-----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, P/rPN/P9dWhOqk21v7ZZyWa/LdZJQUyb3vxBt6MZrgnISzUwT+lb54dzmiCAD/dg x05aT/LF7+BOlhV8+ko7lw== 0000950123-06-000063.txt : 20060104 0000950123-06-000063.hdr.sgml : 20060104 20060104161457 ACCESSION NUMBER: 0000950123-06-000063 CONFORMED SUBMISSION TYPE: 10-Q PUBLIC DOCUMENT COUNT: 6 CONFORMED PERIOD OF REPORT: 20051126 FILED AS OF DATE: 20060104 DATE AS OF CHANGE: 20060104 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: 06507881 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 y15952e10vq.txt FORM 10-Q UNITED STATES SECURITIES AND EXCHANGE COMMISSION WASHINGTON, D.C. 20549 ---------- FORM 10-Q [X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the quarterly period ended November 26, 2005 OR [ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 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) (401) 392-1000 (Registrant's telephone number, including area code) ---------- 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 Exchange Act). Yes [X] No [ ] Indicate by check mark whether the Registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes [ ] No [X] Number of shares of Registrant's Common Stock outstanding as of December 31, 2005: 126,447,032 INDEX GTECH HOLDINGS CORPORATION AND SUBSIDIARIES
Page PART I. FINANCIAL INFORMATION Number ------ Item 1. Financial Statements Consolidated Balance Sheets 3 Consolidated Income Statements 4-5 Consolidated Statements of Cash Flows 6 Consolidated Statement of Shareholders' Equity 7 Notes to Consolidated Financial Statements 8-26 Item 2. Management's Discussion and Analysis of Financial Condition 27-43 and Results of Operations Item 3. Quantitative and Qualitative Disclosures about Market Risk 44 Item 4. Controls and Procedures 44 PART II. OTHER INFORMATION Item 1. Legal Proceedings 44 Item 2. Unregistered Sales of Equity Securities and Use of Proceeds 45 Item 6. Exhibits 46 SIGNATURES 46 EXHIBITS
PART 1. FINANCIAL INFORMATION Item 1. FINANCIAL STATEMENTS GTECH HOLDINGS CORPORATION AND SUBSIDIARIES CONSOLIDATED BALANCE SHEETS
(Unaudited) November 26, February 26, 2005 2005 ------------ ------------ (Dollars in thousands) ASSETS CURRENT ASSETS: Cash and cash equivalents $ 167,587 $ 94,446 Investment securities available-for-sale 261,275 196,825 Trade accounts receivable, net 159,324 168,706 Sales-type lease receivables 3,138 3,461 Refundable performance deposit 8,000 8,000 Inventories 86,958 61,135 Deferred income taxes 24,416 31,435 Other current assets 32,902 26,646 ------------ ------------ TOTAL CURRENT ASSETS 743,600 590,654 SYSTEMS, EQUIPMENT AND OTHER ASSETS RELATING TO CONTRACTS, net 685,832 720,438 GOODWILL 345,809 331,022 PROPERTY, PLANT AND EQUIPMENT, net 94,454 74,558 INTANGIBLE ASSETS, net 68,645 70,839 REFUNDABLE PERFORMANCE DEPOSIT 12,000 12,000 SALES-TYPE LEASE RECEIVABLES 2,722 4,756 OTHER ASSETS 41,870 50,874 ------------ ------------ TOTAL ASSETS $ 1,994,932 $ 1,855,141 ============ ============ LIABILITIES AND SHAREHOLDERS' EQUITY CURRENT LIABILITIES: Accounts payable $ 58,802 $ 99,234 Accrued expenses 56,516 54,227 Employee compensation 33,383 21,862 Advance payments from customers 55,493 42,865 Deferred revenue and advance billings 40,377 29,705 Income taxes payable 45,966 16,499 Taxes other than income taxes 17,867 16,572 Short term borrowings -- 334 Current portion of long-term debt 2,518 2,476 ------------ ------------ TOTAL CURRENT LIABILITIES 310,922 283,774 LONG-TERM DEBT, less current portion 561,850 726,329 OTHER LIABILITIES 99,946 83,260 DEFERRED INCOME TAXES 92,034 106,010 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 - 200,000,000 shares authorized, 126,366,782 and 116,551,144 shares issued; 126,366,782 and 115,006,751 shares outstanding at November 26, 2005 and February 26, 2005, respectively 1,264 1,166 Additional paid-in capital 427,528 278,204 Accumulated other comprehensive loss (44,950) (43,227) Retained earnings 546,338 455,537 ------------ ------------ 930,180 691,680 Less cost of 1,544,393 shares in treasury at February 26, 2005 -- (35,912) ------------ ------------ 930,180 655,768 ------------ ------------ TOTAL LIABILITIES AND SHAREHOLDERS' EQUITY $ 1,994,932 $ 1,855,141 ============ ============
See Notes to Consolidated Financial Statements -3- GTECH HOLDINGS CORPORATION AND SUBSIDIARIES CONSOLIDATED INCOME STATEMENTS
(Unaudited) Three Months Ended ------------------------------ November 26, November 27, 2005 2004 ------------ ------------ (Dollars in thousands, except per share amounts) Revenues: Services $ 270,889 $ 251,945 Sales of products 29,249 63,702 ------------ ------------ 300,138 315,647 Costs and expenses: Costs of services 164,984 155,962 Costs of sales 17,330 44,187 ------------ ------------ 182,314 200,149 ------------ ------------ Gross profit 117,824 115,498 Selling, general and administrative 33,751 29,740 Research and development 11,446 13,007 ------------ ------------ Operating expenses 45,197 42,747 ------------ ------------ Operating income 72,627 72,751 Other income (expense): Interest income 2,836 642 Equity in earnings of unconsolidated affiliates 817 810 Other expense (1,018) (2,070) Interest expense (7,892) (3,688) ------------ ------------ (5,257) (4,306) ------------ ------------ Income before income taxes 67,370 68,445 Income taxes 19,537 22,590 ------------ ------------ Net income $ 47,833 $ 45,855 ============ ============ Basic earnings per share $ 0.38 $ 0.40 ============ ============ Diluted earnings per share $ 0.37 $ 0.35 ============ ============ Weighted average shares outstanding - basic 125,333 115,708 ============ ============ Weighted average shares outstanding - diluted 130,875 131,435 ============ ============ Cash dividends declared per common share $ 0.085 $ 0.085 ============ ============ See Notes to Consolidated Financial Statements
-4- GTECH HOLDINGS CORPORATION AND SUBSIDIARIES CONSOLIDATED INCOME STATEMENTS
(Unaudited) Nine Months Ended ------------------------------ November 26, November 27, 2005 2004 ------------ ------------ (Dollars in thousands, except per share amounts) Revenues: Services $ 828,594 $ 753,385 Sales of products 107,885 165,982 ------------ ------------ 936,479 919,367 Costs and expenses: Costs of services 495,525 451,736 Costs of sales 63,678 103,978 ------------ ------------ 559,203 555,714 ------------ ------------ Gross profit 377,276 363,653 Selling, general and administrative 95,608 87,264 Research and development 35,627 38,741 ------------ ------------ Operating expenses 131,235 126,005 ------------ ------------ Operating income 246,041 237,648 Other income (expense): Interest income 6,986 2,958 Equity in earnings of unconsolidated affiliates 3,135 2,409 Other income (expense) (3,450) 6,531 Interest expense (23,162) (11,743) ------------ ------------ (16,491) 155 ------------ ------------ Income before income taxes 229,550 237,803 Income taxes 77,921 85,252 ------------ ------------ Net income $ 151,629 $ 152,551 ============ ============ Basic earnings per share $ 1.26 $ 1.30 ============ ============ Diluted earnings per share $ 1.17 $ 1.16 ============ ============ Weighted average shares outstanding - basic 120,277 117,133 ============ ============ Weighted average shares outstanding - diluted 130,257 133,050 ============ ============ Cash dividends declared per common share $ 0.255 $ 0.255 ============ ============
See Notes to Consolidated Financial Statements -5- GTECH HOLDINGS CORPORATION AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF CASH FLOWS
(Unaudited) Nine Months Ended ------------------------------ November 26, November 27, 2005 2004 ------------ ------------ (Dollars in thousands) OPERATING ACTIVITIES Net income $ 151,629 $ 152,551 Adjustments to reconcile net income to net cash provided by operating activities: Depreciation 125,081 105,645 Intangibles amortization 7,945 9,127 Deferred income taxes 4,407 28,213 Tax benefit related to stock award plans 7,110 10,889 Minority interest 2,287 2,178 Equity in earnings of unconsolidated affiliates, net of dividends received (612) 1,071 Gain on sale of investments (751) (10,924) Other 16,718 12,695 Changes in operating assets and liabilities: Trade accounts receivable 2,532 (27,832) Inventories (25,884) 4,207 Accounts payable (35,873) (8,695) Employee compensation 10,083 (10,433) Advance payments from customers 12,628 (13,762) Deferred revenue and advance billings 10,672 15,158 Income taxes payable 29,456 14,232 Other assets and liabilities (8,906) (5,844) ------------ ------------ NET CASH PROVIDED BY OPERATING ACTIVITIES 308,522 278,476 INVESTING ACTIVITIES Acquisitions (net of cash acquired) (21,869) (200,764) Purchases of systems, equipment and other assets relating to contracts (92,382) (189,374) Purchases of available-for-sale investment securities (147,275) (50,150) Maturities and sales of available-for-sale investment securities 82,825 272,000 Purchases of property, plant and equipment (6,712) (9,134) License fee (1,750) -- Investments in and advances to unconsolidated subsidiaries (1,488) (2,503) (Increase) decrease in restricted cash 5,080 (5,138) Proceeds from sale of investment 3,000 11,773 ------------ ------------ NET CASH USED FOR INVESTING ACTIVITIES (180,571) (173,290) FINANCING ACTIVITIES Net proceeds from issuance of long-term debt -- 343,254 Principal payments on long-term debt (2,259) (142,657) Purchases of treasury stock (32,051) (100,536) Dividends paid (30,921) (29,988) Premiums and fees paid in connection with the early retirement of debt -- (10,610) Proceeds from stock options 9,406 11,810 Other 594 2,339 ------------ ------------ NET CASH PROVIDED BY (USED FOR) FINANCING ACTIVITIES (55,231) 73,612 Effect of exchange rate changes on cash 421 1,464 ------------ ------------ INCREASE IN CASH AND CASH EQUIVALENTS 73,141 180,262 Cash and cash equivalents at beginning of period 94,446 129,339 ------------ ------------ CASH AND CASH EQUIVALENTS AT END OF PERIOD $ 167,587 $ 309,601 ============ ============
See Notes to Consolidated Financial Statements -6- GTECH HOLDINGS CORPORATION AND SUBSIDIARIES CONSOLIDATED STATEMENT OF SHAREHOLDERS' EQUITY - (Unaudited)
Accumulated Additional Other Outstanding Common Paid-in Comprehensive Retained Treasury Shares Stock Capital Loss Earnings Stock Total ----------- ------ ---------- ------------- -------- -------- -------- (Dollars in thousands) Balance at February 26, 2005 115,006,751 $1,166 $ 278,204 $ (43,227) $455,537 $(35,912) $655,768 Comprehensive income: Net income -- -- -- -- 151,629 -- 151,629 Other comprehensive income (loss), net of tax: Foreign currency translation -- -- -- (2,709) -- -- (2,709) Amortization of unrecognized gain on interest rate locks to interest expense -- -- -- (248) -- -- (248) Unrecognized net gain on derivative instruments -- -- -- 1,159 -- -- 1,159 Unrealized gain on investments -- -- -- 75 -- -- 75 -------- Comprehensive income 149,906 Treasury shares purchased (1,326,100) -- -- -- -- (32,051) (32,051) Cash dividends on common stock ($0.255 per share) -- -- -- -- (31,131) -- (31,131) Shares issued under employee stock purchase and stock award plans 295,631 1 1,693 -- (1,233) 4,509 4,970 Shares issued upon exercise of stock options 926,875 5 5,630 -- (5,407) 9,178 9,406 Shares issued upon conversion of debentures 11,463,625 92 134,891 -- (23,057) 54,276 166,202 Tax benefits related to stock award plans -- -- 7,110 -- -- -- 7,110 ----------- ------ ---------- ------------- -------- -------- -------- Balance at November 26, 2005 126,366,782 $1,264 $ 427,528 $ (44,950) $546,338 $ -- $930,180 =========== ====== ========== ============= ======== ======== ========
See Notes to Consolidated Financial Statements -7- 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 gaming and technology company providing software, networks and professional services that power high-performance, transaction processing systems. We are the world's leading operator of highly-secure online lottery transaction processing systems, doing business in 52 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 2005 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 nine-month period ended November 26, 2005 are not necessarily indicative of the results that may be expected for the full fiscal year ending February 25, 2006. The balance sheet at February 26, 2005 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 2005 Annual Report on Form 10-K. Certain amounts in our prior period financial statements have been reclassified to conform to the current period presentation. STOCK-BASED COMPENSATION PLANS We follow Accounting Principles Board Opinion No. 25, "Accounting for Stock Issued to Employees" ("APB 25") 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. -8- 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. During the three and nine-month periods of fiscal 2005, the fair value of each grant was estimated on the date of grant using the Black-Scholes option pricing model. During the three and nine-month periods of fiscal 2006, the fair value of each grant was estimated on the date of grant using a binomial option pricing model. We changed our option pricing model to a binomial model as we believe the binomial model provides a better estimate of fair value.
Three Months Ended Nine Months Ended --------------------------- ---------------------------- November 26, November 27, November 26, November 27, 2005 2004 2005 2004 ------------ ------------ ------------ ------------ (Dollars in thousands, except per share amounts) Net income, as reported $ 47,833 $ 45,855 $ 151,629 $ 152,551 Add: Stock-based compensation expense included in reported net income, net of related tax effects 786 1,124 3,114 2,347 Deduct: Total stock-based compensation expense determined under the fair value method for all awards, net of related tax effects (1,956) (2,589) (6,575) (6,934) ------------ ------------ ------------ ------------ Pro forma net income $ 46,663 $ 44,390 $ 148,168 $ 147,964 ============ ============ ============ ============ Basic earnings per share: As reported $ 0.38 $ 0.40 $ 1.26 $ 1.30 Pro forma 0.37 0.38 1.23 1.26 Diluted earnings per share: As reported $ 0.37 $ 0.35 $ 1.17 $ 1.16 Pro forma 0.36 0.34 1.14 1.12
In December 2004, the Financial Accounting Standards Board ("FASB") issued Statement of Financial Accounting Standards No. 123 (revised 2004), "Share-Based Payment" ("SFAS 123R"), which is a revision of FASB Statement No. 123, "Accounting for Stock-Based Compensation" and supersedes APB 25. SFAS 123R requires all share-based payments to employees, including grants of employee stock options, be recognized in the financial statements based on their fair values. Pro forma disclosure will no longer be an alternative. We plan to adopt SFAS 123R on the first day of fiscal 2007 (February 26, 2006). We currently estimate the impact of adopting SFAS 123R will be in a range of $0.04 to $0.06 per diluted share in fiscal 2007. This estimate includes the impact of unvested stock options and assumes that stock options granted in fiscal 2007 and forfeiture rates will be consistent with historical patterns. -9- NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued) NOTE 2 - COMMON STOCK SPLIT In the second quarter of fiscal 2005, our Board of Directors approved a 2-for-1 common stock split, payable in the form of a stock dividend, which entitled 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 was distributed on July 30, 2004. All references to common shares and per share amounts herein have been restated to reflect the stock splits for all periods presented. NOTE 3 - POTENTIAL CHANGE IN CONTROL OF THE COMPANY In September 2005, we announced that we received a non-binding preliminary expression of interest from an unidentified third party regarding the potential acquisition of the Company. In light of this expression of interest, the independent members of our board of directors are examining our options with the assistance of Citigroup Global Markets as their financial advisor. As previously announced, our board has not concluded that we should enter into any extraordinary transaction and, in any event, there can be no assurance that, if the directors determine that a sale of the Company at this time is an attractive option, a transaction will be successfully negotiated or consummated, or as to the form or terms of such a transaction. NOTE 4 - INVENTORIES Inventories consist of the following:
November 26, February 26, 2005 2005 ------------ ------------ (Dollars in thousands) Raw materials $ 20,958 $ 29,622 Work in progress 53,593 15,492 Finished goods 12,407 16,021 ------------ ------------ $ 86,958 $ 61,135 ============ ============
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 November 26, 2005 and February 26, 2005 includes approximately $48.6 million and $12.0 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 and finished goods above) totaled $55.5 million and $42.9 million at November 26, 2005 and February 26, 2005, respectively. -10- NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued) NOTE 5 - RESTRICTED ASSETS Pursuant to a June 2004 ruling (the "Ruling") in a civil action initiated by federal attorneys with Brazil's Public Ministry, certain of our Brazilian assets totaling approximately $10.7 million (including $5.1 million of cash that was included in Other Assets in our Consolidated Balance Sheet at February 26, 2005), was restricted from transfer or sale. In July 2004, we filed an appeal of the Ruling and in March 2005, an appellate court decision ordered that the restrictions on the transfer or sale of our Brazilian assets be removed. Accordingly, there were no restricted assets as of November 26, 2005. NOTE 6 - PRODUCT WARRANTY 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 for the three and nine months ended November 26, 2005 and November 27, 2004 is as follows:
Three Months Ended Nine Months Ended ----------------------------- ----------------------------- November 26, November 27, November 26, November 27, 2005 2004 2005 2004 ------------ ------------ ------------ ------------ (Dollars in thousands) Balance at beginning of period $ 994 $ 1,226 $ 1,634 $ 749 Additional reserves 258 314 508 875 Charges incurred (35) (90) (504) (1,037) Change in estimate (76) (2) (510) (300) Opening reserve balance associated with acquisitions -- -- -- 1,126 Other 16 42 29 77 ------------ ------------ ------------ ------------ Balance at end of period $ 1,157 $ 1,490 $ 1,157 $ 1,490 ============ ============ ============ ============
Our reserves for product warranty are included in Accrued Expenses in our Consolidated Balance Sheets. -11- NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued) NOTE 7 - LONG-TERM DEBT Long-term debt consists of the following:
November 26, February 26, 2005 2005 ------------ ------------ (Dollars in thousands) 4.75% Senior Notes due October 2010 $ 249,732 $ 249,690 4.50% Senior Notes due December 2009 149,666 149,604 5.25% Senior Notes due December 2014 148,804 148,704 1.75% Convertible Debentures due December 2021 17,375 175,000 Fair value of interest rate swaps (3,800) 541 Other, due through October 2007 2,591 5,266 ------------ ------------ 564,368 728,805 Less current portion 2,518 2,476 ------------ ------------ $ 561,850 $ 726,329 ============ ============
1.75% CONVERTIBLE DEBENTURES Our 1.75% Convertible Debentures due December 2021 (the "Debentures") are convertible at the option of the holder into shares of our common stock in certain specified circumstances. The Debentures became convertible on May 1, 2003 and remained convertible through the end of the third quarter of fiscal 2006 (November 26, 2005) because the sale price of our common stock was more than 120% of the conversion price (approximately $16.50 per share) for at least 20 trading days in a 30 trading-day period. During the first nine months of fiscal 2006, approximately $157.6 million principal amount of the Debentures were converted by holders of the Debentures, resulting in the issuance of 11,463,625 shares of our common stock. CREDIT FACILITY We have a $500 million unsecured senior revolving credit facility expiring in October 2009 (the "Credit Facility"). There were no outstanding borrowings under the Credit Facility at November 26, 2005 or February 26, 2005. Up to $100 million of the Credit Facility may be used for the issuance of letters of credit. At November 26, 2005 there was $493.3 million available for borrowing under the Credit Facility, after considering $6.7 million of letters of credit issued and outstanding. -12- NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued) NOTE 8 - COMMITMENTS AND CONTINGENCIES OPTION TO PURCHASE POLCARD OUTSTANDING EQUITY In May 2003, we completed the acquisition of a controlling equity position in PolCard S.A. ("PolCard"), for a purchase price, net of cash acquired, of $35.9 million. On September 28, 2005, we purchased an additional 11.681% of PolCard from Innova Capital Sp. z o.o. ("Innova") for cash consideration of approximately $21.5 million, resulting in PolCard's outstanding equity being owned 74.5% by us, 25.2% by two funds managed by Innova, and 0.3% by the Polish Bank Association, one of PolCard's previous owners. The terms of the Share Purchase Agreement which govern the purchase of the additional 11.681% of PolCard included a commitment by GTECH and Innova, as the majority shareholders of PolCard, to vote in favor of a general shareholder dividend of approximately $25.0 million to be paid after the close of PolCard's fiscal year ending on February 25, 2006, and for PolCard to loan to Innova approximately $6.3 million in anticipation of the dividend. This loan was advanced on December 22, 2005 (after the close of our fiscal 2006 third quarter), bears interest at WIBOR plus 1.75% (6.35% as of December 22, 2005), and is fully secured by the dividend and by PolCard shares currently owned by Innova. We have three fair value options to purchase Innova's interest in PolCard, and Innova has the reciprocal right to sell its interest in PolCard to us at fair value. Each fair value option has a duration of 90 days and is to be based on an appraised value from at least two investment banks at the date of each option period. Taking into consideration our purchase of an additional 11.681% of PolCard as described above, we estimate that the buyout prices of each fair value option, based on discounted cash flows, could be as follows:
Buyout Percentage of the PolCard Range of Exercise Date Commencing In Outstanding Equity Buyout Price - --------------------------- ------------------ ------------------ May 2007 12.6% $20 to $30 million May 2008 6.3% $11 to $17 million May 2009 6.3% $13 to $19 million
OTHER 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. -13- NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued) NOTE 9 - 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 certain specified events 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 November 26, 2005:
Total potential commitments --------------- (in thousands) Performance bonds $ 228,897 Financial guarantees 31,907 Litigation bonds 8,870 All other bonds 5,168 --------------- $ 274,842 ===============
LOTTERY TECHNOLOGY SERVICES INVESTMENT CORPORATION We have a 44% interest in Lottery Technology Services Corporation ("LTSC"), which we account for using the equity method of accounting. LTSC provides equipment and services (which we supplied to LTSC), to the Taipei Fubon Bank. The Taipei Fubon Bank holds the license to operate the Taiwan Public Welfare Lottery. In fiscal 2002, we signed an agreement with Acer, Inc. ("Acer"), the partner that holds the remaining 56% interest in LTSC, which provides that in the event a third party lender to LTSC requires the guarantee of GTECH or Acer as a condition of making a loan to LTSC, we, along with Acer, will provide such a guarantee on reasonable terms. This potential guarantee is limited to 44% of any such third-party loan and would expire on December 31, 2006. At November 26, 2005, LTSC had no borrowings that we guaranteed. 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. ("DELTA"). 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 may be jointly and severally liable, with DELTA, for the obligations of the joint venture. -14- NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued) NOTE 9 - GUARANTEES AND INDEMNIFICATIONS (continued) ATRONIC In December 2004, we entered into an agreement to acquire a 50% controlling equity position in the Atronic group of companies ("Atronic") privately held by the Gauselmann Group ("Gauselmann"). The remaining 50% of Atronic will be retained by the owners of Gauselmann. Atronic is a video slot machine manufacturer and develops slot machine games and customized solutions for dynamic gaming operations. This transaction is contingent upon regulatory and gaming license approvals and other closing conditions, and is expected to be completed on December 31, 2006. On March 24, 2005, we guaranteed Euro 25 million of Atronic's obligations due under a Euro 50 million loan made by a commercial lender to Atronic (the "Agreement"). Our maximum liability under this guarantee is equal to the lesser of Euro 25 million or 50% of Atronic's obligations under the Agreement. At November 26, 2005, our maximum liability under this guarantee was Euro 25 million (approximately $29 million). On December 22, 2005 (after the close of our fiscal 2006 third quarter), Atronic repaid Euro 25 million principal amount of the loan. The guarantee arose in connection with our planned acquisition of Atronic on December 31, 2006. We would be required to perform under the guarantee should Atronic fail to make any interest or principal payments in accordance with the terms and conditions of the Agreement. Our guarantee expires on April 26, 2010. As of November 26, 2005, the carrying amount of the liability for our obligations under this guarantee is $2.0 million, which is included in Other Liabilities in our Consolidated Balance Sheets. A corresponding asset of $2.0 million is included in Other Assets in our Consolidated Balance Sheets. The Agreement stipulates that if any event of default should occur and be continuing under our Credit Facility, we would be required to deposit in an account with the commercial lender, Euro 25 million, which would be held by the commercial lender as collateral for the payment and performance of our obligations under the guarantee. The commercial lender would have control over this account. The cash deposit would be released to us three business days after all the events of default have been cured or waived. LOXLEY GTECH PRIVATE LIMITED We have a 49% interest in Loxley GTECH Private Limited Co. ("LGT"), which is accounted for using the equity method of accounting. LGT is a corporate joint venture that will provide the online lottery system in Thailand. On March 29, 2005, in order to assist LGT with obtaining the financing they require to enable them to perform under their obligation to operate the online lottery system in Thailand, we guaranteed, along with the 51% shareholder in LGT, Baht 1.925 billion (approximately $47 million at the November 26, 2005 exchange rate) principal amount in loans and Baht 455 million (approximately $11 million at the November 26, 2005 exchange rate) in performance bonds and trade finance facilities made to LGT by an unrelated commercial lender (collectively, the "Facilities"). We are jointly and severally liable with the other shareholder in LGT for this guarantee. We would be required to perform under the guarantee should LGT fail to make interest or principal payments in accordance with the terms and conditions of the Facilities. Our guarantee obligations commenced in July 2005 and will terminate upon the start-up of the online lottery system in Thailand, which is currently expected to occur in our fiscal 2006 fourth quarter. At November 26, 2005, the principal amount of loans outstanding that we guaranteed totaled $2.6 million. As of November 26, 2005, the carrying amount of the liability for our obligations under this guarantee is $0.5 million, which is included in Accrued Expenses in our Consolidated Balance Sheets. A corresponding asset of $0.5 million is included in Other Current Assets in our Consolidated Balance Sheets. -15- NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued) NOTE 9 - GUARANTEES AND INDEMNIFICATIONS (continued) WORLD HEADQUARTERS FACILITY Under our Master Contract with the State of Rhode Island, 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 development of a new world headquarters facility in Providence, Rhode Island (the "Facility") by December 31, 2006. We have entered into (i) a development agreement with US Real Estate Limited Partnership (the "Developer"), whereby the Developer will develop and own the Facility; and (ii) an office lease with the Developer, whereby we will lease a portion of the Facility from the Developer for 20 years. We also entered into (i) a 149 year ground lease with Capital Properties, Inc. (the "Ground Landlord") with respect to the land upon which the Facility will be constructed; and (ii) a completion guarantee in favor of the Ground Landlord whereby we guaranteed the completion of the Facility and the payment of the rent and real estate taxes under the ground lease until the completion of the Facility. We have assigned the ground lease to the Developer but remain liable under the ground lease and the completion guarantee. Rent payable under the ground lease is currently $0.1 million per year. It is our position that our liability under the ground lease will expire upon completion of the Facility. Upon completion of the Facility, the Ground Landlord's recourse in the event of a default by the Developer under the ground lease is limited to the Facility. Under Emerging Issues Task Force Issue No. 97-10, "The Effect of Lessee Involvement in Asset Construction", we are considered the owner of the Facility. We are recording the construction cost of the Facility along with a related liability in our Consolidated Balance Sheets, which is included in Property, Plant and Equipment, net and Other Liabilities, respectively. NOTE 10 - COMPREHENSIVE INCOME The components of comprehensive income are as follows:
Three Months Ended Nine Months Ended ------------------------------ ---------------------------- November 26, November 27, November 26, November 27, 2005 2004 2005 2004 ------------- ------------ ------------ ------------ (Dollars in thousands) Net income $ 47,833 $ 45,855 $ 151,629 $ 152,551 Other comprehensive income (loss), net of tax Foreign currency translation 1,297 20,510 (2,709) 20,244 Unrecognized gain on interest rate locks -- 2,071 -- 2,071 Amortization of unrecognized gain on interest rate locks to interest expense (83) -- (248) -- Unrecognized net gain (loss) on derivative instruments 678 (1,317) 1,159 90 Unrealized gain (loss) on investments -- -- 75 (2) ------------- ------------ ------------ ----------- Comprehensive income $ 49,725 $ 67,119 $ 149,906 $ 174,954 ============= ============ ============ ===========
-16- NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued) NOTE 11 - EARNINGS PER SHARE The computation of basic and diluted earnings per share is shown in the following table:
Three Months Ended Nine Months Ended ---------------------------- ---------------------------- November 26, November 27, November 26, November 27, 2005 2004 2005 2004 ------------ ------------ ------------ ------------ (In thousands, except per share amounts) Numerator: Net income (Numerator for basic earnings per share) $ 47,833 $ 45,855 $ 151,629 $ 152,551 Effect of dilutive securities: Interest expense on 1.75% Convertible Debentures, net of tax 109 551 909 1,598 ------------ ------------ ------------ ------------ Numerator for diluted earnings per share $ 47,942 $ 46,406 $ 152,538 $ 154,149 ============ ============ ============ ============ Denominator: Denominator for basic earnings per share- weighted average shares 125,333 115,708 120,277 117,133 Effect of dilutive securities: 1.75% Convertible Debentures 2,241 12,727 7,084 12,727 Employee stock options 2,933 2,759 2,657 2,961 Unvested stock awards and employee stock purchase plan shares 368 241 239 229 ------------ ------------ ------------ ------------ Dilutive potential common shares 5,542 15,727 9,980 15,917 Denominator for diluted earnings per share-adjusted weighted average shares and assumed conversions 130,875 131,435 130,257 133,050 ============ ============ ============ ============ Basic earnings per share $ 0.38 $ 0.40 $ 1.26 $ 1.30 ============ ============ ============ ============ Diluted earnings per share $ 0.37 $ 0.35 $ 1.17 $ 1.16 ============ ============ ============ ============
NOTE 12 - INCOME TAXES Our 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. In October 2004, the American Jobs Creation Act of 2004 (the "Act") was signed into law. Among its provisions, the Act provides for a one-time special deduction for certain qualifying dividends from foreign subsidiaries. We have made the determination that it is not economical to repatriate foreign dividends at this time. -17- NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued) NOTE 13 - SUPPLEMENTAL CASH FLOW INFORMATION Non-cash investing and financing activities are excluded from the consolidated statement of cash flows. Non-cash activities that occurred during the first nine months of fiscal 2006 and 2005 are summarized as follows:
November 26, November 27, 2005 2004 ------------ ------------ (Dollars in thousands) Non-cash activities that occurred in connection with the conversion of our 1.75% Convertible Debentures: Issuance of 9,193,119 shares of Holdings common stock $ 126,406 $ -- Issuance of 2,270,506 treasury shares 31,219 -- Excess deferred tax liabilities associated with the contingent interest feature 12,177 -- Forfeited interest 267 -- Debt issuance costs (3,867) -- ------------ ------------ Reclassification to Shareholders' Equity $ 166,202 $ -- ============ ============ Non-cash investment related to our new world headquarters facility in Providence, RI (see Note 9) $ 19,115 $ 2,250 Shares issued under stock award plans 2,583 2,889
NOTE 14 - 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, and on November 16, 2004, issued $150 million principal amount of 4.75% Senior Notes due December 1, 2009 and $150 million principal amount of 5.25% Senior Notes due December 1, 2014 (collectively, the "Senior Notes"). All of the Senior Notes were subsequently exchanged for Senior Notes registered under the Securities Act of 1933. 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. -18- NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued) NOTE 14 - SUPPLEMENTAL GUARANTOR/NON-GUARANTOR FINANCIAL INFORMATION (continued) Condensed Consolidating Balance Sheets November 26, 2005
Parent Guarantor Non-Guarantor Eliminating Company Subsidiaries Subsidiaries Entries Consolidated ------------ ------------ ------------- ------------ ------------ (Dollars in thousands) Assets Current Assets: Cash and cash equivalents $ -- $ 99,071 $ 68,516 $ -- $ 167,587 Investment securities available-for-sale -- 261,275 -- -- 261,275 Trade accounts receivable, net -- 87,818 71,506 -- 159,324 Due from subsidiaries and affiliates -- 60,490 -- (60,490) -- Sales-type lease receivables -- 2,961 177 -- 3,138 Refundable performance deposit -- -- 8,000 -- 8,000 Inventories -- 37,210 55,261 (5,513) 86,958 Deferred income taxes -- 8,457 15,959 -- 24,416 Other current assets -- 9,822 23,080 -- 32,902 ------------ ------------ ------------- ------------ ------------ Total Current Assets -- 567,104 242,499 (66,003) 743,600 Systems, Equipment and Other Assets Relating to Contracts, net -- 592,049 106,260 (12,477) 685,832 Investment in Subsidiaries and Affiliates 930,180 466,828 -- (1,397,008) -- Goodwill -- 115,981 229,828 -- 345,809 Property, Plant and Equipment, net -- 59,696 34,758 -- 94,454 Intangible Assets, net -- 19,996 48,649 -- 68,645 Refundable Performance Deposit -- -- 12,000 -- 12,000 Sales-Type Lease Receivables -- 2,690 32 -- 2,722 Other Assets -- 14,364 27,506 -- 41,870 ------------ ------------ ------------- ------------ ------------ Total Assets $ 930,180 $ 1,838,708 $ 701,532 $ (1,475,488) $ 1,994,932 ============ ============ ============= ============ ============ Liabilities and Shareholders' Equity Current Liabilities: Accounts payable $ -- $ 33,033 $ 25,769 $ -- $ 58,802 Due to subsidiaries and affiliates -- -- 60,490 (60,490) -- Accrued expenses -- 31,312 25,204 -- 56,516 Employee compensation -- 22,767 10,616 -- 33,383 Advance payments from customers -- 15,200 40,293 -- 55,493 Deferred revenue and advance billings -- 21,032 19,345 -- 40,377 Income taxes payable -- 43,290 2,676 -- 45,966 Taxes other than income taxes -- 8,029 9,838 -- 17,867 Current portion of long-term debt -- -- 2,518 -- 2,518 ------------ ------------ ------------- ------------ ------------ Total Current Liabilities -- 174,663 196,749 (60,490) 310,922 Long-Term Debt, less current portion -- 561,777 73 -- 561,850 Other Liabilities -- 79,604 20,342 -- 99,946 Deferred Income Taxes -- 74,494 17,540 -- 92,034 Shareholders' Equity 930,180 948,170 466,828 (1,414,998) 930,180 ------------ ------------ ------------- ------------ ------------ Total Liabilities and Shareholders' Equity $ 930,180 $ 1,838,708 $ 701,532 $ (1,475,488) $ 1,994,932 ============ ============ ============= ============ ============
-19- NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued) NOTE 14 - SUPPLEMENTAL GUARANTOR/NON-GUARANTOR FINANCIAL INFORMATION (continued) Condensed Consolidating Balance Sheets February 26, 2005
Parent Guarantor Non-Guarantor Eliminating Company Subsidiaries Subsidiaries Entries Consolidated ------------ ------------ ------------- ------------ ------------ (Dollars in thousands) Assets Current Assets: Cash and cash equivalents $ -- $ 23,020 $ 71,426 $ -- $ 94,446 Investment securities available-for-sale -- 196,825 -- -- 196,825 Trade accounts receivable, net -- 82,212 86,494 -- 168,706 Due from subsidiaries and affiliates -- 53,345 -- (53,345) -- Sales-type lease receivables -- 3,215 246 -- 3,461 Refundable performance deposit -- -- 8,000 -- 8,000 Inventories -- 30,387 34,366 (3,618) 61,135 Deferred income taxes -- 14,030 17,405 -- 31,435 Other current assets -- 6,669 19,977 -- 26,646 ------------ ------------ ------------- ------------ ------------ Total Current Assets -- 409,703 237,914 (56,963) 590,654 Systems, Equipment and Other Assets Relating to Contracts, net -- 616,204 118,436 (14,202) 720,438 Investment in Subsidiaries and Affiliates 655,768 448,499 -- (1,104,267) -- Goodwill -- 115,981 215,041 -- 331,022 Property, Plant and Equipment, net -- 40,120 34,438 -- 74,558 Intangible Assets, net -- 22,157 48,682 -- 70,839 Refundable Performance Deposit -- -- 12,000 -- 12,000 Sales-Type Lease Receivables -- 4,681 75 -- 4,756 Other Assets -- 28,209 22,665 -- 50,874 ------------ ------------ ------------- ------------ ------------ Total Assets $ 655,768 $ 1,685,554 $ 689,251 $ (1,175,432) $ 1,855,141 ============ ============ ============= ============ ============ Liabilities and Shareholders' Equity Current Liabilities: Accounts payable $ -- $ 41,525 $ 57,709 $ -- $ 99,234 Due to subsidiaries and affiliates -- -- 53,345 (53,345) -- Accrued expenses -- 29,277 24,950 -- 54,227 Employee compensation -- 13,252 8,610 -- 21,862 Advance payments from customers -- 8,113 34,752 -- 42,865 Deferred revenue and advance billings -- 11,369 18,336 -- 29,705 Income taxes payable -- 11,902 4,597 -- 16,499 Taxes other than income taxes -- 7,688 8,884 -- 16,572 Short term borrowings -- -- 334 -- 334 Current portion of long-term debt -- -- 2,476 -- 2,476 ------------ ------------ ------------- ------------ ------------ Total Current Liabilities -- 123,126 213,993 (53,345) 283,774 Long-Term Debt, less current portion -- 723,539 2,790 -- 726,329 Other Liabilities -- 64,035 19,225 -- 83,260 Deferred Income Taxes -- 101,266 4,744 -- 106,010 Shareholders' Equity 655,768 673,588 448,499 (1,122,087) 655,768 ------------ ------------ ------------- ------------ ------------ Total Liabilities and Shareholders' Equity $ 655,768 $ 1,685,554 $ 689,251 $ (1,175,432) $ 1,855,141 ============ ============ ============= ============ ============
-20- NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued) NOTE 14 - SUPPLEMENTAL GUARANTOR/NON-GUARANTOR FINANCIAL INFORMATION (continued) Condensed Consolidating Income Statements Three Months Ended November 26, 2005
Parent Guarantor Non-Guarantor Eliminating Company Subsidiaries Subsidiaries Entries Consolidated ------------ ------------ ------------- ------------ ------------ (Dollars in thousands) Revenues: Services $ -- $ 184,599 $ 86,290 $ -- $ 270,889 Sales of products -- 15,294 13,955 -- 29,249 Intercompany sales and fees -- 36,756 12,057 (48,813) -- ------------ ------------ ------------- ------------ ------------ -- 236,649 112,302 (48,813) 300,138 Costs and expenses: Costs of services -- 113,964 51,961 (941) 164,984 Costs of sales -- 9,365 7,965 -- 17,330 Intercompany cost of sales and fees -- 30,919 977 (31,896) -- ------------ ------------ ------------- ------------ ------------ -- 154,248 60,903 (32,837) 182,314 ------------ ------------ ------------- ------------ ------------ Gross profit -- 82,401 51,399 (15,976) 117,824 Selling, general & administrative -- 22,354 11,397 -- 33,751 Research and development -- 7,637 3,809 -- 11,446 ------------ ------------ ------------- ------------ ------------ Operating expenses -- 29,991 15,206 -- 45,197 ------------ ------------ ------------- ------------ ------------ Operating income -- 52,410 36,193 (15,976) 72,627 Other income (expense): Interest income -- 2,208 628 -- 2,836 Equity in earnings of unconsolidated affiliates -- 484 333 -- 817 Equity in earnings of consolidated affiliates 47,833 25,751 -- (73,584) -- Other expense -- (875) (143) -- (1,018) Interest expense -- (7,248) (644) -- (7,892) ------------ ------------ ------------- ------------ ------------ 47,833 20,320 174 (73,584) (5,257) ------------ ------------ ------------- ------------ ------------ Income before income taxes 47,833 72,730 36,367 (89,560) 67,370 Income taxes -- 21,096 10,616 (12,175) 19,537 ------------ ------------ ------------- ------------ ------------ Net income $ 47,833 $ 51,634 $ 25,751 $ (77,385) $ 47,833 ============ ============ ============= ============ ============
-21- NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued) NOTE 14 - SUPPLEMENTAL GUARANTOR/NON-GUARANTOR FINANCIAL INFORMATION (continued) Condensed Consolidating Income Statements Nine Months Ended November 26, 2005
Parent Guarantor Non-Guarantor Eliminating Company Subsidiaries Subsidiaries Entries Consolidated ------------ ------------ ------------- ------------ ------------ (Dollars in thousands) Revenues: Services $ -- $ 555,646 $ 272,948 $ -- $ 828,594 Sales of products -- 43,326 64,559 -- 107,885 Intercompany sales and fees -- 114,927 36,631 (151,558) -- ------------ ------------ ------------- ------------ ------------ -- 713,899 374,138 (151,558) 936,479 Costs and expenses: Costs of services -- 339,356 159,711 (3,542) 495,525 Costs of sales -- 23,677 40,001 -- 63,678 Intercompany cost of sales and fees -- 87,983 7,377 (95,360) -- ------------ ------------ ------------- ------------ ------------ -- 451,016 207,089 (98,902) 559,203 ------------ ------------ ------------- ------------ ------------ Gross profit -- 262,883 167,049 (52,656) 377,276 Selling, general & administrative -- 61,149 34,459 -- 95,608 Research and development -- 22,802 12,825 -- 35,627 ------------ ------------ ------------- ------------ ------------ Operating expenses -- 83,951 47,284 -- 131,235 ------------ ------------ ------------- ------------ ------------ Operating income -- 178,932 119,765 (52,656) 246,041 Other income (expense): Interest income -- 5,116 1,870 -- 6,986 Equity in earnings of unconsolidated affiliates -- 2,696 439 -- 3,135 Equity in earnings of consolidated affiliates 151,629 77,953 -- (229,582) -- Other expense -- (469) (2,981) -- (3,450) Interest expense -- (22,001) (1,161) -- (23,162) ------------ ------------ ------------- ------------ ------------ 151,629 63,295 (1,833) (229,582) (16,491) ------------ ------------ ------------- ------------ ------------ Income before income taxes 151,629 242,227 117,932 (282,238) 229,550 Income taxes -- 82,115 39,979 (44,173) 77,921 ------------ ------------ ------------- ------------ ------------ Net income $ 151,629 $ 160,112 $ 77,953 $ (238,065) $ 151,629 ============ ============ ============= ============ ============
-22- NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued) NOTE 14 - SUPPLEMENTAL GUARANTOR/NON-GUARANTOR FINANCIAL INFORMATION (continued) Condensed Consolidating Income Statements Three Months Ended November 27, 2004
Parent Guarantor Non-Guarantor Eliminating Company Subsidiaries Subsidiaries Entries Consolidated ------------ ------------ ------------- ------------- ------------ (Dollars in thousands) Revenues: Services $ -- $ 176,902 $ 75,043 $ -- $ 251,945 Sales of products -- 34,844 28,858 -- 63,702 Intercompany sales and fees -- 21,371 12,777 (34,148) -- ------------ ------------ ------------- ------------- ------------ -- 233,117 116,678 (34,148) 315,647 Costs and expenses: Costs of services -- 103,598 53,330 (966) 155,962 Costs of sales -- 20,338 23,849 -- 44,187 Intercompany cost of sales and fees -- 27,162 4,974 (32,136) -- ------------ ------------ ------------- ------------- ------------ -- 151,098 82,153 (33,102) 200,149 ------------ ------------ ------------- ------------- ------------ Gross profit -- 82,019 34,525 (1,046) 115,498 Selling, general & administrative -- 19,955 9,785 -- 29,740 Research and development -- 8,728 4,279 -- 13,007 ------------ ------------ ------------- ------------- ------------ Operating expenses -- 28,683 14,064 -- 42,747 ------------ ------------ ------------- ------------- ------------ Operating income -- 53,336 20,461 (1,046) 72,751 Other income (expense): Interest income -- 96 546 -- 642 Equity in earnings of unconsolidated affiliates -- 766 44 -- 810 Equity in earnings of consolidated affiliates 45,855 10,714 -- (56,569) -- Other income (expense) -- 3,184 (5,254) -- (2,070) Interest expense -- (3,340) (348) -- (3,688) ------------ ------------ ------------- ------------- ------------ 45,855 11,420 (5,012) (56,569) (4,306) ------------ ------------ ------------- ------------- ------------ Income before income taxes 45,855 64,756 15,449 (57,615) 68,445 Income taxes -- 21,336 4,735 (3,481) 22,590 ------------ ------------ ------------- ------------- ------------ Net income $ 45,855 $ 43,420 $ 10,714 $ (54,134) $ 45,855 ============ ============ ============= ============= ============
-23- NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued) NOTE 14 - SUPPLEMENTAL GUARANTOR/NON-GUARANTOR FINANCIAL INFORMATION (continued) Condensed Consolidating Income Statements Nine Months Ended November 27, 2004
Parent Guarantor Non-Guarantor Eliminating Company Subsidiaries Subsidiaries Entries Consolidated ------------ ------------ ------------- ----------- ------------ (Dollars in thousands) Revenues: Services $ -- $ 532,255 $ 221,130 $ -- $ 753,385 Sales of products -- 93,682 72,300 -- 165,982 Intercompany sales and fees -- 71,234 37,774 (109,008) -- ------------ ------------ ------------- ----------- ------------ -- 697,171 331,204 (109,008) 919,367 Costs and expenses: Costs of services -- 309,428 144,636 (2,328) 451,736 Costs of sales -- 52,086 51,905 (13) 103,978 Intercompany cost of sales and fees -- 72,179 13,551 (85,730) -- ------------ ------------ ------------- ----------- ------------ -- 433,693 210,092 (88,071) 555,714 ------------ ------------ ------------- ----------- ------------ Gross profit -- 263,478 121,112 (20,937) 363,653 Selling, general & administrative -- 59,417 27,847 -- 87,264 Research and development -- 26,388 12,353 -- 38,741 ------------ ------------ ------------- ----------- ------------ Operating expenses -- 85,805 40,200 -- 126,005 ------------ ------------ ------------- ----------- ------------ Operating income -- 177,673 80,912 (20,937) 237,648 Other income (expense): Interest income -- 881 2,077 -- 2,958 Equity in earnings (loss) of unconsolidated affiliates -- 2,680 (271) -- 2,409 Equity in earnings of consolidated affiliates 152,551 54,736 -- (207,287) -- Other income -- 2,826 3,705 -- 6,531 Interest expense -- (10,645) (1,098) -- (11,743) ------------ ------------ ------------- ----------- ------------ 152,551 50,478 4,413 (207,287) 155 ------------ ------------ ------------- ----------- ------------ Income before income taxes 152,551 228,151 85,325 (228,224) 237,803 Income taxes -- 81,792 30,589 (27,129) 85,252 ------------ ------------ ------------- ----------- ------------ Net income $ 152,551 $ 146,359 $ 54,736 $ (201,095) $ 152,551 ============ ============ ============= =========== ============
-24- NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued) NOTE 14 - SUPPLEMENTAL GUARANTOR/NON-GUARANTOR FINANCIAL INFORMATION (continued) Condensed Consolidating Statements of Cash Flows Nine Months Ended November 26, 2005
Parent Guarantor Non-Guarantor Eliminating Company Subsidiaries Subsidiaries Entries Consolidated ------------ ------------ ------------- ----------- ------------ (Dollars in thousands) Net cash provided by operating activities $ -- $ 267,677 $ 42,455 $ (1,610) $ 308,522 Investing Activities Acquisitions (net of cash acquired) -- -- (21,869) -- (21,869) Purchases of systems, equipment and other assets relating to contracts -- (70,436) (23,556) 1,610 (92,382) Purchases of available-for-sale investment securities -- (147,275) -- -- (147,275) Maturities and sales of available-for-sale investment securities -- 82,825 -- -- 82,825 Purchases of property, plant and equipment -- (5,474) (1,238) -- (6,712) License fee -- -- (1,750) -- (1,750) Investment in advances to unconsolidated subsidiaries -- -- (1,488) -- (1,488) Decrease in restricted cash -- -- 5,080 -- 5,080 Proceeds from sale of investment -- -- 3,000 -- 3,000 ------------ ------------ ------------- ----------- ------------ Net cash provided by (used for) investing activities -- (140,360) (41,821) 1,610 (180,571) Financing Activities Principal payments on long-term debt -- -- (2,259) -- (2,259) Purchases of treasury stock (32,051) -- -- -- (32,051) Dividends paid (30,921) -- -- -- (30,921) Proceeds from stock options 9,406 -- -- -- 9,406 Intercompany capital transactions 51,179 (51,179) -- -- -- Other 2,387 (130) (1,663) -- 594 ------------ ------------ ------------- ----------- ------------ Net cash used for financing activities -- (51,309) (3,922) -- (55,231) Effect of exchange rate changes on cash -- 43 378 -- 421 ------------ ------------ ------------- ----------- ------------ Increase (decrease) in cash and cash equivalents -- 76,051 (2,910) -- 73,141 Cash and cash equivalents at beginning of period -- 23,020 71,426 -- 94,446 ------------ ------------ ------------- ----------- ------------ Cash and cash equivalents at end of period $ -- $ 99,071 $ 68,516 $ -- $ 167,587 ============ ============ ============= =========== ============
-25- NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued) NOTE 14 - SUPPLEMENTAL GUARANTOR/NON-GUARANTOR FINANCIAL INFORMATION (continued) Condensed Consolidating Statements of Cash Flows Nine Months Ended November 27, 2004
Parent Guarantor Non-Guarantor Eliminating Company Subsidiaries Subsidiaries Entries Consolidated ------------ ------------ ------------- ----------- ------------ (Dollars in thousands) Net cash provided by operating activities $ -- $ 244,112 $ 36,771 $ (2,407) $ 278,476 Investing Activities Acquisitions (net of cash acquired) -- -- (200,764) -- (200,764) Purchases of systems, equipment and other assets relating to contracts -- (164,308) (27,473) 2,407 (189,374) Purchases of available-for-sale investment securities -- (50,150) -- -- (50,150) Maturities and sales of available-for-sale investment securities -- 272,000 -- -- 272,000 Proceeds from sale of investment -- -- 11,773 -- 11,773 Purchases of property, plant and equipment -- (8,826) (308) -- (9,134) Increase in restricted cash -- -- (5,138) -- (5,138) Investments in and advances to unconsolidated subsidiaries -- -- (2,503) -- (2,503) ------------ ------------ ------------- ------------ ------------ Net cash provided by (used for) investing activities -- 48,716 (224,413) 2,407 (173,290) Financing Activities Net proceeds from issuance of long-term debt -- 343,254 -- -- 343,254 Principal payments on long-term debt -- (135,000) (7,657) -- (142,657) Purchases of treasury stock (100,536) -- -- -- (100,536) Dividends paid (29,988) -- -- -- (29,988) Premiums and fees paid in connection with the early retirement of debt -- (10,610) -- -- (10,610) Proceeds from stock options 11,810 -- -- -- 11,810 Intercompany capital transactions 116,719 (284,719) 168,000 -- -- Other 1,995 (2,711) 3,055 -- 2,339 ------------ ------------ ------------- ------------ ------------ Net cash provided by (used for) financing activities -- (89,786) 163,398 -- 73,612 Effect of exchange rate changes on cash -- (113) 1,577 -- 1,464 ------------ ------------ ------------- ------------ ------------ Increase (decrease) in cash and cash equivalents -- 202,929 (22,667) -- 180,262 Cash and cash equivalents at beginning of period -- 68,956 60,383 -- 129,339 ------------ ------------ ------------- ------------ ------------ Cash and cash equivalents at end of period $ -- $ 271,885 $ 37,716 $ -- $ 309,601 ============ ============ ============= ============ ============
-26- 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: o FORWARD-LOOKING STATEMENTS - cautionary information about forward-looking statements. o OUR BUSINESS - a general description of our business; our growth strategy; the potential change in control of our company; and Brazil matters. o COMMON STOCK SPLIT - information about our prior year common stock split. o OPERATIONS REVIEW - an analysis of our consolidated results of operations for the three and nine month periods ended November 26, 2005 and November 27, 2004 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. o LIQUIDITY, CAPITAL RESOURCES AND FINANCIAL POSITION - an analysis of cash flows; financial position; and commitments. o FINANCIAL RISK MANAGEMENT AND DIVIDEND POLICY - information about financial risk management; interest rate market risk; foreign currency exchange rate risk; and our dividend policy. 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 Certain statements contained or incorporated by reference in this report are forward-looking statements within the meaning of the United States Private Litigation Reform Act of 1995. We identify forward-looking statements by words such as "may," "will," "should," "could," "expect," "plan," "anticipate," "intend," "believe," "estimate," "continue," "project" or similar terms that refer to the future. Such statements include, without limitation, statements relating to: o the future prospects for and stability of the lottery industry and other businesses in which we are engaged or expect to be engaged; o our future operating and financial performance (including, without limitation, expected future growth in revenues, profit margins and earnings per share); o our ability to secure and protect trademarks and other intellectual property rights; o our ability to retain existing contracts and to obtain and retain new contracts; o competition in the online lottery industry and other businesses in which we are engaged or may engage and the impact of competition on our revenues and profitability; o our ability to realize the anticipated benefits of our acquisitions; and o the results and effects of legal proceedings and investigations. -27- 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: o government regulations and other actions affecting the online lottery industry could have a negative effect on our business and sales; o we may be subject to adverse determinations in legal proceedings (including previously announced legal proceedings in Brazil) which could result in substantial monetary judgments or reputational damage; o our lottery operations are dependent upon our continued ability to retain and extend our existing contracts and win new contracts; o slow growth or declines in sales of online lottery goods and services could lead to lower revenues and cash flows; o we derive over half of our revenues from foreign jurisdictions (including over 7.4% in fiscal 2005 from Brazilian operations) and are subject to the economic, political and social instability risks of doing business in foreign jurisdictions; o 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; o 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; o 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; o we operate in a highly competitive environment and increased competition may cause us to experience lower cash flows or to lose contracts; o we are subject to substantial penalties for failure to perform under our contracts; o 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; o if we are unable to manage potential risks related to acquisitions, our business and growth prospects could suffer; o expansion of the gaming industry faces opposition which could limit our access to some markets; o our business prospects and future success depend upon our ability to attract and retain qualified employees; o our business prospects and future success rely heavily upon the integrity of our employees and executives and the security of our systems; o 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; o our non-lottery ventures, which are an increasingly important aspect of our business, may fail; and o other risks and uncertainties set forth below and elsewhere in this report, in our fiscal 2005 Annual Report on Form 10-K, and in our subsequent press releases and Forms 10-Q and other reports and filings with the Securities and Exchange Commission. The foregoing list of important factors is not all-inclusive. -28- OUR BUSINESS GENERAL We operate on a 52-week or 53-week fiscal year ending on the last Saturday in February and fiscal 2006 is a 52-week year that ends on February 25, 2006. We are a global gaming and technology company providing software, networks and professional services that power high-performance, transaction processing systems. We are the world's leading operator of highly-secure online lottery transaction processing systems, doing business in 52 countries worldwide and we have a growing presence in commercial gaming technology ("Gaming Solutions") and financial services transaction processing ("Commercial Services"). A comparison of our revenue concentration is as follows:
Nine Months Ended November 26, Fiscal Fiscal Consolidated Revenues 2005 2005 2004 - --------------------- ------------ ----------- ----------- Lottery 85% 87% 91% Commercial Services 9% 7% 7% Gaming Solutions 6% 6% 2% ------------ ----------- ----------- 100% 100% 100% ============ =========== ===========
Being a global business, we derive a substantial portion of our revenue from our operations outside of the United States. In particular, in fiscal 2005, we derived 52.2% of our revenues from international operations, including 7.4% of our revenues from our Brazilian operations alone (including 7.2% of our revenues from Caixa Economica Federal, the operator of Brazil's National Lottery, our second largest customer in fiscal 2005 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. Our service revenues are derived primarily from lottery service contracts, which are typically at least five to seven years in duration for the base contract term with three to five years of extension options resulting in total contract lives of eight to ten years. Our contracts 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 2006, we currently anticipate that product sales will be in the range of $190 million to $200 million. 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 of 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. In addition, we have developed and continue to develop new lottery games designed to maintain a strong level of same store sales growth for our customers. -29- Our business is highly regulated, and the competition to secure new government contracts is often intense. In addition, our ability to consummate the acquisition, which we announced in December 2004, of a 50% controlling equity interest in the Atronic group of companies, and to otherwise expand our business in non-lottery gaming markets, is contingent upon obtaining required gaming licenses. 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 government authorities into possible improprieties and wrongdoing in connection with efforts to obtain and/or the awarding of lottery contracts and related matters. Because 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, gaming licensing, 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, obtain new or renewal contracts and to expand our business in non-lottery gaming markets. In addition, continuing adverse publicity resulting from these investigations and related matters could have a material adverse effect on our reputation and business. For further information concerning these matters and other contingencies, see "Legal Proceedings" in Part II, Item 1 in this report and also the following: o 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 2005 Annual Report on Form 10-K; o Part I, Item 3 - "Legal Proceedings" in our fiscal 2005 Annual Report on Form 10-K; and o Note 14 to the Consolidated Financial Statements in our fiscal 2005 Annual Report on Form 10-K. GROWTH STRATEGY Fiscal 2005 was a year of significant strategic progress for us with the acquisition of three privately-held companies that strengthened our growth strategy in Commercial Services and Gaming Solutions. In addition, our growth strategy in Gaming Solutions was significantly advanced when in December 2004, we signed an agreement to acquire a 50% controlling equity position in the Atronic group of companies, a video slot machine manufacturer that also develops slot machine games and customized solutions for dynamic gaming operations. Our Commercial Services market includes the processing and transmission of commercial, non-lottery transactions including debit and credit card transactions (both acquiring and issuing processing), bill payments, electronic tax payments, prepaid utility payments and prepaid cellular telephone recharges. Currently, our networks in Brazil, Poland, Chile, the Czech Republic, Jamaica and other countries process debit and credit card transactions, bill payments and other commercial services transactions. In the near term, we expect to concentrate our efforts to grow commercial services revenues principally in Central and Eastern Europe and other selected emerging economies, with the goal of leveraging our existing technology, infrastructure and relationships to drive growth in Commercial Services. In addition, we will continue to identify and evaluate a variety of selective opportunities for acquisitions in the Lottery, Commercial Services, and Gaming Solutions markets, as well as investing in growth through licensing when the right opportunities present themselves. -30- POTENTIAL CHANGE IN CONTROL OF OUR COMPANY In September 2005, we announced that we received a non-binding preliminary expression of interest from an unidentified third party regarding the potential acquisition of the Company. In light of this expression of interest, the independent members of our board of directors are examining our options with the assistance of Citigroup Global Markets as their financial advisor. As previously announced, our board has not concluded that we should enter into any extraordinary transaction and, in any event, there can be no assurance that, if the directors determine that a sale of the Company at this time is an attractive option, a transaction will be successfully negotiated or consummated, or as to the form or terms of such a transaction. BRAZIL MATTERS GTECH Brasil Ltda., our Brazilian subsidiary ("GTECH Brazil"), has provided online lottery services and technology to Caixa Economica Federal ("CEF"), the Brazilian bank and operator of Brazil's National Lottery since 1997. Revenues from our lottery contract with CEF accounted for 7.2% of our total fiscal 2005 revenues, making CEF our second largest customer in fiscal 2005 based upon annual revenues. In June 2004, a ruling (the "Ruling") in a civil action initiated by federal attorneys with Brazil's Public Ministry had the effect in fiscal 2005 of materially reducing payments that we otherwise would have received from our lottery contract with CEF. The Ruling ordered that 30% of payments subsequent to the date of the Ruling due to GTECH Brazil by CEF, be withheld and deposited in an account maintained by the Court. As of February 26, 2005, the total amount withheld and deposited pursuant to the Ruling was approximately 68 million Brazilian reals, or $26 million. In fiscal 2005, we did not recognize service revenues for the payments that were withheld from GTECH Brazil, as realization of these amounts was not reasonably assured. In July 2004, we filed an appeal of the Ruling and in March 2005, an appellate court decision ordered that the withholding be discontinued and that all funds currently held in escrow in excess of 40 million Brazilian reals be returned to us, which amounts to $11 million of the $26 million withheld as of February 26, 2005. We received and recognized these funds as service revenue on April 13, 2005. In addition, the Ruling's restrictions on the transfer or sale of our Brazilian assets was removed and accordingly, there were no restricted cash balances as of November 26, 2005. The Ruling also put in place certain restrictions on the transfer or sale of certain of our Brazilian assets. Such restrictions were lifted in March 2005. See Note 5 of this report for further information. In May 2005, GTECH Brazil entered into a new one-year contract with CEF, which expires in May 2006. Accumulated foreign currency translation losses related to our operations in Brazil of $54.1 million (which are recorded in Accumulated Other Comprehensive Loss in our Consolidated Balance Sheet at November 26, 2005), would be recorded as a charge to our consolidated income statement upon the expiration of our contract with CEF should we determine that the expiration of the CEF contract results in a substantial liquidation of our investment in Brazil. Refer to Note 14 to the Consolidated Financial Statements in our fiscal 2005 Annual Report on Form 10-K for detailed disclosures regarding Brazil matters. -31- COMMON STOCK SPLIT In the second quarter of fiscal 2005, our Board of Directors approved a 2-for-1 common stock split, payable in the form of a stock dividend, which entitled 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 was distributed on July 30, 2004. All references to common shares and per share amounts herein have been restated to reflect the stock splits for all periods presented. OPERATIONS REVIEW COMPARISON OF THE THREE MONTH PERIODS ENDED NOVEMBER 26, 2005 AND NOVEMBER 27, 2004 REVENUES AND GROSS MARGIN
Three Months Ended ----------------------------------------------------- Change November 26, November 27, --------------------- 2005 2004 $ % ------------ ------------ --------- --------- (Dollars in millions) Domestic lottery $ 143.4 $ 127.4 $ 16.0 12.6 International lottery 91.4 94.4 (3.0) (3.2) Commercial services 27.2 22.0 5.2 23.6 Gaming solutions 8.9 7.3 1.6 21.9 All other -- 0.8 (0.8) (100.0) ------------ ------------ --------- --------- Services $ 270.9 $ 251.9 $ 19.0 7.5 Sales of products 29.2 63.7 (34.5) (54.2) ------------ ------------ --------- --------- Total revenues $ 300.1 $ 315.6 $ (15.5) (4.9) ============ ============ ========= =========
Three Months Ended ----------------------------------------------------- Change November 26, November 27, --------------------- 2005 2004 Percentage Points ------------ ------------ --------------------- Service gross margin 39.1% 38.1% 1.0 Product gross margin 40.8% 30.6% 10.2
The 12.6% increase in domestic lottery service revenues, which was tempered by the impact of severe weather conditions in the Southeastern United States, was primarily due to higher revenues from an increase in sales by our domestic lottery customers of approximately 3%, combined with net contract wins of approximately 3% (including the impact of our new service contract in Florida and the loss of the Colorado contract), and higher jackpot activity. International lottery service revenues, which were tempered by the impact of severe weather conditions in the Caribbean Islands, declined by 3.2%. Contractual rate changes and lower revenues from the loss of the Puerto Rico contract resulted in a decrease of approximately 19%. This was partially offset by favorable foreign exchange rates of approximately 5%, higher service revenues from an increase in sales by our international lottery customers of approximately 7%, and higher revenues from Brazil related to the court ordered cessation of withholding of approximately 5%. The 23.6% increase in commercial transaction processing service revenues was primarily due to higher revenues from Brazil related to the court ordered cessation of withholding of approximately 18%, favorable foreign exchange rates of approximately 13%, and higher service revenues from an increase in transaction volumes by our commercial transaction processing customers of approximately 8%. These increases were partially offset by contractual rate changes. -32- Our service margins were up 1.0 percentage point over last year, primarily due to higher service revenues from Brazil and higher jackpot activity, partially offset by the current year impact of higher depreciation and amortization related to the implementation of new contracts. Product sales were down principally due to the prior year sale of lottery terminals and a communications network to our customer in Belgium which did not reoccur in the current year. Our product margins fluctuate depending on the mix, volume and timing of product sales contracts and were up 10.2 percentage points over last year. This increase was principally due to higher margins associated with Spielo Manufacturing ULC ("Spielo") product sales (primarily related to the one-time adjustment in the prior year required to step-up then existing Spielo product sale contracts to fair value in connection with the April 30, 2004 acquisition), and the mix of sales. OPERATING EXPENSES Operating expenses are comprised of selling, general and administrative (SG&A) expenses and research and development (R&D) expenses.
Three Months Ended ------------------------------------------------------- Change November 26, November 27, ----------------------- 2005 2004 $ % ------------ ------------ --------- --------- (Dollars in millions) SG&A expenses $ 33.8 $ 29.7 $ 4.1 13.8 R&D expenses 11.4 13.0 (1.6) (12.3) ------------ ------------ --------- --------- $ 45.2 $ 42.7 $ 2.5 5.9 ============ ============ ========= ========= PERCENTAGE OF TOTAL REVENUE SG&A expenses 11.2% 9.4% R&D expenses 3.8% 4.1%
The $4.1 million increase in SG&A expenses was principally due to increased activities in new business development and costs associated with examining the Company's options after receiving a non-binding preliminary expression of interest regarding a potential acquisition of our Company. The $1.6 million decrease in R&D expenses was principally due to the timing of development initiatives, partially offset by higher spending by Spielo. INTEREST INCOME
Three Months Ended ------------------------------------------------------- Change November 26, November 27, ----------------------- 2005 2004 $ % ------------ ------------ --------- --------- (Dollars in millions) Interest income $ 2.8 $ 0.6 $ 2.2 >100.0
Interest income was up over last year primarily due to higher invested funds and higher interest rates earned on those invested funds. INTEREST EXPENSE
Three Months Ended ------------------------------------------------------- Change November 26, November 27, ----------------------- 2005 2004 $ % ------------ ------------ --------- --------- (Dollars in millions) Interest expense $ 7.9 $ 3.7 $ 4.2 >100.0
Interest expense was up over last year primarily due to higher average debt balances resulting from the issuance of $300 million of Senior Notes in November 2004. -33- INCOME TAXES Our effective income tax rate of 29% in the third quarter of fiscal 2006 was down from 33% in the third quarter of fiscal 2005 primarily due to a larger percentage of international profits that are taxed at rates lower than the U.S. statutory income tax rate, along with the new domestic manufacturing deduction. 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 tax audits and contingencies. In October 2004, the American Jobs Creation Act of 2004 (the "Act") was signed into law. Among its provisions, the Act provides for a one-time special deduction for certain qualifying dividends from foreign subsidiaries. We have determined that it is not economical to repatriate foreign dividends at this time. COMPARISON OF THE NINE MONTH PERIODS ENDED NOVEMBER 26, 2005 AND NOVEMBER 27, 2004 REVENUES AND GROSS MARGIN
Nine Months Ended ------------------------------------------------- Change November 26, November 27, ----------------- 2005 2004 $ % ------------ ------------ ------ ------ (Dollars in millions) Domestic lottery $ 425.7 $ 384.7 $ 41.0 10.7 International lottery 290.1 284.0 6.1 2.1 Commercial services 87.8 61.9 25.9 41.8 Gaming solutions 25.0 20.4 4.6 22.5 All other -- 2.4 (2.4) (100.0) ------------ ------------ ------ ------ Services $ 828.6 $ 753.4 $ 75.2 10.0 Sales of products 107.9 166.0 (58.1) (35.0) ------------ ------------ ------ ------ Total revenues $ 936.5 $ 919.4 $ 17.1 1.9 ============ ============ ====== ======
Nine Months Ended ------------------------------------------------- Change November 26, November 27, ----------------- 2005 2004 Percentage Points ------------ ------------ ----------------- Service gross margin 40.2% 40.0% 0.2 Product gross margin 41.0% 37.4% 3.6
The principal drivers of the 10.7% increase in domestic lottery service revenues were higher revenues from an increase in sales by our domestic lottery customers of approximately 4%, net contract wins of approximately 3% (including the impact of our new service contract in Florida and the loss of the Colorado contract), and the benefit of our instant ticket vending machine contract in Illinois. The 2.1% increase in international lottery service revenues was primarily due to favorable foreign exchange rates of approximately 6%, an increase in sales by our international lottery customers of approximately 5%, and higher revenues from Brazil of approximately 4% related to the combined impact of the court ordered return of funds previously held in escrow and the cessation of withholding. These increases were partially offset by the combined effect of contractual rate changes and lower revenues from the loss of the Puerto Rico contract. -34- The 41.8% increase in commercial transaction processing service revenues was primarily due to favorable foreign exchange rates of approximately 19%, higher revenues from Brazil of approximately 19% related to the combined impact of the court ordered return of funds previously held in escrow and the cessation of withholding, and higher service revenues from an increase in transaction volumes by our commercial transaction processing customers of approximately 11%. These increases were partially offset by contractual rate changes. The principal drivers of the 22.5% increase in gaming solutions service revenues were a full nine months of service revenues from Spielo (versus seven months in the prior fiscal year) and the installation of additional video lottery terminals in the state of Rhode Island, along with higher service revenues from an increase in sales by our gaming solutions customers of approximately 6%. Our service margins were up 0.2 percentage points over last year primarily due to higher margins from Brazil related to higher service revenues resulting from the court ordered return of funds previously held in escrow, and higher jackpot activity, partially offset by the current year impact of higher depreciation and amortization related to the implementation of new contracts. Product sales were down principally due to the prior year sale of lottery terminals and a communications network to our customer in Belgium which did not reoccur in the current year. Our product margins were up 3.6 percentage points over last year, principally due to higher margins associated with Spielo product sales (primarily related to the one-time adjustment in the prior year required to step-up then existing Spielo product sale contracts to fair value in connection with the acquisition), and the mix of sales. OPERATING EXPENSES
Nine Months Ended --------------------------------------------------- Change November 26, November 27, ----------------- 2005 2004 $ % ------------ ------------ ------ ------ (Dollars in millions) SG&A expenses $ 95.6 $ 87.3 $ 8.3 9.5 R&D expenses 35.6 38.7 (3.1) (8.0) ------------ ------------ ------ ------ $ 131.2 $ 126.0 $ 5.2 4.1 ============ ============ ====== ====== PERCENTAGE OF TOTAL REVENUE SG&A expenses 10.2% 9.5% R&D expenses 3.8% 4.2%
The $8.3 million increase in SG&A expenses was principally due to an acceleration in regulatory licensing activity in worldwide commercial gaming markets, increased activities in new business development, higher incentive compensation costs and a full nine months of spending by Spielo (versus seven months of spending in the prior fiscal year). The $3.1 million decrease in R&D expenses was principally due to the timing of development initiatives, partially offset by a full nine months of spending by Spielo. INTEREST INCOME
Nine Months Ended --------------------------------------------------- Change November 26, November 27, ----------------- 2005 2004 $ % ------------ ------------ ------ ------ (Dollars in millions) Interest income $ 7.0 $ 3.0 $ 4.0 >100.0
Interest income increased over last year primarily due to higher invested funds and higher interest rates earned on those invested funds. -35- OTHER INCOME (EXPENSE) The components of other income (expense) in the first nine months of fiscal 2006 and fiscal 2005 are as follows:
Nine Months Ended ------------------------------------------------------ Change November 26, November 27, ------------------- 2005 2004 $ % ------------ ------------ ------- ------- (Dollars in millions) Minority interest in consolidated subsidiaries $ (2.3) $ (2.2) $ (0.1) (4.5) Foreign exchange loss (2.0) (1.5) (0.5) (33.3) Brazil financial lending tax (1.0) -- (1.0) (100.0) Gain on sale of investment 1.3 10.9 (9.6) (88.1) Other 0.5 (0.7) 1.2 >100.0 ------------ ------------ ------- ------- $ (3.5) $ 6.5 $ (10.0) (>100.0) ============ ============ ======= =======
Minority interest in consolidated subsidiaries principally relates to our controlling interest in PolCard. The $1.0 million Brazil financial lending tax represents the accrual for a tax assessment made during our second quarter related to intercompany loans made to us by our Brazilian subsidiary. The current year $1.3 million gain on sale of investment principally resulted from the sale of our 33% interest in Turfway Park to Harrah's Entertainment and the Keeneland Association. The prior year $10.9 million gain on sale of investment resulted from the sale of our 50% interest in Gaming Entertainment (Delaware) L.L.C. to Harrington Raceway, Inc. INTEREST EXPENSE
Nine Months Ended ----------------------------------------------------- Change November 26, November 27, ------------------- 2005 2004 $ % ------------ ------------ ------- ------- (Dollars in millions) Interest expense $ 23.2 $ 11.7 $ 11.5 98.3
Interest expense increased over last year primarily due to higher average debt balances resulting from the issuance of $300 million of Senior Notes in November 2004. WEIGHTED AVERAGE DILUTED SHARES Weighted average diluted shares in the first nine months of fiscal 2006 decreased by 2.8 million shares to 130.3 million shares, primarily due to treasury share repurchases made under our share buyback program. 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 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 from Standard and Poor's contribute to our ability to access capital markets at attractive prices. On September 12, 2005, we announced that our board of directors was examining the Company's options after receiving a non-binding preliminary expression of interest regarding a potential acquisition of our Company. Following this announcement, both Moody's and Standard and Poor's placed our ratings on negative outlook. -36- ANALYSIS OF CASH FLOWS During the first nine months of fiscal 2006, we generated $308.5 million of cash from operations. This cash was principally used to fund $92.4 million of systems, equipment and other assets relating to contracts; to repurchase $32.1 million, or 1,326,100 shares of our common stock; and to pay cash dividends of $30.9 million. At November 26, 2005, we had $167.6 million of cash and cash equivalents and $261.3 million of short-term investment securities on hand. Our business is capital-intensive. We currently estimate that net cash to be used for investing activities in fiscal 2006 will be in the range of $190 million to $200 million. We expect our principal sources of liquidity to be existing cash and short-term investment securities balances, along with cash we generate from operations and borrowings under our revolving credit facility. Our credit facility provides for an unsecured revolving line of credit of $500 million and matures in October 2009. There were no borrowings under the credit facility as of November 26, 2005. Up to $100 million of the Credit Facility may be used for the issuance of letters of credit. As of November 26, 2005, after considering $6.7 million of letters of credit issued and outstanding, there was $493.3 million available for borrowing under the credit facility. The credit facility contains various covenants, including among other things, requirements relating to the maintenance of certain financial ratios. None of these covenants are expected to impact our liquidity or capital resources. There are no covenants in our credit facility that restrict our ability to pay dividends. At November 26, 2005, we were in compliance with all applicable covenants. We currently expect that our cash flow from operations, existing cash, 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 program. 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 our planned investing activities in fiscal 2006. -37- FINANCIAL POSITION Our consolidated balance sheet at November 26, 2005 as compared to our consolidated balance sheet at February 26, 2005 was impacted by the material changes described below.
Change November 26, February 26, ----------------- 2005 2005 $ % ------------ ------------ ------ ------ (Dollars in millions) Inventories $ 87.0 $ 61.1 $ 25.9 42.4 Systems, equipment and other assets relating to contracts, net 685.8 720.4 (34.6) (4.8) Goodwill 345.8 331.0 14.8 4.5 Property, plant and equipment, net 94.5 74.6 19.9 26.7 Accounts payable 58.8 99.2 (40.4) (40.7) Employee compensation 33.4 21.9 11.5 52.5 Advance payments from customers 55.5 42.9 12.6 29.4 Deferred revenue and advance billings 40.4 29.7 10.7 36.0 Income taxes payable 46.0 16.5 29.5 >100.0 Long-term debt 561.9 726.3 (164.4) (22.6) Other liabilities 99.9 83.3 16.6 19.9 Deferred income taxes 92.0 106.0 (14.0) (13.2) Cost of treasury shares -- 35.9 (35.9) (100.0)
The increase in inventories was primarily due to inventory associated with product sales that are expected to be recorded during the fourth quarter of fiscal 2006 and inventory related to our new contract with our customer in Finland. Revenue under the Finland contract is expected to be recorded in fiscal 2009. The decrease in systems, equipment and other assets relating to contracts, net was primarily due to depreciation expense, partially offset by the purchase of $92.4 million of systems, equipment and other assets relating to contracts (principally related to spending in Missouri, Florida, Rhode Island and the Czech Republic). The increase in goodwill was primarily due to the acquisition of an additional 12% of PolCard. The increase in property, plant and equipment, net was primarily due to $19.1 million of spending by the developer on our new corporate headquarters building in Providence, Rhode Island. -38- The decrease in accounts payable was primarily due to the timing of PolCard's settlement of card related transactions, along with payments to the vendor that supplied the handheld lottery terminals for our current year product sale to our customer in Spain. The increase in employee compensation was primarily due to higher current year provisions for incentive compensation. The increase in advance payments from customers was primarily due to advances received related to our new contract with our customer in Finland. The increase in deferred revenue and advance billings was primarily due to customer progress billings related to a product sale expected to be recorded during the fourth quarter of fiscal 2006. The increase in income taxes payable was primarily due to the timing of income tax payments. The decrease in long-term debt was principally due to the conversion to equity of $157.6 million of our convertible debentures in the first nine months of fiscal 2006. The increase in other liabilities was primarily due to $19.1 million of spending by the developer of our new corporate headquarters building in Providence, Rhode Island. The decrease in deferred income taxes was primarily due to the conversion to equity of $157.6 million of our convertible debentures in the first nine months of fiscal 2006. The decrease in the cost of treasury shares was primarily due to the issuance of treasury shares in connection with the conversion of convertible debentures in the first nine months of fiscal 2006. COMMITMENTS 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 certain specified events 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 they will do so. The following table provides information related to potential commitments at November 26, 2005:
Total Potential Commitments ------------------ (in millions) Performance bonds $ 228.9 Financial guarantees 31.9 Litigation bonds 8.9 All other bonds 5.1 ------------------ $ 274.8 ==================
-39- MASTER CONTRACT WITH THE RHODE ISLAND LOTTERY In May 2003, we entered into a Master Contract with the Rhode Island Lottery (the "Lottery") that amended our existing contracts with the Lottery and grants us the right to be the Lottery's exclusive provider of online, instant ticket and video lottery central systems and services 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. 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: o approximately $39 million was invested during fiscal 2004 and 2005; o approximately $47 million will be invested during fiscal 2006; and o the balance will be invested during fiscal 2007. 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 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. ACQUISITION OF ATRONIC In December 2004, we entered into an agreement to acquire a 50% controlling equity position in the Atronic group of companies ("Atronic") privately held by the Gauselmann Group ("Gauselmann"). The remaining 50% of Atronic will be retained by the owners of Gauselmann. Atronic is a video slot machine manufacturer and develops slot machine games and customized solutions for dynamic gaming operations. The final purchase price for Atronic will be calculated through a performance-based formula equal to eight times Atronic's EBITDA (earnings before interest, taxes, depreciation and amortization) for its year ending December 31, 2006. In addition, in the 12 months after the closing, Atronic will also have the potential to receive an earn-out amount based on its 2007 performance above specified thresholds. We currently expect the all-cash transaction will have a total value of approximately $100 million to $150 million, for our 50% share, including the assumption of debt. Beginning in 2012, we have the option to purchase Gauselmann's interest in Atronic and Gauselmann has a reciprocal right to sell its interest to us at a value determined by independent appraisers. There are also mutual put/call rights that may become effective before 2012, under certain circumstances. The exercise price under these circumstances will be calculated through a performance based formula. This transaction is contingent upon regulatory and gaming license approvals and other closing conditions, and is expected to be completed on December 31, 2006. -40- OPTION TO PURCHASE POLCARD OUTSTANDING EQUITY In May 2003, we completed the acquisition of a controlling equity position in PolCard S.A. ("PolCard"), for a purchase price, net of cash acquired, of $35.9 million. On September 28, 2005, we purchased an additional 11.681% of PolCard from Innova Capital Sp. z o.o. ("Innova") for cash consideration of approximately $21.5 million, resulting in PolCard's outstanding equity being owned 74.5% by us, 25.2% by two funds managed by Innova, and 0.3% by the Polish Bank Association, one of PolCard's previous owners. The terms of the Share Purchase Agreement which govern the purchase of the additional 11.681% of PolCard included a commitment by GTECH and Innova, as the majority shareholders of PolCard, to vote in favor of a general shareholder dividend of approximately $25.0 million to be paid after the close of PolCard's fiscal year ending on February 25, 2006, and for PolCard to loan to Innova approximately $6.3 million in anticipation of the dividend. This loan was advanced on December 22, 2005 (after the close of our fiscal 2006 third quarter), bears interest at WIBOR plus 1.75% (6.35% as of December 22, 2005), and is fully secured by the dividend and by PolCard shares currently owned by Innova. We have three fair value options to purchase Innova's interest in PolCard, and Innova has the reciprocal right to sell its interest in PolCard to us at fair value. Each fair value option has a duration of 90 days and is to be based on an appraised value from at least two investment banks at the date of each option period. Taking into consideration our purchase of an additional 11.681% of PolCard as described above, we estimate that the buyout prices of each fair value option, based on discounted cash flows, could be as follows:
Buyout Percentage Exercise Date of the PolCard Range of Commencing In Outstanding Equity Buyout Price - ------------- ------------------ ------------------ May 2007 12.6% $20 to $30 million May 2008 6.3% $11 to $17 million May 2009 6.3% $13 to $19 million
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. -41- 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 November 26, 10% Increase in 10% Decrease in 2005 Interest Rates Interest Rates --------------- --------------- --------------- $250 million of 4.75% Senior Notes $ 228.1 $ 224.7 $ 231.7 $150 million of 4.50% Senior Notes 138.4 136.5 140.4 $150 million of 5.25% Senior Notes 128.4 124.8 132.2 $17 million of 1.75% Convertible 40.0 40.0 40.0 Debentures
The estimated fair values above were determined by an independent investment banker and take into consideration $225 million of interest rate swaps as follows:
Estimated Fair Value ------------------------------------ Debt Fair Interest Rate Value Swaps Outstanding ------------- ----------------- $250 million of 4.75% Senior Notes $ 228.1 $ 150.0 $150 million of 4.50% Senior Notes 138.4 50.0 $150 million of 5.25% Senior Notes 128.4 25.0
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 swap and treasury rate lock agreements. 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. -42- 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. As of November 26, 2005, we had contracts for the sale of approximately $66.0 million of foreign currency (primarily Euro, Brazilian real and pounds sterling) and the purchase of approximately $48.3 million of foreign currency (primarily pounds sterling, Brazilian real and Canadian dollars). At November 26, 2005, a hypothetical 10% adverse change in foreign exchange rates would result in a translation loss of $17.5 million that would be recorded in the equity section of our balance sheet. At November 26, 2005, a hypothetical 10% adverse change in foreign exchange rates would result in a net pre-tax transaction loss of $4.0 million that would be recorded in current earnings after considering the effects of foreign exchange contracts currently in place. At November 26, 2005, 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 2006 of $3.2 million, after considering the effects of foreign exchange contracts currently in place. The percentage of fiscal 2006 anticipatory cash flows that were hedged varied throughout the first nine months of the fiscal year, but averaged 23%. 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 $0.085 per share, equivalent to a full-year dividend of $0.34 per share. We currently plan to continue paying dividends in the foreseeable future. -43- Item 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK See "Financial Risk Management and Dividend Policy" above. Item 4. CONTROLS AND PROCEDURES We carried out an evaluation, under the supervision and with the participation of our management, including our Chief Executive Officer ("CEO") and our Senior Vice President and Chief Financial Officer ("CFO"), of the effectiveness of our disclosure controls and procedures (as defined in Exchange Act Rule 13a-15 (e)) as of the end of the period covered by this report. Based upon that evaluation, our CEO and CFO concluded that our disclosure controls and procedures were effective as of the end of the period covered by this report. PART II. OTHER INFORMATION Item 1. LEGAL PROCEEDINGS For information respecting certain legal proceedings, see Item 1, "Certain Factors That May Affect Future Performance," Item 7, "Management's Discussion and Analysis of Financial Condition and Results of Operations," and Item 8, Note 14 to Notes to Consolidated Financial Statements of our fiscal 2005 Annual Report on Form 10-K. -44- Item 2. UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS Holders of our 1.75% Convertible Debentures, due December 2021 (the "Debentures"), have the right to convert the Debentures into shares of our Common Stock pursuant to the terms of an Indenture, dated as of December 18, 2001. Specifically, the Debentures are convertible at the option of the holders of the Debentures into shares of our Common Stock at an initial conversion rate of 72.7272 shares of Common Stock per $1,000 principal amount of Debentures, which is equivalent to an initial conversion price of approximately $13.75 per share, subject to certain adjustments, in the following circumstances: (i) if the sale price of our Common Stock is more than 120% of the conversion price (approximately $16.50 per share) for at least 20 trading days in a 30 trading-day period prior to the date of surrender for conversion; (ii) if, during any period, the credit ratings assigned to the Debentures by Moody's or Standard & Poor's are reduced below Ba1 or BB, respectively, or the credit rating assigned to the Debentures is suspended or withdrawn by either rating agency; (iii) if the Debentures have been called for redemption; or (iv) upon the occurrence of specified corporate transactions. During our fiscal 2006 third quarter, we issued shares of our Common Stock upon the exercise of conversion rights by Holders of the Debentures, in the amounts, for consideration and pursuant to conversion notices dated, as follows:
Consideration (Dollars of Retired Date of Notice of Conversion Debenture Principal Amount) Common Shares Issued - ---------------------------- --------------------------------- -------------------- August 29, 2005 15,200,000 1,105,454 September 20, 2005 300,000 21,818 September 21, 2005 423,000 30,763 September 28, 2005 60,000 4,363 October 21, 2005 8,000 581 November 8, 2005 16,500,000 1,199,999
This information was previously included in Current Reports on Forms 8-K. We claim exemption from registration under the Securities Act of 1933, as amended (the "Securities Act") in respect to the issuance of shares of Common Stock upon the conversion of the Debentures by virtue of compliance (on the basis of facts described herein) with Section 3 (a) (9) of the Securities Act. We made no purchases of shares of our Common Stock during the third quarter of fiscal 2006. We have authority remaining under the stock buy-back program that we announced in November 2004 to purchase up to $47.3 million of our Common Stock. -45- Item 6. 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 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: January 4, 2006 By /s/ Jaymin B. Patel --------------------------------- Jaymin B. Patel, Senior Vice President and Chief Financial Officer (Principal Financial Officer) Date: January 4, 2006 By /s/ Robert J. Plourde --------------------------------------- Robert J. Plourde, Vice President, Corporate Controller and Chief Accounting Officer (Principal Accounting Officer) -46- EX-12.1 2 y15952exv12w1.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) Nine Months Ended ------------------------------ November 26, November 27, 2005 2004 ------------ ------------ (Dollars in thousands) Earnings: Income before income taxes $ 229,550 $ 237,803 Add: Interest on indebtedness 23,162 11,743 Equity income, net of distributions (612) 1,071 Minority losses 2,287 2,178 Portion of rents representative of the interest factor 944 986 Amortization of capitalized interest 596 502 ------------ ------------ Earnings available for fixed charges $ 255,927 $ 254,283 ============ ============ Fixed charges: Interest on indebtedness 23,162 11,743 Portion of rents representative of the interest factor 944 986 Capitalized interest 13 650 ------------ ------------ Total fixed charges $ 24,119 $ 13,379 ============ ============ Ratio of earnings to fixed charges 10.61 19.01 ============ ============
EX-31.1 3 y15952exv31w1.txt CERTIFICATION 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 internal control over financial reporting (as defined in Exchange Act Rules 13a-15(f) and 15d-15(f)) for the Company and 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) designed such internal control over financial reporting, or caused such internal control over financial reporting to be designed under our supervision, to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles; (c) 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 (d) disclosed in this quarterly report any change in the Company's internal control over financial reporting that occurred during the Company's most recent 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. Date: January 4, 2006 /s/ W. Bruce Turner ------------------------------------- W. Bruce Turner President and Chief Executive Officer EX-31.2 4 y15952exv31w2.txt CERTIFICATION 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 internal control over financial reporting (as defined in Exchange Act Rules 13a-15(f) and 15d-15(f)) for the Company and 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) designed such internal control over financial reporting, or caused such internal control over financial reporting to be designed under our supervision, to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles; (c) 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 (d) disclosed in this quarterly report any change in the Company's internal control over financial reporting that occurred during the Company's most recent 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. Date: January 4, 2006 /s/ Jaymin B. Patel ------------------------------------------ Jaymin B. Patel, Senior Vice President and Chief Financial Officer EX-32.1 5 y15952exv32w1.txt CERTIFICATION 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 November 26, 2005 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 section 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. Date: January 4, 2006 /s/ W. Bruce Turner ------------------------------------- W. Bruce Turner President and Chief Executive Officer EX-32.2 6 y15952exv32w2.txt CERTIFICATION 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 November 26, 2005 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 section 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. Date: January 4, 2006 /s/ Jaymin B. Patel -------------------------------------- Jaymin B. Patel, Senior Vice President and Chief Financial Officer -----END PRIVACY-ENHANCED MESSAGE-----