-----BEGIN PRIVACY-ENHANCED MESSAGE----- Proc-Type: 2001,MIC-CLEAR Originator-Name: webmaster@www.sec.gov Originator-Key-Asymmetric: MFgwCgYEVQgBAQICAf8DSgAwRwJAW2sNKK9AVtBzYZmr6aGjlWyK3XmZv3dTINen TWSM7vrzLADbmYQaionwg5sDW3P6oaM5D3tdezXMm7z1T+B+twIDAQAB MIC-Info: RSA-MD5,RSA, Hs7a9J0WWSc+W4cQ0sIdAUFWzuWNAk1dURvOXTIJbmC6aSDM+pNGL3DC+p/Eh/o8 y/lpx5mcbPdlO7xrOHkWzw== 0000936392-98-000518.txt : 19980401 0000936392-98-000518.hdr.sgml : 19980401 ACCESSION NUMBER: 0000936392-98-000518 CONFORMED SUBMISSION TYPE: 10-K PUBLIC DOCUMENT COUNT: 9 CONFORMED PERIOD OF REPORT: 19971231 FILED AS OF DATE: 19980331 SROS: NASD FILER: COMPANY DATA: COMPANY CONFORMED NAME: INTERNATIONAL LOTTERY & TOTALIZATOR SYSTEMS INC CENTRAL INDEX KEY: 0000354813 STANDARD INDUSTRIAL CLASSIFICATION: CALCULATING & ACCOUNTING MACHINES (NO ELECTRONIC COMPUTERS) [3578] IRS NUMBER: 953276269 STATE OF INCORPORATION: CA FISCAL YEAR END: 1231 FILING VALUES: FORM TYPE: 10-K SEC ACT: SEC FILE NUMBER: 000-10294 FILM NUMBER: 98580276 BUSINESS ADDRESS: STREET 1: 2131 FARADAY AVE CITY: CARLSBAD STATE: CA ZIP: 92008-7297 BUSINESS PHONE: 6199314000 MAIL ADDRESS: STREET 1: 2131 FARADAY AVE CITY: CARLSBAD STATE: CA ZIP: 92008 FORMER COMPANY: FORMER CONFORMED NAME: INTERNATIONAL TOTALIZATOR SYSTEMS INC DATE OF NAME CHANGE: 19920703 10-K 1 FORM 10-K 1 ================================================================================ UNITED STATES SECURITIES AND EXCHANGE COMMISSION WASHINGTON, D.C. 20549 ------------------------ FORM 10-K ------------------------ (MARK ONE) [X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE SECURITIES EXCHANGE ACT OF 1934 FOR THE YEAR ENDED DECEMBER 31, 1997 [ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE SECURITIES EXCHANGE ACT OF 1934 FOR THE TRANSITION PERIOD FROM TO COMMISSION FILE NUMBER 0-10294 INTERNATIONAL LOTTERY & TOTALIZATOR SYSTEMS, INC. (EXACT NAME OF REGISTRANT AS SPECIFIED IN ITS CHARTER) FORMERLY INTERNATIONAL TOTALIZATOR SYSTEMS, INC. ------------------------ CALIFORNIA 95-3276269 (STATE OR OTHER JURISDICTION OF INCORPORATION (I.R.S. EMPLOYER IDENTIFICATION NO.) OR ORGANIZATION) 2131 FARADAY AVENUE, CARLSBAD, CALIFORNIA 92008 (ADDRESS OF PRINCIPAL EXECUTIVE OFFICES) (ZIP CODE)
REGISTRANT'S TELEPHONE NUMBER, INCLUDING AREA CODE (760) 931-4000 REGISTRANT'S HOME PAGE HTTP://WWW.ILTS.COM SECURITIES REGISTERED PURSUANT TO SECTION 12(G) OF THE ACT: (TITLE OF CLASS) COMMON SHARES ------------------------ 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 [ ] Aggregate market value of voting stock held by non-affiliates of the Registrant as of March 24, 1998 was approximately $7,584,336 ------------------------ Number of common shares outstanding at March 24, 1998 was 18,027,548 DOCUMENTS INCORPORATED BY REFERENCE Portions of the 1997 Annual Report to Stockholders of the Registrant: Parts II and IV Portions of the Proxy Statement for Annual Meeting of Stockholders, June 1, 1998: Part III ------------------------ Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of the Registrant's knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. Yes [ ] ================================================================================ 2 TABLE OF CONTENTS PART I
PAGE ---- ITEM 1. BUSINESS.................................................... 1 General..................................................... 1 DATAMARK(R) Terminals....................................... 1 Wagering and Other Terminal Products........................ 2 Lottery Systems/Sales and Service Agreements................ 2 Revenue Sources............................................. 3 Product Development......................................... 3 Backlog..................................................... 3 Marketing and Business Development.......................... 4 Manufacturing and Materials................................. 4 Competition................................................. 4 Employees................................................... 5 Patents, Trademarks and Licenses............................ 5 Regulation.................................................. 5 Dependence Upon a Few Customers............................. 5 Year 2000................................................... 5 Seasonality................................................. 6 Working Capital Practices................................... 6 Environment Effects......................................... 6 Export Sales................................................ 6 ITEM 2. PROPERTIES.................................................. 6 ITEM 3. LEGAL PROCEEDINGS........................................... 6 ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS......... 7 Special Shareholders Meeting................................ 7 EXECUTIVE OFFICERS OF THE REGISTRANT........................ 7 PART II ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED SHAREHOLDER MATTERS......................................... 7 ITEM 6. SELECTED FINANCIAL DATA..................................... 8 ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS................................... 8 ITEM 8. CONSOLIDATED FINANCIAL STATEMENTS........................... 8 ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE.................................... 8 PART III ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT.......... 8 ITEM 11. EXECUTIVE COMPENSATION...................................... 8 ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT.................................................. 8 ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS.............. 8 PART IV ITEM 14. EXHIBITS, CONSOLIDATED FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K......................................... 9
i 3 PART I ITEM 1. BUSINESS General The Registrant designs, manufactures, sells, manages, supports and services computerized ticket issuing systems and terminals for the global pari-mutuel and on-line lottery industries. The Registrant has also bid for long-term service contracts under which it intends to operate on-line lottery systems. The Registrant's technology can be used in other ticket-processing applications, such as keno gaming and automated ticket printer/readers for toll turnpike systems. The principal proprietary component of the Registrant's systems are the DATAMARK(R) terminals, a compact, reliable microprocessor-based ticketing terminal, which can print and process up to approximately 30 tickets per minute. The Registrant sells the DATAMARK(R) terminal separately or as part of a turnkey wagering application system and can modify a terminal's features or configurations and central system software to meet specific customer requirements. The Registrant's wagering application systems include DATAMARK(R) terminals, a central computer installation, communication network and display equipment. System features include real-time central processing of data received from multiple locations, back-up hardware capability and complete communications redundancy designed to provide fault tolerant operation. DATAMARK(R) Terminals The Registrant has developed several models of DATAMARK(R) terminals for different wagering applications. All are microprocessor-based and have a compact, lightweight design for countertop operation. The Registrant has recently developed a product called the DMNXT(TM) which allows a simple and inexpensive means for existing DATAMARK(R) customers to upgrade their older generation terminals to an Intel PC platform with improved features. The features include faster processing, higher resolution printing, and the ability to utilize cost effective, commercial off-the-shelf PC peripherals. Most DATAMARK(R) terminals are approximately 12" deep, 12" wide, 10" high, weigh approximately 27 pounds, and are accompanied by a built-in or external display and keyboards. The latest DATAMARK(R) models utilize a compact ticket path which allows the terminal to print on either side and read from both sides of the same ticket. The terminal contains a thermal printer which prints tickets quickly and quietly without ink, ribbons or impact, thereby improving print quality and reliability, and reducing maintenance expenses. The terminals use either pre-cut thermal coated tickets or thermal coated roll stock tickets or both. The terminals can also be configured to use impact printing on plain paper. Some models will sequentially read and print up to 50 tickets entered at one time. The basic functions of the DATAMARK(R) terminal are similar in all its wagering system applications. Initially, wagering or other selection data is entered into the terminal either manually by the operator via a keyboard, or by a ticket marked by the customer. The terminal transmits that information to the central computer, where a serial number is assigned to the transaction and a response is sent back to the terminal which then thermally prints the data either on the back of the customer-marked ticket or on a new ticket. As the data is being printed, the intelligent terminal verifies the readability of the bar code prior to ejecting the ticket to the player. When a ticket is cashed or presented for validation, the terminal optically reads the bar code and accesses the central computer to verify that payment is to be made with respect to the ticket. The central computer calculates the payout amount, transmits this data to the terminal and records the fact that the ticket has been paid, ensuring that tickets are not paid twice. The terminal prints the payout amount on the ticket giving visual evidence that the ticket has been paid, and directs the processed ticket to the operator. The DATAMARK(R) terminal's basic functions are supplemented by various features. In the horse racing industry, the DATAMARK(R) terminal is capable of issuing tickets for win, place or show betting, as well as for any feature pool currently being used in pari-mutuel wagering. The terminals are designed to facilitate multiple bets on one ticket and multiple selections for each bet. In addition, the bettor is able to mark bets on 1 4 a pre-printed playslip, which is then read optically by the terminal, the amount wagered is calculated and the bet details printed on the back of the same ticket. Because the ticket is prepared away from the pari-mutuel clerk's window, betting transaction time is reduced, efficiency of the operation is improved and the bettor obtains more privacy in the betting transaction. Similarly, in the lottery industry, a player marks the numbers selected on a pre-printed ticket or playslip which is read optically by the DATAMARK(R) terminal and entered into the central system. The selections and the transaction total are then either printed on the back of the playslip or on a separate ticket and delivered to the player. Wagering and Other Terminal Products The Registrant historically has derived revenue in the horse racing industry from sales contracts for DATAMARK(R) terminals and for wagering systems, which include DATAMARK(R) terminals, a central computer installation and peripheral and display equipment. The Registrant's systems are "sell-pay" systems, which means that each terminal is capable of being used both for selling all types of wagering tickets and for making payment to the ticket holders after validation of winning tickets. The nucleus of each wagering system is the central computer installation that receives information from ticket-issuing terminals, accumulates wagering data, calculates odds and payouts, distributes information to the display systems and terminals, and generates management information reports. In cooperation with the customer, the Registrant designs the configuration of the central computer installation to provide fault-tolerant operation, high throughput and security. Each central computer installation typically includes a computer configuration and various peripheral devices, such as magnetic storage devices, management terminals and hardcopy printers, all of which are manufactured by others. Although certain of the Registrant's customers presently use software in their pari-mutuel systems which is proprietary to the Registrant, the software presently offered by the Registrant in its horse racing system is software, as enhanced and modified by the Registrant, acquired by license from The Hong Kong Jockey Club (The HKJC) and others. In addition to sales of terminals and systems, the Registrant realizes ongoing revenue from the sale of spare parts for use in the maintenance of its terminals, of which approximately 30,000 have been delivered to date. The Registrant also enters into contracts with its customers to provide software modifications, upgrades and support for its installed products. Lottery Systems/Sales and Service Agreements Computerized, or on-line, lotteries are currently operated in many countries. Existing lottery systems include both manual systems and modern on-line systems. In an on-line lottery system, betting terminals are connected to a central computer installation by a communications network and the system typically utilizes a pari-mutuel pool or fixed payout, or both, in offering "lotto" and other numbers games. The Registrant owns non-exclusive rights to use the central system software developed by The HKJC for use in its pari-mutuel wagering and lottery systems. Under the terms of the amended license, the Registrant pays The HKJC a royalty equal to a percentage of the revenue it receives in connection with a sale, lease or providing a service of any lottery system using this software. In addition, the Registrant is obligated to provide The HKJC with any modifications which the Registrant makes to the software, except where ownership to such modifications vests in the Registrant's customers. The Registrant has made significant modifications to The HKJC software. Chief among them is the migration of the system to a client-server architecture, the incorporation of Sybase relational database software, and the utilization of a Windows operating system for the management information subsystem called DataTrak(TM). These enhancements allow the system to be scaled to meet each customer's unique requirements and enables the customer to process data within a familiar software user interface environment. The Registrant has also added numerous new features to the base software, including instant ticket validation and player registration. In the Registrant's DataTrak lottery system, tickets are processed on DATAMARK(R) terminals which are connected to a central computer installation, usually by telephone lines. The central 2 5 computer installation utilizes Digital Equipment Corporation hardware. The system has the following characteristics: rapid processing, storage and retrieval of transaction data in high volumes and in multiple applications; the ability to down-line load, i.e., to reprogram the wagering terminals from the central computer installation via the communications network; a high degree of security and redundancy to guard against unauthorized access and tampering and to ensure fault tolerant operation without data loss; and a comprehensive management information and control system. In July 1995, the Registrant sold its facilities management and equipment lease contracts for the lottery in Papua New Guinea to the principal shareholders of the operating company, The Lotto Pty. Ltd ("Lotto Pty."). The Registrant has recognized revenues in 1996 and 1997 from this sale and will continue to receive a percentage of Lotto Pty.'s sales over the next three years. Revenue Sources The following table sets forth the revenue for the periods indicated attributable to different applications of the Registrant's technology:
YEARS ENDED DECEMBER 31, --------------------------------------------------- 1997 1996 1995 1994 1993 ------- ------- ------- ------- ------- (DOLLARS IN THOUSANDS) Racing Products and Services... $ 2,443 $11,183 $10,448 $13,932 $14,680 Lottery Products and Services..................... 7,729 5,105 7,680 9,231 10,322 Other.......................... 654 305 513 926 15 ------- ------- ------- ------- ------- Total.......................... $10,826 $16,594 $18,641 $24,089 $25,017 ======= ======= ======= ======= =======
Product Development The Registrant's ability to compete successfully depends in part upon its ability to meet the current and anticipated needs of its customers. To that end, the Registrant devotes a significant portion of its research and development activity to refining and enhancing the features of existing products, systems and software. In 1997 the Registrant spent approximately $1.7 million on engineering, research and development, as compared to $1.7 million and $1.4 million in 1996 and 1995, respectively. The Registrant developed the single roller DATAMARK Flipper(R) terminal (Flipper(TM)) with a unique reader/printer mechanism that meets the needs of many different applications by combining into one unit all of the functional capabilities of previous DATAMARK(R) reader/printer mechanisms in a modular fashion. Also, the Registrant has developed a terminal specifically aimed at lottery applications called the DATAMARK(R) XClaim(TM). This terminal can be configured to print tickets using thermal or impact printing. The Registrant has recently developed a product called the DMNXT(TM) which allows for a simple and inexpensive means for existing DATAMARK(R) customers to upgrade their older generation terminals to an Intel PC platform with improved features which include faster processing, higher resolution printing, and the ability to utilize cost effective, commercial off-the-shelf PC peripherals. The Registrant has been certified since February 1996 under ISO 9001 registration. This certification demonstrates quality in design development and manufacturing under ISO standards. Backlog The backlog of orders for its products and services believed by the Registrant to be firm, amounted to approximately $5.0 million as of December 31, 1997, as compared to a backlog of approximately $1.7 million as of December 31, 1996. Of such backlog at December 31, 1997, approximately $3.3 million is expected to be filled during 1998. See BUSINESS-Dependence Upon A Few Customers. 3 6 Marketing and Business Development Management believes that the Registrant's continuing ability to obtain and retain contracts for its wagering systems and terminals is directly related to its reputation in its various fields of expertise. Because of its reputation, the Registrant often receives unsolicited inquiries from potential customers. The Registrant also learns of new business opportunities through the close contacts which its personnel maintain with key officials in the international horse racing and lottery industries. Contracts to provide products to the horse racing and lottery industries often are awarded through a competitive bidding process which can begin years before a contract is awarded and involves substantial expenditures by the Registrant. Through its contacts with existing customers and others in these industries, the Registrant often becomes aware of prospective projects before the customer circulates a request for proposal. If the Registrant is interested in the project it typically submits a proposal, either before or after the customer circulates a formal request for proposal, outlining the products it would provide and the services it would perform. If the proposal is accepted, the Registrant and its customer negotiate and enter into a contract on agreed terms. The Registrant's marketing efforts are carried out by the Registrant's professional marketing and engineering staff and frequently involve other executive officers of the Registrant. Marketing of the Registrant's products and services throughout the world is often performed in conjunction with consultants with whom the Registrant contracts, from time to time, for representation in specific market areas. The Registrant's success depends in large part on its ability to obtain new contracts to replace its existing contracts. The Registrant currently has proposals outstanding to supply systems, terminals or components for use in the pari-mutuel wagering industry and for lotteries in various foreign countries. In addition to contract sales for terminals and systems, the Registrant has had discussions with both new and existing customers regarding supplying products for their operations and expects to bid for additional contracts in the future. Because the realization of revenue from these prospects is dependent upon a number of factors, including the bidding process and product development, there can be no assurance that the Registrant will be successful in realizing revenue from any of these activities. Olympic Gold Holdings Limited, of the British Virgin Islands, a new customer of the Registrant placed a $2.6 million order for DATAMARK(R) lottery terminals and a computer operations system in May 1997. Olympic Gold operates an on-line lottery in the Ukraine, which began operations in December 1997. Manufacturing and Materials Manufacture of the Registrant's systems and terminals is performed at its facilities in Carlsbad, California, and consists principally of the assembly of parts, components and subassemblies (most of which are designed by the Registrant) into finished products. The Registrant purchases many parts, components and subassemblies (some of which are designed by the Registrant) necessary for its terminals and the systems manufactured by the Registrant from outside sources and assembles them into finished products. These products and purchased computers are then integrated with standard peripherals purchased by the Registrant to construct racing and lottery systems. The Registrant generally has multiple sources for the various items purchased from vendors, but some of these items are state-of-the-art and could, from time to time, be in short supply. Certain other items are available only from a single supplier. For the twelve months ended December 31, 1997 no vendor accounted for 10% or more of the Registrant's raw material purchases. Competition The Registrant competes primarily in the horse racing industry and the on-line lottery industry. The Registrant competes by providing high-quality wagering systems and terminals that are reliable, secure and fast. In addition, management believes that the Registrant offers its customers more flexibility in design and custom options than do most of its competitors. Management believes that the Registrant's main competitors in the sale of horse racing systems and on-line lottery systems in the domestic and international marketplace are: AWA Limited, an Australian company, 4 7 Essnet, a Swedish company, International Des Jeux, the French national lottery company, and four United States companies; GTECH Holdings Corporation, Autotote Limited, Video Lottery Technologies, and Scientific Games Holding Corporation. Management believes that the Registrant has been a substantial factor in the international marketplace. The Registrant's sales or leases in the United States have been insignificant. In general the Registrant's competitors have significantly greater resources than the Registrant. Competition for on-line lottery system contracts is intense. Employees As of December 31, 1997, the Registrant employs 116 people worldwide on a full-time equivalent basis. Of this total, 54 were engaged in manufacturing and operations support, 30 in engineering and software development and 32 in marketing and administrative positions. None of the Registrant's employees is represented by a union, and the Registrant believes its relations with its employees are good. Patents, Trademarks and Licenses The Registrant has five U.S. patents issued on its products. The Registrant believes that its technical expertise, trade secrets and the creative skills of its personnel are of substantially greater importance to the success of the Registrant than the benefits of patent protection. The Registrant typically requires customers, employees, licensees, subcontractors and joint venturers who have access to proprietary information concerning the Registrant's products to sign nondisclosure agreements, and the Registrant relies on such agreements, other security measures and trade secret law to protect such proprietary information. Central system software used in the Registrant's lottery system has been obtained under a non-exclusive license with The HKJC. Regulation The countries in which the Registrant markets its products generally have regulations governing horse racing or lottery operations, and the appropriate governing body could restrict or eliminate these operations in these countries. Any such action could have a material adverse effect on the Registrant. Foreign countries also often impose restrictions on corporations seeking to do business within their borders, including foreign exchange controls and requirements for domestic manufacturing content. In addition, laws and legal procedures in these countries may differ from those generally existing in the United States and conducting business in these countries may involve additional risk for the Registrant in protecting its business and assets, including proprietary information. Changes in foreign business restrictions or laws could have a significant impact on the Registrant's operations. Dependence Upon a Few Customers The Registrant's business to date has been dependent on major contracts and the loss of one or failure to replace completed contracts with new contracts would have a materially adverse effect on the Registrant's business. During 1997, the Registrant's revenues were derived primarily from contracts with Olympic Gold Holding ($2.56 million), New South Wales Lotteries Corporation ($1.7 million); Leisure Management Berhad ($1.67 million); AB Travoch Galopp (ATG) of Sweden ($0.76 million); and The Revenue Markets, Inc. ($0.64 million). Year 2000 Management has initiated an enterprise-wide program to prepare the Company's computer systems and applications for the year 2000. The Company expects to incur internal staff costs as well as other expenses related to infrastructure and facilities enhancements necessary to prepare the systems for the year 2000. The Company is still evaluating the effort required and the related costs will be expensed as incurred. Forward Looking Statement The statements in this filing which are not historical facts are forward-looking statements that are subject to risks and uncertainties that could cause actual results to differ materially from those set forth or implied by 5 8 forward-looking statements. These risks and uncertainties include the absence of significant contract backlog, the dependence on business from foreign customers sometimes in politically unstable regions, political and governmental decisions as to the establishment of lotteries and other wagering industries in which the Company's products are marketed, fluctuations in quarter-by-quarter operating results and other factors described in this Annual Report. Seasonality In general, the Registrant's business is not subject to seasonal effects. Working Capital Practices The Registrant's sales contracts typically provide for deposits and progress payments which, have provided sufficient working capital for operations. With the Registrant entering into long-term lottery service agreements, a substantial portion of its working capital has been expended in previous years in attempting to establish viable operations in these investments. See "Management's Discussion and Analysis of Financial Condition and Results of Operations" incorporated by reference herein. Environment Effects There are no significant capital expenditures required of the Registrant in order to comply with laws relating to protection of the environment. Export Sales The majority of the Registrant's revenues are derived from contracts with foreign companies. As of December 31, 1997 the Registrant's equipment has been delivered and installed in Sweden, Norway, Hong Kong, Singapore, Ukraine, Australia, Finland, England, the Netherlands, Malaysia, Macau, China, Papua New Guinea, Belgium and the Philippines. The companies with which the Registrant contracts are normally sizeable organizations with substantial assets and are capable of meeting the financial obligations undertaken. The Registrant has entered into a few contracts specifying payment in currencies other than the U.S. dollar, thereby assuming the risk associated with fluctuations in value of foreign currencies. The majority of the Company's sales are denominated in U.S. dollars and thus not subject to foreign currency fluctuations. However, the ultimate cost of the Company's products to its customers have increased due to recent fluctuations in the foreign exchange rates of many southeast Asian countries. At this point the Company does not believe that these fluctuations in exchange rates have had a material impact on any potential sales. However, any further significant decline in the economies of such Asian countries or in the value of their currencies could have a material adverse impact on the Company. The Registrant operates a wholly-owned subsidiary in Australia. Also, see Note 5 of Notes to Consolidated Financial Statements, incorporated by reference in Part II, Item 8. ITEM 2. PROPERTIES The Registrant's U.S. facilities consist of approximately 41,500 square feet of leased office, warehouse and manufacturing space in Carlsbad, California. The lease on this facility expires in the year 2000. The Registrant's Australian subsidiary leases approximately 13,000 square feet consisting of a manufacturing and administrative facility. The lease on this property expires in October 2001. The Registrant's United Kingdom subsidiary occupies an office-technical support facility in West Drayton, England of approximately 2,400 square feet, under a lease expiring in March, 1998, which will not be renewed. See Note 6 of Notes to Consolidated Financial Statements, incorporated by reference in Part II, Item 8. 6 9 ITEM 3. LEGAL PROCEEDINGS Shareholders' Class Action Litigation In 1994, shareholders of the Registrant filed class action lawsuits against the Registrant and several of its officers and directors. Those actions were consolidated in the United States District Court for the South District of California. Plaintiffs contended that during the class period (June 22, 1993 through June 21, 1994) the Registrant and the individual defendants made a series of public statements that failed to disclose adverse information about the Registrant's lottery service contracts, that these purported nondisclosures artificially inflated the price of the Registrant's stock, and that those purchasers who acquired their shares in reliance on the integrity of the market suffered damages as a result. On June 17, 1996, the court entered, in favor of the class shareholders, a judgment of a cash payment and 1.2 million shares of authorized but unissued common stock of the Registrant. In 1997, the final shares were distributed to the class shareholders. WALTERS V ILTS, ET AL In November, 1995, Mr. James Walters, the former chairman and president of the Registrant, filed an action in the San Diego County Superior Court against the Registrant and its then current president, Frederick A. Brunn, alleging that certain statements in a magazine article were slander per se by the Registrant and Brunn and libel by the publishing company and the author, and that Mr. Walters suffered an invasion of privacy by all defendants. In addition, Mr. Walters alleged that erroneous information in the Registrant's 1995 proxy statement resulted in two other magazine articles publishing allegedly incorrect information. Mr. Walters seeks general and special damages of $9 million and punitive damages. On November 1, 1996, the San Diego County Superior Court entered a summary judgement in favor of the Registrant and Mr. Brunn. Mr. Walters has filed an appeal with the California Fourth District Court of Appeal. ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS Special Shareholders Meeting On December 30,1997 the Registrant's shareholders approved an amendment to the Corporation's Articles of Incorporation authorizing the issuance of up to 20,000,000 shares of preferred stock, no par value, in one or more classes or series having such rights, privileges, designations and preferences as may be determined from time to time by the Board of Directors. The shareholder vote was as follows:
PERCENTAGE OF VOTE (IN SHARES) OUTSTANDING SHARES ---------------- ------------------ For the amendment.......................... 10,411,499 57.75 Against the amendment...................... 965,346 5.35 Abstain.................................... 131,370 0.73 Broker Non-Vote............................ 6,520,950 36.17
EXECUTIVE OFFICERS OF THE REGISTRANT
NAME AGE V POSITION ---- --- ---------- M. Mark Michalko........ 43 President Robert F. McPhail....... 64 Vice President, International Sales & Marketing Timothy R. Groth........ 48 Vice President, Technical Operations Dennis D. Klahn......... 39 Chief Financial Officer Lawrence E. Logue....... 61 Corporate Secretary
7 10 PART II ITEM 5. MARKET FOR THE REGISTRANT'S COMMON EQUITY AND RELATED SHAREHOLDER MATTERS The information required by this item is included in the Registrant's Annual Report to Shareholders for the year ended December 31, 1997 under the same caption and is incorporated herein by reference to such Annual Report. Solely for the purpose of calculating the aggregate market value of the voting stock held by non-affiliates of the Registrant, as set forth on the cover of this report, it has been assumed that all executive officers and directors of the Registrant and Berjaya Lottery Management (H.K.) Ltd. were affiliated persons. All of the Registrant's Common shares, the only voting stock outstanding, beneficially owned by each such person (as defined in Rule 13d-3 under the Securities Exchange Act of 1934) have been assumed to be held by that person for this calculation. The market value of the Common shares is based on the closing price reported in the Wall Street Journal for March 24, 1998, of $.7187 per share. ITEM 6. SELECTED FINANCIAL DATA The information required by this item is included on page 6 of the Registrant's Annual Report to Shareholders for the year ended December 31, 1997 under the same caption and is incorporated herein by reference to such Annual Report. ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS The information required by this item is included on pages 7 through 10 of the Registrant's Annual Report to Shareholders for the year ended December 31, 1997 under the same caption and is incorporated herein by reference to such Annual Report. ITEM 8. CONSOLIDATED FINANCIAL STATEMENTS The information required by this item is included on pages 11 through 21 of the Registrant's Annual Report to Shareholders for the year ended December 31, 1997 and is incorporated herein by reference to such Annual Report. ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE Inapplicable. PART III ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT The information required is incorporated herein by reference to the Registrant's definitive Proxy Statement for the 1998 Annual Meeting of Shareholders. ITEM 11. EXECUTIVE COMPENSATION The information required is incorporated herein by reference to the Registrant's definitive Proxy Statement for the 1998 Annual Meeting of Shareholders. ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT The information required is incorporated herein by reference to the Registrant's definitive Proxy Statement for the 1998 Annual Meeting of Shareholders. 8 11 ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS The information required is incorporated herein by reference to the Registrant's definitive Proxy Statement for the 1998 Annual Meeting of Shareholders. PART IV ITEM 14. EXHIBITS, CONSOLIDATED FINANCIAL STATEMENT SCHEDULE, AND REPORTS ON FORM 8-K (a) List the following documents filed as a part of the report: 1. and 2. Index to Consolidated Financial Statements and Financial Statement Schedule: (i) Report of Arthur Andersen LLP, Independent Public Accountants Report of Ernst & Young LLP, Independent Auditors (ii) Consolidated Balance Sheets at December 31, 1997 and 1996* (iii) Consolidated Statements of Operations for each of the three years in the period ended December 31, 1997*IM (iv) Consolidated Statements of Shareholders' Equity for each of the three years in the period ended December 31, 1997* (v) Consolidated Statements of Cash Flows for each of the three years in the period ended December 31, 1997* (vi) Notes to Consolidated Financial Statements* *incorporated by reference to the Annual Report to Shareholders for the year ended December 31, 1997. (vii) Schedule II -- Valuation and Qualifying Accounts (Form 10-K, page 10) All other schedules are omitted since the required information is not applicable. 3. EXHIBITS (3) Articles of Incorporation, as amended September 13, 1994, reflecting corporate name change, and as amended January 7, 1998, reflecting authorization for 20 million shares of preferred stock and By-laws (incorporated by reference to Form 10-K for the year ended December 31, 1994, File No. 0-10294). (10) (a) Lease for the Registrant's facility in Carlsbad, California dated June 30, 1992, as amended by First Amendment to Lease dated January 23, 1987 (incorporated by reference to Exhibit 10.11 to Registration Statement File No. 33-18238 effective February 19, 1988). (b) Agreement with Sir Michael G. R. Sandberg dated May 20, 1987 (incorporated by reference to Exhibit 10.15 to Registration Statement File No. 33-18238 effective February 19, 1988). (c) The Registrant's 1986 Employee Stock Option Plan (incorporated by reference to Exhibit 4(b) to the Form S-8 Registration Statement, File No. 33-34123, as filed on April 4, 1990). (d) The Registrant's 1988 Employee Stock Option Plan (incorporated by reference to Exhibit 4(b) to the Form S-8 Registration Statement, File No. 33-34123, as filed on April 4, 1990). (e) The Registrant's 1990 Stock Incentive Plan (incorporated by reference to Form 10-K for the year ended December 31, 1990, File No. 0-10294 and File No. 33-79938). 9 12 (f) Agreement with The Hong Kong Jockey Club dated May 11, 1989 and amended on January 13, 1992 (incorporated by reference to Form 10-K for the year ended December 31, 1991, File No. 0-10294). (g) The Registrant's 1997 Directors' Stock Option Plan. (13) Annual Report to Shareholders for the year ended December 31, 1997. With the exception of the information incorporated by reference into items 5, 6, 7, and 8 of this Form 10-K, the 1997 Annual Report to Shareholders is not deemed filed as part of this report. (21) Subsidiaries of the Registrant. (23A) Consent of Arthur Andersen LLP, Independent Public Accountants (23B) Report of Arthur Andersen LLP, Independent Public Accountants (23C) Consent of Ernst & Young LLP, Independent Auditors (23D) Report of Ernst & Young LLP, Independent Auditors (b) A report on Form 8-K was filed during the last quarter of the period covered by this report reflecting a change in Registrant's Independent Accountants. 10 13 SCHEDULE II INTERNATIONAL LOTTERY & TOTALIZATOR SYSTEMS, INC. VALUATION AND QUALIFYING ACCOUNTS
ADDITIONS BALANCE AT CHARGED TO BEGINNING COSTS AND BALANCE AT DESCRIPTION OF YEAR EXPENSES DEDUCTIONS END OF YEAR ----------- ---------- ---------- ---------- ----------- Years Ended: December 31, 1997 -- Warranty Reserves.......................... $257,921 $75,258 $ 88,558 $244,621 -- Allowance for Doubtful Accounts............ $111,112 $64,596 $ 2,410 173,298 December 31, 1996 -- Warranty Reserves.......................... $297,727 $84,594 $124,400 $257,921 -- Allowance for Doubtful Accounts............ $ 62,956 $61,764 $ 13,608 $111,112 December 31, 1995 -- Warranty Reserves.......................... $347,117 $76,015 $125,405 $297,727 -- Allowance for Doubtful Accounts............ $208,550 $60,000 $205,594 $ 62,956
Warranty reserve deductions primarily reflect actual warranty costs incurred by the Registrant. 11 14 SIGNATURES Pursuant to the requirements of Section 13 or 15(d) 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. INTERNATIONAL LOTTERY & TOTALIZATOR SYSTEMS, INC.(TM) /s/ DENNIS D. KLAHN By: -------------------------------------- Dennis D. Klahn Chief Financial Officer Dated: Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the Registrant and in the capacities and on the dates indicated.
SIGNATURE TITLE DATE --------- ----- ---- /s/ THEODORE A. JOHNSON Chairman of the Board March 26, 1998 - --------------------------------------------- Theodore A. Johnson /s/ M. MARK MICHALKO President March 26, 1998 - --------------------------------------------- M. Mark Michalko /s/ DENNIS D. KLAHN Chief Financial Officer March 26, 1998 - --------------------------------------------- Dennis D. Klahn /s/ FREDERICK A. BRUNN Director March 26, 1998 - --------------------------------------------- Frederick A. Brunn Director March 26, 1998 - --------------------------------------------- Ng Foo Leong /s/ MARTIN J. O'MEARA, JR. Director March 26, 1998 - --------------------------------------------- Martin J. O'Meara, Jr. Director March 26, 1998 - --------------------------------------------- Michael G.R. Sandberg Director March 26, 1998 - --------------------------------------------- Chan Kien Sing /s/ NG AIK CHIN Director March 26, 1998 - --------------------------------------------- Ng Aik Chin
12 EX-3 2 EXHIBIT 3 1 EXHIBIT 3 CERTIFICATE OF AMENDMENT OF ARTICLES OF INCORPORATION OF INTERNATIONAL LOTTERY & TOTALIZATOR SYSTEMS, INC. a California corporation M. Mark Michalko and Lawrence E. Logue certify that: 1. They are the President and Secretary of International Lottery & Totalizator Systems, Inc., a California corporation. 2. The Articles of Incorporation of this corporation shall be amended to add an Article Five to read as follows: "FIVE: (a) The liability of the directors of this corporation for monetary damages shall be eliminated to the fullest extent permissible under California law. (b) This corporation is authorized to provide indemnification of agents (as defined in Section 317 of the California Corporations Code) through bylaw provisions, agreements with agents, vote of shareholders or disinterested directors or otherwise, in excess of the indemnification otherwise permitted by Section 317 of the California Corporations Code, subject only to applicable limits set forth in Section 204 of the California Corporations Code with respect to actions for breach of duty to the corporation and its shareholders. (c) Any repeal or modification of this Article Five shall be prospective and shall not affect the rights of indemnification or limitation of liability in effect at the time of the alleged occurrence of any act or omission to act giving rise to liability or indemnification." 3. The foregoing amendment of the Articles of Incorporation has been duly approved by the Board of Directors. 4. The foregoing amendment of the Articles of Incorporation has been duly approved by the required vote of shareholders in accordance with Section 902 of the California Corporations Code. The total number of outstanding shares is 18,027,548. The number of shares voting in favor of the amendment equaled or exceeded the vote required. The percentage vote required was more than 50%. We further declare under penalty of perjury under the laws of the State of California that the matters set forth in this certificate are true and correct of our own knowledge. Date: January 5, 1998 /s/ M. Mark Michalko --------------------------------------- M. Mark Michalko /s/ Lawrence E. Logue --------------------------------------- Lawrence E. Logue EX-13 3 EXHIBIT 13 1 EXHIBIT 13 1997 ANNUAL REPORT [GRAPHIC] [ILTS(R) LOGO] INTERNATIONAL LOTTERY & TOTALIZATOR SYSTEMS, INC. 2 MISSION STATEMENT International Lottery & Totalizator Systems provides computerized wagering equipment and systems to racing organizations and lotteries worldwide. We are committed to providing innovative gaming solutions through quality products and service to maximize the revenue of our customers and bring a fair return to our shareholders. ILTS is an ISO 9001 registered company. [PHOTO] COMPANY PROFILE In 1994, International Totalizator Systems, changed its name to International Lottery & Totalizator Systems (ILTS) to more accurately reflect the primary business activities of the Company. As supplier to more than 200 race tracks worldwide, ILTS has long been recognized as an industry leader in pari-mutuel wagering. In recent years ILTS has become a major supplier to state lotteries, and in the last decade has grown to serve customers in 18 countries, providing advanced on-line wagering systems and facilities management. BACKGROUND & EXPERIENCE International Totalizator Systems was incorporated in California in 1978 and began operations in 1979. ITS became a public company in 1981, with its stock traded on the NASDAQ System (symbol: ITSI). In 1993 Berjaya Lottery Management became a major shareholder of ILTS, providing substantial resources for continued growth and expansion. ILTS management, engineering staff, customer support groups and wagering specialists represent a unique blend of experience in mechanical design, software and applied systems technology. The Company's technical expertise in partnership with its customers and suppliers has resulted in innovative solutions that have put ILTS systems at the leading edge of automated wagering technology. RESEARCH & DEVELOPMENT ILTS is committed to maintaining technological leadership through continued research and development to provide innovative features and enhancements to the entire product line. Over the past five years the Company has invested heavily in research and development, and will continue to devote a significant portion of revenues to explore new bet-processing technologies, software and data management systems to maintain a competitive level of excellence. 1 3 QUALITY ASSURANCE At ILTS the quality goal is to provide the best products and service possible, by not only meeting customer requirements, but by exceeding customer expectations. To achieve this ILTS has established a formal quality assurance program that includes product design and development, and all manufacturing and assembly operations, in compliance with ISO 9000 guidelines. ILTS received a certificate of compliance to ISO 9001 in February of 1996. The audit demonstrated ongoing conformance to ISO 9001 and continuous improvement in the ILTS quality program. Registration to ISO 9001 puts ILTS in an elite group of companies worldwide who have met the most stringent requirements of the International Organization for Standardization. At ILTS, quality is more than inspection guidelines and standards. Quality is an integral part of the Company's management and work philosophy. MANAGEMENT ORGANIZATION The collective knowledge and experience of ILTS' people is the Company's most important asset and the cornerstone of an effective work environment. ILTS has an experienced management team, well trained staff and established management systems, procedures and controls. The effectiveness of the ILTS management approach has been demonstrated in the successful installation of numerous automated wagering systems since 1981. The Company has designed and installed a variety of wagering systems within budget and on schedule. Subcontractor, vendor management and after sales support are also well-established disciplines within the organization. MARKET-DRIVEN ILTS delivers more than advanced technology and innovative solutions. As a company and as individuals, ILTS is committed to customer satisfaction. By combining technical expertise with dedicated service, the Company endeavors to do it right, on time, the first time, every time! Extensive experience combined with the efforts of a talented and dedicated staff have helped ILTS become one of the most respected names in state-of-the-art computerized wagering systems. STRATEGIES & OBJECTIVES CONDUCT our business in an ethical and forthright manner and to be a responsible member of our community. REALIZE increased value to our shareholders through revenue growth and consistent profitability. ESTABLISH an industry benchmark for leadership in customer service and quality. DEFINE primary market segments within the lottery and pari-mutuel wagering industries. DEVELOP quality products and solutions to meet the current and future needs of customers in our primary markets. ACHIEVE operational excellence and quality management throughout the Company to maximize the effect of product development and reduce costs through improved planning and control. INITIATE strategic alliances with companies whose technology and products complement and expand our product offering. PROVIDE an environment for employees that encourages teamwork and creativity to maximize job satisfaction, personal development and career growth opportunities. 2 4 YEAR IN REVIEW Over the past year, management has aggressively initiated steps to transform the Company from an engineering-driven organization to a market-driven organization. An integral part of this transformation has been to ensure that we have the requisite products to serve our target markets. This convergence of product development with market opportunity has resulted in the launch of several new products that have helped position ILTS to strongly compete for business in our targeted markets. PRODUCTS & MARKETS ILTS provides on-line lottery products to the worldwide market. To meet the requirements of lottery customers in search of total system solutions, the Company developed the DataTrak(TM) on-line gaming system, a client/server distributed processing system built around an open architecture. The system incorporates a proven high-performance bet engine, and can be scaled to meet specific customer [PHOTO] [DATATRAK INSTANT LOGO] TO OUR SHAREHOLDERS [PHOTO] Nineteen ninety-seven was a productive year for ILTS. We improved our performance in many facets of our business, and laid the foundation for future improvements in others. We made several fundamental changes that have already borne fruit, and which will position the Company for future growth and sustained profitability. From its inception, ILTS has been an engineering-driven company. Emphasis was on product innovation and development, and justifiably so, as the Company won much of its early business based on precisely these factors. As we move toward a new century, market dynamics demand more than technical competence. We must become a market-driven organization, and we have taken aggressive steps to effect this transformation. In the short time since the management change last summer, we have implemented a broad range of strategic initiatives. We carefully and critically analyzed the way ILTS historically has done business, retained that which has produced positive results, and changed those areas where there was room for improvement. First and foremost, we sharpened the Company's focus to concentrate on the industry in which we historically have been most successful -- gaming. And within the broader gaming market, we have identified three distinct target markets: [i] long-standing customers, [ii] new customers in established markets, and [iii] new customers in emerging markets. Most importantly, we have strategically developed products to competitively address the unique requirements of each market segment. To pursue business in these target markets, we redeployed our sales force to form task-oriented teams, and retained experienced consultants to augment our internal capabilities. And we are concentrating on those opportunities where we can create a specific competitive advantage. 3 5 We have also formed strategic alliances with world-class partners to strengthen our product offerings. Recognizing that the cornerstone of any growth strategy is retention of existing business, virtually my first official action was to visit all of our long-standing customers to ascertain how we can strengthen and improve our relationship with them. I am pleased to report that several new product contracts were obtained with such long-standing customers as ATG of Sweden, South Australia TAB and Leisure Management of Malaysia. We have also paved the way for future business by introducing the DATAMARK NXT, a technology upgrade which cost-effectively extends the serviceability of customers' existing terminals. In the area of new business, we are pleased to add the Singapore Turf Club and Olympic Gold Holdings to our growing customer list. As of this writing, we have several bids pending for new business from both our long-standing customers and new prospects as well. In terms of product offerings, we completed development of DataTrak, our leading-edge lottery software product for lotteries in developed markets. For emerging markets, in conjunction with a strategic partner, we have developed a unique terminal which can expand sales into areas where marginal electrical power or telecommunications service would preclude traditional on-line systems. On the totalizator side of the business, through another strategic alliance, we now can offer racing prospects a scalable, field-proven software system known as InterTote. We will always be subject to the vagaries of contract timing, and 1997 was no exception. Several excellent opportunities were pushed forward into 1998. However, our task is to ensure that ILTS is well-positioned to win new business whenever the opportunities arise. We believe we have done precisely that. In evaluating our performance, we acknowledge that there is still much to be done. Financially, we must further improve our performance and achieve consistent profitability. To that end, we must continue to succeed in our traditional market, while we hone our product offerings and sales strategies to be even more competitive in new markets. As we continue to implement these new strategies and tactics, I am confident that we will complete ILTS' transformation into a more vibrant, stronger, and consistently profitable Company for years to come. /s/M. Mark Michalko M. Mark Michalko President / Director YEAR IN REVIEW (CONTINUED) - --------------------------------- [PHOTO] requirements, large or small. The first release of this system was in October of 1996. In 1997 two new DataTrak modules were developed: DataTrak Instant and Player Registration, demonstrating the flexibility and upward compatible path of the system. DataTrak Instant is a fully integrated, on-line instant ticket validation and management system that provides real-time validation of instant lottery tickets together with a host of accounting, distribution and inventory control functions. It is designed to operate seamlessly with the ILTS DataTrak gaming system and shares the same client/server architecture and security features. The Player Registration application allows players to be registered with a lottery and to maintain a betting account. The application is used to create and update a player's account, request payment of a player's winnings, display a history of player's winnings and activities, and a host of other data. DataTrak is a dynamic system and it will continue to expand to meet the future needs of lotteries. Two new terminal products have been tailored for the targeted lottery markets. The DATAMARK XClaim was introduced in 1996 to meet the general requirements of lotteries and facilities management contracts. The XClaim is robust, affordable and provides all features and functions required for lottery operations. 4 6 Year in Review (Continued) - --------------------------------- [PHOTO] In late 1997 ILTS introduced the DATAMARK NXT, the next generation of the DATAMARK Flipper. This terminal provides a number of high-end features for technically sophisticated lotteries that typically purchase and operate their own systems. The DATAMARK NXT also provides an upgrade path for earlier DATAMARK terminals. This new option allows ILTS customers to integrate their existing reader/printer mechanisms with new PC electronics, a higher resolution printhead and an attractive, ergonomic enclosure. Benefits include expanded memory, use of high-level programming language, improved speed, better print quality, and continuity in appearance of bet slips and tickets. In addition to providing lottery systems, ILTS remains a leading provider of computerized on-line wagering systems to the racing industry. In 1996, the Company introduced the ILTS InterTote System, an open systems totalizator with broad application. The system encompasses both on-track and off-track betting, and can provide multi-track operation. It handles numerous wagering options including standard bet types and special features, which can easily be adapted to local rules and regulations. InterTote is designed to run on the UNIX operating system, which permits the use of virtually any hardware platform including IBM, Digital and Intel-based PCs. It is extremely flexible, with well-defined technology upgrade paths. [PHOTO] STRATEGIC ALLIANCES Management's critical analysis has determined that in the development of new products for the Company's target markets, in certain cases it is more efficient to form strategic alliances with synergistic partners than to develop and manufacture internally. Such relationships bring higher expertise, lower costs and expedite delivery to market. To strengthen the ILTS product offering, the Company has formed strategic alliances with several world-class organizations, including: [PHOTO] Racecourse Totalizators, a leading designer and operator of scalable pari-mutuel wagering systems. ILTS has licensed this software system, and is marketing it worldwide under the name ILTS InterTote as a feature-rich, cost-effective wagering system for race tracks. Symbol Technologies, a world leader in bar-code technology, spread spectrum radio technology and battery-powered hand-held computers. ILTS is partnering with Symbol to develop 1D and 2D bar-code reading solutions for instant ticket validation and player registration products. Symbol is also providing radio equipment for our wireless terminal product. ICL/Natech South Africa, a leader in the computer service sector and point of sale industry. ICL/Natech is working with ILTS to provide installation and maintenance repair service for certain customers and prospects. The companies have also jointly developed a portable hand-held off-line betting terminal, the DATAMARK Passport, for use in emerging markets where power and telecommunications are problematic. 5 7 SELECTED FINANCIAL DATA
YEARS ENDED DECEMBER 31, 1997 1996 1995 1994 1993 - -------------------------------------------------------------------------------------------------------------------------- Thousands of dollars except per share amounts and non-monetary items Statement of operations data Revenue $ 10,826 $ 16,594 $ 18,641 $ 24,089 $25,017 Gross profit(1) 1,179 3,441 1,185 4,527 9,038 Operating income (loss) (6,700) (6,894) (14,221) (22,943) 302 Net income (loss) (5,938) (5,498) (13,869) (22,620) 605 Earnings (loss) per share - basic (0.33) (0.31) (0.83) (1.35) 0.05 Earnings (loss) per share - diluted (0.33) (0.31) (0.83) (1.35) 0.04 Balance sheet data Total assets 8,662 13,883 21,352 31,888 54,924 Shareholders' equity 4,092 8,519 13,412 27,145 48,855 Key ratios and statistics Gross profit(1) 10.9% 20.7% 6.4% 18.8% 36.1% Working capital 3,212 6,614 8,679 22,236 31,670 Book value per share 0.23 (2) 0.47 0.80 1.62 2.94 Current ratio 1.70 2.23 2.12 5.69 6.22 Backlog 4,988 1,709 9,214 11,168 15,250 Employees 116 144 176 277 249 Shares outstanding 18,028 (2) 18,016 16,816 16,804 16,574 - --------------------------------------------------------------------------------------------------------------------------
(1) Amounts are before lottery service agreement write-offs and write downs of $2,793, $2,807 and $17,444 for 1996, 1995 and 1994, respectively. (2) Includes 840 thousand shares issued in 1997 to the shareholder class in settlement of a class action lawsuit. See note 11 to the consolidated financial statements. 6 8 MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS 1997 VS. 1996 REVENUES: Revenue from the sale of products decreased by 40% to $8.4 million in 1997 from $14.0 million in 1996. The decrease was primarily the result of the low backlog of contracts at the end of 1996 and the level of new contracts which were delivered in 1997. Service related revenues, which include terminal maintenance and software service agreements, decreased 8% to $2.4 million in 1997 from $2.6 million in 1996. This decrease was due to a lower level of customer support contract requirements. New orders received in 1997 were $8.0 million compared to $3.0 million in 1996. GROSS PROFIT: During 1997 the Company recognized a gross profit of 7% on sales of products compared to a gross profit of 21% (before write offs and write-downs of lottery service agreements) in 1996. The decrease in gross profit is due to unfavorable manufacturing variances related to the decrease in sales, charges of approximately $1.3 million taken to recognize impairment in the value of software capitalized in previous years, for which sales orders have not yet been received, additional reserves for inventory obsolescence, to record provisions for certain development contracts and costs related to the closing of the Company's United Kingdom subsidiary. The Company recognized a gross profit of 24% on services in 1997 compared to 31% (before write offs of lottery service agreements) in 1996. This decrease was the result of the mix of services provided and the increase in the foreign exchange rate of the U.S. dollar versus the Australian dollar in 1997. ENGINEERING, RESEARCH & DEVELOPMENT: Engineering, research and development expenses of $1.7 million in 1997 were equal to those of 1996. Of the $1.7 million expended in 1997, $1.3 million was for additional development of Data Trak lottery software and the related instant ticket validation and player registration modules. Additional funds were expended to reduce the manufactured cost of the Company's terminals. The 1996 expenditures related primarily to development of the Data Trak software. Selling, General and Administrative: Selling, general and administrative expenses increased $0.3 million in 1997 compared to 1996. The 1997 selling, general and administrative costs were actually less than 1996 costs if the 1996 benefit from the $1.2 million reduction to the June 1996 judgment to settle the shareholders class action lawsuit was omitted. GAIN ON SALES OF SUBSIDIARY AND LOTTERY SERVICE AGREEMENT: In 1993 the Company sold its subsidiary McKinnie & Associates. In the fourth quarter of 1997, the Company negotiated and received a final settlement on this agreement. The Company recognized a gain on the sale of $438 thousand and $691 thousand in 1997 and 1996 respectively. In 1995, the Company sold its Papua New Guinea lottery service agreement. The Company recognized a gain on the sale of $419 thousand and $624 thousand in 1997 and 1996 respectively. Both of these sales have been recorded under the cost recovery method and, as such, no income was recognized until 1996, when the basis of these investments had been recovered. Provision for Income Taxes: The provision of income taxes in 1997 and 1996 relates to income earned in the Company's Australian subsidiary. 7 9 1996 VS. 1995 REVENUES: Revenue decreased by 11% to $16.6 million in 1996 from $18.6 million in 1995. The decrease is a result of lower levels of contract revenues caused by the booking by the Company of $3.0 million in new orders in 1996 compared to $12.6 million of new orders in 1995. Spares sales in 1996 increased 103% or $1,087 over 1995 sales. This increase in spares was due to the increased number of ILTS terminals in service and the timing of customer orders. GROSS PROFIT: During 1996 the Company had gross profits of 21% (before write offs and write-downs of Lottery Service Agreements) compared to a gross profit of 6% (before write offs and write-downs of Lottery Service Agreements) in 1995. The increase in gross profit is due to more favorable sales mix in 1996, the accrual of $660 thousand as a loss on a contract in 1995, costs related to the winding down of the Russian lottery project in 1995 and the effect of cost-saving measures which were implemented in late 1995. WRITE-OFFS AND WRITE-DOWNS OF LOTTERY SERVICE AGREEMENTS: During 1996, the charge of $2.8 million relates entirely to the U.K. lottery. The reserve was established after an affiliate of the customer was unable to obtain the additional funding necessary for the project start-up and ongoing operations. At this time, the customer has not indicated when a start-up may occur. The amount of the charge approximates the Company's tangible investment, previously carried on the balance sheet as "Investment in Lottery Service Contracts." In 1997 the Company was able to recover $2.6 million of its investment through the sale of the system and terminals. The 1995 charge relates to the withdrawal by the Company from its Russian Lottery project. At December 31, 1996, the Company's net book value of its investment in Lottery Service agreements was zero. ENGINEERING, RESEARCH & DEVELOPMENT: Engineering, research and development expenses in 1996 increased $302 thousand, or 22%, compared to 1995. Of the $1.7 million expended in 1996, $1.0 million went toward development of DataTrak lottery software. The DataTrak software was completed for release in October 1996 and future research and development costs will be expended to provide additional features. The 1995 expenditures related to development of the Flipper terminal and the DataTrak software. SELLING, GENERAL AND ADMINISTRATIVE: Selling, general and administrative expenses decreased $5.4 million in 1996 compared to 1995. The decrease was due to a $4.2 million accrual in 1995 for the estimated cost to settle the shareholders class action litigation. The June 1996 judgment fixed the cost at an amount approximately $1.2 million less than the 1995 estimate. This $1.2 million was recorded as a reduction to the 1996 second quarter selling, general and administrative costs. GAIN ON SALES OF SUBSIDIARY AND LOTTERY SERVICE AGREEMENT: During 1996, the Company recognized gains of $691 thousand and $624 thousand on the sales of its subsidiary McKinnie & Associates, and the Papua New Guinea lottery service agreement, respectively. These sales which occurred in 1993 and 1995, respectively, have been recorded under the cost recovery method and, as such, no income was recognized until the basis of these investments had been recovered. This occurred in 1996. No related gains were recognized prior to 1996. PROVISION FOR INCOME TAXES: The provision for income taxes in 1996 relates to income earned in the Company's Australia subsidiary. LIQUIDITY AND CAPITAL RESOURCES During 1997, the Company's working capital decreased approximately $3.4 million, primarily due to the Company's net loss of $5.9 million. The accrued litigation settlement of $1.7 million was extinguished through the issuance in 1997 of 840 thousand shares of common stock of the Company. During 1997 the Company generated cashflows of $857 thousand primarily as a result of proceeds of $438 thousand and $419 thousand relating to the sale, in previous years, of McKinnie & Associates and of the Papua New Guinea lottery, respectively. During 1997 8 10 MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (CONTINUED) the Company invested $150 thousand in additional equipment. As part of its strategic plan, the Company intends to pursue long-term service contracts as a source of revenue. Service contracts pose new capital investment risks for the Company that do not exist in its product sale business. Payments are received only after a system becomes operational, based upon a percentage of the customer's gross receipts from the system. The Company therefore bears the risk that scheduling delays may occur and that a system may not become operational. The Company's consolidated financial statements have been prepared on a continuing operations basis which contemplates the realization of assets and the settlement of liabilities and commitments in the normal course of business. Management recognizes that the Company must generate additional contract sales to maintain its current level of operations. Additionally, management is currently seeking additional sources of funding through debt or equity financing and consideration of other business transactions which would generate sufficient resources to assure continuation of the Company's operations. Management anticipates that it will be successful in obtaining sufficient contracts to enable the Company to continue normal operations; however, no assurances can be given that the Company will be successful in realizing sufficient contract revenue or obtaining additional funding. If the Company is unable to obtain sufficient contract revenue or funding, management will be required to sharply curtail the Company's operations. On February 27, 1998, the Company's largest shareholder, Berjaya Lottery Management (Berjaya), agreed to provide financial support if and when necessary to ensure that the Company's operations continue for at least one year from December 31, 1997. The Company's reporting currency is the U.S. dollar. Historically, a majority of the Company's sales have been denominated in U.S. dollars, with the balance denominated in foreign currencies. These foreign currency sales have been effected principally by the Company's international subsidiaries. In accordance with U.S. accounting requirements, sales denominated in foreign currencies are translated into the local functional currency and then into U.S. dollars, at an average exchange rate in effect during the period. In addition, the Company incurs operating and technical support related expenses in Australian dollars in connection with its Australian operations and also incurred operating expenses in local currency at its United Kingdom location through 1998. Thus, changes from reporting period to reporting period in the exchange rates between various foreign currencies and the U.S. dollar have had, and will in the future continue to have, an impact on revenues and expenses reported by the Company, and such effect may be material in any individual reporting period. To the extent that the Company incurs operating expenses in local currencies at its foreign subsidiaries, the Company has a natural hedge against a portion of the possible fluctuation in foreign currency exchange rates of revenues in such currencies. As the contracts are predominantly denominated in the functional currency 9 11 of the subsidiary performing under the contract, the Company has historically incurred immaterial amounts of transaction gains or losses. The majority of the Company's sales are denominated in U.S. dollars and thus not subject to foreign currency fluctuations. However, the ultimate cost of the Company's products to its customers have increased due to recent fluctuations in the foreign exchange rates of many southeast Asian countries. At this point the Company does not believe that these fluctuations in exchange rates has had an impact on any potential sales. However, any further significant decline in the economy of such Asian countries or in the value of their currencies could have a material adverse impact on the Company. The balance sheets of the Company's international subsidiaries are translated into U.S. dollars and consolidated with the balance sheets of the Company's domestic subsidiary in accordance with U.S. accounting requirements. Changes in the U.S. dollar value of the foreign currency denominated assets are accounted for as an adjustment to stockholders' equity. Therefore, changes from reporting period to reporting period in the exchange rates between various foreign currencies and the U.S. dollar have had, and will continue to have, an impact on the foreign currency translation component of stockholders' equity reported by the Company, and such effect may be material in any individual reporting period. Within the 1997 calendar year the Australian dollar decreased 17% against the U.S. dollar, which increased the foreign currency translation adjustment component of the equity section. YEAR 2000 Management has initiated an enterprise-wide program to prepare the Company's computer systems and applications for the Year 2000. The Company expects to incur internal staff costs as well as other expenses related to infrastructure and facilities enhancements necessary to prepare the systems for the Year 2000. The Company is still evaluating the effort required, and the related costs will be expensed as incurred. FORWARD LOOKING STATEMENT The statements in this filing which are not historical facts are forward-looking statements that are subject to risks and uncertainties that could cause actual results to differ materially from those set forth or implied by forward-looking statements. These risks and uncertainties include the absence of significant contract backlog, the dependence on business from foreign customers sometimes in politically unstable regions, political and governmental decisions as to the establishment of lotteries and other wagering industries in which the Company's products are marketed, fluctuations in quarter-by-quarter operating results and other factors described in the Company's Annual Report on Form 10-K for the year ended December 31, 1997. 10 12 CONSOLIDATED STATEMENTS OF OPERATIONS
YEARS ENDED DECEMBER 31, 1997 1996 1995 - ----------------------------------------------------------------------------------------------------------- Thousands of dollars, except per share amounts Revenues: Sales of products $ 8,392 $ 13,954 $ 16,195 Services 2,434 2,640 2,446 - ----------------------------------------------------------------------------------------------------------- Total revenues 10,826 16,594 18,641 - ----------------------------------------------------------------------------------------------------------- Costs of revenues: Cost of sales of products 7,804 11,342 15,705 Cost of services 1,843 1,811 1,751 Write-offs and write-downs of lottery service agreements -- 2,793 2,807 - ----------------------------------------------------------------------------------------------------------- Total costs of revenues 9,647 15,946 20,263 - ----------------------------------------------------------------------------------------------------------- Gross profit 1,179 648 (1,622) Engineering, research and development 1,684 1,662 1,360 Selling, general and administrative 6,195 5,880 11,239 - ----------------------------------------------------------------------------------------------------------- Loss from operations (6,700) (6,894) (14,221) Other income: Interest income, net 135 173 352 Exchange rate loss (150) -- -- Gain on sale of subsidiary and lottery service agreement 857 1,315 -- - ----------------------------------------------------------------------------------------------------------- Loss before provision for income taxes (5,858) (5,406) (13,869) Provision for income taxes 80 92 -- - ----------------------------------------------------------------------------------------------------------- Net loss $ (5,938) $ (5,498) $(13,869) - ----------------------------------------------------------------------------------------------------------- Net loss per share - Basic and diluted $ (0.33) $ (0.31) $ (0.83) - ----------------------------------------------------------------------------------------------------------- Shares used in determination of net loss per share - Basic and diluted 18,021 17,465 16,812 - -----------------------------------------------------------------------------------------------------------
See accompanying notes. 11 13 CONSOLIDATED BALANCE SHEETS
AS OF DECEMBER 31, 1997 1996 - -------------------------------------------------------------------------------------------------------------------- Thousands of dollars, except share amounts Assets Current Assets: Cash and cash equivalents $ 2,371 $ 5,387 Accounts receivable, net of allowance for doubtful accounts of $173 ($111 in 1996) 1,040 979 Costs and estimated earnings in excess of billings on uncompleted contracts 1,716 2,452 Inventories, at lower of cost (first-in, first-out method) or market: Finished goods -- -- Work in process 1,151 283 Raw materials 1,393 2,735 - -------------------------------------------------------------------------------------------------------------------- Total inventories 2,544 3,018 Other current assets 111 142 - -------------------------------------------------------------------------------------------------------------------- Total current assets 7,782 11,978 - -------------------------------------------------------------------------------------------------------------------- Equipment, furniture and fixtures at cost, less accumulated depreciation of $4,078 ($3,737 in 1996) 802 1,128 Computer software costs, less accumulated amortization of $1,983 ($1,420 in 1996) -- 688 Other 78 89 - -------------------------------------------------------------------------------------------------------------------- Total assets $ 8,662 $ 13,883 - -------------------------------------------------------------------------------------------------------------------- Liabilities and Shareholders' Equity Current Liabilities: Accounts payable $ 575 $ 491 Billings in excess of costs and estimated earnings on uncompleted contracts 386 161 Accrued payroll and related taxes 839 893 Accrued litigation settlement -- 1,680 Related party liability 146 366 Other current liabilities 2,624 1,773 - -------------------------------------------------------------------------------------------------------------------- Total current liabilities 4,570 5,364 - -------------------------------------------------------------------------------------------------------------------- Commitments and contingencies Shareholders' equity: Common shares; no par value, 50,000,000 shares authorized; 18,027,548 shares issued and outstanding (17,176,211 in 1996) 51,103 49,407 Retained deficit (46,659) (40,721) Foreign currency translation adjustment (352) (167) - -------------------------------------------------------------------------------------------------------------------- Total shareholders' equity 4,092 8,519 - -------------------------------------------------------------------------------------------------------------------- Total liabilities and shareholders' equity $ 8,662 $ 13,883 - --------------------------------------------------------------------------------------------------------------------
See accompanying notes. 12 14 CONSOLIDATED STATEMENTS OF CASH FLOWS
THOUSANDS OF DOLLARS 1997 1996 1995 - --------------------------------------------------------------------------------------------------------------------------------- Years Ended December 31, Cash flows from operating activities: Net loss $(5,938) $(5,498) $(13,869) Adjustments to reconcile net loss to net cash provided by (used for) operating activities: Depreciation and amortization 1,107 601 1,061 Gain on sale of subsidiaries and lottery service operations 857 (1,315) -- Adjustment in value of stock issued as settlement of litigation -- (1,200) -- Write-offs and write-downs of lottery service agreements -- 2,793 2,807 Changes in operating assets and liabilities: Accounts receivable (61) 609 810 Costs and estimated earnings in excess of billings on uncompleted contracts 736 1,213 (283) Inventories 474 3,802 3,679 Accounts payable 85 260 (678) Billings in excess of costs and estimated earnings on uncompleted contracts 225 46 (853) Accrued payroll and related taxes (54) (56) 354 Related party liability -- 366 -- Accrued litigation settlement -- (600) 4,200 Other (139) (560) 572 - --------------------------------------------------------------------------------------------------------------------------------- Net cash provided by (used for) operating activities (2,708) 461 (2,200) - --------------------------------------------------------------------------------------------------------------------------------- Cash flows from investing activities: Investment in lottery service agreements -- (34) (4,044) Lottery service agreement sale proceeds and repayment of advances -- 962 651 Other non-current assets 11 (37) -- Additions to equipment (150) (283) (250) Additions to computer software costs -- (211) (67) Proceeds from sale of subsidiary -- 740 525 - --------------------------------------------------------------------------------------------------------------------------------- Net cash provided by (used for) investing activities (139) 1,137 (3,185) - --------------------------------------------------------------------------------------------------------------------------------- Cash flows from financing activities: Payments on notes payable -- -- (300) Proceeds from issuance of common shares and warrants 16 -- 23 - --------------------------------------------------------------------------------------------------------------------------------- Net cash provided by (used for) financing activities 16 -- (277) - --------------------------------------------------------------------------------------------------------------------------------- Effect of exchange rate changes on cash (185) (115) 99 - --------------------------------------------------------------------------------------------------------------------------------- Increase (decrease) in cash and cash equivalents (3,016) 1,483 (5,563) - --------------------------------------------------------------------------------------------------------------------------------- Cash and cash equivalents, beginning of year 5,387 3,904 9,467 - --------------------------------------------------------------------------------------------------------------------------------- Cash and cash equivalents, end of year $ 2,371 $ 5,387 $ 3,904 - --------------------------------------------------------------------------------------------------------------------------------- Supplemental cash flow information: Cash paid during the year for interest $ 9 $ 20 $ 46 - --------------------------------------------------------------------------------------------------------------------------------- Cash paid during the year for income taxes $ 98 $ 46 $ 7 - ---------------------------------------------------------------------------------------------------------------------------------
See accompanying notes. 13 15 CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY
FOREIGN COMMON STOCK CURRENCY ---------------------- RETAINED TRANSLATION SHARES AMOUNT DEFICIT ADJUSTMENT TOTAL - ------------------------------------------------------------------------------------------------------------------------------------ Thousands of shares/dollars Balance at December 31, 1994 16,804 $48,650 $(21,354) $(151) $ 27,145 - ------------------------------------------------------------------------------------------------------------------------------------ Proceeds from exercise of stock options 12 23 -- -- 23 Accelerated vesting of stock options for terminated employees -- 14 -- -- 14 Foreign currency translation adjustment -- -- -- 99 99 Net loss - 1995 -- -- (13,869) -- (13,869) - ------------------------------------------------------------------------------------------------------------------------------------ Balance at December 31, 1995 16,816 48,687 (35,223) (52) 13,412 - ------------------------------------------------------------------------------------------------------------------------------------ Issuance of shares in settlement of shareholders' lawsuit 360 720 -- -- 720 Foreign currency translation adjustment -- -- -- (115) (115) Net loss - 1996 -- -- (5,498) -- (5,498) - ------------------------------------------------------------------------------------------------------------------------------------ Balance at December 31, 1996 17,176 49,407 (40,721) (167) 8,519 - ------------------------------------------------------------------------------------------------------------------------------------ Proceeds from exercise of stock options 12 16 -- -- 16 Issuance of shares in settlement of shareholders' lawsuit 840 1,680 -- -- 1,680 Foreign currency translation adjustment -- -- -- (185) (185) Net loss - 1997 -- -- (5,938) -- (5,938) - ------------------------------------------------------------------------------------------------------------------------------------ Balance at December 31, 1997 18,028 $51,103 ($46,659) ($352) $ 4,092 - ------------------------------------------------------------------------------------------------------------------------------------
See accompanying notes. 14 16 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS 1. OPERATIONS AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES International Lottery & Totalizator Systems, Inc. ("the Company") provides computerized, on-line wagering systems including system software, betting terminals, data communications, consulting, training, facilities management and maintenance support to the worldwide wagering market. The principle applications for the Company's products are in the automated pari-mutuel (horse racing) wagering and on-line government sponsored lotteries. The Company has developed several models of DATAMARK(R) terminals for specific wagering applications. All are microprocessor based and have a lightweight, compact design. The most recent models, the DATAMARK(R) Flipper and DATAMARK XClaim feature PC compatible architecture which provides greater flexibility for future enhancements such as smart card readers and POS displays. Many models offer industry unique features such as reading two-sided bet slips, printing on the back of a bet slip and batch feeding of up to 50 customer marked bet slips. ILTS is recognized as a world leader in providing computerized, on-line wagering systems to the racing industry. The Company's pari-mutual wagering system, ILTS InterTote, is designed to run on the Unix operating system, an open systems architecture which permits the use of virtually any Unix hardware platform. The system can be scaled to efficiently serve either small tracks with just a few betting stations, or large installations of more than a thousand terminals. This open approach provides a system that can be cost configured to meet specific current needs while providing a built-in expansion path to meet future requirements. The ILTS DataTrak on-line gaming system is the product of more than a decade of development and refinement of on-line lottery transaction processing experience. It was designed to support a large terminal base and to handle virtually any required transaction volume with ease. It retains all the speed, security and reliability of a proven transaction processing system and extensive game library, while offering the increased flexibility of interfacing with a variety of information management solutions and standard software development tools in one fully integrated system. The Company's consolidated financial statements for the year ended December 31, 1997 have been prepared on a continuing operations basis which contemplates the realization of assets and the settlement of liabilities and commitments in the normal course of business. The Company has incurred net losses of $13.9 million, $5.5 million and $5.9 million in 1995, 1996 and 1997, respectively, while revenues have decreased from $18.6 in 1995 to $10.8 million in 1997. The Company is largely dependent upon significant contracts for its revenue, which typically include a deposit upon contract signing and up to 3 months lead-time before delivery of hardware begins. As of December 31, 1997, the Company had a backlog (unaudited) of $5.0 million compared to backlogs (unaudited) of $1.7 million and $9.2 million in 1996 and 1995, respectively. At December 31, 1997, the Company had working capital of $3.2 million. Management recognizes that the Company must recover its investment in existing contracts (Note 3) and generate additional contract sales to maintain its current level of operations. Additionally, management is currently seeking additional sources of funding through debt or equity financing and consideration of other business transactions which would generate sufficient resources to assure continuation of the Company's operations. Management anticipates that it will be successful in recovering its investment in existing contracts (Note 3) and obtaining sufficient contracts to enable the Company to continue normal operations; however, no assurances can be given that the Company will be successful in realizing sufficient new contract revenues or obtaining additional financing. If the Company is unable to recover its investment in existing contracts, obtain sufficient new contract revenue or financing, management will be required to reduce the Company's operations. On February 27, 1998, the Company's largest shareholder, Berjaya Lottery Management (Berjaya), agreed to provide financial support, if and when necessary, to ensure the Company's operations continue for at least one year from December 31, 1997. The Company's ability to continue its ongoing operations on a long-term basis is dependent upon its ability to recover its investment in existing contracts, to obtain additional financing, secure additional new contracts and ultimately achieve a sustainable level of profit from operations. PRINCIPLES OF CONSOLIDATION - The accompanying consolidating financial statements include the accounts of the Company and its subsidiaries, all of which are wholly-owned. All significant intercompany accounts and transactions are eliminated in consolidation. REVENUE RECOGNITION - The Company recognizes long-term contract revenue on the percentage-of-completion method, based on contract costs incurred to date compared to total estimated contract costs. The effects of changes in contract cost estimates are recognized in the period they are determined. Estimated contract losses are fully charged to operations when identified. Revenues relating to the sale of certain assets, when the ultimate total collection is not reasonably assured, are being recorded under the cost recovery method. All other revenue is recorded on the basis of shipments of products or performance of services. USE OF ESTIMATES - The preparation of financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates. DEPRECIATION - Depreciation of equipment, furniture and fixtures is provided principally using the straight-line method over estimated useful lives of 3 - 7 years. COMPUTER SOFTWARE COSTS - The Company has capitalized the costs of computer software incurred in the development of specific products, after technological feasibility has been established. The capitalized software costs are amortized using the greater of the amount computed using the ratio of current product revenue to estimated total product revenue or the straight-line method over the remaining estimated economic lives of the products (3 years). Amortization expense totaled $688 thousand, $89 thousand and $510 thousand for the years ended December 31, 1997, 1996 and 1995, respectively. In 1997, the Company determined that software which had been capitalized in prior years had become impaired, and accordingly, took a charge for the remaining asset value of $457 thousand. RECENT ACCOUNTING PRONOUNCEMENTS - In June 1997, the Financial Accounting Standards Board issued SFAS No. 130, "Reporting Comprehensive Income," and SFAS No. 131, "Disclosure about Segments of an Enterprise and Related Information." SFAS No. 130 establishes 15 17 standards for reporting of comprehensive income and its components in a full set of general-purpose financial statements. SFAS No. 131 requires reporting certain information about operating segments in annual and interim period financial statements. Both standards were required to be adopted beginning January 1, 1998. The adoption of these standards is not expected to have a material effect on the Company's financial position or results of operations. WARRANTY RESERVES - Estimated expenses for warranty obligations are accrued as income is recognized on related contracts. The reserves are adjusted periodically to reflect actual experience. FOREIGN CURRENCY - The Company has contracts with certain customers that are denominated in foreign currencies, and related transaction gains and losses are recognized as a component of current operations. The consolidated accounts of the Company's Australian subsidiary have been translated from its functional currency, the Australian dollar. The effect of the exchange rate fluctuations between the U.S. dollar and the Australian dollar is recorded as a separate component of shareholders' equity. The Company's other foreign subsidiary uses the U.S. dollar as its functional currency and, accordingly, related translation gains and losses are recognized in current operations. PER SHARE INFORMATION - Net loss per share is based on the weighted average number of shares outstanding during the year. The 1996 computation includes 840 thousand shares of common stock which were issued in 1997, pursuant to a class action lawsuit settlement rendered by the court on June 17, 1996. In 1997, the Company adopted SFAS No. 128 "Earnings Per Share," which requires companies to present basic and diluted earnings per share. There was no impact to earnings per share from the adoption of SFAS No.128 due to the Company's net loss position. RESEARCH AND DEVELOPMENT - Engineering, research and development costs are expensed as incurred. Substantially all engineering, research and development expenses are related to new product development and designing significant improvements. CONCENTRATION OF CREDIT RISK - Accounts receivable and costs and estimated earnings in excess of billings on uncompleted contracts are primarily related to contracts with a few major customers. These amounts are payable in accordance with the terms of individual contracts and generally collateral is not required. Estimated credit losses are provided for in the financial statements. The Company conducts business in the Asia/Pacific region. Certain Asian countries are currently experiencing severe economic turmoil represented by depressed business conditions and volatility in local currencies. Any significant further decline in these economies and in the value of their currencies could have a material adverse effect on the Company. CASH AND CASH EQUIVALENTS - The Company considers all highly liquid investments with a maturity of three months or less when purchased to be cash equivalents. Included in cash and cash equivalents at December 31, 1997 and 1996 are investments in commercial paper totaling $1.0 and $2.3 million, respectively, which mature in January 1998 and January 1997, respectively. The estimated fair value of these investments approximate the amortized cost; therefore, there are no unrealized gains or losses as of December 31, 1997 or 1996. STOCK OPTIONS - As permitted, the Company has elected the disclosure only provisions of SFAS No. 123. Accordingly, the Company continues to follow Accounting Principles Board Opinion No. 25 "Accounting for Stock Issued to Employees" (APB 25) and related interpretations in accounting for its employee stock options. Under APB 25, because the exercise price of the Company's stock options equals the market price of the underlying stock on the date of grant, no compensation expense is recognized. MAJOR CUSTOMERS - During 1997 approximately $7.4 million or 69% of the Company's revenues were derived from five customers. In 1996 and 1995 the amounts were $11.7 million or 70% from 5 customers and $13.1 million or 70% from 6 customers, respectively. RECLASSIFICATIONS - Certain prior year balances have been reclassified to conform with the 1997 presentation. 2. RELATED PARTY TRANSACTIONS The Company has entered into sales agreements to supply terminals, spares and services to entities in which the Company's largest shareholder, Berjaya Lottery Management (Berjaya), has a significant equity interest. Revenues related to these agreements totaled $0.8 million, $2.0 million and $3.5 million in 1997, 1996 and 1995, respectively. Included in accounts receivable and costs and estimated earnings in excess of billings on uncompleted contracts were $0.2 million and $0.5 million at December 31, 1997 and 1996 respectively, relating to these customers. During 1996 the Company entered into an agreement with Berjaya to purchase specific inventory on behalf of Berjaya to enable the Company to satisfy certain future potential orders in a timely manner. Title to the inventory purchased resides with Berjaya; therefore, no amounts are reflected in the consolidated balance sheet for inventory purchased on their behalf. Advances received in excess of inventory purchased aggregated approximately $146 thousand and $366 thousand and have been reflected as a related party liability in the accompanying consolidated balance sheet as of December 31, 1997 and 1996, respectively. 3. CONTRACTS IN PROCESS The amounts by which total costs and estimated earnings exceeded or were less than billings on uncompleted contracts are as follows (in thousands):
YEARS ENDED DECEMBER 31, 1997 1996 - ----------------------------------------------------------------------------------------------------------------- Costs incurred $9,696 $13,449 Estimated earnings 1,666 1,745 ----- ----- 11,362 15,194 Less: billings (10,032) (12,903) ------- ------- $1,330 $2,291 ====== ====== Included in the accompanying consolidated balance sheets as follows: Costs and estimated earnings in excess of billings on uncompleted contracts $1,716 $2,452 Billings in excess of costs and estimated earnings on uncompleted contracts (386) (161) ---- ---- $1,330 $2,291 ====== ======
16 18 4. LOTTERY SERVICE AGREEMENTS The Company entered into contracts to provide lottery equipment and management of on-line lottery systems on a long-term basis in Papua New Guinea in 1992, the Russian Federation in 1993 and entered into a contract to provide lottery equipment in the United Kingdom in 1995. The Company committed lottery equipment costing approximately $2.8 million to its United Kingdom lottery service agreement in 1995. The Company agreed to provide a complete lottery system for a percentage of lottery revenues. In September 1996, it became apparent that an affiliate of the customer was unable to obtain the additional funding necessary for the project start-up and ongoing operations, and the Company recorded a $2.8 million charge to reflect a reserve for the project. The amount of the charge approximates the Company's tangible investment, previously carried on the balance sheet as "Investment in Lottery Service Contracts." The Company recovered part of its U.K. investment in 1997 through a sale of a system and terminals to Olympic Gold for $2.6 million. The Papua New Guinea lottery commenced operation in March 1993. In July 1995, the Company sold all interests in the Papua New Guinea lottery operation to the principal shareholders of the lottery licensee, for $175 thousand in cash and a note of $1.3 million to be paid in monthly installments of approximately $79 thousand per month for a period of 17 months commencing in September 1995. Additionally, the Company will receive a percentage of the annual gross lottery sales or an annual sum of $260 thousand, whichever is greater, for a period of five years, provided that the additional sums shall not exceed $3.0 million. The Company is accounting for the sale under the cost recovery method. The installment payments and the minimum percentage payments are secured by all lottery assets and certain personal guarantees. During 1997, the Company recognized approximately $419 thousand as a gain on the sale of the lottery service agreement. The amount reflects the aggregate amount of payments received under the sale agreement in excess of the Company's carrying amount of its investment in the lottery service agreement on the date of the sale. Under the cost recovery method, no amount of gain on the sale was recognized until the net investment in the lottery service agreement on the date of sale was recovered in 1996. At December 31, 1997, the Company has no investment remaining on its balance sheet as the proceeds from the sale have exceeded the net book value. Due to uncertainties which arose in November 1994 regarding the Russian lottery license process and the continued economic, political and legal instability in Russia, the Company recorded a provision of $7.6 million to write down the assets to estimated net realizable value with respect to the Russian lottery investment. Subsequently, the Company terminated its Russian lottery project in November 1995. In 1995, the Company incurred $2.8 million in costs toward its Russian lottery project, including the write-off of costs related to a reduction in its Russian work force and future costs to liquidate the operation. 5. INDUSTRY SEGMENT AND GEOGRAPHICAL DATA The Company operates in one industry segment which includes totalizator and lottery systems. The Company has an Australian subsidiary, International Lottery & Totalizator Systems Australia Pty., Ltd., and a United Kingdom subsidiary, International Lottery & Totalizator Systems (U.K.) Ltd. Sales between geographic areas are generally priced to recover material costs plus an appropriate markup. Revenue by major customers is as follows (in thousands):
CUSTOMER LOCATION 1997 1996 1995 - ----------------------------------------------------------- Ukraine $ 2,600 $ -- $ -- Malaysia 2,000 -- 2,300 Australia* 1,700 2,000 4,400 Sweden 1,400 4,300 2,700 Hong Kong 400 2,400 600 Philippines 400 900 2,900 All other 2,300 7,000 5,700 ------- ------- ------- Total $10,800 $16,600 $18,600 ======= ======= =======
* Different customer in 1995 as compared to 1997 and 1996. 17 19 The following table summarizes information about the Company's operations in different geographic areas for the years ended December 31, 1997, 1996 and 1995 (in thousands).
YEARS ENDED DECEMBER 31, 1997 1996 -------------------------------------------------------------------------------------------------------- EASTERN EASTERN EUROPE/ CONSOLI- EUROPE/ CONSOLI- USA PACIFIC EUROPE DATED USA PACIFIC EUROPE DATED - ------------------------------------------------------------------------------------------------------------------------------------ Sales to unaffiliated customers: Export $ 7,750 -- -- $ 7,750 $ 11,313 -- -- $ 11,313 Domestic 643 2,123 310 3,076 293 4,482 506 5,281 - ------------------------------------------------------------------------------------------------------------------------------------ Sales to: Australia subsidiary 557 -- -- 557 1,738 -- -- 1,738 - ------------------------------------------------------------------------------------------------------------------------------------ 8,950 2,123 310 11,383 13,344 4,482 506 18,332 - ------------------------------------------------------------------------------------------------------------------------------------ Elimination of inter- company sales (557) -- -- (557) (1,738) -- -- (1,738) - ------------------------------------------------------------------------------------------------------------------------------------ Total revenue 8,393 2,123 310 10,826 11,606 4,482 506 16,594 - ------------------------------------------------------------------------------------------------------------------------------------ Write-offs and write- downs of lottery service agreements -- -- -- -- (2,793) -- -- (2,793) - ------------------------------------------------------------------------------------------------------------------------------------ Net income (loss) $(5,709) $ (206) $ (22) $ (5,938) $ (5,865) $ 476 $ (109) $ (5,498) - ------------------------------------------------------------------------------------------------------------------------------------ Identifiable assets $ 7,272 $ 1,356 $ 34 $ 8,662 $ 11,638 $2,096 $ 149 $ 13,883 - ------------------------------------------------------------------------------------------------------------------------------------
YEARS ENDED DECEMBER 31, 1995 ----------------------------------------------------- EASTERN EUROPE/ CONSOLI- USA PACIFIC EUROPE DATED - --------------------------------------------------------------------------------- Sales to unaffiliated customers: Export $ 15,006 -- -- $ 15,006 Domestic 513 2,614 508 3,635 - --------------------------------------------------------------------------------- Sales to: Australia subsidiary 508 -- -- 508 - --------------------------------------------------------------------------------- 16,027 2,614 508 19,149 - --------------------------------------------------------------------------------- Elimination of inter- company sales (508) -- -- (508) - --------------------------------------------------------------------------------- Total revenue 15,519 2,614 508 18,641 - --------------------------------------------------------------------------------- Write-offs and write- downs of lottery service agreements -- -- (2,807) (2,807) - --------------------------------------------------------------------------------- Net income (loss) $(13,561) $ (76) $ (232) $(13,869) - --------------------------------------------------------------------------------- Identifiable assets $ 19,572 $ 1,478 $ 302 $ 21,352 - ---------------------------------------------------------------------------------
6. LEASES The Company leases its facilities under operating lease agreements which expire at various dates through October 2001. Certain lease agreements provide for increases in minimum annual rent based on increases in various market indices. Also, the Company has the option to renew the lease on its U.S. facility for one additional ten-year term. Rent expense for the years ended December 31, 1997, 1996, and 1995 was $595 thousand, $605 thousand and $674 thousand, respectively. Minimum future obligations for these leases are as follows (in thousands): 1998 - $634; 1999 - $606; 2000 - $365; 2001 - $79. 7. INCOME TAXES The provision for income taxes of $80 thousand in 1997 and $92 thousand in 1996 primarily relates to income earned by the Company's Australian subsidiary. The following is a reconciliation of the actual tax provision to the expected tax benefit computed by applying the statutory federal income tax rate to the loss before provision for income taxes (in thousands):
YEARS ENDED DECEMBER 31, 1997 1996 1995 - ------------------------------------------------------------------------------------------------- Expected federal income tax benefit at statutory rate $(1,932) $(1,892) $(4,715) U.S. and foreign net operating losses - no benefit 1,932 1,892 4,715 Other, net 79 92 -- Provision for income taxes $ 79 $ 92 -- - -------------------------------------------------------------------------------------------------
Deferred income taxes reflect the net tax effects of temporary differences between the carrying amounts of assets and liabilities for financial reporting purposes and amounts used for income tax purposes. The components of the Company's deferred tax liabilities and assets are as follows (in thousands):
DECEMBER 31, 1997 1996 - ---------------------------------------------------------------------------------------- Deferred tax liabilities: Computer software costs $ 310 $ 310 - ---------------------------------------------------------------------------------------- Total deferred tax liabilities 310 310 - ---------------------------------------------------------------------------------------- Deferred tax assets: Installment sale PNG 1,152 1,209 Reserves against investment in lottery service agreements 1,203 1,401 Reserves and accruals 2,151 1,514 Rent expense 115 177 Employee benefits 69 88 Patent expense 28 31 Net operating loss and credit carryforwards 19,120 17,589 Other 131 29 - ---------------------------------------------------------------------------------------- Total deferred tax assets 23,969 22,038 - ---------------------------------------------------------------------------------------- Net deferred tax assets 23,660 21,728 Valuation allowance (23,660) (21,728) - ---------------------------------------------------------------------------------------- Net deferred taxes $ 0 $ 0 - ----------------------------------------------------------------------------------------
18 20 The Company has Federal and California net operating losses of approximately $51 million and $22 million, respectively, which will begin to expire in 2008 and 1998, respectively, unless previously utilized. The difference between the Federal and California net operating loss carryforwards relates primarily to California's statutory 50% annual reduction rule. The Company also has Federal general business credit carryforwards of approximately of $588 thousand, which begin to expire in 2002. Pursuant to the Tax Reform Act of 1986, use of the Company's business credit and net operating loss carryforwards may be limited if a cumulative change in ownership of more than 50% occurs within any three-year period. 8. EMPLOYEE STOCK BONUS PLAN The Company has an employee stock bonus plan, commonly referred to as a 401(k) plan, qualified under the Internal Revenue Code, in which all eligible employees, as defined in the Internal Revenue Code, may elect to participate. Under the Plan, employees may voluntarily make tax-deferred contributions of up to 15% of their compensation to a trust which provides the participant with various investment alternatives. In addition, the Company, at the discretion of the Board of Directors, may contribute an amount of Company stock for each fiscal year which does not exceed 5% of the annual compensation of all participants in the Plan. Company contributions charged to operations were $82 thousand, $82 thousand and $198 thousand in 1997, 1996 and 1995, respectively. 9. STOCK OPTION PLANS The Company has three current employee stock option plans and a directors option plan whereby options to purchase 2.7 million and 400 thousand shares, respectively, of the Company's common stock may be granted. Options granted have 5-to-10 year terms that vest and become fully exercisable 4 to 5 years from the date of grant. Pro forma information regarding net loss and net loss per share is required by SFAS No. 123, and has been determined as if the Company has accounted for its employee stock options under the fair value method of SFAS No. 123. The fair value of these options was estimated at the date of grant using the Black-Scholes option pricing model with the following weighted average assumptions for 1997 and 1996, respectively: risk-free interest rates of 5.3% - 5.9% and 5.4% - 6.0%, respectively; dividend yields of 0% in both 1997 and 1996; volatility factors of the expected market price of the Company's common stock of 1.2 for both 1997 and 1996; and a weighted-average life of the option of 7.21 years for both 1997 and 1996. The Black-Scholes option valuation model was developed for use in estimating the fair value of traded options which have no vesting restrictions and are fully transferable. In addition, option valuation models require the input of highly subjective assumptions including the expected stock price volatility. Because the Company's employee stock options have characteristics significantly different from those of traded options, and because changes in the subjective input assumptions can materially affect the fair value estimate, in management's opinion, the existing models do not necessarily provide a reliable single measure of the fair value of its employee stock options. For purposes of pro forma disclosures, the estimated fair value of the options is amortized to expense over the options' vesting period. The effects of applying SFAS No. 123 for pro forma disclosure purposes are not likely to be representative of the effects on pro forma net loss in future years because it does not take into consideration pro forma compensation expense related to grants made prior to 1995. The Company's pro forma information follows (in thousands, except per share amounts):
1997 1996 Pro forma net loss $ (6,204) $ (5,645) - -------------------------------------------------------- Pro forma loss per share $ (0.34) $ (0.32)
A summary of the Company's stock option activity, and related information for the years ended December 31 follows (options in thousands):
- ----------------------------------------------------------------------------------------------------------------------- YEARS ENDED DECEMBER 31, 1997 1996 1995 Weighted- Weighted- Weighted- Average Average Average Exercise Exercise Exercise Options Price Options Price Options Price - ----------------------------------------------------------------------------------------------------------------------- Outstanding - beginning of year 1,501 $ 5.74 1,325 $ 7.28 1,351 $ 7.50 Granted 480 $ 1.33 320 $ 1.22 75 $ 2.28 Exercised (11) $ 1.38 -- -- (12) $ 1.87 Cancelled (491) $ 6.09 (144) $ 9.86 (89) $ 7.16 - ----------------------------------------------------------------------------------------------------------------------- Outstanding - end of year 1,479 $ 4.13 1,501 $ 5.74 1,325 $ 7.28 - ----------------------------------------------------------------------------------------------------------------------- Exercisable at end of year 857 $ 6.22 1,007 $ 6.95 931 $ 7.35 - ----------------------------------------------------------------------------------------------------------------------- Weighted-average fair value of options granted during the year $ 1.33 $ 1.22 $ 2.28 - -----------------------------------------------------------------------------------------------------------------------
Exercise prices for options outstanding as of December 31, 1997 ranged from $1.03 to $15.75. The weighted-average remaining contractual life of those options is approximately 6 years. 19 21 At December 31, 1997, options for 1,225,332 shares were available for future grant. The following table summarizes information about stock options at December 31, 1997 (shares in thousands):
OUTSTANDING STOCK OPTIONS EXERCISABLE STOCK OPTIONS - ----------------------------------------------------------------------------------------------------------------- WEIGHTED- WEIGHTED- WEIGHTED- AVERAGE AVERAGE AVERAGE REMAINING EXERCISE EXERCISE SHARES CONTRACTUAL LIFE PRICE SHARES PRICE RANGE OF EXERCISE PRICES $1.0310 to $1.2813 398 8.50 years $1.1857 58 $1.0311 $1.2815 to $1.5620 320 6.79 years $1.4218 69 $1.4141 $2.2188 to $3.0000 357 3.07 years $2.6591 336 $2.6383 $3.6250 to $11.500 249 3.55 years $7.7494 239 $7.7076 $15.7500 to $15.7500 155 3.12 years $15.7500 155 $15.7500 - -----------------------------------------------------------------------------------------------------------------
10. SALE OF SUBSIDIARY On March 31, 1993, the Company sold its subsidiary, McKinnie & Associates, Inc. to Shreveport Acquisition for cash and a note. During 1997, the Company negotiated and received a final settlement of the remaining balance due on the note and recorded a gain of $438 thousand from receipts during the year. 11. LITIGATION In 1994, shareholders of the Company filed class action lawsuits against the Company and several of its officers and directors. Those actions were consolidated in the United States District Court for the Southern District of California. Plaintiffs contended that during the class period (June 22, 1993 through June 21, 1994) the Company and the individual defendants made a series of public statements that failed to disclose adverse information about the Company's lottery service contracts, that these purported nondisclosures artificially inflated the price of the Company's stock, and that those purchasers who acquired their shares in reliance on the integrity of the market suffered damages as a result. On June 17, 1996, the court entered a judgment of a cash payment to the class shareholders and 1.2 million shares of authorized but unissued common stock of the Company, of which, 360 thousand shares were issued in September 1996 and 840 thousand shares were issued in 1997. Such shares were included in the calculation of earnings per share for the year ended December 31, 1996. The estimated settlement was accrued as of September 30, 1995 and an adjustment of approximately $1.2 million was recorded during the three months ended June 30, 1996 to reduce the accrual to the actual settlement amount, valued as of the judgment date. In November, 1995, Mr. James Walters, the former chairman and president of the Company, filed an action in the San Diego County Superior Court against the Company, its then current president, Frederick A. Brunn, a publishing company and an author alleging that certain statements in a magazine article were slander per se by ILTS and Brunn and libel by the publishing company and the author, and that Mr. Walters suffered an invasion of privacy by all defendants. In addition, Walters alleged that erroneous information in the Company's 1995 Proxy Statement resulted in two other magazine articles publishing allegedly incorrect information. Mr. Walters seeks general and special damages of $9 million and punitive damages. On November 1, 1996, the San Diego County Superior Court entered a summary judgment in favor of the Company. Mr. Walters has filed an appeal with the California appellate court. Management, based on the advice of counsel, believes that the outcome of this case will not result in any liability to the Company. Accordingly, no provision for any liability that may result has been included in the consolidated financial statements. The Company is also subject to other legal proceedings and claims that arise in the normal course of business. While the outcome of these proceedings and claims cannot be predicted with certainty, management does not believe that the outcome of any of these matters will have a material adverse effect on the Company's consolidated financial position or results of operations. 20 22 REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS TO THE BOARD OF DIRECTORS AND SHAREHOLDERS OF INTERNATIONAL LOTTERY & TOTALIZATOR SYSTEMS, INC. We have audited the accompanying consolidated balance sheet of International Lottery & Totalizator Systems, Inc. (a California corporation) and subsidiaries as of December 31, 1997 and the related consolidated statements of operations, shareholders' equity and cash flows for the year then ended. These financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements based on our audit. The consolidated balance sheet as of December 31, 1996, and the related consolidated statements of operations, shareholders' equity and cash flows for each of the two years in the period ended December 31, 1996, were audited by other accountants whose report, dated February 21, 1997, expressed an unqualified opinion on those statements. We conducted our audit in accordance with generally accepted auditing standards. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatements. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audit provides a reasonable basis for our opinion. In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of International Lottery & Totalizator Systems, Inc. and subsidiaries as of December 31, 1997, and the results of their operations and their cash flows for the year then ended, in conformity with generally accepted accounting principles. ARTHUR ANDERSEN LLP San Diego, California February 18, 1998 21 23 CORPORATE AND COMMON SHARE INFORMATION DIRECTORS Theodore A. Johnson Chairman of the Board Frederick A. Brunn Chan Kien Sing Group Executive Director Berjaya Group Berhad M. Mark Michalko President Ng Aik Chin Executive Assistant to the President Ng Foo Leong Executive Director, Sports Toto Malaysia Martin J. O'Meara Jr. President, The Budget Plan, Inc. Lord Michael G.R. Sandberg Private Investor OFFICERS [PHOTO] M. Mark Michalko President [PHOTO] Timothy R. Groth Vice President Technical Operations [PHOTO] Dennis D. Klahn Chief Financial Officer [PHOTO] Ng Aik Chin Executive Assistant to the President [PHOTO] Robert F. McPhail Vice President International Marketing MARKET FOR COMMON STOCK The Company's Common Stock is traded under the symbol ITSI on the NASDAQ National Market system. As of December 31, 1997, there were 18,027,548 common shares outstanding and 2,385 shareholders of record. Berjaya Lottery Management owned 36.6% of the total outstanding shares and the Company's management owned 1%. 1997 HIGH LOW First Quarter 1 38/64 5/8 Second Quarter 2 5/16 25/32 Third Quarter 2 1/4 1 3/16 Fourth Quarter 1 15/16 13/16 Average Daily Volume 60,836 Total Annual Trading Volume 16,060,597 1996 HIGH LOW First Quarter 1 25/32 1 1/16 Second Quarter 3 3/16 1 1/16 Third Quarter 2 1/2 1 1/8 Fourth Quarter 1 5/16 25/32 Average Daily Volume 42,045 Total Annual Trading Volume 10,679,305 DIVIDEND POLICY The Company retains earnings to support operations. FORM 10-K A Copy of Form 10-K as filed with the Securities and Exchange Commission can be obtained by contacting: Investor Relations ILTS 2131 Faraday Avenue Carlsbad, CA 92008-7297 USA (760) 931-4000 ANNUAL MEETING OF SHAREHOLDERS The 1998 Annual Meeting will be held at 3:00 p.m. PDT on Monday, May 18, 1998, at La Costa Resort and Spa, Costa Del Mar Road, Carlsbad, California, (760) 438-9111. Shareholders and interested parties are invited to attend. TRANSFER AGENT AND REGISTRAR ChaseMellon Shareholder Services 85 Challenger Road Ridgefield Park, New Jersey USA 1-800-522-6645 (231) 553-9719 (213) 553-9735 Fax LEGAL COUNSEL Lawrence E. Logue General Counsel ILTS 2131 Faraday Avenue Carlsbad, CA 92008-7297 USA (760) 931-4000 INDEPENDENT AUDITORS Arthur Andersen LLP 701 West Broadway, Suite 1600 San Diego, CA 92101-8195 USA (619) 699-6600 INVESTOR RELATIONS ILTS 2131 Faraday Avenue Carlsbad, CA 92008-7297 USA (760) 931-4000 To receive Company information via facsimile, call the Investor Relations Hotline: 1-800-859-5903. 24 HEADQUARTERS International Lottery & Totalizator Systems, Inc. 2131 Faraday Avenue Carlsbad, CA 92008-7297 USA (760) 931-4000 (760) 931-1789 Fax TECHNICAL AND MARKETING/SALES SUPPORT FACILITIES AUSTRALIA International Lottery & Totalizator Systems Australia Pty. Ltd. Unit 1A, 167 Prospect Highway Seven Hills, New South Wales 2147 Australia (61) (2) 9624-4300 (61) (2) 9674-6832 Fax [GRAPHIC] SALES OFFICES Asia/Pacific Sales Office Christina Bldg. Unit 304 Herrera Corner Legaspi Sts. Legaspi Village, Makati, Philippines (63) (2) 816-6989 (63) (2) 815-3270 Europe ILTS Europe Vollsveien 168 N-1343 Eiksmarka Norway (47) (67) 14 73 76 (47) (67) 14 80 68 South Africa ILTS South Africa c/o First Floor, Export House Corner West & Maude Streets Sandown P.O. Box 651525 Benmore 2010 Johannesburg Republic of South Africa (27) (11) 320-6971 (27) (11) 320-6873 Fax [ILTS(R) LOGO] INTERNATIONAL LOTTERY & TOTALIZATOR SYSTEMS, INC. Visit the ILTS Home Page: http://www.ilts.com Registered to ISO 9001 Certificate No. A3960 International Lottery & Totalizator Systems, Inc.(R), ILTS(R), DataTrak(R) and DATAMARK XClaim(TM) are registered trademarks of International Lottery & Totalizator Systems, Inc. EX-21 4 EXHIBIT 21 1 EXHIBIT 21 SUBSIDIARIES OF THE REGISTRANT The Registrant had 10 wholly-owned subsidiaries as of December 31, 1997: International Lottery & Totalizator Systems Australia Pty. Ltd., an Australia corporation; International Lottery & Totalizator Systems (UK) Ltd., a United Kingdom corporation, International Ticketing Systems, Inc., ITS Service Corp., ITS Service Corp. II, ITS Service Corp. III, Air Fair, Inc., ITS Overseas, Inc., ITS Export, Inc., ILTS (Brazil), Inc., all of which corporations are incorporated in California, U.S.A. EX-23.A 5 EXHIBIT 23A 1 EXHIBIT 23A CONSENT OF INDEPENDENT PUBLIC ACCOUNTANTS The consolidated balance sheets as of December 31, 1997 and 1996 and the consolidated statements of operations, stockholders' equity and cash flows for each of the three years in the period ended December 31, 1997 together with the report of independent public accountants contained on page 21 of the Company's Annual Report to Stockholders for the year ended December 31, 1997 are incorporated herein by reference. As independent public accountants, we hereby consent to the incorporation by reference of our report dated February 18, 1998 included in this Form 10-K, into International Lottery & Totalizator Systems, Inc.'s previously filed Form S-8, No. 2-99618 , No. 33-34121, No. 33-34123, No. 33-79938, No. 33-69008, and Form S-3 No. 33-78194. It should be noted that we have not audited any financial statements of the Company subsequent to December 31,1997, or performed any audit procedures subsequent to the date of our report. ARTHUR ANDERSEN LLP San Diego, California March 26, 1998 EX-23.B 6 EXHIBIT 23B 1 EXHIBIT 23B REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS To International Lottery & Totalizator Systems, Inc.: We have audited the accompanying consolidated balance sheet of International Lottery & Totalizator Systems, Inc. (a California corporation) and subsidiaries as of December 31, 1997, and the related consolidated statements of operations, shareholders' equity and cash flows for the year then ended. These financial statements and the schedule referred to below are the responsibility of the Registrant's management. Our responsibility is to express an opinion on these financial statements and schedule based on our audit. We conducted our audit in accordance with generally accepted auditing standards. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audit provides a reasonable basis for our opinion. In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of International Lottery & Totalizator Systems, Inc. and subsidiaries as of December 31, 1997, and the results of their operations and their cash flows for the year then ended in conformity with generally accepted accounting principles. Our audit was made for the purpose of forming an opinion on the basic consolidated financial statements taken as a whole. The accompanying Schedule II - Valuation and Qualifying Accounts is presented for purposes of complying with the Securities and Exchange Commission's rules and is not a required part of the basic consolidated financial statements. This information has been subjected to the auditing procedures applied in our audit of the basic consolidated financial statements and, in our opinion, if fairly stated in all material respects in relation to the basic consolidated financial statements taken as a whole. ARTHUR ANDERSEN LLP San Diego, California February 18, 1998 EX-23.C 7 EXHIBIT 23C 1 EXHIBIT 23C CONSENT OF ERNST & YOUNG LLP, INDEPENDENT AUDITORS We consent to the incorporation by reference in this Annual Report (Form 10-K) of International Lottery & Totalizator Systems, Inc. of our report dated February 21, 1997, included in the 1997 Annual Report to Shareholders of International Lottery & Totalizator Systems, Inc. Our audits also included the financial statement schedule of International Lottery & Totalizator Systems, Inc. listed in Item 14(a) as it relates to the years ended December 31, 1995 and 1996. This schedule is the responsibility of the Company's management. Our responsibility is to express an opinion based on our audits. In our opinion, the financial statement schedule referred to above, when considered in relation to the basic financial statements taken as a whole, presents fairly in all material respects the information set forth therein. We also consent to the incorporation by reference in the Registration Statements (Form S-8, No. 33-34121) pertaining to the 1986 Employee Stock Option Plan, (Form S-8, No. 33-34123) pertaining to the 1988 Employee Stock Option Plan (Form S-8, No.33-79938) pertaining to the 1990 Stock Incentive Plan, (Form S-8, No. 33-69008) pertaining to the 1993 Directors' Stock Option Plan and the Registration Statement (Form S-3, No. 33-78194) and in the related Prospectuses of our report dated February 21, 1997, with respect to the 1996 and 1995 consolidated financial statements and schedule of International Lottery & Totalizator Systems, Inc. included and incorporated by reference in this Annual Report (Form 10-K) for the year ended December 31, 1997. ERNST & YOUNG LLP San Diego, California March 26, 1998 EX-23.D 8 EXHIBIT 23D 1 EXHIBIT 23D REPORT OF ERNST & YOUNG LLP, INDEPENDENT AUDITORS The Board of Directors and Shareholders International Lottery & Totalizator Systems, Inc. We have audited the accompanying consolidated balance sheet of International Lottery & Totalizator Systems, Inc. as of December 31, 1996, and the related consolidated statements of operations, shareholders' equity and cash flows for each of the two years in the period ended December 31, 1996. These financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements based on our audits. We conducted our audits in accordance with generally accepted auditing standards. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion. In our opinion, the financial statements referred to above present fairly, in all material respects, the consolidated financial position of International Lottery and Totalizator Systems, Inc. at December 31, 1996, and the results of its operations and its cash flows for each of the two years in the period ended December 31, 1996, in conformity with generally accepted accounting principles. ERNST & YOUNG LLP San Diego, California February 21, 1997 EX-27 9 FINANCIAL DATA SCHEDULE
5 1,000 12-MOS DEC-31-1997 DEC-31-1997 2,371 0 1,040 0 2,544 7,782 802 0 8,662 4,570 0 51,103 0 0 (46,659) 8,662 10,826 10,826 9,647 17,526 0 60 9 (5,858) 80 (5,938) 0 0 0 (5,938) (0.33) 0
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