-----BEGIN PRIVACY-ENHANCED MESSAGE----- Proc-Type: 2001,MIC-CLEAR Originator-Name: webmaster@www.sec.gov Originator-Key-Asymmetric: MFgwCgYEVQgBAQICAf8DSgAwRwJAW2sNKK9AVtBzYZmr6aGjlWyK3XmZv3dTINen TWSM7vrzLADbmYQaionwg5sDW3P6oaM5D3tdezXMm7z1T+B+twIDAQAB MIC-Info: RSA-MD5,RSA, GpSyZ1D49btfKyuqOf4bm0nrdfvS6CGpG8wjPZXdruIr23p/kbmyaXU2myLAzcFc SbNj4/CM2YuqG1e6gTSItw== 0001046386-00-000055.txt : 20000331 0001046386-00-000055.hdr.sgml : 20000331 ACCESSION NUMBER: 0001046386-00-000055 CONFORMED SUBMISSION TYPE: 10-K PUBLIC DOCUMENT COUNT: 6 CONFORMED PERIOD OF REPORT: 19991231 FILED AS OF DATE: 20000330 FILER: COMPANY DATA: COMPANY CONFORMED NAME: INTERLOTT TECHNOLOGIES INC CENTRAL INDEX KEY: 0000873998 STANDARD INDUSTRIAL CLASSIFICATION: REFRIGERATION & SERVICE INDUSTRY MACHINERY [3580] IRS NUMBER: 311297916 STATE OF INCORPORATION: DE FISCAL YEAR END: 1231 FILING VALUES: FORM TYPE: 10-K SEC ACT: SEC FILE NUMBER: 001-12986 FILM NUMBER: 585564 BUSINESS ADDRESS: STREET 1: 10830 MILLINGTON CT CITY: CINCINNATI STATE: OH ZIP: 45242 BUSINESS PHONE: 5137297000 MAIL ADDRESS: STREET 1: 6655 CREEK ROAD CITY: CINCINNATI STATE: OH ZIP: 45242 FORMER COMPANY: FORMER CONFORMED NAME: INTERNATIONAL LOTTERY INC DATE OF NAME CHANGE: 19940203 10-K 1 ANNUAL REPORT ON FORM 10-K SECURITIES AND EXCHANGE COMMISSION WASHINGTON, D.C. 20549 FORM 10-K [X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 FOR THE FISCAL YEAR ENDED DECEMBER 31,1999 [ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the Transition Period From _____ to _____ Commission file number 001-12986 INTERLOTT TECHNOLOGIES, INC. (Exact name of Registrant as specified in its charter) DELAWARE 31-1297916 (State of incorporation) (IRS Employer Identification Number) 7697 Innovation Way, Mason, Ohio 45040 (Address of principal executive offices, including zip code) (513) 792-7000 (Registrant's telephone number, including area code) Securities registered pursuant to Section 12(b) of the Act: Title of each class Name of each exchange on which registered Common Stock, $.01 Par Value American Stock Exchange Securities registered pursuant to Section 12(g) of the Act: None Indicate by check mark whether the Registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the Registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes [X] No [ ] Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of the Registrant's knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. [ ] The aggregate market value of the Registrant's outstanding Common Stock held by non-affiliates of the Registrant on March 23, 2000 was $7,408,406. There were 3,210,000 shares of Common Stock outstanding as of March 23, 2000. DOCUMENTS INCORPORATED BY REFERENCE Portions of the Registrant's Proxy Statement for the 2000 Annual Meeting of Stockholders to be held on May 4, 2000 are incorporated by reference in Part III hereof. INTERLOTT TECHNOLOGIES, INC. Annual Report On Form 10-K For the Fiscal Year Ended December 31, 1999
Table of Contents Item Page Number Number PART I............................................................................................................2 1. Business...............................................................................................3 2. Properties............................................................................................12 3. Legal Proceedings.....................................................................................12 4. Submission of Matters to a Vote of Security Holders...................................................13 PART II..........................................................................................................13 5. Market for the Registrant's Common Stock and Related Stockholder Matters..............................13 6. Selected Financial Data...............................................................................14 7. Management's Discussion and Analysis of Financial Condition and Results of Operations.................16 7(A). Quantitative and Qualitative Disclosures About Market Risk............................................23 8. Financial Statements and Supplementary Data...........................................................24 9. Changes In and Disagreements With Accountants on Accounting and Financial Disclosure..................39 PART III.........................................................................................................39 10. Directors and Executive Officers of the Registrant....................................................40 11. Executive Compensation.................................................................................. 12. Security Ownership of Certain Beneficial Owners and Management.......................................... 13. Certain Relationships and Related Transactions.......................................................... PART IV..........................................................................................................40 14. Exhibits, Financial Statement Schedules, and Reports on Form 8-K......................................40 SIGNATURES............................................................................................41 INDEX OF FINANCIAL STATEMENT SCHEDULES...............................................................S-1 INDEX OF EXHIBITS....................................................................................E-1
PART I -2- ITEM 1. BUSINESS Interlott Technologies, Inc. (the "Company" or "Interlott") is engaged primarily in the design, manufacture, sale, lease and service of instant winner lottery ticket vending machines ("ITVMs"). ITVMs are used by public lotteries operated by states and international public entities to dispense instant winner lottery tickets primarily in retail locations such as supermarkets and convenience stores. An instant lottery commonly is played by players scratching off a latex coating from a pre-printed ticket or tearing pull-tabs from a pre-printed ticket to determine the outcome of the game. The Company's ITVMs dispense instant lottery tickets without the assistance of an employee of the lottery instant ticket retailer or agent, thereby permitting the retailer or agent to sell tickets without disrupting the normal duties of its employees. The Company's ITVMs dispense scratch-off instant lottery tickets using a dispensing process that incorporates the Company's patented "burster technology." The Company believes that this burster technology is superior to any other ITVM scratch-off dispensing technology on the market and considers it to be a key to its marketing efforts and the ITVM procurement decisions of the various lotteries. The Company is unaware of any competitor that incorporates a substantially equivalent or superior scratch-off dispensing mechanism in its ITVMs. To dispense pull-tab instant lottery tickets, the Company has developed an ITVM that incorporates a patented dispensing technology which is different than the burster technology but that is also believed by the Company to be superior to any other currently available pull-tab dispensing technology. ITVMs that dispense pull-tab tickets are sometimes referred to herein as "pull tab vending machines" or "PTVMs." The term "ITVM" includes both scratch-off vending machines and PTVMs unless the context indicates otherwise. As of December 31, 1999, the Company had sold or leased over 20,000 ITVMs under agreements with 23 different state lotteries and the District of Columbia and eight international jurisdictions, or their licensees or contractors. The Company was awarded six of the six contracts that were awarded to the industry in 1999. The Company continually seeks to enhance its existing product lines and develop new products. In 1998, the Company introduced its Modular Vending Platform ("MVP") to increase over-the-counter instant ticket sales and reduce ticket shrinkage. Also in 1998, the Company introduced its Advanced Communication Software, which significantly increases and enhances the flow of information between the ITVMs in the field and the lotteries. Taking advantage of its expertise in dispensing technology, the Company introduced a prepaid phone card dispensing machine ("PCDM") in 1995 that enables providers of long distance telephone service to dispense prepaid telephone calling cards in retail locations without the assistance of an employee of the retailer. The dispensing process used in the Company's PCDM incorporates the same patented technology used in the Company's PTVM, and the Company believes that this dispensing technology is superior to any other PCDM dispensing technology on the market. Although PCDM revenues in 1999 represented less than 1% of total revenues, it continues to be a potential source of future sales growth. Interlott is a Delaware corporation. The Company completed its initial public offering of Common Stock in April 1994. The Company's Common Stock trades on the American Stock Exchange under the symbol "ILI." Products The ITVM In 1987, Edmund F. Turek, a director of and consultant to the Company, developed the technology for what the Company believes to be the first automated ITVM. The burster dispensing technology is a key component of the Company's ITVM for scratch-off instant lottery tickets and is protected by a patent that the Company acquired from Mr. Turek's family-owned corporation. See "Patents, Trademarks and Copyrights" below. The Company's ITVMs automatically dispense instant lottery tickets upon payment from the user. The burster technology in the Company's ITVMs automatically separates one scratch-off instant ticket from another along the perforations between tickets to help prevent tearing of the tickets or scarring of the latex on the tickets. This technology also enables the Company's ITVMs to dispense and account for virtually any known type of scratch-off instant lottery -3- ticket, allowing the use of a wide range of sizes, shapes, paper stocks or perforations, without the intervention of a lottery retailer or agent. This feature allows lotteries to purchase virtually any known type of scratch-off instant ticket from their instant ticket manufacturer without having to request from the manufacturer major alterations in the ticket perforations. For example, the Company's ITVM can dispense recyclable scratch-off tickets without tearing or scarring the tickets. The Company believes that lotteries will increasingly require the use of recyclable tickets in their ITVMs. This feature also is particularly beneficial to international lottery jurisdictions that may use non-standard sizes, shapes and paper stocks. In addition, the ITVM for scratch-off tickets is faster than manual sales of scratch-off tickets as the ITVM's entire dispensing process is completed in less than 1.5 seconds once the ticket selector button has been pushed. The Company's ITVMs for scratch-off tickets have a record of reliability. Based on an analysis of actual field service data regarding the dispensing of approximately 55 million scratch-off instant tickets by the Company's ITVMs during a 48-week period, the Company determined that the Mean Time Between Failure of these ITVMs is approximately 3.78 years and that the Mean Time to Repair is approximately 15 minutes. The Company's ITVM for scratch-off tickets has the capacity to dispense tickets from one to 16 different bins. Because each bin can dispense tickets of different sizes, paper stocks and price levels, lotteries can sell scratch-off tickets for up to 16 different instant-winner games with a single ITVM. The ITVM can accommodate up to 16,000 tickets in the 16-game unit and can dispense all tickets in the bin without manual intervention. When all of the tickets in a bin have been dispensed, tickets can be easily reloaded by an employee of the retailer or agent. The ability of the Company's ITVM to dispense every ticket in each bin not only facilitates the ticket reloading process but also enhances the accuracy of the inventory and accounting functions. All of the Company's ITVMs accept bills in $1, $2, $5, $10 and $20 denominations and, in some applications, accept international currency. The size of the Company's ITVM for scratch-off tickets varies from 69 inches tall, 28 inches wide and 24 inches deep for a 16-game unit to 19.75 inches tall, 15.5 inches wide and 20.5 inches deep for a countertop unit. All models are anchored to the floor or counter. The ITVMs typically are custom designed to meet any color and other appearance specifications requested by a lottery. All models are Underwriters Laboratory ("UL((R))") listed and Federal Communications Commission ("FCC") approved, which ensures that the ITVM has passed nationally recognized safety standards and stringent requirements designed to preclude machine damage and personal injury due to non-approved components, devices, installation or application. Each ITVM is standardized with an information display that provides the player with easy-to-read instructions on how to use the machine and gives the lottery retailer or agent the ability to read sales reports without printing the report. The ITVM can be ordered with a "BETA BRITE((R))" multi-color LED sign mounted on the top of the ITVM which is intended to increase attention to the machine and thereby increase ticket sales. The BETA BRITE((R)) sign is programmed at the Company's manufacturing facility and can display any message the lottery may desire. The BETA BRITE((R)) also may be programmed by the retailer or agent or can be programmed from the lottery headquarters by utilizing the Company's optional modem communications system. The Company currently is utilizing the BETA BRITE((R)) on ITVMs installed in approximately 16 states. For security and durability purposes, each of the Company's ITVM cabinets is manufactured with 16 gauge and 11 gauge steel. The surface of the ITVM is coated with durable and fade resistant paints. The display windows are fabricated from a flame resistant, high impact polycarbonate sheet material. This material is shatter resistant, and to date to the knowledge of the Company, none of the Company's installed ITVMs has had a polycarbonate window broken or shattered. Additionally, to the knowledge of the Company, the cabinets have not had any fading, marring, scratching, chipping or rusting. All of the Company's ITVMs are manufactured with high security locks which are coded to prevent unauthorized duplication, and each ITVM is keyed separately, except for ITVMs deployed in Maryland where the Lottery desired a master key system. For further security, each of the Company's bill acceptor units must be accessed with a key unique to the particular acceptor unit. All of the Company's ITVMs for scratch-off tickets utilize copyrighted software that can supply up to 11 different reports for accounting and inventory purposes. These reports can provide to the lottery and its retailers or agents a complete summary of daily sales, weekly sales, total sales, sales by game, current status of the machine, inventory of the product currently in the ITVM, the last three transactions of the ITVM and other types of information. The -4- software system allows for a simple diagnostic test to identify any malfunction of the ITVM. The diagnostic mode communicates various information such as ticket size setting, status of electronics, status of each game and other information concerning the system software. The Company's ITVM software system may be programmed to the detail specifications of the specific lottery. To dispense pull-tab instant lottery tickets, the Company's PTVM uses the same technology, design and specifications as are incorporated in the Company's PCDM. The Company's PCDM is described in detail below. The PCDM Like the Company's ITVM for scratch-off tickets, the key component of the Company's PCDM is the dispensing technology. The Company has the exclusive right to the use of this patented dispensing technology, which it acquired from a company owned by Kazmier J. Kasper, a director of the Company. Similar to the Company's ITVM for scratch-off tickets, the Company's PCDM automatically dispenses prepaid telephone calling cards upon payment from the user. The dispensing technology in the Company's PCDM automatically pulls one prepaid telephone calling card from the bottom of the stack of cards without the jamming that is associated with other dispensing processes. The Company's dispensing technology also enables the Company's PCDM to dispense and account for virtually any known thickness of calling card without the intervention of the retailer. In addition, the PCDM is faster than manual sales of prepaid telephone calling cards as the PCDM's entire dispensing process is completed in less than three seconds once the selector button has been pushed. The Company's PCDMs have the capacity to dispense cards from two to six different bins. The PCDM can accommodate up to 3,600 cards in the six-bin unit and can dispense all prepaid telephone calling cards in the bin without manual intervention. When all of the cards in a bin have been dispensed, cards easily can be reloaded by an employee of the retailer. The ability of the Company's PCDM to dispense every card in each bin not only facilitates the card reloading process but also enhances the accuracy of the inventory and accounting functions. All of the Company's PCDMs accept bills in $1, $2, $5, $10 and $20 denominations and, in some applications, accept international currency. The size of the Company's PCDMs varies from 66 inches tall, 26 inches wide and 19 inches deep for a six-bin dispenser unit to 22 inches tall, 14 inches wide and 10 inches deep for a countertop unit. All models are anchored to the floor or counter, except that the two bin model may be mounted on an optional pedestal. All models are UL((R)) listed and FCC approved. Each PCDM is standardized with an information display that provides the user with easy-to-read instructions on how to use the machine and gives the retailer the ability to read sales reports without printing the report. For security and durability purposes, each of the Company's PCDM cabinets is manufactured with 16 gauge and 11 gauge steel. The surface of the PCDM is coated with durable and fade resistant paints. The display windows are fabricated from a flame resistant, high impact polycarbonate sheet material. To the knowledge of the Company, the cabinets have not had any fading, marring, scratching, chipping or rusting. All of the Company's PCDMs are manufactured with high security locks that are coded to prevent unauthorized duplication, and each PCDM is keyed separately. For further security, each of the Company's bill acceptor units must be accessed with a key unique to the particular acceptor unit. All of the Company's PCDMs utilize copyrighted software that can supply up to nine different reports for accounting and inventory purposes. These reports can provide retailers a complete summary of daily sales, weekly sales, total sales, sales by bin, current status of the machine, inventory of the product currently in the PCDM, the last three transactions of the PCDM and other types of information. The software system allows for a simple diagnostic test to identify any malfunction of the PCDM. Marketing and Sales ITVMs The Company markets its ITVMs to both domestic and international lotteries and their licensees or prime contractors. The Company attends lottery and gaming trade shows, maintains personal contact with lottery officials through its sales force and advertises in trade publications to increase its presence in the lottery industry. The focus of the Company's marketing strategy is on the superior performance and reliability of its ITVMs, as well as continued competitive -5- pricing. Information developed through actual field use and product field tests demonstrates that a significant factor in increasing instant ticket sales is the reliability of the ITVM. Increased maintenance visits impair the ITVM "uptime," which in turn reduce ticket sales. The Company believes that its ITVMs, based on actual field performance and product testing, are the most reliable and technologically superior in the industry. The Company's ITVMs require preventive maintenance only twice a year. The ITVM "downtime" resulting from this semi-annual preventive maintenance averages approximately 20 minutes. To further increase the likelihood of receiving ITVM orders from lotteries, the Company has offered additional and more flexible financing alternatives to the lotteries. The Company believes that many state lotteries, due to budget considerations, cannot afford the high capital costs required to purchase ITVMs. However, if the Company can provide attractive variations of its standard and percentage lease financing options for the lotteries, the lotteries can more affordably deploy ITVMs. The Company is expanding its marketing presence with the retail grocers associations, convenience store operators associations, retail stores at both the corporate and store levels, and other types of corporate or association member entities to familiarize these groups with the Company's ITVM. These retailers are the lotteries' distribution system for all scratch-off and pull-tab lottery tickets. While the lotteries must abide by the established procurement laws of their respective jurisdictions in selecting an ITVM manufacturer, in many lottery jurisdictions retailer advisory boards provide input to the lotteries on various issues affecting the lottery. The Company believes that retailers' opinions are a significant factor in a customer's decision regarding which manufacturer's ITVM to deploy in its instant ticket distribution system. On occasion, the Company participates in cooperative supply arrangements with other lottery suppliers.. These arrangements allow lotteries to reduce their operating costs and provide a more efficient means for contracting products and services. The Company's ITVMs are deployed in Georgia and West Virginia pursuant to cooperative supply arrangements between the Company and Scientific Games, Inc., which is a primary contractor for the Georgia and West Virginia Lotteries, and are deployed in New Jersey pursuant to a purchase agreement between the Company and GTECH Corporation, which is the on-line supplier to the New Jersey Lottery. The Company is responsible for installing, servicing and maintaining the ITVMs in Georgia but is not required to provide preventive maintenance or servicing for the ITVMs supplied for use in West Virginia and New Jersey. PCDMs The Company has been marketing its PCDMs since late 1995 and to date has employed a marketing strategy that is similar to the strategy that it has used successfully to market its ITVMs. The focus of the Company's marketing strategy is on the superior performance and reliability of its PCDMs as well as on competitive pricing. The Company markets its PCDMs to both domestic and international providers of long distance telephone service. The Company attends telecommunications trade shows, maintains personal contact with telecommunications companies through its sales force of two employees and advertises in trade publications to increase its presence in the telecommunications industry. The Company is expanding its marketing presence with the retail grocers associations, convenience store operators associations, retail stores at both the corporate and store levels, and other types of corporate or association member entities to familiarize these groups with the Company's PCDM. These retailers are the distribution system for prepaid telephone calling cards. To further increase the likelihood of receiving PCDM orders from sellers of prepaid telephone calling cards, the Company is offering additional and more flexible financing alternatives. Contracts ITVMs General. The Company's lottery contracts typically are entered into following a competitive bidding process. Once a lottery has determined to utilize ITVMs in its distribution network, the lottery usually will request proposals from ITVM providers. Lotteries within the United States typically follow a procedure whereby the lottery issues a Request for Proposal ("RFP") to determine the contract award for installation of ITVMs. The RFP generally seeks information concerning each company's products, cost of the products or services to be provided, quality of management, experience in the industry and other -6- factors that the lottery may deem material to a contract award. The RFP also may specify product criteria and other qualifications or conditions that must be satisfied, such as UL((R)) listing and FCC approval of the ITVM and in-state or minority supplier requirements. Generally, an evaluation committee comprised of key lottery staff members appraises the proposals based on an established point system, and the contract is awarded to the company with the most points. The nature of the RFP process varies from jurisdiction to jurisdiction. The length of time that a lottery might take to award a contract can be difficult to predict, and delays in the contract award process are frequent and unpredictable. Additionally, the point system or the weighing of the various points varies from jurisdiction to jurisdiction, which often makes it difficult for the bidding companies to determine the relative importance of the various factors to be considered by the evaluation committee. In certain cases the contract award is challenged by the losing bidder, which can result in protracted legal proceedings for all parties. The Company offers lotteries a choice of three types of contracts: (i) Standard Lease Agreements, (ii) Sales Agreements, and (iii) Percentage Lease Agreements. ITVM lease revenues as a percentage of the Company's total revenues were 67.3%, 57.9% and 75.7% in 1997, 1998 and 1999, respectively. The Standard Lease Agreements provide that the lottery will pay a fixed monthly price per machine for a specific period of time. These agreements typically specify a number of years for the initial contract term with additional option periods at the election of the lottery. The lottery may award a separate service contract for the maintenance of the machines, incorporate the cost of service into the established monthly lease price or perform machine service themselves. Similar arrangements are available for replacement parts for the ITVMs. As noted above, the lease payments provided for in the typical Standard Lease Agreement are fixed in most cases during the term of the agreement, and these agreements typically permit the lottery to order additional ITVMs at any time during the lease term. If the lottery orders a significant number of ITVMs near the end of the lease term, the Company would have to incur significant manufacturing costs but may receive lease payments for only a relatively short period of time through the remainder of the lease term. However, the Company believes that it is more likely that the lottery would elect to extend the lease term rather than return the ITVMs after only a short period of use. Additionally, the Company is unable to pass along to the lottery any increases in its manufacturing and service costs during the term of the typical Standard Lease Agreement. In the case of a Standard Lease Agreement which provides for a short initial term (such as one year) with an option for the lottery to extend the lease term for additional one-year periods, if the lottery does not extend the initial lease term, the Company might incur a loss on the manufacture of the ITVMs leased to the lottery under the initial lease agreement. Sales Agreements typically provide that the lottery will buy a certain number of ITVMs over a specific period of time. Under the Sales Agreement, the lottery generally pays for the ITVMs when delivered and has complete ownership of the ITVMs. The lottery usually will contract with the vendor to maintain and service the ITVMs, although some lotteries provide the maintenance and service with their own service staffs. The lottery generally will enter into a parts replacement contract with the vendor for replacement parts. Percentage Lease Agreements provide that the lottery will pay a percentage of sales for tickets sold through our ITVMS. This amount will vary depending upon the location of the machine, the number of games available and the general trends in instant lottery sales. All types of ITVM contracts typically contain stringent installation, performance and maintenance requirements. Failure to perform the contract requirements may result in significant liquidated damages or contract termination. To date, the Company has not had to pay liquidated damages or had any contract terminated by any lottery. The Company's lottery contracts also typically require the Company to indemnify the lottery, its officers and retailers for any liabilities arising from the operation of the ITVMs or any services provided by the Company. The Company maintains liability insurance, fidelity insurance and performance and litigation bonds to protect itself and the lottery from potential liability. No such indemnification or insurance claims have ever been asserted against the Company. The Company's contracts generally have an initial term of one to five years with options to extend the duration of the contracts for periods between one and five years. The option extensions generally are under the same terms and conditions as the original contract. The Company's contracts with lotteries, like most other types of state contracts, typically permit a lottery to terminate the contract upon 30 days written notice for any reason. Upon -7- termination of a lease contract, the lottery would return the leased equipment to the Company. To date, no lottery has terminated its contract with the Company. 30 states and the District of Columbia utilize ITVMs in some manner as part of their instant ticket distribution system. The Company's ITVMs have been deployed in 23 of these states and the District of Columbia as well as eight international jurisdictions. As of December 31, 1999, the Company had sold or leased over 20,000 ITVMs and currently has 9,232 under lease with 17 states and the District of Columbia. These leases expire on various dates through 2003. In certain cases, the Company's contracts are with third parties who are the primary contractors to the lottery. See "Marketing and Sales - ITVMs" above. During 1999, the Company's contract with the Ohio Lottery accounted for 18% of the Company's revenues, and contracts with New York, Texas and Florida accounted for 13%,11% and 10% of the Company's revenues, respectively. PCDMs Unlike the competitive bidding process applicable to the lotteries' awards of ITVM contracts, purchasers of PCDMs typically do not issue RFPs or otherwise mandate a competitive bidding process. Information regarding the Company and its PCDM, and information regarding a telephone company's product needs and criteria and other qualifications or conditions that must be satisfied, typically is exchanged on a less formal basis in sales presentations and subsequent meetings between representatives of the Company and representatives of the telephone company. Most PCDMs to date have been acquired through purchase orders rather than contracts. The Company also has several lease agreements for PCDMs. Like contracts with the lotteries, the purchase orders may contain stringent installation, performance and service requirements. As of December 31, 1999, the Company had sold 756 PCDMs and had 95 PCDMs under lease. Manufacturing Process The manufacturing process consists of purchasing component parts, assembling the ITVMs and PCDMs and then testing the final products. Generally, the Company's machines use components which are built to Company specifications and are available from multiple sources. The Company has a primary vendor and secondary suppliers for most of its components and typically has been able to obtain adequate supplies of required components on a timely basis.. However, certain important components, such as components of the Company's ITVM burster, PTVM dispensing mechanism and PCDM dispensing mechanism currently are purchased from a single source. Because other suppliers exist that can duplicate these components should the Company elect or be forced to use a different supplier, the Company does not believe that a change in suppliers would result in the termination of a production contract. However, the Company could experience a delay of 30 to 60 days in production which could adversely affect the Company's ability to make timely deliveries of machines and to obtain new contracts. The single-source supplier of certain components of the Company's burster mechanism, PTVM dispensing mechanism and PCDM dispensing mechanism is Algonquin Industries, Inc. Kazmier J. Kasper, a director of the Company, is the President and owner of Algonquin Industries. See "Item 13. Certain Relationships and Related Transactions. " The Company assembles the components utilizing a core group of manufacturing employees and, on an as-needed basis, contracting with employment agencies for appropriately trained manufacturing labor. The use of temporary, contract manufacturing labor gives the Company the flexibility to meet the production schedules required by large orders. The Company's manufacturing has the capacity to produce approximately 300 machines per week. -8- Research And New Product Development The Company has developed many of the technological advancements used in the ITVM industry. The Company was the first to obtain UL((R)) listing and FCC approval. The Company also was the first to (i) manufacture and deliver ITVMs under a lease contract agreement, (ii) offer a "random play" push button selector option through which the ITVM rather than the player randomly selects the game to be played and (iii) receive patent protection for the technology used in its ITVM burster dispensing mechanism. The Company currently employs several engineers and technicians for research and development. To reduce costs, the Company subcontracts the majority of its research and development projects to independent contractors. The Company's copyrighted software is upgraded continually to meet the different demands of the various lotteries. In many instances, after an ITVM feature has been developed for a specific lottery, it is incorporated into the product line as a standard feature of the machine. The Company's ITVMs may be purchased with optional modem communication software which allows lotteries to gather sales data from each ITVM on an hourly, daily, weekly or monthly basis, depending on the needs of the customer. This data includes the daily or weekly sales totals and breakdown of these totals by game, including the total tickets sold. The Company has developed software that enables a modem equipped ITVM to communicate to the host system automatically if the ITVM malfunctions, thus greatly enhancing the Company's ability to provide prompt service, or if a ticket bin is empty, which allows the lottery to call the retailer or agent and inform them of the situation. Additionally, by utilizing this system with the optional BETA BRITE((R)) message display, the lottery can change the message display on any or all of its ITVMs. The Company has incorporated its patented pull-tab lottery ticket dispensing mechanism into a combination ITVM which also contains the Company's patented burster mechanism. The pull-tab dispensing mechanism also has been incorporated into the Company's PCDMs, and the Company believes that the ability of the mechanism to dispense a variety of thicknesses of prepaid telephone calling cards significantly differentiates the Company's PCDMs from those of its competitors. The Company has developed the MVP to address the specific needs of convenience store and grocery check-out lanes. The MVP may be installed in a variety of configurations including under-the-counter. This new technology reduces ticket shrinkage and increases sales volume of instant tickets and may also be tied into the Point of Service register. In an effort to expand its product lines into new markets, the Company has developed a device which dispenses stored value "smart cards." This product will be marketed in the future to the financial services industry to the extent that consumer use of smart cards develops in the future. Research and development expenditures were $545,039, $618,819 and $581,885 for 1997, 1998 and 1999, respectively. Customer Service and Product Repair Typically, the Company or its subcontractors install and service the machines purchased or leased by the Company's customers. The Company maintains a toll-free telephone line for service calls. If the service dispatcher cannot resolve the problem over the telephone, he or she will immediately dispatch one of the Company's service technicians to the machine's location. The modular design and manufacturing standards of the Company's machines enable the Company to conduct any necessary repairs and maintenance quickly and efficiently. The Company estimates that the mean time for all repairs is less than 15 minutes after the service technician arrives at the machine's location. The Company generally grants a 360-day repair or replacement warranty covering all parts and components of its machines. However, the warranty period may vary depending on the bid specifications. In certain circumstances, the Company may warrant the product for the complete life of the contract. In these instances, the contract generally will be a lease with the Company retaining ownership of the machine. Provisions for estimated warranty costs are recorded at the time of sale and are periodically adjusted to reflect actual experience. -9- Patents, Trademarks and Copyrights The Company currently has five U.S. patents and one pending patent application relating to its ITVMs and has filed a disclosure document with the United States Patent and Trademark Office ("PTO). The Company owns by assignment U.S. Patent No. 4,982,337 entitled "System for Distributing Lottery Tickets." The assignment is recorded at the PTO. This patent is for the Company's burster technology, which is the key component of the Company's ITVM. The patent expires December 31, 2007. Improvements to the burster technology developed by the Company are the subject of U.S. Patent No. 5,836,498. The improved burster provides for an increased range of operation for reliable and effective separation of the adjacent tickets along the lines of weakness. Additionally, foreign patent applications are pending on these improvements. The Company has developed a new system designed specifically for retail vending of lottery tickets and other items at the point of sale. The system utilizes the Company's burster technology and includes other modular and distributed components that can be adapted for use at the point of sale. The Company has a pending U.S. patent application on this technology as well as corresponding foreign pending patent applications. The Company owns U.S. Patent No. 5,330,185 for the "Method and Apparatus for Random Play of Lottery Games," which expires March 30, 2013; U.S. Patent No. 5,472 for a "Multi-Point High Security Locking Mechanism for Lottery Machines," which expires July 18, 2014; and U.S. Design Patent No. 376,621 for the Company's double-game countertop ITVM, which expires December 17, 2010. The Company believes that each of these patents is important but not essential to the Company's business. The Company has an Information Disclosure Document on file with the PTO for the purpose of identifying technology relating to its "Software Release Control and Data Security for ITVMs." The technology allows secure remote transmissions of software updates and operations data between the ITVM and the Company or the respective lottery. The invention also includes a key management system to control the keys used to encrypt data sent to and decrypt the data received at the ITVM. The Company is the exclusive licensee of the dispensing technology used in its PTVMs and PCDMs pursuant to an agreement with Algonquin Industries. Algonquin Industries has been granted six U.S. Patents, and one is pending for the licensed technology. Under the terms of the license agreement, the Company is the sole entity entitled to use this technology on its ITVMs. See "Item 13. Certain Relationships and Related Transactions." The Company has obtained federal registration in the United States of the following trademarks: INTERLOTT, INTERLOTT and design, and INSTANT SUCCESS. The Company does not deem the trademarks to be critical to the future of its business. The Company requires all of its employees and subcontractors to execute confidentiality and proprietary rights agreements, which prohibit disclosure of the trade secrets of the Company and provides that all inventions or discoveries during the term of their employment or contract for service will be assigned to the Company. Competition Competition in the markets for the Company's ITVM and PCDM is based on a number of factors, including technological features, product quality and reliability, price, compatibility, ease of installation and use, marketing and distribution capabilities, product delivery time, and service and support. The Company is aware of four manufacturers of ITVMs and approximately four manufacturers of PCDMs in the United States, and competition among these manufacturers is intense. Of the four ITVM competitors, the Company has the largest share of the ITVM market in the United States. The Company is not aware of any published data regarding market shares in the PCDM industry, but the Company does not believe that it has the largest market share in the PCDM industry. Additional domestic and international manufacturers, some of which have substantially greater resources and experience than the Company, may elect to enter the ITVM and PCDM markets. The instant ticket market also faces competition from other types of lottery and gaming products, including particularly on-line lottery products. The long distance telephone market similarly may face competition from other types of communications products, including facsimile, e-mail and other on-line products. -10- The Company believes that its patented dispensing technologies make its ITVM and PCDM dispensing mechanisms technologically superior to the dispensing mechanisms of its competitors and that this is a significant competitive advantage for the Company. The Company also believes that its products have earned a strong reputation for their performance, reliability and cost effectiveness. To remain competitive, the Company believes that it will need to continue to incorporate new technological developments into its existing products and to develop new products, as well as to maintain a competitive price for its products. These efforts, together with the Company's continuing sales and marketing efforts, will be critical to the Company's future success. Although the Company believes that its current successes, coupled with its history of continued product enhancement and cost reduction, will enable it to compete favorably with its competitors, there can be no assurance that the Company will be able to maintain or improve its competitive position in the ITVM and PCDM markets. On January 10, 2000, the Company's main competitor, On-Point Technology Systems, Inc., entered into an agreement to be acquired by GTECH Holdings Corporation, a major supplier of on-line lottery terminals to many of the same lotteries served by the Company. Shortly after the merger announcement, On-Point filed an 8-K report with the Securities and Exchange Commission announcing that its previously issued financial statements for 1997, 1998 and 1999 were being restated and should no longer be relied upon. By press release dated February 29, 2000, On-Point disclosed that GTECH had informed it that "in light of the restatement, no assurance can be given that the merger will be consumated, if at all, on the terms set forth in the definitive merger agreement." Government Regulation ITVMs Lotteries are not permitted in the various states and jurisdictions of the United States unless expressly authorized by legislation. Similarly, the commencement of ITVM sales and leasing in a jurisdiction requires authorizing legislation and implementing regulations. Currently, 37 states and the District of Columbia have enacted legislation to allow for the operation of a lottery, and 31 of these jurisdictions utilize ITVMs in some manner as part of their instant ticket distribution process. The operation of the lotteries in each of these jurisdictions is strictly regulated. The formal rules and regulations governing lotteries vary from jurisdiction to jurisdiction but typically authorize the lottery, create the governing authority, dictate the price structure, establish allocation of revenues, determine the type of games permitted, detail appropriate marketing structures, specify procedures for selecting vendors and define the qualifications of lottery personnel. Although the Company currently believes that it is unlikely that states which have enacted legislation that expressly authorize the use of ITVMs will adopt legislation in the foreseeable future that prohibits the use of ITVMs, there can be no assurance that this will not occur. To ensure the integrity of the lottery, state laws provide for extensive background investigations of each of the lottery's vendors and their affiliates, subcontractors, officers, directors, employees and principal stockholders. These regulations generally require detailed continuing disclosure. If the lottery deems a person unsuitable, the lottery may require the termination of the person's relationship with the Company. The failure of a person associated with the Company to obtain or retain approval in any jurisdiction could have a material adverse effect on the Company. Generally, regulatory authorities have broad discretion when granting such approvals. The Company has never been disqualified from a lottery contract as a result of a failure to obtain any such approvals. The Federal Gambling Devices Act of 1962 (the "Act") makes it unlawful, with certain exceptions, for a person or entity to transport any gambling devices across interstate lines unless that person or entity has first registered with the United States Department of Justice. Although the Company believes that it is not required to register under such Act, the Company has voluntarily registered under the Act and intends to renew its registration annually. The Act also imposes various record keeping and equipment identification requirements. Violation of the Act may result in seizure or forfeiture of equipment, as well as other penalties. The Company may retain governmental affairs representatives in various jurisdictions of the United States to monitor legislation, advise the Company on contract proposals, and assist with other issues that may affect the Company. The Company believes it has complied with all applicable state regulatory provisions relating to disclosure of its activities and those of its advisors. -11- International jurisdictions that operate lotteries also impose strict regulations. International regulations may vary from those in the United States. Additionally, international regulations frequently impose restrictions on international corporations doing business within the specific jurisdiction. As a result, the Company may contract with local representation or align itself with a local partner when pursuing international contracts. PCDMs The Company is not aware of any federal, state or local regulations that apply to the manufacture, lease or sale of PCDMs. Backlog The Company's backlog of ITVMs committed for production as of December 31, 1999 was approximately $24,365,000, which was equal to the total base lease payments or sales value for ITVMs that were committed for production but had not been shipped to various lotteries as of December 31, 1999. At December 31, 1998, the comparable backlog was approximately $5,640,000. Approximately 69% of the backlog at December 31, 1999 related to a contract awarded by a state lottery earlier in the month. It is anticipated that substantially all of the Company's backlog at December 31, 1999 will be shipped on or before December 31, 2000. The Company had no backlog of PCDMs committed for production at December 31, 1999 or 1998. The Company has entered into various lease or sales agreements that permit the lotteries, at their sole option, to lease or purchase additional ITVMs as of December 31, 1999. However, the Company does not include these additional ITVMs in backlog ITVMs that may be sold or leased under existing contracts unless the Company has received a firm order for the ITVMs. Due to the relatively large size of individual orders, the small number of customers and the long sales cycle of the lottery industry, management considers backlog to be an indicator of current activity and not necessarily predictive of future orders. Employees The Company utilizes a work force of full-time employees supported from time to time by temporary or contract manufacturing and engineering personnel. As of December 31, 1999, the Company had 190 full-time employees, of which 71 were manufacturing employees, eight were engineering employees, 93 were service employees, eight were clerical and administrative employees and 10 were executives or senior managers. Two of the executives and senior managers were devoted to sales and eight were devoted to management and administration. No Company employees are represented by any union, and the Company believes that its relations with its employees are good. ITEM 2. PROPERTIES The Company's manufacturing, distribution and executive offices are in the process of relocating to approximately 52,500 square feet of newly leased space in Mason, Ohio. This facility houses the Company's executive, administrative, sales, engineering production and service personnel and is comprised of 15,000 square feet of office space and 37,500 square feet of manufacturing and storage space. The Company believes that this facility is suitable for and adequate to support its operations for the foreseeable future. The lease for this facility expires on March 31, 2005. ITEM 3. LEGAL PROCEEDINGS The Company is involved from time to time in litigation in the ordinary course of its business. The Company does not believe that there is any currently pending or threatened litigation against the Company that, individually or in the aggregate, is likely to have a material adverse effect on its business, financial condition or results of operations. -12- ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS No matters were submitted by the Company to a vote of its stockholders during the fourth quarter ended December 31, 1999. PART II ITEM 5. MARKET FOR THE REGISTRANT'S COMMON STOCK AND RELATED STOCKHOLDER MATTERS The Company's common stock has been traded on the American Stock Exchange under the symbol "ILI" since the Company's initial public offering. The following tables show the high and low closing sale prices per share for the common stock as reported by the American Stock Exchange for the periods indicated: 1998: High Low ----- ----- First Quarter $9.75 $7.75 Second Quarter 14.00 9.63 Third Quarter 10.75 7.88 Fourth Quarter 8.13 6.50 1999: First Quarter 7.00 6.00 Second Quarter 6.25 5.63 Third Quarter 6.38 5.50 Fourth Quarter 5.75 4.00 At March 17, 2000 there were approximately 63 stockholders of record and an unknown number of beneficial owners holding stock in nominee or "street" name. The Company has paid no cash dividends on its common stock and currently intends to retain all future earnings for use in the development of its business. -13- ITEM 6. SELECTED FINANCIAL DATA The following table presents selected financial data derived from the Company's audited financial statements for each year in the five-year period ended December 31, 1999 and should be read in conjunction with the Company's Financial Statements and with Management's Discussion and Analysis of Financial Condition and Results of Operations set forth below.
SELECTED FINANCIAL DATA Year Ended --------------------------------------------------------------------------------------------------------------------------------- Dec. 31 Dec. 31 Dec. 31 Dec. 31 Dec. 31 1995 1996 1997 1998 1999 --------------------------------------------------------------------------------------------------------------------------------- Revenues Machine sales $ 9,746,339 $ 5,596,698 $ 4,567,441 $ 8,229,950 $ 3,311,874 Machine leases 9,132,132 11,766,623 12,874,450 14,165,379 16,901,911 Other 435,137 1,235,368 1,669,160 2,078,644 2,120,245 Net revenues 19,313,608 18,598,689 19,111,051 24,473,973 22,334,030 Net income 1,987,219 1,320,597 1,451,654 1,622,313 2,070,298 Net income per share 0.62 0.41 0.45 0.51 0.65 Depreciation and amortization 2,982,547 3,902,387 4,143,408 4,585,325 5,547,909 Leased ITVM's, less accumulated depreciation 10,779,929 10,940,398 14,740,462 17,105,891 21,549,400 Total assets 20,483,686 20,992,733 24,612,884 28,774,249 36,203,867 Total debt 9,040,784 7,715,140 9,458,004 11,645,374 16,291,727 --------------------------------------------------------------------------------------------------------------------------------- Redeemable preferred stock 1,335,000 1,335,000 1,335,000 1,335,000 1,335,000 ---------------------------------------------------------------------------------------------------------------------------------
-14- RESULTS OF OPERATIONS The table below presents selected financial information derived from the Company's statements of income expressed as a percentage of revenues for the years indicated
Year Ended Dec. 31 Dec. 31 Dec. 31 1997 1998 1999 Revenues Machine sales 24.0% 33.6% 14.8% Machine leases 67.3 57.9 75.7 Other 8.7 8.5 9.5 Total revenues 100.0 100.0 100.0 Cost of revenues excluding depreciation 41.7 48.4 39.0 Depreciation 20.6 17.5 23.9 Gross margin 37.7 34.1 37.1 Selling, general and administrative expenses 18.3 16.5 18.8 Research and development costs 2.9 2.5 2.6 Operating income 16.5 15.1 15.7 Interest expenses 3.7 4.0 4.9 Income before income taxes 12.8 11.1 14.7 Income taxes 5.2 4.5 5.4 Net income 7.6% 6.6% 9.3%
SUMMARY OF QUARTERLY DATA Quarterly financial data for the years ended December 31, 1998 and 1999 shown here in thousands, except for per share data.
1998 First Second Third Fourth Net sales $5,884 7,323 5,714 5,554 Gross profit 1,718 2,492 1,874 2,270 Net earnings 291 630 225 476 Basic earnings per share 0.09 0.19 0.07 0.15 Diluted earnings per share 0.09 0.19 0.07 0.15 1999 First Second Third Fourth Net sales $4,960 5,138 4,995 7,240 Gross profit 1,761 1,687 1,525 3,314 Net earnings 654 76 182 1,158 Basic earnings per share 0.20 0.02 0.06 0.36 Diluted earnings per share 0.20 0.02 0.06 0.36
-15- ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS OVERVIEW The Company's revenue base consists of (1) payments from instant ticket vending machine "ITVM" and phone card dispensing machine "PCDM" Leases (2) sales of ITVMs and PCDMs, (3) and to a lesser extent, sales of parts for ITVMs and PCDMs and service agreements. The Company emphasizes leasing rather than selling ITVMs to lotteries when possible. Leases provide the Company with a consistent revenue stream, opportunities to generate income on financing, and the potential to deploy a greater number of ITVMs within a lottery's budget due to the lower initial cash outlay required by the lottery. Leasing ITVMs also gives the lotteries the flexibility to enhance their ITVMs in the future with new technology from the Company. On the other hand, leasing ITVMs requires the Company to invest capital or otherwise finance the manufacture of ITVMs, whereas sales of ITVMs result in the receipt of payment in full upon delivery of the ITVMs. When the Company sells ITVMs, the Company generally is able to manufacture and deliver the ITVMs and receive full payment for them before it must pay for the materials used to manufacture the ITVMs. Nevertheless, the Company believes that the advantages of leasing ITVMs, as described above, justify the initial capital investment or financing costs required to manufacture ITVMs for lease. For similar reasons, the Company emphasizes leasing rather than selling PCDMs to providers of prepaid telephone cards. As with ITVMs, the Company believes that the benefits to the Company of leasing PCDMs warrant the initial capital investment required to manufacture PCDMs. However, the great majority of the PCDMs deployed to date have been sold rather than leased. The Company historically has experienced fluctuations in its financial results due to its dependence upon a small number of major customers, the unpredictable nature, timing and results of the lotteries' contract bid and award process. The Company's revenues and capital expenditures can vary significantly from period to period because the Company's sales cycle may be relatively long and because the amount and timing of revenues and capital expenditures depend on factors such as the amount and timing of awarded contracts and changes in customer budgets and demands. Operating results may be affected by the lead-time sometimes required for business opportunities to result in signed lease or sales agreements, working capital requirements associated with manufacturing ITVMs pursuant to new orders, increased competition and the extended time that may elapse between the award of a contract and the receipt of revenues from the sale or lease of ITVMs. 1998 as Compared to 1999 Total revenues decreased by $2,139,943 from $24,473,973 to $22,334,030 in 1999, or 9%, due primarily to a $4,918,076 decrease in machine sales and a $2,736,532 increase in lease revenues accompanied by a $41,601 increase in other revenues. Revenues from leases increased by 19% from $14,165,379 in 1998 to $16,901,911 in 1999, resulting from a new lease in one state, the continuation of leases in seven states and the renewal of eight leases in other states that had reached the conclusion of their original terms. Revenues from sales decreased by 60% from $8,229,950 in 1998 to $3,311,874 in 1999, as a result of a decrease in ITVMs and PCDMs sold in 1999 over 1998. The total number of ITVMs and PCDMs under lease increased in 1999 as a result of deployment of new units, partially offset by the retirement of older units. Lease revenues were 58% and 76% of total revenues for 1998 and 1999, respectively. Revenues from sales of ITVMs and PCDMs were 34% and 15% of total revenues in 1998 and 1999, respectively. The increase in lease revenues and decrease in sales revenues reflects the cumulative effect of continuing revenues from machines under lease which were deployed prior to 1999 and the incremental revenue of new machines leased or deployed in 1999. Other revenues increased by 10% from $2,078,644 in 1998 to $2,120,245 in 1999, as machines deployed prior to 1999 generated service revenue for the entire year. -16- Cost of revenues for machine sales and other decreased 75% from $5,809,057 in 1998 to $1,466,153 in 1999. This decrease reflects the 79% decrease in the number of machines sold in 1999. Cost of revenues for leased ITVMs and PCDMs, excluding depreciation, increased 20% from $6,020,437 in 1998 to $7,243,770 in 1999. The increase in cost of lease revenues was the result of higher personnel and subcontractor costs related to the larger number of machines deployed during 1999. Depreciation of ITVMs and PCDMs increased by 24% from $4,290,128 in 1998 to $5,337,018 in 1999. The increase was greater than the related 16% increase in number of leased ITVMs and PCDMs, as newer units have more capacity and cost more. Selling, general and administrative expenses increased 4% from $4,048,751 in 1998 to $4,202,825 in 1999. Selling, general and administrative expenses, as a percentage of revenues, increased slightly from 17% in 1998 to 19% in 1999, in part because revenues in 1999 were lower. Research and development costs decreased by 6% from $618,819 in 1998 to $581,885 in 1999. The Company maintains its philosophy of using contractors as the primary source of research and development efforts, allowing the Company to focus its expenditures on the technical expertise necessary to accomplish the specific project. Operating income decreased by 5% from $3,686,781 in 1998 to $3,502,379 in 1999. This decrease resulted primarily from the decrease in the number of machines sold in 1999 as compared to 1998. As a percentage of revenues, operating income increased from 15% in 1998 to 16% in 1999. Interest expense increased by 14% from $967,768 in 1998 to $1,102,478 in 1999. The increase reflects the cost of additional borrowings to finance leased equipment built and deployed in 1999, and higher interest rates. Other income in 1999 of $598,832 consists of a one time non-recurring credit of $625,000 from settlement of litigation with a competitor offset by $26,168 in other non-related expenses. Income before income taxes and extraordinary item increased 10% from $2,719,013 in 1998 to $2,998,733 in 1999. Income taxes increased by 1% from $1,096,700 in 1998 to $1,106,594 in 1999 as a result of the increase in income before taxes. As a result of the above factors, the Company's net income before extraordinary items increased by 17% from $1,622,313 in 1998 to $1,892,139 in 1999. The extraordinary item of $178,159, net of tax, relates to a gain on the involuntary conversion of assets lost in a tornado which were covered by insurance at replacement cost. 1997 as Compared to 1998 Total revenues increased by $5,362,922 from $19,111,051 to $24,473,973 in 1998, or 28%, due primarily to a $3,662,509 increase in machine sales and a $1,290,929 increase in lease revenues accompanied by a $409,484 increase in other revenues. Revenues from leases increased by 10% from $12,874,450 in 1997 to $14,165,379 in 1998, resulting from the continuation of leases in nine states and the renewal of seven leases in other states that had reached the conclusion of their original terms. Other revenues increased by 25% from $1,669,160 in 1997 to $2,078,644 in 1998, as machines deployed prior to 1998 generated service revenue for the entire year and service for ITVMs in one state was taken over from a sub-contractor. Revenues from sales increased by 80% from $4,567,441 in 1997 to $8,229,950 in 1998, as a result of an increase in ITVMs and PCDMs sold in 1998 over 1997. The units sold in 1998 included a greater number of higher priced machines than 1997. The total number of ITVMs and PCDMs under lease increased in 1998 as a result of deployment of new units, partially offset by the retirement of older units. Lease revenues were 67% and 58% of total revenues for 1997 and 1998, respectively. Revenues from sales of ITVMs and PCDMs were 24% and 34% of total revenues in 1997 and 1998, respectively. The increase in lease revenues reflects the cumulative effect of continuing revenues from machines under lease which were deployed prior to 1998 and the incremental revenue of new machines leased or deployed in 1998. -17- Cost of revenues for machine sales and other increased 33% from $4,378,669 in 1997 to $5,809,057 in 1998. This increase reflects the 47% increase in number of machines sold, offset by lower costs of the units sold in 1998. Cost of revenues for leased ITVMs and PCDMs, excluding depreciation, increased 67% from $3,584,017 in 1997 to $6,020,437 in 1998. The increase in cost of leased revenues was the result of higher personnel and subcontractor costs related to the larger number of machines deployed during 1998. Depreciation of ITVMs and PCDMs increased by 9% from $3,924,244 in 1997 to $4,290,128 in 1998. The increase was lower than the related increase in number of ITVMs and PCDMs, as certain units had been fully depreciated by the end of 1997. Selling, general and administrative expenses increased 16% from $3,492,020 in 1997 to $4,048,751 in 1998. As a percentage of revenues, selling, general and administrative expenses decreased slightly from 18% in 1997 to 17% in 1998. Research and development costs increased by 14% from $545,039 in 1997 to $618,819 in 1998. This increase results from continuing development and refinement of existing products to meet the variety of the needs of the customers for our dispensing technologies. The Company maintains its philosophy of using contractors as the primary source of research and development efforts, allowing the Company to focus its expenditures on the technical expertise necessary to accomplish the specific project. Operating income increased by 16% from $3,187,062 in 1997 to $3,686,781 in 1998. This increase resulted from the continuing benefit of revenues derived from machines deployed in prior periods, including machines which had been fully depreciated, combined with ongoing machine sales and leases. Interest expense increased by 30% from $747,008 in 1997 to $967,795 in 1998. The increase reflects the cost of additional borrowings to finance leased equipment built and deployed in 1998, partially offset by lower interest rates resulting from utilization of the LIBOR option in our loan agreement. Income taxes increased by 11% from $988,400 in 1997 to $1,096,673 in 1998 as a result of an increase in income before taxes of 11%. As a result of the above factors, the Company's net income increased by 12% from $1,451,654 in 1997 to $1,622,313 in 1998. Liquidity and Capital Resources Net cash provided by operating activities increased 1% from $7,435,079 in 1998 to $7,519,552 in 1999. Net cash used in investing activities increased 24% from $9,735,516 in 1998 to $12,063,408 in 1999. Net cash provided by financing activities increased by 112% from $2,187,370 in 1998 to $4,646,353 in 1999. The Company's liquidity and capital resources continue to be impacted by its decision to use leasing as a means to market its ITVMs and PCDMs. Leasing generally offers the Company better gross margins than direct sales agreements. However, leasing inherently requires more capital and a longer-term payout than sales. As of December 31, 1999, the Company had a total of 9,356 ITVMs and PCDMs under operating and sales type leases. At December 31, 1998 and 1999, the Company had working capital deficits of $7,466,831 and $9,440,256 respectively. These deficits reflect the classification of the Company's revolving credit facility as a current debt due to the revolver clause of the facility. At December 31, 1999, the Company was indebted to Mercantile Business Credit, Inc. (MBC) in the aggregate principal amount of $16,005,029 pursuant to a revolving credit agreement entered into as of October 29, 1997. The facility permits the Company to borrow through October 2000, with two one-year extensions to October 2002, up to $25,000,000 at the prime interest rate or the respective LIBOR rate plus two percent. Borrowings under this facility are collateralized by all of the assets of the Company and assignment of proceeds from lease agreements. At December 31, 1999, the Company had $8,994,971 available under this agreement. -18- At December 31, 1999, the Company also was indebted to two stockholders in the aggregate principal amount of $286,698 incurred to finance the manufacture of ITVMs. See Note 6 of Notes to Financial Statements. The Company's capital expenditures totaled $9,735,516 and $12,063,408 for 1998 and 1999, respectively. These amounts include $9,611,623 and $11,985,736 for the manufacture of machines leased during the respective periods. Other expenditures represent machinery and equipment costs for expanded office capacity. The Company had no material commitments for additional capital expenditures as of December 31, 1999 other than for the manufacture of ITVMs and PCDMs for future lease. At December 31, 1999, the Company had estimated tax net operating loss carryforwards of approximately $859,400, which are available to offset future federal taxable income, if any, through 2009. The use of these carryforwards is subject to certain annual limitations due to ownership changes in 1992. Special Note Regarding Forward-looking Statements The words "expect", "anticipate", "intend", "plan", "believe", "seek", "estimate" and similar expressions used in this report are intended to identify forward-looking statements, although this report also contains other forward-looking statements. Any forward-looking statements in this report are made pursuant to the "safe harbor" provisions of the Private Securities Litigation Act of 1995. Investors are cautioned that actual results may differ substantially from such forward-looking statements. Forward-looking statements involve risks and uncertainties including, but not limited to, continued acceptance of the Company's products and services in the marketplace, competitive factors, new products and technological changes, dependence upon third party vendors, a limited number of customers, political and other uncertainties related to customer purchases and other risks detailed in the Company's periodic filings with the Securities and Exchange Commission. The following risk factors apply to Interlott and its business: We may experience fluctuations in our financial results and, as a result, our stock price. In the past, we have experienced significant fluctuations in our financial results. Our revenues, capital expenditures and operating results can vary significantly due to: o our dependence on a small number of major customers; o relatively long sales cycles; o the unpredictable timing and amount of contracts awarded by state lotteries and telephone companies; o the extended time between the award of a contract and the receipt of revenues from the sale or lease of ITVMs and PCDMs; o changes in customer budgets; and o working capital required to manufacture ITVMs and PCDMs pursuant to new orders. These factors may make it difficult to forecast revenues and expenditures over extended periods. Consequently, our operating results for any period could be below the expectations of securities analysts and investors. This in turn could lead to sudden and sometimes dramatic declines in the market price of our stock. Our growth will depend upon continued market acceptance of ITVMs and PCDMs. Our ability to generate additional revenues and earnings will depend upon the continuation of existing leases of ITVMs and PCDMs, the distribution of ITVMs and PCDMs in additional states and international jurisdictions, the approval of lotteries in remaining states and international jurisdictions and increased future orders of ITVMs and PCDMs. As of December 31, 1999, 30 states, the District of Columbia and eight international jurisdictions used ITVMs as part of their instant ticket distribution system. We leased or sold ITVMs in 23 of those states, the District of Columbia and in eight international -19- jurisdictions. Similarly, the use of PCDMs to distribute prepaid telephone calling cards has grown significantly in the last few years. We have marketed PCDMs since 1995, and as of December 31, 1999, we had sold or leased 851 PCDMs. However, the popularity of instant lottery games and prepaid telephone calling cards and the demand for ITVMs and PCDMs may not continue and, as a result, we may not be able to successfully market and sell our products. Although the total dollar amount of instant ticket sales continues to increase, the rate of increase has declined from 23.7% to .4% for the lottery industry's fiscal year ended June 30, 1992 through June 30, 1999. It is important but not critical that we develop relationships with additional lotteries and telephone companies and that additional states authorize instant lotteries. We depend on large contracts from a limited number of ITVM customers. We have traditionally derived a significant portion of our revenues from a limited number of state lottery authorities or their representatives for the lease, sale or service of ITVMs. In particular, during 1999, a contract with the Ohio Lottery accounted for 18% of our total revenues and 24% of our lease revenue. Additionally, a contract with the New York Lottery accounted for 38% of our machine sales revenues and 13% of our total revenue in 1999, This can cause our revenues and earnings to fluctuate between quarters based on the timing of orders and realization of revenues from these orders. Further, none of our large customers has any obligation to lease or purchase additional machines from us. A loss of any of these large contracts could have a material adverse effect on our business, financial condition and results of operations. We may not be successful in protecting our proprietary rights or avoiding claims that we infringe the proprietary rights of others. We principally rely upon patent, copyright, trademark and trade secret laws, license agreements and employee nondisclosure agreements to protect our proprietary rights and technology. These laws and contractual provisions provide only limited protection. Our success depends largely on our burster technology that is protected by a patent that expires on December 31, 2007. Additionally, we have four other patents and one pending patent application with the United States Patent and Trademark Office. We also have an exclusive license agreement with Algonquin Industries, Inc. for use of their patented pull-tab instant ticket dispensing mechanism in our PTVM and PCDM. We cannot be certain that we and Algonquin have taken adequate steps to prevent misappropriation of the technology that we use or that competitors will not independently develop technologies that are substantially equivalent or superior to our technology. Moreover, we could incur substantial costs and diversion of management resources in the defense of any claims relating to the proprietary rights of others, which could have a material adverse effect on our business, financial condition and results of operations. We may not be able to adapt to changes in technology, products and industry standards. The instant ticket market, the ITVM market, the prepaid telephone calling card market and the PCDM market are characterized by rapidly changing technology and evolving industry practices. Competitors may introduce other types of lottery, gaming and prepaid telephone calling card products. To be successful, we must: o use leading technologies effectively; o continue developing our technical expertise; o enhance our existing products and services; and o develop new products and services. If we fail to do any of these things, our customers may choose to purchase products and services from our competitors. Our inability to anticipate changes in technology and industry practices and to develop and introduce new products and services in a timely manner would likely result in a material adverse effect on our business, financial condition and results of operation. The state lotteries can cancel their contracts with us for any reason and can assess significant damages against us if we do not satisfactorily perform the contracts. Our contracts with lotteries, like most other types of state contracts, typically permit a lottery to terminate the contract upon 30 days written notice for any reason. We may not be able to re-lease or sell any ITVMs that are returned to us by a lottery following the cancellation or expiration of a lease. These lottery contracts also impose demanding installation, performance and maintenance requirements. Our failure to perform the contract requirements could result in significant liquidated damages or contract termination. Our lottery -20- contracts typically require us to indemnify the lottery, its officers and retailers for any liabilities arising from the operation of the ITVMs or any services that we provide. These provisions present an ongoing risk of significant damage assessments or contract terminations, which could have a material adverse effect on our business, financial condition and results of operation. A single stockholder controls a majority of our stock and can exert significant influence over our corporate matters. As of December 31, 1999, Mr. L. Roger Wells, Jr. beneficially owned 53.3% of the outstanding common stock. As a result, Mr. Wells can control the election of directors and the outcome of certain corporate actions requiring stockholder approval. This concentration of ownership in a single stockholder also can delay or prevent a change of control. Our ITVM lease contracts may result in losses. Our ITVM lease revenues as a percentage of our total revenues were 67.3% in 1997, 57.9% in 1998 and 75.7% in 1999. Our standard lease agreements provide for fixed lease payments during the term of the agreement and some permit the lottery to order additional ITVMs at any time during the lease term. If one of these lotteries were to order a large number of ITVMs near the end of the lease term, we would incur significant manufacturing costs but might receive lease payments for only a relatively short period of time through the remainder of the lease term. Additionally, we are unable to pass along to the lottery any increases in manufacturing and service costs during the term of the lease agreement. Our standard lease agreements provide for a short initial term, such as one year, with an option for the lottery to extend the lease term for additional one-year periods. If the lottery does not extend the initial lease term, we might incur a loss on the manufacture of the ITVMs if we are unable to re-lease or sell the ITVM. The ITVM and PCDM markets are very competitive. The ITVM and PCDM markets are markets that have grown rapidly in recent years. We may not be able to compete successfully against current or future competitors, some of whom may have greater resources and experience than us. The instant ticket market also may face competition from other types of lottery and gaming products, particularly on-line lottery products. The long distance telephone market similarly may face competition from other types of communications products, including facsimile, e-mail and other on-line products. If the ability to provide ITVMs and PCDMs internationally becomes a competitive advantage in the instant ticket lottery and prepaid calling card industries, we will have to expand our presence internationally or risk a disadvantage relative to our competitors. Increased competition could cause us to increase our selling and marketing expenses and research and development costs. We may not be able to offset the effects of any such increased costs through an increase in the number of lottery contracts and higher revenue from sales and leases of ITVMs and PCDMs, and we may not have the resources to compete successfully. These developments could have a material adverse effect on our business, financial condition and results of operation. Because we depend upon single or limited source suppliers, we could temporarily lose our supply of some critical parts or experience significant price increases. We currently purchase certain important parts, such as components of our ITVM burster, PTVM dispensing mechanism and PCDM dispensing mechanism, from a single source. The purchase of these components from outside suppliers on a sole source basis subjects us to certain risks, including the continued availability of suppliers, price increases and potential quality assurance problems. Because other suppliers exist that can duplicate these components should we elect or be forced to use a different supplier, we do not believe that a change in suppliers would result in the termination of a production contract. However, we could experience a delay of 30 to 60 days in the production of ITVMs and PCDMs should we elect or be forced to use other suppliers. Any delay of 30 to 60 days could have a material adverse effect on our business, financial condition and results of operation. We may not be able to retain our key executives and engineering and marketing personnel. As a small company with only 190 employees, our success depends in large part on the continued service of our key management, sales, product development and operational personnel, including Mr. L. Rogers Wells, Jr., our Chairman, and David F. Nichols, our President and Chief Executive Officer. We do not currently have employment agreements with any of our employees. Our success also depends -21- on our ability to attract and retain additional personnel with a variety of skills, especially engineering and marketing expertise. Our inability to hire and retain qualified personnel would likely have a material adverse effect on our current business, any new product development efforts and future business prospects. The success of our international operations is subject to many uncertainties. In each of 1998 and 1999, our sales and leases of ITVMs and PCDMs outside the United States represented an immaterial percentage of our total revenues. However, we are increasing our marketing activities in international jurisdictions, including expansion into several countries. Our ability to expand our business into international markets may be adversely affected by the following: o customizing our products for use in international countries; o longer accounts receivable payment cycles; o difficulties in managing international operations; o availability of trained personnel to install and implement our systems; o exchange rate fluctuations; o political instability; o tariffs and other trade barriers; o potentially adverse tax obligations; o restrictions on the repatriation of earnings; o the burdens of complying with a wide variety of international laws and regulations; and o the risk that our intellectual property rights will not be protected to as great an extent as in the United States. These factors could have a material adverse effect on our international revenues and earnings and our overall financial performance. Our industry is subject to significant government regulation which could negatively affect us. State and local governments strictly regulate the operation of lotteries and the sales and leasing of ITVMs. Further, international jurisdictions that operate lotteries impose strict regulations which may vary from those in the United States. Any adverse change in the lottery laws of any jurisdiction in which we sell and lease ITVMs could impose burdensome requirements or requirements that we may be unable to satisfy. Our failure to comply with changing lottery-related laws and regulations could have a material adverse effect on our business, financial condition and results of operation. In addition, state laws provide for background investigations on each of the lottery's vendors and their affiliates, subcontractors, officers, directors, employees and principal stockholders. The failure of any of these parties associated with us to obtain or retain approval in any jurisdiction could have a material adverse effect on our business, financial condition and results of operation. Future sales of our common stock in the public market could adversely affect our stock price and our ability to raise funds in new stock offerings. The market price of our common stock could drop as a result of sales of large numbers of shares in the market, or the perception that such sales could occur. This is particularly true due to our relatively small number of stockholders and the resulting low trading volume of our common stock in the public market. All outstanding shares of our common stock either are freely tradeable without restriction or may be sold in accordance with the volume limitations of Rule 144 of the Securities Act of 1933. These factors also could make it more difficult for us to raise funds through future offerings. Our principal stockholder, Mr. L. Rogers Wells, Jr., owns a majority of our common stock. Our forward looking statements may be incorrect. Some of the statements in this report are forward looking statements about what may happen in the future. They include statements regarding our current beliefs, plans, expectations and assumptions about matters such as our -22- expected financial position and operating results, our business strategy and our financing plans. These statements can sometimes be identified by our use of forward looking words such as "anticipate," "believe," "estimate," "expect," "intend," "plan," "seek," "should" and similar expressions. Our forward looking statements are subject to numerous risks, uncertainties and assumptions, many of which are beyond our control. These risks, uncertainties and assumptions include the risk factors discussed above. We cannot guarantee that our forward looking statements will turn out to be correct or that our beliefs, plans, expectations and assumptions will not change. Our actual results could be very different from and worse than our expectations as expressed in our forward looking statements. ITEM 7(A). QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK Not applicable. ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA Independent Auditors' Report The Board of Directors and Shareholders Interlott Technologies, Inc.: We have audited the accompanying balance sheet of Interlott Technologies, Inc. as of December 31, 1999, and the related statements of income, stockholders' equity, and cash flows for the year then ended. These financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements based on our audit. We conducted our audit in accordance with generally accepted auditing standards. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audit provides a reasonable basis for our opinion. In our opinion, the financial statements referred to above present fairly, in all material respects, the financial position of Interlott Technologies, Inc. as of December 31, 1999, and the results of its operations and its cash flows for the year then ended, in conformity with generally accepted accounting principles. /s/ Grant Thornton LLP Cincinnati, Ohio February 7, 2000 Independent Auditors' Report The Board of Directors and Stockholers Interlott Technologies, Inc.: We have audited the balance sheet of Interlott Technologies, Inc. as of December 31, 1998, and the related statements of income, stockholders' equity (deficit) and cash flows for each of the years in the two-year period ended December 31, 1998. In connection with our audits of the financial statements, we also have audited the related financial statement schedule as listed in the accompanying index. These financial statements and financial statement schedule are the resposibility of the Company's management. Our responsibility is to express an opinion on these financial statements and financial statement schedule based on our audits. We conducted our audits in accordance with generally accepted auditing standards. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion. In our opinion, the financial statements referred to above present fairly, in all material respects, the financial position of Interlott Technologies, Inc. as of December 31, 1998, and the results of its operations and its cash flows for each of the years in the two-year period ended December 31, 1998, in conformity with generally accepted accounting principles. Also in our opinion, the related financial statement schedule, when considered in relation to the basic financial statements taken as a whole, presents fairly, in all material respects, the information set forth therein. /s/ KMPG LLP Cincinnati, Ohio February 26, 1999 -23- INTERLOTT TECHNOLOGIES, INC.
Balance Sheets December 31, 1998 and 1999 1998 1999 ----------------- ---------------- Assets Current assets: Cash $ 30,004 132,501 Accounts receivable, less allowance for doubtful accounts of $153,501 in 1998 and $158,793 in 1999 2,816,589 3,305,486 Investment in sales type leases, current portion 888,627 1,251,144 Inventories 3,129,959 5,214,106 Prepaid expenses 82,105 267,838 - ------------------------------------------------------------------------------------------------------------------------- Total current assets 6,947,284 10,171,075 - ------------------------------------------------------------------------------------------------------------------------- Property and equipment: Leased machines 29,484,623 35,244,923 Machinery and equipment 631,111 610,968 Building and leasehold improvements 271,433 202,441 Furniture and fixtures 130,950 60,237 - ------------------------------------------------------------------------------------------------------------------------- 30,518,117 36,118,569 Less accumulated depreciation and amortization (12,970,895) (14,301,656) - ------------------------------------------------------------------------------------------------------------------------- Net property and equipment 17,547,222 21,816,913 - ------------------------------------------------------------------------------------------------------------------------- Investment in sales type leases, less current portion 3,766,408 3,775,876 Product development rights, net of accumulated amortization of $586,665 in 1998 and $659,997 in 1999 513,335 440,003 - ------------------------------------------------------------------------------------------------------------------------- $28,774,249 36,203,867 - -------------------------------------------------------------------------------------------------------------------------
See accompanying notes to financial statements. -24- INTERLOTT TECHNOLOGIES, INC.
Balance Sheets, Continued December 31, 1998 and 1999 1998 1999 --------------- --------------- Liabilities and Stockholders' Equity Current liabilities: Notes payable to financial institutions $11,166,374 16,005,029 Current portion of notes payable - related parties 192,302 286,698 Accounts payable 1,479,831 1,781,884 Accounts payable - related parties 215,734 179,469 Accrued expenses 1,111,416 1,358,253 Income taxes payable 248,458 - - --------------------------------------------------------------------------------------------------------------- Total current liabilities 14,414,115 19,611,333 - --------------------------------------------------------------------------------------------------------------- Notes payable - related parties, excluding current portion 286,698 - Deferred income taxes 121,900 570,700 - --------------------------------------------------------------------------------------------------------------- Total liabilities 14,822,713 20,182,033 - --------------------------------------------------------------------------------------------------------------- Commitments and contingent liabilities - --------------------------------------------------------------------------------------------------------------- Series A redeemable preferred stock, $.01 par value; 20,000,000 shares authorized, 1,335,000 shares issued and outstanding 1,335,000 1,335,000 - --------------------------------------------------------------------------------------------------------------- Stockholders' equity: Common stock, $.01 par value; 20,000,000 shares authorized, 3,210,000 shares issued and outstanding in 1998 and 1999 32,100 32,100 Additional paid-in capital 10,376,017 10,376,017 Retained earnings 2,208,419 4,278,717 - --------------------------------------------------------------------------------------------------------------- Total stockholders' equity 12,616,536 14,686,834 ---------- ---------- $28,774,249 36,203,867 - ---------------------------------------------------------------------------------------------------------------
See accompanying notes to financial statements. -25- INTERLOTT TECHNOLOGIES, INC.
Statements of Income Years Ended December 31, 1997, 1998 and 1999 1997 1998 1999 --------------- --------------- --------------- Revenues: Machine sales $ 4,567,441 8,229,950 3,311,874 Machine leases 12,874,450 14,165,379 16,901,911 Other 1,669,160 2,078,644 2,120,245 - ------------------------------------------------------------------------------------------------------------------------- 19,111,051 24,473,973 22,334,030 - ------------------------------------------------------------------------------------------------------------------------- Cost of revenues: Machine sales and other 4,378,669 5,809,057 1,466,153 Machine leases 7,508,261 10,310,565 12,580,788 - ------------------------------------------------------------------------------------------------------------------------- 11,886,930 16,119,622 14,046,941 - ------------------------------------------------------------------------------------------------------------------------- Gross margin 7,224,121 8,354,351 8,287,089 - ------------------------------------------------------------------------------------------------------------------------- Operating expenses: Selling, general and administrative expenses 3,492,020 4,048,751 4,202,825 Research and development costs 545,039 618,819 581,885 - ------------------------------------------------------------------------------------------------------------------------- 4,037,059 4,667,570 4,784,710 - ------------------------------------------------------------------------------------------------------------------------- Operating income 3,187,062 3,686,781 3,502,379 - ------------------------------------------------------------------------------------------------------------------------- Other income (expense) Interest expense (747,008) (967,768) (1,102,478) Other - - 598,832 - ------------------------------------------------------------------------------------------------------------------------- (747,008) (967,768) (503,646) - ------------------------------------------------------------------------------------------------------------------------- Income before income taxes and extraordinary item 2,440,054 2,719,013 2,998,733 - ------------------------------------------------------------------------------------------------------------------------- Income tax provision 988,400 1,096,700 1,106,594 - ------------------------------------------------------------------------------------------------------------------------- Income before extraordinary item 1,451,654 1,622,313 1,892,139 - ------------------------------------------------------------------------------------------------------------------------- Extraordinary item (less applicable income taxes of $109,195) - - 178,159 - ------------------------------------------------------------------------------------------------------------------------- Net income $ 1,451,654 1,622,313 2,070,298 - ------------------------------------------------------------------------------------------------------------------------- Basic income per share before extraordinary item $0.45 0.51 0.59 - ------------------------------------------------------------------------------------------------------------------------- Diluted income per share before extraordinary item $0.45 0.50 0.59 - ------------------------------------------------------------------------------------------------------------------------- Basic and diluted extraordinary item per share $ - - 0.06 - ------------------------------------------------------------------------------------------------------------------------- Basic net income per share $0.45 0.51 0.65 - ------------------------------------------------------------------------------------------------------------------------- Diluted net income per share $0.45 0.50 0.65 - -------------------------------------------------------------------------------------------------------------------------
See accompanying notes to financial statements. -26- INTERLOTT TECHNOLOGIES, INC.
Statements of Stockholders' Equity Years ended December 31, 1997, 1998 and 1999 Common Stock Additional ------------------------- Paid-in Retained Shares Amount Capital Earnings Total ---------- --------- ----------- ----------- ------------ Balances at December 31, 1996 3,210,000 $32,100 $10,376,017 $ (865,548) $ 9,542,569 Net income - - - 1,451,654 1,451,654 - -------------------------------------------------------------------------------------------------------------------------------- Balances at December 31, 1997 3,210,000 32,100 10,376,017 586,106 10,994,223 Net income - - - 1,622,313 1,622,313 - -------------------------------------------------------------------------------------------------------------------------------- Balances at December 31, 1998 3,210,000 32,100 10,376,017 2,208,419 12,616,536 Net income - - - 2,070,298 2,070,298 - -------------------------------------------------------------------------------------------------------------------------------- Balances at December 31, 1999 3,210,000 $32,100 $10,376,017 $4,278,717 $14,686,834 - --------------------------------------------------------------------------------------------------------------------------------
See accompanying notes to financial statements. -27- INTERLOTT TECHNOLOGIES, INC.
Statements of Cash Flows Years ended December 31, 1997, 1998 and 1999 1997 1998 1999 ----------- ---------- --------- Cash flows from operating activities: Net income $1,451,654 1,622,313 2,070,298 Adjustments to reconcile net income to net cash provided by operating activities: Net book value of equipment lost in involuntary conversion - - 113,563 Depreciation and amortization 4,143,408 4,585,325 5,547,909 Principal portion of sales type leases received 164,194 557,116 909,184 Deferred income taxes 203,700 374,200 448,800 Gain on sale of equipment under sales type lease (447,915) (1,177,773) (331,170) Decrease (increase) in accounts receivable 298,927 101,503 (488,897) Decrease (increase) in inventories 1,035,052 1,110,268 (828,568) Decrease (increase) in prepaid expenses 6,804 32,345 (185,733) Increase in accounts payable 217,852 337,766 302,052 Increase (decrease) in accounts payable - related parties 22,431 (113,226) (36,265) Increase (decrease) in accrued expenses 186,650 (142,766) 246,837 (Decrease) increase in income taxes payable (1,300) 148,008 (248,458) - --------------------------------------------------------------------------------------------------------------------------------- Net cash provided by operating activities 7,281,457 7,435,079 7,519,552 - --------------------------------------------------------------------------------------------------------------------------------- Cash flows from investing activities: Cost of leased machines (8,710,315) (9,611,623) (11,985,736) Purchases of property and equipment (359,521) (123,893) (77,672) - --------------------------------------------------------------------------------------------------------------------------------- Net cash used in investing activities (9,069,836) (9,735,516) (12,063,408) - --------------------------------------------------------------------------------------------------------------------------------- Cash flows from financing activities: Increase in notes payable 1,747,865 2,188,338 4,838,655 Repayment of long-term debt (5,001) (968) (192,302) --------- --------- ---------- Net cash provided by financing activities 1,742,864 2,187,370 4,646,353 - --------------------------------------------------------------------------------------------------------------------------------- (Decrease) increase in cash (45,515) (113,067) 102,497 Cash at beginning of year 188,586 143,071 30,004 - --------------------------------------------------------------------------------------------------------------------------------- Cash at end of year $ 143,071 30,004 132,501 - --------------------------------------------------------------------------------------------------------------------------------- Supplemental disclosures of cash flow information: Interest paid $ 671,515 902,252 1,216,285 Income taxes paid $ 631,610 526,807 1,104,789 - ---------------------------------------------------------------------------------------------------------------------------------
See accompanying notes to financial statements. -28- Notes to Financial Statements Years ended December 31, 1997, 1998, 1999 (1) Summary of Significant Accounting Policies (a) Business Description Interlott Technologies, Inc. (the Company), a Delaware corporation, designs, manufactures, leases, sells and services vending machines for use in connection with public lotteries operated by states and foreign public entities, as well as for use by providers of prepaid telephone cards. (b) Operating and Sales Type Leases Depending on the specific terms contained in the lease agreement, the lease is either classified as an operating lease or capitalized as a sales type lease, in accordance with Statement of Financial Accounting Standards (SFAS) No. 13, Accounting for Leases, as amended. The net investment in operating leases consists of leased machines, which are carried at cost, less the amount depreciated to date. Operating lease revenue consists of the contractual lease payments and is recognized ratably over the lease term. Expenses are principally depreciation of the leased machines (see Note 1d). The net investment in sales type leases consists of the present value of the future minimum lease payments. Sales type lease revenues consists of the profits earned on the sale of the leased machines and interest earned on the present value of the lease payments. Interest revenue is recognized as a constant percentage return on the net investment. Any future losses related to lease cancellations would be recorded in the period such losses became known and estimable. (c) Inventories Inventories consist of parts and supplies, and vending machines assembled or in the process of assembly. Inventories are stated at the lower of cost or market, with cost determined using standard costing, which approximates the first-in, first-out method. (d) Property and Equipment Property and equipment are stated at cost. Depreciation of property and equipment is calculated on the straight-line method over the estimated useful lives of the assets, to the Company's estimate of the assets' residual values, as follows: Leased machines 5 years Machinery and equipment 10 years Furniture and fixtures 5 years Leasehold improvements are amortized on the straight-line method over the lease term. Amortization of assets held under leasehold improvements is included with depreciation expense. -29- (e) Product Development Rights Product development rights represent the exclusive rights to certain patents and other related manufacturing technologies to manufacture and assemble the instant ticket vending machines. The asset is amortized on the straight-line method over fifteen years, which represents the lower of the remaining life of the patents or the estimated remaining life of the technology currently in use. (f) Income Taxes The Company accounts for income taxes using the asset and liability method. In accordance with this method, deferred tax assets and liabilities are recognized for the future tax consequences attributable to differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax bases and operating loss and tax credit carryforwards. Deferred tax assets and liabilities are measured using the enacted tax rates expected to apply to taxable income in the years in which those temporary differences are expected to be recovered or settled. (g) Disclosure About Fair Value of Financial Instruments SFAS No. 107, Disclosure About Fair Value of Financial Instruments, defines the fair value of a financial instrument as the amount at which the instrument could be exchanged in a current transaction between willing parties. The carrying amounts as of December 31, 1999 of cash, accounts receivable, accounts payable, accounts payable - related parties, accrued expenses and income taxes payable approximate fair value due to the short maturity of these investments. The carrying amount of notes payable and notes payable - related parties approximate fair value, as such borrowings bear interest at the Company's current rates for such types of instruments. (h) Stock Incentive Plans On January 1, 1996, the Company adopted SFAS No. 123, Accounting for Stock-Based Compensation, which permits entities to recognize compensation expense over the vesting period the fair value of all stock-based awards on the date of grant. Alternatively, SFAS No. 123 allows entities to continue to apply the provisions of APB Opinion No. 25 and provide pro forma net income and pro forma earnings per share disclosures for employee stock option grants as if the fair-value-based method defined in SFAS No. 123 had been applied. The Company has elected to continue to apply the provisions of APB Opinion No. 25 and provide the pro forma disclosures of SFAS No. 123. (i) Warranty Costs Provision for estimated warranty costs on machines sold is recorded at the time of sale and periodically adjusted to reflect actual experience. (j) Research and Development Costs Research and development costs are charged to expense in the year incurred. -30- (k) Earnings Per Share Effective December 31, 1997, the Company adopted SFAS No. 128, Earnings Per Share, which simplifies the standards for computing earnings per share. There was no material impact on the Company's previously reported annual or interim period earnings per share, as a result of the adoption. Basic earnings per share is based upon the weighted average number of common shares outstanding. Diluted earnings per share is based upon the weighted average number of common shares outstanding, including the effects of all dilutive potential common shares outstanding. (l) Use of Estimates Management of the Company has made a number of estimates and assumptions relating to the reporting of assets and liabilities and the disclosure of contingent liabilities to prepare these financial statements in conformity with generally accepted accounting principles. Actual results could differ from those estimates. (2) Investment in Sales Type Leases The Company leases 200 instant ticket vending machines (ITVMs) to one state lottery under a sales type lease that commenced in May 1997 and 775 ITVMs to another state lottery under a sales type lease that commenced in May 1998. The components of the net investment in sales type leases at December 31, 1998 and 1999 are as follows:
1998 1999 Minimum lease payments receivable $6,134,450 $6,306,800 Less unearned revenue on lease payments receivable 1,479,415 1,279,780 --------- --------- 4,655,035 5,027,020 Less current portion 888,627 1,251,144 --------- --------- Investment in sales type leases, less current portion $3,766,408 $3,775,876 ========= =========
-31- Future minimum lease payments to be received by the Company under these sales type leases are as follows: Years ending December 31, 2000 $1,820,400 2001 1,820,400 2002 1,535,600 2003 838,650 2004 291,750 ---------- $6,306,800 ========= (3) Inventories Inventories at December 31, 1998 and 1999 consist of the following:
1998 1999 Finished goods $1,528,656 $1,350,719 Work in process 302,766 376,243 Raw materials and supplies 1,298,537 3,487,144 --------- --------- $3,129,959 $5,214,106 ========= =========
(4) Leased Machines At December 31, 1998 and 1999, the Company leased 7,027 and 8,246 ITVMS to 14 and 16 state lotteries, respectively, under operating leases. The leases generally provide for the lotteries to make monthly or quarterly payments for rentals of the ITVMs over various lease terms. The components of the net investment in operating leases, which includes estimated residual values, at December 31, 1998 and 1999 are as follows:
1998 1999 Leased machines $29,484,623 $35,244,923 Less accumulated depreciation 12,378,732 13,695,523 ---------- ---------- $17,105,891 $21,549,400 ========== ==========
Future minimum lease payments to be received by the Company under operating leases are as follows: December 31, 2000 $14,171,372 2001 6,584,092 2002 2,781,412 2003 437,500 ------------ $23,974,376 ========== (5) Notes Payable to financial institutions In October 1997, the Company entered into a revolving credit facility with a financial institution that permitted the Company to borrow through -32- October 2000 up to $15,000,000 at the prime interest rate (8.50% at December 31, 1999). Initial proceeds from the note were used to retire the prior revolving credit facility. In conjunction with the establishment of the facility, the Company opened a lockbox and controlled disbursement account with the bank parent of the financial institution. All lockbox receipts are recorded as payments against the facility, and presented checks are recorded as draws on the facility. Borrowings under this credit facility are collateralized by all assets of the Company and assignment of proceeds from lease agreements. In October 1999, this facility was amended to permit borrowings of up to $25,000,000. At December 31, 1998 and 1999, the Company had borrowings of $11,166,374 and $16,005,029 outstanding with additional borrowings of $3,833,626 and $8,994,971 available under the facility, respectively. (6) Notes Payable - Related Parties The Company has the following notes payable to related parties at December 31, 1998 and 1999:
1998 1999 Note payable to a stockholder, in the initial principal amount of $400,000, due in annual installments limited to twenty-five percent (25%) of the net profits, if any, of the Company from its business operations as reported in the Company's annual financial statements. Any required payment is due on the first business day of the fourth month following the close of the fiscal year. The note bears interest at the prime rate of Chase Manhattan Bank of New York (8.50% at December 31, 1999). The note is unsecured. $400,000 $207,698 Note payable to a stockholder, in the original amount of $79,000, due and limited to twenty-five percent (25%) of the net profits of the Company, if any, from its business operations as reported in the Company's annual financial statements. The payments shall begin on the first business day of the fourth month of the Company's fiscal year, for income tax purposes, immediately following payment in full of principal and interest due by the Company to a stockholder in the amount of $400,000. The note does not provide for any interest and is unsecured. 79,000 79,000 ------- ------- 479,000 286,698 Less current portion 192,302 286,698 ------- ------- $286,698 $ - ======= ========
-33- (7) Additional Financial Instrument The Company has entered into an interest rate swap agreement with a total notional principal amount of $10,000,000 at December 31, 1999, which expires on November 7, 2002. The objective of the agreement is to convert a portion of the Company's floating rate revolving credit facility to a fixed rate. The estimated fair value of the interest rate swap agreement was approximately $176,000 at December 31, 1999. The estimated fair value is based upon appropriate market information and projected interest rate changes obtained from a reputable institution. (8) Income Taxes Income tax expense is summarized as follows:
Year ended December 31, -------------------------------- 1997 1998 1999 Current: Federal $557,400 $ 566,000 $ 612,400 State and local 156,000 156,500 154,600 Deferred: Federal 275,000 374,200 448,800 ------- --------- --------- $988,400 $1,096,700 $1,215,800 ======= ========= =========
A reconciliation of income tax expense in relation to the amounts computed by application of the U.S. federal income tax rate of 34% to pretax income follows:
1997 1998 1999 Federal income tax expense at the statutory rate $830,000 $ 924,400 $1,117,300 Non-deductible lobbyist expenses - - 3,200 Officers life insurance - - 8,000 Amortization of product development rights 25,000 25,000 25,000 State and local taxes, net of federal benefit 103,000 103,300 102,000 Other 30,400 44,000 (39,700) ------- --------- --------- $988,400 $1,096,700 $1,215,800 ======= ========= =========
The tax effects of temporary differences that give rise to significant portions of the deferred tax assets and deferred tax liabilities at December 31, 1998 and 1999 are presented below:
1998 1999 Deferred tax assets: Bad debt allowance $ 52,200 $ 54,000 Warranty costs 10,100 1,200 Net operating loss carryforwards 347,100 292,200 Inventory valuation reserve 317,300 249,600 Other, net - 52,600 ------- --------- Total gross deferred tax assets $726,700 $ 649,600 ======= ========= Deferred tax liabilities: Property and equipment, principally due to differences in depreciation $537,800 $ 987,800 Investment in sales type leases 310,800 134,800 Involuntary conversion of assets - 97,700 ------- --------- Total gross deferred tax liabilities 848,600 1,220,300 ------- --------- Net deferred tax liabilities $(121,900) $ (570,700) ======= =========
-34- In assessing the realizability of deferred tax assets, management considers whether it is more likely than not that some portion or all of the deferred tax assets will not be realized. The ultimate realization of deferred tax assets is dependent upon the generation of future taxable income during the periods in which those temporary differences become deductible. Management considers the scheduled reversal of deferred tax liabilities, projected future income and tax planning strategies in making this assessment. At December 31, 1999, the Company has net operating loss carryforwards for Federal income tax purposes of approximately $859,400, which are available to offset future Federal taxable income, if any, through 2009. However, due to an ownership change on September 25, 1992, utilization of these carryforwards is subject to certain annual limitations. (9) Redeemable Preferred Stock The Company's preferred stock is nonparticipating and has no rights to dividends. The holders of the preferred stock are entitled to sell to the Company all of their shares of preferred stock at a price of $1.00 per share upon (i) the reporting by the Company of retained earnings of at least $1,000,000 determined in accordance with generally accepted accounting principles and (ii) the payment in full by the Company of a promissory note in the original amount of $400,000 to a related party. Due to the redemption feature of the preferred stock, it has been classified separately from stockholders' equity in the Company's balance sheet. The Company may, at its discretion, redeem all or part of the outstanding preferred stock at any time. The redemption price for the preferred stock is $1.00 per share and payment may be made in the form of a promissory note. (10) Stock Incentive Plans The Company's 1994 Stock Incentive Plan and 1994 Directors' Stock Incentive Plan (collectively, the Plans) provide for the issuance of up to 260,000 shares of common stock to officers and employees of, and advisers, consultants and other supporters of the Company and up to 60,000 shares of common stock to nonemployee directors of the Company. Stock options are granted with an exercise price equal to the stock's fair market value at the date of grant. Options vest at the rate of 25% per year beginning one year from the date of grant, subject to the recipient's continued employment or service to the Company, and must be exercised within 10 years after that date. As permitted by SFAS No. 123, the Company applies the intrinsic value method prescribed by APB Opinion No. 25 and related interpretations in accounting for its stock option plans. Accordingly, no compensation cost has been recognized in the accompanying statements of income. -35- A summary of the status of the Company's stock option plans as of December 31, 1997, 1998, and 1999 and the changes therein for the years then ended is presented below:
1997 1998 1999 Weighted Weighted Weighted Average Average Average Exercise Exercise Exercise Shares Price Shares Price Shares Price Outstanding at beginning of year 147,225 $ 9.38 180,875 $ 9.12 212,175 $8.65 Granted 37,000 8.00 36,300 6.75 57,750 5.18 Exercised - - - - - - Forfeited 3,350 11.50 5,000 11.50 13,375 9.15 Outstanding at end of year 180,875 9.12 212,175 8.65 256,550 7.81 Options exercisable at year-end 79,660 9.77 120,794 9.48 152,081 8.95 Weighted-average fair value of options granted during the year $ 5.82 $ 5.16 $5.18 ===== ===== ====
Had compensation cost for options granted during 1997, 1998 and 1999 been determined consistent with the fair value methodology of SFAS No. 123, the Company's net income and earnings per share would have been reduced to the pro forma amounts presented below:
1997 1998 1999 Net income As reported $1,451,654 $1,622,313 $2,070,298 Pro forma 1,324,003 1,512,186 2,054,057 Basic and diluted earnings per share As reported .45 .51 .65 Pro forma .41 .47 .64 ========= ========== =========
The full impact of calculating compensation cost for stock options under SFAS No. 123 is not reflected in the pro forma net income amounts presented above because compensation cost is recognized over the options' vesting period of four years and compensation cost for options granted prior to January 1, 1995 is not considered. The fair value of options granted during 1997, 1998 and 1999 for purposes of the accompanying pro forma disclosures is estimated on the grant date using the Black-Scholes option-pricing model with the following weighted-average assumptions: no dividends paid, as it has been the Company's policy not to declare or pay dividends since its initial public offering in 1994 and the Company does not anticipate paying dividends in the foreseeable future; expected volatility of 56%, 65% and 43%, respectively, based on the calculated volatility of the Company's stock since its initial public offering; risk-free rates of return of 5.86%, 4.93% and 4.83%, respectively; and expected lives of 10 years. -36- Information about stock options outstanding at December 31, 1999 is as follows:
Options Outstanding Options Exercisable ----------------------------------------------- ----------------------------- Weighted- Average Weighted- Weighted- Remaining Average Average Range of Number Contractual Exercise Number Exercise Exercise Prices Outstanding Life Price Exercisable Price - --------------------- -------------- -------------- --------------- -------------- ------------- $4.81 - 8.63 215,350 7.47 $ 7.15 112,900 $ 8.15 $10.13 - 11.50 41,200 4.59 11.43 39,181 11.32 ------- ---- ----- ------- ----- 256,550 7.26 $ 8.65 152,081 $ 9.49 ======= ==== ===== ======= =====
(11) Earnings Per Share
Net Per Earnings Shares Share 1997 (Numerator) (Denominator) Amount --------------- ------------------ --------------- Basic earnings per share: Net earnings available to common stockholders $1,451,654 3,210,000 $0.45 Diluted earnings per share: Effect of dilutive securities stock options 2,661 Earnings available to common stockholders and assumed conversions 1,451,654 3,212,661 0.45 1998 Basic earnings per share: Net earnings available to common stockholders 1,622,313 3,210,000 0.51 Diluted earnings per share: Effect of dilutive securities stock options 10,649 Earnings available to common stockholders and assumed conversions 1,622,313 3,220,649 0.50 1999 Basic earnings per share: Net earnings available to common stockholders 2,070,298 3,210,000 0.65 Diluted earnings per share: Effect of dilutive securities stock options 903 Earnings available to common stockholders and assumed conversions 2,070,298 3,210,903 0.65
Options to purchase 129,725, 52,475 and 223,025 shares of common stock were outstanding in 1997, 1998 and 1999, respectively, but were not included in the computation of diluted earnings per share because the options' exercise prices were greater than the average market price of common shares. -37- (12) Noncash Investing Activities Leased machines with net book values of $442,897 in 1998 and $1,255,578 in 1999, were returned to the Company's inventories upon lease expirations. The Company used parts from these returned machines in the manufacturing of certified new machines, a portion of which were deployed in the current year under new leases. (13) Related Party Transactions Accounts payable - related parties of $215,734 and $179,469 at December 31, 1998 and 1999, respectively, represent management fees and expenses payable to a company owned 100% by the majority stockholder as well as parts expenses payable to an entity which is owned by a director. Amounts expensed related to the company owned by the majority stockholder were $36,000 for each of the years ended December 31, 1997, 1998 and 1999, respectively. The entity owned by a director supplies the Company with certain parts for its dispensing mechanisms. In addition, on January 13, 1994, the Company entered into a manufacturing and license agreement with this entity pursuant to which the Company purchased an exclusive license to make, use and sell pull-tab lottery ticket dispensing mechanisms produced by this entity. The Company had purchases from this entity which were charged to cost of revenues of approximately $2,996,000, $3,800,887 and $4,116,674 for the years ended December 31, 1997, 1998 and 1999, respectively. Interest expense arising from notes payable-related parties amounted to $33,714, $33,401 and $20,275 for the years ended December 31, 1997, 1998 and 1999, respectively. (14) Customer and Supplier Concentrations A significant portion of the Company's revenues are derived from a limited number of state lottery authorities or their representatives. For the years ended December 31, 1997, 1998 and 1999, one customer generated 29%, 24% and 24%, respectively, of the machine lease revenues. In addition, single state contracts generated 32%, 48% and 38% of the machine sales revenues for the years ended December 31, 1997, 1998 and 1999, respectively. Future revenue from machine sales and leases is dependent upon winning awards in a competitive bidding process. The Company currently purchases certain components used in its vending machines, including components used in its burster mechanism, from single suppliers. The purchase of components from outside suppliers on a sole source basis subjects the Company to certain risks, including the continued availability of suppliers, price increases and potential quality assurance problems. Because other suppliers exist that can duplicate these components should the Company elect or be forced to use a different supplier, the Company does not believe that a change in suppliers would result in the termination of a production contract. However, the Company could experience a delay of 30 to 60 days in production, which could adversely affect the Company's ability to make timely deliveries of vending machines and to obtain new contracts. (15) Lease Commitments The Company leases its office and manufacturing facilities under noncancelable operating leases. The leases expired on December 31, 1999, and are now on a month-to-moth basis requiring lease payments of $14,355 per month. Total rent expense under these leases approximated $141,000, $210,000 and $179,000 for the years ended December 31, 1997, 1998 and 1999, respectively. -38- The Company is currently negotiating a lease on a new, 52,500 square foot facility in Mason, Ohio, which will allow for the consolidation of all operations into one facility. (16) Commitments and Contingent Liabilities As of December 31, 1999, the Company had outstanding approximately $11,154,895 in purchase commitments for raw materials which are used in the manufacturing of instant ticket vending machines. Management intends to utilize these commitments as machines are produced. (17) Other Income and Extraordinary Item Other income in 1999 of $598,832 consists of a one time non-recurring credit of $625,000 from settlement of litigation with a competitor offset by $26,168 in other non-related expenses. On April 9, 1999, a tornado destroyed the corporate office and a warehouse facility. The excess of the insurance proceeds over the net book value of the assets lost resulted in an after tax gain of $178,159 on the involuntary conversion of these assets. ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE The information required by this item has been reported in the Company's Current Report on Form 8-K, Date of Report: October 4, 1999, filed October 12, 1999. PART III Except as set forth below, the information required by this Part is incorporated by reference from the definitive Proxy Statement, filed or to be filed with Securities and Exchange Commission, for the Company's 2000 Annual Meeting of Stockholders. ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT The executive officers of the Company (at March 29, 2000) are as follows: Name Age Title L. Rogers Wells 62 Chairman of the Board David F. Nichols 38 President and Chief Executive Officer Thomas W. Stokes 36 Chief Operating Officer Dennis W. Blazer 52 Chief Financial Officer Information about Messrs. Wells and Nichols is incorporated by reference from the Company's definitive Proxy Statement for the 2000 Annual Meeting. Thomas W. Stokes, age 36, has been Chief Operating Officer since March 2000. Mr. Stokes served as the Company's Vice President of Operations since May 1997, as Director of Operations from January 1996 to May 1997 and as Purchasing Manager from March 1993 to December 1995. From 1988 to 1992, he served as unit controller for a food management company. -39- Dennis W. Blazer, age 52, has been Chief Financial Officer of the Company since July 1998. From December 1973 to July 1998, he served in various capacities for The Plastic Moldings Corporation, most recently as Vice President of Finance and Administration. Mr. Blazer previously served as an auditor and tax consultant with Ernst & Ernst, certified public accountants. Mr. Blazer is a certified public accountant. The executive officers of the Company are appointed by and serve at the discretion of the Board of Directors. PART IV ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K (a) Documents Filed as Part of This Report. 1. Financial Statements Independent Auditors' Report of Grant Thornton LLP Independent Auditors' Report of KPMG LLP Balance Sheets at December 31, 1998 and 1999 Statements of Income for each of the years in the three-year period ended December 31, 1999. Statements of Stockholders' Equity for each of the years in the three-year period ended 31, 1999. Statements of Cash Flows for each of the years in the three year period ended December 31, 1999. Notes to Financial Statements 2. Financial Statement Schedules The following financial statement schedule is set forth beginning on page S-1 of this report: Schedule II - Valuation and Qualifying Accounts All other schedules have been omitted because they are not required or are inapplicable or because the information required is included in the financial statements or notes thereto. 3. Exhibits See Index of Exhibits (page E-1) for a list of the exhibits filed with and incorporated by reference in this report. (b) Reports on Form 8-K. Current Report on Form 8-K, Date of Report: October 4, 1999, October 12, 1999 (Items 4 and 7) -40- SIGNATURES Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized, on March 29, 2000. Interlott Technologies, Inc. (Registrant) By /s/ L. Rogers Wells, Jr. ------------------------ L. Rogers Wells, Jr. Chairman of the Board Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the Registrant and in the capacities indicated on March 29, 2000.
Signature Title /s/ L. Rogers Wells, Jr. Chairman of the Board - ----------------------------------------------------- L. Rogers Wells, Jr. /s/ Edmund F. Turek Director - ----------------------------------------------------- Edmund F. Turek /s/ David F. Nichols President, Chief Executive Officer and Director - ----------------------------------------------------- David F. Nichols Gary S. Bell * Secretary, Treasurer and Director - ----------------------------------------------------- Gary S. Bell Kazmier J. Kasper * Director - ----------------------------------------------------- Kazmier J. Kasper H. Jean Marshall * Director - ----------------------------------------------------- H. Jean Marshall John J. Wingfield * Director - ----------------------------------------------------- John J. Wingfield /s/ Dennis W. Blazer Chief Financial and Accounting Officer - ----------------------------------------------------- Dennis W. Blazer
*By: /s/ L. Rogers Wells, Jr. ------------------------ L. Rogers Wells, Jr. as attorney-in-fact -41- INDEX OF FINANCIAL STATEMENT SCHEDULES Page Report of Independent Certified Public Accountants on Schedule ............S-2 Schedule II - Valuation and Qualifying Accounts ...........................S-3 S-1 Report of Independent Certified Public Accountants on Schedule Board of Directors and Stockholders Interlott Technologies, Inc. In connection with our audit of the financial statements of Interlott Technologies, Inc. referred to in our report dated February 7, 2000, which is included in the annual report to security holders and included in Part II of this form, we have also audited Schedule II for the year ended December 31, 1999. In our opinion, this schedule presents fairly, in all material respects, the information required to be set forth therein. /s/GRANT THORNTON LLP Cincinnati, Ohio February 7, 2000 S-2 INTERLOTT TECHNOLOGIES, INC.
Schedule II - Valuation and Qualifying Accounts Column A Column B Column C Column D Column E - ----------------------- ----------------- --------------------------------------- ----------------- ------------------ Additions Description Balance at Charged to Charged to Deductions Balance at Beginning Costs and Other End of Period Expenses Accounts of Period - ----------------------- ----------------- ------------------- ------------------- ----------------- ------------------ Allowance for doubtful accounts 1997 $ 115,425 $ 52,500 $0 $ 74,424 $ 93,501 - ----------------------------------------------------------------------------------------------------------------- 1998 93,501 60,000 0 0 153,501 - ----------------------------------------------------------------------------------------------------------------- 1999 153,501 96,000 0 90,708 158,793 - ----------------------------------------------------------------------------------------------------------------- Inventory valuation reserve 1997 275,000 0 0 0 275,000 - ----------------------------------------------------------------------------------------------------------------- 1998 275,000 933,110 0 0 1,208,110 - ----------------------------------------------------------------------------------------------------------------- 1999 $1,208,110 $305,000 $0 $512,824 $1,000,286 - -----------------------------------------------------------------------------------------------------------------
S-3 INTERLOTT TECHNOLOGIES, INC. INDEX OF EXHIBITS The following exhibits are filed with or incorporated by reference in this report. Where the exhibit is incorporated by reference from a previously filed document, that document is identified in parenthesis.
Exhibit No. Description 3.1 Certificate of Incorporation of the Company, as amended, including Certificate of Designation of Series A Preferred Stock (Exhibit 3.1 to the Company's Registration Statement on Form S-1, No. 33-75142). 3.2 Bylaws of the Company (Exhibit 3.2 to the Company's Registration Statement on Form S-1, No. 33-75142). 4.1 Promissory Note of the Company dated September 22, 1992 to Baumgartner & Brucher Radiology Associates, Inc. Profit Sharing Plan for the benefit of Thomas E. Turek, M.D. (Exhibit 4.2 to the Company's Registration Statement on Form S-1, No. 33-75142). 4.2 Promissory Note of the Company dated September 22, 1990 to Mr. Thomas Goila (Exhibit 4.3 to the Company's Registration Statement on Form S-1, No. 33-75142). 4.3 Loan Agreement dated October 29, 1997 between the Company and Mercantile Business Credit, Inc. (Exhibit 4.3 to the Company's Annual Report on Form 10-K for the year ended December 31, 1997). 4.3(a) Revolving Credit Note dated October 29, 1997 between the Company and Mercantile Business Credit, Inc. (Exhibit 4.3(a) to the Company's Annual Report on Form 10-K for the year ended December 31, 1997). 4.3(b) Security Agreement dated October 29, 1997 between the Company and Mercantile Business Credit, Inc. (Exhibit 4.3 (b) to the Company's Annual Report on Form 10-K for the year ended December 31, 1997). 4.3(c) Patent, Trademark and License Security Agreement dated October 29, 1997 between the Company and Mercantile Business Credit, Inc. (Exhibit 4.3 (c) to the Company's Annual Report on Form 10-K for the year ended December 31, 1997). 4.3(d) First Amendment to the Loan Agreement dated October 29, 1998 between the Company and Mercantile Business Credit, Inc. (Exhibit 4.3 (d) to the Company's Annual Report on Form 10-K for the year ended December 31, 1997). 4.3(e) Second Amendment to the Loan Agreement dated September 28, 1999 between the Company and Mercantile Business Credit, Inc. -- filed herewith.
E-1
10.1 Assignment of United States Letters Patent from BLM Resources, Inc. to the Company with respect to United States Patent No. 4,982,337, "Systems for Distributing Lottery Tickets" (Exhibit 10.5 to the Company's Registration Statement on Form S-1, No. 33-75142). 10.2 Pull-Tab Manufacturing and License Agreement between Algonquin Industries, Inc., Kazmier Kasper and the Company dates as of January 13, 1994 (Exhibit 10.6 to the Company's Registration Statement on Form S-1, No. 33-75142). 10.3 Management Compensatory Plans (a) 1994 Stock Incentive Plan (Exhibit 10.24 to the Company's Registration Statement on Form S-1, No. 33-75142). (b) 1994 Directors Stock Incentive Plan (Exhibit 10.25 to the Company's Registration Statement on Form S-1, No. 33-75142). 23.1 Consent of Grant Thornton LLP -- filed herewith. 23.2 Consent of KPMG LLP -- filed herewith. 25 Powers of Attorney -- filed herewith. 27 Financial Data Schedule (for SEC use only) -- filed herewith.
E-2 EX-4.3(E) 2 SECOND AMENDMENT TO LOAN AGREEMENT SECOND AMENDMENT TO LOAN AGREEMENT THIS SECOND AMENDMENT TO LOAN AGREEMENT (this "Amendment") is made and entered into this 28th day of September, 1999, by and between INTERLOTT TECHNOLOGIES, INC., a Delaware corporation ("Borrower"), and MERCANTILE BUSINESS CREDIT INC., a Missouri corporation ("Lender"). WITNESSETH: WHEREAS, Borrower and Lender have heretofore entered into that certain Loan Agreement dated October 29, 1997, as amended by that certain First Amendment to Loan Agreement dated as of October 29. 1998 (as so amended, the "Loan Agreement"; all capitalized terms used and not otherwise defined in this Amendment shall have the respective meanings ascribed to them in the Loan Agreement as amended by this Amendment); and WHEREAS, Borrower and Lender desire to amend the Loan Agreement in the manner hereinafter set forth; NOW, THEREFORE, in consideration of the premises and for other good and valuable consideration, the receipt and sufficiency of which are hereby acknowledged, Borrower and Lender hereby agree as follows: 1. The definitions of "Eligible Lease Payments" and "Lender's Revolving Credit Commitment" set forth in Section 1.01 of the Loan Agreement hereby are amended in their entirety to read as follows, respectively: Eligible Lease Payments shall mean, with respect to each Eligible Lease, as of any date, the aggregate minimum base rental payments (excluding any percentage rental payments) due or to become due under such Eligible Lease for instant lottery vending machines, prepaid phone card dispensing machines and/or smart card dispensing machines delivered to and accepted by the lessee(s) under such Eligible Lease on or prior to such date during the shorter of (a) the period commencing on such date and ending twenty-four (24) months thereafter and (b) the remaining term of such Lease (determined without giving effect to any renewal or extension terms exercisable at the option of the lessee(s) which have not been exercised by such lessee(s)). Lender's Revolving Credit Commitment shall mean the sum of $25,000,000.00. 2. Section 2.01(b) of the Loan Agreement hereby is deleted in its entirety and the following substituted in lieu thereof: (b) For purposes of this Agreement, the "Borrowing Base" shall mean the sum of: (i) (A) Eighty-Five Percent (85%) if the Rate of Dilution of Borrower's Accounts is less than or equal to Five Percent (5%), (B) Eighty Percent (80%) if the Rate of Dilution of Borrower's Accounts is greater than Five Percent (5%) but less than or equal to Eight Percent (8%), (C) Seventy-Five Percent (75%) if the Rate of Dilution of Borrower's Accounts is greater than Eight Percent (8%) but less than or equal to Ten Percent (10%) or (D) such percentage as Lender may determine in its sole and absolute discretion if the Rate of Dilution of Borrower's Accounts is greater than Ten Percent (10%), of the face amount of all then existing Eligible Accounts (less maximum discounts, credits and allowances which may be taken by or granted to Account Debtors in connection therewith and/or adjustments for reserves and allowances deemed appropriate by Lender in its good faith discretion exercised in accordance with its customary business practices and in a commercially reasonable manner to protect Lender with respect to the repayment of the Borrower's Obligations); plus (ii) the lesser of (A) Fifty Percent (50%) of the Eligible Inventory of Borrower, valued at the lower of cost or market in accordance with GAAP or (B) $2,500,000.00; plus (iii) (A) From the date of this Agreement until September 13, 1999, Sixty-Five Percent (65%) and (B) from and after September 13, 1999, Seventy Percent (70%), of the aggregate amount of all Eligible Lease Payments of Borrower; provided, however, that in no event may the aggregate amount of all Eligible Lease Payments of Borrower which are due from lessees who are not the United States of America or a state of the United States or a department, agency or instrumentality of any of the foregoing exceed the sum of $500,000.00; plus (iv) an amount up to Seven Hundred Fifty Thousand Dollars ($750,000.00) during the period commencing on September 13, 1999 and ending June 30, 2000 (the "Overadvance Amount"). 3. Exhibit A to the Loan Agreement (the form of Borrowing, Base Certificate) referenced in Section 2.01(c) of the Loan Agreement hereby is deleted in its entirety and Exhibit A attached to this Amendment substituted in lieu thereof. 4. Section 2.02(a)(iii) of the Loan Agreement hereby is deleted in its entirety and the following substituted in lieu thereof: (iii) whether such Revolving Credit Loan is to be a Prime Loan or a LIBOR Loan; provided, however, any Revolving Credit Loan constituting an Overadvance Amount under Section 2.01 (b) (iv) shall be a Prime Loan. 5. Section 2.03(a) of the Loan Agreement hereby is deleted in its entirety and the following substituted in lieu thereof: (a) the Revolving Credit Loans of Lender to Borrower shall be evidenced by an Amended and Restated Revolving Credit Note dated September 13, 1999 and payable to the order of Lender in the principal amount of $25,000,000.00, which Amended and Restated Revolving Credit Note shall be in substantially the form of Exhibit B attached hereto and incorporated herein by reference (as the same may from time to time be amended, modified, extended, renewed or restated, the "Revolving Credit Note") 6. Exhibit B to the Loan Agreement hereby is deleted in its entirety and Exhibit B attached to this Amendment substituted in lieu thereof. 7. Section 2.05(x) of the Loan Agreement hereby is deleted in its entirety and the following substituted in lieu thereof: 2.05 Interest Rates. (a) So long as no Event of Default under this Agreement has been declared by Lender and is continuing, (i) each Prime Loan (other than a Prime Loan constituting all or part off the Overadvance Amount) shall bear interest prior to maturity at a rate per annum equal to the Prime Rate (fluctuating as and when the Prime Rate shall change) and (ii) each Prime Loan constituting all or part of the Overadvance Amount shall bear interest prior to maturity at a rate per annum equal to One-Half of One Percent (.5%) over and above the Prime Rate (fluctuating as and when the Prime Rate shall change). So long as any Event of Default under this Agreement has been declared by Lender and is continuing, (i) each Prime Loan (other than a Prime Loan constituting all or part of the Overadvance Amount) shall bear interest prior to maturity at a rate per annum equal to Four Percent (4%) over and above the Prime Rate (fluctuating as and when the Prime Rate shall change) and (ii) each Prime Loan constituting all or part of the Overadvance Amount shall bear interest prior to maturity at a rate per annum equal to Four and One Half Percent (4.5%) over and above the Prime Rate (fluctuating as and when the Prime Rate shall change). Interest on Prime Loans shall be payable monthly in arrears on the first (1st) day of each month, commencing on the first such date after such Prime Loan is made, and at the maturity of the Revolving Credit Note, whether by reason of acceleration or otherwise. From and after the maturity of the Revolving Credit Note, whether by reason of acceleration or otherwise, (i) each Prime Loan (other than a Prime Loan constituting all or part of the Overadvance Amount) shall bear interest payable on demand until paid at a rate per annum equal to Four Percent (4(degree)/a) over and above the Prime Rate (fluctuating as and when the Prime Rate shall change) and (ii) each Prime Loan constituting all or part of the Overadvance Amount shall bear interest payable on demand until paid at a rate per annum equal to Four and One-Half Percent (4.5%) over and above the Prime Rate (fluctuating as and when the Prime Rate shall change). 8. New subsection (g) hereby is added to Section 2.08 of the Loan Agreement immediately following subsection (f) as follows: (g) Borrower hereby agrees to pay Lender a nonrefundable commitment fee (the "Commitment Fee") at the rate of One Quarter of One Percent (1/4%) per annum on the amount, if any, by which the Total Revolving Credit Outstandings is less than the amount of Lender's Revolving Credit Commitment, which Commitment Fee shall be computed on a daily basis and shall be payable monthly in arrears on the first (lst) day of each month during the Revolving Credit Period commencing September 1, 1999, and on the last day of the Revolving Credit Period. Said Commitment Fee shall be calculated on an actual day, 360-day year basis. 9. Borrower hereby agrees to pay to Lender on the date hereof an amendment fee in the amount of Twelve Thousand Five Hundred Dollars ($12,500.00). 10. Borrower hereby agrees to reimburse Lender upon demand for all out-of-pocket costs and expenses (including, without limitation, reasonable attorneys' fees and expenses) incurred by Lender in the preparation, negotiation and execution of this Amendment and any and all other agreements, documents, instruments and/or certificates relating to the amendment of Borrower's existing credit facilities with Lender (collectively, the "Loan Documents"). Borrower further agrees to pay or reimburse Lender for (a) any stamp or other taxes (excluding income or gross receipts taxes) which may be payable with respect to the execution, delivery, filing and/or recording of the Loan Documents and (b) the cost of any filings and searches, including, without limitation, Uniform Commercial Code filings and searches. All of the obligations of Borrower under this paragraph shall survive the payment of the Borrower's Obligations and the termination of the Loan Agreement. 11. All references in the Loan Agreement to "this Agreement" and any other references of similar import shall henceforth mean the Loan Agreement as amended by this Amendment. 12. Except to the extent specifically amended by this Amendment, all of the terms, provisions, conditions, covenants, representations and warranties contained in the Loan Agreement shall be and remain in full force and effect and the same are hereby ratified and confirmed. 13. This Amendment shall be binding upon and inure to the benefit of Borrower and Lender and their respective successors and assigns, except that Borrower may not assign, transfer or delegate any of its rights or obligations under the Loan Agreement as amended by this Amendment. 14. Borrower hereby represents and warrants to Lender that: (a) the execution, delivery and performance by Borrower of this Amendment are within the corporate powers of Borrower, have been duly authorized by all necessary corporate action and require no action by or in respect of, consent of or filing or recording with, any governmental or regulatory body, agency or official or any other Person; (b) the execution, delivery and performance by Borrower of this Amendment do not conflict with, or result in a breach of the terms, conditions or provisions of, or constitute a default under or result in any violation of, the terms of the Certificate or Articles of Incorporation or By-Laws of Borrower, any applicable law, rule, regulation, order, writ, judgment or decree of any court or governmental or regulatory agency or instrumentality or any agreement, document or instrument to which Borrower is a party or by which Borrower or any of its Property or assets is bound or to which Borrower or any of its Property or assets is subject; (c) this Amendment has been duly executed and delivered by Borrower and constitutes the legal, valid and binding obligation of Borrower enforceable against Borrower in accordance with its terms, except as such enforceability may be limited by (i) applicable bankruptcy, insolvency or similar laws affecting the enforcement of creditors' rights generally and (ii) general principles of equity (regardless of whether such enforceability is considered in a proceeding in equity or at law); (d) all of the representations and warranties of Borrower set forth in the Loan Agreement and the other Transaction Documents are true and correct in all material respects on and as of the date of this Amendment as if made on and as of the date of this Amendment; and (e) as of the date of this Amendment, no Default or Event of Default under or within the meaning of the Loan Agreement has occurred and is continuing. 15. In the event of any inconsistency or conflict between this Amendment and the Loan Agreement, the terms, provisions and conditions contained in this Amendment shall govern and control. 16. This Amendment shall be governed by and construed in accordance with the substantive laws of the State of Missouri (without reference to conflict of law principles). 17. ORAL AGREEMENTS OR COMMITMENTS TO LOAN MONEY, EXTEND CREDIT OR TO FORBEAR FROM ENFORCING REPAYMENT OF A DEBT, INCLUDING PROMISES TO EXTEND OR RENEW SUCH DEBT, ARE NOT ENFORCEABLE. TO PROTECT BORROWER AND LENDER FROM MISUNDERSTANDING OR DISAPPOINTMENT, ANY AGREEMENTS REACHED BY BORROWER AND LENDER COVERING SUCH MATTERS ARE CONTAINED IN THE LOAN AGREEMENT AS AMENDED BY THIS AMENDMENT AND THE OTHER TRANSACTION DOCUMENTS, WHICH LOAN AGREEMENT AS AMENDED BY THIS AMENDMENT AND OTHER TRANSACTION DOCUMENTS ARE A COMPLETE AND EXCLUSIVE STATEMENT OF THE AGREEMENTS BETWEEN BORROWER AND LENDER, EXCEPT AS BORROWER AND LENDER MAY LATER AGREE IN WRITING TO MODIFY THEM. 18. Notwithstanding any provision contained in this Amendment to the contrary, this Amendment shall not be effective unless and until Lender shall have received: (a) this Amendment, duly executed by Borrower; (b) The Amended and Restated Revolving Credit Note payable to the order of Lender in the principal amount of up to $25,000,000.00, duly executed by Borrower; and (c) a Secretary's Certificate certifying as to duly adopted resolutions of the Board of Directors of Borrower which authorize the execution, delivery and performance of this Amendment and containing an incumbency certificate, which shall identify by name and title and bear the signatures of all of the officers of Borrower executing this Amendment. IN WITNESS WHEREOF, Borrower and Lender have executed this Second Amendment to Loan Agreement as of the date first set forth above. INTERLOTT TECHNOLOGIES, INC. By: /s/David F. Nichols Title: President and CEO MERCANTILE BUSINESS CREDIT INC. By: /s/Dennis W. Blazer Title: CFO EXHIBIT A BORROWING BASE CERTIFICATE This Borrowing Base Certificate is delivered pursuant to Section 2.01(c) of that certain Loan Agreement dated October 29, 1997, by and among Interlott Technologies, Inc. ("Borrower") and Mercantile Business Credit Inc. ("Lender"), as the same may from time to time be amended, modified, extended, renewed or restated (the "Loan Agreement"). All capitalized terms used and not otherwise defined herein shall have the respective meanings ascribed to them in the Loan Agreement. Borrower hereby represents and warrants to Lender that the following information is true and correct as of , 19__ 1. 85% of face amount of Eligible Accounts of Borrower $ ------------- 2. 50% of Eligible Inventory of Borrower, valued in accordance with GAAP $ ------------- 3. Inventory Sub limit $2,500,000.00 4. Inventory Availability (Lesser of Item 2 or Item 3) $ ------------- 5. 70% of Eligible Lease Payments $ ------------- 6. Overadvance Amount (limit $750,000) $25,000,000.00 7. Borrowing Base (Sum of Item 1 plus Item 4 plus Item 5 plus Item 6) $ ------------- 8. Lender's Revolving Credit Commitment $ ------------- 9. Borrower's Maximum Availability (Lesser of Item 7 or Item 8) $ ------------- 10. Aggregate principal amount of outstanding Revolving Credit Loans $ ------------- 11. Aggregate undrawn face amount of outstanding Letters of Credit $ ------------- 12. Total Outstandings [Sum of Item 10 pl Item 11] $ ------------- 13. Borrowing Availability Excess (Deficit) [Item 9 minus Item 12] (Negative amount represents mandatory repayment) $ ------------- If Item 13 above is negative, this Certificate is accompanied by the mandatory repayment required by Section 2.01(d) of the Loan Agreement. This Borrowing Base Certificate is dated the day of , 19 INTERLOTT TECHNOLOGIES, INC. By Title: EXHIBIT B AMENDED AND RESTATED REVOLVING CREDIT NOTE $25,000,000.00 St. Louis, Missouri September 28, 1999 FOR VALUE RECEIVED, on the last day of the Revolving Credit Period, the undersigned, INTERLOTT TECHNOLOGIES, INC., a Delaware corporation ("Borrower"), hereby promises to pay to the order of MERCANTILE BUSINESS CREDIT INC., a Missouri corporation ("Lender"), the principal sum of Twenty-Five Million Dollars ($25,000,000.00), or such lesser sum as may then constitute the aggregate unpaid principal amount of all Revolving Credit Loans made by Lender to Borrower pursuant to the Loan Agreement referred to below. The aggregate principal amount of Revolving Credit Loans which Lender shall be committed to have outstanding under this Note at any one time shall not exceed Twenty-Five Million Dollars ($25,000,000.00), which amount may be borrowed, paid, reborrowed and repaid, in whole or in part, subject to the terms and conditions of this Note and of the Loan Agreement referred to below. Borrower further promises to pay to the order of Lender interest on the unpaid principal balance from time to time outstanding under this Note on the dates and at the rates set forth in the Loan Agreement referred to below. All payments received by Lender under this Note shall be allocated among the principal, interest, collection costs and expenses and other amounts due under this Note as follows: (a) so long as no Event of Default under the Loan Agreement has occurred and is continuing, as directed by Borrower; and (b) so long as any Event of Default under the Loan Agreement has occurred and is continuing, in such order and manner as Lender shall elect. The amount of interest accruing under this Note shall be computed on an actual day, 360-day year basis. All payments of principal and interest under this Note shall be made in lawful currency of the United States at the office of Lender situated at 100 South Brentwood Boulevard, Suite 500, St. Louis, Missouri 63105, or at such other place as the holder of this Note may from time to time designate in writing. Lender shall record in its books and records the date and amount of each Revolving Credit Loan made by it to Borrower and the date and amount of each payment of principal and/or interest made by Borrower with respect thereto; provided, however, that the obligation of Borrower to repay each Revolving Credit Loan made to Borrower under this Note shall be absolute and unconditional, notwithstanding any failure of Lender to make any such recordation or any mistake by Lender in connection with any such recordation. The books and records of Lender showing the account between Lender and Borrower shall be admissible in evidence in any action or proceeding and shall constitute prima facie proof of the items therein set forth in the absence of manifest error. Subject to the terms of the Loan Agreement referred to below, Borrower shall have the right to prepay all at any time or any portion from time to time of the unpaid principal of this Note prior to maturity, without penalty or premium. This Note is the Revolving Credit Note referred to in that certain Loan Agreement dated October 29, 1997 by and between Borrower and Lender, as amended by that certain First Amendment to Loan Agreement dated as of October 29, 1998 and that certain Second Amendment to Loan Agreement dated the date hereof (as so amended, and as the same may from time to time be further amended, modified, extended, renewed or restated, the "Loan Agreement"). The Loan Agreement, among other things, contains provisions for acceleration of the maturity of this Note upon the occurrence of certain stated events and also for prepayments on account of the principal of this Note and interest on this Note prior to the maturity of this Note upon the terms and conditions specified therein. All capitalized terms used and not otherwise defined in this Note shall have the respective meanings ascribed to them in the Loan Agreement. This Note is secured by, among other things, that certain Security Agreement dated October 29, 1997 and executed by Borrower in favor of Lender (as the same may from time to time be amended, modified, extended, renewed or restated, the "Security Agreement") and that certain Patent, Trademark and License Security Agreement dated October 29, 1997 and executed by Borrower in favor of Lender (as the same may from time to time be amended, modified, extended, renewed or restated, the "Patent, Trademark and License Security Agreement"), to which Security Agreement and Patent, Trademark and License Security Agreement reference is hereby made for a description of the security and a statement of the terms and conditions upon which this Note is secured. If any Event of Default under the Loan Agreement shall occur and be continuing, then Lender's obligation to make additional Revolving Credit Loans under this Note may be terminated in the manner and with the effect as provided in the Loan Agreement and the entire outstanding principal balance of this Note and all accrued and unpaid interest thereon may be declared to be immediately due and payable in the manner and with the effect as provided in the Loan Agreement. In the event that arty payment of any principal of or interest on this Note is not paid when due, whether by reason of maturity, acceleration or otherwise, and this Note is placed in the hands of an attorney or attorneys for collection or for foreclosure of the Security Agreement or the Patent, Trademark and License Security Agreement, or if this Note is placed in the hands of an attorney or attorneys for representation of Lender in connection with bankruptcy or insolvency proceedings relating hereto, Borrower promises to pay to the order of Lender, in addition to all other amounts otherwise due hereon, the costs and expenses of such collection, foreclosure and representation, including, without limitation, reasonable attorneys' fees and expenses (whether or not litigation shall be commenced in aid thereof). All parties hereto severally waive presentment for payment, demand for payment, protest, notice of protest and notice of dishonor. This Note shall be governed by and construed in accordance with the substantive laws of the State of Missouri (without reference to conflict of law principles). This Note is an amendment, restatement and continuation of that certain Revolving Credit Note of Borrower dated October 29, 1997 and payable to the order of Lender in the principal amount of $15,000,000.00 and is not a novation thereof. All interest accrued on the instrument being amended and restated by this Note shall continue to be due and payable to Lender until paid. 1NTERLOTT TECHNOLOGIES, INC. By: /s/David F. Nichols Title: President and CEO By: /s/Dennis W. Blazer Title: CFO EX-23.1 3 CONSENT OF GRANT THORNTON LLP We have issued our report dated February 7, 2000, accompanying the financial statements included in the Annual Report of Interlott Technologies, Inc. on Form 10-K for the year ended December 31, 1999. We hereby consent to the incorporation by reference of said report in the Registration Statement of Interlott Technologies, Inc. on Form S-8 (No. 33-78092). /s/Grant Thornton LLP Cincinnati, Ohio March 29, 2000 EX-23.2 4 CONSENT OF KPMG LLP The Board of Directors Interlott Technologies, Inc.: We consent to incorporation by reference in the registration statement (No. 33-78092) on Form S-8 of Interlott Technologies, Inc. of our report dated February 26, 1999, relating to the balance sheet of Interlott Technologies, Inc. as of December 31, 1998, and the related statements of income, stockholders' equity (deficit), and cash flows for each of the years in the two-year period ended December 31, 1998, and the related schedule, which report appears in the December 31, 1998, annual report on Form 10-K of Interlott Technologies, Inc. /s/KPMG LLP Cincinnati, Ohio March 27, 2000 EX-25 5 POWERS OF ATTORNEY POWER OF ATTORNEY KNOW ALL MEN BY THESE PRESENT, that the undersigned constitutes and appoints L. Rogers Wells, Jr. and Dennis W. Blazer and each of them, his true and lawful attorneys-in-fact and agents, with full power of substitution, for him and in his name, place and stead, in any and all capacities, to sign the Annual Report on Form 10-K of Interlott Technologies, Inc. for the fiscal year ended December 31, 1999, and any and all amendments thereto, and to file the same, with all exhibits thereto and other documents in connection therewith, with the Securities and Exchange Commission and the American Stock Exchange, granting unto said attorneys-in-fact and agents. and each of them, full power and authority to do and perform each and every act and thing requisite or necessary to be done, as fully to all intents and purposes as he might or could do in person, hereby ratifying and confirming all that said attorneys-in-fact and agents or any of them, or their or his substitute or substitutes, may lawfully do or cause to be done by virtue hereof. This 20 day of March, 2000. /s/John J. Wingfield ------------------------ John J. Wingfield POWER OF ATTORNEY KNOW ALL MEN BY THESE PRESENT, that the undersigned constitutes and appoints L. Rogers Wells, Jr. and Dennis W. Blazer and each of them, his true and lawful attorneys-in-fact and agents, with full power of substitution, for him and in his name, place and stead, in any and all capacities, to sign the Annual Report on Form 10-K of Interlott Technologies, Inc. for the fiscal year ended December 31, 1999, and any and all amendments thereto, and to file the same, with all exhibits thereto and other documents in connection therewith, with the Securities and Exchange Commission and the American Stock Exchange, granting unto said attorneys-in-fact and agents. and each of them, full power and authority to do and perform each and every act and thing requisite or necessary to be done, as fully to all intents and purposes as he might or could do in person, hereby ratifying and confirming all that said attorneys-in-fact and agents or any of them, or their or his substitute or substitutes, may lawfully do or cause to be done by virtue hereof. This 17 day of March, 2000. /s/H. Jean Marshall ------------------------ H. Jean Marshall POWER OF ATTORNEY KNOW ALL MEN BY THESE PRESENT, that the undersigned constitutes and appoints L. Rogers Wells, Jr. and Dennis W. Blazer and each of them, his true and lawful attorneys-in-fact and agents, with full power of substitution, for him and in his name, place and stead, in any and all capacities, to sign the Annual Report on Form 10-K of Interlott Technologies, Inc. for the fiscal year ended December 31, 1999, and any and all amendments thereto, and to file the same, with all exhibits thereto and other documents in connection therewith, with the Securities and Exchange Commission and the American Stock Exchange, granting unto said attorneys-in-fact and agents. and each of them, full power and authority to do and perform each and every act and thing requisite or necessary to be done, as fully to all intents and purposes as he might or could do in person, hereby ratifying and confirming all that said attorneys-in-fact and agents or any of them, or their or his substitute or substitutes, may lawfully do or cause to be done by virtue hereof. This 20 day of March, 2000. /s/Kazmier J. Kasper ------------------------ Kazmier J. Kasper POWER OF ATTORNEY KNOW ALL MEN BY THESE PRESENT, that the undersigned constitutes and appoints L. Rogers Wells, Jr. and Dennis W. Blazer and each of them, his true and lawful attorneys-in-fact and agents, with full power of substitution, for him and in his name, place and stead, in any and all capacities, to sign the Annual Report on Form 10-K of Interlott Technologies, Inc. for the fiscal year ended December 31, 1999, and any and all amendments thereto, and to file the same, with all exhibits thereto and other documents in connection therewith, with the Securities and Exchange Commission and the American Stock Exchange, granting unto said attorneys-in-fact and agents. and each of them, full power and authority to do and perform each and every act and thing requisite or necessary to be done, as fully to all intents and purposes as he might or could do in person, hereby ratifying and confirming all that said attorneys-in-fact and agents or any of them, or their or his substitute or substitutes, may lawfully do or cause to be done by virtue hereof. This 22 day of March, 2000. /s/Gary S. Bell ------------------------ Gary S. Bell EX-27 6 FINANCIAL DATA SCHEDULE
5 1,000 YEAR DEC-31-1999 JAN-01-1999 DEC-31-1999 133 0 3,305 0 5,214 10,171 36,119 14,302 36,204 19,611 0 1,335 0 32 14,654 36,204 3,312 22,334 14,047 13,093 0 0 1,102 2,999 1,107 1,892 0 178 0 2,070 .65 .65
-----END PRIVACY-ENHANCED MESSAGE-----