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 MARCH 31, 1998 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
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.)
2311 South Seventh Avenue
Bozeman, Montana 59715
(Address of principal executive officers) (Zip code)
(406) 585-6600
(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 March 31, 1998, was 10,804,155 shares.
<PAGE>
POWERHOUSE TECHNOLOGIES, INC.
AND SUBSIDIARIES
INDEX
Page
PART I. FINANCIAL INFORMATION
- - ------------------------------
ITEM 1. Consolidated Financial Statements
Statements of Operations
Three Months Ended March 31, 1998 and 1997 4
Balance Sheets
March 31, 1998 and December 31, 1997 5
Statement of Stockholders' Equity
Three Months Ended March 31, 1998 6
Statements of Cash Flows
Three Months Ended March 31, 1998 and 1997 7
Notes to Consolidated Financial Statements 8
ITEM 2. Management's Discussion and Analysis of Financial Condition
and Results of Operations 12
ITEM 3. Quantitative and Qualitative Disclosures About Market Risk 17
PART II. OTHER INFORMATION
- - --------------------------
ITEM 1. Legal Proceedings 17
ITEM 2. Changes in Securities 17
ITEM 3. Defaults Upon Senior Securities 17
ITEM 4. Submission of Matters to a Vote of Security Holders 17
ITEM 5. Other Information 17
ITEM 6. Exhibits and Reports on Form 8-K 17
Signatures 18
2
<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.
3
<PAGE>
PART I. FINANCIAL INFORMATION
ITEM 1. CONSOLIDATED FINANCIAL STATEMENTS
POWERHOUSE TECHNOLOGIES, INC. AND SUBSIDIARIES
STATEMENTS OF OPERATIONS
(in thousands except for per share data)
<TABLE>
<CAPTION>
Three Months Ended March 31,
----------------------------
1998 1997
---- ----
<S> <C> <C>
REVENUES:
On-line lottery $29,264 22,994
Gaming machine and route operations 14,379 17,739
Wagering systems and racetrack operations 6,587 7,271
------- ------
50,230 48,004
------- ------
COSTS OF REVENUES:
On-line lottery 19,107 15,155
Gaming machine and route operations 8,046 9,238
Wagering systems and racetrack operations 5,499 5,639
------- ------
32,652 30,032
------- ------
Gross profit 17,578 17,972
OTHER OPERATING EXPENSES
Selling, general and administrative 8,526 7,694
Research and development 2,565 2,497
Depreciation and amortization 4,820 6,035
------- ------
15,911 16,226
------- ------
Earnings from operations 1,667 1,746
------- ------
OTHER INCOME (EXPENSE):
Interest and other income 368 235
Interest expense (790) (994)
------- ------
(422) (759)
------- ------
Earnings before income taxes and extraordinary item 1,245 987
Income tax expense 632 703
------- ------
Net earnings before extraordinary item 613 284
Extraordinary gain, net --- 13,269
------- ------
Net earnings $ 613 13,553
======= ======
Net earnings per share (Basic and Diluted):
Before extraordinary item $ .06 .03
From extraordinary item --- 1.27
------- ------
$ .06 1.30
======= ======
Weighted average shares:
Basic 10,467 10,424
Potential Common Stock 405 9
------- ------
Diluted 10,872 10,433
======= ======
</TABLE>
See accompanying notes to consolidated financial statements.
4
<PAGE>
POWERHOUSE TECHNOLOGIES, INC. AND SUBSIDIARIES
BALANCE SHEETS
(in thousands except share data)
<TABLE>
<CAPTION>
March 31, December 31,
1998 1997
---- ----
<S> <C> <C>
ASSETS
Current assets:
Cash and cash equivalents $ 13,963 13,772
Restricted short-term deposits 3,180 1,423
Accounts receivable, net 20,933 25,839
Current installments of notes receivable, net 3,581 3,192
Inventories 19,619 15,942
Prepaid expenses 1,256 1,037
Deferred income taxes 10,555 11,444
-------- -------
Total current assets 73,087 72,649
-------- -------
Property, plant and equipment 152,916 152,074
Less accumulated depreciation (91,824) (88,914)
-------- -------
Net property, plant and equipment 61,092 63,160
-------- -------
Restricted cash deposits 410 2,408
Notes receivable, excluding current installments 2,392 2,547
Goodwill, net9,110 9,314
Intangible and other assets, net 10,746 11,319
-------- -------
$156,837 161,397
======== =======
LIABILITIES
Current liabilities:
Current installments of long-term debt $ 3,497 4,381
Accounts payable 7,080 9,513
Accrued expenses 19,444 21,705
-------- -------
Total current liabilities 30,021 35,599
-------- -------
Long-term debt, excluding current installments 29,952 31,446
Deferred income taxes 11,941 12,206
-------- -------
Total liabilities 71,914 79,251
-------- -------
Commitments and contingencies
STOCKHOLDERS' EQUITY
Preferred stock, $.01 par value. Authorized 8,087,272
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 113 110
Paid-in capital 92,885 89,427
Deferred restricted stock compensation (1,514) (217)
Accumulated deficit (6,580) (7,193)
-------- -------
Total stockholders' equity 84,923 82,146
-------- -------
$156,837 161,397
======== =======
</TABLE>
See accompanying notes to consolidated financial statements.
5
<PAGE>
POWERHOUSE TECHNOLOGIES, INC. AND SUBSIDIARIES
STATEMENT OF STOCKHOLDERS' EQUITY
(in thousands except for share data)
<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 --- --- --- --- 613 613
Restricted stock
issued --- 1 1,380 (1,381) --- ---
Amortization of
deferred
restricted stock
compensation --- --- --- 84 --- 84
Proceeds from sale of
common stock --- 2 2,078 --- --- 2,080
--- --- ------ ----- ----- ------
March 31, 1998 $19 113 92,885 (1,514) (6,580) 84,923
=== === ====== ===== ====== ======
- - ------------------------------------------------------------------------------------------------------------------------
</TABLE>
1998 Share Data(1)
<TABLE>
<CAPTION>
Series A Common
Balance Preferred Stock Issued Stock Issued
- - ------- ---------------------- ------------
<S> <C> <C>
December 31, 1997 1,912,728 11,023,406
Restricted Common Stock issued --- 106,000
Common Stock issued --- 220,203
--------- ----------
March 31, 1998 1,912,728 11,349,609
========= ==========
</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
Financial Statements).
See accompanying notes to consolidated financial statements.
6
<PAGE>
POWERHOUSE TECHNOLOGIES, INC. AND SUBSIDIARIES
STATEMENTS OF CASH FLOWS
(in thousands)
<TABLE>
<CAPTION>
Three months ended March 31,
----------------------------
1998 1997
---- ----
<S> <C> <C>
CASH FLOWS FROM OPERATING ACTIVITIES:
Net earnings $ 613 13,553
Adjustments to reconcile net earnings to net cash
provided by operating activities:
Depreciation and amortization 4,820 6,035
Extraordinary gain, net --- (13,269)
Other, net 135 31
Changes in operating assets and liabilities:
Receivables, net 4,672 (940)
Inventories (3,276) 3,778
Prepaid expenses (219) (277)
Accounts payable (2,434) (722)
Accrued expenses (2,065) (1,231)
Income taxes 624 4,504
------- ------
Net cash provided by operating activities 2,870 11,462
------- ------
CASH FLOWS FROM INVESTING ACTIVITIES:
Capital expenditures (2,493) (2,141)
Expenditures on intangible and other noncurrent assets (115) (375)
Proceeds from sales of equipment 97 5
Change in restricted cash deposits 241 (16)
------- ------
Net cash used in investing activities (2,270) (2,527)
------- ------
CASH FLOWS FROM FINANCING ACTIVITIES:
Net payments on notes payable --- (6,000)
Repayments of long-term debt (2,489) (3,024)
-
Proceeds from issuance of common stock 2,080 ---
------- ------
Net cash used in financing activities (409) (9,024)
------- ------
Net increase (decrease) in cash and cash equivalents 191 (89)
Cash and cash equivalents, beginning of period 13,772 4,322
------- ------
Cash and cash equivalents, end of period $13,963 4,233
======= ======
</TABLE>
See accompanying notes to consolidated financial statements.
7
<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 intercompany balances and transactions have
been eliminated in consolidation.
The consolidated balance sheet as of March 31, 1998 and the
consolidated statements of operations and cash flows for the three-month
periods ended March 31, 1998 and 1997 and the consolidated statement of
stockholders' equity for the three-month period ended March 31, 1998 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, 1997
consolidated balance sheet was derived from consolidated financial
statements audited by KPMG Peat Marwick LLP in connection with the
Company's annual audit.
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 March 31, 1998, the Company
has capitalized approximately $0.1 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.
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.
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
8
<PAGE>
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 ($1.27 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:
March 31, December 31,
1998 1997
---- ----
(000) (000)
Manufacturing:
Raw materials $7,692 6,703
Work-in-process 1,490 662
Finished goods 8,947 7,427
Customer service and other 1,490 1,150
------- ------
$19,619 15,942
======= ======
4. STOCKHOLDERS' EQUITY
On February 10, 1998, the Company effected a secondary offering of
currently outstanding shares held by an investor group representing
approximately 14.5% of the Company's outstanding common stock (approximately 1.5
million shares). Approximately 220,000 additional shares were issued pursuant to
the exercise of an option by the underwriters to cover over-allotments.
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. 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 any net losses in fulfilling
the terms of these contracts when the 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 operation of the Company,
including both internal systems and systems delivered to customers, will be
affected in some
9
<PAGE>
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 timely or
properly, the Year 2000 issue may have a material impact on the business and
operations of the Company. The costs of modifications and conversions are not
anticipated to be material, but 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 March 31, 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.
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. 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 which has delayed
contract negotiations. The existing contract had an expiration date 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.
The Company has submitted a bid and been awarded a contract with the
Pennsylvania Lottery for an on-line lottery contract 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 may be
required in advance of any anticipated capital generated by a new Florida or
Pennsylvania contract. Accordingly, the Company is seeking additional financing,
the availability and the terms of which are subject to various uncertainties,
with no assurance that such financing can be obtained.
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 third or
fourth quarter of 1998. 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 $8.0 million of capital expenditures for
facility enhancements, gaming machines and related equipment to be funded from
operations.
10
<PAGE>
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 which 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. Additional 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, such as a
prolonged economic downturn in Europe or the Asian-Pacific region. 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
has not historically attempted to hedge the risks of fluctuating exchange rates
given the currencies involved and the terms of payment granted to its customers.
In January 1998, a breach of contract claim was filed against the Company
and AWI in the U. S. District Court, Southern District of New York by MR
International, Inc. and American Lottery Systems. The plaintiffs allege that the
Company and AWI breached their obligations in a joint venture in the Rostov
region of the Republic of Russia. The complaint seeks monetary damages. The
Company believes the claim is entirely without merit and intends to vigorously
defend the action.
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
or results of operations or liquidity.
11
<PAGE>
POWERHOUSE 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 states in which the Company
operated as well as revenue from on-line lottery equipment sales and software
license fees. The segment revenue will 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 in 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.
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. 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. When and if new jurisdictions approve legislation for new or
expanded gaming operations or when the Company first enters a new jurisdiction,
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.
The Company is actively seeking to expand its operations into jurisdictions
that have legalized gaming. There can be no assurance, however, that the Company
will be able to identify or capitalize on any opportunities in suitable markets.
The Company's ability to expand will be dependent upon a number of factors, many
of which are beyond the Company's control, including negotiating acceptable
terms, securing required governmental licenses, permits, and approvals, securing
adequate financing on acceptable terms, voter and other political approvals,
demographic trends, and consumers' gaming preferences. As a result, there can be
no assurance that the Company will be able to develop new markets for its
products. In addition, the Company may incur costs in connection with pursuing
new opportunities that it cannot recover and may be required to expense certain
of these costs, which may negatively affect the Company's reported operating
performance for the periods during which such costs are expensed.
Revenue from wagering systems and racetrack operations is generated
primarily from a contractual percentage of handle processed through computerized
pari-mutuel wagering systems from over 120 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. 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 wagering
handle during the same period. Due to the significant increase of alternate
forms of gaming during the last several years, there can be no assurance that
such historical patterns will remain the same in the future, nor can the Company
predict the magnitude of any resulting net economic effects on this segment of
its business. The Company expects wagering systems and racetrack operations
revenue to be a significant component of total revenues.
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 locations 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
totalisator equipment at the racetracks at which the Company has a contract as
well as direct costs of equipment sales.
12
<PAGE>
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 or
research and development as discussed below.
Research and development 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 the costs are labor, material,
consulting, occupancy and other expenses associated with the research and
development efforts. Development costs are capitalized in accordance with
Statement of Financial Accounting Standards Board Statement No. 86 for certain
software developed for sale or lease.
First Quarter 1998 Compared with First Quarter 1997
- - ---------------------------------------------------
Consolidated revenues increased by $2.2 million, or 5%, to $50.2 million
from $48.0 million in the first quarter 1997. The consolidated gross profit
decreased by $0.4 million, or 2%, to $17.6 million from $18.0 million in the
first quarter 1996. Earnings from operations were $1.7 million in 1998 and 1997.
Net earnings before extraordinary items were $0.6 million in the first quarter
1998 as compared to $0.3 million in 1997.
In January 1997 the Company settled a dispute with EDS over performance
issues under the Company's 1994 agreement with EDS that called for EDS to
provide technology services for the Company's on-line lottery customers. The
settlement included, among other things, an extinguishment of outstanding fees
payable to EDS in consideration of a promissory note with a present value of
approximately $26.1 million and resulted in a net of taxes extraordinary gain of
$13.3 million. See Note 2 to the Consolidated Financial Statements.
On-line Lottery
Total revenues from the on-line lottery segment increased by $6.3 million,
or 27% to $29.3 million from $23.0 million in the first quarter 1997. The
increase reflects revenues from enhancements to on-line lottery systems
previously installed for customers in Norway and Chile as well as a domestic
sale of instant ticket validation terminals.
The Company expects the on-line lottery segment to remain a significant
segment of the Company and the segment's growth is dependent upon management's
strategy to selectively bid on domestic lottery contract and aggressively pursue
international on-line lottery opportunities. On-line lottery contracts for a
number of state lotteries will be up for procurement over the next several
years. Due to the high cost of procuring new lottery contracts, the Company is
targeting those states which 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 jurisdictions, worldwide, that are expected to
implement on-line lottery programs within the next two years. In the first
quarter 1998, revenues from lottery system enhancements and equipment sales,
primarily to international customers, was $6.8 million as compared to $0.7
million in 1997.
Additionally, the Company's on-line lottery system MasterLink(R) affords
the Company the ability to develop add-on products and services. Given the
maturity of the on-line lottery industry, operators are in need of ways to
increase lottery ticket sales and reduce costs. The Company expects to develop
new products and services every year for its existing customers as well as
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 notified by the Florida Lottery
that the Company had been selected as the most highly qualified bidder for the
award of a new five-year contract pursuant to a re-evaluation that resulted from
an earlier protest by a competitor of the Florida Lottery's previous selection
of the Company. The competitor protested the Florida
13
<PAGE>
Lottery's re-selection of the Company 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. The Florida Lottery may commence contract negotiations with the Company.
The competitor has petitioned the Florida Lottery to stay these negotiations. 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 either the award and implementation of a new agreement or through
January 1, 2000. Under the terms of the Florida 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 gross profit margin for on-line lottery revenues was 35% in the first
quarter 1998 as compared to 34% in 1997. The gross profit margin from on-line
lottery service revenues was 33% in the first quarter 1998 and 34% in 1997. The
gross profit on on-line lottery system and equipment sales was 41% in the first
quarter 1998 and 43% in 1997. The Company expects gross profit margins from
on-line lottery revenues to increase over time although no assurances of
increased margins can be given.
Gaming Machine and Route Operations
Revenue from the gaming machine and route operations segment decreased by
$3.3 million, or 19%, to $14.4 million from $17.7 million in the first quarter
of 1997. Revenue was recognized on delivery of 835 units in the first quarter
1998 as compared to 2,508 units in 1997. The reduction in revenues and gaming
machine shipments in the first quarter of 1998 reflects a higher level of gaming
machine and related parts sales in 1997 in Oregon and Quebec, Canada, partially
offset by increased sales in Nevada, where the Company began selling gaming
machines in mid-1996. Revenue from the Company's route operations was $4.5
million in the first quarter 1998 as compared to $4.4 million in 1997. Revenue
from leases of gaming machines was $2.7 million in the first quarter 1998 as
compared to $3.0 million in 1997.
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.
The gross profit margin on gaming machine and route operations revenue was
44% in the first quarter 1998 as compared to 48% in 1997. The decrease reflects
a combination of higher revenues from chipset, central site equipment and
consulting revenue primarily from Australia in 1997. The gross profit margin
from route operations revenue was 27% in the first 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 above 40% for the segment.
Wagering Systems and Racetrack Operations
Revenue from the wagering systems and racetrack operation segments
decreased by $0.7 million to $6.6 million from $7.3 million in 1997 reflecting a
higher level of equipment sales in 1997. Revenue from
14
<PAGE>
wagering systems service contracts was $4.0 million in the first quarter 1998
and 1997. Racetrack operation revenue was $2.4 million in the first quarter 1998
and $2.2 million in 1997. Pari-mutuel wagering systems equipment sales were $0.3
million in the first quarter 1998 as compared to $1.2 million in 1997.
The gross profit from wagering systems service contracts was $1.1 million
in the first quarter 1998 compared to $1.6 million in 1997. The higher gross
profit level in 1997 reflects the higher level of wagering systems equipment
sales in 1997. Gross profit for the racetrack operations was $(0.3) million in
the first quarter 1998 as compared to $(0.2) 1997.
The Company expects the wagering systems segment to remain a significant
segment. However, declines in on-track wagering at pari-mutuel facilities has
created increased pricing pressures for the Company and its pari-mutuel wagering
systems supplier 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 maintaining or
reducing 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, including Churchill Downs which has
consistently set new attendance and wagering records with the Company's wagering
system and services.
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 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 third or
fourth quarter of 1998. 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 $8.0 million of additional capital
expenditures for facility enhancements, gaming machines and related equipment to
be funded from operations.
Selling, General and Administrative Expenses
- - --------------------------------------------
Selling, general and administrative ("SG&A") expenses increased by $0.8
million, or 11%, to $8.5 million in the first quarter 1998 from $7.7 million in
1997. The increase reflects the Company's continued increased marketing and
business development efforts. The increase was in both the on-line lottery and
gaming machine segments. 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 first quarter 1998, the Company expended $2.6 million on research
and development activities as compared to $2.5 million in 1997. In the first
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 development costs as the projects continue.
Research and development expenditures were 5.1% and 5.7% of consolidated
revenues in the first quarters of 1998 and 1997, respectively.
15
<PAGE>
Depreciation and Amortization
- - -----------------------------
Depreciation and amortization decreased by $1.2 million to $4.8 million in
the first quarter 1998 from $6.0 million in 1997. The decrease is primarily
attributable to various extensions of on-line lottery contracts that occurred in
1997. The respective lottery authorities exercised extension options in
Delaware, Florida, Minnesota, and South Dakota.
Liquidity and Capital Resources
- - -------------------------------
In the first quarter 1998 the Company generated nearly $2.9 million of cash
from operations as compared to $11.5 million in 1997. The reduction reflects a
number of significant 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 trade accounts receivable. Working capital increased by
approximately $6.0 million from December 31, 1997 to $43.1 million at March 31,
1998. Approximately $2.6 million was invested in property, plant and equipment
and intangible and other assets in the first quarter 1998 as compared to $2.5
million in 1997. Approximately $1.0 million related to the manufacture, purchase
and installation of pari-mutuel wagering equipment by the Company's wagering
system segment and approximately $1.0 million for on-line lottery equipment.
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 March 31, 1998. The note payable ($25.5 million at March 31, 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 payable also provides for
acceleration payments for a change in control of the Company.
The Company repaid long-term debt of $2.5 million in the first quarter 1998
including the outstanding term loans with US Bank (formerly known as First Bank
N.A.). On February 28, 1998, the Company and US 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, 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 existing
contract had an expiration date of 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 the award and
implementation of a new agreement or through January 1, 2000.
In November 1997, the Company was awarded a new five-year contract
commencing in January 1999 to continue operating the Pennsylvania Lottery.
Current estimates of capital necessary to implement a lottery system, under the
contract that has been submitted to Pennsylvania Lottery officials for
signature, are in the range of $40.0 million over a three year period with as
much as $29.0 million by January 1999.
Also, the Company has begun construction for casino gaming at the racetrack
facility in Sunland Park, New Mexico. Current plans call for approximately $8.0
million of capital expenditures for facility enhancements, gaming machines and
related equipment over the next several quarters.
Sizable capital expenditures in excess of current capital sources may be
required in advance of any anticipated capital generated by a new Florida or
Pennsylvania contract. Furthermore, the Company does
16
<PAGE>
not anticipate that any revenues will be generated from casino gaming at Sunland
Park until the third or fourth quarter of 1998.
Accordingly, the Company is seeking additional financing which may or may
not include refinancing current long-term debt obligations of the Company. The
availability and the terms of additional financing are subject to various
uncertainties and the Company can provide no assurance that such financing can
be obtained. Historically, cash flow requirements have been met primarily with
cash provided by operations, public offerings of equity securities, and with
borrowings from financial institutions. Primarily all operating leases are for
office and warehousing space as discussed in the Company's 1997 annual report on
Form 10-K filed with the Securities and Exchange Commission.
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
None
ITEM 5. OTHER INFORMATION
None
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
None
17
<PAGE>
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: May 15, 1998 /S/ SUSAN J. CARSTENSEN
--------------------------------------------
Susan J. Carstensen, Chief Financial Officer
(authorized to sign on behalf of Registrant)
18
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