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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, 2000
[ ] 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) 701-7000
(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 21, 2001 was $9,581,640. There were
6,432,042 shares of Common Stock outstanding as of March 21, 2001.
DOCUMENTS INCORPORATED BY REFERENCE
Portions of the Registrant's Proxy Statement for the 2001 Annual Meeting of
Stockholders to be held on May 3, 2001 are incorporated by reference in Part III
hereof.
INTERLOTT TECHNOLOGIES, INC.
Annual Report On Form 10-K
For the Fiscal Year Ended December 31, 2000
Table of Contents
Item Page
Number Number
PART I.........................................................................................................4
1. Business............................................................................................4
2. Properties.........................................................................................13
3. Legal Proceedings..................................................................................14
4. Submission of Matters to a Vote of Security Holders................................................14
PART II.......................................................................................................14
5. Market for the Registrant's Common Stock and Related Stockholder Matters...........................14
6. Selected Financial Data............................................................................15
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...............41
PART III......................................................................................................42
10. Directors and Executive Officers of the Registrant.................................................42
11. Executive Compensation.............................................................................42
12. Security Ownership of Certain Beneficial Owners and Management.....................................42
13. Certain Relationships and Related Transactions.....................................................42
PART IV.......................................................................................................42
14. Exhibits, Financial Statement Schedules, and Reports on Form 8-K...................................42
SIGNATURES.........................................................................................44
INDEX OF FINANCIAL STATEMENT SCHEDULES.............................................................S-1
INDEX OF EXHIBITS..................................................................................E-1
PART I
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 directly to players, 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, 2000, the Company had sold or leased over 23,000
ITVMs through agreements with 25 different state lotteries and the District of
Columbia and five international jurisdictions, or their licensees or
contractors. The Company was awarded seven of the seven contracts that were
awarded to the industry in 2000.
On February 23, 2001 the Company entered into a definitive agreement
with On-Point Technology Systems, Inc. to acquire the lottery assets of
On-Point, including patents, technology, inventory and contracts. On-Point
designs, manufactures, sells, leases and services high-security automated point
of sale transaction vending terminals for the sale of instant-winner lottery
tickets. Currently it has contracts with four state and two international
lotteries. Lottery related revenues during 2000 were $10.2 million. The closing
of the acquisition is subject to necessary consents and approvals, including the
approval of the sale by the shareholders of On-Point. Upon the closing of the
acquisition, the Company and On-Point will enter into a separate agreement to
market a patented design for an online activated instant lottery ticket.
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 2000 represented less than
2% of total revenues, the Company continues to believe that PCDMs may be a
source of future sales growth.
Interlott is a Delaware corporation. 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.
4
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
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 a lottery to purchase virtually all types of scratch-off instant
tickets from its 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. 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. The Company believes that the mean time between failure of its
ITVMs is approximately 3.75 years and that the mean time to repair is
approximately 15 minutes.
Due to the recent introduction of the new modular expandable dispensing
system ("EDS") The Company's ITVM for scratch-off tickets now has the capacity
to dispense tickets from one to 24 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 24 different instant-winner games with a single
ITVM. The ITVM can accommodate up to 24,000 tickets in the 24-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 33.5 inches deep for a 24-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.
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 12 different reports for accounting and inventory
purposes. These reports can provide to the lottery and its retailers or agents a
5
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
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, described 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 twelve 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.
6
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
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 offers 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 Pennsylvania and West
Virginia pursuant to cooperative supply arrangements between the Company and
Automated Wagering, Inc., which is the primary contractor for the Pennsylvania
and West Virginia Lotteries. ITVMs are deployed in Georgia pursuant to a
cooperative supply arrangement with Scientific Games, Inc. and 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 Pennsylvania, 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 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; however, almost all the PCDMs in the field today have
been sold rather than leased.
7
Contracts
ITVMs
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 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, a committee of key lottery staff members
evaluates 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.
Additionally, the point system or the weighting 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 57.9%, 75.7% and 42.2% in 1998, 1999 and 2000, 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 itself. 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
8
requirements may result in significant liquidated damages or contract
termination. To date, the Company has not had to pay any 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
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.
Thirty states and the District of Columbia utilize ITVMs in some manner
as part of their instant ticket distribution system. As of December 31, 2000,
Company ITVMs had been deployed in 25 of these states and the District of
Columbia as well as five international jurisdictions. The Company currently has
10,427 ITVMs under lease with 19 states and the District of Columbia. These
leases expire on various dates through 2005. 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 2000, the Company's contract with the Pennsylvania Lottery
accounted for 39.3% of the Company's revenues and a contract with Ohio accounted
for 9.3%.
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 and are sold rather than leased. Like contracts with the
lotteries, the purchase orders may contain stringent installation, performance
and service requirements. As of December 31, 2000, the Company had sold 829
PCDMs.
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
9
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.
Research And New Product Development
The Company continually seeks to enhance its existing product lines and
to develop new products and 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.
In 1998, the Company introduced its Modular Vending Platform ("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 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 $618,819, $581,885 and
$640,151 for 1998, 1999 and 2000, 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.
10
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.
Patents, Trademarks and Copyrights
The Company currently has eight U.S. and foreign patents and 13 pending
patent applications 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, which expires April 10, 2016. The improved burster provides for an
increased range of operation for reliable and effective separation of the
adjacent tickets along the lines of weakness. Additional patent applications are
pending on these and other improvements to the burster technology.
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 owns U.S. Patent Nos. 5,943,241 and 6,038,492 and 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.
5,472,247 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 transmission
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
PTVMSs and PCDMs pursuant to an agreement with Algonquin Industries. Algonquin
Industries has been granted nine U.S. patents 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 five manufacturers of ITVMs and approximately four
manufacturers of PCDMs in the United States, and competition among these
11
manufacturers is intense. Of the five 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.
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 February 23, 2001 the Company entered into a definitive agreement
with On-Point Technology Systems, Inc. to acquire the lottery assets of
On-Point, including patents, technology, inventory and contracts. On-Point
designs, manufactures, sells, leases and services high-security automated point
of sale transaction vending terminals for the sale of instant-winner lottery
tickets. Currently it has contracts with four state and two international
lotteries. Lottery related revenues during 2000 were $10.2 million. The closing
of the acquisition is subject to necessary consents and approvals, including the
approval of the sale by the shareholders of On-Point.
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 30 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 authorizes 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
12
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.
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 as of December 31, 2000 was
approximately $17,637,660, 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, 2000. At December 31, 1999, the
comparable backlog was approximately $24,365,000. Approximately 63% of the
backlog at December 31, 2000 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, 2000 will be shipped on or before December 31, 2001. The
Company had a backlog of PCDMs committed for production at December 31, 2000 of
$189,750.
The Company has various lease or sales agreements that permit the
lotteries, at their sole option, to lease or purchase additional ITVMs. 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, 2000, the Company had 184 full-time employees, of which 62
were manufacturing employees, 8 were engineering employees, 92 were service
employees, 5 were clerical and administrative employees and 6 were executives or
senior managers. Two of the executives and senior managers were devoted to sales
and four 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, sales, distribution and executive offices
are located in approximately 52,500 square feet of leased space in Mason, Ohio.
The facility 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.
13
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.
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, 2000.
PART II
ITEM 5. MARKET FOR THE REGISTRANT'S COMMON STOCK AND RELATED STOCKHOLDER
MATTERS
The Company's common stock is traded on the American Stock Exchange
under the symbol "ILI." The table below shows the high and low closing sale
prices per share for the common stock as reported by the American Stock Exchange
for the periods indicated. All prices are adjusted to reflect a 2-for-1 split of
the common stock on December 20, 2000.
High Low
1999:
First Quarter $3.50 $3.00
Second Quarter 3.13 2.81
Third Quarter 3.19 2.75
Fourth Quarter 2.88 2.00
2000:
First Quarter 3.06 2.38
Second Quarter 3.19 2.63
Third Quarter 7.69 3.13
Fourth Quarter 8.63 4.22
At March 19, 2001 there were approximately 57 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.
14
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, 2000 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
2000 1999 1998 1997 1996
-----------------------------------------------------------------------------------------------------------------------------
Revenues
Machine sales $21,958,631 $ 3,311,874 $ 8,229,950 $ 4,567,441 $ 5,596,698
Machine leases 17,966,445 16,901,911 14,165,379 12,874,450 11,766,623
Other 2,664,014 2,120,245 2,078,644 1,669,160 1,235,368
Net revenues 42,589,090 22,334,030 24,473,973 19,111,051 18,598,689
Net income 3,610,199 2,070,298 1,622,313 1,451,654 1,320,597
Net income per share 0.56 0.32 0.25 0.23 0.21
Depreciation and amortization 6,622,439 5,547,909 4,585,325 4,143,408 3,902,387
Leased ITVM's, less
accumulated depreciation 21,572,590 21,549,400 17,105,891 14,740,462 10,940,398
Total assets 40,003,767 36,203,867 28,774,249 24,612,884 20,992,733
Total debt 16,000,160 16,291,727 11,645,374 9,458,004 7,715,140
-----------------------------------------------------------------------------------------------------------------------------
Redeemable preferred stock - 1,335,000 1,335,000 1,335,000 1,335,000
-----------------------------------------------------------------------------------------------------------------------------
Results of Operations Year Ended
-------------------------------------
Dec. 31 Dec. 31 Dec. 31
2000 1999 1998
Revenues
The table at right presents -----------------------------------------------------------------------
selected financial information Machine sales 51.6% 14.8% 33.6%
derived from the Company's Machine leases 42.2 75.7 57.9
statements of income expressed Other 6.2 9.5 8.5
as a percentage of revenues Total revenues 100.0 100.0 100.0
for the years indicated. Cost of revenues
excluding depreciation 53.4 39.0 48.4
Depreciation 14.9 23.9 17.5
Gross margin 31.7 37.1 34.1
Selling, general and
administrative expenses 12.8 18.8 16.5
Research and
development costs 1.5 2.6 2.5
Operating income 17.4 15.7 15.1
Interest expense 3.8 4.9 4.0
Income before income
taxes 13.6 14.7 11.1
Income taxes 5.1 5.4 4.5
Net income 8.5 9.3 6.6
-----------------------------------------------------------------------
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, and (3) to a lesser extent, sales of parts for ITVMs
and PCDMs and service agreements. 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 a lottery
the flexibility to enhance its 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.
Some of the benefits of leasing described above apply to PCDMs; however
due to the typically smaller size of a PCDM customer order, a 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 and 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.
16
On February 23, 2001, the Company entered into a definitive agreement
with On-Point Technology Systems, Inc. to acquire the lottery assets of
On-Point, including patents, technology, inventory and contracts. On-Point
designs, manufactures, sells, leases and services high security automated point
of sale transaction vending terminals for the sale of instant-winner lottery
tickets. Currently it has contracts with four state and two international
lotteries. Lottery related revenues during 2000 were $10.2 million. The purchase
price for the lottery assets includes $13.5 million to be paid at the closing,
deferred payments of $9 million payable, subject to adjustment, over five years,
and an earn out amount of up to $6 million which amount is tied to certain
future revenues. The closing of the acquisition is subject to necessary consents
and approvals, including the approval of the sale by the shareholders of
On-Point. Upon the closing of the acquisition, the Company and On-Point will
enter into a separate agreement to market a patented design for an online
activated instant lottery ticket.
2000 as Compared to 1999
Total revenues increased by $20,255,060 from $22,334,030 in 1999 to
$42,589,090 in 2000, or 91%, due to an $18,646,757 increase in machine sales, a
$1,064,534 increase in lease revenues and a $543,769 increase in other revenues.
Revenues from leases increased by 6% from $16,901,911 in 1999 to $17,966,445 in
2000, resulting from the continuation of leases in thirteen states and the
renewal of three leases in other states that had reached the conclusion of their
original terms. The total number of ITVMs and PCDMs under lease increased in
2000 as a result of deployment of new units, partially offset by the retirement
of older units. Lease revenues were 76% and 42% of total revenues for 1999 and
2000, respectively. The dollar increase in lease revenues reflects the
cumulative effect of continuing revenues from machines under lease which were
deployed prior to 2000 and the incremental revenue of new machines leased or
deployed in 2000. Revenues from sales increased by 563% from $3,311,874 in 1999
to $21,958,631 in 2000, primarily due to new sales and sales type leases to
three state lotteries. A single state contract accounted for approximately 89.6%
of this increase. Revenues from sales of ITVMs and PCDMs were 15% and 52% of
total revenues in 1999 and 2000, respectively. Other revenues increased by 26%
from $2,120,245 in 1999 to $2,664,014 in 2000, as machines deployed prior to
2000 generated service revenue for the entire year.
Cost of revenues for machine sales and other increased 981% from
$1,466,153 in 1999 to $15,850,677 in 2000. This increase reflects the 1,201%
increase in number of machines sold in 2000. Excluding depreciation, cost of
revenues for leased ITVMs and PCDMs decreased 6% from $7,243,770 in 1999 to
$6,798,596 in 2000. The dollar increase in cost of lease revenues was the result
of higher personnel and subcontractor costs related to the larger number of
machines deployed during 2000.
Depreciation of ITVMs and PCDMs increased by 19% from $5,337,018 in
1999 to $6,366,899 in 2000. The increase was greater than the related 11%
increase in number of leased ITVMs and PCDMs, as newer units have more
dispensing capacity and cost more.
Selling, general and administrative expenses increased 29% from
$4,202,825 in 1999 to $5,421,062 in 2000. The increase resulted primarily from
higher salary and wage expenses and an increase in legal and professional fees
relating to potential acquisitions as well as new and existing lottery contract
negotiations. As a percentage of revenues, however, selling, general and
administrative expenses decreased from 19% in 1999 to 13% in 2000.
Research and development costs increased by 10% from $581,885 in 1999
to $640,150 in 2000. 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 112% from $3,502,379 in 1999 to
$7,425,152 in 2000. This increase resulted primarily from the increase in the
number of machines sold in 2000 as compared to 1999. As a percentage of
revenues, operating income increased from 16% in 1999 to 17% in 2000.
Interest expense increased by 43% from $1,102,478 in 1999 to $1,580,969
in 2000. The increase reflects the cost of additional borrowings to finance
leased equipment built and deployed in 2000, and higher interest rates in 2000.
Other income in 1999 of $598,832 consisted 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.
17
Income before income taxes and extraordinary item increased 93% from
$2,998,733 in 1999 to $5,786,798 in 2000.
The effective income tax rate increased from 37.0% in 1999 to 37.6% in
2000. This increase was due primarily to income being taxed at higher marginal
brackets on state and local returns.
As a result of the above factors, the Company's net income before
extraordinary items increased by 91% from $1,892,139 in 1999 to $3,610,199 in
2000.
The extraordinary item in 1999 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.
1999 as Compared to 1998
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.
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 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.
18
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.
Liquidity and Capital Resources
Net cash provided by operating activities increased 50% from $7,519,552
in 1999 to $11,555,661 in 2000. Net cash used in investing activities decreased
15% from $12,063,408 in 1999 to $10,297,498 in 2000. Net cash provided by (used
in) financing activities decreased by $5,980,372 from net cash provided by
financing activities of $4,646,353 in 1999 to net cash used in financing
activities of $1,334,019 in 2000. This was due to an advance to a shareholder of
$280,000, repayment in 2000 of $207,698 in long-term debt, and an decrease in
notes payable of $907,417.
The Company's liquidity and capital resources continue to be impacted
by its decision to lease a significant portion of 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, 2000, the Company had a total of 10,427 ITVMs and
PCDMs under operating and sales type leases.
At December 31, 1999 and 2000, the Company had working capital deficits
of $9,440,256 and $6,868,537 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, 2000, the Company was indebted to Firstar Bank
(formerly Mercantile Business Credit) in the aggregate principal amount of
$15,097,611 pursuant to a revolving credit agreement entered into in 1997. The
facility permited the Company to borrow, through January 2001, up to $25,000,000
at the prime interest rate or at LIBOR plus two percent. Borrowings under this
facility were collateralized by all of the assets of the Company and assignment
of proceeds from lease agreements. At December 31, 2000, the Company had $6.3
million available under this agreement.
On January 23, 2001, the Company entered into a new, three year
revolving credit agreement with Fifth Third Bank of Cincinnati which replaced
the Firstar credit agreement. Borrowings under this facility are collateralized
by all of the assets of the Company and assignment of proceeds from lease
agreements. The facility permits the Company to borrow, through January 2004, up
to $25,000,000 at the prime interest rate or at LIBOR plus 1.75 percent. At
February 28, 2001, the Company had $1.7 million available under this agreement.
At December 31, 2000, the Company was indebted to one stockholder in
the amount of $79,000. Additionally in 2000, four stockholders elected to
convert their shares of redeemable preferred stock to notes payable in the
amount of $1,335,000. The notes held by these five stockholders require, among
other things, that 25% of the net income of the Company for the prior fiscal
year shall be paid toward the principal on the first business day of the fourth
month following the fiscal year end. Consequently, on April 2, 2001, $902,549
will be paid on these notes. See Note 6 of Notes to Financial Statements.
The Company's capital expenditures totaled $10,297,498 and $12,063,408
for 2000 and 1999, respectively. These amounts included $9,580,471and
$11,985,736 for the manufacture of machines leased during the respective
periods. Other expenditures represented machinery and equipment costs for
expanded plant and office capacity.
The Company had no material commitments for additional capital
expenditures as of December 31, 2000 other than for the manufacture of ITVMs and
PCDMs for future sale or lease; however, the potential acquisition of the
19
lottery assets of On-Point Technology Systems, Inc., as described earlier, will
require additional financing in excess of funds generated by operations and
available under the Company's current line of credit, of at least $13.5 million
to cover the payment due at the closing. It is anticipated that the balance of
the purchase price will be funded by the cash flow generated by the current
lottery contracts that are being assumed. The Company is currently in discussion
with several financial institutions, including Fifth Third Bank of Cincinnati,
and has been assured that financing on commercially reasonable terms will be
available for this transaction.
At December 31, 2000, the Company had estimated tax net operating loss
carryforwards of approximately $697,883 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 the Company's 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 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, 2000, 30 states,
the District of Columbia and 14 international jurisdictions used ITVMs as part
of their instant ticket distribution system. We had leased or sold ITVMs in 25
of those states, the District of Columbia and in five international
jurisdictions. We have marketed PCDMs since 1995, and as of December 31, 2000,
we had sold or leased 924 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. It is important but
not critical that we develop relationships with additional lotteries and
telephone companies and that additional states authorize instant lotteries.
20
Significant portions of our annual revenue frequently are derived from
a limited number of contracts, which vary in size and by customer from year to
year.
We have traditionally derived a significant portion of our annual
revenues from a limited number of state lottery authorities or their
representatives for the lease, sale or service of ITVMs. In particular, during
2000, a contract with Automated Wagering, Inc., the supplier for the
Pennsylvania Lottery, accounted for 39% of our total revenues. Additionally, a
contract with the Ohio Lottery accounted for 19% of our lease revenues and 9% of
our total revenue in 2000. 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 have difficulty integrating the operations of On-Point.
There are risks associated with our acquisition of the lottery assets
of On-Point. Success of the acquisition will depend on our ability to integrate
On-Point's operations, technology and customers with our own in a timely and
efficient manner. This will require, among other things, that the relationships
with On-Point's key customers, state and international lotteries, are
maintained. Other risks include the additional financial resources that may be
needed to fund operations, the ability of management to manage the expansion of
our customer base, and the different geographic locations of the operations and
customers of On-Point. Diversion of management and any difficulties encountered
in the process of integration could cause disruption of our business and harm to
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 seven other patents and 13 pending patent applications 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.
21
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
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, 2000, Mr. L. Roger Wells, Jr. beneficially owned 53.2%
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 57.9% in
1998, 75.7% in 1999 and 42.2% in 2000. 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.
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
22
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.
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.
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
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
The Company 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 ($102,940) at
December 31, 2000. The estimated fair value is based upon appropriate market
information and projected interest rate changes obtained from a reputable
institution. This agreement inherently carries an element of credit risk if the
counter party is unable to meet its obligation.
23
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 sheets of Interlott Technologies, Inc.
as of December 31, 2000 and 1999, and the related statements of income,
stockholders' equity, and cash flows for the two years 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 audits. The financial statements of Interlott Technologies, Inc. for the
year ended December 31, 1998 were audited by other auditors whose report dated
February 26, 1999 expressed an unqualified opinion on those statements.
We conducted our audits in accordance with auditing standards generally accepted
in the United States of America. Those standards require that we plan and
perform the audits 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, 2000 and 1999, and the results of its operations and its cash
flows for the years then ended, in conformity with accounting principles
generally accepted in the United States of America.
/s/ Grant Thornton LLP
Cincinnati, Ohio
February 9, 2001
24
Independent Auditors' Report
The Board of Directors and Shareholders
Interlott Technologies, Inc.:
We have audited the statements of income, stockholders' equity, and cash flows
of Interlott Technologies, Inc. for the year ended December 31, 1998, as listed
in the accompanying index. In connection with our audit of these financial
statements, we have also audited the 1998 financial statement schedule as listed
in the accompanying index. These financial statements and the financial
statement schedule are the responsibility of the Company's management. Our
responsibility is to express an opinion on these financial statements and the
financial statement schedule based on our audit.
We conducted our audit in accordance with auditing standards generally accepted
in the United States of America. Those standards require that we plan and
perform the audits 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 results of operations and cash flows of Interlott
Technologies, Inc. for the year ended December 31, 1998, in conformity with
accounting principles generally accepted in the United States of America. Also
in our opinion, the related 1998 financial statement schedule, when considered
in relation to the 1998 basic financial statements taken as a whole, presents
fairly, in all material respects, the information set forth therein.
/s/ KPMG LLP
Cincinnati, Ohio
February 26, 1999
25
INTERLOTT TECHNOLOGIES, INC.
Balance Sheets
December 31, 2000 and 1999
2000 1999
----------- -----------
Assets
Current assets:
Cash $ 46,645 $ 132,501
Accounts receivable, less allowance for doubtful accounts
of $245,872 in 2000 and $158,793 in 1999 4,015,934 3,305,486
Investment in sales type leases, current portion 1,649,654 1,251,144
Inventories 5,920,032 5,214,106
Prepaid & refundable taxes 940,000 72,319
Note receivable from shareholder 280,000 -
Deferred income taxes 231,100 357,400
Prepaid expenses 196,084 195,519
---------- ----------
Total current assets 13,279,449 10,528,475
Property and equipment:
Leased machines 38,037,036 35,244,923
Machinery and equipment 797,117 610,968
Building and leasehold improvements 704,174 202,441
Furniture and fixtures 89,381 60,237
---------- ----------
39,627,708 36,118,569
Less accumulated depreciation and amortization (17,252,787) (14,301,656)
---------- ----------
Net property and equipment 22,374,921 21,816,913
---------- ----------
Investment in sales type leases, less current portion 3,982,726 3,775,876
Product development rights, net of accumulated amortization of
$733,333 in 2000 and $659,997 in 1999 366,671 440,003
---------- ----------
$40,003,767 $36,561,267
========== ==========
See accompanying notes to financial statements.
26
INTERLOTT TECHNOLOGIES, INC.
Balance Sheets, Continued
December 31, 2000 and 1999
2000 1999
----------- -----------
Liabilities and Stockholders' Equity
Current liabilities:
Notes payable to financial institutions $15,097,611 $16,005,029
Notes payable - related parties 902,549 286,698
Accounts payable 2,043,736 1,781,884
Accounts payable - related parties 180,291 179,469
Accrued expenses 1,923,799 1,358,253
---------- ----------
Total current liabilities 20,147,986 19,611,333
---------- ----------
Deferred income taxes 996,200 928,100
---------- ----------
Total liabilities 21,144,186 20,539,433
---------- ----------
Commitments and contingent liabilities
Notes payable - related parties 511,451 -
Series A preferred stock, $.01 par value;
20,000,000 shares authorized, 1,335,000 shares issued and
outstanding in 1999 - 1,335,000
Stockholders' equity:
Common stock, $.01 par value; 20,000,000 shares authorized, 6,429,910 shares
issued and outstanding in 2000
and 6,420,000 shares issued and outstanding in 1999 32,135 32,100
Additional paid-in capital 10,427,079 10,376,017
Retained earnings 7,888,916 4,278,717
---------- ----------
Total stockholders' equity 18,348,130 14,686,834
---------- ----------
$40,003,767 $36,561,267
========== ==========
See accompanying notes to financial statements.
27
INTERLOTT TECHNOLOGIES, INC.
Statements of Income
Years Ended December 31, 2000, 1999 and 1998
2000 1999 1998
----------- ----------- -----------
Revenues:
Machine sales $21,958,631 $ 3,311,874 $ 8,229,950
Machine leases 17,966,445 16,901,911 14,165,379
Other 2,664,014 2,120,245 2,078,644
---------- ---------- ----------
42,589,090 22,334,030 24,473,973
Cost of revenues:
Machine sales and other 15,850,677 1,466,153 5,809,057
Machine leases 13,252,049 12,580,788 10,310,565
---------- ---------- ----------
29,102,726 14,046,941 16,119,622
---------- ---------- ----------
Gross margin 13,486,364 8,287,089 8,354,351
Operating expenses:
Selling, general and administrative expenses 5,421,062 4,202,825 4,048,751
Research and development costs 640,150 581,885 618,819
---------- ---------- ----------
6,061,212 4,784,710 4,667,570
---------- ---------- ----------
Operating income 7,425,152 3,502,379 3,686,781
Other income (expense)
Interest expense (1,580,969) (1,102,478) (967,768)
Other (57,385) 598,832 -
---------- ---------- ----------
(1,638,354) (503,646) (967,768)
Income before income taxes and extraordinary item 5,786,798 2,998,733 2,719,013
Income tax provision 2,176,599 1,106,594 1,096,700
---------- ---------- ----------
Income before extraordinary item 3,610,199 1,892,139 1,622,313
---------- ---------- ----------
Extraordinary item (less applicable income taxes of
$109,195) - 178,159 -
---------- ---------- ----------
Net Income $ 3,610,199 $ 2,070,298 $ 1,622,313
========== ========== ==========
Basic income per share before extraordinary item $0.56 $0.29 $0.25
==== ==== ====
Diluted income per share before extraordinary item $0.56 $0.29 $0.25
==== ==== ====
Basic and diluted extraordinary item per share $ - $0.03 $ -
==== ==== ====
Basic net income per share $0.56 $0.32 $0.25
==== ==== ====
Diluted net income per share $0.56 $0.32 $0.25
==== ==== ====
See accompanying notes to financial statements.
28
INTERLOTT TECHNOLOGIES, INC.
Statements of Stockholders' Equity
Years ended December 31, 1998, 1999 and 2000
Common Stock Additional
-------------------- Paid-in Retained
Shares Amount Capital Earnings Total
--------- ------- ----------- ---------- ----------
Balances at December 31, 1997 6,420,000 $32,100 $10,376,017 $ 586,106 $10,994,223
Net income - - - 1,622,313 1,622,313
--------- ------ ---------- --------- ----------
Balances at December 31, 1998 6,420,000 32,100 10,376,017 2,208,419 12,616,536
Net income - - - 2,070,298 2,070,298
--------- ------ ---------- --------- ----------
Balances at December 31, 1999 6,420,000 32,100 10,376,017 4,278,717 14,686,834
Shares issued for exercise of options 7,000 35 51,062 - 51,097
Shares issued in connection with Employee
Stock Purchase Plan 2,910 - - - -
Net income - - - 3,610,199 3,610,199
--------- ------ ---------- --------- ----------
Balances at December 31, 2000 6,429,910 $32,135 $10,427,079 $7,888,916 $18,348,130
========= ====== ========== ========= ==========
See accompanying notes to financial statements.
29
INTERLOTT TECHNOLOGIES, INC.
Statements of Cash Flows
Years ended December 31, 2000, 1999 and 1998
2000 1999 1998
----------- ----------- -----------
Cash flows from operating activities:
Net income $ 3,610,199 $ 2,070,298 $1,622,313
Adjustments to reconcile net income to net cash
provided by operating activities:
Net book value of equipment disposals 86,499 113,563 -
Depreciation and amortization 6,622,439 5,547,909 4,585,325
Principal portion of sales type leases received 1,441,971 909,184 557,116
Deferred income taxes 194,400 448,800 374,200
Gain on sale of equipment under sales type lease (301,019) (331,170) (1,177,773)
(Increase) decrease in accounts receivable (710,448) (488,897) 101,503
Decrease (increase) in inventories - net of leased equipment returned 651,645 (828,568) 1,110,268
Decrease (increase) in prepaid expenses (565) (185,733) 32,345
Increase in accounts payable 261,853 302,052 337,766
Increase (decrease) in accounts payable - related parties 822 (36,265) (113,226)
Increase (decrease) in accrued expenses 565,546 246,837 (142,766)
(Decrease) increase in income taxes payable (867,681) (248,458) 148,008
---------- ---------- ---------
Net cash provided by operating activities 11,555,661 7,519,552 7,435,079
Cash flows from investing activities:
Cost of leased machines (9,580,471) (11,985,736) (9,611,623)
Purchases of property and equipment (717,027) (77,672) (123,893)
---------- ---------- ---------
Net cash used in investing activities (10,297,498) (12,063,408) (9,735,516)
Cash flows from financing activities:
Increase in notes receivable from shareholder (280,000) - -
(Decrease) increase in notes payable (907,417) 4,838,655 2,188,338
Proceeds from exercise of stock options 51,096 - -
Repayment of long-term debt (207,698) (192,302) (968)
---------- ---------- ---------
Net cash (used in) provided by financing activities (1,344,019) 4,646,353 2,187,370
---------- ---------- ---------
(Decrease) increase in cash (85,856) 102,497 (113,067)
Cash at beginning of year 132,501 30,004 143,071
---------- ---------- ---------
Cash at end of year $ 46,645 $ 132,501 $ 30,004
========== ========== =========
Supplemental disclosures of cash flow information:
Net book value of leased equipment returned from the field $ 1,357,572 $ 1,255,578 $ 188,732
========== ========== =========
Interest paid $ 1,578,357 $ 1,216,285 $ 902,252
========== ========== =========
Notes payable to shareholders issued in exchange for
redeemable preferred stock $ 1,335,000 $ - $ -
========== ========== =========
Income taxes paid $ 1,847,415 $ 1,104,789 $ 526,807
========== ========== =========
See accompanying notes to financial statements.
30
(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.
31
(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.
(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, 2000 and 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 of 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
32
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.
(k) Earnings Per Share
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.
(m) Accounts payable
Accounts payable included $540,908 and $554,585, respectively, of
outstanding checks at December 31, 2000 and 1999.
(2) Investment in Sales Type Leases
The Company leases instant ticket vending machines (ITVMs) to several
state lotteries under sales type leases. The components of the net
investment in sales type leases at December 31, 2000 and 1999 were as
follows:
2000 1999
Minimum lease payments receivable $6,767,616 $6,306,800
Less unearned revenue on lease payments receivable 1,135,236 1,279,780
--------- ---------
5,632,380 5,027,020
Less current portion 1,649,654 1,251,144
--------- ---------
Investment in sales type leases, less current portion $3,982,726 $3,775,876
========= =========
33
Future minimum lease payments to be received by the Company under these
sales type leases are as follows:
Years ending December 31,
2001 $2,343,576
2002 2,058,776
2003 1,361,826
2004 814,926
2005 188,512
---------
$6,767,616
=========
(3) Inventories
Inventories at December 31, 2000 and 1999 consisted of the following:
2000 1999
Finished goods $1,375,188 $1,350,719
Work in process 449,471 376,243
Raw materials and supplies 4,095,373 3,487,144
--------- ---------
$5,920,032 $5,214,106
========= =========
(4) Leased Machines
At December 31, 2000 and 1999, the Company leased ITVMs to various state
lotteries 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 include estimated residual values, at December
31, 2000 and 1999 were as follows:
2000 1999
Leased machines $38,037,036 $35,244,923
Less accumulated depreciation 16,464,446 13,695,523
---------- ----------
$21,572,590 $21,549,400
========== ==========
Future minimum lease payments to be received by the Company under
operating leases are as follows:
December 31,
2001 $11,658,954
2002 6,037,537
2003 2,576,484
2004 1,681,800
-----------
$21,954,775
==========
34
(5) Notes Payable to Financial Institutions
In October 1997, the Company entered into a three year revolving credit
facility with a financial institution that permitted the Company to
borrow through October 2000 up to $15,000,000 (amended in October 1999 to
$25,000,000) at the prime interest rate (9.50% at December 31, 2000). In
October 2000, and each month thereafter through December 31, 2000, the
facility was amended to extend the agreement for an additional 30 days.
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. At December 31, 2000 and 1999,
respectively, the Company had borrowings of $15,097,611 and $16,005,029
outstanding with additional borrowings of $9,902,389 and $8,994,971
available under the facility.
(6) Notes Payable - Related Parties
The Company had the following notes payable to related parties at
December 31, 2000 and 1999:
2000 1999
Notes payable to former preferred stockholders, in the principal
amount of $1,335,000 due in annual installments limited in the
aggregate with the stockholder note identified in the immediately
following paragraph 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. The notes were issued in
exchange for shares of redeemable preferred stock. Payments must begin
April 2, 2001. The notes do not provide for any interest and are
unsecured. $1,335,000 $ -
Note payable to a stockholder, in the original amount of $79,000, due
and limited in the aggregate with the preferred shareholder notes
identified in the preceding paragraph 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. Payments
must begin April 2, 2001. The note does not provide for any interest
and is unsecured. 79,000 79,000
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.
The note was repaid on April 1, 2000. - 207,698
--------- -------
1,414,000 286,698
Less current portion 902,549 286,698
--------- -------
$ 511,451 $ -
========= =======
35
(7) Additional Financial Instrument
The Company 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 ($102,940) at December 31, 2000.
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,
------------------------------------------------
2000 1999 1998
Current:
Federal $1,629,300 $ 612,400 $ 566,000
State and local 352,899 154,600 156,500
Deferred:
Federal 194,400 448,800 374,200
--------- --------- ---------
$2,176,599 $1,215,800 $1,096,700
========= ========= =========
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:
2000 1999 1998
Federal income tax expense at the statutory rate $1,967,500 $1,117,300 $ 924,400
Non-deductible lobbyist expenses - 3,200 -
Officers life insurance 8,000 8,000 -
Amortization of product development rights 25,000 25,000 25,000
State and local taxes, net of federal benefit 232,900 102,000 103,300
Other (56,801) (39,711) 44,000
--------- --------- ---------
$2,176,599 $1,215,789 $1,096,700
========= ========= =========
36
The tax effects of temporary differences that give rise to significant
portions of the deferred tax assets and deferred tax liabilities at
December 31, 2000 and 1999 are presented below:
2000 1999
Deferred tax assets:
Bad debt allowance $ 83,600 $ 54,000
Warranty costs 1,200 1,200
Investment in sales type leases 249,600 -
Net operating loss carryforwards 237,200 292,200
Inventory valuation reserve 73,100 249,600
Other, net 73,200 52,600
--------- ---------
Total gross deferred tax assets $ 717,900 $ 649,600
========= =========
Deferred tax liabilities:
Property and equipment, principally due to
differences in depreciation $1,385,300 $ 987,800
Investment in sales type leases - 134,800
Involuntary conversion of assets 97,700 97,700
--------- ---------
Total gross deferred tax liabilities 1,483,000 1,220,300
--------- ---------
Net deferred tax liabilities $ (765,100) $ (570,700)
========== =========
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, 2000, the Company had net operating loss carryforwards
for federal income tax purposes of approximately $697,900 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 was nonparticipating and had no rights to
dividends. The holders of the preferred stock were 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.
All the holders of the preferred stock exercised their put option and all
of the outstanding preferred stock was redeemed as of April 17, 2000,
with payment made in the form of non-interest bearing promissory notes.
Based on a payment formula that calls for payments limited in the
aggregate, along with payment on the stockholder note in the principal
amount of $79,000 identified in Note 6 above, to 25% of the current
year's net income, principal payments in the aggregate amount of $902,549
will be due on April 2, 2001.
37
(10) Stock Incentive Plans
The Company's 1994 Stock Incentive Plan was amended and restated
effective December 29, 2000. The Company also has a 1994 Directors Stock
Incentive Plan under which options were granted prior to the amendment of
the 1994 Stock Incentive Plan. 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.
A summary of the status of the Company's stock options as of December 31,
2000, 1999, and 1998 and the changes therein for the years then ended is
presented below:
2000 1999 1998
-------------------------- ---------------------------- ----------------------------
Weighted Weighted Weighted
Average Average Average
Exercise Exercise Exercise
Shares Price Shares Price Shares Price
---------- -------------- ----------- -------------- ------------ --------------
Outstanding at beginning of year 513,100 $3.91 424,350 $4.33 361,750 $4.56
Granted - - 115,500 2.59 72,600 3.38
Exercised 7,000 5.02 - - - -
Forfeited 3,300 3.22 26,750 4.58 10,000 5.75
------- ---- ------- ---- ------- ----
Outstanding at end of year 502,800 3.92 513,100 3.91 424,350 4.33
Options exercisable at year-end 434,850 4.27 304,162 4.48 241,588 4.74
------- ---- ------- ---- ------- ----
Weighted-average fair value of
options granted during the
year N/A $2.59 $2.58
Had compensation cost for options granted during 1999 and 1998 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:
1999 1998
Net income As reported $2,070,298 $1,622,313
========= =========
Pro forma $2,054,057 $1,512,186
========= =========
Basic and diluted earnings per share As reported $.65 $.51
=== ===
Pro forma $.64 $.47
=== ===
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 1999 and 1998 for purposes of
the accompanying pro forma disclosures is estimated on the grant date
using the Black-Scholes option-pricing model with the following
38
weighted-average assumptions: no dividends paid, as it has been the
Company's policy not to declare or pay dividends and the Company does not
anticipate paying dividends in the foreseeable future; expected
volatility of 43% and 65%, respectively, based on the calculated
volatility of the Company's stock; risk-free rates of return of 4.83% and
4.93%, respectively; and expected lives of 10 years.
Information about stock options outstanding at December 31, 2000 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
- --------------------- -------------- -------------- --------------- -------------- -------------
$2.41 - 4.32 421,400 6.46 $3.58 289,013 $3.89
$5.07 - 5.75 81,400 3.59 5.63 78,900 5.65
------- ---- ---- ------- ----
502,800 5.99 $3.92 434,850 $4.27
======= ==== ==== ======= ====
(11) Earnings Per Share
Net Per
Earnings Shares Share
1998 (Numerator) (Denominator) Amount
--------------- ------------------ ---------------
Basic earnings per share:
Net earnings available to common stockholders $1,622,313 6,420,000 $0.25
Diluted earnings per share:
Effect of dilutive stock options 21,298
Earnings available to common stockholders
and assumed conversions 1,622,313 6,441,298 0.25
1999
Basic earnings per share:
Net earnings available to common stockholders 2,070,298 6,420,000 0.32
Diluted earnings per share:
Effect of dilutive stock options 1,806
Earnings available to common stockholders
and assumed conversions 2,070,298 6,421,806 0.32
2000
Basic earnings per share:
Net earnings available to common stockholders 3,610,199 6,422,914 0.56
Diluted earnings per share:
Effect of dilutive stock options 71,592
Earnings available to common stockholders
and assumed conversions $3,610,199 6,494,506 $0.56
39
Options to purchase 243,950, 446,050 and 104,950 shares of common stock
were outstanding in 2000, 1999 and 1998, 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
the common shares.
(12) Noncash Investing Activities
Leased machines with net book values of $742,114 in 2000 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 2000 under new leases.
(13) Related Party Transactions
Accounts payable - related parties of $180,291 and $179,469 at December
31, 2000 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, 2000, 1999 and
1998, 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 $6,205,187, $4,116,674 and
$3,800,887 for the years ended December 31, 2000, 1999 and 1998,
respectively.
Note receivable - shareholder of $280,000 represents an advance to Edmund
Turek, a director. The note bears interest at the prime rate of interest
and will be repaid from the payments to be made on April 2, 2001 on
the $1,335,000 of stockholder notes.
Interest expense arising from notes payable-related parties amounted to
$4,510, $20,275 and $33,401 for the years ended December 31, 2000, 1999
and 1998, 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, 2000, 1999 and 1998 one customer generated
19%, 24% and 24%, respectively, of the machine lease revenues. In
addition, single state contracts generated 76%, 38% and 48% of the
machine sales revenues for the years ended December 31, 2000, 1999 and
1998 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
40
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 facility under a
noncancelable operating lease. The current lease, which was entered into
on April 1, 2000, expires on March 31, 2005, and requires lease payments
of $25,186 per month. Total rent expense under this lease approximated
$274,902, for the year ended December 31, 2000, and $179,000 and $141,000
for the various facility leases in 1999 and 1998, respectively.
(16) Commitments and Contingent Liabilities
As of December 31, 2000, the Company had outstanding approximately
$8,600,000 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.
(18) Employee Benefit Plans
In 1999, the Company established a savings plan intended to qualify under
sections 401(a) and 401(k) of the Internal Revenue Code. The plan covers
substantially all employees of the Company. Under this plan, the
Company's expenses in 2000 and 1999 were $53,283 and $49,119 respectively
which represents one half of the employees' contributions not exceeding
4% of gross pay.
In March 2000, the Board of Directors of the Company approved the
Interlott Technologies, Inc. Employee Stock Purchase Plan under section
423 of the Internal Revenue Code. The Plan provides substantially all
employees of the Company with an opportunity to purchase, through payroll
deductions, shares of the Company's common stock. The purchase price per
share is determined by whichever of two prices is lower: 85% of the
closing market price of the common stock on the first day of the calendar
quarter or 85% of the closing market price of the common stock on the
last day of the calendar quarter. 25,000 shares of common stock of the
Company are reserved for issuance under this plan.
Summary 2000 First Second Third Fourth
-----------------------------------------------------------------------------------
Quarterly Net sales $7,657 $13,489 $11,579 $9,864
Financial Data Gross profit 2,626 4,467 3,743 2,650
Net income 597 1,471 1,090 452
Quarterly financial data Basic income per share 0.09 0.23 0.17 0.07
for the years ended December Diluted income per share 0.09 0.23 0.17 0.07
-----------------------------------------------------------------------------------
31, 2000 and 1999 shown here
(in thousands, except for per 1999 First Second Third Fourth
-----------------------------------------------------------------------------------
share data). Net sales $4,960 $5,138 $4,995 $7,240
Gross profit 1,761 1,687 1,525 3,314
Net income 654 76 182 1,158
Basic income per share 0.10 0.01 0.03 0.18
Diluted income per share 0.10 0.01 0.03 0.18
-----------------------------------------------------------------------------------
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.
41
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 2001 Annual
Meeting of Stockholders.
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
The executive officers of the Company (at March 30, 2001) are as
follows:
Name Age Title
L. Rogers Wells 63 Chairman of the Board
David F. Nichols 39 President and Chief Executive Officer
Thomas W. Stokes 37 Chief Operating Officer
Dennis W. Blazer 53 Chief Financial Officer
Information about Messrs. Wells and Nichols is incorporated by reference from
the Company's definitive Proxy Statement for the 2001 Annual Meeting.
Thomas W. Stokes has been Chief Operating Officer since March 2000. Prior
to that, Mr. Stokes had served as the Company's Vice President of Operations
since 1997, as Director of Operations from 1996 to 1997 and as Purchasing
Manager from 1993 to 1995. From 1988 to 1992, he served as unit controller for a
food management company.
Dennis W. Blazer has been Chief Financial Officer of the Company since July
1998. From 1973 to 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, 1999 and 2000
Statements of Income for each of the years in the three-year period
ended December 31, 2000.
42
Statements of Stockholders' Equity for each of the years in the
three-year period ended 31, 2000.
Statements of Cash Flows for each of the years in the three-year
period ended December 31, 2000
Notes to Financial Statements
2. Financial Statement Schedules
The following financial statement schedule and the independent
auditors' reports thereon are 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. None.
43
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 30, 2001.
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 30, 2001.
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
/S/Gary S. Bell *
- -------------------------------- Secretary, Treasurer and Director
Gary S. Bell
/s/Kasmier J. Kasper *
- -------------------------------- Director
Kazmier J. Kasper
/s/H. Jean Marshall-McEntire *
- -------------------------------- Director
H. Jean Marshall-McEntire
/s/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
44
INDEX OF FINANCIAL STATEMENT SCHEDULES
Page
Schedule II - Valuation and Qualifying Accounts ...........................S-2
S-1
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
1998 $ 93,501 $ 60,000 $0 $ 0 $ 153,501
1999 153,501 96,000 0 90,708 158,793
2000 158,793 90,000 0 2,921 245,872
Inventory valuation
reserve
1998 $ 275,000 $933,110 $0 $ 0 $1,208,110
1999 1,208,110 305,000 0 512,824 1,000,286
2000 1,000,286 401,292 0 920,494 481,084
S-2
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 Form of promissory note of the Company issued as of April 17, 2000 to former
holders of redeemable preferred stock (contained in Exhibit 3.1)
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 Credit Agreement dated January 25, 2001 between the Company and Fifth Third
Bank - filed herewith.
4.3(a) Revolving Note dated January 25, 2001 between the Company and Fifth
Third Bank. (contained in Exhibit 4.3)
4.3(b) Security Agreement dated January 25, 2001 between the Company and Fifth
Third Bank. (contained in Exhibit 4.3)
4.3(c) Mortgage of Intellectual Property dated January 25, 2001 between the Company
and Fifth Third Bank - filed herewith.
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, "System for
Distributing Lottery Tickets" (Exhibit 10.5 to the Company's Registration
Statement on Form S-1, No. 33-75142).
E-1
10.2 Pull-Tab Manufacturing and License Agreement between Algonquin Industries,
Inc., Kazmier Kasper and the Company dated 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).
(c) Employment Agreement dated as of January 1, 2001 between the
Company and David F. Nichols - filed herewith.
23.1 Consent of Grant Thornton LLP - filed herewith.
23.2 Consent of KPMG LLP - filed herewith
24 Powers of Attorney - filed herewith.
E-2