<PAGE> 1
As filed with the Securities and Exchange Commission on March 19, 1996
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-K
(Mark One)
/X/ ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934 [FEE REQUIRED]
FOR THE FISCAL YEAR ENDED DECEMBER 31, 1995
----------------------------------------------
/ / TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934 [NO FEE REQUIRED]
FOR THE TRANSITION PERIOD FROM TO
----------------------- ----------------
Commission file number 0-10294
-----------------------------
INTERNATIONAL LOTTERY & TOTALIZATOR SYSTEMS, INC.
(Exact name of registrant as specified in its charter)
Formerly International Totalizator Systems, Inc.
CALIFORNIA 95-3276269
- ---------------------------------------------------- -----------------------
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification Number)
2131 FARADAY AVENUE
CARLSBAD, CALIFORNIA 92008
- ---------------------------------------------------- -----------------------
(Address of principal executive offices) (Zip Code)
Registrant's telephone number, including area code (619) 931-4000
--------------------
Securities registered pursuant to Section 12(g) of the Act:
(Title of Class)
COMMON SHARES
- --------------------------------------------------------------------------------
Indicate by check mark whether the Registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months (or for such shorter period that the Registrant was
required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days. Yes /X/ No / /
Aggregate market value of voting stock held by non-affiliates of the Registrant
as of March 19, 1996 was approximately $ 22,071,277
- --------------------------------------------------------------------------------
Number of common shares outstanding at March 19, 1996 was 16,816,211
DOCUMENTS INCORPORATED BY REFERENCE
Portions of the 1995 Annual Report to Stockholders of the Registrant: Parts II
and IV Portions of the Proxy Statement for Annual Meeting of Stockholders, June
6, 1996: Part III
- --------------------------------------------------------------------------------
Indicate by check mark if disclosure of delinquent filers pursuant to Item 405
of Regulation S-K is not contained herein, and will not be contained, to the
best of the Registrant's knowledge, in definitive proxy or information
statements incorporated by reference in Part III of this Form 10-K or any
amendment to this Form 10-K./ /
<PAGE> 2
TABLE OF CONTENTS
PART I
<TABLE>
<S> <C> <C>
ITEM 1. BUSINESS................................................. 1
General.................................................. 1
DATAMARK(R) Terminals.................................... 1
Wagering and Other Terminal Products..................... 2
Lottery Systems/Sales and Service Agreements............. 2
Revenue Sources.......................................... 3
Product Development...................................... 3
Backlog.................................................. 3
Marketing and Business Development....................... 3
Manufacturing and Materials.............................. 4
Competition.............................................. 4
Employees................................................ 5
Patents, Trademarks and Licenses......................... 5
Regulation............................................... 5
Dependence Upon a Few Customers.......................... 5
Seasonality.............................................. 5
Working Capital Practices................................ 5
Environment Effects...................................... 5
Export Sales............................................. 5
ITEM 2. PROPERTIES............................................... 6
ITEM 3. LEGAL PROCEEDINGS........................................ 6
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS...... 7
EXECUTIVE OFFICERS OF THE REGISTRANT..................... 7
PART II
ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY
AND RELATED STOCKHOLDER MATTERS.......................... 7
ITEM 6. SELECTED FINANCIAL DATA.................................. 7
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS............ 7
ITEM 8. CONSOLIDATED FINANCIAL STATEMENTS........................ 8
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS
ON ACCOUNTING AND FINANCIAL DISCLOSURE................... 8
PART III
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT....... 8
ITEM 11. EXECUTIVE COMPENSATION................................... 8
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS
AND MANAGEMENT........................................... 8
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS........... 8
PART IV
ITEM 14. EXHIBITS, CONSOLIDATED FINANCIAL STATEMENT SCHEDULES,
AND REPORTS ON FORM 8-K.................................. 8
</TABLE>
<PAGE> 3
PART I
ITEM 1. BUSINESS
GENERAL The Registrant designs, manufactures, sells, leases, manages, supports
and services computerized ticket issuing systems and terminals for the global
pari-mutuel and on-line lottery industries. The principal applications for the
Registrant's products are in the automated horse racing and on-line government
sponsored lottery industries. The Registrant has also entered into long-term
service contracts under which it intends to operate on-line lottery systems. The
Registrant utilizes its technology in other ticket-processing applications, such
as keno gaming and automated ticket printer/readers for toll turnpike systems.
The principal proprietary component of the Registrant's systems is the
DATAMARK(R) terminal, a compact, reliable microprocessor-based ticketing
terminal, which can print and process up to approximately 30 tickets per minute.
The Registrant sells the DATAMARK(R) terminal separately or as part of turnkey
wagering application system and can modify the terminal's features or
configurations and central system software to meet specific customer
requirements.
The Registrant's wagering application systems include DATAMARK(R)
terminals, a central computer installation, communication network and display
equipment. System features include real-time central processing of data received
from multiple locations, back-up hardware capability and complete communications
redundancy designed to provide fault tolerant operation.
DATAMARK(R) TERMINALS The Registrant has developed several models of DATAMARK(R)
terminals for different wagering applications. All are microprocessor-based and
have a compact, lightweight design for countertop operation. The more recent
models use the "Flipper" concept and are approximately 12" deep, 12" wide, 10"
high, weigh approximately 27 pounds, and are accompanied by a detached keyboard
that may be positioned to suit the convenience of the operator. Other models are
slightly larger and may have built-in or external displays or keyboards.
The latest DATAMARK(R) models utilize a compact ticket path which
allows the terminal to print on one side and read from both sides of the same
ticket. The terminal contains a thermal printer which prints tickets quickly and
quietly without ink, ribbons or impact, thereby improving print quality and
reliability, and reducing maintenance expenses. The terminals use either pre-cut
thermal-coated tickets or thermal- coated roll stock tickets or both. Some
models will sequentially process up to 50 tickets entered at one time.
The basic functions of the DATAMARK(R) terminal are similar in all its
wagering system applications. Initially, wagering or other selection data is
entered into the terminal either manually by the operator via a keyboard, or by
a ticket marked by the customer. The terminal transmits that information to the
central computer, where a serial number is assigned to the transaction and a
response is sent back to the terminal which then thermally prints the data
either on the back of the customer-marked ticket or on a new ticket. After the
data has been printed on the ticket, in both numerical and machine readable (bar
code) form, but before the ticket is delivered to the customer, the terminal
reads the bar code in order to verify that it is correct and readable when later
presented to any terminal for cashing or validation. When a ticket is cashed or
presented for validation, the terminal optically reads the bar code and accesses
the central computer to verify that payment is to be made with respect to the
ticket. The central computer calculates the payout amount, transmits this data
to the terminal and records the fact that the ticket has been paid, ensuring
that tickets are not paid twice. The terminal prints the payout amount on the
ticket giving visual evidence that the ticket has been paid, and directs the
ticket to the operator.
The DATAMARK(R) terminal's basic functions are supplemented by various
features. In the horse racing industry, the DATAMARK(R) terminal is capable of
issuing tickets for pool or for any feature pool currently being used in horse
racing. The terminals are designed to facilitate multiple bets on one ticket and
multiple selections for each bet. In addition, the bettor is able to mark bets
on a pre-printed playslip, which is then read optically by the terminal, the
amount wagered calculated and the bet details printed on the back of the same
ticket. Because the ticket is prepared away from the pari-mutuel clerk's window,
betting transaction time is reduced, efficiency of the operation is improved and
the bettor obtains more privacy in the betting transaction.
<PAGE> 4
Similarly, in the lottery industry, a player marks the numbers selected
on a pre-printed ticket or playslip which is read optically by the DATAMARK(R)
terminal and entered into the central system. The selections and the transaction
total are then either printed on the back of the playslip or on a separate
ticket and delivered to the player.
WAGERING AND OTHER TERMINAL PRODUCTS The Registrant historically has derived
revenue in the horse racing industry from sales contracts for DATAMARK(R)
terminals and for wagering systems, which include DATAMARK(R) terminals, a
central computer installation and peripheral and display equipment. The
Registrant's systems are "sell-pay" systems, which means that each terminal is
capable of being used both for selling all types of wagering tickets and for
making payment to the ticket holders after validation of winning tickets.
The nucleus of each wagering system is the central computer
installation that receives information from ticket-issuing terminals,
accumulates wagering data, calculates odds and payouts, distributes information
to the display systems and terminals, and generates management information
reports. In cooperation with the customer, the Registrant designs the
configuration of the central computer installation to provide fault-tolerant
operation, high throughput and security. Each central computer installation
typically includes a computer configuration and various peripheral devices, such
as magnetic storage devices, management terminals and hardcopy printers, all of
which are manufactured by others. Although certain of the Registrant's customers
presently use software in their pari-mutuel systems which is proprietary to the
Registrant, the software presently being offered by the Registrant in its horse
racing system is software, as enhanced and modified by the Registrant, acquired
by license from The Royal Hong Kong Jockey Club (The RHKJC).
In addition to sales of terminals and systems, the Registrant realizes
ongoing revenue from the sale of spare parts for use in the maintenance of its
terminals of which approximately 30,000 have been delivered to date. The
Registrant also enters into contracts with its customers to provide software
modifications, upgrades and support for its installed products.
LOTTERY SYSTEMS/SALES AND SERVICE AGREEMENTS Computerized, or on-line, lotteries
are currently operated in many countries. Existing lottery systems include both
manual systems and modern on-line systems. In an on-line lottery system, betting
terminals are connected to a central computer installation by a communications
network and the system typically utilizes a pari-mutuel pool or fixed payout or
both in offering "lotto" and other numbers games.
Prior to 1994, the Registrant entered into contracts to provide lottery
equipment and management of on-line lottery systems on a long-term basis in
Papua New Guinea, the Republic of Georgia, the Dominican Republic and the
Russian Federation. In 1994, the Registrant recorded $9.8 million in write-offs
and a write-down against all of these service projects, except Russia. In
January 1995, Registrant discontinued its operation in the Dominican Republic.
In July 1995, ILTS sold its facilities management and equipment lease contracts
for the lottery in Papua New Guinea to the principal shareholders of the
operating company, The Lotto Pty. Ltd ("Lotto Pty."). ILTS is being paid in cash
installments over a 17 month period plus a percentage of Lotto Pty.'s sales over
the next five years. Proceeds of the sale are anticipated to accelerate the
Registrant's return on its investment, and to ultimately provide a greater
return than if the Registrant had continued to operate the lottery for Lotto
Pty.
On November 1, 1994, the Russian government issued a decree which required all
existing lottery license holders, including the charitable foundation with which
the Registrant had a management and supply agreement, to apply for
re-registration of their license by February 1, 1995. Due to the uncertainty
regarding the license registration and with the continued economic, legal, and
political instability in Russia, the Registrant recorded a provision of $7.6
million in its quarter ended December 31, 1994. The Registrant terminated the
Russian lottery project in November 1995, after exhausting numerous options to
secure outside financing or joint venture partners for the project.
In June 1995, the Registrant announced a ten year service and supply agreement
with Pascal & Company (Pascal) of the United Kingdom. The Registrant will
provide a lottery system and services to Pascal for operation of an on-line
lottery on behalf of the National Hospital Trust (NHT) in England and provided
1,000 DATAMARK(R) on-line terminals and associated software, a central computer
system and software, training, support, installation and maintenance. The
Registrant will be compensated as a percentage of gross weekly lottery sales.
Due primarily to a change in ownership of Pascal and a corporate reorganization
of its new corporate owners no production order for the terminals has been
placed pursuant to the supply agreement.
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The Registrant owns non-exclusive rights to use the central system
software developed by The RHKJC for use in its pari-mutuel wagering and lottery
systems. Under the terms of the amended license, the Registrant pays The RHKJC a
royalty equal to a percentage of the revenue it receives in connection with a
sale, lease or providing a service of any lottery system using this software. In
addition, the Registrant is obligated to provide The RHKJC with any
modifications which the Registrant makes to the software, except where ownership
to such modifications vests in the Registrant's customers.
The Registrant has made significant modifications to The RHKJC
software, including changes to the system's communications network and changes
which permit the generation of more detailed management reports. In the
Registrant's lottery system, tickets are processed on DATAMARK(R) terminals
which are connected to a central computer installation, usually by telephone
lines. The central computer installation utilizes Digital Equipment Corporation
hardware. The system has the following characteristics: rapid processing,
storage and retrieval of transaction data in high volumes and in multiple
applications; the ability to down-line load, i.e., to reprogram the wagering
terminals from the central computer installation via the communications network;
a high degree of security and redundancy to guard against unauthorized access
and tampering and to ensure fault tolerant operation without data loss; and, a
comprehensive management information and control system.
REVENUE SOURCES The following table sets forth the revenue for the periods
indicated attributable to different applications of the Registrant's technology:
<TABLE>
<CAPTION>
Years Ended December 31,
1995 1994 1993 1992 1991
<S> <C> <C> <C> <C> <C>
(dollars in thousands)
Racing Products and Services $10,448 $13,932 $14,680 $14,851 $22,629
Lottery Products and Services 7,680 9,231 10,322 4,417 6,701
Other 513 926 15 569 161
------- ------- ------- ------- -------
Total $18,641 $24,089 $25,017 $19,837 $29,491
======= ======= ======= ======= =======
</TABLE>
PRODUCT DEVELOPMENT The Registrant's ability to compete successfully depends in
part upon its ability to meet the current and anticipated needs of its
customers. To that end, the Registrant devotes a significant portion of its
research and development activity to refining and enhancing the features of
existing products, systems and software. In 1995, the Registrant spent
approximately $1.4 million on engineering, research and development, as compared
to $1.6 million and $2.0 million in 1994 and 1993, respectively.
In recent years, the Registrant introduced a new lottery terminal
utilizing an advanced version of a Charge Coupled Device (CCD) reader capable of
reading hand written information such as signatures and addresses, as well as
other graphics on customer-marked tickets. Charge Coupled Device (CCD)
technology is a requirement for certain European lotteries. In addition, the
Registrant developed the Single Roller Flipper Terminal with a unique
reader/printer mechanism that meets the needs of many different applications by
combining into one unit all of the functional capabilities of previous
DATAMARK(R) reader/printer mechanisms in a modular fashion.
In late 1995, the Registrant successfully completed the ISO audit
performed by Underwriters Laboratories and in February 1996, was granted ISO
9001 registration. This demonstrates quality in design development and
manufacture under ISO standards.
BACKLOG The backlog of orders for its products and services believed by the
Registrant to be firm, amounted to approximately $9.2 million as of December 31,
1995, as compared to a backlog of approximately $11.2 million as of December 31,
1994. Of such backlog at December 31, 1995, approximately $9.2 million is
expected to be filled during 1996. See BUSINESS - Dependence Upon a Few
Customers.
MARKETING AND BUSINESS DEVELOPMENT Management believes that the Registrant's
continuing ability to obtain and retain contracts for its wagering systems and
terminals is directly related to its reputation in its various fields of
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expertise. Because of its reputation, the Registrant often receives unsolicited
inquiries from potential customers. The Registrant also learns of new business
opportunities through the close contacts which its personnel maintain with key
officials in the international horse racing and lottery industries.
Contracts to provide products to the horse racing and lottery
industries often are awarded through a competitive bidding process which can
begin years before a contract is awarded and involves substantial expenditures
by the Registrant. Through its contacts with existing customers and others in
these industries, the Registrant often becomes aware of prospective projects
before the customer circulates a request for proposal. If the Registrant is
interested in the project it typically submits a proposal, either before or
after the customer circulates a formal request for proposal, outlining the
products it would provide and the services it would perform. If the proposal is
accepted, the Registrant and its customer will negotiate and enter into a
contract on agreed terms.
The Registrant's marketing efforts are carried out by the Registrant's
professional marketing and engineering staff and frequently involves other
executive officers of the Registrant. Marketing of the Registrant's products and
services throughout the world is often performed in conjunction with consultants
with whom the Registrant contracts, from time to time, for representation in
specific market areas.
The Registrant's success depends in large part on its ability to
obtain new contracts to replace its existing contracts. The Registrant currently
has proposals outstanding to supply systems, terminals or components for use in
the pari-mutuel wagering industry and for lotteries in various foreign
countries. In 1995, the Registrant unsuccessfully bid on one service/operating
contract for a U.S. state lottery and it intends to continue this marketing
effort in 1996 and future years. In addition, the Registrant has had discussions
with both new and existing customers regarding supplying products for their
operations and expects to bid for additional contracts in the future. Because
the realization of revenue from these prospects is dependent upon a number of
factors, including the bidding process and product development, there can be no
assurance that the Registrant will be successful in realizing revenue from any
of these activities. Late in 1994, prototype deliveries began on the $2.4
million contract announced in 1993 with The Revenue Markets, Inc. (TRIMI) which
is automating the New York State Thruway toll road system. These units are
currently being operated in a pilot test mode.
Natural Avenue Sdn, Bhd of Malaysia, a new customer of the Registrant
placed a $2.2 million order for DATAMARK(R) lottery terminals and a computer
operations system. Natural Avenue operates an on-line lottery in the state of
Sarawak, in eastern Malaysia, which began in February 1996.
MANUFACTURING AND MATERIALS Manufacture of the Registrant's systems and
terminals is performed at its facilities in Carlsbad, California, and consists
principally of the assembly of parts, components and subassemblies (most of
which are designed by the Registrant) into finished products. The Registrant
purchases many parts, components and subassemblies (some of which are designed
by The Registrant) necessary for its terminals and the systems manufactured by
the Registrant from outside sources and assembles them into finished products.
These products and purchased computers are then integrated with standard
peripherals purchased by the Registrant to construct racing and lottery systems.
The Registrant generally has multiple sources for the various items purchased
from vendors, but some of these items are state-of-the-art and could, from time
to time, be in short supply. Certain other items are available only from a
single supplier. For the twelve months ended December 31, 1995 no vendor
accounted for 10% or more of the Registrant's raw material purchases.
COMPETITION The Registrant competes primarily in the horse racing industry and
the on-line lottery industry. The Registrant competes by providing high-quality
wagering systems and terminals that are reliable, secure and fast. In addition,
management believes that the Registrant offers its customers more flexibility in
design and custom options than do most of its competitors.
Management believes that the Registrant's main competitors in the sale
of horse racing systems and on-line lottery systems in the domestic and
international marketplace are: AWA Limited, an Australian company, Essnet, a
Swedish company, International Des Jeux, the French national lottery company,
GTECH Holdings Corporation, Autotote Limited and Video Lottery Technologies, all
United States companies. Management believes that the Registrant's sales of its
products in the past five years have been a substantial factor in the
international marketplace.
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The Registrant's sales or leases in the United States have been insignificant.
In general, the Registrant's competitors have significantly greater resources
than the Registrant. Competition for on-line lottery system contracts is
intense.
EMPLOYEES As of December 31, 1995, the Registrant employs 176 persons worldwide
on a full-time equivalent basis. Of this total, 62 were engaged in manufacturing
and operations support, 54 in engineering and software development and 60 in
marketing and administrative positions. None of the Registrant's employees is
represented by a union, and the Registrant believes its relations with its
employees are good.
PATENTS, TRADEMARKS AND LICENSES The Registrant has filed five patent
applications on its products, all of which have been issued by the U.S. Patent
Office. The Registrant believes that its technical expertise, trade secrets and
the creative skills of its personnel are of substantially greater importance to
the success of the Registrant than the benefits of patent protection. The
Registrant typically requires customers, employees, licensees, subcontractors
and joint venturers who have access to proprietary information concerning the
Registrant's products to sign nondisclosure agreements, and the Registrant
relies on such agreements, other security measures and trade secret law to
protect such proprietary information. Central system software used in the
Registrant's lottery system has been obtained under a non-exclusive license with
The RHKJC.
REGULATION The countries in which the Registrant markets its products generally
have regulations governing horse racing or lottery operations, and the
appropriate governing body could restrict or eliminate these operations in these
countries. Any such action could have a material adverse effect on the
Registrant. Foreign countries also often impose restrictions on corporations
seeking to do business within their borders, including foreign exchange controls
and requirements for domestic manufacturing content. In addition, laws and legal
procedures in these countries may differ from those generally existing in the
United States and conducting business in these countries may involve additional
risk for the Registrant in protecting its business and assets, including
proprietary information. Changes in foreign business restrictions or laws could
have a significant impact on the Registrant's operations.
DEPENDENCE UPON A FEW CUSTOMERS The Registrant's business to date has been
dependent on major contracts and the loss of one or failure to replace completed
contracts with new contracts would have a materially adverse effect on the
Registrant's business. During 1995, the Registrant's revenues were derived
primarily from contracts with the Western Australia Totalisator Agency Board,
($4.4 million); the Phillippines Gaming Management Company, ($2.9 million); AB
Travoch Galopp (ATG) of Sweden ($1.9 million), New South Wales Lottery ($1.6
million), Natural Ave Sdn Bhd, a Malaysian company ($1.3 million) and Leisure
Management Berhad, a Malaysian company ($1.0 million). See Note 4 of Notes to
Consolidated Financial Statements, incorporated by reference in Part II, Item 8,
and Management's Discussion and Analysis of Financial Condition and Results of
Operations incorporated by reference in Part II, Item 7.
SEASONALITY In general, the Registrant's business is not subject to seasonal
effects.
WORKING CAPITAL PRACTICES The Registrant's sales contracts typically provide for
deposits and progress payments which, with interim short-term bank financing,
have provided sufficient working capital for operations. With the Registrant
entering into long-term lottery service agreements, a substantial portion of its
working capital has been expended in attempting to establish viable operations
in these investments. See "Management's Discussion and Analysis of Financial
Condition and Results of Operations" incorporated by reference herein.
ENVIRONMENT EFFECTS There are no significant capital expenditures required of
the Registrant in order to comply with laws relating to protection of the
environment.
EXPORT SALES The majority of the Registrant's revenues are derived from
contracts with foreign companies. As of December 31, 1995 the Registrant's
equipment has been delivered and installed in Sweden, Norway, Hong Kong, France,
Australia, Singapore, Finland, England, the Netherlands, Malaysia, Macau, China,
Papua New Guinea, Belgium, the Philippines. The companies with which the
Registrant contracts are normally sizeable organizations with substantial assets
and are capable of meeting the financial obligations undertaken. The Registrant
has entered into a few contracts specifying payment in currencies other than the
U.S. dollar, thereby assuming the risk associated with fluctuations in value of
foreign currencies. These currencies include the Australian dollar, and
Malaysian ringgit.
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<PAGE> 8
The Registrant has a wholly-owned foreign sales corporation and
conducts its foreign business through such subsidiary in order to obtain U.S.
tax benefits associated with this corporation. In addition, the Registrant
operates wholly-owned subsidiaries in Australia, and the United Kingdom. Also,
see Note 5 of Notes to Consolidated Financial Statements, incorporated by
reference in Part II, Item 8.
ITEM 2. PROPERTIES
The Registrant's U.S. facilities consist of approximately 41,500
square feet of leased office, warehouse and manufacturing space in Carlsbad,
California. The lease on this facility expires in the year 2000. The
Registrant's Australian subsidiary leases approximately 13,000 square feet
consisting of a manufacturing and administrative facility. The lease on this
property expires in October 1997. The Registrant's United Kingdom subsidiary
currently occupies an office-technical support facility in West Drayton, England
of approximately 2,400 square feet, under a lease expiring in April, 1998. See
Note 6 of Notes to Consolidated Financial Statements, incorporated by reference
in Part II, Item 8.
ITEM 3. LEGAL PROCEEDINGS
SHAREHOLDERS' CLASS ACTION LITIGATION In June and July 1994, shareholders of the
Registrant filed class action lawsuits against the Registrant and several of its
officers and directors. Those actions were consolidated by stipulation and order
and are now pending in the United States District Court for the Southern
District of California. Plaintiffs contend that during the class period (June
22, 1993 through June 21, 1994) the Registrant and the individual defendants
made a series of public statements that failed to disclose adverse information
about the Registrant's lottery service contracts, that these purported
nondisclosures artificially inflated the price of the Registrant's stock, and
that those purchasers who acquired their shares in reliance on the integrity of
the market suffered damages as a result. Plaintiffs seek unspecified damages.
The defendants deny all material allegations. On March 15, 1996, the attorneys
for all defendants entered into a Stipulation of Settlement with the law firm
representing the plaintiffs. The proposed settlement includes a cash payment and
1.2 million of authorized but unissued common shares of the Registrant. The
proposed settlement is subject to agreement by the shareholders included in the
class period and approval by the court. The Registrant has recorded a reserve
for its obligations anticipated under the proposed settlement, which includes an
estimate of the value of the shares as a current liability.
WALTERS V ILTS, ET AL On November 3, 1995, Mr. James Walters, the former
chairman and president of the Registrant, who retired in 1994, filed an action
in the San Diego County Superior Court against the Registrant, its current
president, Frederick A. Brunn, a publishing company and an author alleging that
certain statements in a magazine article were slander per se by ILTS and Brunn
and libel by the publishing company and the author, and that Mr. Walters
suffered an invasion of privacy by all defendants. In addition, Mr. Walters
alleged that information in the Registrant's 1995 proxy statement relating to
Mr. Walters' compensation and retirement date was erroneous, resulting in two
other magazine articles publishing allegedly incorrect information. Mr. Walters
seeks general and special damages of $9 million and punitive damages. The
Registrant and Mr. Brunn deny all allegations in Mr. Walters' complaint and will
defend the litigation accordingly. No trial date has been set.
Various other litigation in which the Registrant is a defendant is
pending, none of which is expected individually or in aggregate, to have a
materially adverse effect on the Registrant.
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ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
Inapplicable.
EXECUTIVE OFFICERS OF THE REGISTRANT
<TABLE>
<CAPTION>
Name Age Position
- ---- --- --------
<S> <C> <C>
Frederick A. Brunn 51 President
Timothy R. Groth 46 Vice President, Technical Operations
William A. Hainke 54 Chief Financial Officer, Corporate Secretary and Treasurer
M. Mark Michalko 41 Executive Vice President
Lennart K. Sundin 60 Senior Vice President, Marketing and Sales
</TABLE>
PART II
ITEM 5. MARKET FOR THE REGISTRANT'S COMMON EQUITY AND RELATED
STOCKHOLDER MATTERS
The information required by this item is included in the Registrant's
Annual Report to Shareholders for the fiscal year ended December 31, 1995 under
the same caption and is incorporated herein by reference to such Annual Report.
Solely for the purpose of calculating the aggregate market value of
the voting stock held by non-affiliates of the Registrant, as set forth on the
cover of this report, it has been assumed that all executive officers and
directors of the Registrant and Berjaya Lottery Management (H.K.) Ltd. were
affiliated persons. All of the Registrant's Common shares, the only voting stock
outstanding, beneficially owned by each such person (as defined in Rule 13d-3
under the Securities Exchange Act of 1934) have been assumed to be held by that
person for this calculation. The market value of the Common shares is based on
the closing price reported in the Wall Street Journal for March 19, 1996, of
$1.3125 per share.
ITEM 6. SELECTED FINANCIAL DATA
The information required by this item is included on page 5 of the
Registrant's Annual Report to Shareholders for the fiscal year ended December
31, 1995 under the same caption and is incorporated herein by reference to such
Annual Report.
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS
The information required by this item is included on pages 6 and 7 of
the Registrant's Annual Report to Shareholders for the fiscal year ended
December 31, 1995 under the same caption and is incorporated herein by reference
to such Annual Report.
7
<PAGE> 10
ITEM 8. CONSOLIDATED FINANCIAL STATEMENTS
The information required by this item is included on pages 8 through
11 of the Registrant's Annual Report to Shareholders for the fiscal year ended
December 31, 1995 and is incorporated herein by reference to such Annual Report.
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON
ACCOUNTING AND FINANCIAL DISCLOSURE
Inapplicable.
PART III
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
The information required is incorporated herein by reference to the
Registrant's definitive Proxy Statement for the 1996 Annual Meeting of
Shareholders.
ITEM 11. EXECUTIVE COMPENSATION
The information required is incorporated herein by reference to the
Registrant's definitive Proxy Statement for the 1996 Annual Meeting of
Shareholders.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
The information required is incorporated herein by reference to the
Registrant's definitive Proxy Statement for the 1996 Annual Meeting of
Shareholders.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
The information required is incorporated herein by reference to the
Registrant's definitive Proxy Statement for the 1996 Annual Meeting of
Shareholders.
PART IV
ITEM 14. EXHIBITS, CONSOLIDATED FINANCIAL STATEMENT SCHEDULES, AND
REPORTS ON FORM 8-K
(a) List the following documents filed as a part of the report:
1. and 2. Index to Consolidated Financial Statements and Financial
Statement Schedules:
(i) Report of Ernst & Young LLP, Independent Auditors*
(ii) Consolidated Balance Sheets at December 31, 1995 and
1994*
8
<PAGE> 11
(iii) Consolidated Statements of Operations for each of the
three years in the period ended December 31, 1995*
(iv) Consolidated Statements of Shareholders' Equity for
each of the three years in the period ended December
31, 1995*
(v) Consolidated Statements of Cash Flows for each of the
three years in the period ended December 31, 1995*
(vi) Notes to Consolidated Financial Statements*
*incorporated by reference to the Annual Report to
Shareholders for the fiscal year ended December 31,
1995.
(vii) Schedule II - Valuation and Qualifying Accounts (Form
10-K, page 11)
All other schedules are omitted since the required
information is not present or is not present in
amounts sufficient to require a submission of the
schedule, or because the information required is
included in the financial statements and notes
thereto.
3. Exhibits
(3) Articles of Incorporation, as amended September 13,
1994, reflecting corporate name change, and By-laws
(incorporated by reference to Form 10-K for the
fiscal year ended December 31, 1994, File No.
0-10294).
(10) (a) Lease for the Registrant's facility in Carlsbad,
California dated June 30, 1992, as amended by First
Amendment to Lease dated January 23, 1987
(incorporated by reference to Exhibit 10.11 to
Registration Statement File No. 33-18238 effective
February 19, 1988).
(b) Agreement with Sir Michael G. R. Sandberg dated May
20, 1987 (incorporated by reference to Exhibit 10.15
to Registration Statement File No. 33-18238 effective
February 19, 1988).
(c) The Registrant's 1982 Employee Stock Option Plan
(incorporated by reference to Exhibit 4(b) to
Post-Effective Amendment No. 1 to Form S-8
Registration Statement, File No. 2-99618, as filed on
April 4, 1990).
(d) The Registrant's 1986 Employee Stock Option Plan
(incorporated by reference to Exhibit 4(b) to the
Form S-8 Registration Statement, File No. 33-34121,
as filed on April 4, 1990).
(e) The Registrant's 1988 Employee Stock Option Plan
(incorporated by reference to Exhibit 4(b) to the
Form S-8 Registration Statement, File No. 33-34123,
as filed on April 4, 1990).
(f) The Registrant's 1990 Stock Incentive Plan
(incorporated by reference to Form 10-K for the
fiscal year ended December 31, 1990, File No. 0-10294
and File No. 33- 79938).
(g) Agreement with The Royal Hong Kong Jockey Club dated
May 11, 1989 and amended on January 13, 1992
(incorporated by reference to Form 10-K for the
fiscal year ended December 31, 1991, File No.
0-10294).
9
<PAGE> 12
(h) The Registrant's 1993 Directors' Stock Option Plan as
amended May 26, 1995 (incorporated herein by
reference to Form 10-K for the fiscal year ended
December 31, 1994, File No. 0-10294).
(i) Retirement Agreement, dated June 20, 1995 and
Consulting Agreement dated July 15, 1995 for James T.
Walters (incorporated herein by reference to Form
10-K for the fiscal year ended December 31, 1994,
File No. 0-10294).
(13) Annual Report to Shareholders for the fiscal year ended
December 31, 1995. With the exception of the information
incorporated by reference into items 5, 6, 7, and 8 of this
Form 10-K, the 1995 Annual Report to Shareholders is not
deemed filed as part of this report.
(21) Subsidiaries of the Registrant.
(23) Consent of Ernst & Young LLP, Independent Auditors
(b) No reports on Form 8-K have been filed during the
last quarter of the period covered by this report.
10
<PAGE> 13
SCHEDULE II
INTERNATIONAL LOTTERY & TOTALIZATOR SYSTEMS, INC.
Valuation and Qualifying Accounts
<TABLE>
<CAPTION>
Additions
Balance at Charged to
Beginning Costs and Balance at
Description of Year Expenses Deductions End of Year
- ----------- ---------- ---------- ---------- -----------
<S> <C> <C> <C> <C>
Years Ended:
December 31, 1995
-- Warranty Reserves $ 347,117 $ 76,015 $ 125,405 $ 297,727
-- Allowance for
Doubtful Accounts $ 208,550 $ 60,000 $ 205,594 $ 62,956
December 31, 1994
-- Warranty Reserves $ 193,000 $ 255,370 $ 101,253 $ 347,117
-- Allowance for
Doubtful Accounts $ 75,000 $ 140,000 $ 6,450 $ 208,550
December 31, 1993
-- Warranty Reserves $ 221,000 $ 16,000 $ 44,000 $ 193,000
-- Allowance for
Doubtful Accounts $ 100,000 $ 9,000 $ 34,000 $ 75,000
</TABLE>
Warranty reserve deductions primarily reflect actual warranty costs incurred
by the Registrant.
11
<PAGE> 14
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities
Exchange Act of 1934, the Registrant has duly caused this report to be signed on
its behalf by the undersigned, thereunto duly authorized.
INTERNATIONAL LOTTERY & TOTALIZATOR SYSTEMS, INC.(TM)
By: /s/ William A. Hainke
---------------------
William A. Hainke
Chief Financial Officer, Corporate Secretary and
Treasurer
Dated:
Pursuant to the requirements of the Securities Exchange Act of
1934, this report has been signed below by the following persons on behalf of
the Registrant and in the capacities and on the dates indicated.
<TABLE>
<CAPTION>
Signature Title Date
- --------- ----- ----
<S> <C> <C>
/s/ Theodore A. Johnson Chairman of the Board March 15, 1996
- ----------------------------------------
Theodore A. Johnson
/s/ Frederick A. Brunn President
- ----------------------------------------
Frederick A. Brunn Director March 15, 1996
/s/ William A. Hainke Chief Financial Officer, Corporate
- ----------------------------------------
William A. Hainke Secretary and Treasurer March 15, 1996
/s/ M. Mark Michalko Executive Vice President
- ----------------------------------------
M. Mark Michalko Director March 15, 1996
/s/ Ng Foo Leong Director
- ----------------------------------------
Ng Foo Leong March 15, 1996
/s/ Martin J. O'Meara, Jr. Director
- ----------------------------------------
Martin J. O'Meara, Jr. March 15, 1996
/s/ Michael G.R. Sandberg Director
- ----------------------------------------
Sir Michael G.R. Sandberg March 15, 1996
Director
- ----------------------------------------
Chan Kien Sing March 15, 1996
Director
- ----------------------------------------
Tan Sri Dato Vincent Tan Chee Yioun March 15, 1996
</TABLE>
12
<PAGE> 1
EXHIBIT 13
INTERNATIONAL LOTTERY & TOTALIZATOR SYSTEMS, INC.
1995 ANNUAL REPORT
[MISCELLANEOUS PHOTOS]
<PAGE> 2
International Lottery & Totalizator Systems,
Inc.(TM) (NASDAQ:ITSI) provides computerized ticket processing equipment,
systems and services to racing organizations and lotteries worldwide.
<PAGE> 3
QUALITY COMMITMENT
ILTS is an ISO 9001 registered company, which
demonstrates that we meet the highest level of quality standards for both our
design and manufacturing processes. ILTS has a long-established reputation of
providing the best technology and highest quality products to the markets we
serve. The Company's quality commitment is to achieve customer satisfaction by:
- Providing products designed and manufactured for durability and
reliability.
- Providing delivery performance that competitors cannot match.
- Providing customer service that meets or exceeds customer expectations.
ILTS / 1
<PAGE> 4
PRESIDENT'S MESSAGE TO
THE SHAREHOLDERS
Nineteen ninety-five was another challenging year for ILTS. We continued to
strategically reposition the Company for future growth and profitability while
simultaneously resolving some difficult issues from the past.
The strategic shift initiated in 1992 to transition the Company from relying
solely on contract sales to also becoming a lottery facilities management
service provider remains a sound objective. However, the initial lottery service
projects have proven costly. Chief among those has been the Russian lottery
project. Begun in 1993, this project has been both difficult and frustrating.
Among the lessons learned, we found that everything in Russia takes longer and
costs more than anyone ever imagined. Although almost all of the project was
written off or reserved at year-end 1994, the project was finally terminated in
November of 1995 after exhausting numerous options to secure outside financing
or joint venture partners for the project. The remaining investment and costs of
the project were expensed in 1995.
Another major contributor to the 1995 loss was the shareholders' class
action lawsuit. This suit was filed in mid-1994
[CAPTION]
ILTS provides innovative gaming solutions with quality products
and services to maximize the revenue of our customers and
bring a fair return to our shareholders.
[PHOTOS]
2 / ILTS
<PAGE> 5
following the announced write-off of costs associated with the lottery service
projects in the Republic of Georgia and the Dominican Republic and the
write-down of the Company's investment in the Papua New Guinea project. The
Company's total legal expenses in 1995 exceeded $1 million dollars; the majority
of this related to the shareholders' suit. Additionally, the Company recorded a
reserve for the costs associated with the proposed settlement, which includes
legal fees plus 1.2 million authorized and unissued common shares.
Yet another factor in the 1995 loss was lower-than-expected sales volume
primarily due to delays and postponements of anticipated procurements by both
existing customers and new prospects.
Notwithstanding the negative effects of the Russian project, the
shareholders' lawsuit, and the reduced contract volume, there were a number of
notable positive events for ILTS in 1995:
- We sold the facilities management and equipment lease contracts for the
lottery in Papua New Guinea to the principal shareholders of the operating
company, The Lotto Pty. Ltd. Proceeds from the sale are anticipated to
accelerate the Company's return on its investment, and ultimately should provide
a greater return than if the Company had continued to operate the lottery for
Lotto Pty.
- We negotiated several significant strategic partnerships and alliances
during 1995. Among these was a participation and licensing agreement with The
Royal Hong Kong Jockey Club (RHKJC) where, in exchange for the Company's
participation in developing a new, high-performance betting system for the
RHKJC, we receive the rights to market that software system. A second alliance
involved a licensing agreement with Racecourse Totalizators Pty. Ltd. of
Australia, wherein ILTS has licensed Racecourse Totalizators' UNIX-based
[CAPTION]
Widespread employee involvement, teamwork and pride of workmanship
are keys to the Company's success in providing customer satisfaction.
[PHOTOS]
ILTS / 3
<PAGE> 6
betting system software products for incorporation into the Company's
pari-mutuel system. Another strategic alliance was established with a company
that has developed a low-cost terminal for entering and storing bets off-line.
In combination with our on-line technology, we are confident this alliance will
facilitate new opportunities for automating lotteries in many developing
countries around the world.
In total, we expect all of these new alliances to make our product offerings
stronger and to aid us in establishing competitive advantages in several of the
markets we serve.
- We added two new lottery customers in 1995, Pascal & Company (Pascal) of
the United Kingdom and Natural Avenue Sdn. Berhad of Malaysia. For Pascal, we
will provide a lottery system and services for operation of an on-line lottery
on behalf of the National Health Service and the National Hospital Trust in
England. Natural Avenue is the operator of a lottery in the state of Sarawak, in
east Malaysia. On-line sales began on February 12, 1996.
- We continued to book new orders from several of our established customers,
including ATG in Sweden, PGMC in the Philippines and SATAB in Australia. All of
these orders include the DATAMARK Flipper terminal, which gained wide support
with our customers in 1995.
- We completed an ISO audit performed by Underwriters Laboratories and
received ISO 9001 certification. This was a strategic target for the Company and
demonstrates our continued commitment to quality in design, development and
manufacturing under rigid standards.
- We continued to develop and refine our lottery system software to enable
the Company to compete successfully in the lottery service business.
- We continued to streamline internal operations, including more efficient
employee utilization and reducing operating expenses wherever possible.
Our goal is to become profitable in 1996, and establish a pattern of
consistent profitability. To do so, we will continue to streamline our
operations, control and reduce costs where possible, and work toward improving
our manufacturing efficiencies and project costs. At the same time, we are
implementing an aggressive sales effort.
It is important to mention that although this is our goal several factors
outside our control, such as delays in receiving new orders and foreign
political uncertainties, could affect our ability to accomplish this objective.
I believe we have eliminated many of the past problems and have positioned
the Company for future profitability. I offer my sincere gratitude and
appreciation to our shareholders who have shown continued loyalty, and to our
employees who remain dedicated and enthusiastic. With the continued support and
patience of our shareholders and employees together with that of our valued
customers, we will build a strong and profitable company.
[PHOTO OF FREDERICK A. BRUNN]
/s/ Frederick A. Brunn
FREDERICK A. BRUNN
PRESIDENT
DIRECTOR
4 / ILTS
<PAGE> 7
SELECTED FINANCIAL DATA
<TABLE>
<CAPTION>
YEARS ENDED DECEMBER 31, 1995 1994 1993 1992 1991
- ---------------------------------------------------------------------------------------
Thousands of dollars except per share amounts and non-monetary items
<S> <C> <C> <C> <C> <C>
Income statement data
Revenue $ 18,641 $ 24,089 $ 25,017 $ 19,837 $ 29,491
Gross profit 1,185 4,527 9,038 6,796 10,474
Operating income (loss) (14,221) (22,943) 302 (679) 2,428
Net income (loss) (13,869) (22,620) 605 (629) 1,701
Earnings (loss) per share (.83) (1.35) .05 (.06) .18
Balance sheet data
Total assets 21,352 31,888 54,924 19,883 19,295
Long-term obligations 109 -- -- -- 84
Shareholders' equity 13,412 27,145 48,855 10,828 11,285
Key ratios & statistics
Gross margin 6.4% 18.8% 36.1% 34.3% 35.5%
Operating margin/(loss) (76.3%) (95.2%) 1.2% (3.4%) 8.2%
Working capital 8,788 22,236 31,670 3,774 8,264
Book value .80 1.62 2.94 1.10 1.17
Current ratio 2.12 5.69 6.22 1.42 2.05
Backlog 9,214 11,168 15,250 16,819 19,387
Employees 176 277 249 216 201
Shares outstanding 16,816 16,804 16,574 9,782 9,632
</TABLE>
ILTS / 5
<PAGE> 8
MANAGEMENT'S DISCUSSION AND
ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS
1995 vs. 1994
1995 revenue decreased $5.4 million or 23% compared to 1994. This change mainly
reflects a lower level of contract business in 1995. New orders received in 1995
were $12.6 million compared to $20.0 million in 1994. As part of its strategic
plan, the Company has pursued long-term service contracts as a source of
revenue. Service contracts pose capital investment risks for the Company that do
not exist in its product sale business. Revenues are received only after a
system becomes operational, based upon a percentage of the customer's gross
receipts from the system. The Company, therefore, bears the risk that scheduling
delays may occur, that a system may never become operational, or that revenue
levels may not be sufficient to provide a return of costs invested. During 1992,
the Company entered into a lottery service agreement in Papua New Guinea. A
minimal amount of revenues was earned on this service contract in the first six
months of 1995. In July 1995, the Company sold all interest in its Papua New
Guinea lottery operations to the principal shareholders of the lottery licensee,
The Lotto Pty. Ltd., in return for $175 thousand cash and a note of $1.3 million
to be paid in monthly installments of approximately $79 thousand per month for a
period of 17 months commencing in September 1995. Additionally, the Company will
receive a percentage of the annual gross lottery sales or an annual sum of $260
thousand, whichever is greater for a period of five years, provided that the
additional sums shall not exceed $3 million. The installment payments and the
minimum percentage payments are secured by all lottery assets and certain
personal guarantees and indemnifications of all of the shareholders of The Lotto
Pty. Ltd. The Company's remaining investment in the PNG lottery is approximately
$338 thousand and is included in other assets. The Company will not record any
gain until the balance of the receivable has been collected.
In August 1993, the Company entered into management and equipment lease
agreements to operate an on-line lottery within the Russian Federation ("the
Project") with Zodiac On-Line ("Zodiac"), a Russian lottery operating company.
Under the terms of the agreements, the lottery was to be conducted under a
non-exclusive license held by a Russian charitable organization (the
"Foundation"). In 1994, the Company acquired Zodiac making it a wholly owned
subsidiary. In December 1994, the Company recorded a provision with respect to
its investment and subsequently has expensed all related costs as they were
incurred. In June 1995, the Company became the lottery operator under a license
granted to the Russian Federal Postal Service. In November 1995, the Company
terminated the Project after exhausting numerous financing and joint venture
possibilities. In 1995, project related expenses, including a provision for
future costs to liquidate the operation totaled $2.8 million. In May 1995, the
Company entered into an equipment lease agreement in the United Kingdom (U.K.)
to operate a lottery to benefit the National Hospital System. The Company has
invested $2.8 million in the Project as of December 31, 1995, which comprises
the entire amount invested in lottery service agreements at that date. See Note
4 of Notes to Consolidated Financial Statements on page 13. The Company believes
it will ultimately recover its investment in the U.K. lottery service agreement.
However, realization of this investment is dependent upon future events,
including the successful operation of the lottery at revenue levels sufficient
to provide a return of costs invested. Cost of sales as a percentage of revenue
increased to 94% in 1995 from 81% in 1994 due mainly to unfavorable
manufacturing variances in 1995, costs associated with a reduction in work force
and operational costs in support of the Company's lottery service operations.
Engineering, research and development expenses in 1995 decreased $258 thousand
or 16% compared to 1994. Of the $1.4 million expended in 1995, $0.9 million went
toward development of lottery software. Selling, general and administrative
expenses increased $2.8 million in 1995 compared to 1994. The increase in
selling, general and administrative expenses from 1994 is due to increased legal
expenses and a proposed settlement of a shareholders' lawsuit, costs incurred
for domestic lottery proposals, and costs associated with a reduction in work
force. Net interest income was $407 thousand in 1995 compared to net interest
income of $467 thousand in 1994. Interest income is generated from short term
investments.
1994 vs. 1993
1994 revenue decreased $0.9 million or 4% compared to 1993. This change mainly
reflects a lower level of contract business in 1994. New orders received in 1994
were $20.0 million compared to $20.9 million in 1993. As part of its strategic
plan, the Company has pursued
6 / ILTS
<PAGE> 9
long-term service contracts as a source of revenue. Service contracts pose
capital investment risks for the Company that do not exist in its product sale
business. Revenues are received only after a system becomes operational, based
upon a percentage of the customer's gross receipts from the system. The Company,
therefore, bears the risk that scheduling delays may occur, that a system may
never become operational, or that revenue levels may not be sufficient to
provide a return of costs invested. During 1992, the Company entered into
lottery service agreements in Papua New Guinea and the Republic of Georgia. In
1993, two additional lottery service agreements, in the Russian Federation and
Dominican Republic, were added. A minimal amount of revenues was earned on
service contracts in 1994. In the second quarter of 1994, the Company took a
$9.8 million accounting charge to write-off its investment in the Dominican
Republic and the Republic of Georgia and to write down its investment in Papua
New Guinea. The Company abandoned its investment of $1.2 million in the Republic
of Georgia due to worsening of the political and economic environment there.
Based on projected revenues, the Papua New Guinea investment was written down by
$3.0 million to the estimated future cash flows of that project and the
Dominican Republic investment of $5.6 million was written off.
In August 1993, the Company entered into management and equipment lease
agreements to operate an on-line lottery within the Russian Federation ("the
Project") with Zodiac On-Line ("Zodiac"), a Russian lottery operating company.
Under the terms of the agreements, the lottery was to be conducted under a
non-exclusive license held by a Russian charitable organization ("the
Foundation"). In 1994, the Company acquired Zodiac making it a wholly-owned
subsidiary. On November 1, 1994, the Russian government issued a decree which
required all existing lottery license holders, including the Foundation, to
apply for re-registration of their license by February 1, 1995. The Company
initially understood that the re-registration was to be a straightforward,
administrative process. However, at December 31, 1994, the re-registration
process had not been defined by the government and the Company was awaiting
official notification of the re-registration requirements. The Company had
invested $9.0 million in the Project through December 31, 1994 and, subject to
resolution of the re-registration of the license described above, expects to
continue with the Project. Because of this uncertainty, there can be no
assurance that the Company will ultimately implement the Project or, if
implemented, that the Project will be successful. Due to the above change in
circumstances, combined with the continued economic, political and legal
instability in Russia, the Company recorded a provision of $7.6 million in its
quarter ended December 31, 1994 with respect to the investment made in the
Project. The remaining $1.4 million represents the estimated net realizable
value of the terminal and related equipment, should the project be terminated.
Further, due to the circumstances noted above, future costs of the Project, in
excess of the recoverable value of the terminals and related equipment, will now
be expensed as incurred by the Company rather than capitalized. See Note 4 of
Notes to Consolidated Financial Statements on page 13. The Company has net
assets of $2.3 million at December 31, 1994 in lottery service agreements. The
Company believes it will ultimately recover its investment in these lottery
service agreements. However, realization of this investment is dependent upon
future events, including the successful operation of the lotteries at revenue
levels sufficient to provide a return of costs invested. In addition, in the
quarter ended December 31, 1994, the Company discontinued its airline
ticket/boarding pass terminal product line, resulting in a charge of $0.5
million in the quarter and a total of $1.5 million through December 31, 1994.
Cost of sales as a percentage of revenue increased to 81% in 1994 from 64% in
1993 due mainly to unfavorable manufacturing variances, inventory reserves;
costs associated with a reduction in work force and operational costs in support
of the Company's lottery service operations. Engineering, research and
development expenses in 1994 decreased $415 thousand or 20% compared to 1993. Of
the $1.6 million expended in 1994, $0.9 million went toward development of the
DATAMARK Flipper terminal. Selling, general and administrative expenses
increased $1.7 million in 1994 compared to 1993. The increase in selling,
general and administrative expenses from 1993 is due to increased legal expenses
relating to a shareholders lawsuit, costs associated with the retirement and
consulting agreement with the Company's former chairman and chief executive
officer, costs incurred for domestic lottery proposals and costs associated with
a reduction in work force. Net interest income was $467 thousand in 1994
compared to net interest income of $107 thousand in 1993. Interest income is
generated from short term investments.
Liquidity and Capital Resources
During 1995, the Company's working capital decreased approximately $13.5 million
due to costs relating to a shareholders lawsuit, manufacturing variances, and
expenses associated with the Russian lottery project. Cash and current
receivable balances totaled approximately $5.5 million at December 31, 1995. The
Company is dependent upon its few major customers. Advance and progress payments
from these customers are also an important source of working capital. Management
believes that existing cash and cash equivalents, plus cash provided from
operations will provide adequate resources to fund 1996 operations. As of
December 31, 1995, there are no commitments for major capital expenditures.
ILTS / 7
<PAGE> 10
CONSOLIDATED STATEMENTS OF OPERATIONS
<TABLE>
<CAPTION>
YEARS ENDED DECEMBER 31, 1995 1994 1993
- ---------------------------------------------------------------------------------------------------------------
Thousands of dollars, except per share amounts
<S> <C> <C> <C>
Contract revenue and sales $ 18,641 $ 24,089 $ 25,017
- ---------------------------------------------------------------------------------------------------------------
Costs and expenses:
Costs of sales 17,456 19,562 15,979
Write-offs and write-downs of lottery service agreements 2,807 17,444 --
Engineering, research and development 1,360 1,618 2,033
Selling, general and administrative 11,239 8,408 6,703
- ---------------------------------------------------------------------------------------------------------------
Total costs and expenses 32,862 47,032 24,715
- ---------------------------------------------------------------------------------------------------------------
Income (loss) from operations (14,221) (22,943) 302
Other income:
Foreign exchange gain -- -- 25
Interest income, net 352 467 107
Gain on sale of subsidiary -- -- 268
- ---------------------------------------------------------------------------------------------------------------
Income (loss) before provision for taxes based on income (13,869) (22,476) 702
- ---------------------------------------------------------------------------------------------------------------
Provision for income taxes -- 144 97
- ---------------------------------------------------------------------------------------------------------------
Net income (loss) $ (13,869) $ (22,620) $ 605
- ---------------------------------------------------------------------------------------------------------------
Net income (loss) per share:
Primary $ (.83) $ (1.35) $ .05
- ---------------------------------------------------------------------------------------------------------------
Fully-diluted $ (.83) $ (1.35) $ .04
- ---------------------------------------------------------------------------------------------------------------
Shares used in determination of net income (loss) per share:
Primary 16,812 16,760 13,261
- ---------------------------------------------------------------------------------------------------------------
Fully-diluted 16,812 16,760 13,780
- ---------------------------------------------------------------------------------------------------------------
</TABLE>
See accompanying notes.
8 / ILTS
<PAGE> 11
CONSOLIDATED BALANCE SHEETS
<TABLE>
<CAPTION>
DECEMBER 31, 1995 1994
- --------------------------------------------------------------------------------------------------------------------------
Thousands of dollars, except share amounts
<S> <C> <C>
Assets
Current assets:
Cash and cash equivalents $ 3,904 $ 9,467
Accounts receivable, net of allowance for doubtful accounts of $63 ($209 in 1994) 1,588 2,398
Costs and estimated earnings in excess of billings on uncompleted contracts 3,665 3,382
Inventories, at lower of cost (first-in, first-out method) or market:
Finished goods 150 831
Work in process 173 2,173
Raw materials 6,497 7,495
- --------------------------------------------------------------------------------------------------------------------------
Total inventories 6,820 10,499
- --------------------------------------------------------------------------------------------------------------------------
Other current assets 642 1,233
- --------------------------------------------------------------------------------------------------------------------------
Total current assets 16,619 26,979
- --------------------------------------------------------------------------------------------------------------------------
Non-current account receivable 52 --
Investment in lottery service agreements, net 2,759 2,254
Equipment, furniture and fixtures at cost, less accumulated depreciation of $3,222 ($2,903 in 1994) 1,361 1,650
Computer software costs, less accumulated amortization of $1,331 ($821 in 1994) 561 1,005
- --------------------------------------------------------------------------------------------------------------------------
Total assets $ 21,352 $ 31,888
- --------------------------------------------------------------------------------------------------------------------------
Liabilities and shareholders' equity
Current liabilities:
Note payable to bank $ -- $ 300
Accounts payable 231 909
Billings in excess of costs and estimated earnings on uncompleted contracts 115 968
Accrued payroll and related taxes 949 595
Warranty reserves 298 348
Accrued litigation settlement 4,200 --
Other current liabilities 2,038 1,623
--------------------------------------------------------------------------------------------------------------------------
Total current liabilities 7,831 4,743
- --------------------------------------------------------------------------------------------------------------------------
Capital lease obligations 109 --
Commitments and contingencies
Shareholders' equity:
Common shares; no par value, 50,000,000 shares authorized; 16,816,211 shares issued
and outstanding (16,803,711 in 1994) 48,687 48,650
Retained earnings (deficit) (35,223) (21,354)
Foreign currency translation adjustment (52) (151)
- --------------------------------------------------------------------------------------------------------------------------
Total shareholders' equity 13,412 27,145
- --------------------------------------------------------------------------------------------------------------------------
Total liabilities and shareholders' equity $ 21,352 $ 31,888
- --------------------------------------------------------------------------------------------------------------------------
</TABLE>
See accompanying notes.
ILTS / 9
<PAGE> 12
CONSOLIDATED STATEMENTS OF CASH FLOWS
<TABLE>
<CAPTION>
YEARS ENDED DECEMBER 31, 1995 1994 1993
- ---------------------------------------------------------------------------------------------------------------------------
Thousands of dollars
<S> <C> <C> <C>
Cash flows from operating activities:
Net income (loss) $(13,869) $(22,620) $ 605
Adjustments to reconcile net income (loss) to net cash used for operating activities:
Depreciation and amortization 1,061 1,656 1,444
Deferred income taxes -- 148 (148)
Foreign exchange gain -- -- (25)
Stock option compensation -- 304 --
Write-offs and write-downs of lottery service agreements 2,807 17,444 --
Gain on sale of subsidiary -- -- (268)
Changes in operating assets and liabilities:
Accounts receivable 810 1,635 (264)
Costs and estimated earnings in excess of billings on uncompleted contracts (283) (856) (2,133)
Inventories 3,679 (4,003) 1,441
Accounts payable (678) (633) (650)
Billings in excess of costs and estimated earnings on uncompleted contracts (853) (1,432) (968)
Accrued payroll and related taxes 354 (66) 222
Income taxes -- -- (121)
Accrued litigation settlement 4,200 -- --
Other 572 580 (27)
- ---------------------------------------------------------------------------------------------------------------------------
Net cash used for operating activities (2,200) (7,843) (892)
- ---------------------------------------------------------------------------------------------------------------------------
Cash flows used for investing activities:
Investment in lottery service agreements (4,044) (5,934) (9,912)
Lottery service agreement sale proceeds and advance repayments 651 402 --
Non-current account receivable -- 330 202
Additions to equipment (250) (1,209) (259)
Additions to computer software costs (67) (413) (718)
Proceeds from sale of subsidiary 525 325 325
- ---------------------------------------------------------------------------------------------------------------------------
Net cash used for investing activities (3,185) (6,499) (10,362)
- ---------------------------------------------------------------------------------------------------------------------------
Cash flows provided by (used for) financing activities:
Additions to notes payable -- 300 --
Payments on notes payable (300) -- (2,250)
Proceeds from issuance of subordinated notes -- -- 2,350
Payments on subordinated notes -- -- (2,350)
Proceeds from issuance of common shares and warrants 23 614 35,944
- ---------------------------------------------------------------------------------------------------------------------------
Net cash provided by (used for) financing activities (277) 914 33,694
- ---------------------------------------------------------------------------------------------------------------------------
Effect of exchange rate changes on cash 99 (8) 22
- ---------------------------------------------------------------------------------------------------------------------------
Increase (decrease) in cash and cash equivalents (5,563) (13,436) 22,462
- ---------------------------------------------------------------------------------------------------------------------------
Cash and cash equivalents at beginning of year 9,467 22,903 441
- ---------------------------------------------------------------------------------------------------------------------------
Cash and cash equivalents at end of year $ 3,904 $ 9,467 $ 22,903
- ---------------------------------------------------------------------------------------------------------------------------
Supplemental cash flow information:
Cash paid during the year for interest 46 47 330
- ---------------------------------------------------------------------------------------------------------------------------
Cash paid during the year for income taxes 7 8 220
- ---------------------------------------------------------------------------------------------------------------------------
</TABLE>
See accompanying notes.
10 / ILTS
<PAGE> 13
CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY
<TABLE>
<CAPTION>
FOREIGN
RETAINED CURRENCY
COMMON SHARES EARNINGS TRANSLATION
SHARES AMOUNT (DEFICIT) ADJUSTMENT TOTAL
- -----------------------------------------------------------------------------------------------------------------------------
Thousands of shares/dollars
<S> <C> <C> <C> <C> <C>
Balance at December 31, 1992 9,782 $ 10,349 $ 661 $ (182) $ 10,828
- -----------------------------------------------------------------------------------------------------------------------------
Proceeds from exercise of stock options,
including related tax benefits 192 459 -- -- 459
Proceeds from sale of shares to Berjaya
Lottery Management 6,600 35,325 -- -- 35,325
Issuance of warrants and stock options -- 1,599 -- -- 1,599
Foreign currency translation adjustment -- -- -- 39 39
Net income - 1993 -- -- 605 -- 605
- -----------------------------------------------------------------------------------------------------------------------------
Balance at December 31, 1993 16,574 47,732 1,266 (143) 48,855
- -----------------------------------------------------------------------------------------------------------------------------
Proceeds from exercise of warrants 98 471 -- -- 471
Proceeds from exercise of stock options 132 143 -- -- 143
Accelerated vesting of options for
terminated employees -- 304 -- -- 304
Foreign currency translation adjustment -- -- -- (8) (8)
Net loss - 1994 -- -- (22,620) -- (22,620)
- -----------------------------------------------------------------------------------------------------------------------------
Balance at December 31, 1994 16,804 48,650 (21,354) (151) 27,145
- -----------------------------------------------------------------------------------------------------------------------------
Proceeds from exercise of stock options 12 23 -- -- 23
Accelerated vesting of stock options for
terminated employees -- 14 -- -- 14
Foreign currency translation adjustment -- -- -- 99 99
Net loss - 1995 -- -- (13,869) -- (13,869)
- -----------------------------------------------------------------------------------------------------------------------------
Balance at December 31, 1995 16,816 $ 48,687 $ (35,223) $ (52) $ 13,412
- -----------------------------------------------------------------------------------------------------------------------------
</TABLE>
See accompanying notes.
ILTS / 11
<PAGE> 14
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
International Lottery & Totalizator Systems, Inc. ("the Company") designs,
manufactures, sells, leases, manages, supports and services computerized ticket
issuing systems and terminals for global pari-mutuel and on-line lottery
industries. The principal applications for the Company's products are in the
automated pari-mutuel (horse racing) wagering and on-line government sponsored
lottery industries.
The principal proprietary component of the Company's system is the DATAMARK
terminal, a compact, reliable microprocessor-based ticketing terminal which can
be modified to meet specific customer feature and configuration requirements.
The Company sells its product principally in international markets.
1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
PRINCIPLES OF CONSOLIDATION The accompanying financial statements consolidate
the accounts of the Company and its subsidiaries, all of which are wholly-owned.
Intercompany accounts and transactions are eliminated in consolidation.
REVENUE RECOGNITION The Company recognizes long-term contract revenue on the
percentage-of-completion method, based on contract costs incurred to date
compared to total estimated contract costs. The effects of changes in contract
cost estimates are recognized in the period they are determined. Revenues under
lottery services agreements are based on a percentage of the customer's lottery
sales volume and recognized upon receipt. Revenues relating to certain assets
when the ultimate total collection is not reasonably assured are being recorded
under the cost recovery method. All other revenue is recorded on the basis of
shipments of products or performance of services.
USE OF ESTIMATES The preparation of financial statements in conformity with
generally accepted accounting principles requires management to make estimates
and assumptions that affect the reported amounts of assets and liabilities and
disclosure of contingent assets and liabilities at the date of the financial
statements and the reported amounts of revenues and expenses during the
reporting period. Actual results could differ from those estimates.
DEPRECIATION Depreciation of equipment, furniture and fixtures is provided
principally using the straight-line method over estimated useful lives of 3 to 8
years.
COMPUTER SOFTWARE COSTS The Company capitalizes the costs of computer software
incurred in the development of specific products, after technological
feasibility has been established. The capitalized software costs are amortized
using the greater of the amount computed using the ratio of current product
revenue to estimated total product revenue or the straight-line method over the
remaining estimated economic lives of the products (2 to 5 years). Amortization
expense totaled $510 thousand, $687 thousand, and $666 thousand for the years
ended December 31, 1995, 1994, and 1993 respectively.
WARRANTY RESERVES Estimated expenses for warranty obligations are accrued as
income is recognized on related contracts. The reserves are adjusted
periodically to reflect actual results.
FOREIGN CURRENCY The Company has contracts with certain customers that are
denominated in foreign currencies and related transaction gains and losses are
recognized as a component of current operations. The consolidated accounts of
the Company's Australian subsidiary have been translated from its functional
currency, the Australian dollar. The effect of the exchange rate fluctuations
between the U.S. dollar and the Australian dollar is recorded as an increase
(decrease) to a separate component of shareholders' equity. The Company's other
foreign subsidiary uses the U.S. dollar as its functional currency and,
accordingly, related translation gains and losses are recognized in current
operations.
PER SHARE INFORMATION Primary earnings per share are based on the weighted
average number of shares outstanding during the year and the dilutive effect of
common share equivalents.
RESEARCH AND DEVELOPMENT Research and development expense for the years ended
December 31, 1995, 1994, and 1993 was $1.4 million, $1.6 million, and $2.0
million, respectively.
CONCENTRATION OF CREDIT RISK Accounts receivable and costs and estimated
earnings in excess of billings on uncompleted contracts are primarily related to
contracts with a few major customers. These amounts are payable in accordance
with the terms of individual contracts and generally collateral is not required.
Credit losses are provided for in the financial statements and consistently have
been within management's expectations.
CASH AND CASH EQUIVALENTS The Company considers all highly liquid investments
with a maturity of three months or less when purchased to be cash equivalents.
Included in cash and cash equivalents at December 31, 1995 and 1994 are
investments in commercial paper and municipal bonds totaling $2.2 and $7.9
million, respectively, which mature in January 1996 and March 1995,
respectively. The estimated fair value of these investments approximate the
amortized cost; therefore, there are no unrealized gains or losses as of
December 31, 1995 or 1994.
INVESTMENT IN LOTTERY SERVICE AGREEMENTS The investment in lottery service
agreements includes the direct costs of manufacture and installation of
computerized electronic lotteries, including the terminals, central computer
systems and start-up related implementation costs to the extent that recovery of
such costs is determined to be reasonably assured. The Company depreciates the
system cost over the shorter of the estimated useful life or initial contract.
STOCK OPTIONS The Company has elected to follow Accounting Principles Board
Opinion No. 25, "Accounting for Stock Issued to Employees" (APB 25) and related
Interpretations in accounting for its employee stock options. Under APB 25,
because the exercise price of the Company's employee stock options equal the
market price of the underlying stock on the date of grant, no compensation
expense is recognized.
NOTE PAYABLE TO BANK The maximum amount of month-end borrowings under short-term
notes payable to a bank were $.58 million, $.3 million and $2.2 million in 1995,
1994 and 1993 respectively. The average month-end amount outstanding during 1995
was $115 thousand, (1994 -$54 thousand and 1993 - $797 thousand) with a weighted
average interest rate of 8.3% (1994- 9.1% and 1993-8.0%)
2. RELATED PARTY TRANSACTIONS
The Company has entered several sales agreements to supply terminals to entities
in which a substantial shareholder of the Company has a significant equity
interest. These revenues totaled $3.5 million and $5.2 million in 1995 and 1994
respectively. Included in accounts receivable and costs and estimated earnings
in excess of billings on uncompleted contracts were $2.3 million and $1.4
million at December 31, 1995 and 1994, respectively, relating to these
customers.
12 / ILTS
<PAGE> 15
3. CONTRACTS IN PROCESS
The amounts by which total costs and estimated earnings exceeded or were less
than billings on uncompleted contracts are as follows (in thousands):
<TABLE>
<CAPTION>
DECEMBER 31, 1995 1994
- -------------------------------------------------------------------------------
<S> <C> <C>
Costs incurred $ 15,665 $ 12,572
Estimated earnings 4,612 5,820
- -------------------------------------------------------------------------------
20,277 18,392
- -------------------------------------------------------------------------------
Less: billings (16,727) (15,978)
- -------------------------------------------------------------------------------
$ 3,550 $ 2,414
- -------------------------------------------------------------------------------
Included in the accompanying
consolidated balance sheets as follows:
Costs and estimated earnings in excess of
billings on uncompleted contracts $ 3,665 $ 3,382
Billings in excess of costs and estimated
earnings on uncompleted contracts (115) (968)
- -------------------------------------------------------------------------------
$ 3,550 $ 2,414
- -------------------------------------------------------------------------------
</TABLE>
The Company is obligated under a $2.8 million contract to supply ticket
issuing equipment. The contract provides for certain late delivery penalties and
the Company is contingently liable for successful performance under a
performance bond with an insurance company for $2.7 million. The Company has
experienced difficulty in satisfying some of the customer's ultimate
requirements during the initial pilot testing period of the program. The Company
has $1.1 million recorded as costs and estimated earnings in excess of billings
on uncompleted contracts at December 31, 1995. The Company does not anticipate
any losses beyond amounts accrued. Although not probable, the Company could
sustain a loss that could be material to the financial statements.
4. LOTTERY SERVICE AGREEMENTS
The Company entered into contracts to provide lottery equipment and management
of on-line lottery system on a long-term basis in Papua New Guinea and the
Russian Federation in 1992 and 1993, respectively, and it entered into a
contract to provide lottery equipment in the United Kingdom in 1995.
The Company has committed lottery equipment costing approximately $2.8
million to its United Kingdom lottery service agreement in 1995. The Company has
agreed to provide a complete lottery system and will receive a percentage of
lottery revenues. The lottery is scheduled to commence operations in 1997.
The Papua New Guinea lottery commenced operation in March 1993. Revenues
from the lottery in Papua New Guinea did not meet expectations and in June 1994,
the Company wrote down its investment in Papua New Guinea by $3.0 million to its
estimated future cash flows. In July 1995, the Company sold all interests in the
Papua New Guinea lottery operation to the principal shareholders of the lottery
licensee, for $175 thousand in cash and a note of $1.3 million to be paid in
monthly installments of approximately $79 thousand per month for a period of 17
months commencing in September 1995. Additionally, the Company will receive a
percentage of the annual gross lottery sales or an annual sum of $260 thousand,
whichever is greater, for a period of five years, provided that the additional
sums shall not exceed $3.0 million. The Company is accounting for the sale under
the cost recovery method. The installment payments and the minimum percentage
payments are secured by all lottery assets and certain personal guarantees. The
Company's remaining investment in the Papua New Guinea lottery at December 31,
1995 is approximately $338 thousand and is included in other current assets.
Due to uncertainties which arose in November 1994 regarding the Russian
lottery license process and the continued economic, political and legal
instability in Russia, the Company recorded a provision of $7.6 million to
record the assets at estimated net realizable value with respect to the Russian
lottery investment. In November 1995, the Company terminated its Russian
project. In 1995, the Company incurred $2.8 million in costs toward its Russian
lottery project, including the write-off of costs related to a reduction in its
Russian work force and future costs to liquidate the operation.
In June 1994, the Company wrote off its investment in two lottery service
agreements which totaled $6.8 million, $1.2 million in the Republic of Georgia
and $5.6 million in the Dominican Republic, as projected revenues indicated the
Company would not be able to recover its investment. In January 1995, the
Company ceased operations in the Dominican Republic and in 1994 closed its
office in the Republic of Georgia
Although the Company believes that its remaining lottery service agreement
investment in the U.K. represents a good business investment the realization of
this investment is dependent upon future events, including the successful
operation of the lottery at levels sufficient to provide the Company a return of
its costs invested. The investment in lottery service agreements is comprised of
the following (in thousands):
<TABLE>
<CAPTION>
DECEMBER 31, 1995 1994
- -------------------------------------------------------------------------------
<S> <C> <C>
Systems, equipment and other start-up
costs relating to lottery contracts $2,759 $ 13,236
Less accumulated depreciation,
amortization and write-down -- (10,982)
- -------------------------------------------------------------------------------
Total: $2,759 $ 2,254
- -------------------------------------------------------------------------------
</TABLE>
5. INDUSTRY SEGMENT AND GEOGRAPHICAL DATA
The Company operates in one industry segment which includes totalizator and
lottery systems. The Company has an Australian subsidiary, International Lottery
& Totalizator Systems Australia Pty., Ltd., and a United Kingdom subsidiary,
Totalizator Systems (UK) Ltd. and a Russian subsidiary, Zodiac On-line.
Sales between geographic areas are generally priced to recover material
costs plus an appropriate markup. Revenue from major customers is as follows (in
thousands):
<TABLE>
<CAPTION>
CUSTOMER LOCATION 1995 1994 1993
- --------------------------------------------------------------------------------
<S> <C> <C> <C>
Australia $ 4400 $2,400 $3,300
Philippines 2900 5,200 --
Sweden, Stockholm 2700 400 700
Malaysia 2300 2,100 600
Norway 900 1,200 --
Hong Kong 600 9,400 9,500
China -- 800 4,900
</TABLE>
The following table at the top of page 14 summarizes information about the
Company's operations in different geographic areas for the years ended December
31, 1995, 1994 and 1993 (in thousands).
Sales, income and identifiable assets of the Dominican Republic are included
in the U.S., Europe consists of the U.K. subsidiary, Russia and Georgia, and
Pacific includes the Australian subsidiary and Papua New Guinea.
ILTS / 13
<PAGE> 16
NOTES TO CONSOLIDATED
FINANCIAL STATEMENTS (CONT.)
<TABLE>
<CAPTION>
Years Ended December 31, 1995 1994
------------------------------------------- ---------------------------------------------
Eastern Eastern
Europe/ Consoli- Europe/ Consoli-
USA Pacific Europe dated USA Pacific Europe dated
- -------------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C> <C> <C>
Sales to unaffiliated customers:
Export $ 15,006 $ -- $ -- $ 15,006 $ 19,923 $ -- $ -- $ 19,923
Domestic 513 2,614 508 3,635 946 2,612 608 4,166
- -------------------------------------------------------------------------------------------------------------------------------
Sales to:
Australia subsidiary 508 -- -- 508 423 -- -- 423
- -------------------------------------------------------------------------------------------------------------------------------
16,027 2,614 508 19,149 21,292 2,612 608 24,512
- -------------------------------------------------------------------------------------------------------------------------------
Elimination of inter-
company sales (508) -- -- (508) (423) -- -- (423)
- -------------------------------------------------------------------------------------------------------------------------------
Total revenue 15,519 2,614 508 18,641 20,869 2,612 608 24,089
- -------------------------------------------------------------------------------------------------------------------------------
Write-offs and write-
downs of lottery
service agreements -- -- (2,807) (2,807) (5,663) (3,000) (8,781) 17,444
- -------------------------------------------------------------------------------------------------------------------------------
Net income (loss) $(13,561) $ (76) $ (232) $(13,869) $(10,700) $(3,084) $ (8,836) $(22,620)
- -------------------------------------------------------------------------------------------------------------------------------
Identifiable assets $ 19,572 $ 1,478 $ 302 $ 21,352 $ 27,952 $ 2,322 $ 1,614 $ 31,888
- -------------------------------------------------------------------------------------------------------------------------------
</TABLE>
<TABLE>
<CAPTION>
Years Ended December 31, 1993
-----------------------------------------
Eastern
Europe/ Consoli-
USA Pacific Europe dated
- ----------------------------------------------------------------------------
<S> <C> <C> <C> <C>
Sales to unaffiliated customers:
Export $ 21,141 $ -- $ 88 $ 21,229
Domestic 15 3,340 433 3,788
- ----------------------------------------------------------------------------
Sales to:
Australia subsidiary 296 -- -- 296
- ----------------------------------------------------------------------------
21,452 3,340 521 25,313
- ----------------------------------------------------------------------------
Elimination of inter-
company sales (296) -- -- (296)
- ----------------------------------------------------------------------------
Total revenue 21,156 3,340 521 25,017
- ----------------------------------------------------------------------------
Write-offs and write-
downs of lottery
service agreements -- -- -- --
- ----------------------------------------------------------------------------
Net income (loss) $ 372 $ 152 $ 81 $ 605
- ----------------------------------------------------------------------------
Identifiable assets $ 42,836 $5,124 $ 6,964 $ 54,924
- ----------------------------------------------------------------------------
</TABLE>
6. LEASES
The Company leases its facilities under operating lease agreements which expire
at various dates through March 2002. Certain lease agreements provide for
increases in minimum annual rent based on increases in various market indices.
Also, the Company has the option to renew the lease on its U.S. facility for one
additional ten year term. Rent expense for the years ended December 31, 1995,
1994, and 1993 was $674 thousand, $551 thousand, and $493 thousand respectively.
Minimum future obligations for these leases are as follows (in thousands): 1996
- - $700; 1997 - $646; 1998 - $534; 1999 - $546; 2000 - $297, and $96 thereafter.
In 1995, the Company purchased $209 thousand of equipment under capital lease
obligations. Future minimum lease obligations for capital leases total $205
thousand and are due as follows: 1996 - $96 thousand, 1997 - $93 thousand and
1998 - $16 thousand; including total imputed interest of $18 thousand.
7. INCOME TAXES
The provision (credit) for taxes based on income (loss) consists of the
following (in thousands):
<TABLE>
<CAPTION>
YEARS ENDED DECEMBER 31, 1995 1994 1993
- -------------------------------------------------------------------------------
<S> <C> <C> <C>
Current:
Federal provision $ -- $ -- $ 160
State provision -- -- 61
Foreign provision -- -- 24
Tax benefit of federal net
operating loss carry forwards -- -- --
- -------------------------------------------------------------------------------
Total current -- -- 245
Deferred:
Federal provision (credit) -- 88 (92)
State provision -- 56 (56)
- -------------------------------------------------------------------------------
Total deferred -- 144 (148)
- -------------------------------------------------------------------------------
Total provision $ -- $144 $ 97
- -------------------------------------------------------------------------------
</TABLE>
Income taxes differed from the amount calculated using the federal statutory
rate of 34% as a result of the following (in thousands):
<TABLE>
<CAPTION>
DECEMBER 31, 1995 1994 1993
- -------------------------------------------------------------------------------
<S> <C> <C> <C>
Expected federal income tax
(credit) at statutory rate $(4,715) $(7,642) $ 239
U.S. and foreign net operating
losses - no benefit 4,715 7,642 --
State taxes net of federal income
tax benefit -- -- 42
Effect of earnings of foreign
subsidiaries subject to
different tax rates -- -- 9
Benefit of U.S. and foreign
business credit and net
operating loss carryforwards -- -- (175)
Other, net -- 144 (18)
- -------------------------------------------------------------------------------
Total $ -- $ 144 $ 97
- -------------------------------------------------------------------------------
</TABLE>
Deferred income taxes reflect the net tax effects of temporary differences
between the carrying amounts of assets and liabilities for financial reporting
purposes and amounts used for income tax purposes. The components of the
Company's deferred tax liabilities and assets are as follows (in thousands):
14 / ILTS
<PAGE> 17
<TABLE>
<CAPTION>
YEARS ENDED DECEMBER 31, 1995 1994
- -------------------------------------------------------------------------------
<S> <C> <C>
Deferred tax liabilities:
Computer software costs $ 225 $ 243
- -------------------------------------------------------------------------------
Total deferred tax liabilities 225 243
- -------------------------------------------------------------------------------
Deferred tax assets:
Reserves against investment in lottery
service agreements 235 6,940
Reserves and accruals 2620 1,540
Rent expense 160 177
Employee benefits 130 162
Patent expense 35 40
Net operating loss and credit carryforwards 12,120 1,515
Other 18 54
- -------------------------------------------------------------------------------
Total deferred tax assets 15,318 10,428
- -------------------------------------------------------------------------------
Net deferred tax assets 15,093 10,185
- -------------------------------------------------------------------------------
Valuation allowance (15,093) (10,185)
- -------------------------------------------------------------------------------
Net deferred tax accounts $ -- $ --
- -------------------------------------------------------------------------------
</TABLE>
The Company has Federal and California net operating losses of approximately
$30.7 million and $14.7 million respectively, which will begin to expire in 1998
unless previously utilized. The difference between the Federal and California
net operating loss carryforwards relates primarily to California's statutory 50%
annual reduction rule. The Company also has Federal general business credit
carryforwards of approximately of $575 thousand, which begin to expire in 1996.
Pursuant to the Tax Reform Act of 1986, use of the Company's business credit and
net operating loss carryforwards may be limited if a cumulative change in
ownership of more than 50% occurs within any three year period. Management
believes such a change in ownership has not occurred.
8. COMMON STOCK
In 1993, the Company sold 6.6 million shares of its common stock to Berjaya
Lottery Management for total consideration of $35.3 million. Berjaya Lottery
Management's interest in the Company represented approximately 39% of the total
outstanding shares at December 31, 1995.
In March and April 1993, the Company issued warrants to purchase a total of
502 thousand shares of the Company's common stock in conjunction with a private
offering of subordinated notes. The notes were fully paid in October 1993. The
warrants are exercisable at $4.31 per share and expire on March 17, 1996.
In 1995, a warrant to purchase 500 thousand shares of the Company's common
stock at $4.75 per share, which was issued in 1993 in conjunction with acquiring
the Company's Russian lottery service agreement, was cancelled.
The Company has three current Employee Stock Option Plans whereby options to
purchase 2.6 million shares of the Company's common stock may be granted.
Pursuant to these Plans, options for 1.1 million shares at prices ranging from
$1.375 to $15.75 per share were outstanding at December 31, 1995. Options for .9
million shares were exercisable at December 31, 1995.
In September 1993, the Company adopted a Directors Option Plan under which
240 thousand shares of the Company's common stock may be granted only to outside
directors of the Company. Pursuant to this Plan, the Company has issued options
totaling 180 thousand shares, at prices ranging from $2.219 to $10.25 per share.
At December 31, 1995, 180 thousand shares were outstanding and 60 thousand
shares were exercisable.
At December 31, 1995 there were 1.8 million shares reserved for issuance in
connection with all of the Company's outstanding options and warrants.
The Company has an Employee Stock Bonus Plan, commonly referred to as a
401(k) plan, qualified under the Internal Revenue Code, in which all eligible
employees, as defined in the Internal Revenue Code, may elect to participate.
Under the Plan, employees may voluntarily make tax-deferred contributions of up
to 15% of their compensation to a trust which provides the participant with
various investment alternatives. In addition, the Company, at the discretion of
the Board of Directors, may contribute an amount for each fiscal year which does
not exceed 5% of the annual compensation of all participants in the Plan.
Company contributions charged to operations were $198 thousand, $272 thousand,
and $245 thousand in 1995, 1994 and 1993 respectively.
9. MCKINNIE & ASSOCIATES
On March 31, 1993, the Company sold its subsidiary, McKinnie & Associates, Inc.
to Shreveport Acquisition for cash and a note. The recorded balance of the
receivable on the McKinnie sale of $49 thousand is included in the December 31,
1995 balance sheet with accounts receivable. Unrecorded gain and interest of
$1.5 million will be recognized using the cost recovery method as payments are
received.
10. LITIGATION
In June and July 1994, shareholders of the Company filed class action lawsuits
against the Company and several of its officers and directors. Those actions
were consolidated by stipulation and order and are now pending in the United
States District Court for the Southern District of California. Plaintiffs
contend that during the class period (June 22, 1993 through June 21, 1994) the
Company and the individual defendants made a series of public statements that
failed to disclose adverse information about the Company's lottery service
contracts, that these purported nondisclosures artificially inflated the price
of the Company's stock, and that those purchasers who acquired their shares in
reliance on the integrity of the market suffered damages as a result. Attorneys
for all defendants have executed a stipulation settlement with the law firm
representing the plaintiffs. The proposed settlement includes a cash payment and
1.2 million authorized but unissued common shares of the Company, and is subject
to agreement by the shareholders included in the class period and approval by
the court. Accordingly, a provision for the proposed settlement has been
included in the consolidated financial statements, which includes an estimate of
the value of the shares at date of issuance as a current liability.
In November, 1995, Mr. James Walters, the former chairman and president of
the Company, filed an action in the San Diego County Superior Court against the
Company, its current president, Frederick A. Brunn, a publishing company and an
author alleging that certain statements in a magazine article were slander per
se by ILTS and Brunn and libel by the publishing company and the author, and
that Mr. Walters suffered an invasion of privacy by all defendants. In addition,
Walters' alleged that erroneous information in the Company's 1995 Proxy
Statement resulted in two other magazine articles publishing allegedly incorrect
information. Mr. Walters seeks general and special damages of $9 million and
punitive damages. The Company and Mr. Brunn deny all allegations in Mr. Walters'
complaint and will defend the litigation accordingly. Since the outcome of the
case is not expected to result in any liability to the Company, no provision for
any liability that may result has been included in the consolidated financial
statements.
ILTS / 15
<PAGE> 18
REPORT OF ERNST & YOUNG LLP,
INDEPENDENT AUDITORS
THE BOARD OF DIRECTORS AND SHAREHOLDERS
INTERNATIONAL LOTTERY & TOTALIZATOR SYSTEMS, INC.
We have audited the accompanying consolidated balance sheets of International
Lottery & Totalizator Systems, Inc. as of December 31, 1995 and 1994 and the
related consolidated statements of operations, shareholders' equity and cash
flows for each of the three years in the period ended December 31, 1995. These
financial statements are the responsibility of the Company's management. Our
responsibility is to express an opinion on these financial statements based on
our audits.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of material
misstatements. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the financial statements referred to above present fairly,
in all material respects, the consolidated financial position of International
Lottery & Totalizator Systems, Inc. at December 31, 1995 and 1994, and the
consolidated results of its operations and its cash flows for each of the three
years in the period ended December 31, 1995, in conformity with generally
accepted accounting principles.
/s/ Ernst & Young LLP
Ernst & Young LLP
San Diego, California
February 9, 1996
16 / ILTS
<PAGE> 19
CORPORATE AND COMMON
SHARE INFORMATION
DIRECTORS
Theodore A. Johnson
Chairman of the Board
Frederick A. Brunn
President
Chan Kien Sing
Group Executive Director,
Berjaya Group Berhad
M. Mark Michalko
Executive Vice President
Martin J. O'Meara, Jr.
President,
The Budget Plan, Inc.
Ng Foo Leong
Executive Director, Sports
Toto Malaysia Sdn Bhd
Sir Michael G.R. Sandberg
Private Investor
Tan Sri Dato Vincent Tan Chee Yioun
Group Chief Executive Officer,
Berjaya Group Berhad
OFFICERS
Frederick A. Brunn
President
Timothy R. Groth
Vice President,
Technical Operations
William A. Hainke
Chief Financial Officer,
Corporate Secretary and Treasurer
M. Mark Michalko
Executive Vice President
Lennart K. Sundin
Senior Vice President,
Marketing and Sales
MARKET FOR COMMON STOCK
The Company's common stock is traded under the symbol ITSI on the NASDAQ
National Market System. At December 31, 1995, there were 16,816,211 common
shares outstanding and 896 shareholders of record. Berjaya Lottery Management
owned 39% of the total outstanding shares and the Company's management owned
1%.
<TABLE>
<CAPTION>
1995 HIGH LOW
<S> <C> <C>
First Quarter 4-7/8 1-15/16
Second Quarter 4-3/8 1-7/8
Third Quarter 3-3/8 2-1/8
Fourth Quarter 2-11/16 15/16
Average Daily Volume 52,267
Total Annual Trading Volume 13,171,342
<CAPTION>
1994 HIGH LOW
<S> <C> <C>
First Quarter 15-7/8 9-7/8
Second Quarter 11 4
Third Quarter 6-1/2 4-3/8
Fourth Quarter 5 2-1/2
Average Daily Volume 77,660
Total Annual Trading Volume 19,570,320
</TABLE>
DIVIDEND POLICY
The Company retains earnings to support operations.
FORM 10-K
A copy of Form 10-K as filed with the Securities and Exchange Commission may be
obtained by contacting:
Investor Relations
ILTS
2131 Faraday Avenue
Carlsbad, CA 92008-7297 USA
(619) 931-4027
ANNUAL MEETING OF SHAREHOLDERS
The 1996 Annual Meeting will be held at 3:00 p.m. PDT on Thursday, June 6,
1996, at Pea Soup Andersen's 850 Palomar Airport Road, Carlsbad, California,
(619) 438-0880. Shareholders and interested parties are invited to attend.
TRANSFER AGENT AND REGISTRAR
Stock Transfer Administration
First Interstate Bank, Ltd.
P.O. Box 54261
Los Angeles, CA 90054-0261 USA
(213) 614-2404
LEGAL COUNSEL
Lawrence E. Logue
General Counsel
ILTS
2131 Faraday Avenue
Carlsbad, CA 92008-7297 USA
(619) 931-4000
INDEPENDENT AUDITORS
Ernst & Young LLP
501 West Broadway, Suite 1100
San Diego, CA 92101-3536 USA
(619) 235-5000
INVESTOR RELATIONS
ILTS
2131 Faraday Avenue
Carlsbad, CA 92008-7297 USA
(619) 931-4027
To receive Company information via facsimile, call the Investor Relations
Hotline: 1-800-859-5903
Designed and produced by GornKellerMartinez, Inc., Del Mar, California
<PAGE> 20
[PHOTO OF CORPORATE OFFICE]
HEADQUARTERS
International Lottery & Totalizator Systems, Inc.
2131 Faraday Avenue
Carlsbad, CA 92008-7297 USA
Tel: (619) 931-4000
Fax: (619) 931-1789
TECHNICAL AND MARKETING/SALES SUPPORT FACILITIES
United Kingdom
Totalizator Systems (UK) Ltd.
241 Horton Road
Yiewsley, West Drayton
Middlesex, UB7 8HT ENGLAND
Tel: (44) (1895) 449550
Fax: (44) (1895) 420600
Australia
International Lottery & Totalizator Systems
Australia Pty. Ltd.
IA, 167 Prospect Highway
Seven Hills, New South Wales 2147 AUSTRALIA
Tel: (61) (2) 624-4300
Fax: (61) (2) 674-6832
SALES OFFICES
Asia Pacific
Sales Office
Christina Bldg. Unit 304
Herrera Corner Legaspi Sts.
Legaspi Village, Makati PHILIPPINES
Tel: (63) (2) 816-6989
Fax: (63) (2) 815-3270
Scandinavia/Europe
ITS Europe
Vollsveien 168
N-1343 Eiksmarka NORWAY
Tel: (47) (67) 14 73 76
Fax: (47) (67) 14 80 68
[INTERNATIONAL LOTTERY & TOTALIZATOR SYSTEMS, INC. LOGO]
Visit the ILTS Home Page: http://www.ilts.com
International Lottery & Totalizator Systems, Inc.(TM) and DATAMARK(R) are
registered trademarks of International Lottery & Totalizator Systems, Inc.
Registered to ISO 9001 Certificate No. 43960
<PAGE> 1
EXHIBIT 21
SUBSIDIARIES OF THE REGISTRANT
The Registrant had 13 wholly-owned subsidiaries as of December 31, 1995:
ITS Export, Inc., a California corporation; ITS Overseas, Inc., a California
corporation; ITS Service Corp., a California corporation; ITS Service Corp. II,
a California corporation; ITS Service Corp. III, a California corporation;
Amer-Russ Firebird Lottery, Inc., a Delaware corporation; Air Fair, Inc., a
California corporation; ILTS (Brazil), Inc., a California corporation; ITS
Virgin Islands, a Virgin Island corporation; International Lottery &
Totalizator Systems Australia Pty. Ltd., an Australia corporation; Totalizator
Systems (UK) Ltd., a United Kingdom corporation; Zodiac On-Line, a Russian
corporation, and Transactional Systems, a Russian corporation.
<PAGE> 1
EXHIBIT 23
CONSENT OF ERNST & YOUNG LLP, INDEPENDENT AUDITORS
We consent to the incorporation by reference in this Annual Report (Form
10-K) of International Lottery & Totalizator Systems, Inc. of our report dated
February 9, 1996 included in the 1995 Annual Report to Shareholders of
International Lottery & Totalizator Systems, Inc.
Our audits also included the financial statement schedule of International
Lottery & Totalizator Systems, Inc. listed in Item 14(a). This schedule is the
responsibility of the Company's management. Our responsibility is to express an
opinion based on our audits. In our opinion, the financial statement schedule
referred to above, when considered in relation to the basic financial statements
taken as a whole, presents fairly in all material respects the information set
forth therein.
We also consent to the incorporation by reference in the Registration
Statements (Form S-8, No. 2-99618) pertaining to the 1982 Employee Stock Option
Plan, (Form S-8, No. 33-34121) pertaining to the 1986 Employee Stock Option
Plan, (Form S-8, No. 33-34123) pertaining to the 1988 Employee Stock Option Plan
of International Lottery & Totalizator Systems, Inc., (Form S-8, No.33-79938)
pertaining to the 1990 Stock Incentive Plan, (Form S-8, No. 33-69008) pertaining
to the 1993 Directors' Stock Option Plan and the Registration Statement (Form
S-3, No. 33-78194) and in the related Prospectuses of our report dated February
9, 1996, with respect to the consolidated financial statements and schedule of
International Lottery & Totalizator Systems, Inc. included and incorporated by
reference in this Annual Report (Form 10-K) for the year ended December 31,
1995.
ERNST & YOUNG LLP
San Diego, California
March 15, 1996
<TABLE> <S> <C>
<ARTICLE> 5
<MULTIPLIER> 1,000
<S> <C>
<PERIOD-TYPE> 12-MOS
<FISCAL-YEAR-END> DEC-31-1995
<PERIOD-END> DEC-31-1995
<CASH> 3,904
<SECURITIES> 0
<RECEIVABLES> 1,588
<ALLOWANCES> 0
<INVENTORY> 6,820
<CURRENT-ASSETS> 16,619
<PP&E> 1,361
<DEPRECIATION> 0
<TOTAL-ASSETS> 21,352
<CURRENT-LIABILITIES> 7,831
<BONDS> 0
0
0
<COMMON> 48,687
<OTHER-SE> (35,275)
<TOTAL-LIABILITY-AND-EQUITY> 21,352
<SALES> 18,641
<TOTAL-REVENUES> 18,641
<CGS> 20,263
<TOTAL-COSTS> 32,862
<OTHER-EXPENSES> 0
<LOSS-PROVISION> 60
<INTEREST-EXPENSE> 46
<INCOME-PRETAX> (13,869)
<INCOME-TAX> 0
<INCOME-CONTINUING> (13,869)
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> (13,869)
<EPS-PRIMARY> (0.83)
<EPS-DILUTED> 0
</TABLE>
