<PAGE> 1
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-Q
(MARK ONE)
X QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE SECURITIES
------ EXCHANGE ACT OF 1934 FOR THE QUARTERLY PERIOD ENDED SEPTEMBER 30, 1996
OR
------ TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE SECURITIES
EXCHANGE ACT OF 1934 FOR THE TRANSITION PERIOD FROM TO
------- --------
COMMISSION FILE NUMBER 0-19322
-------
VIDEO LOTTERY TECHNOLOGIES, INC.
(Exact name of registrant as specified in its charter)
DELAWARE 81-0470853
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
115 PERIMETER CENTER PLACE, SUITE 911
ATLANTA, GEORGIA 30346
(Address of principal executive officers) (Zip code)
(770) 481-1800
(Registrant's telephone number, including area code)
Indicate by check mark whether the registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months (or for such shorter period that the registrant was
required to file such report(s), and (2) has been subject to such filing
requirements for the past 90 days. Yes X No
---- -----
Applicable only to issuers involved in bankruptcy proceedings during the
preceding five years:
Indicate by check mark whether the registrant has filed all documents and
reports required to be filed by Section 12, 13 or 15(d) of the Securities
Exchange Act of 1934 subsequent to the distribution of securities under a plan
confirmed by a court. Yes No
----- ------
Applicable only to corporate issuers:
Indicate the number of shares outstanding of each of the issuer's classes of
common stock, as of the latest practicable date. 10,682,109 shares of Common
Stock, $.01 par value, outstanding as of September 30, 1996.
1
<PAGE> 2
Certain statements in this Quarterly Report on Form 10-Q constitute
"forward-looking statements" within the meaning of Section 27A of the Securities
Act of 1933 and Section 21E of the Securities Exchange Act of 1934. Such
forward-looking statements involve known and unknown risks, uncertainties and
other factors which may cause the actual results, performance or achievements of
the Company, or industry results, to be materially different from any future
results, performance, or achievements expressed or implied by such
forward-looking statements. Such factors include, among others, the following:
general economic and business conditions; competitive factors in the industry,
including additional competition from existing competitors or future entrants to
the industry; social and economic conditions; local, state and federal
regulations; changes in business strategy or development plans; the Company's
indebtedness; quality of management; availability, terms and deployment of
capital; business abilities and judgment of personnel; availability of qualified
personnel; and other factors.
2
<PAGE> 3
VIDEO LOTTERY TECHNOLOGIES, INC.
AND SUBSIDIARIES
INDEX
<TABLE>
<CAPTION>
PART I. FINANCIAL INFORMATION
Page
----
ITEM 1 Financial Statements
<C> <C> <C>
Consolidated Statements of Operations
Nine Months Ended September 30, 1996 and 1995,
Three Months Ended September 30, 1996 and 1995 4
Consolidated Balance Sheets
September 30, 1996 and December 31, 1995 5
Consolidated Statement of Stockholders' Equity
Nine Months Ended September 30, 1996 6
Consolidated Statements of Cash Flows
Nine Months Ended September 30, 1996 and 1995 7
Notes to Consolidated Financial Statements 8
ITEM 2 Management's Discussion and Analysis of Financial Condition
and Results of Operations 13
PART II OTHER INFORMATION
ITEM 1 Legal Proceedings 22
ITEM 2 Changes in Securities 22
ITEM 3 Defaults Upon Senior Securities 22
ITEM 4 Submission of Matters to a Vote of Securities Holders 22
ITEM 5 Other Information 22
ITEM 6 Exhibits and Reports on Form 8-K 23
Signatures 24
</TABLE>
3
<PAGE> 4
PART I. FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
VIDEO LOTTERY TECHNOLOGIES, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
<TABLE>
<CAPTION>
Nine Months Ended Three Months Ended
September 30, September 30,
1996 1995 1996 1995
------------- ------------ ----------- -----------
<S> <C> <C> <C> <C>
REVENUES:
On-line lottery $ 65,789,607 69,343,364 20,436,532 20,303,518
Gaming machine and route operations 43,560,497 48,892,107 13,107,388 15,566,307
Wagering systems and racetrack operations 21,533,031 20,183,329 7,389,920 7,066,547
------------- ------------ ----------- -----------
Total revenues 130,883,135 138,418,800 40,933,840 42,936,372
------------- ------------ ----------- -----------
COSTS AND EXPENSES:
On-line lottery 42,596,851 44,908,241 15,235,340 13,490,928
Gaming machine and route operations 23,282,815 29,227,268 7,222,174 9,566,648
Wagering systems and racetrack operations 15,407,789 16,066,061 4,996,160 4,564,507
Selling, general and administrative 21,616,832 22,979,035 6,408,447 6,249,157
Research and development 5,062,198 7,532,546 1,938,018 2,547,611
Other charges 12,934,982 3,080,000 4,700,000 --
Depreciation and amortization 17,315,282 17,588,576 5,852,853 5,695,812
------------- ------------ ----------- -----------
Total costs and expenses 138,216,749 141,381,727 46,352,992 42,114,663
------------- ------------ ----------- -----------
Earnings (loss) from continuing operations (7,333,614) (2,962,927) (5,419,152) 821,709
------------- ------------ ----------- -----------
OTHER INCOME (EXPENSE):
Interest and other income 752,277 788,714 311,290 240,049
Interest expense (2,910,763) (2,223,782) (734,533) (1,696,932)
------------- ------------ ----------- -----------
(2,158,486) (1,435,068) (423,243) (1,456,883)
------------- ------------ ----------- -----------
Loss from continuing operations
before income taxes and extraordinary
items (9,492,100) (4,397,995) (5,842,395) (635,174)
Income tax benefit 1,197,146 1,659,054 531,637 973,821
------------- ------------ ----------- -----------
Net earnings (loss) from continuing operations (8,294,954) (2,738,941) (5,310,758) 338,647
Reversal of (provision) for loss on discontinuance
of wagering systems operations 5,482,279 (5,772,632) 5,540,939 (5,772,632)
------------- ------------ ----------- -----------
Net earnings (loss) before extraordinary items (2,812,675) (8,511,573) 230,181 (5,433,985)
Extraordinary gain, net 4,014,050 -- -- --
------------- ------------ ----------- -----------
Net earnings (loss) $ 1,201,375 (8,511,573) 230,181 (5,433,985)
============= ============ =========== ===========
Net earnings (loss) per share:
From continuing operations $ (.66) (.26) (.42) .03
From discontinued operations .44 (.54) .44 (.54)
From extraordinary items .32 -- -- --
------------- ------------ ----------- -----------
$ .10 (.80) .02 (.51)
============= ============ =========== ===========
Weighted average shares 12,594,837 10,616,511 12,594,837 10,583,544
============= ============ =========== ===========
</TABLE>
See accompanying notes to consolidated financial statements.
4
<PAGE> 5
VIDEO LOTTERY TECHNOLOGIES, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
<TABLE>
<CAPTION>
September 30, December 31,
1996 1995
---- ----
<S> <C> <C>
ASSETS
Current assets:
Cash and cash equivalents $ 785,031 1,992,667
Available-for-sale securities and restricted
short-term deposits 1,864,051 3,768,385
Accounts receivable, net 20,273,651 22,254,361
Current installments of notes receivable, net 3,611,683 2,814,814
Inventories 27,569,181 26,399,936
Prepaid expenses 1,506,162 1,261,963
Income tax refund receivable 3,787,437 2,431,068
Deferred income taxes 10,147,220 7,732,606
------------- ------------
Total current assets 69,544,416 68,655,800
------------- ------------
Property, plant and equipment 159,394,579 132,325,663
Less accumulated depreciation (75,062,309) (60,493,819)
------------- ------------
Net property, plant and equipment 84,332,270 71,831,844
------------- ------------
Restricted cash deposits 571,378 817,024
Notes receivable, excluding current installments 3,575,979 3,101,503
Goodwill, net 10,338,082 10,952,241
Intangible and other assets, net 17,187,708 10,492,573
------------- ------------
$ 185,549,833 165,850,985
LIABILITIES ============= ============
Current liabilities:
Notes payable $ 7,500,000 8,250,000
Current installments of long-term debt 11,373,533 9,588,708
Accounts payable 4,438,369 4,808,638
Due to EDS 37,176,751 10,682,000
Accrued expenses 14,419,557 15,339,707
------------- ------------
Total current liabilities 74,908,210 48,669,053
------------- ------------
Long-term debt, excluding current installments 12,314,956 12,884,564
Other liabilities -- 10,000,000
Deferred income taxes 10,560,643 7,849,206
------------- ------------
Total liabilities 97,783,809 79,402,823
------------- ------------
Commitments and contingencies
STOCKHOLDERS' EQUITY
Preferred stock, $.01 par value. Authorized 10,000,000
shares; no shares issued -- --
Series A Junior Preferred stock, $.01 par value, convertible
non-cumulative. Authorized 1,912,728 shares 19,127 19,127
Common stock, $.01 par value. Authorized 25,000,000
shares 106,821 106,821
Paid-in capital 97,284,358 97,284,358
Deferred restricted stock compensation (336,504) (452,991)
Accumulated deficit (9,307,778) (10,509,153)
------------- ------------
Total stockholders' equity 87,766,024 86,448,162
------------- ------------
$ 185,549,833 165,850,985
============= ===========
</TABLE>
See accompanying notes to consolidated financial statements.
5
<PAGE> 6
VIDEO LOTTERY TECHNOLOGIES, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENT OF STOCKHOLDERS' EQUITY
<TABLE>
<CAPTION>
- -------------------------------------------------------------------------------------------
Series A Restricted
Preferred Common Stock Total Stock-
Stock Stock Paid-in Compen- Accumu- holders'
par value par value Capital sation lated Deficit Equity
- -------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C>
December 31, $19,127 106,821 97,284,358 (452,991) (10,509,153) 86,448,162
1995
Net earnings -- -- -- -- 1,201,375 1,201,375
Amortization of
deferred
restricted stock
compensation -- -- -- 116,487 -- 116,487
------- ------- ---------- -------- ----------- ----------
September 30,
1996 $19,127 106,821 97,284,358 (336,504) (9,307,778) 87,766,024
======= ======= ========== ======== =========== ==========
- -------------------------------------------------------------------------------------------
</TABLE>
1996 SHARES ISSUED AND OUTSTANDING
<TABLE>
<CAPTION>
Series A Common
Balance Preferred Stock Stock
- ------- --------------- -----
<S> <C> <C>
Beginning and end of period 1,912,728 10,682,109
========= ==========
</TABLE>
See accompanying notes to consolidated financial statements.
6
<PAGE> 7
VIDEO LOTTERY TECHNOLOGIES, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
<TABLE>
<CAPTION>
Nine Months Ended September 30,
------------------------------
1996 1995
------------- ------------
<S> <C> <C>
CASH FLOWS FROM OPERATING ACTIVITIES:
Net earnings (loss) $ 1,201,375 (8,511,573)
Adjustments to reconcile net earnings (loss) to net
cash provided by operating activities:
(Reversal of provision) provision for loss from
discontinued operations (5,482,279) 5,772,632
Depreciation and amortization 17,315,282 17,588,576
Other charges 12,934,982 3,080,000
Extraordinary gain, net (4,014,050) --
Sales of receivables -- 1,207,501
Other, net 322 170,149
Changes in operating assets and liabilities:
Receivables, net (2,845,116) (6,329,947)
Inventories (4,108,500) 2,661,756
Prepaid expenses (244,199) (76,134)
Accounts payable 1,658,170 854,799
Due to EDS 26,494,751 (9,584,000)
Accrued expenses (5,750,242) (8,784,257)
Deferred and refundable income taxes (1,059,546) (802,898)
------------- ------------
Net cash provided (used) by continuing operating activities 36,100,950 (2,753,396)
------------- ------------
CASH FLOWS FROM INVESTING ACTIVITIES:
Capital expenditures (23,927,563) (13,061,467)
Expenditures on intangible and other noncurrent assets (9,860,223) (1,190,372)
Proceeds from sales of equipment 21,871 43,539
Change in restricted cash deposits 245,646 (395,876)
Maturities of available-for-sale securities, net of purchases 1,904,334 3,588,821
------------- ------------
Net cash used by investing activities (31,615,935) (11,015,355)
------------- ------------
CASH FLOWS FROM FINANCING ACTIVITIES:
Net (payments) proceeds from notes payable to banks (750,000) 6,100,000
Proceeds from issuance of long-term debt 4,364,424 19,086,477
Repayments of long-term debt (9,307,075) (13,162,719)
------------- ------------
Net cash (used) provided by financing activities (5,692,651) 12,023,758
------------- ------------
Net decrease in cash and cash equivalents (1,207,636) (1,744,993)
Cash and cash equivalents, beginning of period 1,992,667 3,869,749
------------- ------------
Cash and cash equivalents, end of period $ 785,031 2,124,756
============= ============
</TABLE>
See accompanying notes to consolidated financial statements.
7
<PAGE> 8
VIDEO LOTTERY TECHNOLOGIES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
a. Presentation
The consolidated financial statements include the accounts of
Video Lottery Technologies, Inc. and subsidiaries (the "Company"). All
significant intercompany balances and transactions have been eliminated
in consolidation.
The consolidated balance sheet as of September 30, 1996 and
the consolidated statements of operations and cash flows for the
three-month periods ended September 30, 1996 and 1995 and nine-months
ended September 30, 1996 and 1995, respectively, and the consolidated
statement of stockholders' equity for the nine-month period ended
September 30, 1996 have been prepared by the Company, without audit. In
the opinion of management, all adjustments (consisting of normal
recurring accruals) necessary to present fairly the financial position,
results of operations and cash flows as of and for the periods
indicated have been made. The December 31, 1995 consolidated balance
sheet was derived from consolidated financial statements audited by
KPMG Peat Marwick LLP in connection with the Company's annual audit.
Certain reclassifications, including items discussed in Note 2
regarding the reversal of certain discontinued operations, have been
made to the 1995 amounts to conform to the 1996 presentation.
b. Earnings (Loss) Per Common Share
Earnings per common share is computed by dividing net earnings
by the weighted average number of common shares outstanding and the
common stock equivalents of convertible preferred stock and stock
options outstanding using the treasury stock method. Common stock
equivalents are excluded from the loss per share calculation when the
effect is anti-dilutive.
2. WAGERING SYSTEMS SEGMENT
The Company, in the fourth quarter 1995, made a decision to sell United
Wagering Systems, Inc. ("UWS"), its wagering systems segment, exclusive of the
racetrack in Sunland Park, New Mexico. The Company entered into a non-binding
letter of intent in the fourth quarter 1995 for the sale of this segment;
however, this transaction was abandoned because final terms could not be
negotiated. The Company continued to review other potential opportunities for
the sale of this operation through the second quarter 1996; however, due to
operational improvements and industry and market conditions, the Company has
decided to no longer actively pursue the disposal of the wagering systems
segment. In accordance with the requirements outlined in Financial Accounting
Standards Board Emerging Issues Task Force issue No. 90-16 "Accounting for
Discontinued Operations Subsequently Retained," the results of operations of the
wagering systems segment have been reclassified to continuing operations in all
periods presented. The remaining estimated provision for loss on disposal of
approximately $5,500,000, recorded in 1995, has been reversed in the third
quarter 1996. Concurrent with the reversal, the Company recorded an impairment
charge on certain long-lived assets of the wagering systems segment of
approximately $2,800,000. Additionally, in the third quarter 1996, the Company
implemented a restructuring plan of the manufacturing and repair and maintenance
operations of the wagering systems segment inclusive of closing a facility in
Shepherd, Montana. The manufacturing of wagering system terminals will be
performed in the Company's Bozeman, Montana facility. Costs and expenses
recorded in the third quarter 1996 for the restructuring plan were approximately
$300,000.
8
<PAGE> 9
VIDEO LOTTERY TECHNOLOGIES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
3. INVENTORIES
A summary of inventory follows:
<TABLE>
<CAPTION>
September 30, December 31,
1996 1995
---- ----
<S> <C> <C>
Manufacturing:
Raw materials $12,616,512 15,159,742
Work-in-process 277,163 673,082
Finished goods 13,537,326 8,602,181
Customer service and other 1,138,180 1,964,931
----------- ----------
$27,569,181 26,399,936
=========== ==========
</TABLE>
4. FINANCING AND INVESTING ACTIVITIES
During the nine-month period ending September 30, 1995, the Company
recorded non-cash transfers of approximately $1,030,000 of 1994 inventory to
property, plant and equipment in connection with leasing activities and
approximately $3,900,000 in connection with installations of terminals under
on-line lottery contracts. The Company had no significant non-cash transfers in
the nine-month period ending September 30, 1996. During the third quarter 1996,
the Company transferred on-line lottery equipment with a depreciated cost of
approximately $6,400,000 from depreciable equipment to equipment pending
placement. The transfer was made in conjunction with the Arizona contract
termination. (See Note 7.) The equipment will be depreciated when placed in
service or charged to costs if sold.
During the nine-month period ending September 30, 1995, the Company
sold notes receivable from equipment sales, with a face value of $1,207,501 to
banks and other third parties. The notes are secured by the underlying
equipment. The receivables sold are subject to recourse provisions in the event
of default by the primary obligor. The Company had no significant sales of notes
receivable in the nine-month period ending September 30, 1996. As of September
30, 1996 outstanding receivables sold with recourse totaled approximately
$4,900,000. Additionally, the Company has guaranteed or pledged securities for
the indebtedness of others of approximately $1,199,000.
5. RELATED PARTY ACTIVITIES
In January 1994, the Company entered into a Master Services Agreement
("MSA") with Electronic Data Systems Corporation ("EDS") which became effective
March 1, 1994. Under the MSA, EDS provides system engineering, field maintenance
and computing services to the Company over an initial ten-year period with
successive automatic one-year renewal periods unless notice of non-renewal is
given by either party. EDS purchased 545,454 shares of the Company's Common
Stock and 1,912,728 shares of Series A Junior Preferred Stock (Series A
Preferred Stock), each at a share price of $27.50. The Series A Preferred Stock
carries dividend rights equal to the Company's Common stock, is non-voting, and
is convertible to 1,912,728 shares of Common Stock after ninety days' prior
written notice. Effective November 1, 1996, the Company and EDS reached an
agreement to transition essentially all services and selected personnel
primarily associated with the Company's gaming machine segment technical
support, research and development back to the Company.
As a result of various disputes between the Company and EDS, the
Company has withheld certain payments to EDS. In July 1996, the MSA was
terminated and an interim operating arrangement has been implemented while the
parties continue efforts to resolve the disputes. (See Note 7.) The ultimate
outcome of these efforts, including whether or not EDS will continue to provide
services, cannot be predicted. The interim operating arrangement provides for
the continuation of certain services by EDS on a week-to-week basis. The current
arrangement calls for weekly payments in advance of services. The weekly
payments are allocated by the Company, primarily to costs of on-line lottery
revenues, research and development (including capitalized software development),
selling, general and administrative expenses and deferred start-up costs based
on pre-MSAtermination allocations and other information available. The
allocations represent management's best estimate of the fees attributable to
services being provided by EDS. At September 30, 1996, and December 31, 1995,
the
9
<PAGE> 10
VIDEO LOTTERY TECHNOLOGIES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Company had recorded a net payable to EDS of approximately $37,200,000 and
$10,682,000 representing outstanding amounts billed by EDS for services. The
repayment (if any) of the outstanding balance due EDS recorded at September 30,
1996, could not be made in the near term from current working capital and
available amounts under the Company's loan agreement with its primary lender,
First Bank, NA.
In the nine-month periods ending September 30, 1996 and 1995, the
Company recorded amounts billed for services, primarily related to on-line
lottery contracts, from EDS of approximately $68,243,000 and $67,083,000,
respectively. Of the total amounts, approximately $8,500,000 and $800,000 have
been capitalized as software development and deferred start-up costs associated
with on-line lottery contracts in the nine-month periods ending September 30,
1996 and 1995, respectively.
6. EXTRAORDINARY ITEMS
During 1995, the Company did not pay principal and interest obligations
under the terms of the promissory notes from the Company to the sellers, in the
aggregate amount of $10,000,000, made in conjunction with the acquisition by the
Company of all the outstanding shares of UWS in May 1994. At December 31, 1995,
the amount was recorded as other long-term liability on the Company's
consolidated balance sheet. On March 25, 1996, the Company reached an agreement
with the sellers settling all outstanding claims and disputes between them,
including dismissal of all outstanding litigation, and restructured and reduced
notes payable resulting in the extraordinary gain on debt extinguishment, net of
taxes, of $4,014,050.
7. COMMITMENTS AND CONTINGENCIES
The Company is obligated to provide services and/or equipment under
certain of its contracts. In addition, the various state on-line lottery and
video gaming contracts contain provisions under which the Company may be subject
to monetary penalties for central computer downtime, terminal failures, delays
in servicing inoperable terminals within specified time periods and ticket stock
shortages, among other things. EDS provides indemnity to the Company's
subsidiary, Automated Wagering International, Inc. ("AWI"), against certain
liabilities under its contracts. The Company accrues net losses in fulfilling
the terms of these contracts when the loss is probable and can be reasonably
estimated.
The Company typically posts bid, litigation, and performance bonds for
on-line lottery contracts. At September 30, 1996, the Company had issued
collateral in support of the various bonds outstanding consisting of $1,850,000
of restricted short-term deposits and $7,500,000 of irrevocable standby letters
of credit. Should the Company fail to meet contractually specified obligations
during the contract term, the lottery authority may assess damages and exercise
its right, under its contract, to collect, in part or in whole, on the
applicable bond.
In 1996, the Company has had disputes with several of its on-line
lottery customers over certain performance measures under the respective lottery
contracts. On May 14, 1996, the Minnesota Lottery notified AWI that under its
contract it has not met certain of its obligations. As a result of these issues,
the Minnesota Lottery has assessed penalties and withheld certain payments to
the Company. On August 9, 1996, the Minnesota Lottery notified the Company that
its contract would not be extended beyond the expiration of the contract's base
term in August 1997.
The Company has various other performance disputes with on-line lottery
customers. As of September 30, 1996, the Company had a net receivable balance of
approximately $3,400,000 from one lottery customer with which the Company has
disputes. The ultimate outcome of the dispute resolution process with the
on-line customers cannot be predicted; however, management believes that the
ultimate resolution will not have a materially adverse effect on the
consolidated financial position.
The Maryland Lottery contract requires maintenance of a performance
bond in the amount of $30,000,000 for the term of the contract. Such performance
bond may be annually renewed on the anniversary date of contract execution. The
Company currently is working with its surety company, the Maryland Lottery and
other parties to satisfy the bonding requirements. There can be no assurance as
to the satisfactory resolution of this requirement.
10
<PAGE> 11
VIDEO LOTTERY TECHNOLOGIES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
On May 17, 1996 the Arizona Lottery Commission terminated its on-line
lottery contract with AWI, due to the claimed inability of AWI to comply with
certain contractual requirements in a timely fashion, and threatened to assess
substantial damages for related claims of non-performance. In July 1996, the
Commission replaced the Company's on-line lottery system in Arizona with a
competitor's system. In October, 1996, the Company, the State of Arizona, EDS
and the insurers of AWI and EDS agreed to an $8,000,000 settlement of all
outstanding disputes with the Arizona Lottery. The Company recorded asset
impairments and contingent liabilities in the first and second quarters of 1996
totaling approximately $4,700,000. The settlement resulted in no additional
charges in the third quarter 1996 to the Company's consolidated statement of
operations and the Company will receive payment for outstanding trade
receivables form the Arizona Lottery net of payments due under the settlement
agreement. The net receipt anticipated is approximately $1,300,000.
On August 6 and August 7, 1996, respectively, AWI and the Company
received notice of a complaint filed by EDS in state court in Collin County,
Texas, against the Company and AWI alleging breach of an agreement entered into
in connection with services provided by EDS under the MSA. EDS is seeking
payment of charges totaling in excess of $33,000,000 and has requested an
injunction to bar the Company and AWI from diverting any further proceeds
received from on-line lottery contracts until total payment of the disputed
amounts have been made, or a declaration that EDS has properly terminated the
MSA and is, therefore, not subject to the mandatory arbitration provisions of
the MSA. The Company has been withholding these amounts because of EDS
performance issues. The Company continues to evaluate its strategic direction
for the on-line lottery segment in light of the disputes with certain customers
and EDS and to enhance shareholder value. Should the Company fail to resolve and
settle the disputes satisfactorily or change its strategic plan, the Company's
consolidated financial position and results of operations could experience a
material adverse change.
Historically, the Company has met its cash flow requirements primarily
with cash provided by operations, public offerings of equity securities, and
from borrowings from financial institutions. At September 30, 1996, the Company
had a deficit working capital position of approximately $5,400,000. The deficit
includes a recorded payable of approximately $37,200,000 to EDS, the repayment
of which (if any) could not be made from current working capital and available
credit resources with the Company's primary lender.
The Company, in 1996, has been selected by the Florida Lottery as the
most highly qualified bidder for the award of a new five-year on-line lottery
contract. A competitor, GTECH Corporation, has protested the Florida Lottery's
selection of the Company. Pending resolution of the protest, the Company will
commence contract negotiations. Under the terms of the request for proposal,
sizable capital expenditures in excess of current credit facilities would be
required to fulfill its terms. The availability of and terms of new financing
are subject to numerous uncertainties and cannot be reasonably predicted.
The termination of the MSA with EDS constituted an event of default
under the Company's loan agreement with First Bank, NA. The default has been
waived in conjunction with an amendment to the loan agreement which, among other
things, reduced the revolving line of credit from $20,000,000 to $17,500,000.
The Company, at September 30, 1996, has $2,500,000 available on the revolving
line of credit.
In the quarter ended September 30, 1996, the Company recorded
$4,700,000 of other special charges for restructuring costs and asset
impairments, consisting of approximately $3,100,000 related to the wagering
systems segment as discussed in Note 2 and $1,600,000 of inventory writeoffs and
reserves and writeoffs of deferred start-up costs in conjunction with the
Company's agreement with the Kentucky Lottery Corporation not to proceed with
the finalization of a contract which was previously awarded to the Company. The
special charges recorded in the third quarter 1996 are in addition to $8,200,000
recorded in the first six months of 1996. The cumulative charges of
approximately $12,900,000 consist of approximately $3,100,000 recorded in the
third quarter 1996 related to the wagering systems segment discussed in Note 2
of the Notes to Consolidated Financial Statements, approximately $3,200,000 for
inventory reserves and writeoffs, $1,000,000 of deferred start-up costs,
$2,000,000 for contingent liabilities and $1,600,000 for net uncollectible
receivable accounts and $2,000,000 for contractual commitments. The special
charges and reserves represent management's best estimate of the realizability
of assets, and estimate of loss contingencies based on the current information,
facts and circumstances.
11
<PAGE> 12
VIDEO LOTTERY TECHNOLOGIES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
The recovery of a significant amount of the Company's investment in the
racetrack operations in New Mexico is largely contingent upon the passage of
gaming legislation in the State which would permit the racetrack to operate
gaming machines. There can be no assurance of such legislation being enacted in
the foreseeable future. The Company's investment in the racetrack operations is
approximately $18,400,000 at September 30, 1996.
As previously reported, a purported class action, alleging violations
of the federal antitrust laws, was filed in June 1994, in the federal district
court in South Dakota against the Company and certain video lottery machine
operators in South Dakota by a group of other video lottery machine operators,
alleging, among other things, a combination and conspiracy to unlawfully
restrain trade in video lottery machines by fixing lease prices for such
machines, allocating territories and refusing to deal with other operators.
Unspecified treble damages are sought, along with injunctive relief to bar the
alleged practices. On November 6, 1996, the court granted the defendant's motion
for summary judgment and dismissed, with prejudice, all claims against the
plaintiffs.
The Company is involved in various other claims and legal actions
arising in the ordinary course of business. In the opinion of management, after
consultation with legal counsel, the ultimate disposition of these other matters
will not have a material adverse effect on its consolidated financial position
and statement of operations.
12
<PAGE> 13
VIDEO LOTTERY TECHNOLOGIES, INC. AND SUBSIDIARIES
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
Revenue from the on-line lottery segment consists primarily of a
contractual percentage of lottery ticket sales in seven states as well as
revenue from on-line lottery equipment sales. The segment revenue will
experience fluctuations depending on relative sizes of jackpots and the number
of terminals on-line and selling tickets in the states in which the Company
operates. The Company continues to evaluate its strategic direction for the
on-line lottery segment in light of the disputes with certain customers and EDS
and to enhance shareholder value. Should the Company fail to resolve and settle
the disputes satisfactorily or change its strategic plan, the Company's
consolidated financial position and results of operations could experience a
material adverse change.
Revenue from the gaming machine and route operations segment consists
of sales and lease of video gaming machines, sales of parts, central control
site hardware and software, service of terminals, license fees, and from
operation of gaming machine route operations. The revenue from route operations
consists primarily of machine gaming wagers net of pay-outs to patrons and state
gaming taxes. Revenue from gaming machine sales is subject to significant
fluctuations as new jurisdictions approve legislation for video lottery gaming
operations and if the Company is awarded a contract in any such jurisdictions.
Gaming machine and route operations includes lease revenue which is derived from
the lease of terminals to the Oregon Lottery, which commenced video lottery in
April 1992, to the Rhode Island Lottery, which implemented a limited form of
video lottery at two pari-mutuel facilities in September 1992, and to the
Delaware Lottery, at two pari-mutuel venues within the state. The Company began
leasing video lottery gaming machines to the Delaware Lottery in December 1995.
The Company expects video lottery and route operations revenue to continue to be
a significant component of total revenues. Gaming machine revenue is generated
primarily by the Company's Video Lottery Consultants, Inc. ("VLC"), subsidiary.
Revenue from wagering systems and racetrack operations is generated
primarily from a contractual percentage of handle processed through computerized
pari-mutuel wagering systems from approximately 130 contracts in North America,
international sales and lease of pari-mutuel wagering systems, and ownership and
operation of a racetrack in Sunland Park, New Mexico. Wagering systems and
racetrack operations revenue is primarily generated by the Company's UWS
subsidiary.
Gross profit for each segment is herein defined as revenues for that
segment less the corresponding costs and expenses (excluding depreciation and
amortization expense and other special charges). Costs and expenses related to
on-line lottery revenue include all direct costs and allocated indirect costs
involved in operating the on-line lottery equipment in each jurisdiction in
which the Company has a contract as well as direct costs of equipment sales.
Costs and expenses related to gaming machine revenue include direct costs of
production, including labor and allocated manufacturing overhead. Costs and
expenses related to route operations include the locations owners' share of the
net machine revenues. Costs and expenses related to racetrack operations include
direct and allocated indirect costs associated with the operation of the
racetrack.
Selling, general and administrative expenses consist of labor costs,
professional fees, repairs and maintenance expense, promotion and advertising
costs, occupancy and other costs, other than those included in costs and
expenses applicable to the determination of gross profit as defined above.
THIRD QUARTER 1996 COMPARED WITH THIRD QUARTER 1995
Total revenue in the third quarter 1996 decreased by $2.0 million
(4.6%) to $40.9 million from $42.9 million in the third quarter 1995. Overall
gross profit decreased by $1.8 million (12.0%) to $13.5 million from $15.3
million in the third quarter 1995. The Company experienced a net loss from
continuing operations before extraordinary items of $5.3 million as compared to
net earnings of $.3 million in the third quarter 1995. The operating results
from continuing operations reflect pre-tax other charges of $4.7 million and
none in the third quarters ended September 30, 1996 and 1995, respectively.
Approximately $3.1 million of the $4.7 million of special charges recorded in
the third quarter 1996 is related to the Company's decision to not actively
pursue the disposal of the wagering systems segment as discussed below. The
remaining $1.6 million of special charges recorded in the third quarter is
related to the Company's agreement with the Kentucky Lottery Corporation not to
13
<PAGE> 14
VIDEO LOTTERY TECHNOLOGIES, INC. AND SUBSIDIARIES
proceed with the finalization of a contract. The Company had net earnings of $.2
million in the third quarter 1996 as compared to a net loss of $5.4 million in
the third quarter 1995.
The Company, in the fourth quarter 1995, made a decision to sell United
Wagering Systems, Inc. ("UWS"), its wagering systems segment, exclusive of the
racetrack in Sunland Park, New Mexico. The Company entered into a non-binding
letter of intent in the fourth quarter 1995 for the sale of this segment;
however, this transaction was abandoned because final terms could not be
negotiated. The Company continued to review other potential opportunities for
the sale of this operation through the second quarter 1996; however, due to
operational improvements and industry and market conditions, the Company has
decided to no longer pursue the disposal of the wagering systems segment. In
accordance with the requirements outlined in Financial Accounting Standards
Board Emerging Issues Task Force issue No. 90-16 "Accounting for Discontinued
Operations Subsequently Retained," the results of operations of the wagering
systems segment have been reclassified to continuing operations in all periods
presented. The remaining estimated provision for loss on disposal of
approximately $5.5 million, recorded in 1995, has been reversed in the third
quarter 1996. Concurrent with the reversal, the Company recorded an impairment
charge on certain long-lived assets of the wagering systems segment of
approximately $2.8 million. Additionally, in the third quarter 1996, the Company
implemented a restructuring plan of the manufacturing and repair and maintenance
operations of the wagering systems segment inclusive of closing a facility in
Shepherd, Montana. The manufacturing of wagering system terminals will be
performed in the Company's Bozeman, Montana facility. Costs and expenses
recorded in the third quarter 1996 for the restructuring plan were approximately
$.3 million.
ON-LINE LOTTERY
Revenue from the on-line lottery segment increased by $.1 million (.5%)
to $20.4 million from $20.3 million in the third quarter 1995. Third quarter
1996 revenue reflects the absence of revenue from the Washington State Lottery
contract which expired in June 1996. The comparative 1995 revenues were $2.4
million. The loss of revenues from the Washington Lottery contract were offset
by additional revenue from the Delaware Lottery contract ($1.5 million) and the
Maryland Lottery contract ($.9 million). The Maryland Lottery started up on
August 19, 1996. Revenues from sales of on-line lottery equipment and parts was
$1.7 million and $.8 million in the third quarters of 1996 and 1995,
respectively.
The gross profit margin of the on-line lottery segment was 25.5% in the
third quarter 1996 as compared to 33.6% in the third quarter 1995. The gross
profit margin on services revenue in the on-line lottery segment was 27.3% in
the third quarter 1996 as compared to 32.8% in the third quarter 1995. The
decrease reflects relatively higher fees for services provided by EDS in the
third quarter 1996 in conjunction with relatively lower on-line lottery services
revenue. Management anticipates continuation of lower gross profit levels under
the interim operating arrangement with EDS. The gross profit margin on on-line
lottery equipment sales was 5.1% and 54.4% in the third quarter 1996 and 1995,
respectively.
In 1996, the Company has had disputes with several of its on-line
lottery customers over certain performance measures under the respective lottery
contracts. On May 14, 1996, the Minnesota Lottery notified AWI that under its
contract it has not met certain of its obligations. As a result of these issues,
the Minnesota Lottery has assessed penalties and withheld certain payments to
the Company. On August 9, 1996, the Minnesota Lottery notified the Company that
its contract would not be extended beyond the expiration of the contract's base
term in August 1997.
The Company has various other performance disputes with on-line lottery
customers. As of September 30, 1996, the Company had a net receivable balance of
approximately $3.4 million from one lottery customer with which the Company has
disputes. The ultimate outcome of the dispute resolution process with the
on-line customers cannot be predicted; however, management believes that the
ultimate resolution will not have a materially adverse effect on the
consolidated financial position.
The Maryland Lottery contract requires maintenance of a performance
bond in the amount of $30 million for the term of the contract. Such performance
bond may be annually renewed on the anniversary date of contract execution. The
Company currently is working with its surety company, the Maryland Lottery and
other parties to satisfy the bonding requirements. There can be no assurance as
to the satisfactory resolution of this requirement.
14
<PAGE> 15
VIDEO LOTTERY TECHNOLOGIES, INC. AND SUBSIDIARIES
On May 17, 1996 the Arizona Lottery Commission terminated its on-line
lottery contract with AWI, due to the claimed inability of AWI to comply with
certain contractual requirements in a timely fashion, and threatened to assess
substantial damages for related claims of non-performance. In July 1996, the
Commission replaced the Company's on-line lottery system in Arizona with a
competitor's system. In October, 1996, the Company, the State of Arizona, EDS
and the insurers of AWI and EDS agreed to an $8 million settlement of all
outstanding disputes with the Arizona Lottery. The Company recorded asset
impairments and contingent liabilities in the first and second quarters of 1996
totaling approximately $4.7 million. the settlement resulted in no additional
charges in the third quarter 1996 to the Company's consolidated statement of
operations and the Company will receive payment for outstanding trade
receivables form the Arizona Lottery net of payments due under the settlement
agreement. The net receipt anticipated is approximately $1.3 million.
As a result of various disputes between the Company and EDS, the
Company has withheld certain payments to EDS. In July 1996, the MSA was
terminated and an interim operating arrangement has been implemented while the
parties continue efforts to resolve the disputes. (See Note 7.) The ultimate
outcome of these efforts, including whether or not EDS will continue to provide
services, cannot be predicted. The interim operating arrangement provides for
the continuation of certain services by EDS on a week-to-week basis. The current
arrangement calls for weekly payments in advance of services. The weekly
payments are allocated by the Company, primarily to costs of on-line lottery
revenues, research and development (including capitalized software development,
selling, general and administrative expenses and deferred start-up costs based
on pre-MSAtermination allocations and other information available. The
allocations represent management's best estimate of the fees attributable to
services being provided by EDS. At September 30, 1996, and December 31, 1995,
the Company had recorded a net payable to EDS of approximately $37.2 million and
$10.7 representing outstanding amounts billed by EDS for services. The repayment
(if any) of the outstanding balance due EDS recorded at September 30, 1996,
could not be made in the near term from current working capital and available
amounts under the Company's loan agreement with its primary lender, First Bank,
NA.
In the three-month periods ending September 30, 1996 and 1995, the
Company recorded amounts billed for services from EDS of approximately $21.4
million and $19.8 million, respectively. The Company capitalized approximately
$2.8 million and $.3 million of these amounts as software development and
deferred start-up costs in the three-month periods ending September 30, 1996 and
1995, respectively, primarily related to on-line lottery contracts.
On August 6 and August 7, 1996, respectively, AWI and the Company
received notice of a complaint filed by EDS in state court in Collin County,
Texas, against the Company and AWI alleging breach of an agreement entered into
in connection with services provided by EDS under the MSA. EDS is seeking
payment of charges totaling in excess of $33 million and has requested an
injunction to bar the Company and AWI from diverting any further proceeds
received from on-line lottery contracts until total payment of the disputed
amounts have been made, or a declaration that EDS has properly terminated the
MSA and is, therefore, not subject to the mandatory arbitration provisions of
the MSA. The Company has been withholding these amounts because of EDS
performance issues. The Company continues to evaluate its strategic direction
for the on-line lottery segment in light of the disputes with certain customers
and EDS and to enhance shareholder value. Should the Company fail to resolve and
settle the disputes satisfactorily or change its strategic plan, the Company's
consolidated financial position and results of operations could experience a
material adverse change.
In the quarter ended September 30, 1996, the Company recorded $4.7
million of other special charges for restructuring costs and asset impairments,
consisting of approximately $3.1 million related to the wagering systems segment
as discussed in Note 2 and $1.6 million of inventory writeoffs and reserves and
writeoffs of deferred start-up costs in conjunction with the Company's agreement
with the Kentucky Lottery Corporation not to proceed with the finalization of a
contract which was previously awarded to the Company. The special charges
recorded in the third quarter 1996 are in addition to $8.2 million recorded in
the first six months of 1996. The cumulative charges of approximately $12.9
million consist of approximately $3.1 million recorded in the third quarter 1996
related to the wagering systems segment discussed in Note 2 of the Notes to
Consolidated Financial Statements, approximately $3.2 million for inventory
reserves and writeoffs, $1 million of deferred start-up costs, $2 million for
contingent liabilities and $1.6 million for net uncollectible receivable
accounts and $2 million for contractual commitments. The special charges and
reserves represent management's best estimate of the
15
<PAGE> 16
VIDEO LOTTERY TECHNOLOGIES, INC. AND SUBSIDIARIES
realizability of assets, and estimate of loss contingencies based on the current
information, facts and circumstances.
The expiration date of the current contract with the Florida Lottery
was extended from June 30, 1996, to December 27, 1996, as a result of a delay of
the award of a new contract. On October 31, 1996, the Company was notified by
the Florida Lottery that the Company has been selected as the most highly
qualified bidder for the award of a new five-year on-line lottery contract. A
competitor, GTECH Corporation, has protested the Florida Lottery's selection of
the Company. Pending resolution of the protest, the Company will commence
contract negotiations. Under the terms of the request for proposal, sizable
capital expenditures in excess of current credit facilities would be required to
fulfill its terms. The availability of and terms of new financing are subject to
numerous uncertainties and cannot be reasonably predicted. The Florida Lottery
contract accounted for 38.5% of on-line lottery revenues and 22.9% of total
consolidated revenues in 1995 and 38.9% and 34.0%, respectively, in the
nine-month period ending September 30, 1996.
GAMING MACHINE AND ROUTE OPERATIONS
Revenue from gaming machine and route operations decreased by $2.5
million (15.8%) to $13.1 million from $15.6 million in the third quarter 1995.
Revenue was recognized on shipments of 739 units in the third quarter
1996 as compared to 1,983 in the third quarter 1995. The reduction in unit sales
primarily reflects lower sales in Quebec, Canada, and Louisiana and lower
royalty unit sales in Australia. There were approximately 236 royalty unit sales
in the third quarter 1995 as compared to none in the third quarter 1996.
Additionally, the Company shipped 475 gaming machines under lease arrangements
to the Oregon Lottery in the third quarter 1996 as compared to 300 units in the
third quarter 1995. As of September 30, 1996, the Company had approximately 283
gaming machine terminals placed on a test basis with potential customers in
various casino jurisdictions for which no revenue has been recognized.
The following table reflects domestic and foreign revenues for the
third quarters of 1996 and 1995 (amounts in millions):
<TABLE>
<CAPTION>
Three Months Ended September 30,
----------------------------------------------------------------
1996 1995 $ Change % Change
---- ---- -------- --------
<S> <C> <C> <C> <C>
Domestic:
Montana $ 0.9 0.5 0.4 80.0
Montana routes 4.3 3.9 0.4 10.3
Nevada 0.1 --- 0.1 ---
South Dakota 0.6 0.7 (0.1) (14.3)
Louisiana --- 1.6 (1.6) ---
Oregon 0.2 0.2 --- ---
Oregon leases 1.5 1.2 0.3 25.0
Rhode Island lease 0.6 0.6 --- ---
Delaware lease 0.6 --- 0.6 ---
Other 0.9 0.9 --- ---
----- ----- ----- -----
9.7 9.6 0.1 1.0
----- ----- ----- -----
Foreign:
Atlantic Canada 0.4 0.3 0.1 33.3
Quebec, Canada 0.1 5.2 (5.1) (98.1)
Victoria, Australia 0.2 0.4 (0.2) (50.0)
Norway 1.2 --- 1.2 ---
Peru
Iceland 0.7 0.1 0.6 600.0
Other 0.8 --- 0.8 ---
----- ----- ----- -----
3.4 6.0 (2.6) (43.3)
----- ----- ----- -----
$ 13.1 15.6 (2.5) (16.0)
====== ===== ===== =====
</TABLE>
16
<PAGE> 17
VIDEO LOTTERY TECHNOLOGIES, INC. AND SUBSIDIARIES
The gross profit margin from the gaming machine segment, which includes
equipment sales and contract revenue, as well as royalty and lease revenue was
44.9% in the third quarter 1996 as compared to 38.6% in the third quarter 1995.
The increase reflects the absence of gaming machine sales in Quebec, Canada and
lower sales levels in Louisiana in the third quarter 1996, which carry lower
gross margins, an increase in central site sales over 1995 levels and an
increase in leasing revenues over third quarter 1995 levels. The Company has
delivered approximately 1,450 gaming machines under lease arrangements since the
third quarter of 1995 including approximately 275 to the Delaware Lottery which
initiated a gaming machine program in December 1995. The gross profit margin
from route operations increased from 27.8% to 28.7% in the third quarter 1996
over the third quarter 1995.
WAGERING SYSTEMS AND RACETRACK OPERATIONS
Revenue from the wagering systems and racetrack operations segment
increased by $.3 million (4.2%) to $7.4 million from $7.1 million in the third
quarter 1995. The segment had gross margins of 32.4% and 35.4% in the third
quarters of 1996 and 1995, respectively. The increase in revenue is a result of
increased revenues from simulcasting activities and equipment sales in the
wagering systems segment, partially offset by decreases due to closing of
customer facilities. Margins from wagering systems were 39% compared to 42% in
the prior year. Equipment sales in the third quarter at 42% were at less
favorable margins than in 1995 (53%). Revenues from racetrack operations were
$1.4 million in the third quarter of 1996 and 1995. Racetrack operations yielded
margins in the third quarter of 2% compared to 7% in 1995. The margin decline at
the racetrack is a result of changes in statutory expenses during 1996.
Historically, UWS experiences lower operating margins in the first and
fourth quarters. As simulcasting and off-track betting become legalized in more
jurisdictions, and increase at racetracks, the Company may experience improved
revenues and margins; however, given increased competition from other forms of
gambling, and the volatility and declines in handle in the pari-mutuel industry,
there can be no assurance of increased margins.
The Company, in the fourth quarter 1995, made a decision to sell United
Wagering Systems, Inc. ("UWS"), its wagering systems segment, exclusive of the
racetrack in Sunland Park, New Mexico. The Company entered into a non-binding
letter of intent in the fourth quarter 1995 for the sale of this segment;
however, this transaction was abandoned because final terms could not be
negotiated. The Company continued to review other potential opportunities for
the sale of this operation through the second quarter 1996; however, due to
operational improvements and industry and market conditions, the Company has
decided to no longer actively pursue the disposal of the wagering systems
segment. In accordance with the requirements outlined in Financial Accounting
Standards Board Emerging Issues Task Force issue No. 90-16 "Accounting for
Discontinued Operations Subsequently Retained," the results of operations of the
wagering systems segment have been reclassified to continuing operations in all
periods presented. The remaining estimated provision for loss on disposal of
approximately $5.5 million, recorded in 1995, has been reversed in the third
quarter 1996. Concurrent with the reversal, the Company recorded an impairment
charge on certain long-lived assets of the wagering systems segment of
approximately $2.8 million Additionally, in the third quarter 1996, the Company
implemented a restructuring plan of the manufacturing and repair and maintenance
operations of the wagering systems segment inclusive of closing a facility in
Shepherd, Montana. The manufacturing of wagering system terminals will be
performed in the Company's Bozeman, Montana facility. Costs and expenses
recorded in the third quarter 1996 for the restructuring plan were approximately
$.3 million
The recovery of a significant amount of the Company's investment in the
racetrack operations in New Mexico is largely contingent upon the passage of
gaming legislation in the State which would permit the racetrack to operate
gaming machines. There can be no assurance of such legislation being enacted in
the foreseeable future. The Company's investment in the racetrack operations is
approximately $18.4 million at September 30, 1996.
SELLING, GENERAL AND ADMINISTRATIVE
Total selling, general and administrative ("SG&A")expenses increased by
$.2 million (3.2%) to $6.4 million from $6.2 million in the third quarter 1995.
The increase primarily reflects additional legal and professional fees. The
Company expects SG&A expenses in the fourth quarter 1996 to reflect increased
marketing activities.
17
<PAGE> 18
VIDEO LOTTERY TECHNOLOGIES, INC. AND SUBSIDIARIES
Net research and development expense decreased by $.6 million reflecting
relatively more amounts capitalized as software development in the third quarter
1996 as compared to 1995. The Company capitalized $1.0 million and $.2 million
in the third quarters of 1996 and 1995, respectively. The capitalized costs are
related to the continued development and enhancements of the Company's central
system software MasterLink(TM).
NINE MONTHS ENDED SEPTEMBER 30, 1996 AND 1995
Total revenue decreased by $7.5 million (5.4%) to $130.9 million from
$138.4 million in the nine months ended September 30, 1995. The overall gross
profit increased by $1.4 million (2.9%) to $49.6 million from $48.2 million in
the nine months ended September 30, 1995. The Company had net earnings of $1.2
million and a net loss of $8.5 million in the nine-month periods ended September
30, 1996 and 1995, respectively. The $1.2 million net earnings in the nine
months ended September 30, 1996 includes a pre-tax charge of $12.9 million for
special charges discussed below, is net of the extraordinary gain on debt
extinguishment of $4.0 million, and includes a $5.5 million reversal of a
provision for loss on disposal of the wagering systems segment which is no
longer actively held for sale. This reversal is subsequent to the fourth quarter
1995 decision to dispose of this segment and report it as a discontinued
operation. The net loss of $8.5 million in the nine months ended September 30,
1995 includes $3.1 million of pre-tax special charges and a $5.8 million
provision for loss on disposal of discontinued operations. Earnings before
income taxes, extraordinary items and special charges from continuing operations
was $3.4 million in the nine months ended September 30, 1996, as compared to a
net loss of $1.3 million in the nine-month period ended September 30, 1995.
During 1995, the Company did not pay principal and interest obligations
under the terms of the promissory notes to the sellers in the aggregate amount
of $10.0 million made in conjunction with the acquisition of UWS. On March 25,
1996, the Company reached an agreement with the sellers settling all outstanding
claims and disputes, including dismissal of all outstanding litigation,
resulting in an extraordinary net gain on debt extinguishment of $4.0 million.
ON-LINE LOTTERY
Revenue from the on-line lottery segment decreased by $3.6 million (5.1%)
to $65.8 million from $69.3 million for the nine months ended September 30,
1995. Included in the on-line lottery revenue for the nine months ended
September 30, 1996 and 1995 is $2.2 million and $5.1 million, respectively, of
revenue from international on-line lottery equipment and parts sales. Revenue
from the Company's contract with the Florida Lottery decreased by $4.6 million
primarily due to a decline in lottery ticket sales and the reduction in the
contractual fee rate. This decrease was partially offset by an increase in
revenues of $3.6 million from the Company's contract with the Delaware Lottery
which implemented a video lottery program in December 1995. The video lottery
program is operated through AWI's on-line central system using the video lottery
application of MasterLink(TM). Also included in on-line lottery revenue for the
first three months of the nine months ended September 30, 1996, is $1.6 million
attributable to the contract with the Arizona Lottery which was terminated
during the second quarter 1996 as discussed earlier.
The contract for the Washington State Lottery expired in June 1996, and
was awarded to a competitor. The contract generated revenues of $5.7 and $8.0
million in the nine months ended September 30, 1996 and 1995, respectively.
The gross profit margin in the on-line lottery segment was 35.2% in both
of the nine-month periods ended September 30, 1996 and 1995. The gross profit
margin on services revenue in the on-line lottery segment for the nine months
ended September 30, 1996 was 36.0% as compared to 36.4% in the nine months ended
September 30, 1995. The gross profit margin on on-line central system parts and
equipment sales was 12.6% and 20.4% for the nine months ended September 30, 1996
and 1995, respectively.
GAMING MACHINE AND ROUTE OPERATIONS
Revenue from gaming machines and route operations decreased by $5.3
million (10.8%) to $43.6 million from $48.9 million in the nine months ended
September 30, 1995.
18
<PAGE> 19
VIDEO LOTTERY TECHNOLOGIES, INC. AND SUBSIDIARIES
Revenue was recognized on shipments of 3,252 units as compared to 6,332
for the nine months ended September 30, 1995. The reduction in unit sales
primarily reflects lower sales in Louisiana and Quebec, Canada and lower royalty
unit sales in Australia. Included in the total units were approximately 120 and
1,299, respectively, of royalty unit sales for the nine months ended September
30, 1996 and 1995, respectively. Additionally, the Company shipped 1,175 gaming
machines under lease arrangements in the nine months ended September 30, 1996,
as compared to 1,173 in the same period in 1995.
The following table reflects domestic and foreign sales for the months
ended September 30, 1996 and 1995 (amounts in millions):
<TABLE>
<CAPTION>
Nine Months Ended September 30,
----------------------------------------------------------------
1996 1995 $ Change % Change
---- ---- -------- --------
<S> <C> <C> <C> <C>
Domestic:
Montana $ 2.5 1.8 0.7 38.9
Montana routes 12.2 11.4 .8 7.0
Nevada 1.0 --- 1.0 ---
South Dakota 2.1 3.4 (1.3) (38.2)
Louisiana 0.4 7.6 (7.2) (94.7)
Oregon 0.5 1.6 (1.1) (68.8)
Oregon leases 4.3 3.1 1.2 38.7
Rhode Island lease 1.8 1.8 --- ---
Delaware lease 1.7 --- 1.7 ---
Other 1.6 1.8 (0.2) (11.1)
------ ------ ----- -----
28.1 32.5 (4.4) (13.5)
------ ------ ----- -----
Foreign:
Alberta, Canada 3.1 0.6 2.5 416.7
Atlantic Canada 0.9 1.2 (0.3) (25.0)
Quebec, Canada 2.0 11.3 (9.3) (82.3)
Victoria, Australia 0.7 2.7 (2.0) (74.1)
Northern Territory, Australia 0.6 --- 0.6 ---
Norway 3.0 --- 3.0 ---
Peru 3.6 --- 3.6 ---
Iceland 0.7 0.1 0.6 600.0
Other 0.9 0.5 0.4 80.0
------ ------ ----- -----
15.5 16.4 (0.9) (5.5)
------ ------ ----- -----
$ 43.6 48.9 (5.3) (10.8)
====== ====== ===== =====
</TABLE>
The gross profit margin from the gaming machine segment, which includes
equipment sales and contract revenue, as well as royalty and lease revenue, was
53.5% as compared to 44.0% for the nine months ended September 30, 1995. The
increase reflects the absence of gaming machine sales in Louisiana and Quebec,
Canada in the nine months ended September 30, 1996, which carry lower gross
margins, an increase in central site sales over 1995 levels and an increase in
leasing revenues over 1995 levels. The gross profit margin from route operations
was 28.7% compared to 27.6% for the nine months ended September 30, 1995.
WAGERING SYSTEMS AND RACETRACK OPERATIONS
Revenue from the wagering systems and racetrack operations segment
increased by $1.4 million (7.0%) to $21.5 million from $20.1 million in the nine
months ended September 30, 1995. The segment had gross margins of 28.5% and
20.4% in the nine months September 30, 1996 and 1995. Increased revenues and
margins are the result of increased simulcasting at racetracks, the addition of
a large customer in Texas, partially offset by the closing of customer
facilities in the third quarter, and higher equipment sales in 1996 compared to
1995. Margins from customer contracts were 39% in 1996 compared to 23% in 1995
due to increases in 1996 from simulcasting and cost reduction efforts. Revenues
in 1996 include equipment sales of $1.7 million compared to $.8 million in
19
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VIDEO LOTTERY TECHNOLOGIES, INC. AND SUBSIDIARIES
1995. Revenues from racetrack operations were $5.5 million and $5.7 million in
the nine-month periods ending September 30, 1996 and 1995, respectively.
SELLING, GENERAL AND ADMINISTRATIVE
Total SG&A decreased by $1.4 million (5.9%) to $21.6 from $23.0 million in
the nine months ended September 30, 1995. As a percentage of sales, SG&A
expenses were 16.5% for the nine months ended September 30, 1996 as compared to
16.6% for the nine months ended September 30, 1995.
Net research and development expense decreased by $2.5 million reflecting
primarily relatively more amounts capitalized as software development in the
nine months ended September 30, 1996 as compared to 1995. The Company
capitalized $3.7 million and $.7 million in the nine months ended September 30,
1996 and 1995, respectively. The capitalized costs are related to the Company's
central system software, MasterLink(TM).
LIQUIDITY AND CAPITAL RESOURCES
Working capital, defined as current assets less current liabilities,
decreased by $28.4 million to a deficit of $5.4 million from $23.0 million at
December 31, 1995. The decrease reflects the growth in trade accounts payable to
EDS as a result of the Company's decision to withhold certain payments to EDS
due to various disputes with EDS discussed elsewhere. At September 30, 1996, the
Company has a current payable recorded to EDS of approximately $37.2 million.
Due to the various performance disputes with EDS the Company is withholding
payment. The repayment (if any) of the recorded payable could not be made from
current working capital and available credit resources with the Company's
primary lender. The ultimate outcome of the dispute resolution process cannot be
predicted.
The increase in inventories of $1.2 million is net of the impairment
charge, primarily for on-line inventories, of approximately $3.2 million (see
Note 7 to the Notes to Consolidated Financial Statements), and an increase in
gaming machine inventories of approximately $6.0 million. The increase in gaming
machine inventories reflects forecasted increased sales in the Nevada, New
Jersey and various other casino markets, although there can be no assurance of
increased sales in these jurisdictions. As of September 30, 1996, the Company
had approximately 283 gaming machine terminals placed on a test basis with
potential customers in these casino jurisdictions. The Company is actively
marketing on-line lottery terminals, with a carrying value of approximately
$17.2 million, in a number of jurisdictions. Should marketing plans not be met
due to changes in international operations or domestic events, management will
consider the necessity of recording additional reserves and charges to recognize
asset value impairment.
The Company had proceeds from issuance of long-term debt of approximately
$4.3 million in the first quarter 1996 representing the securitization of gaming
machines under lease arrangement with the Oregon Lottery. This issuance is in
addition to $5.2 million of long-term debt issued in the fourth quarter 1995
secured by similar assets. The term of the debt issued in the fourth quarter
1995 and first quarter 1996 is approximately five years.
The termination of the MSA with EDS constituted an event of default under
the Company's loan agreement with First Bank, NA. The default has been waived in
conjunction with an amendment to the loan agreement. The Company, at September
30, 1996, had $2.5 million available on the $17.5 million revolving line of
credit.
As discussed earlier, the Company reached a favorable settlement with the
sellers of UWS, acquired by the Company in May 1994. The settlement, among other
things, resulted in the extinguishment of approximately $4.0 million of $10.0
million of notes payable to the sellers which had been recorded as an other
non-current liability on the consolidated balance sheet at December 31, 1995.
The remaining $6.0 million is payable over a five-year period with acceleration
clauses for the occurrence of certain events including disposal of certain
business segments.
In the nine months ended September 30, 1996, the Company expended $23.9
million on fixed assets composed primarily of $15.6 million for on-line lottery
equipment, $5.3 million for gaming machine and routes operations and $3.0
million for wagering systems and racetrack operations. The on-line lottery
segment capital expenditures were primarily for the Maryland Lottery contractual
commitments. The on-line lottery system
20
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VIDEO LOTTERY TECHNOLOGIES, INC. AND SUBSIDIARIES
commenced operations in Maryland in August 1996. The capital expenditures in the
gaming machine segment were primarily for the delivery of 1,175 terminals under
lease agreement with the Oregon Lottery. The capital expenditures for the
wagering systems and racetrack operations segment were primarily for the
upgrading of current customers.
The on-line lottery segment also expended and capitalized approximately
$9.9 million for intangible and other assets including approximately $3.7
million for continued software development to be initially implemented with the
Maryland on-line lottery system and $6.2 million for deferred start-up costs
associated with on-line lottery contracts.
The expiration date of the current contract with the Florida Lottery was
extended from June 30, 1996, to December 27, 1996, as a result of a delay of the
award of a new contract. On October 31, 1996, the Company was notified by the
Florida Lottery that the Company has been selected as the most highly qualified
bidder for the award of a new five-year on-line lottery contract. A competitor,
GTECH Corporation, has protested the Florida Lottery's selection of the Company.
Pending resolution of the protest, the Company will commence contract
negotiations. Under the terms of the request for proposal, sizable capital
expenditures in excess of current credit facilities would be required to fulfill
its terms. The availability of and terms of new financing are subject to
numerous uncertainties and cannot be reasonably predicted. The Florida Lottery
contract accounted for 38.5% of on-line lottery revenues and 22.9% of total
consolidated revenues in 1995 and 38.9% and 34.0%, respectively, in the
nine-month period ending September 30, 1996.
21
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VIDEO LOTTERY TECHNOLOGIES, INC. AND SUBSIDIARIES
PART II. OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS
No significant changes have occurred with regard to legal proceedings as
disclosed in Part 1, Item 3, of the Company's December 31, 1995 Form 10-K and
Part II, Item 1 of the Company's Form 10-Q for the quarter ended June 30, 1996,
except as follows:
On November 6, 1996, the South Dakota District Court granted defendant's
motion for summary judgment, dismissing, with prejudice, all claims against the
plaintiffs in the class action anti-trust matter.
ITEM 2. CHANGES IN SECURITIES
None
ITEM 3. DEFAULTS UPON SENIOR SECURITIES
None
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITIES HOLDERS
None
ITEM 5. OTHER INFORMATION
The Board of Directors, through its Strategic Planning Committee, is
continuing, with the assistance of its investment banker, Salomon Brothers, to
explore and evaluate various strategic alternatives and opportunities designed
to enhance shareholder value.
On August 22, 1996, AWI announced the successful implementation of its
MasterLink(TM) gaming technology for Maryland's new lottery program. Lottery
agents and customers are expected to benefit form the new state-of-the-art
games, Keno graphics and easier-to-operate agent terminals.
On August 28, 1996, VLT announced the election of Richard M. Haddrill as
president of the Company, and being named to its Board of Directors.
On September 27, 1995, VLT announced that AWI had withdrawn its on-line
lottery system proposal to the Kentucky Lottery Corporation because of time
constraints due to ongoing divestiture and subcontracting considerations
affecting AWI and state law prohibition.
On October 18, 1996, VLT announced that AWI, the State of Arizona on
behalf of the Lottery, EDS and the insurers of AWI and EDS have agreed to an $8
million settlement of all outstanding disputes with the Arizona Lottery. The
decision by the Arizona Lottery Commission to seek termination of its on-line
lottery contract with AWI was reported on a Form 8-K dated May 9, 1996. The
settlement resulted in no additional charges in the third quarter 1996 to the
Company's consolidated statement of operations and the Company will receive
payment for outstanding trade receivables from the Arizona Lottery net of
payments due under the settlement agreement. The net receipt anticipated is
approximately $1.3 million.
On November 1, 1996, VLT announced that AWI has been selected for the
award of a new five-year contract to continue operating Florida's lottery
system. The contract also has two, two-year renewal options. AWI has been the
on-line lottery provider for Florida for the past eight years, operating over
8,200 terminals throughout the State of Florida. In its decision awarding the
contract, the Florida Lottery accepted a unanimous recommendation of its
evaluation committee, which favored AWI by a wide margin. The committee's report
ranked AWI best, based on its technical superiority and its pricing.
22
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VIDEO LOTTERY TECHNOLOGIES, INC. AND SUBSIDIARIES
On November 11, 1966 VLT announced that VLC received its permanent license
from the New Jersey Gaming Commission on November 6, 1996. Previously, VLC had
been doing business in New Jersey using a transaction waiver approval process.
23
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VIDEO LOTTERY TECHNOLOGIES, INC. AND SUBSIDIARIES
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
a. Listing of Exhibits
EX-27 Financial Data Schedule (For SEC Use Only)
b. Reports on Form 8-K
(1) Form 8-K dated July 15, 1996, reporting, among other things,
certain information regarding the termination of its
contract with EDS under which EDS has provided VLT's
subsidiary, AWI with technical and other outsourcing
services, and the initiation of an arrangement between EDS
and VLT under which EDS will continue to provide, on a
week-to-week basis, similar services as previously provided
by EDS under the terminated contract.
(2) Form 8-K dated August 28, 1996, reporting, among other
things, certain information regarding the election of
Richard M. Haddrill as president of the Company, and being
named to its Board of Directors.
(3) Form 8-K dated September 27, 1996, reporting, among other
things, certain information regarding AWI's withdrawal of
its on-line lottery system proposal to the Kentucky Lottery
Corporation because of time constraints due to ongoing
divestiture and subcontracting considerations affecting AWI
and state law prohibition.
24
<PAGE> 25
VIDEO LOTTERY TECHNOLOGIES, INC. AND SUBSIDIARIES
SIGNATURES
Pursuant to the requirements of the Securities Act of 1934, the Registrant has
duly caused this report to be signed on its behalf by the undersigned thereunto
duly authorized.
VIDEO LOTTERY TECHNOLOGIES, INC.
Date: November 12, 1996 /s/ Richard M. Haddrill
--------------------------------------------
Richard M. Haddrill, Chief Financial Officer
(authorized to sign on behalf of Registrant)
25
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