SECURITIES AND EXCHANGE COMMISSION
Washington, D. C. 20549
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FORM 10-K/A
AMENDMENT NO. 1
(PART II, ITEM 6, 7 AND 8)
(Mark One)
X Annual Report pursuant to Section 13 or 15(d) of the Securities Exchange
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Act of 1934 for the fiscal year ended December 31, 1996 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)
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Delaware 81-0470853
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
2311 South Seventh Avenue
Bozeman, Montana 59715
(Address of principal executive offices) (Zip Code)
(406) 585-6600
(Registrant's telephone number, including area code)
Securities registered pursuant to Section 12(b) of the Act: None
Securities registered pursuant to Section 12(g) of the Act: Common Stock, $.01
par value
Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days. Yes X No
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Indicate by check mark if disclosure of delinquent filers pursuant to Item
405 of Regulation S-K is not contained herein, and will not be contained, to the
best of registrant's knowledge, in definitive proxy or information statements
incorporated by reference in Part III of this Form 10-K or any amendment to this
Form 10-K. [ X ]
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The aggregate market value of voting stock held by non-affiliates of the
registrant as of March 1, 1997, was approximately $34,050,000 (based on the last
sale price of such stock as reported by NASDAQ National Market System on such
date).
The number of shares outstanding of the registrant's common stock, $.01 par
value ("Common Stock"), as of March 1, 1997, was 10,318,730.
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<PAGE>
TABLE OF CONTENTS
Page
PART II
ITEM 6. Selected Financial Data 4
ITEM 7. Management's Discussion and Analysis of Financial
Condition and Results of Operations 6
ITEM 8. Financial Statements and Supplementary Data 17
Signatures 42
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<PAGE>
Certain statements in this Annual Report on Form 10-K 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 II
ITEM 6. SELECTED FINANCIAL DATA
The selected data presented below for, and as of the end of, each of the
years in the five-year period ended December 31, 1996, are derived from the
consolidated financial statements of the Company and subsidiaries, which
financial statements have been audited by KPMG Peat Marwick LLP, independent
certified public accountants. The consolidated financial statements as of
December 31, 1996 and 1995, and for each of the years in the three-year period
ended December 31, 1996, and the report thereon, are included elsewhere in this
Form 10-K. The selected consolidated financial data should be read in
conjunction with the consolidated financial statements and notes thereto of the
Company and "Item 7. Management's Discussion and Analysis of Financial Condition
and Results of Operations" included elsewhere in this Form 10-K.
<TABLE>
<CAPTION>
Selected Financial Information
(Dollars in thousands, except per share data)
Years Ended December 31,
OPERATIONS DATA 1996 1995 1994 1993 1992
---- ---- ---- ---- ----
<S> <C> <C> <C> <C> <C>
REVENUES
On-line lottery $ 88,843 91,653 101,559 115,544 51,552
Gaming machine and route operations 60,186 61,398 68,571 59,069 59,299
Wagering systems and racetrack operations(1) 27,652 28,111 18,652 --- ---
-------- ------- ------- ------- -------
Total revenues 176,681 181,162 188,782 174,613 110,851
COSTS AND EXPENSES
On-line lottery 59,333 59,438 62,397 67,985 32,757
Gaming machine and route operations 32,911 35,992 39,815 35,074 37,219
Wagering systems and racetrack operations 20,104 22,286 13,992 --- ---
Selling, general and administrative 28,697 31,139 34,000 30,362 15,873
Research and development 7,969 8,888 8,513 6,629 2,570
Other charges(2) 34,135 2,763 23,994 --- ---
Depreciation and amortization 23,822 22,587 20,694 18,033 10,351
-------- ------- ------- ------- -------
Total costs and expenses 206,971 183,093 203,405 158,083 98,770
-------- ------- ------- ------- -------
(Loss) earnings from operations (30,290) (1,931) (14,623) 16,530 12,081
Other income (expense) (2,694) (1,833) (242) (9,032) 258
Income taxes benefit (expense) 8,753 846 (1,303) (3,152) (3,990)
-------- ------- ------- ------- -------
Net (loss) earnings from continuing
operations (24,231) (2,918) (16,168) 4,346 8,349
Discontinued operations(1) 5,482 (5,482) --- --- ---
Extraordinary item 4,014 --- --- --- ---
-------- ------- ------- ------- -------
Net (loss) earnings $(14,735) (8,400) (16,168) 4,346 8,349
======== ======= ======== ========= =======
(Loss) earnings per share data:
Continuing operations $(2.27) (.28) (1.54) .35 .74
Discontinued operations .51 (.51) --- --- ---
Extraordinary item .38 --- --- --- ---
------ ---- ------- --- ----
$(1.38) (.79) (1.54) .35 .74
====== ===== ====== === ====
Weighted average shares(3) 10,699 10,608 10,507 12,312 11,316
====== ====== ====== ====== ======
OTHER DATA
Adjusted EBITDA(4) $ 27,667 23,419 30,065 34,563 22,432
Cash provided (used) by:
Operations $ 18,702 1,943 12,167 31,354 19,882
Investing activities (34,750) (22,020) (15,097) (28,666) (48,198)
Financing activities 18,378 18,199 (1,931) (10,540) 42,963
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December 31,
BALANCE SHEET DATA 1996 1995 1994 1993 1992
---- ---- ---- ---- ----
Working capital $ 28,084 19,987 23,344 51,458 25,111
Total assets 168,043 165,851 174,032 139,513 150,029
Total long-term debt(5)
(excluding current installments) 9,312 12,885 9,060 855 3,006
Stockholders' equity 72,231 86,448 94,112 108,215 103,435
======== ======= ======= ======= =======
</TABLE>
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(1) Wagering systems and racetrack operations revenue and costs since May 3,
1994. (See Note 2 to the Consolidated Financial Statements.)
(2) In 1996, the Company recorded approximately $34.1 million of special
charges consisting of approximately $18.0 million for inventory write-downs
primarily related to the on-line lottery segment, $8.4 million associated
with on-line lottery customer disputes and contract liabilities , $4.6
million for impairment of intangible and other assets for an on-line
lottery contract and $3.1 million related to the wagering systems segment.
In 1995, the Company recorded approximately $2.8 million of special and
other unusual charges associated with exit costs and charges and asset
impairments related to five contracts. In 1994, the Company recorded
approximately $24.0 million of special and other unusual charges consisting
of $6.7 million related to inventory and international contract investments
and $17.3 million for impairment of the goodwill attributable to the
acquisition of UWS.
(3) Common stock equivalents are excluded if antidilutive.
(4) Adjusted EBITDA consists of income from operations plus depreciation and
amortization plus the special or other charges described in footnote 2.
Adjusted EBITDA should not be construed as an alternative to net income or
any other measure of the Company's performance under generally accepted
accounting principles or to cash flows generated by operating, investing
and financing activities as an indicator of the Company's cash flows or a
measure of its liquidity. Management believes that Adjusted EBITDA is a
useful adjunct to net income and other measurements under generally
accepted accounting principles and is a conventionally used financial
indicator.
(5) On January 30, 1997, the Company and EDS reached an agreement to settle
certain outstanding all claims against each other. The agreement, among
other things, provided for the extinguishment of outstanding fees of
approximately $38.0 million in exchange for a note payable of approximately
$26.1 million which amortizes between 1999 and 2004 and the return to the
Company of approximately 2.5 million of the Company's preferred and common
shares. The settlement resulted in an extraordinary gain of $13.3 million.
(See Note 16 to the Consolidated Financial Statements.)
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<PAGE>
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
Results of Operations
The following table presents for the years indicated, the percentage of
revenues represented by certain operational data, as well as the percentage
change in such items.
<TABLE>
<CAPTION>
Percentage (%) of Total Revenues
-------------------------------- Percentage (%) Increase
Years Ended (Decrease)
December 31, -----------------------
------------ Year 1996 Year 1995
1996 1995 1994 Over 1995 Over 1994
---- ---- ---- --------- ---------
<S> <C> <C> <C> <C> <C>
Revenues:
On-line lottery 50.2 50.6 53.8 (3.1) (9.7)
Gaming machine and route operations 34.0 33.9 36.3 (2.0) (10.5)
Wagering systems and racetrack operations 15.8 15.5 9.9 (1.4) 50.3
----- ----- -----
100.0 100.0 100.0 (2.5) (4.0)
----- ----- -----
Costs and expenses:
On-line lottery 33.6 32.8 33.1 (0.2) (4.8)
Gaming machine and route operations 18.6 19.9 21.1 (8.6) (9.5)
Wagering systems and racetrack operations 11.4 12.3 7.3 (9.9) 59.3
Selling, general and
administrative 16.2 17.1 18.0 (7.7) (8.5)
Research and development 4.5 4.9 4.5 (10.1) 4.7
Other charges 19.3 1.5 12.7 1,135.4 (88.3)
Depreciation and
amortization 13.5 12.5 11.0 5.3 9.2
----- ----- -----
117.1 101.0 107.7 13.0 (10.0)
----- ----- -----
Loss from operations (17.1) (1.0) (7.7) 1,468.6 (87.0)
Other (expense) income, net (1.5) (1.0) (0.1) 50.0 800.0
----- ----- -----
Net loss before income taxes,
discontinued operations and extraordinary
items (18.6) (2.0) (7.8) 789.2 (75.0)
===== ===== ===== ======= =====
</TABLE>
Wagering systems and racetrack operations revenue and costs relate to a
subsidiary which was acquired by the Company on May 3, 1994. Consequently,
certain percentages from 1994 are not comparable to 1995 and 1996.
Revenue from the on-line lottery segment consists primarily of a
contractual percentage of lottery ticket sales in eight states as well as
revenue from on-line lottery equipment sales. The segment revenue will
experience fluctuations depending on relative sizes of jackpots and the number
of terminals on-line and selling tickets in the states in which the Company
operates. The Company 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 video gaming machines, sales of parts, central control site
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 video
lottery gaming operations or forms of casino gaming, 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 decline dramatically depending on the
jurisdiction and gaming venue. Gaming machine and route operations includes
lease revenue
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<PAGE>
which is derived from the lease of terminals to the Oregon and Rhode Island
lotteries which implemented video lottery programs in 1992. The Rhode Island
program is a limited form of video lottery at two pari-mutuel facilities. In
December 1995 the Company began leasing video gaming machines to the Delaware
Lottery. The Company expects video lottery 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.
Revenue from wagering systems and racetrack operations is generated
primarily from a contractual percentage of handle processed through computerized
pari-mutuel wagering systems from approximately 124 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. Wagering systems and
racetrack operations revenue is generated by the Company's UWS subsidiary.
Gross profit for each segment is herein defined as revenues for that
segment less the corresponding costs and expenses (excluding depreciation and
amortization expense and 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.
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.
Other charges include special and unusual charges recorded by the Company
for restructurings, asset valuation impairments, liquidated damage assessments
and other contract losses. The Company excludes these other charges from the
calculation of gross profit margin for each segment of the Company's operations
due to their nature and the Company believes that the inclusion of such other
charges in the determination of gross profit would not be indicative of past,
current or anticipated future gross profit margins.
1996 Compared with 1995
- -----------------------
Total revenue in 1996 decreased by $4.5 million (2.5%) to $176.7 million
from $181.2 million in 1995. The overall gross profit increased by $.9 million
(1.4%) to $64.3 million from $63.4 million in 1995. The Company had a net loss
from operations of $24.2 million in 1996 as compared to net loss from operations
of $2.9 million in 1995. The increase in loss reflects significant special and
other unusual charges recorded in 1996. Absent the special and other unusual
charges, the Company would have had net earnings before income taxes of $1.2
million in 1996 and a net loss before income taxes of $1.0 million in 1995. The
improvement reflects the $.9 million increase in gross profit and reductions in
selling, general and administrative costs and research and development costs,
net of capitalization.
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<PAGE>
On-line Lottery
Revenue from the on-line lottery segment decreased by $2.9 million (3.1%)
to $88.8 million from $91.7 million in 1995. Included in the on-line lottery
revenue in 1996 and 1995 is $4.4 million and $5.3 million, respectively, of
revenue from international on-line lottery equipment sales. The Company is
actively marketing inventory, with a carrying value of approximately $3.8
million, of on-line lottery terminals in a number of international locations;
however, there can be no assurance of additional international on-line lottery
equipment sales in the near future.
The Company experienced a decline in revenues from its contract with the
Florida Lottery of approximately $5.0 million from 1995 levels as a result of
lower lottery ticket sales and a reduction in the contractual fee percentage.
The Florida Lottery contract accounted for approximately 34% or more of on-line
lottery revenues in the last three years.
The Company's contract with the Washington Lottery expired in June 1996 and
the new contract was awarded to a competitor. The contract accounted for $5.7
million (6.5%) and $10.4 million (11.3%) of on-line lottery revenues in 1996 and
1995, respectively.
In December 1995, the Delaware Lottery implemented a video gaming program
which is centrally controlled and monitored by the Company's on-line lottery
system in the state. The implementation of the video gaming program is the
primary reason for a $5.1 million increase in revenues from 1995 levels from the
contract with the Delaware Lottery. The implementation of the video gaming
program in Delaware has also resulted in additional lease revenues for the
Company's gaming machine segment.
In the third quarter 1996 the Company implemented an on-line lottery system
under contract with the Maryland Lottery. The new contract generated $2.9
million of on-line lottery revenue from start-up through December 31, 1996.
The gross profit margin of the on-line lottery segment was 33% in 1996 as
compared to 35% in 1995. The gross profit margin on services revenue in the
on-line lottery segment was 33% in 1996 as compared to 36% in 1995. The decrease
is primarily attributable to a contractual reduction in the fee structure with
the Florida Lottery in 1996. Management does not anticipate significant
fluctuations in gross profit margins in the near future. The gross profit margin
on on-line central system and equipment sales was 24% and 20% in 1996 and 1995,
respectively.
The following describes the Company's accounting for "other" charges
related to the on-line lottery segment. Other charges include charges for
inventory impairments, restructurings, contract exit charges and long-lived
asset impairments. The Company manufactures inventories for sale and lease as
well as use in the provision of services under long-term contracts. Inventories
purchased and manufactured for use in the provision of services are transferred
to property, plant and equipment when installed pursuant to the terms of such
long-term contracts. The inventory charges discussed below have been excluded
from the determination of gross profit. Had these inventories been placed in
service under long-term contracts, depreciation expense would have been
recognized in accordance with the Company's accounting policy.
In 1996, the Company recorded approximately $31.0 million of special
charges related to the Company's on-line lottery segment, which consisted of
$18.0 million for inventory reserves and write-downs, $8.4 million for penalties
and contractual liabilities resulting from customer disputes and $4.6 million
for impairment of intangible and other assets in connection with an on-line
lottery contract. Approximately $9.8 million of the charges were recorded in the
first nine months of 1996. $8.0 million of those charges related to customer
disputes stemming from performance issues with EDS. The remaining $1.8 million
recorded in the first nine months represented charges for inventory
iimpairments. The $21.2 million of charges recorded in the fourth quarter of
1996 primarily related to impairments of inventories and intangible assets.
During the three-year period ending December 31, 1996, the Company recorded
approximately $22.7 million of charges representing impairments to on-line
lottery equipment inventories. An aggressive revenue growth strategy in 1994 led
the Company to procure significant levels of inventory in advance of obtaining a
contract to operate an on-line lottery system in the United Kingdom. The Company
was notified in May 1994 that the contract was awarded to a competitor. In the
fourth quarter of 1994, the Company recorded a $4.1
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<PAGE>
million charge representing costs to retrofit inventories related to the United
Kingdom procurement for which there was no other demand in the U. S. market. The
Company anticipated demand from a customer in Norway for a portion of such
inventories. The carrying value of inventories related to the on-line lottery
segment was approximately $19.3 at December 31, 1994, and the Company believed
that potential market opportunities at that time indicated that such inventory
value would be recovered. In the second quarter of 1995, the Company recorded an
additional $0.6 million charge to inventories due to a reduction in estimated
demand by its Norway customer. The carrying value of inventories related to the
on-line lottery segment was approximately $15.9 million at December 31, 1995,
and potential sales opportunities in various international markets indicated
that the remaining value could be recovered. In the second quarter 1996, the
Company recorded an additional charge of $1.1 million to inventories for another
identified reduction in demand. In the fourth quarter of 1996, the Company
determined that the remaining inventory related to the United Kingdom
procurement had no remaining market value and charged to expense approximately
$10.4 million. At December 31, 1996, inventories related to the on-line lottery
segment had a carrying value of approximately $2.9 million.
The Company's domestic growth strategy led to the contracts being awarded
to the Company by the Arizona and Kentucky lottery authorities during 1995. The
Arizona lottery system was implemented in late 1995. However, due to a number of
factors, including a short development and installation period, the lottery had
a number of deficiencies that contributed to the early termination of the
contract by the Arizona Lottery in 1996. The Company recognized an impairment
charge of $4.0 million on equipment inventory to reduce the carrying value to
net realizable value for used equipment. Also in 1996, the Company and the
Kentucky Lottery agreed to terminate efforts to finalize a contract. The Company
incurred approximately $2.5 million that was charged to expense as a result of
the agreement.
The United Kingdom, Arizona and Kentucky on-line inventory, which the
Company had planned to place in service to perform specific contracts, was
reviewed in light of existing market conditions and written down to its
estimated market value. Following these charges and write-offs attributable to
unsuccessful business ventures, the Company revised its international strategy
from selling long-term service agreements to one of selling on-line lottery
equipment and licensing technology to use the equipment to partners who would
operate the lottery system. While this strategy may result in lower revenues,
costs of sales and operating profits, it is considered by management to be a
more effective growth strategy.
Domestically, the Company has adopted a strategy of selectively bidding
opportunities where the customer requirements best fit with the Company's
products and services. There can be no assurance that these revised strategies
will be successful. In 1995, the Company recorded approximately $2.5 million of
other charges associated with exit costs and asset impairments related to four
contracts. These charges have been excluded from the determination of gross
profit due to their nature, and they are not considered by the Company to be
indicative of anticipated future gross profits.
In 1996, the Company withheld certain payments to EDS primarily due to EDS
performance issues and related on-line lottery customer disputes. In mid-1996
the agreement between EDS and the Company 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 and personnel to the Company. The terms of the
settlement include the receipt by the Company of all of the common and preferred
shares owned by EDS (545,454 common and 1,912,728 preferred shares) certain
property, plant and equipment used in the provision of services to on-line
lottery customers and the extinguishment of approximately $38,000,000 of
outstanding fees in return for a $26,100,000 note payable. The note payable
calls for interest payments only for the first two years and principal and
interest payments in years three through seven (maturity). The note is secured
by the 2,458,182 shares of redeemed Common and 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's on-line lottery subsidiary. The transition of the EDS services and
related employees to the Company is anticipated to be completed in the second
quarter of 1997.
The Company paid or accrued approximately $81,600,000 and $70,300,000 to
EDS for costs and expenses in 1996 and 1995, respectively. Of those costs and
expenses approximately $9,687,000 and $2,675,000 were capitalized primarily in
conjunction with software development and deferred start-up costs in 1996 and
1995, respectively.
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<PAGE>
Gaming Machine and Route Operations
Revenue from gaming machine sales and route operations decreased by $1.2
million (2.0%) to $60.2 million from $61.4 million in 1995.
Revenue was recognized on delivery of 4,557 units in 1996 as compared to
7,772 in 1995. Included in the total units were approximately 917 and 1,562 of
royalty unit sales in 1996 and 1995, respectively. Revenues from sales of units
pursuant to royalty arrangements have minimal related direct costs. The Company
previously earned revenues from sales of units under a royalty arrangement with
an Australian company in certain Australian jurisdictions. The royalty
arrangement was terminated effective mid-1997. Additionally, the Company shipped
1,175 gaming machines under lease arrangements to the Oregon, Rhode Island and
Delaware lotteries in 1996 as compared to 1,570 gaming machines shipped to the
Oregon, Rhode Island and Delaware lotteries in 1995.
The following table reflects domestic and foreign revenue sources for the
years ended December 31, 1996 and 1995 (amounts in millions):
<TABLE>
<CAPTION>
Years Ended
December 31,
Jurisdiction 1996 1995 $ Change % Change
------------ ---- ---- -------- --------
<S> <C> <C> <C> <C>
Domestic:
Montana $19.7 19.3 0.4 2.0
Nevada 1.3 --- 1.3 ---
South Dakota 3.0 3.8 (0.8) (21.1)
Louisiana 1.4 9.0 (7.6) (84.4)
Oregon 7.1 6.0 1.1 18.3
Rhode Island 2.3 2.4 (0.1) (4.2)
Delaware 2.3 --- 2.3 ---
Other 2.4 1.6 0.8 0.5
----- ---- ----- -----
39.5 42.1 (2.6) (6.2)
Foreign:
Alberta, Canada 3.1 0.7 2.4 342.9
Atlantic Canada 0.9 1.6 (0.7) (43.8)
Norway 2.9 --- 2.9 ---
Quebec 2.2 12.3 (10.1) (82.1)
Victoria, Australia 5.9 3.4 2.5 73.5
South Australia 0.7 0.2 0.5 250.0
Peru 3.6 --- 3.6 ---
Iceland 0.7 0.8 (0.1) (12.5)
Other 0.7 0.3 0.4 133.3
----- ---- ----- -----
20.7 19.3 1.4 7.3
----- ---- ----- -----
$60.2 61.4 (1.2) (2.0)
===== ==== ===== =====
</TABLE>
Montana revenue includes $16.5 and $15.3 million from route operations in
1996 and 1995, respectively.
In 1996, voters in approximately one-half of the state's parishes in
Louisiana voted to discontinue video lottery operations in those parishes.
Existing locations will be allowed to operate for approximately two years before
the gaming machines must be removed.
The gross profit margin from the gaming machine segment, which includes
equipment sales and contract revenue, as well as leases revenue, increased to
45% from 41% in 1995. The increase is primarily attributable to the lower sales
levels in Louisiana and Quebec which historically carry lower margins for the
Company relative to other jurisdictions and higher software sales which carry
higher gross profit margins. The gross profit margin from route operations was
28.5% in 1996 as compared to 27.5% in 1995.
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<PAGE>
Wagering Systems and Racetrack Operations
Revenue from the wagering systems and racetrack operations segment
decreased by $.5 million or (1.6%) to $27.6 million from $28.1 million in 1995.
The decrease is attributable to a decline in revenues from the racetrack
operations at Sunland Park, New Mexico of approximately $.9 million offset by an
increase of $.4 million in revenues generated from wagering systems services and
equipment sales. The decline in revenue at Sunland Park is the result of lower
handle and attendance and lower revenues resulting from a shorter 1996- 1997
live racing season. The increase in revenues for wagering systems is
attributable to revenues from additional services under existing contracts,
renegotiation of existing contracts under more favorable terms and increased
interface fees resulting from increased levels of simulcasting. Lost revenues
from closed customer facilities were offset by these increases as well as
additional revenues generated at customer facilities that are now open year
round for simulcasting and the addition of new customers.
The Company believes that a growing market exists for video lottery gaming
at pari-mutuel racetracks, which have suffered from declining attendance in
recent years due to proliferation of casino gaming outside of Las Vegas and
Atlantic City. To permit the racing industry to become more competitive, some
states have enacted legislation that allows video gaming devices at racetracks,
a trend that the Company believes will continue. The Company intends to
participate in this growth by supplying its gaming machines and systems,
partnering with or purchasing racetracks and owning and operating its own
facility, Sunland Park. The Company is the only full service supplier of gaming
and pari-mutuel systems and services to racetracks in North America and believes
it has a competitive advantage due to its existing United Tote customer
relationships in the pari-mutuel industry.
The number of customer contracts declined in 1996 primarily due to closing
of six customer facilities in Kansas, South Dakota, Texas, and Wisconsin. In
1996, United Tote signed contracts with five new customers, and renewed
contracts with six U. S. customers and seven Canadian customers. The company
plans to continue to renew existing contracts at margins at least comparable to
existing contracts and plans to secure new contracts at comparable margins,
although no assurance can be given that existing contracts will be renewed or
new contracts will be entered into with comparable gross profit margins.
The gross profit margin from the wagering systems and racetrack operations
segment was 27% in 1996 as compared to 21% in 1995. The gross profit margins for
wagering systems services and equipment sales were 38% in 1996 and 30% in 1995.
The increase in margin is due to increases in the simulcasting and interface
revenues which carry higher margins, combined with lower operating expenses from
wagering systems. The Sunland Park racetrack operations yielded a negative gross
profit of $0.3 million in 1996 and $0.2 million in 1995.
The Company recorded other charges of approximately $3.1 million in 1996
associated with the Company's wagering systems segment. $2.8 million of the
charges represented impairments of long-lived assets recorded in conjunction
with the Company's strategic decision to retain and operate the wagering systems
segment previously reported as discontinued. $0.3 million of the charges related
to the consolidation of the manufacturing operations of that segment. In 1995,
the Company recorded $0.3 million of other charges associated with exit costs
for one contract. These charges have been excluded from the determination of
gross profit due to their nature and are not considered to be indicative of
gross profits.
On March 21 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, New Mexico. The recently enacted legislation will permit the
Company to operate up to 300 video 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
state's formation of a separate commission to oversee the gaming and other
regulatory matters (including the grant of necessary licenses to the Company).
Consequently, the Company does not anticipate that any revenues will be
generated from the approved gaming until the third or fourth quarter of 1998.
Selling, General and Administrative
Total selling, general and administrative expenses ("SG&A") decreased by
$2.4 million (7.7%) to $28.7 million from $31.1 million in 1995. The decrease is
primarily attributable to administrative head-count
- 11 -
<PAGE>
reductions, cost containment measures and lower trade show spending offset in
part by additional marketing efforts primarily in casino markets.
As a percentage of sales, SG&A expenses were 16.2% in 1996 as compared to
17.2% in 1995. Management anticipates 1997 SG&A levels to be at or near 1996
levels given the current level of activity. Should business development
activities increase in the next several fiscal quarters, the SG&A levels would
follow.
Research and Development
In 1996, the Company expended $8.0 million (net of capitalization) on
research and development activities as compared to $8.9 million (net of
capitalization) in 1995. The Company capitalized approximately $4.1 million and
$2.7 million, respectively, of the development costs primarily in conjunction
with the development of the Company's MasterLinkTM system central system
software. The new modules and significant enhancements related to the
MasterLinkTM system in 1996 were implemented with the Delaware and Maryland
on-line lottery systems in 1996. The Delaware Lottery installation was the first
installation of the video gaming module of the MasterLinkTM system. The Maryland
on-line lottery system reached start-up in the third quarter of 1996 with the
most recent version of the MasterLinkTM system including a module for keno
games. The Company expects to continue to refine and enhance the Company's
MasterLinkTM system in 1997 for video and on-line lottery applications as well
as continue the development and enhancement of other on-line, video gaming and
wagering systems hardware and software products.
Other Charges
In 1996, the Company recorded approximately $34.1 million of special
charges consisting of approximately $18.0 million for inventory write-downs
primarily related to the on-line lottery segment, $8.4 million associated with
on-line lottery customer disputes and contract liabilities, $4.6 million for
impairment of intangible and other assets for an on-line lottery contract and
$3.1 million related to the wagering systems segment as discussed in Note 2 to
the Consolidated Financial Statements.
The Company's 1995 consolidated statement of operations includes
approximately $2.8 million of unusual reserves and write-offs associated with
exit costs and charges and asset impairments related to five contracts.
Depreciation and Amortization
Depreciation and amortization increased by $1.2 million to $23.8 million
from $22.6 million in 1995. The increase is attributable to approximately $25.5
million of new capital assets placed in service and $10.0 million of capitalized
deferred start-up and software development costs in 1996. The majority of
capital assets procured and manufactured in 1996 were placed in service in the
third quarter in conjunction with the on-line lottery implementation in Maryland
and the delivery of video gaming machines under lease agreement with the Oregon
Lottery.
1995 Compared with 1994
- -----------------------
Total revenue in 1995 decreased by $7.6 million (4.0%) to $181.2 million
from $188.8 million in 1994. The overall gross profit decreased by $9.1 million
(12.6%) to $63.4 million from $72.5 million in 1994. The Company had a net loss
from operations of $2.9 million in 1995 as compared to $16.2 million in 1994.
The decrease in losses primarily reflects less special and other charges
recorded. The 1994 charges of $24.0 million represented goodwill impairment of
$17.3 million and other charges primarily for inventories of $6.7 million. The
Company also experienced a decline in gross profit margins in 1995 from 1994
levels.
On-line Lottery
Revenue from the on-line lottery segment decreased by $9.9 million (9.7%)
to $91.7 million from $101.6 million in 1994. Included in the on-line lottery
revenue in 1995 and 1994 is $5.3 million and $9.9 million, respectively, of
revenue from international on-line lottery equipment sales. Revenue from the
Company's contract with the Florida Lottery of $35.2 million decreased by $2.4
million from 1994 primarily
- 12 -
<PAGE>
reflecting a decline in the contractual fee rate. Also, included in 1994 revenue
is $3.1 million from contracts with two off-track betting corporations in the
state of New York that expired in December 1994.
The gross profit margin of the on-line lottery segment was 35.2% in 1995 as
compared to 38.6% in 1994. The gross profit margin on services revenue in the
on-line lottery segment was 36.1% in 1995 as compared to 39.3% in 1994. The
decrease is primarily attributable to a contractual reduction in the fee
structure with the Florida Lottery in 1995. The gross profit margin on on-line
central system and equipment sales was 19.7% and 32.1% in 1995 and 1994,
respectively.
In 1995, the Company recorded approximately $2.5 million of other charges
associated with exit costs and asset impairments related to four contracts. $0.6
million of the charges were to record an additional reserve on the lottery
equipment inventory initially provided for the United Kingdom Lottery, due to a
reduction in market value. In the fourth quarter 1994, the Company recorded a
special charge of approximately $5.9 million, which amount represents reserves
and write-offs for inventory of $4.1 million and write-offs and accruals of
foreign contract investments and commitments of $1.8 million. The Company had
purchased inventory in anticipation of a contract in the United Kingdom that was
not awarded to the Company. The 1994 inventory charge represented the initial
adjustment associated with the retrofitting of inventories for alternative
markets. These special charges have been excluded from the determination of
gross profit due to their nature and they are not considered by the Company to
be indicative of anticipated future gross profits.
Gaming Machine and Route Operations
Revenue from gaming machine sales and route operations decreased by $7.2
million (10.5%) to $61.4 million from $68.6 million in 1994.
Revenue was recognized on delivery of 7,772 units in 1995 as compared to
10,008 in 1994. Included in the total units were approximately 1,562 and 2,792
of royalty unit sales in 1995 and 1994, respectively. Additionally, the Company
shipped 1,570 gaming machines under lease arrangements to the Oregon, Rhode
Island and Delaware lotteries in 1995 as compared to 400 gaming machines shipped
to the Oregon Lottery in 1994.
The following table reflects domestic and foreign revenues for the years
ended December 31, 1995 and 1994 (amounts in millions):
<TABLE>
<CAPTION>
Years Ended
December 31,
Jurisdiction 1995 1994 $ Change % Change
------------ ---- ---- -------- --------
<S> <C> <C> <C> <C>
Domestic:
Montana $19.3 17.9 1.4 7.8
South Dakota 3.8 5.9 (2.1) (35.6)
Louisiana 9.0 12.0 (3.0) (25.0)
Oregon 6.0 4.4 1.6 36.4
Rhode Island 2.4 2.1 0.3 14.3
Other 1.6 1.4 0.2 14.3
----- ---- ---- -----
42.1 43.7 (1.6) (3.6)
Foreign:
Alberta, Canada 0.7 5.4 (4.7) (87.0)
Atlantic Canada 1.6 0.8 0.8 100.0
Quebec 12.3 10.5 1.8 17.1
Victoria, Australia 3.4 5.2 (1.8) (34.6)
South Australia 0.2 2.0 (1.8) (90.0)
Iceland 0.8 0.5 0.3 60.0
Other 0.3 0.5 (0.2) (40.0)
----- ---- ---- -----
19.3 24.9 (5.6) (22.5)
----- ---- ---- -----
$61.4 68.6 (7.2) (10.5)
===== ==== ==== =====
</TABLE>
Montana revenue includes $15.3 and $15.4 million from route operations in
1995 and 1994, respectively.
- 13 -
<PAGE>
The gross profit margin from the gaming machine segment, which includes
equipment sales and contract revenue, as well as leases revenue, decreased
slightly to 41.4% from 41.9% in 1994. The decrease is primarily attributable to
a revenue decline from the lower royalty unit sales under a technology transfer
agreement between the Company and a Victoria, Australia
manufacturer/distributor. The royalty revenue has nominal direct cost
components. The gross profit margin from route operations was 27.5% in 1995 as
compared to 28.6% in 1994.
Wagering Systems and Racetrack Operations
Revenue from the wagering systems and racetrack operations was $28.1
million in 1995 compared to $18.7 million for the eight months ended December
31, 1994. The gross profit margin decreased to 21% in 1995 from 25% in the eight
months ended in 1994.
In 1995, the Company recorded $0.3 million of other charges associated with
exit charges related to one contract. In 1994, the Company recorded $18.1
million of special charges related to the wagering systems segment, $17.3
million of which represented a goodwill impairment charge and $0.8 million of
which was to accrue the exit costs related to one contract. These charges have
been excluded from the determination of gross profit due to their nature and are
not considered to be indicative of anticipated future gross profits.
On May 3, 1994, the Company completed the purchase of all of the
outstanding stock of UWS. The original purchase price of $29.6 million included
$19.6 million in cash and the issuance of $10.0 million of promissory notes,
payable over a three-year period. The Company also assumed liabilities of
approximately $23.4 million and, in connection with the transaction, recorded
goodwill of approximately $30.3 million. At the time of the acquisition of UWS,
the Company anticipated profits from the ongoing operations of UWS as well as
potential growth for pari-mutuel contracts and operations and favorable gaming
legislation in New Mexico and other jurisdictions.
During the fourth quarter of 1994 and the first quarter of 1995, certain
negative developments affecting UWS and the pari-mutuel wagering industry became
increasingly apparent. These developments included significant declines in gross
revenues and gross margins at pari-mutuel wagering and other facilities due to
pricing pressures and increased competition from other forms of gaming (which
declines the Company believed were permanent), significant unanticipated capital
investment of approximately $15.0 million to meet customer commitments and the
failure of various state legislative initiatives authorizing the introduction of
gaming devices at tracks to materialize as anticipated. The Company took steps
to restructure the business of UWS, including changing management, reducing
costs and renegotiating contracts to the extent possible in an attempt to
mitigate these negative developments. These developments in the aggregate
indicated that the purchase price it had paid for UWS exceeded UWS's value, and
that, therefore, the goodwill associated with the wagering systems segment was
not recoverable from future operations. As a result, an impairment of $17.3
million was recorded in the fourth quarter of 1994. The impairment was
determined by using the present value of estimated future operating cash flows
of the wagering segment. After the impairment charge, approximately $11.7
million of goodwill associated with the racetrack operations segment of UWS
remained.
During 1995, the Company did not pay principal and interest obligations
under the terms of the promissory notes to sellers in the aggregate amount of
$10.0 million, which had been issued in conjunction with the acquisition of UWS
in May 1994, because of disputes related to the acquisition. On March 25, 1996,
the Company reached an agreement with the sellers settling all outstanding
claims and disputes, including dismissal of all outstanding litigation,
resulting in an approximate $4.0 million gain on debt extinguishment. This gain
was recorded in the Company's 1996 consolidated financial statements.
Selling, General and Administrative
Total selling, general and administrative expenses ("SG&A") decreased by
$2.9 million (8.5%) to $31.1 million from $34.0 million in 1994. The decrease is
primarily attributable to lower legal and professional fees as well as reduced
business development expenses. Business development expenses are primarily
lobbying, political contributions, trade shows, travel, meals and lodging. As a
percentage of sales, SG&A expenses were 17.2% in 1995 as compared to 18.0% in
1994.
- 14 -
<PAGE>
Research and Development
In 1995, the Company expended $8.9 million (net of capitalization) on
research and development activities as compared to $8.5 million (net of
capitalization) in 1994. The Company capitalized approximately $2.7 million and
$5.2 million, respectively, of the development costs primarily in conjunction
with the development of the MasterLinkTM system central system software.
Depreciation and Amortization
Depreciation and amortization increased by $1.9 million to $22.6 million
from $20.7 million in 1994. The increase is attributable to approximately $19.0
million of new capital assets placed in service and $3.5 million of capitalized
deferred start-up and software development costs in 1995. Approximately $8.1
million was placed in service in November and December of 1995 in conjunction
with the Arizona on-line lottery implementation and start-up and the delivery of
approximately 300 gaming machine terminals to the Oregon and Delaware lotteries
as part of the leasing programs with those jurisdictions. Approximately $2.4
million of the $3.5 million capitalized deferred start-up and software
development costs were capitalized in the fourth quarter 1995 in conjunction
with the Arizona on-line lottery implementation and start-up and significant
enhancements to the MasterLinkTM system.
Liquidity and Capital Resources
- -------------------------------
Working capital, defined as current assets less current liabilities,
increased by $8.0 million to $28.0 million at December 31, 1996 from $20.0
million at December 31, 1995.
The increase in working capital primarily reflects a decrease in current
amounts payable to EDS from December 31, 1995. Included in trade accounts
payable at December 31, 1996 and 1995, respectively, are amounts payable to EDS
of $1.2 million and $10.7 million. In January 1997, the Company settled all
outstanding disputes with EDS which included, among other things (see Note 16 to
the Consolidated Financial Statements), a reduction of the amounts payable to
EDS from the $38.0 million, recorded as a non-current liability at December 31,
1996, to a note payable with a net present value of $26.1 million. The note
payable calls for interest only payments for years one and two, and principal
and interest payments in years three through maturity in 2004. The note is
secured by the 2.4 million shares of Common and Preferred Stock returned by EDS
in the settlement and certain assets of the Company's on-line lottery subsidiary
and has provisions for accelerated payments upon the sale of the secured assets
as well as the Company or certain of its subsidiaries.
Despite the operating losses incurred in 1996, the Company generated
approximately $18.7 million of cash from operations in 1996 as compared to $1.9
million in 1995. The cash provided by operations combined with cash provided by
financing activities in excess of $18 million in 1996, was used to invest in
capital and intangible assets of in excess of $35 million in 1996. While a
portion ($4.6 million) of intangible assets were written off in conjunction with
other special charges recorded in 1996, the remaining expenditures are
investments expected to be recoverable from the future operations of the
Company. The investments were primarily for the implementation of an on-line
lottery system in Maryland, development of the MasterLinkTM system software,
manufacture and delivery of video gaming machines under lease agreement to the
Oregon Lottery and the manufacture and placement of pari-mutuel wagering system
terminals.
In 1996, the Company was named the successful bidder with both the
Minnesota and Florida lotteries for on-line lottery contracts. Discussions and
negotiations with the Minnesota Lottery are currently in progress. Subject to
the final ruling by the administrative judge in the protest proceedings
initiated by a competitor, discussions and negotiations on the contract terms
will begin with the Florida Lottery. Under the terms of the Florida request for
proposal, sizable capital expenditures in excess of current credit facilities
could be required. The availability of and terms of new financing are subject to
numerous uncertainties and cannot be reasonably predicted.
The Company's credit facility with First Bank, N.A., expires in February
1998. The credit facility allows additional third party financing within certain
parameters specified in the credit agreement, including Amendment No. 5 to the
agreement dated January 30, 1997.
- 15 -
<PAGE>
During 1996, 1995 and 1994, the Company sold notes receivable from gaming
machine equipment sales, with a face value of $1.5 million, $2.3 million and
$4.3 million respectively, to banks and other third parties. The notes are
secured by the underlying equipment. The receivables sold are subject to
recourse provisions in the event of default by the primary obligor. The
outstanding balance of the notes receivable sold with recourse was approximately
$4.7 million at December 31, 1996. At September 30, 1997, the Company had a
reserve of $0.3 million established for any losses under the recourse provisions
which reflects a $0.1 million reduction from the December 31, 1996 balance of
$0.4 million. At December 31, 1996, the Company had guaranteed or pledged
security for the indebtedness of others in the amount of approximately $5.8
million (including $4.7 million notes receivable sold to banks and other third
parties.
- 16 -
<PAGE>
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
Index to Consolidated Financial Statements Page
Independent Auditors' Report 18
Consolidated Financial Statements:
Statements of Operations for the years
ended December 31, 1996, 1995 and 1994 19
Balance Sheets as of December 31, 1996 and 1995 20
Statements of Stockholders' Equity for the years
ended December 31, 1996, 1995 and 1994 21
Statements of Cash Flows for the years
ended December 31, 1996, 1995 and 1994 22
Notes to Consolidated Financial Statements 23
All schedules are omitted because the information prescribed thereon is not
applicable nor required or is furnished in the consolidated financial statements
or notes thereto.
- 17 -
<PAGE>
INDEPENDENT AUDITORS' REPORT
The Board of Directors and Stockholders
Powerhouse Technologies, Inc.:
We have audited the accompanying consolidated balance sheets of Powerhouse
Technologies, Inc. and subsidiaries as of December 31, 1996 and 1995, and the
related consolidated statements of operations, stockholders' equity and cash
flows for each of the years in the three-year period ended December 31, 1996.
These consolidated financial statements are the responsibility of the Company's
management. Our responsibility is to express an opinion on these consolidated
financial statements based on our audits.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above
present fairly, in all material respects, the financial position of Powerhouse
Technologies, Inc. and subsidiaries as of December 31, 1996 and 1995 and the
results of their operations and their cash flows for each of the years in the
three-year period ended December 31, 1996 in conformity with generally accepted
accounting principles.
/S/ KPMG PEAT MARWICK LLP
Billings, Montana
February 28, 1997
- 18 -
<PAGE>
POWERHOUSE TECHNOLOGIES, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
<TABLE>
<CAPTION>
Years Ended December 31
-----------------------
1996 1995 1994
---- ---- ----
<S> <C> <C> <C>
REVENUES
On-line lottery $ 88,842,968 91,653,710 101,559,326
Gaming machine and route operations 60,186,249 61,397,937 68,571,177
Wagering systems and racetrack operations 27,651,989 28,110,605 18,651,802
------------ ----------- -----------
Total revenues 176,681,206 181,162,252 188,782,305
------------ ----------- -----------
COSTS AND EXPENSES:
On-line lottery 59,332,807 59,438,258 62,396,996
Gaming machine and route operations 32,910,623 35,991,531 39,814,825
Wagering systems and racetrack operations 20,103,761 22,286,127 13,991,770
Selling, general and administrative 28,697,610 31,139,361 34,000,545
Research and development 7,969,025 8,887,785 8,513,137
Other charges 34,135,000 2,762,667 23,994,000
Depreciation and amortization 23,822,437 22,587,049 20,694,018
------------ ----------- -----------
Total costs and expenses 206,971,263 183,092,778 203,405,291
------------ ----------- -----------
Loss from operations (30,290,057) (1,930,526) (14,622,986)
------------ ----------- -----------
OTHER INCOME (EXPENSE):
Interest and other income 1,059,794 1,243,471 1,445,688
Interest expense (3,753,555) (3,077,183) (1,687,441)
------------ ----------- -----------
(2,693,761) (1,833,712) (241,753)
------------ ----------- -----------
Loss before income taxes and extraordinary
items (32,983,818) (3,764,238) (14,864,739)
Income tax benefit (expense) 8,752,842 846,374 (1,303,034)
------------ ----------- -----------
Net loss from operations (24,230,976) (2,917,864) (16,167,773)
Reversal of (provision for) loss on discontinuance of
wagering systems operations, net 5,482,279 (5,482,279) ---
------------ ----------- -----------
Net loss before extraordinary items (18,748,697) (8,400,143) (16,167,773)
Extraordinary gain, net 4,014,050 --- ---
------------ ----------- -----------
Net loss $(14,734,647) (8,400,143) (16,167,773)
============ =========== ===========
Net earnings (loss) per share:
From continuing operations $(2.27) (.28) (1.54)
From discontinued operations .51 (.51) ---
From extraordinary items .38 --- ---
------ ---- -----
$(1.38) (.79) (1.54)
====== ==== =====
Weighted average shares outstanding 10,698,926 10,608,472 10,506,687
========== ========== ==========
</TABLE>
See accompanying notes to consolidated financial statements.
- 19 -
<PAGE>
POWERHOUSE TECHNOLOGIES, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
<TABLE>
<CAPTION>
December 31,
1996 1995
---- ----
<S> <C> <C>
ASSETS
Current assets:
Cash and cash equivalents $ 4,321,884 1,992,667
Restricted short-term deposits 1,364,231 3,768,385
Accounts receivable, net 19,352,571 22,254,361
Current installments of notes receivable, net 2,818,371 2,814,814
Inventories 18,296,801 26,399,936
Prepaid expenses 1,027,256 1,261,963
Income tax refund receivable 3,551,415 2,431,068
Deferred income taxes 15,499,722 7,732,606
------------ -----------
Total current assets 66,232,251 68,655,800
------------ -----------
Property, plant and equipment 153,123,865 132,325,663
Less accumulated depreciation (78,416,733) (60,493,819)
------------ -----------
Net property, plant and equipment 74,707,132 71,831,844
------------ -----------
Restricted cash deposits 2,521,075 817,024
Notes receivable, excluding current installments 2,216,074 3,101,503
Goodwill, net 10,133,364 10,952,241
Intangible and other assets, net 12,232,860 10,492,573
------------ -----------
$168,042,756 165,850,985
============ ===========
LIABILITIES
Current liabilities:
Notes payable $ 7,650,000 8,250,000
Current installments of long-term debt 10,604,402 9,588,708
Accounts payable 6,645,855 15,490,638
Accrued expenses 13,247,658 15,339,707
------------ -----------
Total current liabilities 38,147,915 48,669,053
------------ -----------
Long-term debt, excluding current installments 9,312,371 12,884,564
Due to EDS 38,025,010 ---
Other liabilities --- 10,000,000
Deferred income taxes 10,326,000 7,849,206
------------ -----------
Total liabilities 95,811,296 79,402,823
------------ -----------
Commitments and contingencies (Note 13)
STOCKHOLDERS' EQUITY
Preferred stock, $.01 par value. Authorized 10,000,000 shares; no
shares issued --- ---
Series A Junior Preferred stock, $.01 par value, convertible non-
cumulative. Authorized 1,912,728 shares 19,127 19,127
Common stock, $.01 par value. Authorized 25,000,000 shares 108,292 106,821
Paid-in capital 97,764,970 97,284,358
Deferred restricted stock compensation (417,129) (452,991)
Accumulated deficit (25,243,800) (10,509,153)
------------ -----------
Total stockholders' equity 72,231,460 86,448,162
------------ -----------
$168,042,756 165,850,985
============ ===========
</TABLE>
See accompanying notes to consolidated financial statements.
- 20 -
<PAGE>
POWERHOUSE TECHNOLOGIES, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
<TABLE>
<CAPTION>
- -------------------------------------------------------------------------------------------------------------------
Series A
Preferred Common Restricted Total
Stock Stock Paid-in stock compen- Accumulated stockholders'
par value par value capital sation deficit equity
- ------------------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C>
December 31, 1993 $ --- 123,188 94,032,726 --- 14,058,763 108,214,677
Net loss --- --- --- --- (16,167,773) (16,167,773)
Restricted stock issued --- 1,700 1,694,550 (1,696,250) --- ---
Amortization of deferred restricted
stock compensation --- --- --- 169,714 --- 169,714
Stock redemption --- (24,582) (65,117,241) --- --- (65,141,823)
Stock issued, net of issue costs 19,127 5,455 66,427,887 --- --- 66,452,469
Stock issued under stock purchase
plan --- 337 272,299 --- --- 272,636
Stock options exercised --- 237 326,420 --- --- 326,657
------- ------- ----------- ---------- ---------- -----------
December 31, 1994 19,127 106,335 97,636,641 (1,526,536) (2,109,010) 94,126,557
Net loss --- --- --- --- (8,400,143) (8,400,143)
Amortization of deferred restricted
stock compensation --- --- --- 323,545 --- 323,545
Rescission of deferred restricted stock
compensation --- (500) (749,500) 750,000 --- ---
Stock issued under stock purchase
plan --- 986 397,217 --- --- 398,203
------- ------- ----------- ---------- ---------- -----------
December 31, 1995 19,127 106,821 97,284,358 (452,991) (10,509,153) 86,448,162
Net loss --- --- --- --- (14,734,647) (14,734,647)
Deferred restricted stock
compensation --- 300 132,900 35,862 --- 169,062
Stock issued under stock purchase
plan --- 1,171 347,712 --- --- 348,883
------- ------- ----------- ---------- ---------- -----------
December 31, 1996 $19,127 108,292 97,764,970 (417,129) (25,243,800) 72,231,460
======= ======= =========== ========== =========== ===========
</TABLE>
<TABLE>
<CAPTION>
- -----------------------------------------------------------------------------------------------------------------------------------
Share Amounts Outstanding 1994 1995 1996
---- ---- ----
Series A Common Series A Common Series A Common
Balance Preferred Stock Stock Preferred Stock Stock Preferred Stock Stock
- -----------------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C>
Beginning of year --- 12,318,805 1,912,728 10,633,544 1,912,728 10,682,109
Sale of stock 1,912,728 545,454 --- --- --- ---
Stock issued under stock
purchase plan --- 33,742 --- 98,565 --- 117,075
Stock redemption --- (2,458,182) --- --- --- ---
Restricted stock issued (rescinded) --- 170,000 --- (50,000) --- 30,000
Stock options exercised --- 23,725 --- --- --- ---
--------------- ---------- --------- ---------- --------- ----------
End of year 1,912,728 10,633,544 1,912,728 10,682,109 1,912,728 10,829,184
========= ========== ========= ========== ========= ==========
</TABLE>
See accompanying notes to consolidated financial statements.
- 21 -
<PAGE>
POWERHOUSE TECHNOLOGIES, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
<TABLE>
<CAPTION>
Years Ended December 31
-----------------------
1996 1995 1994
---- ---- ----
<S> <C> <C> <C>
CASH FLOWS FROM OPERATING ACTIVITIES:
Net loss $(14,734,647) (8,400,143) (16,167,773)
Adjustments to reconcile net loss to
net cash provided by operating
activities:
(Reversal of) provision for loss on sale of
wagering systems operations (5,482,279) 5,482,279 ---
Depreciation and amortization 23,822,437 22,587,049 20,694,018
Other charges 34,135,000 2,762,667 23,994,000
Extraordinary gain, net (4,014,050) --- ---
Other, net 78,447 (50,856) 4,418
Changes in operating assets and liabilities:
Sales of receivables 1,466,952 2,339,710 4,311,874
Receivables, net 1,942,256 (7,502,586) (6,312,382)
Inventories (3,488,868) 6,923,294 (26,066,800)
Prepaid expenses 234,707 103,334 (27,995)
Accounts payable 2,006,279 (12,616,174) 18,538,836
Accrued expenses (10,853,878) (7,044,732) (7,152,483)
Deferred and refundable income taxes (6,410,669) (2,640,409) 351,387
------------ ----------- -----------
Net cash provided by operating activities 18,701,687 1,943,433 12,167,100
------------ ----------- -----------
CASH FLOWS FROM INVESTING ACTIVITIES:
Capital expenditures (25,522,476) (19,046,937) (13,332,480)
Expenditures on intangible and other noncurrent assets (10,037,063) (3,540,804) (7,058,678)
Acquisition of business operations, net of cash acquired --- --- (26,969,161)
Proceeds from sales of equipment 109,440 386,063 357,287
Change in restricted cash deposits 700,103 181,728 7,298,152
Maturities (purchases) of available-for-sale
securities, net of purchases --- --- 24,607,595
------------ ----------- -----------
Net cash used in investing activities (34,749,996) (22,019,950) (15,097,285)
------------ ----------- -----------
CASH FLOWS FROM FINANCING ACTIVITIES:
Net (payments) proceeds from notes payable to banks (600,000) 8,250,000 ---
Proceeds from issuance of long-term debt 4,364,424 24,286,477 213,900
Repayments of long-term debt (13,078,791) (14,735,245) (4,055,255)
Amounts payable to EDS 27,343,010 --- ---
Common stock sold under employee benefit plans 348,883 398,203 599,293
Sale of stock, net --- --- 66,452,469
Redemption of common stock --- --- (65,141,823)
------------ ----------- -----------
Net cash provided by (used in) financing activities 18,377,526 18,199,435 (1,931,416)
------------ ----------- ------------
Net increase (decrease) in cash and cash equivalents 2,329,217 (1,877,082) (4,861,601)
------------ ----------- ------------
Cash and cash equivalents, beginning of year 1,992,667 3,869,749 8,731,350
------------ ----------- ------------
Cash and cash equivalents, end of year $ 4,321,884 1,992,667 3,869,749
============ =========== ============
</TABLE>
See accompanying notes to consolidated financial statements.
- 22 -
<PAGE>
POWERHOUSE TECHNOLOGIES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(1) SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Principles of Consolidation. The consolidated financial statements include
the accounts of Powerhouse Technologies, Inc. and subsidiaries (the "Company").
All significant intercompany balances and transactions have been eliminated in
consolidation.
Revenue Recognition. Revenue from the sale of video gaming machines,
on-line lottery terminals and related parts is recognized upon delivery to the
customer. Revenue from sales of on-line lottery and video gaming central site
systems and equipment is recognized using the percentage of completion method of
accounting for long-term construction type contracts where costs to complete can
reasonably be estimated or upon acceptance of the system when costs to complete
cannot reasonably be estimated. Prior to revenue recognition on system sales,
costs incurred are applied against progress billings and recorded as a net
accrued liability or other current asset as appropriate.
On-line lottery and wagering systems contract services revenues are
recognized as the services are performed and primarily relate to revenues from
long-term contracts which require installation and operation of on-line lottery
and pari-mutuel wagering networks. Revenues under these contracts are generally
based on a percentage of sales volume, which may fluctuate over the life of the
contracts.
Route operations revenue consists primarily of video machine gaming wagers,
net of payouts and state gaming taxes generated under revenue sharing agreements
with route customers. Route operations revenue is recorded weekly as the
revenues are earned.
Revenue from racetrack operations primarily represents commissions on
wagers placed on live and simulcast pari-mutuel racing at the Company's
racetrack in Sunland Park, New Mexico, and is recorded on the day of each race.
Equipment leased to others is accounted for as operating leases, whereby
monthly rentals are recorded as income when earned.
Cash and Cash Equivalents. Cash deposits and all highly liquid debt
instruments with maturities of three months or less are considered cash
equivalents in the statements of cash flows.
Restricted deposits. Cash deposits expected to be refunded or released
within one year are considered restricted short-term deposits. The deposits are
primarily for bonds that are required by customers for proposals and long-term
contracts.
Inventories. The Company manufactures inventories for sale and lease as
well as use in the provision of services under long-term contracts. Inventories
purchased and manufactured for use in the provision of services are transferred
to property, plant and equipment when installed pursuant to the terms of such
long-term contracts. Inventories are carried at the lower of cost or market
value. Cost is determined using the first-in, first-out method and includes
materials, labor, allocated indirect manufacturing overhead as well as initial
tooling and other setup charges.
Accounts and Notes Receivable. Accounts and notes receivable are recorded
at cost, less the related allowance for impaired notes receivable. (See Note 5.)
Property, Plant and Equipment. Property, plant and equipment is stated at
cost. Equipment under capital leases is stated at the lower of the present value
of minimum lease payments at the beginning of the lease term or the fair market
value of the asset at the inception of the lease.
Depreciation of property, plant and equipment is calculated using the
straight-line method over the estimated useful lives of the assets or the life
of the related contract (including contract extensions) as follows:
- 23 -
<PAGE>
POWERHOUSE TECHNOLOGIES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(continued)
Item Estimated life
---- --------------
Wagering systems and on-line lottery equipment 3 - 7 years
Buildings and improvements 7 - 40 years
Machinery and equipment 3 - 10 years
Game operations equipment 7 years
Furniture and fixtures 5 - 10 years
Equipment under capital leases is depreciated on a straight-line basis over
the shorter of the lease term or estimated useful life of the asset.
The Company in 1996 reclassified approximately $2,400,000 of on-line
lottery equipment from property, plant and equipment to inventories held for
sale. (See Note 15.)
Goodwill, Intangible and Other Assets. Goodwill, which represents the
excess of purchase price over fair value of net assets acquired, is amortized on
a straight-line basis over the expected periods to be benefited, currently
estimated at 15 years from acquisition date May 1994 (see Note 2). Intangible
and other assets are stated at cost net of accumulated amortization. Intangible
and other assets are amortized over their respective economic useful lives
ranging up to 10 years. Accumulated amortization of Goodwill, Intangible and
other assets was approximately $12,100,000 and $7,594,000 at December 31, 1996
and 1995, respectively. In 1994, the Company recorded impairment losses on
goodwill based on estimates of discounted future operating cash flows related to
the asset. In June 1995, the Company adopted Statement of Financial Accounting
Standards Board Statement No. 121, "Accounting for the Impairment of Long-Lived
Assets and for Long-Lived Assets to Be Disposed of" (the "Statement"). The
Statement requires that long-lived assets and certain identifiable intangibles
be reviewed for impairment whenever events or changes in circumstances indicate
that the carrying amount of an asset may not be recoverable. In performing the
review for recoverability, the Company estimates the future cash flows expected
to result from the use of the asset and its eventual disposition. If the sum of
these expected future cash flows (undiscounted and without interest charges) is
less than the carrying amount of the asset, the asset is considered "impaired"
and an impairment loss is recognized. Measurement of the impairment loss amount
is based on the fair value of the asset. Fair value is measured based on the
present value of the expected future net cash flows calculated using a discount
rate commensurate with the risks involved.
Foreign Currency Translations and Transactions. Gains and losses from
foreign currency transactions and remeasurements are included in results of
operations.
Income Taxes. Deferred tax assets and liabilities are recognized for the
estimated future consequences attributable to differences between the financial
statement carrying amounts of assets and liabilities and their respective tax
bases. The current and noncurrent portions of these deferred tax assets and
liabilities are classified in the balance sheet based on the respective
classification of the assets and liabilities which give rise to such deferred
income taxes.
Earnings per Common Share. Earnings per common share is computed by
dividing net earnings by the weighted average number of common shares
outstanding and the common stock equivalents of convertible preferred stock and
stock options outstanding using the treasury stock method. Common stock
equivalents are excluded from the loss per share calculation when the effect is
antidilutive.
Fair Value of Financial Instruments. The carrying value of financial
instruments, consisting primarily of cash, accounts receivable and accounts
payable, approximates fair value due to the liquid nature of the instruments.
(See Notes 5 and 10 for fair value estimates of notes receivable and long-term
debt.)
- 24 -
<PAGE>
POWERHOUSE TECHNOLOGIES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(continued)
Stock based compensation plans. The Company applies Accounting Principles
Board Opinion 25 and related interpretations in accounting for its stock based
compensation plan. Accordingly, no compensation cost has been recognized for
options granted under the plans. (See Note 12.)
Reclassifications. Certain reclassifications have been made to the 1995 and
1994 amounts to conform to the 1996 presentation. (See Note 2.)
Accounting Pronouncements Not Yet Adopted. The Company has capitalized
start-up costs in conjunction with its long-term contracts in the on-line
lottery and wagering systems segments in accordance with Statement of Position
(SOP) 81-1. The AICPA Accounting Standards Executive Committee (AcSEC) approved
for issuance the SOP, Reporting on the Costs of Start-Up Activities, which will
require that costs incurred during a start-up activity (including organization
costs) be expensed as incurred. Before issuance, the SOP must be reviewed and
cleared by the FASB. If cleared by the FASB, it is anticipated that the final
SOP would be released in the second quarter of 1998 and be effective for fiscal
years beginning after December 15, 1998. (See Note 8.) Depending on the level of
the Company's start-up activities, this change in accounting method may be
material.
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) DISCONTINUED OPERATIONS SUBSEQUENTLY RETAINED/EXTRAORDINARY ITEM
On May 3, 1994, the Company completed the purchase of all of the
outstanding stock of United Wagering Systems, Inc. ("UWS"). UWS is involved in
the design, manufacture, operation, sale and lease of computerized wagering
systems, primarily pari-mutuel wagering systems, and the ownership and operation
of a racetrack facility. The original purchase price of $29,600,000 included
$19,600,000 in cash and the issuance of $10,000,000 notes, payable over a
three-year period.
During the fourth quarter 1994 and the first quarter 1995, certain negative
developments affecting UWS and the pari-mutuel wagering industry became
increasingly apparent. These developments included a significant decline in the
gross revenues at pari-mutuel wagering and other facilities, sharp reductions in
gross margins and the failure of various state legislative initiatives
authorizing the introduction of gaming devices at tracks to occur as
anticipated. The Company's investment in Goodwill, net of amortization,
attributable to the wagering systems segment of UWS of $17,300,000 was written
off in the fourth quarter of 1994, leaving approximately $11,700,000 of Goodwill
associated with the racetrack operations segment of UWS.
During 1995, the Company did not pay principal and interest obligations
under the terms of the promissory notes to the sellers in the aggregate amount
of $10,000,000 made in conjunction with the acquisition of UWS in May 1994. On
March 25, 1996, the Company reached an agreement with the sellers settling all
outstanding claims and disputes, including dismissal of all outstanding
litigation, resulting in a $4,014,050 gain on debt extinguishment. (See Note
10.)
The Company, in the fourth quarter 1995, made a decision to sell UWS,
exclusive of the racetrack in Sunland Park, New Mexico. The Company entered into
a non-binding letter of intent in the fourth quarter 1995 for the sale of this
segment; however, this transaction was abandoned because final terms could not
be negotiated. The Company continued to review other potential opportunities for
the sale of this operation through the second quarter 1996; however, due to
operational improvements and industry and market conditions, the Company decided
to no longer actively pursue the disposal of the wagering systems segment. In
accordance with the requirements outlined in Financial Accounting Standards
Board Emerging Issues Task Force issue No. 90-16 "Accounting for Discontinued
Operations Subsequently Retained," the results of
- 25 -
<PAGE>
POWERHOUSE TECHNOLOGIES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(continued)
operations of the wagering systems segment have been reclassified to continuing
operations in all periods presented. The estimated provision for loss on
disposal of $5,482,279, recorded in 1995, was reversed in the third quarter
1996. Concurrent with the reversal, the Company recorded an impairment charge on
certain long-lived assets of the wagering systems segment of approximately
$2,800,000. Additionally, in 1996 the Company implemented a restructuring plan
of the manufacturing and repair and maintenance operations of the wagering
systems segment inclusive of closing a facility in Shepherd, Montana. The
manufacturing of wagering system terminals will be performed in the Company's
Bozeman, Montana facility. Costs and expenses recorded in the third quarter 1996
for the restructuring plan were approximately $300,000.
(3) BUSINESS SEGMENTS
The Company operates principally in three business segments: the sale,
design, manufacture, installation and operation of on-line lotteries; the
design, manufacture, marketing and leasing of video gaming machines and central
control systems and related services; and the design, manufacture, sale and
operation of computerized pari-mutuel wagering systems for dog and horse racing
tracks. These segments operate throughout the United States and on a limited
international basis.
<TABLE>
<CAPTION>
Years Ended December 31,
------------------------
1996 1995 1994
---- ---- ----
<S> <C> <C> <C>
Revenues:
On-line lottery $ 88,842,968 91,653,710 101,559,326
Gaming machine and route operations 64,530,676 62,889,528 83,249,299
Wagering systems and racetrack operations 27,651,989 28,110,605 18,651,802
Less intercompany revenues (4,344,427) (1,491,591) (14,678,122)
------------ ----------- -----------
Total revenues $176,681,206 181,162,252 188,782,305
============ =========== ===========
Operating profit (loss):
On-line lottery $(29,449,203) (3,464,191) (1,166,855)
Gaming machine and route operations 9,432,769 13,171,240 18,216,598
Wagering systems and racetrack operations (3,994,922) (3,831,614) (21,384,805)
General corporate expenses (6,825,851) (8,010,609) (9,284,023)
Intercompany profit 547,150 204,648 (1,003,901)
------------ ----------- -----------
Total operating profit (loss) $(30,290,057) (1,930,526) (14,622,986)
============ =========== ===========
Operating profit (loss) before "other" charges:
On-line lottery $ 1,622,909 967,167 4,777,145
Gaming machine and route operations 9,432,769 11,894,459 18,216,598
Wagering systems and racetrack operations (932,052) (3,568,947) (3,334,805)
General corporate expenses (6,825,851) (8,665,186) (9,284,023)
Intercompany profit 547,150 204,648 (1,003,901)
------------ ----------- -----------
Total operating profit before "other"
charges $ 3,844,925 832,141 9,371,014
============ =========== ===========
Capital expenditures:
On-line lottery $ 16,270,712 8,079,300 7,080,663
Gaming machine and route operations 5,809,103 5,353,786 2,403,181
Wagering systems and racetrack operations 3,455,358 4,762,307 3,846,948
Corporate 402,877 1,352,647 1,284,709
Less intercompany step-up in basis (415,574) (501,103) (1,283,021)
------------ ----------- -----------
Total capital expenditures $ 25,522,476 19,046,937 13,332,480
============ =========== ===========
</TABLE>
- 26 -
<PAGE>
POWERHOUSE TECHNOLOGIES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(continued)
<TABLE>
<CAPTION>
Years Ended December 31,
------------------------
1996 1995 1994
---- ---- ----
<S> <C> <C> <C>
Depreciation and amortization:
On-line lottery $ 14,247,555 14,242,014 13,237,470
Gaming machine and route operations 4,908,125 3,772,100 3,424,638
Wagering systems and racetrack operations 5,085,807 4,657,756 3,836,063
Corporate 501,481 620,931 486,193
Less depreciation on intercompany
step-up basis (920,531) (705,752) (290,346)
------------ ----------- -----------
Total depreciation and amortization $ 23,822,437 22,587,049 20,694,018
============ =========== ===========
Identifiable assets:
On-line lottery $ 62,349,531 77,547,719 68,292,863
Gaming machine and route operations 45,656,205 34,904,859 47,149,696
Wagering systems and racetrack operations 42,692,115 46,106,131 49,261,426
Corporate 19,066,692 9,546,562 11,770,845
Less intercompany step-up in basis (1,721,787) (2,254,286) (2,443,218)
------------ ----------- -----------
Total identifiable assets $168,042,756 165,850,985 174,031,612
============ =========== ===========
</TABLE>
Operating profit (loss) before other charges excludes special and other
charges discussed in Note 15.
Included in the on-line lottery segment is revenue from equipment sales of
approximately $4,408,000, $5,314,000 and $9,940,000 and costs and expenses
associated with equipment sales revenue of approximately $3,062,000, $4,267,000
and $8,235,000 in the years ended December 31, 1996, 1995 and 1994,
respectively.
The gaming machine segment includes operating lease revenue of
approximately $10,726,000, $6,783,000 and $6,047,000 and revenues from royalties
of approximately $627,000, $3,600,000 and $7,200,000 in the years ended December
31, 1996, 1995 and 1994, respectively.
Included in the wagering systems segment is revenue from equipment sales of
approximately $2,140,000, $2,124,000 and $2,330,000 and costs and expenses
associated with equipment sales revenue of approximately $1,295,000, $1,133,000
and $1,143,000 in the years ended December 31, 1996, 1995 and eight months ended
December 31, 1994, respectively.
Revenue related to racetrack operations was approximately $7,153,000,
$7,968,000 and $4,821,000 and operating losses related to racetrack operations
were approximately $(1,569,000), $(1,327,000), and $(874,000) in the years ended
December 31, 1996, 1995 and the eight months ended December 31, 1994,
respectively.
Total identifiable assets of the racetrack operations were approximately
$22,710,000, $23,889,000 and $22,255,000 at December 31, 1996, 1995 and 1994,
respectively.
(4) REVENUE CONCENTRATION
The Company had revenues from customers or distributors within a specific
jurisdiction which accounted for more than 10% of the Company's gaming machine
and route operations revenues approximately as follows:
- 27 -
<PAGE>
POWERHOUSE TECHNOLOGIES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(continued)
<TABLE>
<CAPTION>
Years Ended December 31,
------------------------
1996 1995 1994
---- ---- ----
Amount % Amount % Amount %
------ - ------ - ------ -
<S> <C> <C> <C> <C> <C> <C>
Montana $19,748,000 32.8 $19,523,000 31.2 $17,927,000 26.1
Quebec 2,169,000 3.6 12,291,000 19.6 10,532,000 15.4
Louisiana 1,389,000 2.3 8,999,000 14.4 12,044,000 17.6
Oregon 7,090,000 11.7 6,054,000 9.7 4,327,000 6.3
</TABLE>
Montana revenue includes total revenues from route operations of
approximately $16,548,000, $15,269,000 and $15,422,000 in the years ended
December 31, 1996, 1995 and 1994, respectively.
The Company derives on-line lottery revenue from contracts ranging from one
to five years with varying options for extensions and renewals and from on-line
lottery system software and equipment sales from customers in ten individual
states and three international jurisdictions. For the years ended December 31,
1996, 1995 and 1994, the following customers accounted for more than 10% of the
Company's on-line lottery revenue:
<TABLE>
<CAPTION>
1996 1995 1994
Contract ---- ---- ----
Expiration Amount % Amount % Amount %
---------- ------ - ------ - ------ -
<S> <C> <C> <C> <C> <C> <C> <C>
Florida 6/96 $30,203,000 34.0 $35,247,000 38.5 $37,692,000 37.1
Pennsylvania 12/98 23,164,000 26.1 22,101,000 24.1 22,229,000 21.9
</TABLE>
The Company's contract with the Washington State Lottery expired in June
1996. The expired contract accounted for approximately $5,739,000 (6.5%) of the
lottery services revenue in 1996, $10,382,000 (11.3%) in 1995 and $10,930,000
(10.8%) in 1994. 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 October 31, 1996, the Company was notified by the Florida
Lottery that the Company has been selected as the most highly qualified bidder
for the award of a new five-year on-line lottery contract. A competitor, GTECH
Corporation, has protested the Florida Lottery's selection of the Company.
Pending resolution of the protest, the Company will commence contract
negotiations. Under the terms of the request for proposal, sizable capital
expenditures in excess of current credit facilities would be required to fulfill
its terms. The availability of and terms of new financing are subject to
numerous uncertainties and cannot be reasonably predicted.
Export Sales. The Company had total export sales from the United States of
approximately $28,600,000, $30,200,000 and $38,500,000 during the years ended
December 31, 1996, 1995 and 1994, respectively.
(5) NOTES AND ACCOUNTS RECEIVABLE
A summary of receivables follows:
<TABLE>
<CAPTION>
December 31,
------------
1996 1995
---- ----
<S> <C> <C>
Trade $20,438,177 23,423,223
Notes receivable 5,260,118 7,783,514
Accrued interest 5,415 113,621
----------- -----------
25,703,710 31,320,358
Less allowance for doubtful accounts (1,316,694) (3,149,680)
Less current portion (22,170,942) (25,069,175)
----------- -----------
$ 2,216,074 3,101,503
=========== ============
</TABLE>
- 28 -
<PAGE>
POWERHOUSE TECHNOLOGIES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(continued)
The Company finances sales of gaming machine equipment to certain customers
meeting minimum credit standards. Installment notes bear interest at interest
rates of up to 18% and generally mature within one to five years.
At December 31, 1996, approximately 39% of the Company's receivables were
from various governments or their designated agencies. The Company estimates the
fair value of gross notes receivable at December 31, 1996 to approximate
carrying value. This estimate is based on current discount rates for instruments
of similar credit quality available in the secondary market.
Amounts charged to expense for estimated bad debts were approximately
$217,000, $528,000 and $1,275,000 in the years ended December 31, 1996, 1995 and
1994, respectively. The Company wrote off previously reserved doubtful accounts
of approximately $2,050,000, $20,000 and none for the years ended December 31,
1996, 1995 and 1994, respectively. In 1994, the Company recorded as part of the
purchase accounting entries of the UWS purchase (see Note 2) approximately
$1,073,000 of allowance for doubtful accounts.
(6) INVENTORIES
A summary of inventories, net of valuation reserves, follows:
December 31,
------------
1996 1995
---- ----
Manufacturing:
Raw materials $5,461,972 15,159,742
Work-in-process 733,436 673,082
Finished goods 11,321,877 8,602,181
Customer service and other 779,516 1,964,931
----------- -----------
$18,296,801 26,399,936
=========== ==========
The Company had reserves for inventories of approximately $14,200,000 and
$5,200,000 at December 31, 1996 and 1995, respectively, primarily related to
finished goods. The Company charged to expense for reserves and impairments of
inventories approximately $18,000,000, $1,023,000 and $4,392,000 in the years
ended December 31, 1996, 1995 and 1994, respectively. Of these charges,
$18,000,000, $550,000 and $4,100,000 in the years ended December 31, 1996, 1995
and 1994, respectively, related to the termination of three on-line lottery
projects for which inventory was specifically procured. As of December 31, 1996,
the remaining on-line equipment balance was approximately $2,900,000. The
Company wrote off previously reserved inventories of approximately $9,000,000,
$215,000 and none in the years ended December 31, 1996, 1995 and 1994,
respectively. At December 31, 1996, the Company had approximately 500 finished
video gaming machines located in various casino gaming locations, under trial
arrangements with customers, included in inventory.
(7) PROPERTY, PLANT AND EQUIPMENT
A summary of property, plant and equipment follows:
<TABLE>
<CAPTION>
December 31,
------------
1996 1995
---- ----
<S> <C> <C>
Wagering systems and on-line lottery equipment $103,572,304 88,207,880
Land, buildings and improvements 14,280,158 14,201,871
Machinery and equipment 5,931,264 5,046,108
Game operations equipment 27,676,069 23,507,049
Furniture and fixtures 1,664,070 1,362,755
------------ -----------
$153,123,865 132,325,663
============ ===========
</TABLE>
- 29 -
<PAGE>
POWERHOUSE TECHNOLOGIES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(continued)
In 1996, the Company transferred on-line lottery equipment with a net book
value of approximately $2,400,000 to inventories held for sale in conjunction
with the termination of an on-line lottery contract. During 1995 and 1994, the
Company transferred approximately $1,030,000 and $1,221,000, respectively, of
game operations equipment from inventory to property, plant and equipment in
conjunction with leasing activities and $3,900,000 and none, respectively, from
inventory to property and equipment in connection with installations of
terminals under on-line lottery contracts. Other additions to game operations
equipment and on-line lottery equipment in the three-years ended December 31,
1996, are included in the Consolidated Statement of Cash Flows.
Game operations equipment at December 31, 1996 and 1995 includes video
gaming machines with an aggregate cost of approximately $20,866,000 and
16,972,000, respectively, and carrying value of approximately $11,900,000 and
$10,837,000, respectively, which is being leased to customers. For the years
ended December 31, 1996, 1995 and 1994, depreciation expense on this equipment
was approximately $2,830,000, $2,021,000 and $1,710,000, respectively. Two lease
agreements provide rent payments to the Company based on a percentage of net
gaming receipts. One agreement is on a month-to-month basis, the other is for a
five-year period ending in December 2000 with provisions for three one-year
extensions. Another agreement is a master lease whereby individual terminal
shipment lease terms are for one year, with four consecutive automatic one-year
renewals with decreasing lease payments, with an option by the lessee to
terminate the lease at the end of each such year. Future lease receipts, by the
Company, under the contractual lease agreements, assuming renewals, based on the
terminals accepted through December 31, 1996, are approximately as follows:
Year ending December 31,
1997 $ 7,292,000
1998 5,167,000
1999 4,235,000
2000 3,565,000
2001 386,000
-----------
$20,645,000
===========
Lease income was approximately $10,726,000, $6,783,000 and $6,047,000 in
1996, 1995 and 1994, respectively.
(8) INTANGIBLE AND OTHER ASSETS
A summary of intangible and other assets, net of amortization, follows:
December 31,
------------
1996 1995
---- ----
Software development costs $ 9,059,037 6,679,014
Deferred start-up costs and other 2,646,043 2,260,780
Non-compete agreements 527,780 1,552,779
----------- ----------
$12,232,860 10,492,573
=========== ==========
The Company capitalized approximately $4,124,000, $2,675,000 and $5,154,000
of software development costs in the years ended December 31, 1996, 1995 and
1994, respectively. The costs are primarily related to the development of the
MasterLinkTM system.
Total amortization expense of intangible and other assets (including
Goodwill) was approximately $4,229,000, $3,454,000 and $3,091,000 in 1996, 1995
and 1994, respectively. Amortization of software development costs, included in
total amortization of intangible and other assets, was approximately $1,266,000,
$941,000 and $233,000 in 1996, 1995 and 1994, respectively.
- 30 -
<PAGE>
POWERHOUSE TECHNOLOGIES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(continued)
Management estimates that all capitalized development and deferred start-up
costs will be recovered through operations. Should plans for a jurisdiction,
product or product enhancements be abandoned or otherwise expire, the related
costs are expensed. (See Note 15.)
(9) LEASE OBLIGATIONS
The Company has noncancelable operating leases for office space, equipment
and vehicles which expire at various dates over the next five years. Future
minimum lease payments under noncancelable operating leases as of December 31,
1996, including leases to be assumed by the Company in conjunction with the
settlement agreement between the Company and EDS (see Note 16), are
approximately as follows:
Year ending December 31,
1997 $2,754,000
1998 2,276,000
1999 968,000
2000 518,000
2001 93,000
==========
In 1996, 1995 and 1994, rental expense was approximately $752,000, $633,000
and $1,709,000, respectively.
(10) LONG-TERM DEBT
A summary of long-term debt, including capitalized lease obligations,
follows:
<TABLE>
<CAPTION>
December 31,
1996 1995
---- ----
<S> <C> <C>
8.25%note payable in monthly installments
including interest, through September 2001
(see Note 2) $ 5,728,870 ---
7.2% to 10.4% capital lease obligations, due in monthly
installments of $4,573 to $26,567 including
interest, maturing through November 1999 1,753,139 3,753,272
9.0% note payable in monthly installments
including interest through December 1998,
secured by assets leased to others (see Note 7) 5,164,764 5,200,000
LIBOR plus 2.25% notes payable in equivalent monthly
installments of $250,000 plus interest through
February 1998. Secured by stock of subsidiaries 7,270,000 13,520,000
----------- ----------
19,916,773 22,473,272
Less current installments 10,604,402 9,588,708
----------- ----------
Long-term debt, excluding current installments $ 9,312,371 12,884,564
=========== ==========
</TABLE>
The aggregate maturities of long-term debt are as follows:
Year ending December 31,
1997 $10,604,402
1998 4,417,997
1999 2,252,298
2000 1,638,507
2001 1,003,569
===========
- 31 -
<PAGE>
POWERHOUSE TECHNOLOGIES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(continued)
Cash paid for interest was approximately $2,567,000, $2,762,000 and
$1,524,000 for the years ended December 31, 1996, 1995 and 1994, respectively.
Based on borrowing rates currently available to the Company for borrowings
with similar terms and maturities, the fair value of long-term debt at December
31, 1996 approximates carrying value.
The Company maintains a credit facility with First Bank, N.A. In
conjunction with the Company's settlement with EDS, effective January 30, 1997
(see Note 16), the credit agreement with First 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 18, 1998, and increase the line of credit from $17,500,000 to
$19,500,000. In addition to the revolving line of credit, the facility is
structured with two three-year term loans payable through February 1998. The
revolving line of credit which matures February 28, 1998, bears interest at
LIBOR (5.59% at December 31, 1996) plus 2.25% and carries a commitment fee of
.25% on the unadvanced amount. The credit agreement contains certain restrictive
covenants including leverage and cash flow ratios, change in control, payments
of dividend's restrictions and minimum stockholders' equity. Primarily as a
result of the termination of the agreement with EDS in July 1996, the Company
was in default of certain provisions of the credit agreement. The defaults have
been waived by First Bank, N.A. As of December 31, 1996, the Company had
utilized $17,150,000 (including $9,500,000 allocated for irrevocable letters of
credit for the Company's bonding program. ) of the revolving line of credit.
(11) INCOME TAXES
Income tax expense (benefit) from operations consists of the following:
<TABLE>
<CAPTION>
Years Ended December 31,
------------------------
1996 1995 1994
---- ---- ----
<S> <C> <C> <C>
Current:
Federal $(3,532,520) (1,218,616) 645,838
State 70,000 --- (285,448)
Foreign --- 581,583 591,257
----------- ---------- ---------
(3,462,520) (637,033) 951,647
----------- ---------- ---------
Deferred:
Federal (3,614,436) 306,354 157,622
State (1,602,006) (515,695) 193,765
Foreign (73,880) --- ---
----------- ---------- ---------
(5,290,322) (209,341) 351,387
----------- ---------- ---------
$(8,752,842) (846,374) 1,303,034
=========== ========== =========
</TABLE>
The provision for income tax (benefit) expense differs from the amount
which would be provided by applying the Federal statutory income tax rate to
loss from operations before income taxes as follows:
<TABLE>
<CAPTION>
Years Ended December 31,
------------------------
1996 1995 1994
---- ---- ----
<S> <C> <C> <C>
Computed expected tax (benefit) $(8,402,621) (3,236,281) (5,202,659)
Goodwill impairment --- --- 6,055,002
Extraordinary gain (1,344,718) --- ---
State taxes, net of Federal impact (995,804) (335,202) (59,594)
Increase in valuation reserve 1,582,000 1,772,254 ---
Tax exempt interest income --- (10,159) (107,621)
Non-deductible expenses 218,703 371,200 507,002
Goodwill amortization 286,607 286,607 471,011
Foreign taxes (73,880) 581,583 591,257
Foreign sales credit --- (276,376) (473,000)
Other, net (23,129) --- (478,364)
----------- ---------- ----------
$(8,752,842) (846,374) 1,303,034
=========== ========== ==========
</TABLE>
- 32 -
<PAGE>
POWERHOUSE TECHNOLOGIES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(continued)
The tax effects of temporary differences that give rise to deferred tax
assets and liabilities consist of the following:
<TABLE>
<CAPTION>
December 31,
------------
1996 1995
---- ----
<S> <C> <C>
Deferred tax assets:
Allowance for doubtful accounts $ 500,971 1,217,481
Inventory reserves 4,843,591 2,076,717
Provision for discontinued operations --- 2,168,241
Net operating loss carryforward 10,774,111 1,639,562
Tax credits 1,321,006 1,321,006
Accrued liabilities 3,367,418 3,034,974
----------- ----------
Deferred tax assets 20,807,097 11,457,981
----------- ----------
Less valuation reserve (5,307,375) (3,725,375)
----------- ----------
Net deferred tax assets 15,499,722 7,732,606
----------- ----------
Deferred tax liabilities:
Fixed assets, principally depreciation (7,797,992) (6,830,385)
Deferred costs (3,546,568) (2,094,356)
Lease obligations 638,883 1,075,535
Other 379,677 ---
----------- ----------
Net deferred tax liabilities (10,326,000) (7,849,206)
------------ ----------
Net deferred income tax asset (liability) $ 5,173,722 (116,600)
=========== ==========
</TABLE>
The ultimate realization of deferred tax assets is dependent upon the
existence of, or generation of, taxable income in the periods in which those
temporary differences are deductible. Management considers the scheduled
reversal of deferred tax liabilities, taxes paid in carryback years, projected
future taxable income and tax planning strategies in making this assessment.
Based upon the level of historical taxable income and projections for future
taxable income over the periods the net deferred tax assets are deductible, at
December 31, 1996, management believes it is more likely than not that the
Company will realize the benefits of these net deductible differences.
The Tax Reform Act of 1986 expanded the corporate alternative minimum tax
(AMT). Under the Act, the Company's tax liability is the greater of its regular
tax or the AMT. The Company is subject to the AMT primarily due to depreciation
limitations for AMT purposes. The AMT actually paid will be allowed as a credit
against regular tax in the future to the extent future regular tax expense
exceeds AMT. At December 31, 1996, the Company has approximately $1,321,000 of
AMT credit carryforwards which are available to reduce future federal regular
income taxes over an indefinite period. In addition, at December 31, 1996, the
Company has approximately $27,200,000 of net operating loss carryforwards
primarily for federal regular income tax purposes which expire in 2011. A
significant amount of the net operating loss carryforward balance is anticipated
to be utilized in 1997, primarily as a result of the gain on extinguishment of
debt discussed in Note 16.
Net cash received from prior period refunds was approximately $2,442,000 in
1996. Cash paid for income taxes was approximately $1,516,000 and $2,254,000
during 1995 and 1994, respectively.
(12) BENEFIT PLANS
On May 16, 1994, the Board of Directors adopted the 1994 Stock Incentive
Plan (the "Plan") which was approved by the Company's stockholders on June 15,
1994. The Plan provides for the granting of options, stock appreciation rights,
restricted stock, performance units and performance shares to employees,
consultants and advisors of the Company and the granting of options to
non-employee directors of the Company (collectively or individually, "Awards").
The total number of shares authorized for issuance under
- 33 -
<PAGE>
POWERHOUSE TECHNOLOGIES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(continued)
the Plan was 1,000,000. At December 31, 1996, the remaining number of shares
available for issuance under the Plan was 189,500. The Plan replaces the 1992
Stock Incentive Plan which replaced the 1991 Stock Option Plan. No further stock
options will be granted under the 1991 and 1992 plans. All stock options
presently outstanding under the 1991 and 1992 plans will continue to be governed
by the terms of the 1991 Stock Option Plan and 1992 Stock Incentive Plan.
Options granted under the Plan are designated as either incentive stock
options or as non-incentive stock options. The term of the option may not exceed
10 years from the date the option is granted or 15 years in the case of
non-incentive stock options. Incentive stock options owned by stockholders with
more than 10% of the total combined voting power of all classes of stock of the
Company shall be granted at an option price of not less than 100% of the fair
market value at the grant date, and the term of the option may not exceed 5
years from the date of grant.
On February 23, 1993, the Board of Directors adopted a Non-Employee Stock
Option Plan whereby non-employee directors of the Company elected or appointed
after January 1, 1993 shall receive a one-time grant of options to acquire
20,000 shares of Common Stock. The exercise, pricing, vesting, duration and all
other terms and conditions applicable to each option granted under the
Non-Employee Stock Option Plan shall be in accordance with the provisions of the
1992 Stock Incentive Plan.
All options currently outstanding are 100% exercisable no later than 4
years after grant date.
Weighted Average
Options Exercise Price
------- --------------
Year ended December 31, 1994
----------------------------
Outstanding, beginning of year 511,214 $14.23
Granted 782,500 11.10
Exercised (23,725) 13.77
Cancelled (58,620) 14.16
---------
Outstanding, end of year 1,211,369 12.12
=========
Exercisable, end of year 372,690 14.54
========= ======
Year ended December 31, 1995
Granted 70,000 $ 8.33
Exercised --- ---
Cancelled (361,587) 14.20
---------
Outstanding, end of year 919,782 11.45
=========
Exercisable, end of year 539,657 12.44
========= ======
Year ended December 31, 1996
Granted 352,500 $ 4.78
Exercised --- ---
Cancelled (348,693) 11.74
---------
Outstanding, end of year 923,589 8.76
=========
Exercisable, end of year 547,749 9.67
========= ======
- 34 -
<PAGE>
POWERHOUSE TECHNOLOGIES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(continued)
Information regarding options outstanding and exercisable at December 31,
1996, follows:
<TABLE>
<CAPTION>
Options Outstanding Options Exercisable
Range of ------------------- -------------------
Exercise Weighted Average Weighted Average Weighted Average
Price Number Exercise Price Remain Life (Yrs) Number Exercise Price
-------- ------ ---------------- ----------------- ------ --------------
<S> <C> <C> <C> <C> <C> <C>
$3.00 - 5.00 200,000 $4.24 9.9 98,333 $4.25
$5.00 - 10.00 438,333 7.69 8.3 234,160 8.53
$10.00 - 15.00 241,256 13.03 6.2 206,256 13.07
$15.00 - 28.00 44,000 16.47 7.4 9,000 20.81
------- -------
$3.00 - 28.00 923,589 8.76 8.0 547,749 9.67
============== ======= ====== === ======= ======
</TABLE>
The Company applies Accounting Principles Board Opinion 25 and related
interpretations in accounting for stock option and employee stock purchase
benefit plans. Accordingly, no compensation cost has been recognized in the
Company's consolidated statement of operations for options granted and shares
purchased by employees under the plans. Had compensation cost for the options
granted and the shares of Common Stock issued under the Company's employee stock
purchase plan been determined based on the fair value at the grant dates for
awards under the plan consistent with the method of Financial Accounting
Standards Board Statement 123, the Company's net loss and loss per share amounts
would have been as reflected in the pro-forma amounts indicated below:
1996 1995
---- ----
Net loss $(15,352,162) (8,843,278)
============ ==========
Loss per share $(1.43) (.83)
====== ====
The fair value of the options granted in 1996 and 1995 was estimated using
the Black-Scholes model with the following assumptions for 1996 and 1995:
dividend yield of 0%; expected life of 5 years; volatility of 57% and a
risk-free interest rate of 6%. The effects of applying Financial Accounting
Standards Board Statement No. 123 in this pro-forma disclosure may not be
indicative of future results. Statement 123 does not apply to awards prior to
1995 and additional awards in future years are anticipated.
A stock purchase plan was established in 1991, which is available to all
permanent full-time employees. The Stock Purchase Plan provides for the purchase
of the Company's Common Stock through payroll deductions of up to 3% of an
employee's current compensation. In addition, the Company may make cash
contributions to each employee's stock purchase account in an amount up to 50%
of each payroll deduction credited to the account. The Board of Directors has
authorized 200,000 shares of the Company's Common Stock for issuance under the
Stock Purchase Plan. Under the Stock Purchase Plan, the Company will offer to
sell shares of its Common Stock at the end of each one year period (the
"Purchase Period"), which begins January 1 and ends December 31 of each year.
Shares will be purchased at the lesser of 85% of the fair market value of the
Company's Common Stock on the first or last day of the Purchase Period. There
were 117,075 shares at $2.98 per share purchased in January of 1997 for the 1996
Purchase Period; 98,565 shares at $4.04 per share purchased in January of 1996
for the 1995 Purchase Period; and 33,742 shares at $8.08 per share purchased in
January of 1995 for the 1994 Purchase Period. Under the Stock Purchase Plan, the
Company contributed approximately $117,000, $102,000 and $91,000 for 1996, 1995
and 1994, respectively.
In 1992, the Board of Directors adopted a 401(K) employee savings plan.
Employer contributions are discretionary under the plan. Employer contributions
under the plan were approximately $237,000, $206,000 and $357,000 for 1996, 1995
and 1994, respectively.
- 35 -
<PAGE>
POWERHOUSE TECHNOLOGIES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(continued)
(13) COMMITMENTS AND CONTINGENCIES
During 1996, 1995 and 1994, the Company sold notes receivable from gaming
machine equipment sales, with a face value of $1,466,952, $2,339,710 and
$4,311,874. respectively, to banks and other third parties. The notes are
secured by the underlying equipment. The receivables sold are subject to
recourse provisions in the event of default by the primary obligor. The
outstanding balance of the notes receivable sold with recourse was approximately
$4,678,000 at December 31, 1996. The Company has established reserves for
estimated losses under the recourse provisions. At December 31, 1996, the
Company had guaranteed or pledged security for the indebtedness of others in the
amount of approximately $5,801,000 (including $4,678,000 notes receivable sold
to banks and other third parties).
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 (see Note 15). At December 31, 1996 and 1995, respectively, the
Company had accrued liabilities of approximately $3,115,000 and $2,859,000
representing progress billings and estimated costs to fulfill its obligations to
deliver products and services under certain customer contracts.
The Company is currently conducting a comprehensive review of its computer
systems to identify the systems that could be affected by the "Year 2000" issue
and is developing an implementation plan to resolve 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 way by the roll-over 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 operational 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 December 31, 1996, the Company had collateral in
support of the various bonds outstanding consisting of $3,350,000 of restricted
deposits and $9,500,000 of irrevocable standby letters of credit. Should the
Company fail to meet contractually specified obligations during the contract
term, the lottery authority may assess damages and exercise its right 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 on-line lottery contracts with the Minnesota and Florida
lottery authorities. The negotiations for a new contract with the Minnesota
Lottery have been initiated. The award by the Florida Lottery has been protested
by a competitor. If the award is upheld, the Company will begin negotiations of
a new contract. Sizable capital expenditures in excess of current capital
sources may be required in advance of any anticipated capital generated by the
Florida contract, accordingly, the Company may
- 36 -
<PAGE>
POWERHOUSE TECHNOLOGIES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(continued)
need additional financing, the availability and the terms of which are subject
to various uncertainties, with no assurance that such financing can be obtained.
International sales denominated in foreign currencies accounted for
approximately $16.6 million or 9.8% of the Company's total revenues for the
fiscal year ended December 31, 1996. 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.
The recovery of a significant amount of the Company's investment in the
racetrack operations in New Mexico is largely contingent upon the implementation
of gaming legislation in the state. On March 21 the New Mexico legislature voted
to allow casino gaming at pari-mutuel racetracks in New Mexico, including the
Company's racetrack in Sunland Park, New Mexico. The bill, which is anticipated
to be signed by the state's Governor, allows, among other things, the operation
of up to 300 video 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 state's formation
of a separate commission to oversee the gaming and other regulatory matters
(including the grant of necessary licenses to the Company). Consequently, the
Company does not anticipate that any revenues will be generated from the
approved gaming until late 1997 or early 1998.
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.
As previously reported, a purported class action, alleging violations of
the federal antitrust laws, was filed in June 1994, in the federal district
court in South Dakota against the Company and certain video lottery machine
operators in South Dakota by a group of other video lottery machine operators,
alleging, among other things, a combination and conspiracy to unlawfully
restrain trade in video lottery machines by fixing lease prices for such
machines, allocating territories and refusing to deal with other operators.
Unspecified treble damages were sought, along with injunctive relief to bar the
alleged practices. On November 6, 1996, the court granted the Company's and
other defendants' motion for summary judgment and dismissed, with prejudice, all
claims of the plaintiffs. In December 1996, plaintiffs filed an appeal of this
ruling with the Eighth Circuit of the U. S. Court of Appeals. The Company cannot
predict the outcome of the appeal.
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.
- 37 -
<PAGE>
POWERHOUSE TECHNOLOGIES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(continued)
(14) STOCKHOLDERS' EQUITY
In January 1994, Electronic Data Systems Corporation ("EDS") purchased
545,454 shares of the Company's Common Stock and 1,912,728 shares of Series A
Junior Preferred Stock (Series A Preferred Stock), each at a share price of
$27.50. The Series A Preferred Stock carries dividend rights equal to the
Company's Common Stock, is non-voting, and is convertible to 1,912,728 shares of
Common Stock after ninety days prior written notice (see Note 16).
In February 1994, the Company completed a transaction with an investor
group represented by William Spier, a director of the Company. As a result of
this transaction, the Company repurchased 2,458,182 shares of its Common Stock
at a cash price of, in effect, $26.50 per share.
(15) OTHER CHARGES
A summary of other charges follows:
<TABLE>
<CAPTION>
December 31,
------------------------------------
1996 1995 1994
----------- --------- ----------
<S> <C> <C> <C>
Inventory impairments $18,000,000 550,000 4,099,000
Customer disputes and contract liabilities 8,435,000 1,763,000 2,595,000
Restructuring charges and long-lived assets
and goodwill impairments 7,700,000 450,000 17,300,000
----------- --------- ----------
$34,135,000 2,763,000 23,994,000
=========== ========= ==========
</TABLE>
In 1996 the Company recorded approximately $34,100,000 of special charges
for restructuring costs and asset impairments, consisting of $18,000,000 for
inventory value impairments primarily related to the on-line lottery segment,
$8,435,000 associated with on-line lottery customer disputes and contract
liabilities, $4,600,000 for impairment of intangible and other assets for an
on-line lottery contract and approximately $3,100,000 related to the wagering
systems segment of United Wagering Systems, as discussed in Note 2. The
impairment losses recorded on long-lived assets were measured based on the fair
value of each asset. Fair value was calculated based on the present value of
expected future net cash flows. The $4,600,000 impairment charge related to an
on-line lottery contract that did not meet Company expectations of profitability
levels. The $2,800,000 impairment discussed in Note 2 was a result of the
Company's decision to replace a predecessor model of a wagering systems
terminal. Approximately $21,200,000 of the charges were recorded in the fourth
quarter of 1996, primarily related to the Company's revised strategies and
resulting estimates regarding on-line lottery operations.
In 1996, the Company recorded approximately $31,000,000 of special charges
related to the Company's on-line lottery segment, which consisted of $18,000,00
for inventory reserves and write-downs, $8,400,000 for penalties and contractual
liabilities resulting from customer disputes and $4,600,000 for impairment of
intangible and other assets in connection with an on-line lottery contract.
Approximately $9,800,000 of the charges were recorded in the first nine months
of 1996, $8,000,000 of those charges related to customer disputes stemming from
performance issues with EDS. The remaining $1,800,000 recorded in the first nine
months represented charges for inventory impairments. The $21,200,000 of charges
recorded in the fourth quarter of 1996 primarily related to impairments of
inventories and intangible assets.
During the three-year period ending December 31, 1996, the Company recorded
approximately $22,700,000 of charges representing impairments to on-line lottery
equipment inventories. An aggressive revenue growth strategy in 1994 led the
Company to procure or commit to procure significant levels of inventory in
advance of obtaining a contract to operate an on-line lottery system in the
United Kingdom. The Company was notified in May 1994 that the contract was
awarded to a competitor. In the fourth quarter of 1994, the Company recorded a
$4,100,000 charge representing costs to retrofit inventories related to the
United Kingdom procurement for which there was no other demand in the U. S.
market. The Company
- 38 -
<PAGE>
POWERHOUSE TECHNOLOGIES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(continued)
anticipated demand from a customer in Norway for a portion of such inventories.
The carrying value of inventories related to the on-line lottery segment was
approximately $19,300,000 at December 31, 1994, and the Company believed that
potential market opportunities at that time indicated that such inventory value
would be recovered. In the second quarter of 1995, the Company recorded an
additional $550,000 charge to inventories due to a reduction in estimated demand
by its Norway customer. The carrying value of inventories related to the on-line
lottery segment was approximately $15,900,000 at December 31, 1995, and
potential sales opportunities in various international markets indicated that
the remaining value could be recovered. In the second quarter 1996, the Company
recorded an additional charge of $1,100,000 to inventories for another
identified reduction in demand. In the fourth quarter of 1996, the Company
determined that the remaining inventory related to the United Kingdom
procurement had no remaining market value and charged to expense approximately
$10,400,000. At December 31, 1996, inventories related to the on-line lottery
segment had a carrying value of approximately $2,900,000.
The Company's domestic growth strategy led to the contracts being awarded
to the Company by the Arizona and Kentucky lottery authorities during 1995. The
Arizona lottery system was implemented in late 1995. However, due to a number of
factors, including a short development and installation period, the lottery
system had a number of deficiencies that contributed to the early termination of
the contract by the Arizona Lottery in 1996. The Company recognized an
impairment charge of $4,000,000 on equipment inventory to reduce the carrying
value to net realizable value for used equipment. Also in 1996, the Company and
the Kentucky Lottery agreed to terminate efforts to finalize a contract. The
Company incurred approximately $2,500,000 that was charged to expense as a
result of the agreement.
The United Kingdom, Arizona and Kentucky on-line inventory which the
Company had planned to place in service to perform specific contracts was
reviewed in light of existing market conditions and written down to its market
value. Following these charges and write-offs attributable to unsuccessful
business ventures, the Company revised its international strategy from selling
long-term service agreements to one of selling on-line lottery equipment and
licensing technology to use the equipment to partners who would operate the
lottery system. While this strategy may result in lower revenues, costs of sales
and operating profits, it is considered by management to be a more effective
growth strategy.
Domestically, the Company has adopted a strategy of selectively bidding
opportunities where the customer requirements best fit with the Company's
products and services. There can be no assurance that these revised strategies
will be successful. In 1995, the Company recorded approximately $2,500,000 of
other charges associated with exit costs and asset impairments related to four
on-line lottery contracts.
In 1995, the Company recorded approximately $2,763,000 of special and other
unusual charges associated with exit costs and charges and asset impairments
related to five contracts. In the second quarter of 1995, the Company determined
that continuing to expend capital resources on certain domestic and
international contract prospects was not in the best interests of the Company
and, to terminate such activities, recorded the necessary charges to write down
applicable investments in long-lived assets to fair value and to record
estimated liabilities. Approximately $2,500,000 of such charges were related to
the on-line lottery segment and $263,000 were related to the wagering systems
segment.
In the fourth quarter 1994, the Company revised its international and
domestic operations strategies. The revision of the international operations to
a strategy of alliances in selective markets and developments in the
international market place resulted in a special charge of $6,694,000
representing reserves and write-offs for inventory of $4,099,000 and write-offs
and accruals of foreign contract investments and commitments of $2,595,000. In
addition to the $6,694,000 of charges, the Company recorded an impairment charge
of approximately $17,300,000 related to the goodwill attributable to the
acquisition of UWS. (See Note 2.) Events and circumstances discussed in Note 2
indicated that the goodwill was not recoverable. Accordingly, the impairment of
goodwill was determined using the present value of estimated future operating
cash flows of the wagering systems segment. The Company adopted Statement of
Financial Accounting Standards No. 121 (SFAS No. 121) in the second quarter of
1995. Accordingly, impairments of long-lived assets recorded
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<PAGE>
POWERHOUSE TECHNOLOGIES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(continued)
subsequent to the adoption of SFAS No. 121 were based on the fair value of such
assets measured as the present value of expected future net cash flows after a
determination that the undiscounted net cash flows were less than the carrying
value thereof.
In addition to the restructuring charges discussed above, the Company's
1994 consolidated statement of operations includes approximately $3,115,000 of
unusual reserves and write-offs recorded in the fourth quarter 1994. Included in
the amount is approximately $1,000,000 of inventory adjustments which resulted
from the Company's reevaluation of future customer needs and product
obsolescence, $450,000 for severance charges, $1,025,000 for estimated
settlements of disputed obligations and $640,000 for write-down of intangible
assets.
(16) EDS RELATIONSHIP/SUBSEQUENT EVENT
In conjunction with the stock sale to EDS in 1994 as discussed in Note 14,
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 the
lottery services subsidiary's on-line lottery contracts. In 1996, the Company
withheld certain payments to EDS primarily 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 $13,280,000 for the Company. The terms of the settlement
include the receipt by the Company of all of the common and preferred shares
owned by EDS (545,454 common and 1,912,728 preferred shares) certain property,
plant and equipment used in the provision of EDS services to on-line lottery
customers and the extinguishment of approximately $38,000,000 of outstanding
fees in return for a $26,100,000 note payable. The note payable calls for
interest payments only for the first two years and principal and interest
payments in years three through seven (maturity). The note is secured by the
2,458,182 shares of redeemed Common and 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
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<PAGE>
POWERHOUSE TECHNOLOGIES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(continued)
or certain of its subsidiaries. The transition of the EDS services and related
employees to the Company is anticipated to be completed in the second quarter of
1997. The following schedule reflects pro-forma amounts as if the settlement had
occurred at December 31, 1996:
<TABLE>
<CAPTION>
December 31, Settlement/Extra- December 31,
1996 Reported ordinary Gain, Net 1996, Pro-forma
------------- ------------------ ---------------
<S> <C> <C> <C>
Current assets $ 66,232,251 (3,470,000) 62,762,251
Non-current assets 101,810,505 2,700,000 104,510,505
------------ ----------- -----------
Total assets $168,042,756 (770,000) 167,272,756
============ =========== ===========
Current liabilities $ 38,147,915 7,000,000 45,147,915
Non-current liabilities 57,663,381 (11,950,000) 45,713,381
------------ ----------- -----------
Total liabilities 95,811,296 (4,950,000) 90,861,296
------------ ----------- -----------
Stockholders equity
exclusive of accumulated deficit 97,475,260 (9,100,000) 88,375,260
Accumulated deficit (25,243,800) 13,280,000 (11,963,800)
------------ ----------- -----------
Stockholders' equity 72,231,460 4,180,000 76,411,460
------------ ----------- -----------
Total liabilities and equity $168,042,756 (770,000) 167,272,756
============ =========== ===========
Shares outstanding:
Common 10,829,184 (545,454) 10,283,730
Preferred 1,912,728 (1,912,728) ---
============ ========== =================
</TABLE>
The Company paid or accrued approximately $81,600,000, $70,300,000 and
$69,400,000 to EDS for costs and expenses in 1996, 1995 and 1994, respectively.
Of those costs and expenses approximately $5,087,000 (net of $4,600,00
impairment charge discussed in Note 15), $2,675,000 and $4,406,000 were
capitalized primarily in conjunction with software development and deferred
start-up costs in 1996, 1995 and 1994, respectively. Included in trade accounts
payable are current balances due to EDS of approximately $1,200,000 and
$10,682,000 at December 31, 1996 and 1995, respectively.
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<PAGE>
POWERHOUSE TECHNOLOGIES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(continued)
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) 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: February 8, 1998 /s/ SUSAN J. CARSTENSEN
--------------------------------------------
Susan J. Carstensen, Chief Financial Officer
(authorized to sign on behalf of Registrant
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