10-K 1 y48042e10-k.txt FORM 10-K 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 24, 2001 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. [ ] The aggregate market value of the registrant's Common Stock (its only voting stock) held by non-affiliates of the registrant as of April 10, 2001 was $863,287,810 (Reference is made to Page 35 herein for a statement of the assumptions upon which this calculation is based.) On April 10, 2001, there were 29,413,554 outstanding shares of the registrant's Common Stock. Documents Incorporated By Reference: Certain portions of the registrant's 2001 definitive proxy statement relating to its scheduled July 2001 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 26 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 57 of the 104 international online lottery authorities. 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. However, in recent years the Company has witnessed a downward trend in sales generated by certain of its United States lottery customers. 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 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 2001 (which ended on February 24, 2001) approximately 93% of the Company's lottery revenues were derived from online lottery service contracts. 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 currently is offered by 16 of the Company's customers. The Company currently provides instant ticket support services, products and systems in 24 domestic 3 jurisdictions and 22 jurisdictions outside of the United States. The Company also offers 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. See "Certain Products and Services" below. In recent years, 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, since the start of fiscal 2000, the Company has entered into agreements which permit bill payments over its Brazilian and Chilean lottery networks. In addition, the Company continues to develop and, where permitted, to market, its UWin!(TM) internet based platform through which international providers of government-sponsored lottery products and services may offer interactive games. During fiscal 2001, the Company announced that Dreamport, Inc., the Company's gaming and entertainment subsidiary, would henceforth focus on assisting lotteries to expand their offerings in the area of video-machine gaming and central systems and that activities and assets of Dreamport which were peripheral to the Company's core lottery business would be consolidated and/or divested. See "Certain Significant Developments Since the Start of Fiscal 2001" and "Certain Products and Services" below. GTECH was founded in 1980. Holdings acquired GTECH in a leveraged buy-out in February 1990, in which members of then-senior management of GTECH participated. 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. 2 4 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 engaged 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, and (iv) 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 subsequent press releases and Form 10Qs, and other reports and filings with the Securities and Exchange Commission. 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. 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. 3 5 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 have 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. Further, there have been and may continue to be investigations of various types, including grand jury investigations, conducted by governmental authorities into possible improprieties and wrong-doing in connection with efforts to obtain and/or the awarding of lottery contracts and related matters. In light of the fact that such investigations frequently are conducted in secret, the Company would not necessarily know of the existence of an investigation which might involve 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, 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 also Item 3 - "Legal Proceedings" below. 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. 4 6 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 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 0.25%, 0.21%, 0.35%, 0.56% and 0.47% of annual revenues in each of the five fiscal years ending February 1997 through 2001, respectively. 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. 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 during fiscal 1999 to endorse a non-binding recommendation for a moratorium on the spread of casinos, lotteries and slot machines in the United States. In addition, during fiscal 2000, the voters of Alabama defeated a referendum to authorize the introduction of state lottery in Alabama. Moreover, online lottery sales in a number of US jurisdictions have leveled off or have declined in recent years, a phenomenon which may reflect, in part, opposition to gaming. 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. Such increased competition also may have an adverse effect on the profitability of contracts which the Company does obtain. Through fiscal 2003 (which ends in February 2003), several of 5 7 the Company's larger contracts (including the National Lottery of Brazil and Texas, its two largest in fiscal 2001) are expected to be the subject of competitive procurement procedures to select contractors to supply lottery goods and services upon the termination of the Company's current contracts. See "Certain Significant Developments Since the Start of Fiscal 2001 - Other New Online Contracts and Extensions," "Facilities Management Contracts" and "Competition" below. See also Item 7, "Management's Discussion and Analysis of Financial Condition and Results of Operations" below. ATTRACTING AND RETAINING EMPLOYEES As is the case with all technology companies, the Company's business prospects and future success depend upon its ability to attract and to retain qualified managerial, marketing and technical employees. Competition for such employees is sometimes intense, especially during times of general economic prosperity. If the Company is unable to continue to attract and retain the technical and managerial personnel it requires, its business, financial condition and operating results could be adversely affected. 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 employs a variety of strategies in its effort to manage 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 2001 LOTTERY CONTRACT AWARDS AND RELATED SIGNIFICANT DEVELOPMENTS Since the start of fiscal 2001 (which ended on February 24, 2001), the Company has received a number of service contract awards and extensions from lottery authorities. NEW ONLINE CUSTOMERS. During fiscal 2001, the Company received awards to install online systems from six new online customers. In April 2000, the Company announced that it had been selected after a competitive procurement as the preferred supplier to provide new online lottery equipment to Santa Casa da Misericordia ("SCML"), the operator of the National Lottery of Portugal. Under the terms of the product sale agreement entered into with SCML in October 2000, GTECH agreed to replace SCML's offline system with a full turn-key online lottery system. For a period of eight years, the Company also agreed to provide ongoing services to SCML, including central system maintenance, terminal maintenance and repairs, software and operations support, and field services. Online sales with respect to the SCML lottery are expected to begin in June 2001. In June 2000, the Company entered into an agreement with the Virginia lottery authority to provide 4,000 ISYS(TM) terminals offering advanced marketing capabilities and implementation, software customisation and warranty maintenance services. The Virginia lottery 6 8 authority has the option to purchase additional terminals and other products under its three-year contract with the Company. In August 2000, the Company entered into a facilities management agreement to provide online lottery equipment and services to the Ukranian National Lottery through 2010, subject to the Lottery's option to discontinue certain services if a five-year revenue forecast is not achieved. The Company has agreed to convert the Ukranian National Lottery's existing online lottery system, expand the Lottery's existing terminal base from approximately 1,000 terminals to approximately 5,000 Tiffany(TM) terminals, provide a variety of installation, maintenance and marketing services, and install and maintain a secure, nationwide communications network. Sales of online lottery tickets on the Ukranian National Lottery system commenced in April 2001. In September 2000, the Company announced that it had signed a new product sale agreement to provide a turn-key online lottery system, including central system hardware and software, and 1,500 Altura(TM) terminals to CMC Prospects Import and Export Company, a China-based corporation, which in turn will supply the Company's equipment to the Beijing Welfare Lottery Center. In addition, the Company entered into agreements to provide a variety of lottery services to the Beijing lottery authority. Sales of online lottery tickets commenced on the Beijing lottery authority's system in March 2001, after the close of fiscal 2001. In January 2001, the Company entered into an agreement with Supreme Ventures Limited ("Supreme Ventures") under which it is the exclusive provider of a fully integrated and secure online lottery system and supporting services to Supreme Venture, the holder of a ten-year license issued by the Jamaica Betting, Gaming & Lotteries Commission to operate certain on-line lottery games in Jamaica. Lottery sales on Supreme Venture's new Company-provided system are expected to commence in June 2001, after the close of fiscal 2001. In addition to these awards, in May 2000, the Company announced that it had entered into an eight-year facilities management contract to provide a fully integrated and secure online lottery system for the Ivory Coast National Lottery. Implementation of the Ivory Coast National Lottery project has been suspended indefinitely, however, pending the resolution of political uncertainties in the Ivory Coast. OTHER NEW ONLINE CONTRACTS AND EXTENSIONS. Since the start of fiscal 2001, the Company also has been awarded online contracts by, or has received contract extensions from, a number of its existing customers. In June 2000, the Company announced that it had been selected by the Ohio lottery authority, following a competitive procurement, to enter into a new long-term facilities management contract to supply an integrated online and instant ticket lottery system (including new central system hardware, software, and terminals and a wide variety of services). The lottery system which is to be installed under the Company's new agreement with the Ohio lottery authority is expected to be operational in June 2001. In September 2000, the Company announced that following a competitive procurement it had been awarded a contract to supply an instant ticket lottery system, and related products and services, to the Nebraska lottery authority. In December 2000, the Company announced that Camelot Group plc ("Camelot") had been selected as the preferred applicant for the next operating license for the United Kingdom's National Lottery by the National Lottery Commission (the "NLC"). Since July 1994, the United Kingdom National Lottery has been operated under a license held by Camelot and the Company has been a supplier of lottery goods and services to Camelot for the National Lottery. Camelot was selected by the NLC as the preferred applicant for the next operating license following a competitive procurement process. As part of Camelot's proposal for the new 7 9 procurement process. As part of Camelot's proposal for the new license, the Company entered into technology transfer and training arrangements with Camelot to, among other things, transfer to Camelot the Company's National Lottery equipment, facilities and U.K. technology employees (in a transaction which was subsequently completed in February 2001), complete a technology transfer to Camelot, and grant to Camelot exclusive rights to operate the Company's gaming system software in the U.K. for the term of the new license, in consideration for receiving certain license fees payable by Camelot over the term of the new license. In February 2001, the Company entered into an agreement to supply Camelot with more than 26,000 new ISYS(TM) terminals prior to the commencement of Camelot's second operating license in January 2002. The Company is also obligated to assist Camelot in converting the National Lottery's current online gaming and instant ticket systems to the Company's AlphaGols(TM) system during the term of the second operating license. See Item 3-"Legal Proceedings" and Note F to "Notes to Consolidated Financial Statements" below. In March 2000, the Company announced that it had signed a new agreement to provide online lottery equipment, software and services to the Western Australia Lotteries Commission. In connection with this product sale of central system hardware, network communication equipment, and software the Company entered into an agreement to provide software license and software support to the Western Australia Lotteries Commission for a term of at least five years. In July 2000, the Company announced that it had been selected, following a competitive procurement, as the preferred supplier to provide lottery equipment to Sistemas Tecnicos de Loterios del Estado ("STL"), provider of the online system for the Spanish National Lottery. Under the terms of the product sale agreement the STL, the Company will provide STL with Altura(TM) terminals and AccuTherm(TM) printers, and a variety of services, including software development, technology transfer and training. In February 2001, after the close of fiscal 2001, the Company announced that Totalizator Sportowy Sp. Zo.o., a government-sponsored lottery authority in Poland ("TS"), had selected the Company after a competitive procurement as the preferred applicant for award of a ten-year operating license for Poland's National Lottery, such term to take effect upon the expiration of the Company's current facilities management contract with TS in October 2001. However, recently it has been reported in the Polish press that the contract may be rebid. Since the commencement of fiscal 2001, the lottery authorities of Barbados (T.L Lotteries Ltd.), New Jersey and Missouri have extended the terms of their online contracts with the Company. In addition, SAZKA, the Czech lottery authority, entered into an agreement with the Company to extend the Company's online contract as part of the resolution of certain matters which were the subject of an arbitration between the parties. See Item 3, "Legal Proceedings" and Note F to "Notes to Consolidated Financial Statements," below. During fiscal 2001, the Company also reported that the Iowa lottery authority, currently a customer of the Company, had selected another vendor to provide equipment and services for a new online and instant ticket lottery system following expiration of the Company's current contract in June 2001. 8 10 NON-LOTTERY PRODUCTS AND SERVICES Since the commencement of fiscal 2001, the Company has made several announcements respecting its non-lottery products and services. During fiscal 2001, the Company continued to make progress in its efforts to broaden its offerings of high-volume transaction processing services outside its core online lottery application. In June 2000, the Company signed a new contract with Caixa Economica Federal, operator of Brazil's National Lottery, to include additional financial transaction services (including bill and tax payment, social security contribution, credit card, and traditional banking transaction services) over the Company's dedicated network infrastructure. Under the terms of the agreement, the Company will install 7,300 terminals of which 4,800 will process financial transactions exclusively, with the remaining 2,500 processing financial and lottery transactions. In December 2000, the Company signed agreements with more than 500 of its lottery retailers in Chile to provide electronic bill payment services at lottery retailer outlets throughout Chile. In May 2000, the Company announced that it had been selected by the Texas Department of Human Services to provide call center support services for the state's electronic benefit transfer system. In August 2000, in connection with the Company's value assessment described below, the Company announced that Dreamport, Inc. ("Dreamport"), the Company's gaming and entertainment subsidiary, would henceforth focus on assisting lotteries to expand their offerings in the area of video-machine gaming and central systems. Activities and assets of Dreamport which were peripheral to the Company's core lottery business, such as casino and slot operations, would be consolidated and/or divested and Dreamport's operations would be relocated from Florida to Rhode Island. In March 2001, after the close of fiscal 2001, the Company reported that it had sold its 50% interest in three limited liability companies which were pursuing non-lottery gaming opportunities in Michigan, Oregon and California, respectively, to Full House Resorts, Inc., the owner of the remaining 50% interest in these companies, for a cash purchase price of $1,800,000. VALUE ASSESSMENT In July 2000, the Company announced that it would conduct, and in February 2001 the Company announced that it had completed, a comprehensive value assessment of its operations. In the wake of this value assessment, the Company undertook a number of measures to strengthen its focus on its business strategy. Such measures included the strategic and operational decisions respecting Dreamport, described above, as well as the decision by the Company to reduce its workforce by approximately 255 employees. The Company recorded special charges of $42.3 million in fiscal 2001 in connection with this value assessment. See "Note P of Notes to Consolidated Financial Statements" included in this report. MANAGEMENT DEVELOPMENTS Since the start of fiscal 2001, there have been a number of significant managerial developments. In May 2000, the Company appointed Kathleen McKeough as Senior Vice President of Human Resources. In July 2000, W. Bruce Turner was appointed as non-executive Chairman of the Company's Board of Directors following the resignations of William Y. O'Connor, the Company's Chairman of the Board of Directors and Chief Executive Officer, and Steven P. 9 11 Nowick, the Company's President and Chief Operating Officer. In September 2000, the Company appointed Robert Vincent as Vice President of Corporate Communications, and in February 2001, the Company appointed Antonio Carlos Rocha as Senior Vice President of Marketing. In March 2001, after the close of fiscal 2001, the Company announced the appointment of Howard S. Cohen as Chief Executive Officer, and Marc A. Crisafulli as Senior Vice President and General Counsel of the Company. 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 190 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 into 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, 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. 10 12 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 2000, total annual lottery ticket sales in the United States grew from approximately $147.5 million to approximately $38.4 billion, although the Company has witnessed, in recent years, a downward trend in sales generated by certain of 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 57.8% of total lottery ticket sales in 2000. There are currently 38 jurisdictions operating online lotteries in the United States. Implementation of lotteries in other jurisdictions, including in South Carolina (where in November 2000 voters approved an initiative to introduce an online lottery), 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, 104 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 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 and the South African National Lottery provide important exceptions 11 13 to the general rule in that in each case a licensee operates all aspects of the respective 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 also "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. 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. 12 14 Under a number of the Company's lottery contracts, in addition to providing, operating and maintaining the online lottery system in these jurisdictions, the company 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. Unless otherwise indicated, the table below sets forth the lottery authorities with which the Company had Facilities Management Contracts and fully installed, operational lottery systems as of March 30, 2001, and as to which the Company is the sole supplier of central computers and terminals and material services. The table also sets forth information regarding the term of each contract and, as of March 30, 2001, the approximate number of terminals installed in each jurisdiction. 13 15
APPROXIMATE CURRENT NUMBER OF LOTTERY DATE OF COMMENCEMENT DATE OF EXPIRATION OF EXTENSION JURISDICTION TERMINALS INSTALLED(1) OF CURRENT CONTRACT CURRENT CONTRACT TERM OPTIONS* ------------ ---------------------- ------------------- --------------------- -------- UNITED STATES: Arizona 2,500 9/99 9/04 2 one-year California (2) 20,310 10/93 10/03 -- Colorado 4,000 3/95 10/04 -- D.C. (3) 575 6/99 11/09 -- Georgia 6,930 4/93 9/03 -- Illinois 6,660 4/00 10/07 1 one-year Iowa (4) 1,485 4/91 6/01 1 two-year 1 three-year Kansas 1,830 7/97 6/02 1 two-year Kentucky 3,000 4/97 6/03 5 one-year Louisiana 2,775 6/97 6/05 5 one- year Maine (4) 970 4/89 6/01 -- Michigan 9,500 1/98 1/06 3 one-year Missouri 2,800 7/96 6/03 -- Nebraska 900 4/94 6/04 -- New Jersey 6,000 6/96 11/06 -- New Mexico 1,235 6/96 11/03 5 one-year New York 13,700 11/00 3/07 3 one-year Ohio 7,500 10/93 6/03 (5) 3 two-year Oregon 2,760 12/96 6/05 3 one-year Rhode Island 1,100 1/97 7/02 5 one-year Texas 17,050 3/92 8/02 -- Washington 3,640 9/95 6/04 -- Wisconsin 3,137 6/97 6/02 2 one-year INTERNATIONAL: Barbados 200 10/94 11/04 -- -T.L. Lotteries Brazil (6) -National Lottery (6) 22,000 1/97 1/03 -- -Minas Gerais 770 10/94 11/06 -- -Parana 720 9/99 9/03 one 1-year -Goias 120 7/97 7/01 one 1-year
14 16
APPROXIMATE CURRENT NUMBER OF LOTTERY DATE OF COMMENCEMENT DATE OF EXPIRATION OF EXTENSION JURISDICTION TERMINALS INSTALLED(1) OF CURRENT CONTRACT CURRENT CONTRACT TERM OPTIONS* ------------ ---------------------- ---------------- --------------------- -------- Chile -Polla Chilena de Beneficencia S.A. 1,650 12/93 8/02 -- Czech Republic -SAZKA 5,700 10/92 12/05 (7) -- Ireland (8) -An Post Nat'l Lottery Company 2,050 3/93 3/01 (8) Ivory Coast -Ivory Coast National Lottery (9) (9) (9) (9) Jamaica -Supreme Ventures Limited (10) 11/00 01/11 -- Lithuania (11) -OLIFEJA 800 12/94 12/09 (11) Morocco -La Societe de Gestion de la Loterie Nationale -La Marocaine des Jeux et Les Sports 800 8/99 8/08 -- Poland (12) -Totalizator Sportowy 6,400 3/91 10/01 (12) Puerto Rico -Loteria Electronica de Puerto Rico 1,860 3/99 3/05 1 three-year Slovak Republic - TIPOS a.s. 1,140 3/96 10/04 -- South Africa (13) -National Lottery 4,900 7/99 7/09 -- Spain -L'Entitat Autonoma de Jocs I Apostes de la Generalitat de Catalunya 2,510 10/97 10/03 1 six-month Trinidad & Tobago -National Lotteries Control Board 665 12/93 7/06 1 three
15 17
APPROXIMATE CURRENT NUMBER OF LOTTERY DATE OF COMMENCEMENT DATE OF EXPIRATION OF EXTENSION JURISDICTION TERMINALS INSTALLED(1) OF CURRENT CONTRACT CURRENT CONTRACT TERM OPTIONS* ------------ ---------------------- ------------------- --------------------- -------- United Kingdom -The National Lottery (14) 24,865 7/94 9/01 -- Ukraine -Ukrainian National Lottery (15) 8/00 (15) --
* 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) 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. (3) Operated by Lottery Technology Enterprises, a joint venture in which the Company has a 1% interest, and to which the Company supplies lottery goods and services. (4) During fiscal 2001, the Iowa Lottery authority, and during fiscal 2000, the Maine lottery authority, selected another vendor to provide lottery goods and services, respectively, at the expiration of the Company's current contract term. (5) During fiscal 2001, the Company entered into a new facilities management agreement to install a system which is expected to be operational in June 2001. (6) Operated by GTECH Brasil Holdings, S.A., a Brazilian company in which the Company owns all voting stock. During fiscal 2001, CAIXA, the lottery authority operating the Brazilian National Lottery, commenced a competitive procurement process to determine the provider of lottery goods and services upon the termination of the Company's contract in January 2003. The terms of this competitive procurement provide for more than one vendor to supply the lottery goods and services which are provided exclusively by the Company under the present contract. (7) In March 2001, the Company and SAZKA resolved certain business and contractual issues that had been the subject of an arbitration by, among other things, agreeing to extend the current contract through December 2005. (8) The contracts with the Ireland licensee may either be extended for any period mutually acceptable to the Company and the lottery authority or continue indefinitely until termination by the licensee. (9) In May 2000, the Company entered into an eight-year facilities management contract to provide an integrated lottery system to the Ivory Coast National Lottery. Implementation of this project has been suspended for the indefinite future pending resolution of political uncertainties in the Ivory Coast. (10) Lottery sales are scheduled to commence in June 2001. The Company plans to have installed 700 terminals by the end of fiscal second quarter of 2002. (11) The Company's contract with the Lithuania lottery authority automatically extends from year-to-year unless either party gives timely notice of non-renewal. (12) In February 2001, after the close of fiscal 2001, the Company announced that the Poland Lottery authority had selected the Company after a competitive procurement as the preferred applicant for award of a ten-year operating license upon expiration of the Company's current facilities management contract in October 2001. Subsequent to this, the Company has received indications that it is possible that requisite governmental approvals will not be granted with respect to this contract. (13) Operated by Uthingo consortium, in which GTECH is a 10 percent equity owner. (14) Operated by Camelot Group plc, a consortium, on a facilities management basis. During fiscal 2001, Camelot was granted an interim license to operate the National Lottery through January 2002, and a second running license commencing upon the expiration of its current license to operate the National Lottery through January 2009. During fiscal 2001, the Company and Camelot entered into agreements under which the Company agrees to provide to Camelot technology transfer and training, software licensing and lottery terminals with respect to Camelot's second running license. See "Certain Significant Developments Since the Start of Fiscal 2001." (15) Operated by the Company under an agreement entered into in August 2000 which expires December 2010, subject to earlier termination by the Ukrainian National Lottery if, among other things, certain revenue targets are not achieved. The lottery commenced on-line lottery sales in April 2001 with an initial installation of 1800 terminals. 16 18 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 March 30, 2001. 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 30, 2001, the approximate number of terminals installed in each jurisdiction. OPERATING CONTRACTS
APPROXIMATE NUMBER OF LOTTERY DATE OF EXPIRATION CURRENT TERMINALS DATE OF COMMENCEMENT OF CURRENT EXTENSION JURISDICTION INSTALLED(1) OF CURRENT CONTRACT CONTRACT TERM OPTIONS* ------------ ------------ ------------------- ------------- -------- UNITED STATES: Idaho 975 2/99 2/03 4 one-year INTERNATIONAL: Argentina -Loteria National 790 11/93 4/03 -- Sociedad del Estado Turkey -Turkish National Lottery 4,000 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. (1) Total does not include instant ticket validation terminals. (2) The term of the contract with the Turkey lottery authority automatically renews 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. 17 19 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 since March 1, 1998 have purchased (or have agreed to purchase) from the Company new online lottery systems, software and/or lottery terminals and equipment in connection with the expansion of existing lottery systems. Argentina --National Lottery of Argentina Australia --Lotteries Commission of New South Wales Australia --Lotteries Commission of South Australia Australia --Western Australia Lotteries Commission Belgium --Loterie Nationale de Belgique China --Beijing Welfare Lottery Center Denmark --Dansk Tipstjanst France --La Francaise des Jeux Israel --Mifal Hapayis Italy --Teseo S.r.l Massachusetts --Massachusetts State Lottery Commission Netherlands --Stichting de Nationale Sport Totalisator Portugal --Santa Casa de Misericordia de Lisboa Singapore --Singapore Pools (Pte) Ltd. South Africa --Uthingo Spain --Sistemas Tecnicos de Loterias del Estado Sweden --AB Svenska Spel Switzerland --Loterie de la Suisse Romande
18 20 United Kingdom --The National Lottery Virginia --Virginia 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 or extended contract term, a lottery authority in the United States generally may either seek to 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. 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. 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 19 21 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 basic functions of the Company's systems, which are 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 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. The Company's 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. The Company's Spectra(R) terminal series (GT-401/0M, 402/0M and 403/OM), first introduced in 1989, is distinguished by its modular internal and external architecture. The Company's ISYS terminal series, (GT-501, 502 and 503), 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. 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, such as grocery stores, with numerous checkout lanes. The Company has subsequently entered into agreements with the Nebraska, Ohio, Washington, California, New Jersey, New York, Rhode Island, Israel, Ireland, , Loto-Quebec, The Netherlands and New Zealand lottery authorities to supply PlayerExpress(TM) terminals. During fiscal 1999, the Company also announced the launch of its Altura(TM) family of terminals. See "Certain Products and Services" below. SOFTWARE The Company designs and provides all applications solutions 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 20 22 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, ProSys(R), 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 "Certain Products and Services" 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, Estonia, Jamaica, Lithuania, Mexico, Morocco, New Mexico, Poland, Puerto Rico, Slovakia, South Africa, Trinidad and Tobago, and Ukraine, 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 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, Nebraska, New Mexico, Texas and Washington, and internationally in Argentina, the Czech Republic, Brazil, Chile, Israel, South Africa 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. GAMES 21 23 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 (which is 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), SplitLevel(TM) and DoubleChance(TM)). 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, Georgia, Illinois, Louisiana, Massachusetts, Missouri, New Jersey, New York, Ohio, Rhode Island, Texas and Washington currently utilize GMark systems, and many customers contact the Market Research Group at GameScape(TM) from time to time to obtain GMark services. 22 24 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 fiscal years 2001, 2000 and 1999 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. CERTAIN PRODUCTS AND SERVICES ONLINE LOTTERY Lottery authorities for years 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 also launched in recent years its Altura(TM) series terminals, Players Express(TM) terminal and ProSys(R) 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. The Company introduced in April 1990 the first online keno game for the Lotteries Commission of South Australia and currently assists lottery authorities in Australia (Lotteries Commission of South Australia), Brazil (Parana, Minas Gerais, and Goias), California, Georgia, Kansas, 23 25 Lithuania, Massachusetts, New York, Oregon, Rhode Island, Catalunya (Spain), Switzerland (La Societe de la Loterie de la Suisse Romande), Trinidad and Tobago, and West Virginia in implementing and operating 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 $1.9 billion and accounting for more than 8.7% of total United States online lottery revenues in calendar year 2000. 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, 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. In August 1999, the New York legislature extended the legislation authorizing the game through March 2001 and sales of Quick Draw resumed. The New York legislature subsequently extended authorization for Quick-Draw through June 2001. It is uncertain at present whether Quick-Draw will be authorized in New York beyond June 2001. 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 24 26 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 or has contracted to provide 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, Kansas, Kentucky, Louisiana, Massachusetts, Michigan, Missouri, Nebraska, New Jersey, New Mexico, New York, Ohio, Oregon, Rhode Island, Texas, Washington and Wisconsin. Internationally, the Company currently supplies lottery authorities in Australia, Belgium, Brazil, Chile, Denmark, Finland, Ireland, Israel, Mexico, Morocco, Netherlands, New Zealand, Portugal, The Slovak Republic, South Africa, 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, The Slovak Republic, 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 Lithuania; and is actively marketing these and other games to other lottery authorities. THE PROSYS(R) SOFTWARE SYSTEM. ProSys(R) is the Company's latest software system. Employing a user friendly interface, lotteries can use ProSys(R) 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. ProSys(R) was first installed in September 1994 for Societe de la Loterie de la Suisse Romande, Switzerland. Since that time, the Company has installed ProSys(R) in systems used by the lottery authorities of Arizona, Washington, D.C.; Colorado; Idaho; Ontario, Canada; Leipzig, Germany; Washington State; Missouri; Denmark; New Mexico; Massachusetts; New Jersey; Thuringen, Germany; Kansas; Kentucky; Ohio; Oregon; Rhode Island; Wisconsin; New Zealand; Belgium; Sweden; Switzerland; Michigan; Texas; Mexico; Netherlands; Israel; South Africa; South Australia; New South Wales, Western Australia and Illinois and is in the process of installing ProSys(R) in three 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 25 27 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 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. Since its acquisition by the Company, VideoSite has been 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. During fiscal 2000, VideoSite launched NextVision(TM), which brings new lottery-animation, high quality graphics and full-motion video to monitor games and began selling advertising over Rhode Island's keno network. 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. 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. 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. During fiscal 2001, the Company announced that Dreamport would focus upon assisting lotteries to expand their offerings in the area of video machine gaming systems and would consolidate 26 28 and/or divest gaming activities and assets which were peripheral to the Company's core lottery business. See "Certain Significant Developments Since the Start of Fiscal 2001." UWIN! During fiscal 1999, the Company established UWin!(TM) to provide Internet-based interactive games to international providers of government-sponsored lottery products and services. The Company continues to actively market its UWin!(TM) offering, where permitted, to international lottery authorities. PRODUCT DEVELOPMENT The Company devotes substantial resources in order to enhance its present products and systems and develop new products. In fiscal 2001, the Company spent approximately $49.3 million on research and development, as compared to $46.1 million in fiscal 2000 and $40.2 million in fiscal 1999. 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 believed by the Company to be firm amounted to approximately $199.9 million as of February 24, 2001, as compared to a backlog of approximately $101.8 million as of February 26, 2000. Approximately $30.2 million, or 15.1% of the backlog at February 24, 2001, is not expected to be filled during fiscal 2002. 27 29 COMPETITION The online lottery business is highly competitive in the United States and internationally. Both in the United States and internationally, price is an increasingly 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, 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 2001, 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) were as follows: Automated Wagering International, Inc. ("AWI"), a subsidiary of Anchor Gaming (by virtue of its merger, described below, with Powerhouse Technologies, Inc., the prior corporate parent of AWI) (14); Autotote Corporation ("Autotote") (18); International Totalizator Systems, Inc. (5); and Essnet/Alcatel (15). During fiscal 2000, Anchor Gaming, an operator and developer of gaming machines and casinos, and Powerhouse Technologies, Inc., merged. 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. In addition, during fiscal 2001, Scientific Games Holdings Corporation, a leading provider of instant ticket lottery technology as well as of online lottery systems and services, was acquired by Autotote, and the lottery divisions of these two companies were integrated. This merger provides the combined entity with a broader range of product offerings than the entities had previously offered individually. PERSONNEL As of April 2, 2001, the Company had approximately 4,650 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 research and development and main production facility are located in its approximately 260,000 square foot building 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 the Company has an option to purchase the property. The Company owns approximately 24 acres adjoining its headquarters in West Greenwich, Rhode Island. 28 30 The Company also owns an approximately 140,000 square foot manufacturing and central storage facility in Coventry, Rhode Island. In addition, the Company leases approximately 22,650 square feet of an office building in Warwick, Rhode Island which it uses to house its finance and external training departments. 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 Corporation, the Company's benefits delivery subsidiary, 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 a number of other locations. The Company's facilities are in good condition and are adequate for its present needs. ITEM 3. LEGAL PROCEEDINGS As publicly reported, 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 the 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 pounds 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 "Irish NLC"), issued a Request for Proposals respecting online and instant ticket lottery goods and services, and in September 1992 the Company, which was then the incumbent provider of lottery goods and services to the Irish NLC under an agreement awarded to the Company in 1987, submitted a Proposal to the Irish NLC in response to the Irish NLC's Request for Proposals. In November 1992, the Irish NLC selected the Company to provide online and instant ticket goods and services to the Irish NLC under the terms of the competitive procurement and, following negotiations, a definitive agreement was entered into between the Irish NLC and the Company in March 1993. In calendar 1999, the Tribunal requested that the Company provide various documents regarding the Company's business in Ireland, which the Company has done, and the Company has been 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 Irish NLC. Mr. Snowden has advised the Company through his 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 Irish NLC and was not intended to and did not influence the Irish NLC's decision to renew the Company's contract. 29 31 No charges of wrongdoing have been brought against the Company in connection with the Moriarty investigation, and the Company does not believe that it has engaged in any wrongdoing in connection with this matter. However, since this investigation is or may still be underway and, investigations of this type customarily are conducted in whole or in part in secret, the Company lacks sufficient information to determine with certainty its ultimate scope and whether the government authorities will assert claims resulting from this investigation 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 a government authority were to make an allegation, or if there were to be a finding, of improper conduct on the part of or attributable to the Company in any matter, including in respect of the Moriarty investigation, 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 this investigation and related matters could have such a material adverse effect. Since July 1994, the United Kingdom National Lottery has been operated under a license held by Camelot Group plc ("Camelot"), and the Company has been a supplier of lottery goods and services to Camelot for the lottery. As publicly reported, in or around April or May 2000, the United Kingdom National Lottery Commission (the "NLC"), the regulator of the United Kingdom National Lottery, commenced an investigation into a lottery terminal software malfunction in the United Kingdom in which, under certain rare circumstances, a duplicate transaction was recorded on the Company's central system while only one ticket was presented to the retailer. The software malfunction resulted in a relatively small amount of overcharges to lottery retailers with respect to the duplicate transactions and a relatively small amount of overpayments or underpayments to certain prizewinners. The Company first identified this software malfunction in the United Kingdom in June 1998 and corrected the malfunction in July 1998, but without notifying Camelot or the NLC, as it should have done. The Company fully cooperated with the NLC's investigation and undertook to implement a number of measures respecting its corporate compliance and governance functions and software development processes in the wake of the investigation. The Company has also agreed to reimburse United Kingdom lottery players and retailers for any financial losses incurred by virtue of the software malfunction. As has also been publicly reported, the developments described above took place in the context of a competitive procurement respecting the award by the NLC of a new license to operate the National Lottery with effect from October 1, 2001. In 1999, the NLC established a competitive procedure for the award of the new license, and two bidders, Camelot and The People's Lottery ("TPL"), subsequently submitted bids for the new license. Camelot's bid was supported by agreements with the Company pursuant to which the Company had contracted to continue to supply lottery goods and services to Camelot during the term of the new license in the event that Camelot was awarded the new license. In August 2000, the NLC announced that it had decided that the NLC would proceed on the basis of a new procedure under which it would negotiate exclusively with TPL for one month. 30 32 Promptly after the NLC's announcement, Camelot initiated legal proceedings in the United Kingdom challenging the legality of the NLC's decision to initiate a new procedure of negotiation with TPL to the exclusion of Camelot. In September 2000, the High Court of Justice (Queen's Bench Division) overturned the NLC's August 2000 decision to negotiate exclusively with TPL and directed that the NLC enter into an exclusive negotiation period with Camelot so as to afford Camelot the same opportunity granted to TPL to improve its bid to address the NLC's concerns. As part of the improved Camelot proposal for the new license, the Company entered into technology transfer and training arrangements with Camelot providing for the transfer to Camelot of the Company's National Lottery equipment, facilities and U.K. technology employees, a technology transfer to Camelot (after a period of training), and a grant to Camelot of exclusive rights to operate the Company's gaming system software in the U.K. for the term of the new license. Under these new arrangements, the Company will license its software and provide a range of support services to Camelot for which the Company expects to receive compensation during the term of the new license in the range of between $40 to $45 million per year commencing in fiscal year 2003. The Company also anticipates receiving revenues of approximately $65 million with respect to the sale to Camelot of new terminals prior to the commencement of the new license term. The Company further agreed to negotiate a technology transfer and a related software license for the exclusive use by Camelot under the new license of the internet gaming applications of the Company's UWin! subsidiary. In December 2000, the NLC announced its decision to award a new seven-year license to operate the National Lottery to Camelot and that it will grant Camelot an interim license to cover the period from October 1, 2001 through January 30, 2002 in order to provide a twelve-month conversion period prior to the beginning of the new license. TPL has not protested the NLC's decision to award the new license to Camelot and the period in which a protest must be made has since lapsed. In April 2001, the NLC issued a report of its investigation into the above described lottery software terminal malfunction. The NLC report states that its investigation of the lottery software incident had established breaches of Camelot's license, including in respect of the failure of the Company to give proper notification before rectifying the software fault. The report further states that Camelot has agreed to pay pounds sterling 115,000 (approximately $175,000) into the National Lottery prize fund as compensation for underpayments to players resulting from the software malfunction, and that Camelot has undertaken to identify the amounts by which individual retailers have been overcharged. The NLC has declined, however, to fine Camelot with respect to breaches of its license resulting from (or revealed by the NLC investigation of) the software incident. The NLC report summarizes the steps taken and to be undertaken by the Company in the wake of investigation of the lottery software malfunction (including the measures implemented by the Company with respect to its corporate compliance and governance functions and software development processes and the technology transfer arrangements, as described above) and concludes, in light of these steps, that the Company sufficiently addressed the NLC's ongoing concerns about whether it is a "fit and proper" body for purposes of involvement in the operation of the National Lottery. Payment by the Company of amounts: (i) to reimburse Camelot for payments with respect to underpayments to United Kingdom players and overcharges of retailers, 31 33 as described above, (ii) to reimburse Camelot with respect to any other out-of-pocket costs incurred by Camelot with respect to the lottery terminal software malfunction, and (iii) to reimburse other customers of the Company with respect to effects of the lottery terminal software malfunction outside the United Kingdom, which amounts have been accrued in the accompanying financial statements, are not expected to have a material adverse effect on the Company's consolidated financial position or results of operation. As publicly reported, in August 2000, a shareholder class action lawsuit on behalf of all persons who purchased Company stock during the period from April 11, 2000 to July 25, 2000, was brought against the Company, the Company's former Chairman and Chief Executive Officer, William Y. O'Connor, and the Company's current Chairman, W. Bruce Turner, in the U.S. District Court of Rhode Island relating to various Company announcements made between April 11, 2000 and July 25, 2000. The complaint filed in the case, Sandra Kafenbaum, individually and on behalf of all others similarly situated, v. GTECH Holdings Corporation, William Y. O'Connor and W. Bruce Turner, generally alleges that the defendants violated federal securities laws (including Section 10(b) of the Securities Exchange Act of 1934) by making allegedly false and misleading statements (including statements alleged to be overly optimistic respecting certain lottery contract awards to the Company and respecting the Company's prospects in certain non-lottery business lines and investments), while failing to disclose in a timely manner certain allegedly material adverse information that it purportedly had a duty to disclose (including an alleged inability to close certain contract awards and as to certain alleged cost overruns). The complaint seeks to recover monetary damages from the Company and the individual defendants. In February 2001, the plaintiffs filed an amended complaint which added Steven P. Nowick, the Company's former President and Chief Operating Officer, as an individual defendant. In addition, the amended complaint expands the purported class of plaintiffs to include all persons who purchased common stock of the Company during the period from July 13, 1998 through August 29, 2000. The type of relief sought in the amended complaint is similar to that sought in the original action. The Company believes that it has good defenses to the claims made in this lawsuit and intends to file a motion to dismiss the amended complaint as to all of the defendants. At the present time, however, the Company is unable to predict the outcome, or the financial statement impact, if any, of this lawsuit. As publicly reported, in May 2000, Sazka, a.s., a lottery customer of the Company in the Czech Republic ("Sazka"), filed a Request for Arbitration with the International Arbitral Centre of the Austrian Federal Economic Chamber of Commerce in Vienna, Austria, seeking to arbitrate certain business and contractual issues under the Company's online lottery contract with Sazka. Sazka sought damages valued at approximately $2.6 million in connection with alleged delays in the recent extensive expansion of the lottery sales network. Sazka also sought a determination that its online contract with the Company would expire approximately two years earlier than the date on which the Company maintained its contract would terminate. The Company, believing the claims made by Sazka to be without merit, filed a Memorandum in Reply and Counterclaim disputing such claims and raising counterclaims for breach of contract by Sazka. In March 2001, the Company entered into an agreement with Sazka which, among other things, resolved the arbitration. Under the agreed settlement, Sazka dropped its demand for liquidated damages, paid to the Company certain disputed amounts which it had previously withheld and agreed to extend the term of the contract. The Company in turn agreed to reduce its fee and to provide certain additional equipment and services under its contract with Sazka. 32 34 In February 1999, the Company was sued by a Florida corporation called EIG Gaming International, Inc. ("EIG"), in the Circuit Court of the Eleventh Judicial Circuit of Florida. The Company removed the case to the U.S. District Court for the Southern District of Florida, where it is captioned EIG Gaming International, Inc. v. GTECH Corporation, Case No. 99-1808-Civ-Jordan. In its complaint EIG alleges that it entered into a Letter of Intent with the Company pursuant to which it would assist the Company to obtain the lottery contract for Peru in return for a percentage of the lottery's receipts. EIG further contends that it secured the Peruvian contract for the Company but that the Company thereupon declined to pursue it. Plaintiff claims damages exceeding $80 million. The Company vigorously denies plaintiff's allegations, to which it believes it has good defenses, and, in November 2000, moved for summary judgment. That motion is pending. In April 2001, the court entered an order tentatively scheduling a trial in the case during July 2001. At the present time, the Company is unable to predict the outcome, or the financial statement impact, if any, of this lawsuit. For further information respecting legal proceedings, see 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 F of Notes to Consolidated Financial Statements included in this report. The Company also is subject to certain other 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. 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 2001. ADDITIONAL INFORMATION The following information is furnished in this Part I pursuant to Instruction 3 to Item 401(b) of Regulation S-K: 33 35 EXECUTIVE OFFICERS OF THE COMPANY The Executive Officers of Holdings as of April 1, 2001 are: Name Age Position ---- --- -------- Howard S. Cohen 54 Chief Executive Officer (since March 2001). Previously, Mr. Cohen was President and Chief Executive Officer of Bell & Howell, a leading information solutions and services provider, from January 2000 to January 2001; President, Chief Executive Officer and Chairman of Sidus Systems, Inc., a Toronto Canada based systems integrator, contract manufacturer and distributor, from 1998 to 2000; and President, Chief Executive Officer, and Chief Operating Officer of Peak Technologies Group, a systems integrator of data capture, printing, service solutions and software products, from 1996 to 1998. Prior to this, Mr. Cohen was President of OCE Systems, Inc., a U.S. subsidiary of the Netherlands-based OCE Corporation, which specializes in printing systems and reprographic equipment, from 1992 to 1996. David J. Calabro 51 Senior Vice President, with responsibility for the Company's worldwide facilities management business, since March 1999. Previously, Mr. Calabro was employed by Unisys Corporation, a leading provider of information technology, from May 1995 through February 1999 as its Vice President and General Manager of the United States and Canada Public Sector Market Group, and prior to that, was Director of Business Operations (Government Systems Group) from August 1987 through April 1995 for Digital Equipment Corporation, a leading supplier of computer goods and services. Marc A. Crisafulli 32 Senior Vice President and General Counsel (since March 2001). Previously, Mr. Crisafulli was an associate (from September 1994 through June 2000) and a partner (from July 2000 through March 2001) of the Providence-based law firm of Edwards & Angell, LLP where he practiced as a commercial trial lawyer. Jean-Pierre Desbiens 50 Senior Vice President, with responsibility for product sales and business development, since August 1998. Previously, Mr. Desbiens was employed by BABN Technologies Inc., one of the world's largest printers of lottery tickets, in a series of increasingly responsible positions over the course of 16 years including, from September 1990 until January 1998, as its President and Chief Executive Officer. 34 36 Kathleen E. McKeough 50 Senior Vice President of Human Resources (since May 2000). Previously, Ms. McKeough was Senior Vice President of Human Resources of Allied Domecq Retailing U.S., a subsidiary of Allied Domecq, a leading producer and distributor of wines and spirits and owner of quick-service restaurants, from 1996 to 1999, and prior to that was Chief Financial Officer and Treasurer of Allied Domecq Retailing U.S. from 1994 to 1996. Jaymin B. Patel 33 Senior Vice President and Chief Financial Officer since January 2000. Previously, beginning in 1994 Mr. Patel was employed by the Company in a series of increasingly responsible positions including, from April 1998 until January 2000, as GTECH's Vice President, Financial Planning and Business Evaluation. Antonio Carlos Rocha 52 Senior Vice President of Marketing (since February 2001). Previously, Mr. Rocha served as President of GTECH Brasil Lda, the Company's Brazilian subsidiary, from January, 1996 during which time the Company obtained the contract to provide online lottery services to Caixa Economica Federale, which operates Brazil's National Lottery. Prior to this, Mr. Rocha was Chairman of the Executive Committee of AT&T Brazil from July 1993 until late 1995, and President of NCR Brazil from April 1991 to July 1993. Donald L. Stanford 50 Senior Vice President, with responsibility for technology, for more than five years. Donald R. Sweitzer 53 Senior Vice President - Public Affairs 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 the Political Director of the Democratic National Committee from April 1993 through January 1995, and served as the Finance Director of this same body from April 1985 through January 1989. 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, 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 35 37 shareholders of Holdings will be included in Holdings' definitive proxy statement relating to its scheduled July 2001 Annual Meeting of Shareholders to be filed with the Securities and Exchange Commission. 36 38 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 2000 HIGH LOW ----------- ---- --- First Quarter (February 28 - May 29, 1999) $28 3/16 $22 1/8 Second Quarter (May 30 - August 28, 1999) $25 11/16 $22 1/2 Third Quarter (August 29 - November 27, 1999) $26 $19 3/8 Fourth Quarter (November 28, 1999 - February 26, 2000) $23 1/8 $19 3/8
FISCAL 2001 HIGH LOW ----------- ---- --- First Quarter (February 27 - May 27, 2000) $23 $17 7/8 Second Quarter (May 28 - August 26, 2000) $23 1/2 $17 5/8 Third Quarter (August 27 - November 25, 2000) $19 1/4 $15 3/8 Fourth Quarter (November 26, 2000 - February 24, 2001) $27 3/4 $18 1/4
The closing price of the Common Stock on the New York Stock Exchange on April 10, 2001 was $29.26. As of April 10, 2001, there were approximately 900 holders of record of the Common Stock. 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 and, from time to time, to execute repurchases of shares of Holdings' Common Stock under the Company's open market share repurchase program. Further, Holdings is a holding company and its operations are conducted through the Company and its 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. 37 39 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 in this report. 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.
Fiscal Year Ended ------------------------------------------------------------------------ February 24, February 26, February 27, February 28, February 22, 2001 2000 1999 1998 (a) 1997 ------------ ----------- ------------ ------------ ------------ (Dollars in thousands, except per share amounts) OPERATING DATA: Revenues: Services $ 856,475 $ 860,419 $ 887,395 $ 868,522 $ 789,534 Sales of products 80,068 150,379 85,528 122,045 114,738 ------------ ------------ ------------ ------------ ------------ Total 936,543 1,010,798 972,923 990,567 904,272 Gross Profit: Services (b) 292,380 305,110 297,630 266,940 239,332 Sales of products 5,224 48,426 25,703 48,230 47,297 ------------ ------------ ------------ ------------ ------------ Total 297,604 353,536 323,333 315,170 286,629 Special charges (credit) (c) 42,270 (1,104) 15,000 99,382 --- Operating income 81,905 180,000 141,720 44,104 127,091 Interest expense, net of interest income 21,569 25,523 23,326 24,578 16,388 Net income 43,148 93,585 89,063 27,214 77,803 PER SHARE DATA: Basic $ 1.25 $ 2.58 $ 2.17 $ .65 $ 1.81 Diluted 1.25 2.58 2.16 .64 1.80 OTHER DATA: Earnings before depreciation, amortization, interest, taxes and other special and noncash charges $ 305,223 $ 361,126 $ 376,158 $ 347,099 $ 326,054 Cumulative number of lottery terminals shipped (d) 434,139 408,906 377,857 360,202 316,614 Number of lottery terminals sold 5,570 13,293 4,921 11,963 13,609 Number of lottery customers at year-end 83 82 81 78 79 BALANCE SHEET DATA (AT END OF PERIOD): Working capital $ 65,273 $ 28,253 $ 3,755 $ 27,371 $ 36,914 Total assets 938,160 891,023 874,215 1,023,812 956,541 Long-term debt, less current portion 316,961 349,400 319,078 453,587 382,499 Shareholders' equity (f) 314,362 296,576 283,906 345,210 358,133
---------------------------------------- (a) 53-week year. (b) Fiscal years prior to 2001 have been reclassified to present goodwill amortization as a single operating expense line item in the Consolidated Income Statements. (c) The impact of the special charges (credit) on earnings per share on a diluted basis was $0.74, $(0.02), $0.22 and $1.44, in fiscal 2001, 2000, 1999 and 1998, respectively. See Note P to the Consolidated Financial Statements. (d) Terminals shipped represents lottery terminals sold under product sale contracts and lottery terminals supplied under service contracts. (f) In March 2001, after the close of its 2001 fiscal year, the Company repurchased five million shares of its Common Stock for $130.0 million. 38 40 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 in which the Company is engaged 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, and (iv) 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 subsequent press releases and Form 10-Q's and other reports and filings with the Securities and Exchange Commission. General The Company operates on a 52- to 53-week fiscal year ending on the last Saturday in February and fiscal 2001 ended on February 24, 2001. 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, installation of new software 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 sales during fiscal 2002 will be in a range of $160 million to $170 million. 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 has entered into agreements which permit bill payments over its Brazilian and Chilean lottery networks. In addition, the Company continues to develop, and where permitted, market, its UWin! internet based platform through which international providers of government-sponsored lottery products and services may offer interactive 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 may continue to be investigations of various types, including grand jury investigations, conducted by governmental authorities into possible improprieties and wrongdoing in connection with efforts to obtain and/or the awarding of lottery contracts and related matters. In light of the fact that such investigations frequently are 41 conducted in secret, the Company would not necessarily know of the existence of an investigation which might involve 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 F 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. 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. 42 The following discussion should be read in conjunction with the table below.
SUMMARY FINANCIAL DATA Fiscal Year Ended ------------------------------------------------------------------------------------ February 24, February 26, February 27, 2001 2000 1999 ------------------------------------------------------------------------------------ (Dollars in thousands) Revenues: Services $ 856,475 91.5 % $ 860,419 85.1 % $ 887,395 91.2 % Sales of products 80,068 8.5 150,379 14.9 85,528 8.8 ------------ ---------- ------------- ---------- ------------ -------- Total 936,543 100.0 1,010,798 100.0 972,923 100.0 Costs and expenses: Costs of services (a)(b) 564,095 65.9 555,309 64.5 589,765 66.5 Costs of sales (a) 74,844 93.5 101,953 67.8 59,825 69.9 ------------ ---------- ------------- ---------- ------------ -------- Total 638,939 68.2 657,262 65.0 649,590 66.8 ------------ ---------- ------------- ---------- ------------ -------- Gross profit 297,604 31.8 353,536 35.0 323,333 33.2 Selling, general and administrative (b) 117,997 12.6 122,334 12.1 120,601 12.4 Research and development 49,267 5.3 46,053 4.6 40,158 4.1 Goodwill amortization (b) 6,165 0.6 6,253 0.6 5,854 0.6 ------------ ---------- ------------- ---------- ------------ -------- Operating expenses 173,429 18.5 174,640 17.3 166,613 17.1 Special charges (credit) 42,270 4.5 (1,104) (0.1) 15,000 1.5 Operating income 81,905 8.8 180,000 17.8 141,720 14.6 Other income (expense): Interest income 5,596 0.6 3,509 0.3 4,079 0.4 Equity in earnings of unconsolidated affiliates 3,167 0.3 2,843 0.3 7,113 0.7 Other income (expense) 7,232 0.8 (1,343) (0.1) 25,447 2.6 Interest expense (27,165) (2.9) (29,032) (2.9) (27,405) (2.8) ------------ ---------- ------------- ---------- ------------ -------- Income before income taxes 70,735 7.6 155,977 15.4 150,954 15.5 Income taxes 27,587 3.0 62,392 6.1 61,891 6.3 ------------ ---------- ------------- ---------- ------------ -------- Net income $ 43,148 4.6 % $ 93,585 9.3 % $ 89,063 9.2 % ============ ========== ============= ========== ============ ========
(a) Percentages are computed based on cost as a percentage of related revenue. (b) Fiscal years 2000 and 1999 have been reclassified to present goodwill amortization as a single operating expense line item in the Consolidated Income Statements. 43 Special Charges In fiscal 2001, the Company recorded special charges of $42.3 million ($25.8 million after-tax, or $0.74 per share) in connection with certain contractual obligations and a value assessment of the Company's business operations. The major components of the special charges consisted of $14.0 million for a workforce reduction that eliminated approximately 255 Company positions worldwide, $11.5 million for contractual obligations in connection with the departures in July 2000 of the Company's former Chairman and Chief Executive Officer and former President and Chief Operating Officer, $8.5 million for costs associated with the exit of certain business strategies and product lines and $8.3 million for the termination of consulting agreements and facility exit costs, net of gains on the disposition of Company aircraft. See Note P to the Consolidated Financial Statements. The Company realized approximately $12.0 to $13.0 million of pre-tax savings in fiscal 2001 from the value assessment. Beginning in fiscal 2002, the Company expects annual net pre-tax operating expense savings in the range of $30.0 to $32.0 million from the value assessment. Upcoming Significant Contract Rebids A significant portion of the Company's revenues and cash flow is derived from its portfolio of long-term online lottery service contracts, each of which in the ordinary course of the Company's business periodically is the subject of competitive procurement or renegotiation. Through fiscal 2003 (which ends in February 2003), several of the Company's larger contracts (including the National Lottery of Brazil and Texas, its two largest in fiscal 2001) are expected to be the subject of competitive procurements to select contractors to supply lottery goods and services upon the termination of the Company's current contracts. See Part I, Item 1, -- "Certain Factors That May Affect Future Performance -- Strengthening of Competition" and "Lottery Contract Awards and Related Significant Developments" herein for further information concerning these matters. Results of Operations COMPARISON OF FISCAL 2001 WITH 2000 Revenues for fiscal 2001 were $936.5 million, representing a $74.3 million, or 7.3%, decrease from revenues of $1.0 billion in fiscal 2000. Service revenues, including lottery and other services, in fiscal 2001 were $856.5 million, representing a $3.9 million, or 0.5%, decrease from the $860.4 million of service revenues in fiscal 2000. This decrease reflects a decline in domestic lottery service revenues, partially offset by an increase in international lottery service revenues. The Company's domestic lottery service revenues were $465.4 million in fiscal 2001, a decrease of 2.8% from the $478.8 million recorded in the same period of fiscal 2000. This decrease was 44 primarily due to the loss of online lottery contracts in Indiana, West Virginia, Vermont and New Hampshire and the loss of an instant ticket validation contract in New York. These decreases were partially offset by increases in lottery sales generated by a number of the Company's existing domestic customers, including Texas, New York and New Jersey. The Company's international lottery service revenues increased 4.5% in fiscal 2001 to $360.3 million compared with the $344.7 million recorded in the same period last year, primarily due to the launch of the national lotteries in South Africa and Morocco, along with growth in sales for existing customers in Brazil, Poland and Mexico and a contractual rate increase in Brazil. These increases were partially offset by the impact of the reduction in the dollar value of foreign currencies. Product sales in fiscal 2001 were $80.1 million, a decrease of $70.3 million from the $150.4 million of product sales in fiscal 2000. Prior year product sales included sales of an online lottery system to Israel, a new central system with instant ticket capabilities to Sweden, and equipment to South Africa. The Company sold approximately 5,600 lottery terminals in fiscal 2001, compared to approximately 13,300 lottery terminals in fiscal 2000. Gross margins on service revenues were 34.1% in fiscal 2001 compared to 35.5% in fiscal 2000, primarily driven by start-up losses on the lottery system installation in Morocco, along with additional costs incurred relating to the delayed start-up of the Colombia lottery that launched on January 17, 2001. Gross margins on product sales fluctuate depending on the mix, volume and timing of product sales contracts. Gross margins on product sales decreased from 32.2% in fiscal 2000 to 6.5% in fiscal 2001, primarily due to previously announced cost over-runs on the lottery system conversion the Company is implementing in New South Wales, Australia, and the lower volume of equipment sales to South Africa in fiscal 2001 compared to fiscal 2000. Selling, general and administrative expenses in fiscal 2001 were $118.0 million, representing a $4.3 million, or 3.5%, decrease from the $122.3 million incurred in fiscal 2000. This decrease was primarily attributable to cost reductions resulting from the value assessment, partially offset by non-cash charges associated with the implementation of the Company's Restricted Stock Plan in August 2000. As a percentage of revenues, selling, general and administrative expenses were 12.6% and 12.1% during fiscal 2001 and 2000, respectively. Research and development expenses in fiscal 2001 were $49.3 million, representing a $3.2 million, or 7.0%, increase over research and development expenses of $46.1 million in fiscal 2000. This increase reflects higher spending on the Company's central system software and interactive media offerings. As a percentage of revenues, research and development expenses were 5.3% and 4.6% during fiscal 2001 and 2000, respectively. Other income of $7.2 million in fiscal 2001 was comprised principally of the amortization of the gain on the sale of the Company's 22.5% equity interest in Camelot Group plc ("Camelot"), which the Company sold in April 1998, and which is being amortized over the remaining period of Camelot's first operating license, due to expire in September 2001. Other expense in fiscal 2000 of $1.3 million, was comprised of net foreign exchange losses associated with the Company's global asset protection and foreign exchange management programs designed to provide a degree of protection for future cash flows, partially offset by the amortization of the 45 gain on the sale of Camelot. The Company recorded $0.4 million of net foreign exchange gains in fiscal 2001, compared to $6.7 million of net foreign exchange losses in the prior year. Interest expense in fiscal 2001 was $27.2 million, a decrease of $1.8 million from interest expense of $29.0 million incurred during fiscal 2000. This decrease was primarily due to lower average debt outstanding under the Company's revolving credit facility. The Company's effective income tax rate decreased from 40% in fiscal 2000 to 39% in fiscal 2001, principally due to lower state taxes and increased research and development tax credits. 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. Weighted average shares in fiscal 2001 declined 1.7 million shares to 34.6 million shares as a result of the Company's share repurchase program. On March 19, 2001, after the end of its 2001 fiscal year, the Company repurchased 5 million shares of its common stock from Tiger Management, its largest shareholder, for $130.0 million. COMPARISON OF FISCAL 2000 WITH 1999 Revenues for fiscal 2000 were $1.0 billion, representing a $37.9 million, or 3.9%, increase over revenues of $972.9 million in fiscal 1999. Service revenues, including lottery and other services, in fiscal 2000 were $860.4 million, representing a $27.0 million, or 3.0%, decrease from the $887.4 million of service revenues in fiscal 1999. This decrease reflects a 6.1% decline in domestic lottery service revenues, partially offset by a 1.8% increase in international lottery service revenues. In fiscal 2000, lottery sales by the Company's domestic customers declined approximately 4.0% compared with fiscal 1999, primarily reflecting lower sales in Texas, the temporary suspension of Quick Draw in New York and lower jackpot activity. This decline, coupled with the loss of the Company's Indiana lottery contract and contractual rate changes, resulted in a 6.1% decline in the Company's domestic service revenues. Lottery sales by the Company's international customers increased 14.6% in fiscal 2000 compared with fiscal 1999, driven primarily by growth in Brazil, Germany, the Czech Republic, Poland and Mexico. This increase, coupled with contractual rate increases in Brazil was almost fully offset by the impact of the reduction in the dollar value of foreign currencies, resulting in a 1.8% increase in the Company's international lottery service revenues. Product sales were $150.4 million in fiscal 2000, an increase of $64.9 million over the $85.5 million of product sales in fiscal 1999. This increase was primarily driven by equipment sales to South Africa, an on-line lottery system to Israel and a new central system, including instant ticket validation capabilities to Sweden. The Company sold approximately 13,300 lottery terminals during fiscal 2000, compared to approximately 4,900 lottery terminals during fiscal 1999. Gross margins on service revenues improved from 33.5% in fiscal 1999 to 35.5% in fiscal 2000 due to improved margins from the Company's operations in Brazil. 46 Gross margins on product sales fluctuate depending on the mix, volume and timing of product sales contracts. Gross margins on product sales increased from 30.1% in fiscal 1999 to 32.2% in fiscal 2000, primarily due to the change in product mix. Selling, general and administrative expenses in fiscal 2000 were $122.3 million, representing a $1.7 million, or 1.4%, increase from the $120.6 million incurred in fiscal 1999. This increase was primarily attributable to the Company's bi-annual user's conference held during the second quarter of fiscal 2000. As a percentage of revenues, selling, general and administrative expenses were 12.1% and 12.4% during fiscal 2000 and 1999, respectively. Research and development expenses in fiscal 2000 were $46.1 million, representing a $5.9 million, or 14.7%, increase over research and development expenses of $40.2 million in fiscal 1999. This increase reflected development activities associated with the Company's next generation lottery operating system and terminals along with increased spending on a number of new products in the development pipeline. As a percentage of revenues, research and development expenses were 4.6% and 4.1% during fiscal 2000 and 1999, respectively. Equity in earnings of unconsolidated affiliates in fiscal 2000 was $2.8 million, a decrease of $4.3 million from the $7.1 million earned during fiscal 1999. This decrease resulted principally from the Company's sale, in April 1998, of its 22.5% equity interest in Camelot. Other expense in fiscal 2000 was $1.3 million and was comprised of net foreign exchange losses associated with the Company's global asset protection and foreign exchange management programs designed to provide a degree of protection for future cash flows, partially offset by the amortization of the gain on the sale of Camelot. The foreign exchange losses during fiscal 2000 were more than offset by higher cash gross margin from the Company's foreign operations due to stronger than expected foreign currencies relative to the U.S. dollar. Other income of $25.4 million in fiscal 1999 was comprised principally of 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. As a result of the material devaluation that took place in Brazil in January 1999, and the hedging strategy that the Company had in place at the time, the Company recognized a one-time foreign exchange gain of approximately $17 million. Interest expense in fiscal 2000 was $29.0 million, an increase of $1.6 million over interest expense of $27.4 million incurred during fiscal 1999. This increase was primarily due to higher average debt outstanding under the Company's revolving credit facility, along with higher average interest rates on the Company's outstanding debt. The Company's effective income tax rate decreased from 41% in fiscal 1999 to 40% in fiscal 2000 due principally to lower state taxes and increased research and development tax credits. 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. 47 Changes in Financial Position, Liquidity and Capital Resources During fiscal 2001, the Company generated $252.0 million of cash from operations. This cash was used principally to fund the purchase of $136.9 million of systems, equipment and other assets relating to contracts, repurchase $19.6 million of the Company's common stock and repay $42.8 million of the Company's long-term debt. Inventories increased by $50.4 million, from $67.4 million at February 26, 2000 to $117.8 million at February 24, 2001, primarily due to spending related to product sales expected to be delivered during fiscal 2002 in France, Spain and China, along with inventory purchased for new system installations in New York and Ohio. Advance payments of $23.4 million have been received related to these product sales expected to be delivered in fiscal 2002. Current deferred income taxes increased by $11.0 million, from $15.9 million at February 26, 2000 to $26.9 million at February 24, 2001, primarily due to accrued expenses that are not currently deductible for income tax purposes. Other assets decreased by $28.5 million, from $145.2 million at February 26, 2000 to $116.7 million at February 24, 2001, primarily due to the return of deposits on a corporate aircraft which was sold in August 2000, along with the amortization of capitalized software. Accrued expenses increased by $11.8 million, from $43.3 million at February 26, 2000 to $55.1 million at February 24, 2001, primarily due to the additional cost to complete the lottery system conversion underway in New South Wales, Australia. The special charge accrual of $10.4 million at February 24, 2001 consists primarily of $7.9 million of severance payments remaining under the workforce reduction and $1.6 million of payments remaining under contractual obligations to former executives. Advance payments from customers increased by $22.0 million, from $33.4 million at February 26, 2000 to $55.4 million at February 24, 2001, primarily due to advances received from customers in France, Spain and China related to product sales expected to be delivered during fiscal 2002. Income taxes payable, that are reported net of income tax refunds receivable, increased by $15.2 million, from $49.4 million at February 26, 2000 to $64.6 million at February 24, 2001. This increase was primarily due to a $16.0 million income tax refund relating to the fiscal 2001 special charge, along with the timing of income tax payments. 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 2002 will be in a range of $220 million to $245 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. 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, to fund anticipated internal growth and to repurchase shares of the Company's Common Stock, from time to time, under the Company's open market share repurchase program in the foreseeable future. The Company is currently in discussions with its lenders to refinance its credit facility which is scheduled to expire in June 2002. 48 On March 19, 2001, the Company repurchased 5 million shares of its Common Stock from Tiger Management, its largest shareholder, for $130.0 million. This purchase was outside of the Company's open market share repurchase program. As of March 31, 2001 the Company had utilized approximately $63.3 million of its $400 million Credit Facility, including $13.6 million of letters of credit issued under the Credit Facility. 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 2001. 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 24, 2001, and February 26, 2000, the estimated fair value of the Company's fixed rate debt, as determined by an independent investment banker, approximated $305.7 million and $293.9 million, respectively. At February 24, 2001, a hypothetical 10% increase in interest rates would change the estimated fair value of the Company's fixed rate debt to $300.1 million and a hypothetical 10% decrease in interest rates would change the estimated fair value of the Company's fixed rate debt to $311.5 million. Comparatively, at February 26, 2000, after taking into consideration $150.0 million of interest rate swaps, a hypothetical 10% increase in interest rates would change the estimated fair value of the Company's fixed rate debt to $290.5 million and a hypothetical 10% decrease in interest rates would change the estimated fair value of the Company's fixed rate debt to $297.2 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 mitigate the risk associated with future changes in interest rates, including entering into interest rate swaps and the private placement of fixed rate debt. In February 2000, the Company entered into two interest rate swaps with an aggregate notional amount of $150.0 million that provided interest rate protection over the period February 25, 2000 to May 15, 2007. The swaps effectively entitled the Company to exchange fixed rate payments for variable rate payments. On February 1, 2001, the Company sold the two interest rate swaps for $13.0 million. The Company has deferred the recognition of the gain on the sale as a component of long-term debt and is recognizing such gain ratably over the period February 2001 through May 2007. 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 United States 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 49 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 24, 2001 and February 26, 2000, a hypothetical 10% adverse change in foreign exchange rates would result in a translation loss of $14.6 million and $16.3 million, respectively, that would be recorded in the equity section of the Company's balance sheet. At February 24, 2001 and February 26, 2000, a hypothetical 10% adverse change in foreign exchange rates would result in a net transaction loss of $3.4 million in both years that would be recorded in current earnings after considering the effects of foreign exchange contracts currently in place. At February 24, 2001, a hypothetical 10% adverse change in foreign exchange rates would result in a net reduction of cash flows from anticipatory transactions in fiscal 2002 of $21.2 million. Comparatively, at February 26, 2000, the result of a hypothetical 10% adverse change in foreign exchange rates would have resulted in a net reduction of cash flows from anticipatory transactions of $12.1 million in fiscal 2001. The percentage of fiscal 2001 and fiscal 2000 anticipatory cash flows that were hedged varied throughout each fiscal year, but averaged 51% in fiscal 2001 compared to 73% in fiscal 2000. As of February 24, 2001, the Company had contracts for the sale of foreign currency of approximately $94.8 million (primarily Spanish pesetas, Australian dollars and pounds sterling) and the purchase of foreign currency of approximately $65.5 million (primarily pounds sterling), compared to contracts for the sale of foreign currency of approximately $87.7 million (primarily Spanish pesetas, South African rand and Irish punts) and the purchase of foreign currency of approximately $66.7 million (primarily pounds sterling) at February 26, 2000. 50 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. 51 ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA 52 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 24, 2001 and February 26, 2000 and the related consolidated statements of income, shareholders' equity, and cash flows for each of the three years in the period ended February 24, 2001. These financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements based on our audits. We conducted our audits in accordance with auditing standards generally accepted in 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 our audits provide a reasonable basis for our opinion. In our opinion, the financial statements referred to above present fairly, in all material respects, the consolidated financial position of GTECH Holdings Corporation and subsidiaries at February 24, 2001 and February 26, 2000 and the consolidated results of their operations and their cash flows for each of the three years in the period ended February 24, 2001, in conformity with accounting principles generally accepted in the United States. ERNST & YOUNG LLP Boston, Massachusetts March 27, 2001 53 GTECH HOLDINGS CORPORATION AND SUBSIDIARIES CONSOLIDATED BALANCE SHEETS
February 24, February 26, 2001 2000 --------------------------- (Dollars in thousands) ASSETS CURRENT ASSETS: Cash and cash equivalents $ 46,948 $ 11,115 Trade accounts receivable 118,721 115,358 Sales-type lease receivables 8,722 10,110 Inventories 117,789 67,418 Deferred income taxes 26,850 15,853 Other current assets 18,798 19,346 --------- --------- TOTAL CURRENT ASSETS 337,828 239,200 SYSTEMS, EQUIPMENT AND OTHER ASSETS RELATING TO CONTRACTS 361,334 375,918 GOODWILL 122,325 130,710 OTHER ASSETS 116,673 145,195 --------- --------- TOTAL ASSETS $ 938,160 $ 891,023 ========= ========= LIABILITIES AND SHAREHOLDERS' EQUITY CURRENT LIABILITIES: Short term borrowings $ 2,316 $ 1,620 Accounts payable 49,267 53,103 Accrued expenses 55,140 43,278 Special charge 10,431 -- Employee compensation 31,898 30,057 Advance payments from customers 55,418 33,438 Income taxes payable 64,573 49,382 Current portion of long-term debt 3,512 69 --------- --------- TOTAL CURRENT LIABILITIES 272,555 210,947 LONG-TERM DEBT, less current portion 316,961 349,400 OTHER LIABILITIES 29,883 27,363 DEFERRED INCOME TAXES 4,399 6,737 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, 44,507,315 and 44,171,315 shares issued; 34,257,527 and 34,804,004 shares outstanding at February 24, 2001 and February 26, 2000, respectively 445 442 Additional paid-in capital 183,294 176,750 Equity carryover basis adjustment (7,008) (7,008) Accumulated other comprehensive loss (85,852) (69,493) Retained earnings 479,305 437,830 --------- --------- 570,184 538,521 Less cost of 10,249,788 and 9,367,311 shares in treasury at February 24, 2001 and February 26, 2000, respectively (255,822) (241,945) --------- --------- 314,362 296,576 --------- --------- TOTAL LIABILITIES AND SHAREHOLDERS' EQUITY $ 938,160 $ 891,023 ========= =========
See Notes to Consolidated Financial Statements 54 GTECH HOLDINGS CORPORATION AND SUBSIDIARIES CONSOLIDATED INCOME STATEMENTS
Fiscal Year Ended ----------------------------------------------------- February 24, February 26, February 27, 2001 2000 1999 ---------------- ----------------- ----------------- (Dollars in thousands, except per share amounts) Revenues: Services $ 856,475 $ 860,419 $ 887,395 Sales of products 80,068 150,379 85,528 ---------------- ----------------- ----------------- 936,543 1,010,798 972,923 Costs and expenses: Costs of services 564,095 555,309 589,765 Costs of sales 74,844 101,953 59,825 ---------------- ----------------- ----------------- 638,939 657,262 649,590 ---------------- ----------------- ----------------- Gross profit 297,604 353,536 323,333 Selling, general and administrative 117,997 122,334 120,601 Research and development 49,267 46,053 40,158 Goodwill amortization 6,165 6,253 5,854 Special charges (credit) 42,270 (1,104) 15,000 ---------------- ----------------- ----------------- Operating income 81,905 180,000 141,720 Other income (expense): Interest income 5,596 3,509 4,079 Equity in earnings of unconsolidated affiliates 3,167 2,843 7,113 Other income (expense) 7,232 (1,343) 25,447 Interest expense (27,165) (29,032) (27,405) ---------------- ----------------- ----------------- Income before income taxes 70,735 155,977 150,954 Income taxes 27,587 62,392 61,891 ---------------- ----------------- ----------------- Net income $ 43,148 $ 93,585 $ 89,063 ================ ================= ================= ---------------- ----------------- ----------------- Basic earnings per share $ 1.25 $ 2.58 $ 2.17 ================ ================= ================= ---------------- ----------------- ----------------- Diluted earnings per share $ 1.25 $ 2.58 $ 2.16 ================ ================= =================
See Notes to Consolidated Financial Statements 55 GTECH HOLDINGS CORPORATION AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY
Equity Additional Carryover Outstanding Common Paid-in Basis Shares Stock Capital Adjustment ---------------- ---------------- ------------------ --------------- (Dollars in thousands) Balance at February 28, 1998 41,284,146 $ 439 $ 171,302 $ (7,008) Comprehensive income: Net income - - - - Other comprehensive income (loss), net of tax: Foreign currency translation - - - - Net gain on derivative instruments - - - - Comprehensive income Treasury shares repurchased (2,794,100) - - - Shares issued under stock award plans 5,688 - 159 - Shares reissued under stock award plans 2,079 - - - Shares issued upon exercise of stock options 224,250 3 4,973 - ---------------- ---------------- ------------------ --------------- Balance at February 27, 1999 38,722,063 $ 442 $ 176,434 $ (7,008) Comprehensive income: Net income - - - - Other comprehensive income, net of tax: Foreign currency translation - - - - Net gain on derivative instruments - - - - Comprehensive income Treasury shares repurchased (4,049,100) - - - Shares reissued under employee stock purchase and stock award plans 112,291 - - - Shares issued upon exercise of stock options 18,750 - 316 - ---------------- ---------------- ------------------ --------------- Balance at February 26, 2000 34,804,004 $ 442 $ 176,750 $ (7,008) Comprehensive income: Net income - - - - Other comprehensive income (loss), net of tax: Foreign currency translation - - - - Net loss on derivative instruments - - - - Unrealized gain on investments - - - - Comprehensive income Director stock compensation - - 92 - Treasury shares repurchased (1,105,200) - - - Shares reissued under employee stock purchase and stock award plans 222,723 - - - Shares issued upon exercise of stock options 336,000 3 6,452 - ---------------- ---------------- ------------------ --------------- Balance at February 24, 2001 34,257,527 $ 445 $ 183,294 $ (7,008) ================ ================ ================== =============== Accumulated Other Comprehensive Retained Treasury Income (Loss) Earnings Stock Total ------------------ ----------------- ------------------ ----------------- (Dollars in thousands) Balance at February 28, 1998 $ (42) $ 255,955 $ (75,436) $ 345,210 Comprehensive income: Net income - 89,063 - 89,063 Other comprehensive income (loss), net of tax: Foreign currency translation (85,094) - - (85,094) Net gain on derivative instruments 294 - - 294 ----------------- Comprehensive income 4,263 Treasury shares repurchased - - (70,757) (70,757) Shares issued under stock award plans - - - 159 Shares reissued under stock award plans - - 55 55 Shares issued upon exercise of stock options - - - 4,976 ------------------ ----------------- ------------------ ----------------- Balance at February 27, 1999 $ (84,842) $ 345,018 $ (146,138) $ 283,906 Comprehensive income: Net income - 93,585 - 93,585 Other comprehensive income, net of tax: Foreign currency translation 15,223 - - 15,223 Net gain on derivative instruments 126 - - 126 ----------------- Comprehensive income 108,934 Treasury shares repurchased - - (98,747) (98,747) Shares reissued under employee stock purchase and stock award plans - (773) 2,940 2,167 Shares issued upon exercise of stock options - - - 316 ------------------ ----------------- ------------------ ----------------- Balance at February 26, 2000 $ (69,493) $ 437,830 $ (241,945) $ 296,576 Comprehensive income: Net income - 43,148 - 43,148 Other comprehensive income (loss), net of tax: Foreign currency translation (16,004) - - (16,004) Net loss on derivative instruments (447) - - (447) Unrealized gain on investments 92 - - 92 ----------------- Comprehensive income 26,789 Director stock compensation - - - 92 Treasury shares repurchased - - (19,587) (19,587) Shares reissued under employee stock purchase and stock award plans - (1,673) 5,710 4,037 Shares issued upon exercise of stock options - - - 6,455 ------------------ ----------------- ------------------ ----------------- Balance at February 24, 2001 $ (85,852) $ 479,305 $ (255,822) $ 314,362 ================== ================= ================== =================
See Notes to Consolidated Financial Statements 56 GTECH HOLDINGS CORPORATION AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF CASH FLOWS
Fiscal Year Ended ---------------------------------------- February 24, February 26, February 27, 2001 2000 1999 ------------ ------------ ------------ (Dollars in thousands) OPERATING ACTIVITIES Net income $ 43,148 $ 93,585 $ 89,063 Adjustments to reconcile net income to net cash provided by operating activities: Depreciation 156,262 168,284 184,748 Intangibles amortization 11,968 10,839 8,719 Goodwill amortization 6,165 6,253 5,854 Special charges (credit) 42,270 (1,104) 15,000 Deferred income taxes provision (benefit) (13,335) 1,753 9,868 Termination of interest rate swap 12,970 --- --- Equity in earnings (losses) of unconsolidated affiliates, net of dividends received 1,343 (376) (3,117) Foreign currency transaction losses (gains) (970) 900 (8,650) Other 1,408 954 2,405 Changes in operating assets and liabilities, net of effects of acquisitions: Trade accounts receivable 956 (10,006) (10,716) Inventories (50,369) (5,659) (33,479) Special charge (23,426) (4,954) (26,105) Other assets and liabilities 63,580 (29,687) 52,692 --------- --------- --------- NET CASH PROVIDED BY OPERATING ACTIVITIES 251,970 230,782 286,282 INVESTING ACTIVITIES Purchases of systems, equipment and other assets relating to contracts (136,891) (128,618) (121,198) Acquisitions (net of cash acquired) -- (318) (19,687) Investments in and advances to unconsolidated affiliates (16,601) (16,209) (529) Cash received from affiliates 2,075 -- 1,906 Proceeds from sale of investments -- -- 84,904 Other (11,149) (19,198) (22,627) --------- --------- --------- NET CASH USED FOR INVESTING ACTIVITIES (162,566) (164,343) (77,231) FINANCING ACTIVITIES Net proceeds from issuance of long-term debt 95,908 221,500 117,706 Principal payments on long-term debt (138,737) (192,936) (254,768) Purchases of treasury stock (19,587) (98,747) (70,757) Proceeds from stock options 6,455 316 4,976 Other 5,236 2,114 (205) --------- --------- --------- NET CASH USED FOR FINANCING ACTIVITIES (50,725) (67,753) (203,048) Effect of exchange rate changes on cash (2,846) 4,696 (6,520) --------- --------- --------- INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS 35,833 3,382 (517) Cash and cash equivalents at beginning of year 11,115 7,733 8,250 --------- --------- --------- CASH AND CASH EQUIVALENTS AT END OF YEAR $ 46,948 $ 11,115 $ 7,733 ========= ========= ========= SUPPLEMENTAL CASH FLOW INFORMATION: Interest payments (net of amounts capitalized) $ 26,937 $ 28,697 $ 27,574 Income tax payments 44,297 66,883 24,945 Income tax refunds (18,701) (662) (13,345)
See Notes to Consolidated Financial Statements 57 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, all majority and wholly owned subsidiaries and other entities controlled by GTECH (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, investments in corporate joint ventures and other entities that are not controlled by GTECH 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. Goodwill amortization, that was included in cost of services and selling, general and administrative expense in prior periods has been presented as a single line item in the Consolidated Income Statements. Industry Segment and Nature of Operations: The Company operates in one reportable 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. Fiscal Year: The Company operates on a 52- to 53-week fiscal year ending on the last Saturday in February. Fiscal 2001, 2000 and 1999 were 52-week years. 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 (as defined in Note F) are recorded as a reduction in revenue in the period in which it is determined that they are probable and estimable. Revenues from product sales or sales-type leases are recognized when installation is complete and the customer accepts the product, when acceptance is a stipulated contractual term. In those instances where the Company is not responsible for installation, revenue is recognized when the product is shipped. Product sales under long-term contracts are recorded under the percentage of completion method. Costs and estimated gross margins are recorded as sales as work is completed and accepted by the customer by utilizing the most recent estimates of cost to complete. Adjustments in estimates are made in the period in which the information necessary to make the adjustment becomes available. If the current contract estimate indicates a loss, provision is made for the estimated loss when it becomes known and quantifiable. Effective November 26, 2000, the Company adopted Staff Accounting Bulletin (SAB) 101, "Revenue Recognition in Financial Statements". SAB 101 summarizes the Securities and Exchange Commission's views regarding the application of generally accepted accounting principles to selected revenue recognition issues. The adoption and implementation of SAB 101 did not have a material effect on the results of operations or financial position of the Company. 58 GTECH HOLDINGS CORPORATION AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS NOTE A - SIGNIFICANT ACCOUNTING POLICIES-(CONTINUED) 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 $434,000, $(6,683,000) and $15,268,000 in fiscal 2001, 2000 and 1999, respectively, which 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 and liabilities 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. 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 nonemployee 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 related Interpretations. The Company has not recognized any compensation expense for stock option grants. Derivatives: The Company uses derivative financial instruments principally to manage the risk of foreign currency exchange rate and interest 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"). 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 certain contracts used to provide a degree of protection to the Company against foreign exchange risk on its variable service revenues at fair value in its Consolidated Balance Sheets. 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 Sheets at fair value and the related gains or losses on these contracts are immediately recognized in earnings 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. 59 GTECH HOLDINGS CORPORATION AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS NOTE A - SIGNIFICANT ACCOUNTING POLICIES-(CONTINUED) 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. Trade Accounts Receivable: Trade accounts receivable are reflected net of allowances for doubtful accounts and liquidated damages of $7,373,000 and $3,187,000 at February 24, 2001 and February 26, 2000, respectively. Inventories: Inventories include amounts related to the Company's long-term service contracts and product sales contracts, including product sales under long-term contracts, and are stated at the lower of cost (first-in, first-out method) or market. Provision for potentially obsolete or slow-moving inventory is made based on management's analysis of inventory levels and future sales forecasts. Inventory allowances were $6,708,000 and $5,142,000 at February 24, 2001 and February 26, 2000, respectively. Inventory manufactured or assembled by the Company for its long-term service contracts is transferred to systems, equipment and other assets relating to contracts upon shipment. Systems, Equipment and Other Assets Relating to Contracts: Systems, equipment and other assets relating to contracts are stated on the basis of cost. The cost less any salvage value is depreciated over the base contract term, not to exceed ten years, using the straight-line method for financial reporting purposes and accelerated methods for income tax purposes. 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 $36,393,000 and $44,291,000 at February 24, 2001 and February 26, 2000, respectively. Related amortization expense amounted to $19,018,000, $17,167,000 and $12,821,000 in fiscal 2001, 2000 and 1999, respectively, and is included in cost of services or cost of sales in the Company's Consolidated Income Statements. 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. During fiscal 2001, 2000 and 1999, the Company recorded charges of $4,236,000, $1,000,000 and $18,165,000, respectively, relating to impairments of certain long-lived assets. Goodwill: Goodwill represents the excess of cost over the fair value of net assets acquired and is amortized on a straight-line basis over periods ranging from seven to 40 years. As of February 24, 2001 and February 26, 2000, accumulated amortization was $40,850,000 and $36,271,000, respectively. Goodwill is periodically reviewed for impairment by comparing the carrying amount to the estimated future undiscounted cash flows of the businesses acquired. If this review indicates that goodwill is not recoverable, the carrying amount would be reduced to fair value. During fiscal 2001, the Company reduced goodwill by $2,220,000 to reflect impairment associated with a prior acquisition. Accumulated Other Comprehensive Income: Accumulated other comprehensive income as of February 24, 2001, included $(85,917,000), $(27,000) and $92,000 related to foreign currency translation, net loss on derivative instruments and unrealized gain on investments, respectively. Accumulated other comprehensive income as of February 26, 2000, included $(69,913,000) and $420,000 related to foreign currency translation and net gain on derivative instruments, respectively. 60 GTECH HOLDINGS CORPORATION AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS 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. The acquisition was accounted for using the purchase method of accounting, whereby the purchase price was allocated to the assets acquired and liabilities assumed based on their respective fair values. Purchase price in excess of these fair values has been recorded as goodwill. The Company has included the operating results of Europrint and its wholly owned subsidiaries in its consolidated results since the date of acquisition. Pro forma information has not been provided because the acquisition was not material to the Company's operations. NOTE C - INVENTORIES Inventories consist of:
February 24, 2001 February 26, 2000 ----------------- ----------------- (Dollars in thousands) Raw materials $ 45,689 $ 23,623 Work in progress 57,210 42,701 Finished goods 14,890 1,094 -------------------- -------------------- $ 117,789 $ 67,418 ==================== ====================
NOTE D - SYSTEMS, EQUIPMENT AND OTHER ASSETS RELATING TO CONTRACTS Systems, equipment and other assets relating to contracts consists of:
February 24, 2001 February 26, 2000 ----------------- ----------------- (Dollars in thousands) Land and buildings $ 5,259 $ 5,259 Computer terminals and systems 1,122,286 1,069,541 Furniture and equipment 116,098 110,734 Contracts in progress 39,771 46,221 -------------------- -------------------- 1,283,414 1,231,755 Less accumulated depreciation and amortization 922,080 855,837 -------------------- -------------------- $ 361,334 $ 375,918 ==================== ====================
61 GTECH HOLDINGS CORPORATION AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS NOTE E - LONG-TERM DEBT Long-term debt consists of:
February 24, 2001 February 26, 2000 ----------------- ----------------- (Dollars in thousands) Revolving credit facility $ ---- $ 45,000 7.75% Series A Senior Notes due 2004 150,000 150,000 7.87% Series B Senior Notes due 2007 150,000 150,000 Deferred gain on interest rate swaps 12,810 ---- Other 7,663 4,469 -------------------- -------------------- 320,473 349,469 Less current portion 3,512 69 -------------------- -------------------- $ 316,961 $ 349,400 ==================== ====================
The Company has an unsecured revolving credit facility of $400,000,000 expiring in June 2002 (the "Credit Facility"). At February 24, 2001, there were no outstanding borrowings under the Credit Facility. 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 24, 2001, under the most restrictive covenants, the Company had available $141,476,000 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 Company and to repurchase shares of the Company's Common Stock, from time to time, under the Company's open market share repurchase program. The Company's 7.75% Series A Senior Notes due 2004 and 7.87% Series B Senior Notes due 2007 (collectively, the "Senior Notes") are unsecured. Interest on each issue is payable semiannually in arrears. Up to $100,000,000 of the Credit Facility may be used for the issuance of letters of credit. The Company had, at February 24, 2001, $12,117,000 of letters of credit issued and outstanding under the Credit Facility and $65,512,000 of letters of credit issued and outstanding outside of the Credit Facility. The total weighted average annual cost for all letters of credit was 0.6%. At February 24, 2001, long-term debt matures as follows:
Fiscal Year (Dollars in thousands) ----------- 2002 3,512 2003 3,991 2004 3,991 2005 153,991 2006 2,553 2007 2,075 2008 150,360
Long-term debt includes a deferred gain on the sale of interest rate swaps. (See Note O for additional information.) 62 GTECH HOLDINGS CORPORATION AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS NOTE F - 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 publicly reported 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 the 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 pounds 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 "Irish NLC"), issued a Request for Proposals respecting online and instant ticket lottery goods and services, and in September 1992 the Company, which was then the incumbent provider of lottery goods and services to the Irish NLC under an agreement awarded to the Company in 1987, submitted a Proposal to the Irish NLC in response to the Irish NLC's Request for Proposals. In November 1992, the Irish NLC selected the Company to provide online and instant ticket goods and services to the Irish NLC under the terms of the competitive procurement and, following negotiations, a definitive agreement was entered into between the Irish NLC and the Company in March 1993. In calendar 1999, the Tribunal requested that the Company provide various documents regarding the Company's business in Ireland, which the Company has done, and the Company has been 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 Irish NLC. Mr. Snowden has advised the Company through his 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 Irish NLC and was not intended to and did not influence the Irish NLC's decision to renew the Company's contract. No charges of wrongdoing have been brought against the Company in connection with the Moriarty investigation, and the Company does not believe that it has engaged in any wrongdoing in connection with this matter. However, since this investigation is or may still be underway, and investigations of this type customarily are conducted in whole or in part in secret, the Company lacks sufficient information to determine with certainty its ultimate scope and whether the government authorities will assert claims resulting from this investigation 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 a government authority were to make an allegation, or if there were to be a finding, of improper conduct on the part of or attributable to the Company in any matter, including in respect of the Moriarty investigation, 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 this investigation and related matters could have such a material adverse effect. 63 GTECH HOLDINGS CORPORATION AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS NOTE F - COMMITMENTS AND CONTINGENCIES-(CONTINUED) Since July 1994, the United Kingdom National Lottery has been operated under a license held by Camelot Group plc ("Camelot"), and the Company has been a supplier of lottery goods and services to Camelot for the lottery. As publicly reported, in or around April or May 2000, the United Kingdom National Lottery Commission (the "NLC"), the regulator of the United Kingdom National Lottery, commenced an investigation into a lottery terminal software malfunction in the United Kingdom in which, under certain rare circumstances, a duplicate transaction was recorded on the Company's central system while only one ticket was presented to the retailer. The software malfunction resulted in a relatively small amount of overcharges to lottery retailers with respect to the duplicate transactions and a relatively small amount of overpayments or underpayments to certain prizewinners. The Company first identified this software malfunction in the United Kingdom in June 1998 and corrected the malfunction in July 1998, but without notifying Camelot or the NLC, as it should have done. The Company fully cooperated with the NLC's investigation and undertook to implement a number of measures respecting its corporate compliance and governance functions and software development processes in the wake of the investigation. The Company has also agreed to reimburse United Kingdom lottery players and retailers for any financial losses incurred by virtue of the software malfunction. As has also been publicly reported, the developments described above took place in the context of a competitive procurement respecting the award by the NLC of a new license to operate the National Lottery with effect from October 1, 2001. In 1999, the NLC established a competitive procedure for the award of the new license, and two bidders, Camelot and The People's Lottery ("TPL"), subsequently submitted bids for the new license. Camelot's bid was supported by agreements with the Company pursuant to which the Company had contracted to continue to supply lottery goods and services to Camelot during the term of the new license in the event that Camelot was awarded the new license. In August 2000, the NLC announced that it had decided that the NLC would proceed on the basis of a new procedure under which it would negotiate exclusively with TPL for one month. Promptly after the NLC's announcement, Camelot initiated legal proceedings in the United Kingdom challenging the legality of the NLC's decision to initiate a new procedure of negotiation with TPL to the exclusion of Camelot. In September 2000, the High Court of Justice (Queen's Bench Division) overturned the NLC's August 2000 decision to negotiate exclusively with TPL and directed that the NLC enter into an exclusive negotiation period with Camelot so as to afford Camelot the same opportunity granted to TPL to improve its bid to address the NLC's concerns. As part of the improved Camelot proposal for the new license, the Company entered into technology transfer and training arrangements with Camelot providing for the transfer to Camelot of the Company's National Lottery equipment, facilities and U.K. technology employees, a technology transfer to Camelot (after a period of training), and a grant to Camelot exclusive rights to operate the Company's gaming system software in the U.K. for the term of the new license. Under these new arrangements, the Company will license its software and provide a range of support services to Camelot for which the Company expects to receive compensation during the term of the new license in the range of $40,000,000 to $45,000,000 per year commencing in fiscal year 2003. The Company also anticipates receiving revenues of approximately $65,000,000 with respect to the sale to Camelot of new terminals prior to the commencement of the new license term. The Company further agreed to negotiate a technology transfer and a related software license for the exclusive use by Camelot under the new license of the internet gaming applications of the Company's UWin! subsidiary. In December 2000, the NLC announced its decision to award a new seven-year license to operate the National Lottery to Camelot and that it will grant Camelot an interim license to cover the period from October 1, 2001 through January 30, 2002 in order to provide a twelve-month conversion period prior to the beginning of the new license. TPL has not protested the NLC's decision to award the new license to Camelot and the period in which a protest must be made has since lapsed. 64 GTECH HOLDINGS CORPORATION AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS NOTE F - COMMITMENTS AND CONTINGENCIES-(CONTINUED) In April 2001, the NLC issued a report of its investigation into the above described lottery software terminal malfunction. The NLC report states that its investigation of the lottery software incident had established breaches of Camelot's license, including in respect of the failure of the Company to give proper notification before rectifying the software fault. The report further states that Camelot has agreed to pay pounds sterling 115,000 (approximately $175,000) into the National Lottery prize fund as compensation for underpayments to players resulting from the software malfunction, and that Camelot has undertaken to identify the amounts by which individual retailers have been overcharged. The NLC has declined, however, to fine Camelot with respect to breaches of its license resulting from (or revealed by the NLC investigation of) the software incident. The NLC report summarizes the steps taken and to be undertaken by the Company in the wake of investigation of the lottery software malfunction (including the measures implemented by the Company with respect to its corporate compliance and governance functions and software development processes and the technology transfer arrangements, as described above) and concludes, in light of these steps, that the Company sufficiently addressed the NLC's ongoing concerns about whether it is a "fit and proper" body for purposes of involvement in the operation of the National Lottery. Payment by the Company of amounts: (i) to reimburse Camelot for payments with respect to underpayments to United Kingdom players and overcharges of retailers, as described above, (ii) to reimburse Camelot with respect to any other out-of-pocket costs incurred by Camelot with respect to the lottery terminal software malfunction, and (iii) to reimburse other customers of the Company with respect to effects of the lottery terminal software malfunction outside the United Kingdom, which amounts have been accrued in the accompanying financial statements, are not expected to have a material adverse effect on the Company's consolidated financial position or results of operation. As publicly reported, in August 2000, a shareholder class action lawsuit on behalf of all persons who purchased Company stock during the period from April 11, 2000 to July 25, 2000, was brought against the Company, the Company's former Chairman and Chief Executive Officer, William Y. O'Connor, and the Company's current Chairman, W. Bruce Turner, in the U.S. District Court of Rhode Island relating to various Company announcements made between April 11, 2000 and July 25, 2000. The complaint filed in the case, Sandra Kafenbaum, individually and on behalf of all others similarly situated, v. GTECH Holdings Corporation, William Y. O'Connor and W. Bruce Turner, generally alleges that the defendants violated federal securities laws (including Section 10(b) of the Securities Exchange Act of 1934) by making allegedly false and misleading statements (including statements alleged to be overly optimistic respecting certain lottery contract awards to the Company and respecting the Company's prospects in certain non-lottery business lines and investments), while failing to disclose in a timely manner certain allegedly material adverse information that it purportedly had a duty to disclose (including an alleged inability to close certain contract awards and as to certain alleged cost overruns). The complaint seeks to recover monetary damages from the Company and the individual defendants. In February 2001, the plaintiffs filed an amended complaint which added Steven P. Nowick, the Company's former President and Chief Operating Officer, as an individual defendant. In addition, the amended complaint expands the purported class of plaintiffs to include all persons who purchased common stock of the Company during the period from July 13, 1998 through August 29, 2000. The type of relief sought in the amended complaint is similar to that sought in the original action. The Company believes that it has good defenses to the claims made in this lawsuit and intends to file a motion to dismiss the amended complaint as to all of the defendants. At the present time, however, the Company is unable to predict the outcome, or the financial statement impact, if any, of this lawsuit. As publicly reported, in May 2000, Sazka, a.s., a lottery customer of the Company in the Czech Republic ("Sazka"), filed a Request for Arbitration with the International Arbitral Centre of the Austrian Federal Economic Chamber of Commerce in Vienna, Austria, seeking to arbitrate certain business and contractual issues under the Company's online lottery contract with Sazka. Sazka sought damages valued at approximately $2,600,000 in connection with alleged delays in the recent extensive expansion of the lottery sales network. Sazka also sought a determination that its online contract with the Company would expire approximately two years earlier than the date on which the Company maintained its contract would terminate. The Company, believing the claims made by Sazka to be without merit, filed a Memorandum in Reply and Counterclaim disputing such claims and raising counterclaims for breach of contract by Sazka. In March 2001, the Company entered into an agreement with Sazka which, among 65 GTECH HOLDINGS CORPORATION AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS NOTE F - COMMITMENTS AND CONTINGENCIES-(CONTINUED) other things, resolved the arbitration. Under the agreed settlement, Sazka dropped its demand for liquidated damages, paid to the Company certain disputed amounts which it had previously withheld and agreed to extend the term of the contract. The Company in turn agreed to reduce its fee and to provide certain additional equipment and services under its contract with Sazka. In February 1999, the Company was sued by a Florida corporation called EIG Gaming International, Inc. ("EIG"), in the Circuit Court of the Eleventh Judicial Circuit of Florida. The Company removed the case to the U.S. District Court for the Southern District of Florida, where it is captioned EIG Gaming International, Inc. v. GTECH Corporation, Case No. 99-1808-Civ-Jordan. In its complaint EIG alleges that it entered into a Letter of Intent with the Company pursuant to which it would assist the Company to obtain the lottery contract for Peru in return for a percentage of the lottery's receipts. EIG further contends that it secured the Peruvian contract for the Company but that the Company thereupon declined to pursue it. Plaintiff claims damages exceeding $80,000,000. The Company vigorously denies plaintiff's allegations, to which it believes it has good defenses, and, in November 2000, moved for summary judgment. That motion is pending. In April 2001, the court entered an order tentatively scheduling a trial in the case during July 2001. At the present time, the Company is unable to predict the outcome, or the financial statement impact, if any, of this lawsuit. The Company also is subject to certain other 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. 66 GTECH HOLDINGS CORPORATION AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS NOTE G - STOCK-BASED COMPENSATION PLANS Under various stock-based compensation plans, officers and other key employees of the Company may receive grants of incentive stock options, nonqualified stock options, restricted stock, stock appreciation rights and performance awards and nonemployee members of the Company's Board of Directors automatically are granted annual stock options and may elect to receive stock in lieu of directors' fees. The Company is authorized to grant up to 5,240,000 shares of Common Stock under these plans and, at February 24, 2001, 3,026,250 stock options and restricted stock had been granted. All current outstanding shares are nonqualified stock options and restricted stock. The stock options granted under these plans are to purchase Common Stock at a price not less than fair market value at the date of grant. Employee stock options generally become exercisable ratably over a four-year period from date of grant and expire 10 years after date of grant unless an earlier expiration date is set at time of grant. Nonemployee director stock options are exercisable approximately one year after date of grant and expire 10 years after date of grant. Both employee and nonemployee directors' stock options are subject to possible earlier exercise and termination in certain circumstances. During fiscal 2001, the Company awarded 387,250 shares of restricted stock to officers and certain key employees, with a weighted average fair value at the date of grant of $19.00 per share. The fair value of the restricted stock award is being charged to expense over the vesting period. Grants generally vest within two years from the date of grant. Recipients of restricted stock do not pay any cash consideration to the Company for the shares. During fiscal 2001, the Company recorded noncash charges to operations of $4,549,000 as compensation expense related to restricted stock. The Company follows Accounting Principles Board Opinion No. 25, "Accounting for Stock Issued to Employees" and related Interpretations in accounting for its stock option grants, whereby no compensation expense is deducted in determining net income. Had compensation expense for stock option grants under the plans been determined pursuant to Statement of Financial Accounting Standards No. 123, "Accounting for Stock-Based Compensation", the Company's net income would have decreased accordingly. Using the Black-Scholes option pricing model, the Company's pro forma net income and pro forma weighted average fair value of options granted, with related assumptions, are as follows:
Fiscal Year Ended -------------------------------------------------------------------------------- February 24, 2001 February 26, 2000 February 27, 1999 ----------------------- ------------------------ ---------------------- Pro forma net income (in thousands) $ 39,269 $ 89,936 $ 85,797 Pro forma basic earnings per share $ 1.14 $ 2.48 $ 2.09 Pro forma diluted earnings per share $ 1.13 $ 2.48 $ 2.09 Pro forma weighted average fair value per share of options granted $ 7.00 $ 10.00 $ 15.00 Expected life (in years) 4.4 5.4 5.3 Risk-free interest rates 6.12% 5.21% 5.77% Volatility factors of the expected market price of the Common Stock .34 .35 .40 Dividend yield --- --- ---
The effects on fiscal 2001, 2000 and 1999 pro forma net income and earnings per share of expensing the estimated fair value of stock options are not necessarily representative of the effects on reported net income for future years because of the vesting period of the stock options and the potential for issuance of additional stock options in future years. 67 GTECH HOLDINGS CORPORATION AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS NOTE G - STOCK-BASED COMPENSATION PLANS-(CONTINUED) The Company's stock option activity and related information is summarized as follows:
Fiscal Year Ended -------------------------------------------------------------------------------------------- February 24, 2001 February 26, 2000 February 27, 1999 ------------------------------- --------------------------- --------------------------- 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 2,824,175 $ 27.71 2,083,300 $ 29.26 1,501,550 $ 25.13 Granted 1,279,000 19.78 1,075,500 24.79 1,012,500 34.04 Exercised (336,000) 19.21 (18,750) 16.88 (228,750) 22.30 Forfeited (472,800) 25.08 (315,875) 28.62 (202,000) 30.46 ------------- ------------ ------------ Outstanding at end of year 3,294,375 $ 25.87 2,824,175 $ 27.71 2,083,300 $ 29.26 ============= ============ ============ Exercisable at end of year 1,681,750 $ 28.30 1,176,800 $ 26.62 890,550 $ 24.22 ============= ============ ============
Exercise prices for stock options outstanding under the plans as of February 24, 2001 are summarized as follows:
Weighted Average ------------------------- Weighted Remaining Average Range of Options Contractual Exercise Options Exercise Exercise Prices Outstanding Life (Years) Price Exercisable Price ------------------------ ----------- ------------ ---------- ----------- ---------- $16.88 - $22.19 1,037,250 8.6 $ 19.25 163,500 $ 18.48 $22.25 - $25.31 838,500 7.9 $ 24.86 415,125 $ 24.96 $25.69 - $35.28 1,418,625 6.0 $ 31.32 1,103,125 $ 31.02 --------- --------- 3,294,375 1,681,750 ========= =========
NOTE H - EMPLOYEE STOCK PURCHASE PLAN 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. 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 24, 2001, 212,807 shares of Common Stock had been issued under the Plan. 68 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 24, 2001 February 26, 2000 February 27, 1999 ----------------- ----------------- ----------------- (Dollars and shares in thousands, except per share amounts) Numerator: Net income $ 43,148 $ 93,585 $ 89,063 Denominator: Weighted average shares - Basic 34,564 36,217 40,957 Effect of dilutive securities: Employee stock options and unvested restricted shares 91 43 188 --------------- --------------- --------------- Weighted average shares - Diluted 34,655 36,260 41,145 =============== =============== =============== Basic earnings per share $ 1.25 $ 2.58 $ 2.17 =============== =============== =============== Diluted earnings per share $ 1.25 $ 2.58 $ 2.16 =============== =============== ===============
69 GTECH HOLDINGS CORPORATION AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS NOTE J - INCOME TAXES The components of income before income taxes were as follows:
Fiscal Year Ended --------------------------------------------------------- February 24, 2001 February 26, 2000 February 27, 1999 ----------------- ----------------- ----------------- (Dollars in thousands) United States $ 13,455 $ 93,848 $ 51,773 Foreign 57,280 62,129 99,181 ---------------- ---------------- ------------- $ 70,735 $ 155,977 $ 150,954 ================ ================ =============
Significant components of the provision for income taxes were as follows:
Fiscal Year Ended -------------------------------------------------------- February 24, 2001 February 26, 2000 February 27, 1999 ----------------- ----------------- ----------------- (Dollars in thousands) Current: Federal $ 10,634 $ 12,375 $ 3,135 State 3,101 5,780 4,448 Foreign 27,187 42,484 44,440 --------------- ---------------- --------------- Total Current 40,922 60,639 52,023 --------------- ---------------- --------------- Deferred: Federal $ (17,149) $ (129) $ 14,216 State (931) 107 2,521 Foreign 4,745 1,775 (6,869) --------------- ---------------- --------------- Total Deferred (13,335) 1,753 9,868 --------------- ---------------- --------------- Total Provision $ 27,587 $ 62,392 $ 61,891 =============== ================ ===============
Significant components of the Company's deferred tax assets and liabilities were as follows:
February 24, 2001 February 26, 2000 ----------------- ----------------- (Dollars in thousands) Deferred tax assets: Accruals not currently deductible for tax purposes $ 19,956 $ 14,034 Tax credits 7,517 --- Special charges 3,822 --- Cash collected in excess of revenue recognized 3,690 5,398 Inventory reserves 2,207 2,788 Other 3,750 5,578 ------------- ------------ 40,942 27,798 Deferred tax liabilities: Depreciation (15,070) (15,553) Other (3,421) (3,129) ------------- ------------- (18,491) (18,682) ------------- ------------- Net deferred tax assets $ 22,451 $ 9,116 ============= ============
70 GTECH HOLDINGS CORPORATION AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS NOTE J - INCOME TAXES-(CONTINUED) 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 $5,977,000 at February 24, 2001. 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 $598,000. At February 24, 2001, the Company had $7,517,000 of tax credit carryforwards which will begin to expire in fiscal year 2020 if not utilized. 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 24, 2001 February 26, 2000 February 27, 1999 ----------------- ----------------- ----------------- Federal income tax using statutory rate 35.0% 35.0% 35.0% State taxes, net of federal benefit 2.0 2.5 3.0 Equity in earnings of unconsolidated affiliates --- .4 --- Nondeductible expenses 2.9 1.7 1.6 Goodwill 3.4 1.1 1.1 Tax credits (2.5) (1.0) (.8) Other (1.8) .3 1.1 ----------------- ------------------ ------------------ 39.0% 40.0% 41.0% ================= ================== ==================
71 GTECH HOLDINGS CORPORATION AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS NOTE K - TRANSACTIONS WITH RELATED PARTIES The Company has a 10% interest in Uthingo Management Proprietary Limited ("Uthingo"), which is accounted for using the equity method. Uthingo is a corporate joint venture that holds the license to operate the South African National Lottery. Sales of products and services to Uthingo were $28,236,000 and $41,845,000 in fiscal 2001 and 2000, respectively. At February 24, 2001 and February 26, 2000 the Company had trade receivables of $6,355,000 and $12,092,000 and loans receivable of $4,791,000 and $9,151,000 from Uthingo. Prior to February 24, 2001, the Company had a 50% interest in each of four joint ventures with Full House Resorts, Inc, ("Full House"). The joint ventures with Full House are engaged in the financing and development of Native American and other casino gaming ventures. At February 24, 2001 and February 26, 2000, the Company had a promissory note receivable ("Note") from Full House of $3,000,000. The Note bears interest at the prime rate due monthly. The principal balance on the Note was due on January 25, 2001. On March 30, 2001, after the close of its 2001 fiscal year, the Company sold its interest in three of the four joint ventures with Full House for cash consideration of $1,800,000 which approximated carrying value. In connection with this transaction, the Company amended the terms of the Note to extend the maturity date until January 25, 2002. The Company paid rent of $3,510,000, $3,510,000 and $2,612,000 to West Greenwich Technology Associates Limited Partnership (which is 50% owned by the Company and 50% owned by an unrelated third party), in fiscal 2001, 2000 and 1999, respectively, for the Company's West Greenwich, Rhode Island corporate headquarters and research and development and main production facility. Rent payments will escalate to $3,531,000 beginning March 1, 2004. Prior to February 2001, the Company held a 40% interest in Lottery Technology Enterprises ("LTE"). The Company's interest is now 1%. 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. Sales of products and services to LTE were $2,125,000, $3,598,000 and $4,155,000 in fiscal 2001, 2000 and 1999, respectively. At February 24, 2001 and February 26, 2000, the Company had receivables of $2,893,000 and $682,000, respectively, from LTE. 72 GTECH HOLDINGS CORPORATION AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS 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 24, 2001:
Fiscal Year (Dollars in thousands) ----------- 2002 $ 31,614 2003 28,699 2004 15,445 2005 12,504 2006 11,245 Thereafter 34,959 ------------------ Total minimum lease payments $ 134,466 ==================
Rental expense for operating leases was $31,632,000, $31,412,000 and $28,358,000 for fiscal 2001, 2000 and 1999, respectively. NOTE M - EMPLOYEE BENEFITS The Company has two defined contribution 401(k) retirement savings and profit sharing plans (the "Plans") covering substantially all 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 each year. The Company contributes this amount on the employee's behalf to the Plans and also makes a matching contribution. For periods prior to January 1, 2001, the employer matching contribution was equal to 50% of the amount that the employee elected to defer, up to a maximum matching contribution of 2 1/2% of the employee's base pay. Effective January 1, 2001, and subject to Board of Director approval, the Company increased the matching contribution for the U.S. Plan to 100% on the first 3% and 50% on the next 2% that the employee elects to defer, up to a maximum matching contribution of 4% of the employee's base pay. Participants are 100% vested at all times in the amounts they defer and the Company's matching contributions on these amounts. 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. Employees become 100% vested in these profit sharing contributions one year from their hire date. Benefits under the Plans generally will be paid to participants upon retirement or in certain other limited circumstances. In fiscal 2001, 2000, and 1999, the Company recorded expense under these Plans of $6,559,000, $5,840,000, and $7,070,000, 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 2001, 2000, and 1999 the Company recorded expense under this plan of $266,000, $275,000, and $415,000, respectively. 73 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, which 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. The "All Other" category (as reported below) is comprised of the Company's Transactive and IGI/Europrint subsidiaries (See Note P for additional information regarding the Company's Transactive subsidiary). The composition of the "All Other" category for all periods presented was changed during fiscal 2001 to reflect a value assessment of the Company's business whereby the Company's Dreamport business unit was consolidated into the Lottery segment. The Company's business segment data is summarized below:
Lottery All Other Consolidated -------------- --------- ------------ (Dollars in thousands) February 24, 2001 ----------------- OPERATING DATA: Revenues from external sources $ 889,522 $ 47,021 $ 936,543 Net operating profit after income taxes 85,708 3,570 89,278 Interest income 5,548 48 5,596 Equity in earnings of unconsolidated affiliates 3,167 --- 3,167 Depreciation 155,329 933 156,262 Intangibles amortization 11,968 --- 11,968 Goodwill amortization 5,006 1,159 6,165 BALANCE SHEET DATA (AT END OF PERIOD): Segment assets 896,010 42,150 938,160 CASH FLOW DATA: Capital expenditures 136,804 87 136,891 February 26, 2000 ----------------- OPERATING DATA: Revenues from external sources $ 956,054 $ 54,744 $ 1,010,798 Net operating profit after income taxes 113,651 1,528 115,179 Interest income 3,466 43 3,509 Equity in earnings of unconsolidated affiliates 2,843 --- 2,843 Depreciation 167,446 838 168,284 Intangibles amortization 10,839 --- 10,839 Goodwill amortization 5,094 1,159 6,253 BALANCE SHEET DATA (AT END OF PERIOD): Segment assets 852,766 38,257 891,023 CASH FLOW DATA: Capital expenditures 128,392 226 128,618
74 GTECH HOLDINGS CORPORATION AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS NOTE N - BUSINESS SEGMENT AND GEOGRAPHIC DATA-(CONTINUED)
Lottery All Other Consolidated -------------- --------- ------------ (Dollars in thousands) February 27, 1999 ----------------- OPERATING DATA: Revenues from external sources $ 917,284 $ 55,639 $ 972,923 Net operating profit after income taxes 112,694 608 113,302 Interest income 3,968 111 4,079 Equity in earnings of unconsolidated affiliates 7,113 --- 7,113 Depreciation 184,003 745 184,748 Intangibles amortization 8,719 --- 8,719 Goodwill amortization 5,082 772 5,854 BALANCE SHEET DATA (AT END OF PERIOD): Segment assets 834,988 39,227 874,215 CASH FLOW DATA: Capital expenditures 120,616 582 121,198
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 24, 2001 February 26, 2000 February 27, 1999 ----------------- ----------------- ----------------- (Dollars in thousands) Net operating profit after income taxes $ 89,278 $ 115,179 $ 113,302 Reconciling items, net of tax: Interest expense (16,571) (17,419) (16,169) Special (charges) credit (25,785) 662 (8,850) Other (3,774) (4,837) 780 -------------------- --------------------- ---------------- Net income $ 43,148 $ 93,585 $ 89,063 ==================== ===================== ================
The Company's geographic data is summarized below:
Fiscal Year Ended ------------------------------------------------------------------ February 24, 2001 February 26, 2000 February 27, 1999 ----------------- ----------------- ----------------- (Dollars in thousands) Revenues from external sources: United States $ 522,132 $ 530,193 $ 570,548 Brazil 127,015 117,639 118,611 Other foreign 287,396 362,966 283,764 -------------------- --------------------- ----------------- $ 936,543 $ 1,010,798 $ 972,923 ==================== ===================== =================
Revenues are attributed to countries based on the location of the customer. 75 GTECH HOLDINGS CORPORATION AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS NOTE N - BUSINESS SEGMENT AND GEOGRAPHIC DATA-(CONTINUED)
Fiscal Year Ended ------------------------------------------------------------------ February 24, 2001 February 26, 2000 February 27, 1999 ----------------- ----------------- ----------------- (Dollars in thousands) Systems, equipment and other assets relating to contracts: United States $ 185,717 $ 216,498 $ 260,585 Brazil 68,309 58,104 63,015 Other foreign 107,308 101,316 73,961 ------------------- --------------------- ----------------- $ 361,334 $ 375,918 $ 397,561 =================== ===================== =================
For fiscal 2001, 2000 and 1999, the aggregate revenues from Caixa Economica Federal in Brazil represented 12.1%, 10.7% and 11.2% of the Company's consolidated revenues, respectively. For fiscal 1999, the aggregate revenues from the Company's lottery operations in the state of Texas represented 10.6% of the Company's consolidated revenues. No other customer accounted for more than 10% of the consolidated revenues in such years. 76 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 at February 26, 2000 approximate fair value due primarily to its variable interest rate characteristics and its short-term tenure. At February 24, 2001, the Company had no outstanding borrowings under the Credit Facility. At February 24, 2001 and February 26, 2000, the estimated fair value of the Senior Notes as determined by an independent investment banker approximated $305,732,000 and $293,942,000, respectively. Foreign Currency Exchange Contracts At February 24, 2001, the Company had contracts for the sale of foreign currency of $94,820,000 (primarily Spanish pesetas, Australian dollars, and pounds sterling) and the purchase of foreign currency of $65,501,000 (primarily pounds sterling), compared to contracts for the sale of foreign currency of $87,749,000 (primarily Spanish pesetas, South African rand, and Irish punts) and the purchase of foreign currency of $66,675,000 (primarily pounds sterling) at February 26, 2000. 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 24, 2001 and February 26, 2000. The Company had minimal exposure to loss from nonperformance by the counterparties to its forward exchange contract agreements at the end of fiscal 2001 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. Interest Rate Swaps The Company uses various interest rate hedging instruments to reduce the risk associated with future interest rate fluctuations. In February 2000, the Company entered into two interest rate swaps with an aggregate notional amount of $150,000,000 that provided interest rate protection over the period February 25, 2000 to May 15, 2007. The swaps were designated as fair value hedges and effectively entitled the Company to exchange fixed rate payments for variable rate payments. Accordingly, the fair value of the swaps was recorded as an asset and the carrying value of the underlying debt was adjusted by an equal amount in accordance with FAS 133. On February 1, 2001, the Company sold the two interest rate swaps for $12,970,000. Under FAS 133, the carrying value of debt has been increased by $12,970,000, the fair value of the swaps prior to termination. This amount will be amortized as a reduction of interest expense over the period February 2001 through May 2007 on an effective yield basis. 77 GTECH HOLDINGS CORPORATION AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS NOTE P - SPECIAL CHARGES In the fourth quarter of fiscal 1998, the Company recorded a $99,382,000 special charge which consisted principally of costs to exit the electronic benefit transfer (EBT) business conducted by the Company's Transactive subsidiary ("Transactive"), costs associated with a worldwide workforce reduction and contractual obligations in connection with the departures of the Company's former Chairman and Vice-Chairman from the Company. 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. As a result, the Company recorded an additional special charge of $15,000,000 ($8,850,000 after-tax, or $.22 per 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. In fiscal 2001, the Company recorded special charges of $42,270,000 ($25,785,000 after-tax, or $0.74 per diluted share) in connection with certain contractual obligations and a value assessment of the Company's business operations. The major components of the special charges consisted of $13,958,000 for a workforce reduction that eliminated approximately 255 Company positions worldwide, $11,518,000 for contractual obligations in connection with the departures in July 2000 of the Company's former Chairman and Chief Executive Officer and former President and Chief Operating Officer, $8,536,000 for costs associated with the exit of certain business strategies and product lines and $8,258,000 for the termination of consulting agreements and facility exit costs, net of gains on the disposition of Company aircraft. A summary of the special charge activity is as follows:
Exit of Certain Business Disposition Worldwide Executive Strategies of EBT Workforce Contractual and Product Business Reduction Obligations Lines Other Total ----------- ---------- ----------- ---------------- -------- ---------- (Dollars in thousands) Balance at February 28, 1998 $ 5,929 $ 12,280 $ 8,513 $ --- $ 6,909 $ 33,631 Change in estimate 13,601 (2,948) (20) --- 4,367 15,000 Cash expenditures (3,662) (7,868) (8,493) --- (6,082) (26,105) Noncash charges (14,241) --- --- --- (2,227) (16,468) ----------- ---------- ----------- ---------- ---------- ---------- Balance at February 27, 1999 1,627 1,464 --- --- 2,967 6,058 ----------- ----------- ----------- ---------- ---------- ---------- Change in estimate (930) (37) --- --- (137) (1,104) Cash expenditures (697) (1,427) --- --- (2,830) (4,954) ----------- ---------- ----------- ---------- ---------- ---------- Balance at February 26, 2000 --- --- --- --- --- --- ----------- ---------- ----------- ---------- ---------- ---------- Special charges --- 13,958 11,518 8,536 8,258 42,270 Cash expenditures --- (6,032) (9,965) (4,140) (3,289) (23,426) Noncash charges --- --- --- (4,396) (4,017) (8,413) ----------- ---------- ----------- ---------- ---------- ---------- Balance at February 24, 2001 $ --- $ 7,926 $ 1,553 $ --- $ 952 $ 10,431 =========== ========== =========== ========== ========== ==========
78 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 2001 and 2000:
First Second Third Fourth Quarter Quarter Quarter Quarter ------------- -------------- ------------- ------------- (Dollars in thousands, except per share amounts) Fiscal year ended February 24, 2001: Service revenues $ 222,631 $ 204,209 $ 213,827 $ 215,808 Sales of products 19,367 23,399 7,204 30,098 Gross profit 83,424 55,371 68,421 90,388 Net income (loss) 20,229 (21,266) 18,287 25,898 Basic earnings (loss) per share $ .58 $ (.61) $ .53 $ .76 Diluted earnings (loss) per share $ .58 $ (.61) $ .53 $ .75 Fiscal year ended February 26, 2000: Service revenues $ 211,158 $ 209,843 $ 221,093 $ 218,325 Sales of products 27,502 45,546 28,473 48,858 Gross profit 80,630 82,664 90,065 100,177 Net income 18,935 21,754 22,779 30,117 Basic earnings per share $ .50 $ .58 $ .65 $ .87 Diluted earnings per share $ .50 $ .58 $ .65 $ .87
The Company recorded special charges of $40,018,000 and $2,252,000 in the second and fourth quarters of fiscal 2001, respectively (See Note P). Earnings per share are computed independently for each of the quarters presented. Therefore, the sum of the quarterly basic earnings per share in fiscal 2001 and the sum of the quarterly basic and diluted earnings per share in fiscal 2000 do not equal the total computed for the year. Certain reclassifications have been made to the prior years' financial statements to conform to the current year presentation. Goodwill amortization, that was included in cost of services and selling, general and administrative expense in prior periods has been presented as a single line item in the Consolidated Income Statements. NOTE R - SUBSEQUENT EVENT On March 19, 2001, the Company repurchased 5,000,000 shares of its Common Stock from its largest shareholder for $130,000,000. 79 ITEM 9. CHANGES AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE Not applicable. 80 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 Holdings' definitive proxy statement for its Annual Meeting of Shareholders scheduled to be held in July 2001, 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. 81 PART IV ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K (a) Financial Statement Schedules and Exhibits: Page(s) Report of Ernst & Young LLP, Independent Auditors The following consolidated financial statements of GTECH Holdings Corporation and subsidiaries are included in Item 8: Consolidated Balance Sheets at February 24, 2001 and February 26, 2000 Consolidated Income Statements Fiscal year ended February 24, 2001, Fiscal year ended February 26, 2000, and Fiscal year ended February 27, 1999 Consolidated Statements of Shareholders' Equity-- Fiscal year ended February 24,2001, Fiscal year ended February 26, 2000, and Fiscal year ended February 27, 1999 Consolidated Statements of Cash Flows-- Fiscal year ended February 24, 2001, Fiscal year ended February 26, 2000, and Fiscal year ended February 27, 1999 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. 82 (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 26, 2000). 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 (incorporated by reference to Exhibit 4.2 of Holdings' 1999 10-K). 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 (incorporated by reference to Exhibit 4.4 of Holdings' 1999 10-K). 4.5 Specimen Form of certificate of Common Stock (incorporated by reference to Exhibit 4.18 of the December 1992 S-1). +10.1 Agreement dated March 5, 2001 between Holdings and Howard S. Cohen.* +10.2 Amendment to Agreement dated March 28, 2001 between Holdings and Howard S. Cohen.*
83 10.3 Agreement dated August 9, 2000 between Holdings and W. Bruce Turner (incorporated by reference to Exhibit 10.3 of Holdings' 10-Q for the quarterly period ended August 26, 2000).* 10.4 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).* 10.5 First Amendment to Employment Agreement dated as of April 6, 1998 by and among GTECH, Holdings and William Y. O'Connor. (incorporated by reference to Exhibit 10.11 of Holdings' 1998 10-K).* 10.6 Severance Agreement and Release dated as of July 5, 2000 by and among GTECH, Holdings and William Y. O'Connor (incorporated by reference to Exhibit 10.1 of Holdings' 10-Q for the quarterly period ended August 26, 2000).* 10.7 Agreement dated January 15, 1999 by and between Steven P. Nowick and Holdings. (incorporated by reference to Exhibit 10.4 of Holdings' 1999 10-K).* 10.8 Resignation and Acceptance dated July 5, 2000 by and between Steven P. Nowick and Holdings (incorporated by reference to Exhibit 10.2 of Holdings' 10-Q for the quarterly period ended August 26, 2000).* 10.9 Form of Agreement, relating to a potential change of control involving Holdings, entered into between Holdings and, respectively, certain members of senior management (incorporated by reference to Exhibit 10.5 of Holdings' 2000 10-K).* +10.10 List of signatories to Agreement relating to potential change of control involving Holdings and certain members of senior management, with the respective dates of such Agreements.* 10.11 GTECH Corporation Executive Perquisites Program (incorporated by reference to Exhibit 10.6 of Holdings' 2000 10-K).* +10.12 List of participants in GTECH Corporation Executive Perquisites Program.* 10.13 Form of Executive Separation Agreement (incorporated by reference to Exhibit 10.18 of Holdings' 1996 10-K).* +10.14 Schedule of Recipients of Executive Separation Agreement. 10.15 Supplemental Retirement Plan effective January 1, 1992 (incorporated by reference to Exhibit 10.8 of Holdings 2000 10-K).* +10.16 List of Participants in Supplemental Retirement Plan.*
84 10.17 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 (available through the Public Reference Branch of the Securities and Exchange Commission, Washington, D.C.). 10.18 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). 10.19 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). 10.20 Agreement between Caixa Economica Federale and RACIMEC Informatica Brasileira S.A. (predecessor to GTECH Brasil Holdings, S.A.) respecting the provision of goods and services for the Brazil National Lottery (incorporated by reference to Exhibit 10.12 of Holdings' 2000 10-K). +10.21 Amendment to Agreement between Caixa Economica Federale and RACIMEC Informatica Brasileira S.A. (predecessor to GTECH Brasil Holdings, S.A.). 10.22 Amended and Restated Agreement of Limited Partnership by and among GTECH, GP Technology Associates, L.P. and GP Technology, Inc. dated August 26, 1993; 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 (available through the Public Reference Branch of the Securities and Exchange Commission, Washington, D.C.). 10.23 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). 10.24 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). 10.25 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).*
85 10.26 1996 Non-Employee Directors' Stock Option Plan (incorporated by reference to Exhibit 10.2 of Holdings' 10-Q for the quarterly period ended May 31, 1997).* +10.27 First Amendment to the 1996 Non-Employee Directors' Stock Option Plan.* 10.28 1997 Stock Option Plan (incorporated herein by reference to the Appendix of Holdings' 1997 Notice of Annual Meeting and Proxy Statement).* 10.29 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). 10.30 Income Deferral Plan - 1998 (incorporated by reference to Exhibit 10 of the Holdings' 10-Q for the quarterly period ended November 28, 1998).* 10.31 1999 Non-Employee Directors' Stock Option Plan (incorporated by reference to the Appendix of Holdings' 1999 Notice of Annual Meeting and Proxy Statement).* +10.32 First Amendment to the 1999 Non-Employee Directors' Stock Option Plan.* 10.33 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).* 10.34 Holdings' 2000 Restricted Stock Plan and Form of Restricted Stock Agreement (incorporated by reference to Exhibit 10.4 of Holdings' 10-Q for the quarterly period ended August 26, 2000).* 10.35 Holdings' 2000 Omnibus Stock Option and Long-Term Incentive Plan (incorporated by reference to Holdings' Proxy Statement filed on September 22, 2000).* +21.1 Subsidiaries of the Company. +23.1 Consent of Ernst & Young, LLP.
--------------------------- + 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. 86 (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. 87 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 April 23, 2001. GTECH HOLDINGS CORPORATION By: /s/ Howard S. Cohen ----------------------------------------------- Howard S. Cohen, Chief Executive Officer 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/ Howard S. Cohen Chief Executive Officer (principal executive officer) and Director April 23, 2001 ------------------------------------ Howard S. Cohen /s/ Jaymin B. Patel Senior Vice President & Chief Financial Officer (principal financial April 23, 2001 ------------------------------------ officer) Jaymin B. Patel /s/ Robert J. Plourde Vice President and Corporate Controller (principal accounting April 23, 2001 ------------------------------------ officer) Robert J. Plourde
88
SIGNATURE TITLE DATE /s/ Willam Bruce Turner ------------------------------------- Willam Bruce Turner Director, Chairman of the Board April 23, 2001 /s/ Robert M. Dewey, Jr. Director April 23, 2001 ------------------------------------ Robert M. Dewey, Jr. /s/ Burnett W. Donoho Director April 23, 2001 ------------------------------------ Burnett W. Donoho /s/ Philip R. Lochner, Jr. Director April 23, 2001 ------------------------------------ Philip R. Lochner, Jr. /s/ Moore Director April 23, 2001 ------------------------------------ The Rt. Hon. Lord Moore of Lower Marsh, P.C. /s/ Emmett Paige ------------------------------------- Lt. Gen. (Ret.) Emmett Paige, Jr. Director April 23, 2001 /s/ Anthony Ruys Director April 23, 2001 ------------------------------------ Anthony Ruys