UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
----------------------
FORM 10-Q
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the quarterly period ended August 28, 2004
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15 (d) OF THE SECURITIES
EXCHANGE ACT OF 1934
Commission file number 1-11250
----------------------
GTECH Holdings Corporation
(Exact name of Registrant as specified in its charter)
Delaware 05-0450121
(State or other Jurisdiction of (I.R.S. Employer Identification
Incorporation or Organization) Number)
55 Technology Way, West Greenwich, Rhode Island 02817
(Address of Principal Executive Offices) (Zip Code)
(401) 392-1000
(Registrant's telephone number, including area code)
----------------------
Indicate by check mark whether the registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months (or for such shorter period that the registrant was
required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days.
Yes [X] No [ ]
Indicate by check mark whether the registrant is an accelerated filer (as
defined in Rule 12b-2 of the Securities Exchange Act of 1934)
Yes [X] No [ ]
Number of shares of Common Stock outstanding as of September 28, 2004:
115,843,583
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 8-24
Item 2. Management's Discussion and Analysis of Financial Condition
and Results of Operations 25-40
Item 3. Quantitative and Qualitative Disclosures about Market Risk 41
Item 4. Controls and Procedures 41
PART II. OTHER INFORMATION
Item 1. Legal Proceedings 42-46
Item 4. Submission of Matters to a Vote of Security Holders 47
Item 6. Exhibits and Reports on Form 8-K 48
SIGNATURES 49
EXHIBITS
PART 1. FINANCIAL INFORMATION
Item 1. FINANCIAL STATEMENTS
GTECH HOLDINGS CORPORATION AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
(Unaudited)
August 28, February 28,
2004 2004
----------- ------------
(Dollars in thousands)
ASSETS
CURRENT ASSETS:
Cash and cash equivalents $ 30,267 $ 129,339
Investment securities available-for-sale - 221,850
Trade accounts receivable, net 134,449 118,902
Sales-type lease receivables 7,848 7,705
Inventories 94,025 76,784
Deferred income taxes 32,559 34,396
Other current assets 31,868 24,426
----------- -----------
TOTAL CURRENT ASSETS 331,016 613,402
SYSTEMS, EQUIPMENT AND OTHER ASSETS RELATING TO CONTRACTS, net 649,800 591,362
GOODWILL, net 324,916 188,612
PROPERTY, PLANT AND EQUIPMENT, net 66,484 57,576
INTANGIBLE ASSETS, net 72,614 28,231
REFUNDABLE PERFORMANCE DEPOSIT 20,000 20,000
SALES-TYPE LEASE RECEIVABLES 13,664 17,653
OTHER ASSETS 43,858 42,295
----------- -----------
TOTAL ASSETS $ 1,522,352 $ 1,559,131
=========== ===========
LIABILITIES AND SHAREHOLDERS' EQUITY
CURRENT LIABILITIES:
Accounts payable $ 73,344 $ 80,004
Accrued expenses 50,881 47,428
Employee compensation 19,798 33,981
Advance payments from customers 70,955 104,128
Deferred revenue and advance billings 32,159 14,459
Income taxes payable 27,173 12,394
Taxes other than income taxes 19,443 19,459
Current portion of long-term debt 4,848 106,319
----------- -----------
TOTAL CURRENT LIABILITIES 298,601 418,172
LONG-TERM DEBT, less current portion 474,099 463,215
OTHER LIABILITIES 79,265 53,736
DEFERRED INCOME TAXES 88,233 61,719
COMMITMENTS AND CONTINGENCIES - -
SHAREHOLDERS' EQUITY:
Preferred Stock, par value $.01 per share - 20,000,000 shares authorized, none issued - -
Common Stock, par value $.01 per share - 200,000,000 shares authorized,
116,551,144 and 184,590,808 shares issued; 115,621,098 and 118,395,168
shares outstanding at August 28, 2004 and February 28, 2004, respectively
(shares adjusted to reflect July 2004 two-for-one stock split and treasury stock
retirement) 1,166 923
Additional paid-in capital 272,935 266,320
Accumulated other comprehensive loss (69,369) (70,508)
Retained earnings 396,629 839,270
----------- -----------
601,361 1,036,005
Less cost of 930,046 and 66,195,640 shares in treasury at August 28, 2004 and
February 28, 2004, respectively (shares adjusted to
reflect July 2004 two-for-one stock split and treasury stock retirement) (19,207) (473,716)
----------- -----------
582,154 562,289
----------- -----------
TOTAL LIABILITIES AND SHAREHOLDERS' EQUITY $ 1,522,352 $ 1,559,131
=========== ===========
See Notes to Consolidated Financial Statements
-3-
GTECH HOLDINGS CORPORATION AND SUBSIDIARIES
CONSOLIDATED INCOME STATEMENTS
(Unaudited)
Three Months Ended
-------------------------
August 28, August 23,
2004 2003
----------- ------------
(Dollars in thousands,
except per share amounts)
Revenues:
Services $ 248,114 $ 238,019
Sales of products 75,401 39,228
----------- ------------
323,515 277,247
Costs and expenses:
Costs of services 148,481 132,805
Costs of sales 43,874 28,810
----------- ------------
192,355 161,615
----------- ------------
Gross profit 131,160 115,632
Selling, general and administrative 29,889 27,051
Research and development 12,647 14,106
----------- ------------
Operating expenses 42,536 41,157
----------- ------------
Operating income 88,624 74,475
Other income (expense):
Interest income 981 1,021
Equity in earnings of unconsolidated affiliates 293 2,691
Other income (expense) (1,924) 465
Interest expense (3,719) (1,705)
----------- ------------
(4,369) 2,472
----------- ------------
Income before income taxes 84,255 76,947
Income taxes 31,174 28,471
----------- ------------
Net income $ 53,081 $ 48,476
=========== ============
Basic earnings per share $ 0.45 $ 0.42
=========== ============
Diluted earnings per share $ 0.40 $ 0.37
=========== ============
Weighted average shares outstanding - basic 117,070 115,836
=========== ============
Weighted average shares outstanding - diluted 132,743 131,815
=========== ============
Dividends per share - common stock $ 0.085 $ 0.085
=========== ============
See Notes to Consolidated Financial Statements
-4-
GTECH HOLDINGS CORPORATION AND SUBSIDIARIES
CONSOLIDATED INCOME STATEMENTS
(Unaudited)
Six Months Ended
-------------------------
August 28, August 23,
2004 2003
---------- ------------
(Dollars in thousands,
except per share amounts)
Revenues:
Services $ 501,440 $ 461,557
Sales of products 102,280 55,275
---------- ------------
603,720 516,832
Costs and expenses:
Costs of services 295,774 259,602
Costs of sales 59,791 37,439
---------- ------------
355,565 297,041
---------- ------------
Gross profit 248,155 219,791
Selling, general and administrative 57,524 51,331
Research and development 25,734 28,496
---------- ------------
Operating expenses 83,258 79,827
---------- ------------
Operating income 164,897 139,964
Other income (expense):
Interest income 2,316 2,209
Equity in earnings of unconsolidated affiliates 1,599 4,620
Other income (expense) 8,601 (715)
Interest expense (8,055) (4,011)
---------- ------------
4,461 2,103
---------- ------------
Income before income taxes 169,358 142,067
Income taxes 62,662 52,565
---------- ------------
Net income $ 106,696 $ 89,502
========== ============
Basic earnings per share $ 0.91 $ 0.78
========== ============
Diluted earnings per share $ 0.80 $ 0.72
========== ============
Weighted average shares outstanding - basic 117,848 114,826
========== ============
Weighted average shares outstanding - diluted 133,860 125,988
========== ============
Dividends per share - common stock $ 0.17 $ 0.085
========== ============
See Notes to Consolidated Financial Statements
-5-
GTECH HOLDINGS CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(Unaudited)
Six Months Ended
-----------------------
August 28, August 23,
2004 2003
---------- ----------
(Dollars in thousands)
OPERATING ACTIVITIES
Net income $ 106,696 $ 89,502
Adjustments to reconcile net income to net cash provided by
operating activities:
Depreciation 68,504 51,924
Intangibles amortization 4,510 1,609
Deferred income taxes benefit 13,904 -
Tax benefit related to stock award plans 6,615 10,696
Net charge associated with the early retirement of debt 751 -
Gain on sale of investment (10,924) -
Other 7,977 3,612
Changes in operating assets and liabilities:
Trade accounts receivable (11,894) 9,769
Inventories (5,255) 14,839
Accounts payable (9,111) (3,723)
Employee compensation (15,996) (8,437)
Advance payments from customers (5,904) 10,066
Deferred revenue and advance billings 17,700 (4,610)
Income taxes payable 15,664 (3,858)
Other assets and liabilities (11,480) (935)
---------- ----------
NET CASH PROVIDED BY OPERATING ACTIVITIES 171,757 170,454
INVESTING ACTIVITIES
Acquisitions (net of cash acquired) (192,402) (41,023)
Purchases of systems, equipment and other assets relating to contracts (113,011) (143,774)
Purchases of available-for-sale investment securities (50,150) -
Maturities and sales of available-for-sale investment securities 272,000 -
Proceeds from sale of investment 11,773 -
Purchases of property, plant and equipment (6,359) (6,285)
Increase in restricted cash (5,112) -
Investments in and advances to unconsolidated subsidiaries (1,435) (1,185)
License fee - (12,500)
---------- ----------
NET CASH USED FOR INVESTING ACTIVITIES (84,696) (204,767)
FINANCING ACTIVITIES
Net proceeds from issuance of long-term debt 15,000 1,409
Principal payments on long-term debt (92,249) (2,146)
Purchases of treasury stock (82,808) -
Redemption premium paid in connection with the early retirement of debt (10,610) -
Dividends paid (20,135) (9,883)
Proceeds from stock options 4,966 21,101
Other 739 (484)
---------- ----------
NET CASH PROVIDED BY (USED FOR) FINANCING ACTIVITIES (185,097) 9,997
Effect of exchange rate changes on cash (1,036) 2,464
---------- ----------
DECREASE IN CASH AND CASH EQUIVALENTS (99,072) (21,852)
Cash and cash equivalents at beginning of period 129,339 116,174
---------- ----------
CASH AND CASH EQUIVALENTS AT END OF PERIOD $ 30,267 $ 94,322
========== ==========
See Notes to Consolidated Financial Statements
-6-
GTECH HOLDINGS CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY - (Unaudited)
Accumulated
Additional Other
Outstanding Common Paid-in Comprehensive
Shares Stock Capital Loss
----------- ---------- ------------ -------------
(Dollars in thousands)
Balance at February 28, 2004 118,395,168 $ 923 $ 266,320 $ (70,508)
Comprehensive income:
Net income - - - -
Other comprehensive income (loss), net of tax:
Foreign currency translation - - - (266)
Unrecognized net gain on derivative instruments - - - 1,407
Unrealized loss on investments - - - (2)
Comprehensive income
Treasury stock purchased (3,649,500) - - -
Cash dividends on common stock ($0.17 per share) - - - -
Shares issued under employee stock purchase
and stock award plans 239,980 - - -
Shares issued upon exercise of stock options 635,450 - - -
Tax benefits related to stock award plans - - 6,615 -
Treasury stock retirement - (349) - -
July 2004 two-for-one stock split - 592 - -
----------- ---------- ------------ -------------
Balance at August 28, 2004 115,621,098 $ 1,166 $ 272,935 $ (69,369)
=========== ========== ============ ==============
Retained Treasury
Earnings Stock Total
----------- ---------- ------------
(Dollars in thousands)
Balance at February 28, 2004 $ 839,270 $ (473,716) $ 562,289
Comprehensive income:
Net income 106,696 - 106,696
Other comprehensive income (loss), net of tax:
Foreign currency translation - - (266)
Unrecognized net gain on derivative instruments - - 1,407
Unrealized loss on investments - - (2)
------------
Comprehensive income 107,835
Treasury stock purchased - (82,808) (82,808)
Cash dividends on common stock ($0.17 per share) (20,280) - (20,280)
Shares issued under employee stock purchase
and stock award plans 1,659 1,878 3,537
Shares issued upon exercise of stock options (1,286) 6,252 4,966
Tax benefits related to stock award plans - - 6,615
Treasury stock retirement (528,838) 529,187 -
July 2004 two-for-one stock split (592) - -
----------- ---------- ------------
Balance at August 28, 2004 $ 396,629 $ (19,207) $ 582,154
=========== ========== ============
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 technology services company
providing software, networks and professional services that power
high-performance solutions. We are the world's leading operator of highly-secure
online lottery transaction processing systems, doing business in 53 countries
worldwide and we have a growing presence in commercial gaming technology and
financial services transaction processing. We have a single operating and
reportable business segment, the Transaction Processing segment. In these notes,
the terms "Holdings," "Company," "we," "our," and "us" refer to GTECH Holdings
Corporation and all subsidiaries included in the consolidated financial
statements, unless otherwise specified. The accounting policies of the
Transaction Processing segment are the same as those described in Note 1 -
"Organization and Summary of Significant Accounting Policies" in our
Consolidated Financial Statements and footnotes included in our fiscal 2004
Annual Report on Form 10-K. Management evaluates the performance of this segment
based on operating income.
BASIS OF PRESENTATION
The accompanying unaudited consolidated financial statements of Holdings, the
parent of GTECH Corporation ("GTECH"), have been prepared in accordance with
generally accepted accounting principles ("GAAP") for interim financial
information and with the instructions to Form 10-Q and Article 10 of Regulation
S-X. They do not include all information and notes required by GAAP for complete
financial statements. In the opinion of management, all adjustments (consisting
of normal recurring accruals) considered necessary for a fair presentation have
been included. Operating results for the six-month period ended August 28, 2004
are not necessarily indicative of the results that may be expected for the full
fiscal year ending February 26, 2005. The balance sheet at February 28, 2004 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 2004 Annual Report on Form 10-K.
Certain amounts in our prior period financial statements have been reclassified
to conform to the current period presentation.
STOCK-BASED COMPENSATION PLANS
We follow Accounting Principles Board Opinion No. 25, "Accounting for Stock
Issued to Employees" and related Interpretations in accounting for our
stock-based compensation plans and we have elected to continue to use the
intrinsic value-based method to account for stock option grants. We have adopted
the disclosure-only provisions of Statement of Financial Accounting Standards
No. 148, "Accounting for Stock-Based Compensation - Transition and Disclosure,"
an amendment of Statement of Financial Accounting Standards No. 123.
Accordingly, no compensation expense has been recognized for our stock-based
compensation plans other than for restricted stock.
-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 Six Months Ended
------------------------------- -------------------------------
August 28, August 23, August 28, August 23,
2004 2003 2004 2003
-------------- --------------- -------------- ---------------
(Dollars and shares in thousands, except per share amounts)
Net income, as reported $ 53,081 $ 48,476 $ 106,696 $ 89,502
Add: Stock-based compensation expense
included in reported net income, net of
related tax effects 656 805 1,254 1,225
Deduct: Total stock-based compensation
expense determined under the fair value
method for all awards, net of related
tax effects (2,380) (2,237) (4,392) (4,134)
-------------- --------------- -------------- ---------------
Pro forma net income $ 51,357 $ 47,044 $ 103,558 $ 86,593
============== =============== ============== ===============
Basic earnings per share:
As reported $ .45 $ .42 $ .91 $ .78
Pro forma .44 .41 .88 .75
Diluted earnings per share:
As reported $ .40 $ .37 $ .80 $ .72
Pro forma .39 .36 .78 .69
NOTE 2 - COMMON STOCK SPLIT AND TREASURY STOCK RETIREMENT
On June 17, 2004, our Board of Directors approved a 2-for-1 common stock split,
payable in the form of a stock dividend, which entitled each shareholder of
record on July 1, 2004 to receive one share of common stock for each outstanding
share of common stock held on that date. The stock dividend was distributed on
July 30, 2004. All references to common shares and per share amounts herein have
been restated to reflect the stock split for all periods presented.
In connection with the declaration of the stock dividend, our Board of Directors
approved the retirement of 69.8 million shares of our common stock held in
treasury on July 29, 2004 (stated on a basis reflecting the stock split which
occurred subsequent to the retirement). The $528.8 million of treasury stock at
the time of the retirement was eliminated from treasury stock through a charge
to retained earnings and common stock.
-9-
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)
NOTE 3 - BUSINESS ACQUISITIONS
BILLBIRD S.A.
In September 2004 (after the close of our fiscal 2005 second quarter), our
majority-owned subsidiary, PolCard S.A, completed the acquisition of
privately-held BillBird S.A., the leading provider of electronic bill payment
services in Poland, for an all-cash purchase price of approximately $6.0
million. Approval of this transaction by our shareholders was not required.
SPIELO MANUFACTURING INCORPORATED
On April 30, 2004, we completed the acquisition of privately-held Spielo
Manufacturing Incorporated ("Spielo"), a leading provider of video lottery
terminals ("VLT's") and related products and services to the global gaming
industry, for an all-cash purchase price of approximately $150 million. In
addition, we paid Spielo shareholders approximately $7 million out of a
potential maximum earn-out amount of up to $35 million, which Spielo
shareholders are entitled to receive in the 18 months following the closing,
based upon Spielo achieving certain VLT installation objectives in New York.
Approval of this transaction by our shareholders was not required.
LEEWARD ISLANDS LOTTERY HOLDING COMPANY INC.
On May 5, 2004, we completed the acquisition of privately-held Leeward Islands
Lottery Holding Company Inc. ("LILHCo"), a lottery operating company
headquartered on the Caribbean islands of Antigua and St. Croix, for an all-cash
purchase price of approximately $40 million. Approval of this transaction by our
shareholders was not required.
We have not yet finalized the evaluation and allocation of the purchase price
for the Spielo and LILHCo acquisitions. However, we do not expect the final
purchase price allocation will be materially different than our preliminary
allocation.
These acquisitions are individually and in the aggregate, not material to our
consolidated financial statements and accordingly, pro forma financial
information has not been presented.
NOTE 4 - INVENTORIES
August 28, February 28,
2004 2004
------------------ -----------------
(Dollars in thousands)
Inventories consist of:
Raw materials $ 31,300 $ 14,540
Work in progress 53,135 60,470
Finished goods 9,590 1,774
------------------ -----------------
$ 94,025 $ 76,784
================== =================
Inventories include amounts we manufacture or assemble for our long-term service
contracts and amounts related to product sales contracts, including product
sales which are accounted for using contract accounting. Work in progress at
August 28, 2004 and February 28, 2004, includes approximately $44.2 million and
$54.9 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
$71.0 million and $104.1 million at August 28, 2004 and February 28, 2004,
respectively.
-10-
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)
NOTE 5 - RESTRICTED ASSETS
A June 25, 2004 ruling in a civil action initiated by federal attorneys with
Brazil's Public Ministry has reduced payments that we otherwise would receive
from our lottery contract with Caixa Economica Federal ("CEF"), our customer and
the operator of Brazil's National Lottery, which expires in May 2005. This
ruling ordered that 30% of payments subsequent to the June 25, 2004 ruling due
to GTECH Brasil Ltda., our Brazilian subsidiary ("GTECH Brazil") from CEF, be
withheld and deposited in an account maintained by the Court (as further
discussed in "Legal Proceedings - Brazilian-Related Legal Proceedings" in Part
II, Item 1 in this report).
Accordingly, we have not recognized service revenues for the payments that were
withheld from GTECH Brazil, as realization of these amounts is not reasonably
assured. In addition, the ruling ordered that all assets of GTECH Brazil be
identified to the Court so as to prevent their transfer or disposition. As of
August 28, 2004, GTECH Brazil assets were as follows (dollars in thousands):
Systems, Equipment and Other Assets Relating to Contracts, net $ 7,819
Cash 5,112
--------------
Assets restricted from transfer or disposition $ 12,931
All other 12,339
--------------
GTECH Brazil assets at August 28, 2004 $ 25,270
==============
The restricted cash is included in Other Assets in our Consolidated Balance
Sheet.
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 28, 2004 $ 749
Opening reserve balance associated with acquisitions 1,126
Additional reserves 561
Charges incurred (945)
Change in estimate (300)
Other 35
--------------
Balance at August 28, 2004 $ 1,226
==============
-11-
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)
NOTE 7 - LONG-TERM DEBT
August 28, February 28,
2004 2004
---------------- ---------------
(Dollars in thousands)
Long-term debt consists of:
4.75% Senior Notes due October 2010 $ 249,663 $ 249,636
1.75% Convertible Debentures due December 2021 175,000 175,000
World Headquarters loan due January 2007 27,933 27,933
Revolving credit facility due June 2006 15,000 -
Fair value of interest rate swaps 1,945 4,893
Deferred interest rate swap gains due through October 2010 1,222 12,009
7.87% Series B Guaranteed Senior Notes due May 2007 - 90,000
Other, due through April 2006 8,184 10,063
---------------- ---------------
478,947 569,534
Less current portion 4,848 106,319
---------------- ---------------
$ 474,099 $ 463,215
================ ===============
We have a $300 million unsecured revolving credit facility expiring in June 2006
(the "Credit Facility"). At August 28, 2004, the weighted average interest rate
for all outstanding borrowings under the Credit Facility was 2.53%. Up to $100
million of the Credit Facility may be used for the issuance of letters of
credit. At August 28, 2004, there was $255.9 million available for borrowing
under the Credit Facility, after considering $29.1 million of letters of credit
issued and outstanding.
Holders of our 1.75% Convertible Debentures due December 2021 ("Debentures") may
require us to repurchase all or part of their Debentures on December 15, 2004,
December 15, 2006, December 15, 2011 and December 15, 2016 at a price equal to
100% of the principal amount of the Debentures, plus accrued interest. We have
classified the Debentures as long-term liabilities in our Consolidated Balance
Sheets at August 28, 2004 and February 28, 2004 because we intend to borrow
under our $300 million Credit Facility to refinance any amount holders of the
Debentures require us to repurchase on December 15, 2004. Any amount borrowed
under the Credit Facility is expected to remain outstanding for an uninterrupted
period extending beyond one year from August 28, 2004.
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.
-12-
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 certain specified events occur. In the case of
performance bonds, which generally have a term of one year, such events include
our failure to perform our obligations under the applicable contract. To obtain
these bonds, we are required to indemnify the issuers against the costs they
incur if a beneficiary exercises its rights under a bond. Historically, our
customers have not exercised their rights under these bonds and we do not
currently anticipate that they will do so. The following table provides
information related to potential commitments at August 28, 2004:
Total potential
commitments
---------------
(in thousands)
Performance bonds $ 202,773
Litigation bonds 6,975
Financial guarantees 3,142
All other bonds 3,691
-------------
$ 216,581
=============
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 fiscal 2002, 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, we guaranteed loans made to
LTSC by an unrelated commercial lender. The loans have a maturity date of March
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. At
August 28, 2004, the principal amount of the loans was $2.1 million and our
guarantee was $0.9 million.
We recognize 56% of gross profit on product sales to LTSC and defer the
remaining 44% as a result of our equity interest in LTSIC. We recognize these
deferrals ratably over the life of our contract with LTSC. At August 28, 2004,
deferred product gross profit totaling $2.8 million is included in Deferred
Revenue and Advance Billings and Other Liabilities in our Consolidated Balance
Sheets.
In fiscal years prior to 2005, we deferred service revenue from LTSC in an
amount equal to our 44% guarantee of LTSC's debt and these deferrals are being
recognized as the guaranteed debt is repaid. At August 28, 2004, deferred
service revenue totaling $0.9 million is included in Deferred Revenue and
Advance Billings in our Consolidated Balance Sheets.
-13-
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)
NOTE 10 - GUARANTEES AND INDEMNIFICATIONS (continued)
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 August 28, 2004, was $2.2 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. ("DELTA"). The joint venture agreement terminates on December
31, 2012. LTE holds a 10-year contract (which expires in November 2009) with the
District of Columbia Lottery and Charitable Games Control Board. Under
Washington, D.C. law, by virtue of our 1% interest in LTE, we may be jointly and
severally liable, with DELTA, for the obligations of the joint venture.
NOTE 11 -- COMPREHENSIVE INCOME
The components of comprehensive income are as follows:
Three Months Ended Six Months Ended
---------------------- -----------------------
August 28, August 23, August 28, August 23,
2004 2003 2004 2003
---------- ---------- ---------- ----------
(Dollars in thousands)
Net income $ 53,081 $ 48,476 $ 106,696 $ 89,502
Other comprehensive income (loss),
net of tax
Foreign currency translation 1,954 (4,113) (266) 5,104
Unrecognized net gain (loss) on
derivative instruments 513 4,000 1,407 (1,048)
Unrealized loss on investments - (1) (2) (1)
---------- ---------- ---------- ----------
Comprehensive income $ 55,548 $ 48,362 $ 107,835 $ 93,557
========== ========== ========== ==========
NOTE 12 - SALE OF INVESTMENT
At February 28, 2004, we held a 50% interest in Gaming Entertainment (Delaware)
L.L.C. ("GED"), an entity that manages a racino for Harrington Raceway, Inc.
("Harrington"). During the first quarter of fiscal 2005, we sold our 50%
interest in GED to Harrington for $11.8 million and recognized a gain of $10.9
million which was recorded in Other Income (Expense) in our Consolidated Income
Statements.
-14-
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)
NOTE 13 - EARNINGS PER SHARE
The following table shows the computation of basic and diluted earnings per
share:
Three Months Ended Six Months Ended
---------------------------- ----------------------------
August 28, August 23, August 28, August 23,
2004 2003 2004 2003
---------- ---------- ---------- ----------
(Dollars and shares in thousands, except per share amounts)
Numerator:
Net income (Numerator for basic earnings
per share) $ 53,081 $ 48,476 $ 106,696 $ 89,502
Effect of dilutive securities:
Interest expense on 1.75% Convertible
Debentures, net of tax 518 517 1,047 662
--------- --------- --------- ---------
Numerator for diluted earnings per share $ 53,599 $ 48,993 $ 107,743 $ 90,164
========= ========= ========= =========
Denominator:
Denominator for basic earnings per share-
weighted-average shares 117,070 115,836 117,848 114,826
Effect of dilutive securities:
1.75% Convertible Debentures 12,727 12,727 12,727 7,902
Employee stock options 2,744 2,968 3,062 3,052
Unvested restricted and stock bonus
discount shares 202 284 223 208
--------- --------- --------- ---------
Dilutive potential common shares 15,673 15,979 16,012 11,162
Denominator for diluted earnings per
share-adjusted weighted-average shares
and assumed conversions 132,743 131,815 133,860 125,988
========= ========= ========= =========
Basic earnings per share $ .45 $ .42 $ .91 $ .78
========= ========= ========= =========
Diluted earnings per share $ .40 $ .37 $ .80 $ .72
========= ========= ========= =========
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
72.7272 shares of common stock per $1,000 principal amount of Debentures, which
is equivalent to an initial conversion price of approximately $13.75 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 $16.50 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 12.7
million shares issuable upon the conversion of the Debentures.
The Debentures were convertible for all trading days in the quarters ended
August 28, 2004 and August 23, 2003, resulting in 12.7 million shares included
in the computation of diluted earnings per share.
-15-
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)
NOTE 14 - INCOME TAXES
Our effective income tax rate is greater than the statutory rate primarily due
to state income taxes. The effective income tax rate is based upon expected
income for the year, the composition of income or loss in different
jurisdictions and related statutory tax rates, accruals for tax contingencies
and the tax consequences or benefits from audits or the resolution of tax
contingencies.
NOTE 15 - SUBSEQUENT EVENT
BILLBIRD S.A.
In September 2004, our majority-owned subsidiary, PolCard S.A, completed the
acquisition of privately-held BillBird S.A., the leading provider of electronic
bill payment services in Poland. See Note 3 "Business Acquisitions" for detailed
disclosures.
NOTE 16 - SUPPLEMENTAL GUARANTOR/NON-GUARANTOR FINANCIAL INFORMATION
On December 18, 2001, Holdings (the "Parent Company") issued, in a private
placement, $175 million principal amount of 1.75% Convertible Debentures due
December 15, 2021 (the "Debentures"). On October 9, 2003, the Parent Company
issued, in a private placement, $250 million principal amount of 4.75% Senior
Notes due October 15, 2010, all of which were subsequently exchanged for 4.75%
Senior Notes due October 15, 2010 registered under the Securities Act of 1933
(the "Senior Notes"). The Debentures and Senior Notes are unsecured and
unsubordinated obligations of the Parent Company that are jointly and severally,
fully and unconditionally guaranteed by GTECH and two of its wholly owned
subsidiaries: GTECH Rhode Island Corporation and GTECH Latin America Corporation
(collectively with GTECH, the "Guarantor Subsidiaries"). Condensed consolidating
financial information is presented below.
Selling, general and administrative costs and research and development costs are
allocated to each subsidiary based on the ratio of the subsidiaries' combined
service revenues and sales of products to consolidated revenues.
The Parent Company conducts business through its consolidated subsidiaries and
unconsolidated affiliates and has, as its only material asset, an investment in
GTECH. Equity in earnings of consolidated affiliates recorded by the Parent
Company includes the Parent Company's share of the after-tax earnings of GTECH.
Taxes payable and deferred income taxes are obligations of the subsidiaries.
Income tax expense related to both current and deferred income taxes are
allocated to each subsidiary based on our consolidated effective income tax
rates.
-16-
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)
NOTE 16 - SUPPLEMENTAL GUARANTOR/NON-GUARANTOR FINANCIAL INFORMATION
(continued)
Condensed Consolidating Balance Sheets
August 28, 2004
Parent Guarantor Non-Guarantor Eliminating
Company Subsidiaries Subsidiaries Entries Consolidated
-------------- -------------- -------------- -------------- --------------
(Dollars in thousands)
Assets
Current Assets:
Cash and cash equivalents $ - $ 56 $ 30,211 $ - $ 30,267
Trade accounts receivable, net - 75,747 58,702 - 134,449
Due from subsidiaries and affiliates - 41,404 - (41,404) -
Sales-type lease receivables - 3,567 4,281 - 7,848
Inventories - 52,433 47,266 (5,674) 94,025
Deferred income taxes - 26,171 6,388 - 32,559
Other current assets - 10,111 21,757 - 31,868
-------------- -------------- -------------- -------------- --------------
Total Current Assets - 209,489 168,605 (47,078) 331,016
Systems, Equipment and Other
Assets Relating to Contracts, net - 564,479 93,718 (8,397) 649,800
Investment in Subsidiaries and
Affiliates 582,154 367,878 - (950,032) -
Goodwill, net - 116,347 208,569 - 324,916
Property, Plant and Equipment, net - 32,116 34,368 - 66,484
Intangible Assets, net - 20,661 51,953 - 72,614
Refundable Performance Deposit - - 20,000 - 20,000
Sales-Type Lease Receivables - 6,230 7,434 - 13,664
Other Assets - 15,617 28,241 - 43,858
-------------- -------------- -------------- -------------- --------------
Total Assets $ 582,154 $ 1,332,817 $ 612,888 $ (1,005,507) $ 1,522,352
============== ============== ============== ============== ==============
Liabilities and Shareholders' Equity
Current Liabilities:
Accounts payable $ - $ 38,896 $ 34,448 $ - $ 73,344
Due to subsidiaries and affiliates - - 29,454 (29,454) -
Accrued expenses - 29,297 21,584 - 50,881
Employee compensation - 13,269 6,529 - 19,798
Advance payments from customers - 21,487 49,468 - 70,955
Deferred revenue and advance
billings - 19,657 12,502 - 32,159
Income taxes payable - 20,867 6,306 - 27,173
Taxes other than income taxes - 9,198 10,245 - 19,443
Current portion of long-term debt - 198 4,650 - 4,848
-------------- -------------- -------------- -------------- --------------
Total Current Liabilities - 152,869 175,186 (29,454) 298,601
Long-Term Debt, less current
portion - 442,632 31,467 - 474,099
Other Liabilities - 61,697 17,568 - 79,265
Deferred Income Taxes - 67,444 20,789 - 88,233
Shareholders' Equity 582,154 608,175 367,878 (976,053) 582,154
-------------- -------------- -------------- -------------- --------------
Total Liabilities and
Shareholders' Equity $ 582,154 $ 1,332,817 $ 612,888 $ (1,005,507) $ 1,522,352
============== ============== ============== ============== ==============
-17-
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)
NOTE 16 - SUPPLEMENTAL GUARANTOR/NON-GUARANTOR FINANCIAL INFORMATION
(continued)
Condensed Consolidating Balance Sheets
February 28, 2004
Parent Guarantor Non-Guarantor Eliminating
Company Subsidiaries Subsidiaries Entries Consolidated
-------------- -------------- -------------- -------------- --------------
(Dollars in thousands)
Assets
Current Assets:
Cash and cash equivalents $ - $ 68,956 $ 60,383 $ - $ 129,339
Investment securities
available-for-sale - 221,850 - - 221,850
Trade accounts receivable, net - 75,590 43,312 - 118,902
Due from subsidiaries and affiliates - 49,168 - (49,168) -
Sales-type lease receivables - 3,967 3,738 - 7,705
Inventories - 52,697 29,943 (5,856) 76,784
Deferred income taxes - 30,254 4,142 - 34,396
Other current assets - 5,481 18,945 - 24,426
-------------- -------------- -------------- -------------- --------------
Total Current Assets - 507,963 160,463 (55,024) 613,402
Systems, Equipment and Other
Assets Relating to Contracts, net - 518,976 80,111 (7,725) 591,362
Investment in Subsidiaries and
Affiliates 562,289 162,788 - (725,077) -
Goodwill, net - 115,965 72,647 - 188,612
Property, Plant and Equipment, net - 28,543 29,033 - 57,576
Intangible Assets, net - 21,850 6,381 - 28,231
Refundable Performance Deposit - - 20,000 - 20,000
Sales-Type Lease Receivables - 8,125 9,528 - 17,653
Other Assets - 20,822 21,473 - 42,295
-------------- -------------- -------------- -------------- --------------
Total Assets $ 562,289 $ 1,385,032 $ 399,636 $ (787,826) $ 1,559,131
============== ============== ============== ============== ==============
Liabilities and Shareholders' Equity
Current Liabilities:
Accounts payable $ - $ 54,967 $ 25,037 $ - $ 80,004
Due to subsidiaries and affiliates - - 49,168 (49,168) -
Accrued expenses - 32,041 15,387 - 47,428
Employee compensation - 29,256 4,725 - 33,981
Advance payments from customers - 45,648 58,480 - 104,128
Deferred revenue and advance
billings - 8,282 6,177 - 14,459
Income taxes payable - 4,419 7,975 - 12,394
Taxes other than income taxes - 8,643 10,816 - 19,459
Current portion of long-term debt - 100,886 5,433 - 106,319
-------------- -------------- -------------- -------------- --------------
Total Current Liabilities - 284,142 183,198 (49,168) 418,172
Long-Term Debt, less current
portion - 430,652 32,563 - 463,215
Other Liabilities - 36,526 17,210 - 53,736
Deferred Income Taxes - 57,842 3,877 - 61,719
Shareholders' Equity 562,289 575,870 162,788 (738,658) 562,289
-------------- -------------- -------------- -------------- --------------
Total Liabilities and
Shareholders' Equity $ 562,289 $ 1,385,032 $ 399,636 $ (787,826) $ 1,559,131
============== ============== ============== ============== ==============
-18-
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)
NOTE 16 - SUPPLEMENTAL GUARANTOR/NON-GUARANTOR FINANCIAL INFORMATION
(continued)
Condensed Consolidating Income Statements
Three Months Ended August 28, 2004
Parent Guarantor Non-Guarantor Eliminating
Company Subsidiaries Subsidiaries Entries Consolidated
--------------- ------------- --------------- -------------- --------------
(Dollars in thousands)
Revenues:
Services $ - $ 176,690 $ 71,424 $ - $ 248,114
Sales of products - 40,394 35,007 - 75,401
Intercompany sales and fees - 17,957 10,806 (28,763) -
--------------- ------------- --------------- ------------- --------------
- 235,041 117,237 (28,763) 323,515
Costs and expenses:
Costs of services - 101,756 47,569 (844) 148,481
Costs of sales - 20,380 23,494 - 43,874
Intercompany cost of sales
and fees - 21,321 4,286 (25,607) -
--------------- ------------- --------------- ------------- --------------
- 143,457 75,349 (26,451) 192,355
--------------- ------------- --------------- ------------- --------------
Gross profit - 91,584 41,888 (2,312) 131,160
Selling, general & administrative - 20,020 9,869 - 29,889
Research and development - 8,454 4,193 - 12,647
--------------- ------------- --------------- ------------- --------------
Operating expenses - 28,474 14,062 - 42,536
--------------- ------------- --------------- ------------- --------------
Operating income - 63,110 27,826 (2,312) 88,624
Other income (expense):
Interest income - 172 809 - 981
Equity in earnings (loss) of
unconsolidated affiliates - 573 (280) - 293
Equity in earnings of
consolidated affiliates 53,081 15,781 - (68,862) -
Other income (expense) - 1,071 (2,995) - (1,924)
Interest expense - (3,408) (311) - (3,719)
--------------- ------------- --------------- ------------- --------------
53,081 14,189 (2,777) (68,862) (4,369)
--------------- ------------- --------------- ------------- --------------
Income before income taxes 53,081 77,299 25,049 (71,174) 84,255
Income taxes - 28,600 9,268 (6,694) 31,174
--------------- ------------- --------------- ------------- --------------
Net income $ 53,081 $ 48,699 $ 15,781 $ (64,480) $ 53,081
=============== ============= =============== ============= ==============
-19-
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)
NOTE 16 - SUPPLEMENTAL GUARANTOR/NON-GUARANTOR FINANCIAL INFORMATION
(continued)
Condensed Consolidating Income Statements
Six Months Ended August 28, 2004
Parent Guarantor Non-Guarantor Eliminating
Company Subsidiaries Subsidiaries Entries Consolidated
--------------- ------------- --------------- ------------- -------------
(Dollars in thousands)
Revenues:
Services $ - $ 355,353 $ 146,087 $ - $ 501,440
Sales of products - 58,838 43,442 - 102,280
Intercompany sales and fees - 49,863 24,997 (74,860) -
--------------- ------------- --------------- ------------- -------------
- 464,054 214,526 (74,860) 603,720
Costs and expenses:
Costs of services - 205,830 91,306 (1,362) 295,774
Costs of sales - 31,748 28,056 (13) 59,791
Intercompany cost of sales
and fees - 45,017 8,577 (53,594) -
--------------- ------------- --------------- ------------- -------------
- 282,595 127,939 (54,969) 355,565
--------------- ------------- --------------- ------------- -------------
Gross profit - 181,459 86,587 (19,891) 248,155
Selling, general & administrative - 39,462 18,062 - 57,524
Research and development - 17,660 8,074 - 25,734
--------------- ------------- --------------- ------------- -------------
Operating expenses - 57,122 26,136 - 83,258
--------------- ------------- --------------- ------------- -------------
Operating income - 124,337 60,451 (19,891) 164,897
Other income (expense):
Interest income - 785 1,531 - 2,316
Equity in earnings (loss) of
unconsolidated affiliates - 1,914 (315) - 1,599
Equity in earnings of
consolidated affiliates 106,696 44,022 - (150,718) -
Other income (expense) - (358) 8,959 - 8,601
Interest expense - (7,305) (750) - (8,055)
--------------- ------------- --------------- ------------- -------------
106,696 39,058 9,425 (150,718) 4,461
--------------- ------------- --------------- ------------- -------------
Income before income taxes 106,696 163,395 69,876 (170,609) 169,358
Income taxes - 60,456 25,854 (23,648) 62,662
--------------- ------------- --------------- ------------- -------------
Net income $ 106,696 $ 102,939 $ 44,022 $ (146,961) $ 106,696
=============== ============= =============== ============= =============
-20-
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)
NOTE 16 - SUPPLEMENTAL GUARANTOR/NON-GUARANTOR FINANCIAL INFORMATION
(continued)
Condensed Consolidating Income Statements
Three Months Ended August 23, 2003
Parent Guarantor Non-Guarantor Eliminating
Company Subsidiaries Subsidiaries Entries Consolidated
--------------- ------------ ------------ ------------- ------------
(Dollars in thousands)
Revenues:
Services $ - $ 172,895 $ 65,124 $ - $ 238,019
Sales of products - 8,469 30,759 - 39,228
Intercompany sales and fees - 18,495 11,628 (30,123) -
--------------- ------------- --------------- ------------- --------------
- 199,859 107,511 (30,123) 277,247
Costs and expenses:
Costs of services - 92,010 41,796 (1,001) 132,805
Costs of sales - 3,694 25,150 (34) 28,810
Intercompany cost of sales
and fees - 38,634 3,906 (42,540) -
--------------- ------------- --------------- ------------- --------------
- 134,338 70,852 (43,575) 161,615
--------------- ------------- --------------- ------------- --------------
Gross profit - 65,521 36,659 13,452 115,632
Selling, general and administrative - 17,653 9,398 - 27,051
Research and development - 9,131 4,975 - 14,106
--------------- ------------- --------------- ------------- --------------
Operating expenses - 26,784 14,373 - 41,157
--------------- ------------- --------------- ------------- --------------
Operating income - 38,737 22,286 13,452 74,475
Other income (expense):
Interest income - 201 820 - 1,021
Equity in earnings of
unconsolidated affiliates - 1,381 1,310 - 2,691
Equity in earnings of
consolidated affiliates 48,476 15,035 - (63,511) -
Other income (expense) - 711 (246) - 465
Interest expense - (1,399) (306) - (1,705)
--------------- ------------- --------------- ------------- --------------
48,476 15,929 1,578 (63,511) 2,472
--------------- ------------- --------------- ------------- --------------
Income before income taxes 48,476 54,666 23,864 (50,059) 76,947
Income taxes - 20,226 8,829 (584) 28,471
--------------- ------------- --------------- ------------- --------------
Net income $ 48,476 $ 34,440 $ 15,035 $ (49,475) $ 48,476
=============== ============= =============== ============= ==============
-21-
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)
NOTE 16 - SUPPLEMENTAL GUARANTOR/NON-GUARANTOR FINANCIAL INFORMATION
(continued)
Condensed Consolidating Income Statements
Six Months Ended August 23, 2003
Parent Guarantor Non-Guarantor Eliminating
Company Subsidiaries Subsidiaries Entries Consolidated
--------------- ------------ ------------ ------------- ------------
(Dollars in thousands)
Revenues:
Services $ - $ 339,198 $ 122,359 $ - $ 461,557
Sales of products - 20,085 35,190 - 55,275
Intercompany sales and fees - 45,342 21,933 (67,275) -
--------------- ------------- --------------- ------------- --------------
- 404,625 179,482 (67,275) 516,832
Costs and expenses:
Costs of services - 182,031 79,618 (2,047) 259,602
Costs of sales - 9,981 27,512 (54) 37,439
Intercompany cost of sales
and fees - 54,604 8,552 (63,156) -
--------------- ------------- --------------- ------------- --------------
- 246,616 115,682 (65,257) 297,041
--------------- ------------- --------------- ------------- --------------
Gross profit - 158,009 63,800 (2,018) 219,791
Selling, general and administrative - 35,686 15,645 - 51,331
Research and development - 19,815 8,681 - 28,496
--------------- ------------- --------------- ------------- --------------
Operating expenses - 55,501 24,326 - 79,827
--------------- ------------- --------------- ------------- --------------
Operating income - 102,508 39,474 (2,018) 139,964
Other income (expense):
Interest income - 560 1,649 - 2,209
Equity in earnings of
unconsolidated affiliates - 2,571 2,049 - 4,620
Equity in earnings of
consolidated affiliates 89,502 24,513 - (114,015) -
Other income (expense) - 2,729 (3,444) - (715)
Interest expense - (3,192) (819) - (4,011)
--------------- ------------- --------------- ------------- --------------
89,502 27,181 (565) (114,015) 2,103
--------------- ------------- --------------- ------------- --------------
Income before income taxes 89,502 129,689 38,909 (116,033) 142,067
Income taxes - 47,985 14,396 (9,816) 52,565
--------------- ------------- --------------- ------------- --------------
Net income $ 89,502 $ 81,704 $ 24,513 $ (106,217) $ 89,502
=============== ============= =============== ============= ==============
-22-
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)
NOTE 16 - SUPPLEMENTAL GUARANTOR/NON-GUARANTOR FINANCIAL INFORMATION
(continued)
Condensed Consolidating Statements of Cash Flows
Six Months Ended August 28, 2004
Parent Guarantor Non-Guarantor Eliminating
Company Subsidiaries Subsidiaries Entries Consolidated
--------------- ------------ ------------ ------------- ------------
(Dollars in thousands)
Net cash provided by operating
activities $ - $ 166,112 $ 7,380 $ (1,735) $ 171,757
Investing Activities
Acquisitions (net of cash acquired) - - (192,402) - (192,402)
Purchases of systems, equipment
and other assets relating to
contracts - (99,433) (15,313) 1,735 (113,011)
Purchases of available-for-sale
investment securities - (50,150) - - (50,150)
Maturities and sales of
available-for-sale investment
securities - 272,000 - - 272,000
Proceeds from sale of investment - - 11,773 - 11,773
Purchases of property, plant
and equipment - (6,293) (66) - (6,359)
Increase in restricted cash - - (5,112) - (5,112)
Investment in advances to
unconsolidated subsidiaries - - (1,435) - (1,435)
--------------- ------------- --------------- ------------- --------------
Net cash provided by (used for)
investing activities - 116,124 (202,555) 1,735 (84,696)
Financing Activities
Net proceeds from issuance of
long-term debt - 15,000 - - 15,000
Principal payments on long-term
debt - (90,000) (2,249) - (92,249)
Purchases of treasury stock (82,808) - - - (82,808)
Redemption premium paid in
connection with the early
retirement of debt - (10,610) - - (10,610)
Dividends paid (20,135) - - - (20,135)
Proceeds from stock options 4,966 - - - 4,966
Intercompany capital transactions 97,177 (265,177) 168,000 - -
Other 800 (61) - - 739
--------------- ------------- --------------- ------------- --------------
Net cash provided by (used for)
financing activities - (350,848) 165,751 - (185,097)
Effect of exchange rate changes
on cash - (288) (748) - (1,036)
--------------- ------------- --------------- ------------- --------------
Decrease in cash and
cash equivalents - (68,900) (30,172) - (99,072)
Cash and cash equivalents at
beginning of period - 68,956 60,383 - 129,339
--------------- ------------- --------------- ------------- --------------
Cash and cash equivalents at end
of period $ - $ 56 $ 30,211 $ - $ 30,267
=============== ============= =============== ============= ==============
-23-
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)
NOTE 16 - SUPPLEMENTAL GUARANTOR/NON-GUARANTOR FINANCIAL INFORMATION
(continued)
Condensed Consolidating Statements of Cash Flows
Six Months Ended August 23, 2003
Parent Guarantor Non-Guarantor Eliminating
Company Subsidiaries Subsidiaries Entries Consolidated
--------------- ------------- --------------- ------------- --------------
(Dollars in thousands)
Net cash provided by operating
activities $ - $ 109,427 $ 61,340 $ (313) $ 170,454
Investing Activities
Purchases of systems, equipment
and other assets relating to
contracts - (137,541) (6,546) 313 (143,774)
Acquisitions (net of cash acquired) - - (41,023) - (41,023)
License fee - (12,500) - - (12,500)
Purchases of property, plant
and equipment - (6,285) - - (6,285)
Investments in and advances to
unconsolidated subsidiaries - (1,185) - - (1,185)
--------------- ------------- --------------- ------------- --------------
Net cash used for investing
activities - (157,511) (47,569) 313 (204,767)
Financing Activities
Net proceeds from issuance
of long-term debt - - 1,409 - 1,409
Principal payments on long-term
debt - - (2,146) - (2,146)
Dividends paid (9,883) - - - (9,883)
Proceeds from stock options 21,101 - - - 21,101
Intercompany capital transactions (11,688) 11,688 - - -
Other 470 - (954) - (484)
--------------- ------------- --------------- ------------- --------------
Net cash provided by (used for)
financing activities - 11,688 (1,691) - 9,997
Effect of exchange rate changes
on cash - 100 2,364 - 2,464
--------------- ------------- --------------- ------------- --------------
Increase (decrease) in cash and
cash equivalents - (36,296) 14,444 - (21,852)
Cash and cash equivalents at
beginning of period - 88,739 27,435 - 116,174
--------------- ------------- --------------- ------------- --------------
Cash and cash equivalents at end
of period $ - $ 52,443 $ 41,879 $ - $ 94,322
=============== ============= =============== ============= ==============
-24-
Item 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
OVERVIEW
The following Management's Discussion and Analysis ("MD&A") is intended to help
the reader understand the financial results of GTECH Holdings Corporation. MD&A
is provided as a supplement to, and should be read in conjunction with, our
financial statements and the accompanying notes. This overview provides guidance
on the individual sections of MD&A as follows:
- - FORWARD-LOOKING STATEMENTS - cautionary information about forward-looking
statements.
- - OUR BUSINESS - a general description of our business; Brazilian legal
proceedings; acquisitions; our common stock split and treasury stock
retirement; and other business developments.
- - OPERATIONS REVIEW - an analysis of our consolidated results of operations
for the three and six month periods ended August 28, 2004 and August 23,
2003 presented in our financial statements. We operate in one business -
Transaction Processing, and we have a single operating and reportable
business segment. Therefore, our discussions are not quantified by segment
results.
- - LIQUIDITY, CAPITAL RESOURCES AND FINANCIAL POSITION - an analysis of cash
flows, financial position, and potential commitments.
- - FINANCIAL RISK MANAGEMENT AND DIVIDEND POLICY - information about
financial risk management; interest rate market risk; equity price risk;
foreign currency exchange rate risk; and our dividend policy.
- - SUBSEQUENT EVENT - information about a business acquisition that occurred
subsequent to August 28, 2004.
Unless specified otherwise, we use the terms "Holdings," "the Company," "we,"
"our," and "us" in MD&A to refer to GTECH Holdings Corporation and its
consolidated subsidiaries included in the consolidated financial statements.
FORWARD-LOOKING STATEMENTS
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 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; and
- - the results and effects of legal proceedings and investigations.
-25-
These forward-looking statements reflect management's assessment based on
information currently available, but are not guarantees and are subject to risks
and uncertainties that could cause actual results to differ materially from
those contemplated in the forward-looking statements. These risks and
uncertainties include, among other things, the following:
- - government regulations and other actions affecting the online lottery
industry could have a negative effect on our business and sales;
- - we may be subject to adverse determinations in pending legal proceedings
(including recently announced legal proceedings in Brazil) which could
result in substantial monetary judgments or reputational damage;
- - our lottery operations are dependent upon our continued ability to retain
and extend our existing contracts and win new contracts;
- - slow growth or declines in sales of online lottery goods and services
could lead to lower revenues and cash flow;
- - we derive close to half of our revenues from foreign jurisdictions
(including over ten percent in fiscal 2004 from Brazilian operations) and
are subject to the economic, political and social instability risks of
doing business in foreign jurisdictions;
- - our results of operations are exposed to foreign currency exchange rate
fluctuations which could result in lower revenues, net income and cash
flows when such results are translated into U.S. dollar accounts;
- - we have a concentrated customer base and the loss of any of our larger
customers (or lower sales from any of these customers) could lead to lower
revenue;
- - our quarterly operating results may fluctuate significantly, including as
a result of variations in the amount and timing of product sales, the
occurrence of large jackpots in lotteries (which increase the amount
wagered and our revenue) and expenses incurred in connection with lottery
start-ups;
- - we operate in a highly competitive environment and increased competition
may cause us to experience lower cash flows or to lose contracts;
- - we are subject to substantial penalties for failure to perform under our
contracts;
- - we may not be able to respond to technological changes or to satisfy
future technology demands of our customers, in which case we could fall
behind our competitors;
- - if we are unable to manage potential risks related to acquisitions, our
business and growth prospects could suffer;
- - expansion of the gaming industry faces opposition which could limit our
access to some markets;
- - our business prospects and future success depend upon our ability to
attract and retain qualified employees;
- - our business prospects and future success rely heavily upon the integrity
of our employees and executives and the security of our systems;
- - our dependence on certain suppliers creates a risk of implementation
delays if the supply contract is terminated or breached, and any delays
may result in substantial penalties;
- - our non-lottery ventures, which are an increasingly important aspect of
our business, may fail; and
- - other risks and uncertainties set forth below and elsewhere in this
report, in our fiscal 2004 Form 10-K, 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.
-26-
OUR BUSINESS
GENERAL
We operate on a 52-week or 53-week fiscal year ending on the last Saturday in
February and fiscal 2005 is a 52-week year that ends on February 26, 2005.
Fiscal 2004 was a 53-week year and we included the extra week in our fourth
quarter ended February 28, 2004.
We are a global technology services company providing software, networks and
professional services that power high-performance solutions. We are the world's
leading operator of highly-secure online lottery transaction processing systems,
doing business in 53 countries worldwide and we have a growing presence in
commercial gaming technology ("Gaming solutions") and financial services
transaction processing ("Commercial services"). A comparison of our revenue
concentration is as follows:
Six Months
Ended
August 28, Fiscal Fiscal
Consolidated Revenues 2004 2004 2003
- --------------------- -------------- ------------- --------------
Lottery 88% 91% 93%
Commercial services 7% 7% 5%
Gaming solutions 5% 2% 2%
-------------- ------------- --------------
100% 100% 100%
============== ============= ==============
Being a global business, we derive a substantial portion of our revenue from our
operations outside of the United States. In particular, in fiscal 2004, we
derived 49.4% of our revenues from international operations and 10.2% of our
revenues from our Brazilian operations alone (including 9.7% of our revenues
from Caixa Economica Federal, the operator of Brazil's National Lottery, our
largest customer in fiscal 2004 based on annual revenues). In addition,
substantial portions of our assets, primarily consisting of equipment we use to
operate online lottery systems for our customers, are held outside of the United
States. We are also exposed to more general risks of international operations,
including increased governmental regulation of the online lottery industry in
the markets where we operate; exchange controls or other currency restrictions;
and significant political instability.
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 and instant ticket sales. These percentages vary depending on the
size of the lottery and the scope of services provided to the lottery. We
primarily derive product sale revenues from the installation of new online
lottery systems, installation of new software and sales of lottery terminals and
equipment in connection with the expansion of existing lottery systems. Our
product margins fluctuate depending on the mix, volume and timing of product
sale contracts. Our product sale revenues from period to period may not be
comparable due to the size and timing of product sale transactions. During
fiscal 2005, we currently anticipate that product sales will be in the range of
$210 million to $220 million.
Our compensation under lottery service contracts is typically based upon a
percentage of a lottery's gross online and instant ticket sales. Over the past
several fiscal years, we have experienced and may continue to experience a
reduction in the percentage of lottery ticket sales we receive from certain
customers resulting from contract rebids, extensions and renewals due to a
number of factors, including the substantial growth of lottery sales over the
last decade, reductions in the cost of technology and telecommunications
services, and general market and competitive dynamics. In anticipation and
response to these trends, beginning in fiscal 2001, we began the implementation
of our new Enterprise Series-led technology strategy combined with the
implementation of a number of ongoing cost savings initiatives and efficiency
improvement programs designed to enable us to maintain our market leadership in
the lottery industry. We are unable to determine at this time the likely effect
of this trend on our business.
-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.
Because such investigations frequently are conducted in secret, we may not
necessarily know of the existence of an investigation which might involve us.
Because our reputation for integrity is an important factor in our business
dealings with lottery 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;
- - Part I, Item 1 - "Certain Factors That May Affect Future Performance -
Government regulations and other actions affecting the online lottery
industry could have a negative effect on our business and sales" in our
fiscal 2004 Annual Report on Form 10-K;
- - Part I, Item 3 - "Legal Proceedings" in our fiscal 2004 Annual Report on
Form 10-K;
- - Note 13 to the Consolidated Financial Statements in our fiscal 2004 Annual
Report on Form 10-K.
BRAZILIAN LEGAL PROCEEDINGS
Revenues from our lottery contract with Caixa Economica Federal ("CEF"), our
customer and the operator of Brazil's National Lottery, accounted for 9.7% of
our total fiscal 2004 revenues, making CEF our largest customer in fiscal 2004
based upon annual revenues.
A June 25, 2004 ruling in a civil action initiated by federal attorneys with
Brazil's Public Ministry will have the effect of materially reducing payments
that we otherwise would receive from our lottery contract with CEF, which
expires in May 2005. This ruling has ordered that 30% of payments subsequent to
the June 25, 2004 ruling due to GTECH Brasil Ltda., our Brazilian subsidiary
("GTECH Brazil") from CEF, be withheld and deposited in an account maintained by
the Court. In addition, the ruling ordered that all assets of GTECH Brazil be
identified to the Court so as to prevent their transfer or disposition. As of
August 28, 2004, GTECH Brazil assets approximated $25.2 million as follows
(dollars in millions):
Systems, Equipment and Other Assets Relating to Contracts, net $ 7.8
Cash 5.1
------------------
Assets restricted from transfer or disposition $ 12.9
All other 12.3
------------------
GTECH Brazil assets at August 28, 2004 $ 25.2
==================
The restricted cash is included in Other Assets in our Consolidated Balance
Sheet.
We estimate that this decision will reduce our service revenues and pre-tax
profits from our CEF contract by approximately $22 million to $25 million during
fiscal 2005. Pending our appeal of this ruling, we are undertaking a
comprehensive review of our service and investment levels in Brazil. Refer to
"Legal Proceedings - Brazilian-Related Legal Proceedings" in Part II, Item 1 in
this report; and Part 1, Item 3, "Legal Proceedings - Brazilian Legal
Proceedings, The CEF Contract Extension Proceedings," and Note 13 to the
Consolidated Financial Statements in our fiscal 2004 Annual Report on Form 10-K
for detailed disclosures regarding this, and related matters.
-28-
ACQUISITIONS
BILLBIRD S.A.
In September 2004 (after the close of our fiscal 2005 second quarter), our
majority-owned subsidiary, PolCard S.A. ("PolCard"), acquired privately-held
BillBird S.A ("BillBird"), the leading provider of electronic bill payment
services in Poland, for an all-cash purchase price of approximately $6.0
million. By combining BillBird and PolCard (which is the leading debit and
credit card merchant transaction acquirer and processor company in Poland), we
will enhance our market strategy of providing a product suite including debit
and credit transaction processing, card and ATM management services, electronic
bill payments, and prepaid mobile phone top-ups.
SPIELO MANUFACTURING INCORPORATED
During the first quarter of fiscal 2005, we acquired privately-held Spielo
Manufacturing Incorporated ("Spielo"), a leading provider of video lottery
terminals ("VLT's") and related products and services to the global gaming
industry, for an all-cash purchase price of approximately $150 million. In
addition, we paid Spielo shareholders approximately $7 million out of a
potential maximum earn-out amount of up to $35 million, which Spielo
shareholders are entitled to receive in the 18 months following the closing,
based upon Spielo achieving certain VLT installation objectives in New York. By
acquiring Spielo, we will be better able to deliver a comprehensive, integrated
VLT solution to our existing and potential customers, with a single point of
contact and accountability.
LEEWARD ISLANDS LOTTERY HOLDING COMPANY INC.
During the first quarter of fiscal 2005, we acquired privately-held Leeward
Islands Lottery Holding Company Inc. ("LILHCo"), a lottery operating company
headquartered on the Caribbean islands of Antigua and St. Croix, for an all-cash
purchase price of approximately $40 million. By acquiring Caribbean-based
LILHCo, we will enhance our strategic foothold in that region, as well as
provide significant growth opportunities in additional jurisdictions throughout
the Caribbean.
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,
Poland, Chile, the Czech Republic and Jamaica process bill payments and other
commercial service transactions. In the near term, we expect to concentrate our
efforts to grow commercial service revenues principally in the United States,
Latin America and Eastern Europe. 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 identify an opportunity to gain
access to certain markets through the acquisition of existing businesses, we may
consider making such acquisitions.
COMMON STOCK SPLIT AND TREASURY STOCK RETIREMENT
On June 17, 2004, our Board of Directors approved a 2-for-1 common stock split,
payable in the form of a stock dividend, which entitled each shareholder of
record on July 1, 2004 to receive one share of common stock for each outstanding
share of common stock held on that date. The stock dividend was distributed on
July 30, 2004. All references to common shares and per share amounts herein have
been restated to reflect the stock split for all periods presented.
In connection with the declaration of the stock dividend, our Board of Directors
approved the retirement of 69.8 million shares of our common stock held in
treasury on July 29, 2004 (stated on a basis reflecting the stock split which
occurred subsequent to the retirement). The $528.8 million of treasury stock at
the time of the retirement was eliminated from treasury stock through a charge
to retained earnings and common stock.
-29-
OTHER BUSINESS DEVELOPMENTS
In April 2004, we were notified that our selection in February 2004 as the
apparent successful vendor to provide equipment and services for a new online
lottery system and associated telecommunications network in Mexico to
Pronosticos para la Asistencia Publica ("Pronosticos") was retracted. As part of
a ruling by the Mexican Comptroller Ministry on a protest filed by unsuccessful
competitors, our bid was declared non-compliant and disqualified. In May 2004,
we challenged the Comptroller's decision.
In August 2004, the Mexican Comptroller Ministry declared our bid compliant and
reinstated our contract award. In September 2004 (after the close of our fiscal
2005 second quarter), we signed a six-year integrated services contract with
Pronosticos which is expected to commence in September 2005.
OPERATIONS REVIEW
COMPARISON OF THE THREE MONTH PERIODS ENDED AUGUST 28, 2004 AND AUGUST 23,
2003
TOTAL REVENUES Three Months Ended
----------------------------------------------------------
Change
August 28, August 23, ----------------------
2004 2003 $ %
-------------- -------------- -------- ------
(dollars in millions)
Services $ 248.1 $ 238.0 $ 10.1 4.2
Sales of products 75.4 39.2 36.2 92.3
-------------- -------------- -------- ------
$ 323.5 $ 277.2 $ 46.3 16.7
============== ============== ======== ======
SERVICE REVENUES AND GROSS MARGIN
Three Months Ended
----------------------------------------------------------
Change
August 28, August 23, ----------------------
2004 2003 $ %
-------------- ------------ ------ ------
(dollars in millions)
Domestic lottery $ 129.2 $ 126.4 $ 2.8 2.2
International lottery 91.2 87.4 3.8 4.3
Commercial services 19.4 19.5 (0.1) (0.5)
Gaming solutions 7.6 4.0 3.6 90.0
All other 0.7 0.7 - -
-------------- ---------- ------ ------
$ 248.1 $ 238.0 $ 10.1 4.2
============== ========== ====== ======
Three Months Ended
---------------------------------------------------------
Change
August 28, August 23, -----------------
2004 2003 Percentage Points
---------- ---------- -----------------
Service gross margin 40.2% 44.2% (4.0)
The 2.2% increase in domestic lottery service revenues was primarily due to
higher service revenues from an increase in sales by our domestic lottery
customers of approximately 6% with the balance principally due to the impact of
the Interlott acquisition in the third quarter of fiscal 2004, along with the
launch of our new service contract in Tennessee, partially offset by contractual
rate changes and lower jackpot activity. 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.
-30-
The 4.3% increase in international lottery service revenues includes higher
service revenues from an increase in sales by our international lottery
customers of approximately 2%, with the balance of the increase due to higher
jackpot activity and favorable foreign exchange rates, partially offset by the
impact of contractual rate changes and lower revenues from Brazil related to the
court order to withhold 30% of our revenues. 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, the successful
introduction of new games and modifications to existing games (such as matrix
changes and more frequent drawings).
The 0.5% decrease in commercial transaction processing service revenues was
primarily due to lower revenues from Brazil related to the court order to
withhold 30% of our revenues, partially offset by an increase of approximately
11% in transaction volumes.
The 90.0% increase in gaming solutions service revenues was primarily due to the
acquisition of Spielo and the installation of additional video lottery terminals
in the state of Rhode Island.
Our service margins were down 4.0 percentage points from last year, primarily
due to contractual rate changes and the lower margins from Brazil related to the
court order to withhold 30% of our revenues, along with the impact of higher
depreciation and amortization related principally to contract renewals and the
implementation of new contracts.
PRODUCT REVENUES AND GROSS MARGIN
Three Months Ended
--------------------------------------------------------
Change
August 28, August 23, --------------------
2004 2003 $ %
------------ ---------- ------- -----
(dollars in millions)
Sales of products $ 75.4 $ 39.2 $ 36.2 92.3
Three Months Ended
-------------------------------------------------------
Change
August 28, August 23, -----------------
2004 2003 Percentage Points
---------- ---------- -----------------
(dollars in millions)
Product gross margin 41.8% 26.6% 15.2
Product sales were up principally due to the sale of lottery terminals to our
customers in Belgium and Spain. Our product margins fluctuate depending on the
mix, volume and timing of product sales contracts. Our product margins were up
15.2 percentage points over last year, primarily due to the different mix of
sales, with the current year quarter including a high volume of lottery terminal
sales that carried higher margins than the prior year overall margin.
OPERATING EXPENSES
Operating expenses are comprised of selling, general and administrative (SG&A)
expenses and research and development (R&D) expenses.
Three Months Ended
---------------------------------------------------------
Change
August 28, August 23, -------------------
2004 2003 $ %
---------- ---------- ------- ------
(dollars in millions)
SG&A expenses $ 29.9 $ 27.1 $ 2.8 10.3
R&D expenses 12.6 14.1 (1.5) (10.6)
---------- ---------- ------- ------
$ 42.5 $ 41.2 $ 1.3 3.2
========== ========== ======= ======
PERCENTAGE OF TOTAL REVENUE
SG&A expenses 9.2% 9.7%
R&D expenses 3.9% 5.1%
-31-
The $2.8 million increase in SG&A expenses was principally due to higher legal
expenses associated with acquisition related activity, ongoing legal activities
in Brazil, and an acceleration in regulatory licensing activity in worldwide
commercial gaming markets, along with the consolidation of our recent Spielo
acquisition. The $1.5 million decrease in R&D expenses was primarily due to the
timing of development initiatives, partially offset by the impact of the Spielo
acquisiton.
EQUITY EARNINGS Three Months Ended
----------------------------------------------------------
Change
August 28, August 23, ----------------------
2004 2003 $ %
------------ -------------- ---------- ---------
(dollars in millions)
Equity earnings $ 0.3 $ 2.7 $ (2.4) (88.8)
Equity earnings were down $2.4 million from last year, primarily due to the sale
in April 2004 of our 50% interest in Gaming Entertainment (Delaware) L.L.C. to
Harrington Raceway, Inc.
OTHER INCOME (EXPENSE)
The components of other income in the second quarters of fiscal 2005 and fiscal
2004 are as follows:
Three Months Ended
----------------------------------------------------------
Change
August 28, August 23, ----------------------
2004 2003 $ %
------------ -------------- ---------- ---------
(dollars in millions)
Minority interest in
consolidated subsidiaries $ (1.1) $ (1.0) $ (0.1) (10.0)
Foreign exchange gains (losses) (0.8) 1.2 (2.0) (>100.0)
Other - 0.3 (0.3) (100.0)
---------- ------------- --------- -------
$ (1.9) $ 0.5 $ (2.4) (>100.0)
========== ============= ========= =======
Minority interest in consolidated subsidiaries principally relates to our
controlling interests in PolCard S.A and Wireless Business Solutions
(Proprietary) Limited.
INTEREST EXPENSE Three Months Ended
---------------------------------------------------------
Change
August 28, August 23, ----------------------
2004 2003 $ %
------------ ------------ ---------- --------
(dollars in millions)
Interest expense $ 3.7 $ 1.7 $ 2.0 >100.0
Interest expense was up $2.0 million over last year primarily due to higher debt
balances resulting from the issuance of $250 million of 4.75% Senior Notes in
the third quarter of fiscal 2004.
INCOME TAXES
Our effective income tax rate of 37% in the second quarter of fiscal 2005 was
comparable to the second quarter of fiscal 2004. We currently expect that our
full-year effective income tax rate will be in a range of 35% to 36% based on
the pending resolution of certain tax contingencies and the recent acquisitions
of non-U.S.-based companies. Our aggregate income tax rate in foreign
jurisdictions is lower than our income tax rate in the United States. Our income
tax rate may vary, however, depending on the composition of income or loss in
different countries and the resolution of audits and tax contingencies. We
expect our third quarter income tax rate to be in a range of approximately 30%
to 33%.
-32-
COMPARISON OF THE SIX MONTH PERIODS ENDED AUGUST 28, 2004 AND AUGUST 23, 2003
TOTAL REVENUES Six Months Ended
---------------------------------------------------------
Change
August 28, August 23, ---------------------
2004 2003 $ %
-------------- -------------- ---------- ----
(dollars in millions)
Services $ 501.4 $ 461.5 $ 39.9 8.6
Sales of products 102.3 55.3 47.0 85.0
-------------- -------------- --------- ----
$ 603.7 $ 516.8 $ 86.9 16.8
============== ============== ========= ====
SERVICE REVENUES AND GROSS MARGIN
Six Months Ended
---------------------------------------------------------
Change
August 28, August 23, ---------------------
2004 2003 $ %
-------------- -------------- ---------- ----
(dollars in millions)
Domestic lottery $ 257.3 $ 247.3 $ 10.0 4.0
International lottery 189.7 173.2 16.5 9.5
Commercial services 39.8 31.5 8.3 26.3
Gaming solutions 13.1 8.2 4.9 59.8
All other 1.5 1.3 0.2 15.4
-------------- -------------- --------- ----
$ 501.4 $ 461.5 $ 39.9 8.6
============== ============== ========= ====
Six Months Ended
---------------------------------------------------
Change
August 28, August 23, -----------------
2004 2003 Percentage Points
---------- ---------- -----------------
Service gross margin 41.0% 43.8% (2.8)
The 4.0% increase in domestic lottery service revenues was primarily due to
higher service revenues from an increase in sales by our domestic lottery
customers of approximately 6% with the balance principally due to the impact of
the Interlott acquisition in the third quarter of fiscal 2004, along with the
launch of our new service contract in Tennessee, partially offset by contractual
rate changes.
The 9.5% increase in international lottery service revenues includes higher
service revenues from an increase in sales by our international lottery
customers of approximately 3%, with the balance of the increase due to favorable
foreign exchange rates and higher jackpot activity, partially offset by lower
revenues from Brazil related to the court order to withhold 30% of our revenues.
The 26.3% increase in commercial transaction processing service revenues
includes higher service revenues from an increase in sales by our commercial
transaction processing customers of approximately 13.0%, with the balance of the
increase due to the acquisition of PolCard in the second quarter of fiscal 2004,
partially offset by lower revenues from Brazil related to the court order to
withhold 30% of our revenues.
The 59.8% increase in gaming solutions service revenues was primarily due to the
acquisition of Spielo and the installation of additional video lottery terminals
in existing jurisdictions.
Our service margins were down 2.8 percentage points from last year, primarily
due to contractual rate changes and the lower margins from Brazil related to the
court order to withhold 30% of our revenues, along with the impact of higher
depreciation and amortization related principally to contract renewals and the
implementation of new contracts. These decreases were partially offset by an
increase in sales by our lottery and commercial transaction processing
customers.
-33-
PRODUCT REVENUES AND GROSS MARGIN
Six Months Ended
---------------------------------------------------------
Change
August 28, August 23, ---------------------
2004 2003 $ %
-------------- -------------- ---------- ----
(dollars in millions)
Product revenues $ 102.3 $ 55.3 $ 47.0 85.0
Six Months Ended
-----------------------------------------------------
Change
August 28, August 23, -----------------
2004 2003 Percentage Points
------------- ------------- -----------------
Product gross margin 41.5% 32.3% 9.2
Product sales were up principally due to the sale of lottery terminals to our
customers in Belgium and Spain, along with the impact of acquisitions. Our
product margins were up 9.2 percentage points over last year, primarily due to
the different mix of sales, with the current year quarter including a high
volume of lottery terminal sales that carried higher margins than the prior year
overall margin.
OPERATING EXPENSES
Operating expenses include selling, general and administrative (SG&A) expenses
and research and development (R&D) expenses.
Six Months Ended
---------------------------------------------------------
Change
August 28, August 23, ---------------------
2004 2003 $ %
-------------- -------------- ---------- ----
(dollars in millions)
SG&A expenses $ 57.5 $ 51.3 $ 6.2 12.1
R&D expenses 25.7 28.5 (2.8) (9.8)
-------------- -------------- --------- ----
$ 83.2 $ 79.8 $ 3.4 4.3
============== ============== ========= ====
PERCENTAGE OF TOTAL REVENUE
SG&A expenses 9.5% 9.9%
R&D expenses 4.3% 5.5%
The $6.2 million increase in SG&A expenses was principally due to the
consolidation of our acquisitions of Spielo, PolCard and Interlott. The $2.8
million decrease in R&D expenses was primarily due to the timing of development
initiatives, partially offset by the impact of the Spielo acquisition.
EQUITY EARNINGS Six Months Ended
---------------------------------------------------------
Change
August 28, August 23, ---------------------
2004 2003 $ %
-------------- -------------- ---------- -----
(dollars in millions)
Equity earnings $ 1.6 $ 4.6 $ (3.0) (65.2)
Equity earnings were down $3.0 million from last year, primarily due to the sale
in April 2004 of our 50% interest in Gaming Entertainment (Delaware) L.L.C. to
Harrington Raceway, Inc.
-34-
OTHER INCOME (EXPENSE)
The components of other income in the first six months of fiscal 2005 and fiscal
2004 are as follows:
Six Months Ended
---------------------------------------------------------
Change
August 28, August 23, --------------------
2004 2003 $ %
-------------- -------------- ---------- -------
(dollars in millions)
Gain on sale of investment $ 10.9 $ - $ 10.9 100.0
Foreign exchange gains (losses) (0.2) 0.4 (0.6) (>100.0)
Minority interest in
consolidated subsidiaries (1.5) (1.6) 0.1 6.3
Other (0.6) 0.5 (1.1) (>100.0)
-------------- -------------- --------- -------
$ 8.6 $ (0.7) $ 9.3 >100.0
============== ============== ========= =======
The $10.9 million gain on sale of investment resulted from the sale in April
2004 of our 50% interest in Gaming Entertainment (Delaware) L.L.C. to Harrington
Raceway, Inc.
Minority interest in consolidated subsidiaries principally relates to our
controlling interests in PolCard S.A and Wireless Business Solutions
(Proprietary) Limited.
INTEREST EXPENSE Six Months Ended
-----------------------------------------------------------
Change
August 28, August 23, -----------------------
2004 2003 $ %
-------------- -------------- --------- ------
(dollars in millions)
Interest expense $ 8.1 $ 4.0 $ 4.1 >100.0
Interest expense was up $4.1 million over last year primarily due to higher debt
balances resulting from the issuance of $250 million of 4.75% Senior Notes in
the third quarter of fiscal 2004.
WEIGHTED AVERAGE DILUTED SHARES
Weighted average diluted shares in the first six months of fiscal 2005 increased
by 7.9 million shares to 133.9 million shares, primarily due to the assumed
conversion 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 $0.08. These Debentures are
convertible at the option of the holder into shares of our common stock at a
conversion price of approximately $13.75 per share when, among other
circumstances, our stock closes above $16.50 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 12.7 million shares issuable upon the conversion of the
Debentures. The Debentures were convertible for all 126 trading days in the
first six months of fiscal 2005, and accordingly, 12.7 million shares were
included in the computation of diluted earnings per share. For the first six
months of fiscal 2004, the Debentures were convertible for 80 out of 127 trading
days, and accordingly, 7.9 million shares were included in the computation of
diluted earnings per share.
LIQUIDITY, CAPITAL RESOURCES AND FINANCIAL POSITION
We believe our ability to generate cash from operations to reinvest in our
business is one of our fundamental financial strengths and we expect to meet our
financial commitments and operating needs in the foreseeable future. We expect
to use cash generated from operating activities primarily for aggregate
contractual obligations and to pay dividends. We expect our growth to be
financed through a combination of cash generated from operating activities,
existing sources of liquidity, access to capital markets and other sources of
capital. Our debt ratings of Baa1 (stable outlook) from Moody's and BBB (stable
outlook) from Standard and Poor's contribute to our ability to access capital
markets at attractive prices. These ratings reflect several factors, including
our strong cash flows and balance sheet.
-35-
ANALYSIS OF CASH FLOWS
During the first six months of fiscal 2005, we generated $171.8 million of cash
from operations which, along with other sources of liquidity, was principally
used to fund the Spielo and LILHCo acquisitions of $192.4 million and to
purchase $113.0 million of systems, equipment and other assets relating to
contracts. In addition, we repaid the remaining $90.0 million of our 7.87%
Senior Notes and paid a related redemption premium of $10.6 million; repurchased
$82.8 million, or 3,649,500 shares, of our common stock; and paid cash dividends
of $20.1 million. At August 28, 2004, we had $30.3 million of cash and cash
equivalents on hand.
Our business is capital-intensive. We currently estimate that net cash to be
used for investing activities in fiscal 2005, excluding net purchases of
available-for-sale investment securities of $221.9 million and restricted cash
of $5.1 million, will be in the range of $520 million to $540 million, including
investments we made to acquire Spielo and LILHCo. We expect our principal
sources of liquidity to be existing cash along with cash we generate from
operations and borrowings under our revolving credit facility. Our credit
facility provides for an unsecured revolving line of credit of $300 million and
matures in June 2006. As of August 28, 2004, we had $15.0 million of 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 August 28, 2004, after considering
$29.1 million of letters of credit issued and outstanding, there was $255.9
million available for borrowing under the Credit Facility.
We currently expect that our cash flow from operations, existing cash, available
borrowings under our credit facility and access to additional sources of capital
will be sufficient, for the foreseeable future, to fund our anticipated working
capital and ordinary capital expenditure needs, to service our debt obligations,
to fund anticipated internal growth, to fund all or a portion of the cash needed
for potential acquisitions, to pay dividends, to fund the capital requirements
under our Master Contract with the Rhode Island Lottery and to repurchase shares
of our common stock, from time to time, under our share repurchase programs. We
may also seek alternative sources of financing to fund certain of our
obligations under our Master Contract with the Rhode Island Lottery and to fund
future potential acquisitions and growth opportunities that are not currently
contemplated in the $520 million to $540 million we estimate we will need in
fiscal 2005 for the uses disclosed above.
FINANCIAL POSITION
Our balance sheet as of August 28, 2004, as compared to our balance sheet as of
February 28, 2004, was impacted by our acquisitions of Spielo and LILHCo.
Drivers of the material changes in each specific balance sheet category are
described below.
Investment securities available-for-sale decreased by $221.9 million from
February 28, 2004, reflecting the $192.4 million payment for the Spielo and
LILHCo acquisitions.
Trade accounts receivable, net increased by $15.5 million, from $118.9 million
at February 28, 2004 to $134.4 million at August 28, 2004, primarily due to
receivables related to product sales recorded in the second quarter of fiscal
2005.
Inventories increased by $17.2 million, from $76.8 million at February 28, 2004
to $94.0 million at August 28, 2004, primarily due to inventory associated with
the acquisition of Spielo and finished lottery terminals to be delivered to
domestic lottery customers.
-36-
Systems, equipment and other assets relating to contracts, net, increased by
$58.4 million, from $591.4 million at February 28, 2004 to $649.8 million at
August 28, 2004, primarily due to the purchase of $113.0 million of systems,
equipment and other assets relating to contracts (principally related to lottery
system implementations in Florida, Wisconsin and Tennessee, lottery equipment
installations in Texas, and the acquisition of Spielo), partially offset by
depreciation expense.
Goodwill, net, increased by $136.3 million, from $188.6 million at February 28,
2004 to $324.9 million at August 28, 2004, primarily due to the acquisitions of
Spielo and LILHCo.
Intangible assets, net, increased by $44.4 million, from $28.2 million at
February 28, 2004 to $72.6 million at August 28, 2004, due to intangible assets
recorded as a result of our acquisitions of Spielo and LILHCo.
Employee compensation decreased by $14.2 million, from $34.0 million at February
28, 2004 to $19.8 million at August 28, 2004, primarily due to the payment of
incentive compensation and profit sharing in April 2004, partially offset by
current year provisions for incentive compensation.
Advance payments from customers decreased by $33.1 million, from $104.1 million
at February 28, 2004 to $71.0 million at August 28, 2004, primarily due to the
recognition of sales of lottery terminals to our customers in Belgium and Spain.
Deferred revenue and advance billings increased by $17.7 million, from $14.5
million at February 28, 2004 to $32.2 million at August 28, 2004, primarily due
to customer progress billings related to product sales expected to be recorded
in the second half of fiscal 2005.
Income taxes payable increased by $14.8 million, from $12.4 million at February
28, 2004 to $27.2 million at August 28, 2004, primarily due to the timing of
estimated tax payments.
Current portion of long-term debt decreased by $101.5 million, from $106.3
million at February 28, 2004 to $4.8 million at August 28, 2004, primarily due
to the repurchase in the first quarter of fiscal 2005 of the remaining $90.0
million of our 7.87% Senior Notes.
Long-term debt, less current portion increased by $10.9 million, from $463.2
million at February 28, 2004 to $474.1 million at August 28, 2004, primarily due
to borrowings on our $300 million credit facility.
Other liabilities increased by $25.6 million, from $53.7 million at February 28,
2004 to $79.3 million at August 28, 2004, primarily due to an advance payment we
received from a domestic facilities management lottery customer.
Deferred income taxes increased by $26.5 million, from $61.7 million at February
28, 2004 to $88.2 million at August 28, 2004 primarily due to deferred taxes
associated with the Spielo and LILHCo acquisitions, along with $6.6 million of
accelerated tax deductions relating to depreciation on investments in new and
existing lottery systems.
Cost of treasury shares decreased by $454.5 million, from $473.7 million at
February 28, 2004 to $19.2 million at August 28, 2004 primarily due to the
constructive retirement of 69.8 million treasury shares on July 29, 2004 (stated
on the basis reflecting the stock split which occurred subsequent to the
constructive retirement).
-37-
POTENTIAL COMMITMENTS
Master Contract with the Rhode Island Lottery
As previously reported, on May 12, 2003, we entered into a Master Contract with
the Rhode Island Lottery (the "Lottery") that amends our existing contracts with
the Lottery and grants us the right to be the exclusive provider of online,
instant ticket and video lottery central systems and services for the Lottery
during the 20-year term of the Master Contract for a $12.5 million up-front
license fee which we paid in July 2003. Under the terms of the Master Contract,
we are to invest (or cause to be invested) at least $100 million in the State of
Rhode Island, in the aggregate, by December 31, 2008. This investment commitment
includes the payment of the $12.5 million up-front license fee; the provision of
new online and video lottery related hardware, software and services; the
development of a new world headquarters facility of at least 210,000 square feet
in Providence, Rhode Island by December 31, 2006; and the making of 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 employment obligation.
In addition to being released from the employment obligation, we would be
released from our obligations to invest (or cause to be invested) the $100
million, replace the online lottery gaming system, deliver certain other online
lottery deliverables and replace the video lottery central system (all to the
extent such obligations remain unperformed) and would be entitled to a refund of
a pro-rata portion of the license fee. We currently plan to satisfy our
obligation to invest (or cause to be invested) at least $100 million in the
State of Rhode Island by December 31, 2008 as follows: (i) approximately $24
million that was invested during fiscal 2004; (ii) approximately $22 million
that will be invested during fiscal 2005; (iii) approximately $44 million that
will be invested during fiscal 2006; and (iv) the balance that will be invested
during fiscal 2007. The Lottery may terminate the Master Contract in the event
that we fail to meet our obligations as stated above.
In addition, in July 2003 we entered into a tax stabilization agreement with the
City of Providence (the "City"), whereby the City agreed to stabilize the real
estate and personal property taxes payable in connection with our new world
headquarters facility in the City 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.
In June 2004, the Rhode Island legislature voted to approve a gaming facility
development proposal and to place a question regarding such proposal before
Rhode Island voters for consideration on the November 2004 ballot. The
legislation passed by the Rhode Island legislature made no provision for us to
be a supplier of a percentage of the gaming machines in the proposed gaming
facility, as we believe is contemplated by the Master Contract. The Rhode Island
legislature overrode the Governor's veto of this legislation. Subsequently, the
Rhode Island Supreme Court ruled that the legislation and the question were
unconstitutional and a trial court ordered that the question not be placed on
the November 2004 ballot.
FINANCIAL RISK MANAGEMENT AND DIVIDEND POLICY
FINANCIAL RISK MANAGEMENT
The primary market risk inherent in our financial instruments and exposures is
the potential loss arising from adverse changes in interest rates and foreign
currency exchange rates. Our exposure to commodity price changes is not
considered material and is managed through our procurement and sales practices.
We use various techniques to manage our market risks, including from time to
time, the use of derivative instruments. We manage our exposure to counterparty
credit risk by entering into financial instruments
-38-
with major, financially sound counterparties with high-grade credit ratings and
by limiting exposure to any one counterparty. We do not engage in currency or
interest rate speculation.
INTEREST RATE MARKET RISK
Interest rate market risk is estimated as the potential change in the fair value
of our total debt or current earnings resulting from a hypothetical 10% adverse
change in interest rates.
The estimated fair value of our long-term debt and change in the estimated fair
value due to hypothetical changes in interest rates are as follows (dollars in
millions):
Estimated Fair Value
-----------------------------------------------------------
At August 28, 10% Increase in 10% Decrease in
2004 Interest Rates Interest Rates
--------------- ------------------ -------------------
$250 million of 4.75% Senior Notes $ 245.7 $ 244.9 $ 246.4
$175 million of 1.75% Convertible
Debentures 304.9 304.4 305.5
The estimated fair values above were determined by an independent investment
banker and the values of the Senior Notes were determined after taking into
consideration $150 million of interest rate swaps. 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.
EQUITY PRICE RISK
The estimated fair value of our $175 million of 1.75% Convertible Debentures and
change in the estimated fair value due to hypothetical changes in the market
price of our common stock is as follows (dollars in millions):
Estimated Fair Value
-------------------------------------------------------------
10% Increase in 10% Decrease in
At August 28, Market Price of Market Price of
2004 Common Stock Common Stock
----------------- ------------------ -------------------
$175 million of 1.75% Convertible
Debentures $ 304.9 $ 333.3 $ 276.6
The estimated fair values above were determined by an independent investment
banker and were based on a quoted market price of $174.25 per Debenture.
FOREIGN CURRENCY EXCHANGE RATE RISK
We are subject to foreign exchange exposures arising from current and
anticipated transactions denominated in currencies other than our functional
currency, which is United States dollars, and from the translation of foreign
currency balance sheet accounts into United States dollar balance sheet
accounts.
We seek to manage our foreign exchange risk by securing payment from our
customers in United States dollars, by sharing risk with our customers, by
utilizing foreign currency borrowings, by leading and lagging receipts and
payments, and by entering into foreign currency exchange and option contracts.
In addition, a significant portion of the costs attributable to our foreign
currency revenues are payable in the local currencies. In limited circumstances,
but whenever possible, we negotiate clauses into our contracts that allow for
price adjustments should a material change in foreign exchange rates occur.
-39-
From time to time, we enter into foreign currency exchange and option contracts
to reduce the exposure associated with certain firm commitments, variable
service revenues and certain assets and liabilities denominated in foreign
currencies, but we do not engage in foreign currency speculation. These
contracts generally have maturities of 12 months or less and are regularly
renewed to provide continuing coverage throughout the year. At August 28, 2004,
a hypothetical 10% adverse change in foreign exchange rates would result in a
translation loss of $22.8 million that would be recorded in the equity section
of our balance sheet.
At August 28, 2004, a hypothetical 10% adverse change in foreign exchange rates
would result in a net pre-tax transaction loss of $2.2 million that would be
recorded in current earnings after considering the effects of foreign exchange
contracts currently in place.
At August 28, 2004, 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 2005 of $5.4 million, after considering the
effects of foreign exchange contracts currently in place. The percentage of
fiscal 2005 anticipatory cash flows that were hedged varied throughout the first
six months of the fiscal year, but averaged 29%.
As of August 28, 2004, we had contracts for the sale of foreign currency of
approximately $51.1 million (primarily Euro and pounds sterling) and the
purchase of foreign currency of approximately $53.4 million (primarily Canadian
dollar, Brazilian real, New Taiwan dollars, pounds sterling and Mexican pesos).
DIVIDEND POLICY
We are committed to returning value to our shareholders. Beginning in the second
quarter of fiscal 2004, we commenced paying cash dividends on our common stock
of $0.085 per share, equivalent to a full-year dividend of $0.34 per share. We
currently plan to continue paying dividends in the foreseeable future.
SUBSEQUENT EVENT
BILLBIRD S.A.
In September 2004, our majority-owned subsidiary, PolCard S.A, completed the
acquisition of privately-held BillBird S.A., the leading provider of electronic
bill payment services in Poland, for an all-cash purchase price of approximately
$6.0 million. Approval of this transaction by our shareholders was not required.
-40-
Item 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
See "Financial Risk Management" above.
Item 4. CONTROLS AND PROCEDURES
As of the end of the period covered by this report, we carried out an
evaluation, under the supervision and with the participation of our management,
including our Chief Executive Officer ("CEO") and our Senior Vice President and
Chief Financial Officer ("CFO"), of the effectiveness of the design and
operation of our disclosure controls and procedures pursuant to Rule 13a-15 of
the Securities Exchange Act of 1934. Based upon that evaluation, our CEO and CFO
concluded that our disclosure controls and procedures are effective in alerting
them on a timely basis to material information required to be included in our
periodic filings with the Securities and Exchange Commission.
There was no change in our internal control over financial reporting, or in
other factors, that occurred during the second quarter of fiscal 2005 that has
materially affected, or is reasonably likely to materially affect, the Company's
internal control over financial reporting.
-41-
PART II. OTHER INFORMATION
Item 1. LEGAL PROCEEDINGS
BRAZILIAN-RELATED LEGAL PROCEEDINGS
BRAZILIAN CRIMINAL ALLEGATIONS. As previously reported, in late March 2004
federal attorneys with Brazil's Public Ministry (the "Public Ministry
Attorneys") recommended that criminal charges be brought against nine
individuals, including four senior officers of Caixa Economica Federal, the
Brazilian bank and operator of Brazil's National Lottery ("CEF"); Antonio Carlos
Rocha, the former Senior Vice President of GTECH Holdings Corporation and
President of GTECH Brazil Ltda., our Brazilian subsidiary ("GTECH Brazil"); and
Marcelo Rovai, GTECH Brazil's marketing director. No other present or former
employee of the Company or GTECH Brazil has been implicated by the Public
Ministry Attorneys. Neither the Company nor GTECH Brazil is the subject of this
criminal investigation, and under Brazilian law (which provides that criminal
charges may not be brought against corporations or other entities), we cannot be
subject to criminal charges in connection with this matter.
We understand that the Public Ministry Attorneys had recommended that Messrs.
Rocha and Rovai be charged with offering an improper inducement in connection
with the negotiation of the contract extension that we entered into in April
2003 (the "2003 Contract Extension") to our May 2000 contract with CEF to
provide lottery goods and services and additional financial transaction services
(including bill and tax payment, social security contribution and traditional
banking services) to CEF for a contract term that, as extended, was scheduled to
expire in April 2003 (the "2000 Contract"). We further understand that the
Public Ministry Attorneys had recommended that Messrs. Rocha and Rovai be
charged with effectively co-authoring or aiding and abetting certain allegedly
fraudulent or inappropriate management practices of the CEF management who
agreed to enter into the 2003 Contract Extension.
As previously reported, during the second quarter of fiscal 2005, the Company
learned that the judge reviewing these charges prior to their being filed
refused to initiate the criminal charges against the nine individuals, including
against Messrs Rocha and Rovai. The judge chose not to accept any elements of
the charges, as was his prerogative, but instead, granted a request by the
Brazilian Federal Police to continue the investigation which had been suspended
upon the recommendation of the Public Ministry Attorneys that criminal charges
be brought. The judge cited the prosecutors' rush to bring charges in response
to the pressure of public opinion as a contributing factor to his decision to
return the investigation to the Brazilian Federal Police. The judge's order
pertained to certain procedural aspects, and not to the merits, of the charges.
The Brazilian Federal Police investigation continues.
We have cooperated fully with the investigation by Brazilian authorities
respecting this matter, and have encouraged Messrs Rocha and Rovai to do the
same. In addition, we are conducting an internal investigation of this matter
under the supervision of the independent directors of
-42-
GTECH Holdings Corporation. While this investigation is not yet complete, we are
confident, on the basis of our findings thus far, that the Company has acted
appropriately in this matter. Furthermore, our investigation has not revealed
any reason to believe that any of our present or former employees committed any
of the criminal offenses alleged by the Public Ministry Attorneys in their
initial criminal recommendations. However, in light of the fact that the
Brazilian Federal Police investigation is continuing and its ultimate
conclusions are uncertain, there can be no assurance that the Public Ministry
Attorneys will not recommend once again that such criminal charges be brought
against Messrs. Rocha and Rovai, or that new criminal charges be brought against
Messrs. Rocha and Rovai or additional individuals.
RELATED SEC INVESTIGATION. As previously reported, the United States Securities
and Exchange Commission (the "SEC") is undertaking a formal investigation into
the Brazilian criminal allegations against Messrs. Rocha and Rovai and the
Company's involvement in this matter. In this connection, the SEC has sent the
Company a subpoena for the production of certain documents and records related
to the Company's operations in Brazil. The Company has been cooperating fully
with the SEC, including in responding to its subpoena, and other information
requests.
To date, we have found no evidence that the Company, or any of its employees,
has violated any United States law, or is otherwise guilty of any wrongdoing in
connection with this matter.
Our investigation is not complete, however, and in light of the fact that our
reputation for integrity is an important factor in our business dealings with
lottery and other governmental agencies, an allegation or finding of improper
conduct that is attributable to us could have a material adverse effect on our
business, both within Brazil and elsewhere, including our ability to retain
existing contracts or to obtain new or renewal contracts. In addition,
continuing adverse publicity resulting from any criminal charge involving the
Company or any of its present or former employees, and any resulting, or
related, legal proceedings, could have a material adverse effect on our
reputation and business.
CIVIL ACTION BY THE PUBLIC MINISTRY ATTORNEYS. As previously reported, in April
2004 the Public Ministry Attorneys initiated a civil action in the Federal Court
of Brasilia against GTECH Brazil; 17 former officers and employees of CEF; the
former president of Racimec Informatica Brasileira S.A., GTECH Brazil's
predecessor company ("Racimec"); Antonio Carlos Rocha, the former Senior Vice
President of GTECH Holdings Corporation and President of GTECH Brazil; and
Marcos Andrade, another former officer of GTECH Brazil. The focus of this civil
action is the contractual relationship between CEF, GTECH Brazil and Racimec for
the period 1994 to 2002. This civil action alleges that the defendants acted
illegally in entering into, amending and performing the January 1997 contract
between Racimec and CEF pursuant to which Racimec agreed to provide online
lottery services and technology to CEF (the "1997 Contract"), and the 2000
Contract, and seeks to invalidate the 2000 Contract, which, as extended by the
2003 Contract Extension, is still in force.
This lawsuit also seeks to impose damages equal to the sum of all amounts paid
to the Company under the 1997 Contract and the 2000 Contract and certain other
permitted amounts, minus our proven investment costs. The applicable statute
also permits the assessment of penalties, in the discretion of the court, of up
to three times the amount of the damages imposed. We estimate
-43-
that through the date of the lawsuit we received under the 1997 Contract and the
2000 Contract a total of 1.5 billion Brazilian reals (or approximately 500
million United States dollars). In addition, although it is unclear how
investment costs would be determined for purposes of this lawsuit, we estimate
that our investment costs through the date of the lawsuit were approximately
between 1.2 billion and 1.4 billion Brazilian reals (or approximately between
400 million and 465 million United States dollars) in aggregate; however, these
investment costs could be disputed by CEF, and are ultimately subject to
approval by the court.
As previously reported, during the second quarter of fiscal 2005 we were
formally served with the complaint filed by the Public Ministry Attorneys in
this civil action, and were afforded the opportunity to review the supporting
evidence developed by the Public Ministry Attorneys. Having completed our review
of this evidence, we remain of the view, previously reported, that we have good
and adequate defenses to the claims made in this lawsuit. We intend to defend
ourselves vigorously in these proceedings, which, we have been advised by our
Brazilian counsel, are likely to take several years, and could take as long as
10 to 15 years in certain circumstances, to litigate through the appellate
process to final judgment. It is our position that we were appropriately awarded
the 1997 Contract by CEF after a competitive procurement, and that at all times
since 1997 we have been appropriately compensated for services performed under
valid contracts with the CEF.
While we cannot rule out the possibility that the Company will ultimately be
held liable in this matter, or estimate the amount of such liability in such
event, we believe that the outcome of this lawsuit is not likely to have a
material impact on our financial statements or business.
As previously reported, during the second quarter of fiscal 2005 the Federal
Court of Brasilia granted a procedural injunction in connection with this civil
matter directing that 30% of the payments due to GTECH Brazil from CEF under the
2000 Contract be withheld and deposited into an account maintained by the Court,
which withheld amounts the Company estimates will be approximately $22 million
to $25 million as of the end of fiscal 2005. This injunction also put in place
restrictions that effectively prevent the transfer or sale of the Company's
Brazilian assets, including the share capital of GTECH Brazil, with certain
limited exceptions. The injunction also required that certain assets of the
other defendants, including bank accounts, real estate and other financial
assets, be reported to the court to prevent disposition (or in the case of bank
accounts, to monitor such accounts), and that the Brazilian Central Bank report
any transactions associated with these assets. In granting this injunction, the
judge held that, as a foreign company doing business in Brazil, we do not have
adequate in-country holdings to satisfy the potential claims should the
plaintiff prevail in this lawsuit. The court's order provides a process to
change the percentage of our payments to be withheld based upon a determination
of our effective cost of servicing the 2000 Contract. The injunction was granted
as part of a confidential ex parte proceeding in which we were not afforded an
opportunity to participate. We filed an appeal respecting the court's grant of
this injunction on July 7, 2004. We are unable at this time to predict the
outcome of our appeal of the injunction, or to provide an estimate as to the
timing of the court's decision respecting our appeal.
CEF PROCUREMENT. As previously reported, we are involved in legal proceedings
with CEF respecting the CEF's plans for the operation of Brazil's National
Lottery after expiration of the 2000 Contract, which is currently scheduled to
occur not later than May 2005.
-44-
In June 2003, the Federal Higher Court of Brasilia issued a decision permitting
CEF to obtain goods and services necessary to operate the National Lottery after
termination of the 2000 Contract by publishing four separate Requests For
Proposal. We previously reported our belief that this decision indicated that we
would be unlikely ultimately to prevail in our challenge to the CEF's plans for
a procurement process contemplating multiple vendors supplying lottery goods and
services to CEF after termination of the 2000 Contract (the "Multiple RFP
Procurement").
In August 2004, the Special Court of Brazil's Superior Appellate Court issued a
ruling removing the final legal impediments that had prevented CEF from
proceeding with the Multiple RFP Procurement.
While we will be the incumbent vendor with respect to any future procurement by
CEF, there can be no assurance that we will be selected by CEF to supply goods
and services after termination of the 2000 Contract.
As previously reported, CEF's President has indicated that in order to
accommodate an as-of-yet undisclosed procurement process, it is his intent to
seek to negotiate: (a) certain concessions from GTECH Brazil relating to pending
court action respecting CEF procurement matters, and (b) an extension of the
term of the 2000 Contract. Although we have requested detailed customer
specifications and requirements from CEF in respect of a possible extension
negotiation, to date we have received no such specifications or requirements
from CEF. At this time, it is impossible for us to determine the potential
scope, term or desirability of a potential contract extension beyond the
expiration of the 2000 Contract, or to predict the likely timing, if any, of
negotiations with CEF respecting such a contract extension.
In light of these uncertainties, we have disregarded all CEF revenues with
respect to periods after May 2005 for purposes of providing long-term earnings
and other future guidance, and will continue to do so until such time as we have
greater clarity on what business, if any, we may have an opportunity or desire
to pursue with CEF after the termination of the 2000 Contract.
OTHER LEGAL PROCEEDINGS
SHAREHOLDER CLASS ACTION SUIT. As previously reported, we, together with William
Y. O'Connor, our former Chairman and Chief Executive Officer, Steven P. Nowick,
our former President and Chief Operating Officer, and W. Bruce Turner, our
former Chairman and current President and Chief Executive Officer, were named as
defendants in a shareholder class action suit captioned Sandra Kafenbaum and
Steven Schulman, individually and on behalf of all other similarly situated v.
GTECH Holdings Corporation, et. al., which suit was filed in the U.S. District
Court of Rhode Island in August 2000 and subsequently amended in February 2001.
In September 2002, the court granted our motion to dismiss plaintiff's claim
against Mr. Turner, holding that there were no actionable statements
attributable to him.
As previously reported, we have entered into an agreement with plaintiffs to
settle this class action lawsuit on terms that require payment by us of amounts
that, after taking into account certain insurance proceeds that we expect to
receive, are not material to our financial condition or results of operation. We
have previously fully reserved against such payments.
-45-
In September 2004, following a fairness hearing, the court approved the terms of
our agreement with the class action plaintiffs, as was required to finalize the
terms of settlement, and entered judgment in this matter incorporating the
agreed terms. These developments effectively close this case.
For further information respecting these and certain other legal proceedings,
see Item 1, "Certain Factors Affecting Future Performance," Item 7,
"Management's Discussion and Analysis of Financial Condition and Results of
Operations," and Item 8, Note 13 to Notes to Consolidated Financial Statements
of our fiscal 2004 Annual Report on Form 10-K, and Item 1, "Legal Proceedings"
of Part II of our Quarterly Report for the first quarter of fiscal 2005 on Form
10-Q.
-46-
Item 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
(a) and (c)
The Company's Annual Meeting of Shareholders was held on August 2, 2004 and in
connection therewith, proxies were solicited by management pursuant to
Regulation 14A under the Securities Exchange Act of 1934. An aggregate of
117,999,302 shares of the Company's common stock ("Shares") were issued and
eligible to vote at the meeting. At the meeting, the following matters (not
including ordinary procedural matters) were submitted to a vote of the holders
of Shares, with the results indicated below:
1. Election of three directors to serve until the 2007 Annual Meeting
-------------------------------------------------------------------------
The following incumbent directors were reelected. The tabulation of votes
was as follows:
Nominee For Withheld
- ---------------------- ------------------ ----------------
Christine M. Cournoyer 108,288,148 Shares 472,150 Shares
Robert M. Dewey, Jr. 108,288,476 Shares 471,822 Shares
Philip R. Lochner, Jr. 107,890,322 Shares 869,976 Shares
2. Approval of the Company's 2004 Employee Stock Purchase Plan
-----------------------------------------------------------
The tabulation of votes was as follows:
Abstentions
For Against (including broker non-votes)
- ----------------- ---------------- ----------------------------
93,679,316 Shares 1,700,730 Shares 125,108 Shares
3. Approval of the Amendment of the Certificate of Incorporation of the
Corporation to Increase the Number of Shares of Common Stock the
Corporation is Authorized to Issue from 150,000,000 to 200,000,000
--------------------------------------------------------------------
For Against Abstentions
- ------------------ ---------------- ----------------
106,643,006 Shares 2,051,566 Shares 65,726 Shares
4. Ratification of Ernst & Young LLP, Independent Registered Public
Accounting Firm, as auditors for the fiscal year ending February 26, 2005
-------------------------------------------------------------------------
The tabulation of votes was as follows:
For Against Abstentions
- ------------------ ---------------- ----------------
107,506,206 Shares 1,213,732 Shares 40,360 Shares
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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 June 22, 2004 incorporating by
reference a press release we issued on June 22, 2004 announcing our
fiscal 2005 first quarter results. In addition, we incorporated by
reference the transcripts from our fiscal 2005 first quarter earnings
conference call held on June 22, 2004.
(ii) We filed a report on Form 8-K on July 1, 2004 incorporating by
reference a press release we issued on June 29, 2004 respecting
certain developments in Brazil and adjustments to earnings guidance.
(iii) We filed a report on Form 8-K on July 29, 2004 incorporating by
reference a press release we issued on July 29, 2004 setting forth an
update on certain Brazil matters.
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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: October 6, 2004 By /s/ Jaymin B. Patel
------------------------------------------------
Jaymin B. Patel, Senior Vice President and Chief
Financial Officer (Principal Financial Officer)
Date: October 6, 2004 By /s/ Robert J. Plourde
------------------------------------------------
Robert J. Plourde, Vice President, Corporate
Controller and Chief Accounting Officer
(Principal Accounting Officer)
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