect on current earnings.
We use various techniques to mitigate the risk associated with future changes in
interest rates, including entering into interest rate swaps. In October 2003, we
entered into three interest rate swaps for an aggregate amount of $150 million,
which effectively entitle us to exchange fixed rate payments for variable rate
payments for the period October 15, 2003 to October 15, 2010.
Equity price risk
At November 22, 2003, the estimated fair value of our $175 million principal
amount of 1.75% Convertible Debentures was $312.4 million (based on a quoted
market price of $178.50 per Debenture). At November 22, 2003, a hypothetical 10%
increase in the market price of our common stock would increase the estimated
fair value of the Convertible Debentures to $340.0 million and a hypothetical
10% decrease in the market price of our common stock would reduce the estimated
fair value of the Convertible Debentures to $285.6 million.
Foreign Currency Exchange Rates
We are subject to foreign exchange exposures arising from current and
anticipated transactions denominated in currencies other than our functional
currency (United States dollars) and from the translation of foreign currency
balance sheet accounts into United States dollar balance sheet accounts.
We seek to manage our foreign exchange risk by securing payment from our
customers in United States dollars, by sharing risk with our customers, by
utilizing foreign currency borrowings, by leading and lagging receipts and
payments, and by entering into foreign currency exchange and option contracts.
In addition, a significant portion of the costs attributable to our foreign
currency revenues are payable in the local currencies. In limited circumstances,
but whenever possible, we negotiate clauses into our contracts that allow for
price adjustments should a material change in foreign exchange rates occur.
-41-
From time to time, we enter into foreign currency exchange and option contracts
to reduce the exposure associated with current transactions and anticipated
transactions denominated in foreign currencies. However, we do not engage in
foreign currency speculation. At November 22, 2003, a hypothetical 10% adverse
change in foreign exchange rates would result in a translation loss of $15.9
million that would be recorded in the equity section of our balance sheet.
At November 22, 2003, a hypothetical 10% adverse change in foreign exchange
rates would result in a net pre-tax transaction loss of $1.6 million that would
be recorded in current earnings after considering the effects of foreign
exchange contracts currently in place.
At November 22, 2003, a hypothetical 10% adverse change in foreign exchange
rates would result in a net reduction of cash flows from anticipatory
transactions during the remainder of fiscal 2004 of $3.1 million, after
considering the effects of foreign exchange contracts currently in place. The
percentage of fiscal 2004 anticipatory cash flows that were hedged varied
throughout the first nine months of fiscal 2004, but averaged 50%.
As of November 22, 2003, we had contracts for the sale of foreign currency of
approximately $66.9 million (primarily Euro, pounds sterling and Brazilian real)
and the purchase of foreign currency of approximately $67.2 million (primarily
pounds sterling, Euro, Singapore dollars, Brazilian real and Swedish krona).
-42-
Item 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
See "Market Risk Disclosures" above.
Item 4. CONTROLS AND PROCEDURES
We maintain disclosure controls and procedures that are designed to ensure that
information required to be disclosed in our Securities Exchange Act reports is
recorded, processed, summarized and reported within the time periods specified
in the Securities and Exchange Commission's rules and forms, and that such
information is accumulated and communicated to our management, including our
President and Chief Executive Officer ("CEO") and our Senior Vice President and
Chief Financial Officer ("CFO"), as appropriate, to allow timely decisions
regarding required disclosure. In designing and evaluating the disclosure
controls and procedures, management recognized that any controls and procedures,
no matter how well designed and operated, can provide only reasonable assurance
of achieving the desired control objectives and management was required to apply
its judgment in evaluating the cost-benefit relationship of possible controls
and procedures. Our controls and procedures are designed to provide a reasonable
level of assurance in reaching our desired controls and procedures objectives.
As of the end of the quarterly period covered by this report, we carried out an
evaluation under the supervision and with the participation of our management,
including our CEO and our CFO, of the effectiveness of the design and operation
of our disclosure controls and procedures (as defined in Rule 13a-15(e) under
the Securities Exchange Act of 1934), and of any changes in our internal control
over financial reporting (as defined in Rule 13a-15(f) under the Securities
Exchange Act of 1934) that occurred during the quarterly period covered by this
report. Based upon that evaluation, the CEO and CFO concluded that the Company's
disclosure controls and procedures were effective in reaching a reasonable level
of assurance of achieving management's desired controls and procedures
objectives, and that no change in our internal control over financial reporting
occurred during the quarterly period covered by this report that has materially
affected, or is reasonably likely to materially affect, our internal control
over financial reporting. Subsequent to the date of this evaluation, there have
been no significant changes in our internal controls or in other factors that
could significantly affect these controls, and no corrective actions have been
taken with regard to significant deficiencies or material weaknesses in such
controls.
PART II. OTHER INFORMATION
Item 1. LEGAL PROCEEDINGS
For information respecting certain legal proceedings, refer to Part I, Item 3 -
"Legal Proceedings" and Note 11 to the Consolidated Financial Statements in our
fiscal 2003 Annual Report on Form 10-K, as amended, and Part II, Item 1 - "Legal
Proceedings" in our Quarterly Report for the quarterly period ended May 24,
2003.
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Item 6. EXHIBITS AND REPORTS ON FORM 8-K
(a) Exhibits - The exhibits to this report are as follows:
12.1 Computation of Ratio of Earnings to Fixed Charges
31.1 Certification Pursuant to Section 302 of the Sarbanes-Oxley Act
of 2002, of W. Bruce Turner, President and Chief Executive
Officer of the Company
31.2 Certification Pursuant to Section 302 of the Sarbanes-Oxley Act
of 2002, of Jaymin B. Patel, Senior Vice President and Chief
Financial Officer of the Company
32.1 Certification Pursuant to 18 United States Code Section 1350, as
Adopted Pursuant to Section 906 of the Sarbanes-Oxley Act of
2002, of W. Bruce Turner, President and Chief Executive Officer
of the Company
32.2 Certification Pursuant to 18 United States Code Section 1350, as
Adopted Pursuant to Section 906 of the Sarbanes-Oxley Act of
2002, of Jaymin B. Patel, Senior Vice President and Chief
Financial Officer of the Company
(b) Reports on Form 8-K - We filed the following reports with the Securities
and Exchange Commission on Form 8-K during the quarter to which this report
relates:
(i) We filed a report on Form 8-K on September 12, 2003 incorporating
by reference a press release we issued on September 12, 2003
announcing our fiscal 2004 second quarter results. In addition,
we incorporated by reference the transcripts from our fiscal 2004
second quarter earnings conference call held on September 12,
2003.
(ii) We filed a report on Form 8-K on September 18, 2003 incorporating
by reference a press release we issued on September 18, 2003
describing that we completed the acquisition of Interlott
Technologies, Inc., a leading provider of instant ticket vending
machines for the lottery industry worldwide.
(iii) We filed a report on Form 8-K/A on October 6, 2003 refiling our
September 12, 2003 Form 8-K under the correct filing codes for
GTECH Holdings Corporation.
(iv) We filed a report on Form 8-K on October 8, 2003 incorporating by
reference a press release we issued on October 8, 2003 describing
that we intended to offer approximately $200 million in aggregate
principal amount of seven-year senior notes in an unregistered
offering to qualified institutional buyers pursuant to Rule 144A
under the Securities Act of 1933.
(v) We filed a report on Form 8-K on October 9, 2003 incorporating by
reference a press release we issued on October 9, 2003 describing
that we agreed to sell $250 million of 4.75% senior notes due
2010, for aggregate proceeds of approximately $248.1 million.
(vi) We filed a report on Form 8-K on November 7, 2003 incorporating
by reference a press release we issued on November 7, 2003
describing our agreement to acquire all of the shares of
privately-held Spielo Manufacturing Inc., a leading provider of
video lottery terminals and related products and services to the
global gaming industry. In addition, we incorporated by reference
the transcripts from our conference call held on November 7, 2003
respecting such acquisition.
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SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
GTECH HOLDINGS CORPORATION
Date: January 5, 2004 By /s/ Jaymin B. Patel
-------------------------------------------------
Jaymin B. Patel, Senior Vice President and Chief
Financial Officer (Principal Financial Officer)
Date: January 5, 2004 By /s/ Robert J. Plourde
-------------------------------------------------
Robert J. Plourde, Vice President, Corporate
Controller and Chief Accounting Officer
(Principal Accounting Officer)
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