10-Q 1 l95829ae10vq.txt INTERLOTT TECHNOLOGIES, INC. 10-Q/QTR END 6-30-02 SECURITIES AND EXCHANGE COMMISSION WASHINGTON, D.C. 20549 FORM 10-Q [X] Quarterly Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934 For the Quarterly Period Ended June 30, 2002 OR [ ] Transition Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934 For the Transition Period from____ to ____ Commission File Number 001-12986 INTERLOTT TECHNOLOGIES, INC. (Exact name of Registrant as specified in its charter) Delaware 31-1297916 (State of Incorporation) (I.R.S. Employer Identification No.) 7697 Innovation Way, Mason, Ohio 45040 (Address of principal executive offices, including zip code) (513) 701-7000 (Registrant's telephone number, including area code) -------------------- Indicate by check mark whether the Registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding twelve 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 the number of shares outstanding of each of the issuer's classes of Common Stock as of the latest practicable date. CLASS OUTSTANDING AT AUGUST 14, 2002 ---------------------------- ------------------------------ Common Stock, $.01 Par Value 6,462,669 shares INTERLOTT TECHNOLOGIES, INC. QUARTERLY REPORT ON FORM 10-Q FOR THE QUARTER ENDED JUNE 30, 2002 TABLE OF CONTENTS

2 PART I. FINANCIAL INFORMATION ITEM 1. FINANCIAL STATEMENTS INTERLOTT TECHNOLOGIES, INC. CONDENSED BALANCE SHEETS JUNE 30, 2002 AND DECEMBER 31, 2001

See accompanying notes to condensed financial statements. 3 INTERLOTT TECHNOLOGIES, INC. CONDENSED STATEMENTS OF INCOME THREE MONTHS AND SIX MONTHS ENDED JUNE 30, 2002 AND 2001

4 INTERLOTT TECHNOLOGIES, INC. CONDENSED STATEMENT OF CASH FLOWS (UNAUDITED) SIX MONTHS ENDED JUNE 30, 2002 AND 2001

5 Supplemental Disclosures of Cash Flow Information: Interest paid $1,141,567 $732,949 Income taxes paid 132,686 1,246,656 Net book value of capitalized leased ITVMs returned from field and transferred to inventory 44,738 902,574 Interest swap liability 117,855 - Business combination accounted for as a purchase Accounts receivable 0 1,043,852 Inventory 0 3,422,053 Value of leases acquired 0 4,281,005 Goodwill 0 4,664,769 ---------- ----------- $0 $13,411,679 ========== ===========

See accompanying notes to condensed financial statements. 6 INTERLOTT TECHNOLOGIES, INC. Notes to Condensed Financial Statements 1. BASIS OF PRESENTATION The accounting and reporting policies of Interlott Technologies, Inc. conform to generally accepted accounting principles in the United States of America. The financial statements for the three months and six months ended June 30, 2002 and 2001 are unaudited and do not include all information or footnotes necessary for a complete presentation of financial condition, results of operations and cash flows. The interim financial statements include all adjustments, consisting only of normal recurring accruals, which in the opinion of management are necessary for a fair presentation. The financial statements should be read in conjunction with the financial statements and notes which appear in the Company's 2001 Annual Report on Form 10-K. The results of operations for the three months and six months ended June 30, 2002 are not necessarily indicative of the results to be expected for the entire year ending December 31, 2002. 2. INVENTORIES Inventories at June 30, 2002 and December 31, 2001 consisted of the following: 2002 2001 ----------- ----------- Finished goods $ 2,202,812 $ 2,255,882 Work in process 256,329 531,355 Raw materials and supplies 6,756,889 7,841,053 ----------- ----------- $ 9,216,030 $10,628,290 3. ACQUISITION On June 1, 2001, Interlott Technologies, Inc. completed the acquisition of the lottery assets of On-Point Technology Systems, Inc. of San Marcos, California. Through the purchase, Interlott acquired all of the lottery assets of On-Point, including patents, technology, accounts receivable, inventory, service contracts and lease contracts with the New York, Illinois, Virginia and Missouri state lotteries. The purchase price included approximately $13 million paid at closing, deferred payments of $9 million payable, subject to adjustment, over 5 years, and an earn-out of up to $6 million based upon certain future revenues. In addition, at the closing Interlott and On-Point entered into a separate agreement to market a patented design for an on-line activated instant lottery ticket. Prior to the closing, to finance the cash payment paid at closing, Interlott increased its existing credit facility with Fifth Third Bank, Cincinnati, Ohio (which participated portions of the credit facility to Huntington Bank and National Bank of Canada) from $25 million to $30 million, and completed a mezzanine financing of junior debt in the form of a term note due June 30, 2003 in the principal amount of $5 million with Fifth Third Bank. The note bears interest at the rate of 9% per annum and the Company has paid and must pay a success fee equal to 1% of the unpaid principal balance of the note outstanding on the last day of the fiscal quarter for each of the four (4) fiscal quarters ending on September 30, 2001, December 31, 2001, March 31, 7 2002, and June 30, 2002; and equal to 1.5% of the unpaid principal balance of the note outstanding on the last day of the fiscal quarter for each of the four (4) fiscal quarters ending on September 30, 2002, December 31, 2002, March 31, 2003, and June 30, 2003. The acquisition has been accounted for by the purchase method. Revenues reported during the quarter ending June 30, 2002 from lease and maintenance contracts acquired were approximately $1.5 million. 4. GOODWILL On July 20, 2001, the Financial Accounting Standards Board (FASB) issued SFAS No. 141, Business Combinations and SFAS No. 142, Goodwill and Other Intangible Assets. SFAS No. 141 requires that the purchase method of accounting be used for all business combinations initiated after June 30, 2001. The Company adopted SFAS No. 141 on July 1, 2001. The change had no material effect on the Company's financial position or results of operations. SFAS No. 142 requires that goodwill and intangible assets with indefinite useful lives no longer be amortized, but instead be tested for impairment at least annually in accordance with the provisions of SFAS No. 142. SFAS No. 142 also requires that intangible assets with definite useful lives be amortized over their respective estimated useful lives to their estimated residual values, and reviewed for impairment. The Company adopted SFAS No. 142 on January 1, 2002, as required. As a result, there was no amortization of goodwill relating to the On-Point acquisition for the three or six months ended June 30, 2002. Goodwill amortization for the three months ended June 30, 2001 was $54,427. At this time, the Company believes that no impairment exists. 5. COMPREHENSIVE INCOME Comprehensive income reflects the change in the estimated fair market value of the Company's interest rate swap agreements. The estimated fair value is based upon appropriate market information and projected interest rate changes obtained from a reputable financial institution. Total comprehensive income for the three and six months ended June 30, 2002 is summarized as follows: Three Months Six Months ------------ ---------- Net income $185,390 $707,169 Other comprehensive income 2,670 117,855 -------- -------- Total comprehensive income $188,060 $825,024 ======== ======== 8 ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS. GENERAL Interlott Technologies, Inc. (the "Company") manufactures instant ticket vending machines ("ITVMs") and prepaid phone card dispensing machines ("PCDMs") that dispense instant lottery tickets and prepaid telephone calling cards without the assistance of an employee of the lottery or the telephone card vendor. The Company derives its revenues from (1) the lease of ITVMs and PCDMs, (2) the sale of ITVMs and PCDMs, and (3) to a lesser extent, service agreements and the sale of parts for ITVMs and PCDMs. On June 1, 2001, the Company completed the acquisition of the lottery assets of On-Point Technology Systems, Inc. of San Marcos, California. The assets acquired included patents, technology, accounts receivable of $729,000, $3.4 million of inventory, service contracts, and lease contracts for the New York, Illinois, Virginia and Missouri state lotteries. The purchase price included approximately $13 million paid at closing, deferred payments of $9 million payable, subject to adjustment, over 5 years, and an earn-out of up to $6 million based upon certain future revenues. In addition, at the closing Interlott and On-Point entered into a separate agreement to market a patented design for an on-line activated instant lottery ticket. The Company historically has experienced fluctuations in its financial results due to the variable 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, competitive bidding for contract awards 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. The Company's decision to lease a significant portion of its ITVMs generally offers the Company better gross margins than direct sales agreements. However, leasing inherently requires more capital and a longer-term payout than sales. At June 30, 2002, the Company had a total of 11,431 ITVMs and PCDMs deployed under operating and sales type leases as compared to 11,176 at March 31, 2002. In the aggregate, the Company has sold or leased over 28,000 ITVMs and PCDMs under agreements with 29 domestic and 14 international lotteries and their licensees or contractors, as well as to both domestic and international vendors of prepaid telephone calling cards. RESULTS OF OPERATIONS The Company's net revenues decreased 34% to $10,150,503 from $15,273,003 for the three months, and 8% to $21,292,686 from $23,083,603 for the six months, ended June 30, 2002 and 2001, respectively. Revenues from sales of ITVMs and 9 PCDMs decreased 61% to $3,758,455 from $9,590,951 for the three months, and 30% to $8,534,137 from $12,189,027 for the six months, ended June 30, 2002 and 2001, respectively. The decrease in revenues from sales resulted from a lower number of ITVMs sold in 2002 as compared to a large sale to one domestic lottery and sales to two international lotteries in the three months and six months ended June 30, 2001. Revenues from operating leases increased 2% to $4,797,544 from $4,683,473 for the three months, and 5% to $9,455,263 from $8,986,777 for the six months, ended June 30, 2002 and 2001, respectively. Leases acquired from On-Point contributed $600,886 to lease revenues for the quarter ended June 30, 2002 and $1,223,623 for the six months ended June 30, 2002, offsetting a decrease in other lease revenues of approximately $436,284 and $863,140 for the three and six months, respectively, due to a contract which expired in July, 2001. Lease revenues represented 47% and 31% of total revenues for the three months, and 44% and 39% of total revenues for the six months, ended June 30, 2002 and 2001, respectively. Other revenues increased 60% to $1,594,504 from $998,579 for the three months, and 73% to $3,303,285 from $1,907,799 for the six months, ended June 30, 2002 and 2001 respectively, primarily due to service revenues from the contracts acquired from On-Point. Cost of revenues decreased 34% to $7,238,783 from $10,891,802 for the three months, and 7% to $15,174,344 from 16,352,643 for the six months, ended June 30, 2002 and 2001, respectively. Depreciation charged to cost of revenues increased 3% to $1,739,030 from $1,687,876 for the three months, and 5% to $3,494,856 from $3,328,328 for the six months, ended June 30, 2002 and 2001, respectively, due to newer, more expensive equipment being deployed on new contracts. Service and installation costs increased 31% to $2,894,392 from $2,207,246 for the three months, and increased 36% to $5,713,520 from $4,187,328 for the six months, ended June 30, 2002 and 2001, respectively, due to the leases and maintenance contracts acquired from On-Point. Amortization of leases relating to the On-Point acquisition charged to cost of goods sold was $214,050 for the three months ended June 30, 2002 and $428,100 for the six months ended June 30, 2002. Amortization of leases for the three months and six months ended June 30, 2001 was $71,350 which reflected one month of expense subsequent to the acquisition on June 1, 2001. As a result of these factors and higher margins on equipment sold, cost of revenues as a percentage of revenues remained constant at 71% for the three months and the six months ended June 30, 2002. Due primarily to lower sales volume, gross profit decreased 34% to $2,911,720 from $4,381,201 for the three months, and decreased 9% to $6,118,341 from $6,730,960 for the six months, ended June 30, 2002 and 2001, respectively. Gross profit as a percentage of revenues remained constant at 29% for the three months and six months ended June 30, 2002, as a result of the previously discussed changes in expenses. The Company adopted SFAS No. 142 on January 1, 2002, as required. As a result there was no amortization of goodwill relating to the On-Point acquisition for the three months and six months ended June 30, 2002. Amortization for the three and six months ended June 30, 2001 was $54,427. Selling, general, and administrative expenses increased 7% to $1,688,605 from $1,584,572 for the three months, and 6% to $3,297,765 from $3,117,502 for the six months, ended June 30, 2002 and 2001, respectively. Increases in wages and benefits 10 and legal and professional fees were the primary factors related to the increase in costs for both the three month and six month periods. Interest expense increased 26% to $586,578 from $463,762 for the three months, and increased 54% to $1,260,305 from $815,884 for the six months, ended June 30, 2002 and 2001, respectively. The increase reflects increased overall borrowing under the Company's credit facility partially offset by decreases in interest rates. The increased borrowing was due primarily to the On-Point acquisition but also was related to the financing of a new lease contract with a domestic lottery. Other income (expense) was $(199,805) and $9,842 for the three months, and ($202,410) and $16,524 for the six months, ended June 30, 2002 and 2001, respectively. This increase in expense was due to a non-recurring charge for the settlement of litigation, as described in Part II, Item 1 (Legal Proceedings), in the amount of $200,000 which was recorded in the quarter ended June 30, 2002. As a result of the factors discussed above, income before income taxes decreased 87% to $288,770 from $2,153,815 for the three months, and decreased 54% to $1,130,289 from $2,471,202 for the six months, ended June 30, 2002 and 2001, respectively. Income taxes were $103,380 for the three months and $423,120 for the six months, ended June 30, 2002. The Company's effective tax rate is 38%. As a result of the foregoing factors, net income after tax decreased 86% to $185,390 from $1,335,435 for the three months, and decreased 54% to $707,169 from $1,531,632 for the six months, ended June 30, 2002 and 2001, respectively. LIQUIDITY AND CAPITAL RESOURCES Prior to the closing of the acquisition of the lottery assets of On-Point, to finance the cash payment paid at closing, the Company increased its existing credit facility with its bank from $25 million to $30 million, and also completed a mezzanine financing of junior debt in the principal amount of $5 million with its bank. The amended credit facility is a three year credit line, secured by a lien on all of the assets of the Company. The rate of interest on this loan is based on the prime rate or LIBOR rate adjusted up or down depending on the Company's funded debt to EBITDA ratio. The current rate is LIBOR plus 2.5% (4.32% at August 1, 2002). The mezzanine financing consists of a $5 million term note due June 30, 2003, which is subordinate to the credit facility. This note bears interest at a fixed rate of 9% per annum and the Company has paid and must pay a success fee equal to 1% of the unpaid principal balance of the note outstanding on the last day of the fiscal quarter for each of the four (4) fiscal quarters ending on September 30, 2001, December 31, 2001, March 31, 2002, and June 30, 2002; and equal to 1.5% of the unpaid principal balance of the note outstanding on the last day of the fiscal quarter for each of the four (4) fiscal quarters ending on September 30, 2002, December 31, 2002, March 31, 2003, and June 30, 2003. The note may be prepaid when availability on the credit facility exceeds $2 million and the Company is in compliance with all loan covenants. The Company intends to pay down all or part of this note prior to the maturity date using funds generated from operations. In the event 11 that the Company secures a large lease contract requiring a significant capital investment, the redemption of this debt may be delayed. Net cash provided by operations for the six months ended June 30, 2002 and 2001 was $7,410,714 and $5,370,852, respectively. The increase for the first six months of 2002 as compared to the same period in 2001 resulted primarily from a decrease in accounts receivable, partially offset by a decrease in accounts payable. Net cash used in investing activities was $2,253,330 and $17,665,995 for the six months ended June 30, 2002 and 2001, respectively. The six months ended June 30, 2001 included the purchase of the lottery assets of On-Point for $13.4 million offset in part by the lower amount spent on equipment deployed under leases in the first six months of 2001. Net cash used in investing activities for the six months ended June 30, 2002 consisted primarily of the cost of leased machines built for deployment under lease contracts. Net cash used for financing activities was $5,319,648 for the six months ended June 30, 2002 as compared to net cash provided by financing activities of $12,945,754 for the six months ended June 30, 2001. The change is primarily the result of payments made on the credit facility in 2002 as compared to additional borrowings on the credit facility in 2001 related to the On-Point acquisition. On August 1, 2002, the Company was indebted to Fifth Third Bank in the aggregate principal amount of $19,089,583 and had $10,910,417 available on the credit facility, as well as the aggregate principal of $5,000,000 on the subordinated term note. ITEM 3. 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 and an interest rate swap agreement with a total notional principal amount of $5,000,000 at July 3, 2001 which expires on May 31, 2004. The objective of these agreements 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 agreements was approximately ($402,982) at June 30, 2002. The estimated fair value is based upon appropriate market information and projected interest rate changes obtained from a reputable institution. 12 PART II. OTHER INFORMATION ITEM 1. LEGAL PROCEEDINGS On July 23, 2002, The United States District Court for the Western District of Washington, approved the settlement of a class action lawsuit styled PAUL DOYON AND ALBERT DELARA, ON THEIR BEHALF, AND ON THE BEHALF OF ALL MEMBERS OF THE SIMILARLY SITUATED CLASS OF PERSONS, PLAINTIFFS, V. INTERLOTT TECHNOLOGIES, INC., DEFENDANT CASE NO. C01-0988C. This action was filed by a former Interlott field service representative on behalf of himself and others similarly situated asserting an entitlement to overtime pay relating to hours worked while in the employment of the Company. In connection with the settlement, the lawsuit has been dismissed by the United States District Court without any admission or finding of liability on the part of Interlott. The Company is paying a total of $25,000 to settle the claims, and $175,000 in reimbursement of class counsel's attorney's fees and expenses. This case was previously reported in the Company's 2001 Form 10-K Report filed on March 29, 2002, at Part I, Item 3. ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K (a) Exhibits: Exhibit 99.1 - Certification Pursuant to 18 U.S.C. Section 1350, as Adopted Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002. (b) Reports on Form 8-K. None 13 SIGNATURES Pursuant to the requirements 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. INTERLOTT TECHNOLOGIES, INC. (Registrant) Date: August 14, 2002 /s/ David F. Nichols -------------------------------------------- David F. Nichols President and Chief Executive Officer /s/ Dennis W. Blazer -------------------------------------------- Dennis W. Blazer Chief Financial and Accounting Officer 14

INTERLOTT TECHNOLOGIES INC 10-Q