-----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, WuZwX6ho1pn8LxcYAofi8j6RJU2QGhFP+LeIgbNLbvz73a5I08DzIYJSid5GDZkn QMBd8VvaVmOQcWVeJEXDMw== 0000950123-99-004522.txt : 19990513 0000950123-99-004522.hdr.sgml : 19990513 ACCESSION NUMBER: 0000950123-99-004522 CONFORMED SUBMISSION TYPE: 10-K405 PUBLIC DOCUMENT COUNT: 9 CONFORMED PERIOD OF REPORT: 19990227 FILED AS OF DATE: 19990512 FILER: COMPANY DATA: COMPANY CONFORMED NAME: GTECH HOLDINGS CORP CENTRAL INDEX KEY: 0000857323 STANDARD INDUSTRIAL CLASSIFICATION: SERVICES-COMPUTER PROGRAMMING, DATA PROCESSING, ETC. [7370] IRS NUMBER: 050450121 STATE OF INCORPORATION: DE FISCAL YEAR END: 0223 FILING VALUES: FORM TYPE: 10-K405 SEC ACT: SEC FILE NUMBER: 001-11250 FILM NUMBER: 99618846 BUSINESS ADDRESS: STREET 1: 55 TECNOLOGY WAY CITY: WEST GREENWICH STATE: RI ZIP: 02817 BUSINESS PHONE: 4013921000 MAIL ADDRESS: STREET 1: 55 TECHNOLOGY WAY STREET 2: LEGAL DEPARTMENT CITY: WEST GREENWICH STATE: RI ZIP: 02817 10-K405 1 GTECH HOLDINGS CORPORATION 1 FORM 10-K SECURITIES AND EXCHANGE COMMISSION Washington, DC 20549 ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the fiscal year ended: February 27, 1999 Commission File No: 1-11250 GTECH HOLDINGS CORPORATION Delaware 05-0450121 (State or other jurisdiction (IRS Employer ID Number) of incorporation or organization) 55 Technology Way, West Greenwich, Rhode Island 02817 (401) 392-1000 (Address and telephone number of Principal Executive Offices) Securities registered pursuant to Section 12(b) of the Act: Title of Each Class: Common Stock $.01 par value Name of Each Exchange on which Registered: New York Stock Exchange 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 twelve 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. [X] Indicate by check mark if disclosure of delinquent filers pursuant to Rule 405 of Regulation S-K is not contained herein, and will not be contained, to the best of registrant's knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendments to this Form 10-K. [x] The aggregate market value of the registrant's Common Stock (its only voting stock) held by non-affiliates of the registrant as of May 3, 1999 was $987,743,750. (Reference is made to Page 39 herein for a statement of the assumptions upon which this calculation is based.) On May 3, 1999, there were outstanding 37,556,150 shares of the registrant's Common Stock. Documents Incorporated By Reference: Certain portions of the registrant's 1999 definitive proxy statement relating to its scheduled July 1999 Annual Meeting of Shareholders (which proxy statement is expected to be filed with the Commission not later than 120 days after the end of the registrant's last fiscal year) are incorporated by reference into Part III of this report. 2 PART I ITEM 1. BUSINESS GENERAL GTECH Corporation ("GTECH") is the world's leading operator of computerized online lottery systems and the wholly owned subsidiary of GTECH Holdings Corporation ("Holdings"; collectively with its direct and indirect subsidiaries, including GTECH, the "Company"). The Company currently operates, or supplies equipment to, online lottery systems for 29 of the 38 online lottery authorities in the United States and has supplied, currently operates or has entered into contracts to operate in the future online lottery systems for 52 of the 84 international online lottery authorities. The Company, seeking to develop growth opportunities outside of the online lottery industry, is actively involved in the pursuit of other gaming and entertainment opportunities, such as venue-based gaming and video lottery. The Company also is considering expanding into other complimentary areas of business, especially those involving transaction processing. Since the establishment of the first online lottery in 1975, the online lottery industry has experienced substantial growth, as governments have increasingly relied on lotteries as a non-tax source of revenue. After a number of years of growth, the Company has witnessed over the past two years a downward trend in the sales generated by its United States lottery customers. During calendar 1998, ticket sales in the online lottery industry were approximately $20.1 billion in the United States, representing a decline of approximately 6% from online lottery ticket sales in the United States during calendar 1997. During fiscal 1999 (which ended February 27, 1999), lottery sales by the Company's domestic customers declined approximately 2% from fiscal 1998 levels, resulting in a decline in the Company's domestic service revenues of 5.6%. Notwithstanding this, worldwide sales by the Company's lottery customers increased approximately 5% in fiscal 1999 over fiscal 1998. See "Item 7 - Management's Discussion and Analysis of Financial Condition and Results of Operations" below. The Company's core business consists of providing online lottery services and products to governmental lottery authorities and governmental licensees worldwide. The Company offers its customers a full range of lottery services, including the design, assembly, installation, operation, maintenance and marketing of online lottery systems and instant ticket support systems and services. The Company's lottery systems consist of numerous lottery terminals located in retail outlets, central computer systems, systems software and game software, and communications equipment which connects the terminals and the central computer systems. Historically, the majority of the Company's lottery customers in the United States have entered into long-term service contracts pursuant to which the Company provides, operates and maintains the customers' online lottery systems in return for a percentage of the gross lottery revenues. Many of the Company's international lottery customers have purchased their online lottery systems, although some, especially lottery authorities in Eastern Europe and Latin America, have entered into long-term service contracts with the Company. In recent years there has been, in general, an industry movement away from product sales in favor of long-term service contracts. In fiscal 1993, approximately 70% of the Company's lottery revenues were 3 derived from its portfolio of long-term online lottery service contracts with substantially all of the remainder being derived from lottery product sales. In fiscal 1999, approximately 95% of the Company's lottery revenues were derived from online lottery service contracts. As anticipated, product sales declined from $122.0 million in fiscal 1998 to $85.5 million in fiscal 1999. Notwithstanding this, and the general industry trend away from product sales described above, the Company currently anticipates that revenues attributable to product sales to lotteries during fiscal 2000 are likely to return to approximately fiscal 1998 levels. In recent years, lottery authorities have recognized that by offering new games or products, they often are able to generate significant additional revenues. An important part of the Company's strategy is to develop new products and services for its customers in order to increase their lottery revenues. The Company's principal online products and services introduced in recent years consist of keno, instant ticket support systems and services and televised lottery programs such as BingoVision(TM). Keno, an online lottery game which features drawings as often as every five minutes, was first introduced by the Company and the Lotteries Commission of South Australia in 1990 and subsequently has been introduced successfully by the Company and lottery authorities in 20 additional jurisdictions on four continents. The Company currently provides instant ticket support services, products and systems in 26 domestic jurisdictions and 13 jurisdictions outside of the United States. In recent years, the Company has offered customers television lottery games. BingoVision(TM), the Company's best known television game, is a televised bingo-based lottery game which is played in 10 jurisdictions. During fiscal 1999, the Company augmented its game design expertise by acquiring 80% of the equity of Europrint Holdings Ltd. and its wholly-owned subsidiary, Interactive Games International, which pioneered the development of interactive, televised lottery games, including BingoVision(TM). See "Certain Significant Developments Since the Start of Fiscal 1999" and "Products and Services Introduced in Recent Years" below. During fiscal 1999, the Company announced that it had established a business unit, UWin!(TM), to provide internet-based interactive games to its international customers in the government-sponsored lottery market. In May 1999, after the close of fiscal 1999, the Company entered into a contract with the An Post National Lottery Company, the Irish lottery authority, to provide, maintain and operate its UWin!(TM) internet solution in the Republic of Ireland through March 2000. See "Certain Significant Developments Since the Start of Fiscal 1999" and "Products and Services Introduced in Recent Years" below. In recent years, the Company also has broadened its product lines outside of its core business of providing online lottery services and products. In September 1995, the Company incorporated its Dreamport, Inc. ("Dreamport") subsidiary, to pursue gaming opportunities other than online lottery, including video lottery and venue-based gaming. Dreamport now provides a comprehensive array of creative management and technology solutions and development and strategic services to the gaming and entertainment markets, as well as video lottery systems and other gaming technology. Dreamport, through a joint venture with Full House Resorts, Inc., provides financing, gaming development and management services to the Midway Slots and Simulcast emporium at Harrington Raceway in Delaware and the Huron Potawatomi Tribe in Battle Creek, Michigan, which recently entered into a tribal 2 4 compact with the State of Michigan. Dreamport currently independently provides machine gaming video lottery products and services to 10 jurisdictions worldwide. During fiscal 1999, Dreamport, in equal partnership with Harrah's Entertainment, Inc. and Keeneland Association, purchased the assets of Turfway Park, a thoroughbred race course in Florence, Kentucky. See "Certain Significant Developments Since the Start of Fiscal 1999" below. Since August 1993, the Company, principally through its wholly-owned subsidiary, Transactive Corporation ("Transactive"), has been in the business of providing electronic benefits delivery ("EBT") systems and services on behalf of government authorities. During fiscal 1998, the Company announced that it had entered into an agreement to sell to Citicorp Services, Inc., a subsidiary of Citicorp ("Citicorp Services"), certain of its EBT contracts, subject to receiving necessary customer consents and regulatory approvals, and that it had decided not to pursue future opportunities that may arise in the electronic benefits delivery industry. During fiscal 1999, the Company reported that the U.S. Department of Justice had commenced a legal action to enjoin the consummation of the transaction on anti-trust grounds and, subsequently, that Citicorp Services had terminated the agreement to purchase certain of Transactive's EBT contracts. The Department of Justice's legal proceeding was dismissed as a result of this termination, and the Company announced that it would continue to perform all EBT contracts through their terms. See "Certain Significant Developments Since the Start of Fiscal 1999," below. GTECH was founded in 1980. Holdings acquired GTECH in a leveraged buy-out, in which members of then-senior management of GTECH participated, that was completed in February 1990. The Company's principal executive offices are located at 55 Technology Way, West Greenwich, Rhode Island 02817, and its telephone number is (401) 392-1000. 3 5 CERTAIN FACTORS THAT MAY AFFECT FUTURE PERFORMANCE The future performance of the Company's business is subject to the factors set forth below, as well as the other considerations described elsewhere herein. Certain statements contained in this Report are forward looking statements within the meaning of Section 27A of the Securities Act and Section 21E of the Securities Exchange Act of 1934. Such statements include, without limitation, statements relating to (i) the future prospects for and stability of the lottery industry and other businesses in which the Company is or expects to be engaged, (ii) the future operating and financial performance of the Company, (iii) the ability of the Company to retain existing business and to obtain and retain new business, (iv) the Company's program to address potential issues relating to the change of date to January 1, 2000 ("Year 2000"), and (v) the results and effects of legal proceedings and investigations. Such forward looking statements reflect management's assessment based on information currently available, but are not guarantees and are subject to risks and uncertainties which could cause actual results to differ materially from those contemplated in the forward looking statements. These risks and uncertainties include but are not limited to those set forth herein and in the Company's press releases and its Forms 10-K, 10-Q, 8-K and other reports and filings with the Securities and Exchange Commission (the "SEC"). GOVERNMENTAL REGULATION In the United States, lotteries are not permitted in a particular jurisdiction unless expressly authorized by law in such jurisdiction. Once authorized, the ongoing operation of a lottery is highly regulated. Lottery authorities, which generally conduct an intensive investigation of the Company and its employees prior to and after the award of a lottery contract, may require the removal of any Company employees deemed to be unsuitable and are generally empowered to disqualify the Company from receiving a lottery contract or operating a lottery system as a result of any such investigation. Certain jurisdictions also require extensive personal and financial disclosure and background checks from persons and entities beneficially owning a specified percentage (typically 5% or more) of the Company's securities. The failure of such beneficial owners to submit to such background checks and provide such disclosure could jeopardize the award of a lottery contract to the Company or provide grounds for termination of an existing lottery contract. The international jurisdictions in which the Company markets its lottery systems also usually have legislation and regulations governing lottery operations. The regulation of lotteries in these international jurisdictions typically varies from the regulation of lotteries in the United States. In addition, restrictions are often imposed on foreign corporations seeking to do business in such jurisdictions. As a result, the Company has found it desirable in a number of instances to ally itself as a subcontractor or joint venture partner with one or more local companies in seeking international lottery contracts. 4 6 MAINTENANCE OF BUSINESS RELATIONSHIPS AND CERTAIN LEGAL MATTERS A significant portion of the Company's revenues and cash flow is derived from its portfolio of long-term online lottery service contracts. The Company's online lottery service contracts typically have an initial term of five years and usually provide the customer with options to extend the contract under the same terms and conditions for additional periods generally ranging from one to five years. The Company's customers have generally exercised some or all of the extension options under their contracts or negotiated extensions on different terms and conditions. Upon the expiration of a contract, lottery authorities may award new contracts through a competitive procurement process. There can be no assurance that, in the future, the Company's contracts will be extended or that it will be awarded new contracts as a result of competitive procurement processes. The Company's lottery contracts typically permit a lottery authority to terminate the contract at any time for failure to perform and other specified reasons, and many of such contracts permit the lottery authority to terminate the contract at will and do not specify the compensation, if any, to which the Company would be entitled were such termination to occur. The termination of or failure to renew one or more lottery contracts could, depending upon the circumstances, have a material adverse effect on the Company's business, financial condition and results and prospects. The Company regularly engages public affairs and governmental relations advisors, including lobbyists, in various jurisdictions to advise legislators, other governmental officials and the public in connection with lottery legislation, to monitor potential lottery legislation and to advise the Company in connection with the Company's lottery proposals. The Company also makes contributions to various political parties and associations but does not make contributions to individual candidates or their campaigns. As previously publicly reported, in October 1994, the U.S. Attorney's Office for the District of New Jersey indicted J. David Smith, the former sales manager of the Company (who resigned in early 1994 for reasons unrelated to the indictments), and two other individuals who served as consultants to the Company through their wholly-owned company, The Benchmark Group, Inc. ("Benchmark"). The indictment alleged essentially that, unbeknownst to the Company, Mr. Smith had received kickbacks from the consultants for his own benefit. The indictment did not charge the Company with any wrongdoing, and the actions complained of did not affect the Company's New Jersey lottery operations. The trial of Mr. Smith and the two consultants commenced in September 1996 in the U.S. District Court for New Jersey, and on October 4, 1996, Mr. Smith and one of the two consultants were found guilty of all charges. The other consultant, Joseph LaPorta, was found not guilty. The New Jersey U.S. Attorney immediately announced in a press release that a grand jury investigation in that jurisdiction was continuing but did not specify the scope of such investigation. In the midst of these events, the New Jersey Lottery Commission awarded the Company a contract to continue operating its State lottery. In October 1998, the Court sentenced Mr. Smith to a prison term of 63 months, ordered him to pay restitution to the Company in the amount of $169,500 and fined him $20,000. Mr. Smith filed a notice of appeal in the United States Court of Appeals for the Third Circuit and in April 1999 oral argument on this appeal was heard. In November 1998, the U.S. Attorney's Office for the 5 7 District of New Jersey advised the Company that currently GTECH is not the subject or target of an ongoing grand jury investigation by that office. In 1995, the Texas U.S. Attorney's Office also issued grand jury document subpoenas to the Company, and the Company has cooperated with this investigation. In February 1999, a witness appearing before the Moriarty Tribunal, an investigative body convened by the Irish Parliament and chaired by Mr. Justice Moriarty to investigate the business affairs generally of former Taoiseach (Prime Minister) of Ireland Charles Haughey, testified that in February 1993 Guy B. Snowden, then Chief Executive Officer of the Company, had invested pound sterling 67,000 (approximately $100,000) of his personal funds in a company owned by Mr. Haughey's son. Mr. Haughey had resigned as Taoiseach in February 1992. In July 1992, the An Post Irish National Lottery Company, the Irish lottery authority (the "NLC"), issued a Request for Proposals respecting online and instant ticket lottery goods and services, and in September 1992 the Company, which was the then incumbent provider of lottery goods and services to the NLC under an agreement awarded to the Company in 1987, submitted a Proposal to the NLC in response to the NLC's Request for Proposals. In November 1992, the NLC selected the Company to provide online and instant ticket goods and services to the NLC under the terms of the competitive procurement and, following negotiations, a definitive agreement was entered into between the NLC and the Company in March 1993. The Tribunal has requested that the Company provide various documents regarding the Company's business in Ireland. The Company is cooperating with the Tribunal. In addition, the Company has made its own inquiry into the facts surrounding Mr. Snowden's investment and the extent, if any, of the Company's involvement in or knowledge of that investment. The Company's investigation has determined that no Company funds were used to make Mr. Snowden's investment, and there is no information to suggest that Mr. Snowden ever sought reimbursement for the investment from the Company. Further, there is no information to suggest that Mr. Snowden informed anyone else at the Company of his investment at the time or that his investment was related in any way to the renewal of the Company's contract to supply systems and support to the NLC. Mr. Snowden has advised the Company through counsel that (i) his investment was a strictly personal one, (ii) the investment was made from his personal funds, (iii) he never sought reimbursement for any portion of his investment from the Company or any other entity, and (iv) his investment was not related to the NLC and was not intended to and did not influence the NLC's decision to renew the Company's contract. No charges of wrongdoing have ever been brought against the Company by any grand jury or other governmental authority. The Company does not believe that it has engaged in any wrongdoing in connection with these matters. However, since current investigations are still or maybe underway and are conducted in whole or in part in secret, the Company lacks sufficient information to determine with certainty their ultimate scope and whether the government authorities will assert claims resulting from these or other investigations that could implicate or reflect adversely upon the Company. Because the Company's reputation for integrity is an important factor in its business dealings 6 8 with lottery and other governmental agencies, if government authorities were to make an allegation of, or if there were to be a finding of, improper conduct on the part of or attributable to the Company in any matter, such an allegation or finding could have a material adverse effect on the Company's business, including its ability to retain existing contracts and to obtain new or renewal contracts. In addition, continuing adverse publicity resulting from these investigations and related matters could have such a material adverse effect. In November 1998, Benchmark and Joseph LaPorta, the consultant and shareholder of Benchmark who was found not guilty in the criminal proceeding described in the paragraph above respecting J. David Smith, filed suit in the Superior Court of New Jersey (Atlantic County - Law Division) against GTECH and Victor Markowicz, the Company's former Co-Chairman, alleging that GTECH had wrongfully terminated and otherwise breached a May 1992 contract, as amended, between the Company and Benchmark pursuant to which Benchmark provided government relations services on behalf of GTECH in New Jersey. The complaint filed by Benchmark and Mr. LaPorta also alleged that GTECH had breached an implied covenant of good faith and fair dealing by allegedly authorizing and directing Benchmark to make payments that were not within the contemplation of the contract and by terminating its contract with Benchmark after allegedly receiving substantial benefits from Benchmark; that GTECH had committed fraud upon Benchmark by allegedly making knowingly false representations to Benchmark prior to termination of the May 1992 contract; and that GTECH and Mr. Markowicz had committed fraud upon and had made negligent representations to Benchmark by allegedly concealing that certain payments which the Company is said to have directed that Benchmark make to third parties were allegedly made for the personal benefit of Mr. Markowicz and unspecified others. The complaint seeks unspecified compensatory and punitive damages and costs and such other further relief as the Court deems equitable and just. In December 1998, the Company filed a motion to dismiss, or in the alternative for summary judgment. The Company believes that Benchmark's complaint, and the allegations underlying the complaint, are wholly without merit. The Company intends to continue to vigorously defend itself in these proceedings. In December 1998, Lawrence Littwin, the former Executive Director of the Texas Lottery Commission from June 1997 to October 1997, filed suit against GTECH in the United States District Court for the Northern District of Texas alleging that GTECH, as operator of the Texas lottery, unlawfully attempted to have Mr. Littwin removed as Executive Director of the Texas Lottery Commission in order to continue its alleged unlawful control of the Texas Lottery Commission and the Texas lottery. The specific causes of action alleged by Mr. Littwin include alleged tortious interference by GTECH with Mr. Littwin's employment relationship with the Texas Lottery Commission which caused him to be removed as the Executive Director; alleged conspiracy with unspecified third parties to maintain control of the Texas Lottery Commission and the Texas lottery; and various alleged civil violations by GTECH of the Racketeer Influenced Corrupt Organization Act (18 Sections 1961(4) and 1962(b), (c) and (d)) ("RICO"). Mr. Littwin's complaint seeks unspecified damages (including treble damages in the case of RICO violations) and costs. Discovery is proceeding in this matter. The Company believes that Mr. Littwin's complaint, and the allegations underlying the complaint, are wholly without merit. The Company continues to vigorously defend itself in these proceedings. 7 9 FLUCTUATION OF QUARTERLY OPERATING RESULTS The Company has experienced and may continue to experience significant fluctuations in operating results from quarter to quarter due to such factors as the amount and timing of product sales, the occurrence of large jackpots in lotteries (which increase the amount wagered and the Company's revenue) and expenses incurred in connection with lottery start-ups and other new ventures. LIQUIDATED DAMAGES UNDER CONTRACTS The Company's lottery contracts typically permit termination of the contract at any time for failure of the Company to perform and for other specified reasons and generally contain demanding implementation schedules and performance schedules. Failure to perform under such contracts may result in substantial monetary liquidated damages, as well as contract termination. Many of the Company's lottery contracts also permit the lottery authority to terminate the contract at will and do not specify the compensation, if any, to which the Company would be entitled should such termination occur. Certain of the Company's United States lottery contracts have contained provisions for up to $700,000 a day in liquidated damages for late system start-up and provide for up to $10,000 or more in penalties per minute for system downtime in excess of a stipulated grace period, and certain of the Company's international customers (most notably the United Kingdom's National Lottery) similarly reserve the right to assess substantial monetary damages in the event of contract termination or breach. Although such liquidated damages provisions are customary in the lottery industry and the actual liquidated damages imposed are generally subject to negotiation, such provisions in the Company's lottery contracts present an ongoing potential for substantial expense. Liquidated damages are generally deducted directly from revenues the Company has otherwise earned from the lottery authorities and are budgeted by the Company on an annual basis. Lottery contracts generally require the vendor (i.e., the Company) to post a performance bond, which in some cases may be substantial, securing the vendor's performance under such contracts. Liquidated damages paid or incurred by the Company with respect to its contracts equaled 0.50%, 0.23%, 0.25%, 0.21% and 0.35% of annual revenues in each of the five fiscal years ending February 1995 through 1999, respectively. IMPACT OF YEAR 2000 Many computer programs, including those used by the Company and its suppliers and customers, use only two digits to identify a year and were not designed to handle years beginning after 1999. This Year 2000 computer issue creates potentially significant risks for the Company. If lottery, gaming or EBT systems that the Company supplies to customers, or management information systems that the Company uses internally, do not correctly recognize and process date information beyond the year 1999, there could be an adverse impact on customers' and/or the Company's operations. See Item 7, "Management's Discussion and Analysis of Financial Condition and Results of Operations" below. 8 10 GAMING OPPOSITION While the Company believes that legalized gaming, especially lottery, generally enjoys widespread public support, gaming opponents have continued to persist in efforts to curtail the expansion of legalized gaming. Recently, for example, the National Gaming Impact Study Commission, a commission created by the U.S. Congress in 1997 to study the economic and social effects of legalized gambling, narrowly voted to endorse a non-binding recommendation for a moratorium on the spread of casinos, lotteries and slot machines in the United States. STRENGTHENING OF COMPETITION The online lottery industry is increasingly competitive in the United States and internationally, which increased competition could adversely affect the Company's ability to win renewals of contracts from its existing customers and to win contract awards from other lottery authorities. In addition, such increased competition may affect the profitability of contracts which the Company does obtain. Through fiscal 2001 (which ends in February 2001), a number of the Company's larger contracts are expected to come up for renewal, including its contracts with the lottery authorities of New York, Ohio, Brazil (National Lottery) and the United Kingdom. See "Competition" below. FOREIGN CURRENCY EXCHANGE RATES Foreign currency exchange exposure arises from currency transactions and anticipated transactions denominated by the Company in a currency other than U.S. dollars and from the translation by the Company of foreign currency balance sheet accounts into U.S. dollar balance sheet accounts. The Company employs a variety of strategies in its effort to mange its substantial foreign currency exchange exposure. See Item 7, "Management's Discussion and Analysis of Financial Condition and Results of Operation" below. CERTAIN SIGNIFICANT DEVELOPMENTS SINCE THE START OF FISCAL 1999 LOTTERY CONTRACT AWARDS AND RELATED SIGNIFICANT DEVELOPMENTS Since the start of fiscal 1999 (which ended on February 27, 1999) the Company has received a number of service contract awards and extensions from lottery authorities. NEW-ONLINE CUSTOMERS. During fiscal 1999, the Company received awards to install online lottery systems from two new online customers, and commenced online sales under a contract 9 11 signed in late fiscal 1998 with a third new online customer. In October 1998, the Company announced that it had signed a product sales and services contract to supply online lottery equipment, software and services to New South Wales Lotteries Corporation following a competitive procurement. Under the terms of the contract, the Company will replace the Lottery's existing system with new central system hardware and PRO:SYS(TM) software. In addition, the Company will replace the Lottery's existing terminal equipment with the Company's new Altura(TM) terminal, the Company's latest generation online terminal. Also in October 1998, the Company announced that following a competitive procurement it had been selected to provide under a product sales and services contract a fully integrated gaming system, consisting of online lottery equipment, software and services, to Mifal Hapayis, the Israeli National Lottery. Online lottery sales are scheduled to commence under the New South Wales Lotteries Corporation and Mifal Hapayis contracts in March 2000 and August 1999, respectively. In addition, in March 1998, online lottery sales commenced under the agreement which it entered into in February 1998, prior to the start of fiscal 1999, with Sport Toto Teskilat Mudurlugu (Sports Toto Organization Directorate), the Company's second lottery customer in Turkey. Under the terms of this agreement, the Turkish sports betting organization shares an existing lottery system provided by the Company to Milli Piyango, the Turkish National Lottery. In addition to contracts to provide online systems to the new customers described above, in September 1998, the Company signed an agreement to provide BingoVision(TM), the Company's online lottery game which combines a bingo drawing with a television game show, and related services to five German state lotteries: Berlin, Brandenburg, Saxony, Saxony-Anhalt and Thuringen. The Company is currently the online vendor to two of these states, Saxony and Thuringen. The Company will provide the technology to enable the online vendors in Berlin, Brandenburg and Saxony-Anhalt to offer the game. This contract marks the first implementation of a Company lottery game in a jurisdiction where the Company is not the primary vendor. OTHER NEW ONLINE CONTRACTS AND EXTENSIONS. Since the start of fiscal 1999, the Company has been awarded new online service contracts by, or has received contract extensions from, a number of its existing customers. In March 1998, the Company announced that it had signed a new eight year facilities management contract with the Michigan lottery authority to provide an online lottery system and services. In February 1999, the Company entered into a new five year contract to provide online products and services to the Arizona lottery, including new central system hardware, PRO:SYS(TM) online gaming software and approximately 2,500 ISYS(TM) terminals. The award has two one-year extension options and followed a competitive procurement. In November 1998, the Company announced that it had been selected under a three year agreement to provide and to service the California lottery authority with instant ticket vending machines leased from On-Point Technology Systems, Inc., a premier supplier of automated, self-service lottery ticket vending machines. In March 1999, after the close of fiscal 1999, the Company announced it signed a new six-year facilities management contract to provide online lottery products and services to Loteria Electronica de Puerto Rico. 10 12 In October 1998, the Company, reporting its sole loss in a competitive procurement for fiscal 1999, announced that the Indiana lottery authority had awarded a contract to provide equipment and services for a new online lottery system to a competitor of the Company. In addition to entering into the new facilities management contracts described above, the Company entered into a number of significant product sale agreements with existing customers since the start of fiscal 1999. In March 1998, the Company announced that it had completed the first installation of its PRO:SYS(TM) system in Asia under a product sales agreement with Singapore Pools (Private) Limited and in February 1999, the Company announced that it had signed another product sales agreement with this customer for the development and installation of sports betting games. In May 1998, the Company entered into a new contract to provide online lottery equipment, software and services under a product sale and multi-year service agreement with South Australia Lotteries Corporation. In July 1998, the Company announced that it had signed a product sale and service agreement with AB Svenska Spel, a Swedish lottery authority, to provide the latest version of its PRO:SYS(TM) software system, barcode readers for the lottery's online retailers, GVT instant ticket validators and network support equipment. In July 1998, the Company also announced that it had entered into a product sales agreement to provide online lottery equipment and services to DeLotto Stichting de Nationale Sporttotalisator of the Netherlands following a competitive procurement. In December 1998, the Company announced that it had signed a new contract with La Loterie Nationale de Belgique, Belgium's National Lottery. In January 1999, the Company announced that it had entered into a new product sales agreement with Dansk Tipstjeneste, Denmark's National Lottery operator, to replace the lottery's existing terminals. In February 1999, the Company signed a product sales agreement with Sports Toto Malayasia Sdn. Bhd. for the Company's Spectra II terminals. Also in February 1999, the Company announced that it had entered into a new product sales and services agreement to provide online lottery products and services to the Idaho lottery authority. In addition, since the start of fiscal 1999, the lottery authorities of Colorado, Denmark, New York, Nebraska and Ohio have extended the terms of their online contracts with the Company. DREAMPORT AND NON-LOTTERY GAMING Since the start of fiscal 1999, there have been several significant developments respecting the Company's non-lottery gaming and entertainment business. In July 1998, the Company announced that it had entered into an agreement with la Societe de la Loterie de la Suisse Romande - the non-profit lottery company operating in the six French-speaking cantons in Switzerland - to provide, through Dreamport, the Company's non-lottery gaming and entertainment subsidiary, touch screen terminals, validation management terminals and Dreamport's Video PRO:SYS(TM) central system for the operation of an electronic instant lottery game. The system was sold, and the related technology licensed, to the Loterie Romande. In January 1999, Dreamport announced that Turfway Park LLC, a newly formed company where membership interests are owned equally by Keeneland Association, Inc., Dreamport and a wholly-owned subsidiary of Harrah's Entertainment, had entered into an agreement with Turfway Park Racing Association, Inc. to purchase Turfway Park, a traditional racetrack located in Florence, Kentucky (in the Cincinnati, Ohio market) featuring thoroughbred racing and simulcast 11 13 wagering, and related assets for $37 million. This transaction closed in March 1999. In February 1999, Dreamport entered into a five-year distribution and services agreement with Jenosys Technologies, Inc., a leading provider of table-based and wireless electronic bingo systems, under which Dreamport will act as the exclusive distributor of Jenosys electronic bingo products to government agencies in the provinces of Canada. During fiscal 1999, Dreamport also announced an agreement with Penn National Gaming, Inc. to sell the Company's assets related to the provision of gaming technology at Charles Town Races in West Virginia. See "Products and Services Introduced in Recent Years---Non-Lottery Gaming Products and Services" below. NEW PRODUCTS AND SERVICES Since the start of fiscal 1999, the Company also has made several announcements respecting new products and services. In March 1998, the Company announced its agreement to provide to the Colorado lottery its new terminal product, PlayerExpress(TM). PlayerExpress(TM), part of the Company's new generation of terminals, which is designed specifically for large retail environments with numerous checkout lanes, allows customers to conveniently play lottery at the checkout area of their retail store as part of their regular shopping. The Company subsequently entered into agreements with the Nebraska lottery authority and (after the close of fiscal 1999) the New Zealand lottery authority to supply Player Express(TM) terminals. In October 1998, the Company launched its Altura(TM) family of terminals. Altura(TM), which represents the initial offering of the Company's ninth generation of online lottery terminals, permits applications to be written in the Java programming language enabling the rapid development of a wide variety of games that are compatible with numerous software environments. In July 1998, the Company acquired 80% of the equity of Europrint Holdings Ltd. ("Europrint") and its wholly-owned subsidiaries, including Interactive Games International ("IGI"), for a net cash purchase price of $21.6 million, including related acquisition costs. The Company has the option, and under certain circumstances the obligation, to acquire the remaining 20% of the equity of Europrint and IGI within five years from the date of acquisition. The Company augmented its game design expertise with the acquisition of Europrint, which is among the world's largest providers of media promotional games, and IGI which has pioneered the development of interactive, televised lottery games including BingoVision(TM) and SplitLevel(TM). In July 1998, the Company established a business unit, UWin!(TM), to provide internet-based interactive games to its international customers in the government-sponsored lottery market. In May 1999, after the close of fiscal 1999, the Company entered into a contract with the An Post National Lottery Company, the Irish lottery authority, to provide, maintain and operate its UWin!(TM) internet solution in the Republic of Ireland through March 2000. OTHER NEWS The Company also reported other important developments since the start of fiscal 1999. In April 1998 the Company announced that it had reached an agreement with Camelot Group, plc, the operator of the United Kingdom's National Lottery, for the repurchase of the equity formerly owned by the Company in Camelot for pound sterling 51 million. The Company also reported significant developments respecting the agreement announced in February 1998, by Transactive Corporation, the Company's electronic benefits transfer (EBT) subsidiary, to sell to Citicorp Services, Inc., Transactive's EBT contracts and certain related assets. In July 1998, the U.S. Department of Justice commenced a legal action to enjoin the 12 14 consummation of this transaction on anti-trust grounds and, in January 1999 Citicorp Services, Inc. terminated this agreement. The legal proceeding was dismissed as a result of this termination and the Company announced that it would continue to perform all EBT contracts through their terms. Finally, in March 1999, after the close of fiscal 1999, the Company announced that Quick Draw, the keno-style game operated in New York state on a lottery system provided by the Company, would terminate effective April 1, 1999, and the game did terminate as announced, due to the failure of the New York State legislature to extend the legislation authorizing the game. See Item 7, "Management's Discussion and Analysis of Financial Condition and Results of Operations" below. MANAGEMENT DEVELOPMENTS Since the beginning of fiscal 1999, there were a number of significant managerial developments. In March 1998, Steven P. Nowick, who had joined the Company as Senior Vice President, Corporate Development, in September 1997, was elected Chief Operating Officer of the Company. The Company also strengthened its management team by hiring Donald R. Sweitzer as the Company's Senior Vice President of Government Relations in July 1998, Jean-Pierre Desbiens, as Senior Vice President, Product Sales and Development, in August 1998, and David J. Calabro, as the Company's Senior Vice President responsible for Company's facilities management business, in March 1999, after the close of fiscal 1999. The Company also announced the departure of Laurance W. Gay, formerly Senior Vice President, Sales and Business Development, in March 1998, and Michael R. Chambrello, formerly the Company's Executive Vice President, in July 1998. LOTTERY INDUSTRY Statements relating to the lottery industry contained in this Report are based on information compiled by the Company, or derived from independent public sources which the Company believes to be reliable. No assurance can be given, however, regarding the accuracy of such statements. In general, there is less publicly-available information concerning the international lottery industry than the lottery industry in the United States. Lotteries are operated by state and foreign governmental authorities and their licensees in approximately 195 jurisdictions worldwide. Governments have authorized lotteries primarily as a means of generating non-tax revenues. In the United States, lottery revenues are frequently designated for particular purposes, such as education, economic development, conservation, transportation and aid to the elderly. Many states have become increasingly dependent on their lotteries as revenues from lottery ticket sales are often a significant source of funding for these programs. Although there are many types of lotteries in the world, it is possible to categorize government authorized lotteries in two principal groups: online lotteries and off-line lotteries. An online lottery is conducted through a computerized lottery system in which lottery terminals are connected to a central computer system, typically by dedicated telephone lines. An online lottery system is generally utilized for conducting games such as lotto, sports pools, keno and numbers, 13 15 in which players make their own selections. Off-line lotteries feature lottery games which are not computerized, including traditional off-line lottery games and instant ticket games. Traditional off-line lottery games, in which players purchase tickets which are manually processed for a future drawing, generally are conducted only in international jurisdictions. Instant ticket games, in which players scratch off a coating from a pre-printed ticket to determine if it is a winning ticket, are conducted both internationally and in the United States. In general, online lotteries generate significantly greater revenues than both traditional off-line lottery games and instant ticket games. In addition, there are several other advantages to online lotteries as compared to traditional off-line lotteries. Unlike traditional off-line lottery games, wagers can be accepted and processed by an online lottery system until minutes before a drawing, thereby significantly increasing the lottery's revenue in cases in which a large prize has attracted substantial wagering interest. Online lottery systems also provide greater reliability and security, allow a wider variety of games to be offered and automate accounting and administrative procedures which are otherwise manually performed. Typically, approximately 50% of the gross revenues of an online lottery in the United States is returned to the public in the form of prizes. Approximately 35% is used by the state to support specific public programs or as a contribution to the state's general funds. The remaining 15% is generally used to fund the operations of the lottery, including the cost of advertising, sales commissions to point-of-purchase retailers and service fees to vendors such as GTECH. From 1971 through 1998, total annual lottery ticket sales in the United States grew from approximately $147.5 million to approximately $34.1 billion, although the Company has witnessed, over the last two years, a downward trend in sales generated by its United States lottery customers. See "General" above. Historically, most of the growth in ticket sales has occurred in the online portion of the lottery business which accounted for approximately 59% of total lottery ticket sales in 1998. There are currently 38 jurisdictions operating online lotteries in the United States. Implementation of lotteries in other jurisdictions, will depend upon successful completion of legislative, regulatory and administrative processes. Outside the United States, government operated or licensed lotteries, many of which are off-line, have a long history. The international online lottery industry has experienced significant growth. Since 1977, when there were no online lotteries operating outside of the United States, 84 international jurisdictions have implemented online lottery systems. A number of other international jurisdictions, principally in Europe, Asia and Latin America, are currently considering the implementation of online lotteries. ONLINE LOTTERY CONTRACTS The Company generally conducts business under one of three types of contractual arrangements: Facilities Management Contracts, Operating Contracts and Product Sales Contracts. Under a typical Facilities Management Contract, the Company installs, operates and maintains a lottery 14 16 system, while retaining ownership of the lottery system. These contracts generally provide for service fees directly from the lottery authority to the Company based on a percentage of online lottery ticket sales. Under an Operating Contract, the Company generally provides the same services as under a Facilities Management Contract, but sells the lottery system and licenses the computer software to the lottery authority. Ongoing service fees to the Company under an Operating Contract are usually based on a percentage of lottery ticket sales. Under a Product Sales Contract, the Company sells, delivers and installs a turnkey lottery system or lottery equipment and licenses the computer software for a fixed price, and the lottery authority subsequently operates and maintains the lottery system. The collection of lottery monies, the selection of winners, the financial responsibility for the payment of prizes and the qualification of retail sales agents are usually the sole responsibility of the lottery authority in each jurisdiction in which the Company operates a lottery. The United Kingdom's National Lottery provides an important exception to the general rule. Camelot, a consortium of companies, is licensed by the United Kingdom government to operate all aspects of the National Lottery with the exception of proceeds allocation. FACILITIES MANAGEMENT CONTRACTS The Company's Facilities Management Contracts generally require the Company to install, operate and maintain an online lottery system for an initial term, which is typically at least five years, and usually contain options permitting the lottery authority to extend the contract under the same terms and conditions for one or more additional periods, generally ranging from one to five years. In addition, the Company's customers occasionally renegotiate extensions on different terms and conditions. See "Certain Factors That May Affect Future Performance- Liquidated Damages Under Contracts" above. The Company's revenues under Facilities Management Contracts are generally based upon a percentage of gross online lottery ticket sales. The level of lottery ticket sales within a given jurisdiction is determined by many factors, including population density, the types of games played and the games' design, the number of terminals, the size and frequency of prizes, the nature of the lottery's marketing efforts and the length of time the online lottery system has been in operation. Under its Facilities Management Contracts, the Company retains title to the lottery system and typically provides its customers with the services necessary to operate and manage the lottery system. The Company installs and commences operations of a lottery system after being awarded a Facilities Management Contract and, following the start-up of the lottery system, is responsible for all aspects of the system's operations. The Company typically operates lottery systems in each jurisdiction on a stand-alone basis through the installation of two or more dedicated central computer systems, although in a few instances several jurisdictions share the same central system. In addition, the Company employs a dedicated work force in each jurisdiction, consisting of a site director, marketing personnel, computer and hotline operators, communications specialists and customer service representatives who service and maintain the system. 15 17 Under certain of the Company's Facilities Management Contracts the lottery authority has the right to purchase the Company's lottery system during the contract term at a predetermined price, which is calculated so that it exceeds the Company's net book value of the system at the time the right is exercisable. The Company's role with respect to the continued operation of a lottery system in the event of the exercise of such a purchase option generally is not specified in such contracts and thus would be subject to negotiation. Under many of the Company's Facilities Management Contracts, the lottery authority also has the option to require the Company to install additional terminals and/or add new lottery games. Such installations may require significant expenditures by the Company. However, since the Company's revenues under such contracts generally depend on the level of lottery ticket sales, such expenditures have generally been recovered through the revenues generated by the additional equipment or games and revenues from existing equipment. Under a number of the Company's lottery contracts (including the Georgia, New York, Texas and United Kingdom contracts), in addition to providing, operating and maintaining the online lottery system in these jurisdictions, GTECH is providing a wide range of support services and equipment for the lottery's instant ticket games, such as marketing, distribution and automation of validation, inventory and accounting systems, for which it receives fees based upon a percentage of the revenues of the instant ticket games. Revenues from Facilities Management Contracts are accounted for as service revenues in the Company's Income Statements. 16 18 The table below sets forth the lottery authorities with which the Company had Facilities Management Contracts as of April 15, 1999. Unless otherwise indicated, the Company is the sole supplier of central computers and terminals and services to each of the lottery authorities listed below. The table also sets forth information regarding the term of each contract and, as of March 31, 1999, the approximate number of terminals installed in each jurisdiction. FACILITIES MANAGEMENT CONTRACTS
CURRENT APPROXIMATE NO. OF LOTTERY DATE OF COMMENCEMENT OF DATE OF EXPIRATION OF EXTENSION JURISDICTION TERMINALS INSTALLED(1) CURRENT CONTRACT CURRENT CONTRACT TERM OPTIONS* UNITED STATES: Arizona 2,466 1/99 9/99 (2) -- California (3) 13,850 10/93 10/03 -- Colorado 2,561 3/95 10/04 -- D.C. (4) 571 5/95 11/99 -- Georgia 6,614 4/93 9/03 -- Illinois 8,480 2/89 10/99 1 one-year Indiana (5) 3,994 3/90 8/99 -- Iowa 1,512 4/91 6/01 1 two-year Kansas 1,806 7/97 6/02 1 three-year 1 two-year Kentucky 2,898 4/97 6/03 5 one-year Louisiana 2,768 6/97 6/05 5 one- year Maine (6) 995 7/90 6/00 -- Michigan 6,513 1/98 1/06 3 one-year Missouri 2,623 7/96 7/01 1 two-year Nebraska 870 4/94 6/04 -- New Hampshire (6) 988 7/90 6/00 -- New Jersey 5,980 6/96 6/01 5 years New Mexico 1,198 6/96 11/03 5 one-year New York 13,701 2/93 2/00 2 one-year Ohio 6,662 10/93 6/01 -- Oregon 2,732 12/96 10/04 3 one-year Rhode Island 949 1/97 7/02 5 one-year Texas 15,347 3/92 8/02 -- Vermont (6) 474 7/90 6/00 --
17 19
CURRENT APPROXIMATE NO. OF LOTTERY DATE OF COMMENCEMENT OF DATE OF EXPIRATION OF EXTENSION JURISDICTION TERMINALS INSTALLED(1) CURRENT CONTRACT CURRENT CONTRACT TERM OPTIONS* - ------------ ---------------------- ---------------- --------------------- -------- Washington State 2,449 9/95 6/01 3 years West Virginia 1,386 2/92 6/00 2 one-year Wisconsin 3,092 6/97 6/02 2 one-year INTERNATIONAL: Barbados - -T.L. Lotteries 185 10/94 1/00 2 one-year Brazil (7) - -National Lottery (7) 12,533 1/97 9/01 (7) - -Minas Gerais 912 10/94 10/00 (7) - -Parana 776 8/94 8/99 (7) - -Santa Caterina 170 5/95 5/00 (7) - -FGFS Sports Club 92 11/94 11/99 (7) Chile - -Polla Chilena de 1,699 12/93 8/99 -- Beneficencia S.A. Czech Republic (8) - -SAZKA 2,980 10/92 (8) (8) Ireland (9) - -An Post Nat'l 2,059 3/93 3/00 (9) Lottery Company Lithuania (10) - -OLIFEJA 796 12/94 12/09 (10) Poland (11) - -Totalizator 5,191 3/91 10/01 (11) Sportowy Puerto Rico - -Loteria 2,072 3/99 3/05 1 three-year Electronica de Puerto Rico Slovakia - -TIPOS, a.s. (12) 1,082 3/96 (12) --
18 20
CURRENT APPROXIMATE NO. OF LOTTERY DATE OF COMMENCEMENT OF DATE OF EXPIRATION OF EXTENSION JURISDICTION TERMINALS INSTALLED(1) CURRENT CONTRACT CURRENT CONTRACT TERM OPTIONS* Spain - -L'Entitat Autonoma 2,502 10/97 10/03 1 six-month de Jocs I Apostes de la Generalitat de Catalunya Trinidad & Tobago - -National Lotteries 628 12/93 7/99 5 one-year Control Board United Kingdom - -The National 9,739 7/94 9/01 -- Lottery (13)
- -------------------- * Reflects extensions available to the lottery authority under the same terms as the current contract. Lottery authorities occasionally negotiate extensions on different terms and conditions. (1) Total does not include instant ticket validation terminals. (2) The Company has entered into a new five-year contract (with two one-year extension options) with the Arizona lottery authority that commences in September 1999. (3) In addition, the Company is a subcontractor to High Integrity Systems, Inc. ("HISI"), which has a contract with the California lottery authority to install and maintain 6,309 terminals using HISI's proprietary dial-up technology for online and instant ticket sales and validation. (4) Operated by Lottery Technology Enterprises, a joint venture in which the Company has a 40% interest. (5) The Indiana lottery authority has entered into a contract with the competitor of the Company commencing in August 1999. (6) The Maine, New Hampshire and Vermont lottery authorities share a central computer system. (7) Operated by GTECH Brasil Holdings, S.A. (formerly RACIMEC Informatica Basileira, S.A.), a Brazilian company in which the Company owns all voting stock. Each of the Brazilian agreements may be extended, at the option of the respective lottery authority, for one or more extension terms not to exceed, in aggregate, the duration of the base term. (8) The contract with the Czech Republic lottery authority runs until seven years after the installation of the 2,000th terminal or three years after the installation of any terminals after the 2,000th terminal, whichever is later. 19 21 (9) The contracts with the Ireland lottery authority may either be extended for any period mutually acceptable to the Company and the lottery authority or continue indefinitely until termination by the lottery authority. (10) The Company's contract with the Lithuania lottery authority automatically extends from year-to-year unless either party gives timely notice of non-renewal. (11) The term of the Company's contract with the Poland lottery authority automatically renews for an indefinite number of one-year extension periods thereafter unless either party gives timely notice of non-renewal. (12) The Company's contract with TIPOS expires seven years after the installation of the 1,000th terminal on the system. (13) Operated by Camelot Group plc, a consortium of which the Company was, until April 1998, a member, on a facilities management basis. The Company will continue to sell equipment to Camelot Group plc for use by The National Lottery. 20 22 OPERATING CONTRACTS Under an Operating Contract, the Company generally operates and maintains the lottery system and provides on-going software support services in the same manner as under a Facilities Management Contract, except that the Company sells the lottery system and licenses the software to the lottery authority at the beginning of the contract rather than retaining ownership of the system. Ongoing service fees to the Company under its Operating Contracts are usually based on a percentage of lottery ticket sales. The initial contract term, extensions, rebidding processes and termination rights for Operating Contracts are generally substantially the same as those under Facilities Management Contracts. Revenues from sales of lottery systems and equipment under Operating Contracts are accounted for as product sales revenue, and services provided under such contracts are accounted for as service revenues in the Company's Income Statements. The table below sets forth the lottery authorities with which the Company had Operating Contracts as of April 15, 1999. Unless otherwise indicated, the Company is the sole supplier of lottery equipment and services to each of the lottery authorities listed below. The table also sets forth information regarding the term of each contract and, as of March 31, 1999, the approximate number of terminals installed in each jurisdiction. OPERATING CONTRACTS
APPROXIMATE NO. OF DATE OF EXPIRATION OF CURRENT LOTTERY TERMINALS DATE OF COMMENCEMENT OF CURRENT CONTRACT TERM EXTENSION JURISDICTION INSTALLED(1) CURRENT CONTRACT OPTIONS* UNITED STATES: Idaho 659 2/99 2/03 4 one-year INTERNATIONAL: Argentina - -Loteria National Sociedad 801 11/93 4/01 1 two-year del Estado Turkey - -Turkish National Lottery 3,591 2/96 11/01 (2)
* Reflects extensions available to the lottery authority under the same terms as the current contract. Lottery authorities occasionally negotiate extensions on different terms and conditions. 21 23 (1) Total does not include instant ticket validation terminals. (2) The term of the contract with the Turkey lottery authority shall automatically renew for successive one-year extension terms unless either party gives timely notice of non-renewal. In addition, the Turkey lottery authority has the option to assume responsibility for the provision of certain lottery services at any time after the second anniversary of system start-up. PRODUCT SALES CONTRACTS The Company sells, delivers and installs online lottery systems for a fixed price under Product Sales Contracts. The Company also sells additional terminals and central computers to expand existing systems and/or replace existing equipment under Product Sales Contracts. In connection with its Product Sales Contracts, the Company generally designs the lottery system, trains the lottery authority's personnel and provides other services required to make and keep the system operational. The Company also generally licenses its software to its customers for a fixed additional fee. Historically, product sales revenues have been derived from the installation of new online lottery systems and the sales of lottery terminals and equipment in connection with the expansion of existing lottery systems. The size and timing of these transactions at times has resulted in variability in product sales revenues from quarter to quarter. See Item 7, "Management's Discussion and Analysis of Financial Condition and Results of Operations." The table below lists certain of the Company's direct and indirect customers that have purchased or as to which they have agreed to purchase lottery terminals and other online lottery equipment from the Company since March 1, 1991. The Company has found the size and timing of product sales often difficult to predict and has experienced variability in product sales revenues from period to period. Argentina --National Lottery of Argentina Argentina --Provincial Lottery of Buenos Aires Australia --Lotteries Commission of New South Wales Australia --Lotteries Commission of South Australia Australia --Tattersall Sweep Consultation Australia --Lotteries Commission of West Australia Austria --Osterreichische Lotto Toto Gesmbh Belgium --Loterie Nationale de Belgique Canada --Atlantic Lottery Corporation Canada --British Columbia Lottery Corporation Canada --Ontario Lottery Corporation Canada --Saskatchewan Gaming Commission 22 24 Canada --Western Canada Lottery Corporation Denmark --Dansk Tipstjanst Finland --Oy Veikkaus AB Germany --Sachsiche Lotto-GmbH Germany --Lotterie Treuhandgesellschaft Mbh Thuringen Iceland --Islensk Getspa Iceland --Islenskar Getraunir Israel --Mifal Hapayis Malaysia --Pan Malaysian Pools Malaysia --Lotteries Corporation (Sabah) Sdn. Bhd. Malaysia --Sports Toto Malaysia Bhd. Massachusetts -- Massachusetts State Lottery Commission Netherlands --Stichting de Nationale Sport Totalisator New Zealand --New Zealand Lotteries Commission Philippines --Philippines Charity Sweepstake Office Singapore --Singapore Pools (Pte) Ltd. Spain --Sistemas Tecnicos de Loterias del Estado Sweden --AB Svenska Spel Switzerland --Sport-Toto Gesellschaft Switzerland --Loterie de la Suisse Romande Turkey --Spor Toto Teskilat Mudurlugu United Kingdom --The National Lottery CONTRACT AWARD PROCESS In the United States, lottery authorities generally commence the contract award process by issuing a request for proposals inviting proposals from various lottery vendors. The request for proposals usually indicates certain requirements specific to the jurisdiction, such as particular games which will be required, particular pricing mechanisms, the experience required of the vendor and the amount of any performance bonds that must be furnished. After the bids have been evaluated and a particular vendor's bid has been accepted, the lottery authority and the vendor generally negotiate a contract in more detailed terms. Once the contract has been finalized, the vendor begins to install the lottery system. After the expiration of the initial contract term and all extensions thereof, a lottery authority in the United States generally may either negotiate further extensions or commence a new competitive bidding process. Internationally, lottery authorities do not typically utilize as formal a bidding process, but rather negotiate proposals with one or more potential vendors. 23 25 The Company's marketing efforts for its lottery products and services frequently involve top management in addition to the Company's professional marketing staff. These efforts consist primarily of marketing presentations to the lottery authorities of jurisdictions in which requests for proposals have been issued. Marketing of the Company's lottery products and services to lottery authorities outside of the United States is often performed in conjunction with licensees and consultants with whom the Company contracts for representation in specific market areas. Although generally neither a condition of their contracts with the Company nor a condition of their contracts with lottery authorities, such licensees and consultants often agree with the Company to provide on-site services after installation of the online lottery system. Pursuant to a 1990 Distributorship and License Agreement (the "D&L Agreement") between the Company and CGK Computer Gesellschaft Konstanz GmbH ("CGK"), a subsidiary of Siemens AG, the Company granted to CGK the exclusive right to distribute, service, sell and market the Company's online lottery systems and components in selected European jurisdictions under separately negotiated Memoranda of Understanding ("MOUs"). Although the D&L Agreement terminated during fiscal 1996, CGK and the Company continue to fulfill their respective obligations under certain MOUs and related agreements entered into under the D&L Agreement. From time to time, there are challenges or other proceedings relating to the awarding of lottery contracts. PRODUCTS AND SERVICES The Company's lottery systems consist of lottery terminals, central computer systems, systems and communications software and game software, and communications equipment which connects the terminals and the central computer systems. The systems' terminals are typically located in high-traffic retail outlets, such as newsstands, convenience stores, food stores, tobacco shops and liquor stores. The Company's online lottery systems control and perform the following functions: entry of wagers using a terminal's keyboard or a fully-integrated optical mark recognition reader; automatic editing of each wager for correctness by the originating terminal; encryption and transmission of the wager and related data to the central computer installation(s); processing of each wager by the central computers, including entry of the wager into redundant data bases; transmission of authorization for the originating terminal to accept the wager and print a receipt or ticket, winning ticket identification and validation; and administrative functions, including determination of prize pools and generation of management information reports. The Company's systems are capable of handling in excess of 100,000 transactions per minute, which rate is in excess of the requirements of any of its customers. The basic functions listed above, as well as various optional or custom-designed functions, are performed under internal controls designed for maximum security and minimum processing time. Security is provided 24 26 through an integrated system of techniques, procedures and controls supported by hardware, software and human resources. Individual systems generally have redundant capacity at multiple levels and sophisticated software to ensure continuous service to the customer. TERMINALS The Company designs, manufactures and provides the point-of-sale terminals used in its online lottery systems. Currently, approximately 153,000 of its model GT-101 FX terminals, introduced in 1983, its model GT-101TF terminals, introduced in 1985, and its model GT-401/OI terminals, introduced in 1989, are installed in numerous jurisdictions. All of these terminals use advanced microprocessors and software programs to provide the increased transaction processing performance levels and communications interfaces required in the online lottery industry. These terminals are designed to allow customization of application functions to each lottery's specifications, including optical mark recognition, ticket graphics printing, user and customer display options and other application functions. The terminals' hardware facilitates independent development of applications programs by the Company. The Company's Spectra(TM) terminal series (GT-401 and 402 O/M), first introduced in 1989, is distinguished by its modular internal and external architecture. The modular design provides an enhanced level of flexibility to lottery jurisdictions by permitting them to choose among a variety of options and terminal subsystem configurations, including readers, printers, keyboards, displays, and communications interfaces. As of February 27, 1999, a total of approximately 62,000 Spectra(TM) terminals were installed in numerous international jurisdictions. The Company's ISYS terminal series, (GT-502), introduced during fiscal 1996, is an integral, single-unit terminal which features modular subassemblies, high performance ticket printer and playslip reader subassemblies, an easy-to-use design, and a host of new features and technologies. As of February 27, 1999, approximately 53,000 ISYS terminals were installed in numerous lottery jurisdictions. During fiscal 1999, the Company announced its agreement to provide to the Colorado lottery its new terminal, Player's Express(TM), which was designed specifically for large retail environments with numerous checkout lanes. The Company subsequently entered into agreements with the Nebraska lottery authority and (after the close of fiscal 1999) the New Zealand lottery authority to supply PlayerExpress(TM) terminals. As of February 27, 1999, approximately 90 PlayerExpress(TM) terminals were installed. In addition, during fiscal 1999, the Company also announced the launch of its Altura(TM) family of terminals. The Company expects the first Altura(TM) terminals to be installed during fiscal 2000. See "Products and Services Introduced in Recent Years" below. SOFTWARE The Company designs and provides all applications software for its lottery systems. The Company's highly sophisticated and specialized software is designed to provide the following system 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 lottery terminals from the central computer installation via the communications system to add new games); a high degree of security and redundancy to guard against unauthorized access and tampering and to 25 27 ensure continued operations without data loss; and a comprehensive management information and control system. In addition to featuring the aforementioned characteristics, the Company's latest generation software system, PRO:SYS(TM), is based on client server architecture and provides open interfaces which allow for the integration and support of third-party and commercial modules and applications. See "Products and Services Introduced in Recent Years" below. CENTRAL COMPUTERS Each of the Company's lottery systems contains one or more central computer sites to which the lottery terminals are connected. The Company's central computer systems are manufactured by Compaq Computer Corporation (formerly Digital Equipment Corporation), and Stratus Computer, Inc. The specifications for the configuration of the Company's central computer installations are designed to provide continuous availability, a high throughput rate and maximum security. Central computer installations typically include: redundant mainframe computers, various peripheral devices (such as magnetic storage devices, management terminals and hard copy printers), and various safety, environmental control and security subsystems (including a back-up power supply), which are all manufactured by third parties, and a microcomputer-based communication and switching subsystem. In addition, the Company supplies management information systems that provide lottery personnel access to important financial and operational data without compromising the security of the online system. COMMUNICATIONS The Company's lottery terminals are typically connected to the central computer installations by dedicated telephone lines owned or leased by the jurisdiction in which the system is located. Due to the varying nature of telecommunications services available in lottery jurisdictions, the Company has developed the capability to interface with a wide range of communications technologies, including UHF Radio capability (narrow-band and Spread Spectrum), GSAT/VSAT, Microwave, Integrated Services Digital Networking (ISDN), Data Over Voice (DOV), fiber optic and cellular telephone. In Argentina, Barbados, Brazil, the Spanish province of Catalunya, Chile, The Czech Republic (to which the Company is supplying the DL-201F, the Company's latest radio technology), Estonia, Lithuania, Mexico, New Mexico, Poland, Puerto Rico, Slovakia, Trinidad and Tobago and Venezuela, the Company utilizes UHF Radio Data-Link Communications system in lieu of telephone lines to provide a data communications pathway between the lottery terminals and the central computers. The Company also uses this technology in the United States to supplement the existing telephone networks in Ohio, Oregon, Rhode Island, Texas, Washington and the District of Columbia. The Company's GSAT satellite technology makes it feasible to serve large market areas where telephone lines are either unavailable, unreliable or too costly. GSAT currently operates in the United States in remote areas of Colorado, New Mexico, Texas and Washington, and internationally in Argentina, the Czech Republic, Brazil, Chile, Poland and the United Kingdom. The Company has also implemented UHF radio in conjunction with GSAT to further enhance reliability and cost savings in remote areas. 26 28 GAMES An important factor in maintaining and increasing public interest in lottery games is innovation in game design. The Company's GameScape(TM) group, in conjunction with lottery authorities, utilizes principles of demographics, sociology, psychology, mathematics and computer technology to design customized lottery games which are intended to appeal to the populations served by its lottery systems. The principal characteristics of game design include: frequency of drawing, size of pool, cost per play and setting of appropriate odds. The Company believes that its expertise in game design has enhanced the marketing of its lottery systems and has contributed to increases in the revenues of the Company's customers. The Company's GameScape(TM) group currently has a substantial number of variations of lottery games in its software library and several promising new games under development. The Company believes that this game library and the "know how" and experience accumulated by its professionals since the Company's inception make it possible for the Company to meet the requirements of its customers for specifically tailored games on a timely and comprehensive basis. During fiscal 1999, the Company augmented its game design expertise by acquiring Europrint Holdings Limited (among the world's largest providers of media promotional games) and its wholly-owned subsidiaries including Interactive Games international, Inc. (which has pioneered the development of interactive, televised lottery games including BingoVision(TM) and SplitLevel(TM)). See "Certain Significant Developments Since the Start of Fiscal 1999" above. MARKETING In United States jurisdictions in which the Company has been awarded a lottery contract, the Company is frequently asked to assist the lottery authority in the marketing of lottery games to the public. Such assistance generally includes advice with respect to game design, and promotion and development and distribution of terminals and advertising programs. As part of such assistance, the Company developed "GMark," a computerized marketing analysis system used to determine favorable locations for new lottery terminals. The lottery authorities of California, Florida, Georgia, Illinois, Missouri, New Jersey, New York, Ohio, Rhode Island, Texas, Washington and Wisconsin currently utilize GMark systems, and many customers contact the Market Research Group at GameScape(TM) from time to time to obtain GMark services. WARRANTY Because the Company retains title to the system under a Facilities Management Contract, no warranty is provided on the Company's products supplied under such contracts. The Company does repair or replace such products as necessary to fulfill its obligations under such contract. There is no standard warranty on products manufactured by the Company. A typical warranty provides that the Company will repair or replace defective products for a period of time (usually one year) from the date a product is delivered and tested. Product warranty expenses for the 27 29 fiscal years 1999, 1998 and 1997 were not material. The Company typically does not provide a warranty on products it sells that are manufactured by third parties, but attempts to pass the manufacturer's warranty, if any, on to the customer. With respect to computer software, the Company typically modifies its software as necessary so that the software conforms to the specifications of the contract with the customer. PRODUCTS AND SERVICES INTRODUCED IN RECENT YEARS ONLINE LOTTERY In recent years, lottery authorities have recognized that by offering new games or products, the lotteries are often able to generate significant additional revenues. An important part of the Company's strategy is to develop new products and services for its customers in order to increase their lottery revenues. The Company's principal online lottery products and services introduced in recent years are keno, instant ticket support services and televised lottery games, such as BingoVision(TM). In addition, the Company has recently launched its Altura(TM) series terminals, Players Express(TM) terminal and PRO:SYS(TM) software system to enhance the functionality and appeal of its existing software and terminal lines. KENO. While new online jurisdictions offer growth by providing access to new players, more mature markets, such as the United States, rely principally upon the introduction of new games to provide growth. One such game introduced by the Company is keno. In keno, players typically choose up to 10 numbers from a field of 80 and attempt to match their numbers against any 20 numbers which are randomly selected by a central computer system. Alternatively, the player may choose up to 10 numbers and wager that none of such numbers will match the 20 numbers randomly selected. This game combines the multiple prize payouts of a lotto-type game with the immediacy of an instant scratch-off lottery game. It is also unique in its play-style and distribution, which decreases the risk that the game will cannibalize existing online lottery revenues. Keno is more interactive than typical online lottery games and is designed to be played in the company of others. While most lotto and numbers games are found in convenience stores and supermarkets, places visited frequently and often individually, keno outlets are often located in restaurants, taverns and bowling alleys and other social settings which tend to be visited by groups of people. From the Company's introduction in April 1990 of the first online keno game for the Lotteries Commission of South Australia through the end of fiscal 1999, the Company had assisted lottery authorities in Belgium, Brazil (Parana, Minas Gerais, Santa Caterina and Goias), California, The Czech Republic, Georgia, Kansas, Lithuania, Massachusetts, New York, Oregon, Rhode Island, Catalunya (Spain), the Slovak Republic, Switzerland (La Societe de la Loterie de la Suisse Romande), Trinidad and Tobago, West Virginia and Venezuela (Loteria de Caracas) in implementing online keno games. Keno illustrates the impact that new games can have on lottery revenues. Since the United States introduction of keno in 1991, United States keno revenues have grown significantly, exceeding $1.8 billion and accounting for more than 9% of total United States online lottery revenues in 28 30 1998. The popularity of keno has led the Company to explore the development of new games based upon keno. Most notably, the Company developed in recent years Keno Plus(TM), a new product that combines expanded keno game characteristics with new hardware and enhanced product support. Keno has been the subject of legal challenges in recent years. Most notably, in June 1996, the California Supreme Court in Western Telecon, Inc. et al v. California State Lottery unexpectedly reversed trial and appellate court decisions and found the California keno game to be a banked game rather than a lottery because it provides for a fixed prize that is not dependent upon the size of the prize pool. Accordingly, the Court concluded that the keno game was not authorized by the California lottery law, and the California State Lottery suspended operation of the keno game in June 1996. In September 1996, the Company launched a parimutuel monitor game designed by the Company and the California State Lottery as a replacement for the suspended game. Although the new game, like keno, features frequent drawings, its payouts are based upon a prize pool determined by sales rather than by predetermined or fixed amounts. Keno was also the subject of an unsuccessful legal challenge in New York which began in August 1995. There can be no assurances that legal challenges to keno will not be brought in the future in these or other jurisdictions, nor can there be any assurances respecting the results of such legal challenges, if any, upon the operations of keno in jurisdictions serviced by the Company. In March 1999, after the close of fiscal 1999, the Company announced that Quick Draw, the keno-style lottery game operated in New York State provided by the Company, would terminate effective April 1, 1999, and the game did terminate as announced, due to the failure by the New York State legislature to extend the legislation authorizing the game. See Item 7, "Management's Discussion and Analysis of Financial Conditions and Results of Operations" below. INSTANT TICKET SUPPORT SERVICES. The Company provides certain products, systems and services to the instant ticket lottery industry. The Company's online support systems for the instant ticket lottery business provide comprehensive functionality, including: instant ticket validation; retailer accounting; inventory control and tracking; ticket stock distribution; electronic funds transfer; finance and sales tracking reports; and marketing support. In order to automate and increase the security of instant ticket lotteries, the Company developed the GTECH Validation Terminal ("GVT"), a point-of-sale device that facilitates instant ticket validation and provides access to the Company's online instant ticket support systems for instant ticket agents who are not part of a lottery's online lottery system. The Company also offers add-on validation terminals which attach to its online lottery terminals and provide the same functionality as the GVT, while using the existing communications network. The Company is providing marketing, distribution, online validation, inventory control and accounting support services and equipment (but not the printing of the instant tickets) for the Texas lottery's instant ticket games. In addition, the Company currently provides instant ticket support services to lottery authorities in Arizona, California, Colorado, District of Columbia, Georgia, Idaho, Illinois, Indiana, Iowa, Kansas, Kentucky, Louisiana, Massachusetts, Michigan, Missouri, New Hampshire, New Jersey, New Mexico, New York, Ohio, Oregon, Rhode Island, 29 31 Texas, Vermont, Washington and Wisconsin. Internationally, the Company currently supplies lottery authorities in Australia, Belgium, Brazil, Chile, Denmark, Finland, Ireland, Netherlands, New Zealand, Spain (Catalunya), Sweden and the United Kingdom with instant ticket support services. TELEVISION LOTTERY GAMES. The Company in recent years has offered a product line of televised lottery games. Players buy tickets from online lottery retailers and mark them while following a live, televised game show which includes a draw of numbers. Through the use of proprietary game-tracking software, the Company is able to display, live, how many at-home players are winners or about to become winners, with each new numbers draw. The Company has implemented BingoVision(TM), a television lottery game featuring a bingo draw, in Estonia, Lithuania, New Zealand, Slovakia, Belgium, and five German states; has implemented SplitLevel(TM), a televised game featuring displayed boards of numbers with winners determined by the number of matches from these boards in Estonia; and is actively marketing these and other games to other lottery authorities. THE PRO:SYS(TM) SOFTWARE SYSTEM. PRO:SYS(TM) is the Company's latest software system. Employing a user friendly interface, lotteries can use PRO:SYS(TM) to manage all aspects of their gaming environment, including online, instant ticket sales and accounting and video games. Features such as promotions management and information analysis allow lottery authorities to tailor the system to their individual needs. PRO:SYS(TM) was first installed in September 1994 for Societe de la Loterie de la Suisse Romande, Switzerland. Since that time, the Company has installed PRO:SYS(TM) in systems used by the lottery authorities of Arizona, Washington, D.C.; Colorado; Idaho; Ontario, Canada; Sachsische Lotto-GmbH in Leipzig, Germany; Washington State; Missouri; Denmark; New Mexico; Massachusetts; New Jersey; Thuringen, Germany; Kansas; Kentucky; Ohio; Oregon; Rhode Island; Wisconsin; New Zealand; Belgium; Finland; Sweden; and Switzerland and is in the process of installing PRO:SYS(TM) in two additional jurisdictions. THE ISYS(TM) TERMINAL SERIES. During fiscal 1996, the Company introduced its ISYS(TM) terminal series. ISYS(TM) is an integral, single-unit terminal which features modular subassemblies, high performance ticket printer and playslip reader subassemblies, an easy-to-use design, and a host of new features and technologies. The Company believes that ISYS(TM) improves upon previous terminal designs by featuring simplified wager entry via intuitive keyboard and screen formats, improved system status monitoring and the latest instant ticket validator technology. The Company has installed ISYS(TM) in systems used by lottery authorities in Brazil, Massachusetts, Missouri, New Jersey, New Mexico, Turkey, Washington State, District of Columbia, Wisconsin and W. Australia, Kansas, and Rhode Island. See "Products and Services--Terminals" above. THE PLAYER EXPRESS(TM) TERMINAL. During fiscal 1999, the Company announced the introduction of its new terminal, the Player Express(TM). Player Express(TM), which had its inaugural installation under the Company's contract with the Colorado lottery authority, was designed as part of the Company's attempt to provide a total solution for selling lottery tickets in large retail 30 32 environments with numerous checkout lanes. Player Express(TM) allows consumers to conveniently play lottery at the checkout area of retail stores as part of their regular shopping. THE ALTURA(TM) TERMINAL. During fiscal 1999, the Company announced the launch of its Altura(TM) family of terminals. Altura(TM), which represents the initial offering of the Company's ninth generation of online lottery terminals, permits applications to be written in the Java programming language enabling the rapid development of a wide variety of games that are compatible with numerous software environments. VIDEOSITE.(TM) During fiscal 1998, the Company acquired VideoSite, Inc., a leading provider of multimedia broadcasting software. VideoSite is in the process of developing lottery and retail advertising and promotional products which will use its broadcasting software to complement the Company's video-based gaming software products. NON-LOTTERY GAMING PRODUCTS AND SERVICES In September 1995, the Company incorporated Dreamport, Inc. to pursue gaming opportunities other than online lottery including video lottery and venue-based gaming. Dreamport provides a comprehensive array of creative management and technology solutions, and development and strategic services to the gaming and entertainment markets as well as video lottery systems and other gaming technology. Dreamport's video lottery machine gaming systems combine the security and integrity of the Company's traditional online lottery systems with entertainment-based video games. These video lottery machine gaming systems include a controlling central computer system, video lottery terminal gaming machines (which the Company acquires through an exclusive OEM manufacturing relationship with Bally Gaming Systems, Inc.), the Company's ticket validation terminals, and a self-diagnostic communications network. Games offered by these video lottery machine gaming systems include poker, blackjack, keno, bingo, reel games and electronic instant lottery games. The Company entered the video lottery machine gaming business during fiscal 1991 and currently provides machine gaming video lottery products and services to lottery jurisdictions in Minas Gerais, Santa Catarina and Parana, Brazil; Switzerland; Alberta, British Columbia, Saskatchewan, Canada; Oregon; and Rhode Island. Through a joint venture with Full House Resorts, Inc., the Company also provides financing, gaming development and management services to the Midway Slots and Simulcast Emporium at Harrington Raceway in Delaware and the Huron Potawatomi Tribe in Battle Creek, Michigan. In March 1999, the Company, in equal partnership with Harrah's Entertainment, Inc. and Keeneland Association, purchased the assets of Turfway Park, a thoroughbred racecourse located in Florence, Kentucky (in the Cincinnati, Ohio market) featuring thoroughbred racing and simulcast wagering. Included with the purchased assets was a 24% ownership interest in, and management contract for, Kentucky Downs, a thoroughbred racetrack and simulcast center on the Kentucky border in close proximity to the Nashville, Tennessee market. See "Certain Significant Developments Since the Start of Fiscal 1999 - Dreamport and Non-Lottery Gaming" above. PRODUCT DEVELOPMENT 31 33 The Company devotes substantial resources in order to enhance its present products and systems and develop new products. In fiscal 1999, the Company spent approximately $40.2 million on research and development, as compared to $36.5 million in fiscal 1998 and $31.0 million in fiscal 1997. As of February 27, 1999, the Company (including subsidiaries) had approximately 450 full-time employees, including certain members of senior management, engaged in research and development. INTELLECTUAL PROPERTY Although the Company occasionally seeks patent protection on certain technological developments, the Company generally has not sought to obtain patents on its products, and it is doubtful whether patents could be obtained in many instances. The Company believes that its technical "know-how," trade secrets and the creative skills of its personnel are of substantially more importance to the success of the Company than the benefit which patent protection ordinarily would afford. The Company typically requires customers, employees, licensees, subcontractors and joint venture partners who have access to proprietary information concerning the Company's products to sign non-disclosure agreements, and the Company relies on such agreements, other security measures and trade secret law to protect such proprietary information. PRODUCTION, ASSEMBLY AND COMPONENTS The Company purchases most of the parts, components and subassemblies (some of which are designed by the Company) necessary for its terminals and other products from outside sources and assembles them into finished products. The Company offers central systems manufactured by Compaq Computer Corporation (formerly Digital Equipment Corporation) and Stratus Computer, Inc. for its lottery systems. BACKLOG The backlog of the Company's orders for sales of its products and services believed by the Company to be firm and the fixed fee portion of service contracts amounted to approximately $305.5 million as of February 27, 1999, as compared to a backlog of approximately $235 million as of February 28, 1998. Approximately $148.1 million, or 48.5% of the backlog at February 27, 1999, is not expected to be filled during fiscal 2000. Not included in such backlog are (i) amounts which are payable to the Company under its lottery contracts based on a percentage of lottery ticket sales which amounts, historically, have represented a substantial portion of the Company's revenues and (ii) revenues related to the Company's Transactive subsidiary, which revenues are variable in nature. COMPETITION The online lottery business is highly competitive in the United States and internationally. Both in the United States and internationally, price is an important, but usually not the sole criterion for selection. Other significant factors that influence the award of lottery contracts are: the ability to optimize lottery revenues through technical capability and applications knowledge; the quality, 32 34 dependability and upgrade capability of the system; the marketing and gaming experience, financial condition and reputation of the vendor; and the satisfaction of other requirements and qualifications that the lottery authority may impose. During fiscal 1999, the Company's principal competitors in the online lottery business (and the number of online lottery jurisdictions currently serviced or under contract worldwide by such competitors) are as follows: Automated Wagering International, Inc., a subsidiary of Powerhouse Technologies, Inc. (formerly, Video Lotteries Technologies, Inc.) (9); Autotote Corporation (3) ("Autotote"); Scientific Games Holdings Corporation (which acquired Telecontrol, the European lottery operation formerly owned by Autotote, during fiscal year 1998, as described below) (8, all of which are jointly serviced with International des Jeux); International Totalizator Systems, Inc. (6); and International des Jeux (Lotto France) (8, all of which are jointly serviced by Telecontrol and International des Jeux); and Essnet/Alcatel (15). Two additional competitors for European online lottery business have emerged in recent years. During fiscal 1996, CGK Computer Gesellschaft Konstanz mbH ("CGK"), a subsidiary of Siemens AG, and the Company agreed to terminate their 1990 Distributorship and License Agreement pursuant to which CGK had exclusive right to distribute, service, sell and market the Company's online lottery systems and components in specified European jurisdictions. Subsequent to August 1995, the effective date of this termination, CGK has been a direct competitor of the Company in Europe. Further, in April 1997, Scientific Games Holdings Corporation completed the purchase of TeleControl, as mentioned above. Under the terms of the acquisition agreement, Scientific Games will have the right to license and purchase Autotote's wagering terminals for use in lottery applications. In March 1999 (after the close of fiscal 1999), Anchor Gaming, an operator and developer of gaming machines and casinos, and Powerhouse Technologies, Inc., announced the signing of a definitive merger agreement. The merger of these two companies is likely to provide Automated Wagering International, Inc., the Company's leading competitor in the U.S. and a subsidiary of Powerhouse Technologies, Inc., with enhanced financial resources. Dreamport faces competition from numerous companies that seek to finance, develop and manage destination gaming facilities, on and off of Native American lands, as well as from technology providers. The principal competitors providing video lottery technology in competition with the Company include Autotote Systems, Inc., Spielo Manufacturing, Inc., Powerhouse Technologies, Inc., Video Lottery Technologies, Inc., WMS Gaming, Inc., International Game Technology, Inc. and Bally Manufacturing, Inc. some of which have supplied substantially more systems and terminals than the Company. 33 35 PERSONNEL As of May 1, 1999 the Company had approximately 4,800 full-time employees worldwide. The Company's employees are not represented by any labor union. The Company believes that its relationship with its employees is satisfactory. ITEM 2. PROPERTIES The Company's corporate headquarters and main research and development and production facility are located in its approximately 260,000 square foot building located on approximately 26 acres in West Greenwich, Rhode Island, which the Company leases from West Greenwich Technology Associates Limited Partnership. The Company is a limited partner in, and owns 50% of, this partnership. The Company's lease term runs until August 26, 2013 with two five-year options to extend the term and also grants the Company an option to purchase the property. The Company owns approximately 24 acres adjoining its headquarters in West Greenwich, Rhode Island. The Company also owns an approximately 23,000 square foot office building in Coventry, Rhode Island, which it uses for electronic benefits delivery and video lottery operations, as well as an approximately 140,000 square foot manufacturing and central storage facility in Coventry, Rhode Island. The Company leases two office buildings of approximately 46,000 and 43,000 square feet in Boca Raton, Florida which it uses to support its Dreamport operations, its Latin American marketing efforts and its Transactive national call center operations. These agreements each provide for a base lease term which expires in 2003 and for one or more extension options thereafter. In addition, except in New York State, where the Company owns its back-up data center facility, and in Austin, Texas, where the Company owns an approximately 39,000 square foot facility which is used by Transactive, the Company leases, or is supplied by the relevant state authorities with, its data center facilities in the various jurisdictions. The Company also leases office, depot maintenance and warehouse space in various other locations. The Company leases facilities in Watford and London, England from which it bases its European sales efforts. The Company also maintains an office in Brussels, Belgium which provides a base of additional support for its European operations. The Company's facilities are in good condition and are adequate for its present needs. 34 36 ITEM 3. LEGAL PROCEEDINGS In September 1996, Jack M. Janis and Linda Janis, both individually and on behalf of a class of persons similarly situated, filed suit against the California State Lottery Commission, Southland Corporation and the Company in the Supreme Court of the State of California (County of Los Angeles). This suit alleged, in light of the June 1996 decision of the California Supreme Court, Western Telcon, Inc. et. al. V. California State Lottery (which held that the California State Lottery's keno game as then structured was not a lottery game and therefore was not authorized by California lottery law), that the defendants were unjustly enriched and were guilty of unfair business practices and misleading advertising in connection with the sale of keno tickets from January 1, 1992 through suspension of the keno game in June 1996. The suit sought restitution of all amounts realized by the defendants through the sale of keno tickets less funds paid to public schools pursuant to relevant California law and proceeds paid to holders of winning keno tickets, together with costs, disbursements and prejudgment interest. In 1997, the Court granted the Company summary judgment but granted the plaintiffs limited leave to amend their complaint; the plaintiffs filed an amended complaint; and the Court granted the Company's motion to strike and for summary judgment as to the amended complaint, this time without leave to amend. Plaintiffs filed a notice of appeal, and in November 1998, the California Court of Appeal affirmed. Plaintiffs then sought review by the California Supreme Court, which denied review in March 1999, effectively ending the case. The Company monitors, and occasionally affirmatively becomes involved in, litigation involving Indian gaming in states where such litigation may, directly or indirectly, concern or call into question the legal rights and operations of state lotteries to which the Company provides contract services. The purpose of this effort is to protect state lottery interests, and thus the Company's revenue streams, from service contracts. As previously publicly reported, one such piece of litigation is Rumsey Indian Rancheria v. Wilson, currently pending in the Ninth Circuit Court of Appeals on appeal from the U.S. District Court for the Eastern District of California, which involves a suit by several California Indian tribes against the State and Governor of California under the federal Indian Gaming Regulatory Act ("IGRA"). The Indian Tribes claimed in the District Court that certain elements of the California State Lottery (which is a customer of the Company) ("CSL") and the equipment on which it is run involve the operation of slot machines and, therefore, under IGRA, the tribes also must be permitted to operate slot machines. The State of California argued at times that the CSL does not involve the operation of slot machines; however, the State at times appeared to be taking the position that, if and to the extent the CSL does involve the operation of slot machines, it must be terminated because the CSL is not exempt from the California law prohibiting the operation of slot machines. The Company filed amicus curiae briefs in the District Court arguing that the CSL does not involve the operation of slot machines and that even if it does, the CSL is exempt from the State law prohibition on slot machines. In September 1998, the Court entered summary judgment for the defendants. The Indian Tribes have since appealed the District Court's decision, and, as noted above, the appeal is now pending before the Ninth Circuit Court of Appeals. 35 37 In July 1998, the U.S. Department of Justice filed suit in the U.S. District Court for the District of Delaware, U.S. v. Citicorp, Inc., Citicorp Services, Inc., GTECH Holdings Corporation and Transactive Corporation, seeking to enjoin the consummation of a transaction between Citicorp Services, Inc. and the Company's Transactive subsidiary respecting the sale to Citicorp of Transactive's electronic benefits transfer contracts and certain related assets (which transaction is described in particularity in connection with the discussion of the $99.4 million-$60.6 million after-tax -- special charge recorded by the Company in the fourth quarter of fiscal 1998 in Item 7 "Management's Discussion and Analysis of Financial Condition and Results of Operations -- Special Charge.") The Department of Justice alleged in the suit that the proposed sale of assets would tend substantially to lessen competition in the electronic benefits transfer market in violation of Section 7 of the Clayton Act, as amended (15 U.S.C. Section 18), and would constitute an unreasonable restraint of trade in violation of Section 1 of the Sherman Act (15 U.S.C. Section 1). In January 1999, the Company announced the termination of the agreement between Citicorp and Transactive, following which the parties to the litigation entered into a settlement and the suit was dismissed. See "Certain Significant Developments Since the Start of Fiscal 1999", above, and Item 7 "Management's Discussion and Analysis of Financial Condition and Results of Operations Special Charges". In April 1999, the Company was served with a lawsuit entitled Pantaleon Arellano, et. al. and Estelle Arellano v. The California State Lottery, et. al. in California Superior Court (Orange County), which was filed in March, 1999. In this action, plaintiffs are a husband and wife who claim to have purchased a winning ticket in the California State Lottery's ("CSL's") April 8, 1998 Super Lotto drawing. That drawing resulted in the award of a $102 million jackpot, which was split evenly among three holders of tickets bearing the winning numbers. Plaintiffs here claim to have purchased a ticket for that drawing with the same winning numbers; plaintiffs and the Company have been told that CSL computer records reveal that the ticket plaintiffs hold was purchased after the close of sales for that drawing, and after the winning numbers were announced. If plaintiffs had purchased a winning ticket in the relevant drawing, they would have a claim against the CSL for one-fourth of that jackpot amount, i.e., approximately $25.5 million. In their complaint, they attempt to state a claim against both the CSL (and its Commission and the State of California) and the Company for $104 million, apparently their approximation of the full amount of the jackpot. They also seek to have this amount trebled, alleging that the defendants' conduct in denying plaintiffs' claim to the jackpot was racially motivated, and they seek various other amounts, including emotional distress damages and attorney fees. The Company believes that this complaint, and the allegations underlying the complaint, are wholly without merit. The Company intends to defend itself vigorously in these proceedings. For information respecting certain other legal proceedings, refer to Item 1, "Certain Factors Affecting Future Performance - Maintenance of Business Relationships and Certain Legal Matters" and Item 7, "Management's Discussion and Analysis of Financial Condition and Results of Operations," of this report, and Note G of Notes to Consolidated Financial Statements included in this report. The Company also is subject to certain legal proceedings and claims which management believes, on the basis of information presently available to it, will not materially adversely affect the Company's consolidated financial position or results of operations. 36 38 ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS No matters were submitted to a vote of Holding's security holders during the last quarter of fiscal 1999. 37 39 ADDITIONAL INFORMATION The following information is furnished in this Part I pursuant to Instruction 3 to Item 401(b) of Regulation S-K: EXECUTIVE OFFICERS OF THE COMPANY The Executive Officers of Holdings as of May 7, 1999 are: Name Age Position William Y. O'Connor 54 Chairman (since February 1998), Chief Executive Officer (since July 1997), President (since December 1994) and director (since July 1995). Mr. O'Connor also served as Chief Operating Officer from December 1994 until March 1998. Previously, Mr. O'Connor was the President and Chief Executive Officer of Ascom Timeplex, a telecommunications company, from 1992 to 1994 and prior to that was Corporate Senior Vice President and President of the Broadband Communications Group of Scientific-Atlanta, Inc. from 1987 to 1992. Stephen A. Davidson 55 Senior Vice President since September 1996 and Vice President - Human Resources from July 1992 to September 1996. Steven P. Nowick 45 Chief Operating Officer since March 1998 and Senior Vice President since July 1997. Previously, Mr. Nowick was President, Corporate Product Management, of Ameritech Corporation, a telecommunications company, from 1994 to 1997 and Practice Leader with respect to telecommunications and related areas of practice with Booz, Allen & Hamilton, a consultancy, from 1992 to 1994. Thomas J. Sauser 55 Senior Vice President and Chief Financial Officer since February 1996. Mr. Sauser has also served as Treasurer from February 1996 until July 1997 and again since November 1997. Previously, Mr. Sauser was Chief Financial Officer and Senior Vice President of EG&G, Inc. from 1994 through 1995. Prior to this, Mr. Sauser was employed by IBM Corporation where, from 1991 to 1994, he was Assistant to the General Manager and Vice President, Finance, Technical Operations and HQ Services. 38 40 Donald L. Stanford 48 Senior Vice President, with responsibility for technology, for more than five years. Donald R. Sweitzer 51 Senior Vice President - Government Relations since July 1998. Previously, Mr. Sweitzer was President of the Dorset Resource and Strategy Group, a government affairs consultancy, from November 1996 through June 1998, and President and Managing Partner of Politics Inc., a political consulting firm, from January 1995 through August 1996. Mr. Sweitzer also served as Kentucky State Director of Clinton/Gore 1996 Inc., President Clinton and Vice President Gore's 1996 political campaign vehicle, from August 1996 through November 1996, and as Political Director of the Democratic National Committee from April 1994 through January 1995. Executive officers and other officers are elected or appointed by, and serve at the pleasure of, the Board of Directors. Some are party to employment contracts with the Company. The information set forth above reflects positions held with Holdings except as expressly provided to the contrary. For the purposes of calculating the aggregate market value of the shares of Common Stock of Holdings held by nonaffiliates, as shown on the cover page of this report, it has been assumed that all the outstanding shares were held by nonaffiliates except for the shares beneficially owned by: directors of Holdings, officers, and employees of and consultants to Holdings and GTECH. However, this should not be deemed to constitute an admission that all such persons or entities are, in fact, affiliates of Holdings, or that there are not other persons who may be deemed to be affiliates of Holdings. Further information concerning shareholdings of officers, directors and principal shareholders of Holdings will be included in Holdings' definitive proxy statement relating to its scheduled July 1999 Annual Meeting of Shareholders to be filed with the Securities and Exchange Commission. 39 41 PART II ITEM 5. MARKET FOR THE REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS The principal United States market on which Holdings' Common Stock is traded is the New York Stock Exchange where it is traded under the symbol "GTK." The following table sets forth on a per share basis the high and low sale prices of Common Stock for the fiscal quarters indicated, as reported on the New York Stock Exchange Composite Tape.
FISCAL 1998 HIGH LOW First Quarter (February 23-May 31, 1997) $34 1/2 $28 3/8 Second Quarter (June 1-August 30, 1997) $34 1/4 $29 3/4 Third Quarter (August 31-November 29, 1997) $35 7/16 $29 1/2 Fourth Quarter (November 30-February 28, 1998) $35 3/4 $26 3/16
FISCAL 1999 HIGH LOW First Quarter (March 1 - May 30, 1998) $40 5/8 $31 Second Quarter (May 31- August 29, 1998) $35 9/16 $27 Third Quarter (August 30 - November 28, 1998) $28 13/16 $21 3/4 Fourth Quarter (November 29 - February 27, 1999) $27 9/16 $20 5/16
The closing price of the Common Stock on the New York Stock Exchange on May 3, 1999 was $26 3/8. As of May 3, 1999, there were approximately 1,050 holders of record of the Common Stock. During fiscal 1999, 5,688 shares of Holdings' unregistered Common Stock vested under stock award plans. Pursuant to the terms of these plans, the shares were issued for no cash consideration. Registration of such shares was not required because the transaction did not constitute a "sale" under Section 2(3) of the Securities Act of 1933 or, alternatively, the transaction was exempt pursuant to the private offering provisions of the Act and the rules thereunder. Holdings has never paid cash dividends on its Common Stock and has no current plan to do so. The current policy of Holdings' Board of Directors is to reinvest earnings in the operation and expansion of the Company's business. Further, Holdings is a holding company and the operations of the Company are conducted through Holdings' subsidiaries. Accordingly, the ability of Holdings to pay dividends on its Common Stock would be dependent on the earnings and cash flow of its subsidiaries and the availability of such cash flow to Holdings. 40 42 ITEM 6. SELECTED CONSOLIDATED FINANCIAL DATA The selected consolidated financial data below should be read in conjunction with Item 7--"Management's Discussion and Analysis of Financial Condition and Results of Operations," the Consolidated Financial Statements and the other financial information included herein. The operating, balance sheet and per share data in the table are derived from the consolidated financial statements of the Company which were audited by independent auditors. 41 43 GTECH HOLDINGS CORPORATION AND SUBSIDIARIES SELECTED CONSOLIDATED FINANCIAL DATA
Fiscal Year Ended ------------------------------------------------------------------------------ February 27, February 28, February 22, February 24, February 25, 1999 1998 (a) 1997 1996 1995 ------------ ------------ ------------ ------------ ------------ (Dollars in thousands, except per share amounts) OPERATING DATA: Revenues: Services (b) $ 887,395 $ 868,522 $ 789,534 $ 686,043 $ 547,767 Sales of products 85,528 122,045 114,738 58,047 147,340 ---------- ---------- ---------- ---------- ---------- Total 972,923 990,567 904,272 744,090 695,107 Gross Profit: Services (b) 295,608 265,038 237,872 244,139 194,097 Sales of products 25,703 48,230 47,297 13,595 41,468 ---------- ---------- ---------- ---------- ---------- Total 321,311 313,268 285,169 257,734 235,565 Operating income (b) 141,720 (c) 44,104 (d) 127,091 117,983 104,481 (e) Interest expense, net of interest income 23,326 24,578 16,388 12,107 13,065 Income from continuing operations before extraordinary charge 89,063 27,214 77,803 66,627 52,319 Loss from operations of AmTote -- -- -- -- (6,583) Loss on disposal of AmTote -- -- -- -- (43,444) Extraordinary charge -- -- -- -- (1,420) Net income 89,063 27,214 77,803 66,627 872 PER SHARE DATA: BASIC: From continuing operations $ 2.17 $ .65 $ 1.81 $ 1.54 $ 1.20 Net income 2.17 .65 1.81 1.54 .02 (f) DILUTED: From continuing operations 2.16 .64 1.80 1.53 1.20 Net income 2.16 .64 1.80 1.53 .02 (f) OTHER DATA: Earnings before depreciation, amortization, interest, taxes and other noncash charges $ 376,158 $ 347,099 $ 326,054 $ 273,570 $ 221,832 Cumulative number of lottery terminals shipped (g) 377,857 360,202 316,614 280,897 261,287 Number of lottery terminals sold 4,921 11,963 13,609 3,658 12,282 Number of lottery customers at year-end 81 78 79 74 72 BALANCE SHEET DATA (AT END OF PERIOD): Working capital $ 3,755 $ 27,371 $ 36,914 $ 21,414 $ 6,086 Total assets 874,215 1,023,812 956,541 859,380 779,254 Long-term debt, less current portion 319,078 453,587 382,499 382,930 338,468 Shareholders' equity 283,906 345,210 358,133 296,725 232,931
(a) 53-week year. (b) The Company's Brazilian operations prior to January 31, 1996 were included in the financial statements of the Company on the equity method of accounting. (c) Includes a special charge of $15.0 million or $.22 per basic share; $.21 per diluted share. See Note P to the consolidated financial statements. (d) Includes a special charge of $99.4 million or $1.45 per basic share; $1.44 per diluted share. See Note P to the consolidated financial statements. (e) Includes an $11.1 million special charge consisting of a $6.1 million charge in connection with the reduction of the Company's workforce and relocation of certain operating functions and $5.0 million to write off its video gaming-related inventory. (f) Includes the effect of operating losses of the Company's former AmTote subsidiary - $.15 per share, loss on disposal of AmTote - $1.00 per share, and extraordinary loss relating to early extinguishment of debt - $.03 per share. (g) Terminals shipped represents lottery terminals sold under product sale contracts and lottery terminals supplied under service contracts. F-1 44 Item 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS Certain statements contained in this section and elsewhere in this report are forward-looking statements within the meaning of Section 27A of the Securities Act and Section 21E of the Securities Exchange Act of 1934. Such statements include, without limitation, statements relating to (i) the future prospects for and stability of the lottery industry and other businesses that the Company is engaged in or expects to engage in, (ii) the future operating and financial performance of the Company, (iii) the ability of the Company to retain existing business and to obtain and retain new business, (iv) the Company's program to address potential issues relating to the change of date to January 1, 2000 ("Year 2000"), and (v) the results and effects of legal proceedings and investigations. Such forward-looking statements reflect management's assessment based on information currently available, but are not guarantees and are subject to risks and uncertainties that could cause actual results to differ materially from those contemplated in the forward-looking statements. These risks and uncertainties include, but are not limited to, those set forth below and elsewhere in this report and in the Company's press releases and its Forms 10-K, 10-Q, 8-K and other reports and filings with the Securities and Exchange Commission (the "SEC"). General The Company has derived substantially all of its revenues from the rendering of services and the sale or supply of computerized online lottery systems and components to government-authorized lotteries. Service revenues have been derived primarily from lottery service contracts. These contracts are typically at least five years in duration, and are generally based upon a percentage of a lottery's gross online lottery sales. These percentages vary depending on the size of the lottery and the scope of services provided to the lottery. Product sale revenues have been derived primarily from the installation of new online lottery systems and sales of lottery terminals and equipment in connection with the expansion of existing lottery systems. The size and timing of these transactions have resulted in variability in product sale revenues from period to period. The Company currently anticipates that product purchases by lotteries during fiscal 2000 will return to approximately fiscal 1998 levels. The Company has taken steps to broaden its offerings of high-volume transaction processing services outside of its core business of providing online lottery services. For example, the Company's Dreamport subsidiary ("Dreamport") provides gaming technology and a comprehensive array of management, development and strategic services to the gaming and entertainment markets. Also, on July 1, 1998, the Company acquired 80% of the equity of Europrint Holdings Ltd. ("Europrint") and its wholly owned subsidiaries, including Interactive Games International ("IGI"), for a net cash purchase price of $21.6 million, including related acquisition costs. The Company has the option, and under certain circumstances the obligation, to acquire the remaining 20% of the equity of Europrint and IGI within five years from the date of acquisition. Europrint is among the world's largest providers of media promotional games and IGI has pioneered the development of interactive, televised lottery games. The Company's business is highly regulated, and the competition to secure new government contracts is often intense. Awards of contracts to the Company are, from time to time, challenged by competitors. Further, there have been and continue to be investigations of various types, including grand jury investigations, conducted by governmental authorities into possible improprieties and wrongdoing in connection with efforts to obtain and/or the awarding of lottery contracts and related matters. Although the Company does not believe that it has engaged in any wrongdoing in connection with these matters, certain investigations that are conducted largely in secret are still under way. Accordingly, the Company lacks sufficient information to determine with certainty their ultimate scope and whether the government authorities will assert claims resulting from these or other investigations that could implicate or reflect adversely upon the Company. Because the Company's reputation for integrity is an important factor in its business dealings with lottery and other government agencies, if government authorities were to make an allegation of, or if there were to be a finding of, improper conduct on the part of or attributable to the Company in any matter, such an allegation or finding could have a material adverse effect on the Company's business, including its ability to retain existing contracts and to obtain new or renewal contracts. In addition, continuing adverse publicity resulting from these investigations and related matters could have such a material adverse effect. See Note G to the Consolidated Financial Statements, Part I, Item 1, -- "Certain Factors That May Affect Future Performance --Maintenance of Business Relationships and Certain Legal Matters" and Part I, Item 3 -- "Legal Proceedings" herein for further information concerning these matters and other contingencies. The Company operates on a 52- to 53-week fiscal year ending on the last Saturday in February. Fiscal 1998 was a 53-week year. All references to the Consolidated Financial Statements of the Company and Notes thereto, are to the Consolidated Financial Statements of the Company and Notes thereto included in Item 8 herein. F-2 45 The following discussion should be read in conjunction with the table below.
SUMMARY FINANCIAL DATA Fiscal Year Ended ---------------------------------------------------------------------- February 27, February 28, February 22, 1999 1998 (a) 1997 -------------------- -------------------- -------------------- (Dollars in thousands) Revenues: Services $ 887,395 91.2% $ 868,522 87.7% $ 789,534 87.3% Sales of products 85,528 8.8 122,045 12.3 114,738 12.7 --------- ----- --------- ----- --------- ----- Total 972,923 100.0 990,567 100.0 904,272 100.0 Costs and expenses: Costs of services (b) 591,787 66.7 603,484 69.5 551,662 69.9 Costs of sales (b) 59,825 69.9 73,815 60.5 67,441 58.8 --------- ----- --------- ----- --------- ----- Total 651,612 67.0 677,299 68.4 619,103 68.5 --------- ----- --------- ----- --------- ----- Gross profit 321,311 33.0 313,268 31.6 285,169 31.5 Selling, general and administrative 124,433 12.8 133,284 13.5 127,080 14.0 Research and development 40,158 4.1 36,498 3.7 30,998 3.4 Special charge 15,000 1.5 99,382 10.0 -- -- --------- ----- --------- ----- --------- ----- Operating income 141,720 14.6 44,104 4.4 127,091 14.1 Other income (expense): Interest income 4,079 0.4 5,733 0.6 4,424 0.5 Equity in earnings of unconsolidated affiliates 7,113 0.7 24,376 2.5 16,727 1.8 Other income 25,447 2.6 711 0.1 4,439 0.5 Interest expense (27,405) (2.8) (30,311) (3.1) (20,812) (2.3) --------- ----- --------- ----- --------- ----- Income before income taxes 150,954 15.5 44,613 4.5 131,869 14.6 Income taxes 61,891 6.3 17,399 1.8 54,066 6.0 --------- ----- --------- ----- --------- ----- Net income $ 89,063 9.2% $ 27,214 2.7% $ 77,803 8.6% ========= ===== ========= ===== ========= =====
(a) 53-week year (b) Percentages are computed based on cost as a percentage of related revenue. F-3 46 Special Charges In the fourth quarter of fiscal 1998 the Company's Board of Directors approved a plan of repositioning and restructuring of the Company's operations (the "Plan") and recorded a $99.4 million special charge ($60.6 million after-tax, or $1.45 per basic share; $1.44 per diluted share) related to the execution of the Plan. The special charge consisted principally of costs to exit the electronic benefits transfer (EBT) business conducted by the Company's Transactive subsidiary ("Transactive"). In addition, the special charge included costs associated with a worldwide workforce reduction, contractual obligations in connection with the departures of the Company's former chairman and vice-chairman from the Company and asset impairment charges relating to two of the Company's lottery contracts. The Company realized pre-tax savings in fiscal 1999 of approximately $43.0 million resulting from the Plan. In February 1998, the Company entered into an asset purchase agreement with Citicorp Services, Inc. ("Citicorp"), to sell EBT contracts and certain related assets held by Transactive. In July 1998, the U.S. Department of Justice commenced a legal action seeking to enjoin the consummation of the transaction, and in January 1999 Citicorp terminated the agreement pursuant to a clause in the contract that permitted termination by either party if the closing did not occur within a timeframe that has expired. Principally as a result of the contract termination, the Company recorded an additional special charge in the fourth quarter of fiscal 1999 of $15.0 million ($8.9 million after-tax; or $.22 per basic and diluted share) in order to write down the assets held for sale to their net realizable value. The proposed sale did not include the contracts or assets in connection with Transactive's provision of benefit identification cards to the state of New York, electronic payment file transfer services to the city of New York, or hunting, fishing and recreational licenses to the state of Texas. The Company plans to continue to honor those contracts and Transactive's EBT contracts, but has decided not to pursue new opportunities in those areas or seek new U.S. EBT contracts. Results of Operations COMPARISON OF FISCAL 1999 WITH 1998 Revenues for fiscal 1999 were $972.9 million, representing a $17.7 million, or 1.8%, decrease from revenues of $990.6 million in fiscal 1998. Service revenues in fiscal 1999 were $887.4 million, representing an $18.9 million, or 2.2%, increase over the $868.5 million of service revenues in fiscal 1998. This increase resulted primarily from $11.3 million of higher service revenues from the Company's existing lottery customer base, including higher lottery jackpot activity, and $6.6 million of incremental service revenues from Dreamport. The increase in service revenues reflects a $15.0 million reduction in service revenue associated with having 13 weeks in the first quarter of fiscal 1999 compared with 14 weeks in the first quarter of fiscal 1998. In fiscal 1999, lottery sales by the Company's domestic customers declined approximately 2% compared with fiscal 1998, primarily reflecting the continued decline in sales in Texas and New F-4 47 York. This decline, coupled with contractual rate reductions in Texas, California and Georgia, resulted in a decline in the Company's domestic service revenues of 5.6%. Excluding Texas, lottery sales for the Company's domestic customers increased approximately 5%. Lottery sales by the Company's international customers increased approximately 19% in fiscal 1999 compared with fiscal 1998, driven primarily by growth in Brazil, Mexico, Poland and Germany. This increase, coupled with contractual rate increases in Brazil and Mexico and partially offset by the impact of the reduction in the dollar value of foreign currencies, resulted in growth of 14% in the Company's international lottery service revenues. Worldwide sales by the Company's lottery customers increased approximately 5% in fiscal 1999 versus fiscal 1998. Incorporating rate and currency changes, the Company's total lottery service revenues grew 1.4%. The weakening of foreign currencies impacted fiscal 1999 lottery service revenues. However, these effects were offset by gains from financial hedges, reflected in other income. Had average exchange rates in fiscal 1998 continued throughout fiscal 1999, service revenues would have been approximately $30.0 million higher than reported. As anticipated, product sales declined from $122.0 million in fiscal 1998 to $85.5 million in fiscal 1999. This decrease resulted primarily from lower terminal sales in fiscal 1999 than in fiscal 1998. The Company sold approximately 4,900 lottery terminals during fiscal 1999, as compared to approximately 12,000 lottery terminals during fiscal 1998. Fiscal 1998 product sales included approximately 6,500 terminals to the state of Massachusetts comprising part of the sale of a new online lottery central system to that customer in the third quarter of fiscal 1998. Gross margins on service revenues were 33.3% in fiscal 1999, up from 30.5% in fiscal 1998, primarily due to cost reductions resulting from the restructuring and repositioning Plan announced by the Company in February 1998, along with higher lottery jackpot activity in fiscal 1999 than in fiscal 1998. Gross margins on product sales fluctuate depending on the mix, volume and timing of product sales contracts. Gross margins on product sales declined from 39.5% in fiscal 1998 to 30.1% in fiscal 1999. This change was primarily due to a shift in product mix along with the acquisition of Europrint, a business with lower margins than the Company has realized historically. Selling, general and administrative expenses in fiscal 1999 were $124.4 million, representing an $8.9 million, or 6.6%, decrease from the $133.3 million incurred in fiscal 1998. This decrease was primarily attributable to lower legal expenses and a reduction in costs resulting from the restructuring and repositioning Plan. These declines were partially offset by selling, general and administrative expenses of Europrint and IGI. As a percentage of revenues, selling, general and administrative expenses were 12.8% and 13.5% during fiscal 1999 and 1998, respectively. Research and development expenses in fiscal 1999 were $40.2 million, representing a $3.7 million, or 10.0%, increase over research and development expenses of $36.5 million in fiscal 1998. This increase reflects costs associated with the continuing development of the Company's Internet wagering platform, as well as an increase in the number of new products in the development pipeline. As a percentage of revenues, research and development expenses were 4.1% and 3.7% during fiscal 1999 and 1998, respectively. F-5 48 Interest income in fiscal 1999 was $4.1 million, a decrease of $1.6 million from interest income of $5.7 million earned during fiscal 1998. During fiscal 1998, the Company had higher dollar-denominated cash balances on hand in Brazil than in fiscal 1999 to fund the online lottery system implementation that was completed for Caixa Economica Federal ("Caixa"), Latin America's largest financial institution, in fiscal 1998. Equity in earnings of unconsolidated affiliates in fiscal 1999 was $7.1 million, a decrease of $17.3 million from the $24.4 million earned during fiscal 1998. This decrease resulted principally from the Company's sale, in April 1998, of its 22.5% equity interest in Camelot Group plc ("Camelot") back to Camelot for $84.9 million. The book value of the Company's Camelot investment at the time of sale was $51.8 million. A portion of the cash received by the Company would have to be returned to Camelot in the event that Camelot's operating license is revoked for certain reasons determined to be attributable to the Company. Accordingly, the Company has deferred the recognition of the gain from the sale of its investment and is recognizing such gain ratably over the remaining period of Camelot's operating license, due to expire in September 2001. The sale of this equity interest does not affect the Company's position as the principal supplier of goods and services to Camelot, but has reduced the Company's equity in earnings of unconsolidated affiliates. Other income in fiscal 1999 was $25.4 million, an increase of $24.7 million over the $.7 million earned in fiscal 1998. Other income in fiscal 1999 includes foreign exchange gains associated with the Company's global asset protection and foreign exchange management programs, as well as the amortization of the gain on the sale of Camelot. The Company, through its asset protection strategy, avoided a cash loss in Brazil by investing accumulated cash in dollar-denominated investments while awaiting government approvals to repatriate these dollars to the U.S. Subsequent to February 27, 1999, government approval was obtained and this cash was repatriated. The success of the Company's foreign exchange management program offset approximately 90% of the gross profit erosion that resulted from the year to year weakening of foreign currencies. Interest expense in fiscal 1999 was $27.4 million, a decrease of $2.9 million from interest expense of $30.3 million incurred during fiscal 1998. This decrease was primarily due to lower debt outstanding under the Company's revolving credit facility, partially offset by higher average interest rates on the Company's outstanding debt. The Company's effective income tax rate increased from 39% in fiscal 1998 to 41% in fiscal 1999 due principally to the loss of the beneficial tax effect of U.K. equity earnings that were reported on an after-tax basis. This increase was partially offset by the congressional extension of the Research and Development tax credit. The Company's effective income tax rate was greater than the statutory rate primarily due to state income taxes and certain expenses that are not deductible for income tax purposes. Subsequent Event On April 1, 1999, after the close of fiscal 1999, Quick Draw, the keno-style game operated in New York on a lottery system provided by the Company, terminated due to the failure of the New York State Legislature to extend the legislation authorizing the game. Quick Draw was authorized by the New York State Legislature, and implemented by the New York State Lottery on September 5, 1995, to increase revenue for New York public schools. In the Lottery's fiscal year ending March 31, 1999, Quick Draw sales totaled approximately $482.0 million. The termination of the Quick Draw game in New York will not have a material impact on the Company's results of operations for the first quarter of fiscal 2000. The Company believes that it is likely that the New York Legislature will enact legislation that will provide for the continuation of Quick Draw during the Company's fiscal 2000 second quarter, however, there can be no assurance that this will be the case. F-6 49 COMPARISON OF FISCAL 1998 WITH 1997 Revenues for fiscal 1998 were $990.6 million, representing an $86.3 million, or 9.5%, increase over revenues of $904.3 million in fiscal 1997. Service revenues in fiscal 1998 were $868.5 million, representing a $78.9 million, or 10.0%, increase over the $789.6 million of service revenues in fiscal 1997. This increase resulted primarily from $46.5 million of higher service revenues from the Company's existing lottery customer base, along with $32.8 million of service revenues from a new online lottery system implemented for the Caixa by the Company in Brazil. After a number of years of growth, the Company witnessed, over the last three fiscal quarters of 1998, a downward trend in the sales generated by its U.S. lottery customers. Product sales for fiscal 1998 were $122.0 million, representing an increase of $7.3 million, or 6.4%, over the $114.7 million of product sales in fiscal 1997. This increase resulted primarily from higher central system sales in fiscal 1998 than in fiscal 1997, including a large product sale to the Massachusetts State Lottery in the third quarter. These increases were partially offset by lower terminal sales and lower sales of component parts and equipment to Camelot and other members of the U.K. lottery consortium. The Company sold approximately 12,000 lottery terminals during fiscal 1998, as compared to approximately 13,600 lottery terminals during fiscal 1997. Gross margins on service revenues were 30.5% in fiscal 1998, up from 30.1% in fiscal 1997, primarily due to improved margins on certain existing lottery contracts, partially offset by lower margins from new lottery and electronic benefit contracts that began in fiscal 1998. Gross margins on product sales fluctuate depending on the mix, volume and timing of product sales contracts. Gross margins on product sales were 39.5% in fiscal 1998 compared with 41.2% in fiscal 1997. Selling, general and administrative expenses in fiscal 1998 were $133.3 million, representing a $6.2 million, or 4.9%, increase over the $127.1 million incurred in fiscal 1997. This increase was primarily attributable to increased sales, marketing and business development costs, along with higher administrative costs that were necessary to support expanded operations (including Dreamport). As a percentage of revenues, selling, general and administrative expenses were 13.5% and 14.0% during fiscal 1998 and 1997, respectively. Research and development expenses in fiscal 1998 were $36.5 million, representing a $5.5 million, or 17.7%, increase over research and development expenses of $31.0 million in fiscal 1997. This increase reflects higher development activity for new hardware products, including the Company's latest generation lottery terminal, the design and related software for new games, and the costs associated with the continuing development of an Internet wagering platform. As a percentage of revenues, research and development expenses were 3.7% and 3.4% during fiscal 1998 and 1997, respectively. Interest income in fiscal 1998 was $5.7 million, an increase of $1.3 million over interest income of $4.4 million earned during fiscal 1997. This increase reflects higher dollar-denominated cash balances that were on hand in Brazil to fund the online lottery system implementation recently completed for Caixa, along with interest earned on sales-type lease receivables. Equity in earnings of unconsolidated affiliates in fiscal 1998 was $24.4 million, an increase of $7.7 million over the $16.7 million earned during fiscal 1997. This increase was primarily due to higher equity income from Camelot, along with higher equity income from Dreamport partnerships in Delaware and Oregon. F-7 50 Other income in fiscal 1998 was $.7 million, a decrease of $3.7 million from the $4.4 million earned in fiscal 1997. Other income of $4.4 million earned during fiscal 1997 primarily represented the gain on the sale of the Company's investment in Pacific Online Systems Corporation. Interest expense in fiscal 1998 was $30.3 million, an increase of $9.5 million over interest expense of $20.8 million incurred during fiscal 1997. This increase was primarily due to higher average debt outstanding to fund the online lottery system implementation for Caixa, along with higher average interest rates. The Company's effective income tax rate decreased to 39% in fiscal 1998 from 41% in fiscal 1997 due principally to a reduction in nondeductible expenditures, increased recognition of tax credits and the full-year effect of the restructuring of financing and operations in Brazil. The Company's effective income tax rate was greater than the statutory rate primarily due to state income taxes and certain expenses that are not deductible for income tax purposes. Changes in Financial Position, Liquidity and Capital Resources During fiscal 1999, the Company generated $286.3 million of cash from operations. This cash, together with $84.9 million of cash received from the sale of the Company's investment in Camelot, was used to pay down $117.0 million on the Company's Credit Facility; to fund the purchase of $121.2 million of systems, equipment and other assets relating to contracts; to repurchase $70.8 million of the Company' common stock and to fund the acquisition of Europrint for $21.6 million. Trade accounts receivable increased by $12.9 million, from $93.8 million at February 28, 1998 to $106.7 million at February 27, 1999, primarily due to a higher level of product sales in the fourth quarter of fiscal 1999 compared to the fourth quarter of fiscal 1998, along with receivables of Europrint and IGI. Inventories increased by $34.0 million, from $27.9 million at February 28, 1998 to $61.9 million at February 27, 1999, primarily due to spending related to product sales expected to be delivered by November 1999 (see advance payments from customers below). Assets held for sale decreased by $14.2 million, due to the termination of the agreement to sell Transactive EBT contracts and certain related assets to Citicorp. The write-off of these assets is included in the fiscal 1999 special charge. The cost of systems, equipment and other assets relating to contracts decreased by $46.9 million, from $1,204.6 million at February 28, 1998 to $1,157.7 million at February 27, 1999. This decrease reflects $102.2 million relating to the devaluation of the Brazilian currency in January 1999, partially offset by the continuing installation of a new lottery system in Michigan and the expansion of lottery systems in several domestic and international locations. Current deferred income taxes decreased by $11.5 million, from $40.9 million at February 28, 1998 to $29.4 million at February 29, 1999, primarily due to the acceleration of tax deductions relating to capitalized software costs. F-8 51 Investments in and advances to unconsolidated affiliates decreased by $54.0 million, from $64.8 million at February 28, 1998 to $10.8 million at February 27, 1999, primarily due to the sale of the Company's investment in Camelot. The special charge accrual decreased by $27.6 million, from $33.6 million at February 28, 1998 to $6.1 million at February 27, 1999, due to severance and related payments and legal costs in connection with the previously reported Branson litigation and judgement in the U.K. Advance payments from customers increased by $30.0 million, from $.5 million at February 28, 1998 to $30.5 million at February 27, 1999. This increase reflects the down payments received on product sales orders from six international customers and that portion of the deferred gain from the sale of the Company's investment in Camelot that will be recognized in other income in fiscal 2000. Income taxes payable, that are reported net of income tax refunds receivable, increased by $32.5 million, from $25.4 million at February 28, 1998 to $57.9 million at February 27, 1999. This increase was primarily due to an income tax refund received relating to the fiscal 1998 special charge and the timing of income tax payments, including those related to the sale of the Company's investment in Camelot. Long-term debt, less current portion decreased by $134.5 million, from $453.6 million at February 28, 1998 to $319.1 million at February 27, 1999. This decrease was primarily due to the application of the proceeds received from the sale of the Company's investment in Camelot and free cash flow generated during fiscal 1999 to the Credit Facility. Other liabilities increased by $10.7 million, from $19.2 million at February 28, 1998 to $29.9 million at February 27, 1999, reflecting the long-term portion of the deferred gain from the sale of the Company's investment in Camelot. The Company's business is capital-intensive. Although it is not possible to estimate precisely, due to the nature of the business, the Company currently anticipates that the level of capital expenditures for systems, equipment and other assets relating to contracts required during fiscal 2000 will be in a range of $200.0 million to $220.0 million. The principal sources of liquidity for the Company are expected to be cash generated from operations and borrowings under the Company's Credit Facility. As of May 1, 1999 the Company had utilized approximately $36.5 million of its $400 million Credit Facility. The Company currently expects that its cash flow from operations and available borrowings under its Credit Facility will be sufficient to fund its anticipated working capital and ordinary capital expenditure needs, to service its debt obligations and to fund anticipated internal growth in the foreseeable future. F-9 52 Inflation The impact of inflation on the Company's operations has not been significant to date. While the Company believes that its business is not highly sensitive to inflation, there can be no assurance that a high rate of inflation in the future would not have an adverse effect on the Company's operations, particularly in emerging markets such as Brazil. The Company historically used the U.S. dollar as the functional currency for its operations in Brazil due to the high levels of inflation in the Brazilian economy. The Company began using the local currency in Brazil as the functional currency on March 1, 1998 because of the significant reduction in the rate of inflation in Brazil. At February 27, 1999, the net book value of the Company's investments in Brazil was approximately $100 million. Market Risk Disclosures The primary market risk inherent in the Company's financial instruments and exposures is the potential loss arising from adverse changes in interest rates and foreign currency rates. The Company's exposure to commodity price changes is not considered material and is managed through its procurement and sales practices. The Company did not own any marketable equity securities during fiscal 1999. Interest rates Interest rate market risk is estimated as the potential change in the fair value of the Company's total debt or current earnings resulting from a hypothetical 10% adverse change in interest rates. At February 27, 1999, the estimated fair value of the Company's fixed rate debt, as determined by an independent investment banker, approximated $313.4 million. A hypothetical 10% adverse change in interest rates would increase the estimated fair value of the Company's fixed rate debt to $322.0 million. A hypothetical 10% favorable change in interest rates would decrease the estimated fair value of the Company's fixed rate debt to $305.1 million. A hypothetical 10% adverse or favorable change in interest rates applied to variable rate debt would not have a material affect on current earnings. The Company uses various techniques to reduce the risk associated with future increases in interest rates, the most significant being the private placement of seven- and 10-year fixed rate debt on May 29, 1997. Foreign Currency Exchange Rates Foreign exchange exposures arise from current transactions and anticipated transactions denominated in a currency other than an entity's functional currency and from the translation of foreign currency balance sheet accounts into U.S. dollar balance sheet accounts. The Company seeks to manage its foreign exchange risk by securing payment from its customers in U.S. dollars, by sharing risk with its customers, by utilizing foreign currency borrowings, by leading and lagging receipts and payments and by entering into foreign currency exchange and option contracts. In addition, a significant portion of the costs attributable to the Company's foreign currency revenues are payable in the local currencies. Whenever possible, the Company negotiates clauses into its contracts that allow for price adjustments should a material change in foreign exchange rates occur. The Company, from time to time, enters into foreign currency exchange and option contracts to reduce the exposure associated with current transactions and anticipated transactions denominated in foreign currencies. However, the Company does not engage in currency speculation. At February 27, 1999, a hypothetical 10% adverse change in foreign exchange rates would result in a translation loss of $17.0 million that would be recorded in the equity section of the Company's balance sheet. At February 27, 1999, a hypothetical 10% adverse change in foreign exchange rates would result in a net transaction loss of $.8 million recorded in current earnings after considering the effects of foreign exchange contracts currently in place. At February 27, 1999, a hypothetical 10% adverse change in foreign exchange rates would result in a net reduction of cash flows from anticipatory transactions in fiscal 2000 by $13.1 million. The percentage of fiscal 1999 anticipatory transactions that were hedged varied throughout fiscal 1999, but averaged 65%. As of May 1, 1999, the Company had approximately $67.8 million of outstanding foreign currency exchange contracts to purchase foreign currencies (primarily pounds sterling) and approximately $94.3 million of outstanding foreign currency exchange and option contracts to sell foreign currencies (primarily Spanish pesetas, Mexican pesos, pounds sterling and Brazilian reals). F-10 53 IMPACT OF YEAR 2000 The Year 2000 computer issue creates potentially significant risks for the Company. If lottery, gaming or EBT systems that the Company supplies to customers or management information systems that the Company uses internally do not correctly recognize and process date information beyond the year 1999, there could be an adverse impact on customers' and/or the Company's operations. The Company is actively managing its program to assess the capability of its lottery, gaming and EBT products and its interfaces to customer systems to handle the Year 2000. With respect to customer systems, the major challenge for the Company in remediating the Year 2000 issue is the multinational nature of the Company's business and the high degree of global coordination that is required with customers, suppliers and employees. The Company has established a Year 2000 project team and a program office at its corporate headquarters, made up of dedicated and shared resources, to provide the guidance and support necessary to accomplish the Year 2000 initiative. The status of the Company's six-phase program as of May 1, 1999 is as follows: - - The inventory phase consists of compiling a comprehensive list of software and hardware technologies in use by the Company. This phase is complete. - - The assessment phase consists of determining the compliance status of each technology identified in the inventory phase. This phase is complete. - - The planning phase consists of developing plans to upgrade hardware and/or software to Year 2000 compliance. This phase is complete. - - The implementation phase consists of executing the tasks identified in the planning phase. This phase is approximately 50% complete and is expected to be completed by September 1, 1999. - - The quality assurance phase consists of testing and validating systems replaced or modified as part of the implementation phase. This phase has begun for approximately 35% of our sites and is expected to be completed by September 1, 1999. - - The special case phase consists of developing and implementing specific plans for any Year 2000 issues that cannot be handled by the previous phases. This phase will include monitoring each site for change control, contingency planning, monitoring vendor compliance issues and other matters that may arise. This phase will commence in September 1999. The Company is actively working with and seeking to enlist the cooperation of its customers to ensure integration with their systems and telecommunications networks. The Company is also actively working with critical suppliers of products and services to determine that the suppliers' operations and the products and services they provide are Year 2000 capable. The Company will continue to monitor their progress toward Year 2000 capability. The majority of the internal management information systems in use by the Company (including SAP's R/3 system, System Union's SUN accounting system and Hyperion's Pillar software) are Year 2000 compliant. The Company has a time tracking system and an accounting system in Brazil that are not Year 2000 compliant. The Company is executing its plan to replace these two systems with SAP's R/3 system by September 1999. The Company has a limited number of non-IT systems that are primarily in use by the engineering and manufacturing departments of the Company. The Company began the inventory and assessment of these systems in October 1998 and plans to complete remediation by September 1, 1999. The Company's contingency planning involves using already established problem resolution processes to resolve any problems encountered during the Year 2000 timeframe. As a standard practice, the Company provides 24 hour a day operational support. This support provides focused individuals in all disciplines that respond in real time to operational issues. The Company's contingency planning will include the expansion of the Year 2000 help desk team and the creation of eight to 10 command centers worldwide to provide the necessary response to issues that may arise as January 1, 2000 approaches. The Company currently expects that the total cost of the Year 2000 program will not exceed $25 million, including $5 million for the purchase of software and hardware that will be capitalized and $20 million that will be expensed. As of May 1, 1999 the Company had spent approximately $8.4 million on the program. The total cost estimate does not include possible costs related to any customer or other claims or the cost of internal software and hardware replaced in the normal course of business but does include the cost to install new software and hardware that is being accelerated to provide a solution to Year 2000 issues. The total cost estimate is based on the Company's current assessment of the program and is subject to change as the program progresses. Year 2000 issues could have a significant impact on the Company's operations and its financial condition and results if modifications cannot be completed on a timely basis, unforeseen needs or problems arise, or systems operated by third parties are not Year 2000 compliant. In addition to the potential for a significant loss of revenues and possible damage claims by third parties associated with Year 2000 issues, certain of the Company's United States lottery contracts provide for up to $10,000 or more in liquidated damages per minute for system downtime in excess of a stipulated grace period and certain of the Company's international customers reserve the right to assess substantial liquidated damages in the event that system downtime does occur. Based on currently available information, management does not believe that the Year 2000 matters discussed above will cause significant operational or financial problems for the Company; however there can be no assurance that this will be the case. F-11 54 ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK The Company's market risk disclosures are included in Item 7, "Management's Discussion and Analysis of Financial Condition and Results of Operations" above. 55 ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA 56 Report of Independent Auditors Board of Directors and Shareholders GTECH Holdings Corporation We have audited the accompanying consolidated balance sheets of GTECH Holdings Corporation and subsidiaries as of February 27, 1999 and February 28, 1998 and the related consolidated statements of income, shareholders' equity, and cash flows for each of the three years in the period ended February 27, 1999. 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. The financial statements of Camelot Group plc (an entity in which the Company had a 22.5% interest until April, 1998) have been audited by other auditors whose report has been furnished to us; insofar as our opinion on the consolidated financial statements of the Company relates to data included for Camelot Group plc, it is based solely on their report. We conducted our audits in accordance with generally accepted auditing standards. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluationg the overall financial statement presentation. We believe our audits and the report of other auditors provide a reasonable basis for our opinion. In our opinion, based on our audits and the report of other auditors, the financial statements referred to above present fairly, in all material respects, the consolidated financial position of GTECH Holdings Corporation and subsidiaries at February 27, 1999 and February 28, 1998 and the consolidated results of their operations and their cash flows for each of the three years in the period ended February 27, 1999, in conformity with generally accepted accounting principles. Ernst & Young LLP Boston, Massachusetts March 29, 1999 F-12 57 REPORT OF INDEPENDENT ACCOUNTANTS TO THE BOARD OF DIRECTORS AND SHAREHOLDERS OF CAMELOT GROUP PLC We have audited the financial statements of Camelot Group plc as of January 31, 1998 and February 1, 1997, and for the years then ended which are expressed in pounds sterling. 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 audit in accordance with auditing standards generally accepted in the United Kingdom and the United States. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion. In our opinion, the financial statements referred to above present fairly the financial position of Camelot Group plc at January 31, 1998 and February 1, 1997, and the results of its operations, total recognised gains and losses and cash flows for each of the years ended January 31, 1998 and February 1, 1997, in conformity with generally accepted accounting principles in the United Kingdom. Accounting principles generally accepted in the United Kingdom vary in certain significant respects from accounting principles generally accepted in the United States. The application of the latter would have affected the determination of net income expressed in pounds sterling for the years ended January 31, 1998 and February 1, 1997 and the determination of shareholders' equity also expressed in pounds sterling at January 31, 1998 and February 1, 1997 to the extent summarized in footnote 24 to the financial statements. Price Waterhouse Chartered Accountants London, England March 23, 1998 F-13 58 GTECH HOLDINGS CORPORATION AND SUBSIDIARIES CONSOLIDATED BALANCE SHEETS
February 27, February 28, 1999 1998 ----------- ----------- (Dollars in thousands) ASSETS CURRENT ASSETS: Cash and cash equivalents $ 7,733 $ 8,250 Trade accounts receivable 106,693 93,778 Sales-type lease receivables 6,743 13,958 Inventories 61,893 27,853 Deferred income taxes 29,419 40,897 Assets held for sale -- 14,178 Other current assets 14,047 14,141 ----------- ----------- TOTAL CURRENT ASSETS 226,528 213,055 SYSTEMS, EQUIPMENT AND OTHER ASSETS RELATING TO CONTRACTS 397,561 526,856 GOODWILL 135,662 118,537 INVESTMENTS IN AND ADVANCES TO UNCONSOLIDATED AFFILIATES 10,801 64,808 OTHER ASSETS 103,663 100,556 ----------- ----------- TOTAL ASSETS $ 874,215 $ 1,023,812 =========== =========== LIABILITIES AND SHAREHOLDERS' EQUITY CURRENT LIABILITIES: Accounts payable $ 43,402 $ 39,451 Accrued expenses 55,609 57,155 Special charge 6,058 33,631 Employee compensation 27,379 25,648 Advance payments from customers 30,458 504 Income taxes payable 57,907 25,392 Current portion of long-term debt 1,960 3,903 ----------- ----------- TOTAL CURRENT LIABILITIES 222,773 185,684 LONG-TERM DEBT, less current portion 319,078 453,587 OTHER LIABILITIES 29,908 19,171 DEFERRED INCOME TAXES 18,550 20,160 COMMITMENTS AND CONTINGENCIES -- -- SHAREHOLDERS' EQUITY: Preferred Stock, par value $.01 per share--20,000,000 shares authorized, none issued -- -- Common Stock, par value $.01 per share--150,000,000 shares authorized, 44,152,565 and 43,922,627 shares issued; 38,722,063 and 41,284,146 shares outstanding at February 27, 1999 and February 28, 1998, respectively 442 439 Additional paid-in capital 176,434 171,302 Equity carryover basis adjustment (7,008) (7,008) Accumulated other comprehensive income (84,842) (42) Retained earnings 345,018 255,955 ----------- ----------- 430,044 420,646 Less cost of 5,430,502 and 2,638,481 shares in treasury at February 27, 1999 and February 28, 1998, respectively (146,138) (75,436) ----------- ----------- 283,906 345,210 ----------- ----------- TOTAL LIABILITIES AND SHAREHOLDERS' EQUITY $ 874,215 $ 1,023,812 =========== ===========
See Notes to Consolidated Financial Statements F-14 59 GTECH HOLDINGS CORPORATION AND SUBSIDIARIES CONSOLIDATED INCOME STATEMENTS
Fiscal Year Ended ---------------------------------------------- February 27, February 28, February 22, 1999 1998 (a) 1997 ------------ ------------ ------------ (Dollars in thousands, except per share amounts) Revenues: Services $ 887,395 $ 868,522 $ 789,534 Sales of products 85,528 122,045 114,738 --------- --------- --------- 972,923 990,567 904,272 Costs and expenses: Costs of services 591,787 603,484 551,662 Costs of sales 59,825 73,815 67,441 --------- --------- --------- 651,612 677,299 619,103 --------- --------- --------- Gross profit 321,311 313,268 285,169 Selling, general and administrative 124,433 133,284 127,080 Research and development 40,158 36,498 30,998 Special charge 15,000 99,382 -- --------- --------- --------- Operating income 141,720 44,104 127,091 Other income (expense): Interest income 4,079 5,733 4,424 Equity in earnings of unconsolidated affiliates 7,113 24,376 16,727 Other income 25,447 711 4,439 Interest expense (27,405) (30,311) (20,812) --------- --------- --------- Income before income taxes 150,954 44,613 131,869 Income taxes 61,891 17,399 54,066 --------- --------- --------- Net income $ 89,063 $ 27,214 $ 77,803 ========= ========= ========= Basic earnings per share $ 2.17 $ .65 $ 1.81 ========= ========= ========= Diluted earnings per share $ 2.16 $ .64 $ 1.80 ========= ========= =========
See Notes to Consolidated Financial Statements (a) 53-week year F-15 60 GTECH HOLDINGS CORPORATION AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY
Common Stock Equity Accumulated ----------------------- Additional Carryover Other Issued Paid-in Basis Comprehensive Retained Shares Amount Capital Adjustment Income Earnings ---------- ---------- ---------- ---------- ------------- ---------- (Dollars in thousands) Balance at February 24, 1996 43,739,520 $ 437 $ 167,758 $ (7,008) $ (463) $ 150,938 Comprehensive income: Net income - - - - - 77,803 Other comprehensive income: Foreign currency translation - - - - 1,935 - Comprehensive income Purchase of 637,200 shares of common stock - - - - - - Common stock issued under stock award plans 106,131 1 1,947 - - - ---------- ---------- ---------- ---------- ---------- ---------- Balance at February 22, 1997 43,845,651 $ 438 $ 169,705 $ (7,008) $ 1,472 $ 228,741 Comprehensive income: Net income - - - - - 27,214 Other comprehensive income: Foreign currency translation - - - - (1,514) - Comprehensive income Purchase of 1,283,600 shares of common stock - - - - - - Common stock issued under stock award plans 76,976 1 1,597 - - - ---------- ---------- ---------- ---------- ---------- ---------- Balance at February 28, 1998 43,922,627 $ 439 $ 171,302 $ (7,008) $ (42) $ 255,955 Comprehensive income: Net income - - - - - 89,063 Other comprehensive income: Foreign currency translation - - - - (85,094) - Net gain on derivative instruments - - - - 294 - Comprehensive income Purchase of 2,794,100 shares of common stock - - - - - - Reissuance of 2,079 shares from treasury under Director Stock election plan - - - - - - Common stock issued under stock award plans 229,938 3 5,132 - - - ---------- ---------- ---------- ---------- ---------- ---------- Balance at February 27, 1999 44,152,565 $ 442 $ 176,434 $ (7,008) $ (84,842) $ 345,018 ========== ========== ========== ========== ========== ==========
Treasury Stock Total ---------- ---------- (Dollars in thousands) Balance at February 24, 1996 $ (14,937) $ 296,725 Comprehensive income: Net income - 77,803 Other comprehensive income: Foreign currency translation - 1,935 ---------- Comprehensive income 79,738 Purchase of 637,200 shares of common stock (20,278) (20,278) Common stock issued under stock award plans - 1,948 ---------- ---------- Balance at February 22, 1997 $ (35,215) $ 358,133 Comprehensive income: Net income - 27,214 Other comprehensive income: Foreign currency translation - (1,514) ---------- Comprehensive income 25,700 Purchase of 1,283,600 shares of common stock (40,221) (40,221) Common stock issued under stock award plans - 1,598 ---------- ---------- Balance at February 28, 1998 $ (75,436) $ 345,210 Comprehensive income: Net income - 89,063 Other comprehensive income: Foreign currency translation - (85,094) Net gain on derivative instruments - 294 ---------- Comprehensive income 4,263 Purchase of 2,794,100 shares of common stock (70,757) (70,757) Reissuance of 2,079 shares from treasury under Director Stock election plan 55 55 Common stock issued under stock award plans - 5,135 ---------- ---------- Balance at February 27, 1999 $ (146,138) $ 283,906 ========== ==========
See Notes to Consolidated Financial Statements F-16 61 GTECH HOLDINGS CORPORATION AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF CASH FLOWS
Fiscal Year Ended ---------------------------------------------- February 27, February 28, February 22, 1999 1998 (a) 1997 ------------ ------------ ------------ (Dollars in thousands) OPERATING ACTIVITIES Net income $ 89,063 $ 27,214 $ 77,803 Adjustments to reconcile net income to net cash provided by operating activities: Depreciation and amortization 199,321 204,768 172,630 Special charge 15,000 99,382 -- Deferred income taxes (benefit) provision 9,868 (24,187) 22,441 Equity in earnings of unconsolidated affiliates, net of dividends received (3,117) (8,632) (9,174) Foreign currency transaction gains (8,650) -- -- Other 2,405 8,214 (346) Changes in operating assets and liabilities, net of effects of acquisitions: Trade accounts receivable (10,716) 17,907 (36,952) Inventories (33,479) 7,693 8,307 Special charge (26,105) (12,163) -- Other assets and liabilities 52,692 (26,061) (15,594) --------- --------- --------- NET CASH PROVIDED BY OPERATING ACTIVITIES 286,282 294,135 219,115 INVESTING ACTIVITIES Purchases of systems, equipment and other assets relating to contracts (121,198) (283,542) (191,970) Acquisitions (net of cash acquired) (19,687) (20,976) (2,000) Investments in and advances to unconsolidated affiliates (529) (5,414) (9,817) Cash received from affiliates 1,906 6,644 11,203 Proceeds from sale of investments 84,904 -- 5,895 Other (22,627) (20,592) (12,341) --------- --------- --------- NET CASH USED FOR INVESTING ACTIVITIES (77,231) (323,880) (199,030) FINANCING ACTIVITIES Net proceeds from issuance of long-term debt 117,706 541,605 6,107 Principal payments on long-term debt (254,768) (472,542) (4,358) Purchases of treasury stock (70,757) (40,221) (20,278) Other 4,771 (2,108) 1,802 --------- --------- --------- NET CASH (USED FOR) PROVIDED BY FINANCING ACTIVITIES (203,048) 26,734 (16,727) Effect of exchange rate changes on cash (6,520) (724) 108 --------- --------- --------- (DECREASE) INCREASE IN CASH AND CASH EQUIVALENTS (517) (3,735) 3,466 Cash and cash equivalents at beginning of year 8,250 11,985 8,519 --------- --------- --------- CASH AND CASH EQUIVALENTS AT END OF YEAR $ 7,733 $ 8,250 $ 11,985 ========= ========= ========= SUPPLEMENTAL CASH FLOW INFORMATION: Interest payments (net of amounts capitalized) $ 27,574 $ 23,647 $ 20,523 Income tax payments 24,945 32,188 30,045 Income tax refunds (13,345) (2,904) (335)
See Notes to Consolidated Financial Statements (a) 53-week year F-17 62 GTECH HOLDINGS CORPORATION AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS NOTE A - SIGNIFICANT ACCOUNTING POLICIES Principles of Consolidation: GTECH Holdings Corporation ("Holdings") conducts business through its consolidated subsidiaries and unconsolidated affiliates and has, as its only asset, an investment in GTECH Corporation ("GTECH"), its wholly-owned subsidiary. The consolidated financial statements include the accounts of Holdings, GTECH and all majority and wholly-owned subsidiaries (collectively referred to herein as the "Company"). Significant intercompany accounts and transactions have been eliminated in preparing the Consolidated Financial Statements. Investments in 20% to 50% owned affiliates are accounted for using the equity method and investments in less than 20% owned affiliates are accounted for using the cost method. Certain reclassifications have been made to the prior years' financial statements to conform to the current year presentation. Industry Segment and Nature of Operations: The Company operates predominately in one business segment that provides online, high speed, highly-secured transaction processing systems to the worldwide lottery industry. The Company's lottery service contracts are generally subject to a new competitive procurement process after the expiration of the contract term and any extensions thereof. The Company's business is highly regulated, and the competition to secure new government contracts is often intense. In 1997, the Financial Accounting Standards Board issued Statement of Financial Accounting Standards No. 131, "Disclosures about Segments of an Enterprise and Related Information" ("FAS 131"). The Company adopted the provisions of FAS 131 during fiscal 1999. The new rules established revised standards for public companies relating to the reporting of financial and descriptive information about their operating segments in financial statements. It also established standards for related disclosures about products and services, geographic areas and major customers. The adoption of FAS 131 did not affect the Company's results of operations or financial position, but did affect the disclosure of segment information contained in the notes to the consolidated financial statements (See Note N). Fiscal Year: The Company operates on a 52- to 53-week fiscal year ending on the last Saturday in February. Fiscal 1999 and 1997 were 52-week years and fiscal 1998 was a 53-week year. 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 amounts reported in the financial statements and accompanying notes. Actual results could differ from those estimates. Revenue Recognition: Service revenues are recognized as the services are performed. Liquidated damages are expensed as incurred. Revenues from product sales or sales-type leases are recognized when installation is complete and the product is accepted by the customer. In those instances where the Company is not responsible for installation, revenue is recognized when the product is shipped. Foreign Currency Translation: The functional currency for the majority of the Company's foreign operations is the applicable local currency. The translation of the applicable foreign currencies into U.S. dollars is performed for balance sheet accounts using exchange rates in effect at the balance sheet date and for revenue and expense accounts using a weighted average exchange rate during the period. The gains or losses resulting from such translation are reported in accumulated other comprehensive income, whereas gains or losses resulting from foreign currency transactions are included in results of operations. The Company recognized net foreign exchange gains (losses) of $15,268,000, $(573,000) and $336,000 in fiscal 1999, 1998 and 1997, respectively, that are included as a component of other income in the Company's consolidated income statements. For those foreign subsidiaries operating in a highly inflationary economy or having the U.S. dollar as their functional currency, nonmonetary assets are translated at historical rates and monetary assets and liabilities are translated at current rates. Translation adjustments are included in the determination of net income. 63 GTECH HOLDINGS CORPORATION AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS NOTE A - SIGNIFICANT ACCOUNTING POLICIES-(CONTINUED) Research and Development: Research and development expenses are charged to operations as incurred. Stock-Based Compensation: The Company grants stock options for a fixed number of shares of the common stock of Holdings ("Common Stock") to employees and non-employee directors with an exercise price equal to the fair value of the shares at the date of grant. The Company accounts for stock option grants in accordance with Accounting Principles Board Opinion No. 25, "Accounting for Stock Issued to Employees" and, accordingly, recognizes no compensation expense for stock option grants. Derivatives: The Company uses derivative financial instruments principally to manage the risk of foreign currency exchange rate fluctuations and accounts for its derivative financial instruments in accordance with Financial Accounting Standards Board Statement 133, "Accounting for Derivative Instruments and Hedging Activities" ("FAS 133"). The adoption of FAS 133 by the Company effective August 30, 1998 (the first day of its fiscal 1999 third quarter) did not have a material effect on the earnings or the financial position of the Company. From time to time, the Company enters into foreign currency exchange and option contracts to reduce the exposure associated with certain firm commitments, variable service revenues and certain assets and liabilities denominated in foreign currencies. These contracts generally have maturities of 12 months or less, and are regularly renewed to provide continuing coverage throughout the year. The Company does not engage in currency speculation. The Company records contracts used to hedge firm commitments at fair value in its consolidated balance sheet and the related gains or losses on these contracts are immediately recognized in earnings. The Company records certain contracts used to protect the Company against foreign exchange risk on its variable service revenues at fair value in its consolidated balance sheet. The related gains or losses on these contracts are either deferred in shareholders' equity (accumulated other comprehensive income) or immediately recognized in earnings dependent on whether the contract can be treated as a hedge. The deferred gains and losses are subsequently recognized in earnings in the period that the related items being hedged are received and recognized in earnings. Contracts used to hedge assets and liabilities denominated in foreign currencies are recorded in the Company's consolidated balance sheet and the related gains or losses on these contracts are immediately recognized in earnings. Gains and losses on foreign exchange contracts are included as a component of other income in the Company's consolidated income statements. Income Taxes: Deferred tax assets and liabilities are determined based on the differences between financial reporting and tax bases of assets and liabilities and are measured using the enacted income tax rates and laws that will be in effect when the temporary differences are expected to reverse. Additionally, deferred tax assets and liabilities are separated into current and noncurrent amounts based on the classification of the related assets and liabilities for financial reporting purposes. Cash Equivalents: The Company considers short-term, highly liquid investments with an original maturity of three months or less at the date of purchase to be cash equivalents. Inventories: Inventories are stated at the lower of cost (first-in, first-out method) or market. Systems, Equipment and Other Assets Relating to Contracts: Systems, equipment and other assets relating to contracts are stated on the basis of cost. Depreciation is computed over the estimated useful lives of the assets using the straight-line method for financial reporting purposes and accelerated methods for income tax purposes. The estimated useful life is generally five years. Capitalized Software Development Costs: Unamortized software development costs, included in systems, equipment and other assets relating to contracts and other assets in the Company's consolidated balance sheets, were $51,900,000 and $41,024,000 at February 27, 1999 and February 28, 1998, respectively. Amortization expense amounted to $12,821,000, $7,457,000 and $3,967,000 in fiscal 1999, 1998 and 1997, respectively, and is included in cost of services in the Company's consolidated income statements. 64 GTECH HOLDINGS CORPORATION AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS NOTE A - SIGNIFICANT ACCOUNTING POLICIES-(CONTINUED) Impairment of Long-Lived Assets: If facts and circumstances were to indicate that the Company's long-lived assets might be impaired, the estimated future undiscounted cash flows associated with the long-lived asset would be compared to its carrying amount to determine if a write-down to fair value is necessary. Goodwill: Goodwill represents the excess of cost over the fair value of net assets acquired and is amortized on a straight-line basis principally over 40 years. As of February 27, 1999 and February 28, 1998, accumulated amortization was $30,018,000 and $24,164,000, respectively. New Accounting Pronouncements: In 1997, the Financial Accounting Standards Board issued Statement of Financial Accounting Standards No. 130, "Reporting Comprehensive Income" ("FAS 130"). The Company adopted FAS 130 during fiscal 1999. The new rules established standards for the reporting of comprehensive income and its components in financial statements. Comprehensive income consists of net income and other gains and losses affecting shareholders' equity that, under generally accepted accounting principles, are excluded from net income. For the Company, such items consist primarily of gains and losses on certain derivative financial instruments and foreign currency translation gains and losses. The adoption of FAS 130 affected the presentation in the accompanying consolidated statement of shareholders' equity. Prior year financial statements have been reclassified to conform to the new requirements. In April 1998, the American Institute of Certified Public Accountants issued Statement of Position 98-5, "Reporting on the Costs of Start-Up Activities" ("SOP 98-5"). SOP 98-5 requires the expensing of start-up costs and was adopted by the Company on February 29, 1999 (the first day of fiscal 2000). The adoption of SOP 98-5 did not have a material impact on the results of operations or the financial position of the Company. NOTE B - BUSINESS ACQUISITIONS On July 1, 1998, the Company acquired 80% of the equity of Europrint Holdings Ltd. ("Europrint") and its wholly owned subsidiaries, including Interactive Games International ("IGI"), for a net cash purchase price of $21,641,000, including related acquisition costs. Europrint is a provider of media promotional games and IGI has pioneered the development of interactive, televised lottery games. The Company has the option, and under certain circumstances the obligation, to acquire the remaining 20% of the equity of Europrint and IGI within five years from the date of acquisition. On October 3, 1997, the Company acquired 100% of the capital stock of VideoFax Systems, Inc., a provider of multimedia broadcasting software, for cash consideration of $15,362,000. Pro forma information has not been provided because on an individual and aggregate basis, the acquisitions were not material to the Company's operations. 65 GTECH HOLDINGS CORPORATION AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS NOTE C - INVENTORIES Inventories consist of:
February 27, 1999 February 28, 1998 ------------------ ------------------ (Dollars in thousands) Purchased components $ 27,323 $ 17,202 Finished subassemblies 2,922 1,719 Work in progress 23,309 7,789 Finished goods 8,339 1,143 ------------------ ------------------ $ 61,893 $ 27,853 ================== ==================
NOTE D - SYSTEMS, EQUIPMENT AND OTHER ASSETS RELATING TO CONTRACTS Systems, equipment and other assets relating to contracts consists of:
February 27, 1999 February 28, 1998 ------------------ ------------------ (Dollars in thousands) Land and buildings $ 5,259 $ 5,226 Computer terminals and systems 1,007,202 1,035,977 Furniture and equipment 110,231 107,233 Contracts in progress 34,991 56,116 ------------------ ------------------ 1,157,683 1,204,552 Less accumulated depreciation and amortization 760,122 677,696 ------------------ ------------------ $ 397,561 $ 526,856 ================== ==================
66 GTECH HOLDINGS CORPORATION AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS NOTE E - UNCONSOLIDATED AFFILIATES The Company has a 40% interest in Lottery Technology Enterprises ("LTE"), a 50% interest in each of four joint ventures with Full House Resorts, Inc. ("Full House") and a 50% interest in Union Temporal de Empress ("UTE"). LTE is a joint venture comprised of the Company and District Enterprise for Lottery Technology Applications of Washington, D.C., that holds a contract with the District of Columbia Lottery and Charitable Games Control Board. The joint ventures with Full House are engaged in the financing and development of Native American and other casino gaming ventures. UTE is a joint venture comprised of the Company and Luditec S.A. that provides facility management services to the Catalunya Lottery in Spain. In addition, as of February 28, 1998, the Company had a 22.5% interest in Camelot Group plc ("Camelot"). Camelot is a consortium that operates the United Kingdom lottery and was the largest of the Company's unconsolidated affiliates. In April 1998, the Company sold its investment back to Camelot for $84,904,000. The book value of the Camelot investment at the time of the sale was $51,763,000. A portion of the cash received by the Company will have to be returned to Camelot in the event that Camelot's operating license is revoked for certain reasons determined to be attributable to the Company. Accordingly, the Company has deferred the recognition of the gain from the sale of its investment and is recognizing such gain ratably over the remaining period of Camelot's operating license due to expire in September 2001. The deferred gain at February 27, 1999 is included in advance payments to customers and other liabilities in the Company's consolidated balance sheets. The Company continues as the principal supplier of goods and services to Camelot. The Company's investments in and advances to Camelot amounted to $52,071,000 and $43,358,000 at February 28, 1998 and February 22, 1997, respectively. The Company's equity in the earnings of Camelot amounted to $2,624,000, $20,988,000 and $14,394,000 for fiscal 1999, 1998 and 1997, respectively. The following is a summary of the combined financial condition of the Company's unconsolidated affiliates along with their combined results of operations, for those investments held at the fiscal year end presented, used as the basis for applying the equity method of accounting:
Fiscal Year Ended ------------------------------------------------------------ February 27, 1999 February 28, 1998 February 22, 1997 ----------------- ----------------- ----------------- (Dollars in thousands) Earnings data: Revenues $ 34,950 $ 9,098,191 $ 7,319,017 Gross profit 8,683 295,169 235,610 Net income 8,847 99,833 65,743 Balance sheet data: Current assets $ 4,659 $ 757,944 $ 646,082 Noncurrent assets 7,452 123,603 156,472 Current liabilities 3,617 599,365 556,011 Noncurrent liabilities 169 45,101 55,798
The Company's share of undistributed earnings of affiliated companies included in retained earnings was $2,258,000, $35,130,000 and $26,203,000 at February 27, 1999, February 28, 1998 and February 22, 1997, respectively. Dividends received from unconsolidated affiliates were $3,996,000, $15,744,000 and $7,553,000 in fiscal 1999, 1998 and 1997, respectively. 67 GTECH HOLDINGS CORPORATION AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS NOTE F - LONG-TERM DEBT Long-term debt consists of:
February 27, 1999 February 28, 1998 ------------------ ------------------ (Dollars in thousands) Revolving credit facility $ 18,000 $ 135,000 7.75% Series A Senior Notes due 2004 150,000 150,000 7.87% Series B Senior Notes due 2007 150,000 150,000 Other 3,038 22,490 ------------------ ------------------ 321,038 457,490 Less current portion 1,960 3,903 ------------------ ------------------ $ 319,078 $ 453,587 ================== ==================
The Company has an unsecured revolving credit facility of $400,000,000 expiring in June 2002 (the "Credit Facility"). At February 27, 1999, the weighted average interest rate for all outstanding borrowings under the Credit Facility was 5.27%. The Company is required to pay a facility fee of .125% per annum on the total revolving credit commitment. The restrictive provisions of the Credit Facility include, among other things, requirements relating to the maintenance of certain financial ratios, restrictions on additional indebtedness and restrictions on the ability of the Company to make cash distributions on its Common Stock under certain circumstances. At February 27, 1999, under the most restrictive covenants, the Company had available $83,906,000 of retained earnings for the payment of dividends. The Company has never paid cash dividends on its Common Stock and does not plan to do so in the foreseeable future. The current policy of the Company's Board of Directors is to reinvest earnings in the operation and expansion of the business of the Company. On May 29, 1997, the Company issued, in a private placement, $150,000,000 of unsecured 7.75% Series A Senior Notes due 2004 and $150,000,000 of unsecured 7.87% Series B Senior Notes due 2007 (collectively, the "Senior Notes"). Interest on each issue is payable semiannually in arrears. The proceeds from the sale of the Senior Notes were used to pay down the Credit Facility. Up to $100,000,000 of the Credit Facility may be used for the issuance of letters of credit. There were no letters of credit outstanding under the Credit Facility as of February 27, 1999. The Company had outstanding, at February 27, 1999, $47,160,000 of letters of credit issued outside of the Credit Facility. The weighted average annual cost for these letters of credit was .5%. At February 27, 1999, long-term debt maturing over the next five fiscal years is as follows:
Fiscal Year (Dollars in thousands) ----------- 2000 $ 1,960 2001 78 2002 --- 2003 19,000 2004 --- Thereafter 300,000
Interest costs incurred by the Company were $29,388,000, $34,659,000 and $25,036,000 (of these amounts, $1,983,000, $4,348,000 and $4,224,000 were capitalized as additional costs of qualifying property during the construction period) during fiscal 1999, 1998 and 1997, respectively. 68 GTECH HOLDINGS CORPORATION AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS NOTE G - COMMITMENTS AND CONTINGENCIES Contracts Contracts generally contain time schedules for, among other things, commencement of system operations and the installation of terminals, as well as detailed performance standards. The Company is typically required to furnish substantial bonds to secure its performance under these contracts. In addition to other possible consequences, including contract termination, failure to meet specified deadlines or performance standards could trigger substantial penalties in the form of liquidated damage assessments. Many of the Company's contracts permit the customer to terminate the contract at will and do not specify the compensation, if any, that the Company would be entitled were such a termination to occur. Legal Matters As previously publicly reported, in October 1994, the U.S. Attorney's Office for the District of New Jersey indicted J. David Smith, the former sales manager of the Company (who resigned in early 1994 for reasons unrelated to the indictments), and two other individuals who served as consultants to the Company through their wholly-owned company, The Benchmark Group, Inc. ("Benchmark"). The indictment alleged essentially that, unbeknownst to the Company, Mr. Smith had received kickbacks from the consultants for his own benefit. The indictment did not charge the Company with any wrongdoing, and the actions complained of did not affect the Company's New Jersey lottery operations. The trial of Mr. Smith and the two consultants commenced in September 1996 in the U.S. District Court for New Jersey, and on October 4, 1996, Mr. Smith and one of the two consultants were found guilty of all charges. The other consultant, Joseph LaPorta, was found not guilty. The New Jersey U.S. Attorney immediately announced in a press release that a grand jury investigation in that jurisdiction was continuing but did not specify the scope of such investigation. In the midst of these events, the New Jersey Lottery Commission awarded the Company a contract to continue operating its State lottery. In October 1998, the Court sentenced Mr. Smith to a prison term of 63 months, ordered him to pay restitution to the Company in the amount of $169,500 and fined him $20,000. Mr. Smith filed a notice of appeal in the United States Court of Appeals for the Third Circuit and in April 1999 oral argument on this appeal was heard. In November 1998, the U.S. Attorney's Office for the District of New Jersey advised the Company that currently GTECH is not the subject or target of an ongoing grand jury investigation by that office. In 1995, the Texas U.S. Attorney's Office also issued grand jury document subpoenas to the Company, and the Company has cooperated with this investigation. In February 1999, a witness appearing before the Moriarty Tribunal, an investigative body convened by the Irish Parliament and chaired by Mr. Justice Moriarty to investigate the business affairs generally of former Taoiseach (Prime Minister) of Ireland Charles Haughey, testified that in February 1993 Guy B. Snowden, then Chief Executive Officer of the Company, had invested pound sterling 67,000 (approximately $100,000) of his personal funds in a company owned by Mr. Haughey's son. Mr. Haughey had resigned as Taoiseach in February 1992. In July 1992, the An Post Irish National Lottery Company, the Irish lottery authority (the "NLC"), issued a Request for Proposals respecting online and instant ticket lottery goods and services, and in September 1992 the Company, which was the then incumbent provider of lottery goods and services to the NLC under an agreement awarded to the Company in 1987, submitted a Proposal to the NLC in response to the NLC's Request for Proposals. In November 1992, the NLC selected the Company to provide online and instant ticket goods and services to the NLC under the terms of the competitive procurement and, following negotiations, a definitive agreement was entered into between the NLC and the Company in March 1993. The Tribunal has requested that the Company provide various documents regarding the Company's business in Ireland. The Company is cooperating with the Tribunal. In addition, the Company has made its own inquiry into the facts surrounding Mr. Snowden's investment and the extent, if any, of the Company's involvement in or knowledge of that investment. The Company's investigation has determined that no Company funds were used to make Mr. Snowden's investment, and there is no information to suggest that Mr. Snowden ever sought reimbursement for the investment from the Company. Further, there is no information to suggest that Mr. Snowden informed anyone else at the Company of his investment at the time or that his investment was related in any way to the renewal of the Company's contract to supply systems and support to the NLC. Mr. Snowden has advised the Company through counsel that (i) his investment was a strictly personal one, (ii) the investment was made from his 69 GTECH HOLDINGS CORPORATION AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS NOTE G - COMMITMENTS AND CONTINGENCIES-(CONTINUED) personal funds, (iii) he never sought reimbursement for any portion of his investment from the Company or any other entity, and (iv) his investment was not related to the NLC and was not intended to and did not influence the NLC's decision to renew the Company's contract. No charges of wrongdoing have ever been brought against the Company by any grand jury or other governmental authority. The Company does not believe that it has engaged in any wrongdoing in connection with these matters. However, since current investigations are still or maybe underway and are conducted in whole or in part in secret, the Company lacks sufficient information to determine with certainty their ultimate scope and whether the government authorities will assert claims resulting from these or other investigations that could implicate or reflect adversely upon the Company. Because the Company's reputation for integrity is an important factor in its business dealings with lottery and other governmental agencies, if government authorities were to make an allegation of, or if there were to be a finding of, improper conduct on the part of or attributable to the Company in any matter, such an allegation or finding could have a material adverse effect on the Company's business, including its ability to retain existing contracts and to obtain new or renewal contracts. In addition, continuing adverse publicity resulting from these investigations and related matters could have such a material adverse effect. In November 1998, Benchmark and Joseph LaPorta, the consultant and shareholder of Benchmark who was found not guilty in the criminal proceeding described in the paragraph above respecting J. David Smith, filed suit in the Superior Court of New Jersey (Atlantic County - Law Division) against GTECH and Victor Markowicz, the Company's former co-chairman, alleging that GTECH had wrongfully terminated and otherwise breached a May 1992 contract, as amended, between the Company and Benchmark pursuant to which Benchmark provided government relations services on behalf of GTECH in New Jersey. The complaint filed by Benchmark and Mr. LaPorta also alleged that GTECH had breached an implied covenant of good faith and fair dealing by allegedly authorizing and directing Benchmark to make payments that were not within the contemplation of the contract and by terminating its contract with Benchmark after allegedly receiving substantial benefits from Benchmark; that GTECH had committed fraud upon Benchmark by allegedly making knowingly false representations to Benchmark prior to termination of the May 1992 contract; and that GTECH and Mr. Markowicz had committed fraud upon and had made negligent representations to Benchmark by allegedly concealing that certain payments which the Company is said to have directed that Benchmark make to third parties were allegedly made for the personal benefit of Mr. Markowicz and unspecified others. The complaint seeks unspecified compensatory and punitive damages and costs and such other further relief as the Court deems equitable and just. In December 1998, the Company filed a motion to dismiss, or in the alternative for summary judgment. The Company believes that Benchmark's complaint, and the allegations underlying the complaint, are wholly without merit. The Company intends to continue to vigorously defend itself in these proceedings. In December 1998, Lawrence Littwin, the former Executive Director of the Texas Lottery Commission from June 1997 to October 1997, filed suit against GTECH in the United States District Court for the Northern District of Texas alleging that GTECH, as operator of the Texas lottery, unlawfully attempted to have Mr. Littwin removed as Executive Director of the Texas Lottery Commission in order to continue its alleged unlawful control of the Texas Lottery Commission and the Texas lottery. The specific causes of action alleged by Mr. Littwin include alleged tortious interference by GTECH with Mr. Littwin's employment relationship with the Texas Lottery Commission which caused him to be removed as the Executive Director; alleged conspiracy with unspecified third parties to maintain control of the Texas Lottery Commission and the Texas lottery; and various alleged civil violations by GTECH of the Racketeer Influenced Corrupt Organization Act (18 Sections 1961(4) and 1962(b), (c) and (d)) ("RICO"). Mr. Littwin's complaint seeks unspecified damages (including treble damages in the case of RICO violations) and costs. Discovery is proceeding in this matter. The Company believes that Mr. Littwin's complaint, and the allegations underlying the complaint, are wholly without merit. The Company continues to vigorously defend itself in these proceedings. 70 GTECH HOLDINGS CORPORATION AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS NOTE G - COMMITMENTS AND CONTINGENCIES-(CONTINUED) In September 1996, Jack M. Janis and Linda Janis, both individually and on behalf of a class of persons similarly situated, filed suit against the California State Lottery Commission, Southland Corporation and the Company in the Supreme Court of the State of California (County of Los Angeles). This suit alleged, in light of the June 1996 decision of the California Supreme Court, Western Telcon, Inc. et al. V. California State Lottery (which held that the California State Lottery's keno game as then structured was not a lottery game and therefore was not authorized by California lottery law), that the defendants were unjustly enriched and were guilty of unfair business practices and misleading advertising in connection with the sale of keno tickets from January 1, 1992 through suspension of the keno game in June 1996. The suit sought restitution of all amounts realized by the defendants through the sale of keno tickets less funds paid to public schools pursuant to relevant California law and proceeds paid to holders of winning keno tickets, together with costs, disbursements and prejudgment interest. In 1997, the Court granted the Company summary judgment but granted the plaintiffs limited leave to amend their complaint; the plaintiffs filed an amended complaint; and the Court granted the Company's motion to strike and for summary judgment as to the amended complaint, this time without leave to amend. Plaintiffs filed a notice of appeal, and in November 1998, the California Court of Appeal affirmed. Plaintiffs then sought review by the California Supreme Court, which denied review in March 1999, effectively ending the case. The Company monitors, and occasionally affirmatively becomes involved in, litigation involving Indian gaming in states where such litigation may, directly or indirectly, concern or call into question the legal rights and operations of state lotteries to which the Company provides contract services. The purpose of this effort is to protect state lottery interests, and thus the Company's revenue streams, from service contracts. As previously publicly reported, one such piece of litigation is Rumsey Indian Rancheria v. Wilson, currently pending in the Ninth Circuit Court of Appeals on appeal from the U.S. District Court for the Eastern District of California, which involves a suit by several California Indian tribes against the State and Governor of California under the federal Indian Gaming Regulatory Act ("IGRA"). The Indian Tribes claimed in the District Court that certain elements of the California State Lottery (which is a customer of the Company) ("CSL") and the equipment on which it is run involve the operation of slot machines and, therefore, under IGRA, the tribes also must be permitted to operate slot machines. The State of California argued at times that the CSL does not involve the operation of slot machines; however, the State at times appeared to be taking the position that, if and to the extent the CSL does involve the operation of slot machines, it must be terminated because the CSL is not exempt from the California law prohibiting the operation of slot machines. The Company filed amicus curiae briefs in the District Court arguing that the CSL does not involve the operation of slot machines and that even if it does, the CSL is exempt from the State law prohibition on slot machines. In September 1998, the Court entered summary judgment for the defendants. The Indian Tribes have since appealed the District Court's decision, and, as noted above, the appeal is now pending before the Ninth Circuit Court of Appeals. In July 1998, the U.S. Department of Justice filed suit in the U.S. District Court for the District of Delaware, U.S. v. Citicorp, Inc., Citicorp Services, Inc., GTECH Holdings Corporation and Transactive Corporation, seeking to enjoin the consummation of a transaction between Citicorp Services, Inc. and the Company's Transactive subsidiary respecting the sale to Citicorp of Transactive's electronic benefits transfer contracts and certain related assets. The Department of Justice alleged in the suit that the proposed sale of assets would tend substantially to lessen competition in the electronic benefits transfer market in violation of Section 7 of the Clayton Act, as amended (15 U.S.C. Section 18), and would constitute an unreasonable restraint of trade in violation of Section 1 of the Sherman Act (15 U.S.C. Section 1). In January 1999, the Company announced the termination of the agreement between Citicorp and Transactive, following which the parties to the litigation entered into a settlement and the suit was dismissed. In April 1999, the Company was served with a lawsuit entitled Pantaleon Arellano, et al. and Estelle Arellano v. The California State Lottery, et al. California Superior Court (Orange County), which was filed in March, 1999. In this action, plaintiffs are a husband and wife who claim to have purchased a winning ticket in the California State Lottery's ("CSL's") April 8, 1998 Super Lotto drawing. That drawing resulted in the award of a $102 million jackpot, which was split evenly among three holders of tickets bearing the winning numbers. Plaintiffs here claim to have purchased a ticket for that drawing with the same winning numbers; plaintiffs and the Company have been told that CSL computer records reveal that the ticket plaintiffs hold was purchased after the close of sales for that drawing, and after the winning numbers were announced. If plaintiffs had purchased a winning ticket in the relevant 71 GTECH HOLDINGS CORPORATION AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS NOTE G - COMMITMENTS AND CONTINGENCIES-(CONTINUED) drawing, they would have a claim against the CSL for one-fourth of that jackpot amount, i.e., approximately $25.5 million. In their complaint, they attempt to state a claim against both the CSL (and its Commission and the State of California) and the Company for $104 million, apparently their approximation of the full amount of the jackpot. They also seek to have this amount trebled, alleging that the defendants' conduct in denying plaintiffs' claim to the jackpot was racially motivated, and they seek various other amounts, including emotional distress damages and attorney fees. The Company believes that this complaint, and the allegations underlying the complaint, are wholly without merit. The Company intends to defend itself vigorously in these proceedings. The Company also is subject to certain legal proceedings and claims which management believes, on the basis of information presently available to it, will not materially adversely affect the Company's consolidated financial position or results of operations. NOTE H - STOCK OPTION AND PURCHASE PLANS The Company has three stock option plans that provide for the granting of incentive stock options and nonqualified stock options to officers and other key employees of the Company and non-employee members of the Company's Board of Directors. All current outstanding options are nonqualified stock options. The options granted under these plans are to purchase Common Stock at a price not less than fair market value at the date of grant. The 1997 employee stock option plan is the only plan where stock options may still be granted. The Company is authorized to grant options for up to 2,800,000 shares of Common Stock under this plan, and at February 27, 1999, 962,500 options had been granted. Employee options generally become exercisable ratably over a four-year period from date of grant. Employee options expire 10 years after date of grant unless an earlier expiration date is set at time of grant. Non-employee director options are exercisable approximately one year after date of grant and expire five years after date of grant, subject to earlier exercise and termination in certain circumstances. The Company has elected to continue to follow Accounting Principles Board Opinion No. 25, "Accounting for Stock Issued to Employees," and related Interpretations in accounting for the plans. Accordingly, no compensation expense has been recognized. Had compensation expense for options granted under the plans after February 25, 1995 been determined based on the estimated fair value at the grant dates for awards under the plan, the Company's pro forma net income and basic and diluted earnings per share for fiscal 1999, 1998 and 1997 would have been $85,797,000 and $2.09 and $2.09, respectively, $25,267,000 and $.60 and $.60, respectively, and $76,331,000 and $1.78 and $1.76, respectively. The fair value of options granted after February 25, 1995 under the plans was estimated at the date of grant using a Black-Scholes option pricing model with the following weighted-average assumptions for fiscal 1999, 1998 and 1997, respectively: risk-free interest rates of 5.77%, 6.14% and 5.80%; volatility factors of the expected market price of the Company's common stock of .40, .28 and .35; and a weighted-average expected life of the option of 5.3 years, 6.5 years and 4.0 years. The Company did not assume a dividend yield for fiscal 1999, 1998 or 1997. Under these assumptions, the weighted-average fair value of an option to purchase one share granted in fiscal 1999, 1998 and 1997, respectively, was approximately $15, $13 and $10. 72 GTECH HOLDINGS CORPORATION AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS NOTE H - STOCK OPTION AND PURCHASE PLANS -(CONTINUED) A summary of the Company's stock option activity and related information follows:
Fiscal Year Ended --------------------------------------------------------------------------------- February 27, 1999 February 28, 1998 February 22, 1997 -------------------------- ------------------------ -------------------------- Weighted Weighted Weighted Shares Average Shares Average Shares Average Under Exercise under Exercise under Exercise Options Price Options Price Options Price --------- -------- ----------- --------- ----------- --------- Outstanding at beginning of year 1,501,550 $ 25.127 1,356,175 $ 23.462 1,214,150 $ 21.964 Granted 1,012,500 34.044 252,000 32.392 245,500 28.446 Exercised (228,750) 22.295 (60,250) 18.043 (79,225) 17.433 Forfeited (202,000) 30.458 (46,375) 25.112 (24,250) 18.603 --------- ----------- ----------- Outstanding at end of year 2,083,300 $ 29.255 1,501,550 $ 25.127 1,356,175 $ 23.462 ========= =========== =========== Exercisable at end of year 890,550 $ 24.220 731,425 $ 23.063 402,675 $ 21.865
Exercise prices for options outstanding under the plans are summarized as follows:
Weighted Average ----------------------- Weighted Remaining Average Range of Options Contractual Exercise Options Exercise Exercise Prices Outstanding Life (Years) Price Exercisable Price ----------------- ----------- ----------- ---------- ----------- -------- February 27, 1999 $16.88 - $22.19 349,175 5.8 $ 18.400 348,300 $ 18.390 $25.69 - $35.28 1,734,125 7.9 31.441 542,250 27.965 February 28, 1998 $16.88 - $22.19 486,300 6.9 $ 17.977 338,175 $ 18.048 $25.69 - $35.28 1,015,250 7.7 28.552 393,250 27.377
In July 1998 shareholders approved the GTECH Holdings Corporation 1998 Employee Stock Purchase Plan (the "Plan") that allows substantially all full-time employees to acquire shares of Common Stock through payroll deductions over six-month offering periods (May 1 and November 1). The purchase price is equal to 85% of the shares' fair market value on either the first or last day of the offering period, whichever is lower. Purchases are limited to 10% of an employee's salary, up to a maximum of $25,000 per calendar year. The Plan expires upon the earlier of July 31, 2003 or the date the shares provided by the plan have been purchased. A total of 750,000 treasury shares are available for purchase under the Plan. At February 27, 1999, no shares of Common Stock had been issued under the Plan. 73 GTECH HOLDINGS CORPORATION AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS NOTE I - EARNINGS PER SHARE The following table sets forth the computation of basic and diluted earnings per share:
Fiscal Year Ended ------------------------------------------------------------ February 27, 1999 February 28, 1998 February 22, 1997 ----------------- ----------------- ----------------- (Dollars and shares in thousands, except per share amounts) Numerator: Net income $ 89,063 $ 27,214 $ 77,803 Denominator: Weighted average shares - Basic 40,957 41,887 42,976 Effect of dilutive securities: Employee stock options 188 342 333 ------------------ ------------------ ------------------ Weighted average shares - Diluted 41,145 42,229 43,309 ================== ================== ================== Basic earnings per share $ 2.17 $ .65 $ 1.81 ================== ================== ================= Diluted earnings per share $ 2.16 $ .64 $ 1.80 ================== ================== =================
NOTE J - INCOME TAXES The components of income before income taxes were as follows:
Fiscal Year Ended ------------------------------------------------------------ February 27, 1999 February 28, 1998 February 22, 1997 ----------------- ----------------- ------------------ (Dollars in thousands) United States $ 51,773 $ 4,883 $ 93,990 Foreign 99,181 39,730 37,879 ------------------ ------------------ ------------------ $ 150,954 $ 44,613 $ 131,869 ================== ================== ==================
Significant components of the provision for income taxes were as follows:
Fiscal Year Ended ------------------------------------------------------------ February 27, 1999 February 28, 1998 February 22, 1997 ----------------- ----------------- ----------------- (Dollars in thousands) Current: Federal $ 3,135 $ 17,254 $ 11,050 State 4,448 5,154 5,970 Foreign 44,440 19,178 14,605 ------------------ ------------------ ------------------ Total Current 52,023 41,586 31,625 ------------------ ------------------ ------------------ Deferred: Federal $ 14,216 $ (21,504) $ 20,040 State 2,521 (2,683) 2,401 Foreign (6,869) --- --- ------------------ ------------------ ------------------ Total Deferred 9,868 (24,187) 22,441 ------------------ ------------------ ------------------ Total Provision $ 61,891 $ 17,399 $ 54,066 ================== ================== ==================
74 GTECH HOLDINGS CORPORATION AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS NOTE J - INCOME TAXES-(CONTINUED) Significant components of the Company's deferred tax assets and liabilities were as follows:
February 27, 1999 February 28, 1998 ----------------- ----------------- (Dollars in thousands) Deferred tax assets: Special charge $ 29,796 $ 24,947 Accruals not currently deductible for tax purposes 16,177 17,422 Cash collected in excess of revenue recognized 7,643 2,446 Other 4,544 2,856 ------------------ ------------------ 58,160 47,671 Deferred tax liabilities: Depreciation (36,293) (17,937) Advance payments from customers (7,065) (7,502) Other (3,933) (1,495) ------------------ ------------------ (47,291) (26,934) ------------------ ------------------ Net deferred tax assets $ 10,869 $ 20,737 ================== ==================
Undistributed earnings of foreign subsidiaries, excluding accumulated net earnings of foreign subsidiaries that, if remitted, would result in little or no additional tax because of the availability of foreign tax credits, amounted to $3,000,000 at February 27, 1999. These earnings reflect full provision for foreign income taxes and are intended to be indefinitely reinvested in foreign operations. United States taxes that would be payable upon the remittance of these earnings are estimated to be $365,000. The effective income tax rate on income before income taxes differed from the statutory federal income tax rate for the following reasons:
Fiscal Year Ended ------------------------------------------------------------ February 27, 1999 February 28, 1998 February 22, 1997 ----------------- ----------------- ----------------- Federal income tax using statutory rate 35.0% 35.0% 35.0% State taxes, net of federal benefit 3.0 3.6 4.0 Equity in earnings of unconsolidated affiliates --- 3.2 (2.7) Nondeductible expenses 1.6 4.2 1.4 Goodwill 1.1 3.7 1.1 Tax credits (.8) (6.5) --- Other 1.1 (4.2) 2.2 ------------------ ------------------ ----------------- 41.0% 39.0% 41.0% ================== ================== =================
75 GTECH HOLDINGS CORPORATION AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS NOTE K - TRANSACTIONS WITH RELATED PARTIES Sales of products and services to Camelot and the other members of the U.K. lottery consortium were $53,355,000 and $53,298,000 in fiscal 1998 and 1997, respectively. At February 28, 1998, the Company had receivables net of advance payments of $7,159,000, from Camelot and the other members of the consortium. In April 1998, the Company sold its 22.5% equity interest in Camelot (See Note E). Sales of products and services to LTE were $4,155,000, $3,907,000 and $3,714,000 in fiscal 1999, 1998 and 1997, respectively. At February 27, 1999 and February 28, 1998, the Company had receivables of $278,000 and $326,000, respectively, from LTE. At February 27, 1999 and February 28, 1998, the Company had a note receivable from Full House of $3,000,000. The note was interest free until January 25, 1998 and interest bearing thereafter at the prime rate. Interest is payable monthly. The principal balance of the note is due on January 25, 2001. The Company paid rent of $2,612,000, $2,612,000 and $2,619,000 to West Greenwich Technology Associates Limited Partnership (that is 50% owned by the Company and 50% owned by an unrelated third party), in fiscal 1999, 1998 and 1997, respectively, for the Company's West Greenwich, Rhode Island corporate headquarters and research and development and main production facility. The agreement calls for rent payments to escalate to $3,510,000 beginning March 1, 1999, and to $3,531,000 beginning March 1, 2004. During fiscal 1995, the Company, pursuant to the terms of an employment agreement with William Y. O'Connor, its Chairman and Chief Executive Officer, made loans to him to enable him to retire certain third-party indebtedness. The loans consisted of $400,000 under a line of credit arrangement that required no interest and that was repaid during fiscal 1997 and $500,000 bearing interest at the rate of 6.0% per annum that was repayable in full on or before November 1, 1999. During fiscal 1998, the Company extended the due date of the $500,000 loan from November 1, 1999 to January 1, 2000 and agreed to forgive the principal amount of the loan in four equal installments on August 1, 1997, January 1, 1998, January 1, 1999, and January 1, 2000. Interest will continue to accrue at 6.0% per annum on the outstanding principal balance of the loan. Loans outstanding, including interest, at February 27, 1999 and February 28, 1998, amounted to $127,000 and $281,000, respectively. NOTE L - LEASES The Company leases certain facilities, equipment and vehicles under noncancelable operating leases that expire at various dates through fiscal 2014. Certain of these leases have escalation clauses and renewal options ranging from one to 10 years. The Company is required to pay all maintenance, taxes and insurance relating to its leased assets. Future minimum lease payments, by year and in the aggregate, under noncancelable operating leases with initial terms greater than one year, consist of the following at February 27, 1999:
Fiscal Year (Dollars in thousands) ----------- 2000 $ 29,307 2001 26,389 2002 16,996 2003 15,253 2004 12,193 Thereafter 46,554 --------------- Total minimum lease payments $ 146,692 ===============
Rental expense for operating leases was $28,358,000, $28,937,000 and $27,471,000 for fiscal 1999, 1998 and 1997, respectively. 76 GTECH HOLDINGS CORPORATION AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS NOTE M - EMPLOYEE BENEFITS The Company has two defined contribution 401(k) retirement savings and profit sharing plans (the "Plans") covering substantially all full-time employees in the United States and the Commonwealth of Puerto Rico. Under these Plans, an eligible employee may elect to defer receipt of a portion of base pay for each year. The Company will contribute this amount on the employee's behalf to the Plans and will also make a matching contribution equal to 50% of the amount that the employee has elected to defer, up to a maximum matching contribution of 2 1/2% of the employee's base pay. The Company, at its discretion, may contribute additional amounts to the Plans on behalf of employees based upon its profits for a given fiscal year. Participants are 100% vested at all times in their entire account balance in the Plans. Benefits under the Plans generally will be paid to participants upon retirement or in certain other limited circumstances. In fiscal 1999, 1998 and 1997, the Company recorded expense under these plans of $7,578,000, $5,706,000 and $7,010,000, respectively. The Company has a defined contribution Supplemental Retirement Plan that provides additional retirement benefits to certain key employees. The Company, at its discretion, may contribute additional amounts to this plan on behalf of such key employees equal to the percentage of profit sharing contributions contributed for the calendar year multiplied by the key employees' compensation (as defined) for such year. In fiscal 1999, 1998 and 1997 the Company recorded expense under this plan of $415,000, $952,000 and $1,254,000, respectively. 77 GTECH HOLDINGS CORPORATION AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS NOTE N - BUSINESS SEGMENT AND GEOGRAPHIC DATA The Company presently has one reportable segment. The Lottery segment provides online, high speed, highly secured transaction processing systems to the worldwide lottery industry. The accounting policies of the Lottery segment are the same as those described in the summary of significant accounting policies. Executive management of the Company evaluates segment performance based on net operating profit after income taxes. All other revenues (as reported below) are comprised principally of revenues from the Company's Transactive and Dreamport subsidiaries (See Note P for additional information regarding the Company's Transactive subsidiary). The Company's business segment data is summarized below:
February 27, 1999 Lottery All Other Consolidated ----------------- ------------ --------- ------------ OPERATING DATA: Revenues from external sources $ 873,984 $ 98,939 $ 972,923 Net operating profit after income taxes 110,846 2,456 113,302 Interest income 3,065 1,014 4,079 Equity in earnings of unconsolidated affiliates 2,791 4,322 7,113 Depreciation and amortization 187,736 11,585 199,321 BALANCE SHEET DATA (AT END OF PERIOD): Segment assets 786,006 88,209 874,215 Investment in and advances to unconsolidated affiliates 68 10,733 10,801 CASH FLOW DATA: Capital expenditures 114,209 6,989 121,198 February 28, 1998 ----------------- OPERATING DATA: Revenues from external sources $ 929,191 $ 61,376 $ 990,567 Net operating profit (loss) after income taxes 120,689 (9,995) 110,694 Interest income 3,763 1,970 5,733 Equity in earnings of unconsolidated affiliates 21,369 3,007 24,376 Depreciation and amortization 189,168 15,600 204,768 BALANCE SHEET DATA (AT END OF PERIOD): Segment assets 955,878 67,934 1,023,812 Investment in and advances to unconsolidated affiliates 52,593 12,215 64,808 CASH FLOW DATA: Capital expenditures 257,806 25,736 283,542 February 22, 1997 ----------------- OPERATING DATA: Revenues from external sources $ 860,398 $ 43,874 $ 904,272 Net operating profit (loss) after income taxes 107,179 (12,872) 94,307 Interest income 3,017 1,407 4,424 Equity in earnings of unconsolidated affiliates 15,066 1,661 16,727 Depreciation and amortization 159,803 12,827 172,630 BALANCE SHEET DATA (AT END OF PERIOD): Segment assets 860,651 95,890 956,541 Investment in and advances to unconsolidated affiliates 43,610 13,083 56,693 CASH FLOW DATA: Capital expenditures 174,189 17,781 191,970
78 GTECH HOLDINGS CORPORATION AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS NOTE N - BUSINESS SEGMENT AND GEOGRAPHIC DATA-(CONTINUED) The following is a reconciliation of net operating profit after income taxes to net income as reported on the consolidated income statements:
Fiscal Year Ended ----------------------------------------------------------- February 27, 1999 February 28, 1998 February 22, 1997 ----------------- ----------------- ----------------- Net operating profit after income taxes $ 113,302 $ 110,694 $ 94,307 Reconciling items, net of tax: Interest expense (16,169) (18,490) (12,279) Special charge (8,850) (60,623) --- Other 780 (4,367) (4,225) ------------------ ------------------- ------------------- Net income $ 89,063 $ 27,214 $ 77,803 =================== =================== ==================
The Company's geographic data is summarized below:
Fiscal Year Ended ----------------------------------------------------------- February 27, 1999 February 28, 1998 February 22, 1997 ----------------- ----------------- ----------------- Revenues from external sources: United States $ 570,548 $ 622,244 $ 568,705 Brazil 118,611 88,589 55,770 Other foreign 283,764 279,734 279,797 ------------------ ------------------ ------------------ $ 972,923 $ 990,567 $ 904,272 ================== ================== ==================
Revenues are attributed to countries based on the location of the customer.
Fiscal Year Ended ----------------------------------------------------------- February 27, 1999 February 28, 1998 February 22, 1997 ----------------- ----------------- ----------------- Systems, equipment and other assets relating to contracts: United States $ 260,585 $ 297,861 $ 369,405 Brazil 63,015 150,301 48,245 Other foreign 73,961 78,694 84,651 ----------------- ------------------ ------------------ $ 397,561 $ 526,856 $ 502,301 ================= ================== ==================
For fiscal 1999, the aggregate revenues from Caixa Economica Federal in Brazil represented 11.2% of the Company's consolidated revenues. For fiscal 1999, 1998 and 1997, the aggregate revenues from the state of Texas represented 10.6%, 14.2% and 15.8% of the Company's consolidated revenues, respectively. No other customer accounted for more than 10% of the consolidated revenues in such years. 79 GTECH HOLDINGS CORPORATION AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS NOTE O - FINANCIAL INSTRUMENTS Cash and cash equivalents Cash equivalents are stated at cost that approximates fair value. Debt The carrying amounts of the Company's borrowings under the Credit Facility approximate fair value due primarily to its variable interest rate characteristics and its short-term tenure. At February 27, 1999, the estimated fair value of the Senior Notes as determined by an independent investment banker approximated $313,449,000. Foreign Currency Exchange Contracts At February 27, 1999, the Company had contracts for the sale of foreign currency of $80,296,000 (primarily Spanish pesetas, Mexican pesos and Brazilian reals) and the purchase of foreign currency of $71,085,000 (primarily pounds sterling), compared to contracts for the sale of $27,018,000 (primarily Spanish pesetas) and the purchase of $9,466,000 (primarily pounds sterling) at February 28, 1998. The fair values of the Company's foreign currency exchange contracts are estimated based on quoted market prices of comparable contracts, adjusted through interpolation when necessary for maturity differences. In the aggregate, the carrying value of these contracts approximated fair value at February 27, 1999 and February 28, 1998. The Company had minimal exposure to loss from nonperformance by the counterparties to its forward exchange contract agreements at the end of fiscal 1999, and does not anticipate nonperformance by counterparties in the periodic settlements of amounts due. The Company currently minimizes this potential for risk by entering into forward exchange contracts exclusively with major, financially sound counterparties, and by limiting exposure with any one financial institution. 80 GTECH HOLDINGS CORPORATION AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS NOTE P - SPECIAL CHARGE In the fourth quarter of fiscal 1998, the Company recorded a $99,382,000 special charge ($60,623,000 after-tax, or $1.45 per basic share; $1.44 per diluted share). The special charge consisted principally of costs to exit the electronic benefit transfer (EBT) business conducted by the Company's Transactive subsidiary ("Transactive"). In addition, the special charge included costs associated with a worldwide workforce reduction, contractual obligations in connection with the departures of the Company's former Chairman and Vice Chairman from the Company and asset impairment charges relating to two of the Company's lottery contracts. In February 1998, the Company entered into an asset purchase agreement with Citicorp Services, Inc. ("Citicorp"), to sell EBT contracts and certain related assets held by Transactive. In July 1998, the U.S. Department of Justice commenced a legal action seeking to enjoin the consummation of the transaction, on anti-trust grounds and in January 1999 Citicorp terminated the agreement pursuant to a clause in the contract that permitted termination by either party if the closing did not occur within a timeframe that has expired. Principally as a result of the contract termination, the Company recorded an additional special charge of $15,000,000 ($8,850,000 after-tax, or $.22 per basic and diluted share) in the fourth quarter of fiscal 1999 in order to write down the assets held for sale in connection with this transaction to their net realizable value. Those assets consisted primarily of EBT contract assets. The major components of the special charge accrual at February 27, 1999 are contractual obligations relating to exiting the EBT business of $1,627,000, severance payments to be made to terminated employees of $1,464,000 and costs associated with the termination of a consulting contract in fiscal 1999 of $2,000,000. During fiscal 1999, the Company made severance payments of $7,868,000 to 464 terminated employees. A summary of the special charge activity is as follows:
Disposition Worldwide Executive Asset of EBT Workforce Contractual Impairment Business Reduction Obligations Charges Other Total ------------- ------------ ------------ ------------ -------------- ------------ Special charge $ 43,556 $ 12,484 $ 17,950 $ 14,903 $ 10,489 $ 99,382 Cash expenditures (241) (204) (9,437) --- (2,281) (12,163) Noncash charges (37,386) --- --- (15,098) (1,104) (53,588) ------------- ------------ ------------ ------------ -------------- ------------ Balance 2/28/98 5,929 12,280 8,513 (195) 7,104 33,631 ------------ ------------ ------------ ------------ ------------- ----------- Change in estimate 13,601 (2,948) (20) 2,604 1,763 15,000 Cash expenditures (3,662) (7,868) (8,493) (1,543) (4,539) (26,105) Noncash charges (14,241) --- --- (866) (1,361) (16,468) ------------- ----------- ------------ ------------ -------------- ------------ Balance 2/27/99 $ 1,627 $ 1,464 $ --- $ --- $ 2,967 $ 6,058 ============ ============ ============ =========== ============= ===========
81 GTECH HOLDINGS CORPORATION AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS NOTE Q - QUARTERLY RESULTS OF OPERATIONS - (UNAUDITED) The following is a summary of the unaudited quarterly results of operations for fiscal 1999 and 1998:
First Second Third Fourth Quarter Quarter Quarter Quarter ------------- -------------- ------------ ----------- (Dollars in thousands, except per share amounts) Fiscal year ended February 27,1999: Service revenues $ 221,881 $ 224,582 $ 226,076 $ 214,856 Sales of products 10,398 8,952 25,599 40,579 Gross profit 75,679 78,199 87,753 79,680 Net income 18,679 21,848 26,476 22,060 Basic earnings per share $ .45 $ .53 $ .64 $ .55 Diluted earnings per share $ .45 $ .53 $ .64 $ .55 Fiscal year ended February 28,1998: Service revenues $ 225,930 $ 209,139 $ 213,116 $ 220,337 Sales of products 19,241 17,671 51,649 33,484 Gross profit 77,128 74,093 82,005 80,042 Net income (loss) 19,320 20,225 23,933 (36,264) Basic earnings per share $ .46 $ .48 $ .57 $ (.87) Diluted earnings per share $ .46 $ .48 $ .57 $ (.87)
There were 13 weeks in the first quarter of fiscal 1999 and 14 weeks in the first quarter of fiscal 1998. The Company recorded special charges of $15,000,000 and $99,382,000 in the fourth quarters of fiscal 1999 and fiscal 1998, respectively (See Note P). Earnings per share are computed independently for each of the quarters presented. Therefore, the sum of the quarterly diluted earnings per share in fiscal 1999 and the sum of the quarterly basic earnings per share in fiscal 1998 do not equal the total computed for the year. NOTE R - SUBSEQUENT EVENT In March 1999, the Company announced that Quick Draw, the keno-style game operated in New York State on a lottery system provided by the Company, would terminate effective April 1, 1999. The game did terminate as announced, due to the failure of the New York State legislature to extend the legislation authorizing the game. 82 ITEM 9. CHANGES AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE Not applicable. 83 PART III INCORPORATED BY REFERENCE The information called for by Item 10--"Directors and Executive Officers of the Registrant" (other than the information concerning executive officers set forth after Item 4 herein), Item 11--"Executive Compensation," Item 12--"Security Ownership of Certain Beneficial Owners and Management" and Item 13--"Certain Relationships and Related Transactions" of Form 10-K is incorporated herein by reference Holding' definitive proxy statement for its Annual Meeting of Shareholders scheduled to be held in July 1999, which definitive proxy statement is expected to be filed with the Commission not later than 120 days after the end of the fiscal year to which this report relates. 84 PART IV ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K (a) Financial Statement Schedules and Exhibits: Page(s) (1) Report of Ernst & Young LLP, Independent Auditors (2) Report of Price Waterhouse, Independent Accountants The following consolidated financial statements of GTECH Holdings Corporation and subsidiaries are included in Item 8: Consolidated Balance Sheets at February 27, 1999 and February 28, 1998 Consolidated Income Statements Fiscal year ended February 27, 1999 Fiscal year ended February 28, 1998, and Fiscal year ended February 22, 1997 Consolidated Statements of Shareholders' Equity-- Fiscal year ended February 27, 1999, Fiscal year ended February 28, 1998, and Fiscal year ended February 22, 1997 Consolidated Statements of Cash Flows-- Fiscal year ended February 27, 1999 Fiscal year ended February 28, 1998, and Fiscal year ended February 22, 1997 Notes to Consolidated Financial Statements SCHEDULES OMITTED: All schedules are omitted as they are not applicable or the information is shown in the financial statements or notes thereto. 85 (3) EXHIBITS: 3.1 Restated Certificate of Incorporation of Holdings, as amended (incorporated by reference to Exhibit 3.1 to the Form S-l of Holdings and GTECH Corporation ("GTECH"), Registration No. 33-31867 (the "1990 S-1"). 3.2 Certificate of Amendment to the Certificate of Incorporation of Holdings (incorporated by reference to Exhibit 3.2 to the Form S-1 of Holdings, Registration No. 33-48264 (the "July 1992 S-1")). 3.3 Amended and Restated By-Laws of Holdings (incorporated by reference to Exhibit 3 of Holdings' 10-Q for the quarterly period ended August 29, 1998. 4.1 Amended and Restated Credit Agreement, dated as of June 18, 1997, among GTECH, certain lenders and Bank of Montreal, Banque Paribas, Fleet National Bank, The Bank of Nova Scotia and BankBoston, N.A., as Co-Agents; The Bank of New York, as Documentation Agent, and NationsBank, as Administrative Agent (incorporated by reference to Exhibit 4.1 of Holdings' 10-Q for the quarterly period ended May 31, 1997.) +4.2 Amendment No. 1 to Amended and Restated Credit Agreement, dated as of February 26, 1999, among GTECH, certain lenders, and Bank of Montreal, Banque Paribas, Fleet National Bank, the Bank of Nova Scotia and Bank Boston, NA, as Co-Agents; The Bank of New York, as Documentation Agent and Nations Bank, as Administrative Agent. 4.3 Note and Guarantee Agreement, dated as of May 15, 1997, among GTECH Holdings and certain financial institutions (incorporated by reference to Exhibit 4.2 of Holdings' 10-Q for the quarterly period ended May 31, 1997). +4.4 Amendment No. 1 to Note and Guarantee Agreement dated as of May 15, 1997, dated as of February 22, 1999. 4.5 Specimen Form of certificate of Common Stock (incorporated by reference to Exhibit 4.18 of the December 1992 5-1). 10.1 Amended and Restated Employment Agreement dated September 19, 1997 between GTECH, Holdings and William Y. O'Connor (incorporated by reference to Exhibit 10.1 of Holdings' 10-Q for the quarterly period ended August 30, 1997).* 10.2 First Amendment to Employment Agreement dated as of April 6, 1998 between GTECH, Holdings and William Y. O'Connor. (incorporated by reference to Exhibit 10.11 of Holdings' 1998 10-K).* 86 10.3 Restricted Rights Arrangement between Holdings and Mr. O'Connor (incorporated by reference to Exhibit 10.44 of Holdings' 1995 10-K).* +10.4 Agreement dated January 15, 1999 by and between Steven P. Nowick and Holdings.* 10.5 Amended and Restated Employment Agreement dated as of December 1, 1995 between GTECH and Laurance W. Gay.* 10.6 Agreement dated July 15, 1997 between Holdings and Laurance W. Gay (incorporated by reference to Exhibit 10.3 of Holdings' 10-Q for the quarterly period ended August 30, 1997).* 10.7 Severance Agreement and Release dated March 9, 1998 between GTECH, Holdings and Laurance W. Gay.* +10.8 Form of Agreement entered into between Holdings and certain members of senior management and list of signatories to Agreements and dates. 10.9 GTECH Corporation Executive Perquisites Program (incorporated by reference to Exhibit 10.8 of Holdings' 1993 10-K).* 10.10 Form of Indemnification Agreement (incorporated by reference as Exhibit 10.14 of GTECH's 1992 10-K). 10.11 List of Indemnification Agreement signatories and dates (incorporated by reference to Exhibit 10.17 of Holdings' 1996 10-K). 10.12 Form of Executive Separation Agreement and Schedule of Recipients (form of Executive Separation Agreement incorporated by reference to Exhibit 10.18 of Holdings' 1996 10-K).* 10.13 Supplemental Retirement Plan effective January 1, 1992 and List of participants (form of Supplemental Retirement Plan incorporated by reference to Exhibit 10.16 of GTECH's 1992 10-K). (List incorporated by reference to Exhibit 10.21 of Holdings' 1998 10-K)* 10.14 Contract for the Texas Lottery Operator for the State of Texas between GTECH and the Texas Comptroller of Public Accounts--Lottery Division, dated March 7, 1992 (incorporated by reference to Exhibit 10.44 of GTECH's 1992 10-K). 10.15 Amendment to the Contract for the Texas Lottery Operator for the State of Texas between GTECH and the Texas Comptroller of Public Accounts--Lottery Division, dated June 1, 1994 (incorporated by reference to Exhibit 10 of Holdings' 10-Q for the quarterly period ended May 25, 1996). 87 10.16 Second Amendment to the Contract for the Texas Lottery Operator for the State of Texas between GTECH and the Texas Comptroller of Public Accounts--Lottery Division, dated May 28, 1996 (incorporated by reference to Exhibit 10.1 to the Form S-3 of Holdings, Registration No. 333-3602). 10.17 Purchase and Sale Agreement dated 8 February 1994 between Camelot Group plc and GTECH (incorporated by reference to Exhibit 10.31 of Holdings' 1995 10-K). 10.18 Terminals Supply Agreement dated 8 February 1994 among Camelot Group plc, International Computers Limited and GTECH (incorporated by reference to Exhibit 10.32 of the Company's 1995 10-K). 10.19 Field Services Agreement dated 8 February 1994 among Camelot Group plc, International Computers Limited and GTECH (incorporated by reference to Exhibit 10.33 of Holdings' 1995 10-K). 10.20 Lottery Technology Support Services Agreement dated 8 February 1994 between Camelot Group plc and GTECH (incorporated by reference to Exhibit 10.34 of Holdings' 1995 10-K). 10.21 Letter dated March 31, 1998 to William Y. O'Connor, Chairman and Chief Executive Officer of GTECH, from Tim Holley, Chief Executive Officer of Camelot Group plc (incorporated by reference to Exhibit 10.1 of Holdings' 8-K filed on May 5, 1998). 10.22 Letter dated April 1, 1998 to William Y. O'Connor, Chairman and Chief Executive Officer of GTECH, from Tim Holley, Chief Executive Officer of Camelot Group plc (incorporated by reference to Exhibit 10.2 of Holdings' 8-K filed on May 5, 1998). 10.23 Agreement dated April 20, 1998 between Camelot Group plc and GTECH U.K. Limited for the purchase by Camelot Group plc of 11,250,000 of its own shares (incorporated by reference to Exhibit 10.3 of Holdings' 8-K filed on May 5, 1998). 10.24 Deed of Variation, dated April 20, 1998, between De La Rue plc, Racal Electronics plc, Cadbury Schweppes plc, International Computers Limited, GTECH UK Limited, Holdings, Camelot Group plc, the Director General of the National Lottery and the Secretary of State for Culture, Media & Sport (incorporated by reference to Exhibit 10.4 of Holdings' 8-K filed on May 5, 1998). 10.25 Exit Agreement between De La Rue plc, Racal Electronics plc, GTECH U.K. Limited, Cadbury Schweppes Public Limited Company, International Computers Limited, GTECH Corporation and Camelot Group (incorporated by reference to Exhibit 10.5 of Holdings' 8-K filed on May 5, 1998). 10.26 Amended and Restated Agreement of Limited Partnership by and among GTECH, GP Technology Associates, L.P. and GP Technology, Inc. dated August 26, 1993; 88 Certificate of Limited Partnership of West Greenwich Technology Associates, L.P. dated August 26, 1993; Amended and Restated Indenture of Lease between GTECH and West Greenwich Technology Associates, L.P. dated August 26, 1993 (incorporated by reference to Exhibit 10.24 of Holdings' 1994 10-K). 10.27 Business Agreement dated December 28, 1990 between Digital Equipment Corporation and GTECH; Work Statement Number NED91188 dated March 11, 1991 to GTECH from Digital Equipment Corporation; First Addendum dated March 19, 1991 to Digital Work Statement Number NED91188 dated March 11, 1991 to GTECH from Digital Equipment Corporation (incorporated by reference to Exhibit 10.57 of the July 1992 S-1). 10.28 Maintenance Agreement Number 117A dated December 1, 1989, between GTECH and Concurrent Computer Corporation (incorporated by reference to Exhibit 10.58 of the July 1992 S-1). 10.29 1992 Outside Directors' Director Stock Unit Plan (incorporated by reference to Exhibit 10.55 of Holdings' 1993 10-K).* 10.30 1994 Stock Option Plan, as amended and restated (incorporated by reference to Exhibit 10.1 of Holdings' 10-Q for the quarterly period ended May 31, 1997).* 10.31 1996 Non-Employee Directors' Stock Option Plan, as amended (incorporated herein by reference to Exhibit 10.2 of Holdings' 10-Q for the quarterly period ended May 31, 1997).* 10.32 1997 Stock Option Plan (incorporated herein by reference to the Appendix of Holdings' 1997 Notice of Annual Meeting and Proxy Statement).* 10.33 Holdings' 1998 Non-Employee Directors' Stock Election Plan (incorporated by reference to Exhibit 4.2 to the Form S-8 of Holdings, Registration Number 333-5781). 10.34 Income Deferral Plan - 1998 (incorporated by reference to Exhibit 10 of the Holdings' 10-Q for the quarterly period ended November 28, 1998).* 10.35 Trust Agreement, dated December 18, 1998, by and between Holdings and The Bank of New York, as Trustee, respecting the Income Deferral Plan - 1998 (incorporated by reference to Exhibit 10.1 of the Holdings' 10-Q for the quarterly period ended November 28, 1998.)* +21.1 Subsidiaries of the Company. +23.1 Consent of Ernst & Young, LLP. +23.2 Consent of Price Waterhouse. 89 +27.1 Fiscal 1999 Financial Data Schedule. - ---------------------------- + Filed herewith. * Indicates a management contract or compensatory plan or arrangement required to be filed as an exhibit pursuant to Item 14(c) of Form 10-K. Certain instruments defining the rights of holders of long-term debt have not been filed pursuant to item 601(b)(4)(iii)(A) of Regulation SK. Copies of such instruments will be furnished to the Commission upon request. (b) Reports on Form 8-K: The Company did not file any reports on Form 8-K during the last quarter of the fiscal year covered by this report. 90 SIGNATURES Pursuant to the requirements of Section 13 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, in West Greenwich, Rhode Island, on May 11, 1999. GTECH HOLDINGS CORPORATION By: /s/ William Y. O'Connor ---------------------------------------------- William Y. O'Connor, Chairman of the Board and CEO 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/ William Y. O'Connor Director, Chairman of the Board, Chief Executive Officer May 11, 1999 - ----------------------- (principal executive officer) William Y. O'Connor /s/ Thomas J. Sauser Senior Vice President & Chief Financial Officer May 11, 1999 - ---------------------- (principal financial officer) Thomas J. Sauser /s/ Robert J. Plourde Vice President and Corporate Controller (principal May 11, 1999 - ---------------------- accounting officer) Robert J. Plourde
91 SIGNATURE TITLE DATE /s/ Robert M. Dewey, Jr. Director May 11, 1999 - ---------------------------------- Robert M. Dewey, Jr. /s/ Burnett W. Donoho Director May 11, 1999 - ---------------------------------- Burnett W. Donoho /s/ Moore Director May 11, 1999 - ---------------------------------- The Rt. Hon. Lord Moore of Lower Marsh, P.C. /s/ Emmett Paige, Jr. Director May 11, 1999 - ---------------------------------- Lt. Gen. (Ret.) Emmett Paige, Jr. /s/ Anthony Ruys Director May 11, 1999 - ---------------------------------- Anthony Ruys EX-4.2 2 AMENDMENT NO. 1 TO CREDIT AGREEMENT 1 Exhibit 4.2 AMENDMENT NO. 1 TO AMENDED AND RESTATED CREDIT AGREEMENT THIS AMENDMENT NO. 1 TO AMENDED AND RESTATED CREDIT AGREEMENT (this "Amendment Agreement") is made and entered into as of this 26th day of February, 1999 (the "Effective Date"), by and among GTECH CORPORATION, a Delaware corporation having its principal place of business in West Greenwich, Rhode Island (the "Borrower"), NATIONSBANK, NATIONAL ASSOCIATION, a national banking association organized and existing under the laws of the United States of America ("NationsBank"), in its capacity as administrative agent for the Lenders (in such capacity, the "Administrative Agent"), THE BANK OF NEW YORK, a New York chartered bank, in its capacity as Documentation Agent for the Lenders (in such capacity, the "Documentation Agent"), BANK OF MONTREAL, PARIBAS, FLEET NATIONAL BANK, THE BANK OF NOVA SCOTIA AND BANKBOSTON, N.A., in their capacity as co-agents for the Lenders (in such capacity, the "Co-Agents" and together with the Administrative Agent and the Documentation Agent, the "Agents"), and the Lenders from time to time party to the Credit Agreement (as defined below). WITNESSETH: WHEREAS, the Borrower, the Lenders and the Agents have entered into that certain Amended and Restated Credit Agreement dated as of June 18, 1997 (as amended, modified, restated, amended and restated or supplemented from time to time, the "Credit Agreement"), pursuant to which the Lenders have made available to the Borrower a revolving credit facility; including thereunder a letter of credit facility. Capitalized terms not otherwise defined herein shall have the respective meanings assigned thereto in the Credit Agreement; and WHEREAS, the Borrower has requested that the Agents and the Lenders agree to amend the Credit Agreement in certain respects as set forth herein; and WHEREAS, the Agents and the Lenders have agreed to amend the Credit Agreement; and NOW, THEREFORE, in consideration of the premises and conditions herein set forth, it is hereby agreed as follows: 1. Amendments to Credit Agreement. The Credit Agreement is hereby amended, effective as of the Effective Date, as follows: (a) Section 1.02 of the Credit Agreement is hereby amended by deleting the definition of "Consolidated Shareholders' Equity" and inserting in its place the following: "Consolidated Shareholders' Equity" means, at any time as of which the amount thereof is to be determined, shareholders' equity of the Parent, the Borrower and its Subsidiaries as 2 determined in accordance with Generally Accepted Accounting Principles applied on a Consistent Basis; provided, however, that in calculating Consolidated Shareholders' Equity, any amount of Brazilian foreign currency translation adjustment, whether positive or negative, shall be excluded in all cases. (b) Section 1.02 of the Credit Agreement is hereby amended by adding each of the following definitions in their proper alphabetical order in the Credit Agreement: "Year 2000 Compliant" means all computer applications (including those affected by information received from its suppliers and vendors) that are material to the Borrower's or any of its Subsidiaries' business and operations are able to perform properly date-sensitive functions involving all dates on and after January 1, 2000. "Year 2000 Problem" means the risk that computer applications used by the Borrower or any of its Subsidiaries (including those affected by information received from its suppliers and vendors) may be unable to recognize and perform properly date-sensitive functions involving certain dates on and after January 1, 2000. (c) Section 6.01 of the Credit Agreement is hereby amended by adding the following new subsection (u): (u) The Borrower and its Subsidiaries have (i) initiated a review and assessment of all areas within its and each of its Subsidiaries' business and operations (including those affected by information received from suppliers and vendors) that could reasonably be expected to be adversely affected by the Year 2000 Problem, (ii) have developed a plan and timeline for addressing the Year 2000 Problem on a timely basis, and (iii) to date, have implemented that plan on a timely basis. The Borrower intends that all computer applications (including those affected by information received from its suppliers and vendors) that are material to its or any of its Subsidiaries' business and operations will, no later than September 9, 1999, be Year 2000 Compliant, except to the extent that a failure to do so could not reasonably be expected to have Material Adverse Effect. (d) Section 8.03 of the Credit Agreement is hereby deleted in its entirety and the following new Section 8.03 is inserted in replacement thereof: 8.03 Consolidated Shareholders' Equity. Permit at any time Consolidated Shareholders' Equity to be less than (a) $200,000,000 2 3 during the current Fiscal Year and each Fiscal Year to and including the Fiscal Year ending on the last Saturday of February 2000, and (b) during each Fiscal Year thereafter, beginning with the Fiscal Year commencing immediately following the last Saturday of February 2000, an amount equal to the sum of (i) the amount of Consolidated Shareholders' Equity required under this Section 8.03 for the immediately preceding Fiscal Year plus (ii) fifty percent (50%) of Consolidated Net Income during the immediately preceding Fiscal Year; provided, however, in no event shall the Consolidated Shareholders' Equity requirement be decreased as a result of a net loss of the Borrower and its Subsidiaries (i.e., negative Consolidated Net Income) for any Fiscal Year. Any increase calculated pursuant hereto shall be determined based upon financial statements delivered in accordance with Section 7.01(a) hereof; provided, however such increase shall be deemed effective as of the first day of the Fiscal Year in which such financial statements are delivered. (e) The Credit Agreement is hereby amended by adding the following new Section 7.20: 7.20 Year 2000 Compliance. In the event the Borrower discovers or determines that any computer application (including those affected by information received from its suppliers and vendors) that is material to its or any of its Subsidiaries' business and operations will not be Year 2000 Compliant on or before September 9, 1999, the Borrower will, promptly upon such discovery or determination, deliver to the Administrative Agent and the Lenders (i) a notice setting forth the identity of those applications and/or systems that will not be Year 2000 Compliant on or before September 9, 1999, and the nature of the problem with such applications and/or systems becoming Year 2000 Compliant, and (ii) a summary of the Borrower's plan for of making such applications and/or systems Year 2000 Compliant in a timely manner and in no event later than December 31, 1999. Notwithstanding the foregoing sentence, all computer applications (including those affected by information received from its suppliers and vendors) that are material to the Borrower's or any of its Subsidiaries' business and operations will be Year 2000 Compliant on or before December 31, 1999. 2. Consent of Guarantors. Each of the Guarantors joins in the execution of this Amendment Agreement for the purposes of consenting to the amendments to the Credit Agreement contained herein and for the further purpose of confirming its guaranty of Obligations (among other things) as provided in the Guaranty Agreement. 3. Conditions Precedent to Effectiveness. The effectiveness of this Amendment Agreement shall be subject to fulfillment of the following conditions precedent: 3 4 (a) the Administrative Agent shall have received fifteen (15) counterparts of this Amendment Agreement duly executed by the Borrower and the Guarantors. (b) the Administrative Agent shall have received evidence from the Borrower either (i) of the existence in the Private Placement Debt documents of a covenant measuring the net worth of the Borrower that is no more restrictive, as determined by the Administrative Agent in its sole discretion, than the Consolidated Shareholders' Equity covenant contained in Section 8.03 of the Credit Agreement, or (ii) that the Private Placement Debt documents do not contain a covenant measuring the net worth of the Borrower. (c) the Administrative Agent shall have received, for the benefit of each of the Lenders according to their respective Applicable Commitment Percentages as of the date hereof, an amendment fee equal to one-eighth of one percent (1/8%) of the Total Revolving Credit Commitment as of the date hereof; and (d) the Administrative Agent shall have received all other documents, and the Borrower shall have taken all other actions, necessary in the reasonable discretion of the Administrative Agent to effectuate the purpose and intent of this Amendment Agreement. 4. Representations and Warranties. By its execution and delivery of this Amendment Agreement, the Borrower represents and warrants to the Agents and the Lenders as follows: (a) The representations and warranties made by the Borrower in Article VI of the Credit Agreement are true and correct on and as of the date hereof; (b) There has been no material adverse change in the condition, financial or otherwise, of the Borrower and its Subsidiaries, taken as a whole, since the date of the most recent financial reports of the Borrower received by the Administrative Agent and the Lenders under Section 7.01 of the Credit Agreement; and (c) No event has occurred and is continuing which constitutes, and no condition exists which upon the consummation of the transaction contemplated hereby would constitute, a Default or an Event of Default on the part of the Borrower under the Credit Agreement. 5. Entire Agreement. This Amendment Agreement sets forth the entire understanding and agreement of the parties hereto in relation to the subject matter hereof and supersedes any prior negotiations and agreements among the parties relative to such subject matter. No promise, condition, representation or warranty, express or implied, not herein set 4 5 forth shall bind any party hereto, and no one of them has relied on any such promise, condition, representation or warranty. 6. Full Force and Effect of Credit Agreement and other Loan Documents. Except as hereby specifically amended, modified or supplemented, the Credit Agreement and all other Loan Documents are hereby confirmed and ratified in all respects and shall remain in full force and effect according to their respective terms. 7. Counterparts. This Amendment Agreement may be executed in any number of counterparts, each of which shall be deemed an original as against any party whose signature appears thereon, and all of which shall together constitute one and the same instrument. 8. Credit Agreement. All references in any of the Loan Documents to the "Credit Agreement" shall mean the Credit Agreement as amended hereby. 9. GOVERNING LAW. THIS AMENDMENT AGREEMENT SHALL IN ALL RESPECTS BE GOVERNED BY THE LAW OF THE STATE OF NEW YORK, WITHOUT REGARD TO ANY OTHERWISE APPLICABLE PRINCIPLES OF CONFLICT OF LAWS. [Signature pages follow.] 5 6 IN WITNESS WHEREOF, the parties have caused this Amendment Agreement to be duly executed by their duly authorized representatives, all as of the day and year first above written. BORROWER: GTECH CORPORATION By:__________________________________ Name:________________________________ Title:_______________________________ GUARANTORS: GTECH TRANSACTIVE GTECH HOLDINGS RHODE ISLAND CORPORATION CORPORATION CORPORATION By:______________________ By:______________________ By:______________________ Name:____________________ Name:____________________ Name:____________________ Title:___________________ Title:___________________ Title:___________________ AGENTS: NATIONSBANK, NATIONAL ASSOCIATION, as Administrative Agent for the Lenders By:__________________________________ Name:________________________________ Title:_______________________________ AMENDMENT NO. 1 SIGNATURE PAGE 1 OF 4 7 THE BANK OF NEW YORK, as Documentation Agent for the Lenders By:___________________________________ Name:_________________________________ Title:________________________________ LENDERS: NATIONSBANK, NATIONAL ASSOCIATION By:___________________________________ Name:_________________________________ Title:________________________________ THE BANK OF NEW YORK By:___________________________________ Name:_________________________________ Title:________________________________ BANK OF MONTREAL By:___________________________________ Name:_________________________________ Title:________________________________ AMENDMENT NO. 1 SIGNATURE PAGE 2 OF 4 8 PARIBAS By:___________________________________ Name:_________________________________ Title:________________________________ By:___________________________________ Name:_________________________________ Title:________________________________ FLEET NATIONAL BANK By:___________________________________ Name:_________________________________ Title:________________________________ THE BANK OF NOVA SCOTIA By:___________________________________ Name:_________________________________ Title:________________________________ BANKBOSTON, N.A. By:___________________________________ Name:_________________________________ Title:________________________________ AMENDMENT NO. 1 SIGNATURE PAGE 3 OF 4 9 BANK OF TOKYO-MITSUBISHI TRUST COMPANY By:___________________________________ Name:_________________________________ Title:________________________________ CREDIT LYONNAIS NEW YORK BRANCH By:___________________________________ Name:_________________________________ Title:________________________________ MELLON BANK, N.A. By:___________________________________ Name:_________________________________ Title:________________________________ COMMERZBANK AG, NEW YORK BRANCH By:___________________________________ Name:_________________________________ Title:________________________________ AMENDMENT NO. 1 SIGNATURE PAGE 4 OF 4 EX-4.4 3 AMENDMENT NO. 1 TO NOTE AND GUARANTEE AGREEMENT 1 Exhibit 4.4 GTECH HOLDINGS CORPORATION GTECH CORPORATION 55 Technology Way West Greenwich, Rhode Island 02817 New York, New York As of February 22, 1999 Re: Amendment No. 1 to Note and Guarantee Agreement dated as of May 15, 1997 To the Noteholders Referred to Below Ladies and Gentlemen: Reference is made to the Note and Guarantee Agreement dated as of May 15, 1997 (the "Agreement") between GTECH CORPORATION, a Delaware corporation (the "Company"), GTECH HOLDINGS CORPORATION, a Delaware corporation (the "Guarantor" and, together with the Company, the "Obligors"), and the Purchasers identified in Schedule A thereto, pursuant to which said Purchasers purchased $300,000,000 aggregate principal amount of the Company's 7.75% Series A Guaranteed Senior Notes due 2004 and 7.87% Series B Guaranteed Senior Notes due 2007 (the "Notes"). The Obligors have requested that the holders of the Notes (the "Noteholders") agree, and the Noteholders party hereto are willing, to amend various provisions of the Agreement, all on the terms and conditions of this Amendment. Accordingly, in consideration of the premises and the mutual agreements contained herein, and for other good and valuable consideration, the receipt and sufficiency of which are hereby acknowledged, the parties hereto agree as follows: Section 1. Definitions. Unless otherwise defined herein, all terms used herein which are defined in the Agreement (as amended hereby) shall have their respective meanings as therein defined. Section 2. Amendments to Agreement. Subject to the satisfaction of the conditions to effectiveness specified in Section 4 below, the Agreement is amended as follows: 2.1. Amendment to Section 10.6. Section 10.6 of the Agreement is amended to read in its entirety as follows: 2 -2- "10.6. INDEBTEDNESS. The Guarantor will not at any time permit the ratio of Consolidated Indebtedness to Consolidated EBDAIT to exceed 3.0 to 1.". 2.2. Amendment to Section 10.7. Section 10.7 of the Agreement is amended to read in its entirety as follows: "10.7. FIXED CHARGES. The Guarantor will not at any time permit the Fixed Charges Coverage Ratio to be less than 2.0 to 1.". 2.3 Amendments to Section 11. (a) Subsection (c) of Section 11 of the Agreement is amended to read in its entirety as follows: "(c) the Guarantor defaults in the performance of or compliance with any terms contained in Section 7.1(d) or Section 10.2, 10.4, 10.5, 10.6, 10.7 or 10.8; or". (b) The second parenthetical phrase contained in Subsection (d) of Section 11 of the Agreement is amended to read in its entirety as follows: "(provided, that, with respect to any default arising under Section 10.1, such Obligor is proceeding diligently and in good faith to remedy such default)". 2.4. Amendments to Schedule B. (a) Schedule B to the Agreement is amended by deleting the defined term "Consolidated Shareholders' Equity" contained therein. (b) Schedule B to the Agreement is further amended by adding the following defined term thereto in the appropriate alphabetical location: "CONSOLIDATED FIXED CHARGES" means, with reference to any period, the sum of (a) Consolidated Interest Expense for such period plus (b) Consolidated Lease Rentals for such period. "CONSOLIDATED INCOME AVAILABLE FOR FIXED CHARGES" means, with reference to any period, the sum (without duplication) of (i) Consolidated Net Income for such period, plus (to the extent deducted in the computation of such Consolidated Net Income) (ii) Consolidated Interest Expense for such period, (iii) Consolidated Lease Rentals for such period and (iv) taxes on income of the Guarantor and its Restricted Subsidiaries for such period, provided, however, that there shall be excluded from the computation of Consolidated Net Income for this purpose the special charge taken by the Guarantor in the fiscal quarter of the Guarantor ending in February 1999 (in an amount not in excess of $15,000,000) relating to the Guarantor's decision not to seek renewal of contracts in the benefits distribution business of Transactive Corporation. 3 -3- "CONSOLIDATED LEASE RENTALS" means, with reference to any period, the sum of the rental and other obligations required to be paid during such period by the Guarantor or any Restricted Subsidiary as lessee under all leases of real or personal property (other than Capital Leases), excluding any amounts required to be paid by the lessee which are on the account of maintenance and repairs, insurance, taxes, assessments and similar charges. "FIXED CHARGES COVERAGE RATIO" means, as of any date of determination, the ratio of (a) Consolidated Income Available For Fixed Charges for the four fiscal quarters ending on, or most recently prior to, such date to (b) Consolidated Fixed Charges for such four fiscal quarters, all determined on a pro forma basis in accordance with generally accepted financial practice giving effect to any acquisition or disposition made during the relevant computation period as if such acquisition or disposition were made on the first day of such period. Section 3. Representations and Warranties. The Obligors represent and warrant, jointly and severally, to the Noteholders on the date hereof and as of the Effective Date as follows (and the parties hereto agree that the following representations and warranties shall be deemed to have been made pursuant to the Agreement for all relevant purposes thereof): 3.1. Power and Authority. Each Obligor has the corporate power and authority to execute and deliver this Amendment and to perform the Agreement as amended hereby (the "Amended Agreement"). 3.2. Authorization, etc. This Amendment has been duly authorized by all necessary corporate action on the part of each Obligor and has been duly executed and delivered by each of the Obligors, and the Amended Agreement constitutes a legal, valid and binding obligation of each Obligor, enforceable against such Obligor in accordance with its terms except as such enforcement may be limited by (i) applicable bankruptcy, insolvency, reorganization, moratorium or other similar laws affecting the enforcement of creditors' rights generally and (ii) general principles of equity (regardless of whether such enforceability is considered in a proceeding in equity or at law). 3.3. No Conflicts. The execution and delivery by the Obligors of this Amendment and the performance by the Obligors of this Amendment and of the Amended Agreement will not (i) contravene, result in any breach of, or constitute a default under, or result in the creation of any Lien in respect of any property of either Obligor or any Subsidiary under, any indenture, mortgage, deed of trust, loan, purchase or credit agreement, lease, corporate charter or by-laws, or any other agreement or instrument to which either Obligor or any Subsidiary is bound or by which either Obligor or any Subsidiary or any of their respective properties may be bound or affected, (ii) conflict with or result in a breach of any of the terms, conditions or provisions of any order, judgment, decree, or ruling of any court, arbitrator or Governmental Authority applicable to either Obligor or any Subsidiary or (iii) violate any provision of any statute or other rule or regulation of any Governmental Authority applicable to either Obligor or any Subsidiary. 3.4. Governmental Authorizations. No consent, approval or authorization of, or registration, filing or declaration with, any Governmental Authority is required in connection 4 -4- with the execution and delivery of this Amendment or for the performance by the Obligors of the Amended Agreement. 3.5. No Defaults. Both immediately prior and after giving effect to this Amendment, no Default or Event of Default shall have occurred and be continuing. Section 4. Conditions to Effectiveness. This Amendment shall become effective as of the date (the "Effective Date") when the following conditions shall have been satisfied: 4.1. Execution and Delivery. This Amendment shall have been duly executed and delivered by each Obligor and the Required Holders. 4.2. Acknowledgements by Subsidiary Guarantors. Each Subsidiary Guarantor shall have acknowledged and consented to the execution and delivery of this Amendment. 4.3 Rating Confirmation. Duff & Phelps Credit Rating Co. shall have confirmed in writing its rating of each series of Notes of at least BBB+. Section 5. Miscellaneous. 5.1. Fees. Without limiting the provisions of Section 16.1 of the Agreement, the Company agrees to pay the reasonable fees and expenses of special counsel to the Noteholders, Milbank, Tweed, Hadley & McCloy LLP, relating to the transactions contemplated hereby. 5.2. Ratification; Waiver. The Agreement, except as amended pursuant hereto, is in all respects ratified and confirmed, and the terms, covenants and agreements thereof shall remain in full force and effect. 5.3. References to Agreement and Notes. From and after the Effective Date, all references to the Agreement in the Agreement, the Notes and the Subsidiary Guarantees shall be deemed to be references to the Agreement as amended by this Amendment. 5.4. Governing Law. This Amendment shall be construed in accordance with and governed by the laws of the State of New York. 5.5. Execution in Counterparts. This Amendment may be executed in counterparts, each of which shall be deemed an original but all of which together shall constitute one and the same instrument. 5 -5- If you are in agreement with the foregoing, please sign the form of acceptance in the space provided below whereupon this Amendment shall become a binding agreement between you, the Company and the Guarantor. Very truly yours, GTECH CORPORATION By:_____________________________ Title: GTECH HOLDINGS CORPORATION By:_____________________________ Title: The foregoing is hereby agreed to as of the date hereof: THE NORTHWESTERN MUTUAL LIFE INSURANCE COMPANY By:_____________________________ Title: TEACHERS INSURANCE AND ANNUITY ASSOCIATION OF AMERICA By:_____________________________ Title: 6 -6- ALLSTATE LIFE INSURANCE COMPANY By:_____________________________ Title: By:_____________________________ Title: Authorized Signatories THE VARIABLE ANNUITY LIFE INSURANCE COMPANY AMERICAN GENERAL LIFE INSURANCE COMPANY By:_____________________________ Title: THE GUARDIAN LIFE INSURANCE COMPANY OF AMERICA By:_____________________________ Title: THE GUARDIAN INSURANCE AND ANNUITY COMPANY, INC. By:_____________________________ Title: 7 -7- FORT DEARBORN LIFE INSURANCE COMPANY By:_____________________________ Title: HARTFORD LIFE INSURANCE COMPANY By:_____________________________ Title: HARTFORD FIRE INSURANCE COMPANY By:_____________________________ Title: HARTFORD LIFE AND ACCIDENT INSURANCE COMPANY By:_____________________________ Title: THE LINCOLN NATIONAL LIFE INSURANCE COMPANY By: Lincoln Investment Management, Inc., its Attorney-In-Fact By:_____________________________ Title: 8 -8- FIRST PENN-PACIFIC LIFE INSURANCE COMPANY By: Lincoln Investment Management, Inc., its Attorney-In-Fact By:_____________________________ Title: LINCOLN NATIONAL REASSURANCE COMPANY By: Lincoln Investment Management, Inc., its Attorney-In-Fact By:_____________________________ Title: LINCOLN NATIONAL REINSURANCE COMPANY (BARBADOS) LTD. By: Lincoln Investment Management, Inc., its Attorney-In-Fact By:_____________________________ Title: PACIFIC LIFE INSURANCE COMPANY By:_____________________________ Title: By:_____________________________ Title: 9 -9- LIFE INVESTORS INSURANCE COMPANY OF AMERICA By:_____________________________ Title: MONUMENTAL LIFE INSURANCE COMPANY By:_____________________________ Title: PFL LIFE INSURANCE COMPANY By:_____________________________ Title: THE EQUITABLE LIFE ASSURANCE SOCIETY OF THE UNITED STATES By:_____________________________ Title: THE EQUITABLE OF COLORADO, INC. By:_____________________________ Title: 10 -10- RELIASTAR BANKERS SECURITY LIFE INSURANCE COMPANY By:_____________________________ Title: RELIASTAR LIFE INSURANCE COMPANY By:_____________________________ Title: RELIASTAR UNITED SERVICES LIFE INSURANCE COMPANY By:_____________________________ Title: NORTHERN LIFE INSURANCE COMPANY By:_____________________________ Title: WASHINGTON SQUARE ADVISORS PRIVATE PLACEMENT TRUST FUND By:_____________________________ Its: Investment Advisor and Authorized Signatory KEYPORT LIFE INSURANCE COMPANY By Stein Roe & Farnham Incorporated, as Agent By:_____________________________ Title: 11 -11- CONNECTICUT GENERAL LIFE INSURANCE COMPANY By CIGNA Investments, Inc. By:_____________________________ Name: Title: CONNECTICUT GENERAL LIFE INSURANCE COMPANY, on behalf of one or more separate accounts By CIGNA Investments, Inc. By:_____________________________ Name: Title: LIFE INSURANCE COMPANY OF NORTH AMERICA By CIGNA Investments, Inc. By:_____________________________ Name: Title: PRINCIPAL LIFE INSURANCE COMPANY By:_____________________________ Title: By:_____________________________ Title: 12 -12- CONSECO ANNUITY ASSURANCE COMPANY "Conseco Capital Management, Inc. acting as Investment Advisor" By:_____________________________ Title: The foregoing is hereby acknowledged and consented to as of the date hereof: TRANSACTIVE CORPORATION By:_____________________________ Title: GTECH RHODE ISLAND CORPORATION By:_____________________________ Title: EX-10.4 4 AGREEMENT DATED JANUARY 15, 1999 1 Exhibit 10.4 EMPLOYMENT AGREEMENT THIS EMPLOYMENT AGREEMENT, dated as of January 15, 1999, by and between GTECH HOLDINGS CORPORATION, a Delaware corporation (the "Company"), and STEVEN P. NOWICK ("Executive"). WHEREAS, the Company desires to retain the services of Executive on the terms and conditions provided in this Agreement; and WHEREAS, Executive, understanding and accepting the terms and conditions of employment set forth herein, desires to render such services on such terms and conditions. NOW, THEREFORE, in consideration of the premises and of the mutual covenants herein contained, the parties hereto hereby covenant and agree as follows: 1. DEFINITIONS. Capitalized terms used in this Agreement and not otherwise defined herein shall have the following meanings: "ACT" means the Securities Exchange Act of 1934, as amended to date. "AFFILIATE" shall mean any joint venture or other entity in which the Company or any of its subsidiaries has an equity interest of at least 20%. "BASE SALARY" has the meaning set forth in Section 5(a) hereof. "BOARD" means the Board of Directors of the Company. "CAUSE" means any of the following: (i) any willful failure by Executive to substantially perform his employment duties as described in Section 4 hereof; (ii) Executive's engaging in serious misconduct which is materially injurious to the Company; (iii) any material breach by Executive of any of the terms of Section 10, 11 or 14(a) hereof; (iv) Executive's having been convicted of, or pleading nolo contendere to, a felony, crime of moral turpitude or a gambling-related offense; or -1- 2 (v) Executive's abuse of illegal drugs or other controlled substances or his habitual intoxication. "CHANGE IN CONTROL" means the happening of any of the following: (i) the members of the Board at the beginning of any consecutive twenty-four calendar month period (the "Incumbent Directors") cease for any reason other than due to death to constitute at least a majority of the members of the Board, provided that any director whose election, or nomination for election by the Company's stockholders, was approved by a vote of at least a majority of the members of the Board then still in office who were members of the Board at the beginning of such twenty-four calendar month period, shall be deemed an Incumbent Director; (ii) any "person," including a "group" (as such terms are used in Sections 13(d) and 14(d) of the Act, but excluding the Company, any of its Affiliates, or any employee benefit plan of the Company or any of its Affiliates) is or becomes the "beneficial owner" (as defined in Rule 13(d)(3) under the Act), directly or indirectly, of securities of the Company representing the greater of 30% or more of the combined voting power of the Company's then outstanding securities; (iii) the stockholders of the Company shall approve a definitive agreement (1) for the merger or other business combination of the Company with or into another corporation if (A) a majority of the directors of the surviving corporation were not directors of the Company immediately prior to the effective date of such merger or (B) the stockholders of the Company immediately prior to the effective date of such merger own less than 50% of the combined voting power in the then outstanding securities in such surviving corporation or (2) for the sale or other disposition of all or substantially all of the assets of the Company; or (iv) the purchase of 30% or more of the Stock pursuant to any tender or exchange offer made by any "person," including a "group" (as such terms are used in Sections 13(d) and 14(d) of the Act), other than the Company, any of its Affiliates, or any employee benefit plan of the Company or any of its Affiliates. "CHANGE OF CONTROL AGREEMENT" means the Agreement between Executive and the Company, in the form of Exhibit A hereof, which shall be entered into pursuant to Section 3(b) hereof. -2- 3 "CHANGE OF CONTROL DATE" means the date on which a Change in Control occurs, provided however that if a Change in Control occurs and if Executive's employment with the Company is terminated prior to the date on which the Change in Control occurs, and if it is reasonably demonstrated by Executive that such termination of employment (i) was at the request of a third party who has taken steps reasonably calculated to effect a Change in Control or (ii) otherwise arose in connection with or in anticipation of a Change in Control, then the "Change of Control Date" shall mean the date immediately prior to the date of such termination of employment. "CODE" means the Internal Revenue Code of 1986, as amended. "COMMITTEE" has the meaning set forth in Section 5(a) hereof. "COMMON STOCK" means the Common Stock, par value $.01 per share, of the Company. "COMPANY" means GTECH Holdings Corporation and any successor thereto. "DISABILITY" shall mean permanent and total disability as determined under the Company's long term disability program. "EFFECTIVE DATE" means July 11, 1997. "EXECUTIVE" means Steven P. Nowick. "GOOD REASON" means any of the following events: (i) the assignment to Executive of any duties inconsistent, in a material respect, with the scope of authority, duties and responsibilities of Executive's position as provided in Section 4(b) hereof (including the office to which he reports, status, offices and titles but excluding any such inconsistency that results primarily by reason of a substantial increase or reduction in the size of the Company or other substantial change in the character or scope of the Company's operations and excluding any interim relieving of Executive's duties pursuant to Section 7(b) hereof); (ii) a material reduction in the compensation and benefits to which Executive has a right hereunder, but excluding any such reduction pursuant to Section 6(f) hereof other than a reduction which is greater than ten percent (10%) of Base Salary or longer than one year in duration; (iii) a reduction in the title of Executive after March 1998 from that of Chief Operating Officer of the Company; or (iv) any material breach by the Company of the terms of this Agreement. -3- 4 "LIFE INSURANCE COVERAGE" has the meaning set forth in Section 9(c) hereof. "MANAGEMENT INCENTIVE BONUS" has the meaning set forth in Section 5(c) hereof. "MEDICAL COVERAGE" has the meaning set forth in Section 9(c) hereof. "1994 PLAN" means the Company's 1994 Stock Option Plan, as amended from time to time. "1997 PLAN" means the Company's 1997 Stock Option Plan, as amended from time to time. "RETIREMENT" means retirement from active employment with the Company with the express consent of the Board or in accordance with the retirement policies of the Company. "TERM" has the meaning set forth in Section 3(a) hereof. 2. EMPLOYMENT. The Company hereby agrees to employ and retain Executive, and Executive agrees to be employed and retained by the Company, to render services to the Company and its subsidiaries, Affiliates and divisions for the period, at the rate of compensation and upon the other terms and conditions set forth in this Agreement. 3. TERM. (a) The term of Executive's employment under this Agreement shall commence on the Effective Date, and, subject to earlier termination as provided in Section 8 hereof, shall continue for an initial term ending February 28, 2001 (the "Term"). On March 1, 2001, and on each subsequent March 1, the Term shall automatically be extended through the last day of February of the next succeeding calendar year, unless either party gives written notice to the other, at least 180 days prior to said March 1, that it or he does not wish so to extend the Term. (For example, on March 1, 2001, the Term shall automatically be extended through February 28, 2002, unless either party has notified the other not later than September 1, 2000 that such party does not wish to extend the term, in which case the Term would end February 28, 2001). The initial Term and any extended Term are subject to earlier termination as hereinafter provided in Section 8 hereof, and the compensation, benefits, etc., if any, payable upon termination shall be as set forth in Section 9 hereof. (b) Simultaneously herewith, the Company and Executive shall enter into an Agreement in the form of Exhibit A hereof (the "Change of Control Agreement") which, subject to the following, shall provide the terms and conditions respecting the Company's employment of Executive from and after the Change of Control Date. Accordingly, in the event of a Change -4- 5 of Control occurring during the Term, this Agreement shall terminate with effect from the commencement of the Change of Control Date and the terms and conditions governing the Company's employment of Executive shall be set forth in the Change of Control Agreement. The termination of this Agreement in such circumstances shall not be deemed to be the expiration or termination of Executive's Term of Employment within the meaning of this Agreement and Executive shall have no right to any compensation or benefit under Section 9 hereof by virtue of such Change of Control. Notwithstanding the above, if, after a Change of Control, a court having jurisdiction finds that the Change of Control Agreement is unenforceable in whole or in part, then the Change of Control Agreement, and the preceding sentence of Section 3(b) of this Agreement, shall be deemed to have been null and void and without force or effect ab initio, in which case the terms and conditions governing the Company's employment of Executive during the Term shall be as set forth in this Agreement without reference to the Change of Control Agreement. 4. POSITION AND DUTIES. (a) Position. During the Term, Executive shall be retained and shall serve as Senior Vice President and, commencing in March 1998, the Chief Operating Officer of the Company and shall be a corporate officer of the Company. Executive shall report directly to the Chief Executive Officer of the Company. During the Term, Executive also agrees to serve, if elected, as a senior executive officer and/or director of any subsidiary or Affiliate of the Company. (b) Duties. During the Term, Executive shall have the authority and power to perform such duties consistent with those of the Senior Vice President and Chief Operating Officer and shall not be required without his consent to undertake responsibilities not commensurate with his position. Executive shall comply fully and promptly with the various policies, procedures and rules governing employees promulgated and/or as amended from time to time by the Company and any applicable subsidiary or Affiliate of the Company (including, without limitation, the Company's Ethical Conduct and Conflicts of Interest Policy and Government Relations Policy) and with any applicable disclosure and other requirements of any governmental authority and of any other entity with which the Company, its subsidiaries and Affiliates are doing or propose to do business. Except for illness, vacations and holidays in accordance with then-current Company policy, Executive shall devote his full business time, attention, skill, undivided loyalty and best efforts to the faithful performance of his duties hereunder; provided, however, that Executive may (i) with the approval of the Chief Executive Officer, serve on corporate, civic and charitable boards and committees, (ii) deliver lectures and fulfill speaking engagements, and (iii) manage personal investments, so long as such activities do not interfere with the performance of Executive's responsibilities. Notwithstanding the foregoing, Executive shall be permitted to continue to serve on Boards of Directors of other entities with the approval of the Chief Executive Officer, which consent shall not be unreasonably withheld. -5- 6 (c) Principal Place of Employment. Executive's principal place of employment shall be at the Company's principal offices (currently located in West Greenwich, Rhode Island) or at such other location as the Company hereafter reasonably may require. Executive agrees to reside within reasonable daily commuting distance by car of such offices. 5. COMPENSATION AND REIMBURSEMENT OF EXPENSES. (a) Base Salary. For all services rendered by Executive in all capacities with the Company, its subsidiaries and Affiliates during the Term, the Company shall pay or cause to be paid to Executive as compensation a salary at an annual rate of $325,000 from the Effective Date through February 28, 1998 and at an annual rate of $360,000 commencing on March 1, 1998 (the "Base Salary"), payable in equal installments not less frequently than monthly. The Base Salary shall be increased on March 1, 1999, and each annual anniversary thereof (the "Annual Adjustment Date") during the Term at a rate equal to the annual rate of increase, if any, in the All Cities Consumer Price Index for Urban Wage Earners and Clerical Workers ("CP1-W") as published by the United States Department of Labor, Bureau of Labor Statistics, at the close of the calendar year immediately preceding the applicable Annual Adjustment Date. The Base Salary also shall be subject to possible further increase from time to time in the sole discretion of the Board or the Compensation Committee of the Board or another Committee of the Board designated for such purpose (the "Committee") and the Chief Executive Officer. The Base Salary shall not be subject to decrease except as provided in Section 6(f) hereof. (b) Special Bonuses. In consideration of Executive's entering into this Agreement, the Company paid to Executive during fiscal 1998 a one-time bonus of $75,000. (c) Management Incentive Bonus. With respect to each fiscal year of the Company during the Term commencing with fiscal year 1999 (i.e. the year ending February 28, 1999), Executive shall be eligible to earn a management incentive bonus of up to a maximum of 200% of Executive's Base Salary for such fiscal year (the "Management Incentive Bonus"). The amount of the Management Incentive Bonus for a given fiscal year shall be determined based upon: (x) the achievement by Executive of certain specified management objectives mutually developed and agreed to by the Chief Executive Officer and Executive for such fiscal year (the "MBOs"), and (y) the achievement by the Company of the Company's business plan for such fiscal year (the "Business Plan"). If Executive achieves his MBOs for a given fiscal year and the Company also achieves its Business Plan for such fiscal year, then Executive will receive a Management Incentive Bonus equal to: (xx) 100% of his Base Salary for such fiscal year plus, (yy) to the extent the MBOs and the Business Plan were exceeded for such fiscal year, such additional amounts as the Chief Executive Officer and Committee may in their sole discretion decide, up to a maximum aggregate Management Incentive Bonus of 200% of Executive's Base Salary. In all circumstances not described in the preceding sentence, the decision as to whether to award Executive a Management Incentive Bonus with respect to a fiscal year and the amount of the Management Incentive Bonus, if so awarded, shall be made in the sole discretion of the Chief Executive Officer and the Committee. Any Management Incentive Bonus which Executive is awarded hereunder shall be paid at the time executive bonuses customarily are paid -6- 7 by the Company, but in no event later than 120 days after the end of the fiscal year with respect to which such Management Incentive Bonus is payable. (d) Certain Requirements. Notwithstanding anything contained in this Agreement to the contrary, Executive shall not be entitled to any Management Incentive Bonus for a given fiscal year, if his employment hereunder has terminated for any reason prior to the end of such fiscal year. (e) Reimbursement of Expenses. Consistent with the Company's established policies, the Company shall pay or reimburse Executive for all reasonable and necessary travel and other expenses of Executive incurred by Executive in performing his duties hereunder upon receipt of written substantiation of such expenses. 6. BENEFITS. (a) Other Arrangements. The payments provided in Section 5 hereof are in addition to any benefits to which Executive may be, or may become, entitled under any benefit plan, program or arrangement (excluding any increase in salaries, generally) of the Company for which senior executives are or may become eligible. (b) Benefits. Except as otherwise expressly provided herein, Executive shall be entitled to receive, during the Term, benefits at least at the level provided generally to other senior executives under any such benefit plan, program or arrangement, subject, to Executive's meeting the eligibility requirements of such plans, programs or arrangements, and in the case of benefit plans, programs or arrangements providing for discretionary grants or awards, to the discretion of the Board or applicable Committee. (c) Stock Options. On July 11, 1997, the Company granted to Executive options to purchase 130,000 shares of Common Stock under the Company's 1994 Stock Option Plan (the "1994 Plan"); and on March 9, 1998, the Company granted to Executive options to purchase 60,000 shares of Common Stock under the Company's 1997 Stock Option Plan (the "1997 Plan"). Further, assuming the Term has not been terminated, the Executive shall be eligible, commencing in March 1999 and annually thereafter, to receive in each such year an additional grant of options to purchase shares of Common Stock under the Company's 1997 Plan, or any successor plan to the 1997 Plan, such additional grants to be made, in the discretion of management and the Committee, on the basis of individual and Company performance. Each time Executive receives a grant of stock options pursuant to this Section 6(c), he shall be asked and shall agree to enter into the Company's standard Non-Qualified Stock Option Agreement (the "Option Agreement") which shall set forth the terms and conditions governing the grant and exercise of the Options including such terms as are set forth in this Section 6(c). The terms and provisions of the options provided for in this subsection (c) shall be essentially as set forth in Appendix A hereto. -7- 8 (d) Deferred Compensation Arrangements. Executive shall be entitled to participate in the Company's Income Deferral Plan 1998 (as amended from time to time, the "Income Deferral Plan"). The Company shall contribute $364,933.33 to the Income Deferral Plan for the account of Executive promptly upon establishment of the Income Deferral Plan. (e) Certain Specific Benefits and Arrangements. Without limiting the generality of subsection (a) and (b) above (except as may otherwise be specified in Appendix B hereto), Executive shall be entitled to the specific benefits and arrangements set forth in Appendix B hereto. (f) Possible Reduction. Notwithstanding anything contained in this Agreement to the contrary, the Company shall have the right to reduce or defer prospectively the compensation and benefits provided to or for Executive, as in effect from time to time, pursuant to an across-the-board compensation and/or benefit reduction or deferral program similarly affecting all senior executive officers of the Company. 7. BENEFITS PAYABLE DURING TERM UPON DISABILITY. (a) Disability Benefits. In the event of Disability of Executive during the Term of his employment hereunder, the Company shall continue to pay Executive the compensation and extend to him the benefits provided in Sections 5 and 6 hereof during the period of Disability, subject to Section 9(g) hereof and to the extent permitted by applicable law, provided that in the event of Executive's Disability for an aggregate period of time exceeding 150 calendar days in any 12 consecutive month period during the Term, the Company, at its election, may terminate the Term of Executive's employment. (b) Services During Disability. During the Term, notwithstanding any Disability, Executive shall, to the extent that he is physically and mentally able to do so, furnish information and assistance to the Company, and, in addition, upon the reasonable request in writing on behalf of the Board, or a senior executive officer designated by the Board, from time to time, he shall make himself available to the Company, its subsidiaries and Affiliates to undertake reasonable assignments consistent with his position and his physical and mental health. During such period of service, he shall be responsible and report to, and shall be subject to the supervision of the Board, or a senior executive officer designated by the Board, as to the method and manner in which he shall perform such assignments and shall keep the Board, or such senior executive officer, as the case may be, appropriately informed of his progress in each such assignment. 8. TERMINATION OF EMPLOYMENT. (a) Expiration and Earlier Termination. Executive's Term of employment shall terminate upon expiration of the Term and shall be subject to earlier termination: (i) upon the death or Retirement of Executive; -8- 9 (ii) at the election of the Company in the event of Executive's Disability (as provided in Section 7(a) hereof); (iii) upon discharge of Executive by the Company for Cause or resignation of Executive other than for Good Reason; and (iv) upon discharge of Executive without Cause or Executive's resignation for Good Reason. As provided in Section 3(b) hereof, this Agreement shall terminate in the event of a Change of Control in which event the terms of Executive's employment shall be governed by the Change of Control Agreement. The termination of this Agreement in such circumstances shall not be deemed to be the expiration or termination of Executive's Term of Employment within the meaning of this Agreement and Executive shall have no right to any compensation or benefit under Section 9 hereof by virtue of such Change of Control. (b) Certain Obligations of the Company. The Company shall give the Executive not less than 60 days prior written notice of any intended termination of Executive's employment by the Company for Cause for any reason described in clause (i) or (iii) of the definition of Cause or without Cause. In the event of a proposed termination for Cause for any reason described in clause (i) or (iii) of the definition of Cause, such notice shall specify the grounds for such termination, and the Company shall only be entitled to terminate the Executive for such Cause if the Executive shall have failed to cure the grounds for such termination within said 60-day notice period. Subject to providing such opportunity to cure as may be required by the preceding sentence, after giving such notice, the Company may relieve Executive of his duties on an interim basis until such time as Executive shall have cured the grounds for termination if cure is permitted or Executive's employment shall have been terminated and Executive shall have been permanently relieved of his duties. The Company may immediately terminate Executive's employment by written notice in the event of the occurrence of any of the events set forth in clauses (ii), (iv) or (v) of the definition of Cause in Section 1 hereof. (c) Certain Obligations of Executive. Executive shall give the Company not less than 60 days prior written notice of any intended termination by Executive of Executive's employment whether for Good Reason or other than for Good Reason. In the event of a proposed termination for Good Reason, such notice shall specify the grounds for such termination, and Executive shall only be entitled to terminate his employment for Good Reason if the Company shall have failed to correct the specified grounds within said 60-day notice period. Executive shall not be entitled to terminate for Good Reason unless he has given notice to the Company of his intention so to terminate within 60 days following the occurrence of the event alleged to constitute such Good Reason. Notwithstanding the foregoing, in the event that Executive has given the Company notice of his intention to resign for "Good Reason" or otherwise, the Board may elect to have such resignation become effective immediately or at such other date, not later than the effective date specified in the notice, as the Board may determine. -9- 10 (d) Upon expiration or earlier termination of Executive's Term of Employment, Executive (unless otherwise requested by the Board) concurrently shall resign any directorships which he holds with the Company, its subsidiaries and Affiliates. 9. COMPENSATION, BENEFITS, ETC. UPON, AND EFFECTS OF, TERMINATION. (a) Death, Retirement, Discharge for Cause and Certain Expirations. If the Term of Executive's employment is terminated by reason of his death, Retirement, or discharge by the Company for Cause, or by reason of expiration of the Term, the Company shall pay or cause to be paid to Executive or his estate, as the case may be, at the time such payment is due (i) his Base Salary accrued through the effective date of such termination at the rate in effect immediately prior to such termination and (ii) any other amounts to which Executive is entitled under the terms of Sections 5 and 6 hereof up to the effective date of such termination. Executive also shall be entitled, to the extent not inconsistent with this Agreement, to receive such additional benefits, if any, as he may be entitled to under the express terms of the applicable benefit plans (other than bonus and severance plans) of the Company, its subsidiaries and Affiliates. (b) Resignation Other than for Good Reason. If the Term of Executive's employment is terminated by reason of Executive's resignation other than for Good Reason, Executive shall be entitled to the compensation and benefits set forth in subsection (a) above. (c) Disability, Discharge Without Cause and Resignation for Good Reason. If the Term of Executive's employment is terminated by the Company by reason of Executive's Disability as provided in Section 7(a) hereof, by the Company without Cause or by reason of Executive's resignation for Good Reason, Executive shall be entitled to the compensation and benefits set forth in subsection (a) above, and the Company shall continue (i) for a period of three years following the effective date of such termination, or until Executive's earlier death, to continue to pay or cause to be paid when due his Base Salary at the rate in effect immediately prior to the effective date of such termination (disregarding any reduction pursuant to Section 6(f) hereof), and (ii) for a period of one year following the effective date of such termination, or until Executive's earlier death and subject to continued employee contributions at levels not to exceed levels existing prior to termination, to continue to provide the life insurance specified in Appendix B in the amount in effect immediately prior to the effective date of such termination ("Life Insurance Coverage") and to continue to provide the medical (including dental and optical) coverage specified in Appendix B ("Medical Coverage") at substantially the same level as provided to Executive at the effective date of such termination. Following the one-year period, Executive shall only be entitled to whatever medical coverage, if any, as is required to be provided by applicable law. (d) [Reserved]. -10- 11 (e) Termination of Certain Benefits Upon Reemployment. In the event that, following termination of Executive's employment by the Company without Cause or by Executive for Good Reason, Executive secures other employment (including employment as a consultant) during the period in which the Company is obligated to continue Medical Coverage or Life Insurance Coverage under subsections (c) above, the Company's obligation to continue such Medical Coverage and Life Insurance Coverage immediately shall terminate, except as may otherwise be required by applicable law. However, subject to subsection (g) below the securing of such other employment by Executive shall not affect the Company's obligations with respect to the continued payment to Executive of this Base Salary. Executive shall notify the Company promptly of his securing of any such employment (including employment as a consultant). (f) Consulting Services by Executive. If Executive's employment is terminated by the Company for Disability, by the Company without Cause or by Executive for Good Reason, Executive, in consideration of and during the period of the continued payments under Sections 9(c), shall provide, to the extent that he is physically and mentally able to do so, such reasonable consulting services to the Company as the Company may from time to time request; provided that, unless otherwise agreed to by Executive, such services (i) shall not require in excess of an aggregate of 60 hours during any fiscal quarter, (ii) may be rendered by telephone and shall not require Executive's presence in person, and (iii) subject to Section 10(b) and 11, shall not preclude Executive from engaging in other employment or activities. Such services shall be at the direction and control of the Board or a senior executive officer designated by the Board. (g) Reductions, Forfeitures, etc. Notwithstanding the foregoing: (i) any payments or benefits required to be paid or provided to Executive pursuant to Sections 7(a) or 9(c) in the event of Executive's Disability shall be reduced to the extent that comparable payments or benefits are received by Executive during such period under the Company's disability plan, as in effect from time to time, (ii) without limiting any other rights the Company may have, any payments or benefits required to be paid or provided to Executive under this Agreement shall be forfeited to the Company by Executive if Executive shall breach any of his obligations under Sections 10(b) or 11 hereof, except as may otherwise be required by applicable law, and (iii) the payments and benefits required by this Section 9 shall be made or provided at such times as they would have been paid or provided if Executive's employment had not been terminated. (h) Full Settlement. In the event of the termination of Executive's employment, the payments and other benefits provided for by this Agreement (and as otherwise provided under the express terms of any compensation or benefit plans of the Company, its subsidiaries or Affiliates, to the extent not inconsistent with this Agreement, or as may otherwise be required by applicable law) shall constitute the entire obligation of the Company, its subsidiaries and Affiliates to Executive for compensation and benefits and shall also constitute full and complete settlement of any claim under law or in equity that the Executive might otherwise assert against the Company, its subsidiaries or Affiliates, for compensation and benefits. -11- 12 10. CERTAIN OBLIGATIONS OF EXECUTIVE. Executive further covenants with the Company as follows and expressly agrees that all payments and benefits due Executive under this Agreement shall be subject to Executive's compliance with the provisions of Sections 10 and 11. As used in Sections 10 and 11, the term the "Company" shall include GTECH Holdings Corporation and its subsidiaries and Affiliates. (a) Assistance in Litigation. During the Term, and for a period of three years thereafter, Executive, upon reasonable notice, shall furnish such information and proper assistance to the Company as may reasonably be required in connection with any litigation in which the Company is, or may become, a party. During the Term, the Company shall maintain insurance covering Executive at least as favorable in all material respects as its existing Directors' and Officers' Insurance. (b) Confidential Information, Proprietary Rights, etc. (i) Executive shall not knowingly use for his own benefit or disclose or reveal to any unauthorized person, during or after the Term, any trade secret or other confidential information relating to the Company, including any customer lists, customer needs, price and performance information, processes, specifications, hardware, software, firmware, programs, devices, supply sources and characteristics, business opportunities, marketing, promotional, pricing and financing techniques, or other information relating to the business of the Company; provided that such restriction on confidential information shall not apply to information which is (i) proven to be generally available in the industry, (ii) disclosed in published literature; (iii) obtained by Executive after the Term from a third party without binder of secrecy; or (iv) required to be disclosed by Executive by court order or other process of law, provided however, that Executive shall to the extent circumstances allow, provide the Company with prior written notice of such requirement and with the opportunity to assist in opposing such court order or other process of law. Executive agrees that, except as otherwise agreed by the Company, he will return to the Company, promptly upon the request of the Board or any executive officer designated by the Board, any physical embodiment of such confidential information. (ii) All rights, title and interest in and to any ideas, inventions, technology, processes, know-how, works, hardware, software, firmware, programs, devices, trade secrets, trade names, trademarks or service marks, which Executive may conceive, create, organize, prepare or product during the period of his employment with the Company and which relate to the business of the Company, and all rights, title and interest in and to any patents, patent applications, copyright registrations and copyright applications resulting therefrom, shall be owned by the Company, and Executive agrees to execute instruments or documents, to provide evidence and testimony, and to otherwise assist the Company in establishing, enforcing and maintaining such rights, title and interest of the Company during and after the Term. (iii) Executive does hereby irrevocably constitute, authorize, empower and appoint the Company, or any of its officers, such Executive's true and lawful attorney (with full -12- 13 power of substitution and delegation) in Executive's name, and in Executive's place and stead, or in the Company's name, to take and do such action, and to make, sign, execute, acknowledge and deliver any and all instruments or documents which the Company, from time to time, may deem desirable or necessary to vest in the Company, its successors and assigns, any of the rights, title or interest granted pursuant to clause (ii) above for the use and benefit of the Company, its successors and assigns. 11. NON-COMPETITION. (a) For the periods specified in clauses (i) and (ii) below following termination of Executive's employment (irrespective of the reason for such termination), Executive shall not engage or propose to engage, directly or indirectly (which includes owning, managing, operating, controlling, being employed by, acting as a consultant to, giving financial assistance to, participating in or being connected in any material way with any business or person so engaged) anywhere in the United States, including its territories and possessions, or in any foreign country (the United States and any such foreign country being deemed to be a separate "Territory") in any business which competes or proposes to compete with any business in which the Company was engaged or proposed to be engaged in such Territory at the time of the termination of Executive's employment; provided, that Executive's ownership as a passive investor of less than one percent of the issued and outstanding stock or equity, or $100,000 principal amount of any debt securities, of any corporation, partnership or other entity so engaged shall not by itself be deemed to constitute such engagement by Executive. The Company shall be deemed to have "proposed" to engage in a business within the meaning of the previous sentence if, at the time of termination of Executive's employment, management of the Company was actively considering entering such line of business (whether by acquisition, internal development or otherwise) as evidenced by a written business plan (or other reasonably detailed substantive delineation of business objectives) in existence at such time and Executive was aware of such active consideration. The aforesaid prohibition on Executive's activities shall extend (i) for a period of three years following termination of Executive's employment with respect to the Lottery and Gaming Business (as defined below), and (ii) for a period of one year following termination of Executive's employment with respect to activities relating to any other business. As used herein, the "Lottery and Gaming Business" shall mean the provision of products or services of every nature relating to the operation of all manner of lotteries, games of chance and parimutuel wagering however and wherever conducted. Executive shall not be deemed to have violated this Section 11(a) merely by virtue of employment by a non-competitive division or subsidiary of a business entity or consolidated group that includes one or more divisions or subsidiaries that does in fact compete with a business carried on by the Company. (b) Further, for a period of three years following termination of Executive's employment (irrespective of the reason for such termination), Executive shall not (i) disturb or interfere with any business relationship between the Company and any of its employees, dealers, customers, suppliers or other business associates, or (ii) solicit or cause to be solicited any -13- 14 officer, employee, customer or shareholder of the Company to terminate such person's relationship with the Company or to take other action contrary to the best interests of the Company. 12. TAX WITHHOLDING. The Company may withhold from any benefits payable under this agreement all Federal, State, City, or other taxes as shall be required pursuant to any law or governmental regulations or ruling. 13. EFFECT OF PRIOR AGREEMENTS. This Agreement, including the Exhibit and Appendices hereto, contains the entire understanding between the parties hereto with respect, to the matters covered herein and supersedes any prior agreement, condition, practice, custom, usage and obligation with respect to such matters insofar as any such prior agreement, condition, practice, custom, usage or obligation might have given rise to any enforceable right. 14. GENERAL PROVISIONS. (a) Certain Representations and Warranties of Executive. Executive represents to the Company that (i) the execution and performance of this Agreement by Executive and his employment hereunder does not and will not constitute a breach of any contract, agreement, obligation or understanding, oral or written, to which he is a party or by which he is bound; (ii) the employment and other personal background information provided by Executive to Company is true and correct in all material respects and (iii) to the best of Executive's knowledge, there is no factor relating to him or his family not previously disclosed in writing to the Company which could reasonably be expected, if he were a senior executive officer or director of the Company, to disqualify the Company, its subsidiaries or Affiliates from, or materially jeopardize their chances of, obtaining lottery contracts or other contracts in the businesses in which they are engaged or propose to engage. (b) Non-assignability. Neither this Agreement nor any rights or interest hereunder shall be assignable by Executive, his beneficiaries, or legal representatives without the Company's prior written consent. (c) Binding Agreement. This Agreement shall be binding upon, and accrue to the benefit of, Executive and the Company and their respective heirs, executors, administrator, successors and permitted assigns, including, in the case of the Company, any person or entity acquiring all or substantially all of the Company's assets. (d) Amendment of Agreement. This Agreement may not be modified or amended except by an instrument in writing signed by the parties hereto. -14- 15 (e) Remedies. Executive acknowledges and agrees that the possible restrictions on his activities which may occur as a result of his performance of his obligations under Sections 10(b) and 11 hereof are required for the reasonable protection of the Company, its subsidiaries and Affiliates, and Executive expressly acknowledges and agrees that such restrictions are fair and reasonable for that purpose. Executive further expressly acknowledges and agrees that damages alone will be an inadequate remedy for any breach or violation by him of this Agreement and that the Company, its subsidiaries and Affiliates, in addition to all other remedies at law or in equity, shall be entitled as a matter of right to injunctive relief, including specific performance, with respect to any such breach or violation, in any court of competent jurisdiction including, without limitation, any state or federal court in Rhode Island. If any of the provisions of such Sections are held to be in any respect an unreasonable or unlawful restriction upon Executive, then they shall be deemed to extend only over the maximum period of time, geographic area, and/or range of activities as to which they may be enforceable. The Company and Executive agree that the prevailing party in any legal proceeding respecting this Agreement shall receive, from the other party, reimbursement for all costs incurred in connection with such proceeding. (f) Waiver. No term or condition of this Agreement shall be deemed to have been waived, nor shall there be any estoppel against the enforcement of any provision of this Agreement, except by written instrument of the party charged with such waiver or estoppel. (g) Severability. If, for any reason, any provision of this Agreement is held invalid, such invalidity shall not affect any other provision of this Agreement not so held invalid, and each such other provision shall to the full extent consistent with law continue in full force and effect. (h) Notices. For the purposes of this Agreement, notice and all other communications provided for in this Agreement shall be in writing and shall be deemed to have been duly given when hand delivered or mailed by United States certified or registered express mail, return receipt requested, postage prepaid, if to Executive, addressed to the address set forth on the signature page of this Agreement; if to the Company, addressed to GTECH Holdings Corporation, 55 Technology Way, West Greenwich, Rhode Island 02817 and directed to the attention of the Board with a copy to the Secretary of the Company; if to a member of the Board, addressed to each member at his respective address on file with the Secretary of the Company with a copy to the Company, or to such other address as either party may have furnished to the others in writing in accordance herewith, except that notice of change of address shall be effective only upon receipt. (i) Counterparts. This Agreement may be executed in several counterparts, each of which shall be deemed to be an original but all of which together will constitute one and the same instrument. (j) Indulgences, Etc. Neither the failure nor any delay on the part of either party to exercise any right, remedy, power or privilege under this Agreement shall operate as a -15- 16 waiver thereof, nor shall any single or partial exercise of any right, remedy, power or privilege preclude any other or further exercise of the same or of any other right, remedy, power or privilege, nor shall any waiver of any right, remedy, power or privilege with respect to any occurrence be construed as a waiver of such right, remedy, power or privilege with respect to any other occurrence. (k) Headings. The headings of Sections and paragraphs herein are included solely for convenience of reference and shall not control the meaning or interpretation of any of the provisions of this Agreement. (l) Governing Law. This Agreement shall be governed by and construed in accordance with the laws of the State of Rhode Island, regardless of the laws that might otherwise govern under applicable principles of conflicts of laws thereof. -16- 17 IN WITNESS WHEREOF, GTECH Holdings Corporation has caused this Agreement to be executed by their duly authorized officers, and Executive has signed this Agreement, all as of the day and year first above written. GTECH HOLDINGS CORPORATION Attest:______________________ By:_________________________________ Name: Name: Title: Title: Witness: EXECUTIVE - ----------------------------- ----------------------------------- Steven P. Nowick Address: 104 Circle Ridge Drive Burr Ridge, IL 60521 -17- 18 APPENDIX A SUMMARY OF TERMS OF STOCK OPTIONS The stock options to be granted under Section 6(d) of the Agreement are to be granted pursuant to the 1994 Plan, in the case of stock options granted on the Effective Date, and the 1997 Plan, in the case of all other stock option grants, and will be subject to the respective terms and conditions of the 1994 Plan and the 1997 Plan and the terms and conditions of the Option Agreement. The following is a summary of the provisions of the stock options provided for in Section 6(d) of this Agreement: Nature of Options - Nonqualified unless otherwise determined by the Committee. Exercisability - Options shall become exercisable (i.e. vest) in four equal annual installments commencing one year from the dates of grant of the particular option, subject to possible acceleration under the terms of the 1994 Plan or the 1997 Plan, as the case may be. Option Price - Fair market value at the date of the grant of the particular option. Term - Ten years from the date of grant of the particular option, subject to earlier termination in certain circumstances under the terms of the 1994 Plan or the 1997 Plan, as the case may be. Termination of Employment - In the event Executive's employment is terminated: (i) by reason of death or Retirement, his outstanding options (i.e. options which have been granted but have not been exercised or terminated and have not expired), to the extent they are vested at 19 the date of such death or Retirement, shall remain exercisable for a period of one year; and (ii) by the Company for Disability or without Cause (as defined in the 1994 Plan), by Executive's resignation for Good Reason, or by the Company in the circumstances set forth in Section 3(b) of the Agreement, his outstanding options, whether or not they have vested on the date of such termination of employment, shall accelerate and become vested in full and shall remain exercisable for a period of one year. Notwithstanding the foregoing, (i) with respect to Executive's options, if any, which may be incentive stock options under the Code, the exercisability period following termination of employment shall not exceed that permitted by the Code, (ii) the period of exercisability of options following termination of employment specified above is subject to possible reduction in certain circumstances under the terms of the 1994 Plan, and (iii) in no event shall any option be exercisable after the expiration of its term. Except as expressly provide above, upon termination of Executive's employment, his options, whether vested or unvested, shall immediately terminate and be of no further force and effect. 20 APPENDIX B SUMMARY OF CERTAIN BENEFITS AND ARRANGEMENTS 1. Relocation & Related Matters. Executive currently owns a home in the Chicago, Illinois vicinity (the "Premises"). The Company will provide Executive with a home buyout option, through HFS Mobility Services ("HFS"), with respect to the Premises. This option, subject to the more detailed rules respecting the HFS Program, involves: (i) the appraisal of the Premises by two appraisers (chosen by Executive from a list of approved appraisers); (ii) the valuation of the Premises on the basis of the average of the two appraisals (the "Average Appraisal"); and (iii) the extension of an offer by HFS to Executive to purchase the Premises at a price equal to the Average Appraisal. Executive has the option of accepting the offer to purchase within sixty days, in which case HFS will purchase the Premises at a price equal to the Average Appraisal subject to normal closing conditions, or rejecting or not accepting the offer within sixty days, in which case Executive shall be responsible for the sale of the Premises. 2. Vacation. During the Term, Executive shall be entitled to a paid vacation of four weeks per year commencing to accrue on the date of Executive's employment hereunder. 3. Automobile. During the Term, the Company shall make available to Executive for his own use a passenger automobile in accordance with the Company's automobile policy, as Executive may select. 4. Life Insurance. During the Term (and thereafter as and to the extent expressly provided in the Agreement), Executive shall receive life insurance coverage in accordance with the Company's policy. 5. Medical. During the Term (and thereafter as and to the extent expressly provided in the Agreement) and subject to the payment by Executive of employee contributions as provided in the plan, the Company shall bear the cost of all medical expenses reasonably incurred by Executive and his family (family eligibility to be determined in accordance with the Company's general policies concerning medical coverage), including hospitalization (private room), dental, optical and choice of physicians. Further, during the Term, the cost of Executive's annual physical examination also shall be borne by the Company. 6. Tax Preparation. During the Term, the Company shall bear the expense for annual tax preparation for Executive subject to such limits as are set forth in the Company plan. 21 7. Perquisites Plan. During the Term, Executive shall have the right to participate in the Company's Executive Perquisites Plan, in accordance with its terms provided that the amount available to Executive under the Plan for calendar year 1997 shall be calculated on the assumption that Executive was employed by the Company during all of calendar year 1997. 8. Income Deferral Plan. During the Term, Executive shall have the right to participate in the Income Deferral Plan in accordance with, and subject to, the terms and conditions of such plan. 22 Exhibit A [Omitted: See Exhibit 10.8] EX-10.8 5 FORM OF AGREEMENT 1 AGREEMENT AGREEMENT, dated this _____ day of _________________, 1998, by and between________________________, ("Executive") and GTECH HOLDINGS CORPORATION, a Delaware corporation (the "Company"). W I T N E S S E T H: WHEREAS, the Company wishes to assure itself of continuity of management in the event of any actual or threatened "Change in Control" (as defined below) of the Company; and WHEREAS, the Company and the Executive desire to embody in a written agreement the terms and conditions under which the Executive shall be employed by the Company in the event of any actual or threatened Change in Control of the Company; NOW, THEREFORE, in consideration of the premises and the mutual covenants contained herein, the parties hereto hereby agree as follows: Section 1. Definitions. 1.1 Act. "Act" means the Securities Exchange Act of 1934, as amended to date. 1.2. Affiliate. "Affiliate" means any corporation which is a subsidiary of the Company within the definition of "subsidiary corporation" under Section 424(f) of the Code. 1.3. Board. "Board" means the Board of Directors of the Company. 1.4. Cause. "Cause" means (i) the Executive's engaging in serious misconduct that is injurious to the Company, (ii) the Executive's having been convicted of, or entered a plea of nolo contendere to a crime that constitutes a felony, (iii) the breach by the Executive of any written covenant or agreement with the Company not to disclose any information pertaining to the Company or not to compete or interfere with the Company, or (iv) abuse of illegal drugs or other controlled substances, or habitual intoxication. 1.5. Change In Control. "Change in Control" means the happening of any of the following: (i) the members of the Board at the beginning of any consecutive twenty-four calendar month period (the "Incumbent Directors") cease for any reason other than due to death to constitute at least a majority of the members of the Board, provided that any director whose election, or nomination for election by the Company's stockholders, was approved by a vote of at least a majority of the members of the Board then still in office who were members of the Board at the beginning of such twenty-four calendar 2 month period, shall be deemed an Incumbent Director; (ii) any "person", including a "group" (as such terms are used in Sections 13(d) and 14(d) of the Act, but excluding the Company, any of its Affiliates, or any employee benefit plan of the Company or any of its Affiliates) is or becomes the "beneficial owner" (as defined in Rule 13(d)(3) under the Act), directly or indirectly, of securities of the Company representing the greater of 30% or more of the combined voting power of the Company's then outstanding securities; (iii) the stockholders of the Company shall approve a definitive agreement (1) for the merger or other business combination of the Company with or into another corporation if (A) a majority of the directors of the surviving corporation were not directors of the Company immediately prior to the effective date of such merger or (B) the stockholders of the Company immediately prior to the effective date of such merger own less than 50% of the combined voting power in the then outstanding securities in such surviving corporation or (2) for the sale or other disposition of all or substantially all of the assets of the Company; or (iv) the purchase of 30% or more of the Stock pursuant to any tender or exchange offer made by any "person", including a "group" (as such terms are used in Sections 13(d) and 14(d) of the Act), other than the Company, any of its Affiliates, or any employee benefit plan of the Company or any of its Affiliates. 1.6. Code. "Code" means the Internal Revenue Code of 1986, as amended from time to time, and any successor thereto. 1.7. Effective Date. "Effective Date" means the date on which a Change in Control occurs. Anything in this Agreement to the contrary notwithstanding, if a Change in Control occurs and if the Executive's employment with the Company is terminated prior to the date on which the Change in Control occurs, and if it is reasonably demonstrated by the Executive that such termination of employment (i) was at the request of a third party who has taken steps reasonably calculated to effect a Change in Control or (ii) otherwise arose in connection with or in anticipation of a Change in Control, then for all purposes of this Agreement, the "Effective Date" shall mean the date immediately prior to the date of such termination of employment. 1.8 Executive Perquisite Program. "Executive Perquisite Program" means the Company's Executive Perquisite Program in effect on the date hereof, as the same may be amended from time to time. 1.9 Non-Qualified Plans. "Non-Qualified Plans" means the Company's Supplemental Retirement Plan in existence as of the date hereof, and any other unfunded, non-qualified, deferred compensation, incentive compensation or retirement plan adopted by the Company -2- 3 subsequent to the date hereof, and/or any successor plan or plans. 1.10. Option. "Option" means any option to purchase shares of Stock granted to Executive pursuant to the Company's 1994 Stock Option Plan, as amended from time to time, the Company's 1997 Stock Option Plan, as amended from time to time, or any other stock option plan adopted by the Company. 1.11 Retirement Plan. "Retirement Plan" means the Company's profit-sharing and 401(k) retirement plan which is qualified under Section 401(a) and 501(a) of the Code in existence as of the date hereof and any other such plan adopted by the Company subsequent to the date hereof and/or any successor plan or plans. 1.12. Stock. "Stock" means the Common Stock $.01 par value per share of the Company. 1.13. Term of Employment. "Term of Employment" means the period commencing on the Effective Date and ending on the earliest of: (a) Executive's death or "Total Disability" (as defined below); (b) Termination of the Term of Employment pursuant to Section 4 below; (c) Three (3) years from the Effective Date. Neither the expiration of the Term of Employment nor the termination of this Agreement will relieve the Company of the obligation to provide Executive, in accordance with the terms hereof, the payments, benefits and coverage to which he has become entitled under this Agreement. 1.14. Total Disability. "Total Disability" shall mean permanent and total disability as determined under the Company's long term disability program. Section 2. Employment. ---------------------- 2.1. Capacity and Situs of Employment. The Company agrees to employ Executive throughout the Term of Employment, during which (a) Executive's position (including reporting relationships, status, offices and titles), authority, duties and responsibilities shall be at least equal in all material respects with the highest position, authority, duties and responsibilities held by, exercised by and assigned to the Executive at any time during the six month period immediately preceding the Change in Control, and (b) Executive's situs of employment will be at the Company's executive headquarters in West Greenwich, Rhode Island or such other situs (the "Other Situs") to which Executive may be assigned prior to the Effective Date (the Company's executive headquarters or the Other Situs, whichever is applicable to the Executive, is herein referred to as the "Applicable Situs") or such other location within a fifty (50) mile radius of the Applicable Situs (hereinafter referred to as the "Area") to which the Applicable Situs be moved. -3- 4 2.2. Services of the Executive. Executive agrees, subject to Sections 4.3 and 4.4 below, to remain in the Company's employ during the Term of Employment, on the terms described in Section 2.1. Excluding periods of vacation and sick leave to which Executive is entitled, Executive agrees to devote substantially all of his attention, energy and time during normal business hours to the business and affairs of the Company and, to the extent necessary, to discharge responsibilities assigned to Executive hereunder, to use his best efforts to perform such responsibilities faithfully and efficiently. Executive may (a) serve on corporate, civic and charitable boards or committees, (b) deliver lectures and fulfill speaking engagements and (c) manage personal investments, so long as such activities do not interfere with the performance of Executive's responsibilities. To the extent that any such activities have been conducted by Executive prior to the Change in Control, such prior conduct, and any subsequent conduct similar in nature and scope, shall not be deemed to interfere with the performance of Executive's responsibilities. Section 3. Compensation and Benefits During the Term of Employment. -------------------------------------------------------------------- 3.1. Compensation. The Company will pay as compensation to Executive for his services as an employee during the Term of Employment: (a) base annual salary at a rate equal to or greater than the rate of base salary in effect for Executive immediately prior to the Effective Date; plus (b) for the year in which a Change in Control occurs, the greater of (i) a bonus under the annual bonus plan(s) in effect as of the Change in Control, calculated on the basis of the Company's performance up to the Change in Control, and payable in accordance with such plan(s) or (ii) an amount equal to the bonus paid to Executive under the annual bonus plan(s) in effect for the year immediately preceding the year in which the Change in Control occurs, payable in accordance with the terms of such plan(s); (c) in years subsequent to the year in which the Change in Control occurs, an annual bonus which is equal to or greater than the annual bonus paid in the year preceding the year in which the Change in Control occurs, payable not later than provided for in the plan(s) in effect for such preceding year. 3.2. Benefits. In addition, for his services as an employee during the Term of Employment, Executive will receive all life, disability, accident and group health insurance benefits, retirement, profit-sharing and deferred compensation, and all other fringe benefits and payments under additional benefit plans, including the Executive Perquisite Program, all in an amount or with a value at least equal to those benefits being provided by the Company to the Executive immediately prior to the Effective Date, including but not limited to the following: -4- 5 (a) Executive will participate fully in the Company's Retirement Plan and Non-Qualified Plans with benefit accruals and Company contributions for the benefit of Executive under all such plans, and all other material provisions of such plans, being at least the same as immediately prior to the Effective Date, or Company shall pay to Executive annual cash payments in advance, each at least being equal to the total value of such benefit accruals and Company contributions under such plans for the last fiscal year of the Company ending prior to the Effective Date; (b) At no additional cost to Executive, Company shall continue to provide coverage to Executive, together with his dependents and beneficiaries, in all life insurance plans, accident and health plans, Section 125 plans, and other welfare plans maintained or sponsored by the Company, at a level and subject to terms which are at least as favorable to Executive as the coverage provided immediately prior to the Effective Date, or the Company shall pay to Executive the full value thereof in cash annually in advance; (c) Executive will participate fully in additional benefit plans offered by the Company to executives immediately prior to or after the Effective Date; and (d) Executive will receive fringe benefits and job perquisites (which shall not include any benefit referred to elsewhere in this Section 3), including the Executive Perquisite Program, automobile in accordance with the Company's Fleet Policy for Vice Presidents and Corporate Officers as in effect as of the date hereof, paid vacation, club memberships, applicable class travel, tax and financial statement preparation assistance, paid financial assistance, executive physical examinations, office, office furnishings and equipment and support staff, at least equivalent to those provided to Executive immediately prior to the Effective Date, as well as reimbursement, upon proper accounting, of reasonable expenses and disbursements incurred by Executive in the course of his duties. 3.3. Funding of Deferred Compensation Benefits. Contemporaneous with the Change in Control, all benefits accrued by Executive under the terms of any of the Company's Non-Qualified Plans shall become fully vested and the Company shall immediately contribute to a rabbi trust for the benefit of the Executive the full amount of all such accrued benefits. Not less frequently than quarterly, the Company shall make additional contributions to the rabbi trust equal to the full amount of any additional benefits accrued by Executive pursuant to Section 3.2(a) hereof. 3.4. Acceleration of Vesting of Options. The Company hereby agrees that on or prior to the date of a Change in Control any and all options awarded to the Executive not previously exercisable and vested shall become fully vested and exercisable. In addition, in the event the Company decides to terminate any Options previously awarded to the Executive pursuant to the applicable provisions of any stock option plan adopted by the Company in connection with a -5- 6 corporate transaction (as that term is described in Section 424(a) of the Code), the Company will give the Executive not less than fourteen days' notice prior to any such termination and such notice shall not be given until any and all Options previously awarded to Executive shall have become fully vested and exercisable. Section 4. Termination of Employment ------------------------------------ 4.1. Compensation Prior To Termination. During the year in which either (i) the Executive's employment is terminated during the Term of Employment for any reason, or (ii) the Executive resigns during the Term of Employment in accordance with Section 4.3(b) below, notwithstanding any other provision of this Agreement, the Company and the Executive hereby agree that the Executive shall have the right to receive base salary, annual bonuses, contributions to Retirement Plans and Non-Qualified Plans, gross-up payments made to cover tax liabilities (to the extent provided in such plans), and all other compensation, benefits and payments earned or paid with respect to the period prior to the date of termination of employment, all such payments or contributions to be made at the times provided for in such plans or in accordance with Company policy as in effect immediately prior to the Effective Date, except as expressly provided below. For purposes of this Section 4.1, the amount of the annual bonuses earned and the amount of the contributions to the Retirement Plans and Non-Qualified Plans earned (i) shall be at least equal to the amounts paid to, or contributed on behalf of, the Executive for the year immediately preceding the year in which the termination of the Executive's employment occurs which amounts shall be prorated based on the number of days in the year in which the termination of the Executive's employment occurs which have passed prior to the date of the termination of the Executive's employment, and (ii) shall be paid or contributed on behalf of the Executive not later than 10 days after the date of termination of employment. Nothing in this Section 4.1 shall in any way alter the Executive's right to receive all the payments and rights and benefits described in Sections 4.2 and 4.3(a). 4.2. (a) Termination other than for Cause. In the event Executive's employment is terminated by the Company during the Term of Employment for any reason other than Cause, the Company will pay Executive, as liquidated damages, a lump sum cash payment, payable within ten (10) days of his termination, equal to two and ninety-nine hundredths (2.99) times the sum of (i) Executive's current annual base salary in effect at the date of termination (including in base salary for this purpose any elective salary reductions made by the Executive and contributed by the Company on his behalf to the Company's Retirement Plan, any Non-Qualified Plan, or a plan meeting the requirements of Section 125 of the Code), plus (ii) the total cash bonus received by the Executive from the Company during the most recent full fiscal year of the Company pursuant to the Company's annual bonus plan(s), plus (iii) the maximum amount allowable under the Executive Perquisite Program during the most recent calendar year of the Company. (b) Participation in Benefit Plans. In the event of a termination described in Section 4.2(a) above, Executive, together with his dependents and beneficiaries, will become fully vested in and continue following his termination to participate fully in, at no additional cost to Executive, all life insurance plans, accident and health plans and other welfare plans, maintained or sponsored by the Company immediately prior to the termination, at the same level and subject -6- 7 to terms at least as favorable to Executive as in effect immediately prior to termination (or the full value thereof in cash) from the Company, until the earlier of (a) the Executive's eligibility for comparable benefit plans with another employer and (b) the third anniversary of termination. Executive will also become fully vested in the Retirement Plan, and all Non-Qualified Plans, and within thirty (30) days of Executive's termination of employment, Company shall pay to Executive the sum of (i) all benefits accrued under the Non-Qualified Plans and (ii) an amount equal to 2.99 times the average benefit accrued and/or Company contributions made to the Retirement Plan and the Non-Qualified Plans over the last three fiscal years. In addition, the Company shall provide Executive with out-placement service through a bona fide out-placement organization acceptable to Executive that, at a minimum, agrees to supply Executive with out-placement counseling, a private office and administrative support including telephone service until such time that Executive secures suitable employment, not to be limited by Section 1.13 hereof. 4.3. Resignation By Executive - Constructive Termination. ------------------------------------------------------------- (a) If Executive resigns during the Term of Employment in accordance with Section 4.3(b) below, his employment will be deemed to have been terminated by the Company for reasons other than Cause (and he will be deemed to have offered to continue to provide services to the Company), and, notwithstanding any provision herein to the contrary, he will be entitled to all the payments and rights and benefits described in Sections 4.1 and 4.2, at the time provided for therein. (b) Executive may resign in accordance with this Section 4.3 upon the occurrence of any of the following events (in each case, "Good Reason"): (i) any reduction of, or failure to pay, Executive's base annual salary or annual bonus in breach of Section 3.1 above; (ii) any failure by the Company to provide the benefits required by Section 3.2 above or to make any contribution to a rabbi trust which might be due in accordance with Section 3.3 above; (iii) assignment to Executive of any duties inconsistent in any respect with his position (including the office to which he reports, status, offices, and titles), authority, duties or responsibilities as contemplated by Section 2.1 above or any other action by the Company which results in a diminution of such position, authority, duties or responsibilities; (iv) as a result of the Change in Control and a change in circumstances thereafter significantly affecting Executive's position, including, without limitation, a change in scope of the business or other activities for which he was responsible immediately prior to the Change in Control, he has been rendered substantially unable to carry out, or has been substantially hindered in the performance of, any of the authority, duties or responsibilities contemplated by -7- 8 Section 2.1 above; (v) the failure of the Company after a Change in Control to comply with and satisfy Section 7.1 or 7.2 below; (vi) relocation by the Company of its principal executive offices, or any event that causes Executive to have his principal location of work changed, to any location outside the Area; (vii) any requirement by the Company that Executive travel away from his office in the course of his duties significantly more than the number of consecutive days or aggregate days in any calendar year than was required of him prior to the Change in Control; or (viii) without limiting the generality or effect of the foregoing any material breach of this Agreement by the Company or any successor thereto or transferee of substantially all of the assets thereof. For purposes of this Agreement, any good faith determination of "Good Reason" made by the Executive shall be presumptively correct. (c) If Executive resigns during the Term of Employment in accordance with Section 4.3(b) above, the Company shall have the right to request that the Executive agree to remain as an employee of the Company during a transition period of up to three months (the "Transition Period") and the Executive hereby agrees that, if requested by the Company, he will remain as an employee of the Company during the Transition Period. During the Transition Period, the Company will continue to pay the Executive the Executive's base salary, annual bonus and all other compensation and benefits on the same basis as such items were paid to the Executive prior to his resignation. 4.4. Resignation by Executive. If Executive resigns during the Term of Employment without Good Reason, the Executive shall have the right to receive base salary, annual bonuses, contributions to Retirement Plans and all other compensation and benefits earned during the calendar year of his resignation up to the date of his resignation. For purposes of this Section 4.4, the amount of the annual bonuses and the amount of the contributions to the Retirement Plan shall be at least equal to the amounts paid to, or contributed on behalf of, the Executive for the year immediately preceding the year in which the resignation of the Executive occurs which amounts shall be prorated based on the number of days in the year in which such resignation occurs which have passed prior to the date of such resignation. In addition all vested Non-Qualified Plan benefits shall be paid within thirty (30) days of resignation. 4.5. Termination for Cause. If Executive is dismissed by the Company for Cause, he will not be entitled to the payments or benefits provided under Section 4.2 hereof. 4.6. Dispute Resolution. All disputes between the parties to this Agreement -8- 9 concerning the matters set forth herein shall be resolved exclusively pursuant to the dispute resolution procedures of this Section 4.6. In furtherance thereof, Executive or the Company, as the case may be, shall initiate binding arbitration in Rhode Island before the American Arbitration Association ("AAA") and under its rules by serving a notice to arbitrate upon the other party hereto and AAA within 90 days of the occurrence of any dispute hereunder that is unable to be resolved by negotiation between the parties. The parties shall bear their respective costs in any such dispute resolution, except that with respect to any such action initiated by the Executive, provided the Executive initiates such action in good faith, the Company agrees (i) to pay the costs and expenses (including fees of counsel to the Executive) of any such arbitration or judicial proceeding, and (ii) to pay interest to Executive on any amounts found to be due to Executive hereunder during any period of time that such amounts are withheld pending arbitration and/or judicial proceedings. Such interest will be at the base or prime rate most recently announced by Rhode Island Hospital Trust National Bank (or its successor) prior to the commencement of the arbitration or litigation. The Company and Executive agree that any arbitration award shall be binding and may be enforced by any court of competent jurisdiction. 4.7. Death or Total Disability of the Executive. (a) If Executive dies or suffers a Total Disability during the Term of Employment, then this Agreement shall terminate and the Company, its successors and assigns shall be relieved and discharged of any and all obligations whatsoever to make further payment to Executive pursuant to the terms of this Agreement after the date of death or Total Disability of Executive, except as to base salary earned for services actually rendered and vacation pay accrued prior to the date of death or Total Disability of Executive. (b) If Executive dies or suffers a Total Disability following a termination of employment which entitled him to payments and benefits under this Section 4 but prior to receipt of all such payments and benefits, his beneficiary (as designated to the Company in writing) or, if none, his estate, will be entitled to receive all unpaid amounts and benefits due under this Agreement. 4.8. Enforcement of Rights. Termination of Executive's employment, whether or not giving rise to payments or benefits under this Section 4, will not in any way prevent Executive from enforcing rights to payments or benefits under Section 3 relating to periods during which he was employed. Section 5. Certain Additional Payments by the Company. (a) Anything in this Agreement to the contrary notwithstanding and except as set forth below, in the event it shall be determined that any payment or distribution by the Company to or for the benefit of the Executive (whether paid or payable or distributed or distributable pursuant to the terms of this Agreement or otherwise, but determined without regard to any additional payments required under this Section 5) (a "Payment") would be subject to the excise tax imposed by Section 4999 of the Code or any interest or penalties are incurred by the Executive with respect to such excise tax (such excise tax, together with any such interest and -9- 10 penalties, are hereinafter collectively referred to as the "Excise Tax"), then the Executive shall be entitled to receive an additional payment (a "Gross-Up Payment") in an amount such that after payment by the Executive of all taxes (including any interest or penalties imposed with respect to such taxes), including, without limitation, any income taxes (and any interest and penalties imposed with respect thereto) and Excise Tax imposed upon the Gross-Up Payment, the Executive retains an amount of the Gross-Up Payment equal to the Excise Tax imposed on the Payments. (b) Subject to the provisions of Section 5(c), all determinations required to be made under this Section 5, including whether and when a Gross-Up Payment is required and the amount of such Gross-Up Payment and the assumptions to be utilized in arriving at such determination, shall be made by Ernst & Young LLP or such other nationally recognized certified public accounting firm as may be designated by the Executive (the "Accounting Firm") which shall provide detailed supporting calculations both to the Company and the Executive within 15 business days of the receipt of notice from the Executive that there has been a Payment, or such earlier time as is requested by the Company. In the event that the Accounting Firm is serving as accountant or auditor for the individual, entity or group effecting the Change in Control, the Executive shall appoint another nationally recognized accounting firm to make the determinations required hereunder (which accounting firm shall then be referred to as the Accounting Firm hereunder). All fees and expenses of the Accounting Firm shall be borne solely by the Company. Any Gross-Up Payment, as determined pursuant to this Section 5, shall be paid by the Company to the Executive within five days of the receipt of the Accounting Firm's determination. Any determination by the Accounting Firm shall be binding upon the Company and the Executive. As a result of the uncertainty in the application of Section 280G and Section 4999 of the Code at the time of the initial determination by the Accounting Firm hereunder, it is possible that Gross-Up Payments which will not have been made by the Company should have been made ("Underpayment"), consistent with the calculations required to be made hereunder. In the event that the Company exhausts its remedies pursuant to Section 5(c) and the Executive thereafter is required to make a payment of any Excise Tax, the Accounting Firm shall determine the amount of the Underpayment that has occurred and any such Underpayment shall be promptly paid by the Company to or for the benefit of the Executive. (c) The Executive shall notify the Company in writing of any claim by the Internal Revenue Service that, if successful, would require the payment by the Company of the Gross-Up Payment. Such notification shall be given as soon as practicable but no later than ten business days after the Executive is informed in writing of such claim and shall apprise the Company of the nature of such claim and the date on which such claim is requested to be paid. The Executive shall not pay such claim prior to the expiration of the 30-day period following the date on which he gives such notice to the Company (or such shorter period ending on the date that any payment of taxes with respect to such claim is due). If the Company notifies the Executive in writing prior to the expiration of such period that it desires to contest such claim, the Executive shall: (i) give the Company any information reasonably requested by the Company relating to such claim, -10- 11 (ii) take such action in connection with contesting such claim as the Company shall reasonably request in writing from time to time, including, without limitation, accepting legal representation with respect to such claim by an attorney reasonably selected by the Company, (iii) cooperate with the Company in good faith in order effectively to contest such claim, and (iv) permit the Company to participate in any proceedings relating to such claim; provided, however, that the Company shall bear and pay directly all costs and expenses (including additional interest and penalties) incurred in connection with such contest and shall indemnify and hold the Executive harmless, on an after-tax basis, for any Excise Tax or income tax (including interest and penalties with respect thereto) imposed as a result of such representation and payment of costs and expenses. Without limitation on the foregoing provisions of this Section 5(c), the Company shall control all proceedings taken in connection with such contest and, at its sole option, may pursue or forgo any and all administrative appeals, proceedings, hearings and conferences with the taxing authority in respect of such claim and may, at its sole option, either direct the Executive to pay the tax claimed and sue for a refund or contest the claim in any permissible manner, and the Executive agrees to prosecute such contest to a determination before any administrative tribunal, in a court of initial jurisdiction and in one or more appellate courts, as the Company shall determine; provided, however, that if the Company directs the Executive to pay such claim and sue for a refund, the Company shall advance the amount of such payment to the Executive, on an interest-free basis and shall indemnify and hold the Executive harmless, on an after-tax basis, from any Excise Tax or income tax (including interest or penalties with respect thereto) imposed with respect to such advance or with respect to any imputed income with respect to such advance; and further provided that any extension of the statute of limitations relating to payment of taxes for the taxable year of the Executive with respect to which such contested amount is claimed to be due is limited solely to such contested amount. Furthermore, the Company's control of the contest shall be limited to issues with respect to which a Gross-Up Payment would be payable hereunder and the Executive shall be entitled to settle or contest, as the case may be, any other issue raised by the Internal Revenue Service or any other taxing authority. (d) If, after the receipt by the Executive of an amount advanced by the Company pursuant to Section 5(c), the Executive becomes entitled to receive any refund with respect to such claim, the Executive shall (subject to the Company's complying with the requirements of Section 5(c)) promptly pay to the Company the amount of such refund (together with any interest paid or credited thereon after taxes applicable thereto). If, after the receipt by the Executive of an amount advanced by the Company pursuant to Section 5(c), a determination is made that the Executive shall not be entitled to any refund with respect to such claim and the Company does not notify the Executive in writing of its intent to contest such denial of refund prior to the expiration of 30 days after such determinative then such advance shall be forgiven and shall not -11- 12 be required to be repaid and the amount of such advance shall offset, to the extent thereof, the amount of Gross-Up Payment required to be paid. Section 6. Payment of Fees, Costs and Expenses. ------------------------------------------------ It is the intent of the Company that the Executive not be required to incur the expenses associated with the enforcement of his rights under this Agreement by litigation or other legal action or arbitration proceeding because the cost and expense thereof would substantially detract from the benefits intended to be extended to the Executive hereunder. Accordingly, if Executive determines in good faith that the Company has failed to comply with any of its obligations under this Agreement or if the Company or any other person takes any action to declare this Agreement void or unenforceable, or institutes any litigation or arbitration proceeding designed to deny, or to recover from, the Executive the benefits intended to be provided to the Executive under Section 6 hereof, the Company will promptly, upon request of the Executive in the event of the likelihood of a Change in Control or upon a Change in Control, use its best efforts to secure an irrevocable standby letter of credit (the "Letter of Credit"), issued by Rhode Island Hospital Trust National Bank or another bank of comparable or greater size (the "Bank") for the benefit of the Executive providing that the fees and expenses of counsel selected from time to time by the Executive pursuant to this Section 6 or in proceedings contemplated by Section 4.6 shall be paid, or reimbursed to the Executive if paid by the Executive, on a regular, periodic basis upon presentation by the Executive to the Bank of a statement or statements prepared by such counsel in accordance with its customary practices. The Company shall pay all amounts and take all action necessary to maintain the Letter of Credit during the Term of Employment and for one (1) year thereafter and if, notwithstanding the Company's complete discharge of such obligations, such Letter of Credit shall be terminated or not renewed, the Company shall use its best efforts to obtain a replacement irrevocable letter of credit drawn upon a commercial bank selected by the Company and reasonably acceptable to the Executive, upon substantially the same terms and conditions as contained in the Letter of Credit, or any similar arrangement which, in any case, assures the Executive the benefits of this Agreement without incurring any cost or expense for enforcement against the Company or the defense thereof. Section 7. Merger or Acquisition. ---------------------------------- 7.1. Assumption of Obligations. If the Company is at any time before or after a Change in Control merged, consolidated or reorganized into or with any other corporation or other entity (whether or not the Company is the surviving entity), or if substantially all of the assets of the Company are transferred to another corporation or other entity, the entity arising from such merger, consolidation or reorganization, or the acquirer of such assets, shall (by agreement in form and substance satisfactory to Executive) expressly assume the obligations of Company under this Agreement. 7.2. Executive's Rights to Benefits. In the event of any merger, consolidation, reorganization or sale of assets described above, nothing contained in this Agreement will detract from or otherwise limit Executive's right to or privilege of participation in any stock option or purchase plan or restricted stock plan or any bonus, profit sharing, savings, pension, group -12- 13 insurance, hospitalization or other incentive or benefit plan or arrangement which may be or become applicable to executives of the corporation resulting from such merger or consolidation or the corporation, acquiring such assets of the Company. 7.3. References. In the event of any merger, consolidation, reorganization or transfer of assets described above, references to the Company in this Agreement shall, unless the context suggests otherwise, be deemed to include the entity resulting from such merger or consolidation or the acquirer of such assets of the Company. Section 8. Change in Control Following Certain Circumstances. ------------------------------------------------------------- Notwithstanding any provision herein to the contrary, should a Change in Control occur subsequent to Executive's death, Total Disability or retirement from the Company, the remainder of any benefits owed under the terms of any stock plans or other non-qualified deferred compensation plan, including interest, shall be paid in full on the date of the Change in Control. Section 9. Termination of this Agreement. ------------------------------------------ Either the Company or Executive may, by giving 60 days written notice to the other party, terminate this Agreement as of the third or any subsequent annual anniversary of the occurrence of a Change in Control. Section 10. Withholding of Taxes. ---------------------------------- All payments required to be made by the Company hereunder to Executive or his dependents, beneficiaries or estate will be subject to the withholding on such amounts relating to tax and/or other payroll deductions as may be required by law. Section 11. Amendment. ----------------------- No amendment, change or modification of this Agreement may be made except in a writing, signed by or on behalf of both parties. Section 12. Miscellaneous. --------------------------- 12.1. Binding Effect. The provisions of this Agreement shall be binding upon and shall inure to the benefit of Executive, his executors, administrators, legal representatives and assigns, and the Company and its successors and assigns. 12.2. Governing Law. The validity, interpretation and effect of this Agreement shall be governed by and construed in accordance with the laws of the State of Rhode Island. 12.3. Severability. The invalidity or enforceability of any provision of this Agreement shall not affect the validity of any other provision. -13- 14 12.4. No Set-Off. There shall be no right of setoff or counterclaim, in respect of any claim, debt or obligation, against any payments to Executive, his dependents, beneficiaries or estate provided for in this Agreement, and nothing in this Agreement shall relieve the Company of its obligations to Executive under any other agreement, plan, contract or arrangement. Subject to Section 12.6 hereof, no right, benefit or interest hereunder shall be subject to anticipation, alienation, sale, assignment, encumbrance, charge, pledge, hypothecation or set-off in respect of any claim, debt or obligation, or to execution, attachment, levy or similar process or assignment by operation of law. Any attempt, voluntary or involuntary, to effect any action specified in the immediately preceding sentence shall, to the full extent permitted by law, be null, void and of no effect. In no event shall the Executive be obligated to seek other employment or take any other action by way of mitigation of the amounts payable to the Executive under any of the provisions of this Agreement and, except as otherwise provided in Section 4.2(b) hereof, such amounts shall not be reduced whether or not the Executive obtains other employment. Notwithstanding anything to the contrary in this Agreement, Executive shall forfeit all future payments and benefits hereunder in the event that Executive is determined, pursuant to procedures established in Section 4.6 hereof, to have materially breached any written covenant or agreement between the Executive and the Company prohibiting the disclosure of confidential information pertaining to the Company or respecting competition or interference with the Company, provided that the Company shall have given the Executive at least thirty (30) days prior written notice of such breach and such breach shall not have been cured by the end of such notice period. 12.5. Remedies. The Company and Executive agree that, because of the unique nature of this Agreement, failure of either party to carry out or abide by the obligations under this Agreement could cause irreparable injury; accordingly, the parties agree that, in addition to any other remedies available to either party, any such failure by either party to perform or abide by this Agreement shall be subject to appropriate equitable remedies, including specific performance and injunctive relief. 12.6. Assignability. No right or interest to or in any payments shall be assignable by the Executive; provided, however, that this provision shall not preclude him from designating one or more beneficiaries to receive any amount that may be payable after his death and shall not preclude the legal representative of his estate from assigning any right hereunder to the person or persons entitled thereto under his will or, in the case of intestacy, to the person or persons entitled thereto under the laws of intestacy applicable to his estate. The term "beneficiaries" as used in this Agreement shall mean a beneficiary or beneficiaries so designated to receive any such amount, or if no beneficiary has been so designated, the legal representative of the Executive's estate. 12.7. Counterparts; Headings; References. This Change in Control Agreement may be executed in two or more counterparts, each of which shall be deemed an original, but all of which together shall constitute one and the same instrument. The headings of the sections of this Agreement are inserted for convenience only and shall not constitute a part hereof. References to the masculine or feminine gender (or to the singular or plural number) herein shall mean the other such gender (or number), as appropriate. -14- 15 12.8. Entire Agreement. This instrument contains the entire agreement of the parties pertaining to the subject matter contained herein and supersedes and is in lieu of any and all other arrangements pertaining to the subject matter contained herein having effect as of the effective date. Nothing herein shall be deemed to modify any existing obligations Executive may have with respect to confidentiality, non-competition and similar obligations. 12.9. Notices. All notices given hereunder shall be in writing and shall be delivered personally or sent by prepaid registered or certified mail, return receipt requested, addressed as follows or to such other address as may be provided by any party hereto to the other party: If to the Company: GTECH Holdings Corporation 55 Technology Way West Greenwich, RI 02817 Attention: If to the Executive: All notices shall be deemed to be given on the date received at the address of the addressee, or if delivered personally, on the date delivered. IN WITNESS WHEREOF, the Company and Executive have each caused this Agreement to be duly executed and delivered as of the date set forth above. ATTEST: GTECH HOLDINGS CORPORATION _______________________________ By:_____________________________ Joseph A. Anesta Stephen Davidson Assistant Secretary Senior Vice President WITNESS: ______________________________ _____________________________ -15- 16 Michael Chambrello* July 15, 1997 Stephen A. Davidson July 15, 1997 Laurance Gay* July 15, 1997 Stephen P. Nowick January 15, 1999 Thomas J. Sauser July 15, 1997 Donald Stanford July 29, 1997 Donald Sweitzer October 13, 1998 Former officer of GTECH Holdings Corporation who was an Executive Officer for a portion of fiscal 1999. EX-21.1 6 SUBSIDIARIES OF THE COMPANY 1 Exhibit 21.1 GTECH HOLDINGS CORPORATION'S SOLE SUBSIDIARY: GTECH Corporation GTECH CORPORATION'S SUBSIDIARIES: Concorde Acquisition Corp. (Delaware) Dreamport, Inc. (Delaware) (formerly GTECH Gaming sub. 1) Dreamport do Brasil Ltda. Environmental Paper Products, Inc. (RI) Europrint Holdings Ltd. (UK) GameScape, Inc. (RI) Gaming Systems Corporation (Delaware) Gana de Mexico S.A. de C.V. GTECH GmbH (German) GRYTEK Co. Ltd. (Poland) GTECH Asia Corporation (Delaware) GTECH Australasia Corporation (Delaware) GTECH do Brasil Holdings Ltda. (Brazil) GTECH Canada Computer Systems Corporation (Canada) GTECH Child Care Center (Rhode Island) GTECH Computer Systems Sdn Bhd (Malaysia) GTECH Corporation (Delaware) GTECH Corporation (Utah) GTECH Czechoslovakia Corporation (Delaware) GTECH De Mexico S.A. de C.V. (Mexico) GTECH Eesti A.S. (Estonia) GTECH Espana Corporation (Delaware) GTECH Europe S.A. (Belgium) GTECH Far East Pte Ltd (Singapore) 2 GTECH Foreign Holdings Corporation (Delaware) GTECH Gaming Subsidiary 2 Corporation (Delaware) GTECH Ireland Corporation (Delaware) GTECH Italia Srl (Italy) GTECH Italy Corporation (Delaware) GTECH Latin America Corporation (Delaware) GTECH LIT Corporation (Lithuania) GTECH Lithuania Corporation (Delaware) GTECH Management P.I. Corporation (Delaware) GTECH Nevada Corporation (Delaware) GTECH Northern Europe Corporation (Delaware) GTECH Offshore Services Limited (Jersey, Channel Islands) GTECH Rhode Island Corporation (Rhode Island) GTECH South Africa Corporation (Delaware) GTECH Suffolk Corporation (Delaware) GTECH Sweden Corporation (Delaware) GTECH Taiwan Corporation (Delaware) GTECH Texas Corporation (Delaware) GTECH U.K. Limited (U.K.) GTECH U.K. Corporation (Delaware) GTECH Worldserv, Inc. (Delaware) GTECH Worldserv International, Inc. (Delaware) GTECH Worldwide Services Corporation (Delaware) Innovative Environmental Technologies, Inc. (Delaware) LAC Corporation (Rhode Island) Oy GTECH Finland Ab. (Finland) 3 SB Industria E Comercio Ltd. (Brazil) Technology Risk Management Services, Inc. Technology Travel Corporation (Delaware) Transactive Corporation (Delaware) (formerly GTECH Administrative Services Corp.) Via Video Corporation (Delaware) VideoSite, Inc. (Delaware) Watson Land Company (Rhode Island) EX-23.1 7 CONSENT OF ERNST & YOUNG, LLP 1 Exhibit 23.1 Consent of Independent Auditors We consent to the incorporation by reference in the Registration Statement (Form S-8 No. 333-64167) pertaining to the 1998 Employee Stock Purchase Plan, in the Registration Statement (Form S-8 No. 333-57781) pertaining to the 1997 Stock Option Plan and the 1998 Non-Employee Directors' Stock Election Plan, in the Registration Statement (Form S-8 No. 33-88426 and No. 333-27835) pertaining to the 1994 Stock Option Plan and in the Registration Statement (Form S-8 No. 333-27831) pertaining to the 1996 Non-Employee Directors' Stock Option Plan and the 1992 Outside Directors' Director Stock Unit Plan, of GTECH Holdings Corporation of our report dated March 29, 1999, with respect to the consolidated financial statements of GTECH Holdings Corporation included in the Annual Report (Form 10-K) for the fiscal year ended February 27, 1999. ERNST & YOUNG LLP Boston, Massachusetts May 11, 1999 EX-23.2 8 CONSENT OF PRICE WATERHOUSE 1 Exhibit 23.2 CONSENT OF INDEPENDENT AUDITORS We consent to the incorporation by reference in the Registration Statement (Form S-8 No. 333-64167) pertaining to the 1998 Employee Stock Purchase Plan and in the Registration Statement (From S-8 No. 333-57781) pertaining to the 1997 Stock Option Plan and the 1998 Non-Employee Directors' Stock Election Plan and in the Registration Statement (Form S-8 No. 33-88426 and No. 333-27835) pertaining to the 1994 Stock Option Plan and in the Registration Statement (Form No. 333-27831) pertaining to the 1996 Non-Employee Directors' Stock Option Plan and the 1992 Outside Directors' Director Stock Unit Plan, of GTECH Holdings Corporation of our report dated March 23, 1998, with respect to the financial statements of Camelot Group plc as of January 31, 1998, and February 1, 1997, and for the years ended January 31, 1998, and February 1, 1997, which is included in the Annual Report (Form 10-K) of GTECH Holdings Corporation for the fiscal year ended February 27, 1999. Price Waterhouse London, England May 10, 1999 EX-27.1 9 FINANCIAL DATA SCHEDULE
5 1,000 12-MOS FEB-27-1999 MAR-01-1998 FEB-27-1999 7,733 0 113,436 0 61,893 226,528 1,157,683 760,122 874,215 222,773 319,078 0 0 442 283,464 874,215 85,528 972,923 59,825 651,612 0 0 27,405 150,954 61,891 89,063 0 0 0 89,063 2.17 2.16
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