Powerhouse Technologies, Inc.

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Powerhouse Technologies, Inc.

2311 South 7th Avenue
Bozeman, Montana 59715
U.S.A.
(406) 585-6617
Fax: (406) 585-6609
Web site: http://www.pwrh.com

Public Company
Incorporated: 1991 as Video Lottery Technologies, Inc.
Employees: 830
Sales: $201.2 million (1998)
Stock Exchanges: NASDAQ
Ticker Symbol: PWRH
SICs: 3999 Manufacturing Industries; 7372 Prepackaged Software; 6719 Holding Companies

Powerhouse Technologies, Inc. is a leader in the development, manufacture, marketing and operation of gaming and wagering systems in the on-line lottery, video lottery, casino gaming, and pari-mutuel wagering markets. Video lottery operations include video terminals on which games such as poker, blackjack, bingo and keno can be played. The company designs and produces on-line computer systems for state lotteries, and places their gaming machines in casinos, riverboat gambling operations, and Native American gaming locations. The company also owns and operates a racetrack in Sunland Park, New Mexico. Powerhouse operates its business through four wholly owned subsidiaries, Automated Wagering International, Inc. (AWI), Video Lottery Consultants, Inc. (VLC), United Wagering Systems (UWS)—more commonly known by the trade name of its principal subsidiary, United Tote—and Sunland Park.

The Early Years

The roots of Powerhouse Technologies, Inc. can be traced to an earlier company called Video Lottery Technologies, Inc. This company was incorporated in 1991 as a holding company for six corporations that had previously been under the control of numerous individuals, including Larry Lippon. VLC, the principal operating subsidiary of the new entity, was a producer and marketer of video lottery terminals and the central control system software. VLC had been incorporated in 1985, but did not achieve profitability until 1988. The other operating subsidiaries that were combined to form Video Lottery Technologies were Raven’s D & R Music, Inc., Automatic Music Service of Billings, Inc., Automation First, Inc., Lucky Lady, Inc., and Piper Lance, Inc. Automation First, Inc., operated three coin-operated machine routes in Montana; Lucky Lady, Inc. operated two video-lottery-licensed food and beverage establishments in Montana; and Piper Lance, Inc. owned and operated an airplane that was used by the other subsidiaries on a rental basis.

The new holding company was reorganized just prior to the initial public offering, as it acquired certain assets and all of the outstanding common stock of the subsidiaries, which until that time had been held by 15 different individuals. After the offering, the new entity’s chief executive officer, Larry Lippon, owned 39.1 percent of the company. The company’s president, Richard Barber, owned 9.7 percent, and another 10.9 percent was owned by other company executives who had joined together in a resolve to discourage future takeovers by outsiders. Proceeds of the offering were used to repay the debt incurred when acquiring the subsidiaries, to repay indebtedness to banks and certain other individuals, and to finance expansion of their principal facility.

The Background of Lotteries Prior to the 1990s

Historically, most lottery systems have been operated by state, local, and foreign governmental authorities. In the United States, lottery revenues are often designated by each individual state for particular purposes: education, aid to the elderly, economic development, conservation, and so on. While only two states were authorizing traditional lotteries in 1970, that number had grown to 32 states and the District of Columbia by 1990—and the growth of lottery operations continued to accelerate. Accounting for the rise in overall gross consumer spending in the gaming industry (including all forms of legal gaming, such as horse races, casinos, bingo, lotteries, etc.) were increases in the number of gaming jurisdictions, as well as increases in spending on existing gaming, which rose to $247 billion by 1989. By 1991, governments in 88 countries had authorized traditional lotteries, including lotto, numbers, and keno—all of which typically create nontax revenues.

The relatively new idea of video lottery came into being in Montana, South Dakota, and three Canadian provinces as a means of generating new sources of gaming revenues. Video lottery used video terminals to provide low-stakes entertainment gaming without increasing general taxation. Video lottery terminals have been used as part of a government-run central control system, as well as on a stand-alone basis. One of the subsidiaries of Video Lottery Technologies—VLC—designed terminals connected to a jurisdiction-wide control system in South Dakota, Newfoundland, Nova Scotia, and New Brunswick. The system was monitored by a central computer using telephonic communications; for example, in Montana, terminals internally recorded net revenues, and owners at each location were required to report amounts to authorities for taxation.

Innovations in the Early 1990s

The success of the terminals that VLC had designed to connect to a central control system within one jurisdiction prompted its new parent company to design and install a multi-jurisdictional control system for video lottery. Within the industry, Video Lottery Technologies had begun as the only company focused primarily on government-authorized video lottery operations, as opposed to traditional lottery systems, casino gaming, or other forms of video gaming. The company’s ability to expand and generate greater revenues and earnings was dependent upon government approval of jurisdiction-wide video lottery operations. Through its direct sales force the company began marketing terminals and software that had been manufactured in its principal facility in Bozeman, Montana. The products were sold to independent operators of coin-operated amusement machines in Montana, South Dakota and New Brunswick, and to the government-operated Atlantic Lottery Commission in Newfoundland and Nova Scotia. The control system software was designed to run on any model or multi-module configuration of the IBM System/88 family of mainframe computers.

In addition to obtaining revenues from the granting of their software licenses, use of software, maintenance, and installation services, as well as the sale of video terminals, three of the company’s subsidiaries sold amusement machines such as pin-ball machines, pool tables, CD players, and jukeboxes. Certain subsidiaries also operated licensed food and beverage establishments in Billings, Montana—in locations that also operated their video lottery terminals. These locations served as testing grounds for new equipment and software concepts.

Changes within the industry in the early to mid-1990s prompted Video Lottery Technologies to create a strategic planning committee for the purpose of considering alternative opportunities and to formulate a long-term strategic plan. Mark Spagnolo, who had served on the company’s board of directors and as the designee for Electronic Data Systems Corp., was appointed as the new CEO.

Soon thereafter, the company introduced its new release of the MasterLink advanced on-line lottery central control system to the Delaware Lottery. The company also released the new Ovation terminals for lotteries in Delaware and Minnesota.

Challenges in the Mid-1990s

Beginning in 1994, profits at Video Lottery began to slide. Total revenues had increased from $174.6 million in 1993 to $188.8 million in 1994, bolstered by the acquisition of the UWS subsidiary and an increase in video lottery gaming revenues. However, the company’s ensuing revenue declines were attributed to a “poor reputation for customer service, high management turnover and quarter-after-quarter losses,” according to a March 6, 1998 Investor’s Business Daily.

In response, the company began to pursue new state contracts. In 1995, Video Lottery Technologies reported that it was awarded a contract to lease 600 additional lottery terminals to the Oregon Lottery; a preliminary award of a five-year on-line lottery services contract with the Arizona lottery to the AWI subsidiary; and a recommendation from the Nevada State Gaming Control Board to the Nevada Gaming Commission for the approval of a license for the manufacture and distribution of gaming devices and operation of a gaming route.

However, AWI’s contract with the state of Arizona was canceled in 1996 due to problems related to the implementation of the on-line system. Thus, the company continued to reorganize. The addition of new subsidiaries since the company had been incorporated in 1991, and the continual shift in focus brought on by the changing demands of gaming consumers, prompted Video Lottery Technologies to change its name in 1997 to Powerhouse Technologies, Inc. The company promoted Richard Haddrill to the CEO position in June 1997, with the hope that he would lead the company out of the tough times.

Company Perspectives:

These guiding principles reflect the quality and integrity of Powerhouse’s products, services and people, and are critical to the realization of the Company’s business vision: Our customers are our priority; Our purpose is to produce above average returns for our shareholders through long-term earnings growth; We provide innovative technology, quality products, and responsive service to our customers; We produce value for our customers and receive fair compensation for that value; We help our people by providing growth opportunities, a team environment, and fair compensation; We take pride in honoring our commitments and ’doing what we say we will do’ We are professional and maintain the highest level of ethics; We plan carefully and do it right the first time; We are positive, yet direct and candid in all our communications; We bring power and energy to everything we do.

One of the things Haddrill blamed for the company’s three years of heavy losses was what he called “A bad marriage to Electronic Data Systems (EDS), which had been our technology partner for three years,” according to Investor’s Business Daily. The partnership and the revolving door of top executives, he explained, “resulted in an active board of directors that tried to run the company, and it’s difficult to run a company by committee.” Another complaint with EDS, according to Haddrill, was that customer service deteriorated greatly while they ran Powerhouse’s systems.

In 1994, Video Lottery Technologies had outsourced its online lottery business to EDS, who had purchased 545,454 shares of Video Lottery Technologies’ common stock and almost two million shares of its preferred stock. The companies had signed a ten year agreement in which EDS became responsible for providing numerous services that were primarily related to the company’s AWI subsidiary. When the deterioration of services became apparent, Powerhouse moved to end the partnership, resulting in EDS’s claim that Powerhouse would have to pay them a $39 million settlement. Instead, Haddrill worked out a deal that allowed Powerhouse to pay EDS back $27 million in a note payable over seven years. Part of the deal stipulated that EDS would have to give back all of the computer equipment it was using to service Powerhouse customers, plus the company stock that it owned. After the split, Powerhouse began bringing more of its operations in-house, having transferred lottery personnel and services back to AWI

The End of the Century and Beyond

After its reorganization, the Powerhouse strategy included the further funding of its Video Lottery Consultants unit, which invented multiple casino games for the casino marketplace. Haddrill’s other priorities involved growing Powerhouse’s AWI unit by winning back customers that had signed on with competitors, and by pursuing new state contracts. The company focused on introducing new on-line lottery technology, beginning with the 1996 software contract for the Maryland lottery. The company positioned itself against GTECH Holdings, Inc., which held a 50 percent share of the worldwide market for lottery systems, and which competed aggressively with AWI for several contracts. AWI only held a seven percent share of the market.

Even after Powerhouse introduced four additional systems, it lost the contract to run the Texas lottery, which company officials predicted would have saved that state $80 million dollars over four years. Instead, the contract was awarded to rival GTECH Holdings. Offsetting that disappointment, however, were contracts awarded to Powerhouse by the state of Florida—one of the largest lotteries in the world—and in New Mexico, where the company was contracted to install up to 300 casino gaming machines at its Sunland Park racetrack.

Sunland Park had become another development target for Haddrill’s new strategy. Although the racetrack itself had not been a very profitable venture up to that point—it had been classified as a discontinued operation in late 1995—management decided to reconsider. They reopened the venture with the expectation that gaming machine revenues would offset the racing segment.

Moreover, the company projected that its United Tote Division was capable of providing the expertise in the racing arena, which would influence the sales of gaming machines to other racetracks, as well as providing the skills to expand through initiating more gaming legislation. United Tote returned to profitability one year later, following a vote by the New Mexico legislature that allowed casino gaming at pari-mutuel racetracks including the Company’s racetrack in Sunland Park. The bill allowed the operation of up to 300 video gaming machines per pari-mutuel racetrack facility for up to 12 hours per day.

Internationally, in 1997 AWI was awarded a $12 million contract for supplying a lottery system and equipment for an established Latin American lottery. Furthermore, the VLC subsidiary received a 500 machine order from the Canadian Province of Quebec, and completed installation of a control system and terminals in Norway for the Norwegian Red Cross. The VLC subsidiary was licensed in parts of South Africa, giving direct access to one of the world’s largest new video lottery markets. Company reports estimated the market’s potential at 45,000-70,000 machines. Permanent licenses were also granted to VLC in Nevada and New Jersey, two of the largest gaming machine markets in the United States, and the California State Lottery ordered in excess of 2,000 instant ticket validation terminals.

Meanwhile, the gaming machine segment had successfully gained approval and licenses to sell video gaming machines in numerous jurisdictions in 1996 including New Jersey, Minnesota, Wisconsin, Connecticut and Arizona. This raised the number of jurisdictions in which the company could sell gaming machines to 43. The VLC subsidiary introduced the newest version of video machines: the Winning Touch Power Series with state-of-the-art enhanced graphics, sound, and color capabilities.

In 1997, Powerhouse received the ISO-9002 certification, which is an international standard of quality covering all facets of the manufacturing process. Powerhouse began exploring the future possibility of penetration into new markets including New South Wales, Australia, and new parts of Canada and South Africa.

It remains to be seen whether AWI, Powerhouse’s principal source of revenues, can remain competitive with on-line lottery giant, GTECH, which in 1997 supplied systems to 29 of the 38 U.S. on-line lottery jurisdictions and had a strong presence internationally. Subsidiary AWI’s success is largely related to innovative game design and its technological advancements. In the meantime, revenues in Powerhouse’s other segments have continued to rise and offer testament to the effectiveness of the most recent management team’s efforts.