-----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, M8uBcZ+2dpv8mbn13YXTy+JW5lQ9cOEKBj6gUvB8uGluheWAI21Q9C1WKiKjavOn +/VmlM8pExXTgFhhWckjAw== 0000936392-96-000073.txt : 19960320 0000936392-96-000073.hdr.sgml : 19960320 ACCESSION NUMBER: 0000936392-96-000073 CONFORMED SUBMISSION TYPE: 10-K PUBLIC DOCUMENT COUNT: 5 CONFORMED PERIOD OF REPORT: 19951231 FILED AS OF DATE: 19960319 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: 1934 Act SEC FILE NUMBER: 000-10294 FILM NUMBER: 96536296 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 INTERNATIONAL LOTTERY & TOTALIZATOR SYSTEMS - 10-K 1 As filed with the Securities and Exchange Commission on March 19, 1996 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 [FEE REQUIRED] FOR THE FISCAL YEAR ENDED DECEMBER 31, 1995 ---------------------------------------------- / / TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 [NO FEE REQUIRED] 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 (I.R.S. Employer incorporation or organization) Identification Number) 2131 FARADAY AVENUE CARLSBAD, CALIFORNIA 92008 - ---------------------------------------------------- ----------------------- (Address of principal executive offices) (Zip Code) Registrant's telephone number, including area code (619) 931-4000 -------------------- 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 19, 1996 was approximately $ 22,071,277 - -------------------------------------------------------------------------------- Number of common shares outstanding at March 19, 1996 was 16,816,211 DOCUMENTS INCORPORATED BY REFERENCE Portions of the 1995 Annual Report to Stockholders of the Registrant: Parts II and IV Portions of the Proxy Statement for Annual Meeting of Stockholders, June 6, 1996: 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./ / 2 TABLE OF CONTENTS PART I 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....................... 3 Manufacturing and Materials.............................. 4 Competition.............................................. 4 Employees................................................ 5 Patents, Trademarks and Licenses......................... 5 Regulation............................................... 5 Dependence Upon a Few Customers.......................... 5 Seasonality.............................................. 5 Working Capital Practices................................ 5 Environment Effects...................................... 5 Export Sales............................................. 5 ITEM 2. PROPERTIES............................................... 6 ITEM 3. LEGAL PROCEEDINGS........................................ 6 ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS...... 7 EXECUTIVE OFFICERS OF THE REGISTRANT..................... 7 PART II ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS.......................... 7 ITEM 6. SELECTED FINANCIAL DATA.................................. 7 ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS............ 7 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.................................. 8
3 PART I ITEM 1. BUSINESS GENERAL The Registrant designs, manufactures, sells, leases, manages, supports and services computerized ticket issuing systems and terminals for the global pari-mutuel and on-line lottery industries. The principal applications for the Registrant's products are in the automated horse racing and on-line government sponsored lottery industries. The Registrant has also entered into long-term service contracts under which it intends to operate on-line lottery systems. The Registrant utilizes its technology 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 is the DATAMARK(R) terminal, 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 turnkey wagering application system and can modify the 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 more recent models use the "Flipper" concept and are approximately 12" deep, 12" wide, 10" high, weigh approximately 27 pounds, and are accompanied by a detached keyboard that may be positioned to suit the convenience of the operator. Other models are slightly larger and may have built-in or external displays or keyboards. The latest DATAMARK(R) models utilize a compact ticket path which allows the terminal to print on one 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. Some models will sequentially process 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. After the data has been printed on the ticket, in both numerical and machine readable (bar code) form, but before the ticket is delivered to the customer, the terminal reads the bar code in order to verify that it is correct and readable when later presented to any terminal for cashing or validation. 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 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 pool or for any feature pool currently being used in horse racing. 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 a pre-printed playslip, which is then read optically by the terminal, the amount wagered 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. 4 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 being offered by the Registrant in its horse racing system is software, as enhanced and modified by the Registrant, acquired by license from The Royal Hong Kong Jockey Club (The RHKJC). 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. Prior to 1994, the Registrant entered into contracts to provide lottery equipment and management of on-line lottery systems on a long-term basis in Papua New Guinea, the Republic of Georgia, the Dominican Republic and the Russian Federation. In 1994, the Registrant recorded $9.8 million in write-offs and a write-down against all of these service projects, except Russia. In January 1995, Registrant discontinued its operation in the Dominican Republic. In July 1995, ILTS 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."). ILTS is being paid in cash installments over a 17 month period plus a percentage of Lotto Pty.'s sales over the next five years. Proceeds of the sale are anticipated to accelerate the Registrant's return on its investment, and to ultimately provide a greater return than if the Registrant had continued to operate the lottery for Lotto Pty. On November 1, 1994, the Russian government issued a decree which required all existing lottery license holders, including the charitable foundation with which the Registrant had a management and supply agreement, to apply for re-registration of their license by February 1, 1995. Due to the uncertainty regarding the license registration and with the continued economic, legal, and political instability in Russia, the Registrant recorded a provision of $7.6 million in its quarter ended December 31, 1994. The Registrant terminated the Russian lottery project in November 1995, after exhausting numerous options to secure outside financing or joint venture partners for the project. In June 1995, the Registrant announced a ten year service and supply agreement with Pascal & Company (Pascal) of the United Kingdom. The Registrant will provide a lottery system and services to Pascal for operation of an on-line lottery on behalf of the National Hospital Trust (NHT) in England and provided 1,000 DATAMARK(R) on-line terminals and associated software, a central computer system and software, training, support, installation and maintenance. The Registrant will be compensated as a percentage of gross weekly lottery sales. Due primarily to a change in ownership of Pascal and a corporate reorganization of its new corporate owners no production order for the terminals has been placed pursuant to the supply agreement. 2 5 The Registrant owns non-exclusive rights to use the central system software developed by The RHKJC for use in its pari-mutuel wagering and lottery systems. Under the terms of the amended license, the Registrant pays The RHKJC 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 RHKJC 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 RHKJC software, including changes to the system's communications network and changes which permit the generation of more detailed management reports. In the Registrant's lottery system, tickets are processed on DATAMARK(R) terminals which are connected to a central computer installation, usually by telephone lines. The central 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. 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, 1995 1994 1993 1992 1991 (dollars in thousands) Racing Products and Services $10,448 $13,932 $14,680 $14,851 $22,629 Lottery Products and Services 7,680 9,231 10,322 4,417 6,701 Other 513 926 15 569 161 ------- ------- ------- ------- ------- Total $18,641 $24,089 $25,017 $19,837 $29,491 ======= ======= ======= ======= =======
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 1995, the Registrant spent approximately $1.4 million on engineering, research and development, as compared to $1.6 million and $2.0 million in 1994 and 1993, respectively. In recent years, the Registrant introduced a new lottery terminal utilizing an advanced version of a Charge Coupled Device (CCD) reader capable of reading hand written information such as signatures and addresses, as well as other graphics on customer-marked tickets. Charge Coupled Device (CCD) technology is a requirement for certain European lotteries. In addition, the Registrant developed the Single Roller Flipper Terminal 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. In late 1995, the Registrant successfully completed the ISO audit performed by Underwriters Laboratories and in February 1996, was granted ISO 9001 registration. This demonstrates quality in design development and manufacture under ISO standards. BACKLOG The backlog of orders for its products and services believed by the Registrant to be firm, amounted to approximately $9.2 million as of December 31, 1995, as compared to a backlog of approximately $11.2 million as of December 31, 1994. Of such backlog at December 31, 1995, approximately $9.2 million is expected to be filled during 1996. See BUSINESS - Dependence Upon a Few Customers. 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 3 6 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 will 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 involves 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 1995, the Registrant unsuccessfully bid on one service/operating contract for a U.S. state lottery and it intends to continue this marketing effort in 1996 and future years. In addition, 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. Late in 1994, prototype deliveries began on the $2.4 million contract announced in 1993 with The Revenue Markets, Inc. (TRIMI) which is automating the New York State Thruway toll road system. These units are currently being operated in a pilot test mode. Natural Avenue Sdn, Bhd of Malaysia, a new customer of the Registrant placed a $2.2 million order for DATAMARK(R) lottery terminals and a computer operations system. Natural Avenue operates an on-line lottery in the state of Sarawak, in eastern Malaysia, which began in February 1996. 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, 1995 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, Essnet, a Swedish company, International Des Jeux, the French national lottery company, GTECH Holdings Corporation, Autotote Limited and Video Lottery Technologies, all United States companies. Management believes that the Registrant's sales of its products in the past five years have been a substantial factor in the international marketplace. 4 7 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, 1995, the Registrant employs 176 persons worldwide on a full-time equivalent basis. Of this total, 62 were engaged in manufacturing and operations support, 54 in engineering and software development and 60 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 filed five patent applications on its products, all of which have been issued by the U.S. Patent Office. 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 RHKJC. 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 1995, the Registrant's revenues were derived primarily from contracts with the Western Australia Totalisator Agency Board, ($4.4 million); the Phillippines Gaming Management Company, ($2.9 million); AB Travoch Galopp (ATG) of Sweden ($1.9 million), New South Wales Lottery ($1.6 million), Natural Ave Sdn Bhd, a Malaysian company ($1.3 million) and Leisure Management Berhad, a Malaysian company ($1.0 million). See Note 4 of Notes to Consolidated Financial Statements, incorporated by reference in Part II, Item 8, and Management's Discussion and Analysis of Financial Condition and Results of Operations incorporated by reference in Part II, Item 7. 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, with interim short-term bank financing, 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 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, 1995 the Registrant's equipment has been delivered and installed in Sweden, Norway, Hong Kong, France, Australia, Singapore, Finland, England, the Netherlands, Malaysia, Macau, China, Papua New Guinea, Belgium, 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. These currencies include the Australian dollar, and Malaysian ringgit. 5 8 The Registrant has a wholly-owned foreign sales corporation and conducts its foreign business through such subsidiary in order to obtain U.S. tax benefits associated with this corporation. In addition, the Registrant operates wholly-owned subsidiaries in Australia, and the United Kingdom. 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 1997. The Registrant's United Kingdom subsidiary currently occupies an office-technical support facility in West Drayton, England of approximately 2,400 square feet, under a lease expiring in April, 1998. See Note 6 of Notes to Consolidated Financial Statements, incorporated by reference in Part II, Item 8. ITEM 3. LEGAL PROCEEDINGS SHAREHOLDERS' CLASS ACTION LITIGATION In June and July 1994, shareholders of the Registrant filed class action lawsuits against the Registrant and several of its officers and directors. Those actions were consolidated by stipulation and order and are now pending in the United States District Court for the Southern District of California. Plaintiffs contend 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. Plaintiffs seek unspecified damages. The defendants deny all material allegations. On March 15, 1996, the attorneys for all defendants entered into a Stipulation of Settlement with the law firm representing the plaintiffs. The proposed settlement includes a cash payment and 1.2 million of authorized but unissued common shares of the Registrant. The proposed settlement is subject to agreement by the shareholders included in the class period and approval by the court. The Registrant has recorded a reserve for its obligations anticipated under the proposed settlement, which includes an estimate of the value of the shares as a current liability. WALTERS V ILTS, ET AL On November 3, 1995, Mr. James Walters, the former chairman and president of the Registrant, who retired in 1994, filed an action in the San Diego County Superior Court against the Registrant, its 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, Mr. Walters alleged that information in the Registrant's 1995 proxy statement relating to Mr. Walters' compensation and retirement date was erroneous, resulting in two other magazine articles publishing allegedly incorrect information. Mr. Walters seeks general and special damages of $9 million and punitive damages. The Registrant and Mr. Brunn deny all allegations in Mr. Walters' complaint and will defend the litigation accordingly. No trial date has been set. Various other litigation in which the Registrant is a defendant is pending, none of which is expected individually or in aggregate, to have a materially adverse effect on the Registrant. 6 9 ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS Inapplicable. EXECUTIVE OFFICERS OF THE REGISTRANT
Name Age Position - ---- --- -------- Frederick A. Brunn 51 President Timothy R. Groth 46 Vice President, Technical Operations William A. Hainke 54 Chief Financial Officer, Corporate Secretary and Treasurer M. Mark Michalko 41 Executive Vice President Lennart K. Sundin 60 Senior Vice President, Marketing and Sales
PART II ITEM 5. MARKET FOR THE REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS The information required by this item is included in the Registrant's Annual Report to Shareholders for the fiscal year ended December 31, 1995 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 19, 1996, of $1.3125 per share. ITEM 6. SELECTED FINANCIAL DATA The information required by this item is included on page 5 of the Registrant's Annual Report to Shareholders for the fiscal year ended December 31, 1995 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 6 and 7 of the Registrant's Annual Report to Shareholders for the fiscal year ended December 31, 1995 under the same caption and is incorporated herein by reference to such Annual Report. 7 10 ITEM 8. CONSOLIDATED FINANCIAL STATEMENTS The information required by this item is included on pages 8 through 11 of the Registrant's Annual Report to Shareholders for the fiscal year ended December 31, 1995 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 1996 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 1996 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 1996 Annual Meeting of Shareholders. ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS The information required is incorporated herein by reference to the Registrant's definitive Proxy Statement for the 1996 Annual Meeting of Shareholders. PART IV ITEM 14. EXHIBITS, CONSOLIDATED FINANCIAL STATEMENT SCHEDULES, 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 Schedules: (i) Report of Ernst & Young LLP, Independent Auditors* (ii) Consolidated Balance Sheets at December 31, 1995 and 1994* 8 11 (iii) Consolidated Statements of Operations for each of the three years in the period ended December 31, 1995* (iv) Consolidated Statements of Shareholders' Equity for each of the three years in the period ended December 31, 1995* (v) Consolidated Statements of Cash Flows for each of the three years in the period ended December 31, 1995* (vi) Notes to Consolidated Financial Statements* *incorporated by reference to the Annual Report to Shareholders for the fiscal year ended December 31, 1995. (vii) Schedule II - Valuation and Qualifying Accounts (Form 10-K, page 11) All other schedules are omitted since the required information is not present or is not present in amounts sufficient to require a submission of the schedule, or because the information required is included in the financial statements and notes thereto. 3. Exhibits (3) Articles of Incorporation, as amended September 13, 1994, reflecting corporate name change, and By-laws (incorporated by reference to Form 10-K for the fiscal 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 1982 Employee Stock Option Plan (incorporated by reference to Exhibit 4(b) to Post-Effective Amendment No. 1 to Form S-8 Registration Statement, File No. 2-99618, as filed on April 4, 1990). (d) The Registrant's 1986 Employee Stock Option Plan (incorporated by reference to Exhibit 4(b) to the Form S-8 Registration Statement, File No. 33-34121, as filed on April 4, 1990). (e) 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). (f) The Registrant's 1990 Stock Incentive Plan (incorporated by reference to Form 10-K for the fiscal year ended December 31, 1990, File No. 0-10294 and File No. 33- 79938). (g) Agreement with The Royal Hong Kong Jockey Club dated May 11, 1989 and amended on January 13, 1992 (incorporated by reference to Form 10-K for the fiscal year ended December 31, 1991, File No. 0-10294). 9 12 (h) The Registrant's 1993 Directors' Stock Option Plan as amended May 26, 1995 (incorporated herein by reference to Form 10-K for the fiscal year ended December 31, 1994, File No. 0-10294). (i) Retirement Agreement, dated June 20, 1995 and Consulting Agreement dated July 15, 1995 for James T. Walters (incorporated herein by reference to Form 10-K for the fiscal year ended December 31, 1994, File No. 0-10294). (13) Annual Report to Shareholders for the fiscal year ended December 31, 1995. With the exception of the information incorporated by reference into items 5, 6, 7, and 8 of this Form 10-K, the 1995 Annual Report to Shareholders is not deemed filed as part of this report. (21) Subsidiaries of the Registrant. (23) Consent of Ernst & Young LLP, Independent Auditors (b) No reports on Form 8-K have been filed during the last quarter of the period covered by this report. 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, 1995 -- Warranty Reserves $ 347,117 $ 76,015 $ 125,405 $ 297,727 -- Allowance for Doubtful Accounts $ 208,550 $ 60,000 $ 205,594 $ 62,956 December 31, 1994 -- Warranty Reserves $ 193,000 $ 255,370 $ 101,253 $ 347,117 -- Allowance for Doubtful Accounts $ 75,000 $ 140,000 $ 6,450 $ 208,550 December 31, 1993 -- Warranty Reserves $ 221,000 $ 16,000 $ 44,000 $ 193,000 -- Allowance for Doubtful Accounts $ 100,000 $ 9,000 $ 34,000 $ 75,000
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) By: /s/ William A. Hainke --------------------- William A. Hainke Chief Financial Officer, Corporate Secretary and Treasurer 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 15, 1996 - ---------------------------------------- Theodore A. Johnson /s/ Frederick A. Brunn President - ---------------------------------------- Frederick A. Brunn Director March 15, 1996 /s/ William A. Hainke Chief Financial Officer, Corporate - ---------------------------------------- William A. Hainke Secretary and Treasurer March 15, 1996 /s/ M. Mark Michalko Executive Vice President - ---------------------------------------- M. Mark Michalko Director March 15, 1996 /s/ Ng Foo Leong Director - ---------------------------------------- Ng Foo Leong March 15, 1996 /s/ Martin J. O'Meara, Jr. Director - ---------------------------------------- Martin J. O'Meara, Jr. March 15, 1996 /s/ Michael G.R. Sandberg Director - ---------------------------------------- Sir Michael G.R. Sandberg March 15, 1996 Director - ---------------------------------------- Chan Kien Sing March 15, 1996 Director - ---------------------------------------- Tan Sri Dato Vincent Tan Chee Yioun March 15, 1996
12 EX-13 2 1995 ANNUAL REPORT TO SHAREHOLDERS 1 EXHIBIT 13 INTERNATIONAL LOTTERY & TOTALIZATOR SYSTEMS, INC. 1995 ANNUAL REPORT [MISCELLANEOUS PHOTOS] 2 International Lottery & Totalizator Systems, Inc.(TM) (NASDAQ:ITSI) provides computerized ticket processing equipment, systems and services to racing organizations and lotteries worldwide. 3 QUALITY COMMITMENT ILTS is an ISO 9001 registered company, which demonstrates that we meet the highest level of quality standards for both our design and manufacturing processes. ILTS has a long-established reputation of providing the best technology and highest quality products to the markets we serve. The Company's quality commitment is to achieve customer satisfaction by: - Providing products designed and manufactured for durability and reliability. - Providing delivery performance that competitors cannot match. - Providing customer service that meets or exceeds customer expectations. ILTS / 1 4 PRESIDENT'S MESSAGE TO THE SHAREHOLDERS Nineteen ninety-five was another challenging year for ILTS. We continued to strategically reposition the Company for future growth and profitability while simultaneously resolving some difficult issues from the past. The strategic shift initiated in 1992 to transition the Company from relying solely on contract sales to also becoming a lottery facilities management service provider remains a sound objective. However, the initial lottery service projects have proven costly. Chief among those has been the Russian lottery project. Begun in 1993, this project has been both difficult and frustrating. Among the lessons learned, we found that everything in Russia takes longer and costs more than anyone ever imagined. Although almost all of the project was written off or reserved at year-end 1994, the project was finally terminated in November of 1995 after exhausting numerous options to secure outside financing or joint venture partners for the project. The remaining investment and costs of the project were expensed in 1995. Another major contributor to the 1995 loss was the shareholders' class action lawsuit. This suit was filed in mid-1994 [CAPTION] ILTS provides innovative gaming solutions with quality products and services to maximize the revenue of our customers and bring a fair return to our shareholders. [PHOTOS] 2 / ILTS 5 following the announced write-off of costs associated with the lottery service projects in the Republic of Georgia and the Dominican Republic and the write-down of the Company's investment in the Papua New Guinea project. The Company's total legal expenses in 1995 exceeded $1 million dollars; the majority of this related to the shareholders' suit. Additionally, the Company recorded a reserve for the costs associated with the proposed settlement, which includes legal fees plus 1.2 million authorized and unissued common shares. Yet another factor in the 1995 loss was lower-than-expected sales volume primarily due to delays and postponements of anticipated procurements by both existing customers and new prospects. Notwithstanding the negative effects of the Russian project, the shareholders' lawsuit, and the reduced contract volume, there were a number of notable positive events for ILTS in 1995: - We sold the 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. Proceeds from the sale are anticipated to accelerate the Company's return on its investment, and ultimately should provide a greater return than if the Company had continued to operate the lottery for Lotto Pty. - We negotiated several significant strategic partnerships and alliances during 1995. Among these was a participation and licensing agreement with The Royal Hong Kong Jockey Club (RHKJC) where, in exchange for the Company's participation in developing a new, high-performance betting system for the RHKJC, we receive the rights to market that software system. A second alliance involved a licensing agreement with Racecourse Totalizators Pty. Ltd. of Australia, wherein ILTS has licensed Racecourse Totalizators' UNIX-based [CAPTION] Widespread employee involvement, teamwork and pride of workmanship are keys to the Company's success in providing customer satisfaction. [PHOTOS] ILTS / 3 6 betting system software products for incorporation into the Company's pari-mutuel system. Another strategic alliance was established with a company that has developed a low-cost terminal for entering and storing bets off-line. In combination with our on-line technology, we are confident this alliance will facilitate new opportunities for automating lotteries in many developing countries around the world. In total, we expect all of these new alliances to make our product offerings stronger and to aid us in establishing competitive advantages in several of the markets we serve. - We added two new lottery customers in 1995, Pascal & Company (Pascal) of the United Kingdom and Natural Avenue Sdn. Berhad of Malaysia. For Pascal, we will provide a lottery system and services for operation of an on-line lottery on behalf of the National Health Service and the National Hospital Trust in England. Natural Avenue is the operator of a lottery in the state of Sarawak, in east Malaysia. On-line sales began on February 12, 1996. - We continued to book new orders from several of our established customers, including ATG in Sweden, PGMC in the Philippines and SATAB in Australia. All of these orders include the DATAMARK Flipper terminal, which gained wide support with our customers in 1995. - We completed an ISO audit performed by Underwriters Laboratories and received ISO 9001 certification. This was a strategic target for the Company and demonstrates our continued commitment to quality in design, development and manufacturing under rigid standards. - We continued to develop and refine our lottery system software to enable the Company to compete successfully in the lottery service business. - We continued to streamline internal operations, including more efficient employee utilization and reducing operating expenses wherever possible. Our goal is to become profitable in 1996, and establish a pattern of consistent profitability. To do so, we will continue to streamline our operations, control and reduce costs where possible, and work toward improving our manufacturing efficiencies and project costs. At the same time, we are implementing an aggressive sales effort. It is important to mention that although this is our goal several factors outside our control, such as delays in receiving new orders and foreign political uncertainties, could affect our ability to accomplish this objective. I believe we have eliminated many of the past problems and have positioned the Company for future profitability. I offer my sincere gratitude and appreciation to our shareholders who have shown continued loyalty, and to our employees who remain dedicated and enthusiastic. With the continued support and patience of our shareholders and employees together with that of our valued customers, we will build a strong and profitable company. [PHOTO OF FREDERICK A. BRUNN] /s/ Frederick A. Brunn FREDERICK A. BRUNN PRESIDENT DIRECTOR 4 / ILTS 7 SELECTED FINANCIAL DATA
YEARS ENDED DECEMBER 31, 1995 1994 1993 1992 1991 - --------------------------------------------------------------------------------------- Thousands of dollars except per share amounts and non-monetary items Income statement data Revenue $ 18,641 $ 24,089 $ 25,017 $ 19,837 $ 29,491 Gross profit 1,185 4,527 9,038 6,796 10,474 Operating income (loss) (14,221) (22,943) 302 (679) 2,428 Net income (loss) (13,869) (22,620) 605 (629) 1,701 Earnings (loss) per share (.83) (1.35) .05 (.06) .18 Balance sheet data Total assets 21,352 31,888 54,924 19,883 19,295 Long-term obligations 109 -- -- -- 84 Shareholders' equity 13,412 27,145 48,855 10,828 11,285 Key ratios & statistics Gross margin 6.4% 18.8% 36.1% 34.3% 35.5% Operating margin/(loss) (76.3%) (95.2%) 1.2% (3.4%) 8.2% Working capital 8,788 22,236 31,670 3,774 8,264 Book value .80 1.62 2.94 1.10 1.17 Current ratio 2.12 5.69 6.22 1.42 2.05 Backlog 9,214 11,168 15,250 16,819 19,387 Employees 176 277 249 216 201 Shares outstanding 16,816 16,804 16,574 9,782 9,632
ILTS / 5 8 MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS 1995 vs. 1994 1995 revenue decreased $5.4 million or 23% compared to 1994. This change mainly reflects a lower level of contract business in 1995. New orders received in 1995 were $12.6 million compared to $20.0 million in 1994. As part of its strategic plan, the Company has pursued long-term service contracts as a source of revenue. Service contracts pose capital investment risks for the Company that do not exist in its product sale business. Revenues 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, that a system may never become operational, or that revenue levels may not be sufficient to provide a return of costs invested. During 1992, the Company entered into a lottery service agreement in Papua New Guinea. A minimal amount of revenues was earned on this service contract in the first six months of 1995. In July 1995, the Company sold all interest in its Papua New Guinea lottery operations to the principal shareholders of the lottery licensee, The Lotto Pty. Ltd., in return for $175 thousand 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 million. The installment payments and the minimum percentage payments are secured by all lottery assets and certain personal guarantees and indemnifications of all of the shareholders of The Lotto Pty. Ltd. The Company's remaining investment in the PNG lottery is approximately $338 thousand and is included in other assets. The Company will not record any gain until the balance of the receivable has been collected. In August 1993, the Company entered into management and equipment lease agreements to operate an on-line lottery within the Russian Federation ("the Project") with Zodiac On-Line ("Zodiac"), a Russian lottery operating company. Under the terms of the agreements, the lottery was to be conducted under a non-exclusive license held by a Russian charitable organization (the "Foundation"). In 1994, the Company acquired Zodiac making it a wholly owned subsidiary. In December 1994, the Company recorded a provision with respect to its investment and subsequently has expensed all related costs as they were incurred. In June 1995, the Company became the lottery operator under a license granted to the Russian Federal Postal Service. In November 1995, the Company terminated the Project after exhausting numerous financing and joint venture possibilities. In 1995, project related expenses, including a provision for future costs to liquidate the operation totaled $2.8 million. In May 1995, the Company entered into an equipment lease agreement in the United Kingdom (U.K.) to operate a lottery to benefit the National Hospital System. The Company has invested $2.8 million in the Project as of December 31, 1995, which comprises the entire amount invested in lottery service agreements at that date. See Note 4 of Notes to Consolidated Financial Statements on page 13. The Company believes it will ultimately recover its investment in the U.K. lottery service agreement. However, realization of this investment is dependent upon future events, including the successful operation of the lottery at revenue levels sufficient to provide a return of costs invested. Cost of sales as a percentage of revenue increased to 94% in 1995 from 81% in 1994 due mainly to unfavorable manufacturing variances in 1995, costs associated with a reduction in work force and operational costs in support of the Company's lottery service operations. Engineering, research and development expenses in 1995 decreased $258 thousand or 16% compared to 1994. Of the $1.4 million expended in 1995, $0.9 million went toward development of lottery software. Selling, general and administrative expenses increased $2.8 million in 1995 compared to 1994. The increase in selling, general and administrative expenses from 1994 is due to increased legal expenses and a proposed settlement of a shareholders' lawsuit, costs incurred for domestic lottery proposals, and costs associated with a reduction in work force. Net interest income was $407 thousand in 1995 compared to net interest income of $467 thousand in 1994. Interest income is generated from short term investments. 1994 vs. 1993 1994 revenue decreased $0.9 million or 4% compared to 1993. This change mainly reflects a lower level of contract business in 1994. New orders received in 1994 were $20.0 million compared to $20.9 million in 1993. As part of its strategic plan, the Company has pursued 6 / ILTS 9 long-term service contracts as a source of revenue. Service contracts pose capital investment risks for the Company that do not exist in its product sale business. Revenues 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, that a system may never become operational, or that revenue levels may not be sufficient to provide a return of costs invested. During 1992, the Company entered into lottery service agreements in Papua New Guinea and the Republic of Georgia. In 1993, two additional lottery service agreements, in the Russian Federation and Dominican Republic, were added. A minimal amount of revenues was earned on service contracts in 1994. In the second quarter of 1994, the Company took a $9.8 million accounting charge to write-off its investment in the Dominican Republic and the Republic of Georgia and to write down its investment in Papua New Guinea. The Company abandoned its investment of $1.2 million in the Republic of Georgia due to worsening of the political and economic environment there. Based on projected revenues, the Papua New Guinea investment was written down by $3.0 million to the estimated future cash flows of that project and the Dominican Republic investment of $5.6 million was written off. In August 1993, the Company entered into management and equipment lease agreements to operate an on-line lottery within the Russian Federation ("the Project") with Zodiac On-Line ("Zodiac"), a Russian lottery operating company. Under the terms of the agreements, the lottery was to be conducted under a non-exclusive license held by a Russian charitable organization ("the Foundation"). In 1994, the Company acquired Zodiac making it a wholly-owned subsidiary. On November 1, 1994, the Russian government issued a decree which required all existing lottery license holders, including the Foundation, to apply for re-registration of their license by February 1, 1995. The Company initially understood that the re-registration was to be a straightforward, administrative process. However, at December 31, 1994, the re-registration process had not been defined by the government and the Company was awaiting official notification of the re-registration requirements. The Company had invested $9.0 million in the Project through December 31, 1994 and, subject to resolution of the re-registration of the license described above, expects to continue with the Project. Because of this uncertainty, there can be no assurance that the Company will ultimately implement the Project or, if implemented, that the Project will be successful. Due to the above change in circumstances, combined with the continued economic, political and legal instability in Russia, the Company recorded a provision of $7.6 million in its quarter ended December 31, 1994 with respect to the investment made in the Project. The remaining $1.4 million represents the estimated net realizable value of the terminal and related equipment, should the project be terminated. Further, due to the circumstances noted above, future costs of the Project, in excess of the recoverable value of the terminals and related equipment, will now be expensed as incurred by the Company rather than capitalized. See Note 4 of Notes to Consolidated Financial Statements on page 13. The Company has net assets of $2.3 million at December 31, 1994 in lottery service agreements. The Company believes it will ultimately recover its investment in these lottery service agreements. However, realization of this investment is dependent upon future events, including the successful operation of the lotteries at revenue levels sufficient to provide a return of costs invested. In addition, in the quarter ended December 31, 1994, the Company discontinued its airline ticket/boarding pass terminal product line, resulting in a charge of $0.5 million in the quarter and a total of $1.5 million through December 31, 1994. Cost of sales as a percentage of revenue increased to 81% in 1994 from 64% in 1993 due mainly to unfavorable manufacturing variances, inventory reserves; costs associated with a reduction in work force and operational costs in support of the Company's lottery service operations. Engineering, research and development expenses in 1994 decreased $415 thousand or 20% compared to 1993. Of the $1.6 million expended in 1994, $0.9 million went toward development of the DATAMARK Flipper terminal. Selling, general and administrative expenses increased $1.7 million in 1994 compared to 1993. The increase in selling, general and administrative expenses from 1993 is due to increased legal expenses relating to a shareholders lawsuit, costs associated with the retirement and consulting agreement with the Company's former chairman and chief executive officer, costs incurred for domestic lottery proposals and costs associated with a reduction in work force. Net interest income was $467 thousand in 1994 compared to net interest income of $107 thousand in 1993. Interest income is generated from short term investments. Liquidity and Capital Resources During 1995, the Company's working capital decreased approximately $13.5 million due to costs relating to a shareholders lawsuit, manufacturing variances, and expenses associated with the Russian lottery project. Cash and current receivable balances totaled approximately $5.5 million at December 31, 1995. The Company is dependent upon its few major customers. Advance and progress payments from these customers are also an important source of working capital. Management believes that existing cash and cash equivalents, plus cash provided from operations will provide adequate resources to fund 1996 operations. As of December 31, 1995, there are no commitments for major capital expenditures. ILTS / 7 10 CONSOLIDATED STATEMENTS OF OPERATIONS
YEARS ENDED DECEMBER 31, 1995 1994 1993 - --------------------------------------------------------------------------------------------------------------- Thousands of dollars, except per share amounts Contract revenue and sales $ 18,641 $ 24,089 $ 25,017 - --------------------------------------------------------------------------------------------------------------- Costs and expenses: Costs of sales 17,456 19,562 15,979 Write-offs and write-downs of lottery service agreements 2,807 17,444 -- Engineering, research and development 1,360 1,618 2,033 Selling, general and administrative 11,239 8,408 6,703 - --------------------------------------------------------------------------------------------------------------- Total costs and expenses 32,862 47,032 24,715 - --------------------------------------------------------------------------------------------------------------- Income (loss) from operations (14,221) (22,943) 302 Other income: Foreign exchange gain -- -- 25 Interest income, net 352 467 107 Gain on sale of subsidiary -- -- 268 - --------------------------------------------------------------------------------------------------------------- Income (loss) before provision for taxes based on income (13,869) (22,476) 702 - --------------------------------------------------------------------------------------------------------------- Provision for income taxes -- 144 97 - --------------------------------------------------------------------------------------------------------------- Net income (loss) $ (13,869) $ (22,620) $ 605 - --------------------------------------------------------------------------------------------------------------- Net income (loss) per share: Primary $ (.83) $ (1.35) $ .05 - --------------------------------------------------------------------------------------------------------------- Fully-diluted $ (.83) $ (1.35) $ .04 - --------------------------------------------------------------------------------------------------------------- Shares used in determination of net income (loss) per share: Primary 16,812 16,760 13,261 - --------------------------------------------------------------------------------------------------------------- Fully-diluted 16,812 16,760 13,780 - ---------------------------------------------------------------------------------------------------------------
See accompanying notes. 8 / ILTS 11 CONSOLIDATED BALANCE SHEETS
DECEMBER 31, 1995 1994 - -------------------------------------------------------------------------------------------------------------------------- Thousands of dollars, except share amounts Assets Current assets: Cash and cash equivalents $ 3,904 $ 9,467 Accounts receivable, net of allowance for doubtful accounts of $63 ($209 in 1994) 1,588 2,398 Costs and estimated earnings in excess of billings on uncompleted contracts 3,665 3,382 Inventories, at lower of cost (first-in, first-out method) or market: Finished goods 150 831 Work in process 173 2,173 Raw materials 6,497 7,495 - -------------------------------------------------------------------------------------------------------------------------- Total inventories 6,820 10,499 - -------------------------------------------------------------------------------------------------------------------------- Other current assets 642 1,233 - -------------------------------------------------------------------------------------------------------------------------- Total current assets 16,619 26,979 - -------------------------------------------------------------------------------------------------------------------------- Non-current account receivable 52 -- Investment in lottery service agreements, net 2,759 2,254 Equipment, furniture and fixtures at cost, less accumulated depreciation of $3,222 ($2,903 in 1994) 1,361 1,650 Computer software costs, less accumulated amortization of $1,331 ($821 in 1994) 561 1,005 - -------------------------------------------------------------------------------------------------------------------------- Total assets $ 21,352 $ 31,888 - -------------------------------------------------------------------------------------------------------------------------- Liabilities and shareholders' equity Current liabilities: Note payable to bank $ -- $ 300 Accounts payable 231 909 Billings in excess of costs and estimated earnings on uncompleted contracts 115 968 Accrued payroll and related taxes 949 595 Warranty reserves 298 348 Accrued litigation settlement 4,200 -- Other current liabilities 2,038 1,623 -------------------------------------------------------------------------------------------------------------------------- Total current liabilities 7,831 4,743 - -------------------------------------------------------------------------------------------------------------------------- Capital lease obligations 109 -- Commitments and contingencies Shareholders' equity: Common shares; no par value, 50,000,000 shares authorized; 16,816,211 shares issued and outstanding (16,803,711 in 1994) 48,687 48,650 Retained earnings (deficit) (35,223) (21,354) Foreign currency translation adjustment (52) (151) - -------------------------------------------------------------------------------------------------------------------------- Total shareholders' equity 13,412 27,145 - -------------------------------------------------------------------------------------------------------------------------- Total liabilities and shareholders' equity $ 21,352 $ 31,888 - --------------------------------------------------------------------------------------------------------------------------
See accompanying notes. ILTS / 9 12 CONSOLIDATED STATEMENTS OF CASH FLOWS
YEARS ENDED DECEMBER 31, 1995 1994 1993 - --------------------------------------------------------------------------------------------------------------------------- Thousands of dollars Cash flows from operating activities: Net income (loss) $(13,869) $(22,620) $ 605 Adjustments to reconcile net income (loss) to net cash used for operating activities: Depreciation and amortization 1,061 1,656 1,444 Deferred income taxes -- 148 (148) Foreign exchange gain -- -- (25) Stock option compensation -- 304 -- Write-offs and write-downs of lottery service agreements 2,807 17,444 -- Gain on sale of subsidiary -- -- (268) Changes in operating assets and liabilities: Accounts receivable 810 1,635 (264) Costs and estimated earnings in excess of billings on uncompleted contracts (283) (856) (2,133) Inventories 3,679 (4,003) 1,441 Accounts payable (678) (633) (650) Billings in excess of costs and estimated earnings on uncompleted contracts (853) (1,432) (968) Accrued payroll and related taxes 354 (66) 222 Income taxes -- -- (121) Accrued litigation settlement 4,200 -- -- Other 572 580 (27) - --------------------------------------------------------------------------------------------------------------------------- Net cash used for operating activities (2,200) (7,843) (892) - --------------------------------------------------------------------------------------------------------------------------- Cash flows used for investing activities: Investment in lottery service agreements (4,044) (5,934) (9,912) Lottery service agreement sale proceeds and advance repayments 651 402 -- Non-current account receivable -- 330 202 Additions to equipment (250) (1,209) (259) Additions to computer software costs (67) (413) (718) Proceeds from sale of subsidiary 525 325 325 - --------------------------------------------------------------------------------------------------------------------------- Net cash used for investing activities (3,185) (6,499) (10,362) - --------------------------------------------------------------------------------------------------------------------------- Cash flows provided by (used for) financing activities: Additions to notes payable -- 300 -- Payments on notes payable (300) -- (2,250) Proceeds from issuance of subordinated notes -- -- 2,350 Payments on subordinated notes -- -- (2,350) Proceeds from issuance of common shares and warrants 23 614 35,944 - --------------------------------------------------------------------------------------------------------------------------- Net cash provided by (used for) financing activities (277) 914 33,694 - --------------------------------------------------------------------------------------------------------------------------- Effect of exchange rate changes on cash 99 (8) 22 - --------------------------------------------------------------------------------------------------------------------------- Increase (decrease) in cash and cash equivalents (5,563) (13,436) 22,462 - --------------------------------------------------------------------------------------------------------------------------- Cash and cash equivalents at beginning of year 9,467 22,903 441 - --------------------------------------------------------------------------------------------------------------------------- Cash and cash equivalents at end of year $ 3,904 $ 9,467 $ 22,903 - --------------------------------------------------------------------------------------------------------------------------- Supplemental cash flow information: Cash paid during the year for interest 46 47 330 - --------------------------------------------------------------------------------------------------------------------------- Cash paid during the year for income taxes 7 8 220 - ---------------------------------------------------------------------------------------------------------------------------
See accompanying notes. 10 / ILTS 13 CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY
FOREIGN RETAINED CURRENCY COMMON SHARES EARNINGS TRANSLATION SHARES AMOUNT (DEFICIT) ADJUSTMENT TOTAL - ----------------------------------------------------------------------------------------------------------------------------- Thousands of shares/dollars Balance at December 31, 1992 9,782 $ 10,349 $ 661 $ (182) $ 10,828 - ----------------------------------------------------------------------------------------------------------------------------- Proceeds from exercise of stock options, including related tax benefits 192 459 -- -- 459 Proceeds from sale of shares to Berjaya Lottery Management 6,600 35,325 -- -- 35,325 Issuance of warrants and stock options -- 1,599 -- -- 1,599 Foreign currency translation adjustment -- -- -- 39 39 Net income - 1993 -- -- 605 -- 605 - ----------------------------------------------------------------------------------------------------------------------------- Balance at December 31, 1993 16,574 47,732 1,266 (143) 48,855 - ----------------------------------------------------------------------------------------------------------------------------- Proceeds from exercise of warrants 98 471 -- -- 471 Proceeds from exercise of stock options 132 143 -- -- 143 Accelerated vesting of options for terminated employees -- 304 -- -- 304 Foreign currency translation adjustment -- -- -- (8) (8) Net loss - 1994 -- -- (22,620) -- (22,620) - ----------------------------------------------------------------------------------------------------------------------------- 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 - -----------------------------------------------------------------------------------------------------------------------------
See accompanying notes. ILTS / 11 14 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS International Lottery & Totalizator Systems, Inc. ("the Company") designs, manufactures, sells, leases, manages, supports and services computerized ticket issuing systems and terminals for global pari-mutuel and on-line lottery industries. The principal applications for the Company's products are in the automated pari-mutuel (horse racing) wagering and on-line government sponsored lottery industries. The principal proprietary component of the Company's system is the DATAMARK terminal, a compact, reliable microprocessor-based ticketing terminal which can be modified to meet specific customer feature and configuration requirements. The Company sells its product principally in international markets. 1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES PRINCIPLES OF CONSOLIDATION The accompanying financial statements consolidate the accounts of the Company and its subsidiaries, all of which are wholly-owned. 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. Revenues under lottery services agreements are based on a percentage of the customer's lottery sales volume and recognized upon receipt. Revenues relating to 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 to 8 years. COMPUTER SOFTWARE COSTS The Company capitalizes 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 (2 to 5 years). Amortization expense totaled $510 thousand, $687 thousand, and $666 thousand for the years ended December 31, 1995, 1994, and 1993 respectively. WARRANTY RESERVES Estimated expenses for warranty obligations are accrued as income is recognized on related contracts. The reserves are adjusted periodically to reflect actual results. 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 an increase (decrease) to 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 Primary earnings per share are based on the weighted average number of shares outstanding during the year and the dilutive effect of common share equivalents. RESEARCH AND DEVELOPMENT Research and development expense for the years ended December 31, 1995, 1994, and 1993 was $1.4 million, $1.6 million, and $2.0 million, respectively. 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. Credit losses are provided for in the financial statements and consistently have been within management's expectations. 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, 1995 and 1994 are investments in commercial paper and municipal bonds totaling $2.2 and $7.9 million, respectively, which mature in January 1996 and March 1995, respectively. The estimated fair value of these investments approximate the amortized cost; therefore, there are no unrealized gains or losses as of December 31, 1995 or 1994. INVESTMENT IN LOTTERY SERVICE AGREEMENTS The investment in lottery service agreements includes the direct costs of manufacture and installation of computerized electronic lotteries, including the terminals, central computer systems and start-up related implementation costs to the extent that recovery of such costs is determined to be reasonably assured. The Company depreciates the system cost over the shorter of the estimated useful life or initial contract. STOCK OPTIONS The Company has elected 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 employee stock options equal the market price of the underlying stock on the date of grant, no compensation expense is recognized. NOTE PAYABLE TO BANK The maximum amount of month-end borrowings under short-term notes payable to a bank were $.58 million, $.3 million and $2.2 million in 1995, 1994 and 1993 respectively. The average month-end amount outstanding during 1995 was $115 thousand, (1994 -$54 thousand and 1993 - $797 thousand) with a weighted average interest rate of 8.3% (1994- 9.1% and 1993-8.0%) 2. RELATED PARTY TRANSACTIONS The Company has entered several sales agreements to supply terminals to entities in which a substantial shareholder of the Company has a significant equity interest. These revenues totaled $3.5 million and $5.2 million in 1995 and 1994 respectively. Included in accounts receivable and costs and estimated earnings in excess of billings on uncompleted contracts were $2.3 million and $1.4 million at December 31, 1995 and 1994, respectively, relating to these customers. 12 / ILTS 15 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):
DECEMBER 31, 1995 1994 - ------------------------------------------------------------------------------- Costs incurred $ 15,665 $ 12,572 Estimated earnings 4,612 5,820 - ------------------------------------------------------------------------------- 20,277 18,392 - ------------------------------------------------------------------------------- Less: billings (16,727) (15,978) - ------------------------------------------------------------------------------- $ 3,550 $ 2,414 - ------------------------------------------------------------------------------- Included in the accompanying consolidated balance sheets as follows: Costs and estimated earnings in excess of billings on uncompleted contracts $ 3,665 $ 3,382 Billings in excess of costs and estimated earnings on uncompleted contracts (115) (968) - ------------------------------------------------------------------------------- $ 3,550 $ 2,414 - -------------------------------------------------------------------------------
The Company is obligated under a $2.8 million contract to supply ticket issuing equipment. The contract provides for certain late delivery penalties and the Company is contingently liable for successful performance under a performance bond with an insurance company for $2.7 million. The Company has experienced difficulty in satisfying some of the customer's ultimate requirements during the initial pilot testing period of the program. The Company has $1.1 million recorded as costs and estimated earnings in excess of billings on uncompleted contracts at December 31, 1995. The Company does not anticipate any losses beyond amounts accrued. Although not probable, the Company could sustain a loss that could be material to the financial statements. 4. LOTTERY SERVICE AGREEMENTS The Company entered into contracts to provide lottery equipment and management of on-line lottery system on a long-term basis in Papua New Guinea and the Russian Federation in 1992 and 1993, respectively, and it entered into a contract to provide lottery equipment in the United Kingdom in 1995. The Company has committed lottery equipment costing approximately $2.8 million to its United Kingdom lottery service agreement in 1995. The Company has agreed to provide a complete lottery system and will receive a percentage of lottery revenues. The lottery is scheduled to commence operations in 1997. The Papua New Guinea lottery commenced operation in March 1993. Revenues from the lottery in Papua New Guinea did not meet expectations and in June 1994, the Company wrote down its investment in Papua New Guinea by $3.0 million to its estimated future cash flows. 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. The Company's remaining investment in the Papua New Guinea lottery at December 31, 1995 is approximately $338 thousand and is included in other current assets. 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 record the assets at estimated net realizable value with respect to the Russian lottery investment. In November 1995, the Company terminated its Russian project. 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. In June 1994, the Company wrote off its investment in two lottery service agreements which totaled $6.8 million, $1.2 million in the Republic of Georgia and $5.6 million in the Dominican Republic, as projected revenues indicated the Company would not be able to recover its investment. In January 1995, the Company ceased operations in the Dominican Republic and in 1994 closed its office in the Republic of Georgia Although the Company believes that its remaining lottery service agreement investment in the U.K. represents a good business investment the realization of this investment is dependent upon future events, including the successful operation of the lottery at levels sufficient to provide the Company a return of its costs invested. The investment in lottery service agreements is comprised of the following (in thousands):
DECEMBER 31, 1995 1994 - ------------------------------------------------------------------------------- Systems, equipment and other start-up costs relating to lottery contracts $2,759 $ 13,236 Less accumulated depreciation, amortization and write-down -- (10,982) - ------------------------------------------------------------------------------- Total: $2,759 $ 2,254 - -------------------------------------------------------------------------------
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, Totalizator Systems (UK) Ltd. and a Russian subsidiary, Zodiac On-line. Sales between geographic areas are generally priced to recover material costs plus an appropriate markup. Revenue from major customers is as follows (in thousands):
CUSTOMER LOCATION 1995 1994 1993 - -------------------------------------------------------------------------------- Australia $ 4400 $2,400 $3,300 Philippines 2900 5,200 -- Sweden, Stockholm 2700 400 700 Malaysia 2300 2,100 600 Norway 900 1,200 -- Hong Kong 600 9,400 9,500 China -- 800 4,900
The following table at the top of page 14 summarizes information about the Company's operations in different geographic areas for the years ended December 31, 1995, 1994 and 1993 (in thousands). Sales, income and identifiable assets of the Dominican Republic are included in the U.S., Europe consists of the U.K. subsidiary, Russia and Georgia, and Pacific includes the Australian subsidiary and Papua New Guinea. ILTS / 13 16 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONT.)
Years Ended December 31, 1995 1994 ------------------------------------------- --------------------------------------------- Eastern Eastern Europe/ Consoli- Europe/ Consoli- USA Pacific Europe dated USA Pacific Europe dated - ------------------------------------------------------------------------------------------------------------------------------- Sales to unaffiliated customers: Export $ 15,006 $ -- $ -- $ 15,006 $ 19,923 $ -- $ -- $ 19,923 Domestic 513 2,614 508 3,635 946 2,612 608 4,166 - ------------------------------------------------------------------------------------------------------------------------------- Sales to: Australia subsidiary 508 -- -- 508 423 -- -- 423 - ------------------------------------------------------------------------------------------------------------------------------- 16,027 2,614 508 19,149 21,292 2,612 608 24,512 - ------------------------------------------------------------------------------------------------------------------------------- Elimination of inter- company sales (508) -- -- (508) (423) -- -- (423) - ------------------------------------------------------------------------------------------------------------------------------- Total revenue 15,519 2,614 508 18,641 20,869 2,612 608 24,089 - ------------------------------------------------------------------------------------------------------------------------------- Write-offs and write- downs of lottery service agreements -- -- (2,807) (2,807) (5,663) (3,000) (8,781) 17,444 - ------------------------------------------------------------------------------------------------------------------------------- Net income (loss) $(13,561) $ (76) $ (232) $(13,869) $(10,700) $(3,084) $ (8,836) $(22,620) - ------------------------------------------------------------------------------------------------------------------------------- Identifiable assets $ 19,572 $ 1,478 $ 302 $ 21,352 $ 27,952 $ 2,322 $ 1,614 $ 31,888 - -------------------------------------------------------------------------------------------------------------------------------
Years Ended December 31, 1993 ----------------------------------------- Eastern Europe/ Consoli- USA Pacific Europe dated - ---------------------------------------------------------------------------- Sales to unaffiliated customers: Export $ 21,141 $ -- $ 88 $ 21,229 Domestic 15 3,340 433 3,788 - ---------------------------------------------------------------------------- Sales to: Australia subsidiary 296 -- -- 296 - ---------------------------------------------------------------------------- 21,452 3,340 521 25,313 - ---------------------------------------------------------------------------- Elimination of inter- company sales (296) -- -- (296) - ---------------------------------------------------------------------------- Total revenue 21,156 3,340 521 25,017 - ---------------------------------------------------------------------------- Write-offs and write- downs of lottery service agreements -- -- -- -- - ---------------------------------------------------------------------------- Net income (loss) $ 372 $ 152 $ 81 $ 605 - ---------------------------------------------------------------------------- Identifiable assets $ 42,836 $5,124 $ 6,964 $ 54,924 - ----------------------------------------------------------------------------
6. LEASES The Company leases its facilities under operating lease agreements which expire at various dates through March 2002. 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, 1995, 1994, and 1993 was $674 thousand, $551 thousand, and $493 thousand respectively. Minimum future obligations for these leases are as follows (in thousands): 1996 - - $700; 1997 - $646; 1998 - $534; 1999 - $546; 2000 - $297, and $96 thereafter. In 1995, the Company purchased $209 thousand of equipment under capital lease obligations. Future minimum lease obligations for capital leases total $205 thousand and are due as follows: 1996 - $96 thousand, 1997 - $93 thousand and 1998 - $16 thousand; including total imputed interest of $18 thousand. 7. INCOME TAXES The provision (credit) for taxes based on income (loss) consists of the following (in thousands):
YEARS ENDED DECEMBER 31, 1995 1994 1993 - ------------------------------------------------------------------------------- Current: Federal provision $ -- $ -- $ 160 State provision -- -- 61 Foreign provision -- -- 24 Tax benefit of federal net operating loss carry forwards -- -- -- - ------------------------------------------------------------------------------- Total current -- -- 245 Deferred: Federal provision (credit) -- 88 (92) State provision -- 56 (56) - ------------------------------------------------------------------------------- Total deferred -- 144 (148) - ------------------------------------------------------------------------------- Total provision $ -- $144 $ 97 - -------------------------------------------------------------------------------
Income taxes differed from the amount calculated using the federal statutory rate of 34% as a result of the following (in thousands):
DECEMBER 31, 1995 1994 1993 - ------------------------------------------------------------------------------- Expected federal income tax (credit) at statutory rate $(4,715) $(7,642) $ 239 U.S. and foreign net operating losses - no benefit 4,715 7,642 -- State taxes net of federal income tax benefit -- -- 42 Effect of earnings of foreign subsidiaries subject to different tax rates -- -- 9 Benefit of U.S. and foreign business credit and net operating loss carryforwards -- -- (175) Other, net -- 144 (18) - ------------------------------------------------------------------------------- Total $ -- $ 144 $ 97 - -------------------------------------------------------------------------------
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): 14 / ILTS 17
YEARS ENDED DECEMBER 31, 1995 1994 - ------------------------------------------------------------------------------- Deferred tax liabilities: Computer software costs $ 225 $ 243 - ------------------------------------------------------------------------------- Total deferred tax liabilities 225 243 - ------------------------------------------------------------------------------- Deferred tax assets: Reserves against investment in lottery service agreements 235 6,940 Reserves and accruals 2620 1,540 Rent expense 160 177 Employee benefits 130 162 Patent expense 35 40 Net operating loss and credit carryforwards 12,120 1,515 Other 18 54 - ------------------------------------------------------------------------------- Total deferred tax assets 15,318 10,428 - ------------------------------------------------------------------------------- Net deferred tax assets 15,093 10,185 - ------------------------------------------------------------------------------- Valuation allowance (15,093) (10,185) - ------------------------------------------------------------------------------- Net deferred tax accounts $ -- $ -- - -------------------------------------------------------------------------------
The Company has Federal and California net operating losses of approximately $30.7 million and $14.7 million respectively, which will begin to expire in 1998 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 $575 thousand, which begin to expire in 1996. 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. Management believes such a change in ownership has not occurred. 8. COMMON STOCK In 1993, the Company sold 6.6 million shares of its common stock to Berjaya Lottery Management for total consideration of $35.3 million. Berjaya Lottery Management's interest in the Company represented approximately 39% of the total outstanding shares at December 31, 1995. In March and April 1993, the Company issued warrants to purchase a total of 502 thousand shares of the Company's common stock in conjunction with a private offering of subordinated notes. The notes were fully paid in October 1993. The warrants are exercisable at $4.31 per share and expire on March 17, 1996. In 1995, a warrant to purchase 500 thousand shares of the Company's common stock at $4.75 per share, which was issued in 1993 in conjunction with acquiring the Company's Russian lottery service agreement, was cancelled. The Company has three current Employee Stock Option Plans whereby options to purchase 2.6 million shares of the Company's common stock may be granted. Pursuant to these Plans, options for 1.1 million shares at prices ranging from $1.375 to $15.75 per share were outstanding at December 31, 1995. Options for .9 million shares were exercisable at December 31, 1995. In September 1993, the Company adopted a Directors Option Plan under which 240 thousand shares of the Company's common stock may be granted only to outside directors of the Company. Pursuant to this Plan, the Company has issued options totaling 180 thousand shares, at prices ranging from $2.219 to $10.25 per share. At December 31, 1995, 180 thousand shares were outstanding and 60 thousand shares were exercisable. At December 31, 1995 there were 1.8 million shares reserved for issuance in connection with all of the Company's outstanding options and warrants. 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 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 $198 thousand, $272 thousand, and $245 thousand in 1995, 1994 and 1993 respectively. 9. MCKINNIE & ASSOCIATES On March 31, 1993, the Company sold its subsidiary, McKinnie & Associates, Inc. to Shreveport Acquisition for cash and a note. The recorded balance of the receivable on the McKinnie sale of $49 thousand is included in the December 31, 1995 balance sheet with accounts receivable. Unrecorded gain and interest of $1.5 million will be recognized using the cost recovery method as payments are received. 10. LITIGATION In June and July 1994, shareholders of the Company filed class action lawsuits against the Company and several of its officers and directors. Those actions were consolidated by stipulation and order and are now pending in the United States District Court for the Southern District of California. Plaintiffs contend 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. Attorneys for all defendants have executed a stipulation settlement with the law firm representing the plaintiffs. The proposed settlement includes a cash payment and 1.2 million authorized but unissued common shares of the Company, and is subject to agreement by the shareholders included in the class period and approval by the court. Accordingly, a provision for the proposed settlement has been included in the consolidated financial statements, which includes an estimate of the value of the shares at date of issuance as a current liability. 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 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. The Company and Mr. Brunn deny all allegations in Mr. Walters' complaint and will defend the litigation accordingly. Since the outcome of the case is not expected to result in any liability to the Company, no provision for any liability that may result has been included in the consolidated financial statements. ILTS / 15 18 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 sheets of International Lottery & Totalizator Systems, Inc. as of December 31, 1995 and 1994 and the related consolidated statements of operations, shareholders' equity and cash flows for each of the three years in the period ended December 31, 1995. 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 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 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 & Totalizator Systems, Inc. at December 31, 1995 and 1994, and the consolidated results of its operations and its cash flows for each of the three years in the period ended December 31, 1995, in conformity with generally accepted accounting principles. /s/ Ernst & Young LLP Ernst & Young LLP San Diego, California February 9, 1996 16 / ILTS 19 CORPORATE AND COMMON SHARE INFORMATION DIRECTORS Theodore A. Johnson Chairman of the Board Frederick A. Brunn President Chan Kien Sing Group Executive Director, Berjaya Group Berhad M. Mark Michalko Executive Vice President Martin J. O'Meara, Jr. President, The Budget Plan, Inc. Ng Foo Leong Executive Director, Sports Toto Malaysia Sdn Bhd Sir Michael G.R. Sandberg Private Investor Tan Sri Dato Vincent Tan Chee Yioun Group Chief Executive Officer, Berjaya Group Berhad OFFICERS Frederick A. Brunn President Timothy R. Groth Vice President, Technical Operations William A. Hainke Chief Financial Officer, Corporate Secretary and Treasurer M. Mark Michalko Executive Vice President Lennart K. Sundin Senior Vice President, Marketing and Sales MARKET FOR COMMON STOCK The Company's common stock is traded under the symbol ITSI on the NASDAQ National Market System. At December 31, 1995, there were 16,816,211 common shares outstanding and 896 shareholders of record. Berjaya Lottery Management owned 39% of the total outstanding shares and the Company's management owned 1%.
1995 HIGH LOW First Quarter 4-7/8 1-15/16 Second Quarter 4-3/8 1-7/8 Third Quarter 3-3/8 2-1/8 Fourth Quarter 2-11/16 15/16 Average Daily Volume 52,267 Total Annual Trading Volume 13,171,342 1994 HIGH LOW First Quarter 15-7/8 9-7/8 Second Quarter 11 4 Third Quarter 6-1/2 4-3/8 Fourth Quarter 5 2-1/2 Average Daily Volume 77,660 Total Annual Trading Volume 19,570,320
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 may be obtained by contacting: Investor Relations ILTS 2131 Faraday Avenue Carlsbad, CA 92008-7297 USA (619) 931-4027 ANNUAL MEETING OF SHAREHOLDERS The 1996 Annual Meeting will be held at 3:00 p.m. PDT on Thursday, June 6, 1996, at Pea Soup Andersen's 850 Palomar Airport Road, Carlsbad, California, (619) 438-0880. Shareholders and interested parties are invited to attend. TRANSFER AGENT AND REGISTRAR Stock Transfer Administration First Interstate Bank, Ltd. P.O. Box 54261 Los Angeles, CA 90054-0261 USA (213) 614-2404 LEGAL COUNSEL Lawrence E. Logue General Counsel ILTS 2131 Faraday Avenue Carlsbad, CA 92008-7297 USA (619) 931-4000 INDEPENDENT AUDITORS Ernst & Young LLP 501 West Broadway, Suite 1100 San Diego, CA 92101-3536 USA (619) 235-5000 INVESTOR RELATIONS ILTS 2131 Faraday Avenue Carlsbad, CA 92008-7297 USA (619) 931-4027 To receive Company information via facsimile, call the Investor Relations Hotline: 1-800-859-5903 Designed and produced by GornKellerMartinez, Inc., Del Mar, California 20 [PHOTO OF CORPORATE OFFICE] HEADQUARTERS International Lottery & Totalizator Systems, Inc. 2131 Faraday Avenue Carlsbad, CA 92008-7297 USA Tel: (619) 931-4000 Fax: (619) 931-1789 TECHNICAL AND MARKETING/SALES SUPPORT FACILITIES United Kingdom Totalizator Systems (UK) Ltd. 241 Horton Road Yiewsley, West Drayton Middlesex, UB7 8HT ENGLAND Tel: (44) (1895) 449550 Fax: (44) (1895) 420600 Australia International Lottery & Totalizator Systems Australia Pty. Ltd. IA, 167 Prospect Highway Seven Hills, New South Wales 2147 AUSTRALIA Tel: (61) (2) 624-4300 Fax: (61) (2) 674-6832 SALES OFFICES Asia Pacific Sales Office Christina Bldg. Unit 304 Herrera Corner Legaspi Sts. Legaspi Village, Makati PHILIPPINES Tel: (63) (2) 816-6989 Fax: (63) (2) 815-3270 Scandinavia/Europe ITS Europe Vollsveien 168 N-1343 Eiksmarka NORWAY Tel: (47) (67) 14 73 76 Fax: (47) (67) 14 80 68 [INTERNATIONAL LOTTERY & TOTALIZATOR SYSTEMS, INC. LOGO] Visit the ILTS Home Page: http://www.ilts.com International Lottery & Totalizator Systems, Inc.(TM) and DATAMARK(R) are registered trademarks of International Lottery & Totalizator Systems, Inc. Registered to ISO 9001 Certificate No. 43960 EX-21 3 SUBSIDIARIES OF THE REGISTRANT 1 EXHIBIT 21 SUBSIDIARIES OF THE REGISTRANT The Registrant had 13 wholly-owned subsidiaries as of December 31, 1995: ITS Export, Inc., a California corporation; ITS Overseas, Inc., a California corporation; ITS Service Corp., a California corporation; ITS Service Corp. II, a California corporation; ITS Service Corp. III, a California corporation; Amer-Russ Firebird Lottery, Inc., a Delaware corporation; Air Fair, Inc., a California corporation; ILTS (Brazil), Inc., a California corporation; ITS Virgin Islands, a Virgin Island corporation; International Lottery & Totalizator Systems Australia Pty. Ltd., an Australia corporation; Totalizator Systems (UK) Ltd., a United Kingdom corporation; Zodiac On-Line, a Russian corporation, and Transactional Systems, a Russian corporation. EX-23 4 CONSENT OF ERNST & YOUNG LLP 1 EXHIBIT 23 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 9, 1996 included in the 1995 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). 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. 2-99618) pertaining to the 1982 Employee Stock Option Plan, (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 of International Lottery & Totalizator Systems, Inc., (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 9, 1996, with respect to the 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, 1995. ERNST & YOUNG LLP San Diego, California March 15, 1996 EX-27 5 FINANCIAL DATA SCHEDULE
5 1,000 12-MOS DEC-31-1995 DEC-31-1995 3,904 0 1,588 0 6,820 16,619 1,361 0 21,352 7,831 0 0 0 48,687 (35,275) 21,352 18,641 18,641 20,263 32,862 0 60 46 (13,869) 0 (13,869) 0 0 0 (13,869) (0.83) 0
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