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SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-K
[X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
FOR THE FISCAL YEAR ENDED DECEMBER 31,1999
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
For the Transition Period From _____ to _____
Commission file number 001-12986
INTERLOTT TECHNOLOGIES, INC.
(Exact name of Registrant as specified in its charter)
DELAWARE 31-1297916
(State of incorporation) (IRS Employer
Identification Number)
7697 Innovation Way, Mason, Ohio 45040
(Address of principal executive offices, including zip code)
(513) 792-7000
(Registrant's telephone number, including area code)
Securities registered pursuant to Section 12(b) of the Act:
Title of each class Name of each exchange on which registered
Common Stock, $.01 Par Value American Stock Exchange
Securities registered pursuant to Section 12(g) of the Act: None
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 [ ]
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 the 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. [ ]
The aggregate market value of the Registrant's outstanding Common Stock held by
non-affiliates of the Registrant on March 23, 2000 was $7,408,406. There were
3,210,000 shares of Common Stock outstanding as of March 23, 2000.
DOCUMENTS INCORPORATED BY REFERENCE
Portions of the Registrant's Proxy Statement for the 2000 Annual Meeting of
Stockholders to be held on May 4, 2000 are incorporated by reference in Part III
hereof.
INTERLOTT TECHNOLOGIES, INC.
Annual Report On Form 10-K
For the Fiscal Year Ended December 31, 1999
Table of Contents
Item Page
Number Number
PART I............................................................................................................2
1. Business...............................................................................................3
2. Properties............................................................................................12
3. Legal Proceedings.....................................................................................12
4. Submission of Matters to a Vote of Security Holders...................................................13
PART II..........................................................................................................13
5. Market for the Registrant's Common Stock and Related Stockholder Matters..............................13
6. Selected Financial Data...............................................................................14
7. Management's Discussion and Analysis of Financial Condition and Results of Operations.................16
7(A). Quantitative and Qualitative Disclosures About Market Risk............................................23
8. Financial Statements and Supplementary Data...........................................................24
9. Changes In and Disagreements With Accountants on Accounting and Financial Disclosure..................39
PART III.........................................................................................................39
10. Directors and Executive Officers of the Registrant....................................................40
11. Executive Compensation..................................................................................
12. Security Ownership of Certain Beneficial Owners and Management..........................................
13. Certain Relationships and Related Transactions..........................................................
PART IV..........................................................................................................40
14. Exhibits, Financial Statement Schedules, and Reports on Form 8-K......................................40
SIGNATURES............................................................................................41
INDEX OF FINANCIAL STATEMENT SCHEDULES...............................................................S-1
INDEX OF EXHIBITS....................................................................................E-1
PART I
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ITEM 1. BUSINESS
Interlott Technologies, Inc. (the "Company" or "Interlott") is engaged
primarily in the design, manufacture, sale, lease and service of instant winner
lottery ticket vending machines ("ITVMs"). ITVMs are used by public lotteries
operated by states and international public entities to dispense instant winner
lottery tickets primarily in retail locations such as supermarkets and
convenience stores. An instant lottery commonly is played by players scratching
off a latex coating from a pre-printed ticket or tearing pull-tabs from a
pre-printed ticket to determine the outcome of the game. The Company's ITVMs
dispense instant lottery tickets without the assistance of an employee of the
lottery instant ticket retailer or agent, thereby permitting the retailer or
agent to sell tickets without disrupting the normal duties of its employees.
The Company's ITVMs dispense scratch-off instant lottery tickets using a
dispensing process that incorporates the Company's patented "burster
technology." The Company believes that this burster technology is superior to
any other ITVM scratch-off dispensing technology on the market and considers it
to be a key to its marketing efforts and the ITVM procurement decisions of the
various lotteries. The Company is unaware of any competitor that incorporates a
substantially equivalent or superior scratch-off dispensing mechanism in its
ITVMs. To dispense pull-tab instant lottery tickets, the Company has developed
an ITVM that incorporates a patented dispensing technology which is different
than the burster technology but that is also believed by the Company to be
superior to any other currently available pull-tab dispensing technology. ITVMs
that dispense pull-tab tickets are sometimes referred to herein as "pull tab
vending machines" or "PTVMs." The term "ITVM" includes both scratch-off vending
machines and PTVMs unless the context indicates otherwise.
As of December 31, 1999, the Company had sold or leased over 20,000 ITVMs
under agreements with 23 different state lotteries and the District of Columbia
and eight international jurisdictions, or their licensees or contractors. The
Company was awarded six of the six contracts that were awarded to the industry
in 1999.
The Company continually seeks to enhance its existing product lines and
develop new products. In 1998, the Company introduced its Modular Vending
Platform ("MVP") to increase over-the-counter instant ticket sales and reduce
ticket shrinkage. Also in 1998, the Company introduced its Advanced
Communication Software, which significantly increases and enhances the flow of
information between the ITVMs in the field and the lotteries.
Taking advantage of its expertise in dispensing technology, the Company
introduced a prepaid phone card dispensing machine ("PCDM") in 1995 that enables
providers of long distance telephone service to dispense prepaid telephone
calling cards in retail locations without the assistance of an employee of the
retailer. The dispensing process used in the Company's PCDM incorporates the
same patented technology used in the Company's PTVM, and the Company believes
that this dispensing technology is superior to any other PCDM dispensing
technology on the market. Although PCDM revenues in 1999 represented less than
1% of total revenues, it continues to be a potential source of future sales
growth.
Interlott is a Delaware corporation. The Company completed its initial
public offering of Common Stock in April 1994. The Company's Common Stock trades
on the American Stock Exchange under the symbol "ILI."
Products
The ITVM
In 1987, Edmund F. Turek, a director of and consultant to the Company,
developed the technology for what the Company believes to be the first automated
ITVM. The burster dispensing technology is a key component of the Company's ITVM
for scratch-off instant lottery tickets and is protected by a patent that the
Company acquired from Mr. Turek's family-owned corporation. See "Patents,
Trademarks and Copyrights" below.
The Company's ITVMs automatically dispense instant lottery tickets upon
payment from the user. The burster technology in the Company's ITVMs
automatically separates one scratch-off instant ticket from another along the
perforations between tickets to help prevent tearing of the tickets or scarring
of the latex on the tickets. This technology also enables the Company's ITVMs to
dispense and account for virtually any known type of scratch-off instant lottery
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ticket, allowing the use of a wide range of sizes, shapes, paper stocks or
perforations, without the intervention of a lottery retailer or agent. This
feature allows lotteries to purchase virtually any known type of scratch-off
instant ticket from their instant ticket manufacturer without having to request
from the manufacturer major alterations in the ticket perforations. For example,
the Company's ITVM can dispense recyclable scratch-off tickets without tearing
or scarring the tickets. The Company believes that lotteries will increasingly
require the use of recyclable tickets in their ITVMs. This feature also is
particularly beneficial to international lottery jurisdictions that may use
non-standard sizes, shapes and paper stocks. In addition, the ITVM for
scratch-off tickets is faster than manual sales of scratch-off tickets as the
ITVM's entire dispensing process is completed in less than 1.5 seconds once the
ticket selector button has been pushed.
The Company's ITVMs for scratch-off tickets have a record of reliability.
Based on an analysis of actual field service data regarding the dispensing of
approximately 55 million scratch-off instant tickets by the Company's ITVMs
during a 48-week period, the Company determined that the Mean Time Between
Failure of these ITVMs is approximately 3.78 years and that the Mean Time to
Repair is approximately 15 minutes.
The Company's ITVM for scratch-off tickets has the capacity to dispense
tickets from one to 16 different bins. Because each bin can dispense tickets of
different sizes, paper stocks and price levels, lotteries can sell scratch-off
tickets for up to 16 different instant-winner games with a single ITVM. The ITVM
can accommodate up to 16,000 tickets in the 16-game unit and can dispense all
tickets in the bin without manual intervention. When all of the tickets in a bin
have been dispensed, tickets can be easily reloaded by an employee of the
retailer or agent. The ability of the Company's ITVM to dispense every ticket in
each bin not only facilitates the ticket reloading process but also enhances the
accuracy of the inventory and accounting functions.
All of the Company's ITVMs accept bills in $1, $2, $5, $10 and $20
denominations and, in some applications, accept international currency. The size
of the Company's ITVM for scratch-off tickets varies from 69 inches tall, 28
inches wide and 24 inches deep for a 16-game unit to 19.75 inches tall, 15.5
inches wide and 20.5 inches deep for a countertop unit.
All models are anchored to the floor or counter. The ITVMs typically are
custom designed to meet any color and other appearance specifications requested
by a lottery. All models are Underwriters Laboratory ("UL((R))") listed and
Federal Communications Commission ("FCC") approved, which ensures that the ITVM
has passed nationally recognized safety standards and stringent requirements
designed to preclude machine damage and personal injury due to non-approved
components, devices, installation or application.
Each ITVM is standardized with an information display that provides the
player with easy-to-read instructions on how to use the machine and gives the
lottery retailer or agent the ability to read sales reports without printing the
report. The ITVM can be ordered with a "BETA BRITE((R))" multi-color LED sign
mounted on the top of the ITVM which is intended to increase attention to the
machine and thereby increase ticket sales. The BETA BRITE((R)) sign is
programmed at the Company's manufacturing facility and can display any message
the lottery may desire. The BETA BRITE((R)) also may be programmed by the
retailer or agent or can be programmed from the lottery headquarters by
utilizing the Company's optional modem communications system. The Company
currently is utilizing the BETA BRITE((R)) on ITVMs installed in approximately
16 states.
For security and durability purposes, each of the Company's ITVM cabinets
is manufactured with 16 gauge and 11 gauge steel. The surface of the ITVM is
coated with durable and fade resistant paints. The display windows are
fabricated from a flame resistant, high impact polycarbonate sheet material.
This material is shatter resistant, and to date to the knowledge of the Company,
none of the Company's installed ITVMs has had a polycarbonate window broken or
shattered. Additionally, to the knowledge of the Company, the cabinets have not
had any fading, marring, scratching, chipping or rusting. All of the Company's
ITVMs are manufactured with high security locks which are coded to prevent
unauthorized duplication, and each ITVM is keyed separately, except for ITVMs
deployed in Maryland where the Lottery desired a master key system. For further
security, each of the Company's bill acceptor units must be accessed with a key
unique to the particular acceptor unit.
All of the Company's ITVMs for scratch-off tickets utilize copyrighted
software that can supply up to 11 different reports for accounting and inventory
purposes. These reports can provide to the lottery and its retailers or agents a
complete summary of daily sales, weekly sales, total sales, sales by game,
current status of the machine, inventory of the product currently in the ITVM,
the last three transactions of the ITVM and other types of information. The
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software system allows for a simple diagnostic test to identify any malfunction
of the ITVM. The diagnostic mode communicates various information such as ticket
size setting, status of electronics, status of each game and other information
concerning the system software. The Company's ITVM software system may be
programmed to the detail specifications of the specific lottery.
To dispense pull-tab instant lottery tickets, the Company's PTVM uses the
same technology, design and specifications as are incorporated in the Company's
PCDM. The Company's PCDM is described in detail below.
The PCDM
Like the Company's ITVM for scratch-off tickets, the key component of the
Company's PCDM is the dispensing technology. The Company has the exclusive right
to the use of this patented dispensing technology, which it acquired from a
company owned by Kazmier J. Kasper, a director of the Company.
Similar to the Company's ITVM for scratch-off tickets, the Company's PCDM
automatically dispenses prepaid telephone calling cards upon payment from the
user. The dispensing technology in the Company's PCDM automatically pulls one
prepaid telephone calling card from the bottom of the stack of cards without the
jamming that is associated with other dispensing processes. The Company's
dispensing technology also enables the Company's PCDM to dispense and account
for virtually any known thickness of calling card without the intervention of
the retailer. In addition, the PCDM is faster than manual sales of prepaid
telephone calling cards as the PCDM's entire dispensing process is completed in
less than three seconds once the selector button has been pushed.
The Company's PCDMs have the capacity to dispense cards from two to six
different bins. The PCDM can accommodate up to 3,600 cards in the six-bin unit
and can dispense all prepaid telephone calling cards in the bin without manual
intervention. When all of the cards in a bin have been dispensed, cards easily
can be reloaded by an employee of the retailer. The ability of the Company's
PCDM to dispense every card in each bin not only facilitates the card reloading
process but also enhances the accuracy of the inventory and accounting
functions.
All of the Company's PCDMs accept bills in $1, $2, $5, $10 and $20
denominations and, in some applications, accept international currency. The size
of the Company's PCDMs varies from 66 inches tall, 26 inches wide and 19 inches
deep for a six-bin dispenser unit to 22 inches tall, 14 inches wide and 10
inches deep for a countertop unit. All models are anchored to the floor or
counter, except that the two bin model may be mounted on an optional pedestal.
All models are UL((R)) listed and FCC approved. Each PCDM is standardized with
an information display that provides the user with easy-to-read instructions on
how to use the machine and gives the retailer the ability to read sales reports
without printing the report.
For security and durability purposes, each of the Company's PCDM cabinets
is manufactured with 16 gauge and 11 gauge steel. The surface of the PCDM is
coated with durable and fade resistant paints. The display windows are
fabricated from a flame resistant, high impact polycarbonate sheet material. To
the knowledge of the Company, the cabinets have not had any fading, marring,
scratching, chipping or rusting. All of the Company's PCDMs are manufactured
with high security locks that are coded to prevent unauthorized duplication, and
each PCDM is keyed separately. For further security, each of the Company's bill
acceptor units must be accessed with a key unique to the particular acceptor
unit.
All of the Company's PCDMs utilize copyrighted software that can supply up
to nine different reports for accounting and inventory purposes. These reports
can provide retailers a complete summary of daily sales, weekly sales, total
sales, sales by bin, current status of the machine, inventory of the product
currently in the PCDM, the last three transactions of the PCDM and other types
of information. The software system allows for a simple diagnostic test to
identify any malfunction of the PCDM.
Marketing and Sales
ITVMs
The Company markets its ITVMs to both domestic and international lotteries
and their licensees or prime contractors. The Company attends lottery and gaming
trade shows, maintains personal contact with lottery officials through its sales
force and advertises in trade publications to increase its presence in the
lottery industry.
The focus of the Company's marketing strategy is on the superior
performance and reliability of its ITVMs, as well as continued competitive
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pricing. Information developed through actual field use and product field tests
demonstrates that a significant factor in increasing instant ticket sales is the
reliability of the ITVM. Increased maintenance visits impair the ITVM "uptime,"
which in turn reduce ticket sales. The Company believes that its ITVMs, based on
actual field performance and product testing, are the most reliable and
technologically superior in the industry. The Company's ITVMs require preventive
maintenance only twice a year. The ITVM "downtime" resulting from this
semi-annual preventive maintenance averages approximately 20 minutes.
To further increase the likelihood of receiving ITVM orders from lotteries,
the Company has offered additional and more flexible financing alternatives to
the lotteries. The Company believes that many state lotteries, due to budget
considerations, cannot afford the high capital costs required to purchase ITVMs.
However, if the Company can provide attractive variations of its standard and
percentage lease financing options for the lotteries, the lotteries can more
affordably deploy ITVMs.
The Company is expanding its marketing presence with the retail grocers
associations, convenience store operators associations, retail stores at both
the corporate and store levels, and other types of corporate or association
member entities to familiarize these groups with the Company's ITVM. These
retailers are the lotteries' distribution system for all scratch-off and
pull-tab lottery tickets. While the lotteries must abide by the established
procurement laws of their respective jurisdictions in selecting an ITVM
manufacturer, in many lottery jurisdictions retailer advisory boards provide
input to the lotteries on various issues affecting the lottery. The Company
believes that retailers' opinions are a significant factor in a customer's
decision regarding which manufacturer's ITVM to deploy in its instant ticket
distribution system.
On occasion, the Company participates in cooperative supply arrangements
with other lottery suppliers.. These arrangements allow lotteries to reduce
their operating costs and provide a more efficient means for contracting
products and services. The Company's ITVMs are deployed in Georgia and West
Virginia pursuant to cooperative supply arrangements between the Company and
Scientific Games, Inc., which is a primary contractor for the Georgia and West
Virginia Lotteries, and are deployed in New Jersey pursuant to a purchase
agreement between the Company and GTECH Corporation, which is the on-line
supplier to the New Jersey Lottery. The Company is responsible for installing,
servicing and maintaining the ITVMs in Georgia but is not required to provide
preventive maintenance or servicing for the ITVMs supplied for use in West
Virginia and New Jersey.
PCDMs
The Company has been marketing its PCDMs since late 1995 and to date has
employed a marketing strategy that is similar to the strategy that it has used
successfully to market its ITVMs. The focus of the Company's marketing strategy
is on the superior performance and reliability of its PCDMs as well as on
competitive pricing. The Company markets its PCDMs to both domestic and
international providers of long distance telephone service. The Company attends
telecommunications trade shows, maintains personal contact with
telecommunications companies through its sales force of two employees and
advertises in trade publications to increase its presence in the
telecommunications industry.
The Company is expanding its marketing presence with the retail grocers
associations, convenience store operators associations, retail stores at both
the corporate and store levels, and other types of corporate or association
member entities to familiarize these groups with the Company's PCDM. These
retailers are the distribution system for prepaid telephone calling cards. To
further increase the likelihood of receiving PCDM orders from sellers of prepaid
telephone calling cards, the Company is offering additional and more flexible
financing alternatives.
Contracts
ITVMs
General. The Company's lottery contracts typically are entered into
following a competitive bidding process. Once a lottery has determined to
utilize ITVMs in its distribution network, the lottery usually will request
proposals from ITVM providers. Lotteries within the United States typically
follow a procedure whereby the lottery issues a Request for Proposal ("RFP") to
determine the contract award for installation of ITVMs. The RFP generally seeks
information concerning each company's products, cost of the products or services
to be provided, quality of management, experience in the industry and other
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factors that the lottery may deem material to a contract award. The RFP also may
specify product criteria and other qualifications or conditions that must be
satisfied, such as UL((R)) listing and FCC approval of the ITVM and in-state or
minority supplier requirements. Generally, an evaluation committee comprised of
key lottery staff members appraises the proposals based on an established point
system, and the contract is awarded to the company with the most points.
The nature of the RFP process varies from jurisdiction to jurisdiction. The
length of time that a lottery might take to award a contract can be difficult to
predict, and delays in the contract award process are frequent and
unpredictable. Additionally, the point system or the weighing of the various
points varies from jurisdiction to jurisdiction, which often makes it difficult
for the bidding companies to determine the relative importance of the various
factors to be considered by the evaluation committee. In certain cases the
contract award is challenged by the losing bidder, which can result in
protracted legal proceedings for all parties.
The Company offers lotteries a choice of three types of contracts: (i)
Standard Lease Agreements, (ii) Sales Agreements, and (iii) Percentage Lease
Agreements. ITVM lease revenues as a percentage of the Company's total revenues
were 67.3%, 57.9% and 75.7% in 1997, 1998 and 1999, respectively.
The Standard Lease Agreements provide that the lottery will pay a fixed
monthly price per machine for a specific period of time. These agreements
typically specify a number of years for the initial contract term with
additional option periods at the election of the lottery. The lottery may award
a separate service contract for the maintenance of the machines, incorporate the
cost of service into the established monthly lease price or perform machine
service themselves. Similar arrangements are available for replacement parts for
the ITVMs.
As noted above, the lease payments provided for in the typical Standard
Lease Agreement are fixed in most cases during the term of the agreement, and
these agreements typically permit the lottery to order additional ITVMs at any
time during the lease term. If the lottery orders a significant number of ITVMs
near the end of the lease term, the Company would have to incur significant
manufacturing costs but may receive lease payments for only a relatively short
period of time through the remainder of the lease term. However, the Company
believes that it is more likely that the lottery would elect to extend the lease
term rather than return the ITVMs after only a short period of use.
Additionally, the Company is unable to pass along to the lottery any increases
in its manufacturing and service costs during the term of the typical Standard
Lease Agreement. In the case of a Standard Lease Agreement which provides for a
short initial term (such as one year) with an option for the lottery to extend
the lease term for additional one-year periods, if the lottery does not extend
the initial lease term, the Company might incur a loss on the manufacture of the
ITVMs leased to the lottery under the initial lease agreement.
Sales Agreements typically provide that the lottery will buy a certain
number of ITVMs over a specific period of time. Under the Sales Agreement, the
lottery generally pays for the ITVMs when delivered and has complete ownership
of the ITVMs. The lottery usually will contract with the vendor to maintain and
service the ITVMs, although some lotteries provide the maintenance and service
with their own service staffs. The lottery generally will enter into a parts
replacement contract with the vendor for replacement parts.
Percentage Lease Agreements provide that the lottery will pay a percentage
of sales for tickets sold through our ITVMS. This amount will vary depending
upon the location of the machine, the number of games available and the general
trends in instant lottery sales.
All types of ITVM contracts typically contain stringent installation,
performance and maintenance requirements. Failure to perform the contract
requirements may result in significant liquidated damages or contract
termination. To date, the Company has not had to pay liquidated damages or had
any contract terminated by any lottery.
The Company's lottery contracts also typically require the Company to
indemnify the lottery, its officers and retailers for any liabilities arising
from the operation of the ITVMs or any services provided by the Company. The
Company maintains liability insurance, fidelity insurance and performance and
litigation bonds to protect itself and the lottery from potential liability. No
such indemnification or insurance claims have ever been asserted against the
Company.
The Company's contracts generally have an initial term of one to five years
with options to extend the duration of the contracts for periods between one and
five years. The option extensions generally are under the same terms and
conditions as the original contract. The Company's contracts with lotteries,
like most other types of state contracts, typically permit a lottery to
terminate the contract upon 30 days written notice for any reason. Upon
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termination of a lease contract, the lottery would return the leased equipment
to the Company. To date, no lottery has terminated its contract with the
Company.
30 states and the District of Columbia utilize ITVMs in some manner as part
of their instant ticket distribution system. The Company's ITVMs have been
deployed in 23 of these states and the District of Columbia as well as eight
international jurisdictions. As of December 31, 1999, the Company had sold or
leased over 20,000 ITVMs and currently has 9,232 under lease with 17 states and
the District of Columbia. These leases expire on various dates through 2003. In
certain cases, the Company's contracts are with third parties who are the
primary contractors to the lottery. See "Marketing and Sales - ITVMs" above.
During 1999, the Company's contract with the Ohio Lottery accounted for 18%
of the Company's revenues, and contracts with New York, Texas and Florida
accounted for 13%,11% and 10% of the Company's revenues, respectively.
PCDMs
Unlike the competitive bidding process applicable to the lotteries' awards
of ITVM contracts, purchasers of PCDMs typically do not issue RFPs or otherwise
mandate a competitive bidding process. Information regarding the Company and its
PCDM, and information regarding a telephone company's product needs and criteria
and other qualifications or conditions that must be satisfied, typically is
exchanged on a less formal basis in sales presentations and subsequent meetings
between representatives of the Company and representatives of the telephone
company.
Most PCDMs to date have been acquired through purchase orders rather than
contracts. The Company also has several lease agreements for PCDMs. Like
contracts with the lotteries, the purchase orders may contain stringent
installation, performance and service requirements. As of December 31, 1999, the
Company had sold 756 PCDMs and had 95 PCDMs under lease.
Manufacturing Process
The manufacturing process consists of purchasing component parts,
assembling the ITVMs and PCDMs and then testing the final products. Generally,
the Company's machines use components which are built to Company specifications
and are available from multiple sources. The Company has a primary vendor and
secondary suppliers for most of its components and typically has been able to
obtain adequate supplies of required components on a timely basis.. However,
certain important components, such as components of the Company's ITVM burster,
PTVM dispensing mechanism and PCDM dispensing mechanism currently are purchased
from a single source. Because other suppliers exist that can duplicate these
components should the Company elect or be forced to use a different supplier,
the Company does not believe that a change in suppliers would result in the
termination of a production contract. However, the Company could experience a
delay of 30 to 60 days in production which could adversely affect the Company's
ability to make timely deliveries of machines and to obtain new contracts. The
single-source supplier of certain components of the Company's burster mechanism,
PTVM dispensing mechanism and PCDM dispensing mechanism is Algonquin Industries,
Inc. Kazmier J. Kasper, a director of the Company, is the President and owner of
Algonquin Industries. See "Item 13. Certain Relationships and Related
Transactions. "
The Company assembles the components utilizing a core group of
manufacturing employees and, on an as-needed basis, contracting with employment
agencies for appropriately trained manufacturing labor. The use of temporary,
contract manufacturing labor gives the Company the flexibility to meet the
production schedules required by large orders.
The Company's manufacturing has the capacity to produce approximately 300
machines per week.
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Research And New Product Development
The Company has developed many of the technological advancements used in
the ITVM industry. The Company was the first to obtain UL((R)) listing and FCC
approval. The Company also was the first to (i) manufacture and deliver ITVMs
under a lease contract agreement, (ii) offer a "random play" push button
selector option through which the ITVM rather than the player randomly selects
the game to be played and (iii) receive patent protection for the technology
used in its ITVM burster dispensing mechanism.
The Company currently employs several engineers and technicians for
research and development. To reduce costs, the Company subcontracts the majority
of its research and development projects to independent contractors. The
Company's copyrighted software is upgraded continually to meet the different
demands of the various lotteries. In many instances, after an ITVM feature has
been developed for a specific lottery, it is incorporated into the product line
as a standard feature of the machine.
The Company's ITVMs may be purchased with optional modem communication
software which allows lotteries to gather sales data from each ITVM on an
hourly, daily, weekly or monthly basis, depending on the needs of the customer.
This data includes the daily or weekly sales totals and breakdown of these
totals by game, including the total tickets sold. The Company has developed
software that enables a modem equipped ITVM to communicate to the host system
automatically if the ITVM malfunctions, thus greatly enhancing the Company's
ability to provide prompt service, or if a ticket bin is empty, which allows the
lottery to call the retailer or agent and inform them of the situation.
Additionally, by utilizing this system with the optional BETA BRITE((R)) message
display, the lottery can change the message display on any or all of its ITVMs.
The Company has incorporated its patented pull-tab lottery ticket
dispensing mechanism into a combination ITVM which also contains the Company's
patented burster mechanism. The pull-tab dispensing mechanism also has been
incorporated into the Company's PCDMs, and the Company believes that the ability
of the mechanism to dispense a variety of thicknesses of prepaid telephone
calling cards significantly differentiates the Company's PCDMs from those of its
competitors.
The Company has developed the MVP to address the specific needs of
convenience store and grocery check-out lanes. The MVP may be installed in a
variety of configurations including under-the-counter. This new technology
reduces ticket shrinkage and increases sales volume of instant tickets and may
also be tied into the Point of Service register.
In an effort to expand its product lines into new markets, the Company has
developed a device which dispenses stored value "smart cards." This product will
be marketed in the future to the financial services industry to the extent that
consumer use of smart cards develops in the future.
Research and development expenditures were $545,039, $618,819 and $581,885
for 1997, 1998 and 1999, respectively.
Customer Service and Product Repair
Typically, the Company or its subcontractors install and service the
machines purchased or leased by the Company's customers. The Company maintains a
toll-free telephone line for service calls. If the service dispatcher cannot
resolve the problem over the telephone, he or she will immediately dispatch one
of the Company's service technicians to the machine's location. The modular
design and manufacturing standards of the Company's machines enable the Company
to conduct any necessary repairs and maintenance quickly and efficiently. The
Company estimates that the mean time for all repairs is less than 15 minutes
after the service technician arrives at the machine's location.
The Company generally grants a 360-day repair or replacement warranty
covering all parts and components of its machines. However, the warranty period
may vary depending on the bid specifications. In certain circumstances, the
Company may warrant the product for the complete life of the contract. In these
instances, the contract generally will be a lease with the Company retaining
ownership of the machine. Provisions for estimated warranty costs are recorded
at the time of sale and are periodically adjusted to reflect actual experience.
-9-
Patents, Trademarks and Copyrights
The Company currently has five U.S. patents and one pending patent
application relating to its ITVMs and has filed a disclosure document with the
United States Patent and Trademark Office ("PTO).
The Company owns by assignment U.S. Patent No. 4,982,337 entitled "System
for Distributing Lottery Tickets." The assignment is recorded at the PTO. This
patent is for the Company's burster technology, which is the key component of
the Company's ITVM. The patent expires December 31, 2007. Improvements to the
burster technology developed by the Company are the subject of U.S. Patent No.
5,836,498. The improved burster provides for an increased range of operation for
reliable and effective separation of the adjacent tickets along the lines of
weakness. Additionally, foreign patent applications are pending on these
improvements.
The Company has developed a new system designed specifically for retail
vending of lottery tickets and other items at the point of sale. The system
utilizes the Company's burster technology and includes other modular and
distributed components that can be adapted for use at the point of sale. The
Company has a pending U.S. patent application on this technology as well as
corresponding foreign pending patent applications.
The Company owns U.S. Patent No. 5,330,185 for the "Method and Apparatus
for Random Play of Lottery Games," which expires March 30, 2013; U.S. Patent No.
5,472 for a "Multi-Point High Security Locking Mechanism for Lottery Machines,"
which expires July 18, 2014; and U.S. Design Patent No. 376,621 for the
Company's double-game countertop ITVM, which expires December 17, 2010. The
Company believes that each of these patents is important but not essential to
the Company's business.
The Company has an Information Disclosure Document on file with the PTO for
the purpose of identifying technology relating to its "Software Release Control
and Data Security for ITVMs." The technology allows secure remote transmissions
of software updates and operations data between the ITVM and the Company or the
respective lottery. The invention also includes a key management system to
control the keys used to encrypt data sent to and decrypt the data received at
the ITVM.
The Company is the exclusive licensee of the dispensing technology used in
its PTVMs and PCDMs pursuant to an agreement with Algonquin Industries.
Algonquin Industries has been granted six U.S. Patents, and one is pending for
the licensed technology. Under the terms of the license agreement, the Company
is the sole entity entitled to use this technology on its ITVMs. See "Item 13.
Certain Relationships and Related Transactions."
The Company has obtained federal registration in the United States of the
following trademarks: INTERLOTT, INTERLOTT and design, and INSTANT SUCCESS. The
Company does not deem the trademarks to be critical to the future of its
business.
The Company requires all of its employees and subcontractors to execute
confidentiality and proprietary rights agreements, which prohibit disclosure of
the trade secrets of the Company and provides that all inventions or discoveries
during the term of their employment or contract for service will be assigned to
the Company.
Competition
Competition in the markets for the Company's ITVM and PCDM is based on a
number of factors, including technological features, product quality and
reliability, price, compatibility, ease of installation and use, marketing and
distribution capabilities, product delivery time, and service and support. The
Company is aware of four manufacturers of ITVMs and approximately four
manufacturers of PCDMs in the United States, and competition among these
manufacturers is intense. Of the four ITVM competitors, the Company has the
largest share of the ITVM market in the United States. The Company is not aware
of any published data regarding market shares in the PCDM industry, but the
Company does not believe that it has the largest market share in the PCDM
industry.
Additional domestic and international manufacturers, some of which have
substantially greater resources and experience than the Company, may elect to
enter the ITVM and PCDM markets. The instant ticket market also faces
competition from other types of lottery and gaming products, including
particularly on-line lottery products. The long distance telephone market
similarly may face competition from other types of communications products,
including facsimile, e-mail and other on-line products.
-10-
The Company believes that its patented dispensing technologies make its
ITVM and PCDM dispensing mechanisms technologically superior to the dispensing
mechanisms of its competitors and that this is a significant competitive
advantage for the Company. The Company also believes that its products have
earned a strong reputation for their performance, reliability and cost
effectiveness. To remain competitive, the Company believes that it will need to
continue to incorporate new technological developments into its existing
products and to develop new products, as well as to maintain a competitive price
for its products. These efforts, together with the Company's continuing sales
and marketing efforts, will be critical to the Company's future success.
Although the Company believes that its current successes, coupled with its
history of continued product enhancement and cost reduction, will enable it to
compete favorably with its competitors, there can be no assurance that the
Company will be able to maintain or improve its competitive position in the ITVM
and PCDM markets.
On January 10, 2000, the Company's main competitor, On-Point Technology
Systems, Inc., entered into an agreement to be acquired by GTECH Holdings
Corporation, a major supplier of on-line lottery terminals to many of the same
lotteries served by the Company. Shortly after the merger announcement, On-Point
filed an 8-K report with the Securities and Exchange Commission announcing that
its previously issued financial statements for 1997, 1998 and 1999 were being
restated and should no longer be relied upon. By press release dated February
29, 2000, On-Point disclosed that GTECH had informed it that "in light of the
restatement, no assurance can be given that the merger will be consumated, if at
all, on the terms set forth in the definitive merger agreement."
Government Regulation
ITVMs
Lotteries are not permitted in the various states and jurisdictions of the
United States unless expressly authorized by legislation. Similarly, the
commencement of ITVM sales and leasing in a jurisdiction requires authorizing
legislation and implementing regulations.
Currently, 37 states and the District of Columbia have enacted legislation
to allow for the operation of a lottery, and 31 of these jurisdictions utilize
ITVMs in some manner as part of their instant ticket distribution process. The
operation of the lotteries in each of these jurisdictions is strictly regulated.
The formal rules and regulations governing lotteries vary from jurisdiction to
jurisdiction but typically authorize the lottery, create the governing
authority, dictate the price structure, establish allocation of revenues,
determine the type of games permitted, detail appropriate marketing structures,
specify procedures for selecting vendors and define the qualifications of
lottery personnel. Although the Company currently believes that it is unlikely
that states which have enacted legislation that expressly authorize the use of
ITVMs will adopt legislation in the foreseeable future that prohibits the use of
ITVMs, there can be no assurance that this will not occur.
To ensure the integrity of the lottery, state laws provide for extensive
background investigations of each of the lottery's vendors and their affiliates,
subcontractors, officers, directors, employees and principal stockholders. These
regulations generally require detailed continuing disclosure. If the lottery
deems a person unsuitable, the lottery may require the termination of the
person's relationship with the Company. The failure of a person associated with
the Company to obtain or retain approval in any jurisdiction could have a
material adverse effect on the Company. Generally, regulatory authorities have
broad discretion when granting such approvals. The Company has never been
disqualified from a lottery contract as a result of a failure to obtain any such
approvals.
The Federal Gambling Devices Act of 1962 (the "Act") makes it unlawful,
with certain exceptions, for a person or entity to transport any gambling
devices across interstate lines unless that person or entity has first
registered with the United States Department of Justice. Although the Company
believes that it is not required to register under such Act, the Company has
voluntarily registered under the Act and intends to renew its registration
annually. The Act also imposes various record keeping and equipment
identification requirements. Violation of the Act may result in seizure or
forfeiture of equipment, as well as other penalties.
The Company may retain governmental affairs representatives in various
jurisdictions of the United States to monitor legislation, advise the Company on
contract proposals, and assist with other issues that may affect the Company.
The Company believes it has complied with all applicable state regulatory
provisions relating to disclosure of its activities and those of its advisors.
-11-
International jurisdictions that operate lotteries also impose strict
regulations. International regulations may vary from those in the United States.
Additionally, international regulations frequently impose restrictions on
international corporations doing business within the specific jurisdiction. As a
result, the Company may contract with local representation or align itself with
a local partner when pursuing international contracts.
PCDMs
The Company is not aware of any federal, state or local regulations that
apply to the manufacture, lease or sale of PCDMs.
Backlog
The Company's backlog of ITVMs committed for production as of December 31,
1999 was approximately $24,365,000, which was equal to the total base lease
payments or sales value for ITVMs that were committed for production but had not
been shipped to various lotteries as of December 31, 1999. At December 31, 1998,
the comparable backlog was approximately $5,640,000. Approximately 69% of the
backlog at December 31, 1999 related to a contract awarded by a state lottery
earlier in the month. It is anticipated that substantially all of the Company's
backlog at December 31, 1999 will be shipped on or before December 31, 2000. The
Company had no backlog of PCDMs committed for production at December 31, 1999 or
1998.
The Company has entered into various lease or sales agreements that permit
the lotteries, at their sole option, to lease or purchase additional ITVMs as of
December 31, 1999. However, the Company does not include these additional ITVMs
in backlog ITVMs that may be sold or leased under existing contracts unless the
Company has received a firm order for the ITVMs. Due to the relatively large
size of individual orders, the small number of customers and the long sales
cycle of the lottery industry, management considers backlog to be an indicator
of current activity and not necessarily predictive of future orders.
Employees
The Company utilizes a work force of full-time employees supported from
time to time by temporary or contract manufacturing and engineering personnel.
As of December 31, 1999, the Company had 190 full-time employees, of which 71
were manufacturing employees, eight were engineering employees, 93 were service
employees, eight were clerical and administrative employees and 10 were
executives or senior managers. Two of the executives and senior managers were
devoted to sales and eight were devoted to management and administration. No
Company employees are represented by any union, and the Company believes that
its relations with its employees are good.
ITEM 2. PROPERTIES
The Company's manufacturing, distribution and executive offices are in the
process of relocating to approximately 52,500 square feet of newly leased space
in Mason, Ohio. This facility houses the Company's executive, administrative,
sales, engineering production and service personnel and is comprised of 15,000
square feet of office space and 37,500 square feet of manufacturing and storage
space. The Company believes that this facility is suitable for and adequate to
support its operations for the foreseeable future. The lease for this facility
expires on March 31, 2005.
ITEM 3. LEGAL PROCEEDINGS
The Company is involved from time to time in litigation in the ordinary
course of its business. The Company does not believe that there is any currently
pending or threatened litigation against the Company that, individually or in
the aggregate, is likely to have a material adverse effect on its business,
financial condition or results of operations.
-12-
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
No matters were submitted by the Company to a vote of its stockholders
during the fourth quarter ended December 31, 1999.
PART II
ITEM 5. MARKET FOR THE REGISTRANT'S COMMON STOCK AND RELATED STOCKHOLDER MATTERS
The Company's common stock has been traded on the American Stock Exchange
under the symbol "ILI" since the Company's initial public offering. The
following tables show the high and low closing sale prices per share for the
common stock as reported by the American Stock Exchange for the periods
indicated:
1998: High Low
----- -----
First Quarter $9.75 $7.75
Second Quarter 14.00 9.63
Third Quarter 10.75 7.88
Fourth Quarter 8.13 6.50
1999:
First Quarter 7.00 6.00
Second Quarter 6.25 5.63
Third Quarter 6.38 5.50
Fourth Quarter 5.75 4.00
At March 17, 2000 there were approximately 63 stockholders of record and an
unknown number of beneficial owners holding stock in nominee or "street" name.
The Company has paid no cash dividends on its common stock and currently intends
to retain all future earnings for use in the development of its business.
-13-
ITEM 6. SELECTED FINANCIAL DATA
The following table presents selected financial data derived from the
Company's audited financial statements for each year in the five-year period
ended December 31, 1999 and should be read in conjunction with the Company's
Financial Statements and with Management's Discussion and Analysis of Financial
Condition and Results of Operations set forth below.
SELECTED FINANCIAL DATA
Year Ended
---------------------------------------------------------------------------------------------------------------------------------
Dec. 31 Dec. 31 Dec. 31 Dec. 31 Dec. 31
1995 1996 1997 1998 1999
---------------------------------------------------------------------------------------------------------------------------------
Revenues
Machine sales $ 9,746,339 $ 5,596,698 $ 4,567,441 $ 8,229,950 $ 3,311,874
Machine leases 9,132,132 11,766,623 12,874,450 14,165,379 16,901,911
Other 435,137 1,235,368 1,669,160 2,078,644 2,120,245
Net revenues 19,313,608 18,598,689 19,111,051 24,473,973 22,334,030
Net income 1,987,219 1,320,597 1,451,654 1,622,313 2,070,298
Net income per share 0.62 0.41 0.45 0.51 0.65
Depreciation and amortization 2,982,547 3,902,387 4,143,408 4,585,325 5,547,909
Leased ITVM's, less
accumulated depreciation 10,779,929 10,940,398 14,740,462 17,105,891 21,549,400
Total assets 20,483,686 20,992,733 24,612,884 28,774,249 36,203,867
Total debt 9,040,784 7,715,140 9,458,004 11,645,374 16,291,727
---------------------------------------------------------------------------------------------------------------------------------
Redeemable preferred stock 1,335,000 1,335,000 1,335,000 1,335,000 1,335,000
---------------------------------------------------------------------------------------------------------------------------------
-14-
RESULTS OF OPERATIONS
The table below presents selected financial information derived from the
Company's statements of income expressed as a percentage of revenues for the
years indicated
Year Ended
Dec. 31 Dec. 31 Dec. 31
1997 1998 1999
Revenues
Machine sales 24.0% 33.6% 14.8%
Machine leases 67.3 57.9 75.7
Other 8.7 8.5 9.5
Total revenues 100.0 100.0 100.0
Cost of revenues
excluding depreciation 41.7 48.4 39.0
Depreciation 20.6 17.5 23.9
Gross margin 37.7 34.1 37.1
Selling, general and
administrative expenses 18.3 16.5 18.8
Research and
development costs 2.9 2.5 2.6
Operating income 16.5 15.1 15.7
Interest expenses 3.7 4.0 4.9
Income before income
taxes 12.8 11.1 14.7
Income taxes 5.2 4.5 5.4
Net income 7.6% 6.6% 9.3%
SUMMARY OF QUARTERLY DATA
Quarterly financial data for the years ended December 31, 1998 and 1999 shown
here in thousands, except for per share data.
1998 First Second Third Fourth
Net sales $5,884 7,323 5,714 5,554
Gross profit 1,718 2,492 1,874 2,270
Net earnings 291 630 225 476
Basic earnings per share 0.09 0.19 0.07 0.15
Diluted earnings per share 0.09 0.19 0.07 0.15
1999 First Second Third Fourth
Net sales $4,960 5,138 4,995 7,240
Gross profit 1,761 1,687 1,525 3,314
Net earnings 654 76 182 1,158
Basic earnings per share 0.20 0.02 0.06 0.36
Diluted earnings per share 0.20 0.02 0.06 0.36
-15-
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
OVERVIEW
The Company's revenue base consists of (1) payments from instant ticket
vending machine "ITVM" and phone card dispensing machine "PCDM" Leases (2) sales
of ITVMs and PCDMs, (3) and to a lesser extent, sales of parts for ITVMs and
PCDMs and service agreements. The Company emphasizes leasing rather than selling
ITVMs to lotteries when possible. Leases provide the Company with a consistent
revenue stream, opportunities to generate income on financing, and the potential
to deploy a greater number of ITVMs within a lottery's budget due to the lower
initial cash outlay required by the lottery. Leasing ITVMs also gives the
lotteries the flexibility to enhance their ITVMs in the future with new
technology from the Company. On the other hand, leasing ITVMs requires the
Company to invest capital or otherwise finance the manufacture of ITVMs, whereas
sales of ITVMs result in the receipt of payment in full upon delivery of the
ITVMs. When the Company sells ITVMs, the Company generally is able to
manufacture and deliver the ITVMs and receive full payment for them before it
must pay for the materials used to manufacture the ITVMs. Nevertheless, the
Company believes that the advantages of leasing ITVMs, as described above,
justify the initial capital investment or financing costs required to
manufacture ITVMs for lease.
For similar reasons, the Company emphasizes leasing rather than selling
PCDMs to providers of prepaid telephone cards. As with ITVMs, the Company
believes that the benefits to the Company of leasing PCDMs warrant the initial
capital investment required to manufacture PCDMs. However, the great majority of
the PCDMs deployed to date have been sold rather than leased.
The Company historically has experienced fluctuations in its financial
results due to its dependence upon a small number of major customers, the
unpredictable nature, timing and results of the lotteries' contract bid and
award process. The Company's revenues and capital expenditures can vary
significantly from period to period because the Company's sales cycle may be
relatively long and because the amount and timing of revenues and capital
expenditures depend on factors such as the amount and timing of awarded
contracts and changes in customer budgets and demands. Operating results may be
affected by the lead-time sometimes required for business opportunities to
result in signed lease or sales agreements, working capital requirements
associated with manufacturing ITVMs pursuant to new orders, increased
competition and the extended time that may elapse between the award of a
contract and the receipt of revenues from the sale or lease of ITVMs.
1998 as Compared to 1999
Total revenues decreased by $2,139,943 from $24,473,973 to $22,334,030 in
1999, or 9%, due primarily to a $4,918,076 decrease in machine sales and a
$2,736,532 increase in lease revenues accompanied by a $41,601 increase in other
revenues. Revenues from leases increased by 19% from $14,165,379 in 1998 to
$16,901,911 in 1999, resulting from a new lease in one state, the continuation
of leases in seven states and the renewal of eight leases in other states that
had reached the conclusion of their original terms. Revenues from sales
decreased by 60% from $8,229,950 in 1998 to $3,311,874 in 1999, as a result of a
decrease in ITVMs and PCDMs sold in 1999 over 1998. The total number of ITVMs
and PCDMs under lease increased in 1999 as a result of deployment of new units,
partially offset by the retirement of older units. Lease revenues were 58% and
76% of total revenues for 1998 and 1999, respectively. Revenues from sales of
ITVMs and PCDMs were 34% and 15% of total revenues in 1998 and 1999,
respectively. The increase in lease revenues and decrease in sales revenues
reflects the cumulative effect of continuing revenues from machines under lease
which were deployed prior to 1999 and the incremental revenue of new machines
leased or deployed in 1999. Other revenues increased by 10% from $2,078,644 in
1998 to $2,120,245 in 1999, as machines deployed prior to 1999 generated service
revenue for the entire year.
-16-
Cost of revenues for machine sales and other decreased 75% from $5,809,057
in 1998 to $1,466,153 in 1999. This decrease reflects the 79% decrease in the
number of machines sold in 1999. Cost of revenues for leased ITVMs and PCDMs,
excluding depreciation, increased 20% from $6,020,437 in 1998 to $7,243,770 in
1999. The increase in cost of lease revenues was the result of higher personnel
and subcontractor costs related to the larger number of machines deployed during
1999.
Depreciation of ITVMs and PCDMs increased by 24% from $4,290,128 in
1998 to $5,337,018 in 1999. The increase was greater than the related 16%
increase in number of leased ITVMs and PCDMs, as newer units have more capacity
and cost more.
Selling, general and administrative expenses increased 4% from
$4,048,751 in 1998 to $4,202,825 in 1999. Selling, general and administrative
expenses, as a percentage of revenues, increased slightly from 17% in 1998 to
19% in 1999, in part because revenues in 1999 were lower.
Research and development costs decreased by 6% from $618,819 in 1998 to
$581,885 in 1999. The Company maintains its philosophy of using contractors as
the primary source of research and development efforts, allowing the Company to
focus its expenditures on the technical expertise necessary to accomplish the
specific project.
Operating income decreased by 5% from $3,686,781 in 1998 to $3,502,379
in 1999. This decrease resulted primarily from the decrease in the number of
machines sold in 1999 as compared to 1998. As a percentage of revenues,
operating income increased from 15% in 1998 to 16% in 1999.
Interest expense increased by 14% from $967,768 in 1998 to $1,102,478
in 1999. The increase reflects the cost of additional borrowings to finance
leased equipment built and deployed in 1999, and higher interest rates.
Other income in 1999 of $598,832 consists of a one time non-recurring
credit of $625,000 from settlement of litigation with a competitor offset by
$26,168 in other non-related expenses.
Income before income taxes and extraordinary item increased 10% from
$2,719,013 in 1998 to $2,998,733 in 1999.
Income taxes increased by 1% from $1,096,700 in 1998 to $1,106,594 in
1999 as a result of the increase in income before taxes.
As a result of the above factors, the Company's net income before
extraordinary items increased by 17% from $1,622,313 in 1998 to $1,892,139 in
1999.
The extraordinary item of $178,159, net of tax, relates to a gain on
the involuntary conversion of assets lost in a tornado which were covered by
insurance at replacement cost.
1997 as Compared to 1998
Total revenues increased by $5,362,922 from $19,111,051 to $24,473,973
in 1998, or 28%, due primarily to a $3,662,509 increase in machine sales and a
$1,290,929 increase in lease revenues accompanied by a $409,484 increase in
other revenues. Revenues from leases increased by 10% from $12,874,450 in 1997
to $14,165,379 in 1998, resulting from the continuation of leases in nine states
and the renewal of seven leases in other states that had reached the conclusion
of their original terms. Other revenues increased by 25% from $1,669,160 in 1997
to $2,078,644 in 1998, as machines deployed prior to 1998 generated service
revenue for the entire year and service for ITVMs in one state was taken over
from a sub-contractor. Revenues from sales increased by 80% from $4,567,441 in
1997 to $8,229,950 in 1998, as a result of an increase in ITVMs and PCDMs sold
in 1998 over 1997. The units sold in 1998 included a greater number of higher
priced machines than 1997. The total number of ITVMs and PCDMs under lease
increased in 1998 as a result of deployment of new units, partially offset by
the retirement of older units. Lease revenues were 67% and 58% of total revenues
for 1997 and 1998, respectively. Revenues from sales of ITVMs and PCDMs were 24%
and 34% of total revenues in 1997 and 1998, respectively. The increase in lease
revenues reflects the cumulative effect of continuing revenues from machines
under lease which were deployed prior to 1998 and the incremental revenue of new
machines leased or deployed in 1998.
-17-
Cost of revenues for machine sales and other increased 33% from
$4,378,669 in 1997 to $5,809,057 in 1998. This increase reflects the 47%
increase in number of machines sold, offset by lower costs of the units sold in
1998. Cost of revenues for leased ITVMs and PCDMs, excluding depreciation,
increased 67% from $3,584,017 in 1997 to $6,020,437 in 1998. The increase in
cost of leased revenues was the result of higher personnel and subcontractor
costs related to the larger number of machines deployed during 1998.
Depreciation of ITVMs and PCDMs increased by 9% from $3,924,244 in 1997
to $4,290,128 in 1998. The increase was lower than the related increase in
number of ITVMs and PCDMs, as certain units had been fully depreciated by the
end of 1997.
Selling, general and administrative expenses increased 16% from
$3,492,020 in 1997 to $4,048,751 in 1998. As a percentage of revenues, selling,
general and administrative expenses decreased slightly from 18% in 1997 to 17%
in 1998.
Research and development costs increased by 14% from $545,039 in 1997
to $618,819 in 1998. This increase results from continuing development and
refinement of existing products to meet the variety of the needs of the
customers for our dispensing technologies. The Company maintains its philosophy
of using contractors as the primary source of research and development efforts,
allowing the Company to focus its expenditures on the technical expertise
necessary to accomplish the specific project.
Operating income increased by 16% from $3,187,062 in 1997 to $3,686,781
in 1998. This increase resulted from the continuing benefit of revenues derived
from machines deployed in prior periods, including machines which had been fully
depreciated, combined with ongoing machine sales and leases.
Interest expense increased by 30% from $747,008 in 1997 to $967,795 in
1998. The increase reflects the cost of additional borrowings to finance leased
equipment built and deployed in 1998, partially offset by lower interest rates
resulting from utilization of the LIBOR option in our loan agreement.
Income taxes increased by 11% from $988,400 in 1997 to $1,096,673 in
1998 as a result of an increase in income before taxes of 11%.
As a result of the above factors, the Company's net income increased by
12% from $1,451,654 in 1997 to $1,622,313 in 1998.
Liquidity and Capital Resources
Net cash provided by operating activities increased 1% from $7,435,079 in
1998 to $7,519,552 in 1999. Net cash used in investing activities increased 24%
from $9,735,516 in 1998 to $12,063,408 in 1999. Net cash provided by financing
activities increased by 112% from $2,187,370 in 1998 to $4,646,353 in 1999.
The Company's liquidity and capital resources continue to be impacted by
its decision to use leasing as a means to market its ITVMs and PCDMs. Leasing
generally offers the Company better gross margins than direct sales agreements.
However, leasing inherently requires more capital and a longer-term payout than
sales. As of December 31, 1999, the Company had a total of 9,356 ITVMs and PCDMs
under operating and sales type leases.
At December 31, 1998 and 1999, the Company had working capital deficits
of $7,466,831 and $9,440,256 respectively. These deficits reflect the
classification of the Company's revolving credit facility as a current debt due
to the revolver clause of the facility.
At December 31, 1999, the Company was indebted to Mercantile Business
Credit, Inc. (MBC) in the aggregate principal amount of $16,005,029 pursuant to
a revolving credit agreement entered into as of October 29, 1997. The facility
permits the Company to borrow through October 2000, with two one-year extensions
to October 2002, up to $25,000,000 at the prime interest rate or the respective
LIBOR rate plus two percent. Borrowings under this facility are collateralized
by all of the assets of the Company and assignment of proceeds from lease
agreements. At December 31, 1999, the Company had $8,994,971 available under
this agreement.
-18-
At December 31, 1999, the Company also was indebted to two stockholders
in the aggregate principal amount of $286,698 incurred to finance the
manufacture of ITVMs. See Note 6 of Notes to Financial Statements.
The Company's capital expenditures totaled $9,735,516 and $12,063,408
for 1998 and 1999, respectively. These amounts include $9,611,623 and
$11,985,736 for the manufacture of machines leased during the respective
periods. Other expenditures represent machinery and equipment costs for expanded
office capacity.
The Company had no material commitments for additional capital
expenditures as of December 31, 1999 other than for the manufacture of ITVMs and
PCDMs for future lease.
At December 31, 1999, the Company had estimated tax net operating loss
carryforwards of approximately $859,400, which are available to offset future
federal taxable income, if any, through 2009. The use of these carryforwards is
subject to certain annual limitations due to ownership changes in 1992.
Special Note Regarding Forward-looking Statements
The words "expect", "anticipate", "intend", "plan", "believe", "seek",
"estimate" and similar expressions used in this report are intended to identify
forward-looking statements, although this report also contains other
forward-looking statements. Any forward-looking statements in this report are
made pursuant to the "safe harbor" provisions of the Private Securities
Litigation Act of 1995. Investors are cautioned that actual results may differ
substantially from such forward-looking statements. Forward-looking statements
involve risks and uncertainties including, but not limited to, continued
acceptance of the Company's products and services in the marketplace,
competitive factors, new products and technological changes, dependence upon
third party vendors, a limited number of customers, political and other
uncertainties related to customer purchases and other risks detailed in the
Company's periodic filings with the Securities and Exchange Commission.
The following risk factors apply to Interlott and its business:
We may experience fluctuations in our financial results and, as a
result, our stock price.
In the past, we have experienced significant fluctuations in our
financial results. Our revenues, capital expenditures and operating results can
vary significantly due to:
o our dependence on a small number of major customers;
o relatively long sales cycles;
o the unpredictable timing and amount of contracts awarded by state
lotteries and telephone companies;
o the extended time between the award of a contract and the receipt of
revenues from the sale or lease of ITVMs and PCDMs;
o changes in customer budgets; and
o working capital required to manufacture ITVMs and PCDMs pursuant to
new orders.
These factors may make it difficult to forecast revenues and
expenditures over extended periods. Consequently, our operating results for any
period could be below the expectations of securities analysts and investors.
This in turn could lead to sudden and sometimes dramatic declines in the market
price of our stock.
Our growth will depend upon continued market acceptance of ITVMs and
PCDMs.
Our ability to generate additional revenues and earnings will depend
upon the continuation of existing leases of ITVMs and PCDMs, the distribution of
ITVMs and PCDMs in additional states and international jurisdictions, the
approval of lotteries in remaining states and international jurisdictions and
increased future orders of ITVMs and PCDMs. As of December 31, 1999, 30 states,
the District of Columbia and eight international jurisdictions used ITVMs as
part of their instant ticket distribution system. We leased or sold ITVMs in 23
of those states, the District of Columbia and in eight international
-19-
jurisdictions. Similarly, the use of PCDMs to distribute prepaid telephone
calling cards has grown significantly in the last few years. We have marketed
PCDMs since 1995, and as of December 31, 1999, we had sold or leased 851 PCDMs.
However, the popularity of instant lottery games and prepaid telephone calling
cards and the demand for ITVMs and PCDMs may not continue and, as a result, we
may not be able to successfully market and sell our products. Although the total
dollar amount of instant ticket sales continues to increase, the rate of
increase has declined from 23.7% to .4% for the lottery industry's fiscal year
ended June 30, 1992 through June 30, 1999. It is important but not critical that
we develop relationships with additional lotteries and telephone companies and
that additional states authorize instant lotteries.
We depend on large contracts from a limited number of ITVM customers.
We have traditionally derived a significant portion of our revenues
from a limited number of state lottery authorities or their representatives for
the lease, sale or service of ITVMs. In particular, during 1999, a contract with
the Ohio Lottery accounted for 18% of our total revenues and 24% of our lease
revenue. Additionally, a contract with the New York Lottery accounted for 38% of
our machine sales revenues and 13% of our total revenue in 1999, This can cause
our revenues and earnings to fluctuate between quarters based on the timing of
orders and realization of revenues from these orders. Further, none of our large
customers has any obligation to lease or purchase additional machines from us. A
loss of any of these large contracts could have a material adverse effect on our
business, financial condition and results of operations.
We may not be successful in protecting our proprietary rights or
avoiding claims that we infringe the proprietary rights of others.
We principally rely upon patent, copyright, trademark and trade secret
laws, license agreements and employee nondisclosure agreements to protect our
proprietary rights and technology. These laws and contractual provisions provide
only limited protection. Our success depends largely on our burster technology
that is protected by a patent that expires on December 31, 2007. Additionally,
we have four other patents and one pending patent application with the United
States Patent and Trademark Office. We also have an exclusive license agreement
with Algonquin Industries, Inc. for use of their patented pull-tab instant
ticket dispensing mechanism in our PTVM and PCDM. We cannot be certain that we
and Algonquin have taken adequate steps to prevent misappropriation of the
technology that we use or that competitors will not independently develop
technologies that are substantially equivalent or superior to our technology.
Moreover, we could incur substantial costs and diversion of management resources
in the defense of any claims relating to the proprietary rights of others, which
could have a material adverse effect on our business, financial condition and
results of operations.
We may not be able to adapt to changes in technology, products and
industry standards.
The instant ticket market, the ITVM market, the prepaid telephone
calling card market and the PCDM market are characterized by rapidly changing
technology and evolving industry practices. Competitors may introduce other
types of lottery, gaming and prepaid telephone calling card products. To be
successful, we must:
o use leading technologies effectively;
o continue developing our technical expertise;
o enhance our existing products and services; and
o develop new products and services.
If we fail to do any of these things, our customers may choose to
purchase products and services from our competitors. Our inability to anticipate
changes in technology and industry practices and to develop and introduce new
products and services in a timely manner would likely result in a material
adverse effect on our business, financial condition and results of operation.
The state lotteries can cancel their contracts with us for any reason
and can assess significant damages against us if we do not satisfactorily
perform the contracts.
Our contracts with lotteries, like most other types of state contracts,
typically permit a lottery to terminate the contract upon 30 days written notice
for any reason. We may not be able to re-lease or sell any ITVMs that are
returned to us by a lottery following the cancellation or expiration of a lease.
These lottery contracts also impose demanding installation, performance and
maintenance requirements. Our failure to perform the contract requirements could
result in significant liquidated damages or contract termination. Our lottery
-20-
contracts typically require us to indemnify the lottery, its officers and
retailers for any liabilities arising from the operation of the ITVMs or any
services that we provide. These provisions present an ongoing risk of
significant damage assessments or contract terminations, which could have a
material adverse effect on our business, financial condition and results of
operation.
A single stockholder controls a majority of our stock and can exert
significant influence over our corporate matters.
As of December 31, 1999, Mr. L. Roger Wells, Jr. beneficially owned 53.3%
of the outstanding common stock. As a result, Mr. Wells can control the election
of directors and the outcome of certain corporate actions requiring stockholder
approval. This concentration of ownership in a single stockholder also can delay
or prevent a change of control.
Our ITVM lease contracts may result in losses.
Our ITVM lease revenues as a percentage of our total revenues were 67.3% in
1997, 57.9% in 1998 and 75.7% in 1999. Our standard lease agreements provide for
fixed lease payments during the term of the agreement and some permit the
lottery to order additional ITVMs at any time during the lease term. If one of
these lotteries were to order a large number of ITVMs near the end of the lease
term, we would incur significant manufacturing costs but might receive lease
payments for only a relatively short period of time through the remainder of the
lease term. Additionally, we are unable to pass along to the lottery any
increases in manufacturing and service costs during the term of the lease
agreement. Our standard lease agreements provide for a short initial term, such
as one year, with an option for the lottery to extend the lease term for
additional one-year periods. If the lottery does not extend the initial lease
term, we might incur a loss on the manufacture of the ITVMs if we are unable to
re-lease or sell the ITVM.
The ITVM and PCDM markets are very competitive.
The ITVM and PCDM markets are markets that have grown rapidly in recent
years. We may not be able to compete successfully against current or future
competitors, some of whom may have greater resources and experience than us. The
instant ticket market also may face competition from other types of lottery and
gaming products, particularly on-line lottery products. The long distance
telephone market similarly may face competition from other types of
communications products, including facsimile, e-mail and other on-line products.
If the ability to provide ITVMs and PCDMs internationally becomes a competitive
advantage in the instant ticket lottery and prepaid calling card industries, we
will have to expand our presence internationally or risk a disadvantage relative
to our competitors. Increased competition could cause us to increase our selling
and marketing expenses and research and development costs. We may not be able to
offset the effects of any such increased costs through an increase in the number
of lottery contracts and higher revenue from sales and leases of ITVMs and
PCDMs, and we may not have the resources to compete successfully. These
developments could have a material adverse effect on our business, financial
condition and results of operation.
Because we depend upon single or limited source suppliers, we could
temporarily lose our supply of some critical parts or experience significant
price increases.
We currently purchase certain important parts, such as components of our
ITVM burster, PTVM dispensing mechanism and PCDM dispensing mechanism, from a
single source. The purchase of these components from outside suppliers on a sole
source basis subjects us to certain risks, including the continued availability
of suppliers, price increases and potential quality assurance problems. Because
other suppliers exist that can duplicate these components should we elect or be
forced to use a different supplier, we do not believe that a change in suppliers
would result in the termination of a production contract. However, we could
experience a delay of 30 to 60 days in the production of ITVMs and PCDMs should
we elect or be forced to use other suppliers. Any delay of 30 to 60 days could
have a material adverse effect on our business, financial condition and results
of operation.
We may not be able to retain our key executives and engineering and
marketing personnel.
As a small company with only 190 employees, our success depends in large
part on the continued service of our key management, sales, product development
and operational personnel, including Mr. L. Rogers Wells, Jr., our Chairman, and
David F. Nichols, our President and Chief Executive Officer. We do not currently
have employment agreements with any of our employees. Our success also depends
-21-
on our ability to attract and retain additional personnel with a variety of
skills, especially engineering and marketing expertise. Our inability to hire
and retain qualified personnel would likely have a material adverse effect on
our current business, any new product development efforts and future business
prospects.
The success of our international operations is subject to many
uncertainties.
In each of 1998 and 1999, our sales and leases of ITVMs and PCDMs
outside the United States represented an immaterial percentage of our total
revenues. However, we are increasing our marketing activities in international
jurisdictions, including expansion into several countries. Our ability to expand
our business into international markets may be adversely affected by the
following:
o customizing our products for use in international countries;
o longer accounts receivable payment cycles;
o difficulties in managing international operations;
o availability of trained personnel to install and implement our
systems;
o exchange rate fluctuations;
o political instability;
o tariffs and other trade barriers;
o potentially adverse tax obligations;
o restrictions on the repatriation of earnings;
o the burdens of complying with a wide variety of international laws and
regulations; and
o the risk that our intellectual property rights will not be protected
to as great an extent as in the United States.
These factors could have a material adverse effect on our international
revenues and earnings and our overall financial performance.
Our industry is subject to significant government regulation which
could negatively affect us.
State and local governments strictly regulate the operation of
lotteries and the sales and leasing of ITVMs. Further, international
jurisdictions that operate lotteries impose strict regulations which may vary
from those in the United States. Any adverse change in the lottery laws of any
jurisdiction in which we sell and lease ITVMs could impose burdensome
requirements or requirements that we may be unable to satisfy. Our failure to
comply with changing lottery-related laws and regulations could have a material
adverse effect on our business, financial condition and results of operation.
In addition, state laws provide for background investigations on each
of the lottery's vendors and their affiliates, subcontractors, officers,
directors, employees and principal stockholders. The failure of any of these
parties associated with us to obtain or retain approval in any jurisdiction
could have a material adverse effect on our business, financial condition and
results of operation.
Future sales of our common stock in the public market could adversely
affect our stock price and our ability to raise funds in new stock offerings.
The market price of our common stock could drop as a result of sales of
large numbers of shares in the market, or the perception that such sales could
occur. This is particularly true due to our relatively small number of
stockholders and the resulting low trading volume of our common stock in the
public market. All outstanding shares of our common stock either are freely
tradeable without restriction or may be sold in accordance with the volume
limitations of Rule 144 of the Securities Act of 1933. These factors also could
make it more difficult for us to raise funds through future offerings. Our
principal stockholder, Mr. L. Rogers Wells, Jr., owns a majority of our common
stock.
Our forward looking statements may be incorrect.
Some of the statements in this report are forward looking statements
about what may happen in the future. They include statements regarding our
current beliefs, plans, expectations and assumptions about matters such as our
-22-
expected financial position and operating results, our business strategy and our
financing plans. These statements can sometimes be identified by our use of
forward looking words such as "anticipate," "believe," "estimate," "expect,"
"intend," "plan," "seek," "should" and similar expressions. Our forward looking
statements are subject to numerous risks, uncertainties and assumptions, many of
which are beyond our control. These risks, uncertainties and assumptions include
the risk factors discussed above. We cannot guarantee that our forward looking
statements will turn out to be correct or that our beliefs, plans, expectations
and assumptions will not change. Our actual results could be very different from
and worse than our expectations as expressed in our forward looking statements.
ITEM 7(A). QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
Not applicable.
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
Independent Auditors' Report
The Board of Directors and Shareholders
Interlott Technologies, Inc.:
We have audited the accompanying balance sheet of Interlott Technologies, Inc.
as of December 31, 1999, and the related statements of income, stockholders'
equity, and cash flows for the year then ended. These financial statements are
the responsibility of the Company's management. Our responsibility is to express
an opinion on these financial statements based on our audit.
We conducted our audit 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 audit provides a reasonable basis for our opinion.
In our opinion, the financial statements referred to above present fairly, in
all material respects, the financial position of Interlott Technologies, Inc. as
of December 31, 1999, and the results of its operations and its cash flows for
the year then ended, in conformity with generally accepted accounting
principles.
/s/ Grant Thornton LLP
Cincinnati, Ohio
February 7, 2000
Independent Auditors' Report
The Board of Directors and Stockholers
Interlott Technologies, Inc.:
We have audited the balance sheet of Interlott Technologies, Inc. as of December
31, 1998, and the related statements of income, stockholders' equity (deficit)
and cash flows for each of the years in the two-year period ended December 31,
1998. In connection with our audits of the financial statements, we also have
audited the related financial statement schedule as listed in the accompanying
index. These financial statements and financial statement schedule are the
resposibility of the Company's management. Our responsibility is to express an
opinion on these financial statements and financial statement schedule 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 financial statements referred to above present fairly, in
all material respects, the financial position of Interlott Technologies, Inc. as
of December 31, 1998, and the results of its operations and its cash flows for
each of the years in the two-year period ended December 31, 1998, in conformity
with generally accepted accounting principles. Also in our opinion, the related
financial statement schedule, when considered in relation to the basic financial
statements taken as a whole, presents fairly, in all material respects, the
information set forth therein.
/s/ KMPG LLP
Cincinnati, Ohio
February 26, 1999
-23-
INTERLOTT TECHNOLOGIES, INC.
Balance Sheets
December 31, 1998 and 1999
1998 1999
----------------- ----------------
Assets
Current assets:
Cash $ 30,004 132,501
Accounts receivable, less allowance for doubtful accounts
of $153,501 in 1998 and $158,793 in 1999 2,816,589 3,305,486
Investment in sales type leases, current portion 888,627 1,251,144
Inventories 3,129,959 5,214,106
Prepaid expenses 82,105 267,838
- -------------------------------------------------------------------------------------------------------------------------
Total current assets 6,947,284 10,171,075
- -------------------------------------------------------------------------------------------------------------------------
Property and equipment:
Leased machines 29,484,623 35,244,923
Machinery and equipment 631,111 610,968
Building and leasehold improvements 271,433 202,441
Furniture and fixtures 130,950 60,237
- -------------------------------------------------------------------------------------------------------------------------
30,518,117 36,118,569
Less accumulated depreciation and amortization (12,970,895) (14,301,656)
- -------------------------------------------------------------------------------------------------------------------------
Net property and equipment 17,547,222 21,816,913
- -------------------------------------------------------------------------------------------------------------------------
Investment in sales type leases, less current portion 3,766,408 3,775,876
Product development rights, net of accumulated amortization of
$586,665 in 1998 and $659,997 in 1999 513,335 440,003
- -------------------------------------------------------------------------------------------------------------------------
$28,774,249 36,203,867
- -------------------------------------------------------------------------------------------------------------------------
See accompanying notes to financial statements.
-24-
INTERLOTT TECHNOLOGIES, INC.
Balance Sheets, Continued
December 31, 1998 and 1999
1998 1999
--------------- ---------------
Liabilities and Stockholders' Equity
Current liabilities:
Notes payable to financial institutions $11,166,374 16,005,029
Current portion of notes payable - related parties 192,302 286,698
Accounts payable 1,479,831 1,781,884
Accounts payable - related parties 215,734 179,469
Accrued expenses 1,111,416 1,358,253
Income taxes payable 248,458 -
- ---------------------------------------------------------------------------------------------------------------
Total current liabilities 14,414,115 19,611,333
- ---------------------------------------------------------------------------------------------------------------
Notes payable - related parties, excluding current portion 286,698 -
Deferred income taxes 121,900 570,700
- ---------------------------------------------------------------------------------------------------------------
Total liabilities 14,822,713 20,182,033
- ---------------------------------------------------------------------------------------------------------------
Commitments and contingent liabilities
- ---------------------------------------------------------------------------------------------------------------
Series A redeemable preferred stock, $.01 par value; 20,000,000 shares
authorized, 1,335,000 shares issued and
outstanding 1,335,000 1,335,000
- ---------------------------------------------------------------------------------------------------------------
Stockholders' equity:
Common stock, $.01 par value; 20,000,000 shares authorized,
3,210,000 shares issued and outstanding in 1998 and 1999 32,100 32,100
Additional paid-in capital 10,376,017 10,376,017
Retained earnings 2,208,419 4,278,717
- ---------------------------------------------------------------------------------------------------------------
Total stockholders' equity 12,616,536 14,686,834
---------- ----------
$28,774,249 36,203,867
- ---------------------------------------------------------------------------------------------------------------
See accompanying notes to financial statements.
-25-
INTERLOTT TECHNOLOGIES, INC.
Statements of Income
Years Ended December 31, 1997, 1998 and 1999
1997 1998 1999
--------------- --------------- ---------------
Revenues:
Machine sales $ 4,567,441 8,229,950 3,311,874
Machine leases 12,874,450 14,165,379 16,901,911
Other 1,669,160 2,078,644 2,120,245
- -------------------------------------------------------------------------------------------------------------------------
19,111,051 24,473,973 22,334,030
- -------------------------------------------------------------------------------------------------------------------------
Cost of revenues:
Machine sales and other 4,378,669 5,809,057 1,466,153
Machine leases 7,508,261 10,310,565 12,580,788
- -------------------------------------------------------------------------------------------------------------------------
11,886,930 16,119,622 14,046,941
- -------------------------------------------------------------------------------------------------------------------------
Gross margin 7,224,121 8,354,351 8,287,089
- -------------------------------------------------------------------------------------------------------------------------
Operating expenses:
Selling, general and administrative expenses 3,492,020 4,048,751 4,202,825
Research and development costs 545,039 618,819 581,885
- -------------------------------------------------------------------------------------------------------------------------
4,037,059 4,667,570 4,784,710
- -------------------------------------------------------------------------------------------------------------------------
Operating income 3,187,062 3,686,781 3,502,379
- -------------------------------------------------------------------------------------------------------------------------
Other income (expense)
Interest expense (747,008) (967,768) (1,102,478)
Other - - 598,832
- -------------------------------------------------------------------------------------------------------------------------
(747,008) (967,768) (503,646)
- -------------------------------------------------------------------------------------------------------------------------
Income before income taxes and extraordinary item 2,440,054 2,719,013 2,998,733
- -------------------------------------------------------------------------------------------------------------------------
Income tax provision 988,400 1,096,700 1,106,594
- -------------------------------------------------------------------------------------------------------------------------
Income before extraordinary item 1,451,654 1,622,313 1,892,139
- -------------------------------------------------------------------------------------------------------------------------
Extraordinary item (less applicable income taxes of
$109,195) - - 178,159
- -------------------------------------------------------------------------------------------------------------------------
Net income $ 1,451,654 1,622,313 2,070,298
- -------------------------------------------------------------------------------------------------------------------------
Basic income per share before extraordinary item $0.45 0.51 0.59
- -------------------------------------------------------------------------------------------------------------------------
Diluted income per share before extraordinary item $0.45 0.50 0.59
- -------------------------------------------------------------------------------------------------------------------------
Basic and diluted extraordinary item per share $ - - 0.06
- -------------------------------------------------------------------------------------------------------------------------
Basic net income per share $0.45 0.51 0.65
- -------------------------------------------------------------------------------------------------------------------------
Diluted net income per share $0.45 0.50 0.65
- -------------------------------------------------------------------------------------------------------------------------
See accompanying notes to financial statements.
-26-
INTERLOTT TECHNOLOGIES, INC.
Statements of Stockholders' Equity
Years ended December 31, 1997, 1998 and 1999
Common Stock Additional
------------------------- Paid-in Retained
Shares Amount Capital Earnings Total
---------- --------- ----------- ----------- ------------
Balances at December 31, 1996 3,210,000 $32,100 $10,376,017 $ (865,548) $ 9,542,569
Net income - - - 1,451,654 1,451,654
- --------------------------------------------------------------------------------------------------------------------------------
Balances at December 31, 1997 3,210,000 32,100 10,376,017 586,106 10,994,223
Net income - - - 1,622,313 1,622,313
- --------------------------------------------------------------------------------------------------------------------------------
Balances at December 31, 1998 3,210,000 32,100 10,376,017 2,208,419 12,616,536
Net income - - - 2,070,298 2,070,298
- --------------------------------------------------------------------------------------------------------------------------------
Balances at December 31, 1999 3,210,000 $32,100 $10,376,017 $4,278,717 $14,686,834
- --------------------------------------------------------------------------------------------------------------------------------
See accompanying notes to financial statements.
-27-
INTERLOTT TECHNOLOGIES, INC.
Statements of Cash Flows
Years ended December 31, 1997, 1998 and 1999
1997 1998 1999
----------- ---------- ---------
Cash flows from operating activities:
Net income $1,451,654 1,622,313 2,070,298
Adjustments to reconcile net income to net cash
provided by operating activities:
Net book value of equipment lost in involuntary conversion - - 113,563
Depreciation and amortization 4,143,408 4,585,325 5,547,909
Principal portion of sales type leases received 164,194 557,116 909,184
Deferred income taxes 203,700 374,200 448,800
Gain on sale of equipment under sales type lease (447,915) (1,177,773) (331,170)
Decrease (increase) in accounts receivable 298,927 101,503 (488,897)
Decrease (increase) in inventories 1,035,052 1,110,268 (828,568)
Decrease (increase) in prepaid expenses 6,804 32,345 (185,733)
Increase in accounts payable 217,852 337,766 302,052
Increase (decrease) in accounts payable - related parties 22,431 (113,226) (36,265)
Increase (decrease) in accrued expenses 186,650 (142,766) 246,837
(Decrease) increase in income taxes payable (1,300) 148,008 (248,458)
- ---------------------------------------------------------------------------------------------------------------------------------
Net cash provided by operating activities 7,281,457 7,435,079 7,519,552
- ---------------------------------------------------------------------------------------------------------------------------------
Cash flows from investing activities:
Cost of leased machines (8,710,315) (9,611,623) (11,985,736)
Purchases of property and equipment (359,521) (123,893) (77,672)
- ---------------------------------------------------------------------------------------------------------------------------------
Net cash used in investing activities (9,069,836) (9,735,516) (12,063,408)
- ---------------------------------------------------------------------------------------------------------------------------------
Cash flows from financing activities:
Increase in notes payable 1,747,865 2,188,338 4,838,655
Repayment of long-term debt (5,001) (968) (192,302)
--------- --------- ----------
Net cash provided by financing activities 1,742,864 2,187,370 4,646,353
- ---------------------------------------------------------------------------------------------------------------------------------
(Decrease) increase in cash (45,515) (113,067) 102,497
Cash at beginning of year 188,586 143,071 30,004
- ---------------------------------------------------------------------------------------------------------------------------------
Cash at end of year $ 143,071 30,004 132,501
- ---------------------------------------------------------------------------------------------------------------------------------
Supplemental disclosures of cash flow information:
Interest paid $ 671,515 902,252 1,216,285
Income taxes paid $ 631,610 526,807 1,104,789
- ---------------------------------------------------------------------------------------------------------------------------------
See accompanying notes to financial statements.
-28-
Notes to Financial Statements
Years ended December 31, 1997, 1998, 1999
(1) Summary of Significant Accounting Policies
(a) Business Description
Interlott Technologies, Inc. (the Company), a Delaware
corporation, designs, manufactures, leases, sells and services
vending machines for use in connection with public lotteries
operated by states and foreign public entities, as well as for use
by providers of prepaid telephone cards.
(b) Operating and Sales Type Leases
Depending on the specific terms contained in the lease agreement,
the lease is either classified as an operating lease or
capitalized as a sales type lease, in accordance with Statement of
Financial Accounting Standards (SFAS) No. 13, Accounting for
Leases, as amended.
The net investment in operating leases consists of leased
machines, which are carried at cost, less the amount depreciated
to date. Operating lease revenue consists of the contractual lease
payments and is recognized ratably over the lease term. Expenses
are principally depreciation of the leased machines (see Note 1d).
The net investment in sales type leases consists of the present
value of the future minimum lease payments. Sales type lease
revenues consists of the profits earned on the sale of the leased
machines and interest earned on the present value of the lease
payments. Interest revenue is recognized as a constant percentage
return on the net investment.
Any future losses related to lease cancellations would be recorded
in the period such losses became known and estimable.
(c) Inventories
Inventories consist of parts and supplies, and vending machines
assembled or in the process of assembly. Inventories are stated at
the lower of cost or market, with cost determined using standard
costing, which approximates the first-in, first-out method.
(d) Property and Equipment
Property and equipment are stated at cost. Depreciation of
property and equipment is calculated on the straight-line method
over the estimated useful lives of the assets, to the Company's
estimate of the assets' residual values, as follows:
Leased machines 5 years
Machinery and equipment 10 years
Furniture and fixtures 5 years
Leasehold improvements are amortized on the straight-line method
over the lease term. Amortization of assets held under leasehold
improvements is included with depreciation expense.
-29-
(e) Product Development Rights
Product development rights represent the exclusive rights to
certain patents and other related manufacturing technologies to
manufacture and assemble the instant ticket vending machines. The
asset is amortized on the straight-line method over fifteen years,
which represents the lower of the remaining life of the patents or
the estimated remaining life of the technology currently in use.
(f) Income Taxes
The Company accounts for income taxes using the asset and
liability method. In accordance with this method, deferred tax
assets and liabilities are recognized for the future tax
consequences attributable to differences between the financial
statement carrying amounts of existing assets and liabilities and
their respective tax bases and operating loss and tax credit
carryforwards. Deferred tax assets and liabilities are measured
using the enacted tax rates expected to apply to taxable income in
the years in which those temporary differences are expected to be
recovered or settled.
(g) Disclosure About Fair Value of Financial Instruments
SFAS No. 107, Disclosure About Fair Value of Financial
Instruments, defines the fair value of a financial instrument as
the amount at which the instrument could be exchanged in a current
transaction between willing parties. The carrying amounts as of
December 31, 1999 of cash, accounts receivable, accounts payable,
accounts payable - related parties, accrued expenses and income
taxes payable approximate fair value due to the short maturity of
these investments. The carrying amount of notes payable and notes
payable - related parties approximate fair value, as such
borrowings bear interest at the Company's current rates for such
types of instruments.
(h) Stock Incentive Plans
On January 1, 1996, the Company adopted SFAS No. 123, Accounting
for Stock-Based Compensation, which permits entities to recognize
compensation expense over the vesting period the fair value of
all stock-based awards on the date of grant. Alternatively, SFAS
No. 123 allows entities to continue to apply the provisions of
APB Opinion No. 25 and provide pro forma net income and pro forma
earnings per share disclosures for employee stock option grants
as if the fair-value-based method defined in SFAS No. 123 had
been applied. The Company has elected to continue to apply the
provisions of APB Opinion No. 25 and provide the pro forma
disclosures of SFAS No. 123.
(i) Warranty Costs
Provision for estimated warranty costs on machines sold is
recorded at the time of sale and periodically adjusted to reflect
actual experience.
(j) Research and Development Costs
Research and development costs are charged to expense in the year
incurred.
-30-
(k) Earnings Per Share
Effective December 31, 1997, the Company adopted SFAS No. 128,
Earnings Per Share, which simplifies the standards for computing
earnings per share. There was no material impact on the Company's
previously reported annual or interim period earnings per share,
as a result of the adoption. Basic earnings per share is based
upon the weighted average number of common shares outstanding.
Diluted earnings per share is based upon the weighted average
number of common shares outstanding, including the effects of all
dilutive potential common shares outstanding.
(l) Use of Estimates
Management of the Company has made a number of estimates and
assumptions relating to the reporting of assets and liabilities
and the disclosure of contingent liabilities to prepare these
financial statements in conformity with generally accepted
accounting principles. Actual results could differ from those
estimates.
(2) Investment in Sales Type Leases
The Company leases 200 instant ticket vending machines (ITVMs) to one
state lottery under a sales type lease that commenced in May 1997 and 775
ITVMs to another state lottery under a sales type lease that commenced in
May 1998. The components of the net investment in sales type leases at
December 31, 1998 and 1999 are as follows:
1998 1999
Minimum lease payments receivable $6,134,450 $6,306,800
Less unearned revenue on lease payments receivable 1,479,415 1,279,780
--------- ---------
4,655,035 5,027,020
Less current portion 888,627 1,251,144
--------- ---------
Investment in sales type leases, less current portion $3,766,408 $3,775,876
========= =========
-31-
Future minimum lease payments to be received by the Company under these
sales type leases are as follows:
Years ending December 31,
2000 $1,820,400
2001 1,820,400
2002 1,535,600
2003 838,650
2004 291,750
----------
$6,306,800
=========
(3) Inventories
Inventories at December 31, 1998 and 1999 consist of the following:
1998 1999
Finished goods $1,528,656 $1,350,719
Work in process 302,766 376,243
Raw materials and supplies 1,298,537 3,487,144
--------- ---------
$3,129,959 $5,214,106
========= =========
(4) Leased Machines
At December 31, 1998 and 1999, the Company leased 7,027 and 8,246 ITVMS
to 14 and 16 state lotteries, respectively, under operating leases. The
leases generally provide for the lotteries to make monthly or quarterly
payments for rentals of the ITVMs over various lease terms. The
components of the net investment in operating leases, which includes
estimated residual values, at December 31, 1998 and 1999 are as follows:
1998 1999
Leased machines $29,484,623 $35,244,923
Less accumulated depreciation 12,378,732 13,695,523
---------- ----------
$17,105,891 $21,549,400
========== ==========
Future minimum lease payments to be received by the Company under
operating leases are as follows:
December 31,
2000 $14,171,372
2001 6,584,092
2002 2,781,412
2003 437,500
------------
$23,974,376
==========
(5) Notes Payable to financial institutions
In October 1997, the Company entered into a revolving credit facility
with a financial institution that permitted the Company to borrow through
-32-
October 2000 up to $15,000,000 at the prime interest rate (8.50% at
December 31, 1999). Initial proceeds from the note were used to retire
the prior revolving credit facility. In conjunction with the
establishment of the facility, the Company opened a lockbox and
controlled disbursement account with the bank parent of the financial
institution. All lockbox receipts are recorded as payments against the
facility, and presented checks are recorded as draws on the facility.
Borrowings under this credit facility are collateralized by all assets of
the Company and assignment of proceeds from lease agreements. In October
1999, this facility was amended to permit borrowings of up to
$25,000,000. At December 31, 1998 and 1999, the Company had borrowings of
$11,166,374 and $16,005,029 outstanding with additional borrowings of
$3,833,626 and $8,994,971 available under the facility, respectively.
(6) Notes Payable - Related Parties
The Company has the following notes payable to related parties at
December 31, 1998 and 1999:
1998 1999
Note payable to a stockholder, in the initial principal amount of
$400,000, due in annual installments limited to twenty-five
percent (25%) of the net profits, if any, of the Company from its
business operations as reported in the Company's annual financial
statements. Any required payment is due on the first business
day of the fourth month following the close of the fiscal year.
The note bears interest at the prime rate of Chase Manhattan Bank
of New York (8.50% at December 31, 1999). The note is unsecured. $400,000 $207,698
Note payable to a stockholder, in the original amount of $79,000, due and
limited to twenty-five percent (25%) of the net profits of the Company,
if any, from its business operations as reported in the Company's annual
financial statements. The payments shall begin on the first business day
of the fourth month of the Company's fiscal year, for income tax
purposes, immediately following payment in full of principal and interest
due by the Company to a stockholder in the amount of $400,000. The note
does not provide for any interest and is unsecured. 79,000 79,000
------- -------
479,000 286,698
Less current portion 192,302 286,698
------- -------
$286,698 $ -
======= ========
-33-
(7) Additional Financial Instrument
The Company has entered into an interest rate swap agreement with a total
notional principal amount of $10,000,000 at December 31, 1999, which
expires on November 7, 2002. The objective of the agreement is to convert
a portion of the Company's floating rate revolving credit facility to a
fixed rate. The estimated fair value of the interest rate swap agreement
was approximately $176,000 at December 31, 1999. The estimated fair value
is based upon appropriate market information and projected interest rate
changes obtained from a reputable institution.
(8) Income Taxes
Income tax expense is summarized as follows:
Year ended December 31,
--------------------------------
1997 1998 1999
Current:
Federal $557,400 $ 566,000 $ 612,400
State and local 156,000 156,500 154,600
Deferred:
Federal 275,000 374,200 448,800
------- --------- ---------
$988,400 $1,096,700 $1,215,800
======= ========= =========
A reconciliation of income tax expense in relation to the amounts computed
by application of the U.S. federal income tax rate of 34% to pretax
income follows:
1997 1998 1999
Federal income tax expense at the statutory rate $830,000 $ 924,400 $1,117,300
Non-deductible lobbyist expenses - - 3,200
Officers life insurance - - 8,000
Amortization of product development rights 25,000 25,000 25,000
State and local taxes, net of federal benefit 103,000 103,300 102,000
Other 30,400 44,000 (39,700)
------- --------- ---------
$988,400 $1,096,700 $1,215,800
======= ========= =========
The tax effects of temporary differences that give rise to significant
portions of the deferred tax assets and deferred tax liabilities at
December 31, 1998 and 1999 are presented below:
1998 1999
Deferred tax assets:
Bad debt allowance $ 52,200 $ 54,000
Warranty costs 10,100 1,200
Net operating loss carryforwards 347,100 292,200
Inventory valuation reserve 317,300 249,600
Other, net - 52,600
------- ---------
Total gross deferred tax assets $726,700 $ 649,600
======= =========
Deferred tax liabilities:
Property and equipment, principally due to
differences in depreciation $537,800 $ 987,800
Investment in sales type leases 310,800 134,800
Involuntary conversion of assets - 97,700
------- ---------
Total gross deferred tax liabilities 848,600 1,220,300
------- ---------
Net deferred tax liabilities $(121,900) $ (570,700)
======= =========
-34-
In assessing the realizability of deferred tax assets, management
considers whether it is more likely than not that some portion or all of
the deferred tax assets will not be realized. The ultimate realization of
deferred tax assets is dependent upon the generation of future taxable
income during the periods in which those temporary differences become
deductible. Management considers the scheduled reversal of deferred tax
liabilities, projected future income and tax planning strategies in
making this assessment.
At December 31, 1999, the Company has net operating loss carryforwards
for Federal income tax purposes of approximately $859,400, which are
available to offset future Federal taxable income, if any, through 2009.
However, due to an ownership change on September 25, 1992, utilization of
these carryforwards is subject to certain annual limitations.
(9) Redeemable Preferred Stock
The Company's preferred stock is nonparticipating and has no rights to
dividends. The holders of the preferred stock are entitled to sell to the
Company all of their shares of preferred stock at a price of $1.00 per
share upon (i) the reporting by the Company of retained earnings of at
least $1,000,000 determined in accordance with generally accepted
accounting principles and (ii) the payment in full by the Company of a
promissory note in the original amount of $400,000 to a related party.
Due to the redemption feature of the preferred stock, it has been
classified separately from stockholders' equity in the Company's balance
sheet.
The Company may, at its discretion, redeem all or part of the outstanding
preferred stock at any time. The redemption price for the preferred stock
is $1.00 per share and payment may be made in the form of a promissory
note.
(10) Stock Incentive Plans
The Company's 1994 Stock Incentive Plan and 1994 Directors' Stock
Incentive Plan (collectively, the Plans) provide for the issuance of up
to 260,000 shares of common stock to officers and employees of, and
advisers, consultants and other supporters of the Company and up to
60,000 shares of common stock to nonemployee directors of the Company.
Stock options are granted with an exercise price equal to the stock's
fair market value at the date of grant. Options vest at the rate of 25%
per year beginning one year from the date of grant, subject to the
recipient's continued employment or service to the Company, and must be
exercised within 10 years after that date.
As permitted by SFAS No. 123, the Company applies the intrinsic value
method prescribed by APB Opinion No. 25 and related interpretations in
accounting for its stock option plans. Accordingly, no compensation cost
has been recognized in the accompanying statements of income.
-35-
A summary of the status of the Company's stock option plans as of
December 31, 1997, 1998, and 1999 and the changes therein for the years
then ended is presented below:
1997 1998 1999
Weighted Weighted Weighted
Average Average Average
Exercise Exercise Exercise
Shares Price Shares Price Shares Price
Outstanding at beginning of year 147,225 $ 9.38 180,875 $ 9.12 212,175 $8.65
Granted 37,000 8.00 36,300 6.75 57,750 5.18
Exercised - - - - - -
Forfeited 3,350 11.50 5,000 11.50 13,375 9.15
Outstanding at end of year 180,875 9.12 212,175 8.65 256,550 7.81
Options exercisable at year-end 79,660 9.77 120,794 9.48 152,081 8.95
Weighted-average fair value of
options granted during the year $ 5.82 $ 5.16 $5.18
===== ===== ====
Had compensation cost for options granted during 1997, 1998 and 1999 been
determined consistent with the fair value methodology of SFAS No. 123,
the Company's net income and earnings per share would have been reduced
to the pro forma amounts presented below:
1997 1998 1999
Net income As reported $1,451,654 $1,622,313 $2,070,298
Pro forma 1,324,003 1,512,186 2,054,057
Basic and diluted earnings per share As reported .45 .51 .65
Pro forma .41 .47 .64
========= ========== =========
The full impact of calculating compensation cost for stock options under
SFAS No. 123 is not reflected in the pro forma net income amounts
presented above because compensation cost is recognized over the options'
vesting period of four years and compensation cost for options granted
prior to January 1, 1995 is not considered.
The fair value of options granted during 1997, 1998 and 1999 for purposes
of the accompanying pro forma disclosures is estimated on the grant date
using the Black-Scholes option-pricing model with the following
weighted-average assumptions: no dividends paid, as it has been the
Company's policy not to declare or pay dividends since its initial public
offering in 1994 and the Company does not anticipate paying dividends in
the foreseeable future; expected volatility of 56%, 65% and 43%,
respectively, based on the calculated volatility of the Company's stock
since its initial public offering; risk-free rates of return of 5.86%,
4.93% and 4.83%, respectively; and expected lives of 10 years.
-36-
Information about stock options outstanding at December 31, 1999 is as
follows:
Options Outstanding Options Exercisable
----------------------------------------------- -----------------------------
Weighted-
Average Weighted- Weighted-
Remaining Average Average
Range of Number Contractual Exercise Number Exercise
Exercise Prices Outstanding Life Price Exercisable Price
- --------------------- -------------- -------------- --------------- -------------- -------------
$4.81 - 8.63 215,350 7.47 $ 7.15 112,900 $ 8.15
$10.13 - 11.50 41,200 4.59 11.43 39,181 11.32
------- ---- ----- ------- -----
256,550 7.26 $ 8.65 152,081 $ 9.49
======= ==== ===== ======= =====
(11) Earnings Per Share
Net Per
Earnings Shares Share
1997 (Numerator) (Denominator) Amount
--------------- ------------------ ---------------
Basic earnings per share:
Net earnings available to common stockholders $1,451,654 3,210,000 $0.45
Diluted earnings per share:
Effect of dilutive securities stock options 2,661
Earnings available to common stockholders
and assumed conversions 1,451,654 3,212,661 0.45
1998
Basic earnings per share:
Net earnings available to common stockholders 1,622,313 3,210,000 0.51
Diluted earnings per share:
Effect of dilutive securities stock options 10,649
Earnings available to common stockholders
and assumed conversions 1,622,313 3,220,649 0.50
1999
Basic earnings per share:
Net earnings available to common stockholders 2,070,298 3,210,000 0.65
Diluted earnings per share:
Effect of dilutive securities stock options 903
Earnings available to common stockholders
and assumed conversions 2,070,298 3,210,903 0.65
Options to purchase 129,725, 52,475 and 223,025 shares of common stock
were outstanding in 1997, 1998 and 1999, respectively, but were not
included in the computation of diluted earnings per share because the
options' exercise prices were greater than the average market price of
common shares.
-37-
(12) Noncash Investing Activities
Leased machines with net book values of $442,897 in 1998 and $1,255,578
in 1999, were returned to the Company's inventories upon lease
expirations. The Company used parts from these returned machines in the
manufacturing of certified new machines, a portion of which were deployed
in the current year under new leases.
(13) Related Party Transactions
Accounts payable - related parties of $215,734 and $179,469 at December
31, 1998 and 1999, respectively, represent management fees and expenses
payable to a company owned 100% by the majority stockholder as well as
parts expenses payable to an entity which is owned by a director.
Amounts expensed related to the company owned by the majority stockholder
were $36,000 for each of the years ended December 31, 1997, 1998 and
1999, respectively.
The entity owned by a director supplies the Company with certain parts
for its dispensing mechanisms. In addition, on January 13, 1994, the
Company entered into a manufacturing and license agreement with this
entity pursuant to which the Company purchased an exclusive license to
make, use and sell pull-tab lottery ticket dispensing mechanisms produced
by this entity. The Company had purchases from this entity which were
charged to cost of revenues of approximately $2,996,000, $3,800,887 and
$4,116,674 for the years ended December 31, 1997, 1998 and 1999,
respectively.
Interest expense arising from notes payable-related parties amounted to
$33,714, $33,401 and $20,275 for the years ended December 31, 1997, 1998
and 1999, respectively.
(14) Customer and Supplier Concentrations
A significant portion of the Company's revenues are derived from a
limited number of state lottery authorities or their representatives. For
the years ended December 31, 1997, 1998 and 1999, one customer generated
29%, 24% and 24%, respectively, of the machine lease revenues. In
addition, single state contracts generated 32%, 48% and 38% of the
machine sales revenues for the years ended December 31, 1997, 1998 and
1999, respectively. Future revenue from machine sales and leases is
dependent upon winning awards in a competitive bidding process.
The Company currently purchases certain components used in its vending
machines, including components used in its burster mechanism, from single
suppliers. The purchase of components from outside suppliers on a sole
source basis subjects the Company to certain risks, including the
continued availability of suppliers, price increases and potential
quality assurance problems. Because other suppliers exist that can
duplicate these components should the Company elect or be forced to use a
different supplier, the Company does not believe that a change in
suppliers would result in the termination of a production contract.
However, the Company could experience a delay of 30 to 60 days in
production, which could adversely affect the Company's ability to make
timely deliveries of vending machines and to obtain new contracts.
(15) Lease Commitments
The Company leases its office and manufacturing facilities under
noncancelable operating leases. The leases expired on December 31, 1999,
and are now on a month-to-moth basis requiring lease payments of $14,355
per month. Total rent expense under these leases approximated $141,000,
$210,000 and $179,000 for the years ended December 31, 1997, 1998 and
1999, respectively.
-38-
The Company is currently negotiating a lease on a new, 52,500 square foot
facility in Mason, Ohio, which will allow for the consolidation of all
operations into one facility.
(16) Commitments and Contingent Liabilities
As of December 31, 1999, the Company had outstanding approximately
$11,154,895 in purchase commitments for raw materials which are used in
the manufacturing of instant ticket vending machines. Management intends
to utilize these commitments as machines are produced.
(17) Other Income and Extraordinary Item
Other income in 1999 of $598,832 consists of a one time non-recurring
credit of $625,000 from settlement of litigation with a competitor offset
by $26,168 in other non-related expenses.
On April 9, 1999, a tornado destroyed the corporate office and a
warehouse facility. The excess of the insurance proceeds over the net
book value of the assets lost resulted in an after tax gain of $178,159
on the involuntary conversion of these assets.
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE
The information required by this item has been reported in the Company's
Current Report on Form 8-K, Date of Report: October 4, 1999, filed October 12,
1999.
PART III
Except as set forth below, the information required by this Part is
incorporated by reference from the definitive Proxy Statement, filed or to be
filed with Securities and Exchange Commission, for the Company's 2000 Annual
Meeting of Stockholders.
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
The executive officers of the Company (at March 29, 2000) are as
follows:
Name Age Title
L. Rogers Wells 62 Chairman of the Board
David F. Nichols 38 President and Chief Executive Officer
Thomas W. Stokes 36 Chief Operating Officer
Dennis W. Blazer 52 Chief Financial Officer
Information about Messrs. Wells and Nichols is incorporated by reference from
the Company's definitive Proxy Statement for the 2000 Annual Meeting.
Thomas W. Stokes, age 36, has been Chief Operating Officer since March
2000. Mr. Stokes served as the Company's Vice President of Operations since May
1997, as Director of Operations from January 1996 to May 1997 and as Purchasing
Manager from March 1993 to December 1995. From 1988 to 1992, he served as unit
controller for a food management company.
-39-
Dennis W. Blazer, age 52, has been Chief Financial Officer of the Company
since July 1998. From December 1973 to July 1998, he served in various
capacities for The Plastic Moldings Corporation, most recently as Vice President
of Finance and Administration. Mr. Blazer previously served as an auditor and
tax consultant with Ernst & Ernst, certified public accountants. Mr. Blazer is a
certified public accountant.
The executive officers of the Company are appointed by and serve at the
discretion of the Board of Directors.
PART IV
ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K
(a) Documents Filed as Part of This Report.
1. Financial Statements
Independent Auditors' Report of Grant Thornton LLP
Independent Auditors' Report of KPMG LLP
Balance Sheets at December 31, 1998 and 1999
Statements of Income for each of the years in the
three-year period ended December 31, 1999.
Statements of Stockholders' Equity for each of the
years in the three-year period ended 31, 1999.
Statements of Cash Flows for each of the years in the
three year period ended December 31, 1999.
Notes to Financial Statements
2. Financial Statement Schedules
The following financial statement schedule is set forth beginning
on page S-1 of this report:
Schedule II - Valuation and Qualifying Accounts
All other schedules have been omitted because they are not
required or are inapplicable or because the information required
is included in the financial statements or notes thereto.
3. Exhibits
See Index of Exhibits (page E-1) for a list of the exhibits filed
with and incorporated by reference in this report.
(b) Reports on Form 8-K. Current Report on Form 8-K, Date of Report: October 4,
1999, October 12, 1999 (Items 4 and 7)
-40-
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities
Exchange Act of 1934, the Registrant has duly caused this report to be signed on
its behalf by the undersigned, thereunto duly authorized, on March 29, 2000.
Interlott Technologies, Inc.
(Registrant)
By /s/ L. Rogers Wells, Jr.
------------------------
L. Rogers Wells, Jr.
Chairman of the Board
Pursuant to the requirements of the Securities Exchange Act of 1934,
this report has been signed below by the following persons on behalf of the
Registrant and in the capacities indicated on March 29, 2000.
Signature Title
/s/ L. Rogers Wells, Jr. Chairman of the Board
- -----------------------------------------------------
L. Rogers Wells, Jr.
/s/ Edmund F. Turek Director
- -----------------------------------------------------
Edmund F. Turek
/s/ David F. Nichols President, Chief Executive Officer and Director
- -----------------------------------------------------
David F. Nichols
Gary S. Bell * Secretary, Treasurer and Director
- -----------------------------------------------------
Gary S. Bell
Kazmier J. Kasper * Director
- -----------------------------------------------------
Kazmier J. Kasper
H. Jean Marshall * Director
- -----------------------------------------------------
H. Jean Marshall
John J. Wingfield * Director
- -----------------------------------------------------
John J. Wingfield
/s/ Dennis W. Blazer Chief Financial and Accounting Officer
- -----------------------------------------------------
Dennis W. Blazer
*By: /s/ L. Rogers Wells, Jr.
------------------------
L. Rogers Wells, Jr.
as attorney-in-fact
-41-
INDEX OF FINANCIAL STATEMENT SCHEDULES
Page
Report of Independent Certified Public Accountants on Schedule ............S-2
Schedule II - Valuation and Qualifying Accounts ...........................S-3
S-1
Report of Independent Certified Public Accountants
on Schedule
Board of Directors and Stockholders
Interlott Technologies, Inc.
In connection with our audit of the financial statements of Interlott
Technologies, Inc. referred to in our report dated February 7, 2000, which is
included in the annual report to security holders and included in Part II of
this form, we have also audited Schedule II for the year ended December 31,
1999. In our opinion, this schedule presents fairly, in all material respects,
the information required to be set forth therein.
/s/GRANT THORNTON LLP
Cincinnati, Ohio
February 7, 2000
S-2
INTERLOTT TECHNOLOGIES, INC.
Schedule II - Valuation and Qualifying Accounts
Column A Column B Column C Column D Column E
- ----------------------- ----------------- --------------------------------------- ----------------- ------------------
Additions
Description Balance at Charged to Charged to Deductions Balance at
Beginning Costs and Other End
of Period Expenses Accounts of Period
- ----------------------- ----------------- ------------------- ------------------- ----------------- ------------------
Allowance for
doubtful accounts
1997 $ 115,425 $ 52,500 $0 $ 74,424 $ 93,501
- -----------------------------------------------------------------------------------------------------------------
1998 93,501 60,000 0 0 153,501
- -----------------------------------------------------------------------------------------------------------------
1999 153,501 96,000 0 90,708 158,793
- -----------------------------------------------------------------------------------------------------------------
Inventory
valuation reserve
1997 275,000 0 0 0 275,000
- -----------------------------------------------------------------------------------------------------------------
1998 275,000 933,110 0 0 1,208,110
- -----------------------------------------------------------------------------------------------------------------
1999 $1,208,110 $305,000 $0 $512,824 $1,000,286
- -----------------------------------------------------------------------------------------------------------------
S-3
INTERLOTT TECHNOLOGIES, INC.
INDEX OF EXHIBITS
The following exhibits are filed with or incorporated by reference in
this report. Where the exhibit is incorporated by reference from a previously
filed document, that document is identified in parenthesis.
Exhibit No. Description
3.1 Certificate of Incorporation of the Company, as amended,
including Certificate of Designation of Series A Preferred
Stock (Exhibit 3.1 to the Company's Registration Statement
on Form S-1, No. 33-75142).
3.2 Bylaws of the Company (Exhibit 3.2 to the Company's
Registration Statement on Form S-1, No. 33-75142).
4.1 Promissory Note of the Company dated September 22, 1992 to
Baumgartner & Brucher Radiology Associates, Inc. Profit
Sharing Plan for the benefit of Thomas E. Turek, M.D.
(Exhibit 4.2 to the Company's Registration Statement
on Form S-1, No. 33-75142).
4.2 Promissory Note of the Company dated September 22, 1990
to Mr. Thomas Goila (Exhibit 4.3 to the Company's
Registration Statement on Form S-1, No. 33-75142).
4.3 Loan Agreement dated October 29, 1997 between the Company
and Mercantile Business Credit, Inc. (Exhibit 4.3 to the
Company's Annual Report on Form 10-K for the year ended
December 31, 1997).
4.3(a) Revolving Credit Note dated October 29, 1997 between
the Company and Mercantile Business Credit, Inc.
(Exhibit 4.3(a) to the Company's Annual Report on Form
10-K for the year ended December 31, 1997).
4.3(b) Security Agreement dated October 29, 1997 between the
Company and Mercantile Business Credit, Inc. (Exhibit
4.3 (b) to the Company's Annual Report on Form 10-K for
the year ended December 31, 1997).
4.3(c) Patent, Trademark and License Security Agreement dated
October 29, 1997 between the Company and Mercantile
Business Credit, Inc. (Exhibit 4.3 (c) to the Company's
Annual Report on Form 10-K for the year ended December 31,
1997).
4.3(d) First Amendment to the Loan Agreement dated October 29,
1998 between the Company and Mercantile Business Credit,
Inc. (Exhibit 4.3 (d) to the Company's Annual Report on
Form 10-K for the year ended December 31, 1997).
4.3(e) Second Amendment to the Loan Agreement dated September 28,
1999 between the Company and Mercantile Business Credit,
Inc. -- filed herewith.
E-1
10.1 Assignment of United States Letters Patent from BLM
Resources, Inc. to the Company with respect to United
States Patent No. 4,982,337, "Systems for Distributing
Lottery Tickets" (Exhibit 10.5 to the Company's
Registration Statement on Form S-1, No. 33-75142).
10.2 Pull-Tab Manufacturing and License Agreement between
Algonquin Industries, Inc., Kazmier Kasper and the
Company dates as of January 13, 1994 (Exhibit 10.6 to the
Company's Registration Statement on Form S-1, No.
33-75142).
10.3 Management Compensatory Plans
(a) 1994 Stock Incentive Plan (Exhibit 10.24 to
the Company's Registration Statement on Form
S-1, No. 33-75142).
(b) 1994 Directors Stock Incentive Plan (Exhibit 10.25
to the Company's Registration Statement on Form
S-1, No. 33-75142).
23.1 Consent of Grant Thornton LLP -- filed herewith.
23.2 Consent of KPMG LLP -- filed herewith.
25 Powers of Attorney -- filed herewith.
27 Financial Data Schedule (for SEC use only) -- filed
herewith.
E-2