10-Q 1 l02623ae10vq.txt INTERLOTT TECHNOLOGIES, INC. 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, 2003 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 by check mark whether the registrant is an accelerated filer (as defined in Rule 12b-2 of the Exchange Act). Yes No x --- --- 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, 2003 -------------------------------------- ------------------------------ Common Stock, $.01 Par Value 6,462,994 shares

INTERLOTT TECHNOLOGIES, INC. QUARTERLY REPORT ON FORM 10-Q FOR THE QUARTER ENDED JUNE 30, 2003 TABLE OF CONTENTS

2 PART I. FINANCIAL INFORMATION ITEM 1. FINANCIAL STATEMENTS INTERLOTT TECHNOLOGIES, INC. CONDENSED BALANCE SHEETS JUNE 30, 2003 AND DECEMBER 31, 2002

See accompanying notes to condensed financial statements. 3 INTERLOTT TECHNOLOGIES, INC. CONDENSED STATEMENTS OF INCOME THREE MONTHS AND SIX MONTHS ENDED JUNE 30, 2003 AND 2002

4 INTERLOTT TECHNOLOGIES, INC. CONDENSED STATEMENT OF CASH FLOWS (UNAUDITED) SIX MONTHS ENDED JUNE 30, 2003 AND 2002

See accompanying notes to condensed financial statements. 5 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, 2003 and 2002 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 Annual Report on Form 10-K. The results of operations for the three months and six months ended June 30, 2003 are not necessarily indicative of the results to be expected for the entire year ending December 31, 2003. 2. Inventories ----------- Inventories at June 30, 2003 and December 31, 2002 consisted of the following:

3. Merger Agreement ---------------- The Company has entered into an Amended and Restated Agreement and Plan of Merger dated as of March 17, 2003 with GTECH Holdings Corporation and subsidiaries of GTECH, pursuant to which the Company will merge into and become a wholly-owned subsidiary of GTECH. Upon the merger, each share of the Company's Common Stock will be changed into the right to receive $9.00 in cash, GTECH common shares or a combination of the two, with 51.5% of the aggregate merger consideration to be paid in GTECH common shares and the balance in cash. Consummation of the merger is subject to satisfaction of various conditions, including the approval of the Company's stockholders, the making of various regulatory filings, the absence of any injunction or certain litigation challenging the merger, the receipt of tax and other legal opinions, the accuracy of the parties' representations and warranties and performance of their agreements, and the receipt of consents to the merger from customers representing 85% of the Company's projected business for 2003 and certain other parties to material contacts. GTECH may terminate the merger agreement if its average stock price for purpose of calculating the number of common shares to be issued in the merger is less than $25.12, unless the Company elects to convert the merger consideration into all cash. The Company has agreed not to solicit a competing offer, but may terminate the merger agreement to accept an unsolicited superior proposal. If it does so, the Company 6 will be required to pay GTECH a termination fee of $2.75 million and reimburse GTECH's expenses up to $750,000. In connection with the Merger Agreement, GTECH also entered into a Stockholder Voting and Option Agreement and a Noncompetition Agreement with L. Rogers Wells, Jr. Under the Voting and Option Agreement, Mr. Wells agreed to vote in favor of the merger and granted GTECH the option to purchase his Company Common Stock at $9.00 per share if the Merger Agreement terminates for specified reasons. The Voting and Option Agreement terminates if the Company terminates the Merger Agreement to accept a superior proposal. If GTECH exercises the option, it is required to make a cash tender offer for the remaining Common Stock of the Company at $9.00 per share. Pursuant to the Noncompetition Agreement, Mr. Wells has agreed not to engage in the lottery business for five years after consummation of the merger. As compensation for this agreement, GTECH will pay him $250,000 per year during that five-year period. 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 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. 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, 2003 is summarized as follows:

7 (6) 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 with 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. Had compensation cost for options granted during 2003 been determined consistent with the fair value methodology of SFAS No. 123, the Company's net income and earnings per share for the three and six months ended June 30, 2003 would have been reduced to the pro forma amounts presented below:

The fair value of options granted during 2003 for purposes of the accompanying pro forma disclosures is estimated on the grant date using the Black-Scholes option-pricing model with the following weighted-average assumptions: no dividends paid, as 8 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 53%, based on the calculated volatility of the Company's stock; risk-free rate of return of 4.41%; and expected lives of 10 years. 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. The Company has entered into an Amended and Restated Agreement and Plan of Merger dated as of March 17, 2003 with GTECH Holdings Corporation and subsidiaries of GTECH, pursuant to which the Company will merge into and become a wholly-owned subsidiary of GTECH. Upon the merger, each share of the Company's Common Stock will be changed into the right to receive $9.00 in cash, GTECH common shares or a combination of the two, with 51.5% of the aggregate merger consideration to be paid in GTECH common shares and the balance in cash. For additional information, see Note 3 of the Notes to Condensed Financial Statements in Item I above. 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, 2003, the Company had a total of 11,874 ITVMs and PCDMs deployed under operating and sales type leases as compared to 11,806 at March 31, 2003. In the aggregate, the Company has sold or leased over 32,000 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. 9 RESULTS OF OPERATIONS The Company's revenues increased 21% to $12,269,360 from $10,150,503 for the three months, and 12% to $23,951,383 from $21,292,685 for the six months, ended June 30, 2003 and 2002, respectively. Revenues from sales of ITVMs increased 63% to $6,114,381 from $3,758,455 for the three months, and 39% to $11,876,090, from $8,534,137 for the six months, ended June 30, 2003 and 2002, respectively. The increase in revenues from sales resulted from a higher number of ITVMs sold in 2003. Revenues from operating leases decreased 6% to $4,521,399 from $4,797,544 for the three months, and 5% to $8,976,955 from $9,455,263 for the six months, ended June 30, 2003 and 2002, respectively. Lease revenues represented 37% and 47% of total revenues for the three months, and 37% and 44% of total revenues for the six months, ended June 30, 2003 and 2002, respectively. Other revenues increased 2% to $1,633,580 from $1,594,504 for the three months, and decreased 6% to $3,098,338 from $3,303,285 for the six months, ended June 30, 2003 and 2002, respectively. Cost of revenues increased 19% to $8,647,229 from $7,238,783 for the three months, and 13% to $17,133,732 from $15,174,344 for the six months, ended June 30, 2003 and 2002, respectively. Depreciation charged to cost of revenues decreased 15% to $1,483,975 from $1,739,030 for the three months, and 14% to $3,002,559 from $3,494,896 for the six months, ended June 30, 2003 and 2002, respectively, due to leased machines becoming fully depreciated. Service and installation costs decreased 5% to $2,757,176 from $2,894,392 for the three months, and decreased 3% to $5,519,596 from $5,713,520 for the six months, ended June 30, 2003 and 2002, respectively, due primarily to the expiration of the Virginia maintenance contract on October 1, 2002 and partially offset by increases in rework and replacement costs. Amortization of leases relating to the acquisition On-Point Technology Systems charged to cost of goods sold remained constant at $214,050 for the three months ended June 30, 2003 and 2002 and $428,100 for the six months ended June 30, 2003 and 2002. As a result of these factors and higher margins on equipment sold, cost of revenues as a percentage of revenues decreased from 71.3 % for the three months ended June 30, 2002 to 70.5% for the three months ended June 30, 2003 and increased slightly from 71.3% for the six months ended June 30, 2002 to 71.5% for the six months ended June 30, 2003. Due primarily to higher sales volume, gross profit increased 24% to $3,622,131 from $2,911,720 for the three months, and increased 11% to $6,817,651 from $6,118,341 for the six months, ended June 30, 2003 and 2002, respectively. Gross profit as a percentage of revenues increased 1% for the three months ended June 30, 2003 and remained constant for the six months ended June 30, 2003, as a result of the previously discussed changes in expenses. Selling, general, and administrative expenses increased 2% to $1,729,568 from $1,688,606 for the three months, and 6% to $3,484,484 from $3,297,765 for the six months, ended June 30, 2003 and 2002, respectively. Increases in legal and professional fees of $43,490 for the three months, and $102,702 for the six months, were the primary reasons for the increase in costs in both periods. Interest expense decreased 53% to $276,928 from $586,578 for the three 10 months, and decreased 57% to $547,577 from $1,260,305 for the six months, ended June 30, 2003 and 2002, respectively. The decrease reflects decreased overall borrowing under the Company's credit facility accompanied by decreases in interest rates. Other income (expense) was ($151,455) and ($199,805) for the three months, and ($655,749) and ($202,410) for the six months, ended June 30, 2003 and 2002, respectively. The increase in expense for the six months, ended June 30, 2003 was due to costs associated with the merger agreement between Interlott and GTECH. These costs included fairness opinion fees, merger related legal fees and Special Committee compensation. As a result of the factors discussed above, income before income taxes increased 377% to $1,376,958 from $288,770 for the three months, and increased 70% to $1,921,979 from $1,130,289 for the six months, ended June 30, 2003 and 2002, respectively. Income taxes were $524,780 for the three months, and $732,430 for the six months, ended June 30, 2003. The Company's effective tax rate is 38%. As a result of the foregoing factors, net income after tax increased 360% to $852,178 from $185,390 for the three months, and increased 68% to $1,189,549 from $707,169 for the six months, ended June 30, 2003 and 2002, respectively. LIQUIDITY AND CAPITAL RESOURCES Net cash provided by operations for the six months ended June 30, 2003 and 2002 was $4,553,360 and $7,410,714, respectively. The decrease for the first six months of 2003 as compared to the same period in 2002 resulted primarily from an increase in accounts receivable of $1,762,392 and an increase in inventories of $1,431,536. The increase in accounts receivable resulted from several large ITVM sales in June 2003, and the increase in inventories was the result of increasing production levels of ITVMs for future sales and deployments under lease contracts. Net cash used in investing activities was $635,548 and $2,253,330 for the six months ended June 30, 2003 and 2002, respectively. The decrease in 2003 was due to the lower amount spent on equipment deployed under leases in the first six months of 2003. Net cash used for financing activities was $3,989,850 for the six months ended June 30, 2003 as compared to net cash used by financing activities of $5,319,648 for the six months ended June 30, 2002. The change is primarily the result of lower payments made on the credit facility in 2003 as compared to payments made on the credit facility in 2002 and also of lower repayments of notes to related parties. The credit facility is a three year credit line, which expires on May 31, 2004 and is secured by a lien on all of the assets of the Company. The interest rate on the credit facility is based on the prime rate or LIBOR, adjusted up or down depending on the 11 Company's funded debt to EBITDA ratio. The current rate is prime (4.0% at August 1, 2003). On August 1, 2003, the Company was indebted to Fifth Third Bank in the aggregate principal amount of $17,025,081 and had $12,974,919 available on the credit facility. 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 $5 million at July 3, 2001 which expires on May 31, 2004 and an interest rate swap agreement with a total notional principal amount of $10 million at November 7, 2002 which also 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 ($366,534) at June 30, 2003. The estimated fair value is based upon appropriate market information and projected interest rate changes obtained from a reputable institution. The estimated amount of deferred loss on the hedge to be reclassified to earnings in 2003 is $320,000. ITEM 4. CONTROLS AND PROCEDURES. As of June 30, 2003, an evaluation was performed under the supervision and with the participation of the Company's management, including the Chief Executive Officer and Chief Financial Officer, of the effectiveness of the design and operation of the Company's disclosure controls and procedures. Based on that evaluation, the Company's management, including the CEO and CFO, concluded that the Company's disclosure controls and procedures were effective as of June 30, 2003. There have been no significant changes in the Company's internal controls or in other factors that could significantly affect internal controls subsequent to June 30, 2003. 12 PART II. OTHER INFORMATION ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K (a) Exhibits. 31.1 Certification of Chief Executive Officer 31.2 Certification of Chief Financial Officer 32 Section 1350 Certifications (b) Reports on Form 8-K. On May 9, 2003, the Company furnished its press release reporting first quarter 2003 results and related information to the Commission on Form 8-K (Item 9, providing information requested by Item 12). 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, 2003 /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