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SECURITIES AND EXCHANGE COMMISSION
Washington, D. C. 20549
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FORM 10-K
(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, 1998 or
Transition Report pursuant to Section 13 or 15(d) of the Securities
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Exchange Act of 1934 for the transition period from to
Commission file number 0-19322
POWERHOUSE TECHNOLOGIES, INC.
(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) entification No.)
115 Perimeter Place, Suite 911
Atlanta, Georgia 30346
(Address of principal executive offices) (Zip Code)
(770) 481-1800
(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, 1999, was approximately $156,688,000 (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, 1999, was 10,622,958.
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TABLE OF CONTENTS
PART I
Page
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ITEM 1. Business 3
ITEM 2. Properties 29
ITEM 3. Legal Proceedings 29
ITEM 4. Submission of Matters to a Vote of Security Holders 29
PART II
ITEM 5. Market for Registrant's Common Equity
and Related Stockholder Matters 30
ITEM 6. Selected Financial Data 31
ITEM 7. Management's Discussion and Analysis of Financial
Condition and Results of Operations 33
ITEM 7a. Quantitative and Qualitative Disclosures About Market Risk 42
ITEM 8. Financial Statements and Supplementary Data 42
ITEM 9. Changes in and Disagreements with Accountants
on Accounting and Financial Disclosure 63
PART III
ITEM 10. Directors and Executive Officers of the Registrant 63
ITEM 11. Executive Compensation 66
ITEM 12. Security Ownership of Certain Beneficial
Owners and Management 70
ITEM 13. Certain Relationships and Related Transactions 71
PART IV
ITEM 14. Exhibits, Financial Statement Schedules,
and Reports on Form 8-K 72
Signatures 74
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PART I
ITEM 1. BUSINESS
Powerhouse Technologies, Inc. (the "Company") was incorporated in Delaware
in May 1991. The Company acts as a holding company for several active
corporations. Unless the context otherwise requires, references in the form 10-K
for fiscal year ended December 31, 1998 ("Form 10-K") to the "Company" or "PTI"
refer to Powerhouse Technologies, Inc. and its subsidiaries; references to "AWI"
refer to Automated Wagering International, Inc., one of the Company's four
principal operating subsidiaries, which provides on-line lottery systems and
services primarily to governmental lottery authorities; references to "VLC"
refer to VLC, Inc., another of the Company's principal operating subsidiaries,
which develops, manufactures and markets video lottery and casino gaming
machines and central control systems; references to "United Tote" refer to the
Company's third principal operating segment whose operating units provide
computerized pari-mutuel wagering systems for horse and greyhound racetracks,
off-track betting facilities and jai alai frontons. References to "Sunland Park"
mean Nuevo Sol Turf Club, Inc., the Company's fourth principal operating
subsidiary which owns and operates a racetrack facility in Sunland Park, New
Mexico. References to the "Subsidiaries" refer to AWI, VLC, United Tote, Sunland
Park and the other subsidiaries of the Company. The Company's principal
executive offices are located at 115 Perimeter Place, Suite 911, Atlanta,
Georgia 30346, and its telephone number is (770) 481-1800.
Note on Forward-looking Statements
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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 laws and
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.
Certain Recent Developments
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On March 10, 1999 the Company, Anchor Gaming ("Parent") and Anchor
Powerhouse Acquisition Corporation, a wholly-owned subsidiary of Parent ("Merger
Sub") announced that they had entered into a definitive Agreement and Plan of
Merger (the "Merger Agreement") providing for, among other things, the merger of
the Merger Sub with and into the Company, with the Company thereupon becoming a
wholly-owned subsidiary of Parent (the "Merger"). The Merger has been approved
by the Boards of Directors of the Company, Parent and Merger Sub.
Pursuant to the Merger Agreement, each outstanding share of common stock,
par value of $.01 per share, of the Company will be converted into the right to
receive cash in the amount of $19.50.
The transaction is expected to be completed in the third quarter 1999. It
is subject to customary conditions, including the absence of any adverse
material changes to the finances of the Company between signing and closing of
the merger, clearance under the Hart-Scott-Rodino Antitrust Improvements Act and
the grant of permits or approvals in some key jurisdictions in which the Company
operates. The Merger is also subject to approval by the Company's stockholders.
In connection with the Merger Agreement, directors and executive officers
of the Company have entered into or agreed to enter into voting agreements with
Parent (each a "Voting Agreement") pursuant to which such directors and
officers, among other things, have agreed to vote an aggregate of approximately
4.4% of the Company's outstanding shares in favor of the Merger.
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On February 22, 1999, the Company opened its casino at the Sunland Park
Racetrack & Casino in New Mexico.
In March 1999, the Company announced that AWI and the Lottery had
renegotiated and signed an amended contract under which AWI will provide an
on-line lottery system and related services to the Florida Lottery. A decision
by the Lottery not to join the multi-state game Powerball(R) necessitated the
renegotiation of the contract entered into in October 1998. Under the amended
contract, the Company will design, install and operate a new statewide on-line
lottery system for an initial term of five years and three months, with two,
two-year renewal options. The Company estimates that revenues from the contract
over the initial 63-month period will be approximately $200 million. AWI will be
compensated at a base rate of on-line sales, and, if on-line ticket sales exceed
targeted amounts, an additional incentive rate. The October 1998 contract
between AWI and the Department of Lottery of the State of Florida was for a
nine-year term. The Lottery had originally awarded the contract to AWI in
October 1996 after a competitive procurement process in which the Lottery's
evaluation committee judged AWI the most highly qualified vendor based on its
superior technology and lower cost. Subsequent to the announcement of the
contract award in 1996, the losing vendor filed two consecutive protests, both
of which were rejected, resulting in a final order from the Lottery awarding the
contract to AWI in March 1998. A further attempt by the losing vendor to enjoin
the contract was rejected by the Florida district court, allowing the parties to
negotiate and finalize the terms of the nine-year agreement.
In January 1999, the Company announced the formal adoption of a corporate
responsible gaming policy and program at the December meeting of its Board of
Directors in Las Vegas. As a matter of policy, the Company has actively
committed to promote responsible gaming with its employees, customers and the
public as well as support those agencies and programs dedicated to researching,
preventing and treating problem gambling.
In January 1999, VLC received an order to provide 1,000 gaming machines to
Tattersall's Gaming Pty. Ltd., Australia. Total revenue over the life of the
contract is estimated to be approximately $8.7 million. Initially, 250 machines
are scheduled to be delivered in the third quarter of 1999. The final 750
machines will be delivered in early 2000, and are subject to agreed performance
criteria.
In December 1998, AWI was selected by the Swiss Sport-Toto Gesellschaft (on
behalf of the Switzerland consortium Gesellschaft Schweizer Zahlenlotto) to
provide a MasterLink(TM) on-line lottery system. The single system will run
three state-sanctioned regional lotteries and one national sports lottery in
Switzerland. Final contract negotiations on the project scope and specific
services are anticipated to be completed in the second quarter 1999. The Company
estimates that the software order will generate a minimum of $7 million of
revenue. Implementation is scheduled to be completed in 2000. In the first
phase, AWI's MasterLink(TM) system will run on-line lotto games, data management
and Internet gaming and, in a further phase, instant ticket game accounting for
the involved lotteries, interfacing with 3,750 on-line terminals and several
thousand instant ticket terminals throughout Switzerland. The program will
incorporate new PC-based touchscreen terminals manufactured by Siemens Nixdorf
Retail and Banking Systems GmbH, Paderborn, Germany. The Lottery Solutions
Division of Siemens Nixdorf in Konstanz, Germany, will develop the interface to
the MasterLink(TM) system, in a joint effort with AWI.
In November 1998, the Company was selected by the South Dakota Lottery to
provide both the on-line lottery and video lottery central systems and services.
In March 1999, the Company and the South Dakota Lottery entered into the new
contract for an initial term of seven years, with extension options for up to an
additional three years. The new contract will continue the Company's nine-year
relationship with the South Dakota Lottery. AWI has been the on-line system
supplier for the South Dakota Lottery since the inception of the state's on-line
games in 1990. VLC supplied the world's first video lottery central control
system to South Dakota in 1989, which will now be replaced with the Company's
new, next-generation Advanced Gaming System. In addition, VLC has sold 7,500
video lottery gaming machines to licensed operators and locations in South
Dakota since 1989.
In October 1998, AWI was selected by the Hoosier Lottery to provide a new
on-line lottery system and related services for the state of Indiana. The
decision by the Lottery was the result of a competitive procurement in which
several companies participated. In January 1999, AWI signed a contract with the
Hoosier Lottery of the State of Indiana to provide the on-line lottery system,
terminals and system
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operation for seven years with extension options for up to an additional three
years. Revenues from the initial seven-year contract are estimated to exceed $80
million. AWI will install its MasterLink(TM) Advanced Gaming System along with
approximately 4,000 lottery retailer terminals. The scheduled date for
completion of the conversion to the new AWI system from the Lottery's current
vendor is August 29, 1999.
In June 1998, the Company announced that its gaming machine division, VLC,
had signed a letter-of-intent which resulted in a contract to provide its
Advanced Gaming System (TM) (AGS) central control system and 4,300 site
controllers to Quebec, Canada-based CASILOC Inc. for the monitoring and control
of 15,000 machines operated by La Societe des Loteries Video du Quebec Inc.
(SLVQ).
In May 1998, the Company announced that AWI had signed a contract with the
Pennsylvania Lottery to provide an on-line system and related services for seven
years through December 2005, with extension options for up to an additional
three years. Revenues from the contract are estimated at $276 million for the
initial seven years. The new agreement continues AWI's 21-year relationship with
Pennsylvania as its on-line lottery system supplier. The Pennsylvania Lottery
announced the contract award in November 1997 after a competitive bidding
process in which the Pennsylvania Lottery review committee ranked AWI's proposal
superior.
Business of the Company
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Powerhouse Technologies, Inc.
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Powerhouse is a diversified technology and entertainment company that
develops, supplies, and operates lottery, gaming and pari-mutuel wagering
systems and equipment worldwide. The Company conducts its operations primarily
through three technology divisions and one operations division: lottery systems
(AWI), gaming machines and systems (VLC), pari-mutuel systems (United Tote) and
gaming operations (Sunland Park and route operations). The Company's primary
markets for its broad product line include the on-line lottery, video lottery,
casino gaming and pari-mutuel wagering markets.
The following table depicts the operating segments and recognized
subsidiaries of the Company:
Lottery systems -- Automated Wagering International, Inc. (AWI)
Gaming machines and systems -- VLC, Inc. (VLC)
VLC of Nevada, Inc.
Pari-mutuel systems -- United Tote Company
United Tote Canada
Gaming operations -- Nuevo Sol Turf Club, Inc. (d/b/a Sunland
Park Racetrack & Casino)
Route operations (Raven's D & R Music, Inc.,
Automation First, Inc. and Automatic
Music Service of Billings, Inc.)
Lottery Systems -- AWI
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AWI develops, manufactures, installs and operates on-line computer-based
systems and presently operates lottery systems for seven state lotteries. A
lottery system consists of terminals located in numerous retail outlets, a
telecommunications network, a central computer system and communications
equipment software as well as the software to operate the system and process
sales and validation of lottery game tickets. In the United States, AWI's
products and services are typically marketed to lottery authorities through
long-term contracts, awarded through a competitive bidding process. AWI
typically maintains ownership of the lottery system and operates it for the
state in return for a percentage of lottery ticket sales. In foreign
jurisdictions, lottery equipment and systems are often sold and related software
is licensed to lottery authorities. Internationally, AWI has sold to and
currently supports and/or maintains lottery systems for customers in Canada,
Chile and Norway. The Company has also recently been awarded contracts in
Switzerland and Vietnam. Delivery to Vietnam began in the fourth quarter 1998.
Governments in approximately 80 countries have authorized lottery games,
such as lotto, numbers and keno as well as instant "scratch-off" games,
primarily as a means of generating non-tax
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revenues. In the United States, lottery revenues are frequently designated for
particular purposes, such as education, economic development, conservation,
transportation and aid to the elderly. Many states have become increasingly
dependent on their lotteries, as revenues from lottery ticket sales have become
a significant source of funding for designated programs. In fiscal 1970, only
two states had authorized traditional lotteries, selling an aggregate of $49.2
million in tickets. As of the end of 1998, 38 jurisdictions in the United States
were operating lottery systems, with aggregate lottery sales in excess of $35
billion. Worldwide lottery sales, excluding North America, exceeded $81 billion
in 1997.
There are many types of government-authorized lotteries in the world. The
Company categorizes traditional (as opposed to video) lottery systems into two
principal groups: "on-line" and "off-line."
An on-line lottery system is generally used to conduct games such as lotto,
sports pools, daily numbers and keno in which lottery players make their own
selections. Various games of chance are offered involving the selection of
numbers from a field of possible numbers. A lottery player requests the desired
numbers and purchases the lottery ticket from the clerk-activated terminal
provided by the Company or other lottery vendor to a lottery ticket retailer.
The amount wagered, also commonly referred to as "handle", per transaction is
determined by individual lottery authorities and is usually $.50 to $1.00 per
wager. The lottery terminals are typically located in high-traffic retail
outlets, such as newsstands, convenience stores, gas stations, food stores,
tobacco shops and liquor stores, which are selected by the lottery authorities
to sell tickets on the lottery authority's behalf. The data is entered either
manually by keyboard or automatically through a mark sense reader or scanner.
The wager information is then transmitted via communication lines to the central
computer system where the information is verified, recorded and stored. Winners
are able to claim their prizes within minutes of the drawing of the winning
number for the game selected.
Off-line lotteries feature games which are not computerized and typically
feature instant ticket games in which players remove coatings from pre-printed
tickets ("scratchers"), which account for substantially all of the off-line
lottery sales in the United States. Outside of the United States, off-line
lotteries may also include traditional games (numbers, lotto, etc.) which are
offered through a manual, off-line system. Players' selections are accumulated
and delivered to a central processing location where the bets are entered into
the computer. Many foreign countries have government-operated or privately
licensed lotteries. Over 200 lotteries are operating worldwide.
There are several advantages to on-line lotteries as compared to off-line
lotteries. Most importantly, wagers can be accepted and processed by an on-line
lottery system until minutes before a drawing. In cases where a large prize has
attracted substantial wagering interest, the extended sales period increases the
potential for higher lottery revenue. Unlike instant games or scratchers, where
the number of winning tickets and amount of awards must be determined in
advance, on-line lotteries allow for the rollover of lottery jackpots. In
addition, on-line lottery systems provide greater reliability and security than
either off-line numbers games or scratchers, allow a wider variety of games to
be offered, and automate accounting and administrative procedures which are
otherwise performed manually. Instant ticket game revenues have been growing at
a faster rate than total domestic U. S. lottery revenues because of relatively
higher payout percentages and the increasing automation of instant ticket
validation and accounting systems. Such games compete with the on-line games
provided by the Company's systems.
Typically 50% of the gross handle of a domestic lottery is returned to the
players in the form of prizes. Approximately 15% is used to fund the operations
of the lottery, including the expenses of the lottery authority, costs of
advertising, payments to point-of-purchase retailers and payments to vendors
such as AWI. The remaining amount, approximately 35%, is available to the state
to support specific public programs or as a contribution to the state's general
fund.
In the United States, products and services are typically marketed to
lottery authorities through long-term contracts, awarded through a competitive
bidding process pursuant to which the vendor supplies, installs and operates the
lottery system for the state or jurisdiction in return for a percentage of
ticket sales. The vendor typically retains title to the lottery system. Once a
contract is awarded to a lottery vendor, that vendor is typically the sole
provider of on-line lottery services and operations to that jurisdiction for a
specified time period within a defined geographic territory.
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The international market, as well as a minority of United States
jurisdictions, is typically characterized by lottery system sales in addition to
long-term contracts. The Company or other vendor develops and installs the
lottery system and trains lottery personnel in the operation of the system for a
fixed or fixed plus percentage of handle fee. Other add-on services, such as
system enhancements, equipment maintenance and ticket stock production, may be
available under separate contracts.
United States. AWI derives revenue primarily from contracts with state
lottery organizations throughout the United States. Revenue consists primarily
of a contractual percentage of lottery ticket sales in each state as well as
revenue from installation and sales of on-line lottery systems and equipment.
The segment experiences fluctuations in revenue levels depending on relative
sizes of jackpots, the number of terminals on-line and the volume of tickets
sold in the states in which the Company operates. The table below sets forth the
lottery authorities in the United States with which AWI presently has lottery
contracts. The table also sets forth information regarding the term of each
contract and, as of December 31, 1998, the approximate number of retail
terminals installed in each jurisdiction, and the revenues generated by the
lottery operations.
<TABLE>
<CAPTION>
Selling Total On-Line
Date of Com- Expiration Lottery Terminals Lottery Authority
mencement Date of Authority Operating at Revenues
of Current Current Extension December 31, in 1998
Jurisdiction Contract Contract(1) Options 1998 (in millions)(2)
------------ ------------ ----------- --------- ------------ ------------------
<S> <C> <C> <C> <C> <C>
Delaware 10/1994 9/2002 --- 333 $514
Florida(3) 10/1999 6/2004 2 two-year 8,159 1,394
Indiana(4) 8/1999 8/2006 3 one-year --- 578
Maryland 7/1996 7/2001 1 three-year plus 4,130 1,053
2 one-year
Minnesota 8/1997 8/2002 5 one-year 1,981 131
Montana 11/1996 3/1999 --- 360 31
Pennsylvania(5) 1/1999 12/2006 3 one-year 5,138 1,201
South Dakota(6) 8/1999 8/2006 --- 360 14
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</TABLE>
(1) Expiration dates do not reflect the exercise of the lottery authorities'
extension options.
(2) Figures are provided for each state for calendar year except for Indiana
reported amounts from fiscal year ended June 30, 1997.
(3) The Florida State Lottery accounted for 15% of consolidated revenue during
1998. In March 1999, the Department of Lottery of the State of Florida
renegotiated and signed an amended contract for on-line lottery system and
related services whereby the Company will design, install and operate a new
statewide on-line lottery system for five years and three months, with two,
two-year renewal options.
(4) In January 1999, the Company signed the contract with the Hoosier Lottery
of the State of Indiana to provide an on-line lottery system, terminals and
system operation for seven years with extension options for up to an
additional three years. The scheduled date for completion of the conversion
to the new AWI system from the Lottery's current vendor is August 29, 1999.
(5) The Pennsylvania State Lottery has awarded AWI a new seven-year contract
commencing January 1999 to continue operating Pennsylvania's lottery
system. The Pennsylvania State Lottery accounted for 11% of consolidated
revenues during 1998.
(6) In November 1998, the Company was awarded a new contract, replacing the
current contract which expires in May 1999, for both on-line and video
gaming system applications with implementation expected to begin in August
1999 with completion by June 2000. The new contract is for a seven-year
term ending August 2006.
Facility Management Contracts. All of AWI's current domestic lottery
contracts are facilities management contracts under which AWI installs, operates
and maintains a lottery network while retaining ownership or control of the
lottery terminal network. The facilities management contracts may have an
initial term of approximately five to nine years, and generally contain one or
more options permitting the lottery authority to extend the initial contract
term for additional periods. Prior to the expiration of the initial or extended
term, a lottery authority is generally required by law to commence a competitive
bidding
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process for a new lottery contract. There can be no assurance that AWI will win
a new contract in connection with this process.
AWI installs and commences operations of a lottery network generally within
six to twelve months after being awarded a new lottery contract and, following
the start-up of the lottery network, is responsible for all aspects of the
network's operations. AWI operates lottery systems in each jurisdiction with two
or more central computer systems. In addition, AWI employs a dedicated work
force in each jurisdiction, consisting of a site manager, computer and hotline
operators, customer service and terminal replacement and repair technicians. The
equipment used in any jurisdiction must typically comply with specifications
established by that jurisdiction. New contracts typically require new equipment
of recent manufacture. The equipment and related implementation costs are
depreciated over the term of the related contract, including extensions upon
their exercise by the lottery authority. Under certain of AWI's facility
management contracts, the lottery authority has the option to purchase AWI's
lottery system during the contract term at a predetermined price. AWI's role
with respect to the continued operation of a lottery system in the event of the
exercise of such purchase option is defined as part of the purchase option with
fees and services included with the original bid. Exercise of such an option
could substantially change the anticipated profitability of the contract to AWI.
Under many of AWI's facilities management contracts, the lottery authority
has the option to require AWI to install additional terminals and/or add new
lottery games. Such installation may require significant capital expenditures by
AWI. However, since AWI's revenues from such contracts generally depend on the
level of lottery ticket sales, and such sales are generally increased by the
addition of new retail outlets and games, such expenditures have generally been
recovered through the revenues generated by the additional equipment or games
and revenues from existing equipment, although there is no assurance this will
continue to be the case. The potential additional terminals and new games are
agreed to in the bidding process and as such are taken into consideration when
determining the vendor's fee in the original bid.
AWI's contracts with the state lotteries contain provisions for assertion
of liquidated damages against AWI for failure to meet certain performance
standards. These conditions include aggressive implementation schedules and
ongoing performance standards and failure to perform may result in substantial
monetary liquidated damages, as well as contract termination. Liquidated damages
ranging from $5,000 to $250,000 per day for late system start-up and from $1,000
to $15,000 per minute for system downtime beyond a stipulated grace period are
common to the domestic market. Although the actual liquidated damages imposed
can be subject to negotiation, such provisions present an ongoing potential for
substantial expense. Damages, if assessed, are usually due within 30 days or may
be deducted from revenues otherwise earned from the lottery. Failure to repair
terminals within a specified time period may subject AWI to damages. The Company
maintains errors and omissions coverage under risk management policies which
would cover certain but not all claims.
Various state on-line lottery contracts contain provisions under which AWI
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. Penalties paid or accrued by AWI
with respect to its contracts were approximately 0.3% of its revenues in 1998,
1.3% in 1997 and 3.9% in 1996.
Typically, state lottery contracts also reserve the right to terminate the
contract for cause (i.e., failure of the vendor to substantially perform any
material requirement) after notice and a cure period. The state also reserves
the right to cancel a contract if the state enacts a statute which removes the
authority or ability of the state to conduct a lottery. In general, a state may
also terminate a contract without cause or for the convenience of the lottery,
typically with at least 12 months prior written notice. Reasonable costs,
excluding anticipatory profits, will be reimbursed to the vender for all
terminations except for a material breach.
In addition to potentially significant capital requirements to manufacture
and install lottery systems, lottery contracts generally require the vendor to
post a substantial bond securing its performance. The terms of such bonds may
require significant collateral in the form of cash, cash equivalents or lines of
credit.
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Products and Services. In 1971, AWI designed and installed, for the New
Jersey State Lottery, the country's first on-line lottery system. Since that
time, AWI has developed and installed many system and service features that have
subsequently become common in the lottery industry, such as the internal control
system, down-line loading for terminals, the cathode ray tube terminal operator
display, microfiche data storage for lottery records, instant game accounting
and integrated computerized terminal maintenance control.
In September 1993, the Company introduced its MasterLink(R) system and
successfully implemented it on a customer's system in January 1994. Since that
time, the Company has implemented eight enhanced versions. The implemented
MasterLink(R) system is designed to manage an organization's on-line lottery
system and in some jurisdictions its video lottery program as well. A system
could include teller-activated lottery ticket terminals, video lottery gaming
machines, player-activated sports betting terminals, instant ticket vending
machines and/or other electronic gaming-related devices. The MasterLink(R)
system allows an organization to monitor the status and performance of the
equipment within its jurisdiction, conduct accounting of and billing on the
revenue from the gaming machines, and control their configuration and
operations. The MasterLink(R) system is intended to be a flexible,
cost-effective means of providing these capabilities.
The lottery system marketed by AWI consists of the following principal
elements:
- Terminals. AWI designs and manufactures the terminals used in system
networks. The terminals are designed for maximum security, minimum
processing time and flexibility to allow for customization of application
functions to each lottery's specifications.
- Software. AWI designs and provides all application software for its
lottery systems. AWI's software is designed to provide the following
network characteristics: rapid processing, storage and retrieval of
transaction data in high volumes; the ability to down-line load, i.e., to
reprogram the lottery terminals from the central computer installation via
the communications network to add new games and feature a high degree of
security and redundancy to guard against unauthorized access and tampering
and to ensure continued operations without data loss; and a comprehensive
management information and control system.
- Central Computers. Each of AWI's lottery systems contains one or more
central computer installations to which the lottery terminals are
connected. AWI's prior generation central control system is designed to run
on the Cyber 930, but the MasterLink(R) product is designed to run on
UNIX-based central computer systems such as IBM RS/6000 systems, instead of
the proprietary Cyber-series computers. The specifications for the
configuration of AWI's central computer installations are designed to
provide continuous availability, high data handling capability and maximum
security.
- Communications. AWI's lottery terminals are typically connected to
central computers by dedicated telephone lines owned or leased by the
jurisdiction in which the network is located in conjunction with
proprietary network communications controllers and are monitored by a
proprietary network management system. Due to the varying nature of
telecommunications services available in lottery jurisdictions, AWI has
developed the capability to interface with a wide range of communications
networks. AWI also has the expertise to provide and integrate alternate
technologies, such as microwave and radio transmission, integrated services
digital networking (ISDN) and data over voice.
- Game Design. An important factor in maintaining and increasing public
interest in lottery games is innovation in game design. The principal
variables of game design include frequency of drawing, types of prizes,
cost per play and setting of appropriate odds. The Company's
MasterLink(R)system and Ovation(TM)line of terminals are designed to
efficiently permit the development and rapid deployment of new games and
targeted on-line game-related promotions. For example, in 1996 the Company
introduced its keno module in Maryland, where keno accounts for over 20% of
total handle. The Company believes that these capabilities will enhance the
ability of the lottery authority to increase on-line ticket sales, and
result in more revenue for the Company. These
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<PAGE>
capabilities may also enhance the Company's success rate in competing for
domestic lottery contracts. There can be no assurance, however, that either
will happen.
Competition. Competition is intense in the traditional on-line lottery
business. It is not unusual in the United States for contract awards to be
challenged by unsuccessful vendors. Relatively few new or rebid on-line
contracts are awarded each year. Although price is a significant competitive
factor, other important competitive factors include the ability to optimize
lottery revenues through game design; customer marketing support; the
dependability, security, technological sophistication and upgrade capability of
the network; and the experience and reputation of the vendor.
AWI's principal competitor in the on-line lottery business, GTECH, is
significantly larger, currently supplying lottery systems to 27 of the 38 United
States on-line lottery jurisdictions. GTECH also has a substantial international
presence. The market dominance of this competitor further enhances its
competitive position. Other competitors include International Lottery and
Totalizer Systems, Inc., Scientific Games, Inc., Autotote Corporation,
International des Jeux (Lotto France), EssNet/Alcatel and several other
companies.
In jurisdictions with both on-line and video lottery gaming products, the
products may compete with each other for entertainment dollars spent on
wagering.
Gaming Machines and Systems -- VLC
- ----------------------------------
VLC develops, manufactures and markets video gaming machines, central
control systems and related services for the gaming machine industry. The gaming
machine industry includes both video lottery and casino gaming venues. Video
lottery gaming is the use of video gaming machines to provide low stakes gaming
entertainment to enhance revenue for states and other jurisdictions. The
machines, offering games, including poker, blackjack, bingo and keno, as well as
spinning reel games, are generally located in age-controlled establishments such
as bars, taverns, restaurants and convenience stores. The gaming machine
industry is subject to governmental regulation and taxation and, depending on
the jurisdiction, may be monitored and controlled by a central computer system.
Video lottery gaming programs provide substantial incremental sources of revenue
to the governmental jurisdictions without increasing general taxation.
VLC also sells its video gaming machines to land-based, riverboat and
Native American casinos. The Company holds licenses to sell gaming machines in
numerous jurisdictions, including Nevada, Mississippi and New Jersey, the three
largest casino markets in the U. S., as well as in most other major North
American casino jurisdictions.
Currently nine U. S. states (Delaware, Louisiana, Montana, New Mexico,
Oregon, South Dakota, Rhode Island, South Carolina and West Virginia), five
states in Australia, eight Canadian provinces, Iceland, Norway, Sweden and South
Africa have authorized various levels and forms of video lottery gaming. While
there can be no assurance that other jurisdictions will introduce video lottery
systems or that existing jurisdictions will continue operations, based on its
current market share, VLC expects to continue as a significant supplier of
machines and central control systems to this segment of the industry.
The video lottery gaming market is different from the casino market and the
traditional lottery market. Unlike video gaming machines designed for the casino
market, most video lottery gaming machines are located in places where gaming is
not the principal attraction (i.e., bars and restaurants). The stakes on video
lottery gaming machines typically range from $0.25 to $2.50 per play, and
payoffs typically are capped at $100 to $1,000. In addition, in most
jurisdictions, the payment of jackpots differs as compared to traditional gaming
machines. After inserting money into a video lottery gaming machine, the player
receives credits to play the machine. Player losses are deducted from the
credits and winnings are added to the credit, instead of any coins being dropped
into a tray. When the player is finished, the video lottery gaming machine
prints out a ticket showing the remaining amount of credit. The ticket is
redeemable for cash at the establishment's register. Recently, some video
lottery jurisdictions, like Delaware, have moved into the more traditional
casino environment with state-owned gaming machines at pari-mutuel facilities
(primarily racetracks). The machines in these locations pay out in coins from a
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<PAGE>
hopper. Video lottery offers players a payback percentage of 80% to 96%, which
is lower than most traditional casino games, but greater than traditional state
lotteries where payback is typically about 50%.
There are two basic ownership structures in jurisdictions in which video
lottery gaming is implemented:
(1) Private sector ownership - The gaming machines may be owned either by
the owners of the establishments in which the gaming machines are placed or
by the operators/distributors of coin-operated machine routes who contract
with location owners to install, service and maintain the gaming machines.
This private sector ownership structure has been adopted in Montana, New
Mexico, South Carolina, South Dakota, Louisiana, West Virginia, New
Brunswick, Prince Edward Island, Victoria and South Australia.
(2) Government sector ownership - This form of ownership is effective in
the Canadian provinces of Alberta, Saskatchewan, Newfoundland, Nova Scotia
and Quebec and in Northern Territory, Australia. In Oregon, the government
has leased and purchased gaming machines. In Delaware and Rhode Island, the
contractor shares in the revenue stream with the state while maintaining
ownership.
In 1996 and 1997 certain jurisdictions, most notably Louisiana and Alberta,
Canada, allowed voters to decide on the continued operation of video lottery
locations and casinos in their cities and counties. In Louisiana, voters in
approximately one-half of the state's parishes (counties) voted to ban video
lottery operations. Existing locations in these parishes will be allowed to
operate until June 30, 1999 before the machines must be removed. In Alberta, one
city voted in 1997 to ban video gaming machines, and voters there gave the local
casino seven days to remove machines. The machines are still operating pending
appeal. Alberta communities across the province held a vote in October 1998 that
resulted in only a few small communities voting to remove approximately 150
gaming machines with Calgary and Edmonton voting to retain video lottery.
The approval of gaming in new land-based casino jurisdictions, riverboat
gaming, Native American casino gaming and networked video lottery systems has
driven gaming equipment demand growth during the 1990s. In the United States,
casino video gaming is permitted in Colorado, Illinois, Indiana, Iowa,
Louisiana, Mississippi, Missouri, Montana, Nevada, New Jersey and South Dakota,
as well as on Native American lands in some of those and in several additional
states including Arizona, California, Connecticut, Iowa, Michigan, Minnesota,
New Mexico, North Dakota, Oregon and Wisconsin. Outside the United States,
Canada, Australia and France are the most developed, but Asia, South Africa and
South and Central America are all expanding or exploring gaming operations.
While most of the demand for casino gaming machines relates to replacement
sales, growth also stems from the development of new casinos. Replacement sales
will continue to grow as existing machines become obsolete. By the year 2000,
domestic replacement sales are expected to surpass sales to new properties.
Casino gaming is considered a subset of consumer entertainment expenditure.
Its contribution is significant with $50.9 billion in U. S. gaming industry
revenue in 1998. This figure exceeds the $6.2 billion spent on movies, the $12.2
billion spent on recorded music, the $7.6 billion spent at theme parks and other
amusement activities and the $6.3 billion spent on spectator sports and other
live events. With this evidence for the intrinsic demand for gaming, the
expected growth drivers for the industry are twofold - a strong consumer
appetite for the product coupled with a desire by state governments to find
alternative revenue sources. These indicators point toward continued expansion
of casino style gaming, although there can be no assurance that this trend will
continue.
Market Overview. Replacement product demand for gaming machines is
anticipated to accelerate in 1999. This creates an opportunity for the Company
to introduce new games and capitalize on its superior machine performance and
advanced technology. Future replacement demand will accelerate as gaming
equipment in markets opened in 1991 gradually reaches replacement age. It is
estimated that over 120,000 machines will need to be replaced over the next
three years. An additional 17,000 expected gaming machine replacements from
government-owned systems brings the total gaming machine replacement demand to
an estimated 137,000 units by 2001.
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<PAGE>
Australia continues to show strong growth potential. Victoria, Australia,
authorized private sector placement of 5,000 terminals when operations commenced
in August 1992, raising the level of permissible terminals to 27,000 by 1996.
The Company has been granted a license in New South Wales, Australia which
represents an 87,000-machine market. Additional growth is expected in South
Africa. To date, one province, Mpumalanga, has approved manufacturers and
operators and has begun to set licensing guidelines for locations. The province
of Gauteng has approved manufacturers of gaming machines. There can be no
assurance, however, as to any such growth prospects.
The Company commenced sales of its gaming machines to state-licensed
casinos in Colorado in 1994 and began selling machines in the Nevada market in
mid-1996. Additionally, the Company began selling gaming machines in New Jersey
in 1996 through a distributor. The Company sells to the riverboat market in
Iowa, Indiana, Louisiana and Mississippi.
In the Native American market, the Company sells to distributors of video
gaming machines who sell to casinos in Connecticut, Iowa, Michigan, Minnesota,
New Mexico, North Dakota, South Dakota and Wisconsin. The Company has placed
additional machines at Native American casinos in Arizona, Louisiana,
Mississippi, North Carolina and Oregon.
The Company believes casino gaming at pari-mutuel racetracks may expand as
more jurisdictions pass legislation allowing gaming. The Company plans to
leverage the relationships developed with the pari-mutuel racetracks through
United Tote to attempt to gain entrance into these markets.
In 1997, the New Mexico legislature voted to allow casino gaming at
pari-mutuel racetracks in New Mexico, including the Company's racetrack at
Sunland Park, New Mexico. Under this legislation, the Company is permitted to
operate up to 300 gaming machines at its Sunland Park racetrack. Casino gaming
at Sunland Park commenced on February 22, 1999.
Video Lottery Markets. The following table, as of December 31, 1998, sets
forth certain information concerning the number of Company and non-Company video
lottery gaming machines in operation in the jurisdictions that currently have
video lottery operations:
<TABLE>
<CAPTION>
Central VLC Share
Commencement Ownership Control Number of ----------------------
Jurisdiction(1) Date Structure System Terminals(2) Terminals(3) %
- --------------- ------------ --------- ------- ------------ ------------ ---------
<S> <C> <C> <C> <C> <C> <C>
Alberta, Canada 1992 Government GTECH 5,941 3,986 67.1%
Atlantic Canada(4) 1990 Private/Government VLC 9,965 2,874 28.8%
Delaware(5) 1995 Government AWI 356 287 80.6%
Iceland 1991 Charitable VLC 580 500 86.2%
Louisiana 1992 Private IGT 14,923 8,836 59.2%
Montana(6) 1985 Private(11) None 16,574 5,323 32.1%
Northern Territory 1996 Government VLC 500 50 10.0%
Oregon(7) 1992 Government GTECH 8,939 3,964 44.3%
Quebec 1994 Government VLC 15,380 6,583 42.8%
Rhode Island(8) 1992 Government GTECH 1,628 223 13.7%
Saskatchewan 1993 Government GTECH 3,343 1,148 34.3%
South Australia 1994 Private VLC 11,055 928 8.4%
South Dakota(9) 1989 Private VLC 8,008 7,641 95.4%
Victoria, Australia(10) 1995 Private VLC 13,700 1,396 10.2%
Victoria, Australia(10) 1995 Trust Private 13,600 4,600 33.8%
West Virginia 1997 Government Various 3,049 664 21.8%
------- ------
Total 127,541 49,003 38.4%
======= ======
- ----------
</TABLE>
(1) Excludes several other jurisdictions in which the Company currently does
not participate, including Manitoba, Sweden, Queensland and Tasmania even
though the Company is licensed in Tasmania.
(2) Estimated number in operation as of December 1998.
(3) Number of VLC gaming machines sold may vary from number in operation.
- 12 -
<PAGE>
(4) Total number of gaming machines and number of VLC gaming machines based on
information provided by Atlantic Lotto. Atlantic Canada encompasses the
provinces of New Brunswick, Newfoundland, Nova Scotia and Prince Edward
Island. New Brunswick and Prince Edward Island have adopted a private
ownership structure, while in the provinces of Newfoundland and Nova
Scotia, the gaming machines are owned by the government or its appointed
agent.
(5) VLC supplies video machines to Dover Downs (120), Delaware Park (155) and
Harrington Midway (12). IGT supplies video machines to Harrington Midway
(57). There are also 2,246 mechanical spinning reel games at the three
racetracks.
(6) Total number of video lottery gaming machines and number of VLC gaming
machines based on number of gaming machines licensed, according to the
Montana Gambling Control Division and VLC shipment reports.
(7) Total number of gaming machines and number of VLC gaming machines based on
contract with Oregon State Lottery.
(8) Video lottery operations are authorized at only two pari-mutuel facilities
to which the Company is one of five suppliers.
(9) Total number of gaming machines based on information provided by the South
Dakota Lottery. Number of VLC gaming machines based on VLC shipment
reports.
(10) Tattersall Sweep Consultation (the lottery) and TABCORP (the off-track
racing association) are the two approved operators in the state of
Victoria.
(11) Private includes coin operators and/or location owners.
Gaming Machines and Game Software. The Company seeks to capture a
significant portion of the market for its gaming machines by offering a
technologically advanced and reliable machine to the operator, and a fun, fast,
easy game to the player. The Company's current generation of gaming machines
incorporates interactive touchscreen control technology on a multi-color video
display. Each gaming machine is capable of storing over 100 different games in
memory, depending on the games' memory requirements. The machine can present up
to twelve different games selected through a menu format, such as poker,
blackjack, bingo and keno and spinning reel games. The player can vary the
amount of each wager. The number of games that may be offered on a gaming
machine, the specific games and the amount that a player can wager are
determined by the regulating authority in each jurisdiction.
The gaming machines also incorporate a variety of menu-driven internal
accounting, security and diagnostic features, such as on screen accounting,
audit and game statistics. The machines have redundant and self-correcting
memory and self-diagnostic circuitry designed for reliability in widely
dispersed locations. The gaming machines are manufactured with a set of custom
components that can interface with various peripheral devices (such as coin and
bill acceptors, coin hoppers, printers and ticket dispensers) in a modular
design for ease of maintenance and flexibility of configuration.
The Company sells two lines of gaming machines: its Winning Touch(R) series
and the Winning Touch(R) Power Series(TM) with enhanced graphics, improved sound
capabilities and more efficient software design. In 1998 the Company introduced
a slant-top version of its machines to give customers a greater choice for
machine placement and location design. The Company's gaming machines typically
sell for between $4,500 and $9,500, depending on the configuration and
generation of the machine and volume of purchases.
The Company believes that innovative graphics and advanced technology that
have been key contributors to VLC's success in the video lottery market have
benefited the Company as it gains market share in the casino marketplace. The
games, the players, and the operator's needs, including enhanced reliability and
revenue generation, are the same for both industries. The knowledge and
experience acquired through its video lottery operations should enable VLC to
further enhance the playability and appeal of its machines in the casino
markets.
The Company recently introduced its Coin-Free(TM) program into the casino
markets of Nevada, Mississippi and Iowa. Using printer machine technology and
site controller communications from the video lottery markets eliminates the
need for coin handling and hopper fills on the part of the casino. Casinos are
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<PAGE>
using this as a means to bring back penny and nickel slots. At the end of 1998,
in excess of 1,000 units were in place and operating under the Coin-Free(TM)
program.
Marketing and Distribution. The Company must obtain a license and approval
of its gaming machines before it can sell machines in either the casino or video
lottery markets. The following chart shows the jurisdictions where VLC or the
Company currently is licensed or authorized to conduct business and where
license applications are filed and approval is pending:
<TABLE>
<CAPTION>
CURRENT JURISDICTIONS IN WHICH THE COMPANY OR CERTAIN SUBSIDIARIES ARE LICENSED TO
CONDUCT BUSINESS
- -------------------------------------------------------------------------------------------------
UNITED STATES
- --------------------------------------------------------------------------
Casino (c)/ Pari-mutuel Native American
Video Lottery Riverboat (r) Racing Market INTERNATIONAL
- ------------- ----------------- ----------------- ------------------------ ---------------------
<S> <C> <C> <C> <C>
Delaware Colorado (c) Arizona Arizona Australia
Louisiana Indiana (r) ------- ------- ---------
Montana Iowa (r) Ak-Chin Ak-Chin New South Wales
Oregon Louisiana (r) Department of Fort McDowell South Australia
Rhode Island Mississippi (r) Racing Gila River Western Australia
South Dakota Nevada (c) Colorado Tonto Apache Tasmania
West Virginia New Jersey (c) -------- White Mountain Apache Victoria
South Dakota (c) Florida Yavapai-Apache Northern Territory
Deadwood ------- Connecticut Canada
- ------------- Idaho ----------- ------
CHARITABLE ----- Mashantucket-Pequot Alberta
Mississippi ----------------- Indiana Mohegan New Brunswick
CASINO OPERATOR'S ------- Louisiana Newfoundland
LICENSE Iowa --------- Nova Scotia
Nuevo Sol Turf ---- Coushatta Ontario
Club d/b/a Iowa Racing & Tunica-Biloxi Prince Edward Island
Sunland Park Gaming Michigan Quebec
Racetrack & Commission -------- Saskatchewan
Casino Sac & Fox of Bay Mills South Africa
the Minnesota ------------
Mississippi --------- Mpumalanga
Kansas Mississippi
------ -----------
Kentucky Choctaw
-------- New Mexico
Louisiana ----------
--------- Acoma LICENSE
Louisiana Pojoaque APPLICATIONS FILED:
State Racing Pueblo of Isleta ---------------------
Commission Pueblo of Sandia Pasqua Yaqui, Arizona
City of San Felipe Gauteng, South Africa
Carencro San Juan Pueblo Quebec (Casino)
Maine Santa Ana Western Cape,
----- Taos South Africa
Montana Tesque Pueblo
------- Oregon
New Jersey ------
---------- Burns-Paiute
New Mexico Coquille
---------- Cow Creek
Ohio Grande Ronde
---- Siletz
Rhode Island Umatilla
----------- Warm Springs
Texas Wisconsin
----- ---------
Wisconsin
---------
</TABLE>
The marketing and distribution of gaming machines is controlled to some
extent by the statutory and regulatory structure adopted in each jurisdiction.
The Company markets its gaming machines both through a direct sales force and
distributors. Currently, the Company sells to distributors in Louisiana, New
Jersey, the Caribbean, South Australia, and a number of Native American markets.
In deciding whether to use a distributor in a new jurisdiction, the Company
considers a variety of factors, including existing
- 14 -
<PAGE>
relationships with operators and location owners, the ability of a distributor
to service the market after the sale, the distributor's financial condition, any
regulatory constraints and the long-term economics to the Company of direct
sales as opposed to sales to distributors.
The Company's gaming machines are typically covered by a 90-day parts and
labor warranty. The Company provides after-market parts and service to route
operators and other servicing agents. These after-market parts and services
include technical repair and hardware and software upgrades and enhancements.
The Company also provides upgrade options for hardware and software on the
Company's gaming machines.
Central Control Systems. The Company derives revenues from its central
control system software through the grant of licenses to use the software and by
providing installation and maintenance services with respect to the software.
Video lottery gaming machines can be operated either through a central control
system controlled by a governmental authority or on a stand-alone basis. In
every video lottery gaming jurisdiction except Montana, the gaming machines are
connected to a central control system. The Company believes that the greater
control and monitoring ability offered through central control systems will
encourage new jurisdictions to adopt a video lottery program and use such
systems. Similar technology can also be used by casinos for its monitoring
ability and the management of progressive systems. The Company's central control
systems are designed with features intended to appeal to the concerns of the
operator, including:
o Security. To ensure security of communications, VLC's machines have
sophisticated features, including encryption, sequencing and timing of
data transmissions.
o Control. Each gaming machine on the system must be enabled by a call
from the central site before it is capable of displaying a playable
game and can be disabled by the central control system at any time.
o Compatibility. The Company's central control system (Advanced Gaming
System(TM) ("AGS") allows gaming machines made by other manufacturers
to run on the system.
o Economy of Operation. The Company's central control system can be
operated in a dial-up format which is economical to install and
operate compared to an on-line lottery system (using dedicated lines).
However, the system can run in a real-time environment (on-line)
should a jurisdiction desire this feature.
o Reports and Audits. The central computer generates on-demand reports
for each gaming machine on the system and automatically audits the
programming of every machine on a periodic basis.
o Electronic Funds Transfer. The central control system is capable of
processing EFT functions which translate to easier and quicker funds
collection.
o Flexibility. The system is designed to be flexible so as to meet the
needs of various sized markets, to accommodate regulatory changes and
to adapt to new game designs and features.
The Company's central control system software is marketed through the
Company's direct sales force. The marketing efforts for the initial video
lottery central control system typically begin when a legislative body is
considering the adoption of video lottery enabling legislation. Once enabling
legislation calling for a central control system is adopted, the selection of
the central control system is normally accomplished through a formal bid process
that involves submittal of proposals followed by a competitive evaluation
period. The Company also retains persons who are registered as lobbyists in a
given jurisdiction.
The Company designed and installed software for the video lottery central
control systems in Delaware, New Mexico, South Dakota, Loto Quebec, the Atlantic
Lottery Commission's ("ALC," the regulatory body governing lotteries in eastern
Canada) multi-jurisdictional system now covering four provinces in eastern
Canada, Tattersall's and TABCORP in Victoria, Australia, Independent Gaming
Corporation in South Australia and the Northern Territory Racing & Gaming
Authority of Northern Territory,
- 15 -
<PAGE>
Australia, the Icelandic Gaming Fund Raising in Iceland. The Company's AGS
system is state-of-the-art technology, utilizing an IBM UNIX platform or DEC
ALPHA platform as is the case with ALC, and offers customers the opportunity to
operate on-line lottery functions and video lottery terminals from a single
central system.
The first video gaming machine application of the AGS system running
concurrently with the traditional on-line lottery application became operational
in Delaware in December 1995. The system is successfully reporting data from
both video gaming machines and spinning reel slot machines as well as the
on-line lottery. A similar system was installed for the New Mexico Gaming
Control Board in Albuquerque, New Mexico that will report data from casinos at
racetracks and small video lottery venues from across the state.
The AGS is modular in design and allows for the addition of in-venue
progressives. Future add-ons include player tracking, wide-area progressives and
downloadable software to gaming machines. The in-venue progressives has
successfully run in pilot in Delaware and it is in final states of approval in
Australia; however, the Company can provide no assurance that future add-ons
will be successful.
Video gaming customers look for a variety of features in video gaming
products. The technology in current machines will develop and improve over time,
forcing manufacturers to invest in ongoing game development. VLC has developed a
library of numerous gaming machine game variations and its gaming machines allow
for swift reprogramming to provide the newest games to gaming patrons. In
addition to offering expansive product lines, casinos require customized
services for specific requests, including video graphics, game development and
floor space design.
Competition. The Company competes with domestic and foreign manufacturers
of video gaming equipment and providers of traditional on-line lottery systems
and casino-based gaming machines and systems in the sale of its gaming machines
and central control system software. Many of the Company's competitors have
greater financial and other resources than the Company. The Company faces
competition from companies marketing complete video lottery gaming machines and
systems and from companies marketing only video lottery gaming machines as well
as increasing competition in the casino gaming market. Among the Company's
competitors are International Game Technology, Inc., Alliance Gaming, Atronic,
Silicon Gaming, Spielo Gaming International, WMS Industries, Casino Data
Systems, Aristocrat and GTECH.
Significant factors which influence the purchase of gaming machines and
central control systems include overall entertainment factor, the earnings power
of the product, price, reliability, technical capability, security, and the
experience, financial condition and reputation of the manufacturer and
distributor. In addition, gaming authorities may impose other qualifications and
requirements on the Company and its competitors in the supply of video gaming
products and services and may also consider the performance record and
reputation for integrity of the vendor.
Pari-mutuel Systems -- United Tote
- ----------------------------------
The Company acquired United Tote as part of its acquisition of United
Wagering Systems, Inc., in 1994. United Tote develops, manufactures, operates
and sells computerized pari-mutuel wagering systems commonly referred to as
"totalisators" for horse and greyhound racetracks, off-track wagering facilities
and jai alai frontons in North America, South America, Spain, the Caribbean and
the Philippines. A totalisator system supports pari-mutuel wagering by
controlling the acceptance of wagers, calculating odds and payout, cashing
winning tickets, and performing assorted management, accounting and reporting
functions. Each system consists of central processing computers, betting
terminals, proprietary software, tote boards and other displays and video
equipment. The products and services of United Tote are typically marketed to
domestic facilities under long-term service contracts. Compensation is usually
based on a minimum fee plus a percentage of the wagering volume of the facility.
International customers typically purchase the hardware and a license to use the
proprietary software for the system's operation. United Tote also provides
wagering terminals for use in casino race/sportsbooks.
The market for pari-mutuel wagering systems in North America includes horse
and greyhound racetracks, a growing number of off-track betting (OTB) facilities
and jai alai frontons. Pari-mutuel wagering is authorized in 43 U. S. states,
all provinces in Canada, and many foreign countries. Pari-mutuel
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<PAGE>
wagering is a form of wagering in which patrons bet against each other in
separate pools, rather than against the operator of the facility or with preset
odds. As a result, wagering odds are determined by the size of the pools and the
distribution of dollars established by the patrons' wagers. The odds change
continually until betting closes at the start of a race or event. The odds and
payout information are conveyed to the public and updated frequently on display
boards and on video monitors located at various places throughout the facility.
The facility operator administers the pool and is compensated by a percentage of
the gross monies wagered at the facility (the "handle"). There are approximately
350 pari-mutuel wagering facilities in North America and numerous others
worldwide.
While on-track attendance and handle from pari-mutuel wagering at live
events in the United States has markedly decreased over the last decade, there
has also been a substantial increase in simulcast and off-track wagering handle
during the same period. There can be no assurance that such historical patterns
will remain the same in the future.
Domestic Contracts. United Tote provides pari-mutuel wagering services to
most North American customer facilities under long-term service contracts,
typically with 5-7 year terms under which the Company provides the pari-mutuel
wagering computer system, as well as the operations, maintenance and supervisory
personnel necessary to operate the system, while the mutuel clerks who issue
tickets on the teller-operated terminals to the patrons of the facility are
employed by the facility. Under such service contracts, the Company at all times
retains ownership of the equipment and is entitled to liquidated damages in the
event a customer cancels the contract without cause.
Service contract revenues received by United Tote from the operation of its
pari-mutuel wagering systems are generally based upon a percentage of the
handle, subject in most instances to minimum fees. Minimum fees under the
service contracts are generally based on the number of days the facility
operates, as well as other factors, including the type of system and number of
terminals installed at the facility and the reliability of the predicted number
of racing days to occur during the term of the contract.
United Tote makes certain warranties regarding the operation and
reliability of its wagering systems. In the event of system failure, United Tote
is generally responsible for certain liquidated damages, subject to a maximum
daily and/or annual amount. In some instances, United Tote may be liable for
tickets paid in error or for counterfeit tickets if processed by the
totalisator. Liquidated damages paid or accrued by United Tote with respect to
its pari-mutuel contracts were approximately 1.0% of its revenues for 1998, 1.0%
for 1997 and 0.3% for 1996.
With the growth of simulcasting, many of United Tote's racetrack customers
and most of its OTB customers operate throughout the year. Facilities which are
seasonal, generally contract for services only during their operating season,
allowing United Tote to move its equipment and personnel to other facilities at
the close of an operating season at a seasonal facility, forming "circuits"
among such facilities.
United Tote provides pari-mutuel wagering services to over 120 of
approximately 350 pari-mutuel facilities in North America. The installed base of
terminals in use was approximately 8,900 at December 31, 1998.
In limited instances, North American facilities purchase a pari-mutuel
wagering system from United Tote. In such cases, the Company usually enters into
separate service and maintenance agreements for the system.
Until recent years, United Tote had historically focused on providing
services to small and medium-sized racetracks; however, since the addition of
contracts with all of the Kentucky thoroughbred racetracks and the Kentucky
statewide OTB network in 1994, United Tote has demonstrated its ability to
perform at large customer facilities. The capabilities of United Tote's Horizon
NT 2000(TM) System were demonstrated by handling the record-setting 124th
running of the Kentucky Derby at Churchill Downs in 1998, where $17.5 million
was wagered at the track; an additional $64.8 million was wagered through hubs
throughout the country for another North American single-day record of $82.3
million total combined system handle. The United Tote system processed a new
industry record of $81.7 million for the 1998 Breeder's Cup Championship with
wagers coming from over 8,900 facilities throughout the world. United Tote
recently signed multi-year contract extensions to its existing totalisator
service contracts with Keeneland in
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<PAGE>
Lexington, Kentucky, and Dover Downs and Harrington Raceway, both in Delaware.
United Tote also recently signed contracts with two new customers, Hinsdale
Greyhound Racing in New Hampshire and Plainridge Racecourse in Massachusetts.
International Sales. United Tote has customers in international
marketplaces, including Canada, Jamaica, Spain, Mexico, Argentina, Ecuador and
the Philippines. Internationally, there has been growth in the utilization of
on-line wagering systems in established markets. As economic and political
situations improve, new market opportunities open up for U. S. suppliers in less
developed countries where there is an increasing demand for advanced technology.
Pari-mutuel wagering systems for facilities outside of North America have
historically been sold rather than operated pursuant to service contracts. Such
sales have been made on a direct sale basis with payments to the Company
generally made in U. S. dollars. Upon the sale of a system, United Tote also
charges the purchaser a license fee for use of the Company's proprietary system
software and provides technical assistance and support. The personnel of the
Company participate in the installation and commissioning of these systems but
typically the systems are thereafter operated by the personnel of the customers
who are trained at United Tote serviced facilities.
Products. United Tote developed and introduced the pari-mutuel wagering
system ("Horizon System") in 1993. It features the dual-purpose VERSA(TM), VERSA
II(TM) and Color VERSA(TM) terminals, which all can be used in either
self-service or teller-operated mode, allowing the racetrack to make full use of
all terminals, even on slow race days. The VERSA(TM) terminal thus allows for
significant labor savings, flexibility and versatility. The VERSA II(TM) and
Color VERSA(TM) terminals feature an enhanced display and a built in magnetic
card reader. Other terminals in the Horizon System family are the portable
wireless ULTIMA(TM); the cashless account-betting PROFILE(TM); the
Tele-PROFILE(TM) for operator input telephone wagering and a bill-accepting
module to convert a VERSA(TM), VERSA II(TM) or Color VERSA(TM) into a full
service, cash accepting, touch-screen, self-service terminal. Approximately
7,300 VERSA(TM) terminals are presently in service at customer locations. Those
new model terminals have been produced since 1993 and are in service at customer
locations.
In 1998, United Tote introduced its new Horizon NT 2000(TM) system, a high
performance wagering system combining Microsoft's Windows NT(R) operating system
with proprietary system software written in "C" language and utilizing Pentium
II based hardware.
United Tote believes that its ability to attract new and retain existing
wagering system customers depends in part on the continuous incorporation of
innovative technological advances to improve its product lines. The Company
maintains a development program directed toward new products and the improvement
and refinement of its present products to expand their uses and applications.
Competition. United Tote's principal competitors are Autotote, AmTote and,
at some facilities, a limited number of other smaller, local and regional
companies. Competition outside of North America is more fragmented, with
competition being provided by several international and regional companies. No
single company maintains a dominant market position internationally, although
certain companies possess regional strengths.
Gaming Operations
- -----------------
The Company's racetrack operation is located in Sunland Park, New Mexico,
adjacent to El Paso, Texas. In 1997 the New Mexico State Legislature voted to
allow casino gaming at pari-mutuel racetracks in New Mexico, including the
Company's racetrack in Sunland Park, New Mexico. The legislation permits the
Company to operate up to 300 gaming machines per pari-mutuel racetrack facility
for up to twelve hours per day. Two million residents live within a 100-mile
radius of Sunland Park, which area includes the cities of El Paso, Texas and
Juarez, Mexico. The Company has expended approximately $4.5 million of an
expected $8.5 million of capital for facility enhancements, gaming machines and
related equipment. The total investment in the racetrack and gaming system is
approximately $23.4 million.
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<PAGE>
Competition. Sunland Park does not have direct competition for horse racing
in the El Paso area, although there is an operating greyhound racing facility in
Juarez, Mexico which also offers sports/race wagering on simulcast racing events
and sporting events.
While Texas permits pari-mutuel wagering, there are no pari-mutuel
racetracks in direct competition with Sunland Park's geographic area, although
there has been some effect upon the number and quality of horses available to
run at Sunland Park. Sunland Park also competes against other forms of
entertainment, including sporting events. There is one illegal casino operating
in Texas in direct competition with Sunland Park. The States of New Mexico and
Texas currently authorize limited forms of gambling, such as a state lottery,
bingo, and/or Native American casinos, all of which compete for the leisure
dollar.
Route Operations. The Company's gaming operations segment operates and
maintains video lottery and amusement machines in business establishments
located in three areas in southern Montana. The Company believes its route
operations, in addition to generating recurring revenue and predictable
operating profit, enable the Company to understand the needs and preferences of
players and coin operators by providing testing grounds for new hardware and
software concepts. This research enables the Company to observe player response
to various terminal configurations and to use this data to improve its terminal
design.
The Company's route operations primarily utilize coin-operated video poker
and video keno machines. The amusement machines consist principally of
coin-operated video machines, pinball machines, pool tables, CD players and juke
boxes. Based on its familiarity with the relatively small number of competitors
of its route operations and its familiarity with substantially all of the
potential locations for video lottery machines in the market areas, the Company
believes that its route operations have a significant share of the video lottery
machine market in Montana. During the year ended December 31, 1998, the route
operations generated approximately $17.4 million or 8% of the Company's
consolidated revenues.
The Company enters into agreements with owners of business establishments
to install video lottery gaming and amusement machines at their businesses. The
number of machines per location is determined by available space, customer base,
competition, preference of the owner of the establishment, and, in the case of
video lottery gaming machines, licensing limitations. The agreements typically
provide for revenue sharing with the location owner based upon a percentage of
the net revenues generated by the Company's machines. In certain instances, the
Company or one of its subsidiaries may assist the location owner with obtaining
financing relating to the location, including providing a guaranty of such
financing. The agreements require the Company to install, maintain and service
machines installed at the location.
The Company's route operations compete directly with other machine route
businesses, including numerous small route operators and several route operators
similar in size to the Company's route operations, and with companies selling
video lottery gaming machines directly to location owners. The principal factors
of competition for route operations are the reputation of the route operator and
the quality and earnings potential of the machines offered by the route
operator, the service provided by the route operator and the terms of its
agreement with the location owner.
Manufacturing
- -------------
The Company's primary manufacturing facility is located in Bozeman,
Montana. The Company's manufacturing operations consist primarily of assembly
and testing of its lottery system terminals, gaming system machines and
pari-mutuel systems machines. The Company purchases most of the parts,
components and subassemblies (some of which are designed by the Company) from
outside sources and then assembles them into finished products. The Company
generally uses standard parts and components that are available from multiple
sources. The Company has contracted with third parties for the assembly of
gaming machines, which the Company utilizes when conditions warrant and/or when
contractually required. The Company also has contracted with outside sources for
the manufacture of some of its components. The Company has historically
experienced low turnover among its work force.
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<PAGE>
The Company became ISO-9002 certified in February 1998 by AFAQ, an
independent quality system certification organization. Created by the
International Organization for Standardization, ISO-9002 represents a series of
standards that specify how quality systems should be established and maintained.
ISO certification is recognized around the world and has become a requirement
for businesses entering into foreign markets. In February 1999, the Company
received ISO certification for another year, meeting all nineteen elements of
the certification process. The Company's ISO-9002 program extends into every
phase of operations, ensuring senior-level commitment to production,
manufacturing, installation and service with a framework for uncompromising,
continuous improvement.
Research and Development
- ------------------------
The future success of the Company depends to a large extent upon its
ability to design, manufacture and market technologically sophisticated products
that achieve high levels of player acceptance. The Company's business is
characterized by rapidly changing technology and frequent new product
introductions and enhancements. The development of a successful new product or
product design by a competitor would adversely affect sales of the Company's
products and force it to respond quickly with its own competing products. There
can be no assurance that the Company will be successful in identifying,
developing and marketing new products or enhancing its existing products. The
Company's business will be adversely affected if the Company experiences delays
in developing new products or enhancements or if such products or enhancements
do not meet and receive all regulatory approvals and/or gain customer
acceptance.
In 1998, the Company expended $10.0 million (net of capitalization) on
research and development activities as compared to $9.8 million in 1997 and $8.0
million in 1996. The Company capitalized approximately $1.0 million in 1997 and
$4.1 million in 1996 of software development costs in conjunction with the
development of the Company's MasterLink(TM) central system software. No costs
were capitalized for MasterLink(TM) development in 1998. Research and
development expenditures were approximately 5.0%, 5.5% and 6.8% of consolidated
revenues in 1998, 1997 and 1996, respectively. Additionally, the Company spends
significant resources and capital on improvement of existing products, services
and techniques for current customers.
Year 2000
- ---------
The Year 2000 issue is pervasive and complex. Virtually every information
technology ("IT") system, including the Company's internal systems, systems
delivered to customers, and suppliers' systems, as well as non-IT systems will
be affected in some way by the rollover of the two-digit year value to "00".
Non-IT systems include manufacturing systems and physical facilities including,
but not limited to, security systems and utilities. The result could create
errors in information or system failures. Recognizing this uncertainty,
management has and is continuing to actively analyze, assess and plan for
various Year 2000 issues. Management has appointed a task force that reports
periodically to the Company's CEO and Board of Directors, and has also engaged
outside consultants to assist and advise management in this assessment process.
The Company's Year 2000 team has completed an inventory of all of its
computer systems and technology that may be impacted by Year 2000 issues. The
programming and testing of mission critical systems was virtually complete by
the end of 1998 and contingency plans are planned for completion by April 1999.
In calendar year 1999, the Company plans to replace or upgrade those systems
that are identified as non-Year-2000 compliant at an incremental cost of
approximately $0.5 million. Non-IT system issues are more difficult to identify
and resolve. The Company is actively identifying non-IT Year 2000 issues
concerning its products and services, as well as its physical facility
locations. As non-IT areas are identified, management formulates the necessary
actions to ensure minimal disruption to its business processes. Although
management believes that its efforts will be successful and the costs will be
immaterial to its consolidated financial position and results of operations, it
also recognizes that any failure or delay could cause a disruption in its
business and may have a significant financial impact.
The Company has evaluated its strategy and legal obligations for any
communication to its customers. The Year 2000 readiness of its customers varies,
and the Company is encouraging its
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customers to evaluate and prepare their own systems. In many cases the Company
is assisting customers by providing new or modified systems to resolve Year 2000
issues.
The Company is also assessing the Year 2000 readiness of its key suppliers.
The Company's direction in this effort is to ensure the adequacy of resources
and supplies to minimize any potential business interruptions. Management
expects to complete this part of its Year 2000 readiness plan in the first half
of 1999. As part of the Company's contingency plans, management will, as
considered necessary, begin to identify and communicate with alternative
suppliers to ensure the continuation of its critical business operations.
The Company believes that because of modifications already made and current
plans for additional modifications of existing computer systems, updates by
vendors and conversion to new software, the Year 2000 issue will not pose
significant operations problems for the Company. However, if such modifications
and conversions are not completed properly or in a timely manner, or third party
software and systems relied on by the Company fail, the Year 2000 issue could
have a material impact on the business and operations of the Company. The costs
of modifications and conversions are not anticipated to be material, and will
principally represent a re-deployment of existing or otherwise planned
resources. No assurance can be given that the Company will successfully avoid
any problems associated with the Year 2000 issue.
Intellectual Property
- ---------------------
The Company may seek and, in some cases, has sought, patents and copyrights
with respect to various aspects of its technology used in its products. No
assurance can be given that any patent applications filed will be granted, that
the patents or copyrights will not be infringed or that other parties will not
develop similar technology that will not violate the patents. The Company
typically requires persons such as customers, employees, licensees and
subcontractors who have access to proprietary information concerning its
products to sign confidentiality and non-disclosure agreements, which prohibit
the use of this information other than for the specific purpose for which it is
provided, and the Company relies on such agreements, other security measures and
trade-secret laws to protect such proprietary information.
The Company has pending applications for registration of trademarks in
connection with its products in the United States, Australia and other foreign
countries. The Company intends to file additional applications to register
trademarks in the United States and other key jurisdictions as considered
necessary. The Company also relies on the laws of trade secrets and copyright to
protect its proprietary rights to its central control system software and
various other software programs.
Employees
- ---------
As of December 31, 1998, the Company employed approximately 1,650 people on
a full and part-time basis. Approximately 625, 205, 280 and 275 were employed in
the lottery systems, gaming machines and systems, pari-mutuel systems and gaming
operations segments, respectively. Another 265 people provided corporate
manufacturing, finance and administration and national marketing services to the
operating segments. Approximately 185 were seasonal or part-time employees in
the pari-mutuel systems and gaming operations segments.
The Company has no collective bargaining agreements with any of its
employees and believes that its overall relations with employees are good.
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<PAGE>
Government Regulation
- ---------------------
In the United States, lotteries are not permitted in a jurisdiction unless
expressly authorized by law in each jurisdiction. Currently, there are
thirty-eight lotteries operating in the United States and District of Columbia.
All these lotteries operate a traditional lottery, namely, offering lotto and
instant scratch-off games. Video lottery, involving video simulated games of
chance and skill played on gaming devices, is not authorized under traditional
lottery statutes in the majority of these jurisdictions. There are presently
seven video lottery operations in the United States. Legislation in each
jurisdiction generally specifies certain standards to ensure the security and
integrity of the lottery operation that include, but are not limited to: the
minimum percentage of gross revenues paid back to players in prize money; the
percentage of gross revenues paid to a state purpose; randomness of play; goods
and services regarded as major procurements requiring state bids; and
suitability standards for agents and vendors of major procurements. Policy and
management decisions of the lottery operations are generally governed by a
commission appointed by the governor of each state with the day-to-day
operations of the lottery administered by a director appointed either by the
governor or lottery commission. The lottery commission and director of each
state generally exercise significant authority, including the determination of
the types of games played, the price of tickets, the manner in which the lottery
is marketed and selection of vendors of equipment and services.
To ensure the integrity of their lottery operations, most jurisdictions
require detailed background disclosure and investigations of vendors providing
goods and services under a contract award for a major procurement, which
typically include: on-line computer systems and services; instant ticket
printing; ticket validation systems; gaming devices; drawing equipment; and
advertising services. Background investigations typically are conducted on
company subsidiaries, affiliates, officers, directors, and stockholders who own
5% or more of the outstanding capital stock of the Company for purposes of
meeting suitability standards defined under statute and regulations of each
jurisdiction. Additionally, vendors are required to respond and meet
comprehensive standards as described in a lottery's request for proposals or
invitations for bid for the goods and services contracted. Failure on the part
of a vendor to meet suitability standards or provider requirements as delineated
in the request for proposals could jeopardize the award of a lottery contract to
the Company or provide grounds for the termination of an existing lottery
contract.
The award of lottery contracts and ongoing operations of lotteries in
international jurisdictions also are highly regulated, although the operations
typically vary from lotteries in the United States. In addition, restrictions
are often imposed on foreign corporations seeking to do business in
international jurisdictions.
The manufacture, distribution and operation of gaming devices or facilities
are subject to extensive federal, state, provincial and local regulation. These
regulations vary from jurisdiction to jurisdiction. All jurisdictions require
various licenses, permits and approvals to be held by companies and their key
personnel in connection with the manufacture, distribution or operation of
gaming devices or facilities. Generally, gaming devices may not be manufactured,
distributed or operated unless such licenses are obtained from the appropriate
regulatory authorities of the jurisdictions. Changes in such laws, regulations
and procedures could have an adverse effect on the Company's operations.
The Federal Gambling Devices Act of 1962 (the "Federal Act") makes it
unlawful for a person to manufacture, deliver or receive gaming machines, gaming
machine devices and components thereof across interstate lines unless that
person has first registered with the Attorney General of the United States.
Certain of the Company's subsidiaries are so registered and must renew their
registrations annually. In addition, various record keeping and equipment
identification requirements are imposed by the Federal Act. Violation of the
Federal Act may result in seizure or forfeiture of equipment, as well as other
penalties.
The U. S. Congress has created the National Gambling Impact and Policy
Commission to conduct a comprehensive study of all matters relating to the
economic and social impact of gaming in the United States. The enabling
legislation provides that, not later than two years after the enactment of such
legislation, the commission would be required to issue a report containing its
findings and conclusions, together with recommendations for legislation and
administrative actions. The Commission's final report is expected to be
presented to the President and Congress in mid-June 1999. Any such
recommendations, if
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<PAGE>
enacted into law, could adversely affect the gaming industry and have a material
adverse effect on the Company's business, financial condition or results of
operations.
From time to time, certain legislators have proposed the imposition of a
federal tax on gross gaming revenues. The Company is not aware of any specific
proposals currently pending for the imposition of such a federal tax; however,
no assurance can be given that such a tax will not be imposed in the future. Any
such tax could have a material adverse effect on the Company's business,
financial condition or results of operations.
Although the regulatory schemes in the jurisdictions in which the Company
sells or operates video lottery gaming machines or systems (the "Operating
Jurisdictions") are not identical, their material attributes are substantially
similar, as described below.
The manufacture, sale and distribution of gaming devices, including video
lottery terminals, and the ownership and operation of gaming facilities in each
Operating Jurisdiction, are subject to various state, provincial, county and/or
municipal laws, regulations and ordinances, which are administered by the
relevant regulatory agency or agencies in that Operating Jurisdiction (the
"Department"). These laws, regulations and ordinances primarily concern the
responsibility, financial stability and character of gaming equipment
manufacturers, distributors and operators, as well as persons financially
interested or involved in gaming or liquor operations.
In addition to the Operating Jurisdictions, the Company will seek to do
business in other jurisdictions if they authorize video lottery gaming
operations in the future. The Company cannot predict the nature of the
regulatory scheme in any such jurisdiction. Certain states do have regulatory
schemes currently in place which authorize forms of video gaming other than
video lottery, such as video poker. There can be no assurance that the Company
will obtain the necessary licenses, permits or approvals to conduct business in
any new jurisdiction.
The Company regularly engages public affairs advisors and lobbyists in
various United States jurisdictions to advise legislators and the public in
connection with lottery legislation and to advise the Company in connection with
contract proposals. Officers of the Company may make authorized campaign
contributions to various candidates of political parties.
The process by which lottery contract awards are made may be subject to
intense scrutiny and review by federal, state and provincial authorities not
directly related to lottery authorities. It is impossible to predict the impact,
if any, on the Company of any such review of lottery procurement decisions
In general, no manufacturing, distributing, owning or operating of gaming
devices may be conducted unless proper licenses and approvals are obtained. An
application for a license or approval may be denied for failure to satisfy any
standard or requirement as determined by the Department. In order to ensure the
integrity of the video lottery gaming system, most jurisdictions have the
authority to conduct background investigations of the Company, its key personnel
and significant stockholders. The Department may at any time revoke, suspend,
condition, limit or restrict a license for any cause deemed in violation of its
law or regulations. Fines for violation of gaming laws or regulations may be
levied against the holder of a license and persons involved. In September 1992,
the then Victoria Gaming Commission of Victoria, Australia, removed VLC from the
roll of approved gaming manufacturers, which prohibited the Company from making
future sales of gaming equipment in Victoria. This decision was based on
concerns regarding the former CEO and the then majority stockholder of the
Company. After severing all his business relationships with the Company, VLC
applied and was approved for placement on the roll of approved manufacturers in
Victoria in December 1993. The Alcohol, Racing and Gaming Board (RACJ) of
Montreal, Quebec, initially rejected VLC's application as a manufacturer of
video lottery equipment in December 1993. The RACJ reconsidered its earlier
decision based on assurances that the former CEO had also sold his entire stock
ownership in the Company in severing all business relationships with the
Company. In March 1994, the RACJ granted VLC a manufacturer license. VLC remains
in good standing with the Victorian Casino & Gaming Authority (successor to the
Victoria Gaming Commission) and the RACJ. Other than the above two licensing
matters, the Company and its key personnel have been approved for licensing upon
completed application in all operating jurisdictions in which the Company has
applied. Suspension or revocation of such licenses could have a material adverse
effect upon the Company's future operations and
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<PAGE>
the experience in Victoria and Quebec indicates that there can be no assurance
that the Company will receive necessary or appropriate licenses, permits or
approvals or, if received, that such licenses, permits or approvals will be
renewed or retained. The actions of any licensing authority may be considered by
regulatory authorities in other jurisdictions. Similarly, the rejection or
termination of the Company, its personnel, or major stockholders in any other
jurisdiction may have adverse consequences in other jurisdictions.
In certain jurisdictions, the Company's pari-mutuel wagering segment is
also subject to extensive state regulatory and licensing requirements similar to
the Company's on-line lottery and video gaming machine subsidiaries. The
Company's racetrack operations in Sunland Park, New Mexico, are subject to
regulation of the New Mexico Racing Commission and other authorities.
Nevada Regulatory Matters
- -------------------------
The manufacture, sale and distribution of gaming devices and associated
equipment for use or play in Nevada or for distribution outside of Nevada and
the operation of slot machine routes in Nevada are subject to: (i) The Nevada
Gaming Control Act and the regulations promulgated thereunder (collectively,
"Nevada Act"); and (ii) various local ordinances and regulations. Such
activities are subject to the licensing and regulatory control of the Nevada
Gaming Commission ("Nevada Commission"), the Nevada State Gaming Control Board
("Nevada Board"), and various local, city and county regulatory agencies
(collectively referred to as the "Nevada Gaming Authorities").
The laws, regulations and supervisory procedures of the Nevada Gaming
Authorities are based upon declarations of public policy which are concerned
with, among other things: (i) the prevention of unsavory or unsuitable persons
from having a direct or indirect involvement with gaming, or manufacturing or
locations, practices, associations and activities related to the operation of
licensed gaming establishments and the manufacture or distribution of gaming
devices and equipment; (ii) the establishment and maintenance of responsible
accounting practices and procedures; (iii) the maintenance of effective controls
over the financial practices of licensees, including the establishment of
minimum procedures for internal fiscal affairs and the safeguarding of assets
and revenues, providing reliable record keeping and requiring the filing of
periodic reports with the Nevada Gaming Authorities; (iv) the prevention of
cheating and fraudulent practices; and (v) to provide a source of state and
local revenues through taxation and licensing fees. Change in such laws,
regulations and procedures could have an adverse effect on the Company's
manufacturing, distribution and slot route operations.
The Company is registered by the Nevada Commission as a publicly traded
corporation (a "Registered Corporation") and has been found suitable to own the
stock of two wholly-owned subsidiaries, VLC and VLC of Nevada, Inc. (the "Nevada
Subsidiary") which are each licensed as a manufacturer and distributor. The
Nevada Subsidiary is also licensed as an operator of a slot machine route. As a
registered corporation, the Company is required periodically to submit detailed
financial and operating reports to the Nevada Commission and furnish any other
information that the Nevada Commission may require. No person may become a
stockholder of, or receive any percentage of profits from VLC or the Nevada
Subsidiary without first obtaining licenses and approvals from the Nevada gaming
authorities. The Company, VLC and the Nevada Subsidiary have obtained from the
Nevada gaming authorities the various registrations, approvals, permits,
findings of suitability and licenses (collectively "Gaming Licenses") in order
to engage in manufacturing, distribution and slot route activities in Nevada as
applicable.
All gaming devices and cashless wagering systems that are manufactured,
sold or distributed for use or play in Nevada, or for distribution outside of
Nevada, must be manufactured by licensed manufacturers and distributed or sold
by licensed distributors. All gaming devices manufactured for use or play in
Nevada must be approved by the Nevada Commission before distribution or exposure
for play. The approval process for gaming devices includes rigorous testing by
the Nevada Board, a field trial and a determination as to whether the gaming
device meets strict technical standards that are set forth in the regulations of
the Nevada Commission. Associated equipment must be administratively approved by
the Chairman of the Nevada Board before it is distributed for use in Nevada. The
Winning Touch (R) gaming machine has been approved by the Nevada Commission.
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<PAGE>
The Nevada Gaming Authorities may investigate any individual who has a
material relationship to, or material involvement with, the Company, the Nevada
Subsidiary or VLC in order to determine whether such individual is suitable or
should be licensed as a business associate of a gaming licensee. Officers,
directors and certain key employees of the Nevada Subsidiary and VLC are
required to file applications with the Nevada Gaming Authorities and may be
required to be licensed or found suitable by the Nevada Gaming Authorities.
Officers, directors and key employees of the Company who are actively and
directly involved in the licensed activities of the Nevada Subsidiary or VLC may
be required to be licensed or found suitable by the Nevada Gaming Authorities.
The Nevada Gaming Authorities may deny an application for licensing for any
cause that they deem reasonable. A finding of suitability is comparable to
licensing, and both require submission of detailed personal and financial
information followed by a thorough investigation. The applicant for licensing or
a finding of suitability must pay all the costs of the investigation. Changes in
licensed positions must be reported to the Nevada Gaming Authorities and in
addition to their authority to deny an application for a finding of suitability
or licensure, the Nevada Gaming Authorities have jurisdiction to disapprove a
change in a corporate position.
If the Nevada Gaming Authorities were to find an officer, director or key
employee unsuitable for licensing or unsuitable to continue having a
relationship with the Company, the Nevada Subsidiary, VLC, or the subsidiaries
involved would have to sever all relationships with such person. In addition,
the Nevada Commission may require the Company, VLC and the Nevada Subsidiary to
terminate the employment of any person who refuses to file appropriate
applications. Determination of suitability or of questions pertaining to
licensing are not subject to judicial review in Nevada.
The Company, VLC and the Nevada Subsidiary are required to submit detailed
financial and operating reports to the Nevada Commission. Substantially all
material loans, leases, sales of securities and similar financing transactions
by VLC and the Nevada Subsidiary are required to be reported to or approved by
the Nevada Commission.
If it were determined that the Nevada Act was violated by the Company, the
Nevada Subsidiary or VLC, the licenses they hold could be limited, conditioned,
suspended or revoked, subject to compliance with certain statutory and
regulatory procedures. In addition, the Nevada Subsidiary, VLC, the Company and
persons involved could be subject to substantial fines for each separate
violation of the Nevada Act at the discretion of the Nevada Commission.
Limitation, conditioning or suspension of the licenses held by the Company, the
Nevada Subsidiary or VLC could (and revocation of any license would) have a
materially adverse effect on the Company's manufacturing and distribution of
gaming machines.
Any beneficial holder of the Company's voting securities, regardless of the
number of shares owned, may be required to file an application, be investigated,
and have his/her suitability determined as a beneficial holder of the Company's
voting securities if the Nevada Commission has reason to believe that such
ownership would otherwise be inconsistent with the declared policies of the
state of Nevada. The applicant must pay all costs of investigation incurred by
the Nevada Gaming Authorities in conducting any such investigation.
The Nevada Act requires any person who acquires beneficial ownership of
more than 5% of a Registered Corporation's voting securities to report the
acquisition to the Nevada Commission. The Nevada Act requires that beneficial
owners of more than 10% of a Registered Corporation's voting securities apply to
the Nevada Commission for a finding of suitability within thirty days after the
Chairman of the Nevada Board mails the written notice requiring such filing.
Under certain circumstances, an "institutional investor," as defined in the
Nevada Act, which acquires more than 10%, but not more than 15%, of the
Registered Corporation's voting securities may apply to the Nevada Commission
for a waiver of such finding of suitability if such institutional investor holds
the voting securities for investment purposes only. An institutional investor
shall not be deemed to hold voting securities for investment purposes unless the
voting securities were acquired and are held in the ordinary course of business
as an institutional investor and not for the purpose of causing, directly or
indirectly, any of the following: the election of a majority of the members of
the board of directors of the Registered Corporation; any change in the
Registered Corporation's corporate charter, bylaws, management, policies or
operations, or in any of its gaming affiliates, or any other action which the
Nevada Commission finds to be inconsistent with holding the Registered
Corporation's voting securities for investment purposes only. Activities which
are not deemed to be inconsistent with holding voting securities for investment
purposes only include: (i) voting on all
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<PAGE>
matters voted on by stockholders; (ii) making financial and other inquiries of
management of the type normally made by securities analysts for informational
purposes and not to cause a change in its management, policies or operations;
and (iii) such other activities as the Nevada Commission may determine to be
consistent with such investment intent. If the beneficial holder of voting
securities who must be found suitable is a corporation, partnership or trust, it
must submit detailed business and financial information including a list of
beneficial owners. The applicant is required to pay all costs of investigation.
Any person who fails or refuses to apply for a finding of suitability or a
license within thirty days after being ordered to do so by the Nevada Commission
or the Chairman of the Nevada Board, may be found unsuitable. The same
restrictions apply to a record owner if the record owner, after request, fails
to identify the beneficial owner. Any stockholder who is found unsuitable and
who holds, directly or indirectly, any beneficial ownership of the Common Stock
beyond such period of time as may be prescribed by the Nevada Commission may be
guilty of a criminal offense. The Company will be subject to disciplinary action
if, after it receives notice that a person is unsuitable to be a stockholder or
to have any other relationship with the Company, the Nevada Subsidiary, VLC or
the Company (i) pays that person any dividend or interest upon voting securities
of the Company, (ii) allows that person to exercise, directly or indirectly, any
voting right conferred through securities held by that person, (iii) pays
remuneration in any form to that person for services rendered or otherwise, or
(iv) fails to pursue all lawful efforts to require such unsuitable person to
relinquish his voting securities, including, if necessary, the immediate
purchase of said voting securities for cash at fair market value.
The Nevada Commission may, in its discretion, require the holder of any
debt security of a Registered Corporation to file applications, be investigated
and be found suitable to own the debt security of a Registered Corporation if
the Nevada Commission has reason to believe that his acquisition of such debt
security would otherwise be inconsistent with the declared policy of the State
of Nevada. If the Nevada Commission determines that a person is unsuitable to
own such security, then pursuant to the Nevada Act, the Registered Corporation
can be sanctioned, including the loss of its approvals, if without the prior
approval of the Nevada Commission, it: (i) pays to the unsuitable person any
dividend, interest, or any distribution whatsoever; (ii) recognizes any voting
right by such unsuitable person in connection with such securities; (iii) pays
the unsuitable person remuneration in any form; or (iv) makes any payment to the
unsuitable person by way of principal, redemption, conversion, exchange,
liquidation, or similar transaction.
The Company, VLC, and the Nevada Subsidiary are required to maintain a
current stock ledger in Nevada that may be examined by the Nevada Gaming
Authorities at any time. If any securities are held in trust by an agent or by a
nominee, the record holder may be required to disclose the identity of the
beneficial owner to the Nevada Gaming Authorities. A failure to make such
disclosure may be grounds for finding the record holder unsuitable. The Company
is also required to render maximum assistance in determining the identity of the
beneficial owner. The Nevada Commission has the power to require the stock
certificates of the Company to bear a legend indicating that the securities are
subject to the Nevada Act. However, to date, the Nevada Commission has not
imposed such a requirement on the Company.
The Company may not make a public offering of its securities without the
prior approval of the Nevada Commission if the securities or proceeds therefrom
are intended to be used to construct, acquire or finance gaming facilities in
Nevada, or to retire or extend obligations incurred for such purposes. Such
approval, if given, does not constitute a finding, recommendation or approval by
the Nevada Commission or the Nevada Board as to the accuracy or adequacy of the
prospectus or the investment merits of the securities offered. Any
representation to the contrary is unlawful.
Changes in control of a Registered Corporation through merger,
consolidation, stock or asset acquisitions, management or consulting agreements,
or any act or conduct by a person whereby he obtains control, may not occur
without the prior approval of the Nevada Commission. Entities seeking to acquire
control of a Registered Corporation must satisfy the Nevada Board and the Nevada
Commission in a variety of stringent standards prior to assuming control of such
Registered Corporation. The Nevada Commission may also require controlling
stockholders, officers, directors and other persons having a material
relationship or involvement with the entity proposing to acquire control, to be
investigated and licensed as part of the approval process relating to the
transaction.
- 26 -
<PAGE>
The Nevada legislature has declared that some corporate acquisitions
opposed by management, repurchases of voting securities and corporate defense
tactics affecting Nevada corporate gaming licensees, and Registered Corporations
that are affiliated with those operations, may be injurious to stable and
productive corporate gaming. The Nevada Commission has established a regulatory
scheme to ameliorate the potentially adverse effects of these business practices
upon Nevada's gaming industry and to further Nevada's policy to: (i) assure the
financial stability of corporate gaming licensees and their affiliates; (ii)
preserve the beneficial aspects of conducting business in the corporate form;
and (iii) promote a neutral environment for the orderly governance of corporate
affairs. Approvals are, in certain circumstances, required from the Nevada
Commission before the Registered Corporation can make exceptional repurchases of
voting securities above the current market price thereof and before a corporate
acquisition opposed by management can be consummated. The Nevada Act also
requires prior approval of a plan of recapitalization proposed by the Registered
Corporation's Board of Directors in response to a tender offer made directly to
the Registered Corporation's stockholders for the purposes of acquiring control
of the Registered Corporation.
License fees and taxes, computed in various ways depending on the type of
gaming or activity involved, are payable to the State of Nevada and to the
counties and cities in which gaming operations are to be conducted. Depending
upon the particular fee or tax involved, these fees and taxes are payable
monthly, quarterly or annually and are based upon either: (i) a percentage of
the gross revenues received; or (ii) the number of gaming devices operated.
Annual fees are also payable to the State of Nevada for renewal of licenses as a
manufacturer, distributor and operator of a slot machine route.
Any person who is licensed, required to be licensed, registered, required
to be registered, or is under common control with such persons (collectively,
"Licensees"), and who proposes to become involved in a gaming venture outside of
Nevada, is required to deposit with the Nevada Board, and thereafter maintain, a
revolving fund in the amount of $10,000 to pay the expenses of investigation by
the Nevada Board of their participation in such foreign gaming. The revolving
fund is subject to increase or decrease in the discretion of the Nevada
Commission. Thereafter, Licensees are required to comply with certain reporting
requirements imposed by the Nevada Act. Licensees are also subject to
disciplinary action by the Nevada Commission if it knowingly violates any laws
of the foreign jurisdiction pertaining to the foreign gaming operation, fails to
conduct the foreign gaming operation in accordance with the standards of honesty
and integrity required of Nevada gaming operations, engages in activities that
are harmful to the state of Nevada or its ability to collect gaming taxes and
fees, or employs a person in the foreign operation who has been denied a license
or finding of suitability in Nevada on the ground of personal unsuitability.
Native American Gaming Regulations
- ----------------------------------
Gaming on Native American lands is extensively regulated under federal law,
tribal-state compacts and tribal law. The Indian Gaming Regulatory Act of 1988
("IGRA") provides the framework for federal and state control over all gaming on
Native American lands. IGRA regulates the conduct of gaming on Native American
lands and the terms and conditions of contracts with third parties for
management of gaming operations. IGRA established the National Indian Gaming
Commission ("NIGC") to operate as an independent agency, within the U. S.
Department of the Interior, to exercise primary federal regulatory
responsibility over such gaming. The NIGC is delegated authority to issue
regulations governing tribal gaming activities, approve tribal ordinances for
regulating Class II and Class III gaming, approve management agreements for
gaming facilities, conduct investigations and monitor tribal gaming generally.
The IGRA classifies games that may be conducted on Native American lands
into three categories. "Class I Gaming" includes social games solely for prizes
of minimal value, or traditional forms of Native American Gaming engaged in by
individuals as part of, or in connection with, tribal ceremonies or
celebrations. "Class II Gaming" includes bingo, pulltabs, lotto, punch boards,
tip jars, instant bingo, and other games similar to bingo, if those games are
played at the same location as bingo is played. "Class III Gaming" includes all
other commercial forms of gaming, such as table games, slots, video casino
games, and other commercial gaming (e.g., sports betting and pari-mutuel
wagering).
Class I Gaming on Native American lands is within the exclusive
jurisdiction of the Native American tribes and is not subject to the provisions
of IGRA. Class II Gaming is permitted on Native American lands if (a) the state
in which the Native American lands lie permits such gaming for any purpose by
any person,
- 27 -
<PAGE>
organization or entity; (b) the gaming is not otherwise specifically prohibited
on Native American lands by federal law; (c) the gaming is conducted in
accordance with a tribal ordinance or resolution which has been approved by the
NIGC; (d) a Native American tribe has sole proprietary interest and
responsibility for the conduct of gaming; (e) the primary management officials
and key employees are tribally licensed; and (f) several other requirements are
met. Class III Gaming is permitted on Native American lands if the conditions
applicable to Class II Gaming are met and, in addition, the gaming is conducted
in conformance with the terms of a written agreement between a tribal government
and the government of the state within whose boundaries the tribe's lands lie (a
"tribal-state compact").
IGRA requires states to negotiate in good faith with Native American tribes
that seek to enter into a tribal-state compact for the conduct of Class III
Gaming. Such tribal-state compact may include provisions for the allocation of
criminal and civil jurisdiction between the state and the Native American tribe
necessary for the enforcement of such laws and regulations, taxation by the
Native American tribe of such activity in amounts comparable to those amounts
assessed by the state for comparable activities, remedies for breach, standards
for the operation of such activity and maintenance of the gaming facility,
including licensing, and any other subjects that are directly related to the
operation of gaming activities. The terms of tribal-state compacts vary from
state to state. Compacts within one state tend to be substantially similar to
each other. Compacts usually specify the types of permitted games, entitle the
states to inspect casinos, require background investigations and licensing of
casino employees and vendors, and may require the tribe to pay a portion of the
state's expenses for establishing and maintaining regulatory agencies.
Other Jurisdictions and Government Approvals
- --------------------------------------------
Most of the other jurisdictions in which the Company and its subsidiaries
conduct business or intend to conduct business in the future require various
licenses, permits, findings of suitability or other approvals (collectively
"Government Approvals") in connection with the manufacture and/or distribution
of gaming devices or provision of goods or services to the Lottery and Racing
Industries. Some jurisdictions allow the Company to operate under a temporary
Government Approval or on a transactional basis during the pendency of a
comprehensive background investigation. While the Company has received
Government Approvals in all of the jurisdictions in which the Company's
applications have been acted upon, there can be no assurance that required
Government approvals will be given or renewed in the future.
Most of the jurisdictions in which the Company and its subsidiaries conduct
business or intend to conduct business in the future require gaming devices to
meet certain standards and specifications established by each jurisdiction. In
addition, most jurisdictions require gaming devices to be reviewed and approved
either by the regulatory agency or an independent testing laboratory prior to
the gaming devices being sold or offered for public play. The Company has
received or is seeking such approvals for its gaming devices, but there can be
no assurance that such approvals will be maintained or that additional requisite
approvals will be obtained.
Additional Financial Information
- --------------------------------
Certain financial information for each of the Company's last three fiscal
years with respect to industry segments and foreign and domestic operations and
export sales is set forth in Notes 2 and 3 of the Company's Consolidated
Financial Statements.
- 28 -
<PAGE>
ITEM 2. PROPERTIES
The Company's executive offices, principal manufacturing and distribution
facilities occupy approximately 82,000 square feet in a building owned by the
Company and located in Bozeman, Montana. The Company leases approximately 38,000
square feet serving as a warehouse/assembly facility in the Bozeman area and
approximately 8,000 square feet serving as executive offices in Atlanta,
Georgia.
The Company's on-line lottery services subsidiary, AWI, leases facilities
in New Jersey located in a complex of which AWI occupies approximately 43,000
square feet and in Arden Hills, Minnesota, where AWI occupies approximately
13,000 square feet. In connection with its operations in the various
jurisdictions, AWI occupies approximately 40 additional sites, most of which it
holds under lease. The Company leases space in Reno (4,800 square feet) and Las
Vegas (13,900 square feet), Nevada, Biloxi, Mississippi (1,000 square feet) and
Victoria, Australia (1,000 square feet), primarily for product sales and support
as well as assembly, repair and storage of gaming machine products. Also in
Bozeman, Montana, the Company leases approximately 5,300 square feet out of
which it operates one of its route businesses. The Company also owns two
buildings, one in Billings, Montana and one in Livingston, Montana, out of which
it operates its other two route businesses.
The Company leases approximately 1,500 square feet of office space near
Baltimore, Maryland for the administrative offices of United Tote. United Tote
leases approximately 12,100 square feet in San Diego, California, which
primarily houses the subsidiary's research and development activities, and
leases approximately 2,900 square feet of space in Winnipeg, Canada, for
administrative and repair services.
The Company's racetrack facility in Sunland Park, New Mexico, rests on
approximately 150 acres and contains in excess of 330,000 square feet inclusive
of the casino, grandstand, stables, barns and offices. The racetrack itself is a
one-mile oval track.
The Company's Bozeman, Montana facility and the real property located at
Sunland Park are subject to mortgages held by the Company's primary lender.
ITEM 3. LEGAL PROCEEDINGS
In December 1996, a purported class action was filed in the Court of
Chancery, Delaware State Court, directing the Company and certain officers and
directors of the company to fulfill their fiduciary obligations by effecting a
transaction for the acquisition of the Company. On January 2, 1997, the Company
and certain other officers and directors of the Company filed a motion to
dismiss the matter. This matter has been informally stayed for an indefinite
period of time by agreement of the parties.
In February of 1999, GTECH Corporation filed a complaint for declaratory
judgment, injunction, and violation of the Public Records Law against the State
of Florida, Department of Lottery and AWI in the Circuit Court, Second Judicial
Circuit, in Leon County, Florida. The complaint requests the Circuit Court to
declare the contract between AWI and the Florida Lottery void in the event the
First District Court of Appeal of Florida upholds the Florida Lottery's decision
to award the on-line lottery services contract to AWI. Subsequent to the
execution of the renegotiated contract between AWI and the Florida Lottery in
March 1999, GTECH Corporation amended the complaint. The Company believes this
action is entirely without merit and intends to vigorously defend this action.
Although the Company is a party to various claims and legal actions arising
in the ordinary course of its business, in the opinion of management, after
consultation with legal counsel, the ultimate disposition of these other matters
as they are currently understood will not likely have a material adverse effect
on the financial position or results of operations of the Company.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
None
- 29 -
<PAGE>
PART II
ITEM 5. MARKET FOR THE COMPANY'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS
The Company's Common Stock trades on The Nasdaq Stock Market under the
symbol PWRH. From July 24, 1991 until December 31, 1997, the Company's Common
Stock traded under the symbol VLTS. Prior to that time, there was no public
market for the Common Stock. The following table sets forth the high and low bid
prices for the common shares for the periods indicated as reported by Nasdaq.
YEAR High Low
---- ---- ---
1998
Quarter ended December 31, 1998 $14.56 $8.63
Quarter ended September 30, 1998 $12.00 $7.38
Quarter ended June 30, 1998 $14.44 $7.75
Quarter ended March 31, 1998 $15.25 $9.88
1997
Quarter ended December 31, 1997 $12.75 $8.75
Quarter ended September 30, 1997 $11.38 $5.94
Quarter ended June 30, 1997 $6.25 $3.50
Quarter ended March 31, 1997 $4.88 $3.25
As of March 1, 1999, there were approximately 900 holders of record of the
Company's Common Stock. Since its formation in May 1991, the Company has not
paid any dividends to its stockholders. The Company currently intends to retain
any earnings to help finance the growth and development of its business and does
not anticipate paying cash dividends on its capital stock in the foreseeable
future. Any future determination as to the payment of dividends on its Common
Stock will depend, among other things, on the future earnings, capital
requirements and financial condition of the Company, and on such other factors
as the Company's Board of Directors may consider relevant. In addition, the
Company's existing bank line of credit restricts the payments of dividends by
the Company. (See Note 10 to the Consolidated Financial Statements.)
- 30 -
<PAGE>
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, 1998, are derived from the
consolidated financial statements of the Company and subsidiaries, which
financial statements have been audited by KPMG LLP, independent certified public
accountants. The consolidated financial statements as of December 31, 1998 and
1997, and for each of the years in the three-year period ended December 31,
1998, 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 1998 1997 1996 1995 1994
---- ---- ---- ---- ----
<S> <C> <C> <C> <C> <C>
REVENUES:
Lottery systems $103,581 94,771 88,843 91,653 101,559
Gaming machines and systems 53,215 57,626 43,632 46,086 53,149
Pari-mutuel systems 20,028 20,177 20,499 20,144 13,831
Gaming operations 24,327 24,361 23,707 23,279 20,243
-------- ------- ------- ------- -------
Total revenues 201,151 196,935 176,681 181,162 188,782
COSTS OF REVENUES
Lottery systems 62,281 62,558 59,333 59,438 62,397
Gaming machines and systems 30,054 31,766 21,084 24,912 28,808
Pari-mutuel systems 12,879 12,784 12,545 14,176 9,338
Gaming operations 20,019 19,873 19,386 19,189 15,661
-------- ------- ------- ------- -------
125,233 126,981 112,348 117,715 116,204
-------- ------- ------- ------- -------
Gross profit 75,918 69,954 64,333 63,447 72,578
OTHER OPERATING EXPENSES:
Selling, general and administrative 36,635 31,655 28,697 31,140 34,000
Research and development 10,011 9,788 7,969 8,888 8,513
Other charges --- --- 34,135 2,763 23,994
Depreciation and amortization 19,701 21,995 23,822 22,587 20,694
-------- ------- ------- ------- -------
66,347 63,438 94,623 65,378 87,201
-------- ------- ------- ------- -------
Earnings (loss) from operations 9,571 6,516 (30,290) (1,931) (14,623)
Other income (expense) (1,590) (2,869) (2,694) (1,833) (242)
-------- ------- ------- ------- -------
Earnings (loss) before income taxes and
extraordinary items 7,981 3,647 (32,984) (3,764) (14,865)
Income tax benefit (expense) (3,405) 1,135 8,753 846 (1,303)
-------- ------- ------- ------- -------
Net earnings (loss) from continuing operations 4,576 4,782 (24,231) (2,918) (16,168)
Reversal of loss on discontinuance of
pari-mutuel systems, net --- --- 5,482 (5,482) ---
-------- ------- ------- ------- -------
Net earnings (loss) before extraordinary items 4,576 4,782 (18,749) (8,400) (16,168)
Extraordinary gain, net --- 13,269 4,014 --- ---
-------- ------- ------- ------- -------
Net earnings (loss) $ 4,576 18,051 (14,735) (8,400) (16,168)
======== ======= ======= ======= ========
</TABLE>
- 31 -
<PAGE>
<TABLE>
<CAPTION>
Years Ended December 31,
1998 1997 1996 1995 1994
---- ---- ---- ---- ----
<S> <C> <C> <C> <C> <C>
EARNINGS (LOSS) PER SHARE DATA:
Basic:
Continuing operations $0.43 0.46 (2.28) (0.28) (1.56)
Net earnings (loss) $0.43 1.75 (1.39) (0.80) (1.56)
===== ==== ===== ===== =====
Diluted:
Continuing operations $0.42 0.46 (2.28) (0.28) (1.56)
Net earnings (loss) $0.42 1.72 (1.39) (0.80) (1.56)
===== ==== ===== ===== =====
Weighted average shares:
Basic 10,580 10,329 10,635 10,555 10,337
Potential Common Stock(1) 323 160 --- --- ---
------ ------ ------ ------ ------
Diluted 10,903 10,489 10,635 10,555 10,337
====== ====== ====== ====== ======
</TABLE>
<TABLE>
<CAPTION>
As of December 31,
1998 1997 1996 1995 1994
---- ---- ---- ---- ----
<S> <C> <C> <C> <C> <C>
BALANCE SHEET DATA
Working capital $41,177 37,050 28,083 19,987 23,344
Total assets 188,475 161,397 168,043 165,851 174,032
Total long-term debt
(excluding current installments) 51,765 31,446 9,312 12,885 9,060
Stockholders' equity 87,978 82,146 72,231 86,448 94,112
</TABLE>
(1) Excluded if antidilutive
- 32 -
<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 1998 Year 1997
1998 1997 1996 Over 1997 Over 1996
---- ---- ---- --------- ---------
<S> <C> <C> <C> <C> <C>
Revenues:
Lottery systems 51.5 48.1 50.3 9.3 6.8
Gaming machines and systems 26.4 29.3 24.7 (7.6) 32.1
Pari-mutuel systems 10.0 10.2 11.6 --- (2.0)
Gaming operations 12.1 12.4 13.4 (0.4) 3.0
----- ----- -----
100.0 100.0 100.0 2.2 (11.5)
----- ----- -----
Costs and expenses:
Lottery systems 31.0 31.7 33.6 (0.3) 5.4
Gaming machines and systems 15.0 16.2 11.9 (5.3) 50.7
Pari-mutuel systems 6.4 6.5 7.1 0.8 2.4
Gaming operations 9.9 10.1 11.0 0.5 2.6
Selling, general and administrative 18.2 16.0 16.3 15.8 10.1
Research and development 5.0 5.0 4.5 2.0 22.5
Depreciation and amortization 9.8 11.2 13.5 (10.5) (7.6)
Other charges --- --- 19.3 --- (100.0)
----- ----- -----
95.2 96.7 117.1 0.6 (7.9)
---- ----- -----
Earnings (loss) from operations 4.8 3.3 (17.1) 47.7 (121.5)
Other expense, net (0.8) (1.5) (1.5) (44.8) 7.4
----- ----- -----
Net earnings (loss) before income taxes
and extraordinary items 4.0 1.8 (18.6) 122.2 (110.9)
===== ===== =====
</TABLE>
As a holding company whose principal assets are the securities of its
subsidiaries, the Company's ability to meet debt service obligations and pay
operating expenses and dividends, if authorized by the Company's board of
directors, depends primarily on the receipt of sufficient dividends from those
operating subsidiaries. In addition, gaming statutes and license requirements in
the jurisdictions in which the Company's subsidiaries currently operate or may
operate in the future may require the maintenance of minimum amounts of
statutory capital and place certain restrictions upon the amount of dividends
that the Company's subsidiaries may pay.
The success of the Company will be dependent, to a significant extent, upon
the continued services of a relatively small group of executive personnel. The
loss or unavailability of one or more of such executive officers or the
inability to attract or retain key employees in the future could have an adverse
effect upon the Company's operations.
Revenues
- --------
Revenue from the lottery systems segment consists primarily of a
contractual percentage of lottery ticket sales in certain states in the U. S. as
well as revenue from software license fees and sales of on-line lottery
equipment. Software license fees and equipment sales revenue is generally
generated from customers outside of the United States. The segment revenue will
experience fluctuations depending on
- 33 -
<PAGE>
contract start and end dates, relative sizes of jackpots and the number of
terminals on-line and selling tickets. The Company expects lottery systems
revenue to continue to be a significant component of consolidated revenues.
Lottery systems revenue is generated by the Company's subsidiary, AWI.
Revenue from the gaming machines and systems segment consists of sales,
repair, service and lease of gaming machines and related parts as well as the
development and sale of central control systems inclusive of software and
hardware to the video lottery and casino markets. If and when new jurisdictions
approve legislation for new or expanded gaming venues, or when the Company first
enters a new jurisdiction (assuming the Company is successful in obtaining sales
contracts in any such jurisdictions), the segment may experience a surge in
sales revenue. Subsequently, revenues from that jurisdiction may or may not
experience significant volatility. The volatility would depend on among other
things, technology availability, timing of replacement, and legislative
expansion. The Company expects gaming machines and systems revenue to continue
to be a significant component of consolidated revenues. Gaming machines and
systems revenue is primarily generated by the Company's subsidiary, VLC.
The Company is actively seeking to expand its operations into jurisdictions
that have legalized gaming. There can be no assurance, however, that the Company
will be able to identify or capitalize on any opportunities in suitable markets.
The Company's ability to expand will be dependent upon a number of factors many
of which are beyond the Company's control, including negotiating acceptable
terms, securing required state, foreign, and local licenses, permits, and
approvals, securing adequate financing on acceptable terms, voter and other
political approvals, demographic trends, and consumers' gaming preferences. As a
result, there can be no assurance that the Company will be able to develop new
markets for its products. In addition, the Company may incur costs in connection
with pursuing new lottery and gaming opportunities that it cannot recover and
may be required to expense certain of these costs, which may negatively affect
the Company's reported operating performance for the periods during which such
costs are incurred.
Revenue from pari-mutuel systems is generated primarily from a contractual
percentage of handle processed through computerized pari-mutuel wagering systems
from over 120 contracts in North America. Outside North America, the Company's
practice had been primarily sales and lease of pari-mutuel wagering systems.
While on-track attendance and handle from pari-mutuel wagering in the United
States has declined over the last decade there has also been a substantial
increase in simulcast and off-track wagering handle. Due to the significant
increase of alternate forms of gaming over 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 pari-mutuel systems revenue
to be a significant component of consolidated revenues.
Gaming operations revenue consists of revenue from the Company's gaming
machine route operations and the operation of a horse racing facility in Sunland
Park, New Mexico. In 1999, the gaming operations segment will include revenues
generated from the operation of a casino which opened in February 1999 at
Sunland Park. Route operations revenue consists primarily of gaming machine
wagers net of payouts to patrons and state gaming taxes.
Gross Profit
- ------------
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 system 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 sales of gaming machines and systems include direct
costs of production, including labor and allocated manufacturing overhead. Costs
and expenses related to gaming operations include direct and indirect costs of
operating the racetrack facility and the location owners' share of the net
machine revenues for route operations. Costs and expenses related to pari-mutuel
systems revenue include direct and indirect costs associated with the operation
of the wagering equipment at racetracks as well as direct costs of equipment
sales.
- 34 -
<PAGE>
Selling, General and Administrative Expenses
- --------------------------------------------
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
- ------------------------
Research and development costs represent costs incurred to gain and develop
new knowledge applicable to the Company's various operating segments. Labor,
material, consulting, occupancy and other expenses associated with the research
and development efforts are included in the costs. Development costs are
capitalized for certain software developed for sale or lease.
Other Charges
- -------------
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 special and unusual charges from
the calculation of gross profit due to the nature of each charge as disclosed in
the discussion of gross profit margin for each segment of the Company's
operations. Such other charges are considered special and unusual in nature and
are not associated with the revenue stream of any segment of the Company's
operations. Accordingly, the Company believes that the inclusion of such other
charges in the determination of gross profit would not be indicative of past,
current or future gross profit margins. The Company has not incurred any "other
charges" since 1996.
Year 2000
- ---------
The Year 2000 issue is pervasive and complex. Virtually every information
technology ("IT") system, including the Company's internal systems, systems
delivered to customers, and suppliers' systems, as well as non-IT systems will
be affected in some way by the rollover of the two-digit year value to "00".
Non-IT systems include manufacturing systems and physical facilities including,
but not limited to, security systems and utilities. The result could create
errors in information or system failures. Recognizing this uncertainty,
management has and is continuing to actively analyze, assess and plan for
various Year 2000 issues. Management has appointed a task force that reports
periodically to the Company's CEO and Board of Directors, and has also engaged
outside consultants to assist and advise management in this assessment process.
The Company's Year 2000 team has completed an inventory of all of its
computer systems and technology that may be impacted by Year 2000 issues. The
programming and testing of mission critical systems was virtually complete by
the end of 1998 and contingency plans are planned for completion by April 1999.
In calendar year 1999, the Company plans to replace or upgrade those systems
that are identified as non-Year-2000 compliant at an incremental cost of
approximately $0.5 million. Non-IT system issues are more difficult to identify
and resolve. The Company is actively identifying non-IT Year 2000 issues
concerning its products and services, as well as its physical facility
locations. As non-IT areas are identified, management formulates the necessary
actions to ensure minimal disruption to its business processes. Although
management believes that its efforts will be successful and the costs will be
immaterial to its consolidated financial position and results of operations, it
also recognizes that any failure or delay could cause a disruption in its
business and may have a significant financial impact.
The Company has evaluated its strategy and legal obligations for any
communication to its customers. The Year 2000 readiness of its customers varies,
and the Company is encouraging its customers to evaluate and prepare their own
systems. In many cases the Company is assisting customers by providing new or
modified systems to resolve Year 2000 issues.
The Company is also assessing the Year 2000 readiness of its key suppliers.
The Company's direction in this effort is to ensure the adequacy of resources
and supplies to minimize any potential business interruptions. Management
expects to complete this part of its Year 2000 readiness plan in the first half
of 1999. As part of the Company's contingency plans, management will, as
considered
- 35 -
<PAGE>
necessary, begin to identify and communicate with alternative suppliers to
ensure the continuation of its critical business operations.
The Company believes that because of modifications already made and current
plans for additional modifications of existing computer systems, updates by
vendors and conversion to new software, the Year 2000 issue will not pose
significant operations problems for the Company. However, if such modifications
and conversions are not completed properly or in a timely manner, or third party
software and systems relied on by the Company fail, the Year 2000 issue could
have a material impact on the business and operations of the Company. The costs
of modifications and conversions are not anticipated to be material, and will
principally represent a re-deployment of existing or otherwise planned
resources. No assurance can be given that the Company will successfully avoid
any problems associated with the Year 2000 issue.
1998 compared with 1997
- -----------------------
Consolidated revenues increased by $4.2 million, or 2%, to $201.2 million
from $196.9 million in 1997. The consolidated gross profit increased by $6.0
million, or 9%, to $75.9 million from $69.9 million in 1997. Earnings from
operations were $9.6 million in 1998 as compared to $6.5 million in 1997.
Earnings from operations as a percentage of revenues were 4.8% in 1998 as
compared to 3.3% in 1997. Earnings before depreciation, amortization, interest
and taxes ("EBITDA") were $29.3 million in 1998 and $28.5 million in 1997.
Lottery Systems
- ---------------
Total revenues from the lottery systems segment increased by $8.8 million,
or 9%, to $103.6 million from $94.8 million in 1997. Approximately, two-thirds
of the increase was generated from certain domestic on-line lottery customers
that experienced significantly higher lottery ticket sales. The remainder of the
increase reflects additional sales of lottery terminals and systems to
international and domestic customers.
The lottery system segment's growth and profitability is dependent upon
management's strategy to selectively bid on domestic lottery contracts and
continue to pursue international opportunities. In addition to finalizing
replacement contracts with the Pennsylvania Lottery in 1998 and the Florida
Lottery in 1999, the Company was awarded contracts by the South Dakota and
Indiana lotteries in 1998. The South Dakota Lottery has been a customer of the
Company since 1990. In 1998, the Pennsylvania and Florida contracts combined
accounted for over 25% of consolidated revenues. The new contracts with Florida,
Pennsylvania and South Dakota have start-up dates in 1999.
Also in 1998, the Company was awarded contracts to deliver lottery systems
or terminals in Vietnam, Norway and Switzerland. The delivery of the lottery
system to Vietnam is in process at December 31, 1998 and the contract to deliver
the lottery system to Switzerland is anticipated to be finalized in the second
quarter 1999.
Lottery contracts for thirteen state lotteries (of which the Company is
currently party to only one) are expected to be up for procurement over the next
three years. Given the significant cost of bidding for new lottery contracts,
the Company targets those states that it believes has established a bidding
process based exclusively on technical capability, price and service. This
strategy allows the Company to efficiently allocate its resources so that it may
also pursue international growth opportunities. The Company is currently
pursuing a number of jurisdictions worldwide that are expected to implement
on-line lottery programs within the next two years. In 1998, revenue from
lottery systems sales to international customers was $8.8 million as compared to
$8.7 million in 1997.
Additionally, the Company's sophisticated on-line lottery system,
MasterLink(TM), affords the Company the ability to develop add-on products and
services. Given the maturity of the on-line lottery industry, state lotteries
desire ways to increase lottery ticket sales and reduce costs. The Company
continues to develop new products and services for its existing customers to
enhance revenues as well as reduce operating costs.
- 36 -
<PAGE>
The gross profit margin for lottery system revenues was 40% in 1998 as
compared to 34% in 1997. The gross profit margin from service revenues was 40%
in 1998 and 33% in 1997. The gross profit on lottery systems and terminal sales
was 50% in 1998 and 48% in 1997. The Company expects gross profit margins for
lottery systems revenues to be 35% to 40% in 1999; however, numerous factors
could cause the margins to vary significantly from expectations.
Gaming Machines and Systems
- ---------------------------
Revenue from the gaming machines and systems segment decreased by $4.4
million, or 8%, to $53.2 million from $57.6 million in 1997. The Company
recorded revenue on shipments of 5,290 units in 1998 as compared to 7,047 units
in 1997. Revenue from leases of gaming machines was $8.4 million in 1998 as
compared to $11.0 million in 1997.
The decline in units and revenues from 1997 levels reflects a significant
level of efforts devoted on bidding for gaming machine sales to the Ontario
video lottery program that was cancelled in 1998. Despite the diversion of
resources to the Ontario bid, the Company more then doubled sales revenue from
the casino market in 1998 compared to 1997. In 1997, the Company delivered
nearly 1,700 gaming machines to Quebec as compared to none in 1998; however,
pursuant to a contract awarded in 1998, the Company will deliver a gaming system
and related communications equipment to Quebec worth approximately $13.0 million
during 1999 and 2000. In the fourth quarter 1998, the Company delivered 600
gaming machines to Peru under a sale and participation agreement. Also in 1998,
the Company was awarded contracts or received orders for gaming machines and
systems in Victoria and South Australia to be delivered to customers in 1999 and
2000.
The growth and success of the gaming machines and systems segment is
dependent upon the Company's ability to expand its leading position in the video
lottery gaming market, penetrate established casino markets such as Nevada and
New Jersey and participate in the growth of new markets. The Company believes
that new markets and the replacement of older gaming machines and systems in
Australia and North America will provide for future growth opportunities for
this segment.
Increasing sales to established casino markets such as Nevada and New
Jersey is primarily dependent on the Company's ability to gain visibility and
acceptance of its gaming machines in the markets while offering a competitive
price. The Company believes that its gaming machines are capable of producing
above average play and net win amounts given gaming machine graphics and
playability.
Developing casino opportunities at pari-mutuel racetracks is dependent
initially upon the enactment of legislation to allow gaming at racetrack
facilities. A small number of states, including New Mexico, Iowa, West Virginia,
Delaware, Rhode Island and Louisiana have enacted legislation to allow gaming at
racetracks. The Company anticipates the trend to continue although there can be
no assurances that such programs will be implemented.
The gross profit margin on gaming machines and systems revenue was 44% in
1998 as compared to 45% in 1997. Revenue from leasing of gaming machines has
minimal ongoing direct costs. Depreciation expense of gaming machines under
lease and revenue share agreements is recorded as a component of depreciation
and amortization expense in the Company's consolidated financial statements.
Although there can be no assurance given, the Company expects gross profit
margin levels in this segment to remain around the 40% level.
Pari-mutuel Systems
- -------------------
Revenue from pari-mutuel systems service contracts was approximately $20
million in 1998 and 1997. Included in the $20.0 million amounts are sales of
equipment of $2.0 million in 1998 and $2.5 million in 1997.
The gross profit margin from pari-mutuel systems revenue was approximately
36% in 1998 and 1997 and is expected to remain at that level. Sales of
pari-mutuel equipment generated gross profit of $0.8 million in 1998 and $1.2
million in 1997.
- 37 -
<PAGE>
Recent declines in general attendance at pari-mutuel facilities has created
pricing pressures for the Company and its competitors. The Company does not
anticipate those pricing pressures to decrease in the near future. Accordingly,
the Company plans to maintain profitability by improving customer service while
maintaining or reducing operating costs. Additionally, as discussed in the
gaming machines and systems segment, a number of jurisdictions have recently
enacted legislation allowing casino style gaming at pari-mutuel racetracks and
facilities. The Company believes that this expansion of gaming at racetracks
will increase the attendance at the racetracks. The Company provides wagering
systems and service to over 120 of the approximate 350 pari-mutuel facilities in
North America.
Gaming Operations
- -----------------
The gaming operations segment generated approximately $24.3 million of
revenue in 1998 and 1997. Revenue from gaming machine route operations was $17.4
million in 1998 and $17.7 million in 1997 and revenue from the operation of the
racetrack in Sunland Park was approximately $6.9 million in 1998 and 1997. The
segments revenue in 1999 will include revenues generated from casino gaming at
the racetrack facility which started in February 1999. The addition of casino
gaming at the racetrack is expected to significantly increase revenues and
profitability over current levels, however, the Company cannot reliably predict
the level of success of casino gaming at the racetrack.
The gross profit margin on route operations revenue was 27% in 1998 and
1997. Gross profit from racetrack operations was ($0.4) million in 1998 and
($0.3) million in 1997.
Selling, General and Administrative Expenses
- --------------------------------------------
Selling, general and administrative ("SG&A") expenses increased by $5.0
million, or 16%, to $36.6 million from $31.6 million in 1997. The increase
primarily reflects higher labor expenses in the areas of business development,
sales and marketing and engineering. The Company anticipates 1999 SG&A expenses
to increase with anticipated business growth and future development; however,
should revenue growth become unlikely, management would implement expense
reduction measures.
Research and Development
- ------------------------
In 1998, the Company expended $10.0 million on research and development
activities as compared to $9.8 million in 1997. In 1997, the Company capitalized
approximately $1.0 million of software development costs in conjunction with the
development of the Company's lottery systems MasterLink(R) central system
software. Research and development expenditures were approximately 4.9% and 5.5%
of consolidated revenues in 1998 and 1997, respectively. The Company is
increasing research and development efforts to maintain and improve its
competitive position.
1997 Compared with 1996
- -----------------------
Consolidated revenues increased by $20.3 million, or 11%, to $196.9 million
from $176.6 million in 1996. The consolidated gross profit increased by $5.6
million, or 9%, to $69.9 million from $64.3 million in 1996. Earnings from
operations were $6.5 million in 1997 as compared to a loss from operations of
$30.3 million in 1996. The 1996 loss from operations included $34.1 million of
special and unusual charges recorded by the Company discussed below. Absent the
special and unusual charges, 1996 earnings from operations would have been
approximately $3.8 million. Earnings from operations as a percentage of revenues
were 3.3% in 1997 as compared to 2.2% in 1996 without the special and unusual
charges.
Lottery Systems
- ---------------
Total revenues from the lottery systems segment increased by $5.9 million,
or 7%, to $94.7 million from $88.8 million in 1996. The increase reflects higher
revenues from certain domestic on-line lottery contracts as well revenues from
the Company's installation and sale of an on-line lottery system in Chile. 1996
lottery system revenues include approximately $7.3 million from lottery
contracts with the Arizona and Washington lottery authorities. Both contracts
terminated in 1996.
- 38 -
<PAGE>
In 1997, revenue from lottery systems sales to international customers was
$8.7 million as compared to $3.1 million in 1996.
The gross profit margin from lottery systems revenue was 34% in 1997 as
compared to 33% in 1996. The gross profit margin from lottery system service
revenues was 33% in 1997 and 1996. The gross profit on lottery terminal and
system sales was 48% in 1997 and 12% in 1996.
In 1996, the Company recorded approximately $31.0 million of special and
unusual charges associated with the lottery systems segment. The charges
consisted of $18.0 million for inventory reserves and write-downs, $8.4 million
for contractual liabilities and settlement of customer disputes that arose
primarily during the Company's former relationship with EDS and $4.6 million for
impairment of intangible and other assets related to an on-line lottery
contract. These charges have been excluded in the determination of gross profit
due to their unusual nature and are not considered by the Company to be
indicative of anticipated future operating results.
Gaming Machines and Systems
- ---------------------------
Revenue from the gaming machines and systems segment increased by $14.0
million, or 32%, to $57.6 million from $43.6 million in 1996. Revenue was
recognized on shipments of 7,047 units in 1997 as compared to 6,235 units in
1996. Revenue from leases of gaming machines was $11.0 million in 1997 as
compared to $10.7 million in 1996.
The increase in revenues over 1996 levels reflects increased sales in
international markets of Quebec, Canada and South Africa as well as domestic
jurisdictions of Nevada, New Jersey and Minnesota. These increased levels of
sales were offset by reductions in sales in international markets of Norway,
Peru and Alberta, Canada.
The gross profit margin on gaming machines and systems revenue was 45% in
1997 as compared to 52% in 1996. The decrease reflects the relative higher
revenues from sales in Quebec, Canada. Revenue from leasing of gaming machines
has minimal ongoing direct costs. Depreciation expense of gaming machines under
lease and revenue share agreements is recorded as a component of depreciation
and amortization expense.
Pari-mutuel Systems
- -------------------
Revenue from pari-mutuel systems service contracts was $17.5 million in
1997 as compared to $18.4 million in 1996. The decrease is the result of the
closure of two customer facilities in Wisconsin and Texas, the loss of two
customers to competitors, and decreased revenues from a Philippine customer
resulting from contractual handle rate decreases and a currency devaluation in
Asia. These decreases were partially offset by increased revenues generated from
the start up of live racing at Lone Star Park in Texas, additional services
under existing contracts, and increased levels of simulcasting in the industry.
In 1997, United Tote signed contracts with two new customers and renewed
contracts with seventeen existing customers. Included in contract renewals in
1997 were extension of contracts with Churchill Downs, Turfway Park, and the Red
Mile in Kentucky. Pari-mutuel wagering systems equipment sales were $2.5 million
in 1997 as compared to $2.1 million in 1996.
The gross profit margin from pari-mutuel systems revenue was approximately
36% in 1997 and 39% in 1996. Sales of pari-mutuel equipment generated gross
profit of $1.2 million in 1997 compared with $.9 million in 1996. The decrease
is the result of the closure of two customer facilities in Wisconsin and Texas,
the loss of two customers to competitors, and decreased revenues from a
Philippine customer resulting from contractual handle rate decreases and the
Asian currency devaluation. Increased operating expenses related to
implementation of a comprehensive employee training program, and liquidated
damages payments to two customers also contributed to the decreased margins.
Gaming Operations
- -----------------
Revenue from route operations was $17.7 million in 1997 as compared to
$16.5 million in 1996. The gross profit margin from route operations revenue was
27% in 1997 and 29% in 1996.
- 39 -
<PAGE>
Racetrack operation revenues were $6.8 million in 1997 and $7.2 million in
1996. The decrease reflects the Company's decision in 1997 to hold fewer live
racing days, which are not profitable. Gross profit for the racetrack operations
was $(.3) million in 1997 and 1996.
Selling, General and Administrative Expenses
- --------------------------------------------
Selling, general and administrative expenses increased by $3.0 million, or
10%, to $31.7 million from $28.7 million in 1996. The Company expended more
capital and resources for marketing and proposal efforts in 1997 over 1996
levels. The increased expenditures were in the Company's on-line lottery and
gaming machine segments which account for over 86% of the Company's 1997
consolidated revenues.
Research and Development
- ------------------------
In 1997, the Company expended $9.8 million (net of capitalization) on
research and development activities as compared to $8.0 million in 1996. The
Company capitalized approximately $1.0 million in 1997 and $4.1 million in 1996
of software development costs in conjunction with the development of the
Company's MasterLink(R) central system software. In 1997 the Company implemented
new modules and other significant enhancements in a number of on-line lottery
systems provided to domestic and international customers. Research and
development expenditures were approximately 5.5% and 6.8% of consolidated
revenues in 1997 and 1996, respectively.
Liquidity and Capital Resources
- -------------------------------
In 1998 the Company generated $19.3 million of cash from operations as
compared to $35.9 million in 1997 representing a number of fluctuations in
operating assets and liabilities. The fluctuations include an increase in
inventory levels, deferred income taxes and accounts receivable and a decrease
in accounts payable and accrued liabilities. Working capital increased by
approximately $4.1 million from December 31, 1997 to $41.2 million at December
31, 1998.
Approximately $34.9 million was invested in property, equipment and
intangible and other assets in 1998 as compared to $9.0 million in 1997.
Approximately $22.2 million has been expended for the initial implementation
cost of the on-line lottery system in Pennsylvania in 1998 and an additional
$19.0 is expected for 1999. The Company spent $4.5 million in 1998 on the
development of the casino at Sunland Park and $3.6 million to manufacture and
install new tote equipment. The Company anticipates expending an additional $3
to $4 million on the casino development and start-up in the first quarter 1999.
In October 1998, the Company completed negotiations for a $100.0 million
(with an option for an additional $25.0 million) credit facility with Lehman
Brothers, Inc. The credit facility replaces the credit facility with U. S. Bank
and, among other things, provides for two $25.0 million term loans maturing in
five and six years, respectively, and a revolving line of credit for $50.0
million expiring September 30, 2003. The Company may utilize up to $15.0 million
of the $50.0 million revolving line of credit as collateral for its bonding
program. Contractual obligations at December 31, 1998 required approximately
$8.5 million in outstanding letters of credit. The proceeds from the two $25.0
million term loans were used to pay off existing debt of approximately $27.9
million and provide capital for existing commitments to manufacture and
implement the on-line lottery system in Pennsylvania, continue the development
of the Company's gaming machine casino at the racetrack in Sunland Park, New
Mexico and other anticipated contracts. At December 31, 1998, the Company had
approximately $41.5 million available under the revolving line of credit.
In March 1999, the Company announced that AWI and the Lottery had
renegotiated and signed an amended contract under which AWI will provide an
on-line lottery system and related services to the Florida Lottery. A decision
by the Lottery not to join the multi-state game Powerball(R) necessitated the
renegotiation of the contract entered into in October 1998. Under the amended
contract, the Company will design, install and operate a new statewide on-line
lottery system for an initial term of five years and three months, with two,
two-year renewal options. The Company estimates that revenues from the contract
over the initial 63-month period will be approximately $200 million. AWI will be
compensated at a
- 40 -
<PAGE>
base rate of on-line sales, and, if on-line ticket sales exceed targeted
amounts, an additional incentive rate. The October 1998 contract between AWI and
the Department of Lottery of the State of Florida was for a nine-year term. The
Lottery had originally awarded the contract to AWI in October 1996 after a
competitive procurement process in which the Lottery's evaluation committee
judged AWI the most highly qualified vendor based on its superior technology and
lower cost. Subsequent to the announcement of the contract award in 1996, the
losing vendor filed two consecutive protests, both of which were rejected,
resulting in a final order from the Lottery awarding the contract to AWI in
March 1998. A further attempt by the losing vendor to enjoin the contract was
rejected by the Florida district court, allowing the parties to negotiate and
finalize the terms of the nine-year agreement.
The Company has entered into a contract with the Pennsylvania Lottery to
replace the contract the Company currently has with the lottery. The new
contract expires in December 2005.
In October 1998, the Company announced that its on-line division, AWI, had
been selected by the Hoosier Lottery to provide a new on-line lottery system and
related services for the State of Indiana. The decision by the Lottery was the
result of a competitive procurement in which several companies participated. In
January 1999, the Company announced that AWI had signed a contract with the
Hoosier Lottery of the State of Indiana to provide the on-line lottery system,
terminals and system operation for seven years with extension options for up to
an additional three years. Revenues from the initial seven-year contract are
estimated to exceed $80 million. The Hoosier Lottery Commission formally
approved the AWI contract in December after announcing the award in October. AWI
will install its MasterLink(TM) Advanced Gaming System along with approximately
4,000 lottery retailer terminals. The scheduled date for completion of the
conversion to the new AWI system from the Lottery's current vender is August 29,
1999.
Total anticipated capital requirements for the Company is estimated at
approximately $60.0 million for 1999. The Company believes that anticipated cash
from operations, borrowing available under the current credit facility and
current working capital are sufficient to satisfy anticipated capital
requirements; however, the Company cannot provide assurance that anticipated
cash flows will be adequate.
- 41 -
<PAGE>
ITEM 7a. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
The Company is exposed to the risk of foreign currency exchange rate
fluctuations. The tables below illustrate the portion of the Company's sales and
receivables denominated in foreign currencies. All foreign receivables are
expected to be collected within the next twelve months. The Company does not
currently hedge against foreign currency exposures.
<TABLE>
<CAPTION>
(Amounts in millions)
1998 1997 1996
----------------- ----------------- -----------------
<S> <C> <C> <C> <C> <C> <C>
Total revenues $201.2 100.0% $196.9 100.0% $176.7 100.0%
Revenues denominated in
foreign currencies $9.2 4.6% $20.3 10.3% $16.6 9.4%
Transaction gain (loss) included
in net income $(0.4) --- $(0.7) --- $0.1 ---
Total accounts and notes
receivable $38.0 100.0% $31.6 100.0%
Receivables denominated in:
Canadian dollars 0.4 1.1% 5.9 18.7%
Australian dollars 0.7 1.8% 2.3 7.3%
Other 0.1 0.2% 0.2 0.6%
</TABLE>
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
Page
----
Index to Consolidated Financial Statements
Independent Auditors' Report 43
Consolidated Financial Statements:
Statements of Earnings for the years
ended December 31, 1998, 1997 and 1996 44
Balance Sheets as of December 31, 1998 and 1997 45
Statements of Stockholders' Equity for the years
ended December 31, 1998, 1997 and 1996 46
Statements of Cash flows for the years
ended December 31, 1998, 1997 and 1996 47
Notes to Consolidated Financial Statements 48
All schedules are omitted because the information prescribed thereon is neither
applicable nor required or is furnished in the consolidated financial statements
or notes thereto.
- 42 -
<PAGE>
(KPMG LLP logo)
P. O. Box 7108
Billings, MT 59103
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, 1998 and 1997,
and the related consolidated statements of earnings, stockholders' equity and
cash flows for each of the years in the three-year period ended December 31,
1998. 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, 1998 and 1997 and the
results of their operations and their cash flows for each of the years in the
three-year period ended December 31, 1998 in conformity with generally accepted
accounting principles.
/S/ KPMG LLP
Billings, Montana
February 19, 1999
- 43 -
<PAGE>
<TABLE>
<CAPTION>
POWERHOUSE TECHNOLOGIES, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF EARNINGS
(in thousands except for share data)
Years Ended December 31
-----------------------
1998 1997 1996
---- ---- ----
<S> <C> <C> <C>
REVENUES:
Lottery systems $103,581 94,771 88,843
Gaming machines and systems 53,215 57,626 43,632
Pari-mutuel systems 20,028 20,177 20,499
Gaming operations 24,327 24,361 23,707
-------- ------- -------
Total revenues 201,151 196,935 176,681
COSTS OF REVENUES:
Lottery systems 62,281 62,558 59,333
Gaming machines and systems 30,054 31,766 21,084
Pari-mutuel systems 12,879 12,784 12,545
Gaming operations 20,019 19,873 19,386
-------- ------- -------
125,233 126,981 112,348
-------- ------- -------
Gross Profit 75,918 69,954 64,333
OTHER OPERATING EXPENSES:
Selling, general and administrative 36,635 31,655 28,697
Research and development 10,011 9,788 7,969
Depreciation and amortization 19,701 21,995 23,822
Other charges --- --- 34,135
-------- ------- -------
66,347 63,438 94,623
-------- ------- -------
Earnings (loss) from operations 9,571 6,516 (30,290)
-------- ------- -------
OTHER INCOME (EXPENSE):
Interest and other income 1,454 1,021 1,060
Interest expense (3,044) (3,890) (3,754)
-------- ------- -------
(1,590) (2,869) (2,694)
-------- ------- -------
Earnings (loss) before income taxes and extraordinary items 7,981 3,647 (32,984)
Income tax (expense) benefit (3,405) 1,135 8,753
-------- ------- -------
Net earnings (loss) from continuing operations 4,576 4,782 (24,231)
Reversal of loss on discontinuance of pari-mutuel systems, net --- --- 5,482
-------- ------- -------
Net earnings (loss) before extraordinary items 4,576 4,782 (18,749)
Extraordinary gain, net --- 13,269 4,014
-------- ------- -------
Net earnings (loss) $ 4,576 18,051 (14,735)
======== ======= =======
EARNINGS (LOSS) PER SHARE DATA:
Basic:
Continuing operations $0.43 0.46 (2.28)
Net earnings (loss) $0.43 1.75 (1.39)
===== ==== =====
Diluted:
Continuing operations $0.42 0.46 (2.28)
Net earnings (loss) $0.42 1.72 (1.39)
===== ==== =====
Weighted average shares:
Basic 10,580 10,329 10,635
Potential Common Stock(1) 323 160 ---
------ -------- ------
Diluted 10,903 10,489 10,635
====== ====== ======
</TABLE>
(1) Excluded if antidilutive
See accompanying notes to consolidated financial statements.
- 44 -
<PAGE>
POWERHOUSE TECHNOLOGIES, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
(in thousands except for share data)
<TABLE>
<CAPTION>
December 31,
------------
1998 1997
---- ----
<S> <C> <C>
ASSETS
Current assets:
Cash and cash equivalents $ 16,371 13,772
Restricted cash and deposits 1,992 1,423
Accounts receivable, net 21,786 25,839
Current installments of notes receivable, net 6,179 3,192
Inventories 18,630 15,942
Prepaid expenses 1,574 1,037
Deferred income taxes 9,549 11,444
-------- -------
Total current assets 76,081 72,649
-------- -------
Property and equipment, net 76,355 63,160
Restricted cash deposits 376 2,408
Notes receivable, excluding current installments 10,049 2,547
Goodwill, net 8,495 9,314
Intangible and other assets, net 17,119 11,319
-------- -------
$188,475 161,397
======== =======
LIABILITIES
Current liabilities:
Current installments of long-term debt $ 4,445 4,381
Accounts payable 12,611 9,513
Accrued expenses 17,848 21,705
-------- -------
Total current liabilities 34,904 35,599
-------- -------
Long-term debt, excluding current installments 51,765 31,446
Deferred income taxes 13,828 12,206
-------- -------
Total liabilities 100,497 79,251
-------- -------
Commitments and contingencies (Note 15)
STOCKHOLDERS' EQUITY
Preferred stock, $.01 par value. Authorized 10,000,000 shares; no
shares issued --- ---
Common stock, $.01 par value. Authorized 25,000,000 shares 106 105
Paid-in capital 91,304 89,451
Deferred restricted stock compensation (815) (217)
Accumulated deficit (2,617) (7,193)
-------- -------
Total stockholders' equity 87,978 82,146
-------- -------
$188,475 161,397
======== =======
</TABLE>
See accompanying notes to consolidated financial statements.
- 45 -
<PAGE>
POWERHOUSE TECHNOLOGIES, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
(in thousands except for share data)
<TABLE>
<CAPTION>
- ---------------------------------------------------------------------------------------------------------------------
Series A Deferred
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, 1995 $19 107 97,284 (453) (10,509) 86,448
Net loss --- --- --- --- (14,735) (14,735)
Amortization of deferred restricted
stock compensation --- --- 133 36 --- 169
Stock issued under stock purchase
plan --- 1 348 --- --- 349
----- ---- ------ ------ ------- ------
December 31, 1996 19 108 97,765 (417) (25,244) 72,231
Net earnings --- --- --- --- 18,051 18,051
Stock options exercised and shares
issued under stock purchase plan --- 2 762 --- --- 764
Shares redeemed pursuant to
EDS settlement (19) (5) (9,076) --- --- (9,100)
Amortization of deferred restricted
stock compensation --- --- --- 200 --- 200
----- ---- ------ ------ ------- ------
December 31, 1997 --- 105 89,451 (217) (7,193) 82,146
Net earnings --- --- --- --- 4,576 4,576
Restricted stock issued --- 1 1,062 (1,063) --- ---
Amortization of deferred restricted
stock compensation --- --- --- 465 465
Proceeds from sale of common stock,
net --- 2 2,078 --- --- 2,080
Stock options exercised and shares
issued under stock purchase
plan --- 1 1,135 --- --- 1,136
Stock redemptions --- (3) (2,422) --- --- (2,425)
----- ---- ------ ------ ------- ------
December 31, 1998 $ --- 106 91,304 (815) (2,617) 87,978
===== ==== ====== ====== ======= ======
- ---------------------------------------------------------------------------------------------------------------------
</TABLE>
<TABLE>
<CAPTION>
- -----------------------------------------------------------------------------------------------------------
Share Amounts 1998 1997 1996
---------- ---------------------------- ------------------------------
Common Series A Common Series A Common
Balance Stock Preferred Stock Stock Preferred Stock Stock
- -----------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C>
Beginning of year 10,477,952 1,912,728 10,829,184 1,912,728 10,682,109
Restricted stock issued 108,000 --- --- --- 30,000
Sale of common stock 220,204 --- --- ---
Stock options exercised and
shares issued 127,161 --- 194,222 117,075
Stock redemptions (285,000) (1,912,728) (545,454) --- ---
---------- ---------- ---------- --------- ----------
End of year 10,648,317 --- 10,477,952 1,912,728 10,829,184
========== ========== ========== ========= ==========
</TABLE>
See accompanying notes to consolidated financial statements.
- 46 -
<PAGE>
POWERHOUSE TECHNOLOGIES, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(in thousands)
<TABLE>
<CAPTION>
Years Ended December 31
-----------------------
1998 1997 1996
---- ---- ----
<S> <C> <C> <C>
CASH FLOWS FROM OPERATING ACTIVITIES:
Net earnings (loss) $ 4,576 18,051 (14,735)
Adjustments to reconcile net earnings (loss) to
net cash provided by operating
activities:
Reversal of provision for loss on sale of
pari-mutuel systems operations --- --- (5,482)
Depreciation and amortization 19,701 21,995 23,822
Other charges --- --- 34,135
Extraordinary gain, net --- (13,269) (4,014)
Other, net 60 337 79
Changes in operating assets and liabilities:
Sales of receivables --- --- 1,467
Receivables, net (6,118) (7,191) 1,942
Inventories (2,110) 5,709 (3,489)
Prepaid expenses (80) (10) 235
Accounts payable 3,099 2,867 2,006
Accrued expenses (3,392) 6,649 (10,854)
Income taxes 3,517 806 (6,411)
------- ------- -------
Net cash provided by operating activities 19,253 35,944 18,701
------- ------- -------
CASH FLOWS FROM INVESTING ACTIVITIES:
Expenditures on property and equipment (28,456) (6,977) (25,522)
Expenditures on intangible and other assets (6,485) (1,974) (10,037)
Proceeds from sales of equipment 395 117 109
Change in restricted cash deposits 1,463 (70) 700
------- ------- -------
Net cash used in investing activities (33,083) (8,904) (34,750)
------- ------- -------
CASH FLOWS FROM FINANCING ACTIVITIES:
Net payments on notes payable --- (7,650) (600)
Proceeds from issuance of long-term debt 50,000 643 4,365
Payments of loan origination fees (2,041) --- ---
Repayments of long-term debt (32,321) (11,220) (13,079)
Amounts payable to EDS --- --- 27,343
Redemption of common stock (2,425) --- ---
Proceeds from sale of common stock 2,080 --- ---
Common stock sold under employee benefit plans 1,136 637 349
------- ------- -------
Net cash provided by (used in) financing activities 16,429 (17,590) 18,378
------- ------- -------
Net increase in cash and cash equivalents 2,599 9,450 2,329
Cash and cash equivalents, beginning of year 13,772 4,322 1,993
------- ------- -------
Cash and cash equivalents, end of year $16,371 13,772 4,322
======= ======= =======
</TABLE>
See accompanying notes to consolidated financial statements.
- 47 -
<PAGE>
(1) SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Principles of consolidation. The consolidated financial statements include
the accounts of Powerhouse Technologies, Inc. and subsidiaries (the "Company").
Prior to January 1, 1998 the Company was known as Video Lottery Technologies,
Inc. All significant intercompany balances and transactions have been eliminated
in consolidation.
Revenue recognition. Revenue from the sale of lottery, gaming and
pari-mutuel system equipment and related parts is recognized upon delivery to
the customer. Revenue from sales of lottery systems and video gaming central
site systems (including customized software 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. 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.
Lottery and pari-mutuel 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 lottery and pari-mutuel
wagering networks. Revenues under these contracts are generally based on a
percentage of sales volume, which may fluctuate over the lives of the contracts.
Gaming operations revenue consists of route and racetrack operations.
Route operations revenue consists primarily of gaming machine 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.
Cash and cash equivalents. Cash deposits and all highly liquid debt
instruments with maturity dates of three months or less when purchased are
considered cash equivalents in the statements of cash flows.
Restricted cash and deposits. Cash deposits expected to be refunded or
released within one year are classified as restricted short-term deposits. The
deposits are for bonds, required by customers, for proposals and performance
under long-term contracts and for prize purses at the Company's horse racing
facility.
Inventories. The Company manufactures inventories for sale and lease.
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 and allocated
indirect manufacturing overhead.
Property and equipment. Property and equipment is stated at cost. Equipment
acquired under capital leases is recorded 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. The Company manufactures
equipment used in the provision of services pursuant to long-term contracts.
Depreciation of property 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 executed contract extensions) as follows:
Item Estimated life
---- --------------
Lottery and pari-mutuel systems equipment 3 - 9 years
Gaming equipment 3 - 7 years
Buildings and improvements 7 - 40 years
Machinery and equipment 3 - 10 years
Furniture and fixtures 5 - 10 years
- 48 -
<PAGE>
Equipment purchased under capital leases is depreciated on a straight-line
basis over the shorter of the lease term or estimated useful life of the asset.
Goodwill, intangible and other assets. Goodwill, which represents the
excess of purchase price over fair value of net assets acquired, is being
amortized on a straight-line basis through 2009. Accumulated amortization was
$4.6 million at December 31, 1998 and $3.8 million at December 31, 1997.
Intangible and other assets are stated at cost net of accumulated
amortization. Intangible and other assets are amortized over their respective
economic useful lives of up to ten years. Accumulated amortization of intangible
and other assets was approximately $8.9 million at December 31, 1998 and $6.9
million at December 31, 1997.
Long-lived assets and certain identifiable intangibles are 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.
Foreign currency transactions and remeasurements. Gains and losses from
foreign currency transactions and remeasurements are included in results of
operations.
Interest rate hedging. The Company uses interest rate swaps to manage
exposure to interest rate fluctuations on its variable rate debt. Premiums paid
on interest rate hedges are deferred and amortized to interest expense over the
term of the hedge contract.
Income taxes. Deferred tax assets and liabilities are generally determined
based on the difference 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 share. In the fourth quarter 1997, the Company adopted the
Financial Accounting Standards Board ("FASB") Statement of Financial Accounting
Standards No. 128 ("SFAS 128"), "Earnings per Share ("EPS")", issued in February
1997. Under SFAS 128 basic EPS includes no dilution and is computed by dividing
income available to common stockholders by the weighted-average number of common
shares outstanding for the period. Diluted EPS reflects the potential dilution
of securities that could share in the earnings of an entity. The Company has a
complex capital structure as defined under SFAS 128. Diluted weighted average
common shares includes potential common stock of approximately 323,000 and
160,000 shares for the years ended December 31, 1998 and 1997. The Company had
losses from continuing operations in 1996. Accordingly, potential common stock
has been excluded from weighted average share computations for that year because
inclusion would have been anti-dilutive.
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 11 for fair value estimates of notes receivable and long-term
debt.)
Stock based compensation plans. Stock-based compensation is recognized
using the intrinsic value method. For disclosure purposes (see Note 13), pro
forma earnings and earnings per share data are provided as if the fair value
method had been applied.
Reclassifications. Certain reclassifications have been made to the 1997 and
1996 amounts to conform to the 1998 presentation. The Company reorganized its
reportable segments in 1998 to reflect changes in the management organization
and how the related financial information is used internally to monitor and
evaluate segment performance and resource allocation. The gaming operations
reporting segment was created and includes operating and financial position
information from the Company's
- 49 -
<PAGE>
Montana route operations and the Company's racetrack operations in Sunland Park,
New Mexico. Previously, the route operations were included with the gaming
machines and systems segment and racetrack operations were included in
pari-mutuel systems segment data.
Accounting pronouncements not yet adopted. In April 1998, the American
Institute of Certified Public Accountants' Accounting Standards Executive
Committee issued Statement of Position (SOP) 98-5, "Reporting on the Costs of
Start-up Activities," which requires that start-up costs and organization costs
be expensed as incurred under certain circumstances. This statement is effective
for fiscal years beginning after December 15, 1998, with early application
permitted. The Company will adopt SOP 98-5 beginning January 1, 1999.
Accordingly, certain start-up costs incurred prior to January 1, 1999 will then
be charged to expense as a cumulative effect of a change in accounting principle
(net of tax effects), and subsequently such start-up costs will be expensed as
incurred. At December 31, 1998, the Company had capitalized $0.4 million related
to the start-up of its Sunland Park Casino. Upon adoption of this statement,
approximately $0.2 million, net of related tax effects, will be charged to
expense.
The FASB, in June 1998, issued SFAS No. 133, "Accounting for Derivative
Instruments and Hedging Activities," which establishes accounting and reporting
standards for derivative instruments, including certain derivative instruments
embedded in other contracts, and for hedging activities. This statement is
effective for all fiscal quarters of all fiscal years beginning after June 15,
1999, although earlier application is encouraged. The statement may not be
applied retroactively. The Company expects to adopt this statement effective
January 1, 1999, and does not expect adoption to have a material effect on
either its financial position or results of operations.
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.
Segment Information. In June 1997, the FASB issued Statement of Financial
Accounting Standards Number 131 (SFAS No. 131), "Disclosures about Segments of
an Enterprise and Related Information." SFAS No. 131 establishes standards for
the way public companies are to report information about operating segments in
annual financial statements and requires those enterprises to report selected
information about operating segments in interim financial reports issued to
stockholders. It also establishes standards for related disclosures about
products and services, geographic areas, and major customers. SFAS No. 131 is
effective for financial statements for periods beginning after December 15,
1997. The Company adopted SFAS No. 131 for the year ended December 31, 1997. The
adoption did not affect the Company's historical presentation of segment data;
however, in 1998, the operating segments were reorganized to reflect management
and other organizational changes within the Company. The reorganization included
combining the route operations and racetrack operations into the gaming
operations segment. Prior to the reorganization, the route and racetrack
operations were included in the gaming machines and systems and pari-mutuel
systems segments, respectively. The Company's casino operation in Sunland Park,
New Mexico will be included in the gaming operations segment upon start-up in
1999.
(2) BUSINESS SEGMENTS
The Company operates principally in four business segments: the sale,
design, manufacture, installation and operation of on-line lottery systems; the
design, manufacture, sale and leasing of video gaming machines and central
control systems and related services; gaming operations and the design,
manufacture, sale and operation of computerized pari-mutuel wagering systems for
dog and horse racing tracks.
- 50 -
<PAGE>
<TABLE>
<CAPTION>
Years Ended December 31,
------------------------
1998 1997 1996
---- ---- ----
(000s) (000s) (000s)
<S> <C> <C> <C>
Revenues:
Lottery systems $103,581 94,771 88,843
Gaming machines and systems 53,593 58,286 44,722
Pari-mutuel systems 20,258 20,194 20,499
Gaming operations 24,327 24,361 23,707
Less intercompany revenues (608) (677) (1,090)
-------- ------- -------
Total revenues $201,151 196,935 176,681
======== ======= =======
Operating profit (loss):
Lottery systems $15,340 4,896 (29,449)
Gaming machines and systems 3,145 9,111 7,954
Pari-mutuel systems 194 463 (1,975)
Gaming operations (686) (338) (541)
General corporate expenses (8,829) (7,866) (6,826)
Intercompany profit 407 250 547
-------- ------- -------
Total operating profit (loss) $ 9,571 6,516 (30,290)
======== ======= =======
Operating profit (loss) before "other charges":
Lottery systems $ 15,340 4,896 1,623
Gaming machines and systems 3,145 9,111 7,954
Pari-mutuel systems 194 463 1,088
Gaming operations (686) (338) (541)
General corporate expenses (8,829) (7,866) (6,826)
Intercompany profit 407 250 547
-------- ------- -------
Total operating profit before "other charges" $ 9,571 6,516 3,845
======== ======= =======
Capital expenditures:
Lottery systems $17,253 1,043 16,271
Gaming machines and systems 1,496 825 4,724
Pari-mutuel systems 3,720 4,084 3,149
Gaming operations 4,609 669 1,391
Corporate 1,416 548 403
Less intercompany step-up in basis (38) (192) (416)
-------- ------- -------
Total capital expenditures $ 28,456 6,977 25,522
======== ======= =======
Depreciation and amortization:
Lottery systems $ 10,290 12,509 14,248
Gaming machines and systems 2,657 3,328 3,851
Pari-mutuel systems 4,332 3,869 3,922
Gaming operations 2,032 2,159 2,221
Corporate 834 563 501
Less depreciation on intercompany step-up basis (444) (433) (921)
-------- ------- -------
Total depreciation and amortization $ 19,701 21,995 23,822
======== ======= =======
</TABLE>
<TABLE>
<CAPTION>
Years Ended December 31,
------------------------
1998 1997 1996
---- ---- ----
(000s) (000s) (000s)
<S> <C> <C> <C>
Identifiable assets:
Lottery systems $ 58,030 46,380 62,350
Gaming machines and systems 52,107 49,935 38,417
Pari-mutuel systems 22,357 21,527 19,982
Gaming operations 29,106 28,401 29,949
Corporate 27,937 16,621 19,067
Less intercompany step-up in basis (1,062) (1,467) (1,722)
-------- ------- -------
Total identifiable assets $188,475 161,397 168,043
======== ======= =======
</TABLE>
- 51 -
<PAGE>
Operating profit (loss) before "other charges" excludes special and other
charges discussed in Note 14.
A summary of revenues and related direct costs of revenues follows:
Years Ended December 31,
------------------------
1998 1997 1996
---- ---- ----
(000s) (000s) (000s)
Revenues:
Services $139,559 128,136 126,543
Tangible products 53,186 57,752 39,438
Lease 8,406 11,047 10,700
-------- ------- -------
$201,151 196,935 176,681
======== ======= =======
Costs of revenues:
Services $90,298 89,430 86,864
Tangible products 34,411 37,551 25,484
Lease 524 --- ---
-------- ------- -------
$125,233 126,981 112,348
======== ======= =======
Gross profit:
Services $41,713 38,706 39,679
Tangible products 26,323 20,201 13,954
Lease 7,882 11,047 10,700
-------- ------- -------
$75,918 69,954 64,333
======= ======= =======
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).
(3) REVENUE CONCENTRATION
The Company derives its revenues from equipment and system sales and
services to customers primarily in jurisdictions that have enacted governmental
legislation and/or regulatory controls over various types of gaming and wagering
activities. The Company recorded revenues from customers or distributors within
a specific gaming or wagering jurisdiction, subject to governmental legislation,
which accounted for more than 10% of the Company's consolidated revenues as
follows:
Years Ended December 31,
------------------------
1998 1997 1996
---- ---- ----
(000s) (000s) (000s)
Florida $29,273 31,528 30,203
Pennsylvania 22,639 23,042 23,164
Montana 23,449 23,434 22,458
======= ====== ======
Revenues from the lottery and pari-mutuel systems segments of the company
are primarily derived from contracts with terms up to ten years with varying
options for extensions and renewals.
Montana revenue includes total revenues from route operations of
approximately $17.4 million in 1998, $17.7 million in 1997, and $16.5 million in
1996.
Export Sales. The Company had total export sales from the United States of
approximately $22.9 million, $37.0 million and $28.6 million during the years
ended December 31, 1998, 1997 and 1996, respectively.
- 52 -
<PAGE>
(4) NOTES AND ACCOUNTS RECEIVABLE
A summary of receivables follows:
December 31,
------------
1998 1997
---- ----
(000s) (000s)
Trade $22,647 26,946
Notes receivable 16,403 5,964
------- ------
39,050 32,910
Less allowance for doubtful accounts (1,036) (1,332)
------- ------
$38,014 31,578
======= ======
The Company finances sales of gaming and pari-mutuel systems equipment to
certain customers meeting minimum credit standards. Installment notes bear
interest at rates up to 18% and mature from one to nine years. The Company
estimates the fair value of gross notes receivable at December 31, 1998 to
approximate carrying value of the associated notes receivable. This estimate is
based on current discount rates for instruments of similar credit quality
available in the secondary market.
At December 31, 1998, approximately 14% of the Company's receivables were
from various governments or their designated agencies.
Amounts charged to expense for estimated bad debts were approximately $0.3
million, $0.1 million and $0.2 million in the years ended December 31, 1998,
1997 and 1996, respectively. The Company wrote off previously reserved doubtful
accounts of approximately $0.5 million, $0.1 million and $2.1 million for the
years ended December 31, 1998, 1997 and 1996, respectively.
(5) INVENTORIES
A summary of inventories, net of valuation reserves, follows:
December 31,
1998 1997
(000s) (000s)
Manufacturing:
Raw materials $ 6,497 6,703
Work-in-process 1,166 662
Finished goods 9,604 7,427
Customer service and other 1,363 1,150
------- ------
$18,630 15,942
======= ======
The Company had reserves for inventories of approximately $4.0 million and
$8.2 million at December 31, 1998 and 1997, respectively, primarily related to
finished goods. The Company charged to expense approximately $0.3 million, $.1
million and $18.0 million in the years ended December 31, 1998, 1997 and 1996,
respectively, for reserves and impairments of inventories. Of these charges,
$18.0 million in the year ended December 31, 1996 related to the termination of
three on-line lottery projects for which inventory was specifically procured.
Inventory reserves were reduced by $4.5 million, $6.1 million and $9.0
million in the years ended December 31, 1998, 1997 and 1996, respectively, as
the applicable inventories were sold or otherwise disposed of. At December 31,
1998 and 1997, respectively, inventories included approximately 700 and 600
finished video gaming machines located in various casino gaming locations, under
trial arrangements with customers.
- 53 -
<PAGE>
(6) PROPERTY AND EQUIPMENT
A summary of property and equipment follows:
December 31,
------------
1998 1997
---- ----
(000s) (000s)
Lottery and pari-mutuel equipment systems $125,623 107,729
Land, buildings and improvements 19,085 14,669
Machinery and equipment 12,464 6,906
Gaming equipment 18,831 20,267
Furniture and fixtures 2,736 2,503
-------- -------
Total 178,739 152,074
-------- -------
Less accumulated depreciation (102,384) (88,914)
-------- --------
$ 76,355 63,160
======== =======
In 1997 the Company transferred to inventory, gaming equipment with a net
book value of approximately $2.2 million, due to the expiration of lease
agreements. In 1996, the Company transferred on-line lottery equipment with a
net book value of approximately $2.4 million to inventories in conjunction with
the termination of an on-line lottery contract. Other additions to gaming
equipment and on-line lottery equipment in the three-years ended December 31,
1998, are included in the Consolidated Statements of Cash Flows as expenditures
on property and equipment.
Gaming equipment at December 31, 1998 and 1997 includes video gaming
machines with an aggregate cost of approximately $10.9 million and $13.4
million, respectively, and a carrying value of approximately $5.4 million and
$7.8 million, respectively, which are under lease or revenue sharing agreements
with customers. For the years ended December 31, 1998, 1997 and 1996,
depreciation expense on this equipment was approximately $1.7 million, $2.3
million and $2.8 million, respectively. Two lease agreements provide rent
payments to the Company based on a percentage of net gaming receipts. One of the
two agreements is on a month-to-month basis and 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 terminal 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 delivered through December
31, 1998, are approximately as follows:
Year ending December 31, (000s)
1999 $3,400
2000 2,713
2001 386
------
$6,499
======
(7) INTANGIBLE AND OTHER ASSETS
A summary of intangible and other assets, net of amortization, follows:
December 31,
------------
1998 1997
---- ----
(000s) (000s)
Software development costs $ 7,606 8,849
Deferred costs 9,513 2,470
------- ------
$17,119 11,319
======= ======
The Company capitalized approximately $1.0 million and $4.1 million of
software development costs in the years ended December 31, 1997 and 1996,
respectively. No costs were capitalized in 1998. The costs are primarily related
to the development of the MasterLink(TM) system.
- 54 -
<PAGE>
Deferred costs include the costs of implementing and installing lottery and
pari-mutuel systems used to provide services under long-term contracts. These
costs are amortized over the lives of the related contracts.
Total amortization expense of intangible and other assets (including
Goodwill) was approximately $2.8 million, $3.7 million and $4.2 million in 1998,
1997 and 1996, respectively. Amortization of software development costs,
included in total amortization expense, was approximately $1.2 million, $1.5
million and $1.3 million in 1998, 1997 and 1996, respectively.
(8) LEASE OBLIGATIONS
The Company has noncancelable operating leases for office space, equipment
and vehicles which expire at various dates over the next eleven years. Future
minimum lease payments under noncancelable operating leases as of December 31,
1998, are approximately as follows:
Year ending December 31, (000s)
------------------------
1999 $4,625
2000 3,770
2001 3,020
2002 2,368
2003 2,009
Thereafter 8,567
In 1998, 1997 and 1996, rental expense was approximately $5.0 million, $4.7
million and $0.8 million, respectively.
(9) ACCRUED EXPENSES
A summary of accrued expenses follows:
December 31,
------------
1998 1997
---- ----
(000s) (000s)
Labor and benefits $ 8,191 5,911
Deferred revenue and estimated costs to complete
long-term contract obligations 880 4,835
Other, combined 8,777 10,959
------- ------
$17,848 21,705
======= ======
Contracts involving a substantial construction component are recorded as
long-term contracts, and associated revenues are recognized on either the
percentage of completion or completed contract method. Included within Accrued
Expenses in the Company's consolidated balance sheets are the following balances
related to such contracts in process:
December 31,
------------
1998 1997
---- ----
(000s) (000s)
Costs and estimated earnings in excess of billings
on uncompleted contracts $2,124 ---
Billings in excess of costs and estimated earnings
on uncompleted contracts (2,162) (2,936)
------ ------
$ (38) (2,936)
====== ======
- 55 -
<PAGE>
(10) LONG-TERM DEBT
A summary of long-term debt, including capitalized lease obligations,
follows:
<TABLE>
<CAPTION>
December 31,
------------
1998 1997
---- ----
(000s) (000s)
<S> <C> <C>
Variable rate term loan (8.04% at December 31, 1998), quarterly
payments of $62,500 through 2004, remaining balance due
December 2004 $24,938 ---
Variable rate term loan (7.54% at December 31, 1998), quarterly
payments increasing from $625,000 to $3,125,000 through
September 2003 24,375 ---
Notes payable paid in October 1998 --- 30,303
8.25% note payable in monthly installments including interest,
through September 2001 4,240 4,940
4.95% to 10.4% various notes and capital lease obligations, due
in monthly installments of $4,189 to $40,448 including
interest maturing through February 2004 2,657 584
------- ------
56,210 35,827
Less current installments 4,445 4,381
------- ------
Long-term debt, excluding current installments $51,765 31,446
======= ======
</TABLE>
The aggregate maturities of long-term debt are as follows:
Year ending December 31, (000s)
1999 $ 4,445
2000 5,661
2001 5,743
2002 6,568
2003 10,033
Thereafter 23,760
-------
$56,210
=======
Cash paid for interest (including capitalized interest) was approximately
$4.6 million, $2.0 million and $2.6 million for the years ended December 31,
1998, 1997 and 1996, respectively. In 1998 the Company capitalized interest of
$0.5 million during construction of capital assets.
Based on interest rates currently available to the Company for borrowings
with similar terms and maturities, the fair value of long-term debt at December
31, 1998 approximates carrying value.
In October 1998, the Company completed negotiations for a $100.0 million
credit facility. The credit facility replaced an existing credit facility and,
among other things, provides for two $25.0 million term loans maturing in five
and six years, respectively, and a revolving line of credit for $50.0 million
expiring September 30, 2003. The credit facility is secured by stock of certain
subsidiaries, inventories, receivables, equipment, intellectual and other
property of the Company. At the Company's option, the credit facility bears
interest at a Base Rate approximating prime or LIBOR plus an applicable margin
percentage. The margin percentage above the LIBOR rate may fluctuate between
1.75% and 2.75% depending on the Company's consolidated leverage ratio as
defined in the credit facility agreements (collectively referred to as the
"Credit Agreement"). The Company may utilize up to $15.0 million of the $50.0
million revolving line of credit to collateralize its bonding program.
Contractual obligations at December 31, 1998 required approximately $8.5 million
in outstanding letters of credit. The Company purchased a 30-month interest rate
swap which caps the base rate interest rate on one of the $25 million
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term loans at 8.5%. Such cap expires 2001. The credit facility carries customary
restrictive covenants including but not limited to minimum leverage and cash
flow ratios, limitations on domestic and foreign capital investments,
restrictions on change in control, restrictions on payments of dividends,
maintenance of minimum consolidated net worth, limitations on additional debt,
liens and asset dispositions. Upon closing, in October, the Company advanced on
the two $25.0 million term loans. The proceeds were used to pay off existing
debt of approximately $27.9 million and provide capital for existing
commitments. At December 31, 1998 the Company had $42.5 million available under
the revolving line of credit.
(11) INCOME TAXES
Income tax expense (benefit) from operations consists of the following:
Years Ended December 31,
------------------------
1998 1997 1996
---- ---- ----
(000s) (000s) (000s)
Current:
Federal $ --- 343 (3,533)
State 14 1,281 70
Foreign (126) (14) ---
------ ----- ------
(112) 1,610 (3,463)
------ ----- ------
Deferred:
Federal 2,762 5,348 (3,614)
State 671 555 (1,602)
Foreign 84 33 (74)
------ ----- ------
3,517 5,936 (5,290)
------ ----- ------
3,405 7,546 (8,753)
Less tax expense on extraordinary items --- 8,681 ---
------ ----- ------
$3,405 (1,135) (8,753)
====== ===== ======
The provision for income tax expense (benefit) differs from the amount
which would be provided by applying the Federal statutory income tax rate of 35%
to income or loss from continuing operations before extraordinary items and
before income taxes as follows:
Years Ended December 31,
------------------------
1998 1997 1996
---- ---- ----
(000s) (000s) (000s)
Computed expected tax expense (benefit) $2,793 1,276 (8,403)
Extraordinary gain --- 7,683 (1,345)
State taxes, net of Federal impact 445 1,193 (996)
Change in valuation reserve (229) (3,000) 1,582
Non-deductible expenses 343 281 219
Goodwill amortization 288 287 287
Other, net (235) (174) (97)
------ ----- ------
$3,405 7,546 (8,753)
====== ===== ======
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<PAGE>
The tax effects of temporary differences and carryforwards that give rise
to deferred tax assets and liabilities consist of the following:
December 31,
------------
1998 1997
---- ----
(000s) (000s)
Deferred tax assets:
Allowance for doubtful accounts $ 407 507
Inventory reserves 1,585 3,237
Net operating loss carryforward and tax credits 9,174 7,867
Other 279 ---
Accrued liabilities 1,730 3,688
------- ------
Deferred tax assets 13,175 15,299
Less valuation reserve (3,626) (3,855)
------- ------
Net deferred tax assets 9,549 11,444
------- ------
Deferred tax liabilities:
Property and equipment, principally depreciation (8,376) (9,367)
Deferred costs (5,271) (3,202)
Lease obligations --- 128
Other (181) 235
------- -------
Net deferred tax liabilities (13,828) (12,206)
------- -------
Net deferred income tax asset (liability) $(4,279 (762)
======= =======
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 and carryforwards 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, 1998, management has a valuation reserve established
for deferred tax assets for which it is more likely than not that the Company
will not realize the benefits of these deductible differences and carryforwards.
This valuation reserve is evaluated and adjusted as facts and circumstances
affecting the Company's tax situation evolve and the likelihood of recovery of
deferred tax assets changes. During the fourth quarter of 1997 the valuation
reserve was adjusted as a result of the Company's 1997 cumulative earnings
substantiating that it is more likely than not that a portion of the deductible
differences will be realized.
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 that is actually paid will potentially be
allowed as a credit against regular tax in the future to the extent future
regular tax expense exceeds AMT. At December 31, 1998, the Company had
approximately $1.1 million of estimated AMT credit carryforwards. In addition,
at December 31, 1998, the Company had approximately $13.5 million of net
operating loss carryforwards primarily for Federal regular income tax purposes
which expire in 2011.
Net cash received from prior period refunds was approximately $0.2 million
in 1998, $1.9 million in 1997 and $2.4 million in 1996.
(12) EXTRAORDINARY ITEMS
In 1994, Electronic Data Systems Corporation ("EDS") purchased 545,454
shares of the Company's Common Stock and 1,912,728 shares of the Company's
Series A Junior Preferred Stock ("Series A Preferred Stock"). Additionally, the
Company entered into an 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 systems contracts.
In 1996, the Company withheld certain payments to EDS due to EDS performance
issues and related on-line lottery customer disputes. In mid-1996 the contract
with EDS was terminated and EDS filed a complaint against the Company seeking
payment of outstanding fees. On January 30, 1997, the Company and EDS settled
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<PAGE>
all claims against each other. The settlement resulted in a net of taxes
extraordinary gain on debt extinguishment of approximately $13.3 million ($1.29
and $1.26 per basic and diluted share, respectively) for the Company. The terms
of the settlement included the redemption by the Company of all of the Common
and Series A Preferred Stock owned by EDS, the transfer to the Company of
certain assets used in the provision of EDS services to on-line lottery
customers and the extinguishment of approximately $38.0 million of outstanding
fees in exchange for a note payable with a present value of $26.1 million. The
note was paid in October 1998. The transition of the EDS services and related
employees to the Company was completed in 1997.
The Company paid or accrued approximately $81.6 million to EDS for costs
and expenses in 1996. Of those costs and expenses approximately $5.1 million
were capitalized primarily in conjunction with software development and deferred
start-up costs in 1996.
In 1994, the Company completed the purchase of all of the outstanding stock
of United Wagering Systems, Inc. ("UWS"). During 1995, the Company did not pay
principal and interest obligations under the terms of the promissory notes to
the sellers because of disputes related to the acquisition. In March 1996, the
Company effected a settlement agreement resulting in a net of taxes
extraordinary gain of $4.0 million ($.37 per basic and diluted share) gain on
debt extinguishment.
In the fourth quarter 1995, the Company 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.
Accordingly, the results of operations of the wagering systems segment have been
reclassified to continuing operations. The estimated provision for loss on
disposal of approximately $5.5 million ($.52 per basic and diluted share),
recorded in 1995, was reversed in the third quarter of 1996.
(13) BENEFIT PLANS
The Company's 1994 Stock Incentive Plan (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 the Plan to 1,500,000. At December 31, 1998, the remaining
number of shares available for issuance under the Plan was approximately
163,000.
Options granted under the Plan are designated as either incentive stock
options or as non-incentive stock options. The term of an option may not exceed
10 years from the date the option is granted or 15 years in the case of certain
non-incentive stock options.
In February 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.
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<PAGE>
Weighted Average
Shares Exercise Price
------ ----------------
Year ended December 31, 1996
Outstanding, beginning of year 919,782 11.45
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
=========
Year ended December 31, 1997
Granted 232,000 5.58
Exercised (26,698) 7.23
Cancelled (126,208) 8.95
---------
Outstanding, end of year 1,002,683 8.04
=========
Exercisable, end of year 644,011 8.96
=========
Year ended December 31, 1998
Granted 286,000 11.65
Exercised (29,165) 5.40
Cancelled (44,854) 10.62
---------
Outstanding, end of year 1,214,664 8.86
=========
Exercisable, end of year 828,645 8.73
=========
Information regarding options outstanding and exercisable at December 31,
1998, follows:
<TABLE>
<CAPTION>
Options Outstanding Options Exercisable
Range of ----------------------------------------------- -------------------------
Exercise Weighted Average Weighted Average Weighted Average
Price Shares Exercise Price Remain Life (Yrs) Shares Exercise Price
-------- ------ ---------------- ----------------- ------ ----------------
<S> <C> <C> <C> <C> <C>
$3.00 - 5.00 268,301 $4.09 8.0 210,291 $4.17
$5.00 - 10.00 444,168 7.69 6.7 347,159 8.05
$10.00 - 15.00 460,195 12.10 7.5 229,195 12.60
$15.00 - 28.00 42,000 16.23 5.5 42,000 16.23
--------- -------
1,214,664 7.2 828,645
========= === =======
</TABLE>
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. In 1997, an additional
500,000 shares were authorized by a vote of stockholders bringing the total
number of shares authorized for issuance under the Stock Purchase Plan to
700,000. 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 97,997 shares
at $9.99 per share purchased in January of 1999 for the 1998 Purchase Period;
132,524 shares at $3.35 per share purchased in January of 1998 for the 1997
Purchase Period; and 117,075 shares at $2.98 per share purchased in January of
1997 for the 1996 Purchase Period. Under the Stock Purchase Plan, the Company
contributed approximately $322,000, $149,000 and $117,000 for 1998, 1997 and
1996, respectively. Remaining authorized shares available for issuance under the
plan were approximately 172,000 at December 31, 1998.
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 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
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fair value at the grant dates for awards under the plans consistent with the
method of Financial Accounting Standards Board Statement 123, the Company's net
earnings (loss) and per share amounts would have been as reflected in the
pro-forma amounts indicated below:
1998 1997 1996
(000s) (000s) (000s)
Net earnings (loss) $3,060 17,637 (15,352)
====== ====== =======
Net earnings (loss) per share:
Basic $0.29 1.71 (1.44)
===== ==== =====
Diluted $0.28 1.68 (1.44)
===== ==== =====
The fair value of the options granted and shares issued under the Company's
employee stock purchase plans in the three years ending December 31, 1998 was
estimated using the Black-Scholes model with the following assumptions: dividend
yield of 0%; expected life of 4 years for 1998, 5 years for 1997 and 1996, and a
risk-free interest rate of 5.25% for 1998 and 6% for 1997 and 1996. The
volatility factors used for the pro-forma amounts are 206% for 1998, 129% for
1997 and 57% for 1996.
Employees aged 21 and above are eligible to participate in the Company's
401(K) employee savings plan the first of the month after hire (or after one day
of service). Employer contributions are discretionary under the plan. Employer
contributions under the plan were approximately $783,000 in 1998, $607,000 in
1997and $237,000 in 1996.
(14) OTHER CHARGES
In 1996 the Company recorded approximately $34.1 million of special charges
for restructuring costs and asset impairments, consisting of $31.0 million
related to the on-line lottery segment and approximately $3.1 million related to
the wagering systems segment as discussed in Note 12.
(15) COMMITMENTS AND CONTINGENCIES
The Company has employment agreements with certain of its executive
officers that provide for lump sum severance payments and accelerated vesting of
options and restricted stock upon termination of employment under certain
circumstances or a change in control, as defined.
The Company is obligated to provide services and/or equipment under certain
of its contracts. In addition, the various state on-line lottery and video
gaming contracts contain provisions under which the Company may be subject to
monetary penalties for central computer downtime, terminal failures, delays in
servicing inoperable terminals within specified time periods and ticket stock
shortages among other things. The Company accrues any net losses in fulfilling
the terms of these contracts when the loss is probable and can be reasonably
estimated (see Note 14).
The Company typically posts bid, litigation, and performance bonds for
on-line lottery contracts. At December 31, 1998, the Company had collateral in
support of the various bonds outstanding consisting of $1.2 million of
restricted deposits and $7.5 million of irrevocable standby letters of credit.
Should the Company fail to meet contractually specified obligations during the
contract term, the lottery authority may assess damages and exercise its right
to collect on the applicable bond. The Company has had disputes with customers
over implementation schedules, deliverables and other issues. The Company works
with these customers to resolve these differences; however, should the Company
be unable to resolve any disputes in a mutually satisfactory manner, the Company
may suffer negative consequences in its relationships with these and other
customers and its pursuit of future business. The ultimate cost to the Company
of such damages (if any) would be net of its claims under risk management
policies in effect as appropriate.
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<PAGE>
The recovery of a significant amount of the Company's investment in the
racetrack operations in Sunland Park, New Mexico is largely contingent upon the
success of gaming at the racetrack. The Company's investment in the racetrack
operations is approximately $23.4 million and current plans call for
approximately $3 million to $4 million of additional expenditures for facility
enhancements, gaming machines and related equipment.
A significant percentage of the Company's consolidated revenues are derived
from sales to customers in jurisdictions that have enacted legislation
permitting various types of gaming. Such enacted legislation may change due to
political and economic conditions within the jurisdiction which could have a
material adverse effect upon the Company's financial position and results of
future operations.
International sales denominated in foreign currencies accounted for
approximately $9.2 million or 4.3% of the Company's consolidated revenues in
1998, $20.3 million or 10% of consolidated revenues in 1997 and $16.6 million or
9% of consolidated revenues in 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.
In March 1996, Ladbroke Holdings del Peru S.A. ("Ladbroke") filed an action
in the United States District Court, Eastern District of Michigan, against
United Tote Company and the Company. The complaint alleged, in part, that United
Tote had violated an agreement that it had entered with Ladbroke to "supply,
install, commission and operate" a number of wagering terminals and that United
Tote, without justification, notified Ladbroke that it was terminating the
agreement. Ladbroke alleged that United Tote and the Company's conduct
constituted a breach of contract, wrongful termination of contract, fraudulent
misrepresentation and tortious interference with contract/business relationship.
The complaint does not specify a damage figure but seeks recovery of all
"actual, incidental and consequential damages." The Company and United Tote
filed a counterclaim against Ladbroke alleging claims for breach of certain of
Ladbroke's obligations under the contract and unjust enrichment. The
counterclaim alleged, in part, that Ladbroke failed to identify a sufficient
number of viable retailer locations, and failed to promote, design and market
the game so as to create sufficient demand. The case is in discovery and the
Company intends to continue to vigorously defend the action. The Company cannot
reasonably predict the ultimate outcome of this litigation.
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.
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<PAGE>
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE.
None
PART III
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS
The directors and executive officers of the Company are as follows:
Name Age Position
---- --- --------
Richard R. Burt 52 Chairman and Director
James J. Davey (1)(2) 57 Vice Chairman and Director
Patricia W. Becker (1) 47 Director
John R. Hardesty (1)(2) 59 Director
Richard M. Haddrill 45 President, Chief Executive Officer, and
Director
Susan J. Carstensen 36 Chief Financial Officer and Treasurer
Michael L. Eide 48 President of Gaming Operations
Alan Rassaby 43 Senior Vice President of Legal and
Administration
Christer S. T. Roman 47 Senior Vice President of Product and Business
Development
- ----------
(1) Member of the Audit Committee.
(2) Member of the Compensation Committee.
Richard R. Burt became a director and chairman of the Company on December
15, 1994. Mr. Burt is a founder and the chairman of IEP Advisors, Inc. in
Washington D.C., a consulting and merchant banking firm. From 1991 to 1994, Mr.
Burt was a partner in McKinsey & Co., a world-wide management consulting firm.
During the period from 1989 to 1991, Mr. Burt served as the Chief Negotiator in
the Strategic Arms Reduction Talks (START) with the former Soviet Union. He was
the U.S. Ambassador to the Federal Republic of Germany from 1985 to 1989. Mr.
Burt was the Assistant Secretary of State for European and Canadian Affairs from
1983 to 1985, and served as Director of Politico-Military Affairs from 1981 to
1983. Mr. Burt also serves as the Chairman of the Board of Weirton Steel, Inc.,
a tin-plate manufacturer, and serves on the Board of Directors of the Paine
Webber Mutual Funds, Hollinger International, a company owning newspapers in
Europe, Canada, Australia and the United States, Archer Daniels Midland, an
agri-business company and Homestake, a gold mining company. In addition, Mr.
Burt is a member of the Textron Corporation's International Advisory Council
James J. Davey was elected as a director of the Company effective February
25, 1993, and was elected as vice chairman on May 31, 1994. He first joined the
Company as chief operating officer in October 1992. Mr. Davey served as chief
executive officer from February 25, 1993 until May 31, 1994, and from February
24, 1994 until May 31, 1994, he also served as president. From October 1992
until February 1993, Mr. Davey served as president of the Company's on-line
lottery services subsidiary, AWI. From 1986 to October 1992, Mr. Davey was the
director for the Oregon State Lottery. From 1985 to 1986, Mr. Davey was deputy
director and assistant director of administration for the Oregon State Lottery.
From 1980 through 1984, Mr. Davey served as administrator for the Oregon
Department of Revenue.
Patricia W. Becker was appointed to the Board of Directors effective
January 18, 1995 to fill a newly created position thereon. Ms. Becker is the
owner of Patricia Becker & Associates, a consulting firm. She is a consultant to
the Company and serves as chair of its Compliance Committee. Ms. Becker served
as the chief of staff to Bob Miller, Governor of Nevada, from October 1993 to
January 1995. Prior to that, she was senior vice president, general counsel and
secretary of Harrah's Casino Hotels from June 1989 to July 1993 and vice
president, general counsel and secretary from 1984 to 1989. Ms. Becker was
deputy and chief deputy attorney general assigned to the Nevada Gaming Division
from 1979 until she was appointed to the State Gaming Control Board, where she
served until September 1984. Ms. Becker is a
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<PAGE>
vice chair for the Gaming Law Section of the American Bar Association, a past
president of the Nevada Trial Lawyers Association and secretary and a trustee of
the International Association of Gaming Attorneys. Ms. Becker currently serves
on the Board of Directors of Fitzgeralds Gaming Company, a Nevada based company
which owns casinos.
John R. Hardesty was appointed to the Board of Directors effective December
18, 1996 to fill a vacancy thereon created by the resignation of Jeffrey D.
Cushman. Mr. Hardesty is chairman of Electro Dynamics Crystal Corporation, a
manufacturer of electronic components for the communication industry. Mr.
Hardesty also owns 100% of Thermo Dynamics, Inc., a manufacturer of synthetic
quartz for the electronics industry and investments, J.G. Inmobiliaria SA De.CV
and Inmobiliaria San Panchos De.RL De.CV, Mexican corporations which hold real
estate investments; and Zona Virtual SA De.CV, a Mexican corporation which is an
internet provider and computer sales and service company in Puerto Vallerta,
Mexico. Mr. Hardesty serves as a director and Chief Financial Officer of LeTeko,
Inc., a gold exploration company. From 1988 until its sale in 1995, Mr. Hardesty
was the owner and chairman of Dixson Inc., a manufacturer of electronic
instruments for the heavy-duty truck market and process control market.
Richard M. Haddrill was appointed as chief executive officer of the Company
on June 18, 1997 and as president of the Company and to its Board of Directors
on August 21, 1996. He filled the Board vacancy created by the resignation of
Stephen Vanderwoude. In addition, on June 18, 1997 he was appointed chief
executive officer of the Company's Automated Wagering International, Inc.
("AWI") subsidiary, and has served as president of AWI since December 1996. Mr.
Haddrill joined the Company in December 1994 as the Company's executive vice
president of operations and chief financial officer. He served as chief
financial officer until May 15, 1997. In December 1994, Mr. Haddrill was also
appointed treasurer of the Company. In August 1995, Mr. Haddrill was appointed
to the Board of Directors of the Company's United Wagering Systems, Inc. ("UWS")
subsidiary, and assumed the position of chief executive officer of UWS in
February 1996. From July 1992 until November 1994, Mr. Haddrill served as
executive vice president -- corporate and president of international
subsidiaries for Knowledgeware, Inc., a provider of application development
software and services worldwide. Prior to joining Knowledgeware, Inc. in 1991 as
an executive vice president and chief financial officer, Mr. Haddrill was the
managing partner of the Colorado and New Mexico offices of the accounting firm
of Ernst & Young from August 1989 to October 1991 and held various positions as
a partner or employee with Ernst & Young from January 1975 to September 1989.
Susan J. Carstensen was appointed treasurer of the Company on June 4, 1998
and has served as chief financial officer since May 15, 1997. Ms. Carstensen was
vice president, finance of the Company from November 7, 1996 to May 15, 1997.
From June 1995 to November 1996 she was corporate controller for the Company.
From February 1995 to June 1995 she was the director of internal audit for the
Company. Ms. Carstensen managed the cost and financial accounting for Martin
Marietta Astronautics Group in Denver, Colorado from May 1991 through February
1995. From August 1985 through May 1991 Ms. Carstensen was with the accounting
firm of Ernst & Young in Denver, Colorado.
Michael L. Eide was appointed President of the Company's recently formed
Gaming Operations Division overseeing the development of Sunland Park and the
Montana Route operations in June of 1998. He is also currently serving as vice
president and director of the Company's wholly-owned subsidiary, VLC. He had
served as president of VLC since December 1, 1994. Prior to that time he served
as treasurer and chief financial officer of the Company from May 1991 until
December 1994 and assistant secretary from October 1992 through December 1994.
He has also held the positions of secretary, treasurer and assistant secretary
with VLC during the period November 1990 through December 1994. From 1977 to
December 1988, Mr. Eide was a principal in the accounting firm of Neil,
Williamson, Eide and Staker in Bozeman, Montana.
Alan Rassaby joined the Company as Senior Vice President of Legal and
Administration on December 3, 1998. Prior to his appointment, Mr. Rassaby was a
partner at Phillips Fox, Lawyers. He has provided counsel to the Company since
1992. Mr. Rassaby was instrumental in developing gaming laws for the Australian
state of Victoria and was active in other government programs prior to joining
Phillips Fox.
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<PAGE>
Christer S. T. Roman joined the Company as Senior Vice President of Product
and Business Development on December 3, 1998. Prior to that time Mr. Roman
served five years as the managing director of EssNet AB, a Sweden-based lottery
systems supplier. From 1984 until 1992 Mr. Roman served as president of the
London-based Datech Group Plc, an international information systems company.
The Board of Directors adopted a new director compensation plan effective
July 1, 1998. Directors, who are not employees of the Company, receive a
calendar year retainer of $25,000 annually, 50% in quarterly cash payments and
50% in common stock of the Company, for serving on the Board of Directors, plus
$1,000 for each Board meeting and $1,000 for each Audit, Compensation or
Executive Committee meeting attended in person or $500 for each telephonic
meeting they attend. A non-employee director serving as chairperson of the
Company's Board of Directors receives an all inclusive calendar year retainer of
$100,000, 75% in quarterly cash payments and 25% in common stock of the Company,
for serving in such capacity. Each non-employee director who serves as the
chairperson of any committee of the Board of Directors receives a further fee of
$2,000 for each committee meeting attended for his or her services in such
capacity. Directors are also reimbursed for out-of-pocket expenses incurred in
attending Board of Directors and committee meetings. Non-employee directors also
receive $1,000 per day for time spent on licensing related matters or fulfilling
special assignments requested by the Chief Executive Officer, up to a maximum of
five (5) days per calendar year. Mr. Burt was granted an option to purchase
10,000 shares of Common Stock pursuant to the Company's 1994 Stock Incentive
Plan, and an option to purchase 20,000 shares pursuant to the Company's 1993
Stock Incentive Plan for Non-Employee Directors, with both options having an
exercise price of $8.25 per share; and Ms. Becker was granted an option to
purchase 10,000 shares of Common Stock pursuant to the Company's 1994 Stock
Incentive Plan and an option to purchase 20,000 shares pursuant to the Company's
1993 Stock Incentive Plan for Non-Employee Directors, with both options having
an exercise price of $9.28 per share. On August 12, 1996, concurrent with his
becoming a non-employee director, Mr. Davey received an option to purchase
10,000 shares of Common Stock pursuant to the Company's 1994 Stock Incentive
Plan and an option to purchase 20,000 shares pursuant to the Company's 1993
Stock Incentive Plan for Non-Employee Directors, with both options having an
exercise price of $3.41 per share. On December 18, 1996, concurrent with his
becoming a non-employee director, Mr. Hardesty received an option to purchase
10,000 shares of Common Stock pursuant to the Company's 1994 Stock Incentive
Plan and an option to purchase 20,000 shares pursuant to the Company's 1993
Stock Incentive Plan for Non-Employee Directors, with both options having an
exercise price of $4.13 per share. Effective June 4, 1998, each non-employee
director receives 500 shares of restricted common stock after each annual
meeting of stockholders. The restricted stock is issued under the Company's
stock incentive plan and the restrictions lapse in one-third increments
beginning on the first anniversary of the grant date. Directors who are
employees of the Company receive no additional compensation for serving as a
director, except that all directors and executive officers receive up to $10,000
in reimbursement of their expenses in connection with matters related to various
regulatory disclosure requirements and up to $1,500 per quarter thereafter to
keep such information current.
Section 16(a) - Beneficial Ownership Reporting Compliance
- ---------------------------------------------------------
Section 16(a) of the Securities Exchange Act of 1934, as amended (the
"Exchange Act"), requires the Company's directors and executive officers, and
persons who own more than ten percent of a registered class of the Company's
equity securities, to file by specific dates with the SEC initial reports of
ownership and reports of changes in ownership of Common Stock and other equity
securities of the Company on Forms 3, 4 and 5. Officers, directors and greater
than ten-percent stockholders are required by SEC regulations to furnish the
Company with copies of all Section 16(a) forms they file. The Company is
required to report any failure to file by the relevant due date any of these
reports based solely on the Company's review of copies of such reports furnished
to it and written representations received by the Company that the filing of a
Form 5 was not required. Based upon this review, the Company is not aware of any
person who at any time during 1998, was a director, officer or a beneficial
owner of ten percent or more of any class of equity securities of the Company
registered pursuant to the Exchange Act who failed to file on a timely basis
reports required by Section 16(a) of the Exchange Act during 1998.
- 65 -
<PAGE>
ITEM 11. EXECUTIVE COMPENSATION
The following table sets forth certain information for the year ended
December 31, 1998 and for years ended December 31, 1997 and 1996 concerning the
compensation of the chief executive officer as of December 31, 1998 and the most
highly compensated executive officers of the Company with compensation in excess
of $100,000 (other than the chief executive officer) who were serving as
executive officers as of December 31, 1998.
<TABLE>
<CAPTION>
SUMMARY COMPENSATION TABLE
Long Term Compensation
----------------------
Other Awards
Annual Compensation Annual ------ All Other
Name and ------------------- Compen- Restricted Stock Options Compen-
Principal Position Year Salary $ Bonus $ sation $ Stock $(1) (Shares) sation
- ------------------ ---- -------- ------- -------- ---------- ------------- ---------
<S> <C> <C> <C> <C> <C> <C> <C>
Richard M. Haddrill 1998 387,015 522,000 34,815(2) 452,000 50,000 ---
President and Chief 1997 260,523 430,000 154,189(2) --- --- ---
Executive Officer 1996 202,133 150,000 --- 133,200 140,000 ---
Susan J. Carstensen 1998 126,508 54,000 --- --- 15,000 ---
Chief Financial Officer 1997 100,031 48,000 --- --- 18,000 ---
and Treasurer 1996 69,276 5,000 --- --- --- ---
Michael L. Eide 1998 203,051 40,500 --- --- --- ---
President - Gaming 1997 203,256 126,000 --- 40,313 8,000 ---
Operations 1996 203,256 40,000 --- --- 20,000 ---
</TABLE>
- ----------
(1) With respect to Mr. Haddrill's restricted stock holdings, of the initial
grant in 1998 of 100,000 shares, 75,000 remained restricted as of January
1, 1999 with a market value of approximately $1,035,937. Restrictions lapse
on 25,000 shares each in January of 2,000, 2,001 and 2002. Mr. Haddrill was
also awarded 30,000 shares of restricted Common Stock in 1996, 10,000 of
which remained restricted as of December 31, 1998 with a market value of
approximately $145,000 and such restrictions on the 10,000 shares will
lapse in September 1999. (See "Employment and Other Contracts.") All
dividends declared and paid by the Company, if any, on the restricted
stock, shall be held by the Company until such restrictions thereon lapse
at which time the dividends, without interest thereon, shall be paid. Mr.
Eide received 3,000 shares of restricted stock in February 1998, of which
3,000 remain restricted at January 1, 1999, with an aggregate market value
of $41,437. Mr. Eide's restricted shares vest in one-third increments on
February 13, 1999, 2000 and 2001.
(2) Relocation assistance.
Option Grants in Last Fiscal Year
- ---------------------------------
The following table sets forth information with respect to options granted
under the Company's 1994 Stock Incentive Plan to each of the executive officers
and directors named in the Summary Compensation Table above during 1998.
- 66 -
<PAGE>
<TABLE>
<CAPTION>
OPTION GRANTS DURING 1998
Individual Grants
------------------------------------------------------- Potential Realizable Value
Number of Percent of at Assumed Annual Rates
Securities Total Options of Stock Price Appreciation
Underlying Granted to Exercise for Option Term(2)
Options Employees Price Expiration ---------------------------
Name Granted in 1998 (per Share)(1) Date 5% 10%
- ------------------- ---------- ------------- -------------- ---------- -------- ----------
<S> <C> <C> <C> <C> <C> <C>
Richard M. Haddrill 50,000(4) 17.5% $11.49 02/13/08 $520,034 $1,168,291
Susan J. Carstensen 7,000(3) 5.2% $11.49 02/13/08 $72,805 $163,561
8,000(3) 2.8% $12.06 12/14/08 $59,115 $151,262
Michael L. Eide --- --- --- --- --- ---
</TABLE>
- ----------
(1) All options were granted at an exercise price equal to the fair market
value of the Common Stock which is the average of the closing value of the
Common Stock for the 20 trading days immediately preceding the date of
grant. Such options may not be exercised later than 10 years, or earlier
than one year, after the date of grant.
(2) These amounts represent certain assumed rates of appreciation only. Actual
gains, if any, on stock option exercises are dependent on the future
performance of the Common Stock and overall market conditions. The amounts
reflected in this table may not necessarily be achieved.
(3) These options vest over a period of three years.
(4) These options fully vest on grant date.
The following table provides certain information with respect to the number and
value of unexercised options outstanding as of December 31, 1998.
<TABLE>
<CAPTION>
Aggregated 1998 Option Exercises
and December 31, 1998 Option Values
Number of Unexercised Options
(in Common Shares) Value of Unexercised In-the-Money
at December 31, 1998 Options at December 31, 1998(1)
----------------------------- ---------------------------------
Exercisable/Unexercisable Exercisable/Unexercisable
----------------------------- ---------------------------------
<S> <C> <C>
Richard M. Haddrill(2) 314,800/--- $1,605,570/---
Susan J. Carstensen 6,000/27,000 $43,744/$117,829
Michael L. Eide 77,333/2,667 $491,655/$26,670
</TABLE>
- ----------
(1) Options are in the money if the fair market value of the underlying
securities exceeds the exercise or base price of the option. Fair market
value of the Common Stock underlying the options on December 31, 1998 was
$13.81, the average of the high and low reported sales price on the Nasdaq
National Market System on that date, which does not exceed the base price.
(2) Mr. Haddrill exercised 8,000 options with an exercise price of $4.44 per
share on December 27, 1998.
DEFINED BENEFIT AND LONG-TERM COMPENSATION PLAN
- -----------------------------------------------
The Company does not have any defined benefit, actuarial or long-term
incentive plan.
- 67 -
<PAGE>
EMPLOYMENT AND CERTAIN OTHER CONTRACTS
Employment Agreement with Richard M. Haddrill: Pursuant to the terms of an
employment agreement with Mr. Haddrill approved by the Board of Directors on
February 26, 1998, Mr. Haddrill serves the Company as its president and chief
executive officer. Unless sooner terminated pursuant to its terms, the
employment agreement terminates on January 1, 2003 and is subject to one-year
extensions thereafter. The employment agreement provides for a base salary of
$380,000. Mr. Haddrill is eligible to receive annual bonuses up to twice the
base salary if certain performance criteria are satisfied for such year. In
addition, Mr. Haddrill was awarded 100,000 shares of restricted Common Stock
that vest at the rate of one-fourth annually over the next four years beginning
on January 1, 1999 and options to purchase 50,000 shares of Common Stock at an
exercise price of $11.48 per share, the average of the closing value of the
Common Stock for the 30 trading days immediately preceding the date of grant.
The employment agreement further provides that if Mr. Haddrill's employment is
terminated for any reason, then all unvested restricted shares shall revert to
the Company. In addition, the employment agreement provides that if Mr.
Haddrill's employment is terminated for "cause" (as defined in the employment
agreement) or by him other than for "good reason" (as defined in the employment
agreement), then all unvested options shall be forfeited. If Mr. Haddrill's
employment is terminated for any other reason, then certain of the options
become exercisable. All such options become immediately exercisable, and all
restrictions on restricted stock held by Mr. Haddrill immediately lapse, upon a
"change in control" (as defined in the employment agreement) of the Company. In
addition, if Mr. Haddrill's employment is terminated for any reason other than
"cause" or if he terminates his employment for "good reason" (including
termination in certain circumstances following a change in control), then he is
entitled to receive all accrued but unpaid salary and bonus and to receive a
lump sum equal to two times the sum of the total base salary plus annual bonus,
as well as payment of certain benefits through the remaining term of the
employment agreement. Mr. Haddrill is entitled to the reimbursement of certain
relocation expenses and other business expenses. Finally, the employment
agreement provides that Mr. Haddrill will not compete with the Company for a
period of 18 months following his termination.
Agreement with Susan J. Carstensen: On December 5, 1996, the Company
entered into an agreement with Ms. Carstensen. If Ms. Carstensen is removed from
her position with the Company without cause, she will receive her then current
salary for a period of six months following termination. In the event there is a
change of control of the Company and Ms. Carstensen's employment is terminated
by the Company without good cause, or by Ms. Carstensen for certain reasons set
forth in the agreement, then Ms. Carstensen is entitled to an amount equal to
one-half of her annual salary. Ms. Carstensen also agreed to certain
confidentiality, non-competition and similar provisions.
Agreement with Michael L. Eide: On January 17, 1995, the Company entered
into an agreement with Mr. Eide to provide for the continuance of his position
as president of VLC. If Mr. Eide is removed from his position with the Company
without cause, he will receive his then current salary for a period of six
months following termination. In the event there is a change of control of the
Company and Mr. Eide's employment is terminated by the Company without good
cause, or by Mr. Eide for certain reasons set forth in the agreement, then Mr.
Eide is entitled to an amount equal to twice his annual salary. Mr. Eide also
agreed to certain confidentiality, non-competition and similar provisions
Agreement with Alan Rassaby: On July 2, 1998, the Company entered into an
agreement with Mr. Rassaby. The agreement provides Mr. Rassaby with a base
salary of $180,000 and an annual bonus potential of $100,000 based upon the
Company's executive incentive compensation plan. In addition, under the
agreement, Mr. Rassaby was awarded an option to purchase 20,000 shares of the
Company's Common Stock on the first day of his employment which vests over a
three-year period from the date of grant. The exercise price of $11.79 per
share. Mr. Rassaby received reimbursement for relocation expenses. In the event
of termination without cause, Mr. Rassaby is entitled to receive a lump sum
payment equal to twelve months salary if terminated in the first year of
employment, eight months salary if terminated in the second or third year or six
months base salary if terminated without cause in year four or subsequent.
Agreement with Christer S. T. Roman: On December 15, 1998, the Company
entered into an agreement with Mr. Roman for a period of three years. The
agreement provides Mr. Roman with a base salary of $180,000 and an annual bonus
potential of $100,000 based upon the Company's executive
- 68 -
<PAGE>
incentive compensation plan. In addition, under the agreement, Mr. Roman was
awarded an option to purchase 20,000 shares of the Company's Common Stock on the
first day of his employment which vests over a three-year period from the date
of grant. The exercise price is $11.79 per share. Mr. Roman received
reimbursement for relocation expenses. In the event of termination without good
cause, Mr. Roman would be entitled to receive his base annual salary in effect
plus guaranteed bonuses for the remaining term of the agreement.
Richard R. Burt, who became the chairman of the Board of Directors in
December 1994, is the chairman and a founder of IEP Advisors, Inc. (IEP), which
has been retained by the Company to provide consulting services and to assist
the Company in connection with its international activities since October 1994
at a rate of $15,000 per month plus expenses. The Company paid IEP an aggregate
of approximately $189,641 in 1998. The current contract with IEP Advisors
terminates in December of 1999 unless terminated upon 30 days notice by the
Company or IEP.
In addition, Mr. Burt and the Company entered into a consulting agreement
in November 1994, under which Mr. Burt is to provide advice and assistance
relating to the promotion of the Company's business and to assist in the
development of business opportunities for the Company. The agreement provides
for a per day rate of $1,000 for each day such services are performed and
reimbursement of out-of-pocket expenses. The agreement is separate and distinct
from Mr. Burt's duties and responsibilities as a director of the Company. The
agreement further provides for termination of the agreement by Mr. Burt or the
Company, without penalty, upon 90 days' prior written notice. During 1998 an
aggregate of approximately $4,000 was paid pursuant to the agreement.
In December 1995 the Company entered into a consulting agreement with
Patricia W. Becker, a director of the Company, for the period of two years
commencing January 16, 1995. In September 1997 the Board renewed the agreement
for an additional period of one year. In December 1998 the agreement was again
renewed and provides that Ms. Becker shall serve as the chairperson of the
Compliance Committee of the Company, and otherwise provide advice and assistance
to the Company on matters of regulatory compliance and such other matters as
requested by the Company. The agreement provides for an annual retainer fee of
$100,000 plus a per day rate of $1,000 for each day such services are performed
and reimbursement of out-of-pocket expenses. The agreement is separate and
distinct from Ms. Becker's duties and responsibilities as a director of the
Company. The agreement further provides for termination of the agreement by Ms.
Becker or the Company, without penalty, upon 90 days' prior written notice. The
Company paid Ms. Becker an aggregate amount of approximately $75,000 during 1998
pursuant to the agreement.
- 69 -
<PAGE>
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
The following table sets forth certain information regarding the beneficial
ownership of the Common Stock as of March 1, 1999 by (i) each person owning
beneficially more than five percent of the outstanding shares of the Common
Stock, (ii) each director and director nominee of the Company, (iii) each person
named in the Summary Compensation Table appearing elsewhere herein and (iv) all
executive officers and directors of the Company as a group. The information
under this caption is based on representations made to the Company by individual
directors or nominees and/or filings made with the SEC. Each person has sole
investment and voting power with respect to the shares indicated except as
otherwise shown. In conjunction with the Merger Agreement entered into on March
10, 1999, the directors and executive officers of the Company have entered into
or agreed to enter into voting agreements with Anchor Gaming pursuant to which
such directors and officers, among other things, agreed to vote an aggregate of
approximately 4.4% of the Company's outstanding shares in favor of the Merger.
On March 10, 1999, the Company announced its pending merger with Anchor
Gaming. A definitive merger agreement has been signed which provides for
Anchor's acquisition of Powerhouse at $19.50 per share. The transaction is
subject to approval by the shareholders of Powerhouse and the expiration of
applicable waiting periods under the Hart-Scott-Rodino Antitrust Improvement
Act. The merger, which will also require approval of various gaming authorities,
is expected to close in the second half of calendar 1999.
<TABLE>
<CAPTION>
SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
Number of Shares Percent of Class
---------------- ----------------
Beneficially Owned(1) March 1, 1999(1)
--------------------- ----------------
<S> <C> <C>
Dimensional Fund Advisors Inc................................ 720,900 (2) 6.4%
1299 Ocean Ave., 11th Floor
Santa Monica, CA 90401-1038
Fir Tree Partners (Fir Tree, Inc. d/b/a Fir Tree Partners)... 697,400 (3) 6.3%
1211 Ave of the Americas, 29th Floor
New York, NY 10036
Capital Technology Inc....................................... 616,100 (4) 5.5%
8314 Pineville-Matthews Road, Suite 295
Charlotte, NC 28226
Richard M. Haddrill+, ++..................................... 590,357 (5)(6) 5.3%
Michael L. Eide.............................................. 216,707 (7) 1.9%
John R. Hardesty+............................................ 117,837 (8) 1.1%
James Davey+................................................. 35,135 (8) *
Richard R. Burt+............................................. 32,285 (8) *
Patricia W. Becker+.......................................... 31,392 (8) *
Susan J. Carstensen ++....................................... 15,653 (9) *
All directors and executive officers as a group.............. 1,039,366 (5)(6)(7)(8)(9) 9.3%
</TABLE>
- ----------
+ Director of the Company
++ Executive Officer of the Company
* Denotes less than 1%
(1) Based on 10,622,958 shares of Common Stock outstanding as of the close of
business on March 1,1999. The share holdings in this table do not include
rights to receive stock or options granted under various Company plans to
directors and executive officers that do not vest or become exercisable
within 60 days of March 1,1999.
(2) Dimensional Fund Advisors Inc. ("Dimensional"), incorporated in Delaware,
an investment advisor registered under the Investment Advisors Act of 1940,
furnishes investment advice to four investment companies registered under
Investment Company Act of 1940, and serves as investment manager to certain
other investment vehicles, including commingled groups trusts. (These
investment companies
- 70 -
<PAGE>
and investment vehicles are the "Portfolios"). In its role as investment
advisor and investment manager, Dimensional possesses both voting and
investment power over the securities of the Company reported in this item
that are owned by the Portfolios. All the securities of the Company
reported in this item are owned by the Portfolios, and Dimensional
disclaims beneficial ownership of such securities.
(3) Fir Tree, Inc. is a New York corporation doing business as Fir Tree
Partners ("Fir Tree Partners"), of which Mr. Jeffrey Tannenbaum is the sole
shareholder, executive officer, director and principal. Mr. Tannenbaum
acquired the shares through his position as principal of Fir Tree Partners
for an institutional account for which Fir Tree Partners serves as trading
advisor and for the account of the Fir Tree Value Fund, L.P. ("Fir Tree
Value Fund") of which Mr. Tannenbaum is the general partner. Fir Tree
Partners' holdings are reported pursuant to amendment to Form 13D. Fir Tree
Partners is the beneficial owner of 697,400 shares of Common Stock of which
45,315 shares are beneficially owned by Fir Tree Partners in its capacity
as investment advisor to Fir Tree LDC, a Cayman Islands limited duration
company ("Fir Tree LDC"). Jeffrey Tannenbaum is the investment advisor of
Fir Tree LDC and, as such, retains voting and dispositive power over the
shares. 546,465 shares are beneficially owned by Fir Tree Partners for the
account of the Fir Tree Value Fund and 105,620 shares are held for the
account of the Fir Tree Institutional Value Fund.
(4) Capital Technology Inc. is an investment advisor organized in North
Carolina. Capital Technology Inc. has sole power to dispose or direct the
disposal of all shares beneficially owned and has sole power to vote or
direct to vote 279,500 shares.
(5) Includes 75,000 shares of restricted stock of the Company vesting in equal
installments on each of January 1, 2000, 2001 and 2002 and 10,000 shares of
restricted stock of the Company vesting on September 9, 1999.
(6) Includes options to purchase 364,800 shares of Common Stock, currently
exercisable or which will be exercisable within 60 days, granted pursuant
to the Company's 1994 Stock Incentive Plan.
(7) Includes options to purchase 78,333 shares of Common Stock currently
exercisable granted pursuant to the Company's 1994 Stock Incentive.
Includes 12,318 shares held by Mr. Eide's son as to which Mr. Eide
disclaims beneficial ownership.
(8) Includes options to purchase 10,000 shares of Common Stock currently
exercisable granted pursuant to the Company's 1994 Stock Incentive Plan and
options to purchase 20,000 shares of Common Stock currently exercisable
pursuant to the Company's 1993 Stock Incentive Plan for Non-Employee
Directors.
(9) Includes options to purchase 11,665 shares of Common Stock granted under
the Company's 1994 Incentive Stock Plan currently exercisable or which will
be exercisable within 60 days.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
During 1998 the Company and its subsidiaries have had no transactions in
which any director of the Company, or any member of the immediate family of any
such director, had a material direct or indirect interest reportable under the
applicable rules of the SEC except as follows:
In December 1997, the Company entered into an agreement with William Spier,
who served as a director from July 1991 to February 1998, with respect to the
exercise of his demand registration rights under a stockholder's agreement,
which provided that a registration include, in the offering, all shares of
Company's Common Stock held by Mr. Spier and the Spier Group. It further
provided that Mr. Spier must resign as a director of the Company. The shares
were marketed and sold principally to a variety of institutional investors. The
sale of all the Spier Group stock was completed on February 10, 1998.
For certain additional information regarding transactions involving the
Company and its officers and directors, see "Item 10. Executive Compensation -
Compensation Committee Interlocks and Insider Participation."
- 71 -
<PAGE>
PART IV
ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K
(a) 1. Financial Statements (See page 42 for the Index to consolidated
financial statements)
Independent Auditors' Report
Consolidated Financial Statements:
Statements of Earnings for the years
ended December 31, 1998, 1997 and 1996
Balance Sheets as of December 31, 1998 and 1997
Statements of Stockholders' Equity for the years
ended December 31, 1998, 1997 and 1996
Statements of Cash Flows for the years
ended December 31, 1998, 1997 and 1996
Notes to Consolidated Financial Statements
(a) 2. Financial Statement Schedules
All schedules are omitted because the information prescribed thereon
is neither applicable nor required or is furnished in the consolidated financial
statements or notes thereto.
(a) 3. Listing of Exhibits
3.1 Certificate of Incorporation of Company (incorporated by
reference to Exhibit 3.1 to the Company's Registration Statement
on Form S-18 (Registration No. 33-41000) (the 1991 Registration
Statement)
3.2 Bylaws of the Company (incorporated by reference to Exhibit 3.2
to the 1991 Registration Statement)
4.1 Specimen form of the Company's Common Stock Certificate
(incorporated by reference to Exhibit 4.1 to the 1991
Registration Statement)
10.1 Video Lottery Technologies, Inc. 1991 Stock Option Plan
(incorporated by reference to Exhibit 10.1 to the 1991
Registration Statement)
10.2 Video Lottery Technologies, Inc. 1991 Employee Stock Purchase
Plan (amended June 18, 1997) (incorporated by reference to
Exhibit 10.2 to the 1997 Form 10-K.)
10.3 1992 Video Lottery Technologies, Inc. Stock Incentive Plan
(incorporated by reference to Exhibit 10.3 to the 1997 Form
10-K.)
10.4 1993 Video Lottery Technologies, Inc. 1993 Stock Option Plan for
Non-Employee Directors (incorporated by reference to Exhibit
10.4 to the 1997 Form 10-K.)
10.5 1994 Powerhouse Technologies, Inc. Stock Incentive Plan (amended
June 18, 1997 and February 13, 1998) (incorporated by reference
to Exhibit 10.5 to the 1997 Form 10-K.)
10.6 Form of Indemnification Agreement between the Company and its
directors and officers (incorporated by reference to Exhibit
10.3 to the 1991 Registration Statement)
10.7 Credit Agreement and related documents among Powerhouse
Technologies, Inc., Lehman Brothers Inc., Lehman Commercial
Paper Inc., and Canadian Imperial Bank of Commerce dated as of
October 9, 1998 (incorporated by reference to Exhibit 10.1 to
the September 30, 1998 Form 10-Q.)
10.8 Settlement Agreement between Video Lottery Technologies, Inc.,
and the Shelhamers (incorporated by reference to Exhibit 10.16
to the 1995 Form 10-K.)
*10.9 International Equity Partners Related Party Consulting Agreement
dated December 15, 1998
- 72 -
<PAGE>
10.10 Richard R. Burt Related Party Consulting Agreement (incorporated
by reference to Exhibit 10.22 to the 1996 Form 10-K)
*10.11 Patricia W. Becker Related Party Consulting Agreement dated
December 15, 1998
10.12 Richard M. Haddrill Employment Agreement dated January 1, 1998
(incorporated by reference to Exhibit 10.23 to the 1997 Form
10-K.)
*10.13 Alan Rassaby Employment Agreement
*10.14 Christer S. T. Roman Employment Agreement
10.15 Susan J. Carstensen Employment Agreement (incorporated by
reference to Exhibit 10.28 to the 1996 Form 10-K)
10.16 Michael L. Eide Employment Agreement (incorporated by reference
to Exhibit 10.26 to the 1996 Form 10-K)
*22.1 List of Subsidiaries
*24.1 Independent Auditors' Consent
*EX-27 Financial Data Schedule (For SEC Use Only)
(b) Reports on Form 8-K filed during the last quarter of the period covered
by this report:
Form 8-K dated March 12, 1999 reporting the Agreement to Merger with Anchor
Gaming.
(c) Exhibits required by Item 601 of Regulation S-K: The exhibits filed
herewith and incorporated by reference herein are set forth in Item 14(a)(3)
above. Included in those exhibits are the following executive compensation plans
and arrangements:
10.1 Video Lottery Technologies, Inc. 1991 Stock Option
10.2 Video Lottery Technologies, Inc. 1991 Employee Stock Purchase
Plan
10.3 1992 Video Lottery Technologies, Inc. Stock Incentive
10.4 1993 Video Lottery Technologies, Inc. 1993 Stock Option Plan for
Non-Employee Directors
10.5 1994 Powerhouse Technologies, Inc. Stock Incentive Plan
10.6 Form of Indemnification Agreement between the Company and its
directors and officers
10.9 International Equity Partners Related Party Consulting Agreement
dated December 15, 1998
10.10 Richard R. Burt Related Party Consulting Agreement
10.11 Patricia W. Becker Related Party Consulting Agreement dated
December 15, 1998
10.12 Richard M. Haddrill Employment Agreement dated January 1, 1998
10.13 Alan Rassaby Employment Agreement
10.14 Christer S. T. Roman Employment Agreement
10.15 Susan J. Carstensen Employment Agreement
10.16 Michael L. Eide Employment Agreement
(d) See page 42 for the Index to consolidated financial statements and
financial statement schedules.
*Filed herewith
- 73 -
<PAGE>
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: March 30, 1999 /s/ RICHARD M. HADDRILL
---------------------------------------------
Richard M. Haddrill
President and Chief Executive Officer
(Principal Executive Officer)
Pursuant to the requirements of the Securities Exchange Act of 1934, this
report has been signed by the following persons on behalf of the registrant and
in the capacities and on the dates indicated:
Signature Title Date
- --------- ----- ----
/s/ SUSAN J. CARSTENSEN Chief Financial Officer and March 30, 1999
- ------------------------ Treasurer (Principal Financial
Susan J. Carstensen and Accounting Officer)
/s/ RICHARD R. BURT Chairman and Director March 30, 1999
- ------------------------
Richard R. Burt
/s/ JAMES J. DAVEY Vice Chairman and Director March 30, 1999
- ------------------------
James J. Davey
/s/ RICHARD M. HADDRILL President, Chief Executive Officer March 30, 1999
- ------------------------ and Director (Principal Executive
Richard M. Haddrill Officer)
/s/ PATRICIA W. BECKER Director March 30, 1999
- ------------------------
Patricia W. Becker
/s/ JOHN R. HARDESTY Director March 30, 1999
- ------------------------
John R. Hardesty
- 74 -
Consulting Agreement
THIS AGREEMENT made this 15th day of December, 1998, between Powerhouse
Technologies, Inc., and its subsidiary corporations, 2311 South 7th Ave.,
Bozeman, MT 59715 (collectively the "Company"), and IEP Advisors, Inc., 1275
Pennsylvania Avenue NW, 10th Floor, Washington, DC 20004 ("IEP").
The parties agree as follows:
Section 1: Scope of Work.
IEP shall assist the Company in expanding its international activities
by:
A) Identifying potential new markets for the Company and its
affiliates to enter;
B) Providing political analysis relevant to market entry in targeted
countries, including identifying and establishing contact with
key decision-makers in target countries;
C) Conducting surveys in new markets for potential local partners;
D) Assisting the Company and its affiliates in preparing and
submitting proposals and bids in new markets; and
E) Evaluating the viability of obtaining outside equity and debt
financing from both private and public sources to support the
Company and its affiliates in their international expansion
plans.
Section 2: Compensation.
A) In consideration of IEP's performing its services hereunder, the
Company shall pay IEP a monthly fee of $15,000, payable within
twenty (20) days after the submission by IEP of a monthly invoice
with a description of the services rendered during the preceding
month by IEP hereunder.
B) The Company shall reimburse IEP its actual expenses incurred in
carrying out the activities described in Section 1 above,
including costs of travel, telephone and post charges, and
printing costs. IEP shall provide the Company with appropriate
documentation to support each expense.
Section 3: Term.
Subject to the annual approval of this Agreement by the Company's
Board of Directors, this Agreement will otherwise continue on a
month-to-month basis, and may be terminated by either party, for
any reason, upon 30 days written notice of intent to terminate to
the other party.
Section 4: During the term hereof, IEP agrees to use its best efforts,
skill, knowledge and experience in the performance of its
services hereunder; and IEP will not directly or indirectly
maintain any business or financial interests, or engage in any
business
1
<PAGE>
or financial activities, or perform similar type services as
provided hereunder which conflict with the interests of the
Company or otherwise interfere with IEP's ability to fully
discharge its services hereunder. IEP also agrees not to
disclose, either during the term hereof or thereafter, any
unpublished or confidential proprietary information concerning
the business of the Company obtained by IEP hereunder.
Section 5:
A) It is understood that IEP will perform its services hereunder as
an independent contractor, and that it is not an employee, agent
or legal representative of the Company for any purpose.
B) This agreement is not assignable by IEP.
C) Nothing in this Agreement shall prejudice or alter the rights of
either party under any other valid existing or future agreements
between these parties.
Section 6. IEP hereby acknowledges that it has received and read the
Company's Code of Conduct and agrees to abide by its provisions.
IEP further agrees that its employees and agents rendering
services on behalf of the Company will be provided a copy of the
Code of Conduct and that such persons will likewise abide by its
provisions.
Section 7. It is understood that the IEP services to be provided hereunder
shall be separate and distinct from (i) any services otherwise
being or to be provided by Richard R. Burt, (in his capacity as
an individual and not as Chairman of IEP), whose relationship
with the Company as a consultant is covered by a separate
agreement; and (ii) Mr. Burt's duties and responsibilities as a
Director and Chairman of the Board of Directors of the Company.
Section 8. IEP understands that: (i) the Company and its directors,
officers, employees and consultants are subject to investigation
and regulation by governmental regulatory agencies; (ii) IEP's
engagement hereunder is subject to review and approval by the
Company's Compliance Committee; ( in addition to approval by the
Board of Directors) and (iii) IEP's engagement hereunder is
subject to the maintenance in good standing of its status with
such agencies.
Section 9. This Agreement shall not be modified except in writing signed by
both parties hereto.
Section 10. This Agreement shall be governed by the laws of Montana and the
parties agree to submit to the exclusive jurisdiction of the
courts of that state.
IEP ADVISORS INC. POWERHOUSE TECHNOLOGIES, INC.
By: /S/ Richard R. Burt By: /S/ Susan J. Carstensen
-------------------------- ------------------------------
Title: Chairman Title: CFO
------------------------ ----------------------------
2
Consulting Agreement
THIS AGREEMENT made this 15th day of December, 1998, between Powerhouse
Technologies, Inc., and its subsidiary corporations, 2311 South 7th Ave.,
Bozeman, MT 59715 (collectively the "Company"), and Patricia Becker, 1800
Wincanton Drive, Las Vegas, NV 89134 ("Consultant").
The parties agree as follows:
Section 1: Scope of Work. Consultant shall:
A) Serve as the Chairman of the Compliance Committee of the Company,
and otherwise to provide advice and assistance to the Company on
matters of regulatory compliance and such other matters as
requested by the President and CEO of the Company.
Section 2: Compensation.
A) In consideration of Consultant's performing services hereunder,
the Company shall pay Consultant an annual fee of $100,000 for
chairing the Compliance Committee and for related activities. The
annual fee is payable in equal monthly installments within twenty
(20) days after the end of each calendar month during the term
hereof.
B) In addition, Consultant shall receive $1,000 per day for each day
of services in assisting the Company in other agreed specific
assignments. Consultant shall submit a monthly invoice with a
description of the services rendered during the preceding month.
C) The Company shall reimburse Consultant's actual expenses incurred
in carrying out the activities described in Section 1 above,
including costs of travel, post charges, and printing costs.
Consultant shall provide the Company with appropriate
documentation to support each expense payable within 15 days
after the end of each month. Such reimbursement of expenses shall
be in accordance with existing Company policy. Rather than phone
actuals, an allowance of $15 per month may be charged.
Section 3: Term.
The term of this Agreement shall be one year commencing January
16, 1999, and terminating on January 15, 2000. Notwithstanding
the foregoing, either party may terminate this agreement for any
reason during the term, upon 90 days written notice of intent to
terminate to the other party.
Section 4: During the term hereof, Consultant agrees to use her best
efforts, skill, knowledge and experience in the performance of
the services hereunder; and Consultant will not directly or
indirectly maintain any business or financial interests, or
engage in any business or financial activities, or perform
similar type services as provided hereunder which conflict with
the interests of the Company. Consultant also agrees not to
disclose, either during the term hereof or thereafter, any
unpublished or confidential proprietary information concerning
the business of the Company
1
<PAGE>
obtained by Consultant hereunder.
Section 5:
A) It is understood that Consultant will perform services hereunder
as an independent contractor, and not as an employee, agent or
legal representative of the Company for any purpose.
B) This agreement is not assignable by Consultant.
C) Nothing in this Agreement shall prejudice or alter the rights of
either party under any other valid existing or future agreements
between these parties.
Section 6. Consultant hereby acknowledges that she has received and read the
Company's Code of Conduct and agrees to abide by its provisions.
Section 7. It is understood that the Consultant's services to be provided
hereunder shall be separate and distinct from Consultant's duties
and responsibilities as a member of the Board of Directors of the
Company.
Section 8. Consultant understands that: (i) the Company and its directors,
officers, employees and consultants are subject to investigation
and regulation by governmental regulatory agencies; (ii)
Consultant's engagement hereunder is subject to review and
approval by the Company's Compliance Committee; and (iii)
Consultant's engagement hereunder is subject to the maintenance
in good standing of its status with such agencies.
Section 9. This Agreement shall not be modified except in writing signed by
both parties hereto.
Section 10. This Agreement shall be governed by the laws of Montana and the
parties agree to submit to the exclusive jurisdiction of the
courts of that state.
CONSULTANT POWERHOUSE TECHNOLOGIES, INC.
/S/ Patricia Becker By: /S. Susan J. Carstensen
- -------------------------- ------------------------------
Patricia Becker Title: CFO
----------------------------
2
(Powerhouse Technologies, Inc. Logo)
2311 south 7th avenue
bozeman, montana 59715 o U.S.A.
TELEPHONE: (406) 585-6600
FAX: (406) 585-6609
July 2, 1998
Mr. Alan Rassaby
60 The Esplanade
Clifton Hill
Victoria 3068 Australia
Dear Mr. Rassaby:
On behalf of Powerhouse Technologies, Inc., we are pleased to offer you the
position of Senior Vice President of Legal & Administration with our Legal
Department, reporting to me and located in Atlanta, Georgia. We would like to
have this position in place by December 1, 1998 or sooner.
Should you decide to accept this offer, you understand that you will be required
to sign a Release of Information form, as well as an Employee Personal
Disclosure form, which will be used to conduct an investigation into your
background, sign a Standard Conditions of Employment Agreement, and sign an
Acknowledgment that you have read and will abide by the Powerhouse Technologies,
Inc. Code of Conduct. A copy of the Release of Information form, Employee
Personal Disclosure Form, the Standard Conditions of Employment form, the Code
of Conduct, and the Acknowledgment are enclosed.
This offer is contingent upon you acquiring an H-1B visa status as well as
successful completion of a background investigation. Should the investigation
into your background disclose information that raises concerns by Powerhouse
Technologies, or you are found unfit by licensing authorities, your employment
may be terminated and any obligation by Powerhouse Technologies pertaining to
your employment will be considered null and void.
This offer includes:
o Annual base salary of $180,000;
o Performance review following one-year of employment with potential
salary increase to $200,000 at that time;
o Annual Bonus Potential of $100,000;
o 20,000 stock options, subject to Board approval, vesting over three
(3) years from grant date; o Payment for all costs associated with
obtaining an H-1B visa;
o Relocation assistance to include:
o Actual expenses incurred in moving clothing and household goods
from Australia to Atlanta, Georgia;
o Business class airfare from Australia to Georgia for you and your
family when you relocate;
o Temporary housing for a maximum of ninety (90) days in a hotel or
corporate housing;
o $20,000 bonus to cover the costs of purchasing electrical goods
and other furnishings, payable one (1) week prior to arrival in
the United States.
o Loan, exercisable at your option at any time from the commencement of
your employment, in the amount of $70,000 to be amortized monthly and
repaid in full with interest at eight (8) percent, two (2) years after
the commencement of employment, secured by second mortgage
<PAGE>
on Atlanta residence and termination payments, if any, and due in full
upon separation from the Company.
o As an exception to the standard benefits, vacation granted at the rate
of four (4) weeks per calendar year ( prorate based upon start date
for the first year) not to be used more than two weeks in any month)
to be used during the year in which it is granted.
As an employee you will be entitled to participate in the Powerhouse
Technologies, Inc. standard benefit package. Presently, the Powerhouse
Technologies standard benefit package includes:
* health/dental insurance with Intermountain Administrators, Inc.
effective on date of hire. The employee has a choice of annual
deductible and contributes to the premium;
* flexible spending plan with health and/or dependent care accounts;
* Company paid life/AD&D insurance at one times annual base salary. The
employee may purchase supplemental life/AD&D and/or dependent life
insurance. UNUM is the carrier;
* 401K plan. Eligibility is first of the month following hire date,
effective 7/1/98;
* employee stock purchase plan. Open enrollment for next calendar year
in December each year;
* short term disability insurance, six (6) months service required;
* employee paid long term disability insurance (30 hours a week
eligibility requirement);
* ten (10) paid holidays during the calendar year;
For clarification and protection of both you and the Company, your acceptance of
this offer, as defined herein and in the enclosed "Employment Letter,"
represents the sole agreement between you and the Company. Employment with the
Company is defined as at-will. At-will is defined as employment and compensation
that can be terminated with or without cause, and with or without notice, at any
time, at the option of either the employer or the employee. No prior promises,
representations, and/or understandings relative to any terms or conditions of
your employment are to be considered as part of this agreement unless expressed
in writing in this letter.
Alan, I am confident that you will make a major contribution to Powerhouse. If
you have questions, please call me. If you accept our offer, please sign the
Acceptance, the Employment Letter, the Release of Information form, the Employee
Personal Disclosure form, the Standard Conditions of Employment form, and the
Code of Conduct Acknowledgment form and return them to Human Resources.
Sincerely,
/S/ Richard M. Haddrill
Richard M. Haddrill
President & CEO
cc: Edward Neuman, Human Resources
<PAGE>
ACCEPTANCE
I accept the position of Senior Vice President of Legal & Administration under
the terms and conditions stated in the letter of July 2, 1998 from Richard M.
Haddrill, President & CEO, to Alan Rassaby.
/S/ Alan Rassaby
- -----------------------
Alan Rassaby
7 July, 1998
- -----------------------
Date
<PAGE>
(Powerhouse Technologies, Inc. Logo)
2311 south 7th avenue
bozeman, montana 59715 o U.S.A.
TELEPHONE: (406) 585-6600
FAX: (406) 585-6609
July 2, 1998
Mr. Alan Rassaby
60 The Esplanade
Clifton Hill
Victoria 3068 Australia
Re: Employment Letter
Dear Alan:
This will confirm the terms and conditions of your employment with Powerhouse
Technologies, Inc., (the "Company"), in the position of Senior Vice President of
Legal & Administration.
In consideration of your expending your best efforts in the performance of your
duties on behalf of the Company, the Company agrees, in the event your
employment with the Company is terminated without good cause during your first
year of employment, the Company will pay you a lump sum equal to twelve (12)
months base salary. If your employment with the Company is terminated without
good cause during your second or third year of employment, or if your H-1B visa
is not renewed, the Company will pay you a lump sum equal to eight (8) months
base salary. If your employment with the Company is terminated without good
cause during your fourth or subsequent years of employment, the Company will pay
you a lump sum equal to six (6) months base salary. During your employment you
may be asked to assume other senior positions within the company or its
subsidiaries, but in no event would your base salary or bonus potential be
reduced without mutual agreement.
It is understood that the Company may, at any time, terminate your employment
for "Cause." A termination for Cause is a termination evidenced by a finding
adopted in good faith by the President of the Company that you (i) willfully and
continually failed to substantially perform your duties with the Company (other
than a failure resulting from your incapacity due to physical or mental
illness), (ii) engaged in willful misconduct, (iii) have breached this Agreement
in any material respect, (iv) engaged in conduct that is dishonest, fraudulent,
unlawful or grossly negligent or conduct which is not in compliance with the
Company's Code of Conduct (Powerhouse Technologies' Code of Conduct is enclosed)
or similar applicable set of standards of conduct and business practices, or (v)
any regulatory authority, gaming commission, lottery agency or similar authority
in any jurisdiction in which the Company is conducting business or intends to
submit a proposal or conduct business provides a reasonable basis for concern
that it likely will find you unsuitable or unfit to continue to act as a
representative, officer, director, or employee of the Company, the Company has
received notice from such authority of such a finding or you fail to file
appropriate applications with, provide requested information to, or otherwise
fail to cooperate with, any such authority. No act, nor failure to act, on your
part, shall be considered "willful" for purposes of (ii) above unless you have
acted or failed to act, with an absence of good faith and without a reasonable
belief that your action or failure to act was in the best interest of the
Company. Notwithstanding anything contained in this Agreement to the contrary,
no failure to perform by you after notice of termination is given shall
constitute Cause for purposes hereof. Termination for Cause shall be by action
of the Board after giving you and your legal advisors an opportunity to meet
with the Board, contest the basis for termination, and to demonstrate that your
continued employment is in the best interests of the Company. If an H-1B visa is
not obtained by August 31, 1999, your employment may be terminated by December
31, 1999 and any obligation by Powerhouse Technologies pertaining to your
employment will be null and void after December 31, 1999.
<PAGE>
It is understood that the foregoing payments that may be payable to you upon
termination of your employment shall be in lieu of any other severance payments
which may otherwise have been provided by the Company to employees under its
severance practices or policy, but shall not otherwise affect any benefits
(including COBRA and pension rights) and payments to which you may be entitled
upon leaving the employ of the Company.
In connection with your employment with the Company, you will be eligible to
participate in any bonus or executive incentive compensation plan as may be
established to be maintained by the Company for its executives, subject to such
factors and discretionary bases as may be determined by the Company's CEO, Board
of Directors or its Compensation Committee.
Finally, you agree to continue to abide by the Company's Standard Conditions of
Employment, the form of which is attached hereto and to be executed by you.
If you are prepared to accept employment with the Company on the basis of the
foregoing terms and conditions, please acknowledge below and return one copy of
this letter to the Company, keeping another copy for your files.
Very truly yours,
/S/ Richard M. Haddrill
Richard M. Haddrill
President & CEO
ACCEPTED AND AGREED TO:
/S/ Alan Rassaby
- ------------------------
Alan Rassaby
DATE: 7.7.98
------------------
(Powerhouse Technologies, Inc. Logo)
2311 south 7th avenue
bozeman, montana 59715 o U.S.A.
TELEPHONE: (406) 585-6600
FAX: (406) 585-6609
May 28, 1998
Mr. Christer S. T. Roman
Runebergsgatan #8
11429 Stockholm, Sweden
Dear Christer:
On behalf of Powerhouse Technologies, Inc., we are pleased to offer you the
position of Sr. Vice President, Product and Business Development. This position
reports to Richard Haddrill. Your start date will be on or before December 15,
1998, as mutually agreed to by you and me on or before June 30, 1998.
Should you decide to accept this offer, you understand that you will be required
to sign a Release of Information form, as well as an Employee Personal
Disclosure Form which will be used to conduct an investigation into your
background, sign a Standard Conditions of Employment Agreement, and sign an
Acknowledgment that you have read and will abide by the Powerhouse Technologies,
Inc. Code of Conduct. A copy of the Release of Information form, Employee
Personal Disclosure Form, the Standard Conditions of Employment form, the Code
of Conduct, and the Acknowledgment are enclosed.
This offer is contingent upon you acquiring an H-1B visa status as well as
successful completion of a background investigation. Should the investigation
into your background disclose information that raises concerns by Powerhouse
Technologies, or the licensing agency, your employment may be terminated and any
obligation by Powerhouse Technologies pertaining to your employment will be
considered null and void. If an H-1B visa is not obtained by August 31, 1999,
your employment may be terminated by December 31, 1999 and any obligation by
Powerhouse Technologies pertaining to your employment will be null and void
after December 31, 1999.
This offer includes:
o annual base salary of $180,000;
o calendar year 1998 Bonus Potential of $70,000, (prorated based on
start date; i.e., if start on 10/1/98, bonus for 1998 is $17,500),
payable by 3/31/1999;
o Annual Bonus Potential of $100,000, (minimum guaranteed for calendar
year 1999 of $70,000, payable by 3/31/2000);
o 20,000 stock options, subject to Board approval, vesting over three
(3) years from grant date;
<PAGE>
Christer Roman
May 28, 1998
Page 2
o another 10,000 stock options to be granted within one (1) year of
start date, subject to Board approval, vesting over three (3) years
from grant date;
o Relocation assistance to include:
o Actual expenses incurred in moving household goods from
Stockholm, Sweden to either Bozeman, Montana or Atlanta, Georgia;
o Airfare from Sweden to either Montana or Georgia for you and your
spouse when you relocate;
o Temporary housing for a maximum of sixty (60) days;
o Roundtrip airfare for you and your spouse from your home in the
United States to Sweden once a year during your employment with
Powerhouse Technologies.
As an employee you will be entitled to participate in the Powerhouse
Technologies, Inc. standard benefit package. Presently, the Powerhouse
Technologies standard benefit package includes:
* health/dental insurance with Intermountain Administrators, Inc., a
copy of the health benefit plan is enclosed. The employee has a choice
of annual deductible and contributes to the premium and has the option
to add dependents (spouse);
* flexible spending plan with health and/or dependent care accounts;
* Company paid life/AD&D insurance at one times annual base salary. The
employee may purchase supplemental life/AD&D and/or dependent life
insurance. UNUM is the carrier;
* 401K plan. Eligibility per the terms of the plan;
* employee stock purchase plan. Open enrollment for next calendar year
in December each year;
* short term disability insurance, six (6) months service required;
* employee paid long term disability insurance (30 hours a week
eligibility requirement);
* ten (10) paid holidays for the 1998 calendar year;
* Vacation/PDO as an exception to the standard plan, you will be granted
thirty-five days of vacation per calendar year, to be prorated for
partial years of service.
For clarification and protection of both you and the Company, your acceptance of
this offer, as defined herein and in the enclosed "Employment Letter,"
represents the sole agreement between you and the Company. Employment with the
Company is defined as at-will. At-will is defined as employment and compensation
that can be terminated with or without cause, and with or without notice, at any
time, at the option of either the employer or the employee. No prior promises,
representations, and/or understandings relative to any terms or conditions of
your employment are to be considered as part of this agreement unless expressed
in writing in this letter.
<PAGE>
Christer Roman
May 28, 1998
Page 3
Christer, I am confident that you will make a major contribution to Powerhouse.
If you have questions, please call me. If you accept our offer, please sign the
Acceptance, the Employment Letter, the Release of Information form, the Employee
Personal Disclosure form, the Standard Conditions of Employment form, and the
Code of Conduct Acknowledgment form and return them to Human Resources on or
before June 15, 1998. This offer is good only until June 15, 1998.
Sincerely,
/S/ Richard M. Haddrill
- -----------------------
Richard M. Haddrill
President & CEO
cc: Ed Neuman, Director of Human Resources
<PAGE>
Christer Roman
May 28, 1998
Page 4
ACCEPTANCE
I accept the position of Sr. Vice President, Research & Development under the
terms and conditions stated in the letter of May 28, 1998 from Richard M.
Haddrill, President & CEO, to Christer S. T. Roman.
/S/ Christer S. T. Roman
- ------------------------
Christer S. T. Roman
3 June 1998
- -----------------------
Date
<PAGE>
(Powerhouse Technologies, Inc. Logo)
2311 south 7th avenue
bozeman, montana 59715 o U.S.A.
TELEPHONE: (406) 585-6600
FAX: (406) 585-6609
May 28, 1998
Mr. Christer S. T. Roman
Runebergsgatan #8
11429 Stockholm, Sweden
Re: Employment Letter
Dear Christer:
This will confirm the terms and conditions of your employment with Powerhouse
Technologies, Inc., (the "Company"), in the position of Sr. Vice President,
Product and Business Development. The terms of this agreement are effective for
three (3) years upon your employment with the Company.
In consideration of your expending your best efforts in the performance of your
duties on behalf of the Company, the Company agrees, in the event your
employment with the Company is terminated without good cause within three (3)
years following your date of hire, the Company will continue to pay you in
accordance with the Company's normal payroll practices an amount equal to your
current base annual salary in effect as of the date of the termination of such
employment with the Company (not to be less than $180,000 annually) for a period
of three (3) years from your date of hire. The guaranteed bonuses for 1998 and
1999, to the extent not previously paid, would also be payable on or before the
specified due dates of 3/31/99 and 3/31/00. During this three (3) year period
you may be asked to assume other senior positions within the company or its
subsidiaries, but in no event would your base salary or bonus be reduced.
It is understood that the Company may, at any time, terminate your employment
for "Cause." A termination for Cause is a termination evidenced by a finding
adopted in good faith by the President of the Company that you (i) willfully and
continually failed to substantially perform your duties with the Company (other
than a failure resulting from your incapacity due to physical or mental
illness), (ii) engaged in willful misconduct, (iii) have breached this Agreement
in any material respect, (iv) engaged in conduct that is dishonest, fraudulent,
unlawful or grossly negligent or conduct which is not in compliance with the
Company's Code of Conduct (Powerhouse Technologies' Code of Conduct is enclosed)
or similar applicable set of standards of conduct and business practices, or (v)
any regulatory authority, gaming commission, lottery agency or similar authority
in any jurisdiction in which the Company is conducting business or intends to
submit a proposal or conduct business provides a reasonable basis for concern
that it likely will find you unsuitable or unfit to continue to act as a
representative, officer, director, or employee of the Company, the Company has
received notice from such authority of such a finding or you fail to file
appropriate applications with, provide requested information to, or otherwise
fail to cooperate with, any such authority. No act, nor failure to act, on your
<PAGE>
Christer S. T. Roman
May 28, 1998
Page 2
part, shall be considered "willful" for purposes of (ii) above unless you have
acted or failed to act, with an absence of good faith and without a reasonable
belief that your action or failure to act was in the best interest of the
Company. Notwithstanding anything contained in this Agreement to the contrary,
no failure to perform by you after notice of termination is given shall
constitute Cause for purposes hereof. Termination for Cause shall be by action
of the Board after giving you and your legal advisors an opportunity to meet
with the Board, contest the basis for termination, and to demonstrate that your
continued employment is in the best interests of the Company. If an H-1B visa is
not obtained by August 31, 1999, your employment may be terminated by December
31, 1999 and any obligation by Powerhouse Technologies pertaining to your
employment will be null and void after December 31, 1999.
It is understood that the foregoing payments that may be payable to you upon
termination of your employment shall be in lieu of any other severance payments
which may otherwise have been provided by the Company to employees under its
severance practices or policy, but shall not otherwise affect any benefits
(including COBRA and pension rights) and payments to which you may be entitled
upon leaving the employ of the Company.
In connection with your employment with the Company, you will be eligible to
participate in any bonus or executive incentive compensation plan as may be
established to be maintained by the Company for its executives, subject to such
factors and discretionary bases as may be determined by the Company's CEO, Board
of Directors or its Compensation Committee.
Finally, you agree to continue to abide by the Company's Standard Conditions of
Employment, the form of which is attached hereto and to be executed by you.
If you are prepared to accept employment with the Company on the basis of the
foregoing terms and conditions, please acknowledge below and return one copy of
this letter to the Company, keeping another copy for your files.
Very truly yours,
/S/ Richard M. Haddrill
Richard M. Haddrill
President & CEO
ACCEPTED AND AGREED TO:
Christer S. T. Roman
- -----------------------
DATE: 3 June 1998
-----------------
EXHIBIT 22.1
The following corporations are either direct or indirect, wholly-owned
subsidiaries of the Company:
Subsidiary Incorporation
Automated Wagering International, Inc. Delaware
Automatic Music Service of Billings, Inc. Montana
Automation First, Inc. Montana
Nuevo Sol Turf Club, Inc., dba Sunland Park New Mexico
Raven's D&R Music, Inc. Montana
United Tote Canada, Inc. Canada
United Tote Company Montana
United Wagering Systems, Inc. Delaware
VLC, Inc. Montana
VLC of Nevada, Inc. Nevada
VLT Company, Inc. Foreign Sales Corporation
(KPMG LLP Logo)
P. O. Box 7108
Billings, MT 59103
Independent Accountants' Consent
--------------------------------
The Board of Directors and Stockholders
Powerhouse Technologies, Inc.:
We consent to the incorporation by reference in the registration statements on
Form S-8 of Powerhouse Technologies, Inc. 1991 Employee Stock Purchase Plan
(33-41953 and Powerhouse Technologies, Inc. 1994 Stock Incentive Plan (33-86430)
our report dated February 19, 1999, relating to the consolidated balance sheets
of Powerhouse Technologies, Inc. and subsidiaries as of December 31, 1998 and
1997, and the related consolidated statements of earnings, stockholders' equity,
and cash flows for each of the years in the three-year period ended December 31,
1998, which report appears in the December 31, 1998 annual report on Form 10-K
of Powerhouse Technologies, Inc.
/S/ KPMG LLP
Billings, Montana
March 26, 1999
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<CURRENCY> U. S. Dollars
<S> <C>
<PERIOD-TYPE> Year
<FISCAL-YEAR-END> DEC-31-1998
<PERIOD-START> JAN-01-1998
<PERIOD-END> DEC-31-1998
<EXCHANGE-RATE> 1
<CASH> 1,992
<SECURITIES> 0
<RECEIVABLES> 39,050
<ALLOWANCES> 1,036
<INVENTORY> 18,630
<CURRENT-ASSETS> 76,081
<PP&E> 178,739
<DEPRECIATION> 102,384
<TOTAL-ASSETS> 188,475
<CURRENT-LIABILITIES> 34,904
<BONDS> 56,210
0
0
<COMMON> 106
<OTHER-SE> 87,872
<TOTAL-LIABILITY-AND-EQUITY> 188,475
<SALES> 53,186
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<CHANGES> 0
<NET-INCOME> 4,576
<EPS-PRIMARY> 0.43
<EPS-DILUTED> 0.42
</TABLE>
