-----BEGIN PRIVACY-ENHANCED MESSAGE----- Proc-Type: 2001,MIC-CLEAR Originator-Name: webmaster@www.sec.gov Originator-Key-Asymmetric: MFgwCgYEVQgBAQICAf8DSgAwRwJAW2sNKK9AVtBzYZmr6aGjlWyK3XmZv3dTINen TWSM7vrzLADbmYQaionwg5sDW3P6oaM5D3tdezXMm7z1T+B+twIDAQAB MIC-Info: RSA-MD5,RSA, LkTM4n053IrkdQnE9DL0Lb8ypv1WGk7+/yrMjuYgFr9FhVMj0QIoJoogduYjcGbh VHcVHqjIQYtF8RKR5fvScg== 0000950123-04-008172.txt : 20040702 0000950123-04-008172.hdr.sgml : 20040702 20040702160705 ACCESSION NUMBER: 0000950123-04-008172 CONFORMED SUBMISSION TYPE: 10-Q PUBLIC DOCUMENT COUNT: 6 CONFORMED PERIOD OF REPORT: 20040529 FILED AS OF DATE: 20040702 FILER: COMPANY DATA: COMPANY CONFORMED NAME: GTECH HOLDINGS CORP CENTRAL INDEX KEY: 0000857323 STANDARD INDUSTRIAL CLASSIFICATION: SERVICES-COMPUTER PROGRAMMING, DATA PROCESSING, ETC. [7370] IRS NUMBER: 050450121 STATE OF INCORPORATION: DE FISCAL YEAR END: 0223 FILING VALUES: FORM TYPE: 10-Q SEC ACT: 1934 Act SEC FILE NUMBER: 001-11250 FILM NUMBER: 04900015 BUSINESS ADDRESS: STREET 1: 55 TECNOLOGY WAY CITY: WEST GREENWICH STATE: RI ZIP: 02817 BUSINESS PHONE: 4013921000 MAIL ADDRESS: STREET 1: 55 TECHNOLOGY WAY STREET 2: LEGAL DEPARTMENT CITY: WEST GREENWICH STATE: RI ZIP: 02817 10-Q 1 y98616e10vq.txt GTECH HOLDINGS CORPORATION FORM 10-Q SECURITIES AND EXCHANGE COMMISSION Washington, D.C. 20549 QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the quarterly period ended May 29, 2004 Commission file number 1-11250 GTECH Holdings Corporation - -------------------------------------------------------------------------------- (Exact name of registrant as specified in its charter) Delaware 05-0450121 - -------------------------------------- ----------------------------------- (State or other jurisdiction of (I.R.S. Employer Identification incorporation or organization) Number) 55 Technology Way, West Greenwich, Rhode Island 02817 - -------------------------------------------------------------------------------- (Address of principal executive offices) (Zip Code) Registrant's telephone number, including area code: (401) 392-1000 Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes [X] No [ ] Indicate by check mark whether the registrant is an accelerated filer (as defined in Rule 12b-2 of the Securities Exchange Act of 1934) Yes [X] No [ ] At June 30, 2004, there were 59,007,693 shares of the registrant's Common Stock outstanding. INDEX GTECH HOLDINGS CORPORATION AND SUBSIDIARIES
Page PART I. FINANCIAL INFORMATION Number - ------------------------------ ------- Item 1. Financial Statements Consolidated Balance Sheets 3 Consolidated Income Statements 4 Consolidated Statements of Cash Flows 5 Consolidated Statements of Shareholders' Equity 6 Notes to Consolidated Financial Statements 7-20 Item 2. Management's Discussion and Analysis of Financial Condition 21-32 and Results of Operations Item 3. Quantitative and Qualitative Disclosures about Market Risk 33 Item 4. Controls and Procedures 33 PART II. OTHER INFORMATION Item 1. Legal Proceedings 34-35 Item 6. Exhibits and Reports on Form 8-K 36 SIGNATURES 37 EXHIBITS
PART 1. FINANCIAL INFORMATION Item 1. FINANCIAL STATEMENTS GTECH HOLDINGS CORPORATION AND SUBSIDIARIES CONSOLIDATED BALANCE SHEETS
(Unaudited) May 29, February 28, 2004 2004 ----------- ----------- (Dollars in thousands) ASSETS CURRENT ASSETS: Cash and cash equivalents $ 60,241 $ 129,339 Investment securities available-for-sale 12,145 221,850 Trade accounts receivable, net 130,431 118,902 Sales-type lease receivables 8,201 7,705 Inventories 97,368 76,784 Deferred income taxes 32,314 34,396 Other current assets 29,886 24,426 ----------- ----------- TOTAL CURRENT ASSETS 370,586 613,402 SYSTEMS, EQUIPMENT AND OTHER ASSETS RELATING TO CONTRACTS, net 620,700 591,362 GOODWILL, net 312,676 188,612 PROPERTY, PLANT AND EQUIPMENT, net 63,634 57,576 INTANGIBLE ASSETS, net 97,562 28,231 REFUNDABLE PERFORMANCE DEPOSIT 20,000 20,000 SALES-TYPE LEASE RECEIVABLES 15,801 17,653 OTHER ASSETS 38,540 42,295 ----------- ----------- TOTAL ASSETS $ 1,539,499 $ 1,559,131 =========== =========== LIABILITIES AND SHAREHOLDERS' EQUITY CURRENT LIABILITIES: Accounts payable $ 75,808 $ 80,004 Accrued expenses 49,465 47,428 Employee compensation 21,963 33,981 Advance payments from customers 127,238 104,128 Deferred revenue and advance billings 30,628 14,459 Income taxes payable 21,395 12,394 Taxes other than income taxes 20,171 19,459 Current portion of long-term debt 5,816 106,319 ----------- ----------- TOTAL CURRENT LIABILITIES 352,484 418,172 LONG-TERM DEBT, less current portion 453,463 463,215 OTHER LIABILITIES 55,898 53,736 DEFERRED INCOME TAXES 89,443 61,719 COMMITMENTS AND CONTINGENCIES - - SHAREHOLDERS' EQUITY: Preferred Stock, par value $.01 per share - 20,000,000 shares authorized, none issued - - Common Stock, par value $.01 per share - 150,000,000 shares authorized, 92,295,404 and 92,295,404 shares issued; 58,993,004 and 59,197,584 shares outstanding at May 29, 2004 and February 28, 2004, respectively 923 923 Additional paid-in capital 271,570 266,320 Accumulated other comprehensive loss (71,836) (70,508) Retained earnings 884,700 839,270 ----------- ----------- 1,085,357 1,036,005 Less cost of 33,302,400 and 33,097,820 shares in treasury at May 29, 2004 and February 28, 2004, respectively (497,146) (473,716) ----------- ----------- 588,211 562,289 ----------- ----------- TOTAL LIABILITIES AND SHAREHOLDERS' EQUITY $ 1,539,499 $ 1,559,131 =========== ===========
See Notes to Consolidated Financial Statements -3- GTECH HOLDINGS CORPORATION AND SUBSIDIARIES CONSOLIDATED INCOME STATEMENTS
(Unaudited) Three Months Ended ------------------------- May 29, May 24, 2004 2003 ---------- ----------- (Dollars in thousands, except per share amounts) Revenues: Services $ 253,326 $ 223,538 Sales of products 26,879 16,047 ---------- ----------- 280,205 239,585 Costs and expenses: Costs of services 147,293 126,797 Costs of sales 15,917 8,629 ---------- ----------- 163,210 135,426 ---------- ----------- Gross profit 116,995 104,159 Selling, general and administrative 27,635 24,280 Research and development 13,087 14,390 ---------- ----------- Operating expenses 40,722 38,670 ---------- ----------- Operating income 76,273 65,489 Other income (expense): Interest income 1,335 1,188 Equity in earnings of unconsolidated affiliates 1,306 1,929 Other income (expense) 10,525 (1,180) Interest expense (4,336) (2,306) ---------- ----------- 8,830 (369) ---------- ----------- Income before income taxes 85,103 65,120 Income taxes 31,488 24,094 ---------- ----------- Net income $ 53,615 $ 41,026 ========== =========== Basic earnings per share $ 0.90 $ 0.72 ========== =========== Diluted earnings per share $ 0.80 $ 0.68 ========== =========== Weighted average shares outstanding - basic 59,312 56,904 ========== =========== Weighted average shares outstanding - diluted 67,489 60,228 ========== =========== Dividends per share - common stock $ 0.17 $ - ========== ===========
See Notes to Consolidated Financial Statements -4- GTECH HOLDINGS CORPORATION AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF CASH FLOWS
(Unaudited) Three Months Ended ---------------------- May 29, May 24, 2004 2003 --------- --------- (Dollars in thousands) OPERATING ACTIVITIES Net income $ 53,615 $ 41,026 Adjustments to reconcile net income to net cash provided by operating activities: Depreciation 33,379 25,692 Intangibles amortization 1,633 447 Deferred income taxes benefit 7,237 - Tax benefit related to stock award plans 5,250 4,415 Net charge associated with the early retirement of debt 751 - Gain on sale of investment (10,924) - Equity in earnings of unconsolidated affiliates, net of dividends received (494) (959) Other 2,725 3,284 Changes in operating assets and liabilities: Trade accounts receivable (6,417) 11,447 Inventories (10,340) (12,426) Accounts payable (7,020) (2,049) Employee compensation (13,802) (17,438) Advance payments from customers 22,610 10,941 Deferred revenue and advance billings 16,169 2,920 Income taxes payable 9,899 (2,799) Other assets and liabilities (7,823) (1,532) --------- --------- NET CASH PROVIDED BY OPERATING ACTIVITIES 96,448 62,969 INVESTING ACTIVITIES Acquisitions (net of cash acquired) (193,018) - Purchases of systems, equipment and other assets relating to contracts (53,932) (58,663) Purchases of available-for-sale investment securities (49,895) - Maturities and sales of available-for-sale investment securities 259,600 - Proceeds from sale of investment 11,773 - Other (2,748) (1,186) --------- --------- NET CASH USED FOR INVESTING ACTIVITIES (28,220) (59,849) FINANCING ACTIVITIES Net proceeds from issuance of long-term debt - 1,409 Principal payments on long-term debt (91,239) (866) Purchases of treasury stock (28,275) - Redemption premium paid in connection with the early retirement of debt (10,610) - Dividends paid (10,103) - Proceeds from stock options 3,508 8,406 Other 769 (52) --------- --------- NET CASH PROVIDED BY (USED FOR) FINANCING ACTIVITIES (135,950) 8,897 Effect of exchange rate changes on cash (1,376) 3,285 --------- --------- INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS (69,098) 15,302 Cash and cash equivalents at beginning of period 129,339 116,174 --------- --------- CASH AND CASH EQUIVALENTS AT END OF PERIOD $ 60,241 $ 131,476 ========= =========
See Notes to Consolidated Financial Statements -5- GTECH HOLDINGS CORPORATION AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY - (Unaudited)
Accumulated Additional Other Outstanding Common Paid-in Comprehensive Retained Shares Stock Capital Loss Earnings ----------- ----------- ----------- ----------- ------------ (Dollars in thousands) Balance at February 28, 2004 59,197,584 $ 923 $ 266,320 $ (70,508) $ 839,270 Comprehensive income: Net income - - - - 53,615 Other comprehensive income (loss), net of tax: Foreign currency translation - - - (2,220) - Unrecognized net gain on derivative instruments - - - 894 - Unrealized loss on investments - - - (2) - Comprehensive income Treasury shares purchased (545,000) - - - - Cash dividends on common stock ($0.17 per share) - - - - (10,176) Shares issued under employee stock purchase and stock award plans 113,595 - - - 1,711 Shares issued upon exercise of stock options 226,825 - - - 280 Tax benefits related to stock award plans - - 5,250 - - ----------- ----------- ----------- ----------- ----------- Balance at May 29, 2004 58,993,004 $ 923 $ 271,570 $ (71,836) $ 884,700 =========== =========== =========== =========== =========== Treasury Stock Total ----------- ----------- Balance at February 28, 2004 $ (473,716) $ 562,289 Comprehensive income: Net income - 53,615 Other comprehensive income (loss), net of tax: Foreign currency translation - (2,220) Unrecognized net gain on derivative instruments - 894 Unrealized loss on investments - (2) ----------- Comprehensive income 52,287 Treasury shares purchased (28,275) (28,275) Cash dividends on common stock ($0.17 per share) - (10,176) Shares issued under employee stock purchase and stock award plans 1,617 3,328 Shares issued upon exercise of stock options 3,228 3,508 Tax benefits related to stock award plans - 5,250 ----------- ----------- Balance at May 29, 2004 $ (497,146) $ 588,211 =========== ===========
See Notes to Consolidated Financial Statements -6- NOTES TO CONSOLIDATED FINANCIAL STATEMENTS GTECH HOLDINGS CORPORATION AND SUBSIDIARIES NOTE 1- ORGANIZATION, BASIS OF PRESENTATION AND STOCK-BASED COMPENSATION PLANS ORGANIZATION GTECH Holdings Corporation ("Holdings") is a global technology services company providing software, networks and professional services that power high-performance solutions. We are the world's leading operator of highly-secure online lottery transaction processing systems, doing business in 45 countries worldwide and we have a growing presence in commercial gaming technology and financial services transaction processing. We have a single operating and reportable business segment, the Transaction Processing segment. In these notes, the terms "Holdings," "Company," "we," "our," and "us" refer to GTECH Holdings Corporation and all subsidiaries included in the consolidated financial statements, unless otherwise specified. The accounting policies of the Transaction Processing segment are the same as those described in Note 1 - "Organization and Summary of Significant Accounting Policies" in our Consolidated Financial Statements and footnotes included in our fiscal 2004 Annual Report on Form 10-K. Management evaluates the performance of this segment based on operating income. BASIS OF PRESENTATION The accompanying unaudited consolidated financial statements of Holdings, the parent of GTECH Corporation ("GTECH"), have been prepared in accordance with generally accepted accounting principles ("GAAP") for interim financial information and with the instructions to Form 10-Q and Article 10 of Regulation S-X. They do not include all information and notes required by GAAP for complete financial statements. In the opinion of management, all adjustments (consisting of normal recurring accruals) considered necessary for a fair presentation have been included. Operating results for the three-month period ended May 29, 2004 are not necessarily indicative of the results that may be expected for the full fiscal year ending February 26, 2005. The balance sheet at February 28, 2004 has been derived from the audited financial statements at that date. For further information refer to the Consolidated Financial Statements and footnotes included in our fiscal 2004 Annual Report on Form 10-K. Certain amounts in our prior period financial statements have been reclassified to conform to the current period presentation. Our Consolidated Statements of Cash Flows presents the $10.6 million redemption premium we paid in connection with the early retirement of debt as a financing activity. Our Form 8-K filing on June 22, 2004 (incorporating by reference a press release we issued on June 22, 2004 announcing our fiscal 2005 first quarter results) included a consolidated statement of cash flows presenting this redemption premium as an operating activity. STOCK-BASED COMPENSATION PLANS We follow Accounting Principles Board Opinion No. 25, "Accounting for Stock Issued to Employees" and related Interpretations in accounting for our stock-based compensation plans and we have elected to continue to use the intrinsic value-based method to account for stock option grants. We have adopted the disclosure-only provisions of Statement of Financial Accounting Standards No. 148, "Accounting for Stock-Based Compensation - Transition and Disclosure," an amendment of Statement of Financial Accounting Standards No. 123. Accordingly, no compensation expense has been recognized for our stock-based compensation plans other than for restricted stock. -7- NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued) NOTE 1 - ORGANIZATION, BASIS OF PRESENTATION AND STOCK-BASED COMPENSATION PLANS (continued) Had we elected to recognize compensation expense based upon the fair value at the grant dates for awards under these plans, net income and earnings per share would have been reduced to the pro forma amounts listed in the table below. The fair value of each grant is estimated on the date of grant using the Black-Scholes option pricing model.
Three Months Ended ------------------------------------------ May 29, May 24, 2004 2003 ------------------ ----------------- (Dollars in thousands, except per share amounts) Net income, as reported $ 53,615 $ 41,026 Add: Stock-based compensation expense included in reported net income, net of related tax effects 598 420 Deduct: Total stock-based compensation expense determined under the fair value method for all awards, net of related tax effects (2,012) (1,897) ------------------ ----------------- Pro forma net income $ 52,201 $ 39,549 ================== ================= Basic earnings per share: As reported $ .90 $ .72 Pro forma .88 .70 Diluted earnings per share: As reported $ .80 $ .68 Pro forma .78 .66
NOTE 2 - BUSINESS ACQUISITIONS SPIELO MANUFACTURING INCORPORATED On April 30, 2004, we completed the acquisition of privately-held Spielo Manufacturing Incorporated ("Spielo"), a leading provider of video lottery terminals ("VLT's") and related products and services to the global gaming industry, for an all-cash purchase price of approximately $150 million. In addition, we paid Spielo shareholders approximately $7 million out of a potential maximum earn-out amount of up to $35 million, which Spielo shareholders are entitled to receive in the 18 months following the closing, based upon Spielo achieving certain VLT installation objectives in New York. Approval of this transaction by our shareholders was not required. LEEWARD ISLANDS LOTTERY HOLDING COMPANY INC. On May 5, 2004, we completed the acquisition of privately-held Leeward Islands Lottery Holding Company Inc. ("LILHCo"), a lottery operating company headquartered on the Caribbean islands of Antigua and St. Croix, for an all-cash purchase price of approximately $40 million. Approval of this transaction by our shareholders was not required. We have not finalized the evaluation and allocation of the purchase price for the Spielo and LILHCo acquisitions as the appraisals associated with the valuation of certain tangible and intangible assets are not yet complete. We do not believe the appraisals will materially modify the preliminary purchase price allocations. These acquisitions are individually and in the aggregate, not material to our consolidated financial statements and accordingly, pro forma financial information has not been presented. -8- NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued) NOTE 3 - INVENTORIES
May 29, February 28, 2004 2004 ------------------ ----------------- (Dollars in thousands) Inventories consist of: Raw materials $ 23,437 $ 14,540 Work in progress 70,530 60,470 Finished goods 3,401 1,774 ------------------ ----------------- $ 97,368 $ 76,784 ================== =================
Inventories include amounts we manufacture or assemble for our long-term service contracts and amounts related to product sales contracts, including product sales which are accounted for using contract accounting. Work in progress at May 29, 2004 and February 28, 2004, includes approximately $65.4 million and $54.9 million, respectively, related to product sale contracts. Amounts received from customers in advance of revenue recognition (primarily related to product sale contracts included in work in progress above) totaled $127.2 million and $104.1 million at May 29, 2004 and February 28, 2004, respectively. NOTE 4 - PRODUCT WARRANTIES We offer a product warranty on all of our manufactured products (primarily terminals and related peripherals) sold to our customers. Although we do not have a standard product warranty, our typical warranty provides that we will repair or replace defective products for a period of time (usually a minimum of 90 days) from the date revenue is recognized or from the date a product is delivered and tested. We estimate product warranty costs that we expect to incur during the warranty period and we record a charge to costs of sales for the estimated warranty cost at the time the product sale is recorded. In determining the appropriate warranty provision, consideration is given to historical warranty cost information, the status of the terminal model in its life cycle and current terminal performance. We periodically assess the adequacy of our product warranty reserves and adjust them as necessary in the period when the information necessary to make the adjustment becomes available. We typically do not provide a product warranty on purchased products sold to our customers but attempt to pass the manufacturer's warranty, if any, on to them. A summary of product warranty activity, which is included in Accrued Expenses in our Consolidated Balance Sheets, is as follows (dollars in thousands): Balance at February 28, 2004 $ 749 Opening reserve balance associated with acquisitions 1,126 Additional reserves 81 Charges incurred (151) Change in estimate (300) ------------------ Balance at May 29, 2004 $ 1,505 ==================
-9- NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued) NOTE 5 - LONG-TERM DEBT
May 29, February 28, 2004 2004 ------------------ ----------------- (Dollars in thousands) Long-term debt consists of: 4.75% Senior Notes due October 2010 $ 249,650 $ 249,636 1.75% Convertible Debentures due December 2021 175,000 175,000 World Headquarters loan due January 2007 27,933 27,933 Deferred interest rate swap gains due through October 2010 1,272 12,009 Fair value of interest rate swaps (3,800) 4,893 7.87% Series B Guaranteed Senior Notes due May 2007 - 90,000 Other, due through April 2006 9,224 10,063 ------------------ ----------------- 459,279 569,534 Less current portion 5,816 106,319 ------------------ ----------------- $ 453,463 $ 463,215 ================== =================
We have a $300 million unsecured revolving credit facility expiring in June 2006 (the "Credit Facility"). There were no outstanding borrowings under the Credit Facility at May 29, 2004 or February 28, 2004. Up to $100 million of the Credit Facility may be used for the issuance of letters of credit. At May 29, 2004, there was $291.5 million available for borrowing under the Credit Facility, after considering $8.5 million of letters of credit issued and outstanding. In May 2004, GTECH repurchased the remaining $90.0 million of its 7.87% Series B Guaranteed Senior Notes due May 2007 (the "2007 Senior Notes"). The 2007 Senior Notes were unsecured and unsubordinated obligations of GTECH that were fully and unconditionally guaranteed by Holdings and certain of its subsidiaries. Interest was payable semi-annually in arrears on May 15 and November 15 of each year. In connection with this repurchase, we incurred a net charge of $0.8 million, principally comprised of a redemption premium net of deferred interest rate swap gains which was recorded in Other Income (Expense) in our Consolidated Income Statements. Holders of our 1.75% Convertible Debentures due December 2021 ("Debentures") may require us to repurchase all or part of their Debentures on December 15, 2004, December 15, 2006, December 15, 2011 and December 15, 2016 at a price equal to 100% of the principal amount of the Debentures, plus accrued interest. We have classified the Debentures as long-term liabilities in our Consolidated Balance Sheets at May 29, 2004 and February 28, 2004 because we intend to borrow under our $300 million Credit Facility to refinance any amount holders of the Debentures require us to repurchase on December 15, 2004. Any amount borrowed under the Credit Facility is expected to remain outstanding for an uninterrupted period extending beyond one year from May 29, 2004. NOTE 6 - COMMITMENTS AND CONTINGENCIES See "Legal Proceedings" in Part II, Item 1 and "Management's Discussion and Analysis of Financial Condition and Results of Operations" in Part I, Item 2 of this report. -10- NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued) NOTE 7 - GUARANTEES AND INDEMNIFICATIONS PERFORMANCE AND OTHER BONDS In connection with certain contracts and procurements, we have been required to deliver performance bonds for the benefit of our customers and bid and litigation bonds for the benefit of potential customers, respectively. These bonds give the beneficiary the right to obtain payment and/or performance from the issuer of the bond if the events set forth in the bond occur. In the case of performance bonds, which generally have a term of one year, such events include our failure to perform our obligations under the applicable contract. To obtain these bonds, we are required to indemnify the issuers against the costs they incur if a beneficiary exercises its rights under a bond. Historically, our customers have not exercised their rights under these bonds and we do not currently anticipate that they will do so. The following table provides information related to potential commitments at May 29, 2004:
Total potential commitments --------------- (in thousands) Performance bonds $ 214,528 Litigation bonds 8,138 Financial guarantees 4,609 All other bonds 2,137 --------------- $ 229,412 ===============
LOTTERY TECHNOLOGY SERVICES INVESTMENT CORPORATION We have a 44% interest in Lottery Technology Services Investment Corporation ("LTSIC"), which we account for using the equity method of accounting. LTSIC's wholly owned subsidiary, Lottery Technology Services Corporation ("LTSC"), provides equipment and services (which we supplied to LTSC), to the Bank of Taipei. The Bank of Taipei holds the license to operate the Taiwan Public Welfare Lottery. In fiscal 2002, in order to assist LTSC with the financing they required to enable them to perform under their obligation to operate the Taiwan Public Welfare Lottery on behalf of the Bank of Taipei, we guaranteed loans made to LTSC by an unrelated commercial lender. The loans have a maturity date of March 2007 and our guarantee expires in July 2007. We did not receive any consideration in exchange for our guarantees on behalf of LTSC. Rather, these guarantees were issued in connection with the formation of LTSC and LTSIC. At May 29, 2004, the principal amount of the loans was $5.3 million and our guarantee was $2.3 million. We are recognizing 56% of our product sales to, and service revenue from, LTSC. The remaining 44% of product sales (and related cost) and service revenue, has been deferred as a result of our equity interest in LTSIC and related guarantee of LTSC's debt, respectively, and is included in Deferred Revenue and Advance Billings and Other Liabilities in our Consolidated Balance Sheets at May 29, 2004 and February 28, 2004. Product sale deferrals are being recognized ratably over the life of our contract with LTSC and service revenue deferrals are being recognized as the guaranteed debt is repaid. At May 29, 2004, deferred product gross profit and deferred service revenue totaled $3.2 million and $2.3 million, respectively. -11- NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued) NOTE 7 - GUARANTEES AND INDEMNIFICATIONS (continued) TIMES SQUARED INCORPORATED We guaranteed outstanding lease obligations of Times Squared Incorporated ("Times Squared") for which we received no monetary consideration. The amount outstanding under the lease at May 29, 2004, was $2.3 million. Our guarantee expires in December 2013. Times Squared is a nonprofit corporation established to provide, among other things, secondary and high school level educational programs. Times Squared operates a Charter School for Engineering, Mathematics, Science and Technology in Providence, Rhode Island that serves inner city children who aspire to careers in the sciences and technology. LOTTERY TECHNOLOGY ENTERPRISES We have a 1% interest in Lottery Technology Enterprises ("LTE"), a joint venture between us and District Enterprise for Lottery Technology Applications of Washington, D.C. The joint venture agreement terminates on December 31, 2012. LTE holds a 10-year contract (which expires in November 2009) with the District of Columbia Lottery and Charitable Games Control Board. Under Washington, D.C. law, by virtue of our 1% interest in LTE, we are jointly and severally liable, with the other partner, for the acts of the joint venture. NOTE 8 -- COMPREHENSIVE INCOME The components of comprehensive income are as follows:
Three Months Ended ------------------------------------- May 29, May 24, 2004 2003 ------------------ ----------------- (Dollars in thousands) Net income $ 53,615 $ 41,026 Other comprehensive income (loss), net of tax Foreign currency translation (2,220) 9,217 Unrecognized net gain (loss) on derivative instruments 894 (5,048) Unrealized loss on investments (2) - ------------------ ----------------- Comprehensive income $ 52,287 $ 45,195 ================== =================
NOTE 9 - SALE OF INVESTMENT At February 28, 2004, we held a 50% interest in Gaming Entertainment (Delaware) L.L.C. ("GED"), an entity that manages a racino for Harrington Raceway, Inc. ("Harrington"). On April 9, 2004, we sold our 50% interest in GED to Harrington for $11.8 million and recognized a gain of $10.9 million which was recorded in Other Income (Expense) in our Consolidated Income Statements. -12- NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued) NOTE 10 - EARNINGS PER SHARE The following table shows the computation of basic and diluted earnings per share:
Three Months Ended ------------------------------------- May 29, May 24, 2004 2003 ------------------ ----------------- (Dollars and shares in thousands, except per share amounts) Numerator: Net income (Numerator for basic earnings per share) $ 53,615 $ 41,026 Effect of dilutive securities: Interest expense on 1.75% Convertible Debentures, net of tax 529 142 ------------------ ----------------- Numerator for diluted earnings per share $ 54,144 $ 41,168 ================== ================= Denominator: Denominator for basic earnings per share - weighted-average shares 59,312 56,904 Effect of dilutive securities: 1.75% Convertible Debentures 6,364 1,690 Employee stock options 1,690 1,567 Unvested restricted and stock bonus discount shares 123 67 ------------------ ----------------- Dilutive potential common shares 8,177 3,324 Denominator for diluted earnings per share - adjusted weighted-average shares and assumed conversions 67,489 60,228 ================== ================= Basic earnings per share $ .90 $ .72 ================== ================= Diluted earnings per share $ .80 $ .68 ================== =================
Our 1.75% Convertible Debentures ("Debentures") are convertible at the option of the holder into shares of our common stock at an initial conversion rate of 36.3636 shares of common stock per $1,000 principal amount of Debentures, which is equivalent to an initial conversion price of approximately $27.50 per share. The Debentures become convertible when, among other circumstances, the closing price of our common stock is more than 120% of the conversion price (approximately $33 per share) for at least 20 out of 30 consecutive trading days prior to the date of surrender for conversion. There are a total of 6.4 million shares issuable upon the conversion of the Debentures. The Debentures were convertible for all 64 trading days in the quarter ended May 29, 2004, and all 6.4 million shares were included in the computation of diluted earnings per share. For the quarter ended May 24, 2003, the debentures were convertible for 17 out of 64 trading days resulting in 1.7 million of the 6.4 million shares included in the computation of diluted earnings per share. -13- NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued) NOTE 11 - INCOME TAXES Our effective income tax rate is greater than the statutory rate primarily due to state income taxes. The effective income tax rate is based upon expected income for the year, the composition of income or loss in different jurisdictions and related statutory tax rates, accruals for tax contingencies and the tax consequences or benefits from audits or the resolution of tax contingencies. NOTE 12 - SUBSEQUENT EVENT On June 17, 2004, our Board of Directors approved a 2-for-1 common stock split, payable in the form of a stock dividend, which entitles each shareholder of record on July 1, 2004 to receive one share of common stock for each outstanding share of common stock held on that date. The stock dividend will be distributed on July 30, 2004. All references to common shares and per share amounts herein are presented on a pre-split basis. A June 25, 2004 ruling in a civil action initiated by federal attorneys with Brazil's Public Ministry will have the effect of materially reducing payments that we otherwise would receive over the remaining term of our lottery contract with Caixa Economica Federal ("CEF"), our customer and the operator of Brazil's National Lottery, which expires in May 2005. This ruling has ordered that 30% of payments subsequent to the June 25, 2004 ruling due to GTECH Brasil Ltda., our Brazilian subsidiary ("GTECH Brazil") from CEF, be withheld and deposited in an account maintained by the Court (as further discussed in "Legal Proceedings - Brazilian Legal Proceedings" in Part II, Item 1 in this report). Accordingly, we will not recognize service revenues for the payments that are withheld from GTECH Brazil, as realization of these amounts is not reasonably assured. In addition, the ruling ordered that all assets of GTECH Brazil be identified to the Court so as to prevent their transfer or disposition. As of May 29, 2004, GTECH Brazil assets approximated $25.0 million. NOTE 13 - SUPPLEMENTAL GUARANTOR/NON-GUARANTOR FINANCIAL INFORMATION On December 18, 2001, Holdings (the "Parent Company") issued, in a private placement, $175 million principal amount of 1.75% Convertible Debentures due December 15, 2021 (the "Debentures"). On October 9, 2003, the Parent Company issued, in a private placement, $250 million principal amount of 4.75% Senior Notes due October 15, 2010, all of which were subsequently exchanged for 4.75% Senior Notes due October 15, 2010 registered under the Securities Act of 1933 (the "Senior Notes"). The Debentures and Senior Notes are unsecured and unsubordinated obligations of the Parent Company that are jointly and severally, fully and unconditionally guaranteed by GTECH and two of its wholly owned subsidiaries: GTECH Rhode Island Corporation and GTECH Latin America Corporation (collectively with GTECH, the "Guarantor Subsidiaries"). Condensed consolidating financial information is presented below. Selling, general and administrative costs and research and development costs are allocated to each subsidiary based on the ratio of the subsidiaries' combined service revenues and sales of products to consolidated revenues. The Parent Company conducts business through its consolidated subsidiaries and unconsolidated affiliates and has, as its only material asset, an investment in GTECH. Equity in earnings of consolidated affiliates recorded by the Parent Company includes the Parent Company's share of the after-tax earnings of GTECH. Taxes payable and deferred income taxes are obligations of the subsidiaries. Income tax expense related to both current and deferred income taxes are allocated to each subsidiary based on our consolidated effective income tax rates. -14- NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued) NOTE 13 - SUPPLEMENTAL GUARANTOR/NON-GUARANTOR FINANCIAL INFORMATION (continued) Condensed Consolidating Balance Sheets May 29, 2004
Parent Guarantor Non-Guarantor Eliminating Company Subsidiaries Subsidiaries Entries Consolidated --------------- ------------- --------------- ------------- -------------- (Dollars in thousands) Assets Current Assets: Cash and cash equivalents $ - $ 15,804 $ 44,437 $ - $ 60,241 Investment securities available-for-sale - 12,145 - - 12,145 Trade accounts receivable, net - 69,728 60,703 - 130,431 Due from subsidiaries and affiliates - 46,143 - (46,143) - Sales-type lease receivables - 3,857 4,344 - 8,201 Inventories - 53,338 49,913 (5,883) 97,368 Deferred income taxes - 27,246 5,068 - 32,314 Other current assets - 11,814 18,072 - 29,886 --------------- ------------- --------------- ------------- -------------- Total Current Assets - 240,075 182,537 (52,026) 370,586 Systems, Equipment and Other Assets Relating to Contracts, net - 536,218 92,845 (8,363) 620,700 Investment in Subsidiaries and Affiliates 588,211 353,110 - (941,321) - Goodwill, net - 116,345 196,331 - 312,676 Property, Plant and Equipment, net - 28,292 35,342 - 63,634 Intangible Assets, net - 21,255 76,307 - 97,562 Refundable Performance Deposit - - 20,000 - 20,000 Sales-Type Lease Receivables - 7,020 8,781 - 15,801 Other Assets - 14,143 24,397 - 38,540 --------------- ------------- --------------- ------------- -------------- Total Assets $ 588,211 $ 1,316,458 $ 636,540 $ (1,001,710) $ 1,539,499 =============== ============= =============== ============== ============== Liabilities and Shareholders' Equity Current Liabilities: Accounts payable $ - $ 36,966 $ 38,842 $ - $ 75,808 Due to subsidiaries and affiliates - - 46,143 (46,143) - Accrued expenses - 26,228 23,237 - 49,465 Employee compensation - 14,972 6,991 - 21,963 Advance payments from customers - 68,937 58,301 - 127,238 Deferred revenue and advance billings - 19,811 10,817 - 30,628 Income taxes payable - 15,361 6,034 - 21,395 Taxes other than income taxes - 9,513 10,658 - 20,171 Current portion of long-term debt - 198 5,618 - 5,816 --------------- ------------- --------------- ------------- -------------- Total Current Liabilities - 191,986 206,641 (46,143) 352,484 Long-Term Debt, less current portion - 421,923 31,540 - 453,463 Other Liabilities - 39,500 16,398 - 55,898 Deferred Income Taxes - 60,592 28,851 - 89,443 Shareholders' Equity 588,211 602,457 353,110 (955,567) 588,211 --------------- ------------- --------------- -------------- -------------- Total Liabilities and Shareholders' Equity $ 588,211 $ 1,316,458 $ 636,540 $ (1,001,710) $ 1,539,499 =============== ============= =============== ============== ==============
-15- NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued) NOTE 13 - SUPPLEMENTAL GUARANTOR/NON-GUARANTOR FINANCIAL INFORMATION (continued) Condensed Consolidating Balance Sheets February 28, 2004
Parent Guarantor Non-Guarantor Eliminating Company Subsidiaries Subsidiaries Entries Consolidated --------------- ------------- --------------- ------------- -------------- (Dollars in thousands) Assets Current Assets: Cash and cash equivalents $ - $ 68,956 $ 60,383 $ - $ 129,339 Investment securities available-for-sale - 221,850 - - 221,850 Trade accounts receivable, net - 75,590 43,312 - 118,902 Due from subsidiaries and affiliates - 49,168 - (49,168) - Sales-type lease receivables - 3,967 3,738 - 7,705 Inventories - 52,697 29,943 (5,856) 76,784 Deferred income taxes - 30,254 4,142 - 34,396 Other current assets - 5,481 18,945 - 24,426 --------------- ------------- --------------- ------------- -------------- Total Current Assets - 507,963 160,463 (55,024) 613,402 Systems, Equipment and Other Assets Relating to Contracts, net - 518,976 80,111 (7,725) 591,362 Investment in Subsidiaries and Affiliates 562,289 162,788 - (725,077) - Goodwill, net - 115,965 72,647 - 188,612 Property, Plant and Equipment, net - 28,543 29,033 - 57,576 Intangible Assets, net - 21,850 6,381 - 28,231 Refundable Performance Deposit - - 20,000 - 20,000 Sales-Type Lease Receivables - 8,125 9,528 - 17,653 Other Assets - 20,822 21,473 - 42,295 --------------- ------------- --------------- ------------- -------------- Total Assets $ 562,289 $ 1,385,032 $ 399,636 $ (787,826) $ 1,559,131 =============== ============= =============== ============== ============== Liabilities and Shareholders' Equity Current Liabilities: Accounts payable $ - $ 54,967 $ 25,037 $ - $ 80,004 Due to subsidiaries and affiliates - - 49,168 (49,168) - Accrued expenses - 32,041 15,387 - 47,428 Employee compensation - 29,256 4,725 - 33,981 Advance payments from customers - 45,648 58,480 - 104,128 Deferred revenue and advance billings - 8,282 6,177 - 14,459 Income taxes payable - 4,419 7,975 - 12,394 Taxes other than income taxes - 8,643 10,816 - 19,459 Current portion of long-term debt - 100,886 5,433 - 106,319 --------------- ------------- --------------- -------------- -------------- Total Current Liabilities - 284,142 183,198 (49,168) 418,172 Long-Term Debt, less current portion - 430,652 32,563 - 463,215 Other Liabilities - 36,526 17,210 - 53,736 Deferred Income Taxes - 57,842 3,877 - 61,719 Shareholders' Equity 562,289 575,870 162,788 (738,658) 562,289 --------------- ------------- --------------- -------------- -------------- Total Liabilities and Shareholders' Equity $ 562,289 $ 1,385,032 $ 399,636 $ (787,826) $ 1,559,131 =============== ============= =============== ============== ==============
-16- NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued) NOTE 13 - SUPPLEMENTAL GUARANTOR/NON-GUARANTOR FINANCIAL INFORMATION (continued) Condensed Consolidating Income Statements Three Months Ended May 29, 2004
Parent Guarantor Non-Guarantor Eliminating Company Subsidiaries Subsidiaries Entries Consolidated --------------- ------------- --------------- -------------- -------------- (Dollars in thousands) Revenues: Services $ - $ 178,663 $ 74,663 $ - $ 253,326 Sales of products - 18,444 8,435 - 26,879 Intercompany sales and fees - 31,906 14,191 (46,097) - --------------- ------------- --------------- -------------- -------------- - 229,013 97,289 (46,097) 280,205 Costs and expenses: Costs of services - 104,074 43,737 (518) 147,293 Costs of sales - 11,368 4,562 (13) 15,917 Intercompany cost of sales and fees - 23,696 4,291 (27,987) - --------------- ------------- --------------- -------------- -------------- - 139,138 52,590 (28,518) 163,210 --------------- ------------- --------------- -------------- -------------- Gross profit - 89,875 44,699 (17,579) 116,995 Selling, general & administrative - 19,442 8,193 - 27,635 Research and development - 9,206 3,881 - 13,087 --------------- ------------- --------------- ------------- -------------- Operating expenses - 28,648 12,074 - 40,722 --------------- ------------- --------------- ------------- -------------- Operating income - 61,227 32,625 (17,579) 76,273 Other income (expense): Interest income - 613 722 - 1,335 Equity in earnings of unconsolidated affiliates - 1,341 (35) - 1,306 Equity in earnings of consolidated affiliates 53,615 28,241 - (81,856) - Other income (expense) - (1,429) 11,954 - 10,525 Interest expense - (3,897) (439) - (4,336) --------------- ------------- --------------- ------------- -------------- Income before income taxes 53,615 86,096 44,827 (99,435) 85,103 Income taxes - 31,856 16,586 (16,954) 31,488 --------------- ------------- --------------- -------------- -------------- Net income $ 53,615 $ 54,240 $ 28,241 $ (82,481) $ 53,615 =============== ============= =============== ============= ==============
-17- NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued) NOTE 13 - SUPPLEMENTAL GUARANTOR/NON-GUARANTOR FINANCIAL INFORMATION (continued) Condensed Consolidating Income Statements Three Months Ended May 24, 2003
Parent Guarantor Non-Guarantor Eliminating Company Subsidiaries Subsidiaries Entries Consolidated --------------- ------------- --------------- -------------- -------------- (Dollars in thousands) Revenues: Services $ - $ 166,303 $ 57,235 $ - $ 223,538 Sales of products - 11,616 4,431 - 16,047 Intercompany sales and fees - 26,847 10,305 (37,152) - --------------- ------------- --------------- ------------- -------------- - 204,766 71,971 (37,152) 239,585 Costs and expenses: Costs of services - 90,021 37,822 (1,046) 126,797 Costs of sales - 6,287 2,362 (20) 8,629 Intercompany cost of sales and fees - 15,970 4,646 (20,616) - --------------- ------------- --------------- ------------- -------------- - 112,278 44,830 (21,682) 135,426 --------------- ------------- --------------- ------------- -------------- Gross profit - 92,488 27,141 (15,470) 104,159 Selling, general & administrative - 18,033 6,247 - 24,280 Research and development - 10,684 3,706 - 14,390 --------------- ------------- --------------- ------------- -------------- Operating expenses - 28,717 9,953 - 38,670 --------------- ------------- --------------- ------------- -------------- Operating income - 63,771 17,188 (15,470) 65,489 Other income (expense): Interest income - 359 829 - 1,188 Equity in earnings of unconsolidated affiliates - 1,190 739 - 1,929 Equity in earnings of consolidated affiliates 41,026 9,478 - (50,504) - Other income (expense) - 2,018 (3,198) - (1,180) Interest expense - (1,793) (513) - (2,306) --------------- ------------- --------------- ------------- -------------- Income before income taxes 41,026 75,023 15,045 (65,974) 65,120 Income taxes - 27,759 5,567 (9,232) 24,094 --------------- ------------- --------------- ------------- -------------- Net income $ 41,026 $ 47,264 $ 9,478 $ (56,742) $ 41,026 =============== ============= =============== ============= ==============
-18- NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued) NOTE 13 - SUPPLEMENTAL GUARANTOR/NON-GUARANTOR FINANCIAL INFORMATION(continued) Condensed Consolidating Statements of Cash Flows Three Months Ended May 29, 2004
Parent Guarantor Non-Guarantor Eliminating Company Subsidiaries Subsidiaries Entries Consolidated ------------- ------------- --------------- ------------- -------------- (Dollars in thousands) Net cash provided by operating activities $ - $ 88,705 $ 8,064 $ (321) $ 96,448 Investing Activities Acquisitions (net of cash acquired) - - (193,018) - (193,018) Purchases of systems, equipment and other assets relating to contracts - (46,887) (7,366) 321 (53,932) Purchases of available-for-sale investment securities - (49,895) - - (49,895) Maturities and sales of available-for-sale investment securities - 259,600 - - 259,600 Proceeds from sale of investment - - 11,773 - 11,773 Other - (1,957) (791) - (2,748) ------------- ------------- --------------- ------------- -------------- Net cash provided by (used for) investing activities - 160,861 (189,402) 321 (28,220) Financing Activities Principal payments on long-term debt - (90,000) (1,239) - (91,239) Purchases of treasury stock (28,275) - - - (28,275) Redemption premium paid in connection with the early retirement of debt - (10,610) - - (10,610) Dividends paid (10,103) - - - (10,103) Proceeds from stock options 3,508 - - - 3,508 Intercompany capital transactions 34,055 (202,055) 168,000 - - Other 815 (46) - - 769 ------------- ------------- --------------- ------------- -------------- Net cash provided by (used for) financing activities - (302,711) 166,761 - (135,950) Effect of exchange rate changes on cash - (7) (1,369) - (1,376) ------------- ------------- --------------- ------------- -------------- Decrease in cash and cash equivalents - (53,152) (15,946) - (69,098) Cash and cash equivalents at beginning of period - 68,956 60,383 - 129,339 ------------- ------------- --------------- ------------- -------------- Cash and cash equivalents at end of period $ - $ 15,804 $ 44,437 $ - $ 60,241 ============= ============= =============== ============= ==============
-19- NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued) NOTE 13 - SUPPLEMENTAL GUARANTOR/NON-GUARANTOR FINANCIAL INFORMATION (continued) Condensed Consolidating Statements of Cash Flows Three Months Ended May 24, 2003
Parent Guarantor Non-Guarantor Eliminating Company Subsidiaries Subsidiaries Entries Consolidated -------------- ------------ -------------- ------------- -------------- (Dollars in thousands) Net cash provided by operating activities $ - $ 58,331 $ 4,675 $ (37) $ 62,969 Investing Activities Purchases of systems, equipment and other assets relating to contracts - (56,750) (1,950) 37 (58,663) Other - (1,186) - - (1,186) -------------- ------------- --------------- ------------- -------------- Net cash used for investing activities - (57,936) (1,950) 37 (59,849) Financing Activities Net proceeds from issuance of long-term debt - - 1,409 - 1,409 Principal payments on long-term debt - - (866) - (866) Proceeds from stock options 8,406 - - - 8,406 Intercompany capital transactions (8,876) 8,876 - - - Other 470 - (522) - (52) -------------- ------------- --------------- ------------- -------------- Net cash provided by financing activities - 8,876 21 - 8,897 Effect of exchange rate changes on cash - (5) 3,290 - 3,285 -------------- ------------- --------------- ------------- -------------- Increase in cash and cash equivalents - 9,266 6,036 - 15,302 Cash and cash equivalents at beginning of period - 88,739 27,435 - 116,174 -------------- ------------- --------------- ------------- -------------- Cash and cash equivalents at end of period $ - $ 98,005 $ 33,471 $ - $ 131,476 ============== ============= =============== ============= ==============
-20- Item 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS OVERVIEW The following Management's Discussion and Analysis ("MD&A") is intended to help the reader understand the financial results of GTECH Holdings Corporation. MD&A is provided as a supplement to, and should be read in conjunction with, our financial statements and the accompanying notes. This overview provides guidance on the individual sections of MD&A as follows: - - FORWARD-LOOKING STATEMENTS - cautionary information about forward-looking statements. - - OUR BUSINESS - a general description of our business; Brazilian legal proceedings; acquisitions; and other business developments. - - OPERATIONS REVIEW - an analysis of our consolidated results of operations for the three months ended May 29, 2004 and May 24, 2003 presented in our financial statements. We operate in one business - Transaction Processing, and we have a single operating and reportable business segment. Therefore, our discussions are not quantified by segment results. - - LIQUIDITY, CAPITAL RESOURCES AND FINANCIAL POSITION - an analysis of cash flows, financial position, and potential commitments. - - FINANCIAL RISK MANAGEMENT AND DIVIDEND POLICY - information about financial risk management; interest rate market risk; equity price risk; foreign currency exchange rate risk; and our dividend policy. - - SUBSEQUENT EVENT - information about our common stock split that occurred subsequent to May 29, 2004. Unless specified otherwise, we use the terms "Holdings," "the Company," "we," "our," and "us" in MD&A to refer to GTECH Holdings Corporation and its consolidated subsidiaries included in the consolidated financial statements. FORWARD-LOOKING STATEMENTS Statements contained in this section and elsewhere in this report which are not historical statements constitute "forward-looking statements" within the meaning of Section 27A of the Securities Act and Section 21E of the Securities Exchange Act of 1934. Generally, the words "believe," "expect," "estimate," "anticipate," "will," "may," "could," "plan," "continue" and similar expressions identify forward-looking statements. Such statements include, without limitation, statements relating to: - - the future prospects for and stability of the lottery industry and other businesses in which we are engaged or expect to be engaged; - - our future operating and financial performance; - - our ability to retain existing contracts and to obtain and retain new contracts; and - - the results and effects of legal proceedings and investigations. -21- These forward-looking statements reflect management's assessment based on information currently available, but are not guarantees and are subject to risks and uncertainties that could cause actual results to differ materially from those contemplated in the forward-looking statements. These risks and uncertainties include, among other things, the following: - - government regulations and other actions affecting the online lottery industry could have a negative effect on our business and sales; - - we may be subject to adverse determinations in legal proceedings (including recently announced legal proceedings in Brazil) which could result in substantial monetary judgments or reputational damage; - - our lottery operations are dependent upon our continued ability to retain and extend our existing contracts and win new contracts; - - slow growth or declines in sales of online lottery goods and services could lead to lower revenues and cash flows; - - we derive close to half of our revenues from foreign jurisdictions (including over ten percent in fiscal 2004 from our Brazilian operations) and are subject to the economic, political and social instability risks of doing business in foreign jurisdictions; - - our results of operations are exposed to foreign currency exchange rate fluctuations which could result in lower revenues, net income and cash flows when such results are translated into U.S. dollar accounts; - - we have a concentrated customer base and the loss of any of our larger customers (or lower sales from any of these customers) could lead to lower revenue; - - our quarterly operating results may fluctuate significantly, including as a result of variations in the amount and timing of product sales, the occurrence of large jackpots in lotteries (which increase the amount wagered and our revenue) and expenses incurred in connection with lottery start-ups; - - we operate in a highly competitive environment and increased competition may cause us to experience lower cash flows or to lose contracts; - - we are subject to substantial penalties for failure to perform under our contracts; - - we may not be able to respond to technological changes or to satisfy future technology demands of our customers in which case we could fall behind our competitors; - - if we are unable to manage potential risks related to acquisitions, our business and growth prospects could suffer; - - expansion of the gaming industry faces opposition which could limit our access to some markets; - - our business prospects and future success depend upon our ability to attract and retain qualified employees; - - our business prospects and future success rely heavily upon the integrity of our employees and executives and the security of our systems; - - our dependence on certain suppliers creates a risk of implementation delays if the supply contract is terminated or breached, and any delays may result in substantial penalties; - - our non-lottery ventures, which are an increasingly important aspect of our business, may fail; and - - other risks and uncertainties set forth below and elsewhere in this report, in our fiscal 2004 Form 10-K, and in our subsequent press releases and Form 10-Q's and other reports and filings with the Securities and Exchange Commission. The foregoing list of important factors is not all-inclusive. -22- OUR BUSINESS GENERAL We operate on a 52-week or 53-week fiscal year ending on the last Saturday in February and fiscal 2005 is a 52-week year that ends on February 26, 2005. Fiscal 2004 was a 53-week year and we included the extra week in our fourth quarter ended February 28, 2004. We are a global technology services company providing software, networks and professional services that power high-performance solutions. We are the world's leading operator of highly-secure online lottery transaction processing systems, doing business in 45 countries worldwide and we have a growing presence in commercial gaming technology and financial services transaction processing. In fiscal 2004, approximately 91% of our consolidated revenues were lottery related, approximately 7% were derived from commercial services transaction processing and approximately 2% were derived from gaming solutions. Comparatively, in fiscal 2003, lottery related revenues, commercial services transaction processing revenues and gaming solution revenues were approximately 93%, 5% and 2% of our consolidated revenues, respectively. Being a global business, we derive a substantial portion of our revenue from our operations outside of the United States. In particular, in fiscal 2004, we derived 49.4% of our revenues from international operations and 10.2% of our revenues from our Brazilian operations alone (including 9.7% of our revenues from Caixa Economica Federal, the operator of Brazil's National Lottery, our largest customer in fiscal 2004 based on annual revenues). In addition, substantial portions of our assets, primarily consisting of equipment we use to operate online lottery systems for our customers, are held outside of the United States. We are also exposed to more general risks of international operations, including increased governmental regulation of the online lottery industry in the markets where we operate; exchange controls or other currency restrictions; and significant political instability. We have derived substantially all of our revenues from the rendering of services and the sale or supply of computerized online lottery systems and components to government-authorized lotteries. Our service revenues are derived primarily from lottery service contracts, which are typically at least five years in duration, and generally provide compensation to us based upon a percentage of a lottery's gross online and instant ticket sales. These percentages vary depending on the size of the lottery and the scope of services provided to the lottery. We primarily derive product sale revenues from the installation of new online lottery systems, installation of new software and sales of lottery terminals and equipment in connection with the expansion of existing lottery systems. Our product margins fluctuate depending on the mix, volume and timing of product sale contracts. Our product sale revenues from period to period may not be comparable due to the size and timing of product sale transactions. During fiscal 2005, we currently anticipate that product sales will be in the range of $210 million to $220 million. Our compensation under lottery service contracts is typically based upon a percentage of a lottery's gross online and instant ticket sales. Over the past several fiscal years, we have experienced and may continue to experience a reduction in the percentage of lottery ticket sales we receive from certain customers resulting from contract rebids, extensions and renewals due to a number of factors, including the substantial growth of lottery sales over the last decade, reductions in the cost of technology and telecommunications services, and general market and competitive dynamics. In anticipation and response to these trends, beginning in fiscal 2001, we began the implementation of our new Enterprise Series-led technology strategy combined with the implementation of a number of ongoing cost savings initiatives and efficiency improvement programs designed to enable us to maintain our market leadership in the lottery industry. We are unable to determine at this time the likely effect of this trend on our business. -23- Our business is highly regulated, and the competition to secure new government contracts is often intense. From time to time, competitors challenge our contract awards and there have been, and may continue to be, investigations of various types, including grand jury investigations conducted by governmental authorities into possible improprieties and wrongdoing in connection with efforts to obtain and/or the awarding of lottery contracts and related matters. In light of the fact that such investigations frequently are conducted in secret, we may not necessarily know of the existence of an investigation which might involve us. Because our reputation for integrity is an important factor in our business dealings with lottery and other governmental agencies, a governmental allegation or a finding of improper conduct on our part or attributable to us in any manner could have a material adverse effect on our business, including our ability to retain existing contracts or to obtain new or renewal contracts. In addition, continuing adverse publicity resulting from these investigations and related matters could have a material adverse effect on our reputation and business. See the following for further information concerning these matters and other contingencies: - - "Legal Proceedings" in Part II, Item 1 in this report; - - Part I, Item 1 - "Certain Factors That May Affect Future Performance - Government regulations and other actions affecting the online lottery industry could have a negative effect on our business and sales" in our fiscal 2004 Annual Report on Form 10-K; - - Part I, Item 3 - "Legal Proceedings" in our fiscal 2004 Annual Report on Form 10-K; - - Note 13 to the Consolidated Financial Statements in our fiscal 2004 Annual Report on Form 10-K. BRAZILIAN LEGAL PROCEEDINGS Revenues from our lottery contract with Caixa Economica Federal ("CEF"), our customer and the operator of Brazil's National Lottery, accounted for 9.7% of our total fiscal 2004 revenues, making CEF our largest customer in fiscal 2004 based upon annual revenues. A June 25, 2004 ruling in a civil action initiated by federal attorneys with Brazil's Public Ministry will have the effect of materially reducing payments that we otherwise would receive over the remaining term of our lottery contract with CEF, which expires in May 2005. This ruling has ordered that 30% of payments subsequent to the June 25, 2004 ruling due to GTECH Brasil Ltda., our Brazilian subsidiary ("GTECH Brazil") from CEF, be withheld and deposited in an account maintained by the Court. In addition, the ruling ordered that all assets of GTECH Brazil be identified to the Court so as to prevent their transfer or disposition. As of May 29, 2004, GTECH Brazil assets approximated $25.0 million. We estimate that this decision will reduce our service revenues and pre-tax profits from our CEF contract by approximately $20 million during the remainder of fiscal 2005. Pending our appeal of this ruling, we intend to undertake a comprehensive review of our service and investment levels in Brazil. Refer to "Legal Proceedings - Brazilian Legal Proceedings" in Part II, Item 1 in this report; and Part 1, Item 3, "Legal Proceedings - Brazilian Legal Proceedings, The CEF Contract Extension Proceedings," and Note 13 to the Consolidated Financial Statements in our fiscal 2004 Annual Report on Form 10-K for detailed disclosures regarding this, and related matters. -24- ACQUISITIONS During the first quarter of fiscal 2005, we acquired privately-held Spielo Manufacturing Incorporated ("Spielo"), a leading provider of video lottery terminals ("VLT's") and related products and services to the global gaming industry, for an all-cash purchase price of approximately $150 million. In addition, we paid Spielo shareholders approximately $7 million out of a potential maximum earn-out amount of up to $35 million, which Spielo shareholders are entitled to receive in the 18 months following the closing, based upon Spielo achieving certain VLT installation objectives in New York. By acquiring Spielo, we will be better able to deliver a comprehensive, integrated VLT solution to our existing and potential customers, with a single point of contact and accountability. We also acquired privately-held Leeward Islands Lottery Holding Company Inc. ("LILHCo"), a lottery operating company headquartered on the Caribbean islands of Antigua and St. Croix, for an all-cash purchase price of approximately $40 million. By acquiring Caribbean-based LILHCo, we will enhance our strategic foothold in that region, as well as provide significant growth opportunities in additional jurisdictions throughout the Caribbean. We continue to evaluate a variety of opportunities to broaden our offerings of high-volume transaction processing services outside of our core market of providing online lottery services, such as the processing and transmission of commercial, non-lottery transactions including bill payments, electronic tax payments, utility payments, prepaid cellular telephone recharges and retail-based programs such as gift cards. Currently, our networks in Brazil, Poland, Chile, the Czech Republic and Jamaica process bill payments and other commercial service transactions. In the near term, we expect to concentrate our efforts to grow commercial service revenues principally in the United States, Latin America and Eastern Europe. While our goal is to leverage our technology, infrastructure and relationships to drive growth in commercial services, if, in the course of pursuing these opportunities, we identify an opportunity to gain access to certain markets through the acquisition of existing businesses, we may consider making such acquisitions. OTHER BUSINESS DEVELOPMENTS In April 2004, we were notified that our selection in February 2004 as the apparent successful vendor to provide equipment and services for a new online lottery system and associated telecommunications network in Mexico to Pronosticos para la Asistencia Publica ("Pronosticos") was retracted. As part of a ruling by the Mexican Comptroller Ministry on a protest filed by unsuccessful competitors, our bid was declared non-compliant and disqualified. Subsequently, Pronosticos announced that it disqualified the sole remaining bidder as also being non-compliant and formally ended the procurement. We believe that we submitted a fully compliant bid to Pronosticos that was in the best interest of the lottery. We are pursuing all appropriate avenues available to contest the Comptroller's decision. In the interim, as the incumbent lottery vendor, we will continue to operate the lottery under our existing contract. In fiscal 2004, the aggregate revenues from Pronosticos represented 1.3% of our consolidated revenues. In May 2004, we were notified by our customer, Loteria Electronica de Puerto Rico ("Loteria Electronica"), of its intent to negotiate a contract to provide equipment and services for a new online lottery system, terminals and associated telecommunications network with another vendor to take effect upon the expiration of our current contract in March 2005. In an effort to understand the rationale behind the decision, we filed a petition with the Court of Appeals to obtain a copy of the evaluation report, which was withheld by Loteria Electronica. We also requested, and were granted, a stay of contract negotiations between Loteria Electronica and the apparent successful vendor. We are currently awaiting the court's decision. In fiscal 2004, the aggregate revenues from Loteria Electronica represented 2.1% of our consolidated revenues. -25- OPERATIONS REVIEW COMPARISON OF THE THREE MONTH PERIODS ENDED MAY 29, 2004 AND MAY 24, 2003 Revenues were $280.2 million in the first quarter of fiscal 2005, compared to $239.6 million in the first quarter of fiscal 2004, up $40.6 million, or 17%. The following discussion on service revenues should be read in conjunction with the table below (in millions):
Three Months Ended ------------------------------------------------ Change May 29, May 24, -------------------- Service revenues 2004 2003 $ % - ---------------- ---------- ---------- ---------- ------ Domestic lottery $ 128.1 $ 120.9 $ 7.2 5.9 International lottery 98.5 85.8 12.7 14.7 Commercial services 20.4 12.0 8.4 70.5 Gaming solutions 5.6 4.2 1.4 33.8 All other 0.7 0.6 0.1 19.5 ---------- ---------- ---------- ---- $ 253.3 $ 223.5 $ 29.8 13.3 ========== ========== ========== ====
The 5.9% increase in domestic lottery service revenues was primarily due to higher service revenues from an increase in sales by our domestic lottery customers of approximately 6% with the balance principally due to the impact of the Interlott acquisition in the third quarter of fiscal 2004, along with higher jackpot activity and the launch of our new service contract in Tennessee, partially offset by contractual rate changes. While we are not able to quantify precisely the reasons for increases in sales by our domestic lottery customers, we believe that in general, such increases are attributable to enhanced marketing efforts by state lottery authorities seeking to offset declining tax revenues and the successful introduction by state lottery authorities of new games and products, modifications to existing games (such as matrix changes and more frequent drawings) and expanded distribution channels, such as Keno. The 14.7% increase in international lottery service revenues includes higher service revenues from an increase in sales by our international lottery customers of approximately 4%, with the balance of the increase due to the recognition of $5.0 million of deferred service revenue associated with our contract in Taiwan, along with the impact of contractual rate changes, favorable foreign exchange rates and the acquisition of LILHCo. While we are not able to quantify precisely the reasons for increases in sales by our international lottery customers, we believe that in general, such increases are attributable to more rapid growth rates typical of newer lottery jurisdictions, the successful introduction of new games and modifications to existing games (such as matrix changes and more frequent drawings). The 70.5% increase in commercial transaction processing service revenues was primarily due to the acquisition of PolCard in the second quarter or fiscal 2004, which contributed $7.1 million of service revenues in the first quarter of fiscal 2005. The 33.8% increase in gaming solutions service revenues was primarily due to the acquisition of Spielo and the installation of additional video lottery terminals in existing jurisdictions. Product, sales were $26.9 million in the first quarter of fiscal 2005, compared to $16.0 million in the first quarter of fiscal 2004, up $10.9 million or 67.5% principally due to the sale of terminals to our customer in Belgium and instant ticket vending machines for Pennsylvania. Our service margins were 41.9% in the first quarter of fiscal 2005 compared to 43.3% in the first quarter of fiscal 2004, primarily due to contractual rate changes and the impact of higher depreciation and amortization related principally to contract renewals and the implementation of new contracts, partially offset by the recognition of deferred service revenue associated with our contract in Taiwan. -26- Our product margins fluctuate depending on the mix, volume and timing of product sales contracts. Our product margins were 40.8% in the first quarter of fiscal 2005 compared to 46.2% in the first quarter of fiscal 2004. This decline was primarily due to the different mix of sales, with the prior year first quarter including several small volume, high margin sales. Operating expenses were $40.7 million in the first quarter of fiscal 2005, compared to $38.7 million in the first quarter of fiscal 2004, up $2.0 million, or 5.3%. This increase was driven by $3.3 million of increased spending on selling, general and administrative expenses, principally due to the consolidation of our recent acquisitions and increased activities in new business development. Our investment in research and development decreased by $1.3 million, primarily due to the timing of development initiatives, partially offset by the impact of the Spielo acquisition. As a percentage of revenues, operating expenses were 14.6% and 16.2% during the first quarters of fiscal 2005 and 2004, respectively. The components of other income in the first quarters of fiscal 2005 and fiscal 2004 are as follows (in millions):
Three Months Ended ----------------------------------- May 29, May 24, 2004 2003 ---------------- ----------------- Gain on sale of investment $ 10.9 $ - Foreign exchange gains (losses) 0.5 (0.8) Minority interest in consolidated subsidiaries (0.4) (0.6) Net charge associated with the early retirement of debt (0.8) - Other 0.3 0.2 ---------------- ----------------- Total other income $ 10.5 $ (1.2) ================ =================
The $10.9 million gain on sale of investment resulted from the sale in April 2004 of our 50% interest in Gaming Entertainment (Delaware) L.L.C. to Harrington Raceway, Inc. In May 2004, GTECH repurchased the remaining $90.0 million of its 7.87% Series B Guaranteed Senior Notes due May 2007 (the "2007 Senior Notes"). In connection with this repurchase, we incurred a net charge of $0.8 million, principally comprised of a redemption premium net of deferred interest rate swap gains. Interest expense was $4.3 million in the first quarter of fiscal 2005, compared to $2.3 million in the first quarter of fiscal 2004, up $2.0 million, or 88%. This increase was primarily due to higher debt balances resulting from the issuance of $250 million of 4.75% Senior Notes in the third quarter of fiscal 2004. Weighted average diluted shares in the first quarter of fiscal 2005 increased by 7.3 million shares to 67.5 million shares, primarily due to the assumed conversion of our $175 million principal amount of 1.75% Convertible Debentures (the "Debentures") into shares of our common stock, resulting in a decrease to diluted earnings per share of approximately $0.08. These Debentures are convertible at the option of the holder into shares of our common stock at a conversion price of approximately $27.50 per share when, among other circumstances, our stock closes above $33 per share for at least 20 out of 30 consecutive trading days prior to the date of surrender for conversion. There are a total of 6.4 million shares issuable upon the conversion of the Debentures. The Debentures were convertible for all 64 trading days in the first quarter of fiscal 2005, and accordingly, 6.4 million shares were included in the computation of diluted earnings per share. For the first quarter of fiscal 2004, the Debentures were convertible for 17 out of 64 trading days, and accordingly, 1.7 million shares were included in the computation of diluted earnings per share. -27- Our effective income tax rate of 37% in the first quarter of fiscal 2005 was comparable to the first quarter of fiscal 2004. We expect the second quarter tax rate to be comparable to the first quarter rate of 37%. We currently expect that our full-year effective income tax rate will be approximately 36% based on the pending resolution of certain tax contingencies and the recent acquisitions of non-U.S.-based companies. Our aggregate income tax rate in foreign jurisdictions is lower than our income tax rate in the United States. Our income tax rate may vary, however, depending on the composition of income or loss in different countries and the resolution of audits and tax contingencies. LIQUIDITY, CAPITAL RESOURCES AND FINANCIAL POSITION We believe our ability to generate cash from operations to reinvest in our business is one of our fundamental financial strengths and we expect to meet our financial commitments and operating needs in the foreseeable future. We expect to use cash generated from operating activities primarily for aggregate contractual obligations and to pay dividends. We expect our growth to be financed through a combination of cash generated from operating activities, existing sources of liquidity, access to capital markets and other sources of capital. Our debt ratings of Baa1 from Moody's and BBB (positive outlook) from Standard and Poor's contribute to our ability to access capital markets at attractive prices. These ratings reflect several factors, including our strong cash flows and balance sheet. ANALYSIS OF CASH FLOWS During the first quarter of fiscal 2005, we generated $96.4 million of cash from operations which, along with cash on hand, available-for-sale investment securities and proceeds of $11.8 million from the sale of our 50% interest in Gaming Entertainment (Delaware) L.L.C., was principally used to fund the Spielo and LILHCo acquisitions of $193.0 million and to purchase $53.9 million of systems, equipment and other assets relating to contracts. In addition, we repaid the remaining $90.0 million of our 7.87% Senior Notes and paid a related redemption premium of $10.6 million; repurchased $28.3 million, or 545,000 shares, of our common stock; and paid cash dividends of $10.1 million. At May 29, 2004, we had $60.2 million of cash and cash equivalents on hand and $12.1 million of available-for-sale investment securities. Our business is capital-intensive. We currently estimate that net cash to be used for investing activities in fiscal 2005, excluding net purchases of available-for-sale investment securities, will be in the range of $550 million to $570 million, including investments we made to acquire Spielo and LILHCo. We expect our principal sources of liquidity to be existing cash and available-for-sale investment securities, along with cash we generate from operations. Our credit facility provides for an unsecured revolving line of credit of $300 million and matures in June 2006. As of May 29, 2004, there were no borrowings under the credit facility. Up to $100 million of the Credit Facility may be used for the issuance of letters of credit. As of May 29, 2004 and June 23, 2004, after considering $8.5 million and $29.5 million of letters of credit issued and outstanding, there was $291.5 million and $270.5 million available for borrowing under the Credit Facility, respectively. We currently expect that our cash flow from operations, existing cash, available-for-sale investment securities, available borrowings under our credit facility and access to additional sources of capital will be sufficient, for the foreseeable future, to fund our anticipated working capital and ordinary capital expenditure needs, to service our debt obligations, to fund anticipated internal growth, to fund all or a portion of the cash needed for potential acquisitions, to pay dividends, to fund the capital requirements under our Master Contract with the Rhode Island Lottery and to repurchase shares of our common stock, from time to time, under our share repurchase programs. We may also seek alternative sources of financing to fund certain of our obligations under our Master Contract with the Rhode Island Lottery and to fund future potential acquisitions and growth opportunities that are not currently contemplated in the $550 million to $570 million we estimate we will need in fiscal 2005 for the uses disclosed above. -28- FINANCIAL POSITION Our balance sheet as of May 29, 2004, as compared to our balance sheet as of February 28, 2004, was impacted by our acquisitions of Spielo and LILHCo. Drivers of the material changes in each specific balance sheet category are described below. Investment securities available-for-sale decreased by $209.8 million, from $221.9 million at February 28, 2004 to $12.1 million at May 29, 2004, reflecting the $193.0 million payment for the Spielo and LILHCo acquisitions. Trade accounts receivable, net increased by $11.5 million, from $118.9 million at February 28, 2004 to $130.4 million at May 29, 2004, primarily due to $6.0 million related to the Spielo and LILHCo acquisitions. Inventories increased by $20.6 million, from $76.8 million at February 28, 2004 to $97.4 million at May 29, 2004, primarily due to $11.2 million of inventory associated with the acquisition of Spielo, along with an increase in inventory associated with product sales expected to be recorded during the second and fourth quarters of fiscal 2005. Systems, equipment and other assets relating to contracts, net, increased by $29.3 million, from $591.4 million at February 28, 2004 to $620.7 million at May 29, 2004, primarily due to the purchase of $53.9 million of systems, equipment and other assets relating to contracts (principally related to lottery system implementations in Wisconsin and Tennessee, lottery equipment installations in Texas, and the acquisition of Spielo), partially offset by depreciation expense. Goodwill, net, increased by $124.1 million, from $188.6 million at February 28, 2004 to $312.7 million at May 29, 2004, primarily due to the acquisitions of Spielo and LILHCo. Intangible assets, net, increased by $69.4 million, from $28.2 million at February 28, 2004 to $97.6 million at May 29, 2004, due to intangible assets recorded as a result of our acquisitions of Spielo and LILHCo. Employee compensation decreased by $12.0 million, from $34.0 million at February 28, 2004 to $22.0 million at May 29, 2004, primarily due to the payment of incentive compensation and profit sharing in April 2004. Advance payments from customers increased by $23.1 million, from $104.1 million at February 28, 2004 to $127.2 million at May 29, 2004, primarily due to advances from customers, including those related to product sales that are expected to be recorded during fiscal 2005 and 2006, partially offset by the sale of terminals to our customer in Belgium. Deferred revenue and advance billings increased by $16.1 million, from $14.5 million at February 28, 2004 to $30.6 million at May 29, 2004, primarily due to customer progress billings related to product sales expected to be recorded in the second quarter of fiscal 2005. Income taxes payable increased by $9.0 million, from $12.4 million at February 28, 2004 to $21.4 million at May 29, 2004, primarily due to the timing of estimated tax payments. Current portion of long-term debt decreased by $100.5 million, from $106.3 million at February 28, 2004 to $5.8 million at May 29, 2004, primarily due to the repayment in May 2004 of the remaining $90.0 million of our 7.87% Senior Notes. Deferred income taxes increased by $27.7, from $61.7 million at February 28, 2004 to $89.4 million at May 29, 2004 primarily due to deferred taxes associated with the Spielo and LILHCo acquisitions. -29- POTENTIAL COMMITMENTS Master Contract with the Rhode Island Lottery As previously reported, on May 12, 2003, we entered into a Master Contract with the Rhode Island Lottery (the "Lottery") that amends our existing contracts with the Lottery and grants us the right to be the exclusive provider of online, instant ticket and video lottery central systems and services for the Lottery during the 20-year term of the Master Contract for a $12.5 million up-front license fee which we paid in July 2003. Under the terms of the Master Contract, we are to invest (or cause to be invested) at least $100 million in the State of Rhode Island, in the aggregate, by December 31, 2008. This investment commitment includes the $12.5 million up-front license fee; new online and video lottery related hardware, software and services; the development of a new world headquarters facility of at least 210,000 square feet in Providence, Rhode Island by December 31, 2006; and improvements to our existing manufacturing facility in West Greenwich, Rhode Island. We have agreed to employ at least 1,000 people full-time in Rhode Island by the end of calendar year 2005 and maintain that level of employment thereafter. In the event the State of Rhode Island takes certain actions which affect our financial performance, we will be automatically released from the in-state employment obligation. In addition to being released from the employment requirement, we would be released from our obligations to invest (or cause to be invested) the $100 million, replace the online lottery gaming system, deliver certain other online lottery deliverables and replace the video lottery central system (all to the extent such obligations remain unperformed) and would be entitled to a refund of a pro-rata portion of the license fee. We currently plan to satisfy our obligation to invest (or cause to be invested) at least $100 million in the State of Rhode Island by December 31, 2008 as follows: (i) approximately $24 million that was invested during fiscal 2004; (ii) approximately $32 million that will be invested during fiscal 2005; and (iii) the balance that will be invested during fiscal 2006. The Lottery may terminate the Master Contract in the event that we fail to meet our obligations as stated above. In addition, in July 2003 we entered into a tax stabilization agreement with the City of Providence (the "City"), whereby the City agreed to stabilize the real estate and personal property taxes payable in connection with our new world headquarters facility in the City and the personal property associated with such facility for 20 years. We also agreed to complete and occupy the facility by December 31, 2006, employ 500 employees at the facility by 2009, and we made certain commitments regarding our employment, purchasing and education activities in the City. In June 2004, the Rhode Island legislature voted to approve a gaming facility development proposal, and to place such proposal before Rhode Island voters for consideration in a November 2004 referendum. The proposal passed by the Rhode Island legislature makes no provision for us to be a supplier of a percentage of the gaming machines in the proposed gaming facility, as we believe is contemplated by the Master Contract. Rhode Island Governor Carcieri has vetoed this legislation. It is widely anticipated, however, that the Rhode Island legislature will act to override Governor Carcieri's veto. In such event, and subject to the proposal receiving the requisite approval by Rhode Island voters, there can be no assurance that this gaming facility development proposal will not be implemented in accordance with its terms. We understand there are questions regarding the constitutionality of this legislation. We are reviewing our rights and obligations under the Master Agreement in light of these developments. -30- FINANCIAL RISK MANAGEMENT AND DIVIDEND POLICY FINANCIAL RISK MANAGEMENT The primary market risk inherent in our financial instruments and exposures is the potential loss arising from adverse changes in interest rates and foreign currency exchange rates. Our exposure to commodity price changes is not considered material and is managed through our procurement and sales practices. We use various techniques to manage our market risks, including from time to time, the use of derivative instruments. We manage our exposure to counterparty credit risk by entering into financial instruments with major, financially sound counterparties with high-grade credit ratings and by limiting exposure to any one counterparty. We do not engage in currency or interest rate speculation. INTEREST RATE MARKET RISK Interest rate market risk is estimated as the potential change in the fair value of our total debt or current earnings resulting from a hypothetical 10% adverse change in interest rates. The estimated fair value of our long-term debt and change in the estimated fair value due to hypothetical changes in interest rates are as follows (dollars in millions):
Estimated Fair Value ----------------------------------------------------------- At May 29, 10% Increase in 10% Decrease in 2004 Interest Rates Interest Rates --------------- ------------------ ------------------- $250 million of 4.75% Senior Notes $ 247.1 $ 246.1 $ 248.1 $175 million of 1.75% Convertible Debentures 362.3 362.0 362.5
The estimated fair values above were determined by an independent investment banker and the values of the Senior Notes were determined after taking into consideration $150 million of interest rate swaps. A hypothetical 10% adverse or favorable change in interest rates applied to variable rate debt would not have a material effect on current earnings. We use various techniques to mitigate the risk associated with future changes in interest rates, including entering into interest rate swaps. EQUITY PRICE RISK The estimated fair value of our $175 million of 1.75% Convertible Debentures and change in the estimated fair value due to hypothetical changes in the market price of our common stock is as follows (dollars in millions):
Estimated Fair Value ----------------------------------------------------------- 10% Increase in 10% Decrease in At May 29, Market Price of Market Price of 2004 Common Stock Common Stock --------------- ------------------ ------------------- $175 million of 1.75% Convertible Debentures $ 362.3 $ 396.7 $ 328.5
The estimated fair values above were determined by an independent investment banker and were based on a quoted market price of $207.00 per Debenture. -31- FOREIGN CURRENCY EXCHANGE RATE RISK We are subject to foreign exchange exposures arising from current and anticipated transactions denominated in currencies other than our functional currency, which is United States dollars, and from the translation of foreign currency balance sheet accounts into United States dollar balance sheet accounts. We seek to manage our foreign exchange risk by securing payment from our customers in United States dollars, by sharing risk with our customers, by utilizing foreign currency borrowings, by leading and lagging receipts and payments, and by entering into foreign currency exchange and option contracts. In addition, a significant portion of the costs attributable to our foreign currency revenues are payable in the local currencies. In limited circumstances, but whenever possible, we negotiate clauses into our contracts that allow for price adjustments should a material change in foreign exchange rates occur. From time to time, we enter into foreign currency exchange and option contracts to reduce the exposure associated with certain firm commitments, variable service revenues and certain assets and liabilities denominated in foreign currencies, but we do not engage in foreign currency speculation. These contracts generally have maturities of 12 months or less and are regularly renewed to provide continuing coverage throughout the year. At May 29, 2004, a hypothetical 10% adverse change in foreign exchange rates would result in a translation loss of $22.3 million that would be recorded in the equity section of our balance sheet. At May 29, 2004, a hypothetical 10% adverse change in foreign exchange rates would result in a net pre-tax transaction loss of $2.7 million that would be recorded in current earnings after considering the effects of foreign exchange contracts currently in place. At May 29, 2004, a hypothetical 10% adverse change in foreign exchange rates would result in a net reduction of cash flows from anticipatory transactions during the remainder of fiscal 2005 of $12.5 million, after considering the effects of foreign exchange contracts currently in place. The percentage of fiscal 2005 first quarter anticipatory cash flows that were hedged varied throughout the quarter, but averaged 28%. As of May 29, 2004, we had contracts for the sale of foreign currency of approximately $71.0 million (primarily Euro, Brazilian real and pounds sterling) and the purchase of foreign currency of approximately $57.0 million (primarily Canadian dollar, Brazilian real, New Taiwan dollars, pounds sterling and Swedish krona). DIVIDEND POLICY We are committed to returning value to our shareholders. Beginning in the second quarter of fiscal 2004, we commenced paying cash dividends on our common stock of $0.17 per share, equivalent to a full-year dividend of $0.68 per share. We currently plan to continue paying dividends in the foreseeable future. SUBSEQUENT EVENT On June 17, 2004, our Board of Directors approved a 2-for-1 common stock split, payable in the form of a stock dividend, which entitles each shareholder of record on July 1, 2004 to receive one share of common stock for each outstanding share of common stock held on that date. The stock dividend will be distributed on July 30, 2004. All references to common shares and per share amounts herein are presented on a pre-split basis. -32- Item 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK See "Financial Risk Management" above. Item 4. CONTROLS AND PROCEDURES We maintain disclosure controls and procedures that are designed to ensure that information required to be disclosed in our Securities Exchange Act reports is recorded, processed, summarized and reported within the time periods specified in the Securities and Exchange Commission's rules and forms, and that such information is accumulated and communicated to our management, including our President and Chief Executive Officer ("CEO") and our Senior Vice President and Chief Financial Officer ("CFO"), as appropriate, to allow timely decisions regarding required disclosure. In designing and evaluating the disclosure controls and procedures, management recognized that any controls and procedures, no matter how well designed and operated, can provide only reasonable assurance of achieving the desired control objectives and management was required to apply its judgment in evaluating the cost-benefit relationship of possible controls and procedures. Our controls and procedures are designed to provide a reasonable level of assurance in reaching our desired controls and procedures objectives. As of the end of the quarterly period covered by this report, we carried out an evaluation under the supervision and with the participation of our management, including our CEO and our CFO, of the effectiveness of the design and operation of our disclosure controls and procedures (as defined in Rule 13a-14(c) under the Securities Exchange Act of 1934). Based upon that evaluation, the CEO and CFO concluded that the Company's disclosure controls and procedures were effective in reaching a reasonable level of assurance of achieving management's desired controls and procedures objectives. In the first quarter of fiscal 2005, there were no significant changes in our internal controls or in other factors that could significantly affect these controls, and no corrective actions have been taken with regard to significant deficiencies or material weaknesses in such controls. -33- PART II. OTHER INFORMATION Item 1. LEGAL PROCEEDINGS BRAZILIAN LEGAL PROCEEDINGS CIVIL ACTION BY THE PUBLIC MINISTRY ATTORNEYS As previously reported, a civil action has been initiated by federal attorneys with Brazil's Public Ministry (the "Public Ministry Attorneys") in the Federal Court of Brasilia against GTECH Brasil Ltda., our Brazilian subsidiary ("GTECH Brazil"); 17 former officers and employees of Caixa Economica Federal, the Brazilian bank and operator of Brazil's National Lottery ("CEF"); the former president of Racimec; Antonio Carlos Rocha, the former Senior Vice President of GTECH Holdings Corporation and President of GTECH Brazil, and Marcos Andrade, another former officer of GTECH Brazil. The focus of this civil action is the contractual relationship between CEF, GTECH Brazil and GTECH Brazil's predecessor company, Racimec Informatica Brasileira S.A., for the period from 1994 to 2002. This civil action, which alleges that the defendants acted illegally in entering into, amending and performing the 1997 Contract and the 2000 Contract, seeks to invalidate the 2000 Contract (which, as extended, is still in force). This lawsuit also seeks to impose penalties equal to the sum of all amounts paid to us under the 1997 Contract and the 2000 Contract from January 1997 to present, which we estimate to be approximately US$650 million at current exchange rates, plus certain other permitted amounts, minus our proven investment costs. We learned earlier this week that on June 25, 2004 the judge hearing this civil action granted a procedural injunction ordering that 30% of payments due to GTECH Brazil from CEF under the 2000 Contract be withheld and deposited into an account maintained by the Court. The judge held that, as a foreign company doing business in Brazil, we do not have adequate in-country holdings to satisfy the potential claims should the plaintiff prevail in this lawsuit. This order provides a process to change the percentage of our payments to be withheld based upon a determination of our effective cost of servicing the 2000 Contract. The Court also ordered that all assets of GTECH Brazil be identified to the Court so as to prevent their transfer or disposition. The injunction was granted as part of a confidential ex parte proceeding in which we were not afforded an opportunity to participate. We intend to appeal the decision to grant this injunction. Pending the outcome of this appeal, we will undertake a comprehensive review of our service and investment levels in Brazil. With regard to the underlying civil action, we continue to believe that we have good and adequate defenses. We intend to vigorously defend ourselves in the proceedings. CRIMINAL ALLEGATIONS AGAINST CERTAIN EMPLOYEES As previously reported, in late March 2004 the Public Ministry Attorneys recommended that criminal charges be brought against nine individuals, including four senior officers of CEF; Antonio Carlos Rocha, the former Senior Vice President of GTECH Holdings Corporation and President of GTECH Brazil; and Marcelo Rovai, GTECH Brazil's marketing director. No other present or former employee of the Company has been implicated by the Public Ministry Attorneys. The Company is not the subject of this criminal investigation, and under Brazilian law (which provides that criminal charges may not be brought against corporations or other entities), we cannot be subject to criminal charges in connection with this matter. We understand that the Public Ministry Attorneys had recommended that Messrs. Rocha and Rovai be charged with offering an improper inducement in connection with the negotiation of the contract extension that we entered into in April 2003 to the 2000 Contract (the "2003 Contract"). We further understand that the Public Ministry Attorneys had recommended that Messrs. Rocha and Rovai be charged with effectively co-authoring or aiding and abetting certain allegedly fraudulent or inappropriate management practices of the CEF management who agreed to enter into the 2003 Contract Extension. -34- GTECH recently has learned that the judge reviewing these charges prior to their being filed has refused to initiate the criminal charges against the nine individuals, including against Messrs Rocha and Rovai. The judge chose not to accept any elements of the charges, as was his prerogative, but instead, has granted a request by the Brazilian Federal Police to continue the investigation which had been suspended by the recommendations of the Pubic Ministry Attorneys. The judge cited the prosecutors' rush to bring charges in response to the pressure of public opinion as a contributing factor to his decision to return the investigation to the Federal Police. The judge's order pertained to procedural aspects and not to the merits of the charges. We have cooperated fully with the investigation by Brazilian authorities respecting this matter, and have encouraged Messrs Rocha and Rovai to do the same. Moreover, the United States Securities and Exchange Commission has made an informal inquiry as to this matter, and we are cooperating fully with its inquiry. In addition, GTECH is currently conducting an internal investigation of this matter that is nearing its completion. We are satisfied from our preliminary findings that we have acted appropriately. OTHER LEGAL PROCEEDINGS SHAREHOLDER CLASS ACTION SUIT As previously reported, we, together with William Y. O'Connor, our former Chairman and Chief Executive Officer, Steven P. Nowick, our former President and Chief Operating Officer, and W. Bruce Turner, our former Chairman and current President and Chief Executive Officer, were named as defendants in a shareholder class action suit captioned Sandra Kafenbaum and Steven Schulman, individually and on behalf of all others similarly situated v. GTECH Holdings Corporation, et. al., which suit was filed in the U.S. District Court of Rhode Island in August 2000 and subsequently amended in February 2001. We recently have entered into an agreement with plaintiffs to settle this class action lawsuit on terms that would require payment by us of amounts that, after taking into account certain insurance proceeds that we expect to receive, will not be material to our financial condition or results of operation. We have previously fully reserved against such payments required of the Company. Final settlement is subject to court approval after a fairness hearing at which any objectors to the settlement will be provided the opportunity to present their views. This fairness hearing is scheduled to take place in September 2004. For further information respecting certain other legal proceedings, see Item 1, "Certain Factors Affecting Future Performance," Item 7, "Management's Discussion and Analysis of Financial Condition and Results of Operations," and Item 8, Note 13 to Notes to Consolidated Financial Statements of our fiscal 2004 Annual Report on Form 10-K. -35- Item 6. EXHIBITS AND REPORTS ON FORM 8-K (a) Exhibits - The exhibits to this report are as follows: 12.1 Computation of Ratio of Earnings to Fixed Charges 31.1 Certification Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002, of W. Bruce Turner, President and Chief Executive Officer of the Company 31.2 Certification Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002, of Jaymin B. Patel, Senior Vice President and Chief Financial Officer of the Company 32.1 Certification Pursuant to 18 United States Code Section 1350, as Adopted Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002, of W. Bruce Turner, President and Chief Executive Officer of the Company 32.2 Certification Pursuant to 18 United States Code Section 1350, as Adopted Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002, of Jaymin B. Patel, Senior Vice President and Chief Financial Officer of the Company (b) Reports on Form 8-K - We filed the following report with the Securities and Exchange Commission on Form 8-K during the quarter to which this report relates: (i) We filed a report on Form 8-K on April 15, 2004 incorporating by reference a press release we issued on April 15, 2004 announcing our fiscal 2004 fourth quarter and year end results. In addition, we incorporated by reference the transcripts and slide presentation from our fiscal 2004 fourth quarter and year earnings conference call held on April 15, 2004. -36- SIGNATURES Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized. GTECH HOLDINGS CORPORATION Date: July 2, 2004 By /s/ Jaymin B. Patel -------------------------------------------------- Jaymin B. Patel, Senior Vice President and Chief Financial Officer (Principal Financial Officer) Date: July 2, 2004 By /s/ Robert J. Plourde -------------------------------------------- Robert J. Plourde, Vice President, Corporate Controller and Chief Accounting Officer (Principal Accounting Officer) -37- EX-12.1 2 y98616exv12w1.txt COMPUTATION OF RATIO OF EARNINGS TO FIXED CHARGES . . . EXHIBIT 12.1 GTECH HOLDINGS CORPORATION AND SUBSIDIARIES COMPUTATION OF RATIO OF EARNINGS TO FIXED CHARGES
(Unaudited) Three Months Ended ------------------------- May 29, May 24, 2004 2003 -------- -------- (Dollars in thousands) Earnings: Income before income taxes $ 85,103 $ 65,120 Add: Interest on indebtedness 4,336 2,306 Equity in earnings of unconsolidated affiliates, net of dividends received (494) (959) Minority losses 353 575 Portion of rents representative of the interest factor 329 1,611 Amortization of capitalized interest 169 211 -------- -------- Adjusted earnings $ 89,796 $ 68,864 ======== ======== Fixed charges: Interest on indebtedness 4,336 2,306 Portion of rents representative of the interest factor 329 1,611 Capitalized interest 146 407 -------- -------- Total fixed charges $ 4,811 $ 4,324 ======== ======== Ratio of earnings to fixed charges 18.66 15.93 ======== ========
EX-31.1 3 y98616exv31w1.txt CERTIFICATE EXHIBIT 31.1 CERTIFICATION I, W. Bruce Turner, President and Chief Executive Officer of GTECH Holdings Corporation (the "Company"), certify that: (1) I have reviewed this quarterly report on Form 10-Q of the Company; (2) Based on my knowledge, this quarterly report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this quarterly report; (3) Based on my knowledge, the financial statements, and other financial information included in this quarterly report, fairly present in all material respects the financial condition, results of operations and cash flows of the Company as of, and for, the periods presented in this quarterly report; (4) The Company's other certifying officer and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a -15(e) and 15d-15(e)) for the Company and we have: (a) designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be designed under our supervision, to ensure that material information relating to the Company, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this quarterly report was being prepared; (b) evaluated the effectiveness of the Company's disclosure controls and procedures and presented in this quarterly report our conclusions about the effectiveness of the disclosure controls and procedures, as of the end of the period covered by this quarterly report based on such evaluation; and (c) disclosed in this quarterly report any change in the Company's internal control over financial reporting (as defined in Exchange Act Rules 13-15(f) and 15d-15(f)) that occurred during the Company's most recent fiscal quarter that has materially affected, or is reasonably likely to materially affect, the Company's internal control over financial reporting; and (5) The Company's other certifying officer and I have disclosed, based on our most recent evaluation, of internal control over financial reporting, to the Company's auditors and the audit committee of the Company's board of directors: (a) all significant deficiencies and material weaknesses in the design or operation of internal control over financial reporting which are reasonably likely to adversely affect the Company's ability to record, process, summarize and report financial information; and (b) any fraud, whether or not material, that involves management or other employees who have a significant role in the Company's internal control over financial reporting. GTECH HOLDINGS CORPORATION Date: July 2, 2004 By /s/ W. Bruce Turner ----------------------------------------------- W. Bruce Turner President and Chief Executive Officer EX-31.2 4 y98616exv31w2.txt CERTIFICATE EXHIBIT 31.2 CERTIFICATION I, Jaymin B. Patel, Senior Vice President and Chief Financial Officer of GTECH Holdings Corporation (the "Company"), certify that: (1) I have reviewed this quarterly report on Form 10-Q of the Company; (2) Based on my knowledge, this quarterly report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this quarterly report; (3) Based on my knowledge, the financial statements, and other financial information included in this quarterly report, fairly present in all material respects the financial condition, results of operations and cash flows of the Company as of, and for, the periods presented in this quarterly report; (4) The Company's other certifying officer and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a -15(e) and 15d-15(e)) for the Company and we have: (a) designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be designed under our supervision, to ensure that material information relating to the Company, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this quarterly report was being prepared; (b) evaluated the effectiveness of the Company's disclosure controls and procedures and presented in this quarterly report our conclusions about the effectiveness of the disclosure controls and procedures, as of the end of the period covered by this quarterly report based on such evaluation; and (c) disclosed in this quarterly report any change in the Company's internal control over financial reporting (as defined in Exchange Act Rules 13-15(f) and 15d-15(f)) that occurred during the Company's most recent fiscal quarter that has materially affected, or is reasonably likely to materially affect, the Company's internal control over financial reporting; and (5) The Company's other certifying officer and I have disclosed, based on our most recent evaluation, of internal control over financial reporting, to the Company's auditors and the audit committee of the Company's board of directors: (a) all significant deficiencies and material weaknesses in the design or operation of internal control over financial reporting which are reasonably likely to adversely affect the Company's ability to record, process, summarize and report financial information; and (b) any fraud, whether or not material, that involves management or other employees who have a significant role in the Company's internal control over financial reporting. GTECH HOLDINGS CORPORATION Date: July 2, 2004 By /s/ Jaymin B. Patel --------------------------------------------- Jaymin B. Patel, Senior Vice President and Chief Financial Officer EX-32.1 5 y98616exv32w1.txt CERTIFICATE EXHIBIT 32.1 GTECH HOLDINGS CORPORATION CERTIFICATION PURSUANT TO 18 U.S.C. SECTION 1350 AS ADOPTED PURSUANT TO SECTION 906 OF THE SARBANES-OXLEY ACT OF 2002 In connection with the Quarterly Report of GTECH Holdings Corporation (the "Company") on Form 10-Q for the period ending May 29, 2004 as filed with the Securities and Exchange Commission on the Date hereof (the "Report"), I, W. Bruce Turner, President and Chief Executive Officer of the Company, certify, pursuant to 18 U.S.C. section 1350, as adopted pursuant to sections 906 of the Sarbanes-Oxley Act of 2002, that: 1. The Report fully complies with the requirements of section 13(a) or 15(d) of the Securities Exchange Act of 1934; and 2. The information contained in the Report fairly presents, in all material respects, the financial condition and result of operations of the Company. GTECH HOLDINGS CORPORATION Date: July 2, 2004 By /s/ W. Bruce Turner -------------------------------------------- W. Bruce Turner President and Chief Executive Officer EX-32.2 6 y98616exv32w2.txt CERTIFICATE EXHIBIT 32.2 GTECH HOLDINGS CORPORATION CERTIFICATION PURSUANT TO 18 U.S.C. SECTION 1350 AS ADOPTED PURSUANT TO SECTION 906 OF THE SARBANES-OXLEY ACT OF 2002 In connection with the Quarterly Report of GTECH Holdings Corporation (the "Company") on Form 10-Q for the period ending May 29, 2004 as filed with the Securities and Exchange Commission on the Date hereof (the "Report"), I, Jaymin B. Patel, Senior Vice President and Chief Financial Officer of the Company, certify, pursuant to 18 U.S.C. section 1350, as adopted pursuant to sections 906 of the Sarbanes-Oxley Act of 2002, that: 1. The Report fully complies with the requirements of section 13(a) or 15(d) of the Securities Exchange Act of 1934; and 2. The information contained in the Report fairly presents, in all material respects, the financial condition and result of operations of the Company. GTECH HOLDINGS CORPORATION Date: July 2, 2004 By /s/ Jaymin B. Patel -------------------------------------------- Jaymin B. Patel, Senior Vice President and Chief Financial Officer -----END PRIVACY-ENHANCED MESSAGE-----