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 JUNE 30, 1998 OR
TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
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EXCHANGE ACT OF 1934 FOR THE TRANSITION PERIOD FROM _______ TO _______
Commission file number 0-19322
POWERHOUSE TECHNOLOGIES, INC.
(Formerly known as Video Lottery Technologies, Inc.)
(Exact name of registrant as specified in its charter)
Delaware 81-0470853
(State or other jurisdiction (I.R.S. Employer
incorporation or organization) Identification No.)
115 Perimeter 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:
The number of shares outstanding the issuer's $ .01 per value Common Stock, as
of the latest practicable date of June 30, 1998, was 10,816,156 shares.
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<PAGE>
POWERHOUSE TECHNOLOGIES, INC.
AND SUBSIDIARIES
INDEX
Page
PART I. FINANCIAL INFORMATION
ITEM 1. Consolidated Financial Statements
Statements of Earnings
Six Months Ended June 30, 1998 and 1997
Three Months Ended June 30, 1998 and 1997 4
Balance Sheets
June 30, 1998 and December 31, 1997 5
Statement of Stockholders' Equity
Six Months Ended June 30, 1998 6
Statements of Cash Flows
Six Months Ended June 30, 1998 and 1997 7
Notes to Consolidated Financial Statements 8
ITEM 2. Management's Discussion and Analysis of Financial Condition and Results
of Operations 13
ITEM 3. Quantitative and Qualitative Disclosures About Market Risk 20
PART II. OTHER INFORMATION
ITEM 1. Legal Proceedings 20
ITEM 2. Changes in Securities 20
ITEM 3. Defaults Upon Senior Securities 20
ITEM 4. Submission of Matters to a Vote of Security Holders 20
ITEM 5. Other Information 20
ITEM 6. Exhibits and Reports on Form 8-K 21
Signatures 22
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<PAGE>
Powerhouse Technologies, Inc. (the "Company") was incorporated in Delaware
in May 1991. The Company acts as a holding company for ten active corporations.
Unless the context otherwise requires, references to the "Company" or "PTI"
refer to Powerhouse Technologies, Inc. and its subsidiaries. References to "AWI"
refer to Automated Wagering International, Inc., one of the Company's three
principal operating subsidiaries, which provides on-line lottery systems and
services primarily to governmental lottery authorities. References to "VLC"
refer to Video Lottery Consultants, Inc., another of the Company's three
principal operating subsidiaries, which designs, manufactures and markets casino
and video lottery gaming machines and central control systems. References to
"UWS" or "United Tote" refer to United Wagering Systems, Inc., the Company's
third principal operating subsidiary whose operating units provide computerized
pari-mutuel wagering systems for horse and greyhound racetracks, off-track
betting facilities and jai alai frontons. The Company also owns and operates a
racetrack facility in Sunland Park, New Mexico, which is accounted for as part
of the UWS operating segment. References to the "Subsidiaries" refer to AWI,
VLC, UWS and the other subsidiaries of the Company.
Certain statements in this 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.
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<PAGE>
PART I. FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
POWERHOUSE TECHNOLOGIES, INC. AND SUBSIDIARIES
STATEMENTS OF EARNINGS
(in thousands except for per share data)
<TABLE>
<CAPTION>
Six Months Ended Three Months Ended
June 30, June 30,
-------- --------
1998 1997 1998 1997
---- ---- ---- ----
<S> <C> <C> <C> <C>
REVENUES:
On-line lottery $53,709 48,907 24,445 25,913
Gaming machine and route operations 31,166 31,501 16,787 13,762
Wagering systems and racetrack operations 13,889 14,737 7,302 7,466
------- ------ ------ ------
Total revenues 98,764 95,145 48,534 47,141
------- ------ ------ ------
COSTS AND EXPENSES:
On-line lottery 33,323 32,312 14,216 17,157
Gaming machine and route operations 18,376 16,555 10,330 7,317
Wagering systems and racetrack operations 10,876 10,904 5,377 5,265
------- ------ ------ ------
62,575 59,771 29,923 29,739
------- ------ ------ ------
Gross profit 36,189 35,374 18,611 17,402
OTHER OPERATING EXPENSES
Selling, general and administrative 17,306 15,240 8,780 7,546
Research and development 5,024 4,843 2,459 2,346
Depreciation and amortization 9,667 11,841 4,847 5,806
------- ------ ------ ------
31,997 31,924 16,086 15,698
------- ------ ------ ------
Earnings from operations 4,192 3,450 2,525 1,704
------- ------ ------ ------
OTHER INCOME (EXPENSE):
Interest and other income 607 390 239 155
Interest expense (1,553) (2,010) (763) (1,016)
------- ------ ------ ------
(946) (1,620) (524) (861)
------- ------ ------ ------
Earnings before income taxes and
extraordinary items 3,246 1,830 2,001 843
Income tax expense 1,333 1,046 701 343
------- ------ ------ ------
Net earnings before extraordinary items 1,913 784 1,300 500
Extraordinary gain, net --- 13,269 --- ---
------- ------ ------ ------
Net earnings $ 1,913 14,053 1,300 500
======= ====== ====== ======
Net earnings per share (Basic and Diluted):
Before extraordinary item $.18 .07 .12 .05
From extraordinary item --- 1.28 --- ---
---- ---- ---- ----
$.18 1.35 .12 .05
==== ==== ==== ====
Weighted average shares:
Basic 10,567 10,338 10,667 10,254
Potential Common Stock 340 31 276 52
------ ------ ------ ------
Diluted 10,907 10,369 10,943 10,306
====== ====== ====== ======
</TABLE>
See accompanying notes to consolidated financial statements.
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<PAGE>
POWERHOUSE TECHNOLOGIES, INC. AND SUBSIDIARIES
BALANCE SHEETS
(in thousands except share data)
<TABLE>
<CAPTION>
June 30, December 31,
1998 1997
---- ----
<S> <C> <C>
ASSETS
Current assets:
Cash and cash equivalents $ 8,255 13,772
Restricted short-term deposits 3,078 1,423
Accounts receivable, net 20,687 25,839
Current installments of notes receivable, net 3,769 3,192
Inventories 21,902 15,942
Prepaid expenses 1,679 1,037
Deferred income taxes 13,423 14,944
-------- -------
Total current assets 72,793 76,149
-------- -------
Property, plant and equipment 156,385 152,074
Less accumulated depreciation (94,685) (88,914)
-------- -------
Net property, plant and equipment 61,700 63,160
-------- -------
Restricted cash deposits 415 2,408
Notes receivable, excluding current installments 2,334 2,547
Goodwill, net 8,905 9,314
Intangible and other assets, net 11,843 11,319
-------- -------
$157,990 164,897
======== =======
LIABILITIES
Current liabilities:
Current installments of long-term debt $ 4,172 4,381
Accounts payable 6,565 9,513
Accrued expenses 20,149 25,205
-------- -------
Total current liabilities 30,886 39,099
-------- -------
Long-term debt, excluding current installments 28,788 31,446
Deferred income taxes 11,867 12,206
-------- -------
Total liabilities 71,541 82,751
-------- -------
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 19
Common stock, $.01 par value. Authorized 25,000,000
shares 114 110
Paid-in capital 92,980 89,427
Deferred restricted stock compensation (1,384) (217)
Accumulated deficit (5,280) (7,193)
-------- -------
Total stockholders' equity 86,449 82,146
-------- -------
$157,990 164,897
======== =======
</TABLE>
See accompanying notes to consolidated financial statements.
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<PAGE>
POWERHOUSE TECHNOLOGIES, INC. AND SUBSIDIARIES
STATEMENT OF STOCKHOLDERS' EQUITY
(in thousands)
<TABLE>
<CAPTION>
- ----------------------------------------------------------------------------------------------------------------------
Series A Restricted Total
Preferred Common Stock Accumu- Stock-
Stock Stock Paid-in Compen- lated holders'
par value par value Capital sation Deficit Equity
- ----------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C>
December 31,
1997 $19 110 89,427 (217) (7,193) 82,146
Net earnings --- --- --- --- 1,913 1,913
Restricted stock
issued --- 1 1,399 (1,400) --- ---
Amortization of
deferred
restricted stock
compensation --- --- --- 233 --- 233
Proceeds from
sale of common
stock --- 3 2,154 --- --- 2,157
--- --- --- --- --- ---
--- --- ------ ------ ------ ------
June 30,1998 $19 114 92,980 (1,384) (5,280) 86,449
=== === ====== ====== ====== ======
- ----------------------------------------------------------------------------------------------------------------------
</TABLE>
1998 Share Data (1)
<TABLE>
<CAPTION>
Series A Common
Balance Preferred Stock Issued Stock Issued
- ------- ---------------------- ------------
<S> <C> <C>
Beginning of period 1,912,728 11,023,406
Restricted Common Stock issued --- 108,000
Common Stock issued --- 230,204
--------- ----------
June 30, 1998 1,912,728 11,361,610
========= ==========
</TABLE>
(1) 1,912,728 shares of Series A Preferred Stock and 545,454 shares of Common
Stock are held in treasury as collateral for a note payable (see Note 2 to
consolidated Financial Statements).
See accompanying notes to consolidated financial statements.
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<PAGE>
POWERHOUSE TECHNOLOGIES, INC. AND SUBSIDIARIES
STATEMENTS OF CASH FLOWS
(in thousands)
<TABLE>
<CAPTION>
Six Months Ended June 30,
-------------------------
1998 1997
---- ----
<S> <C> <C>
CASH FLOWS FROM OPERATING ACTIVITIES:
Net earnings $ 1,913 14,053
Adjustments to reconcile net earnings to net cash
provided by operating activities:
Depreciation and amortization 9,667 11,841
Extraordinary gain, net --- (13,269)
Other, net 297 171
Changes in operating assets and liabilities:
Receivables, net 4,789 2,038
Inventories (5,510) 6,481
Prepaid expenses (642) (120)
Accounts payable (2,948) (1,496)
Accrued expenses (4,576) 1,894
Income taxes 1,182 4,850
------ ------
Net cash provided by operating activities 4,172 26,443
------ ------
CASH FLOWS FROM INVESTING ACTIVITIES:
Capital expenditures (7,468) (4,717)
Expenditures on intangible and other non-current assets (1,743) (828)
Proceeds from sales of equipment 141 ---
Change in restricted cash deposits 338 2
------ ------
Net cash used in investing activities (8,732) (5,547)
------ ------
CASH FLOWS FROM FINANCING ACTIVITIES:
Net payments on notes payable --- (7,650)
Proceeds from issuance of long-term debt --- 643
Repayments of long-term debt (3,114) (5,678)
Proceeds from sale of Common Stock 2,157 ---
------ -------
Net cash used in financing activities (957) (12,685)
------ -------
Net increase (decrease) in cash and cash equivalents (5,517) 8,211
Cash and cash equivalents, beginning of period 13,772 4,322
------ ------
Cash and cash equivalents, end of period $ 8,255 12,533
======= ======
</TABLE>
See accompanying notes to consolidated financial statements.
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<PAGE>
POWERHOUSE 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
Powerhouse Technologies, Inc. and its subsidiaries (collectively the
"Company"). All significant inter-company balances and transactions have
been eliminated in consolidation.
The consolidated balance sheet as of June 30, 1998 and the
consolidated statements of earnings and cash flows for the six-month
periods ended June 30, 1998 and 1997 and the consolidated statement of
stockholders' equity for the six-month period ended June 30, 1998 have been
prepared by the Company in accordance with generally accepted accounting
principles ("GAAP"), for interim financial reporting, and with the
instructions to Form 10-Q and Article 10 of Regulation S-X. Accordingly,
they do not include all of the information and footnotes required by GAAP
for complete annual financial statements. The financial statements have
been prepared without audit and, in the opinion of management, include 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. The December 31, 1997 consolidated balance
sheet was derived from consolidated financial statements audited by KPMG
Peat Marwick LLP in connection with the Company's annual audit. For further
information see the Company's 1997 Annual Report on Form 10-K.
b. Earnings Per Share
Basic earnings per share includes no dilution and is computed by
dividing income available to common stockholders by the weighted average
number of common shares outstanding for the period. Diluted earnings per
share reflects the potential dilution of securities that could share in the
earnings of the Company. Potential common stock is excluded from the
weighted average share calculations when the inclusion would be
anti-dilutive.
c. Accounting Pronouncements Not Yet Adopted
The American Institute of Certified Public Accountants (AICPA)
Accounting Standards Executive Committee (AcSEC) issued Statement of
Position 98-5 (SOP), Reporting on the Costs of Start-Up Activities, which
requires companies to expense start-up costs (including organization costs)
as incurred. The SOP is effective for fiscal years beginning after December
15, 1998 with early adoption permitted. As of June 30, 1998, the Company
has capitalized approximately $0.2 million of start-up costs related to the
development of a casino in Sunland Park, New Mexico (see Note 6). Current
plans for the casino development reflect approximately $1.0 million of
anticipated start-up costs. The Company has capitalized start-up costs in
conjunction with the implementation of its long-term contracts in the
on-line lottery and wagering systems segments. The Company's accounting
policy for start-up costs incurred to implement its long-term service
contracts is not affected by the SOP.
Statement of Financial Accounting Standards No. 133 ("Statement 133"),
issued June 1998, establishes accounting and reporting standards for
derivative instruments, including certain derivative instruments embedded
in other contracts, . (collectively referred to as derivatives) and for
hedging activities. It requires an entity to recognize all derivatives as
either assets or liabilities in the statement of financial position and
measure those instruments at fair value. This statement is effective for
fiscal years beginning after June 15, 1999. Initial application of it
should be as of the beginning of an entity's fiscal quarter. To date the
Company has not held any derivative instruments, including certain
derivative instruments embedded in other contracts.
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<PAGE>
POWERHOUSE TECHNOLOGIES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
d. Management estimates.
The preparation of financial statements in conformity with generally
accepted accounting principles requires management to make estimates and
assumptions that affect the reported amounts of assets and liabilities and
disclosure of contingent assets and liabilities at the date of the
financial statements and the reported amounts of revenues and expenses
during the reporting period. Actual results could differ from those
estimates.
e. Reclassifications.
Certain reclassifications have been made to the December 31,
1997amounts to conform to the 1998 presentation. The Company reclassified
approximately $3.0 million of estimated taxes payable from a valuation
account reducing current deferred tax assets to accrued liabilities.
2. EXTRAORDINARY ITEM - EDS SETTLEMENT
In January 1994, Electronic Data Systems Corporation ("EDS") purchased
545,454 shares of the Company's Common Stock and 1,912,728 shares of the
Company's Series A Junior Preferred Stock ("Series A Preferred Stock"). In
conjunction with the stock sale to EDS in 1994, the Company entered into a
ten-year agreement with EDS which, among other things, called for EDS to provide
to the Company enhanced computing, communications, system and engineering and
field maintenance services under terms of the Company's on-line lottery
contracts. In 1996, the Company withheld certain payments to EDS due to EDS
performance issues and related on-line lottery customer disputes. In mid-1996
the contract with EDS was terminated and EDS filed a complaint against the
Company seeking payment of outstanding fees. On January 30, 1997, the Company
and EDS settled all claims against each other and agreed to transition the EDS
services to the Company. The settlement resulted in a net of taxes extraordinary
gain on debt extinguishment of approximately $13.3 million ($1.28 per basic and
diluted share) for the Company. The terms of the settlement included the
redemption by the Company of all of the Common and Series A Preferred Stock
owned by EDS, the transfer to the Company of certain inventories and property,
plant and equipment used in the provision of EDS services to on-line lottery
customers and the extinguishment of approximately $38.0 million of outstanding
fees in exchange for a note payable with an initial present value of $26.1
million. The note payable calls for interest payments only through 1998 with
provisions for acceleration upon sale of assets securing the note, and principal
and interest payments in years three through maturity in 2004. The note is
secured by the redeemed Common Stock and Series A Preferred Stock, certain
inventories, fixed assets and software technology and carries prepayment
provisions upon the disposal of substantially all the assets or stock of the
Company or certain of its subsidiaries. The transition of the EDS services and
related employees to the Company was completed in 1997.
3. INVENTORIES
A summary of inventory follows:
June 30, December 31,
1998 1997
(000) (000)
Manufacturing:
Raw materials $ 9,884 6,703
Work-in-process 1,244 662
Finished goods 9,299 7,427
Customer service and other 1,475 1,150
------- ------
$21,902 15,942
======= ======
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<PAGE>
POWERHOUSE TECHNOLOGIES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
4. LONG-TERM DEBT
A summary of long-term debt, including capitalized lease obligations,
follows:
<TABLE>
<CAPTION>
June 30, December 31,
1998 1997
---- ----
(000s) (000s)
<S> <C> <C>
Note payable at implicit rate of prime (8.5%) at December 31, 1997 with
interest only payments through 1998. Thereafter due in monthly
installments, including interest, through January 2004. Secured by
certain inventories, property and equipment, intangible
assets and treasury stock (See Note 2.) $25,646 25,850
8.25% note payable in monthly installments including interest,
through September 2001 4,590 4,940
7.2% to 12.25% capital lease obligations, due in monthly
installments of $4,573 to $26,567 including interest
maturing through April 2002 792 1,152
9.0% note payable in monthly installments including interest
through December 1998, secured by assets leased to others
(See Note 7.) 1,931 2,615
LIBOR (5.58%) at December 31, 1997) plus 3.25% notes payable in
equivalent monthly installments of $250,000 plus interest through
February 1998. Secured by stock of certain subsidiaries --- 1,270
------- ------
32,959 35,827
Less current installments 4,171 4,381
------- ------
Long-term debt, excluding current installments $28,788 31,446
======= ======
</TABLE>
The Company maintains a credit facility with U. S. Bank, N. A., (formerly
known as First Bank, N.A). In conjunction with the Company's settlement with
EDS, effective January 30, 1997 (see Note 2), the credit facility with U. S.
Bank, N.A. was amended to, among other things, allow for the pari passu
securitization of certain assets of the Company by EDS, extend the maturity date
of the revolving line of credit to February 28, 1998, and increase the line of
credit from $17.5 million to $19.5 million. At June 30, 1998, $9.5 million of
the revolving line of credit is committed under the Company's bonding program
and the balance of $10.0 million is available for working capital. The revolving
line of credit bears interest at LIBOR (5.6% at June 30, 1998) plus 3.25% and
carries a commitment fee of .25% on the unadvanced amount. The credit agreement
contains certain restrictive covenants, including leverage and cash flow ratios,
restricting a change in control, restricting the payment of dividends and
maintaining minimum stockholders' equity. On February 28, 1998, the credit
agreement with U. S. Bank was amended to extend the expiration date of the
revolving line of credit to August 31, 1998.
The Company is currently negotiating a $100 million credit facility to
replace its credit facility with U. S. Bank, refinance substantially all other
long-term debt and provide capital for the implementation of new on-line lottery
contracts. The credit facility will not be finalized until completion of due
diligence and agreement on definitive terms with respect to the financing. While
no assurances can be given that the credit facility will be finalized,
management is not aware of any reason to conclude that it will not be finalized.
5. STOCKHOLDERS' EQUITY
In February 1998, the Company effected a secondary offering of currently
outstanding shares held by an investor group representing approximately 15% of
the Company's outstanding common stock
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<PAGE>
POWERHOUSE TECHNOLOGIES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(approximately 1.5 million shares). Approximately, 220,000 additional shares
were issued pursuant to the exercise of an option granted by Company to the
underwriters.
6. COMMITMENTS AND CONTINGENCIES
The Company has employment agreements with certain of its executive
officers that provide for lump sum severance payments and accelerated vesting of
options and restricted stock upon termination of employment under certain
circumstances or a change in control, as defined.
The Company is obligated to provide services and/or equipment under certain
of its contracts with customers. 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. The Company accrues estimated
liabilities to fulfill the terms of these contracts when a loss is probable and
can be reasonably estimated.
The Company continues to conduct a comprehensive review of its computer
systems to identify the systems that could be affected by the "Year 2000" issue
and has developed a preliminary plan to address the issue. The Year 2000 issue
is pervasive and complex, as virtually every computer system, including the
Company's internal systems, systems delivered to customers, and suppliers'
systems, will be affected in some way by the rollover of the two-digit year
value to "00." Computer systems that do not properly recognize date-sensitive
information could generate erroneous data or cause a complete system failure.
The Company believes that, with modification of existing computer systems,
updates by vendors and conversion to new software in the ordinary course of its
business, the Year 2000 issue will not pose significant operations problems for
the Company's computer systems. However, if such modifications and conversions
are not completed properly or in a timely manner, or third-party software and
systems relied on by the Company fail, the Year 2000 issue could have a material
impact on the business and operations of the Company. The costs of modifications
and conversions are not anticipated to be material, and will principally
represent a re-deployment of existing or otherwise planned resources. No
assurance can be given that the Company will successfully avoid any problems
associated with the Year 2000 issue.
The Company typically posts bid, litigation, and performance bonds for
on-line lottery contracts. At June 30, 1998, the Company had collateral in
support of the various bonds outstanding consisting of $2.0 million of
restricted deposits and $7.5 million 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
to collect on the applicable bond. The Company has had disputes with customers
over implementation schedules, deliverables and other issues. The Company works
with these customers to resolve these differences; however, should the Company
be unable to resolve any disputes in a mutually satisfactory manner, the Company
may suffer negative consequences in its relationships with these and other
customers and its pursuit of future business. The ultimate cost to the Company
of such damages (if any) would be net of its claims under risk management
policies in effect as appropriate.
The Company, in 1996, was named the successful bidder for a new on-line
lottery contract with the Florida lottery. The award by the Florida Lottery has
been unsuccessfully protested by a competitor twice, and the competitor has
filed another appeal that delayed contract negotiations. The previous contract
expired on of June 30, 1996. The Company is continuing the operation of the
current on-line lottery system under the terms of the expired contract extended
to the earlier of the implementation of a new agreement or January 1, 2000.
Under the terms of the Florida request for proposal, sizable capital
expenditures in advance of any capital generated by a contract, and in excess of
current credit facilities, may be required to fulfill its terms.
The Company has entered into a contract with the Pennsylvania Lottery to
replace the contract the Company currently has with the lottery. The current
contract expires in December 1998. Sizable capital expenditures in excess of
current capital sources are required in advance of any anticipated capital
generated by the new Pennsylvania contract. Total capital expenditures
anticipated for the Pennsylvania
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<PAGE>
POWERHOUSE TECHNOLOGIES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
contract implementation are estimated at $46.0 million with approximately $25.0
million anticipated by January 1999.
The Company is currently negotiating a $100 million credit facility to
replace its credit facility with U. S. Bank, refinance substantially all other
long-term debt and provide capital for the implementation of new on-line lottery
contracts. The credit facility will not be finalized until completion of due
diligence and agreement on definitive terms with respect to the financing. While
no assurances can be given that the credit facility will be finalized,
management is not aware of any reason to conclude that it will not be finalized.
The recovery of a significant amount of the Company's investment in the
racetrack operations in Sunland Park, New Mexico is largely contingent upon the
implementation of gaming at the racetrack. In March, 1997, the New Mexico
legislature voted to allow casino gaming at pari-mutuel racetracks in New
Mexico, including the Company's racetrack in Sunland Park. The bill allows,
among other things, the operation of up to 300 gaming machines per pari-mutuel
racetrack facility for up to twelve hours per day. The implementation of gaming
is subject to the timing and satisfaction of conditions of the legislation,
including the actions of the state's recently appointed board to oversee the
gaming and other regulatory matters. While the Company intends to file for the
necessary licenses and approvals and believes it meets the appropriate criteria
and standards, no assurances can be given that the licenses and approvals will
be granted. The Company is not aware of any reason it would not receive the
necessary licenses or approvals. Consequently, the Company does not anticipate
that any revenues will be generated from the approved gaming until the fourth
quarter of 1998 at the earliest. The Company developed architectural plans for
casino gaming at the racetrack facility and has initiated construction. The
Company's investment in the racetrack operations is approximately $19.4 million
and current plans call for approximately $7.0 million of additional capital
expenditures for facility enhancements, gaming machines and related equipment to
be funded from operations.
A significant percentage of the Company's consolidated revenues are derived
from sales to customers in jurisdictions that have enacted legislation
permitting various types of gaming. Such enacted legislation may change due to
political and economic conditions within the jurisdiction and could have a
material adverse effect upon the Company's financial position and results of
future operations.
International sales denominated in foreign currencies accounted for
approximately 10% of the Company's consolidated revenues in 1997. Management can
give no assurances that changes in currency and exchange rates will not
materially affect the Company's revenues, costs, cash flows and business
practices and plans. The Company historically has not attempted to hedge the
risks of fluctuating exchange rates given the currencies involved and the terms
of payment granted to its customers.
Risks inherent in the Company's international business activities generally
include unexpected changes in regulatory requirements, tariffs and other trade
barriers, delays in receiving payments on accounts receivable balances,
reimbursement approvals (both governmental and private), difficulties in
managing international operations, potentially adverse tax consequences,
restrictions on repatriation of earnings and the burdens of complying with a
wide variety of foreign laws and regulations. In addition, the Company's foreign
operations would be affected by general economic conditions in the international
markets in which the Company does business. There can be no assurances that such
factors will not have a material adverse effect on the Company's future
international revenues and, consequently, on the Company's business, financial
condition, results of operations or cash flows.
The Company is involved in various 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 or results
of operations or liquidity.
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POWERHOUSE TECHNOLOGIES, INC. AND SUBSIDIARIES
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
General
- -------
The Company derives its revenues principally from four business segments in
the gaming and wagering industry. Two of the business segments operate in the
pari-mutuel wagering market and are combined for financial reporting purposes as
the wagering systems and racetrack operations segment. The Company develops,
manufactures, sells, services and operates gaming and wagering systems in the
on-line lottery, video lottery and casino gaming and pari-mutuel wagering
markets.
Revenues from the on-line lottery segment are generated from the rendering
of services and the sale or supply of computerized on-line lottery systems and
components to government-authorized lotteries. Service revenues have been
derived primarily from service contracts. These contracts are typically of at
least five years' duration, and are generally based upon a percentage of a
lottery's gross on-line lottery sales. These percentages vary depending on the
size of the lottery and the scope of services provided to the lottery. Product
sale revenues have been derived primarily from the installation and licensing of
new on-line lottery systems and sales of lottery terminals and equipment in
connection with the expansion of existing lottery programs. The size and timing
of these transactions result in variability in product sales revenues from
period to period. The segment revenue will also experience fluctuations
depending on contract start and end dates and relative sizes of jackpots and the
number of terminals on-line and selling tickets in the states which the Company
operates. The Company expects on-line lottery services revenue to continue to be
a significant component of total revenues. On-line lottery revenue is generated
by the Company's AWI subsidiary.
The Company expects the on-line lottery segment to remain a significant
segment of the Company. The segment's growth is dependent upon management's
ability to selectively bid and win domestic lottery contracts and aggressively
pursue and win international on-line lottery opportunities as well as expand
services to existing customers. On-line lottery contracts for a number of state
lotteries will re-bid over the next several years. Due to the high cost of
procuring new lottery contracts, the Company is targeting states that it
believes will establish a bidding process based exclusively on technical
capability, price and service. This strategy allows the Company to efficiently
allocate its resources so that it may also pursue international growth
opportunities. The Company is currently pursuing potential opportunities in a
number of international jurisdictions that are expected to implement on-line
lottery programs.
Revenue from the gaming machine and route operations segment consists of
sales and lease of gaming machines, sales of parts, central control system
hardware and software, service of terminals, license fees, and from the
operation of gaming machine routes in video lottery and casino gaming markets.
Route operations revenue consists primarily of gaming machine wagers net of
pay-outs to patrons and state gaming taxes. Revenue from gaming machine sales is
subject to potentially significant fluctuations. If jurisdictions approve
legislation for new or expanded gaming operations and if the Company is awarded
a contract in any such jurisdictions, the segment may experience a surge in
sales revenue that may or may not subsequently decline dramatically depending on
the jurisdiction and gaming venue. The Company expects gaming machine and route
operations revenue to continue to be a major component of total revenues. Gaming
machine revenue is primarily generated by the Company's VLC subsidiary.
Wagering systems revenue is generated primarily from a contractual
percentage of handle processed through computerized pari-mutuel wagering systems
from contracts with over 120 horse and dog racing facilities in North America as
well as sales and lease of pari-mutuel wagering systems. Racetrack operations
revenue is derived from the ownership and operation of a horse racing facility
in Sunland Park, New Mexico. While on-track attendance and handle from
pari-mutuel wagering in the United States has markedly decreased over the last
decade as jurisdictions have legalized other forms of gaming, there has also
been a substantial increase in simulcast and off-track betting handle. Due to
the volatility within gaming venues during the last several years, the Company
cannot predict the magnitude of any resulting effects on this segment of its
business. The Company expects wagering systems and racetrack operations revenue
to be a significant component of total revenues.
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POWERHOUSE TECHNOLOGIES, INC. AND SUBSIDIARIES
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 any special or other 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 costs of equipment
sales, inclusive of materials, labor and allocated manufacturing overhead. 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 location's owners' share of the
net machine revenues. Costs and expenses related to wagering systems operations
include direct and allocated indirect costs associated with the operation of
pari-mutuel wagering equipment at the racetracks at which the Company has a
contract as well as direct costs of equipment sales.
Selling, general and administrative expenses ("SG&A") 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 or
research and development as discussed below.
Research and development ("R&D") costs represent costs incurred to gain and
develop new knowledge applicable to the Company's various gaming systems
inclusive of software and hardware technology. Included in R&D costs are labor,
material, consulting, occupancy and other expenses associated with the R&D
efforts. Certain development costs are capitalized in accordance with Statement
of Financial Accounting Standards Board Statement No. 86 for certain software
developed for sale or lease.
Second Quarter 1998 Compared with Second Quarter 1997
- -----------------------------------------------------
Consolidated revenues increased by $1.4 million, or 3%, to $48.5 million
from $47.1 million in the second quarter 1997. The consolidated gross profit
increased by $1.2 million, or 7%, to $18.6 million from $17.4 million in the
second quarter 1997. Earnings from operations were $2.5 million in 1998 as
compared to $1.7 million in 1997. Consolidated net earnings were $1.3 million as
compared to $.5 million in the second quarter 1997.
On-line Lottery
Total revenues from the on-line lottery segment decreased by $1.5 million,
or 6% to $24.4 million from $25.9 million in the second quarter 1998. The
decrease reflects lower recorded revenues from product sales and installations
of on-line lottery systems to customers in Norway and Chile. While revenues from
product sales declined in the second quarter 1998 compared to 1997, revenues
from a number of the Company's domestic lottery customers increased as a result
of higher lottery jackpots, primarily Powerball(R), in the second quarter 1998.
In the second quarter 1998, revenues from lottery system enhancements and
product sales, primarily to international customers in Chile and Norway, were
$1.4 million as compared to $4.8 million in 1997. The gross profit on on-line
lottery system and equipment sales was 54% in the second quarter 1998 and 36% in
1997.
Additionally, the Company's on-line lottery system MasterLink(R) affords
the Company the ability to develop add-on products and services as well as
modify the system for game changes such as the recent change in the Powerball(R)
lottery game. Given the maturity of the on-line lottery industry, lottery
authorities and service providers are in need of ways to increase lottery ticket
sales and reduce costs. While no assurance can be given, the Company expects
that its on-going efforts to develop new products and services every year for
its existing customers will enhance revenues and reduce operating costs.
The expiration date of the current contract with the Florida Lottery was
extended from June 30, 1996, as a result of a delay of the award of a new
contract. On September 2, 1997, the Company was
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POWERHOUSE TECHNOLOGIES, INC. AND SUBSIDIARIES
notified by the Florida Lottery that AWI had been selected as the most highly
qualified bidder for the award of a new five-year contract. The notification was
pursuant to a re-evaluation caused by an earlier protest by a competitor of the
Florida Lottery's previous selection of the Company. The competitor (GTECH
Holdings Corporation) protested the Florida Lottery's re-selection of the AWI as
the most qualified bidder. On March 23, 1998, the Lottery dismissed the protest
and re-awarded the contract to the Company. The competitor filed its notice of
appeal of this order on March 24, 1998. On January 5, 1998 the Company and the
Florida Lottery entered into an interim contract to continue operating the
Florida Lottery's on-line system until the earlier of the award and
implementation of a new agreement or January 1, 2000. Under the terms of the
Florida request for proposal, sizable capital expenditures in advance of any
capital generated by a contract, and in excess of current credit facilities, may
be required to fulfill its terms. See discussion of credit facilities in
Management's Discussion of Liquidity and Capital Resources.
The gross profit margin for on-line lottery revenues was 42% in the second
quarter 1998 as compared to 34% in 1997. The gross profit margin from on-line
lottery service revenues was 41% in the second quarter 1998 and 33% in 1997. The
increase is partially attributable to the $195.0 million Powerball(R) jackpot
experienced in the second quarter 1998. In late 1997 the Multi State Lottery
Association ("MUSL") modified the Powerball(R) lottery game to increase the
statistical expectation of higher jackpots. Four of the Company's seven on-line
lottery contract customers are members of the MUSL, which includes a total of 20
states plus the District of Columbia. The Company is optimistic that the
Powerball(R) game modification will result in periodically higher jackpots,
which results in higher revenues and gross profit margins to the Company
although there can be no assurance that this will happen.
Gaming Machine and Route Operations
Revenue from the gaming machine and route operations segment increased by
$3.0 million, or 22%, to $16.8 million from $13.8 million in the second quarter
of 1997. The increase in revenues in the second quarter of 1998 reflects a
higher level of gaming machine and related parts sales in the Nevada casino
market where the Company began selling gaming machines in mid-1996.
Additionally, the Company sold approximately 200 gaming machines to a
pari-mutuel racetrack facility in West Virginia in the second quarter 1998
reflecting the Company's progress in the development of casino opportunities at
racetracks.
Revenue was recognized on delivery of approximately 1,320 units in the
second quarter 1998 as compared to 1,060 units in 1997. Revenue from the
Company's route operations was $4.3 million in the second quarters of 1998 and
1997. Revenue from leases of gaming machines was $2.0 million in the second
quarter 1998 as compared to $2.5 million in 1997. The decrease in revenue from
leasing arrangements primarily reflects the reduction in gaming machines under
lease from approximately 4,100 units at March 1, 1997 to approximately 3,400 at
June 30, 1998. In March 1997, the lease agreements for approximately 2,200
gaming machines with the Oregon Lottery expired. The Lottery exercised an option
to purchase 1,375 of the expired lease machines.
The Company expects the gaming machine and route operation segment to
remain a significant segment of the Company's operations. The growth and success
of the segment is dependent upon the Company's ability to expand its position in
the worldwide video lottery gaming machine market, to continue to penetrate
casino markets such as Nevada and New Jersey, and to develop casino
opportunities at pari-mutuel racetracks such as the Company's racetrack in
Sunland Park, New Mexico. The Company believes that new markets such as South
Africa, and the replacement of older gaming machines and systems in Australia
and North America will provide for significant future growth opportunities for
the Company. Penetration and growth of sales to casino markets is primarily
dependent on the Company's ability to gain visibility and acceptance of its
gaming machines in the markets while offering a competitive price. The Company
believes that its gaming machines are capable of producing greater than average
play and net win amounts reflecting their superior enhanced graphics and
playability. Developing casino opportunities at pari-mutuel racetracks is
dependent initially upon the enactment of legislation to allow gaming at
racetrack facilities. A small number of states, including New Mexico, West
Virginia, Delaware, Iowa, Rhode Island and Louisiana have enacted legislation to
allow gaming at racetracks and the Company anticipates the trend to continue
although there can be no assurance of it.
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<PAGE>
POWERHOUSE TECHNOLOGIES, INC. AND SUBSIDIARIES
The gross profit margin on gaming machine and route operations revenue was
39% in the second quarter 1998 as compared to 47% in 1997. The decrease reflects
a combination of higher revenues from leasing gaming machines and parts sales in
the second quarter 1997 coupled with lower gross profit margins attained on
sales in the casino market in the second quarter 1998. The gross profit margin
from route operations revenue was 27% in the second quarter 1998 and 28% in
1997. Revenue from leasing of gaming machines has minimal direct costs.
Depreciation expense of gaming machines under lease and revenue share agreements
is recorded as a component of depreciation and amortization expense in the
Company's consolidated financial statements. Although there can be no assurance
given, the Company expects gross profit margin levels to remain near or above
40% for the segment.
Wagering Systems and Racetrack Operations
Revenue from the wagering systems and racetrack operation segments
decreased by $0.2 million to $7.3 million from $7.5 million in the second
quarter 1997. Revenue from wagering systems service contracts was $5.1 million
in the second quarters of 1998 and 1997. Racetrack operation revenue was $1.8
million in the second quarters of 1998 and 1997. Sales of pari-mutuel wagering
systems equipment were $0.4 million in the second quarter 1998 as compared to
$0.6 million in 1997.
The gross profit margin from wagering systems revenue was 38% in the second
quarter 1998 compared to 39% in 1997. The negative gross profit for the
racetrack operations in Sunland Park, New Mexico was $(0.2) million in the
second quarter 1998 as compared to $(0.1) in 1997.
The Company expects the wagering systems segment to remain a significant
segment. However, declines in attendance at pari-mutuel facilities has created
increased pricing pressures for the Company and its competitors. The Company
does not anticipate those pricing pressures to decrease in the near future.
Accordingly, the Company plans to maintain profitability by improving customer
service while attempting to maintain or reduce operating costs. The Company
believes that expansion of video gaming at racetracks could increase attendance
and on-track wagering at racetracks. A number of jurisdictions have considered
or are considering gaming at racetracks. The Company provides wagering systems
and service to over 120 of the approximate 350 pari-mutuel facilities in North
America.
The recovery of a significant amount of the Company's investment in the
racetrack operations in Sunland Park, New Mexico is largely contingent upon the
implementation of casino style gaming at the racetrack. In March 1997, the
legislature of New Mexico voted to allow casino gaming at pari-mutuel
racetracks, including the Company's racetrack in Sunland Park. The bill allows,
among other things, the operation of up to 300 gaming machines per pari-mutuel
racetrack facility for up to twelve hours per day. The implementation of gaming
is subject to the timing and satisfaction of conditions of the legislation,
including the actions of the state's appointed board to oversee the gaming and
other regulatory matters. While the Company intends to file the necessary
licenses and approvals and believes it meets the appropriate criteria and
standards, no assurances can be given that the licenses and approvals will be
granted. The Company is not aware of any reason it would not be granted the
necessary licenses or approvals.
The Company does not anticipate that any revenues will be generated from
gaming at Sunland Park until fourth quarter of 1998 or first quarter of 1999.
The Company developed architectural plans for casino gaming at the racetrack
facility and has begun construction. The Company's investment in the racetrack
operations is approximately $19.4 million and current plans call for
approximately $7.0 million of additional capital expenditures for facility
enhancements, gaming machines and related equipment. Included in the capital
expenditures for the facility is approximately $1.0 million of start-up
expenditures that are subject to the requirements of the AICPA's Statement of
Position 98-5(SOP 98-5). SOP 98-5 requires that start-up expenditures be
expensed as incurred effective for fiscal years beginning after December 15,
1998 with early application permitted. Accordingly, the start-up expenditures
incurred, prior to adoption of SOP 98-5, for the casino will be charged to
expense as a cumulative effect of a change in accounting principle net of tax
effects.
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POWERHOUSE TECHNOLOGIES, INC. AND SUBSIDIARIES
Selling, General and Administrative Expenses
- --------------------------------------------
Selling, general and administrative ("SG&A") expenses increased by $1.3
million, or 17%, to $8.8 million in the second quarter 1998 from $7.5 million in
1997. The increase reflects the Company's continued increased marketing and
business development efforts. The increase was primarily in casino market of the
gaming machine segment. The Company anticipates SG&A expenses to remain at or
above current levels given a continuation of strategic business development
plans.
Research and Development
- ------------------------
In the second quarter 1998, the Company expended $2.5 million on research
and development activities as compared to $2.3 million in 1997. In the second
quarter 1997 the Company capitalized approximately $0.3 million of software
development costs. The Company continues to develop and enhance its central
system and gaming and wagering terminal software and games as well as terminal
hardware for all three operating segments. A number of software development
projects are currently being monitored for technological feasibility and the
Company may capitalize additional software development costs as the projects
continue. Research and development expenditures were 5.2% and 5.5% of
consolidated revenues in the second quarters of 1998 and 1997, respectively.
Depreciation and Amortization
- -----------------------------
Depreciation and amortization decreased by $1.0 million to $4.8 million in
second quarter 1998 from $5.8 million in 1997. The decrease is primarily
attributable to a reduction in the number of gaming machine terminals under
lease with the Oregon Lottery as discussed earlier and extensions of a number of
on-line lottery contracts that occurred in 1997. The lottery authorities in
Delaware, Florida and South Dakota exercised extension options in 1997 or in the
case of Minnesota, executed a new contract using a substantial amount of the
equipment from the previous contract. The Company records depreciation expense
on equipment placed in service pursuant to on-line lottery contracts over the
estimated useful life of the equipment equal to the contract term including
exercised extension options.
Six Months Ended June 30, 1998 and 1997
- ---------------------------------------
Consolidated revenues increased by $3.6 million, or 4%, to $98.8 million
from $95.2 million in the first six months of 1997. The overall gross profit
increased by $.8 million, or 2%, to $36.2 million from $35.4 million in the six
months ended June 30, 1997. The Company had net earnings before extraordinary
items of $1.9 million in the first six months of 1998 as compared to $0.8
million in 1997.
On-line Lottery
Total revenues from the on-line lottery segment increased by $4.8 million,
or 10%, to $53.7 million from $48.9 million in 1997. The increase primarily
reflects increased lottery ticket sales for the multi state lottery game
Powerball(R) which experienced relatively higher jackpots in the 1998 period. In
addition, the Company recorded higher sales of on-line lottery equipment sales
in the six months ended June 30, 1998 to customers in Minnesota, Chile and
Norway.
The gross profit margin in the on-line lottery segment was 42% in the first
six months of 1998 as compared to 34% in the first six months of 1997. The
increase primarily reflects increased lottery ticket sales for Powerball(R) and
higher relative gross profit margins on sales of lottery systems equipment and
software enhancements. The gross profit margin from on-line lottery equipment
and system sales was 37% on $8.3 million of revenue in the first six months of
1998, as compared to gross profit margin of 37% on $5.5 million of revenue in
1997.
Gaming Machine and Route Operations
Revenue from the gaming machine and route operations segment decreased by
$0.3 million, or 1%, to $31.2 million from $31.5 million in the first six months
of 1997. The Company experienced notable
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<PAGE>
POWERHOUSE TECHNOLOGIES, INC. AND SUBSIDIARIES
increases in sales to the Nevada casino market in the first six months of 1998
over 1997 levels. These increases were offset by lower sales in the Quebec video
lottery market. Additionally, the Company sold approximately 200 gaming machines
to a pari-mutuel racetrack facility in West Virginia in the second quarter 1998
reflecting progress in the development of casino opportunities at racetracks.
Revenue was recognized on shipments of 2,146 units in the first six months
of 1998 as compared to 3,657 units in 1997. In the first six months of 1997, the
Company sold approximately 1,400 gaming machines to the Oregon Lottery pursuant
to the exercise of an option to purchase the machines contained in the lease
agreement with the Oregon Lottery. The lease term on the gaming machines had
expired and the Lottery purchased the used terminals at fair value in accordance
with the agreement. Absent the sale of previously leased gaming machines, both
the number of units and revenue amounts for the six months ended June 30, 1998
would have been comparable.
Revenue from leasing and revenue sharing arrangements was $4.7 million in
the first six months of 1998 as compared to $5.5 million in 1997. The lease term
on approximately 2,200 gaming machines leased to the Oregon Lottery expired in
March 1997. As discussed above, a significant number of the machines were
purchased by the Lottery.
The gross profit margin from the gaming machine segment was 41% in the
first six months of 1998 as compared to 47% in 1997. The reduction primarily
reflects lower lease revenue in the 1998 period as well unmatched 1997 sales of
chipsets and parts at relatively higher gross profit margins. Management expects
gross profit margins from gaming machine and router operations revenues to
remain at or above the 40% mark. The gross profit margin from route operations
was 27% in the first six months of 1998 and 28% in 1997.
Wagering Systems and Racetrack Operations
Revenue from the wagering systems and racetrack operation segments combined
was $13.9 million in the first six months of 1998 as compared to $14.7 million
in 1997. Revenue from wagering systems service contracts was $9.1 million in the
first six months of 1998 and 1997. Revenue from sales of wagering systems
equipment was $0.7 million in the first six months of 1998 as compared to $1.8
million in 1997. Revenue from the racetrack operations in Sunland Park, New
Mexico was $4.2 million in the first six months of 1998 as compared to $4.0
million in 1997.
The gross profit margin from wagering systems revenue was 35% in the first
six months of 1998 and 1997. The gross profit margin on wagering systems service
revenue fluctuates from quarter to quarter primarily based on the pari-mutuel
racing seasons of customer racetracks. Management does not anticipate any
significant increase gross profit margin levels on service revenue in the near
future. The gross profit margin from equipment sales of $0.7 million was 42% in
the first six months of 1998, as compared to 51% on $1.8 million of sales in
1997. The Company experienced a negative gross profit from the racetrack
operations of approximately $0.5 million in the first six months of 1998 and
$0.2 million in 1997.
Selling, General and Administrative
- -----------------------------------
Total selling, general and administrative (SG&A) expenses were $17.3
million in the six months ended June 30, 1998 and $15.2 million in 1997. The
$2.1 million increase reflects the Company's continued increased marketing and
business development efforts and is in line with management's expectations. The
increase was primarily in casino market of the gaming machine segment. The
Company anticipates SG&A expenses to remain at or above current levels given a
continuation of strategic business development plans.
Research and Development
- ------------------------
Research and development expense, net of amounts capitalized was $5.0
million in the first six
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<PAGE>
POWERHOUSE TECHNOLOGIES, INC. AND SUBSIDIARIES
months of 1998 as compared to $4.8 million in 1997. The Company capitalized $0.5
million in the first six months of 1997. Total research and development
expenditures approximated 5.1% of consolidated revenues in the first six months
of 1998 and 5.6% in 1997.
Liquidity and Capital Resources
- -------------------------------
In the six months ended June 30, 1998 the Company generated nearly $4.2
million of cash from operations as compared to $26.4 million in 1997. The
reduction reflects a number of fluctuations in operating assets and liabilities
representing a reduction in cash provided by operations. The fluctuations
include an increase in inventory levels and decreases in accounts payable and
accrued liabilities as well as a decrease in income tax refund receivables
offset by decreases in accounts receivable. Working capital increased by
approximately $4.9 million from December 31, 1997 to $41.9 million at June 30,
1998. Approximately $9.2 million was invested in property, plant and equipment
and intangible and other assets in the first six months 1998 as compared to $5.5
million in 1997. Approximately $3.8 million has been expended for the initial
implementation cost of the on-line lottery system in Pennsylvania later this
year. Additionally, the wagering systems segment has expended approximately $3.1
million to manufacture and install new tote equipment in 1998. The Company has
expended over $0.8 million on the development of the casino at Sunland Park in
the first six months of 1998. The Company anticipates expending an additional
$7.0 million on the casino development before start-up anticipated in the fourth
quarter 1998 or first quarter 1999.
The note payable to EDS arising from the settlement discussed in Note 2 to
the Consolidated Financial Statements is secured by certain assets including
on-line lottery equipment inventories with a carrying value of approximately $.7
million at June 30, 1998. The note payable ($25.6 million at June 30, 1998)
provides for acceleration of payment on the note equal to 30% of the sales price
of the equipment as well as proceeds in excess of certain levels from licensing
the Company's MasterLink(R) software. The note also provides for acceleration
payments for a change in control of the Company.
The Company repaid long-term debt of $3.1 million in the six months ended
June 30, 1998 including the outstanding term loans with U. S. Bank (formerly
known as First Bank N.A.). On February 28, 1998, the Company and U. S. Bank
extended the expiration date of the Company's credit facility agreement
including the revolving line of credit and bonding program letters of credit to
August 31, 1998. The revolving line of credit has $10.0 million available to the
Company for working capital.
The Company is currently negotiating a $100 million credit facility to
replace its credit facility with U. S. Bank that expires August 31, 1998,
refinance substantially all other long-term debt and provide capital for the
implementation of new on-line lottery contracts. The credit facility will not be
finalized until completion of due diligence and agreement on definitive terms
with respect to the financing. While no assurances can be given that the credit
facility will be finalized, management is not aware of any reason to conclude
that it will not be finalized.
The Company, in 1996, was named the successful bidder for a new on-line
lottery contract with the Florida Lottery. The award by the Florida Lottery has
been unsuccessfully protested by a competitor twice, and the competitor has
filed another appeal that has delayed contract negotiations. Under the new
contract, AWI would provide services to the Florida Lottery for five more years
with options for two extensions of two additional years each. The previous
contract expired on June 30, 1996. AWI is continuing the operation of the
current on-line lottery system under the terms of the expired contract under
temporary extension expiring the earlier of either the implementation of a new
agreement or January 1, 2000.
In November 1997, the Company was awarded a new seven-year contract
commencing in January 1999 to continue providing equipment and services to the
Pennsylvania Lottery. Current estimates of total capital expenditures for the
on-lottery system, under the contract are $46.0 million over a five- year period
with as much as $25.0 million expended by January 1999.
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POWERHOUSE TECHNOLOGIES, INC. AND SUBSIDIARIES
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
Not Applicable
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, 1997 Form 10-K.
ITEM 2. CHANGES IN SECURITIES
None
ITEM 3. DEFAULTS UPON SENIOR SECURITIES
None
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITIES HOLDERS
The Company's Annual Meeting of Stockholders was held on June 4, 1998, and
in connection therewith, proxies were solicited by management pursuant to
Regulation 14 under the Securities Exchange Act of 1934. An aggregate of
10,802,821 shares of the Company's common stock were outstanding and entitled to
vote at the meeting, of which 9,463,074 were present in person or by proxy. At
the meeting the following matters were submitted to a vote by the stockholders,
with the results indicated below:
1. Election of three directors to serve until the year 2000 Annual
Meeting of Stockholders.
Nominee For Withheld
------- --- --------
Richard R. Burt 9,157,467 335,268
Patricia Becker 9,198,892 293,843
Richard M. Haddrill 9,157,959 334,776
2. Amendment to the Company's 1994 Stock Incentive Plan to fix the
maximum number of shares that any eligible employee may receive pursuant to the
plan at 40% of the maximum number of shares authorized for issuance under the
plan.
For Against Abstained/Not Voted
8,105,396 1,234,036 123,642
ITEM 5. OTHER INFORMATION
In June 1998, the Company filed a statement of claim against the Ontario
Lottery Corporation for damages incurred as a result of the Ontario Lottery
Corporation's termination of the request for proposals for video lottery
terminals and central system.
In April 1998, the Company announced that it has received ISO-9002
certification.
In May 1998, the Company announced that AWI, with its consortium partner
Applied Gaming Solutions of Canada Inc., were selected to supply on-line lottery
equipment and services for a program in Vietnam. The Contract award for this
pilot is expected to provide AWI with approximately $5 million in revenue by the
end of 1998, subject to final contract negotiations.
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POWERHOUSE TECHNOLOGIES, INC. AND SUBSIDIARIES
In June 1998, the Company announced that its gaming machine division, VLC,
has signed a letter of intent to provide its Advanced Gaming System(TM) (AGS)
central control system and 4,300 site controllers to Quebec, Canada-based
CASILOC Inc. for the monitoring and control of 15,000 gaming machines operated
by La Societe des Loteries Video du Quebec Inc. (SLVQ). The software and
hardware order, valued at CAD18.7 million, will be delivered over a two-year
period and has an additional annual maintenance fee for the next seven years.
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
On July 1, 1998, the Company filed a current report on Form 8-K to
report its announcement that it expects to exceed consensus analysts' estimates
for the second quarter ending June 30, 1998 and reporting on the status of its
Sunland Park Casino opening and other business developments.
- 21 -
<PAGE>
POWERHOUSE 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.
POWERHOUSE TECHNOLOGIES, INC.
Date: August 13, 1998 /S/ SUSAN J. CARSTENSEN
--------------------------------------------
Susan J. Carstensen, Chief Financial Officer
and Treasurer (authorized to sign on behalf
of Registrant)
- 22 -
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