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SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-K
[X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(D)
OF THE SECURITIES EXCHANGE ACT OF 1934
FOR THE FISCAL YEAR ENDED DECEMBER 31,1998
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(D)
OF THE SECURITIES EXCHANGE ACT OF 1934
FOR THE TRANSITION PERIOD FROM TO
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COMMISSION FILE NUMBER 001-12986
INTERLOTT TECHNOLOGIES, INC.
(EXACT NAME OF REGISTRANT AS SPECIFIED IN ITS CHARTER)
DELAWARE 31-1297916
(State of incorporation) (IRS Employer
Identification Number)
10830 MILLINGTON COURT, CINCINNATI, OHIO 45242
(Address of principal executive offices, including zip code)
(513) 792-7000
(Registrant's telephone number, including area code)
SECURITIES REGISTERED PURSUANT TO SECTION 12(B) OF THE ACT:
TITLE OF EACH CLASS NAME OF EACH EXCHANGE ON WHICH REGISTERED
Common Stock, $.01 Par Value American Stock Exchange
SECURITIES REGISTERED PURSUANT TO SECTION 12(G) OF THE ACT: NONE
Indicate by check mark whether the Registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months (or for such shorter period that the Registrant was
required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days. Yes X No
Indicate by check mark 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. [X]
The aggregate market value of the Registrant's outstanding Common Stock held by
non-affiliates of the Registrant on March 22, 1999 was $9,630,000. There were
3,210,000 shares of Common Stock outstanding as of March 22, 1999.
DOCUMENTS INCORPORATED BY REFERENCE
Portions of the Registrant's 1998 Annual Report are incorporated by reference in
Part II hereof. Portions of the Registrant's Proxy Statement for the 1999 Annual
Meeting of Stockholders to be held on May 6, 1999 are incorporated by reference
in Part III hereof.
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INTERLOTT TECHNOLOGIES, INC.
ANNUAL REPORT ON FORM 10-K
FOR THE FISCAL YEAR ENDED DECEMBER 31, 1998
TABLE OF CONTENTS
<TABLE>
<CAPTION>
ITEM PAGE
NUMBER NUMBER
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<S> <C>
PART I............................................................................................................3
1. Business...............................................................................................3
2. Properties............................................................................................20
3. Legal Proceedings.....................................................................................20
4. Submission of Matters to a Vote of Security Holders...................................................21
4(A). Executive Officers of the Registrant..................................................................21
PART II..........................................................................................................22
5. Market for the Registrant's Common Stock and Related Stockholder Matters..............................22
6. Selected Financial Data...............................................................................22
7. Management's Discussion and Analysis of Financial Condition and Results of Operations.................22
7(A). Quantitative and Qualitative Disclosures About Market Risk............................................27
8. Financial Statements and Supplementary Data...........................................................27
9. Changes In and Disagreements With Accountants on Accounting and Financial Disclosure..................27
PART III.........................................................................................................28
10. Directors and Executive Officers of the Registrant....................................................28
11. Executive Compensation................................................................................28
12. Security Ownership of Certain Beneficial Owners and Management........................................28
13. Certain Relationships and Related Transactions........................................................28
PART IV..........................................................................................................28
14. Exhibits, Financial Statement Schedules, and Reports on Form 8-K......................................28
SIGNATURES............................................................................................32
INDEX OF FINANCIAL STATEMENT SCHEDULES.................................................................1
INDEX OF EXHIBITS......................................................................................1
</TABLE>
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PART I
ITEM 1. BUSINESS
Interlott Technologies, Inc. (the "Company" or "Interlott") is engaged
primarily in the design, manufacture, sale, lease and service of instant winner
lottery ticket vending machines ("ITVMs"). ITVMs are used by public lotteries
operated by states and international public entities to dispense instant winner
lottery tickets primarily in retail locations such as supermarkets and
convenience stores. An instant lottery commonly is played by players scratching
off a latex coating from a pre-printed ticket or tearing pull-tabs from a
pre-printed ticket to determine the outcome of the game. The Company's ITVMs
dispense instant lottery tickets without the assistance of an employee of the
lottery instant ticket retailer or agent, thereby permitting the retailer or
agent to sell tickets without disrupting the normal duties of its employees.
The Company's ITVMs dispense scratch-off instant lottery tickets using
a dispensing process that incorporates the Company's patented "burster
technology." The Company believes that this burster technology is superior to
any other ITVM scratch-off dispensing technology on the market and considers it
to be a key to its marketing efforts and the ITVM procurement decisions of the
various lotteries. The Company is unaware of any competitor that incorporates a
substantially equivalent or superior scratch-off dispensing mechanism in its
ITVMs. To dispense pull-tab instant lottery tickets, the Company has developed
an ITVM that incorporates a patented dispensing technology which is different
than the burster technology but that is also believed by the Company to be
superior to any other currently available pull-tab dispensing technology. ITVMs
that dispense pull-tab tickets are sometimes referred to herein as "pull tab
vending machines" or "PTVMs." The term "ITVM" includes both scratch-off vending
machines and PTVMs unless the context indicates otherwise.
As of December 31, 1998, the Company had sold or leased 15,045 ITVMs
under agreements with 23 different state lotteries and seven international
jurisdictions, or their licensees or contractors. The Company was awarded four
of the six contracts that were awarded to the industry in 1998. Additionally,
lotteries in four states and five international jurisdictions currently are
testing the Company's products and services or have requested the Company to
provide ITVMs for testing.
The Company continually seeks to enhance its existing product lines and
develop new products. In 1998, the Company introduced its Modular Vending
Platform to increase over-the-counter instant ticket sales and reduce ticket
shrinkage. Also in 1998, the Company introduced the Automated Communication
System, which significantly increases and enhances the flow of information
between the ITVMs in the field and the lotteries.
Taking advantage of its expertise in dispensing technology, the Company
introduced a prepaid phone card dispensing machine ("PCDM") in 1995 that enables
providers of long distance telephone service to dispense prepaid telephone
calling cards in retail locations without the assistance of an employee of the
retailer. The dispensing process used in the Company's PCDM incorporates the
same patented technology used in the Company's PTVM, and the Company believes
that this dispensing technology is superior to any other PCDM dispensing
technology on the market. Sales of the Company's PCDMs began in the latter part
of 1995, and as of December 31, 1998, the Company had sold or leased a total of
851 PCDMs. PCDM revenues in 1998 represented 2.3% of total revenues.
The Company was incorporated on February 20, 1990 under the laws of
Ohio and was reincorporated under the laws of Delaware on March 18, 1994. In
April 1994, the Company completed an initial public offering of Common Stock,
and the Company's Common Stock now trades on the American Stock Exchange under
the symbol "ILI."
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INDUSTRY OVERVIEW
ITVMs
The popularity and success of lotteries has increased worldwide in
recent years, and the popularity of instant lotteries has increased at a rate
that is greater than that of lotteries generally. Currently, 37 states and the
District of Columbia operate lotteries as compared to 29 states as of June 30,
1989, and 37 states and the District of Columbia currently operate instant
lotteries as compared to 28 states as of June 30, 1989. The Company believes
that factors contributing to the rapid growth in the popularity and success of
instant ticket games, which now comprise 45% of total lottery sales in the
United States as compared to 24% in 1989, include more sophisticated marketing
techniques, the introduction of new state instant ticket lotteries, a broader
appeal among lottery consumers and increased technological advances in the
distribution of instant tickets.
ITVMs were first deployed to serve the instant lottery market in 1991,
and the market for ITVMs has grown rapidly in subsequent years. The number of
installed ITVMs has increased from approximately 900 in two states in 1991 to
approximately 25,000 in 31 states, the District of Columbia and eight
international jurisdictions as of December 31, 1998. Four states and five
international jurisdictions currently are testing or preparing to test ITVMs in
the field, and the Company believes that several other states and international
jurisdictions are considering the use of ITVMs. Additionally, because states
that utilize ITVMs typically introduce the ITVMs into the instant ticket
distribution system in stages (preferring to test retail reception to a limited
initial deployment of ITVMs before fully committing funds to the deployment of a
significantly larger number of ITVMs), the Company believes that states
currently utilizing ITVMs represent a growing market for the Company's ITVMs.
PCDMs
Like instant lottery tickets, the use of prepaid telephone calling
cards also has grown significantly in the past few years. Prepaid telephone
calling cards enable callers to make long distance calls at rates that typically
are lower than the rates ordinarily charged for credit card or collect long
distance telephone calls. This factor, together with the usage control that
results from the pre-established value of the card, is perceived as a distinct
value of the card and is believed to be responsible for the popularity of
prepaid telephone calling cards.
The use of PCDMs as a method of distribution of prepaid telephone
calling cards has paralleled the market acceptance of the card. PCDMs are now
being used successfully to sell prepaid telephone calling cards in truck stops,
military bases, convenience stores, airports, and numerous other types of retail
locations. The Company believes that the sale of prepaid long distance telephone
calling cards and the use of PCDMs are in the very early stages of market
development in the United States and anticipates the continued development of
the market.
BUSINESS STRATEGY
The Company's business strategy involves the following elements:
- Expansion of the Company's ITVM into new domestic and
international markets. Lotteries are becoming increasingly
aware of the success of ITVMs in increasing instant ticket
revenues, and many domestic and international jurisdictions
are currently testing and evaluating ITVMs. In the United
States, the Company currently is testing or preparing for
testing of ITVMs for four state lotteries. Internationally,
the Company currently is testing or preparing for testing of
ITVMs for lotteries in five countries. The Company plans to
expand further into new and existing lottery jurisdictions by
expanding its marketing efforts and lowering the cost
associated with the procurement of its ITVMs. The Company also
intends to continue to aggressively market its ITVM products
and services to its existing customers to encourage expanded
use of ITVMs in existing distribution systems.
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- PCDM market penetration. The Company has made only an initial
and limited penetration of the PCDM market to date, but the
Company is actively seeking to become a significant presence
in the PCDM market in the United States. The Company believes
that its ITVM has a reputation for quality, performance and
reliability, and the Company intends to capitalize on this
reputation in marketing its PCDM to providers of long distance
telephone services. The Company also intends to demonstrate to
such providers the advantages which its PCDM affords to the
retailers that sell prepaid telephone calling cards, which in
turn should lead to increased sales of prepaid telephone
calling cards by such providers. The Company intends to
aggressively market its PCDM products to its existing
customers and to expand its marketing efforts to both the
providers and resellers of long distance telephone services,
as well as to market its PCDMs to retailers of prepaid
telephone calling cards.
- Continued product innovation and technological advances.
Management believes that the Company's products are more
technologically advanced than the products of its competitors
and that the technological superiority of the Company's ITVM
is a principal reason for its success to date. To further
expand the Company's market opportunities, the Company
continually seeks to enhance its existing products and develop
complementary products that offer the superior operating
performance of its ITVMs and PCDMs. For example, the Company
has developed a new Modular Vending Platform ("MVP") for use
in convenience stores and grocery check-out lanes which should
increase sales and reduce ticket shrinkage. The Company also
has enhanced its software to interact with currency acceptors
of international currency and display messages in several
languages. Finally, the Company has improved its on-line
communications system through the new Automated Communication
System that significantly increases and enhances the flow of
information between the ITVMs in the field and the lotteries.
- Manufacturing efficiencies. The Company continually seeks to
enhance its manufacturing operations to improve its gross
margins and overall profitability. The Company believes that
through design refinements and continued higher production
volumes, it will continue to achieve lower manufacturing costs
by receiving more favorable terms from vendors.
- Develop dispensing devices for other markets. The Company
intends to expand its existing product lines by developing new
dispensing devices for markets other than lotteries and
prepaid telephone calling cards. For example, the Company has
developed a device which dispenses stored value "smart" cards
for possible use by the financial services industry to the
extent that consumer use of smart cards develops in the
future.
PRODUCTS
The ITVM
In 1987, Edmund F. Turek, who currently serves as a director of and
consultant to the Company, developed the technology for what the Company
believes to be the first automated ITVM. The burster dispensing technology is a
key component of the Company's ITVM for scratch-off instant lottery tickets and
is protected by a patent that the Company acquired from Mr. Turek's family-owned
corporation. See "Patents, Trademarks and Copyrights" below.
The Company's ITVMs automatically dispense instant lottery tickets upon
payment from the user. Unlike the products of some of the Company's competitors,
the burster technology in the Company's ITVMs automatically separates one
scratch-off instant ticket from another along the perforations between tickets
to help prevent tearing of the tickets or scarring of the latex on the tickets.
The Company's burster technology, which the Company believes to be the most
technologically advanced scratch-off dispensing system in the ITVM industry,
also enables the Company's ITVMs to dispense and account for virtually any known
type of scratch-off instant lottery ticket, allowing the use of a wide range of
sizes, shapes, paper stocks or perforations, without the intervention of a
lottery
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retailer or agent. This feature allows lotteries to purchase virtually any known
type of scratch-off instant ticket from their instant ticket manufacturer
without having to request from the manufacturer major alterations in the ticket
perforations. For example, the Company's ITVM, unlike the products of the
Company's competitors, can dispense recyclable scratch-off tickets without
tearing or scarring the tickets. The Company believes that lotteries will
increasingly require the use of recyclable tickets in their ITVMs. This feature
also is particularly beneficial to international lottery jurisdictions that may
use non-standard sizes, shapes and paper stocks. In addition, the ITVM for
scratch-off tickets is faster than manual sales of scratch-off tickets as the
ITVM's entire dispensing process is completed in less than 1.5 seconds once the
ticket selector button has been pushed.
The Company's ITVMs for scratch-off tickets have a proven record of
reliability. Based on an analysis of actual field service data regarding the
dispensing of approximately 55 million scratch-off instant tickets by the
Company's ITVMs during a 48-week period, the Company determined that the Mean
Time Between Failure of these ITVMs is approximately 3.78 years and that the
Mean Time to Repair is approximately 15 minutes. The data indicated that these
ITVMs dispense an average of 392,800 scratch-off instant tickets between
failures. The Company believes that it has developed an ITVM that has proven to
be reliable and that requires less maintenance than the products of its
competitors. The Company believes that the reliability of its ITVMs and the
lower maintenance requirements distinguish the Company's ITVMs for scratch-off
tickets from those of its competitors. See "Competition" below.
The Company's ITVM for scratch-off tickets has the capacity to dispense
tickets from one to 16 different bins. Because each bin can dispense tickets of
different sizes, paper stocks and price levels, lotteries can sell scratch-off
tickets for up to 16 different instant-winner games with a single ITVM. The ITVM
can accommodate up to 16,000 tickets in the 16-game unit and can dispense all
tickets in the bin without manual intervention. When all of the tickets in a bin
have been dispensed, tickets can be easily reloaded by an employee of the
retailer or agent. This is in contrast to the products of the Company's
competitors, which the Company believes require the retailer or other agent to
tape the last few tickets in each bin to the next pack of tickets provided by
the retailer or other agent. The ability of the Company's ITVM to dispense every
ticket in each bin not only facilitates the ticket reloading process but also
enhances the accuracy of the inventory and accounting functions.
All of the Company's ITVMs accept bills in $1, $2, $5, $10 and $20
denominations and, in some applications, accept international currency. The size
of the Company's ITVM for scratch-off tickets varies from 69 inches tall, 28
inches wide and 24 inches deep for a 16-game unit to 19.75 inches tall, 15.5
inches wide and 20.5 inches deep for a countertop unit.
All models are anchored to the floor or counter. The ITVMs typically
are custom designed to meet any color and other appearance specifications that a
lottery may desire. All models are Underwriters Laboratory ("UL((R))") listed
and Federal Communications Commission ("FCC") approved, which ensures that the
ITVM has passed nationally recognized safety standards and stringent
requirements designed to preclude machine damage and personal injury due to
non-approved components, devices, installation or application. The Company was
the first manufacturer of ITVMs to obtain UL((R)) listing and FCC approval for
its ITVMs.
Each ITVM is standardized with an information display that provides the
player with easy-to-read instructions on how to use the machine and gives the
lottery retailer or agent the ability to read sales reports without printing the
report. The ITVM can be ordered with a "BETA BRITE((R))" mulTi-color LED sign
mounted on the top of the ITVM which is intended to increase attention to the
machine and thereby increase ticket sales. The BETA BRITE((R)) sign is
programmed at the Company's manufacturing facility and can display any message
the lottery may desire. The BETA BRITE((R)) also may be programmed by the
retailer or agent or can be programmed from the lottery headquarters by
utilizing the Company's optional modem communications system. The Company
currently is utilizing the BETA BRITE((R)) on ITVMs installed in approximately
15 states.
For security and durability purposes, each of the Company's ITVM
cabinets is manufactured with 16 gauge and 11 gauge steel. The surface of the
ITVM is coated with durable and fade resistant paints. The display windows are
fabricated from a flame resistant, high impact polycarbonate sheet material.
This material is shatter
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resistant, and to date to the knowledge of the Company, none of the Company's
installed ITVMs has had a polycarbonate window broken or shattered.
Additionally, to the knowledge of the Company, the cabinets have not had any
fading, marring, scratching, chipping or rusting. All of the Company's ITVMs are
manufactured with high security locks which are coded to prevent unauthorized
duplication, and each ITVM is keyed separately, except for ITVMs deployed in
Maryland where the Lottery desired a master key system. For further security,
each of the Company's bill acceptor units must be accessed with a key unique to
the particular acceptor unit.
All of the Company's ITVMs for scratch-off tickets utilize copyrighted
software that can supply up to 11 different reports for accounting and inventory
purposes. These reports can provide to the lottery and its retailers or agents a
complete summary of daily sales, weekly sales, total sales, sales by game,
current status of the machine, inventory of the product currently in the ITVM,
the last three transactions of the ITVM and other types of information. The
software system allows for a simple diagnostic test to identify any malfunction
of the ITVM. The diagnostic mode communicates various information such as ticket
size setting, status of electronics, status of each game and other information
concerning the system software. The Company's ITVM software system may be
programmed to the detail specifications of the specific lottery.
The Company incorporates a common electronic system in all of its
equipment. This enables the Company to efficiently develop common software and
to realize cost efficiencies in acquiring electronic components.
To dispense pull-tab instant lottery tickets, the Company's PTVM uses
the same technology, design and specifications as are incorporated in the
Company's PCDM. The Company's PCDM is described in detail below.
The PCDM
Like the Company's ITVM for scratch-off tickets, the key component of
the Company's PCDM is the dispensing technology. The Company has the exclusive
right to the use of this patented dispensing technology, which it acquired from
a company owned by Kazmier J. Kasper, a director of the Company. See "Item 13.
Certain Relationships and Related Transactions."
Similar to the Company's ITVM for scratch-off tickets, the Company's
PCDM automatically dispenses prepaid telephone calling cards upon payment from
the user. Unlike the products of some of the Company's competitors, the
dispensing technology in the Company's PCDM automatically pulls one prepaid
telephone calling card from the bottom of the stack of cards without the jamming
that is associated with other dispensing processes. The Company's dispensing
technology, which the Company believes to be the most technologically advanced
dispensing system in the PCDM industry, also enables the Company's PCDM to
dispense and account for virtually any known thickness of calling card without
the intervention of the retailer. In addition, the PCDM is faster than manual
sales of prepaid telephone calling cards as the PCDM's entire dispensing process
is completed in less than three seconds once the selector button has been
pushed.
The Company's PCDMs have the capacity to dispense cards from two to six
different bins. The PCDM can accommodate up to 3,600 cards in the six-bin unit
and can dispense all prepaid telephone calling cards in the bin without manual
intervention. When all of the cards in a bin have been dispensed, cards easily
can be reloaded by an employee of the retailer. The ability of the Company's
PCDM to dispense every card in each bin not only facilitates the card reloading
process but also enhances the accuracy of the inventory and accounting
functions.
All of the Company's PCDMs accept bills in $1, $2, $5, $10 and $20
denominations and, in some applications, accept international currency. The size
of the Company's PCDMs varies from 66 inches tall, 26 inches wide and 19 inches
deep for a six-bin dispenser unit to 22 inches tall, 14 inches wide and 10
inches deep for a countertop unit. All models are anchored to the floor or
counter, except that the two bin model may be mounted on an optional pedestal.
All models are UL((R)) listed and FCC approved. Each PCDM is standardized with
an information display that provides the user with EASY-to-read instructions on
how to use the machine and gives the retailer the ability to read sales reports
without printing the report.
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For security and durability purposes, each of the Company's PCDM
cabinets is manufactured with 16 gauge and 11 gauge steel. The surface of the
PCDM is coated with durable and fade resistant paints. The display windows are
fabricated from a flame resistant, high impact polycarbonate sheet material. To
the knowledge of the Company, the cabinets have not had any fading, marring,
scratching, chipping or rusting. All of the Company's PCDMs are manufactured
with high security locks that are coded to prevent unauthorized duplication, and
each PCDM is keyed separately. For further security, each of the Company's bill
acceptor units must be accessed with a key unique to the particular acceptor
unit.
All of the Company's PCDMs utilize copyrighted software that can supply
up to nine different reports for accounting and inventory purposes. These
reports can provide retailers a complete summary of daily sales, weekly sales,
total sales, sales by bin, current status of the machine, inventory of the
product currently in the PCDM, the last three transactions of the PCDM and other
types of information. The software system allows for a simple diagnostic test to
identify any malfunction of the PCDM.
MARKETING AND SALES
ITVMs
The Company markets its ITVMs to both domestic and international
lotteries and their licensees or prime contractors. The Company attends lottery
and gaming trade shows, maintains personal contact with lottery officials
through its sales force of five employees and advertises in trade publications
to increase its presence in the lottery industry.
The focus of the Company's marketing strategy is on the superior
performance and reliability of its ITVMs, as well as continued competitive
pricing. Information developed through actual field use and product field tests
demonstrates that a significant factor in increasing instant ticket sales is the
reliability of the ITVM. Increased maintenance visits impair the ITVM "uptime,"
which in turn reduce ticket sales. The Company believes that its ITVMs, based on
actual field performance and product testing, are the most reliable and
technologically superior in the industry. Management believes that actual field
demonstrations comparing the Company's ITVMs with those of its competitors are
the Company's best method of marketing. The Company has been awarded contracts
to provide ITVMs for 13 of the last 17 state lotteries that have requested bid
proposals and 4 of the 6 domestic ITVM contracts that were awarded in 1998.
The Company's ITVMs require preventive maintenance only twice a year.
The ITVM "downtime" resulting from this semi-annual preventive maintenance
averages approximately 20 minutes.
To further increase the likelihood of receiving ITVM orders from
lotteries, the Company intends to offer additional and more flexible financing
alternatives to the lotteries. The Company believes that many state lotteries,
due to budget considerations, cannot afford the high capital costs required to
purchase ITVMs. However, if the Company can provide attractive variations of its
standard and percentage lease financing options for the lotteries, the lotteries
can more affordably deploy ITVMs. The Company believes that these types of
financing alternatives will prove to be increasingly popular.
The Company's ability to generate additional revenues and earnings from
deployments of its ITVMs will depend upon continued market acceptance of ITVMs.
The Company intends to expand its marketing presence with the retail grocers
associations, convenience store operators associations, retail stores at both
the corporate and store levels, and other types of corporate or association
member entities to familiarize these groups with the Company's ITVM. These
retailers are the lotteries' distribution system for all scratch-off and
pull-tab lottery tickets, and management believes that increased exposure to
lottery retailers will be a significant factor in the Company's ability to
expand the market for its lottery products. As the distribution system for all
lottery products, lottery retailers may advise the lotteries with regard to such
matters as new lottery products, improved marketing strategy and improved
product distribution. In many lottery jurisdictions, retailer advisory boards
provide input to the lotteries on various issues affecting the lottery. While
the lotteries must abide by the established procurement
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laws of their respective jurisdictions in selecting an ITVM manufacturer, the
lotteries may solicit the opinions of the lottery retailers concerning the ITVMs
under consideration by the lottery because the retailers are directly affected
by the selection decision. The Company believes that retailers' opinions may be
a significant factor in a customer's decision regarding which manufacturer's
ITVM to deploy in its instant ticket distribution system.
The Company will continue to participate in cooperative service
arrangements with other lottery suppliers as the lotteries increasingly rely on
these types of arrangements. These arrangements allow lotteries to reduce their
operating costs while increasing lottery revenues. Additionally, these
arrangements allow for a more efficient means for contracting products and
services. The Company's ITVMs are deployed in Georgia and West Virginia pursuant
to cooperative service arrangements between the Company and Scientific Games,
Inc., which is a primary contractor for the Georgia and West Virginia Lotteries,
and were deployed in New Jersey pursuant to a purchase agreement between the
Company and GTECH Corporation, which is the on-line supplier to the New Jersey
Lottery. Under these arrangements, the Company supplies ITVMs to Scientific
Games, Inc. for use in Georgia and West Virginia and supplies ITVMs to GTECH
Corporation for use in New Jersey. The Company is responsible for installing,
servicing and maintaining the ITVMs in Georgia but is not required to provide
preventive maintenance or servicing for the ITVMs supplied for use in West
Virginia and New Jersey. Management believes that the deployment of the
Company's ITVMs in Georgia, West Virginia and New Jersey resulted in part from
the Company's cooperative service arrangements with Scientific Games, Inc. and
GTECH Corporation and that such cooperative service arrangements will prove to
be increasingly attractive to both domestic and international lotteries in the
future.
PCDMs
The Company has been marketing its PCDMs since late 1995 and to date
has employed a marketing strategy that is similar to the strategy that it has
used successfully to market its ITVMs. The focus of the Company's marketing
strategy is on the superior performance and reliability of its PCDMs as well as
on competitive pricing. The Company markets its PCDMs to both domestic and
international providers of long distance telephone service. The Company attends
telecommunications trade shows, maintains personal contact with
telecommunications companies through its sales force of two employees and
advertises in trade publications to increase its presence in the
telecommunications industry.
The Company's ability to generate additional revenues and earnings from
the deployment of its PCDMs will depend upon continued market acceptance of
PCDMs. The Company intends to expand its marketing presence with the retail
grocers associations, convenience store operators associations, retail stores at
both the corporate and store levels, and other types of corporate or association
member entities to familiarize these groups with the Company's PCDM. These
retailers are the distribution system for prepaid telephone calling cards, and
management believes that increased exposure to PCDM retailers will be a
significant factor in the Company's ability to expand the market for its PCDM
products. To further increase the likelihood of receiving PCDM orders from
sellers of prepaid telephone calling cards, the Company intends to offer
additional and more flexible financing alternatives.
CONTRACTS
ITVMs
General. The Company's lottery contracts typically are entered into
following a competitive bidding process. Once a lottery has determined to
utilize ITVMs in its distribution network, the lottery usually will request
proposals from ITVM providers. Lotteries within the United States typically
follow a procedure whereby the lottery issues a Request for Proposal ("RFP") to
determine the contract award for installation of ITVMs. The RFP generally seeks
information concerning each company's products, cost of the products or services
to be provided, quality of management, experience in the industry and other
factors that the lottery may deem material to a contract award. The RFP also may
specify product criteria and other qualifications or conditions that must be
satisfied, such as UL((R)) listing and FCC approval of the ITVM and in-state or
minority supplier requirements.
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Generally, an evaluation committee comprised of key lottery staff members
appraises the proposals based on an established point system, and the contract
is awarded to the company with the most points.
The nature of the RFP process varies from jurisdiction to jurisdiction.
The length of time that a lottery might take to award a contract can be
difficult to predict, and delays in the contract award process are frequent and
unpredictable. Additionally, the point system or the weighing of the various
points varies from jurisdiction to jurisdiction, which often makes it difficult
for the bidding companies to determine the relative importance of the various
factors to be considered by the evaluation committee. In certain cases the
contract award is challenged by the losing bidder, which can result in
protracted legal proceedings for all parties.
The Company offers lotteries a choice of three types of contracts: (i)
Standard Lease Agreements, (ii) Sales Agreements, and (iii) Percentage Lease
Agreements. ITVM lease revenues as a percentage of the Company's total revenues
were 63.3%, 67.3% and 57.9% in 1996, 1997 and 1998, respectively.
The Standard Lease Agreements provide that the lottery will pay a fixed
monthly price per machine for a specific period of time. These agreements
typically specify a number of years for the initial contract term with
additional option periods at the election of the lottery. The lottery may award
a separate service contract for the maintenance of the machines, incorporate the
cost of service into the established monthly lease price or perform machine
service themselves. The lotteries also may select a similar type of arrangement
as described above to procure the necessary supply of replacement parts for the
ITVMs.
As noted above, the lease payments provided for in the typical Standard
Lease Agreement are fixed in most cases during the term of the agreement, and
these agreements typically permit the lottery to order additional ITVMs at any
time during the lease term. If the lottery orders a significant number of ITVMs
near the end of the lease term, the Company would have to incur significant
manufacturing costs but may receive lease payments for only a relatively short
period of time through the remainder of the lease term. However, the Company
believes that it is more likely that the lottery would elect to extend the lease
term rather than return the ITVMs after only a short period of use.
Additionally, the Company is unable to pass along to the lottery any increases
in its manufacturing and service costs during the term of the typical Standard
Lease Agreement. In the case of a Standard Lease Agreement which provides for a
short initial term (such as one year) with an option for the lottery to extend
the lease term for additional one-year periods, if the lottery does not extend
the initial lease term, the Company might incur a loss on the manufacture of the
ITVMs leased to the lottery under the initial lease agreement.
Sales Agreements typically provide that the lottery will buy a certain
number of ITVMs over a specific period of time. Under the Sales Agreement, the
lottery generally pays for the ITVMs when delivered and has complete ownership
of the ITVMs. The lottery usually will contract with a vendor to maintain and
service the ITVMs, although some lotteries provide the maintenance and service
with their own service staffs. The lottery generally will enter into a parts
replacement contract with the vendor for replacement parts.
All types of the ITVM contracts typically contain stringent
installation, performance and maintenance requirements. Failure to perform the
contract requirements may result in significant liquidated damages or contract
termination. The Company has various contract performance standards to which it
must adhere. To date, the Company has satisfied all of its contractual
installation, performance and maintenance requirements and therefore has not had
any contracts terminated by any lotteries.
The Company's lottery contracts also typically require the Company to
indemnify the lottery, its officers and retailers for any liabilities arising
from the operation of the ITVMs or any services provided by the Company. The
Company typically is required to obtain liability insurance, fidelity insurance
and performance and litigation bonds to protect itself and the lottery from
potential liability. No such indemnification or insurance claims have ever been
asserted against the Company.
The Company's contracts generally have an initial term of one to five
years with options to extend the duration of the contracts for periods between
one and five years. The option extensions generally are at the
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<PAGE> 11
lottery's discretion and are exercised under the same terms and conditions as
the original contract. As of December 31, 1998, the initial term of five of the
Company's contracts had expired, and in each case, the lottery exercised its
option to extend the term. The Company's contracts with lotteries, like most
other types of state contracts, typically permit a lottery to terminate the
contract upon 30 days written notice for any reason. Upon termination of a lease
contract, the lottery would return the leased equipment to the Company. It is
uncertain, however, whether the Company would be able to re-lease or sell any
ITVMs that may be returned to the Company following the expiration or
cancellation of a lease. To date, no lottery has terminated its contract with
the Company. Upon termination of a contract, the lottery may award new contracts
through a competitive bid process.
As noted above, the Company believes that 31 states and the District of
Columbia utilize ITVMs in some manner as part of their instant ticket
distribution system. The Company's ITVMs have been deployed in 23 of those
states as well as seven international jurisdictions, and four additional states
and five international jurisdictions currently are testing the Company's ITVMs
or have requested that the Company provide ITVMs for testing. Set forth below is
certain information regarding the Company's contract status and the number of
Company ITVMs sold or leased in each of these jurisdictions as of December 31,
1998. All of the Company's existing contracts, except for the contract with the
Maryland Lottery, have provisions that allow the lotteries to order additional
ITVMs in the future.
<TABLE>
<CAPTION>
NO. OF ITVMS
STATE STATUS OF CONTRACT AWARD TYPE OF CONTRACT SOLD OR LEASED
----- ------------------------ ---------------- --------------
<S> <C> <C> <C>
Arizona Awarded in October 1993; renewed through Standard Lease/ 221
June 1999. Maintenance
Colorado Awarded in June 1996; renewed through June Standard Lease/ 484
2000. Maintenance
District of Columbia Awarded December 1997; renewed through Standard Lease 8
December 2000.
Florida Awarded September 1996; renewed through June Standard Lease/ 734
2000. Maintenance
Georgia (1) Awarded in May 1993; renewed through May Standard Lease/ 500
2003. Maintenance
Idaho Purchases made by purchase orders in May and Sales 185
August 1995, August 1996 and August 1997.
Indiana Awarded in July 1995; expired in October Standard Lease 700
1997, with two one-year renewals at the
option of the lottery; both renewal options
have been exercised.
Iowa Awarded in August 1994; expired in December Standard Lease/ 531
1998, with two one-year renewals at the Maintenance
option of the lottery; both renewal options
have been exercised through December 2000.
</TABLE>
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<PAGE> 12
<TABLE>
<S> <C> <C> <C>
Kansas Awarded July 1997; expired July 1998 with Standard Lease/ 74
five one-year renewals at the option of the Maintenance
lottery; renewed through July 1999.
Kentucky Purchased in June 1991. Sales 912
Maine Awarded in July 1995; expired in July 1998, Standard Lease/ 198
with two one-year extensions at the Maintenance
lottery's option; renewed through July 1999.
Maryland Awarded in September 1993; expired in Sales/Maintenance 301
September 1998; additional contract awarded
that expires June 2003
Minnesota Awarded in December 1996; expires three Standard Lease/ 10
years from acceptance of each ITVM, with two Maintenance
one-year renewals at the option of the
lottery
New Hampshire Awarded in August 1994; renewed through June Standard Lease 250
2000
New Jersey (2) Purchase order received in December 1996 Sales 200
New Mexico Awarded May 1997; expires May 2002, with Standard Lease 200
five one-year renewals at the option of the
lottery
New York (3) Awards of purchase contracts made in May Sales/Maintenance/ 3,139
1992 and January 1993; deployment completed Standard Lease
in June 1992 and February 1993,
respectively; initial one-year purchase and
three-year maintenance contract entered into
in March 1995, with a one-year renewal
option by the lottery; initial five-year
lease contract awarded in January 1997 for
up to 1,000 units, with a one-year renewal
option as mutually agreed
Ohio Awarded in January 1992; extended in June Standard Lease/ 1,681
1993 and June 1995; expired in June 1997; Maintenance
new contract awarded April 1997; extended
through June 1999, with two two-year
extensions at the option of the lottery
Oregon Purchase orders issued in May 1995 and Sales 520
January 1997
Rhode Island (4) Awarded in June 1994; renewed through June Standard Lease/ 170
1999 Maintenance
</TABLE>
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<PAGE> 13
<TABLE>
<S> <C> <C> <C>
Texas Awarded in January 1995; renewed through Standard Lease/ 1,466
February 1999; leased on month-to-month Maintenance
basis pending award of new contract.
Washington Awarded in December 1998; expires in Standard Lease/ 136
December 2002, with two one year renewal Maintenance
options.
West Virginia (3) Awarded in May 1992; initial deployment Sales 55
completed in June 1992; additional units
deployed in April 1994
Barcelona, Spain (5) Awarded in February 1994; additional units Standard Lease 11
deployed in October 1995
Brazil Purchase orders received in October 1996 and Sales 104
October 1998.
Denmark Purchase order received in April 1998 Sales 100
Iceland Purchase orders issued in January and Sales 31
October 1997
Israel Purchase order issued in July 1997 Sales 40
Quebec Purchase order received in June 1998 Sales 50
Western Australia Purchase order received in May 1995 Sales 8
Total Sold or Leased 13,019
======
</TABLE>
- -------------------------
(1) The Company's contract is for the lease of ITVMs to Scientific Games,
Inc., the primary contractor for the Georgia Lottery. In September
1994, the Company and Scientific Games, Inc. agreed to convert the
contract from a Percentage Lease Agreement to a Standard Lease
Agreement.
(2) The Company's contract is for the sale of 200 ITVMs to GTECH
Corporation for use by the New Jersey Lottery, which were delivered in
1997.
(3) The Company's contract was for the sale of ITVMs to Scientific Games,
Inc. for use by the New York and West Virginia Lotteries. The Company
is not the sole manufacturer of ITVMs for the New York Lottery. The
Company entered into a sales/maintenance contract in March 1995
directly with the New York Lottery, including maintenance of ITVMs
previously provided.
(4) Effective October 1, 1995, the Company and the Rhode Island Lottery
agreed to convert the contract from a Percentage Lease Agreement to a
Standard Lease Agreement.
(5) The Company's contract is with Entitat Autonomas, which provides
lottery services to various Spanish lotteries.
* * * * *
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<PAGE> 14
Substantially all of the Company's revenues are derived from its
contracts with a limited number of state lottery authorities or their
representatives for the lease, sale or service of ITVMs. In particular, during
1998, the Company's contract with the New York Lottery accounted for 24% of the
Company's revenues, and contracts with the Texas Lottery and the Ohio Lottery
accounted for 16% and 14% of the Company's revenues, respectively.
PCDMs
Unlike the competitive bidding process applicable to the lotteries'
awards of ITVM contracts, purchasers of PCDMs typically do not issue RFPs or
otherwise mandate a competitive bidding process. Information regarding the
Company and its PCDM, and information regarding a telephone company's product
needs and criteria and other qualifications or conditions that must be
satisfied, typically is exchanged on a less formal basis in sales presentations
and subsequent meetings between representatives of the Company and
representatives of the telephone company. Due to the often complex and highly
structured organization of some telephone companies, the length of time that a
company might take to decide whether to select the Company's PCDM can be
difficult to predict and, similar to the lotteries' contract award process,
delays in PCDM selection decisions can be frequent and unpredictable.
Unlike the Company's experience in the ITVM industry in which a lottery
typically enters into a lease or sales contract with the successful bidder, most
purchasers of the Company's PCDMs to date have ordered PCDMs solely through
purchase orders rather than contracts, although several customers entered into a
lease agreement for PCDMs. Like contracts with the lotteries, however, these
purchase orders may contain stringent installation, performance and service
requirements. As of December 31, 1998, the Company had sold 756 PCDMs and had 95
PCDMs under lease.
MANUFACTURING PROCESS
The manufacturing process consists of purchasing component parts,
assembling the ITVMs and PCDMs and then testing the final products. Generally,
the Company's machines use components which are built to Company specifications
and are available from multiple sources. The Company has a strict policy of
product procurement that emphasizes quality, satisfactory inventory of raw
materials, and cost. The Company has a primary vendor and secondary suppliers
for most of its components, and the Company typically has been able to obtain
adequate supplies of required components on a timely basis from its suppliers
or, when necessary, from alternative sources of supply. However, certain
important components, such as components of the Company's ITVM burster, PTVM
dispensing mechanism and PCDM dispensing mechanism currently are purchased from
a single source. The purchase of components from single-source suppliers
subjects the Company to certain risks, including the continued availability of
suppliers, price increases, potential quality assurance problems and lead time
considerations. Because other suppliers exist that can duplicate these
components should the Company elect or be forced to use a different supplier,
the Company does not believe that any such change in suppliers would result in
the termination of a production contract. However, the Company could experience
a delay of 30 to 60 days in the production of machines should it elect or be
forced to use other suppliers for these components. Such a delay adversely could
affect the Company's ability to make timely deliveries of machines and to obtain
new contracts. The single-source supplier of certain components of the Company's
burster mechanism, PTVM dispensing mechanism and PCDM dispensing mechanism is
Algonquin Industries, Inc. Kazmier J. Kasper, a director of the Company, is the
President and owner of Algonquin Industries. See "Item 13. Certain Relationships
and Related Transactions. "
The Company assembles the components utilizing a core group of
manufacturing employees and, on an as-needed basis, contracting with employment
agencies for appropriately trained manufacturing labor. The use of temporary,
contract manufacturing labor gives the Company the flexibility to meet the
production schedules required by large orders.
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<PAGE> 15
The Company's Quality Control Department has responsibility for
measuring quality levels and overseeing appropriate corrective action in all
areas of the business. This includes supplier performance, in-house
manufacturing and field performance. The Quality Control Department is
responsible for measuring part, operator and assembly quality performance at all
stages of the production process, stopping the assembly line or stopping
shipments if necessary to assure that quality standards are met. The Quality
Control Department also is responsible for measuring vendor product quality and
taking appropriate actions, including rejection and disposition of substandard
material. The Quality Control Department also is responsible for vendor quality
system evaluation and vendor disqualification if necessary to ensure superior
product quality.
The Company's manufacturing facility is located in Cincinnati, Ohio and
has the capacity to produce and provide inventory for approximately 300 machines
per week. The Company believes that this facility is suitable and adequate for
its current and anticipated manufacturing needs at the present time.
RESEARCH AND NEW PRODUCT DEVELOPMENT
Since its inception, the Company has developed many of the
technological advancements used in the ITVM industry. The Company believes that
its ITVM was the first to obtain UL((R)) listing and FCC approval. The Company
also believes that it was the first to (i) manufacture and deliver ITVMs under a
lease contract agreement, (ii) offer a "random play" push button selector option
through which the ITVM rather than the player randomly selects the game to be
played and (iii) receive patent protection for the technology used in its ITVM
burster dispensing mechanism.
The Company currently employs two engineers and four technicians for
research and development but currently subcontracts the majority of its research
and development projects to independent contractors to reduce costs. The
Company's copyrighted software is upgraded continually to meet the different
demands of the various lotteries. In many instances, after an ITVM feature has
been developed for a specific lottery, it is incorporated into the product line
as a standard feature of the machine. The Company retains proprietary rights in
all such developments.
The Company's ITVM may be purchased with an optional modem
communication system which allows lotteries to gather sales data from each ITVM
on an hourly, daily, weekly or monthly basis, depending on the needs of the
customer. This data includes the daily or weekly sales totals and breakdown of
these totals by game, including the total tickets sold. The Company has
developed software to enable each ITVM equipped with the system to communicate
to the host system automatically if there is a malfunction with the ITVM, thus
greatly enhancing the Company's ability to provide prompt service for the ITVM.
The Company has developed software to enable an ITVM equipped with the system to
communicate with the host computer if a ticket bin is empty, which allows the
lottery to call the retailer or agent and inform them of the situation.
Additionally, by utilizing this system with the optional BETA BRITE((R)) message
display, the lottery can change the message display on any or all of its ITVMs.
The Company has incorporated its patented pull-tab lottery ticket
dispensing mechanism into a combination ITVM which also contains the Company's
patented burster mechanism. The Company currently has approximately 30
combination ITVMs under lease to two state lotteries. The pull-tab dispensing
mechanism also has been incorporated into the Company's PCDMs, and the Company
believes that the ability of the mechanism to dispense a variety of thicknesses
of prepaid telephone calling cards significantly differentiates the Company's
PCDMs from those of its competitors.
The Company has developed the MVP to address the specific needs of
convenience store and grocery check-out lanes. The MVP may be installed in a
variety of configurations including under-the-counter. This new technology
reduces ticket shrinkage and increases sales volume of instant tickets and may
also be tied into the Point of Service register.
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<PAGE> 16
In an effort to expand its product lines into new markets, the Company
has developed a device which dispenses stored value "smart cards." This product
will be marketed in the future to the financial services industry to the extent
that consumer use of smart cards develops in the future.
Research and development expenditures were $665,449, $545,039 and
$618,819 for 1996, 1997 and 1998, respectively. The Company expects that its
research and development efforts for the foreseeable future will be conducted by
both Company employees and independent contractors.
CUSTOMER SERVICE AND PRODUCT REPAIR
Typically, the Company or its subcontractors install and service the
machines purchased or leased by the Company's customers. The Company also
provides maintenance of the ITVMs leased or sold to certain lotteries.
Additionally, the Company provides part replacement, repair and technical
services for various customers that have leased or purchased the Company's ITVMs
and PCDMs. Service is provided to the retailers by the Company's staff of
trained service technicians and dispatchers after a customer's representative
informs the Company of the problem via the Company's toll-free telephone service
line. The service dispatcher either resolves the matter over the telephone or
immediately dispatches one of the Company's service technicians to the machine's
location. The modular design and manufacturing standards of the Company's
machines enable the Company to conduct any necessary repairs and maintenance
quickly and efficiently. The Company estimates that the meantime for all repairs
is less than 15 minutes after the Company's service technician arrives at the
machine's location.
The Company believes, based on actual data collected from various
customers that have installed the Company's ITVMs and PCDMs, that the Company's
machines have experienced substantially fewer mechanical problems and machine
failures than machines currently sold by other industry participants. The
Company also believes that the superior performance of its ITVMs and PCDMs will
assist in the increased acceptance of these products among lotteries and
providers of long distance telephone service.
The Company generally grants a 360-day repair or replacement warranty
covering all parts and components of its machines. However, the warranty period
may vary depending on the bid specifications. In certain circumstances, the
Company may warrant the product for the complete life of the contract. In these
instances, the contract generally will be a lease with the Company retaining
ownership of the machine. Provisions for estimated warranty costs are recorded
at the time of sale and are periodically adjusted to reflect actual experience.
See Note 1 of Notes to Financial Statements contained in the Company's 1998
Annual Report, which is filed as Exhibit 13 to this report.
PATENTS, TRADEMARKS AND COPYRIGHTS
The Company currently has five U.S. patents and one pending patent
application relating to its ITVMs and has filed a disclosure document with the
United States Patent and Trademark Office ("PTO"), all as described below.
The Company owns by assignment U.S. Patent No. 4,982,337 entitled
"System for Distributing Lottery Tickets." The assignment is recorded at the
PTO. This patent is for the Company's burster technology, which is the key
component of the Company's ITVM. The patent expires no later than December 31,
2007. The Company believes this patent is essential to the Company's business.
Additionally, the Company has developed improvements to the burster technology
disclosed in this patent and the patent application on those improvements has
issued as U.S. Patent No. 5,836,498. The improved burster provides for an
increased range of operation for reliable and effective separation of the
adjacent tickets along the lines of weakness. Additionally, foreign patent
applications are pending on these improvements.
The Company has developed a new system designed specifically for retail
sale of lottery tickets and other items at the retail point of sale. The system
utilizes the Company's burster technology and includes other modular
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<PAGE> 17
and distributed components that can be adapted for use at the point of sale. The
Company has a pending patent application at the PTO on this technology as well
as corresponding foreign pending patent applications.
The Company was issued U.S. Patent No. 5,330,185 on July 19, 1994 for
the "Method and Apparatus for Random Play of Lottery Games." This patent expires
no later than March 30, 2013 and has been assigned to the Company, and the
assignment is recorded at the PTO. The technology disclosed in this patent
allows a lottery game user to select a random play button as opposed to
selecting a specific game of a multiple-game ITVM. Once the random play button
is pressed, the ITVM selects the game to be played based upon a random number
generation algorithm, thereby adding another element of chance to the lottery
ticket purchase. The Company believes that this patent gives the Company a
competitive advantage over other manufacturers that do not have ITVMs with
similar capabilities. The patent for the random play feature is considered
important but not essential to the Company's business.
The Company was issued U.S. Patent No. 5,472,247 on December 5, 1995,
for a "Multi-Point High Security Locking Mechanism for Lottery Machines." This
patent expires no later than July 18, 2014 and has been assigned to the Company,
and the assignment is recorded at the PTO. Because of the threat of break-in and
theft of cash and lottery tickets contained within the ITVMs, the machines must
be secured against unauthorized break-in or theft. The technology disclosed in
this patent is a locking mechanism which provides a number of resistance points,
all of which function to impede the unauthorized opening of a door located on
the chassis of the Company's ITVM. The patent for the multi-point, high security
locking mechanism is considered important but not essential to the Company's
business.
The Company was issued U.S. Design Patent No. 376,621 on December 17,
1996 for the Company's double-game countertop ITVM. This patent expires no later
than December 17, 2010 and has been assigned to the Company, and the assignment
is recorded at the PTO. The Company believes that this patent is important but
not essential to the Company's business.
The Company has submitted an Information Disclosure Document to the PTO
for the purpose of identifying technology relating to its "Software Release
Control and Data Security for ITVMs." The technology allows secure remote
transmissions of software updates and operations data between the ITVM and the
Company or the respective lottery. The invention also includes a key management
system to control the keys used to encrypt data sent to and decrypt the data
received at the ITVM. The Disclosure Document was filed on April 28, 1993.
The dispensing technology used in the Company's PTVM and PCDM was
developed by Algonquin Industries, Inc. and is licensed to the Company pursuant
to an exclusive license agreement with Algonquin Industries. Algonquin
Industries has been granted six U.S. Patents and one is pending for these
mechanisms. Under the terms of the license agreement, the Company is the sole
entity entitled to use this technology on its ITVMs. See "Item 13. Certain
Relationships and Related Transactions."
The Company currently uses operating software to perform all functions
required to dispense and account for instant lottery tickets and prepaid
telephone calling cards. This software is a stand-alone program which does not
require any other software to operate. The software is designed to allow updates
to be made quickly and inexpensively. The software was designed by Future
Designs, a subcontractor to the Company, and employees of the Company. Future
Designs has assigned all of its right, title and interest in and to the software
to the Company. The Company intends to continue to develop software using both
employees and subcontractors who agree to assign the copyright to developed
software to the Company.
The Company has obtained federal registration in the United States of
the following trademarks: INTERLOTT, INTERLOTT and design, and INSTANT SUCCESS.
The Company also has obtained registration of the trademark INTERLOTT in
international class 9 on June 21, 1994. This registration will remain in force
for ten years. The Company does not deem the trademarks to be critical to the
future of its business.
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<PAGE> 18
The Company enforces a policy requiring all of its employees and
subcontractors to execute confidentiality and proprietary rights agreements at
the commencement of their employment or contract for service with the Company.
The agreements generally provide that all inventions or discoveries and all
confidential information developed or made known to the employees or
subcontractors during the term of their employment or contract for service will
be assigned to the Company and will be kept confidential and not disclosed to
third parties.
COMPETITION
Competition in the markets for the Company's ITVM and PCDM is based on
a number of factors, including technological features, product quality and
reliability, price, compatibility, ease of installation and use, marketing and
distribution capabilities, product delivery time, and service and support. The
Company is aware of four manufacturers of ITVMs and approximately four
manufacturers of PCDMs in the United States, and competition among these
manufacturers is intense. Of the four ITVM competitors, the Company has the
largest share of the ITVM market in the United States. The Company is not aware
of any published data regarding market shares in the PCDM industry, but the
Company does not believe that it has the largest market share in the PCDM
industry.
In addition, the ITVM and PCDM markets are relatively new markets that
have grown rapidly, and additional domestic and international manufacturers,
some of which have substantially greater resources and experience than the
Company, may elect to enter these markets. The instant ticket market also may
face competition from other types of lottery and gaming products, including
particularly on-line lottery products. The long distance telephone market
similarly may face competition from other types of communications products,
including facsimile, e-mail and other on-line products.
The Company believes that its patented dispensing technologies make its
ITVM and PCDM dispensing mechanisms technologically superior to the dispensing
mechanisms of its competitors and that this is a significant competitive
advantage for the Company. The Company also believes that its products have
earned a strong reputation for their performance, reliability and cost
effectiveness. To remain competitive, the Company believes that it will need to
continue to incorporate new technological developments into its existing
products and to develop new products, as well as to maintain a competitive price
for its products. These efforts, together with the Company's continuing sales
and marketing efforts, will be critical to the Company's future success.
Although the Company believes that its current successes, coupled with its
history of continued product enhancement and cost reduction, will enable it to
compete favorably with its competitors, there can be no assurance that the
Company will be able to maintain or improve its competitive position in the ITVM
and PCDM markets.
GOVERNMENT REGULATION
ITVMs
Lotteries are not permitted in the various states and jurisdictions of
the United States unless expressly authorized by legislation in the subject
jurisdiction. Similarly, the commencement of ITVM sales and leasing in new
jurisdictions requires authorizing legislation and implementing regulations at
the state level. The Company cannot predict the nature of the regulatory process
in any jurisdiction that may authorize the purchase and lease of ITVMs in the
future. Any such regulatory process may be burdensome to the Company or its key
personnel and stockholders and could include requirements that the Company would
be unable to satisfy.
Currently, 37 states and the District of Columbia have enacted
legislation to allow for the operation of a lottery, and 31 of these
jurisdictions utilize ITVMs in some manner as part of their instant ticket
distribution process. The operation of the lotteries in each of these
jurisdictions is strictly regulated. The formal rules and regulations governing
lotteries vary from jurisdiction to jurisdiction but typically authorize the
lottery, create the governing authority, dictate the price structure, establish
allocation of revenues, determine the type of games permitted, detail
appropriate marketing structures, specify procedures for selecting vendors and
define the qualifications of lottery personnel. No assurance can be given that
there will not be an adverse change in the
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<PAGE> 19
lottery laws of any jurisdiction in which the Company does business. Although
the Company believes that it is unlikely that states which have enacted
legislation that expressly authorize the use of ITVMs will adopt legislation in
the foreseeable future that prohibits the use of ITVMs, there can be no
assurance that such legislation will not be adopted in one or more jurisdictions
in the foreseeable future.
To ensure the integrity of the lottery, state laws provide for
extensive background investigations of each of the lottery's vendors and their
affiliates, subcontractors, officers, directors, employees and principal
stockholders. These investigations generally require detailed disclosure on a
continuous basis with respect to the vendors, affiliates, subcontractors,
officers, directors, employees and principal shareholders and, in the event the
lottery deems any of such persons to be unsuitable, the lottery may require the
termination of such persons. The failure of any such persons associated with the
Company to obtain or retain approval in any jurisdiction could have a material
adverse effect on the Company. Generally, regulatory authorities have broad
discretion when granting such approvals. Although the Company has never been
disqualified from a lottery contract as a result of a failure to obtain any such
approvals, no assurance can be given that such approvals will be obtained or
retained in the future.
The Federal Gambling Devices Act of 1962 (the "Act") makes it unlawful,
with certain exceptions, for a person or entity to transport any gambling
devices across interstate lines unless that person or entity has first
registered with the United States Department of Justice. Although the Company
believes that it is not required to register under such Act, the Company has
voluntarily registered under the Act and intends to renew its registration
annually. The Act also imposes various record keeping and equipment
identification requirements. Violation of the Act may result in seizure or
forfeiture of equipment, as well as other penalties.
The Company may retain governmental affairs representatives in various
jurisdictions of the United States to monitor legislation, advise the Company on
contract proposals, and assist with other issues that may affect the Company.
The Company believes it has complied with all applicable state regulatory
provisions relative to disclosure concerning the activities of itself and its
advisors. The Company is not dependent on any such representative for any
material contract.
International jurisdictions that operate lotteries also impose strict
regulations. International regulations may vary from those in the United States.
Additionally, international regulations frequently impose restrictions on
international corporations doing business within the specific jurisdiction. As a
result, the Company may contract with local representation or align itself with
a local partner when pursuing international contracts.
Laws and regulations of individual states and countries are subject to
change. The failure to comply with such laws and regulations could have an
adverse impact on the operations of the Company.
PCDMs
The Company is not aware of any federal, state or local regulations
that apply to the manufacture, lease or sale of PCDMs.
BACKLOG
The Company's backlog of ITVMs committed for production as of December
31, 1998 was approximately $5,640,000, which was equal to the total base lease
payments or sales value for the 897 ITVMs that were committed for production but
had not been shipped to the Washington Lottery as of December 31, 1998. At
December 31, 1997, the backlog of ITVMs committed for production was
approximately $4,250,000, which was equal to the total base lease payments or
sales value for the 847 ITVMs that were committed for production but had not
been shipped to the Maryland and Ohio Lotteries as of December 31, 1997. See
"Lottery Contracts." It is anticipated that substantially all of the Company's
backlog at December 31, 1998 will be shipped on or before June 30, 1999. The
Company had no backlog of PCDMs committed for production at December 31, 1998.
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The Company has entered into various lease or sales agreements that
permit the lotteries, at their sole option, to lease or purchase up to a total
of 2,500 additional ITVMs as of December 31, 1998. However, the Company does not
include these additional ITVMs in backlog ITVMs that may be sold or leased under
existing contracts unless the Company has received a firm order for the ITVMs.
Due to the relatively large size of individual orders, the small number of
customers and the long sales cycle of the lottery industry, management considers
backlog to be an indicator of current activity and not necessarily predictive of
future orders.
EMPLOYEES
The Company utilizes a work force of full-time employees supported from
time to time by temporary or contract manufacturing and engineering personnel.
As of December 31, 1998, the Company had 194 full-time employees, of which 78
were manufacturing employees, 7 were engineering employees, 84 were service
employees, 15 were clerical and administrative employees and 10 were executives
or senior managers. Two of the executives and senior managers were devoted to
sales and 8 were devoted to management and administration. The Company intends
to increase sales and marketing personnel during 1999 through the addition of
one employee, to increase engineering personnel through the addition of one
employee and to increase management and administrative personnel through the
addition of two employees.
No Company employees are represented by any union, and the Company
believes that its relations with its employees are good.
ITEM 2. PROPERTIES
The Company's executive offices are located in approximately 11,750
square feet of leased space in Cincinnati, Ohio. This facility houses the
Company's executive, administrative, sales, engineering and service personnel.
The lease for this facility expires on December 31, 1999.
The Company's manufacturing and distribution facilities are in a
facility containing approximately 35,000 square feet of leased space located a
very short distance from the Company's executive offices. The facility is
comprised of approximately 5,000 square feet of office space and approximately
30,000 square feet of manufacturing space with the capacity to produce and
provide inventory for approximately 300 machines per week. The lease for this
facility also expires on December 31, 1999. The Company believes that these two
facilities are suitable for and adequate to support its operations for the
foreseeable future.
The Company also leases approximately 1,000 square feet of warehouse
and office space in Alpharetta, Georgia for the purpose of storing and repairing
ITVMs used in connection with the Georgia Lottery. Scientific Games, Inc.
provides this space to the Company at no cost under the terms of the Company's
contract with Scientific Games. The lease has been renewed through May 2003. See
"Item 1. Business -- Contracts -- ITVMs." The Company believes that this
facility is suitable for and adequate to support its operations for the Georgia
Lottery.
ITEM 3. LEGAL PROCEEDINGS
In January 1996, the Company filed a lawsuit in the United States
District Court for the Southern District of Ohio against Lottery Enterprises,
Inc. ("LEI, " now known as On-Point Technology Systems, Inc.) to collect sums
that the Company alleged were owed to it under an Agreement in Principle dated
March 23, 1995, relating to the Company's potential acquisition of LEI by merger
(the "Transaction"). The parties did not consummate the Transaction. The
Agreement in Principle required LEI to reimburse the Company's reasonable
out-of-pocket expenses incurred in connection with the Transaction in the event
the parties failed to execute a definitive merger agreement within 120 days of
March 23, 1995, and the primary reason that the parties did not execute a
definitive merger agreement was other than a breach of the Agreement in
Principle by the Company. The Agreement in Principle also required LEI to pay
the Company a "break-up fee" in the event that, within one year after the
termination or abandonment of the Transaction by LEI, LEI entered into a binding
commitment to engage in a
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recapitalization, debt issuance or working capital financing other than in the
ordinary course of business, and the primary reason for the termination or
abandonment of the Transaction was other than termination or breach of the
Agreement in Principle by the Company. The Company sought reimbursement of
approximately $241,000 in out-of-pocket expenses and a break-up fee exceeding
$988,000.
LEI denied any liability to the Company and also asserted counterclaims
against the Company for unfair competition and tortious interference seeking
unspecified money damages exceeding $500,000. LEI claimed that the Company had
competed unfairly with LEI and had wrongfully interfered with LEI's business by
misrepresenting Lei's financial condition to the Pennsylvania state lottery
agency and by utilizing information about LEI received during the due diligence
conducted in connection with the Transaction. LEI also claimed that it was
entitled to recover from the Company unspecified costs and expenses that it
incurred in connection with the Transaction and sought a declaration from the
Court that it was not obligated to pay the Company a break-up fee under the
Agreement in Principle.
In 1997, the Court ruled that the Company was entitled to summary
judgement in its favor on LEI's counterclaims for unfair competition and
tortious interference. The Court also ruled that within one year after the
Transaction was abandoned or terminated, LEI did enter into a recapitalization,
debt issuance or working capital financing other than in the ordinary course of
business. The Court left open the question whether LEI had abandoned or
terminated the Transaction (as opposed to the Company), and the question of
whether LEI was obligated to reimburse the Company's out-of-pocket expenses
incurred in connection with the Transaction, both of which were to be determined
at trial.
On March 4, 1999, the Company and LEI entered into a confidential
settlement agreement that resolved all claims asserted in the lawsuit on
satisfactory terms.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
No matters were submitted by the Company to a vote of its stockholders
during the fourth quarter ended December 31, 1998.
ITEM 4(A). EXECUTIVE OFFICERS OF THE REGISTRANT
Set forth below, in accordance with General Instruction G(3) to Form
10-K and Instruction 3 to Item 401(b) of Regulation S-K, is certain information
regarding the executive officers of the Company.
L. Rogers Wells, Jr., age 61, is Chairman of the Board and Chief
Executive Officer of the Company and has been the principal stockholder of the
Company since purchasing 80% of the Common Stock of the Company in September
1992. Mr. Wells served as a director of the Company from 1992, and as Chairman
of the Board and Chief Executive Officer of the Company from 1993, until his
resignation from these positions in October 1994. He was re-elected to these
positions in February 1995. In addition, Mr. Wells owns American Materials,
Incorporated, which assembles and distributes automobile and truck components
and serves as a regional warehousing and distribution center for various
businesses. Mr. Wells also owns International Investments, Inc. which invests in
and provides financing to various businesses, including the Company. See "Item
13. Certain Relationships and Related Transactions." Mr. Wells has been active
in various other industries, including manufacturing, mining, explosives and
banking. From 1987 through 1991, Mr. Wells served as Secretary of Finance and
Administration for the Commonwealth of Kentucky, and from 1989 through 1991
served as Secretary to the Governor's Executive Cabinet. During his tenure as
Secretary of Finance and Administration, Mr. Wells served as Chairman of various
finance and development authorities, including the Kentucky Rural Economic
Development Authority, the Kentucky Infrastructure Authority and the Kentucky
Housing Corporation.
Edmund F. Turek, age 72, was Vice Chairman of the Board of Directors of
the Company from May 1997 through February 1999 and has been a director of the
Company since 1990. Mr. Turek served as Chairman of the Board, President and
Chief Executive Officer of the Company from February 1990 to September 1992 and
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continued to serve as President of the Company until May 1997, when he was
appointed Vice Chairman of the Company. Mr. Turek became a consultant to the
Company in February 1999. See Item 13. "Certain Relationships and Related
Transactions." Mr. Turek began to develop the Company's ITVM in 1987 and has
guided the product through six generations to the current model. Mr. Turek was
Vice President of Peripheral Products in the computer division of SCI Systems,
Inc. from 1984 to 1989 where he developed business opportunities in the
commercial market for the design and manufacture of computer products. From 1953
to 1984, Mr. Turek held management, product development and operations positions
with various companies in the computer and aerospace industries.
David F. Nichols, age 37, has been President of the Company since May
1997 and was appointed a director in December 1997. Mr. Nichols served as Senior
Vice President of Sales and Marketing of the Company from August 1994 to May
1997 and as Vice President-Operations of the Company from March 1993 until
August 1994. From December 1991 to December 1992, he was Executive Director of
the Board of Tax Appeals of the Commonwealth of Kentucky. From March 1990 to
December 1991, he was Principal Assistant to the Secretary of Finance and
Administration for the Commonwealth of Kentucky, and from March 1989 to March
1990, he was Principal Assistant to the Kentucky Office for Social Security.
From June 1988 to December 1988, he was Deputy Director of the Kentucky
Democratic Party.
Thomas W. Stokes, age 35, has been Vice President of the Company since
May 1997. Mr. Stokes served as Director of Operations from January 1996 to May
1997 and as Purchasing Manager from March 1993 to December 1995. From 1988 to
1992, he served as unit controller for a food management company.
Dennis W. Blazer, age 51, has been Chief Financial Officer of the
Company since July 1998. From December 1973 to July 1998, he served in various
capacities for The Plastic Moldings Corporation, most recently as Vice President
of Finance and Administration. Mr. Blazer previously served as an auditor and
tax consultant with Ernst & Ernst, certified public accountants. Mr. Blazer is a
certified public accountant.
The executive officers of the Company are appointed by and serve at the
discretion of the Board of Directors.
PART II
ITEM 5. MARKET FOR THE REGISTRANT'S COMMON STOCK AND RELATED
STOCKHOLDER MATTERS
Information relating to the market for, holders of and dividends paid
on the Company's Common Stock is set forth under the caption "Corporate Data and
Shareholder Information" on the inside back cover page of the Company's 1998
Annual Report. Such information is incorporated herein by reference. The 1998
Annual Report is filed as Exhibit 13 to this report.
ITEM 6. SELECTED FINANCIAL DATA
Selected financial data for the Company for each year of the five-year
period ended December 31, 1998 is set forth under the caption "Selected
Financial Data" on page 7 of the 1998 Annual Report. Such financial data is
incorporated herein by reference.
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS
A discussion of Interlott's financial condition and results of
operations as of the dates and for the periods covered by the financial
statements contained in the 1998 Annual Report is set forth under the caption
"Management's Discussion and Analysis" on pages 7 through 9 of the 1998 Annual
Report. Such discussion is incorporated herein by reference.
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The following risk factors apply to Interlott and its business:
WE MAY EXPERIENCE FLUCTUATIONS IN OUR FINANCIAL RESULTS AND, AS A
RESULT, OUR STOCK PRICE.
In the past, we have experienced significant fluctuations in our
financial results. Our revenues, capital expenditures and operating results can
vary significantly due to:
- our dependence on a small number of major customers;
- relatively long sales cycles;
- the unpredictable timing and amount of contracts awarded by
state lotteries and telephone companies; o the extended time
between the award of a contract and the receipt of revenues
from the sale or lease of ITVMs and PCDMs;
- changes in customer budgets; and
- working capital required to manufacture ITVMs and PCDMs
pursuant to new orders.
These factors may make it difficult to forecast revenues and
expenditures over extended periods. Consequently, our operating results for any
period could be below the expectations of securities analysts and investors.
This in turn could lead to sudden and sometimes dramatic declines in the market
price of our stock.
OUR GROWTH WILL DEPEND UPON CONTINUED MARKET ACCEPTANCE OF ITVMS AND
PCDMS.
Our ability to generate additional revenues and earnings will depend
upon the continuation of existing leases of ITVMs and PCDMs, the distribution of
ITVMs and PCDMs in additional states and international jurisdictions, the
approval of lotteries in remaining states and international jurisdictions and
increased future orders of ITVMs and PCDMs. The market for ITVMs has grown
rapidly since first deployed to serve instant lotteries in 1991. As of December
31, 1998, 31 states, the District of Columbia and eight international
jurisdictions used ITVMs as part of their instant ticket distribution system. We
leased or sold ITVMs in 23 of those states and in seven international
jurisdictions. Similarly, the use of PCDMs to distribute prepaid telephone
calling cards has grown significantly in the last few years. We have marketed
PCDMs since 1995, and as of December 31, 1998, we had sold or leased 851 PCDMs.
However, the popularity of instant lottery games and prepaid telephone calling
cards and the demand for ITVMs and PCDMs may not continue and, as a result, we
may not be able to successfully market and sell our products. Although the total
dollar amount of instant ticket sales continues to increase, the rate of
increase has declined from 23.7% to 6.9% for the lottery industry's fiscal year
ended June 30, 1992 through June 30, 1997. It is critical to our continued
success that we develop relationships with additional lotteries and telephone
companies and that additional states authorize instant lotteries.
WE DEPEND ON LARGE CONTRACTS FROM A LIMITED NUMBER OF ITVM CUSTOMERS.
We have traditionally derived a significant portion of our revenues
from a limited number of state lottery authorities or their representatives for
the lease, sale or service of ITVMs. In particular, during 1998, a contract with
the New York Lottery accounted for 24% of our total revenues. Additionally, a
contract with the Texas Lottery accounted for 16% of our machine lease revenues
in 1998, and a contract with the Ohio Lottery generated 14% of our machine sale
revenues in 1998. This can cause our revenues and earnings to fluctuate between
quarters based on the timing of orders and realization of revenues from these
orders. Further, none of our large customers has any obligation to lease or
purchase additional machines from us. A loss of any of these large contracts
could have a material adverse effect on our business, financial condition and
results of operations.
WE MAY NOT BE SUCCESSFUL IN PROTECTING OUR PROPRIETARY RIGHTS OR
AVOIDING CLAIMS THAT WE INFRINGE THE PROPRIETARY RIGHTS OF OTHERS.
We principally rely upon patent, copyright, trademark and trade secret
laws, license agreements and employee nondisclosure agreements to protect our
proprietary rights and technology. These laws and contractual provisions provide
only limited protection. Our success depends largely on our burster technology
that is protected
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by a patent that expires on December 31, 2007. Additionally, we have four other
patents and one pending patent application with the United States Patent and
Trademark Office. We also have an exclusive license agreement with Algonquin
Industries, Inc. for use of their patented pull-tab instant ticket dispensing
mechanism in our PTVM and PCDM. We cannot be certain that we and Algonquin have
taken adequate steps to prevent misappropriation of the technology that we use
or that competitors will not independently develop technologies that are
substantially equivalent or superior to our technology. Moreover, we could incur
substantial costs and diversion of management resources in the defense of any
claims relating to the proprietary rights of others, which could have a material
adverse effect on our business, financial condition and results of operations.
WE MAY NOT BE ABLE TO ADAPT TO CHANGES IN TECHNOLOGY, PRODUCTS AND
INDUSTRY STANDARDS.
The instant ticket market, the ITVM market, the prepaid telephone
calling card market and the PCDM market are characterized by rapidly changing
technology and evolving industry practices. Competitors may introduce other
types of lottery, gaming and prepaid telephone calling card products. To be
successful, we must:
- use leading technologies effectively;
- continue developing our technical expertise;
- enhance our existing products and services; and
- develop new products and services.
If we fail to do any of these things, our customers may choose to
purchase products and services from our competitors. Our inability to anticipate
changes in technology and industry practices and to develop and introduce new
products and services in a timely manner would likely result in a material
adverse effect on our business, financial condition and results of operation.
THE STATE LOTTERIES CAN CANCEL THEIR CONTRACTS WITH US FOR ANY REASON
AND CAN ASSESS SIGNIFICANT DAMAGES AGAINST US IF WE DO NOT SATISFACTORILY
PERFORM THE CONTRACTS.
Our contracts with lotteries, like most other types of state contracts,
typically permit a lottery to terminate the contract upon 30 days written notice
for any reason. We cannot assure you that we could re-lease or sell any ITVMs
that may be returned to us by a lottery following the cancellation or expiration
of a lease. These lottery contracts also impose demanding installation,
performance and maintenance requirements. Our failure to perform the contract
requirements could result in significant liquidated damages or contract
termination. Our lottery contracts typically require us to indemnify the
lottery, its officers and retailers for any liabilities arising from the
operation of the ITVMs or any services that we provide. These provisions present
an ongoing risk of significant damage assessments or contract terminations,
which could have a material adverse effect on our business, financial condition
and results of operation.
A SINGLE STOCKHOLDER CONTROLS A MAJORITY OF OUR STOCK AND CAN EXERT
SIGNIFICANT INFLUENCE OVER OUR CORPORATE MATTERS.
As of December 31, 1998, Mr. L. Roger Wells, Jr. beneficially owned
51.6% of the outstanding common stock. As a result, Mr. Wells may be able to
exert significant influence over the election of directors and the outcome of
certain corporate actions requiring stockholder approval. This concentration of
ownership in a single stockholder also can delay or prevent a change of control.
OUR ITVM LEASE CONTRACTS MAY RESULT IN LOSSES.
Our ITVM lease revenues as a percentage of our total revenues were
63.3% in 1996, 67.3% in 1997 and 57.9% in 1998. Our standard lease agreements
provide for fixed lease payments during the term of the agreement and typically
permit the lottery to order additional ITVMs at any time during the lease term.
If a lottery orders a large number of ITVMs near the end of the lease term, we
would incur significant manufacturing costs but may receive lease payments for
only a relatively short period of time through the remainder of the lease term.
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Additionally, we are unable to pass along to the lottery any increases in
manufacturing and service costs during the term of the lease agreement. Our
standard lease agreements provide for a short initial term, such as one year,
with an option for the lottery to extend the lease term for additional one-year
periods. If the lottery does not extend the initial lease term, we might incur a
loss on the manufacture of the ITVMs if we are unable to re-lease or sell the
ITVM.
THE ITVM AND PCDM MARKETS ARE VERY COMPETITIVE.
The ITVM and PCDM markets are relatively new markets that have grown
rapidly in recent years. We may not be able to compete successfully against
current or future competitors, many of whom may have greater resources and
experience than us. The instant ticket market also may face competition from
other types of lottery and gaming products, particularly on-line lottery
products. The long distance telephone market similarly may face competition from
other types of communications products, including facsimile, e-mail and other
on-line products. If the ability to provide ITVMs and PCDMs internationally
becomes a competitive advantage in the instant ticket lottery and prepaid
calling card industries, we will have to expand our presence internationally or
risk a competitive disadvantage relative to our competitors. Increased
competition could cause us to increase our selling and marketing expenses and
research and development costs. We may not be able to offset the effects of any
such increased costs through an increase in the number of lottery contracts and
higher revenue from sales and leases of ITVMs and PCDMs, and we may not have the
resources to compete successfully. These developments could have a material
adverse effect on our business, financial condition and results of operation.
BECAUSE WE DEPEND UPON SINGLE OR LIMITED SOURCE SUPPLIERS, WE COULD
TEMPORARILY LOSE OUR SUPPLY OF SOME CRITICAL PARTS OR EXPERIENCE SIGNIFICANT
PRICE INCREASES.
We currently purchase certain important parts, such as components of
our ITVM burster, PTVM dispensing mechanism and PCDM dispensing mechanism from a
single source. The purchase of these components from outside suppliers on a sole
source basis subjects us to certain risks, including the continued availability
of suppliers, price increases and potential quality assurance problems. Because
other suppliers exist that can duplicate these components should we elect or be
forced to use a different supplier, we do not believe that any such change in
suppliers would result in the termination of a production contract. However, we
could experience a delay of 30 to 60 days in the production of ITVMs and PCDMs
should we elect or be forced to use other suppliers. Any delay of more than 30
to 60 days could have a material adverse effect on our business, financial
condition and results of operation.
WE MAY NOT BE ABLE TO RETAIN OUR KEY EXECUTIVES AND RESEARCH AND
DEVELOPMENT PERSONNEL.
As a small company with only 194 employees, our success depends in
large part on the continued service of our key management, sales, product
development and operational personnel, including Mr. L. Rogers Wells, Jr., our
Chairman and Chief Executive Officer, and David F. Nichols, our President. We do
not currently have employment agreements with any of our employees. Our success
also depends on our ability to attract and retain additional personnel with a
variety of skills, especially engineering and marketing expertise. Our inability
to hire and retain qualified personnel would likely have a material adverse
effect on our current business, any new product development efforts and future
business prospects.
THE SUCCESS OF OUR INTERNATIONAL OPERATIONS IS SUBJECT TO MANY
UNCERTAINTIES.
In each of 1997 and 1998, our sales and leases of ITVMs and PCDMs
outside the United States represented an immaterial percentage of our total
revenues. However, we intend to increase our marketing activities in
international jurisdictions, including expansion into several countries. Our
ability to expand our business into international markets may be adversely
affected by the following:
- customizing our products for use in international countries;
- longer accounts receivable payment cycles;
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- difficulties in managing international operations;
- availability of trained personnel to install and implement our
systems;
- exchange rate fluctuations;
- political instability;
- tariffs and other trade barriers;
- potentially adverse tax obligations;
- restrictions on the repatriation of earnings; and
- the burdens of complying with a wide variety of international
laws and regulations.
In addition, the laws of some countries do not protect our intellectual
property rights to as great an extent as the laws of the United States. Such
factors could have a material adverse effect on our international revenues and
earnings and our overall financial performance.
FAILURE TO ACHIEVE YEAR 2000 COMPLIANCE COULD NEGATIVELY AFFECT OUR
BUSINESS.
The Year 2000 issue is the result of potential problems with computer
systems or any equipment with computer chips that store dates as two digits
rather than four (e.g., "99" for 1999). On January 1, 2000, these systems and
equipment may read "00" as the year 1900 instead of the year 2000. This problem
could result in an interruption in, or failure of, certain of our normal
business activities and operations.
We have analyzed the Year 2000 issue with respect to the hardware and
software we use to provide our products and services and our computerized
information and operating systems. We do not believe that the costs necessary to
resolve the known Year 2000 problems will be material to our operating results.
If our projected timetable or cost estimates are incorrect, our business,
financial condition and results of operation could be negatively affected. We
are also discussing the Year 2000 issues with our significant customers,
manufacturers and suppliers. If they are unprepared for Year 2000 problems, our
business activities and operations could be negatively affected. We are not yet
certain to what extent our significant customers, manufacturers and suppliers
are Year 2000 compliant. If their systems are not timely converted or if their
converted systems are not compatible with ours, we may experience a significant
number of operational inconveniences and inefficiencies for us and our customers
that may divert our time and attention and financial and human resources from
our ordinary business activities. Any Year 2000 problems we have may result in a
materially adverse affect on our business, financial condition and results of
operation.
OUR INDUSTRY IS SUBJECT TO SIGNIFICANT GOVERNMENT REGULATION WHICH
COULD NEGATIVELY AFFECT US.
State and local governments strictly regulate the operation of
lotteries and the sales and leasing of ITVMs. Further, international
jurisdictions that operate lotteries impose strict regulations which may vary
from those in the United States. Any adverse change in the lottery laws of any
jurisdiction in which we sell and lease ITVMs could impose burdensome
requirements or requirements that we may be unable to satisfy. Our failure to
comply with changing lottery-related laws and regulations could have a material
adverse effect on our business, financial condition and results of operation.
In addition, state laws provide for background investigations on each
of the lottery's vendors and their affiliates, subcontractors, officers,
directors, employees and principal stockholders. The failure of any of these
parties associated with us to obtain or retain approval in any jurisdiction
could have a material adverse effect on our business, financial condition and
results of operation.
FUTURE SALES OF OUR COMMON STOCK IN THE PUBLIC MARKET COULD ADVERSELY
AFFECT OUR STOCK PRICE AND OUR ABILITY TO RAISE FUNDS IN NEW STOCK OFFERINGS.
The market price of our common stock could drop as a result of sales of
large numbers of shares in the market, or the perception that such sales could
occur. This is particularly true due to our relatively small number of
stockholders and the resulting low trading volume of our common stock in the
public market. These factors also
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<PAGE> 27
could make it more difficult for us to raise funds through future offerings. Our
principal stockholder, Mr. L. Rogers Wells, Jr., owns a majority of our common
stock.
We have 3,210,000 shares of common stock outstanding. Approximately
1,400,800 of these shares are freely transferable without restriction or further
registration under the Securities Act of 1933. The remaining 1,809,200 shares
outstanding are held by our executive officers and directors and will become
eligible for sale in the future without registration under the Securities Act at
such times and in such amounts as permitted by Securities and Exchange
Commission Rule 144 or an exemption under the Securities Act. In addition, we
have registered under the Securities Act 320,000 shares of common stock issuable
under our two stock incentive plans.
OUR FORWARD LOOKING STATEMENTS MAY BE INCORRECT.
Some of the statements in this report and in our 1998 Annual Report are
forward looking statements about what may happen in the future. They include
statements regarding our current beliefs, plans, expectations and assumptions
about matters such as our expected financial position and operating results, our
business strategy and our financing plans. These statements can sometimes be
identified by our use of forward looking words such as "anticipate," "believe,"
"estimate," "expect," "intend," "plan," "seek," "should" and similar
expressions. Our forward looking statements are subject to numerous risks,
uncertainties and assumptions, many of which are beyond our control. These
risks, uncertainties and assumptions include the risk factors discussed above.
We cannot guarantee that our forward looking statements will turn out to be
correct or that our beliefs, plans, expectations and assumptions will not
change. Our actual results could be very different from and worse than our
expectations as expressed in our forward looking statements.
ITEM 7(A). QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
Not applicable.
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
The following financial statements of the Company and the independent
auditors' report thereon, which are set forth on pages 9 through 16 of the 1998
Annual Report, are incorporated herein by reference:
Balance Sheets at December 31, 1997 and 1998
Statements of Income for each of the years in the three-year period
ended December 31, 1998
Statements of Stockholders' Equity for each of the years in the
three-year period ended December 31, 1998
Statements of Cash Flows for each of the years in the three-year period
ended December 31, 1998
Notes to Financial Statements
The Company is not required to provide supplementary financial
information specified by Item 302 of Regulation S-K.
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING
AND FINANCIAL DISCLOSURE
Within the two-year period ended December 31, 1998 and subsequently,
the Company had no change in independent accountants or disagreements with
independent accountants on accounting and financial disclosure.
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PART III
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
Information relating to the directors of the Company will be set forth
under the captions "Proposal 1 -- Election of Directors -- Nominees" and
"Proposal 1 -- Election of Directors -- Information Regarding Nominees and
Continuing Directors" in the Company's Proxy Statement for its 1999 Annual
Meeting of Stockholders to be held on May 6, 1999. Such information is
incorporated herein by reference. Pursuant to Instruction 3 to Item 401(b) of
Regulation S-K and General Instruction G(3) to Form 10-K, information relating
to the executive officers of the Company is set forth in Part 1, Item 4(A) of
this report under the caption "Executive Officers of the Registrant."
Information regarding compliance with Section 16(a) of the Securities Exchange
Act of 1934, as amended, by directors and executive officers of the Company and
beneficial owners of more than 10% of the Company's Common Stock will be set
forth under the caption "Section 16(a) Beneficial Ownership Reporting
Compliance" in the Proxy Statement referred to in this Item 10 above. Such
information is incorporated herein by reference.
ITEM 11. EXECUTIVE COMPENSATION
Information relating to executive compensation will be set forth under
the captions "Proposal 1 -- Election of Directors -- Director Compensation" and
"Executive Compensation" in the Proxy Statement referred to in Item 10 above.
Such information (other than the subsection of "Executive Compensation" entitled
"Compensation Committee Report on Executive Compensation") is incorporated
herein by reference.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
Information regarding ownership of the Company's Common Stock as of
December 31, 1998 by certain persons will be set forth under the caption "Stock
Ownership" in the Proxy Statement referred to in Item 10 above. Such information
is incorporated herein by reference.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
Information regarding certain relationships and transactions between
the Company and certain of its affiliates will be set forth under the caption
"Certain Transactions" in the Proxy Statement referred to in Item 10 above. Such
information is incorporated herein by reference.
PART IV
ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM
8-K
(a) Documents Filed as Part of This Report.
1. Financial Statements
The following financial statements of the Company and
the independent auditors' report thereon are included
in the Company's 1998 Annual Report and are
incorporated by reference in Item 8 hereof:
Balance Sheets at December 31, 1997 and 1998
Statements of Income for each of the years in the
three-year period ended December 31, 1998
-28-
<PAGE> 29
Statements of Stockholders' Equity for each of the
years in the three-year period ended December 31,
1998
Statements of Cash Flows for each of the years in the
three-year period ended December 31, 1998
Notes to Financial Statements
2. Financial Statement Schedules
The following financial statement schedule and the
independent auditors' report thereon are set forth
beginning on page S-1 of this report:
Schedule II - Valuation and Qualifying Accounts
All other schedules for which provision is made in
the applicable accounting regulations of the
Securities and Exchange Commission have been omitted
because such schedules are not required under the
related instructions or are inapplicable or because
the information required is included in the financial
statements or notes thereto.
3. Exhibits
The following exhibits are filed with or incorporated
by reference in this report. Where such filing is
made by incorporation by reference to a previously
filed registration statement or report, such
registration statement or report is identified in
parentheses. The Company will furnish any exhibit
upon request to Dennis W. Blazer, Chief Financial
Officer of the Company, 10830 Millington Court,
Cincinnati, Ohio 45242. There is a charge of $.50 per
page to cover expenses of copying and mailing.
3.1 Certificate of Incorporation of the Company,
as amended, including Certificate of
Designation of Series A Preferred Stock
(Exhibit 3.1 to the Company's Registration
Statement on Form S-1, No. 33-75142).
3.2 Bylaws of the Company (Exhibit 3.2 to the
Company's Registration Statement on Form
S-1, No. 33-75142).
4.1 Promissory Note of the Company dated
September 22, 1992 to Baumgartner & Brucher
Radiology Associates, Inc. Profit Sharing
Plan for the benefit of Thomas E. Turek,
M.D. (Exhibit 4.2 to the Company's
Registration Statement on Form S-1, No.
33-75142).
4.2 Promissory Note of the Company dated
September 22, 1990 to Mr. Thomas Goila
(Exhibit 4.3 to the Company's Registration
Statement on Form S-1, No. 33-75142).
4.3 Loan Agreement dated October 29, 1997
between the Company and Mercantile Business
Credit Inc (Exhibit 4.3 to the Company's
Annual Report on Form 10-K for the year
ended December 31, 1997).
4.3(a) Revolving Credit Note dated October 29, 1997
between the Company and Mercantile Business
Credit Inc. (Exhibit 4.3(a) to the Company's
Annual Report on Form 10-K for the year
ended December 31, 1997).
-29-
<PAGE> 30
4.3(b) Security Agreement dated October 29, 1997
between the Company and Mercantile Business
Credit Inc. (Exhibit 4.3(b) to the Company's
Annual Report on Form 10-K for the year
ended December 31, 1997).
4.3(c) Patent, Trademark and License Security
Agreement dated October 29, 1997 between the
Company and Mercantile Business Credit Inc.
(Exhibit 4.3(c) to the Company's Annual
Report on Form 10-K for the year ended
December 31, 1997).
4.3(d) First Amendment to the Loan Agreement dated
October 29, 1998 between the Company and
Mercantile Business Credit, Inc.-- filed
herewith.
10.1 Assignment of United States Letters Patent
from BLM Resources, Inc. to the Company with
respect to United States Patent No.
4,982,337, "System for Distributing Lottery
Tickets" (Exhibit 10.5 to the Company's
Registration Statement on Form S-1, No.
33-75142).
10.2 Pull-Tab Manufacturing and License Agreement
between Algonquin Industries, Inc., Kazmier
Kasper and the Company dated as of January
13, 1994 (Exhibit 10.6 to the Company's
Registration Statement on Form S-1, No.
33-75142).
10.3 Lease Agreement dated January 14, 1991 by
and between Gallenstein & Gallenstein and
the Company related to the Company's
premises located at 6665 Creek Road,
Cincinnati, Ohio 45242 (Exhibit 10.7 to the
Company's Registration Statement on Form
S-1, No.
33-75142).
10.3(a) Addendum dated May 2, 1994 to Lease
Agreement dated January 14, 1991 (Exhibit
10.7) by and between Gallenstein &
Gallenstein and the Company related to the
Company's premises located at 6665 Creek
Road, Cincinnati, Ohio 45242 (Exhibit
10.7(a) to the Company's Annual Report on
Form 10-K for the year ended December 31,
1994).
10.4 Management Contracts and Compensatory Plans
(a) 1994 Stock Incentive Plan (Exhibit
10.24 to the Company's Registration
Statement on Form S-1, No.
33-75142).
(b) 1994 Directors Stock Incentive Plan
(Exhibit 10.25 to the Company's
Registration Statement on Form S-1,
No. 33-75142).
(c) Employment Agreement effective
February 1, 1995 between L. Rogers
Wells, Jr. and the Company (Exhibit
10.4(c) to the Company's Annual
Report on Form 10-K for the year
ended December 31, 1997).
11 Statement Regarding Computation of Per Share
Earnings -- filed herewith.
13 1998 Annual Report -- filed herewith*.
23 Consent of KPMG LLP -- filed herewith.
24 Powers of Attorney -- filed herewith.
27 Financial Data Schedule (for SEC use only)
-- filed herewith.
-30-
<PAGE> 31
(b) Reports on Form 8-K. No Current Reports on Form 8-K were filed
by the Company during the quarter ended December 31, 1998.
(c) See Item 14(a)(3) above.
(d) See Item 14(a)(2) above.
- -----------------
* Except for portions of the 1998 Annual Report that are expressly incorporated
by reference into this Annual Report on Form 10-K, the 1998 Annual Report is
furnished to the Commission solely for the information of the Commission and not
deemed to be "filed" with the Commission for purposes of the Securities Exchange
Act of 1934, as amended.
-31-
<PAGE> 32
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, on March 25, 1999.
INTERLOTT TECHNOLOGIES, INC.
(REGISTRANT)
By:/s/ L. Roger Wells, Jr.
----------------------------------------
L. Rogers Wells, Jr.
Chairman of the Board and Chief
Executive Officer
Pursuant to the requirements of the Securities Exchange Act of 1934,
this report has been signed below by the following persons on behalf of the
Registrant and in the capacities indicated on March 25, 1999.
Signature Title
/s/ L. Rogers Wells, Jr. Chairman of the Board and Chief Executive Officer
- -------------------------
L. Rogers Wells, Jr.
/s/ Edmund F. Turek Director
- -------------------------
Edmund F. Turek
/s/ David F. Nichols President and Director
- -------------------------
David F. Nichols
Gary S. Bell * Secretary, Treasurer and Director
- -------------------------
Gary S. Bell
Kazmier J. Kasper * Director
- -------------------------
Kazmier J. Kasper
H. Jean Marshall * Director
- -------------------------
H. Jean Marshall
John J. Wingfield * Director
- -------------------------
John J. Wingfield
/s/ Dennis W. Blazer Chief Financial and Accounting Officer
- -------------------------
Dennis W. Blazer
*By: /s/ L. Rogers Wells, Jr.
------------------------
L. Rogers Wells, Jr.
as attorney-in-fact
-32-
<PAGE> 33
INDEX OF FINANCIAL STATEMENT SCHEDULES
<TABLE>
<CAPTION>
Page
----
<S> <C>
Report of Independent Auditors ...........................................S-2
Schedule II - Valuation and Qualifying Accounts ..........................S-3
</TABLE>
S-1
<PAGE> 34
Independent Auditors' Report
The Board of Directors and Stockholders
Interlott Technologies, Inc.:
Under date of February 26, 1999, we reported on the balance sheets of Interlott
Technologies, Inc. as of December 31, 1997 and 1998, and the related statements
of income, stockholders' equity, and cash flows for each of the years in the
three-year period ended December 31, 1998, as contained in the 1998 annual
report to stockholders. These financial statements and our report thereon are
incorporated by reference in the annual report on Form 10-K for the year 1998.
In connection with our audits of the aforementioned financial statements, we
also audited the related financial statement schedule as listed in the
accompanying index. This financial statement schedule is the responsibility of
the Company's management. Our responsibility is to express an opinion on this
financial statement schedule based on our audits.
In our opinion, such financial statement schedule, when considered in relation
to the basic financial statements taken as a whole, presents fairly, in all
material respects, the information set forth therein.
KPMG LLP
Cincinnati, Ohio
February 26, 1999
S-2
<PAGE> 35
INTERLOTT TECHNOLOGIES, INC.
SCHEDULE II - VALUATION AND QUALIFYING ACCOUNTS
<TABLE>
<CAPTION>
COLUMN A COLUMN B COLUMN C COLUMN D COLUMN E
- -----------------------------------------------------------------------------------------------------------
ADDITIONS
DESCRIPTION BALANCE AT CHARGED TO CHARGED TO DEDUCTIONS BALANCE AT
BEGINNING COSTS AND OTHER END
OF PERIOD EXPENSES ACCOUNTS OF PERIOD
- -----------------------------------------------------------------------------------------------------------
Allowance for
doubtful accounts
<S> <C> <C> <C> <C> <C>
1996 101,613 57,500 0 43,688 115,425
- -----------------------------------------------------------------------------------------------------------
1997 115,425 52,500 0 74,424 93,501
- -----------------------------------------------------------------------------------------------------------
1998 93,501 60,000 0 0 153,501
- -----------------------------------------------------------------------------------------------------------
Inventory valuation
reserve
1996 0 275,000 0 0 275,000
- -----------------------------------------------------------------------------------------------------------
1997 275,000 0 0 0 275,000
- -----------------------------------------------------------------------------------------------------------
1998 275,000 933,110 0 0 1,208,110
- -----------------------------------------------------------------------------------------------------------
</TABLE>
S-3
<PAGE> 36
INTERLOTT TECHNOLOGIES, INC.
INDEX OF EXHIBITS
The following exhibits are filed with or incorporated by reference in
this report. Where such filing is made by incorporation by reference to a
previously filed registration statement or report, such registration statement
or report is identified in parenthesis.
<TABLE>
<CAPTION>
EXHIBIT NO. DESCRIPTION PAGE
- ----------- ----------- ----
<S> <C> <C>
3.1 Certificate of Incorporation of the Company, as
amended, including Certificate of Designation of
Series A Preferred Stock (Exhibit 3.1 to the
Company's Registration Statement on Form S-1, No.
33-75142).
3.2 Bylaws of the Company (Exhibit 3.2 to the Company's
Registration Statement on Form S-1, No. 33-75142).
4.1 Promissory Note of the Company dated September 22,
1992 to Baumgartner & Brucher Radiology Associates,
Inc. Profit Sharing Plan for the benefit of Thomas E.
Turek, M.D. (Exhibit 4.2 to the Company's
Registration Statement on Form S-1, No. 33-75142).
4.2 Promissory Note of the Company dated September 22,
1990 to Mr. Thomas Goila (Exhibit 4.3 to the
Company's Registration Statement on Form S-1, No.
33-75142).
4.3 Loan Agreement dated October 29, 1997 between the
Company and Mercantile Business Credit, Inc. (Exhibit
4.3 to the Company's Annual Report on Form 10-K for
the year ended December 31, 1997).
4.3(a) Revolving Credit Note dated October 29, 1997 between
the Company and Mercantile Business Credit, Inc.
(Exhibit 4.3(a) to the Company's Annual Report on
Form 10-K for the year ended December 31, 1997).
4.3(b) Security Agreement dated October 29, 1997 between the
Company and Mercantile Business Credit, Inc. (Exhibit
4.3(b) to the Company's Annual Report on Form 10-K
for the year ended December 31, 1997).
4.3(c) Patent, Trademark and License Security Agreement
dated October 29, 1997 between the Company and
Mercantile Business Credit, Inc. (Exhibit 4.3(c) to
the Company's Annual Report on Form 10-K for the year
ended December 31, 1997).
4.3(d) First Amendment to the Loan Agreement dated October
29, 1998 between the Company and Mercantile Business
Credit, Inc. -- filed herewith.
10.1 Assignment of United States Letters Patent from BLM
Resources, Inc. to the Company with respect to United
States Patent No. 4,982,337, "System for Distributing
Lottery Tickets" (Exhibit 10.5 to the Company's
Registration Statement on Form S-1, No. 33-75142).
</TABLE>
E-1
<PAGE> 37
<TABLE>
<S> <C>
10.2 Pull-Tab Manufacturing and License Agreement between
Algonquin Industries, Inc., Kazmier Kasper and the
Company dated as of January 13, 1994 (Exhibit 10.6 to
the Company's Registration Statement on Form S-1, No.
33-75142).
10.3 Lease Agreement dated January 14, 1991 by and between
Gallenstein & Gallenstein and the Company related to
the Company's premises located at 6665 Creek Road,
Cincinnati, Ohio 45242 (Exhibit 10.7 to the Company's
Registration Statement on Form S-1, No. 33-75142).
10.3(a) Addendum dated May 2, 1994 to Lease Agreement dated
January 14, 1991 by and between Gallenstein &
Gallenstein and the Company related to the Company's
premises located at 6665 Creek Road, Cincinnati, Ohio
45242 (Exhibit 10.7(a) to the Company's Annual Report
on Form 10-K for the year ended December 31, 1994).
10.4 Management Contracts and Compensatory Plans
(a) 1994 Stock Incentive Plan (Exhibit 10.24 to
the Company's Registration Statement on Form
S-1, No. 33-75142).
(b) 1994 Directors Stock Incentive Plan (Exhibit
10.25 to the Company's Registration
Statement on Form S-1, No. 33-75142).
(c) Employment Agreement effective February 1,
1995 between L. Rogers Wells and the Company
(Exhibit 10.4(c) to the Company's Annual
Report on Form 10-K for the year ended
December 31, 1997).
11 Statement Regarding Computation of Per Share
Earnings-- filed herewith.
13 1998 Annual Report-- filed herewith*.
23 Consent of KPMG LLP-- filed herewith.
24 Powers of Attorney-- filed herewith.
27 Financial Data Schedule (for SEC use only)-- filed herewith.
</TABLE>
- -----------------
* Except for portions of the 1998 Annual Report that are expressly incorporated
by reference into this Annual Report on Form 10-K, the 1998 Annual Report is
furnished to the Commission solely for the information of the Commission and not
deemed to be "filed" with the Commission for purposes of the Securities Exchange
Act of 1934, as amended.
-2-
<PAGE> 1
EXHIBIT 4.3(d)
FIRST AMENDMENT TO LOAN AGREEMENT
THIS FIRST AMENDMENT TO LOAN AGREEMENT (the "Amendment") is made and
entered into this 29th day of October, 1998, by and between INTERLOTT
TECHNOLOGIES, INC., a Delaware corporation ("Borrower"), and MERCANTILE
BUSINESS CREDIT INC., a Missouri corporation ("Lender").
WITNESSETH:
WHEREAS, Borrower and Lender have heretofore entered into that certain
Loan Agreement dated October 29, 1997 (the "Loan Agreement"; all capitalized
terms used and not otherwise defined in this Amendment shall have the
respective meanings ascribed to them in the Loan Agreement as amended by this
Amendment); and
WHEREAS, Borrower and Lender desire to amend the Loan Agreement in the
manner hereinafter set forth;
NOW, THEREFORE, in consideration of the premises and for other good
and valuable consideration, the receipt and sufficiency of which are hereby
acknowledged, Borrower and Lender hereby agree as follows:
1. Section 2.09 of the Loan Agreement hereby is deleted in its
entirety and the following substituted in lieu thereof:
2.09 Early Termination and Early Termination
Fee. Borrower may elect to terminate this Agreement at any
time. Borrower hereby agrees that in the event that Lender or
Borrower elects to terminate this Agreement (including,
without limitation, any termination by Lender as a result of
the occurrence of any Event of Default under this Agreement),
Borrower will pay to Lender the total of the following: (a)
if such termination occurs prior to the last day of the
Revolving Credit Period, an early termination fee in the
amount of $15,000.00; (b) any amount of interest accrued
through the date of termination with respect to the
outstanding Borrower's Obligations; and (c) the Outstanding
Borrower's Obligations.
2. Pursuant to Borrower's request, Lender hereby waives payment
of the anniversary fee required to be paid by Borrower on October 29, 1998,
pursuant to Section 2.08 of the Loan Agreement. This paragraph is not and shall
not be construed as (a) a waiver of any of the other terms, provisions,
conditions or covenants contained in the Loan Agreement, including, without
limitation, payment of any subsequent anniversary fee payable under Section
2.08 of the Loan Agreement or (b) a commitment on the part of Lender to waive
any future anniversary fee or other fee or payment required to be paid by
Borrower under the Loan Agreement.
<PAGE> 2
3. Borrower hereby agrees to reimburse Lender upon demand for
all out-of-pocket costs and expenses (including, without limitation, reasonable
attorneys' fees and expenses) incurred by Lender in the preparation,
negotiation and execution of this Amendment and any and all other agreements,
documents, instruments and/or certificates relating to the amendment of
Borrower's existing credit facilities with Lender (collectively, the "Loan
Documents"). Borrower further agrees to pay or reimburse Lender for (a) any
stamp or other taxes (excluding income or gross receipts taxes) which may be
payable with respect to the execution, delivery, filing and/or recording of the
Loan Documents and (b) the cost of any filings and searches, including, without
limitation, Uniform Commercial Code filings and searches. All of the
obligations of Borrower under this paragraph shall survive the payment of the
Borrower's Obligations and the termination of the Loan Agreement.
4. All references in the Loan Agreement to "this Agreement" and
any other references of similar import shall henceforth mean the Loan Agreement
as amended by this Agreement.
5. Except to the extent specifically amended by this Amendment,
all of the terms, provisions, conditions, covenants, representations and
warranties contained in the Loan Agreement shall be and remain in full force
and effect and the same are hereby ratified and confirmed.
6. This Amendment shall be binding upon and inure to the benefit
of Borrower and Lender and their respective successors and assigns, except that
Borrower may not assign, transfer or delegate any of its rights or obligations
under the Loan Agreement as amended by this Amendment.
7. Borrower hereby represents and warrants to Lender that:
(a) the execution, delivery and performance by Borrower
of this Amendment are within the corporate powers of Borrower, have
been duly authorized by all necessary corporate action and require no
action by or in respect of, consent of or filing or recording with,
any governmental or regulatory body, agency or official or any other
Person;
(b) the execution, delivery and performance by Borrower
of this Amendment do not conflict with, or result in a breach of the
terms, conditions or provisions of, or constitute a default under or
result in any violation of, the terms of the Certificate or Articles
of Incorporation or By-Laws of Borrower, any applicable law, rule,
regulation, order, writ, judgment or decree of any court or
governmental or regulatory agency or instrumentality or any agreement,
document or instrument to which Borrower is a party or by which
Borrower or any of its Property or assets is bound or to which
Borrower or any of its Property or assets is subject;
-2-
<PAGE> 3
(c) this Amendment has been duly executed and delivered
by Borrower and constitutes the legal, valid and binding obligation of
Borrower enforceable against Borrower in accordance with its terms,
except as such enforceability may be limited by (i) applicable
bankruptcy, insolvency or similar laws affecting the enforcement of
creditors' rights generally and (ii) general principles of equity
(regardless of whether such enforceability is considered in a
proceeding in equity or at law);
(d) all of the representations and warranties of
Borrower set forth in the Loan Agreement and the other Transaction
Documents are true and correct in all material respects on and as of
the date of this Amendment as if made on and as of the date of this
Amendment; and
(e) as of the date of this Amendment, no Default or
Event of Default under or within the meaning of the Loan Agreement has
occurred and is continuing.
8. In the event of any inconsistency or conflict between this
Amendment and the Loan Agreement, the terms, provisions and conditions
contained in this Amendment shall govern and control.
9. This Amendment shall be governed by and construed in
accordance with the substantive laws of the State of Missouri (without
reference to conflict of law principles).
10. ORAL AGREEMENTS OR COMMITMENTS TO LOAN MONEY, EXTEND CREDIT
OR TO FORBEAR FROM ENFORCING REPAYMENT OF A DEBT, INCLUDING PROMISES TO EXTEND
OR RENEW SUCH DEBT, ARE NOT ENFORCEABLE. TO PROTECT BORROWER AND LENDER FROM
MISUNDERSTANDING OR DISAPPOINTMENT, ANY AGREEMENTS REACHED BY BORROWER AND
LENDER COVERING SUCH MATTERS ARE CONTAINED IN THE LOAN AGREEMENT AS AMENDED BY
THIS AMENDMENT AND THE OTHER TRANSACTION DOCUMENTS, WHICH LOAN AGREEMENT AS
AMENDED BY THIS AMENDMENT AND OTHER TRANSACTION DOCUMENTS ARE A COMPLETE AND
EXCLUSIVE STATEMENT OF THE AGREEMENTS BETWEEN BORROWER AND LENDER, EXCEPT AS
BORROWER AND LENDER MAY LATER AGREE IN WRITING TO MODIFY THEM.
11. Notwithstanding any provision contained in this Amendment to
the contrary, this Amendment shall not be effective unless and until Lender
shall have received:
(a) this Amendment, duly executed by Borrower; and
(b) a Secretary's Certificate certifying as to duly adopted
resolutions of the Board of Directors of Borrower which authorize the
execution, delivery and performance
-3-
<PAGE> 4
of this Amendment and containing any incumbency certificate, which shall
identify by name and title and bear the signatures of all of the officers of
Borrower executing this Amendment.
IN WITNESS WHEREOF, Borrower and Lender have executed this First
Amendment to Loan Agreement as of the date first set forth above.
INTERLOTT TECHNOLOGIES, INC.
By
--------------------------------
Title:
----------------------------
MERCANTILE BUSINESS CREDIT INC.
By
--------------------------------
Title:
----------------------------
-4-
<PAGE> 5
SECRETARY'S CERTIFICATE
I, Gary S. Bell , hereby certify to Mercantile Business Credit Inc.
("Mercantile") that I am the duly elected, qualified and acting Secretary of
INTERLOTT TECHNOLOGIES, INC., a Delaware corporation (the "Company"), and as
such have charge of the corporate books and records of the Company.
I further certify to Mercantile as follows:
1. There have been no amendments or other changes to the
Certificate of Incorporation or Bylaws of the Company since October 29, 1997.
2. Exhibit A attached hereto and made a part hereof is a true,
correct and complete copy of certain resolutions duly adopted by the Board of
Directors of the Company effective as of October 29, 1998, in accordance with
the laws of the State of Delaware and the Certificate of Incorporation and
Bylaws of the Company and that such resolutions are on the date hereof still in
full force and effect.
3. The following named individuals are duly elected officers of
the Company and hold the offices opposite their respective names, and that the
signatures written opposite each name and title is such individual's correct
signature.
<TABLE>
<CAPTION>
NAME OFFICE SIGNATURE
<S> <C> <C>
L. Rogers Wells Chairman
------------------------
David Nichols President
------------------------
Gary Bell Secretary
------------------------
Thomas Stokes V.P. Operations
------------------------
Dennis Blazer Chief Financial Officer
------------------------
</TABLE>
Executed as of the 29th day of October, 1998.
-------------------------------------
, Secretary
-------------------------
<PAGE> 1
EXHIBIT 11
INTERLOTT TECHNOLOGIES, INC.
Computation of earnings per share
<TABLE>
<CAPTION>
Three Months Ended Year Ended
December 31, December 31,
------------------------- --------------------------
1998 1997 1998 1997
---------- ---------- ---------- ----------
<S> <C> <C> <C> <C>
Weighted average common 3,210,000 3,210,000 3,210,000 3,210,000
shares outstanding during
the period
Income 476,489 436,709 $1,622,313 $1,451,654
Net Income per share $ 0.15 $ 0.14 $ 0.51 $ 0.45
Assuming full dilution: 3,210,000 3,210,000 3,210,000 3,210,000
Weighted average
common shares
outstanding during
the period
Assuming exercise of 550 4,870 10,649 2,661
options
Weight average common 3,210,550 3,214,870 3,220,649 3,212,661
shares outstanding as
adjusted
Net income 476,489 $ 436,709 $1,622,313 $1,451,654
Income per common share
assuming full dilution $ 0.15 $ 0.14 $ 0.50 $ 0.45
</TABLE>
<PAGE> 1
EXHIBIT 13
Annual Report
1998
INTERLOTT
TECHNOLOGIES, INC.
<PAGE> 2
COMPANY PROFILE
At Interlott Technologies, Inc. we develop new approaches to vending by
engineering systems that utilize our patented technology in concert with the
latest telecommunications, hardware, and software, in response to market needs.
Since the Company's founding in 1990, we have been committed to providing
unsurpassed reliability, dependability, and security through efficient
dispensing technology that offers our customers and their customers convenience,
and sure, quick delivery. Through this commitment, we have become the leading
supplier of Instant Ticket Vending Machines (ITVMs) for lotteries worldwide. Our
dispensing technology and philosophy of responding to our customers' needs have
earned us recognition as a leader and positioned us to expand into new markets
where our innovative technology will enhance the way companies do business.
Table of Contents
<TABLE>
================================================
<S> <C>
To Our Shareholders 1
- ------------------------------------------------
Answering market needs with
innovative products 2
- ------------------------------------------------
Integrating quick, convenient delivery
with market insight 4
- ------------------------------------------------
Conclusion 5
- ------------------------------------------------
Selected Financial Data 7
- ------------------------------------------------
Management's Discussion & Analysis 7
Financial Statements 10
- ------------------------------------------------
Corporate Data &
Shareholder Information 17
================================================
</TABLE>
INTERLOTT
TECHNOLOGIES, INC.
<PAGE> 3
Placing products and information at a fingertip -
Photo of world with
a finger pushing button
on it
<PAGE> 4
Annual Report 1998
Photo of L. Rogers Wells and
David Nichols in front of
Interlott sign
L. Rogers Wells, Jr. David F. Nichols
Chairman of the Board President
and Chief Executive Officer
Dear Fellow Shareholders:
1998 marks the fourth straight year of profitability for our Company. It was
also a year during which we won four of the six contracts awarded for supplying
machines to lottery customers. A year during which we completed the development
of our counter top version of the ITVM. A year during which we developed a
methodology for automated remote machine reporting and signed our first contract
utilizing this technology. The accomplishments of 1998 provide the basis for a
bright future for the Company.
Revenues for 1998 topped $24 million, a 26% increase over 1997 and a record
level for the Company, net income exceeded $1.6 million, a 12% increase over
1997, and cash flow from operations increased 20% to $6.7 million.
The Company was awarded new or extended contracts with Arizona, Florida,
Indiana, Kansas, Ohio, Texas and Washington. We now have contracts with 23 of
the 32 domestic lotteries which utilize vending technology to promote growth of
their instant (scratch-off) games. In addition, phone card machines were
deployed both domestically and internationally.
Our continued commitment to understanding and answering the needs of our
customers was further evidenced with the development of our counter-top vending
units providing for growth of instant ticket sales for the lotteries, while
addressing the retailers' concern for security and optimum use of counter space.
Similarly, our automated reporting system answered the lotteries' need for
tracking sales and obtaining marketing information at minimal cost.
By the end of 1998 we had approximately 9,000 machines leased or on order to be
leased by eighteen domestic lotteries. This clearly illustrates our commitment
to leasing rather than selling our equipment and our desire to "partner" with
our customers. Future lease revenues for this equipment totaled more than $70
million at year end.
Once again, your management and Board of Directors would like to thank you for
your continued loyalty and support as we work together for the continued growth
of the Company.
Sincerely,
/s/ L. Rogers Wells, Jr.
- -----------------------------
L. Rogers Wells, Jr.
Chairman of the Board and CEO
1
<PAGE> 5
Photo of burster with Photo of Photo of montage of pull
instant tickets feeding Ohio 12 game ITVM, tab tickets and various
into it Wisconsin 8 game ITVM plastic cards including
and phone, transit and smart
Kansas 6 game PTVM cards
from
INNOVATION
Answering market needs with innovative products - Our dispensing
systems represent a convergence of today's latest technologies with
uniquely engineered mechanisms. Between the idea and implementation
lies technological innovation -- the intangible commodity that has
made Interlott a leader in the dispensing industry. Interlott succeeds
as a company because we respond to our customers' needs with
breakthrough dispensing systems that place products and information at
a fingertip.
Illustration of the U.S.
indicating what companies
have the ITVM contracts
with the lotteries
to implementation
<TABLE>
<S> <C>
INTERLOTT
TECHNOLOGIES, INC. Current Lottery contracts: Interlott's Competitors' Potential Non-Lottery States
</TABLE>
2
<PAGE> 6
<TABLE>
<S> <C> <C> <C>
Photo of woman Close up of a hand Photo of a woman Photo of a couple
purchasing a phone card inserting a phone card into purchasing a smart card presenting a card for a
from a King's Island a phone slot from an Interlot SCDM purchase
PCDM
</TABLE>
evolution
Interlott's role as a technological leader began with the invention of our
patented Burster. The Burster was the key component in the development of the
first automated Instant Ticket Vending Machine (ITVM) by Interlott. This
state-of-the-art technology gave lotteries the freedom to reliably sell instant
game tickets in a wide variety of sizes, shapes and paper stocks without the
intervention of a ticket agent.
Continually addressing the needs of our customers-lotteries, retailers and
players alike-we refined the ITVM. The request by all to make more games
available in the smallest space possible, led the evolution from our original
four game unit to our present day sixteen game ITVM. As a result of this
technology, instant ticket sales have risen, allowing Interlott to capture more
than 70% of the ITVM market.
refinement
Lotteries also needed a way to securely dispense their individual paper pull-tab
tickets. Our unique, ShurShuttle dispensing process was the answer. Incorporated
in our complete line of our Pull Tab Vending Machines (PTVMs) it ensures that
ticket dispensing is flawless, efficient, and completely secure.
With the emergence of the prepaid telephone card industry, the capabilities of
our unique ShurShuttle dispenser were again recognized. This patented technology
has become the key component in dispensing individual products, from paper
tickets to plastic cards, as utilized in our Phone Card Dispensing Machines
(PCDMs) and Smart Card Dispensing Machines (SCDMs). We continue to explore
opportunities to utilize our dispensing technology in new
looking ahead
arenas. Closed-end environments such as theme parks, college campuses, and
military bases provide us a multitude of opportunities. We continue to identify
venues for our products where speed and convenience are priorities, such as
parking garages, transit terminals, malls, and vacation resorts.
Internationally, with the advent of the Eurodollar, we perceive new applications
for our technology every day.
Interlott's financial strength and technological leadership are enabling us to
take the Company in exciting new directions, responding to market needs with
innovative products. We provide solutions by offering practical methods and
advances in technology that place products and information at a fingertip.
Bringing you tomorrow's solutions... today.
3
<PAGE> 7
<TABLE>
<S> <C> <C>
Close up of someone Close up of a woman A store manager opening
selecting a ticket from an selecting a ticket from an the dispenser units behind
Ohio 12 game ITVM MVP unit on a store check his convenience store
out counter counter
</TABLE>
Integrating convenient, quick delivery with market insight -
Our patented Burster and ShurShuttle dispensers have been the
catalysts enabling Interlott to offer sure, quick, and convenient
delivery of products through our innovative vending systems. But our
mission is ongoing. Capitalizing on the most advanced hardware,
software and telecommunications technology available, we now provide
the vendor the advantage of on-line service data transmission,
inventory status, detailed accounting reports, and valuable market
information.
(from) (automation) automation automation
Close up photo of various
sales tapes with reports
taken from an Interlott
ITVM
INTERLOTT to
TECHNOLOGIES, INC. information
4
<PAGE> 8
<TABLE>
<S> <C> <C> <C>
above of a line "http:/" symbol Man and woman in lottery Man initializing a
out lanes in a representing the internet office reviewing sales transaction at an ITVM,
every store results from the ITVMs in supposedly in the future
their state
</TABLE>
efficiency
We recognized the opportunity to increase over-the-counter sales of instant
scratch tickets and seized it. Customer lines can be long. Sales, inventory, and
record keeping are labor intensive. Tickets are difficult to see. Shrinkage has
eaten into profits. Still, the majority of instant tickets sales are impulse
purchases made at the convenience store checkout.
Over the past two years, we have been working with lotteries, retailers and
players alike to develop the Modular Vending Platform (MVP), the smart instant
ticket dispenser, which combines the latest technologies with our advanced
engineering and design. The MVP reduces transaction time, automates the
accounting process, improves ticket visibility, and eliminates shrinkage,
resulting in more sales, less work, and increased profits. The MVP has been
introduced
insight
across the U.S. in convenience stores, grocery chains, and hyper-markets and
feedback has been overwhelmingly positive.
As instant game sales represent an ever increasing percentage of lotteries'
total revenues, obtaining sales and inventory data on a real time basis has
become a necessity. Our insight into this situation prompted the development of
our Automated Communication System (ACS).
Using the latest telecommunications software and hardware, the ACS provides
lotteries with instant reporting by all ITVMs located throughout each state for
sales data, inventory and maintenance control. The ACS transmits detailed sales
data via modem, generating reports instantaneously, which are made available to
the lottery over the internet.
opportunity
The ACS provides demographic sales data and strategic marketing information to
the lottery, empowering them to give players the games they want, when and where
they want them. This ability translates into increased instant ticket revenues
and the most efficient sales system to date. We continue to explore similar
avenues where the ACS can be used to transform traditional vending into
reliable, convenient market driven sales.
We are breaking new ground, merging our dispensing technology with the latest
innovations in hardware, software and telecommunications, to provide advanced
vending systems to a variety of niche markets worldwide. We envision many
different possibilities--from multifunctional ATMs to systems able to offer
three dimensional products. The potential can be limitless.
5
<PAGE> 9
REDEFINING AN INDUSTRY WITH EMPLOYEES,
PARTNERS, AND TECHNOLOGY...
At Interlott, we realize that it takes more than great products to build a
successful company. To revolutionize an industry through technology, it takes
management and employees who require more than the status quo. Our dispensing
technology receives the insightful guidance of a committed corporate team and
supportive client base. We work together to efficiency develop products that
provide measurable benefits to our customers and in turn, to their customer. We
offer a creative environment where people and ideas flourish to bring products
and information to the world at the touch of a fingertip.
Photo of the world with
computer symbols
surrounding it and a finger
pushing a button on
top of it
Bringing you a tomorrow's solution...TODAY.
INTERLOTT
TECHNOLOGIES, INC.
6
<PAGE> 10
Selected Financial Data
<TABLE>
<CAPTION>
- ---------------------------------------------------------------------------------------------------------------
Year Ended
===============================================================================================================
Dec. 31 Dec. 31 Dec. 31 Dec. 31 Dec. 31
1994 1995 1996 1997 1998
===============================================================================================================
<S> <C> <C> <C> <C> <C>
Revenues
- ---------------------------------------------------------------------------------------------------------------
Machine sales 40,650 9,746,339 5,596,698 4,567,441 8,229,950
- ---------------------------------------------------------------------------------------------------------------
Machine leases 6,093,528 9,132,132 11,766,623 12,874,450 14,165,379
- ---------------------------------------------------------------------------------------------------------------
Other 250,442 435,137 1,235,368 1,669,160 2,078,644
- ---------------------------------------------------------------------------------------------------------------
Net revenues 6,384,620 19,313,608 18,598,689 19,111,051 24,473,973
- ---------------------------------------------------------------------------------------------------------------
Net income (loss) (932,100) 1,987,219 1,320,597 1,451,654 1,622,313
- ---------------------------------------------------------------------------------------------------------------
Income per share(1) (0.32) 0.62 0.41 0.45 0.51
- ---------------------------------------------------------------------------------------------------------------
Depreciation and amortization 1,884,855 2,982,547 3,902,387 4,143,408 4,585,325
- ---------------------------------------------------------------------------------------------------------------
Leased ITVMs, less
accumulated depreciation 8,392,946 10,779,929 10,940,398 14,740,462 17,105,891
- ---------------------------------------------------------------------------------------------------------------
Total assets 15,020,321 20,483,686 20,992,733 24,612,884 28,774,249
- ---------------------------------------------------------------------------------------------------------------
Total debt 5,398,103 9,040,784 7,715,140 9,458,004 11,645,374
- ---------------------------------------------------------------------------------------------------------------
Redeemable preferred stock 1,335,000 1,335,000 1,335,000 1,335,000 1,335,000
===============================================================================================================
(1)Reflects the weighted average number of shares outstanding for the respective periods, taking into account
a 21.5 to 1 split of Common Stock effected in March, 1994.
- ---------------------------------------------------------------------------------------------------------------
</TABLE>
MANAGEMENT'S DISCUSSION & ANALYSIS
OVERVIEW
The Company's revenue base consists of (1) payments from ITVM and PCDM leases
(2) sales of ITVMs and PCDMs, (3) and to a lesser extent, sales of parts for
ITVMs and PCDMs and service agreements. The Company emphasizes leasing rather
than selling ITVMs to lotteries when possible. Leases provide the Company with a
consistent revenue stream, opportunities to generate income on financing, and
the potential to deploy a greater number of ITVMs within a lottery's budget due
to the lower initial cash outlay required by the lottery. Leasing ITVMs also
gives the lotteries the flexibility to enhance their ITVMs in the future with
new technology from the Company. On the other hand, leasing ITVMs requires the
Company to invest capital or otherwise finance the manufacture of ITVMs, unlike
sales of ITVMs that result in the receipt of payment in full upon delivery of
the ITVMs. When the Company sells ITVMs, the Company generally is able to
manufacture and deliver the ITVMs and receive full payment for them before it
must pay for the materials used to manufacture the ITVMs. Nevertheless, the
Company believes that the advantages of leasing ITVMs as described above justify
the initial capital investment or financing costs required to manufacture ITVMs
for lease. The majority of ITVMs to date have been leased.
For similar reasons, the Company emphasizes leasing rather than selling PCDMs to
providers of prepaid telephone cards. As with ITVMs, the Company believes that
the benefits to the Company of leasing PCDMs warrant the initial capital
investment required to manufacture PCDMs. However, the great majority of the
PCDMs deployed to date have been sold rather than leased.
The Company historically has experienced fluctuations in its financial results
primarily due to its dependence upon a small number of major customers and the
unpredictable nature, timing and results of the lotteries' contract bid and
award processes. The Company's revenues and capital expenditures can vary
significantly from period to period because the Company's sales cycle may be
relatively long and because the amount and timing of revenues and capital
expenditures depend on factors such as the amount and timing of awarded
contracts, changes in customer budgets and demands, and general economic
conditions. Operating results may be affected by the lead-time sometimes
required for business opportunities to result in signed lease or sales
agreements, working capital requirements associated with manufacturing ITVMs
pursuant to new orders, increased competition, and the extended time that may
elapse between the award of a contract and the receipt of revenues from the sale
or lease of ITVMs.
- --------------------------------------------------------------------------------
RESULTS OF OPERATIONS
The table below presents selected financial information derived from the
Company's statements of income expressed as a percentage of revenues for the
years indicated.
<TABLE>
<CAPTION>
Year Ended
----------------------------------
Dec. 31 Dec. 31 Dec. 31
1996 1997 1998
Revenues
===================================================================
<S> <C> <C> <C>
Machine sales 30.1% 24.0% 33.6%
- -------------------------------------------------------------------
Machine leases 63.3 67.3 57.9
- -------------------------------------------------------------------
Other 6.6 8.7 8.5
- -------------------------------------------------------------------
Total revenues 100.0 100.0 100.0
- -------------------------------------------------------------------
Cost of revenues,
excluding depreciation 47.6 41.7 48.4
- -------------------------------------------------------------------
Depreciation 20.3 20.6 17.5
- -------------------------------------------------------------------
Gross margin 32.1 37.7 34.1
- -------------------------------------------------------------------
Selling, general and
administrative expenses 18.6 18.3 16.5
- -------------------------------------------------------------------
Research and
development costs 3.6 2.9 2.5
- -------------------------------------------------------------------
Operating income 9.9 16.5 15.1
- -------------------------------------------------------------------
Interest expense 3.8 3.7 4.0
- -------------------------------------------------------------------
Income before
income taxes 6.1 12.8 11.1
- -------------------------------------------------------------------
Income taxes (1.0) 5.2 4.5
===================================================================
Net income 7.1% 7.6% 6.6%
===================================================================
</TABLE>
SUMMARY OF QUARTERLY DATA
Quarterly financial data for the years ended December 31, 1997 and 1998 shown
here (in thousands, except for per share data).
<TABLE>
<CAPTION>
1997 First Second Third Fourth
=====================================================================
<S> <C> <C> <C> <C>
Net sales $4,164 6,931 3,867 4,129
- ---------------------------------------------------------------------
Gross profit 1,232 2,478 1,552 1,941
- ---------------------------------------------------------------------
Net income 30 777 208 437
- ---------------------------------------------------------------------
Basic income per share 0.01 0.24 0.06 0.14
- ---------------------------------------------------------------------
Diluted income per share 0.01 0.24 0.06 0.13
=====================================================================
</TABLE>
<TABLE>
<CAPTION>
1998 First Second Third Fourth
=====================================================================
<S> <C> <C> <C> <C>
Net sales $5,884 7,323 5,714 5,554
- ---------------------------------------------------------------------
Gross profit 1,718 2,492 1,874 2,270
- ---------------------------------------------------------------------
Net income 291 630 225 476
- ---------------------------------------------------------------------
Basic income per share 0.09 0.19 0.07 0.15
- ---------------------------------------------------------------------
Diluted income per share 0.09 0.19 0.07 0.15
=====================================================================
</TABLE>
7
<PAGE> 11
1997 Compared to 1998
Total revenues increased by $5,362,922 from $19,111,051 to $24,473,973 in 1998,
or 28%, due primarily to a $3,662,509 increase in machine sales and a $1,290,929
increase in lease revenues accompanied by a $409,484 increase in other revenues.
Revenues from sales increased by 80% from $4,567,441 in 1997 to $8,229,950 in
1998, as a result of an increase in ITVMs and PCDMs sold in 1998 over 1997. The
units sold in 1998 included a greater number of higher priced machines than
1997. Revenues from leases increased by 10% from $12,874,450 in 1997 to
$14,165,379 in 1998, resulting from the continuation of leases in nine states
and the renewal of five leases in other states that had reached the conclusion
of their original terms. The total number of ITVMs and PCDMs under lease
increased in 1998 as a result of deployment of new units, offset by the
retirement of older units. Other revenues increased by 25% from $1,669,160 in
1997 to $2,078,644 in 1998 as machines deployed prior to 1998 generated parts
and service revenue for the entire year, and service for ITVMs in one state was
taken over from a subcontractor.
Lease revenues were 67% and 58% of total revenues for 1997 and 1998,
respectively. Revenues from sales of ITVMs and PCDMs were 24% and 34% of total
revenues in 1997 and 1998, respectively. The increase in lease revenues and
increase in sales revenues reflect the cumulative effect of continuing revenues
from machines under lease which were deployed prior to 1998 and the incremental
revenue of new machines leased or deployed in 1998.
Cost of revenues for machine sales and other increased 33% from $4,378,669 in
1997 to $5,809,057 in 1998. This increase reflects the 47% increase in number of
machines sold, offset by lower costs of the units sold in 1998. Cost of revenues
for leased ITVMs and PCDMs, excluding depreciation, increased 67% from
$3,584,017 in 1997 to $6,020,437 in 1998. The increase in cost of leased
revenues was the result of higher personnel and subcontractor costs related to
the larger number of machines deployed during 1998.
Depreciation of ITVMs and PCDMs increased by 9% from $3,924,244 in 1997 to
$4,290,128 in 1998. The increase was lower than the related increase in the
number of ITVMs and PCDMs, as certain units had been fully depreciated by the
end of 1997.
Selling, general and administrative expenses increased 16% from $3,492,020 in
1997 to $4,048,751 in 1998 as a result of increases in salaries and wages for
additional staff and increases in travel and entertainment cost. However,
selling, general and administrative expenses as a percentage of revenues,
decreased slightly from 18% in 1997 to 17% in 1998.
Research and development costs increased by 14% from $545,039 in 1997 to
$618,819 in 1998. This increase resulted from continuing development and
refinement of existing products to meet the various needs of customers for the
Company's dispensing technologies. The Company maintains its philosophy of using
contractors as the primary source of research and development efforts, allowing
the Company to focus its expenditures on the technical expertise necessary to
accomplish the specific project.
Operating income increased by 16% from $3,187,062 in 1997 to $3,686,781 in 1998.
This increase resulted from the continuing benefit of revenues derived from
machines deployed in prior periods, including machines which had been fully
depreciated, combined with ongoing machine sales and leases.
Interest expense increased by 30% from $747,008 in 1997 to $967,768 in 1998. The
increase reflects the cost of additional borrowings to finance leased equipment
built and deployed in 1998, offset by lower interest rates resulting from
utilization of the LIBOR option in the Company's agreement.
Income taxes increased by 11% from $988,400 in 1997 to $1,096,673 in 1998 as a
result of an increase in income before taxes of 11%. The effective tax rate
remained consistent at 40% in 1997 and 1998.
As a result of the above factors, the Company's net income increased by 12% from
$1,451,654 in 1997 to $1,622,313 in 1998.
1996 COMPARED TO 1997
Total revenues increased by $512,362 from $18,598,689 to $19,111,051 in 1997, or
3%, due primarily to a $1,107,827 increase in lease revenues accompanied by a
$433,792 increase in other revenues offset by a $1,029,257 decrease in sales of
ITVMs and PCDMs.
Revenues from leases increased by 9% from $11,766,623 in 1996 to $12,874,450 in
1997, resulting from the continuation of leases in nine states, the addition of
leases in three states, and the renewal of a lease in another state which had
reached the conclusion of the original term. The total number of ITVMs and PCDMs
under lease increased to 6,834 in 1997 as a result of deployment of additional
units, offset by the retirement of older units. Other revenues increased by 35%
from $1,235,368 in 1996 to $1,669,160 in 1997 as ITVMs were deployed in one
additional state and machines deployed prior to 1997 generated parts and service
revenue for the entire year. Revenues from sales decreased by 18% from
$5,596,698 in 1996 to $4,567,441 in 1997, as a result of a decrease in ITVMs and
PCDMs sold in 1997 as compared to 1996. The decrease in units sold was partially
offset by a greater number of higher priced units sold in 1997 as compared to
those sold in 1996.
Lease revenues were 63% and 67% of total revenues for 1996 and 1997,
respectively. Revenues from sales of ITVMs and PCDMs were 30% and 24% of total
revenues in 1997 and 1996, respectively.
Cost of revenues for machine sales and other decreased 28% from $6,052,763 in
1996 to $4,378,669 in 1997. This decrease reflects the 35% decrease in number of
machines sold offset by the higher cost of the higher priced units sold in 1997.
Cost of revenues for leased ITVMs and PCDMs, excluding depreciation, increased
26% from $2,839,162 in 1996 to $3,584,017 in 1997. The increase in cost of
leased revenues was the result of higher warranty parts costs and higher
personnel and subcontractor costs related to the larger number of machines
deployed during 1997.
Depreciation of ITVMs and PCDMs increased by 5% from $3,744,065 in 1996 to
$3,924,244 in 1997. The increase was lower than the related increase in the
number of ITVMs and PCDMs, as certain units had been fully depreciated by the
end of 1996.
Selling, general and administrative expenses increased 1% from $3,461,364 in
1996 to $3,492,020 in 1997. Selling, general and administrative expenses as a
percentage of revenues decreased slightly from 19% in 1996 to 18% in 1997.
Research and development costs decreased by 18% from $665,449 in 1996 to
$545,039 in 1997. This decrease results from the wind down of major projects
such as the smart card dispensing machine, as well as the continuing development
and refinement of existing products to meet the variety of the needs of the
customers for our dispensing technologies. The Company maintains its philosophy
of using contractors as the primary source of research and development efforts,
allowing the Company to focus its expenditures on the technical expertise
necessary to accomplish the specific project.
Operating income increased by 74% from $1,835,886 in 1996 to $3,187,062 in 1997.
This increase resulted from the continuing benefit of revenues derived from
machines deployed in prior periods, including machines which had been fully
depreciated, combined with the control of operating expenses.
Interest expense increased by 4% from $718,642 in 1996 to $747,008 in 1997. The
increase reflects the cost of additional borrowings to finance leased equipment
built and deployed in 1997. To a lesser extent, interest expense was affected by
the reduced interest rate of the new credit facility.
The significant change in income taxes in 1997 resulted from the Company having
used available net operating loss carryovers in 1996 and as a result, incurring
taxes at an effective tax rate of 40% in 1997.
As a result of the above factors, the Company's net income increased by 10% from
$1,320,597 in 1996 to $1,451,654 in 1997.
Liquidity and Capital Resources
The Company's liquidity and capital resources are significantly impacted by its
decision to use leasing as a means to market its ITVMs and PCDMs. Leasing
generally offers the Company better gross margins than direct sales agreements.
However, leasing inherently requires more capital and a longer-term payout than
sales. As of December 31, 1998, the Company had a total of 7,812 ITVMs and PCDMs
under operating and sales type leases.
8
<PAGE> 12
Net cash provided by operating activities increased 2% from $7,281,457 in 1997
to $7,435,079 in 1998. Net cash used in investing activities increased 7% from
$9,069,836 in 1997 to $9,735,516 in 1998. Net cash provided by financing
activities increased by 26% from $1,742,864 in 1997 to $2,187,370 in 1998.
At December 31, 1997 and 1998, the Company had working capital deficits of
$4,328,068 and $7,466,831, respectively. These deficits reflect the
classification of the Company's revolving credit facility as a current debt
because of the revolver clause of the facility.
At December 31, 1998, the Company was indebted to Mercantile Business Credit,
Inc. in the aggregate principal amount of $11,166,374 pursuant to this revolving
credit agreement The facility permits the Company to borrow up to $15,000,000 at
the prime interest rate or the respective LIBOR rate plus two percent through
October 2000, with two one-year extensions to October, 2002. Borrowings under
this facility are collateralized by all of the assets of the Company and an
assignment of all proceeds from lease agreements. The facility prohibits the
declaration or payment of cash dividends until the Company has retired debt owed
to two stockholders and all of the outstanding preferred stock of the Company.
At December 31, 1998, the Company had $3,833,626 available under this facility.
At December 31, 1998, the Company was indebted to two stockholders in the
aggregate principal amount of $479,000 which had been incurred prior to 1992 to
finance the manufacture of certain ITVMs. See Note 7 of Notes to Financial
Statements.
The Company's capital expenditures totaled $9,069,836 and $9,735,516 for 1997
and 1998, respectively. These amounts include $8,710,315 and $9,611,623 for the
manufacture of machines leased during the respective periods. Other expenditures
represent machinery and equipment costs for expanded capacity. The Company had
no material commitments for additional capital expenditures as of December 31,
1998 other than for the manufacture of ITVMs and PCDMs for future lease.
At December 31, 1998, the Company had estimated tax net operating loss
carryforwards of approximately $1,021,000, which are available to offset future
federal taxable income, if any, through 2009. The use of these carryforwards is
subject to certain annual limitations due to ownership changes in 1992.
IMPACT OF THE YEAR 2000
The Company relies on computer-based technology and utilizes a variety of
third-party hardware and proprietary and third party software. The Company's
dispensing equipment generally uses proprietary software, with third-party
software being used more extensively for administrative functions, such as
accounting and human resource management. In addition to such information
technology (IT) systems, the Company's operations rely on various non-IT
equipment and systems that contain embedded computer technology. Third parties,
with whom the Company has commercial relationships, including vendors of
materials and components incorporated into the Company's products and of
products and services used by the Company in its operations (such as banking and
financial services, data processing services, telecommunications services and
utilities), also rely highly on computer based technology.
The Company has assessed the potential effects of the Year 2000 issue on the
Company's business, financial condition and results of operations. In
conjunction with this assessment, the Company developed and commenced the
implementation of the compliance program described below.
The Company has undertaken a review of its proprietary IT systems relating to
its dispensing equipment. No systems were identified as relating to the critical
functions of the Company's ITVMs or PCDMs. As such, the Company believes that no
remediation with regard to those proprietary IT systems is necessary at this
time.
The Company has contacted its third party providers of critical hardware and
software and has obtained appropriate representations to the effect that such
hardware or software is or will timely be Year 2000 compliant.
The Company has undertaken a review of its non-IT systems and is implementing a
remediation program with respect to those systems that are within the control of
the Company. Selected non-IT suppliers and vendors have been contacted to
identify any significant exposures that may exist and identify alternate sources
or strategies where necessary.
The Company has incurred minimal costs to date in assessing the potential
effects of the Year 2000 issue on the Company and does not expect or anticipate
any material expenditures in the future in connection with the Year 2000 issue.
Nevertheless, the issues presented by the Year 2000 issue and the proposed
solutions therefor are very complex and the Company's Year 2000 compliance
depends heavily on the technical skills of employees and independent contractors
and the representations and preparedness of third parties. Moreover, Year 2000
issues present a number of risks that are beyond the Company's reasonable
control, such as the failure of utility companies to deliver electricity, the
failure of telecommunications companies to provide voice and data services, the
failure of financial institutions to process transactions and transfer funds,
the failure of vendors to deliver materials or perform services required by the
Company and the collateral effects on the Company of the effects of Year 2000
issues on the economy in general or on the Company's business partners and
customers in particular. Although the Company believes that its Year 2000
compliance program is designed to appropriately identify and address those Year
2000 issues that are subject to the Company's reasonable control, there can be
no assurance that the Company's efforts in this regard will be fully effective
or that the Year 2000 issues will not have a material adverse effect on the
Company's business, financial condition or results of operations.
SPECIAL NOTE REGARDING FORWARD-LOOKING
STATEMENTS
The words "expect", "anticipate", "intend", "plan", "believe", "seek",
"estimate" and similar expressions used in this report are intended to identify
forward-looking statements, although this report also contains other
forward-looking statements. Any forward-looking statements in this report are
made pursuant to the "safe harbor" provisions of the Private Securities
Litigation Act of 1995. Investors are cautioned that actual results may differ
substantially from such forward-looking statements. Forward-looking statements
involve risks and uncertainties including, but not limited to, continued
acceptance of the Company's products and services in the marketplace,
competitive factors, new products and technological changes, dependence upon
third party vendors, a limited number of customers, political and other
uncertainties related to customer purchases and other risks detailed in the
Company's periodic filings with the Securities and Exchange Commission.
INDEPENDENT AUDITORS' REPORT
The Board of Directors and Stockholders:
We have audited the accompanying balance sheets of Interlott
Technologies, Inc. as of December 31, 1997 and 1998, and the related statements
of income, stockholders' equity and cash flows for each of the years in the
three-year period ended December 31, 1998. These financial statements are the
responsibility of the Company's management. Our responsibility is to express an
opinion on these financial statements based on our audits.
We conducted our audit in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as 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 financial position of Interlott
Technologies, Inc. as of December 31, 1997 and 1998, and the results of its
operations and its cash flows for each of the years in the three year period
ended December 31, 1998, in conformity with generally accepted accounting
principles.
/s/ KPMG LLP
February 26, 1999
9
<PAGE> 13
BALANCE SHEETS
<TABLE>
<CAPTION>
December 31,
---------------------------
1997 1998
- ---------------------------------------------------------------------------------------------------------------
<S> <C> <C>
ASSETS
- ---------------------------------------------------------------------------------------------------------------
Current assets:
- ---------------------------------------------------------------------------------------------------------------
Cash $ 143,071 30,004
- ---------------------------------------------------------------------------------------------------------------
Accounts receivable, less allowance for doubtful accounts of $93,501 in 1997
and $153,501 in 1998 2,918,092 2,816,589
- ---------------------------------------------------------------------------------------------------------------
Investment in sales type leases, current portion 216,485 888,627
- ---------------------------------------------------------------------------------------------------------------
Inventories 4,051,495 3,129,959
- ---------------------------------------------------------------------------------------------------------------
Prepaid expenses 147,450 82,105
===============================================================================================================
Total current assets 7,476,593 6,947,284
===============================================================================================================
Property and equipment:
- ---------------------------------------------------------------------------------------------------------------
Leased machines 25,718,832 29,484,623
- ---------------------------------------------------------------------------------------------------------------
Machinery and equipment 519,388 631,111
- ---------------------------------------------------------------------------------------------------------------
Building and leasehold improvements 265,854 271,433
- ---------------------------------------------------------------------------------------------------------------
Furniture and fixtures 124,359 130,950
===============================================================================================================
26,628,433 30,518,117
Less accumulated depreciation and amortization (11,382,120) (12,970,895)
===============================================================================================================
Net property and equipment 15,246,313 17,547,222
===============================================================================================================
Investment in sales type leases, less current portion 1,051,011 3,766,408
- ---------------------------------------------------------------------------------------------------------------
Product development rights, net of accumulated amortization of $513,333 in
1997 and $586,665 in 1998 586,667 513,335
- ---------------------------------------------------------------------------------------------------------------
Deferred tax asset 252,300 --
===============================================================================================================
$ 24,612,884 28,774,249
===============================================================================================================
LIABILITIES AND STOCKHOLDERS' EQUITY
- ---------------------------------------------------------------------------------------------------------------
Current liabilities:
- ---------------------------------------------------------------------------------------------------------------
Notes payable to financial institutions $ 8,978,036 11,166,374
- ---------------------------------------------------------------------------------------------------------------
Current portion of notes payable - related parties -- 192,302
- ---------------------------------------------------------------------------------------------------------------
Current installments of long-term debt 968 --
- ---------------------------------------------------------------------------------------------------------------
Accounts payable 1,142,065 1,479,831
- ---------------------------------------------------------------------------------------------------------------
Accounts payable - related parties 328,960 215,734
- ---------------------------------------------------------------------------------------------------------------
Accrued expenses 1,254,182 1,111,416
- ---------------------------------------------------------------------------------------------------------------
Income taxes payable 100,450 248,458
===============================================================================================================
Total current liabilities 11,804,661 14,414,115
===============================================================================================================
Notes payable - related parties, excluding current portion 479,000 286,698
- ---------------------------------------------------------------------------------------------------------------
Deferred income taxes -- 121,900
===============================================================================================================
Total liabilities 12,283,661 14,822,713
===============================================================================================================
Series A preferred stock, $.01 par value; 20,000,000 shares authorized,
1,335,000 shares issued and outstanding 1,335,000 1,335,000
===============================================================================================================
Stockholders' equity:
- ---------------------------------------------------------------------------------------------------------------
Common stock, $.01 par value; 20,000,000 shares authorized,
3,210,000 shares issued and outstanding in 1997 and 1998 32,100 32,100
- ---------------------------------------------------------------------------------------------------------------
Additional paid-in capital 10,376,017 10,376,017
- ---------------------------------------------------------------------------------------------------------------
Retained earnings 586,106 2,208,419
===============================================================================================================
Total stockholders' equity 10,994,223 12,616,536
- ---------------------------------------------------------------------------------------------------------------
Commitments and contingent liabilities
- ---------------------------------------------------------------------------------------------------------------
$ 24,612,884 28,774,249
===============================================================================================================
See accompanying notes to financial statements.
</TABLE>
10
<PAGE> 14
STATEMENTS OF INCOME
<TABLE>
<CAPTION>
Years Ended December 31,
--------------------------------------------
1996 1997 1998
- ------------------------------------------------------------------------------------------------
<S> <C> <C> <C>
Revenues:
- ------------------------------------------------------------------------------------------------
Machine sales $ 5,596,698 4,567,441 8,229,950
- ------------------------------------------------------------------------------------------------
Machine leases 11,766,623 12,874,450 14,165,379
- ------------------------------------------------------------------------------------------------
Other 1,235,368 1,669,160 2,078,644
================================================================================================
18,598,689 19,111,051 24,473,973
================================================================================================
Cost of revenues:
- ------------------------------------------------------------------------------------------------
Machines sales and other 6,052,763 4,378,669 5,809,057
- ------------------------------------------------------------------------------------------------
Machine leases 6,583,227 7,508,261 10,310,565
================================================================================================
12,635,990 11,886,930 16,119,622
================================================================================================
Gross margin 5,962,699 7,224,121 8,354,351
- ------------------------------------------------------------------------------------------------
Operating expenses:
- ------------------------------------------------------------------------------------------------
Selling, general and administrative expenses 3,461,364 3,492,020 4,048,751
- ------------------------------------------------------------------------------------------------
Research and development costs 665,449 545,039 618,819
================================================================================================
4,126,813 4,037,059 4,667,570
================================================================================================
Operating income 1,835,886 3,187,062 3,686,781
================================================================================================
Other income (expense)
- ------------------------------------------------------------------------------------------------
Interest expense (718,642) (747,008) (967,768)
- ------------------------------------------------------------------------------------------------
Interest income 10,353 -- --
================================================================================================
(708,289) (747,008) (967,768)
================================================================================================
Income before income taxes 1,127,597 2,440,054 2,719,013
- ------------------------------------------------------------------------------------------------
Income taxes (193,000) 988,400 1,096,700
================================================================================================
Net income $ 1,320,597 1,451,654 1,622,313
================================================================================================
Basic income per share $ .41 .45 .51
================================================================================================
Diluted income per share $ .41 .45 .50
================================================================================================
See accompanying notes to financial statements.
</TABLE>
STATEMENTS OF STOCKHOLDERS' EQUITY
<TABLE>
<CAPTION>
Years ended December 31, 1996, 1997 and 1998
- ----------------------------------------------------------------------------------------------------------------------
Common Stock Additional (Accumulated
------------------------ Paid-in Deficit)
Shares Amount Capital Retained Earnings Total
------ ------ ------- ----------------- -----
<S> <C> <C> <C> <C> <C>
- ----------------------------------------------------------------------------------------------------------------------
Balances at December 31, 1995 3,210,000 $32,100 $10,376,017 $(2,186,145) $ 8,221,972
- ----------------------------------------------------------------------------------------------------------------------
Net income -- -- -- 1,320,597 1,320,597
======================================================================================================================
Balances at December 31, 1996 3,210,000 32,100 10,376,017 (865,548) 9,542,569
- ----------------------------------------------------------------------------------------------------------------------
Net income -- -- -- 1,451,654 1,451,654
======================================================================================================================
Balances at December 31, 1997 3,210,000 32,100 10,376,017 586,106 10,994,223
- ----------------------------------------------------------------------------------------------------------------------
Net income -- -- -- 1,622,313 1,622,313
======================================================================================================================
Balances at December 31, 1998 3,210,000 $32,100 $10,376,017 $ 2,208,419 $12,616,536
======================================================================================================================
See accompanying notes to financial statements
</TABLE>
11
<PAGE> 15
STATEMENTS OF CASH FLOWS
<TABLE>
<CAPTION>
Years Ended December 31,
---------------------------------------
1996 1997 1998
- ----------------------------------------------------------------------------------------------------------
<S> <C> <C> <C>
Cash flows from operating activities:
- ----------------------------------------------------------------------------------------------------------
Net income $ 1,320,597 1,451,654 1,622,313
- ----------------------------------------------------------------------------------------------------------
Adjustments to reconcile net income to net
cash provided by operating activities:
- ----------------------------------------------------------------------------------------------------------
Depreciation and amortization 3,902,387 4,143,408 4,585,325
- ----------------------------------------------------------------------------------------------------------
Principal portion of sales type leases received -- 164,194 557,116
- ----------------------------------------------------------------------------------------------------------
Deferred income taxes (456,000) 203,700 374,200
- ----------------------------------------------------------------------------------------------------------
Gain on sale of equipment under sales type leases -- (447,915) (1,177,773)
- ----------------------------------------------------------------------------------------------------------
Decrease in accounts receivable 607,423 298,927 101,503
- ----------------------------------------------------------------------------------------------------------
(Increase) decrease in inventories (605,391) 1,035,052 1,110,268
- ----------------------------------------------------------------------------------------------------------
Decrease in prepaid expenses 183,152 6,804 32,345
- ----------------------------------------------------------------------------------------------------------
(Decrease) increase in accounts payable (100,288) 217,852 337,766
- ----------------------------------------------------------------------------------------------------------
(Decrease) increase in accounts payable - related parties 306,416 22,431 (113,226)
- ----------------------------------------------------------------------------------------------------------
(Decrease) increase in accrued expenses 206,216 186,650 (142,766)
- ----------------------------------------------------------------------------------------------------------
Increase (decrease) in income taxes payable 101,750 (1,300) 148,008
==========================================================================================================
Net cash provided by operating activities 5,466,262 7,281,457 7,435,079
==========================================================================================================
Cash flows from investing activities:
- ----------------------------------------------------------------------------------------------------------
Cost of leased machines (3,904,534) (8,710,315) (9,611,623)
- ----------------------------------------------------------------------------------------------------------
Purchases of property and equipment (47,858) (359,521) (123,893)
==========================================================================================================
Net cash used in investing activities (3,952,392) (9,069,836) (9,735,516)
==========================================================================================================
Cash flows from financing activities:
- ----------------------------------------------------------------------------------------------------------
Increase (decrease) in notes payable (1,320,985) 1,747,865 2,188,338
- ----------------------------------------------------------------------------------------------------------
Repayments of long-term debt (4,659) (5,001) (968)
- ----------------------------------------------------------------------------------------------------------
Net cash provided by (used in) financing activities (1,325,644) 1,742,864 2,187,370
==========================================================================================================
Decrease (increase) in cash 188,226 (45,515) (113,067)
- ----------------------------------------------------------------------------------------------------------
Cash at beginning of year 360 188,586 143,071
==========================================================================================================
Cash at end of year $ 188,586 143,071 30,004
==========================================================================================================
Supplemental disclosures of cash flow information:
- ----------------------------------------------------------------------------------------------------------
Interest paid $ 643,822 671,515 902,252
- ----------------------------------------------------------------------------------------------------------
Income taxes paid $ -- 631,610 526,807
==========================================================================================================
See accompanying notes to financial statements.
</TABLE>
12
<PAGE> 16
NOTES TO FINANCIAL STATEMENTS
Years ended December 31, 1996, 1997, and 1998
1. Summary of Significant Accounting Policies
a. Business Description
Interlott Technologies, Inc. (the Company), as renamed in June
1997 (formerly International Lottery, Inc.) was incorporated
in February 1990 under the laws of Ohio, was reincorporated
under the laws of Delaware on March 18, 1994 and does business
under the name Interlott. The Company designs, manufactures,
leases, sells and services vending machines for use in
connection with public lotteries operated by states and
foreign public entities, as well as for use by providers of
prepaid telephone cards.
b. Operating and Sales Type Leases
Depending on the specific terms contained in a lease
agreement, a lease is either classified as an operating lease
or capitalized as a sales type lease, in accordance with
Statement of Financial Accounting Standards (SFAS) No. 13,
Accounting for Leases, as amended.
The net investment in operating leases consists of leased
machines, which are carried at cost, less the amount
depreciated to date. Operating lease revenue consists of the
contractual lease payments and is recognized ratably over the
lease term. Expenses are principally depreciation and
maintenance of the leased machines (see Note 1d).
The net investment in sales type leases consists of the
present values of the future minimum lease payments. Sales
type lease revenues consist of the profits earned on the sales
of the leased machines and interest earned on the present
value of the lease payments. Interest revenue is recognized as
a constant percentage return on the net investment.
Any future losses related to lease cancellations would be
recorded in the period such losses became known and estimable.
c. Inventories
Inventories consist of parts and supplies, and vending
machines assembled or in the process of assembly. Inventories
are stated at the lower of cost or market, with cost
determined using standard costing which approximates the
first-in, first-out method.
d. Property and Equipment
Property and equipment are stated at cost. Depreciation of
property and equipment is calculated on the straight-line
method over the estimated useful lives of the assets, to the
Company's estimate of the assets' residual values, as follows:
<TABLE>
<S> <C>
-------------------------------------------------------------
Leased machines 5 years
Machinery and equipment 10 years
Furniture and fixtures 5 years
-------------------------------------------------------------
</TABLE>
Leasehold improvements are amortized on the straight-line
method over the lease term. Amortization of assets held under
leasehold improvements is included with depreciation expense.
e. Product Development Rights
Product development rights represent the exclusive rights to
certain patents and other related manufacturing technologies
to manufacture and assemble the instant ticket vending
machines. The asset is amortized on the straight-line method
over fifteen years, which represents the lower of the
remaining life of the patents or the estimated remaining life
of the technology currently in use. The Company assesses the
recoverability of this intangible asset by determining whether
the amortization of the asset balance over its remaining life
can be recovered through undiscounted future cash flows of the
Company. The amount of the asset impairment, if any, is
measured based on projected discounted operating cash flows
using a discount rate reflecting the Company's average cost of
funds. The assessment of the recoverability of the asset will
be impacted if estimated future operating cash flows are not
achieved.
f. Income Taxes
The Company accounts for income taxes using the asset and
liability method. In accordance with this method, deferred tax
assets and liabilities are recognized for the future tax
consequences attributable to differences between the financial
statement carrying amounts of existing assets and liabilities
and their respective tax bases and operating loss and tax
credit carryforwards. Deferred tax assets and liabilities are
measured using the enacted tax rates expected to apply to
taxable income in the years in which those temporary
differences are expected to be recovered or settled. Under
this method, the effect on deferred tax assets and liabilities
of a change in tax rates is recognized in income in the period
that includes the rate change enactment date.
g. Disclosure About Fair Value of Financial Instruments
SFAS No. 107, Disclosure About Fair Value of Financial
Instruments, defines the fair value of a financial instrument
as the amount at which the instrument could be exchanged in a
current transaction between willing parties. The carrying
amounts as of December 31, 1998 of cash, accounts receivable,
accounts payable, accounts payable - related parties, accrued
expenses and income taxes payable approximate fair value due
to the short maturity of these investments. The carrying
amount of notes payable to financial institutions and notes
payable - related parties approximate fair value, as such
borrowings bear interest at the Company's current rates for
such types of instruments.
h. Stock Incentive Plans
Prior to January 1, 1996, the Company accounted for its stock
incentive plans in accordance with the provisions of
Accounting Principles Board (APB) Opinion No. 25, Accounting
for Stock Issued to Employees, and related interpretations. As
such, compensation expense would be recorded on the date of
grant only if the current market price of the underlying stock
exceeded the exercise price. On January 1, 1996, the Company
adopted SFAS No. 123, Accounting for Stock-Based Compensation,
which permits entities to recognize as expense over the
vesting period the fair value of all stock-based awards on the
date of grant. Alternatively, SFAS No. 123 also allows
entities to continue to apply the provisions of APB Opinion
No. 25 and provide pro forma net income and pro forma income
per share disclosures for employee stock option grants made in
1995 and future years as if the fair-value-based method
defined in SFAS No. 123 had been applied. The Company has
elected to continue to apply the provisions of APB Opinion No.
25 and provide the pro forma disclosure provisions of SFAS No.
123.
i. Warranty Costs
Provision for estimated warranty costs on machines sold is
recorded at the time of sale and periodically adjusted to
reflect actual experience.
j. Research and Development Costs
Research and development costs are charged to expense in the
year incurred.
k. Income Per Share
Effective December 31, 1997, the Company adopted SFAS No. 128,
Earnings Per Share, which simplified the standards for
computing income per share. There was no material impact on
the Company's previously reported annual or interim period
income per share amounts, as a result of the adoption. Basic
income per share is based upon the weighted average number of
common shares outstanding. Diluted income per share is based
upon the weighted average number of common shares outstanding,
including the effects of all dilutive potential common shares
outstanding.
l. Use of Estimates
Management of the Company has made a number of estimates and
assumptions relating to the reporting of assets and
liabilities and the disclosure of contingent liabilities to
prepare these financial statements in conformity with
generally accepted accounting principles. Actual results could
differ from those estimates.
m. Reclassifications
Certain prior year amounts have been reclassified to conform
with the current year presentation.
2. Investment in Sales Type Leases The Company leases 200 instant ticket
vending machines (ITVMs) to one state lottery under a sales type lease
that commenced in May 1997 and 585 ITVMs to another state lottery under
a sales type lease that commenced in May 1998. The components of the
net investment in sales type leases at December 31, 1997 and 1998 are
as follows:
13
<PAGE> 17
<TABLE>
<CAPTION>
1997 1998
---------------------------------------------------
<S> <C> <C>
Minimum lease
payments receivable $1,851,200 6,134,450
Less unearned
revenue on lease
payments receivable 583,704 1,479,415
---------------------------------------------------
1,267,496 4,655,035
Less current portion 216,485 888,627
---------------------------------------------------
Investment in sales
type leases, less
current portion $1,051,011 3,766,408
---------------------------------------------------
</TABLE>
Future minimum lease payments to be received by the Company under these
sales type leases are as follows:
<TABLE>
<CAPTION>
Years ending December 31,
----------------------------------------
<S> <C>
1999 $1,480,200
2000 1,480,200
2001 1,480,200
2002 1,195,400
2003 498,450
----------------------------------------
$6,134,450
----------------------------------------
</TABLE>
3. Inventories
Inventories at December 31, 1997 and 1998 consist of the following:
<TABLE>
<CAPTION>
1997 1998
----------------------------------------------
<S> <C> <C>
Finished goods $1,155,808 1,528,656
Work in process 82,162 302,766
Raw materials
and supplies 3,088,525 2,506,647
4,326,495 4,338,069
----------------------------------------------
Less valuation reserve 275,000 1,208,110
----------------------------------------------
$4,051,495 3,129,959
----------------------------------------------
</TABLE>
4. Leased Machines
At December 31, 1997 and 1998, the Company leased 6,834 and 7,027 ITVMs
to 14 state lotteries, respectively, under operating leases. The leases
generally provide for the lotteries to make monthly or quarterly
payments for rentals of the ITVMs over various lease terms. The
components of the net investment in operating leases, which include
estimated residual values, at December 31, 1997 and 1998 are as
follows:
<TABLE>
<CAPTION>
1997 1998
---------------------------------------------
<S> <C> <C>
Leased machines $25,718,832 29,484,623
Less accumulated
depreciation 10,978,370 12,378,732
---------------------------------------------
$14,740,462 17,105,891
---------------------------------------------
</TABLE>
Future minimum lease payments to be received by the Company under
operating leases are as follows:
<TABLE>
<CAPTION>
Years ending December 31,
------------------------------------------
<S> <C>
1999 $ 9,357,250
2000 3,558,582
2001 963,792
2002 963,792
2003 375,000
-------------------------------------------
$15,218,416
-------------------------------------------
</TABLE>
5. Notes Payable
The Company had a revolving credit facility with a financial
institution that permitted the Company to borrow through September 1998
up to $12,500,000 at the prime interest rate plus 1.0%. Draws against
this facility were made in the form of demand notes. The Company paid
an annual commitment fee of .25% on the unused portion of the
commitment and a monthly usage fee equal to .25% of the highest
outstanding balance during each month. Borrowings under this agreement
were collateralized by all assets of the Company and assignment of
proceeds from lease agreements. This borrowing was retired with
proceeds from the new borrowing entered into in October 1997.
In October 1997, the Company entered into a new revolving credit
facility with a financial institution that permits the Company to
borrow through October 2000 up to $15,000,000 at a floating rate
indexed to the London Interbank Borrowing Offer Rate or the financial
institutions prime interest rate of 5.63% and 7.75%, respectively at
December 31, 1998. In conjunction with the establishment of the
facility, the Company opened a lockbox and controlled disbursement
account. All lockbox receipts are recorded as payments against the
facility, and presented checks are recorded as draws on the facility.
Borrowings under this credit facility are collateralized by all assets
of the Company and assignment of proceeds from lease agreements. At
December 31, 1997 and 1998, the Company had borrowings of $8,978,036
and $11,166,374 outstanding with additional borrowings of $6,021,964
and $3,833,626 available under the facility, respectively.
6. Long-Term Debt
Long-term debt at December 31, 1997 represented a term note payable to
a bank with final payment due February 20, 1998, payable in monthly
installments of $448, including interest at a rate of 7.99% per annum.
The note was collateralized by automotive equipment and was repaid in
1998.
7. Notes Payable - Related Parties
The Company has the following notes payable to related parties at
December 31, 1997 and 1998:
<TABLE>
<CAPTION>
1997 1998
----------------------------------------------------------------------
<S> <C> <C>
Note payable to a stockholder due in annual
installments equal to twenty-five percent
(25%) of the net profits, if any, of the
Company from its business operations as
reported in the Company's annual financial
statements prepared in accordance with
generally accepted accounting principles.
The payments shall begin on the first
business day of the fourth month of the
Company's fiscal year, for income tax
purposes, immediately following (1) the
payment of all debts of the Company
outstanding as of September 25, 1992 and (2)
the posting by the Company of retained
earnings of at least $1,000,000 determined
in accordance with generally accepted
accounting principles, and continue on the
same day each year until the principal and
unpaid interest is paid in full. The note
bears interest at the prime rate of Chase
Manhattan Bank of New York (7.75% at
December 31, 1998). The note is unsecured. $400,000 400,000
Note payable to a stockholder due and
limited to twenty-five percent (25%) of the
net profits of the Company, if any, from its
business operations as reported in the
Company's annual financial statements
prepared in accordance with generally
accepted accounting principles. The payments
shall begin on the first business day of the
fourth month of the Company's first year,
for income tax purposes, immediately
following (1) the payments of all debts of
the Company outstanding as of September 25,
1992; (2) the posting by the Company of
retained earnings of at least $1,000,000
determined in accordance with generally
accepted accounting principles; and (3)
payment in full of principal and interest
due by the Company to a stockholder in the
amount of $400,000. The note does not
provide for any interest and is unsecured. 79,000 79,000
----------------------------------------------------------------------
479,000 479,000
Less current portion - 192,302
----------------------------------------------------------------------
$479,000 286,698
----------------------------------------------------------------------
</TABLE>
14
<PAGE> 18
8. Income Taxes
Income tax expense (benefit) is summarized as follows:
<TABLE>
<CAPTION>
Year ended December 31,
---------------------------------------------------
1996 1997 1998
---------------------------------------------------
<S> <C> <C> <C>
Current:
Federal $ 200,000 557,400 566,000
State and
local 63,000 156,000 156,500
Deferred:
State and
local (456,000) 275,000 374,200
---------------------------------------------------
$(193,000) 988,400 1,096,700
---------------------------------------------------
</TABLE>
A reconciliation of income tax expense (benefit) in relation to the
amounts computed by application of the U.S. Federal income tax rate of
34% to pretax income follows:
<TABLE>
<CAPTION>
1996 1997 1998
-----------------------------------------------------------------------
<S> <C> <C> <C>
Federal
income tax
expense at
the statutory
rate $383,000 830,000 924,400
Increase (reduction) in income taxes resulting from:
Change in
the beginning-
of-the-year
balance of
the valuation
allowance
for the
deferred tax
assets
allocated to
income tax
expense (672,000) -
Amortization
of product
development
rights 25,000 25,000 25,000
State and
local taxes,
net of federal
benefit 63,000 103,000 103,300
Other 8,000 30,400 44,000
-----------------------------------------------------------------------
$(193,000) 988,400 1,096,700
-----------------------------------------------------------------------
</TABLE>
The tax effects of temporary differences that give rise to significant
portions of the deferred tax assets and deferred tax liabilities at
December 31, 1997 and 1998 are presented below:
<TABLE>
<CAPTION>
1997 1998
----------------------------------------------------------------------
<S> <C> <C>
Deferred tax assets:
Bad debt allowance $ 32,000 52,200
Warranty costs 9,000 10,100
Net operating
loss carryforwards 400,000 347,100
Inventory valuation reserve -- 317,300
Other, net 73,300 --
----------------------------------------------------------------------
Total gross deferred
tax assets 514,300 726,700
----------------------------------------------------------------------
Deferred tax liabilities:
Property and equipment,
principally due
to differences
in depreciation 127,000 537,800
Investment in
sales type leases 135,000 310,800
----------------------------------------------------------------------
Total gross deferred
tax liabilities 262,000 848,600
----------------------------------------------------------------------
Net deferred tax
assets (liabilities) $252,300 (121,900)
----------------------------------------------------------------------
</TABLE>
In assessing the realizability of deferred tax assets, management
considers whether it is more likely than not that some portion or all
of the deferred tax assets will not be realized. The ultimate
realization of deferred tax assets is dependent upon the generation of
future taxable income during the periods in which those temporary
differences become deductible. Management considers the scheduled
reversal of deferred tax liabilities, projected future income and tax
planning strategies in making this assessment.
At December 31, 1998, the Company has net operating loss carryforwards
for Federal income tax purposes of approximately $1,021,000, which are
available to offset future Federal taxable income, if any, through
2009. However, due to an ownership change on September 25, 1992,
utilization of these carryforwards is subject to certain annual
limitations.
9. Redeemable Preferred Stock
The Company's preferred stock is nonparticipating and has no rights to
dividends. The holders of the preferred stock are entitled to sell to
the Company all of their shares of preferred stock at a price of $1.00
per share upon (1) the payment of all debts of the Company outstanding
as of September 25, 1992, (2) the reporting by the Company of retained
earnings of at least $1,000,000 determined in accordance with generally
accepted accounting principles, and (3) the payment in full by the
Company of a promissory note in the original amount of $400,000 to a
related party. Due to the redemption feature of the preferred stock, it
has been classified separately from stockholders' equity in the
Company's balance sheet.
The Company may, at its discretion, redeem all or part of the
outstanding preferred stock at any time. The redemption price for the
preferred stock is $1.00 per share and may be payable in the form of a
promissory note.
10. Stock Incentive Plans
In March 1994, the Company and its Board of Directors approved and
adopted the Company's 1994 Stock Incentive Plan and the Company's 1994
Directors' Stock Incentive Plan (collectively, the Plans), which became
effective at the date of the initial public offering. The Plans provide
for the issuance of stock options for up to 260,000 shares of common
stock to officers, employees, consultants and other supporters of the
Company and up to 60,000 shares of common stock to nonemployee
directors of the Company. Stock options are granted with an exercise
price equal to the stock's fair market value at the date of grant.
Options may be exercised subject to a vesting schedule which provides
for vesting each year for a period of four years subject to the
recipient's continued employment or service to the Company, and must be
exercised within 10 years after the date of grant.
As permitted by SFAS No. 123, the Company applies the intrinsic value
method prescribed by APB Opinion No. 25 and related interpretations in
accounting for its stock option plans. Accordingly, no compensation
cost has been recognized in the accompanying statements of income.
A summary of the status of the Company's stock option plans as of
December 31, 1996, 1997, and 1998 and the changes therein for the years
then ended is presented below:
<TABLE>
<CAPTION>
1996 1997 1998
---------------------------------------------------------------------------------
Weighted Weighted Weighted
Average Average Average
Exercise Exercise Exercise
Shares Price Shares Price Shares Price
---------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C>
Outstanding at
beginning
of year 131,725 $ 9.66 147,225 $ 9.38 180,875 $ 9.12
Granted 15,500 7.00 37,000 8.00 36,300 6.75
Exercised -- -- -- -- -- --
Forfeited -- -- 3,350 11.50 5,000 11.50
---------------------------------------------------------------------------------
Outstanding at
end of year 147,225 9.38 180,875 9.12 212,175 8.65
Options
exercisable
at year-end 49,926 10.05 79,660 9.77 120,794 9.48
---------------------------------------------------------------------------------
Weighted-average
fair value of
options granted
during the year $ 5.11 $ 5.82 $ 5.16
---------------------------------------------------------------------------------
</TABLE>
Had compensation cost for options granted during 1996, 1997 and 1998 been
determined consistent with the fair value methodology of SFAS No. 123, the
Company's net income and income per share would have been reduced to the pro
forma amounts presented below:
<TABLE>
<CAPTION>
1996 1997 1998
-------------------------------------------------------------------------
<S> <C> <C> <C>
Net income
As reported $ 1,320,597 1,451,654 1,622,313
Pro forma 1,307,807 1,324,003 1,511,265
-------------------------------------------------------------------------
Basic income per share
As reported .41 .45 .51
Pro forma .41 .41 .47
-------------------------------------------------------------------------
Diluted income per share
As reported .41 .45 .50
Pro forma .41 .41 .47
-------------------------------------------------------------------------
</TABLE>
The full impact of calculating compensation cost for stock options
under SFAS No. 123 is not reflected in the pro forma net income amounts
presented above because compensation cost is recognized over the
options' vesting period of four years and compensation cost for options
granted prior to January 1, 1995 is not considered.
The fair value of options granted during 1996, 1997 and 1998 for
purposes of the accompanying pro forma disclosures is estimated on the
grant date using the Black-Scholes option-pricing model with the
following weighted-average assumptions: no
15
<PAGE> 19
dividends paid, as it has been the Company's policy not to declare or
pay dividends since its initial public offering in 1994 and the Company
does not anticipate paying dividends in the foreseeable future;
expected volatility of 52%, 56% and 65%, respectively, based on the
calculated volatility of the Company's stock since its initial public
offering; risk-free rates of return of 6.66%, 5.86% and 4.98%,
respectively; and expected lives of 10 years.
Information about stock options outstanding at December 31, 1998 is as
follows:
<TABLE>
<CAPTION>
Options Outstanding Options Exercisable
------------------------------------------------------------------------------------------
Range Weighted-Avg.
of Remaining Weighted-Avg. Weighted-Avg.
Exercise Number Contractual Exercise Number Exercisable
Prices Outstanding Life Price Exercisable Price
------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C>
6.50 - 8.63 165,550 7.75 $ 7.86 76,813 $ 8.33
10.13 - 11.50 46,625 5.53 11.43 44,125 11.50
------------------------------------------------------------------------------------------
212,175 7.26 $ 8.65 120,938 $ 9.49
==========================================================================================
</TABLE>
11. Income Per Share
The computations of basic and diluted income per share for each year
are as follows:
<TABLE>
<CAPTION>
----------------------------------------------------------------------------
Net Per
Earnings Shares Share
1996 (Numerator) (Denominator) Amount
----------------------------------------------------------------------------
<S> <C> <C> <C>
Basic income per share:
Net income available to
common stockholders $1,320,597 3,210,000 0.41
----------------------------------------------------------------------------
Diluted income per share:
Effect of dilutive
securities stock options -- 2,000
Net income available to
common stockholders and
assumed conversions 1,320,597 3,212,000 0.41
----------------------------------------------------------------------------
1997
----------------------------------------------------------------------------
Basic income per share:
Net income available to
common stockholders 1,451,654 3,210,000 0.45
----------------------------------------------------------------------------
Diluted income per share:
Effect of dilutive
securities stock options -- 2,661
Net income available to
common stockholders and
assumed conversions 1,451,654 3,212,661 0.45
----------------------------------------------------------------------------
1998
----------------------------------------------------------------------------
Basic income per share:
Net income available to
common stockholders 1,622,313 3,210,000 0.51
----------------------------------------------------------------------------
Diluted income per share:
Effect of dilutive
securities stock options -- 10,649
Net income available to
common stockholders and
assumed conversions 1,622,313 3,220,649 0.50
----------------------------------------------------------------------------
</TABLE>
Options to purchase 49,975, 129,725 and 52,475 shares of common stock
were outstanding in 1996, 1997 and 1998, respectively, but were not
included in the computation of diluted income per share because the
options' exercise prices were greater than the average market price of
common shares.
12. Noncash Investing Activities
Upon lease expiration in 1998, one state lottery returned to the
Company leased machines with a net book value of $442, 897. The Company
used parts from these returned machines in the manufacturing of
recertified new machines. Some of the recertified new machines were
deployed in 1998 under new leases.
13. Related Party Transactions
Accounts payable - related parties is $328,960 and $215,734 at December
31, 1997 and 1998, respectively, and represent management fees and
expenses payable to a company owned 100% by the majority stockholder
and parts expenses payable to an entity which is owned by a director.
Amounts expensed related to the company owned by the majority
stockholder were $73,321, $36,000 and $36,000 for the years ended
December 31, 1996, 1997 and 1998, respectively.
The entity owned by a director supplies the Company with certain parts
for its dispensing mechanisms. In addition, on January 13, 1994, the
Company entered into a manufacturing and license agreement with this
entity pursuant to which the Company purchased an exclusive license to
make, use and sell pull-tab lottery ticket dispensing mechanisms
produced by this entity. The Company had purchases from this entity
which were charged to cost of revenues of approximately $1,986,000,
$2,996,000 and $3,800,887 for the years ended December 31, 1996, 1997
and 1998, respectively.
Interest expense arising from notes payable-related parties amounted to
$33,085, $33,714 and $33,401 for the years ended December 31, 1996,
1997 and 1998, respectively.
14. Customer and Supplier Concentrations
A significant portion of the Company's revenues is derived from a
limited number of state lottery authorities or their representatives
for the lease, sale or service of ITVMs. For the years ended December
31, 1996, 1997 and 1998, one customer generated 45%, 29% and 24%,
respectively, of the machine lease revenues. In addition, single state
contracts generated 69%, 32% and 48% of the machine sales revenues for
the years ended December 31, 1996, 1997 and 1998, respectively. Future
revenue from machine sales is dependent upon the Company winning awards
in a competitive bidding process.
The Company currently purchases certain components used in its vending
machines, including components used in its burster mechanism and its
bill acceptor mechanism, from single suppliers.
The purchase of components from outside suppliers on a sole source
basis subjects the Company to certain risks, including the continued
availability of suppliers, price increases and potential quality
assurance problems. Because other suppliers exist that can duplicate
these components should the Company elect or be forced to use a
different supplier, the Company does not believe that any such change
in suppliers would result in the termination of a production contract.
However, the Company could experience a delay of 30 to 60 days in the
production of vending machines should it elect or be forced to use
other suppliers for these components. Any delay of more than 30 to 60
days could adversely affect the Company's ability to make timely
deliveries of vending machines and to obtain new contracts.
15. Lease Commitments
The Company leases its office, manufacturing and warehouse facilities
under noncancelable operating leases. The leases expire on December 31,
1999, and require lease payments of $50,000, $91,000 and $69,000 a
year, respectively, through expiration. Total rent expense under these
leases approximated $91,000, $141,000 and $210,000, for the years ended
December 31, 1996, 1997 and 1998, respectively.
16. Segment and Related Information
Effective January 1, 1998, the Company adopted SFAS No. 131,
Disclosures About Segments of an Enterprise and Related Information,
which changes the way the Company reports information about its
operating segments. The Company has two reportable segments: ITVMs and
prepaid phone card dispensing machines (PCDMs). The ITVM segment is the
larger of the Company's two segments. The Company designs,
manufactures, sells, leases and services ITVMs that are used by public
lotteries operated by states and foreign public entities to dispense
instant winner lottery tickets primarily in retail locations such as
supermarkets and convenience stores. Within the PCDM segment, the
Company designs, manufactures, sells, leases and services PCDMs that
are used by providers of long distance telephone service to dispense
prepaid telephone calling cards in retail locations.
The accounting policies of the segments are the same as those described
in the summary of significant accounting policies. The Company
evaluates performance based on segment operating profits.
<TABLE>
<CAPTION>
ITVM PCDM Total
----------------------------------------------------------------------
1996
<S> <C> <C> <C>
Revenues $18,179,353 419,336 18,598,689
Segment gross margin 5,915,851 46,848 5,962,699
Total assets 19,158,006 745,958 19,903,964
Capital expenditures 3,902,041 2,493 3,904,534
Depreciation 3,734,696 9,369 3,744,065
----------------------------------------------------------------------
1997
Revenues 18,586,960 524,091 19,111,051
Segment gross margin 7,133,182 90,939 7,224,121
Total assets 23,105,044 459,168 23,564,212
Capital expenditures 8,661,022 49,293 8,710,315
Depreciation 3,910,146 14,098 3,924,244
----------------------------------------------------------------------
1998
Revenues 23,965,442 508,531 24,473,973
Segment gross margin 8,310,947 43,404 8,354,351
Total assets 27,478,447 742,362 28,220,809
Capital expenditures 9,486,255 125,368 9,611,623
Depreciation 4,231,700 58,428 4,290,128
----------------------------------------------------------------------
</TABLE>
Total assets for the segments excludes cash, prepaid expenses, net
property and equipment other than leased machines and deferred tax
assets, as such assets are not specifically identifiable to a
particular segment.
17. Commitments and Contingent Liabilities As of December 31, 1998, the
Company had outstanding purchase commitments for raw materials of
approximately $4,368,184, of which $4,050,184 and $318,000 will be used
in the manufacturing of instant ticket and prepaid telephone card
vending machines, respectively. Management intends to utilize these
commitments as machines are produced.
16
<PAGE> 20
Photo of world with
a finger pushing button
on it
Placing products and information at a fingertip-
<PAGE> 21
CORPORATE DATA & SHAREHOLDER INFORMATION
HEADQUARTERS
Interlott Technologies, Inc.
10830 Millington Court
Cincinnati, OH 45242
(513) 792-7000
INVESTOR INQUIRIES
Chief Financial Officer
10830 Millington Court
Cincinnati, OH 45242
(513) 792-7000
REGISTRAR AND TRANSFER AGENT
First Union National Bank
230 South Tryon Street
Charlotte, NC 28288-1154
CORPORATE COUNSEL
Alston & Bird LLP
Atlanta, Georgia
Taft, Stettinius & Hollister LLP
Cincinnati, Ohio
INDEPENDENT AUDITORS
KPMG Peat Marwick LLP
Cincinnati, OH
OFFICERS
L. Rogers Wells, Jr.
Chairman of the Board and CEO
David F. Nichols
President
Gary S. Bell
Secretary
Thomas W. Stokes
Vice President of Operations
Dennis W. Blazer
Chief Financial Officer
DIRECTORS
L. Rogers Wells, Jr.
Chairman of the Board and CEO
Edmund F. Turek
Board Member
Gary S. Bell
Secretary
Kazmier J. Kasper
President, Algonquin Industries, Inc.
a manufacturer of metal and machined parts
H. Jean Marshall
Project Director for the City of Cincinnati
David F. Nichols
President
John J. Wingfield
Manager, A. G. Edwards & Sons, Inc., Louisville
an investment banking company
The Company's Common Stock has been traded on the American Stock Exchange under
the symbol "ILI" since the Company's initial public offering of Common Stock in
April 1994. Prior to the initial public offering, there was no established
trading market for the Company's Common Stock. The following tables show the
high and low closing sale prices per share for the Common Stock as reported by
the American Stock Exchange for the periods indicated:
<TABLE>
<CAPTION>
1997 HIGH LOW
==============================================
<S> <C> <C>
First Quarter $ 8 1/8 6 5/8
- ----------------------------------------------
Second Quarter 8 1/4 6 1/2
- ----------------------------------------------
Third Quarter 10 11/16 6 7/8
- ----------------------------------------------
Fourth Quarter 10 5/8 7 5/8
</TABLE>
<TABLE>
<CAPTION>
1998 HIGH LOW
==============================================
<S> <C> <C>
First Quarter $ 9 3/4 7 3/4
- ----------------------------------------------
Second Quarter 14 9 5/8
- ----------------------------------------------
Third Quarter 10 3/4 7 7/8
- ----------------------------------------------
Fourth Quarter 8 1/8 6 1/2
==============================================
</TABLE>
At March 12,1998, there were approximately 68 stockholders of record and an
unknown number of beneficial owners holding stock in nominee or "street" name.
The Company has paid no cash dividends on its Common Stock and currently intends
to retain all future earnings for use in the development of its business.
Form 10-K: A copy of the Company's 1998 Annual Report on Form 10-K, as filed
with the Securities and Exchange Commission, is available, without exhibits,
free of charge to shareholders. Requests should be addressed to:
Shareholder Relations
Interlott Technologies, Inc.
10830 Millington Court
Cincinnati, OH 45242
The 1999 Annual Meeting will be held at The Holiday Inn Cincinnati North at
I-275, on May 6, 1999 at 10:00am, local time.
INTERLOTT
TECHNOLOGIES, INC.
<PAGE> 22
INTERLOTT
TECHNOLOGIES, INC.
10830 Millington Court
Cincinnati, OH 45242
Phone 513.792.7000
Fax 513.792.7001
www.interlott.com
<PAGE> 1
EXHIBIT 23
Consent of Independent Auditors
The Board of Directors and Stockholders
Interlott Technologies, Inc.:
We consent to incorporation by reference in the Registration Statement No.
333-08999 on Form S-3 of Interlott Technologies, Inc. of our report dated
February 26, 1999, relating to the balance sheets of Interlott Technologies,
Inc. as of December 31, 1997 and 1998, and the related statements of income,
stockholders' equity, and cash flows for each of the years in the three-year
period ended December 31, 1998, and the related schedule, which report appears
in the 1998 annual report to stockholders, which is incorporated by reference in
the December 31, 1998 Form 10-K of Interlott Technologies, Inc.
KPMG LLP
March 24, 1999
<PAGE> 1
EXHIBIT 24
POWER OF ATTORNEY
KNOW ALL MEN BY THESE PRESENT, that the undersigned constitutes and
appoints L. Rogers Wells, Jr. and Dennis W. Blazer and each of them, his true
and lawful attorneys-in-fact and agents, with full power of substitution, for
him and in his name, place and stead, in any and all capacities, to sign the
Annual Report on Form 10-K of Interlott Technologies, Inc. for the fiscal year
ended December 31, 1998, and any and all amendments thereto, and to file the
same, with all exhibits thereto and other documents in connection therewith,
with the Securities and Exchange Commission and the American Stock Exchange,
granting unto said attorneys-in-fact and agents. and each of them, full power
and authority to do and perform each and every act and thing requisite or
necessary to be done, as fully to all intents and purposes as he might or could
do in person, hereby ratifying and confirming all that said attorneys-in-fact
and agents or any of them, or their or his substitute or substitutes, may
lawfully do or cause to be done by virtue hereof.
This 25th day of March, 1999.
/s/ Gary S. Bell
-----------------------------------
Gary S. Bell
<PAGE> 2
POWER OF ATTORNEY
KNOW ALL MEN BY THESE PRESENT, that the undersigned constitutes and
appoints L. Rogers Wells, Jr. and Dennis W. Blazer and each of them, his true
and lawful attorneys-in-fact and agents, with full power of substitution, for
him and in his name, place and stead, in any and all capacities, to sign the
Annual Report on Form 10-K of Interlott Technologies, Inc. for the fiscal year
ended December 31, 1998, and any and all amendments thereto, and to file the
same, with all exhibits thereto and other documents in connection therewith,
with the Securities and Exchange Commission and the American Stock Exchange,
granting unto said attorneys-in-fact and agents. and each of them, full power
and authority to do and perform each and every act and thing requisite or
necessary to be done, as fully to all intents and purposes as he might or could
do in person, hereby ratifying and confirming all that said attorneys-in-fact
and agents or any of them, or their or his substitute or substitutes, may
lawfully do or cause to be done by virtue hereof.
This 25th day of March, 1999.
/s/ Kazmier J. Kasper
--------------------------------------------
Kazmier J. Kasper
<PAGE> 3
POWER OF ATTORNEY
KNOW ALL MEN BY THESE PRESENT, that the undersigned constitutes and
appoints L. Rogers Wells, Jr. and Dennis W. Blazer and each of them, his true
and lawful attorneys-in-fact and agents, with full power of substitution, for
him and in his name, place and stead, in any and all capacities, to sign the
Annual Report on Form 10-K of Interlott Technologies, Inc. for the fiscal year
ended December 31, 1998, and any and all amendments thereto, and to file the
same, with all exhibits thereto and other documents in connection therewith,
with the Securities and Exchange Commission and the American Stock Exchange,
granting unto said attorneys-in-fact and agents. and each of them, full power
and authority to do and perform each and every act and thing requisite or
necessary to be done, as fully to all intents and purposes as he might or could
do in person, hereby ratifying and confirming all that said attorneys-in-fact
and agents or any of them, or their or his substitute or substitutes, may
lawfully do or cause to be done by virtue hereof.
This 25th day of March, 1999.
/s/ H. Jean Marshall
--------------------------------------------
H. Jean Marshall
<PAGE> 4
POWER OF ATTORNEY
KNOW ALL MEN BY THESE PRESENT, that the undersigned constitutes and
appoints L. Rogers Wells, Jr. and Dennis W. Blazer and each of them, his true
and lawful attorneys-in-fact and agents, with full power of substitution, for
him and in his name, place and stead, in any and all capacities, to sign the
Annual Report on Form 10-K of Interlott Technologies, Inc. for the fiscal year
ended December 31, 1998, and any and all amendments thereto, and to file the
same, with all exhibits thereto and other documents in connection therewith,
with the Securities and Exchange Commission and the American Stock Exchange,
granting unto said attorneys-in-fact and agents. and each of them, full power
and authority to do and perform each and every act and thing requisite or
necessary to be done, as fully to all intents and purposes as he might or could
do in person, hereby ratifying and confirming all that said attorneys-in-fact
and agents or any of them, or their or his substitute or substitutes, may
lawfully do or cause to be done by virtue hereof.
This 25th day of March, 1999.
/s/ John J. Wingfield
--------------------------------------------
John J. Wingfield
<TABLE> <S> <C>
<ARTICLE> 5
<LEGEND>
THIS SCHEDULE CONTAINS SUMMARY FINANCIAL INFORMATION EXTRACTED FROM INTERLOTT
TECHNOLOGIES, INC. FINANCIAL STATEMENTS FOR THE PERIOD ENDED DECEMBER 31, 1998
AND IS QUALIFIED IN ITS ENTIRETY BY REFERENCE TO SUCH FINANCIAL STATEMENTS.
</LEGEND> <F1>
<MULTIPLIER> 1,000
<S> <C>
<PERIOD-TYPE> YEAR
<FISCAL-YEAR-END> DEC-31-1998
<PERIOD-END> DEC-31-1998
<CASH> 30
<SECURITIES> 0
<RECEIVABLES> 2,817
<ALLOWANCES> 0
<INVENTORY> 3,130
<CURRENT-ASSETS> 6,947
<PP&E> 30,518
<DEPRECIATION> 12,971
<TOTAL-ASSETS> 28,774
<CURRENT-LIABILITIES> 14,414
<BONDS> 287
1,335
0
<COMMON> 32
<OTHER-SE> 12,584
<TOTAL-LIABILITY-AND-EQUITY> 28,774
<SALES> 8,230
<TOTAL-REVENUES> 24,474
<CGS> 16,120
<TOTAL-COSTS> 20,787
<OTHER-EXPENSES> 0
<LOSS-PROVISION> 0
<INTEREST-EXPENSE> 968
<INCOME-PRETAX> 2,719
<INCOME-TAX> 1,097
<INCOME-CONTINUING> 1,622
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> 1,622
<EPS-PRIMARY> 0.51
<EPS-DILUTED> 0.50
<FN>
<F1> AMOUNTS INAPPLICABLE OR NOT DISCLOSED AS A SEPARATE LINE ON THE CONDENSED
BALANCE SHEETS AND STATEMENT OF OPERATIONS ARE REPORTED AS 0 HEREIN.
RECEIVABLES ARE REPORTED NET OF ALLOWANCES IN THE CONDENSED BALANCE SHEETS.
</FN>
</TABLE>
