Powerhouse Technologies Inc/DE · 10-K405 · For 12/31/98

Filed On 3/31/99   ·   SEC File 0-19322   ·   Accession Number 875459-99-3

Annual Report -- [X] Reg. S-K Item 405   ·   Form 10-K
Filing Table of Contents

Document/Exhibit                   Description                      Pages   Size 

 1: 10-K405     Annual Report                                         74    492K 
 2: EX-10.9     International Equity Partners Consulting Agreement     2     14K 
 3: EX-10.11    Patricia W. Becker Consulting Agreement                2     14K 
 4: EX-10.13    Alan Rassaby Employment Agreement                      5     28K 
 5: EX-10.14    Christer S. T. Roman Employment Agreement              6     29K 
 6: EX-22.1     Wholly-Owned Subsidiaries of the Company               1      5K 
 7: EX-24.1     Independent Auditors' Consent                          1      7K 
 8: EX-27       Article 5 Financial Data Schedule                      1      7K 

10-K405   ·   Annual Report
Document Table of Contents

10-K405
1st Page of 74
TOC
Top
Previous
Next
Bottom
Just 1st
 
Sponsored Ads...


================================================================================

SECURITIES AND EXCHANGE COMMISSION
 Washington, D. C. 20549
 ---------------------

 FORM 10-K

(Mark One)                                                                      
  X   Annual Report pursuant  to Section 13 or 15(d) of the Securities  Exchange
-----                                                                           
Act of 1934 for the  fiscal  year ended  December 31, 1998 or       

      Transition  Report  pursuant  to Section  13 or  15(d)  of  the Securities
-----                                                                           
Exchange Act of 1934 for the transition period from          to     

Commission file number 0-19322                                                  

 POWERHOUSE TECHNOLOGIES, INC.
(Exact name of registrant as specified in its charter)

 ---------------------

         Delaware                                                     81-0470853
(State or other jurisdiction of                                 (I.R.S. Employer
incorporation or organization)                                 entification No.)

115 Perimeter Place, Suite 911                                                  
Atlanta, Georgia                                                           30346
(Address of principal executive offices)                              (Zip Code)

(770) 481-1800
(Registrant's telephone number, including area code)

Securities registered pursuant to Section 12(b) of the Act:  None               
Securities registered pursuant to Section 12(g) of the Act:  Common  Stock, $.01
par value                                                                       

     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 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.    X                                                                 
-----                                                   

     The aggregate  market value of voting stock held by  non-affiliates  of the
registrant as of March 1, 1999,  was  approximately  $156,688,000  (based on the
last sale price of such stock as reported by NASDAQ  National  Market  System on
such date).                                                                     

     The number of shares outstanding of the registrant's common stock, $.01 par
value ("Common Stock"), as of March 1, 1999, was 10,622,958.                    

================================================================================

- 1 - 

10-K405
2nd Page of 74
TOC
1st
Previous
Next
Bottom
Just 2nd

 TABLE OF CONTENTS

PART I

                                                                          Page
                                                                          ----

ITEM 1.  Business                                                              3
ITEM 2.  Properties                                                           29
ITEM 3.  Legal Proceedings                                                    29
ITEM 4.  Submission of Matters to a Vote of Security Holders                  29

 PART II

ITEM 5.  Market for Registrant's Common Equity                                  
              and Related Stockholder Matters                                 30
ITEM 6.  Selected Financial Data                                              31
ITEM 7.  Management's Discussion and Analysis of Financial                      
              Condition and Results of Operations                             33
ITEM 7a. Quantitative and Qualitative Disclosures About Market Risk           42
ITEM 8.  Financial Statements and Supplementary Data                          42
ITEM 9.  Changes in and Disagreements with Accountants                          
              on Accounting and Financial Disclosure                          63

PART III

ITEM 10. Directors and Executive Officers of the Registrant                   63
ITEM 11. Executive Compensation                                               66
ITEM 12. Security Ownership of Certain Beneficial                               
              Owners and Management                                           70
ITEM 13. Certain Relationships and Related Transactions                       71

 PART IV

ITEM 14. Exhibits, Financial Statement Schedules,                               
              and Reports on Form 8-K                                         72

Signatures                                                                    74

- 2 - 

10-K405
3rd Page of 74
TOC
1st
Previous
Next
Bottom
Just 3rd

PART I

ITEM 1. BUSINESS                                                                

     Powerhouse Technologies,  Inc. (the "Company") was incorporated in Delaware
in  May  1991.  The  Company  acts  as a  holding  company  for  several  active
corporations. Unless the context otherwise requires, references in the form 10-K
for fiscal year ended  December 31, 1998 ("Form 10-K") to the "Company" or "PTI"
refer to Powerhouse Technologies, Inc. and its subsidiaries; references to "AWI"
refer to Automated  Wagering  International,  Inc.,  one of the  Company's  four
principal  operating  subsidiaries,  which provides  on-line lottery systems and
services  primarily to  governmental  lottery  authorities;  references to "VLC"
refer to VLC, Inc., another of the Company's principal  operating  subsidiaries,
which  develops,  manufactures  and  markets  video  lottery  and casino  gaming
machines and central control  systems;  references to "United Tote" refer to the
Company's  third  principal  operating  segment  whose  operating  units provide
computerized  pari-mutuel  wagering systems for horse and greyhound  racetracks,
off-track betting facilities and jai alai frontons. References to "Sunland Park"
mean  Nuevo Sol Turf  Club,  Inc.,  the  Company's  fourth  principal  operating
subsidiary  which owns and operates a racetrack  facility in Sunland  Park,  New
Mexico. References to the "Subsidiaries" refer to AWI, VLC, United Tote, Sunland
Park  and  the  other  subsidiaries  of the  Company.  The  Company's  principal
executive  offices  are  located at 115  Perimeter  Place,  Suite 911,  Atlanta,
Georgia 30346, and its telephone number is (770) 481-1800.                      

Note on Forward-looking Statements                                              
----------------------------------                                              

     Certain   statements  in  this  Annual  Report  on  Form  10-K   constitute
"forward-looking statements" within the meaning of Section 27A of the Securities
Act of 1933  and  Section  21E of the  Securities  Exchange  Act of  1934.  Such
forward-looking  statements  involve known and unknown risks,  uncertainties and
other factors which may cause the actual results, performance or achievements of
the Company,  or industry  results,  to be materially  different from any future
results,   performance,   or   achievements   expressed   or   implied  by  such
forward-looking  statements.  Such factors include, among others, the following:
general economic and business  conditions;  competitive factors in the industry,
including additional competition from existing competitors or future entrants to
the industry; social and economic conditions;  local, state and federal laws and
regulations;  changes in business  strategy or development  plans; the Company's
indebtedness;  quality of  management;  availability,  terms and  deployment  of
capital; business abilities and judgment of personnel; availability of qualified
personnel; and other factors.                                                   

Certain Recent Developments                                                     
---------------------------                                                     

     On  March  10,  1999 the  Company,  Anchor  Gaming  ("Parent")  and  Anchor
Powerhouse Acquisition Corporation, a wholly-owned subsidiary of Parent ("Merger
Sub")  announced  that they had entered into a definitive  Agreement and Plan of
Merger (the "Merger Agreement") providing for, among other things, the merger of
the Merger Sub with and into the Company,  with the Company thereupon becoming a
wholly-owned  subsidiary of Parent (the "Merger").  The Merger has been approved
by the Boards of Directors of the Company, Parent and Merger Sub.               

     Pursuant to the Merger  Agreement,  each outstanding share of common stock,
par value of $.01 per share,  of the Company will be converted into the right to
receive cash in the amount of $19.50.                                           

     The  transaction  is expected to be completed in the third quarter 1999. It
is  subject to  customary  conditions,  including  the  absence  of any  adverse
material  changes to the finances of the Company  between signing and closing of
the merger, clearance under the Hart-Scott-Rodino Antitrust Improvements Act and
the grant of permits or approvals in some key jurisdictions in which the Company
operates. The Merger is also subject to approval by the Company's stockholders. 

     In connection with the Merger Agreement,  directors and executive  officers
of the Company have entered into or agreed to enter into voting  agreements with
Parent  (each a  "Voting  Agreement")  pursuant  to  which  such  directors  and
officers,  among other things, have agreed to vote an aggregate of approximately
4.4% of the Company's outstanding shares in favor of the Merger.                

- 3 - 

10-K405
4th Page of 74
TOC
1st
Previous
Next
Bottom
Just 4th

     On February  22,  1999,  the Company  opened its casino at the Sunland Park
Racetrack & Casino in New Mexico.                                               

     In  March  1999,  the  Company  announced  that  AWI  and the  Lottery  had
renegotiated  and signed an amended  contract  under  which AWI will  provide an
on-line lottery system and related services to the Florida  Lottery.  A decision
by the Lottery not to join the multi-state  game  Powerball(R)  necessitated the
renegotiation  of the contract  entered into in October 1998.  Under the amended
contract,  the Company will design,  install and operate a new statewide on-line
lottery  system for an initial  term of five years and three  months,  with two,
two-year renewal options.  The Company estimates that revenues from the contract
over the initial 63-month period will be approximately $200 million. AWI will be
compensated at a base rate of on-line sales, and, if on-line ticket sales exceed
targeted  amounts,  an  additional  incentive  rate.  The October 1998  contract
between  AWI and the  Department  of Lottery  of the State of Florida  was for a
nine-year  term.  The Lottery  had  originally  awarded  the  contract to AWI in
October  1996 after a  competitive  procurement  process in which the  Lottery's
evaluation  committee  judged AWI the most highly  qualified vendor based on its
superior  technology  and lower  cost.  Subsequent  to the  announcement  of the
contract award in 1996, the losing vendor filed two consecutive  protests,  both
of which were rejected, resulting in a final order from the Lottery awarding the
contract to AWI in March 1998. A further  attempt by the losing vendor to enjoin
the contract was rejected by the Florida district court, allowing the parties to
negotiate  and  finalize  the  terms of the  nine-year  agreement.              

     In January 1999, the Company  announced the formal  adoption of a corporate
responsible  gaming  policy and program at the December  meeting of its Board of
Directors  in Las  Vegas.  As a matter  of  policy,  the  Company  has  actively
committed to promote  responsible  gaming with its employees,  customers and the
public as well as support those agencies and programs  dedicated to researching,
preventing and treating problem gambling.                                       

     In January 1999, VLC received an order to provide 1,000 gaming  machines to
Tattersall's  Gaming Pty.  Ltd.,  Australia.  Total revenue over the life of the
contract is estimated to be approximately $8.7 million.  Initially, 250 machines
are  scheduled  to be  delivered  in the third  quarter  of 1999.  The final 750
machines will be delivered in early 2000, and are subject to agreed  performance
criteria.                                                                       

     In December 1998, AWI was selected by the Swiss Sport-Toto Gesellschaft (on
behalf of the  Switzerland  consortium  Gesellschaft  Schweizer  Zahlenlotto) to
provide a  MasterLink(TM)  on-line  lottery  system.  The single system will run
three  state-sanctioned  regional  lotteries and one national  sports lottery in
Switzerland.  Final  contract  negotiations  on the project  scope and  specific
services are anticipated to be completed in the second quarter 1999. The Company
estimates  that the  software  order  will  generate  a minimum of $7 million of
revenue.  Implementation  is scheduled  to be  completed  in 2000.  In the first
phase, AWI's MasterLink(TM) system will run on-line lotto games, data management
and Internet gaming and, in a further phase,  instant ticket game accounting for
the involved  lotteries,  interfacing  with 3,750 on-line  terminals and several
thousand  instant  ticket  terminals  throughout  Switzerland.  The program will
incorporate new PC-based touchscreen  terminals  manufactured by Siemens Nixdorf
Retail and Banking  Systems  GmbH,  Paderborn,  Germany.  The Lottery  Solutions
Division of Siemens Nixdorf in Konstanz,  Germany, will develop the interface to
the MasterLink(TM) system, in a joint effort with AWI.                          

     In November  1998,  the Company was selected by the South Dakota Lottery to
provide both the on-line lottery and video lottery central systems and services.
In March 1999,  the Company and the South  Dakota  Lottery  entered into the new
contract for an initial term of seven years, with extension options for up to an
additional three years.  The new contract will continue the Company's  nine-year
relationship  with the South  Dakota  Lottery.  AWI has been the on-line  system
supplier for the South Dakota Lottery since the inception of the state's on-line
games in 1990.  VLC supplied the world's  first video  lottery  central  control
system to South Dakota in 1989,  which will now be replaced  with the  Company's
new,  next-generation  Advanced Gaming System.  In addition,  VLC has sold 7,500
video  lottery  gaming  machines to licensed  operators  and  locations in South
Dakota since 1989.                                                              

     In October 1998,  AWI was selected by the Hoosier  Lottery to provide a new
on-line  lottery  system and  related  services  for the state of  Indiana.  The
decision  by the Lottery was the result of a  competitive  procurement  in which
several companies participated.  In January 1999, AWI signed a contract with the
Hoosier  Lottery of the State of Indiana to provide the on-line  lottery system,
terminals and system                                                            

- 4 - 

10-K405
5th Page of 74
TOC
1st
Previous
Next
Bottom
Just 5th

operation for seven years with extension  options for up to an additional  three
years. Revenues from the initial seven-year contract are estimated to exceed $80
million.  AWI will install its MasterLink(TM)  Advanced Gaming System along with
approximately  4,000  lottery  retailer   terminals.   The  scheduled  date  for
completion of the  conversion  to the new AWI system from the Lottery's  current
vendor is August 29, 1999.                                                      

     In June 1998, the Company announced that its gaming machine division,  VLC,
had  signed a  letter-of-intent  which  resulted  in a contract  to provide  its
Advanced  Gaming  System  (TM)  (AGS)  central  control  system  and 4,300  site
controllers to Quebec,  Canada-based CASILOC Inc. for the monitoring and control
of 15,000  machines  operated  by La Societe des  Loteries  Video du Quebec Inc.
(SLVQ).                                                                         

     In May 1998, the Company  announced that AWI had signed a contract with the
Pennsylvania Lottery to provide an on-line system and related services for seven
years through  December  2005,  with  extension  options for up to an additional
three years.  Revenues  from the contract are  estimated at $276 million for the
initial seven years. The new agreement continues AWI's 21-year relationship with
Pennsylvania as its on-line lottery system supplier.  The  Pennsylvania  Lottery
announced  the  contract  award in  November  1997 after a  competitive  bidding
process in which the Pennsylvania Lottery review committee ranked AWI's proposal
superior.                                                                       

 Business of the Company
 -----------------------

Powerhouse Technologies, Inc.                                                   
-----------------------------                                                   

     Powerhouse  is a  diversified  technology  and  entertainment  company that
develops,  supplies,  and  operates  lottery,  gaming and  pari-mutuel  wagering
systems and equipment  worldwide.  The Company conducts its operations primarily
through three technology divisions and one operations division:  lottery systems
(AWI), gaming machines and systems (VLC),  pari-mutuel systems (United Tote) and
gaming  operations  (Sunland Park and route  operations).  The Company's primary
markets for its broad product line include the on-line  lottery,  video lottery,
casino gaming and pari-mutuel wagering markets.                                 

     The  following   table  depicts  the  operating   segments  and  recognized
subsidiaries of the Company:                                                    

     Lottery systems             -- Automated Wagering International, Inc. (AWI)
Gaming machines and systems -- VLC, Inc. (VLC)                        
           VLC of Nevada, Inc.
Pari-mutuel systems         -- United Tote Company                    
          United Tote Canada
 Gaming operations           -- Nuevo Sol Turf Club, Inc. (d/b/a Sunland
                          Park Racetrack & Casino)
                                    Route operations (Raven's D & R Music, Inc.,
                                      Automation First, Inc. and Automatic
                                  Music Service of Billings, Inc.)

Lottery Systems -- AWI                                                          
----------------------                                                          

     AWI develops,  manufactures,  installs and operates on-line  computer-based
systems and presently  operates  lottery  systems for seven state  lotteries.  A
lottery  system  consists of terminals  located in numerous  retail  outlets,  a
telecommunications   network,  a  central  computer  system  and  communications
equipment  software  as well as the  software  to operate the system and process
sales and  validation  of lottery  game  tickets.  In the United  States,  AWI's
products and  services are  typically  marketed to lottery  authorities  through
long-term  contracts,   awarded  through  a  competitive  bidding  process.  AWI
typically  maintains  ownership  of the lottery  system and  operates it for the
state  in  return  for  a  percentage  of  lottery  ticket  sales.   In  foreign
jurisdictions, lottery equipment and systems are often sold and related software
is  licensed  to  lottery  authorities.  Internationally,  AWI  has  sold to and
currently  supports  and/or  maintains  lottery systems for customers in Canada,
Chile and Norway.  The Company  has also  recently  been  awarded  contracts  in
Switzerland and Vietnam. Delivery to Vietnam began in the fourth quarter 1998.  

     Governments in  approximately  80 countries have authorized  lottery games,
such  as  lotto,  numbers  and  keno as well  as  instant  "scratch-off"  games,
primarily as a means of generating non-tax                                      

- 5 - 

10-K405
6th Page of 74
TOC
1st
Previous
Next
Bottom
Just 6th

revenues.  In the United States,  lottery revenues are frequently designated for
particular  purposes,  such as education,  economic  development,  conservation,
transportation  and aid to the  elderly.  Many states  have become  increasingly
dependent on their lotteries,  as revenues from lottery ticket sales have become
a significant  source of funding for designated  programs.  In fiscal 1970, only
two states had authorized traditional  lotteries,  selling an aggregate of $49.2
million in tickets. As of the end of 1998, 38 jurisdictions in the United States
were operating  lottery systems,  with aggregate  lottery sales in excess of $35
billion.  Worldwide lottery sales, excluding North America, exceeded $81 billion
in 1997.                                                                        

     There are many types of  government-authorized  lotteries in the world. The
Company  categorizes  traditional (as opposed to video) lottery systems into two
principal groups: "on-line" and "off-line."                                     

     An on-line lottery system is generally used to conduct games such as lotto,
sports pools,  daily  numbers and keno in which  lottery  players make their own
selections.  Various  games of chance are offered  involving  the  selection  of
numbers from a field of possible numbers.  A lottery player requests the desired
numbers and  purchases  the lottery  ticket  from the  clerk-activated  terminal
provided by the Company or other lottery  vendor to a lottery  ticket  retailer.
The amount wagered,  also commonly  referred to as "handle",  per transaction is
determined by individual  lottery  authorities  and is usually $.50 to $1.00 per
wager.  The lottery  terminals  are  typically  located in  high-traffic  retail
outlets,  such as newsstands,  convenience  stores,  gas stations,  food stores,
tobacco shops and liquor stores,  which are selected by the lottery  authorities
to sell tickets on the lottery  authority's  behalf.  The data is entered either
manually by keyboard or  automatically  through a mark sense  reader or scanner.
The wager information is then transmitted via communication lines to the central
computer system where the information is verified,  recorded and stored. Winners
are able to claim  their  prizes  within  minutes of the  drawing of the winning
number for the game selected.                                                   

     Off-line  lotteries  feature games which are not computerized and typically
feature instant ticket games in which players remove  coatings from  pre-printed
tickets  ("scratchers"),  which  account for  substantially  all of the off-line
lottery  sales in the United  States.  Outside of the  United  States,  off-line
lotteries may also include  traditional games (numbers,  lotto,  etc.) which are
offered through a manual,  off-line system.  Players' selections are accumulated
and delivered to a central  processing  location where the bets are entered into
the  computer.  Many foreign  countries  have  government-operated  or privately
licensed lotteries. Over 200 lotteries are operating worldwide.                 

     There are several  advantages to on-line  lotteries as compared to off-line
lotteries. Most importantly,  wagers can be accepted and processed by an on-line
lottery system until minutes before a drawing.  In cases where a large prize has
attracted substantial wagering interest, the extended sales period increases the
potential for higher lottery revenue. Unlike instant games or scratchers,  where
the  number of  winning  tickets  and  amount of awards  must be  determined  in
advance,  on-line  lotteries  allow for the  rollover  of lottery  jackpots.  In
addition,  on-line lottery systems provide greater reliability and security than
either off-line  numbers games or scratchers,  allow a wider variety of games to
be offered,  and automate  accounting and  administrative  procedures  which are
otherwise performed manually.  Instant ticket game revenues have been growing at
a faster rate than total domestic U. S. lottery  revenues  because of relatively
higher  payout  percentages  and the  increasing  automation  of instant  ticket
validation  and  accounting  systems.  Such games compete with the on-line games
provided by the Company's systems.                                              

     Typically 50% of the gross handle of a domestic  lottery is returned to the
players in the form of prizes.  Approximately 15% is used to fund the operations
of the  lottery,  including  the  expenses  of the lottery  authority,  costs of
advertising,  payments to  point-of-purchase  retailers  and payments to vendors
such as AWI. The remaining amount,  approximately 35%, is available to the state
to support  specific public programs or as a contribution to the state's general
fund.                                                                           

     In the United  States,  products  and services  are  typically  marketed to
lottery authorities through long-term  contracts,  awarded through a competitive
bidding process pursuant to which the vendor supplies, installs and operates the
lottery  system  for the state or  jurisdiction  in return for a  percentage  of
ticket sales. The vendor typically  retains title to the lottery system.  Once a
contract  is awarded to a lottery  vendor,  that  vendor is  typically  the sole
provider of on-line lottery  services and operations to that  jurisdiction for a
specified time period within a defined geographic territory.                    

- 6 - 

10-K405
7th Page of 74
TOC
1st
Previous
Next
Bottom
Just 7th

     The  international   market,  as  well  as  a  minority  of  United  States
jurisdictions, is typically characterized by lottery system sales in addition to
long-term  contracts.  The Company or other  vendor  develops  and  installs the
lottery system and trains lottery personnel in the operation of the system for a
fixed or fixed plus  percentage of handle fee.  Other add-on  services,  such as
system enhancements,  equipment maintenance and ticket stock production,  may be
available under separate contracts.                                             

     United  States.  AWI derives  revenue  primarily  from contracts with state
lottery organizations  throughout the United States.  Revenue consists primarily
of a  contractual  percentage  of lottery  ticket sales in each state as well as
revenue from  installation  and sales of on-line  lottery systems and equipment.
The segment  experiences  fluctuations  in revenue levels  depending on relative
sizes of  jackpots,  the number of  terminals  on-line and the volume of tickets
sold in the states in which the Company operates. The table below sets forth the
lottery  authorities  in the United  States with which AWI presently has lottery
contracts.  The table also sets  forth  information  regarding  the term of each
contract  and,  as of  December  31,  1998,  the  approximate  number  of retail
terminals  installed in each  jurisdiction,  and the  revenues  generated by the
lottery operations.                                                             

                                                        · Enlarge/Download Table


                                                               Selling      Total On-Line   
                  Date of Com- Expiration       Lottery       Terminals   Lottery Authority 
                   mencement    Date of        Authority     Operating at      Revenues     
                   of Current   Current        Extension     December 31,      in 1998      
     Jurisdiction  Contract    Contract(1)      Options          1998       (in millions)(2)
     ------------ ------------ -----------     ---------     ------------ ------------------
                                                                                            

Delaware            10/1994      9/2002          ---               333          $514        
Florida(3)          10/1999      6/2004        2 two-year        8,159         1,394        
Indiana(4)           8/1999      8/2006        3 one-year          ---           578        
Maryland             7/1996      7/2001    1 three-year plus     4,130         1,053        
                                               2 one-year                                   
Minnesota            8/1997      8/2002        5 one-year        1,981           131        
Montana             11/1996      3/1999           ---              360            31        
Pennsylvania(5)      1/1999     12/2006        3 one-year        5,138         1,201        
South Dakota(6)      8/1999      8/2006           ---              360            14        
----------                                                                                  

(1)  Expiration  dates do not reflect the  exercise of the lottery  authorities'
extension options.                                                    
(2)  Figures are provided  for each state for  calendar  year except for Indiana
reported amounts from fiscal year ended June 30, 1997.                
(3)  The Florida State Lottery accounted for 15% of consolidated  revenue during
     1998.  In March  1999,  the  Department  of Lottery of the State of Florida
     renegotiated  and signed an amended contract for on-line lottery system and
     related services whereby the Company will design, install and operate a new
     statewide on-line lottery system for five years and three months, with two,
two-year renewal options.                                             
(4)  In January 1999, the Company  signed the contract with the Hoosier  Lottery
     of the State of Indiana to provide an on-line lottery system, terminals and
     system  operation  for seven  years  with  extension  options  for up to an
     additional three years. The scheduled date for completion of the conversion
     to the new AWI system from the Lottery's current vendor is August 29, 1999.
(5)  The  Pennsylvania  State Lottery has awarded AWI a new seven-year  contract
     commencing  January  1999  to  continue  operating  Pennsylvania's  lottery
     system.  The Pennsylvania  State Lottery  accounted for 11% of consolidated
revenues during 1998.                                                 
(6)  In November  1998,  the Company was awarded a new  contract,  replacing the
     current  contract  which  expires in May 1999,  for both  on-line and video
     gaming system applications with implementation  expected to begin in August
     1999 with  completion  by June 2000.  The new  contract is for a seven-year
term ending August 2006.                                              

     Facility  Management  Contracts.  All of  AWI's  current  domestic  lottery
contracts are facilities management contracts under which AWI installs, operates
and  maintains a lottery  network  while  retaining  ownership or control of the
lottery  terminal  network.  The  facilities  management  contracts  may have an
initial term of approximately  five to nine years, and generally  contain one or
more options  permitting  the lottery  authority to extend the initial  contract
term for additional periods.  Prior to the expiration of the initial or extended
term, a lottery authority is generally required by law to commence a competitive
bidding                                                                         

- 7 - 

10-K405
8th Page of 74
TOC
1st
Previous
Next
Bottom
Just 8th

process for a new lottery contract.  There can be no assurance that AWI will win
a new contract in connection with this process.                                 

     AWI installs and commences operations of a lottery network generally within
six to twelve months after being awarded a new lottery  contract and,  following
the  start-up  of the lottery  network,  is  responsible  for all aspects of the
network's operations. AWI operates lottery systems in each jurisdiction with two
or more central  computer  systems.  In addition,  AWI employs a dedicated  work
force in each jurisdiction,  consisting of a site manager,  computer and hotline
operators, customer service and terminal replacement and repair technicians. The
equipment used in any  jurisdiction  must typically  comply with  specifications
established by that jurisdiction.  New contracts typically require new equipment
of recent  manufacture.  The  equipment  and  related  implementation  costs are
depreciated  over the term of the related  contract,  including  extensions upon
their  exercise  by the  lottery  authority.  Under  certain  of AWI's  facility
management  contracts,  the lottery  authority has the option to purchase  AWI's
lottery  system during the contract term at a  predetermined  price.  AWI's role
with respect to the continued  operation of a lottery system in the event of the
exercise of such purchase  option is defined as part of the purchase option with
fees and services  included  with the original  bid.  Exercise of such an option
could substantially change the anticipated profitability of the contract to AWI.

     Under many of AWI's facilities management contracts,  the lottery authority
has the option to require  AWI to install  additional  terminals  and/or add new
lottery games. Such installation may require significant capital expenditures by
AWI. However,  since AWI's revenues from such contracts  generally depend on the
level of lottery  ticket sales,  and such sales are  generally  increased by the
addition of new retail outlets and games,  such expenditures have generally been
recovered  through the revenues  generated by the additional  equipment or games
and revenues from existing  equipment,  although there is no assurance this will
continue to be the case.  The potential  additional  terminals and new games are
agreed to in the bidding process and as such are taken into  consideration  when
determining the vendor's fee in the original bid.                               

     AWI's contracts with the state lotteries  contain  provisions for assertion
of  liquidated  damages  against  AWI for  failure to meet  certain  performance
standards.  These conditions  include  aggressive  implementation  schedules and
ongoing  performance  standards and failure to perform may result in substantial
monetary liquidated damages, as well as contract termination. Liquidated damages
ranging from $5,000 to $250,000 per day for late system start-up and from $1,000
to $15,000 per minute for system downtime  beyond a stipulated  grace period are
common to the domestic market.  Although the actual  liquidated  damages imposed
can be subject to negotiation,  such provisions present an ongoing potential for
substantial expense. Damages, if assessed, are usually due within 30 days or may
be deducted from revenues  otherwise earned from the lottery.  Failure to repair
terminals within a specified time period may subject AWI to damages. The Company
maintains  errors and omissions  coverage under risk  management  policies which
would cover certain but not all claims.                                         

     Various state on-line lottery contracts contain  provisions under which AWI
may be subject to monetary  penalties for central  computer  downtime,  terminal
failures, delays in servicing inoperable terminals within specified time periods
and ticket stock shortages among other things.  Penalties paid or accrued by AWI
with respect to its contracts were  approximately  0.3% of its revenues in 1998,
1.3% in 1997 and 3.9% in 1996.                                                  

     Typically,  state lottery contracts also reserve the right to terminate the
contract for cause  (i.e.,  failure of the vendor to  substantially  perform any
material  requirement)  after notice and a cure period.  The state also reserves
the right to cancel a contract if the state enacts a statute  which  removes the
authority or ability of the state to conduct a lottery.  In general, a state may
also terminate a contract  without cause or for the  convenience of the lottery,
typically  with at least 12  months  prior  written  notice.  Reasonable  costs,
excluding  anticipatory  profits,  will  be  reimbursed  to the  vender  for all
terminations except for a material breach.                                      

     In addition to potentially  significant capital requirements to manufacture
and install lottery systems,  lottery contracts  generally require the vendor to
post a substantial  bond securing its  performance.  The terms of such bonds may
require significant collateral in the form of cash, cash equivalents or lines of
credit.                                                                         

- 8 - 

10-K405
9th Page of 74
TOC
1st
Previous
Next
Bottom
Just 9th

     Products and Services.  In 1971,  AWI designed and  installed,  for the New
Jersey State Lottery,  the country's first on-line  lottery  system.  Since that
time, AWI has developed and installed many system and service features that have
subsequently become common in the lottery industry, such as the internal control
system,  down-line loading for terminals, the cathode ray tube terminal operator
display,  microfiche data storage for lottery  records,  instant game accounting
and integrated computerized terminal maintenance control.                       

     In September  1993,  the Company  introduced its  MasterLink(R)  system and
successfully  implemented it on a customer's  system in January 1994. Since that
time, the Company has  implemented  eight  enhanced  versions.  The  implemented
MasterLink(R)  system is designed to manage an  organization's  on-line  lottery
system and in some  jurisdictions  its video  lottery  program as well. A system
could include  teller-activated  lottery ticket terminals,  video lottery gaming
machines,  player-activated  sports  betting  terminals,  instant ticket vending
machines  and/or other  electronic  gaming-related  devices.  The  MasterLink(R)
system  allows an  organization  to monitor  the status and  performance  of the
equipment  within its  jurisdiction,  conduct  accounting  of and billing on the
revenue  from  the  gaming  machines,   and  control  their   configuration  and
operations.   The   MasterLink(R)   system  is   intended   to  be  a  flexible,
cost-effective means of providing these capabilities.                           

     The lottery  system  marketed by AWI  consists of the  following  principal
elements:                                                                       

     -    Terminals.  AWI designs and  manufactures the terminals used in system
     networks.  The  terminals  are  designed  for  maximum  security,   minimum
     processing time and flexibility to allow for  customization  of application
functions to each lottery's specifications.                           

     -    Software.  AWI designs and provides all  application  software for its
     lottery  systems.  AWI's  software is  designed  to provide  the  following
     network  characteristics:   rapid  processing,  storage  and  retrieval  of
     transaction  data in high volumes;  the ability to down-line load, i.e., to
     reprogram the lottery terminals from the central computer  installation via
     the  communications  network to add new games and  feature a high degree of
     security and redundancy to guard against  unauthorized access and tampering
     and to ensure continued  operations  without data loss; and a comprehensive
management information and control system.                            

     -    Central Computers.  Each of AWI's lottery systems contains one or more
     central  computer   installations  to  which  the  lottery   terminals  are
     connected. AWI's prior generation central control system is designed to run
     on the Cyber  930,  but the  MasterLink(R)  product is  designed  to run on
     UNIX-based central computer systems such as IBM RS/6000 systems, instead of
     the  proprietary   Cyber-series  computers.   The  specifications  for  the
     configuration  of AWI's  central  computer  installations  are  designed to
     provide continuous availability,  high data handling capability and maximum
security.                                                             

     -    Communications.  AWI's lottery  terminals  are typically  connected to
     central  computers  by  dedicated  telephone  lines  owned or leased by the
     jurisdiction   in  which  the  network  is  located  in  conjunction   with
     proprietary  network  communications  controllers  and are  monitored  by a
     proprietary  network  management  system.  Due to  the  varying  nature  of
     telecommunications  services  available in lottery  jurisdictions,  AWI has
     developed the capability to interface  with a wide range of  communications
     networks.  AWI also has the  expertise to provide and  integrate  alternate
     technologies, such as microwave and radio transmission, integrated services
digital networking (ISDN) and data over voice.                        

     -    Game Design.  An important factor in maintaining and increasing public
     interest in lottery  games is  innovation  in game  design.  The  principal
     variables of game design  include  frequency  of drawing,  types of prizes,
     cost  per  play  and   setting   of   appropriate   odds.   The   Company's
     MasterLink(R)system  and  Ovation(TM)line  of  terminals  are  designed  to
     efficiently  permit the development  and rapid  deployment of new games and
     targeted on-line game-related promotions.  For example, in 1996 the Company
     introduced its keno module in Maryland, where keno accounts for over 20% of
     total handle. The Company believes that these capabilities will enhance the
     ability of the lottery  authority to increase  on-line  ticket  sales,  and
result in more revenue for the Company. These                         

- 9 - 

10-K405
10th Page of 74
TOC
1st
Previous
Next
Bottom
Just 10th

     capabilities  may also enhance the Company's  success rate in competing for
     domestic lottery contracts. There can be no assurance, however, that either
will happen.                                                          

     Competition.  Competition  is intense in the  traditional  on-line  lottery
business.  It is not  unusual in the United  States  for  contract  awards to be
challenged  by  unsuccessful  vendors.  Relatively  few  new  or  rebid  on-line
contracts are awarded each year.  Although  price is a  significant  competitive
factor,  other  important  competitive  factors  include the ability to optimize
lottery  revenues  through  game  design;   customer  marketing   support;   the
dependability,  security, technological sophistication and upgrade capability of
the network; and the experience and reputation of the vendor.                   

     AWI's  principal  competitor in the on-line  lottery  business,  GTECH,  is
significantly larger, currently supplying lottery systems to 27 of the 38 United
States on-line lottery jurisdictions. GTECH also has a substantial international
presence.   The  market  dominance  of  this  competitor  further  enhances  its
competitive  position.  Other  competitors  include  International  Lottery  and
Totalizer  Systems,   Inc.,   Scientific  Games,  Inc.,  Autotote   Corporation,
International  des  Jeux  (Lotto  France),   EssNet/Alcatel  and  several  other
companies.                                                                      

     In jurisdictions  with both on-line and video lottery gaming products,  the
products  may  compete  with  each  other  for  entertainment  dollars  spent on
wagering.                                                                       

Gaming Machines and Systems -- VLC                                              
----------------------------------                                              

     VLC  develops,  manufactures  and markets  video gaming  machines,  central
control systems and related services for the gaming machine industry. The gaming
machine  industry  includes both video lottery and casino gaming  venues.  Video
lottery gaming is the use of video gaming  machines to provide low stakes gaming
entertainment  to  enhance  revenue  for  states  and other  jurisdictions.  The
machines, offering games, including poker, blackjack, bingo and keno, as well as
spinning reel games, are generally located in age-controlled establishments such
as bars,  taverns,  restaurants  and  convenience  stores.  The  gaming  machine
industry is subject to  governmental  regulation and taxation and,  depending on
the jurisdiction,  may be monitored and controlled by a central computer system.
Video lottery gaming programs provide substantial incremental sources of revenue
to the governmental jurisdictions without increasing general taxation.          

     VLC also sells its video  gaming  machines  to  land-based,  riverboat  and
Native American  casinos.  The Company holds licenses to sell gaming machines in
numerous jurisdictions,  including Nevada, Mississippi and New Jersey, the three
largest  casino  markets  in the U. S.,  as well as in most  other  major  North
American casino jurisdictions.                                                  

     Currently  nine U. S. states  (Delaware,  Louisiana,  Montana,  New Mexico,
Oregon,  South Dakota,  Rhode Island,  South Carolina and West  Virginia),  five
states in Australia, eight Canadian provinces, Iceland, Norway, Sweden and South
Africa have authorized  various levels and forms of video lottery gaming.  While
there can be no assurance that other  jurisdictions will introduce video lottery
systems or that existing  jurisdictions will continue  operations,  based on its
current  market  share,  VLC expects to continue  as a  significant  supplier of
machines and central control systems to this segment of the industry.           

     The video lottery gaming market is different from the casino market and the
traditional lottery market. Unlike video gaming machines designed for the casino
market, most video lottery gaming machines are located in places where gaming is
not the principal  attraction (i.e., bars and restaurants).  The stakes on video
lottery  gaming  machines  typically  range  from  $0.25 to $2.50 per play,  and
payoffs  typically  are  capped  at  $100  to  $1,000.  In  addition,   in  most
jurisdictions, the payment of jackpots differs as compared to traditional gaming
machines.  After inserting money into a video lottery gaming machine, the player
receives  credits  to play the  machine.  Player  losses are  deducted  from the
credits and winnings are added to the credit, instead of any coins being dropped
into a tray.  When the player is  finished,  the video  lottery  gaming  machine
prints  out a ticket  showing  the  remaining  amount of  credit.  The ticket is
redeemable  for  cash at the  establishment's  register.  Recently,  some  video
lottery  jurisdictions,  like  Delaware,  have moved  into the more  traditional
casino  environment with state-owned  gaming machines at pari-mutuel  facilities
(primarily racetracks). The machines in these locations pay out in coins from a 

- 10 -

10-K405
11th Page of 74
TOC
1st
Previous
Next
Bottom
Just 11th

hopper.  Video lottery offers players a payback  percentage of 80% to 96%, which
is lower than most traditional  casino games, but greater than traditional state
lotteries where payback is typically about 50%.                                 

     There are two basic ownership  structures in  jurisdictions  in which video
lottery gaming is implemented:                                                  

     (1) Private sector  ownership - The gaming  machines may be owned either by
     the owners of the establishments in which the gaming machines are placed or
     by the  operators/distributors of coin-operated machine routes who contract
     with location owners to install,  service and maintain the gaming machines.
     This private sector  ownership  structure has been adopted in Montana,  New
     Mexico,  South  Carolina,  South  Dakota,  Louisiana,  West  Virginia,  New
Brunswick, Prince Edward Island, Victoria and South Australia.        

     (2)  Government  sector  ownership - This form of ownership is effective in
     the Canadian provinces of Alberta, Saskatchewan,  Newfoundland, Nova Scotia
     and Quebec and in Northern Territory,  Australia. In Oregon, the government
     has leased and purchased gaming machines. In Delaware and Rhode Island, the
     contractor  shares in the revenue  stream with the state while  maintaining
ownership.                                                            

     In 1996 and 1997 certain jurisdictions, most notably Louisiana and Alberta,
Canada,  allowed  voters to decide on the  continued  operation of video lottery
locations  and casinos in their cities and  counties.  In  Louisiana,  voters in
approximately  one-half of the state's  parishes  (counties)  voted to ban video
lottery  operations.  Existing  locations in these  parishes  will be allowed to
operate until June 30, 1999 before the machines must be removed. In Alberta, one
city voted in 1997 to ban video gaming machines, and voters there gave the local
casino seven days to remove machines.  The machines are still operating  pending
appeal. Alberta communities across the province held a vote in October 1998 that
resulted  in only a few small  communities  voting to remove  approximately  150
gaming machines with Calgary and Edmonton voting to retain video lottery.       

     The approval of gaming in new land-based  casino  jurisdictions,  riverboat
gaming,  Native  American  casino gaming and networked video lottery systems has
driven gaming  equipment  demand growth during the 1990s.  In the United States,
casino  video  gaming  is  permitted  in  Colorado,   Illinois,  Indiana,  Iowa,
Louisiana, Mississippi,  Missouri, Montana, Nevada, New Jersey and South Dakota,
as well as on Native  American lands in some of those and in several  additional
states including Arizona, California,  Connecticut,  Iowa, Michigan,  Minnesota,
New Mexico,  North  Dakota,  Oregon and  Wisconsin.  Outside the United  States,
Canada,  Australia and France are the most developed, but Asia, South Africa and
South and Central  America are all  expanding  or exploring  gaming  operations.
While  most of the  demand for casino  gaming  machines  relates to  replacement
sales, growth also stems from the development of new casinos.  Replacement sales
will continue to grow as existing  machines become  obsolete.  By the year 2000,
domestic replacement sales are expected to surpass sales to new properties.     

     Casino gaming is considered a subset of consumer entertainment expenditure.
Its  contribution  is  significant  with $50.9 billion in U. S. gaming  industry
revenue in 1998. This figure exceeds the $6.2 billion spent on movies, the $12.2
billion spent on recorded music, the $7.6 billion spent at theme parks and other
amusement  activities  and the $6.3 billion spent on spectator  sports and other
live  events.  With this  evidence  for the  intrinsic  demand for  gaming,  the
expected  growth  drivers  for the  industry  are  twofold  - a strong  consumer
appetite  for the product  coupled  with a desire by state  governments  to find
alternative  revenue sources.  These indicators point toward continued expansion
of casino style gaming,  although there can be no assurance that this trend will
continue.                                                                       

     Market  Overview.   Replacement  product  demand  for  gaming  machines  is
anticipated to accelerate in 1999.  This creates an opportunity  for the Company
to introduce new games and capitalize on its superior  machine  performance  and
advanced  technology.  Future  replacement  demand  will  accelerate  as  gaming
equipment in markets opened in 1991  gradually  reaches  replacement  age. It is
estimated  that over  120,000  machines  will need to be replaced  over the next
three years.  An additional  17,000 expected  gaming machine  replacements  from
government-owned  systems brings the total gaming machine  replacement demand to
an estimated 137,000 units by 2001.                                             

- 11 -

10-K405
12th Page of 74
TOC
1st
Previous
Next
Bottom
Just 12th

     Australia continues to show strong growth potential.  Victoria,  Australia,
authorized private sector placement of 5,000 terminals when operations commenced
in August 1992,  raising the level of  permissible  terminals to 27,000 by 1996.
The  Company  has been  granted a license in New South  Wales,  Australia  which
represents  an  87,000-machine  market.  Additional  growth is expected in South
Africa.  To date,  one  province,  Mpumalanga,  has approved  manufacturers  and
operators and has begun to set licensing guidelines for locations.  The province
of  Gauteng  has  approved  manufacturers  of gaming  machines.  There can be no
assurance, however, as to any such growth prospects.                            

     The  Company  commenced  sales of its  gaming  machines  to  state-licensed
casinos in Colorado in 1994 and began  selling  machines in the Nevada market in
mid-1996.  Additionally, the Company began selling gaming machines in New Jersey
in 1996 through a  distributor.  The Company  sells to the  riverboat  market in
Iowa, Indiana, Louisiana and Mississippi.                                       

     In the Native American  market,  the Company sells to distributors of video
gaming machines who sell to casinos in Connecticut,  Iowa, Michigan,  Minnesota,
New Mexico,  North Dakota,  South Dakota and  Wisconsin.  The Company has placed
additional   machines  at  Native  American   casinos  in  Arizona,   Louisiana,
Mississippi, North Carolina and Oregon.                                         

     The Company believes casino gaming at pari-mutuel  racetracks may expand as
more  jurisdictions  pass  legislation  allowing  gaming.  The Company  plans to
leverage the  relationships  developed with the pari-mutuel  racetracks  through
United Tote to attempt to gain entrance into these markets.                     

     In  1997,  the New  Mexico  legislature  voted to allow  casino  gaming  at
pari-mutuel  racetracks  in New Mexico,  including  the  Company's  racetrack at
Sunland Park, New Mexico.  Under this  legislation,  the Company is permitted to
operate up to 300 gaming machines at its Sunland Park  racetrack.  Casino gaming
at Sunland Park commenced on February 22, 1999.                                 

     Video Lottery  Markets.  The following table, as of December 31, 1998, sets
forth certain information concerning the number of Company and non-Company video
lottery gaming  machines in operation in the  jurisdictions  that currently have
video lottery operations:                                                       

                                                        · Enlarge/Download Table

                                                        Central                     VLC Share      
                        Commencement Ownership          Control  Number of   ----------------------
Jurisdiction(1)             Date     Structure          System  Terminals(2) Terminals(3)         %
---------------         ------------ ---------          ------- ------------ ------------ ---------
                                                                                                   

Alberta, Canada             1992     Government         GTECH        5,941       3,986        67.1%
Atlantic Canada(4)          1990     Private/Government VLC          9,965       2,874        28.8%
Delaware(5)                 1995     Government         AWI            356         287        80.6%
Iceland                     1991     Charitable         VLC            580         500        86.2%
Louisiana                   1992     Private            IGT         14,923       8,836        59.2%
Montana(6)                  1985     Private(11)        None        16,574       5,323        32.1%
Northern Territory          1996     Government         VLC            500          50        10.0%
Oregon(7)                   1992     Government         GTECH        8,939       3,964        44.3%
Quebec                      1994     Government         VLC         15,380       6,583        42.8%
Rhode Island(8)             1992     Government         GTECH        1,628         223        13.7%
Saskatchewan                1993     Government         GTECH        3,343       1,148        34.3%
South Australia             1994     Private            VLC         11,055         928         8.4%
South Dakota(9)             1989     Private            VLC          8,008       7,641        95.4%
Victoria, Australia(10)     1995     Private            VLC         13,700       1,396        10.2%
Victoria, Australia(10)     1995     Trust              Private     13,600       4,600        33.8%
West Virginia               1997     Government         Various      3,049         664        21.8%
                                                                   -------      ------             
         Total                                                     127,541      49,003        38.4%
                                                                   =======      ======             

----------                                                                                         

(1)  Excludes several other  jurisdictions  in which the Company  currently does
     not participate,  including Manitoba,  Sweden, Queensland and Tasmania even
though the Company is licensed in Tasmania.                           
(2)  Estimated number in operation as of December 1998.                         
(3)  Number of VLC gaming machines sold may vary from number in operation.      

- 12 -

10-K405
13th Page of 74
TOC
1st
Previous
Next
Bottom
Just 13th

(4)  Total number of gaming  machines and number of VLC gaming machines based on
     information  provided by Atlantic Lotto.  Atlantic  Canada  encompasses the
     provinces of New  Brunswick,  Newfoundland,  Nova Scotia and Prince  Edward
     Island.  New  Brunswick  and Prince  Edward  Island have  adopted a private
     ownership  structure,  while  in the  provinces  of  Newfoundland  and Nova
     Scotia,  the gaming  machines are owned by the  government or its appointed
agent.                                                                
(5)  VLC supplies video  machines to Dover Downs (120),  Delaware Park (155) and
     Harrington  Midway (12). IGT supplies  video machines to Harrington  Midway
     (57).  There are also  2,246  mechanical  spinning  reel games at the three
racetracks.                                                           
(6)  Total  number of video  lottery  gaming  machines  and number of VLC gaming
     machines  based on number of gaming  machines  licensed,  according  to the
Montana Gambling Control Division and VLC shipment reports.           
(7)  Total number of gaming  machines and number of VLC gaming machines based on
contract with Oregon State Lottery.                                   
(8)  Video lottery operations are authorized at only two pari-mutuel  facilities
to which the Company is one of five suppliers.                        
(9)  Total number of gaming machines based on information  provided by the South
     Dakota  Lottery.  Number  of VLC  gaming  machines  based  on VLC  shipment
reports.                                                              
(10) Tattersall  Sweep  Consultation  (the  lottery) and TABCORP (the  off-track
     racing  association)  are  the  two  approved  operators  in the  state  of
Victoria.                                                             
(11) Private includes coin operators and/or location owners.                    

     Gaming  Machines  and  Game  Software.  The  Company  seeks  to  capture  a
significant  portion  of the  market  for its  gaming  machines  by  offering  a
technologically  advanced and reliable machine to the operator, and a fun, fast,
easy game to the player.  The Company's  current  generation of gaming  machines
incorporates  interactive  touchscreen control technology on a multi-color video
display.  Each gaming machine is capable of storing over 100 different  games in
memory, depending on the games' memory requirements.  The machine can present up
to  twelve  different  games  selected  through  a menu  format,  such as poker,
blackjack,  bingo and keno and  spinning  reel  games.  The  player can vary the
amount of each  wager.  The  number  of games  that may be  offered  on a gaming
machine,  the  specific  games  and the  amount  that a  player  can  wager  are
determined by the regulating authority in each jurisdiction.                    

     The gaming  machines  also  incorporate a variety of  menu-driven  internal
accounting,  security and  diagnostic  features,  such as on screen  accounting,
audit and game  statistics.  The machines  have  redundant  and  self-correcting
memory  and  self-diagnostic   circuitry  designed  for  reliability  in  widely
dispersed  locations.  The gaming machines are manufactured with a set of custom
components that can interface with various  peripheral devices (such as coin and
bill  acceptors,  coin  hoppers,  printers and ticket  dispensers)  in a modular
design for ease of maintenance and flexibility of configuration.                

     The Company sells two lines of gaming machines: its Winning Touch(R) series
and the Winning Touch(R) Power Series(TM) with enhanced graphics, improved sound
capabilities and more efficient  software design. In 1998 the Company introduced
a  slant-top  version of its  machines to give  customers  a greater  choice for
machine placement and location design.  The Company's gaming machines  typically
sell  for  between  $4,500  and  $9,500,  depending  on  the  configuration  and
generation of the machine and volume of purchases.                              

     The Company believes that innovative  graphics and advanced technology that
have been key  contributors  to VLC's success in the video  lottery  market have
benefited  the Company as it gains market share in the casino  marketplace.  The
games, the players, and the operator's needs, including enhanced reliability and
revenue  generation,  are the  same  for  both  industries.  The  knowledge  and
experience  acquired through its video lottery  operations  should enable VLC to
further  enhance  the  playability  and  appeal of its  machines  in the  casino
markets.                                                                        

     The Company recently  introduced its Coin-Free(TM)  program into the casino
markets of Nevada,  Mississippi and Iowa.  Using printer machine  technology and
site controller  communications  from the video lottery  markets  eliminates the
need for coin  handling and hopper fills on the part of the casino.  Casinos are

- 13 -

10-K405
14th Page of 74
TOC
1st
Previous
Next
Bottom
Just 14th

using this as a means to bring back penny and nickel slots.  At the end of 1998,
in excess of 1,000  units were in place and  operating  under the  Coin-Free(TM)
program.                                                                        

     Marketing and Distribution.  The Company must obtain a license and approval
of its gaming machines before it can sell machines in either the casino or video
lottery markets.  The following chart shows the  jurisdictions  where VLC or the
Company  currently  is  licensed or  authorized  to conduct  business  and where
license applications are filed and approval is pending:                         

                                                        · Enlarge/Download Table


      CURRENT JURISDICTIONS IN WHICH THE COMPANY OR CERTAIN SUBSIDIARIES ARE LICENSED TO         
                                  CONDUCT BUSINESS                                               
-------------------------------------------------------------------------------------------------
                        UNITED STATES                                                            
--------------------------------------------------------------------------                       
              Casino (c)/       Pari-mutuel       Native American                                
Video Lottery Riverboat (r)      Racing               Market               INTERNATIONAL         
------------- ----------------- ----------------- ------------------------ --------------------- 
                                                                                                 

Delaware      Colorado (c)       Arizona           Arizona                 Australia             
Louisiana     Indiana (r)        -------           -------                 ---------             
Montana       Iowa (r)             Ak-Chin           Ak-Chin                 New South Wales     
Oregon        Louisiana (r)        Department of     Fort McDowell           South Australia     
Rhode Island  Mississippi (r)       Racing           Gila River              Western Australia   
South Dakota  Nevada (c)         Colorado            Tonto Apache            Tasmania            
West Virginia New Jersey (c)     --------            White Mountain Apache   Victoria            
              South Dakota (c)   Florida             Yavapai-Apache          Northern Territory  
                Deadwood         -------           Connecticut             Canada                
-------------                    Idaho             -----------             ------                
CHARITABLE                       -----               Mashantucket-Pequot     Alberta             
Mississippi   -----------------  Indiana             Mohegan                 New Brunswick       
              CASINO OPERATOR'S  -------           Louisiana                 Newfoundland        
                  LICENSE        Iowa              ---------                 Nova Scotia         
              Nuevo Sol Turf     ----                Coushatta               Ontario             
               Club d/b/a          Iowa Racing &     Tunica-Biloxi           Prince Edward Island
                Sunland Park        Gaming         Michigan                  Quebec              
                Racetrack &         Commission     --------                  Saskatchewan        
                Casino             Sac & Fox of      Bay Mills             South Africa          
                                    the            Minnesota               ------------          
                                    Mississippi    ---------                 Mpumalanga          
                                 Kansas            Mississippi                                   
                                 ------            -----------                                   
                                 Kentucky            Choctaw                                     
                                 --------          New Mexico                                    
                                 Louisiana         ----------                                    
                                 ---------           Acoma                        LICENSE        
                                   Louisiana         Pojoaque                APPLICATIONS FILED: 
                                    State Racing     Pueblo of Isleta      --------------------- 
                                    Commission       Pueblo of Sandia      Pasqua Yaqui, Arizona 
                                   City of           San Felipe            Gauteng, South Africa 
                                    Carencro         San Juan Pueblo       Quebec (Casino)       
                                 Maine               Santa Ana             Western Cape,         
                                 -----               Taos                    South Africa        
                                 Montana             Tesque Pueblo                               
                                 -------           Oregon                                        
                                 New Jersey        ------                                        
                                 ----------          Burns-Paiute                                
                                 New Mexico          Coquille                                    
                                 ----------          Cow Creek                                   
                                 Ohio                Grande Ronde                                
                                 ----                Siletz                                      
                                 Rhode Island        Umatilla                                    
                                 -----------        Warm Springs                                 
                                 Texas             Wisconsin                                     
                                 -----             ---------                                     
                                 Wisconsin                                                       
                                 ---------                                                       

     The marketing  and  distribution  of gaming  machines is controlled to some
extent by the statutory and regulatory  structure adopted in each  jurisdiction.
The Company  markets its gaming  machines  both through a direct sales force and
distributors.  Currently,  the Company sells to distributors  in Louisiana,  New
Jersey, the Caribbean, South Australia, and a number of Native American markets.
In deciding  whether to use a  distributor  in a new  jurisdiction,  the Company
considers a variety of factors,  including existing                             

- 14 -

10-K405
15th Page of 74
TOC
1st
Previous
Next
Bottom
Just 15th

relationships  with operators and location owners,  the ability of a distributor
to service the market after the sale, the distributor's financial condition, any
regulatory  constraints  and the  long-term  economics  to the Company of direct
sales as opposed to sales to distributors.                                      

     The Company's  gaming machines are typically  covered by a 90-day parts and
labor warranty.  The Company  provides  after-market  parts and service to route
operators and other  servicing  agents.  These  after-market  parts and services
include  technical repair and hardware and software  upgrades and  enhancements.
The Company  also  provides  upgrade  options for  hardware  and software on the
Company's gaming machines.                                                      

     Central  Control  Systems.  The Company  derives  revenues from its central
control system software through the grant of licenses to use the software and by
providing  installation  and maintenance  services with respect to the software.
Video lottery gaming  machines can be operated  either through a central control
system  controlled by a  governmental  authority or on a stand-alone  basis.  In
every video lottery gaming jurisdiction except Montana,  the gaming machines are
connected to a central  control  system.  The Company  believes that the greater
control and monitoring  ability  offered  through  central  control systems will
encourage  new  jurisdictions  to  adopt a video  lottery  program  and use such
systems.  Similar  technology  can also be used by  casinos  for its  monitoring
ability and the management of progressive systems. The Company's central control
systems are  designed  with  features  intended to appeal to the concerns of the
operator, including:                                                            

     o    Security.  To ensure security of  communications,  VLC's machines have
          sophisticated features, including encryption, sequencing and timing of
data transmissions.                                         

     o    Control.  Each gaming  machine on the system must be enabled by a call
          from the central  site before it is capable of  displaying  a playable
       game and can be disabled by the central control system at any time.

     o    Compatibility.  The Company's  central control system (Advanced Gaming
          System(TM) ("AGS") allows gaming machines made by other  manufacturers
to run on the system.                                       

     o    Economy of Operation.  The  Company's  central  control  system can be
          operated  in a dial-up  format  which is  economical  to  install  and
          operate compared to an on-line lottery system (using dedicated lines).
          However,  the  system  can run in a  real-time  environment  (on-line)
should a jurisdiction desire this feature.                  

     o    Reports and Audits. The central computer  generates  on-demand reports
          for each  gaming  machine on the system and  automatically  audits the
programming of every machine on a periodic basis.           

     o    Electronic  Funds  Transfer.  The central control system is capable of
          processing EFT functions  which  translate to easier and quicker funds
collection.                                                 

     o    Flexibility.  The system is  designed to be flexible so as to meet the
          needs of various sized markets, to accommodate  regulatory changes and
to adapt to new game designs and features.                  

     The  Company's  central  control  system  software is marketed  through the
Company's  direct  sales  force.  The  marketing  efforts for the initial  video
lottery  central  control  system  typically  begin when a  legislative  body is
considering the adoption of video lottery  enabling  legislation.  Once enabling
legislation  calling for a central  control system is adopted,  the selection of
the central control system is normally accomplished through a formal bid process
that  involves  submittal  of  proposals  followed by a  competitive  evaluation
period.  The Company also retains  persons who are  registered as lobbyists in a
given jurisdiction.                                                             

     The Company  designed and installed  software for the video lottery central
control systems in Delaware, New Mexico, South Dakota, Loto Quebec, the Atlantic
Lottery  Commission's ("ALC," the regulatory body governing lotteries in eastern
Canada)  multi-jurisdictional  system now  covering  four  provinces  in eastern
Canada,  Tattersall's  and TABCORP in Victoria,  Australia,  Independent  Gaming
Corporation  in  South  Australia  and the  Northern  Territory  Racing & Gaming
Authority of Northern Territory,                                                

- 15 -

10-K405
16th Page of 74
TOC
1st
Previous
Next
Bottom
Just 16th

Australia,  the  Icelandic  Gaming Fund Raising in Iceland.  The  Company's  AGS
system is  state-of-the-art  technology,  utilizing an IBM UNIX  platform or DEC
ALPHA platform as is the case with ALC, and offers  customers the opportunity to
operate  on-line  lottery  functions and video lottery  terminals  from a single
central system.                                                                 

     The first  video  gaming  machine  application  of the AGS  system  running
concurrently with the traditional on-line lottery application became operational
in Delaware in December  1995.  The system is  successfully  reporting data from
both video  gaming  machines  and  spinning  reel slot  machines  as well as the
on-line  lottery.  A similar  system was  installed  for the New  Mexico  Gaming
Control Board in  Albuquerque,  New Mexico that will report data from casinos at
racetracks and small video lottery venues from across the state.                

     The AGS is  modular  in design and  allows  for the  addition  of  in-venue
progressives. Future add-ons include player tracking, wide-area progressives and
downloadable  software  to  gaming  machines.   The  in-venue  progressives  has
successfully  run in pilot in Delaware  and it is in final states of approval in
Australia;  however,  the Company can provide no assurance  that future  add-ons
will be successful.                                                             

     Video  gaming  customers  look for a variety of  features  in video  gaming
products. The technology in current machines will develop and improve over time,
forcing manufacturers to invest in ongoing game development. VLC has developed a
library of numerous gaming machine game variations and its gaming machines allow
for swift  reprogramming  to provide  the  newest  games to gaming  patrons.  In
addition  to  offering  expansive  product  lines,  casinos  require  customized
services for specific requests,  including video graphics,  game development and
floor space design.                                                             

     Competition.  The Company competes with domestic and foreign  manufacturers
of video gaming  equipment and providers of traditional  on-line lottery systems
and casino-based  gaming machines and systems in the sale of its gaming machines
and central  control system  software.  Many of the Company's  competitors  have
greater  financial  and other  resources  than the  Company.  The Company  faces
competition from companies  marketing complete video lottery gaming machines and
systems and from companies  marketing only video lottery gaming machines as well
as  increasing  competition  in the casino  gaming  market.  Among the Company's
competitors are International Game Technology,  Inc., Alliance Gaming,  Atronic,
Silicon  Gaming,  Spielo  Gaming  International,  WMS  Industries,  Casino  Data
Systems, Aristocrat and GTECH.                                                  

     Significant  factors which  influence  the purchase of gaming  machines and
central control systems include overall entertainment factor, the earnings power
of the product,  price,  reliability,  technical capability,  security,  and the
experience,   financial   condition  and  reputation  of  the  manufacturer  and
distributor. In addition, gaming authorities may impose other qualifications and
requirements  on the Company and its  competitors  in the supply of video gaming
products  and  services  and  may  also  consider  the  performance  record  and
reputation for integrity of the vendor.                                         

Pari-mutuel Systems -- United Tote                                              
----------------------------------                                              

     The  Company  acquired  United  Tote as part of its  acquisition  of United
Wagering Systems,  Inc., in 1994. United Tote develops,  manufactures,  operates
and sells  computerized  pari-mutuel  wagering systems  commonly  referred to as
"totalisators" for horse and greyhound racetracks, off-track wagering facilities
and jai alai frontons in North America, South America,  Spain, the Caribbean and
the  Philippines.   A  totalisator  system  supports   pari-mutuel  wagering  by
controlling  the  acceptance  of wagers,  calculating  odds and payout,  cashing
winning tickets,  and performing assorted  management,  accounting and reporting
functions.  Each  system  consists  of  central  processing  computers,  betting
terminals,  proprietary  software,  tote  boards  and other  displays  and video
equipment.  The products and services of United Tote are  typically  marketed to
domestic  facilities under long-term service contracts.  Compensation is usually
based on a minimum fee plus a percentage of the wagering volume of the facility.
International customers typically purchase the hardware and a license to use the
proprietary  software  for the  system's  operation.  United Tote also  provides
wagering terminals for use in casino race/sportsbooks.                          

     The market for pari-mutuel wagering systems in North America includes horse
and greyhound racetracks, a growing number of off-track betting (OTB) facilities
and jai alai  frontons.  Pari-mutuel  wagering is authorized in 43 U. S. states,
all provinces in Canada, and many foreign countries.  Pari-mutuel               

- 16 -

10-K405
17th Page of 74
TOC
1st
Previous
Next
Bottom
Just 17th

wagering  is a form of  wagering  in which  patrons  bet  against  each other in
separate pools,  rather than against the operator of the facility or with preset
odds. As a result, wagering odds are determined by the size of the pools and the
distribution  of dollars  established  by the patrons'  wagers.  The odds change
continually  until betting closes at the start of a race or event.  The odds and
payout  information are conveyed to the public and updated frequently on display
boards and on video monitors located at various places  throughout the facility.
The facility operator administers the pool and is compensated by a percentage of
the gross monies wagered at the facility (the "handle"). There are approximately
350  pari-mutuel  wagering  facilities  in North  America  and  numerous  others
worldwide.                                                                      

     While  on-track  attendance  and handle from  pari-mutuel  wagering at live
events in the United States has markedly  decreased over the last decade,  there
has also been a substantial  increase in simulcast and off-track wagering handle
during the same period.  There can be no assurance that such historical patterns
will remain the same in the future.                                             

     Domestic Contracts.  United Tote provides  pari-mutuel wagering services to
most North American  customer  facilities  under  long-term  service  contracts,
typically with 5-7 year terms under which the Company  provides the  pari-mutuel
wagering computer system, as well as the operations, maintenance and supervisory
personnel  necessary  to operate the system,  while the mutuel  clerks who issue
tickets on the  teller-operated  terminals  to the patrons of the  facility  are
employed by the facility. Under such service contracts, the Company at all times
retains ownership of the equipment and is entitled to liquidated  damages in the
event a customer cancels the contract without cause.                            

     Service contract revenues received by United Tote from the operation of its
pari-mutuel  wagering  systems  are  generally  based upon a  percentage  of the
handle,  subject in most  instances  to  minimum  fees.  Minimum  fees under the
service  contracts  are  generally  based on the  number  of days  the  facility
operates,  as well as other factors,  including the type of system and number of
terminals  installed at the facility and the reliability of the predicted number
of racing days to occur during the term of the contract.                        

     United  Tote  makes   certain   warranties   regarding  the  operation  and
reliability of its wagering systems. In the event of system failure, United Tote
is generally  responsible for certain liquidated  damages,  subject to a maximum
daily and/or annual  amount.  In some  instances,  United Tote may be liable for
tickets  paid  in  error  or  for  counterfeit   tickets  if  processed  by  the
totalisator.  Liquidated  damages paid or accrued by United Tote with respect to
its pari-mutuel contracts were approximately 1.0% of its revenues for 1998, 1.0%
for 1997 and 0.3% for 1996.                                                     

     With the growth of simulcasting,  many of United Tote's racetrack customers
and most of its OTB customers operate throughout the year.  Facilities which are
seasonal,  generally  contract for services only during their operating  season,
allowing United Tote to move its equipment and personnel to other  facilities at
the close of an  operating  season at a seasonal  facility,  forming  "circuits"
among such facilities.                                                          

     United  Tote  provides   pari-mutuel  wagering  services  to  over  120  of
approximately 350 pari-mutuel facilities in North America. The installed base of
terminals in use was approximately 8,900 at December 31, 1998.                  

     In limited  instances,  North  American  facilities  purchase a pari-mutuel
wagering system from United Tote. In such cases, the Company usually enters into
separate service and maintenance agreements for the system.                     

     Until  recent  years,  United Tote had  historically  focused on  providing
services to small and medium-sized  racetracks;  however,  since the addition of
contracts  with all of the  Kentucky  thoroughbred  racetracks  and the Kentucky
statewide  OTB  network in 1994,  United  Tote has  demonstrated  its ability to
perform at large customer facilities.  The capabilities of United Tote's Horizon
NT  2000(TM)  System were  demonstrated  by handling  the  record-setting  124th
running of the Kentucky  Derby at Churchill  Downs in 1998,  where $17.5 million
was wagered at the track;  an additional  $64.8 million was wagered through hubs
throughout  the country for another North  American  single-day  record of $82.3
million total  combined  system handle.  The United Tote system  processed a new
industry  record of $81.7 million for the 1998 Breeder's Cup  Championship  with
wagers  coming  from over 8,900  facilities  throughout  the world.  United Tote
recently  signed  multi-year  contract  extensions  to its existing  totalisator
service contracts with Keeneland in                                             

- 17 -

10-K405
18th Page of 74
TOC
1st
Previous
Next
Bottom
Just 18th

Lexington,  Kentucky,  and Dover Downs and Harrington Raceway, both in Delaware.
United Tote also recently  signed  contracts  with two new  customers,  Hinsdale
Greyhound Racing in New Hampshire and Plainridge Racecourse in Massachusetts.   

     International   Sales.   United  Tote  has   customers   in   international
marketplaces,  including Canada, Jamaica, Spain, Mexico, Argentina,  Ecuador and
the  Philippines.  Internationally,  there has been growth in the utilization of
on-line  wagering  systems in  established  markets.  As economic and  political
situations improve, new market opportunities open up for U. S. suppliers in less
developed countries where there is an increasing demand for advanced technology.

     Pari-mutuel  wagering systems for facilities  outside of North America have
historically been sold rather than operated pursuant to service contracts.  Such
sales  have  been made on a direct  sale  basis  with  payments  to the  Company
generally  made in U. S.  dollars.  Upon the sale of a system,  United Tote also
charges the purchaser a license fee for use of the Company's  proprietary system
software and provides  technical  assistance  and support.  The personnel of the
Company  participate in the installation and  commissioning of these systems but
typically the systems are thereafter  operated by the personnel of the customers
who are trained at United Tote serviced facilities.                             

     Products.  United Tote developed and introduced  the  pari-mutuel  wagering
system ("Horizon System") in 1993. It features the dual-purpose VERSA(TM), VERSA
II(TM)  and  Color  VERSA(TM)  terminals,  which  all  can  be  used  in  either
self-service or teller-operated mode, allowing the racetrack to make full use of
all terminals,  even on slow race days.  The VERSA(TM)  terminal thus allows for
significant  labor savings,  flexibility and  versatility.  The VERSA II(TM) and
Color VERSA(TM)  terminals  feature an enhanced  display and a built in magnetic
card  reader.  Other  terminals  in the Horizon  System  family are the portable
wireless   ULTIMA(TM);   the   cashless   account-betting    PROFILE(TM);    the
Tele-PROFILE(TM)  for operator  input  telephone  wagering and a  bill-accepting
module to  convert a  VERSA(TM),  VERSA  II(TM) or Color  VERSA(TM)  into a full
service,  cash accepting,  touch-screen,  self-service  terminal.  Approximately
7,300 VERSA(TM) terminals are presently in service at customer locations.  Those
new model terminals have been produced since 1993 and are in service at customer
locations.                                                                      

     In 1998,  United Tote introduced its new Horizon NT 2000(TM) system, a high
performance wagering system combining Microsoft's Windows NT(R) operating system
with proprietary  system software written in "C" language and utilizing  Pentium
II based hardware.                                                              

     United Tote  believes  that its ability to attract new and retain  existing
wagering system  customers  depends in part on the continuous  incorporation  of
innovative  technological  advances to improve its  product  lines.  The Company
maintains a development program directed toward new products and the improvement
and refinement of its present products to expand their uses and applications.   

     Competition.  United Tote's principal competitors are Autotote, AmTote and,
at some  facilities,  a limited  number  of other  smaller,  local and  regional
companies.  Competition  outside  of  North  America  is more  fragmented,  with
competition being provided by several  international and regional companies.  No
single company  maintains a dominant market position  internationally,  although
certain companies possess regional strengths.                                   

Gaming Operations                                                               
-----------------                                                               

     The Company's  racetrack  operation is located in Sunland Park, New Mexico,
adjacent to El Paso,  Texas. In 1997 the New Mexico State  Legislature  voted to
allow casino  gaming at  pari-mutuel  racetracks  in New Mexico,  including  the
Company's  racetrack in Sunland Park, New Mexico.  The  legislation  permits the
Company to operate up to 300 gaming machines per pari-mutuel  racetrack facility
for up to twelve  hours per day.  Two million  residents  live within a 100-mile
radius of Sunland  Park,  which area  includes the cities of El Paso,  Texas and
Juarez,  Mexico.  The  Company has  expended  approximately  $4.5  million of an
expected $8.5 million of capital for facility enhancements,  gaming machines and
related  equipment.  The total  investment in the racetrack and gaming system is
approximately $23.4 million.                                                    

- 18 -

10-K405
19th Page of 74
TOC
1st
Previous
Next
Bottom
Just 19th

     Competition. Sunland Park does not have direct competition for horse racing
in the El Paso area, although there is an operating greyhound racing facility in
Juarez, Mexico which also offers sports/race wagering on simulcast racing events
and sporting events.                                                            

     While  Texas  permits  pari-mutuel  wagering,   there  are  no  pari-mutuel
racetracks in direct  competition with Sunland Park's geographic area,  although
there has been some effect upon the number and  quality of horses  available  to
run at  Sunland  Park.  Sunland  Park  also  competes  against  other  forms  of
entertainment,  including sporting events. There is one illegal casino operating
in Texas in direct  competition  with Sunland Park. The States of New Mexico and
Texas currently  authorize  limited forms of gambling,  such as a state lottery,
bingo,  and/or  Native  American  casinos,  all of which compete for the leisure
dollar.                                                                         

     Route  Operations.  The Company's  gaming  operations  segment operates and
maintains  video  lottery and  amusement  machines  in  business  establishments
located in three  areas in southern  Montana.  The  Company  believes  its route
operations,   in  addition  to  generating  recurring  revenue  and  predictable
operating profit,  enable the Company to understand the needs and preferences of
players and coin  operators  by providing  testing  grounds for new hardware and
software concepts.  This research enables the Company to observe player response
to various terminal  configurations and to use this data to improve its terminal
design.                                                                         

     The Company's route operations primarily utilize  coin-operated video poker
and  video  keno  machines.   The  amusement  machines  consist  principally  of
coin-operated video machines, pinball machines, pool tables, CD players and juke
boxes.  Based on its familiarity with the relatively small number of competitors
of its  route  operations  and its  familiarity  with  substantially  all of the
potential  locations for video lottery machines in the market areas, the Company
believes that its route operations have a significant share of the video lottery
machine  market in Montana.  During the year ended  December 31, 1998, the route
operations  generated  approximately  $17.4  million  or  8%  of  the  Company's
consolidated revenues.                                                          

     The Company enters into agreements  with owners of business  establishments
to install video lottery gaming and amusement machines at their businesses.  The
number of machines per location is determined by available space, customer base,
competition,  preference of the owner of the establishment,  and, in the case of
video lottery gaming machines,  licensing limitations.  The agreements typically
provide for revenue  sharing with the location  owner based upon a percentage of
the net revenues generated by the Company's machines. In certain instances,  the
Company or one of its  subsidiaries may assist the location owner with obtaining
financing  relating  to the  location,  including  providing  a guaranty of such
financing.  The agreements require the Company to install,  maintain and service
machines installed at the location.                                             

     The Company's route  operations  compete  directly with other machine route
businesses, including numerous small route operators and several route operators
similar in size to the Company's route  operations,  and with companies  selling
video lottery gaming machines directly to location owners. The principal factors
of competition for route operations are the reputation of the route operator and
the  quality  and  earnings  potential  of the  machines  offered  by the  route
operator,  the  service  provided  by the  route  operator  and the terms of its
agreement with the location owner.                                              

Manufacturing                                                                   
-------------                                                                   

     The  Company's  primary  manufacturing  facility  is  located  in  Bozeman,
Montana.  The Company's  manufacturing  operations consist primarily of assembly
and  testing  of its  lottery  system  terminals,  gaming  system  machines  and
pari-mutuel  systems  machines.   The  Company  purchases  most  of  the  parts,
components  and  subassemblies  (some of which are designed by the Company) from
outside  sources and then  assembles  them into finished  products.  The Company
generally uses standard  parts and  components  that are available from multiple
sources.  The  Company has  contracted  with third  parties for the  assembly of
gaming machines,  which the Company utilizes when conditions warrant and/or when
contractually required. The Company also has contracted with outside sources for
the  manufacture  of  some  of its  components.  The  Company  has  historically
experienced low turnover among its work force.                                  

- 19 -

10-K405
20th Page of 74
TOC
1st
Previous
Next
Bottom
Just 20th

     The  Company  became  ISO-9002  certified  in  February  1998 by  AFAQ,  an
independent   quality  system   certification   organization.   Created  by  the
International Organization for Standardization,  ISO-9002 represents a series of
standards that specify how quality systems should be established and maintained.
ISO  certification  is recognized  around the world and has become a requirement
for  businesses  entering into foreign  markets.  In February  1999, the Company
received ISO  certification  for another year,  meeting all nineteen elements of
the  certification  process.  The Company's  ISO-9002 program extends into every
phase  of   operations,   ensuring   senior-level   commitment  to   production,
manufacturing,  installation  and service with a framework  for  uncompromising,
continuous improvement.                                                         

Research and Development                                                        
------------------------                                                        

     The  future  success of the  Company  depends  to a large  extent  upon its
ability to design, manufacture and market technologically sophisticated products
that  achieve  high  levels of player  acceptance.  The  Company's  business  is
characterized   by  rapidly   changing   technology  and  frequent  new  product
introductions and  enhancements.  The development of a successful new product or
product  design by a competitor  would  adversely  affect sales of the Company's
products and force it to respond quickly with its own competing products.  There
can be no  assurance  that  the  Company  will  be  successful  in  identifying,
developing  and marketing new products or enhancing its existing  products.  The
Company's business will be adversely affected if the Company  experiences delays
in developing new products or  enhancements  or if such products or enhancements
do  not  meet  and  receive  all  regulatory   approvals  and/or  gain  customer
acceptance.                                                                     

     In 1998,  the Company  expended  $10.0 million (net of  capitalization)  on
research and development activities as compared to $9.8 million in 1997 and $8.0
million in 1996. The Company capitalized  approximately $1.0 million in 1997 and
$4.1  million in 1996 of  software  development  costs in  conjunction  with the
development of the Company's  MasterLink(TM)  central system software.  No costs
were  capitalized  for   MasterLink(TM)   development  in  1998.   Research  and
development  expenditures were approximately 5.0%, 5.5% and 6.8% of consolidated
revenues in 1998, 1997 and 1996, respectively.  Additionally, the Company spends
significant resources and capital on improvement of existing products,  services
and techniques for current customers.                                           

Year 2000                                                                       
---------                                                                       

     The Year 2000 issue is pervasive and complex.  Virtually every  information
technology  ("IT") system,  including the Company's  internal  systems,  systems
delivered to customers,  and suppliers'  systems, as well as non-IT systems will
be affected in some way by the  rollover  of the  two-digit  year value to "00".
Non-IT systems include  manufacturing systems and physical facilities including,
but not limited to,  security  systems and  utilities.  The result  could create
errors  in  information  or  system  failures.   Recognizing  this  uncertainty,
management  has and is  continuing  to  actively  analyze,  assess  and plan for
various Year 2000  issues.  Management  has  appointed a task force that reports
periodically  to the Company's CEO and Board of Directors,  and has also engaged
outside consultants to assist and advise management in this assessment process. 

     The  Company's  Year 2000 team has  completed  an  inventory  of all of its
computer  systems and technology  that may be impacted by Year 2000 issues.  The
programming and testing of mission  critical  systems was virtually  complete by
the end of 1998 and contingency  plans are planned for completion by April 1999.
In calendar  year 1999,  the Company  plans to replace or upgrade  those systems
that  are  identified  as  non-Year-2000  compliant  at an  incremental  cost of
approximately $0.5 million.  Non-IT system issues are more difficult to identify
and  resolve.  The  Company is  actively  identifying  non-IT  Year 2000  issues
concerning  its  products  and  services,  as  well  as  its  physical  facility
locations.  As non-IT areas are identified,  management formulates the necessary
actions  to  ensure  minimal  disruption  to its  business  processes.  Although
management  believes that its efforts will be  successful  and the costs will be
immaterial to its consolidated financial position and results of operations,  it
also  recognizes  that any  failure or delay  could  cause a  disruption  in its
business and may have a significant financial impact.                           

     The  Company has  evaluated  its  strategy  and legal  obligations  for any
communication to its customers. The Year 2000 readiness of its customers varies,
and the Company is  encouraging  its                                            

- 20 -

10-K405
21st Page of 74
TOC
1st
Previous
Next
Bottom
Just 21st

customers to evaluate and prepare  their own systems.  In many cases the Company
is assisting customers by providing new or modified systems to resolve Year 2000
issues.                                                                         

     The Company is also assessing the Year 2000 readiness of its key suppliers.
The  Company's  direction  in this effort is to ensure the adequacy of resources
and  supplies to  minimize  any  potential  business  interruptions.  Management
expects to complete this part of its Year 2000  readiness plan in the first half
of  1999.  As part of the  Company's  contingency  plans,  management  will,  as
considered  necessary,  begin  to  identify  and  communicate  with  alternative
suppliers to ensure the continuation of its critical business operations.       

     The Company believes that because of modifications already made and current
plans for additional  modifications  of existing  computer  systems,  updates by
vendors  and  conversion  to new  software,  the Year 2000  issue  will not pose
significant operations problems for the Company.  However, if such modifications
and conversions are not completed properly or in a timely manner, or third party
software and systems  relied on by the Company  fail,  the Year 2000 issue could
have a material impact on the business and operations of the Company.  The costs
of  modifications  and conversions are not anticipated to be material,  and will
principally   represent  a  re-deployment  of  existing  or  otherwise   planned
resources.  No assurance can be given that the Company will  successfully  avoid
any problems associated with the Year 2000 issue.                               

Intellectual Property                                                           
---------------------                                                           

     The Company may seek and, in some cases, has sought, patents and copyrights
with  respect to various  aspects of its  technology  used in its  products.  No
assurance can be given that any patent applications filed will be granted,  that
the patents or  copyrights  will not be infringed or that other parties will not
develop  similar  technology  that will not  violate  the  patents.  The Company
typically  requires  persons  such  as  customers,   employees,   licensees  and
subcontractors  who  have  access  to  proprietary  information  concerning  its
products to sign confidentiality and non-disclosure  agreements,  which prohibit
the use of this information  other than for the specific purpose for which it is
provided, and the Company relies on such agreements, other security measures and
trade-secret laws to protect such proprietary information.                      

     The Company has pending  applications  for  registration  of  trademarks in
connection  with its products in the United States,  Australia and other foreign
countries.  The  Company  intends to file  additional  applications  to register
trademarks  in the  United  States  and other key  jurisdictions  as  considered
necessary. The Company also relies on the laws of trade secrets and copyright to
protect  its  proprietary  rights to its central  control  system  software  and
various other software programs.                                                

Employees                                                                       
---------                                                                       

     As of December 31, 1998, the Company employed approximately 1,650 people on
a full and part-time basis. Approximately 625, 205, 280 and 275 were employed in
the lottery systems, gaming machines and systems, pari-mutuel systems and gaming
operations  segments,  respectively.   Another  265  people  provided  corporate
manufacturing, finance and administration and national marketing services to the
operating  segments.  Approximately 185 were seasonal or part-time  employees in
the pari-mutuel systems and gaming operations segments.                         

     The  Company  has  no  collective  bargaining  agreements  with  any of its
employees and believes that its overall relations with employees are good.      

- 21 -

10-K405
22nd Page of 74
TOC
1st
Previous
Next
Bottom
Just 22nd

Government Regulation                                                           
---------------------                                                           

     In the United States,  lotteries are not permitted in a jurisdiction unless
expressly  authorized  by  law  in  each  jurisdiction.   Currently,  there  are
thirty-eight  lotteries operating in the United States and District of Columbia.
All these lotteries operate a traditional  lottery,  namely,  offering lotto and
instant  scratch-off  games.  Video lottery,  involving video simulated games of
chance and skill played on gaming devices,  is not authorized under  traditional
lottery  statutes in the majority of these  jurisdictions.  There are  presently
seven  video  lottery  operations  in the  United  States.  Legislation  in each
jurisdiction  generally  specifies  certain standards to ensure the security and
integrity of the lottery  operation  that  include,  but are not limited to: the
minimum  percentage of gross  revenues paid back to players in prize money;  the
percentage of gross revenues paid to a state purpose;  randomness of play; goods
and  services  regarded  as  major   procurements   requiring  state  bids;  and
suitability  standards for agents and vendors of major procurements.  Policy and
management  decisions  of the lottery  operations  are  generally  governed by a
commission  appointed  by  the  governor  of  each  state  with  the  day-to-day
operations of the lottery  administered  by a director  appointed  either by the
governor or lottery  commission.  The lottery  commission  and  director of each
state generally exercise significant  authority,  including the determination of
the types of games played, the price of tickets, the manner in which the lottery
is marketed and selection of vendors of equipment and services.                 

     To ensure the integrity of their  lottery  operations,  most  jurisdictions
require detailed  background  disclosure and investigations of vendors providing
goods  and  services  under a  contract  award  for a major  procurement,  which
typically  include:  on-line  computer  systems  and  services;  instant  ticket
printing;  ticket validation  systems;  gaming devices;  drawing equipment;  and
advertising  services.  Background  investigations  typically  are  conducted on
company subsidiaries,  affiliates, officers, directors, and stockholders who own
5% or more of the  outstanding  capital  stock of the  Company  for  purposes of
meeting  suitability  standards  defined under statute and  regulations  of each
jurisdiction.   Additionally,   vendors   are   required  to  respond  and  meet
comprehensive  standards as described  in a lottery's  request for  proposals or
invitations for bid for the goods and services  contracted.  Failure on the part
of a vendor to meet suitability standards or provider requirements as delineated
in the request for proposals could jeopardize the award of a lottery contract to
the  Company or provide  grounds  for the  termination  of an  existing  lottery
contract.                                                                       

     The award of lottery  contracts  and ongoing  operations  of  lotteries  in
international  jurisdictions also are highly regulated,  although the operations
typically vary from lotteries in the United  States.  In addition,  restrictions
are  often   imposed  on  foreign   corporations   seeking  to  do  business  in
international jurisdictions.                                                    

     The manufacture, distribution and operation of gaming devices or facilities
are subject to extensive federal, state, provincial and local regulation.  These
regulations vary from jurisdiction to jurisdiction.  All  jurisdictions  require
various  licenses,  permits and  approvals to be held by companies and their key
personnel  in  connection  with the  manufacture,  distribution  or operation of
gaming devices or facilities. Generally, gaming devices may not be manufactured,
distributed or operated  unless such licenses are obtained from the  appropriate
regulatory  authorities of the jurisdictions.  Changes in such laws, regulations
and procedures could have an adverse effect on the Company's operations.        

     The  Federal  Gambling  Devices  Act of 1962 (the  "Federal  Act") makes it
unlawful for a person to manufacture, deliver or receive gaming machines, gaming
machine  devices and  components  thereof  across  interstate  lines unless that
person has first  registered  with the  Attorney  General of the United  States.
Certain of the Company's  subsidiaries  are so  registered  and must renew their
registrations  annually.  In  addition,  various  record  keeping and  equipment
identification  requirements  are imposed by the Federal  Act.  Violation of the
Federal Act may result in seizure or forfeiture  of equipment,  as well as other
penalties.                                                                      

     The U. S.  Congress  has created the  National  Gambling  Impact and Policy
Commission  to conduct a  comprehensive  study of all  matters  relating  to the
economic  and  social  impact of  gaming  in the  United  States.  The  enabling
legislation  provides that, not later than two years after the enactment of such
legislation,  the commission would be required to issue a report  containing its
findings and  conclusions,  together with  recommendations  for  legislation and
administrative  actions.  The  Commission's  final  report  is  expected  to  be
presented  to  the   President   and  Congress  in  mid-June   1999.   Any  such
recommendations, if                                                             

- 22 -

10-K405
23rd Page of 74
TOC
1st
Previous
Next
Bottom
Just 23rd

enacted into law, could adversely affect the gaming industry and have a material
adverse  effect on the  Company's  business,  financial  condition or results of
operations.                                                                     

     From time to time,  certain  legislators  have proposed the imposition of a
federal tax on gross gaming  revenues.  The Company is not aware of any specific
proposals  currently  pending for the imposition of such a federal tax; however,
no assurance can be given that such a tax will not be imposed in the future. Any
such tax  could  have a  material  adverse  effect  on the  Company's  business,
financial condition or results of operations.                                   

     Although the regulatory  schemes in the  jurisdictions in which the Company
sells or operates  video  lottery  gaming  machines or systems  (the  "Operating
Jurisdictions")  are not identical,  their material attributes are substantially
similar, as described below.                                                    

     The manufacture,  sale and distribution of gaming devices,  including video
lottery terminals,  and the ownership and operation of gaming facilities in each
Operating Jurisdiction,  are subject to various state, provincial, county and/or
municipal  laws,  regulations  and  ordinances,  which are  administered  by the
relevant  regulatory  agency or agencies  in that  Operating  Jurisdiction  (the
"Department").  These laws,  regulations  and ordinances  primarily  concern the
responsibility,   financial   stability  and   character  of  gaming   equipment
manufacturers,  distributors  and  operators,  as  well as  persons  financially
interested or involved in gaming or liquor operations.                          

     In addition to the  Operating  Jurisdictions,  the Company  will seek to do
business  in  other   jurisdictions  if  they  authorize  video  lottery  gaming
operations  in  the  future.  The  Company  cannot  predict  the  nature  of the
regulatory  scheme in any such  jurisdiction.  Certain states do have regulatory
schemes  currently  in place which  authorize  forms of video  gaming other than
video lottery,  such as video poker.  There can be no assurance that the Company
will obtain the necessary licenses,  permits or approvals to conduct business in
any new jurisdiction.                                                           

     The Company  regularly  engages  public  affairs  advisors and lobbyists in
various  United States  jurisdictions  to advise  legislators  and the public in
connection with lottery legislation and to advise the Company in connection with
contract  proposals.  Officers  of the  Company  may  make  authorized  campaign
contributions to various candidates of political parties.                       

     The  process by which  lottery  contract  awards are made may be subject to
intense  scrutiny and review by federal,  state and provincial  authorities  not
directly related to lottery authorities. It is impossible to predict the impact,
if any, on the Company of any such review of lottery procurement decisions      

     In general, no manufacturing,  distributing,  owning or operating of gaming
devices may be conducted  unless proper licenses and approvals are obtained.  An
application  for a license or approval  may be denied for failure to satisfy any
standard or requirement as determined by the Department.  In order to ensure the
integrity  of the video  lottery  gaming  system,  most  jurisdictions  have the
authority to conduct background investigations of the Company, its key personnel
and significant  stockholders.  The Department may at any time revoke,  suspend,
condition,  limit or restrict a license for any cause deemed in violation of its
law or  regulations.  Fines for violation of gaming laws or  regulations  may be
levied against the holder of a license and persons involved.  In September 1992,
the then Victoria Gaming Commission of Victoria, Australia, removed VLC from the
roll of approved gaming manufacturers,  which prohibited the Company from making
future  sales of  gaming  equipment  in  Victoria.  This  decision  was based on
concerns  regarding  the former  CEO and the then  majority  stockholder  of the
Company.  After severing all his business  relationships  with the Company,  VLC
applied and was approved for placement on the roll of approved  manufacturers in
Victoria  in December  1993.  The  Alcohol,  Racing and Gaming  Board  (RACJ) of
Montreal,  Quebec,  initially  rejected VLC's  application as a manufacturer  of
video lottery  equipment in December  1993.  The RACJ  reconsidered  its earlier
decision based on assurances  that the former CEO had also sold his entire stock
ownership  in the  Company  in  severing  all  business  relationships  with the
Company. In March 1994, the RACJ granted VLC a manufacturer license. VLC remains
in good standing with the Victorian Casino & Gaming Authority  (successor to the
Victoria  Gaming  Commission)  and the RACJ.  Other than the above two licensing
matters, the Company and its key personnel have been approved for licensing upon
completed  application in all operating  jurisdictions  in which the Company has
applied. Suspension or revocation of such licenses could have a material adverse
effect upon the Company's  future  operations and                               

- 23 -

10-K405
24th Page of 74
TOC
1st
Previous
Next
Bottom
Just 24th

the  experience in Victoria and Quebec  indicates that there can be no assurance
that the Company will  receive  necessary or  appropriate  licenses,  permits or
approvals  or, if received,  that such  licenses,  permits or approvals  will be
renewed or retained. The actions of any licensing authority may be considered by
regulatory  authorities  in other  jurisdictions.  Similarly,  the  rejection or
termination of the Company,  its personnel,  or major  stockholders in any other
jurisdiction may have adverse consequences in other jurisdictions.              

     In certain  jurisdictions,  the Company's  pari-mutuel  wagering segment is
also subject to extensive state regulatory and licensing requirements similar to
the  Company's  on-line  lottery  and video  gaming  machine  subsidiaries.  The
Company's  racetrack  operations  in Sunland  Park,  New Mexico,  are subject to
regulation of the New Mexico Racing Commission and other authorities.           

Nevada Regulatory Matters                                                       
-------------------------                                                       

     The  manufacture,  sale and  distribution  of gaming devices and associated
equipment  for use or play in Nevada or for  distribution  outside of Nevada and
the  operation of slot  machine  routes in Nevada are subject to: (i) The Nevada
Gaming Control Act and the  regulations  promulgated  thereunder  (collectively,
"Nevada  Act");  and  (ii)  various  local  ordinances  and  regulations.   Such
activities  are subject to the  licensing and  regulatory  control of the Nevada
Gaming Commission ("Nevada  Commission"),  the Nevada State Gaming Control Board
("Nevada  Board"),  and  various  local,  city and  county  regulatory  agencies
(collectively referred to as the "Nevada Gaming Authorities").                  

     The laws,  regulations  and  supervisory  procedures  of the Nevada  Gaming
Authorities  are based upon  declarations  of public  policy which are concerned
with, among other things:  (i) the prevention of unsavory or unsuitable  persons
from having a direct or indirect  involvement  with gaming,  or manufacturing or
locations,  practices,  associations and activities  related to the operation of
licensed  gaming  establishments  and the  manufacture or distribution of gaming
devices and equipment;  (ii) the  establishment  and  maintenance of responsible
accounting practices and procedures; (iii) the maintenance of effective controls
over the  financial  practices of  licensees,  including  the  establishment  of
minimum  procedures for internal  fiscal affairs and the  safeguarding of assets
and  revenues,  providing  reliable  record  keeping and requiring the filing of
periodic  reports with the Nevada  Gaming  Authorities;  (iv) the  prevention of
cheating  and  fraudulent  practices;  and (v) to  provide a source of state and
local  revenues  through  taxation  and  licensing  fees.  Change in such  laws,
regulations  and  procedures  could  have an  adverse  effect  on the  Company's
manufacturing, distribution and slot route operations.                          

     The Company is  registered by the Nevada  Commission  as a publicly  traded
corporation (a "Registered  Corporation") and has been found suitable to own the
stock of two wholly-owned subsidiaries, VLC and VLC of Nevada, Inc. (the "Nevada
Subsidiary")  which are each licensed as a  manufacturer  and  distributor.  The
Nevada  Subsidiary is also licensed as an operator of a slot machine route. As a
registered corporation,  the Company is required periodically to submit detailed
financial and operating  reports to the Nevada  Commission and furnish any other
information  that the  Nevada  Commission  may  require.  No person may become a
stockholder  of, or receive  any  percentage  of profits  from VLC or the Nevada
Subsidiary without first obtaining licenses and approvals from the Nevada gaming
authorities.  The Company,  VLC and the Nevada Subsidiary have obtained from the
Nevada  gaming  authorities  the  various  registrations,   approvals,  permits,
findings of suitability and licenses  (collectively  "Gaming Licenses") in order
to engage in manufacturing,  distribution and slot route activities in Nevada as
applicable.                                                                     

     All gaming  devices and cashless  wagering  systems that are  manufactured,
sold or distributed for use or play in Nevada,  or for  distribution  outside of
Nevada,  must be manufactured by licensed  manufacturers and distributed or sold
by licensed  distributors.  All gaming devices  manufactured  for use or play in
Nevada must be approved by the Nevada Commission before distribution or exposure
for play. The approval process for gaming devices  includes  rigorous testing by
the Nevada  Board,  a field trial and a  determination  as to whether the gaming
device meets strict technical standards that are set forth in the regulations of
the Nevada Commission. Associated equipment must be administratively approved by
the Chairman of the Nevada Board before it is distributed for use in Nevada. The
Winning Touch (R) gaming machine has been approved by the Nevada Commission.    

- 24 -

10-K405
25th Page of 74
TOC
1st
Previous
Next
Bottom
Just 25th

     The Nevada Gaming  Authorities  may  investigate  any  individual who has a
material  relationship to, or material involvement with, the Company, the Nevada
Subsidiary or VLC in order to determine  whether such  individual is suitable or
should be  licensed  as a business  associate  of a gaming  licensee.  Officers,
directors  and  certain  key  employees  of the  Nevada  Subsidiary  and VLC are
required to file  applications  with the Nevada  Gaming  Authorities  and may be
required  to be licensed or found  suitable  by the Nevada  Gaming  Authorities.
Officers,  directors  and key  employees  of the  Company who are  actively  and
directly involved in the licensed activities of the Nevada Subsidiary or VLC may
be required to be licensed or found  suitable by the Nevada Gaming  Authorities.
The Nevada  Gaming  Authorities  may deny an  application  for licensing for any
cause that they deem  reasonable.  A finding of  suitability  is  comparable  to
licensing,  and both  require  submission  of detailed  personal  and  financial
information followed by a thorough investigation. The applicant for licensing or
a finding of suitability must pay all the costs of the investigation. Changes in
licensed  positions  must be reported to the Nevada  Gaming  Authorities  and in
addition to their  authority to deny an application for a finding of suitability
or licensure,  the Nevada Gaming  Authorities have  jurisdiction to disapprove a
change in a corporate position.                                                 

     If the Nevada Gaming  Authorities were to find an officer,  director or key
employee   unsuitable   for  licensing  or  unsuitable  to  continue   having  a
relationship with the Company,  the Nevada Subsidiary,  VLC, or the subsidiaries
involved would have to sever all  relationships  with such person.  In addition,
the Nevada Commission may require the Company,  VLC and the Nevada Subsidiary to
terminate  the  employment  of  any  person  who  refuses  to  file  appropriate
applications.  Determination  of  suitability  or  of  questions  pertaining  to
licensing are not subject to judicial review in Nevada.                         

     The Company,  VLC and the Nevada Subsidiary are required to submit detailed
financial  and operating  reports to the Nevada  Commission.  Substantially  all
material loans, leases,  sales of securities and similar financing  transactions
by VLC and the Nevada  Subsidiary  are required to be reported to or approved by
the Nevada Commission.                                                          

     If it were determined that the Nevada Act was violated by the Company,  the
Nevada Subsidiary or VLC, the licenses they hold could be limited,  conditioned,
suspended  or  revoked,   subject  to  compliance  with  certain  statutory  and
regulatory procedures. In addition, the Nevada Subsidiary,  VLC, the Company and
persons  involved  could be  subject  to  substantial  fines  for each  separate
violation  of the  Nevada  Act  at the  discretion  of  the  Nevada  Commission.
Limitation,  conditioning or suspension of the licenses held by the Company, the
Nevada  Subsidiary  or VLC could (and  revocation  of any license  would) have a
materially  adverse effect on the Company's  manufacturing  and  distribution of
gaming machines.                                                                

     Any beneficial holder of the Company's voting securities, regardless of the
number of shares owned, may be required to file an application, be investigated,
and have his/her suitability  determined as a beneficial holder of the Company's
voting  securities  if the Nevada  Commission  has  reason to believe  that such
ownership  would  otherwise be  inconsistent  with the declared  policies of the
state of Nevada.  The applicant must pay all costs of investigation  incurred by
the Nevada Gaming Authorities in conducting any such investigation.             

     The Nevada Act  requires any person who  acquires  beneficial  ownership of
more than 5% of a  Registered  Corporation's  voting  securities  to report  the
acquisition to the Nevada  Commission.  The Nevada Act requires that  beneficial
owners of more than 10% of a Registered Corporation's voting securities apply to
the Nevada Commission for a finding of suitability  within thirty days after the
Chairman of the Nevada  Board mails the written  notice  requiring  such filing.
Under  certain  circumstances,  an  "institutional  investor," as defined in the
Nevada  Act,  which  acquires  more  than 10%,  but not more  than  15%,  of the
Registered  Corporation's  voting  securities may apply to the Nevada Commission
for a waiver of such finding of suitability if such institutional investor holds
the voting  securities for investment  purposes only. An institutional  investor
shall not be deemed to hold voting securities for investment purposes unless the
voting  securities were acquired and are held in the ordinary course of business
as an  institutional  investor  and not for the purpose of causing,  directly or
indirectly,  any of the following:  the election of a majority of the members of
the  board  of  directors  of the  Registered  Corporation;  any  change  in the
Registered  Corporation's  corporate charter,  bylaws,  management,  policies or
operations,  or in any of its gaming  affiliates,  or any other action which the
Nevada   Commission  finds  to  be  inconsistent  with  holding  the  Registered
Corporation's  voting securities for investment purposes only.  Activities which
are not deemed to be inconsistent  with holding voting securities for investment
purposes only include: (i) voting on all                                        

- 25 -

10-K405
26th Page of 74
TOC
1st
Previous
Next
Bottom
Just 26th

matters voted on by  stockholders;  (ii) making financial and other inquiries of
management of the type normally  made by securities  analysts for  informational
purposes and not to cause a change in its  management,  policies or  operations;
and (iii) such other  activities  as the Nevada  Commission  may determine to be
consistent  with such  investment  intent.  If the  beneficial  holder of voting
securities who must be found suitable is a corporation, partnership or trust, it
must submit  detailed  business and  financial  information  including a list of
beneficial owners. The applicant is required to pay all costs of investigation. 

     Any person who fails or refuses to apply for a finding of  suitability or a
license within thirty days after being ordered to do so by the Nevada Commission
or  the  Chairman  of the  Nevada  Board,  may be  found  unsuitable.  The  same
restrictions apply to a record owner if the record owner,  after request,  fails
to identify the beneficial  owner.  Any stockholder who is found  unsuitable and
who holds, directly or indirectly,  any beneficial ownership of the Common Stock
beyond such period of time as may be prescribed by the Nevada  Commission may be
guilty of a criminal offense. The Company will be subject to disciplinary action
if, after it receives  notice that a person is unsuitable to be a stockholder or
to have any other relationship with the Company,  the Nevada Subsidiary,  VLC or
the Company (i) pays that person any dividend or interest upon voting securities
of the Company, (ii) allows that person to exercise, directly or indirectly, any
voting  right  conferred  through  securities  held by that  person,  (iii) pays
remuneration in any form to that person for services  rendered or otherwise,  or
(iv) fails to pursue all lawful  efforts to require  such  unsuitable  person to
relinquish  his  voting  securities,  including,  if  necessary,  the  immediate
purchase of said voting securities for cash at fair market value.               

     The Nevada  Commission  may, in its  discretion,  require the holder of any
debt security of a Registered Corporation to file applications,  be investigated
and be found  suitable to own the debt security of a Registered  Corporation  if
the Nevada  Commission  has reason to believe that his  acquisition of such debt
security would otherwise be  inconsistent  with the declared policy of the State
of Nevada.  If the Nevada  Commission  determines that a person is unsuitable to
own such security,  then pursuant to the Nevada Act, the Registered  Corporation
can be  sanctioned,  including the loss of its  approvals,  if without the prior
approval of the Nevada  Commission,  it: (i) pays to the  unsuitable  person any
dividend,  interest, or any distribution whatsoever;  (ii) recognizes any voting
right by such unsuitable  person in connection with such securities;  (iii) pays
the unsuitable person remuneration in any form; or (iv) makes any payment to the
unsuitable  person  by  way  of  principal,  redemption,  conversion,  exchange,
liquidation, or similar transaction.                                            

     The  Company,  VLC,  and the Nevada  Subsidiary  are required to maintain a
current  stock  ledger in  Nevada  that may be  examined  by the  Nevada  Gaming
Authorities at any time. If any securities are held in trust by an agent or by a
nominee,  the record  holder may be  required to  disclose  the  identity of the
beneficial  owner to the  Nevada  Gaming  Authorities.  A  failure  to make such
disclosure may be grounds for finding the record holder unsuitable.  The Company
is also required to render maximum assistance in determining the identity of the
beneficial  owner.  The Nevada  Commission  has the power to  require  the stock
certificates of the Company to bear a legend  indicating that the securities are
subject to the Nevada  Act.  However,  to date,  the Nevada  Commission  has not
imposed such a requirement on the Company.                                      

     The Company may not make a public  offering of its  securities  without the
prior approval of the Nevada Commission if the securities or proceeds  therefrom
are intended to be used to construct,  acquire or finance  gaming  facilities in
Nevada,  or to retire or extend  obligations  incurred for such  purposes.  Such
approval, if given, does not constitute a finding, recommendation or approval by
the Nevada  Commission or the Nevada Board as to the accuracy or adequacy of the
prospectus  or  the   investment   merits  of  the   securities   offered.   Any
representation to the contrary is unlawful.                                     

     Changes  in   control  of  a   Registered   Corporation   through   merger,
consolidation, stock or asset acquisitions, management or consulting agreements,
or any act or conduct by a person  whereby  he  obtains  control,  may not occur
without the prior approval of the Nevada Commission. Entities seeking to acquire
control of a Registered Corporation must satisfy the Nevada Board and the Nevada
Commission in a variety of stringent standards prior to assuming control of such
Registered  Corporation.  The Nevada  Commission  may also  require  controlling
stockholders,   officers,   directors  and  other  persons   having  a  material
relationship or involvement with the entity proposing to acquire control,  to be
investigated  and  licensed  as part of the  approval  process  relating  to the
transaction.                                                                    

- 26 -

10-K405
27th Page of 74
TOC
1st
Previous
Next
Bottom
Just 27th

     The  Nevada  legislature  has  declared  that some  corporate  acquisitions
opposed by management,  repurchases of voting  securities and corporate  defense
tactics affecting Nevada corporate gaming licensees, and Registered Corporations
that are  affiliated  with  those  operations,  may be  injurious  to stable and
productive  corporate gaming. The Nevada Commission has established a regulatory
scheme to ameliorate the potentially adverse effects of these business practices
upon Nevada's gaming industry and to further  Nevada's policy to: (i) assure the
financial  stability of corporate  gaming licensees and their  affiliates;  (ii)
preserve the beneficial  aspects of conducting  business in the corporate  form;
and (iii) promote a neutral  environment for the orderly governance of corporate
affairs.  Approvals  are,  in certain  circumstances,  required  from the Nevada
Commission before the Registered Corporation can make exceptional repurchases of
voting  securities above the current market price thereof and before a corporate
acquisition  opposed  by  management  can be  consummated.  The  Nevada Act also
requires prior approval of a plan of recapitalization proposed by the Registered
Corporation's  Board of Directors in response to a tender offer made directly to
the Registered Corporation's  stockholders for the purposes of acquiring control
of the Registered Corporation.                                                  

     License fees and taxes,  computed in various ways  depending on the type of
gaming or  activity  involved,  are  payable  to the State of Nevada  and to the
counties and cities in which gaming  operations  are to be conducted.  Depending
upon the  particular  fee or tax  involved,  these  fees and taxes  are  payable
monthly,  quarterly or annually and are based upon either:  (i) a percentage  of
the gross  revenues  received;  or (ii) the number of gaming  devices  operated.
Annual fees are also payable to the State of Nevada for renewal of licenses as a
manufacturer, distributor and operator of a slot machine route.                 

     Any person who is licensed, required to be licensed,  registered,  required
to be registered,  or is under common  control with such persons  (collectively,
"Licensees"), and who proposes to become involved in a gaming venture outside of
Nevada, is required to deposit with the Nevada Board, and thereafter maintain, a
revolving fund in the amount of $10,000 to pay the expenses of  investigation by
the Nevada Board of their  participation  in such foreign gaming.  The revolving
fund is  subject  to  increase  or  decrease  in the  discretion  of the  Nevada
Commission.  Thereafter, Licensees are required to comply with certain reporting
requirements   imposed  by  the  Nevada  Act.  Licensees  are  also  subject  to
disciplinary  action by the Nevada Commission if it knowingly  violates any laws
of the foreign jurisdiction pertaining to the foreign gaming operation, fails to
conduct the foreign gaming operation in accordance with the standards of honesty
and integrity required of Nevada gaming  operations,  engages in activities that
are  harmful to the state of Nevada or its ability to collect  gaming  taxes and
fees, or employs a person in the foreign operation who has been denied a license
or finding of suitability in Nevada on the ground of personal unsuitability.    

Native American Gaming Regulations                                              
----------------------------------                                              

     Gaming on Native American lands is extensively regulated under federal law,
tribal-state  compacts and tribal law. The Indian Gaming  Regulatory Act of 1988
("IGRA") provides the framework for federal and state control over all gaming on
Native American  lands.  IGRA regulates the conduct of gaming on Native American
lands  and the  terms  and  conditions  of  contracts  with  third  parties  for
management of gaming  operations.  IGRA  established  the National Indian Gaming
Commission  ("NIGC")  to  operate  as an  independent  agency,  within the U. S.
Department   of  the   Interior,   to  exercise   primary   federal   regulatory
responsibility  over  such  gaming.  The NIGC is  delegated  authority  to issue
regulations  governing tribal gaming  activities,  approve tribal ordinances for
regulating  Class II and Class III gaming,  approve  management  agreements  for
gaming facilities, conduct investigations and monitor tribal gaming generally.  

     The IGRA  classifies  games that may be conducted on Native  American lands
into three categories.  "Class I Gaming" includes social games solely for prizes
of minimal value,  or traditional  forms of Native American Gaming engaged in by
individuals  as  part  of,  or  in  connection   with,   tribal   ceremonies  or
celebrations.  "Class II Gaming" includes bingo, pulltabs,  lotto, punch boards,
tip jars,  instant bingo,  and other games similar to bingo,  if those games are
played at the same location as bingo is played.  "Class III Gaming" includes all
other  commercial  forms of gaming,  such as table  games,  slots,  video casino
games,  and other  commercial  gaming  (e.g.,  sports  betting  and  pari-mutuel
wagering).                                                                      

     Class  I  Gaming  on  Native   American   lands  is  within  the  exclusive
jurisdiction  of the Native American tribes and is not subject to the provisions
of IGRA.  Class II Gaming is permitted on Native American lands if (a) the state
in which the Native  American  lands lie permits  such gaming for any purpose by
any person,                                                                     

- 27 -

10-K405
28th Page of 74
TOC
1st
Previous
Next
Bottom
Just 28th

organization or entity; (b) the gaming is not otherwise specifically  prohibited
on  Native  American  lands by  federal  law;  (c) the  gaming is  conducted  in
accordance with a tribal  ordinance or resolution which has been approved by the
NIGC;  (d)  a  Native   American  tribe  has  sole   proprietary   interest  and
responsibility for the conduct of gaming;  (e) the primary management  officials
and key employees are tribally licensed;  and (f) several other requirements are
met.  Class III Gaming is permitted on Native  American  lands if the conditions
applicable to Class II Gaming are met and, in addition,  the gaming is conducted
in conformance with the terms of a written agreement between a tribal government
and the government of the state within whose boundaries the tribe's lands lie (a
"tribal-state compact").                                                        

     IGRA requires states to negotiate in good faith with Native American tribes
that seek to enter  into a  tribal-state  compact  for the  conduct of Class III
Gaming.  Such tribal-state  compact may include provisions for the allocation of
criminal and civil jurisdiction  between the state and the Native American tribe
necessary  for the  enforcement  of such laws and  regulations,  taxation by the
Native  American  tribe of such activity in amounts  comparable to those amounts
assessed by the state for comparable activities,  remedies for breach, standards
for the  operation of such  activity  and  maintenance  of the gaming  facility,
including  licensing,  and any other  subjects that are directly  related to the
operation of gaming  activities.  The terms of  tribal-state  compacts vary from
state to state.  Compacts within one state tend to be  substantially  similar to
each other.  Compacts usually specify the types of permitted games,  entitle the
states to inspect casinos,  require  background  investigations and licensing of
casino employees and vendors,  and may require the tribe to pay a portion of the
state's expenses for establishing and maintaining regulatory agencies.          

Other Jurisdictions and Government Approvals                                    
--------------------------------------------                                    

     Most of the other  jurisdictions  in which the Company and its subsidiaries
conduct  business or intend to conduct  business in the future  require  various
licenses,  permits,  findings of  suitability or other  approvals  (collectively
"Government  Approvals") in connection with the manufacture and/or  distribution
of gaming  devices or  provision  of goods or services to the Lottery and Racing
Industries.  Some  jurisdictions  allow the Company to operate under a temporary
Government  Approval  or on a  transactional  basis  during  the  pendency  of a
comprehensive   background   investigation.   While  the  Company  has  received
Government  Approvals  in  all of  the  jurisdictions  in  which  the  Company's
applications  have been acted  upon,  there can be no  assurance  that  required
Government approvals will be given or renewed in the future.                    

     Most of the jurisdictions in which the Company and its subsidiaries conduct
business or intend to conduct  business in the future  require gaming devices to
meet certain standards and specifications  established by each jurisdiction.  In
addition,  most jurisdictions require gaming devices to be reviewed and approved
either by the regulatory  agency or an independent  testing  laboratory prior to
the gaming  devices  being sold or offered  for public  play.  The  Company  has
received or is seeking such approvals for its gaming  devices,  but there can be
no assurance that such approvals will be maintained or that additional requisite
approvals will be obtained.                                                     

Additional Financial Information                                                
--------------------------------                                                

     Certain  financial  information for each of the Company's last three fiscal
years with respect to industry segments and foreign and domestic  operations and
export  sales  is set  forth  in  Notes  2 and 3 of the  Company's  Consolidated
Financial Statements.                                                           

- 28 -

10-K405
29th Page of 74
TOC
1st
Previous
Next
Bottom
Just 29th


ITEM 2.  PROPERTIES                                                             

     The Company's executive offices,  principal  manufacturing and distribution
facilities  occupy  approximately  82,000 square feet in a building owned by the
Company and located in Bozeman, Montana. The Company leases approximately 38,000
square feet  serving as a  warehouse/assembly  facility in the Bozeman  area and
approximately  8,000  square  feet  serving as  executive  offices  in  Atlanta,
Georgia.                                                                        

     The Company's on-line lottery services  subsidiary,  AWI, leases facilities
in New Jersey  located in a complex of which AWI occupies  approximately  43,000
square feet and in Arden  Hills,  Minnesota,  where AWI  occupies  approximately
13,000  square  feet.  In  connection   with  its   operations  in  the  various
jurisdictions,  AWI occupies approximately 40 additional sites, most of which it
holds under lease.  The Company leases space in Reno (4,800 square feet) and Las
Vegas (13,900 square feet), Nevada, Biloxi,  Mississippi (1,000 square feet) and
Victoria, Australia (1,000 square feet), primarily for product sales and support
as well as  assembly,  repair and storage of gaming  machine  products.  Also in
Bozeman,  Montana,  the Company  leases  approximately  5,300 square feet out of
which it  operates  one of its  route  businesses.  The  Company  also  owns two
buildings, one in Billings, Montana and one in Livingston, Montana, out of which
it operates its other two route businesses.                                     

     The Company  leases  approximately  1,500  square feet of office space near
Baltimore,  Maryland for the administrative  offices of United Tote. United Tote
leases  approximately  12,100  square  feet  in  San  Diego,  California,  which
primarily  houses the  subsidiary's  research and  development  activities,  and
leases  approximately  2,900  square  feet of space  in  Winnipeg,  Canada,  for
administrative and repair services.                                             

     The  Company's  racetrack  facility in Sunland Park,  New Mexico,  rests on
approximately  150 acres and contains in excess of 330,000 square feet inclusive
of the casino, grandstand, stables, barns and offices. The racetrack itself is a
one-mile oval track.                                                            

     The Company's  Bozeman,  Montana  facility and the real property located at
Sunland Park are subject to mortgages held by the Company's primary lender.     

ITEM 3.  LEGAL PROCEEDINGS                                                      

     In  December  1996,  a  purported  class  action  was filed in the Court of
Chancery,  Delaware State Court,  directing the Company and certain officers and
directors of the company to fulfill their  fiduciary  obligations by effecting a
transaction for the acquisition of the Company.  On January 2, 1997, the Company
and certain  other  officers  and  directors  of the  Company  filed a motion to
dismiss the matter.  This matter has been  informally  stayed for an  indefinite
period of time by agreement of the parties.                                     

     In February of 1999,  GTECH  Corporation  filed a complaint for declaratory
judgment,  injunction, and violation of the Public Records Law against the State
of Florida,  Department of Lottery and AWI in the Circuit Court, Second Judicial
Circuit,  in Leon County,  Florida.  The complaint requests the Circuit Court to
declare the contract  between AWI and the Florida  Lottery void in the event the
First District Court of Appeal of Florida upholds the Florida Lottery's decision
to award  the  on-line  lottery  services  contract  to AWI.  Subsequent  to the
execution of the  renegotiated  contract  between AWI and the Florida Lottery in
March 1999, GTECH Corporation  amended the complaint.  The Company believes this
action is entirely without merit and intends to vigorously defend this action.  

     Although the Company is a party to various claims and legal actions arising
in the ordinary  course of its  business,  in the opinion of  management,  after
consultation with legal counsel, the ultimate disposition of these other matters
as they are currently  understood will not likely have a material adverse effect
on the financial position or results of operations of the Company.              

ITEM 4.  SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS                    

None                                                                  

- 29 -

10-K405
30th Page of 74
TOC
1st
Previous
Next
Bottom
Just 30th

 PART II

ITEM 5.  MARKET FOR THE COMPANY'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS 

     The  Company's  Common  Stock  trades on The Nasdaq  Stock Market under the
symbol PWRH.  From July 24, 1991 until December 31, 1997,  the Company's  Common
Stock  traded  under the symbol  VLTS.  Prior to that time,  there was no public
market for the Common Stock. The following table sets forth the high and low bid
prices for the common shares for the periods indicated as reported by Nasdaq.   

     YEAR                                               High                 Low
     ----                                               ----                 ---

1998                                                                  
           Quarter ended December 31, 1998            $14.56               $8.63
           Quarter ended September 30, 1998           $12.00               $7.38
           Quarter ended June 30, 1998                $14.44               $7.75
           Quarter ended March 31, 1998               $15.25               $9.88

1997                                                                  
           Quarter ended December 31, 1997            $12.75               $8.75
           Quarter ended September 30, 1997           $11.38               $5.94
           Quarter ended June 30, 1997                 $6.25               $3.50
           Quarter ended March 31, 1997                $4.88               $3.25

     As of March 1, 1999, there were  approximately 900 holders of record of the
Company's  Common Stock.  Since its  formation in May 1991,  the Company has not
paid any dividends to its stockholders.  The Company currently intends to retain
any earnings to help finance the growth and development of its business and does
not  anticipate  paying cash  dividends on its capital stock in the  foreseeable
future.  Any future  determination  as to the payment of dividends on its Common
Stock  will  depend,  among  other  things,  on  the  future  earnings,  capital
requirements and financial  condition of the Company,  and on such other factors
as the Company's  Board of Directors  may consider  relevant.  In addition,  the
Company's  existing  bank line of credit  restricts the payments of dividends by
the Company. (See Note 10 to the Consolidated Financial Statements.)            

- 30 -

10-K405
31st Page of 74
TOC
1st
Previous
Next
Bottom
Just 31st


ITEM 6.  SELECTED FINANCIAL DATA                                                

     The selected  data  presented  below for, and as of the end of, each of the
years in the  five-year  period ended  December  31, 1998,  are derived from the
consolidated  financial  statements  of  the  Company  and  subsidiaries,  which
financial statements have been audited by KPMG LLP, independent certified public
accountants.  The consolidated  financial statements as of December 31, 1998 and
1997,  and for each of the years in the  three-year  period  ended  December 31,
1998,  and the report  thereon,  are included  elsewhere in this Form 10-K.  The
selected  consolidated  financial  data should be read in  conjunction  with the
consolidated  financial statements and notes thereto of the Company and "Item 7.
Management's  Discussion  and  Analysis of  Financial  Condition  and Results of
Operations" included elsewhere in this Form 10-K.                               

                                                        · Enlarge/Download Table

                         Selected Financial Information                                               
                  (Dollars in thousands, except per share data)                                       

                                                                Years Ended December 31,              
OPERATIONS DATA                                  1998         1997        1996        1995     1994   
                                                 ----         ----        ----        ----     ----   
                                                                                                      

REVENUES:                                                                                             
Lottery systems                                $103,581      94,771      88,843      91,653   101,559 
Gaming machines and systems                      53,215      57,626      43,632      46,086    53,149 
Pari-mutuel systems                              20,028      20,177      20,499      20,144    13,831 
Gaming operations                                24,327      24,361      23,707      23,279    20,243 
                                               --------     -------     -------     -------   ------- 
     Total revenues                             201,151     196,935     176,681     181,162   188,782 

COSTS OF REVENUES                                                                                     
Lottery systems                                  62,281      62,558      59,333      59,438    62,397 
Gaming machines and systems                      30,054      31,766      21,084      24,912    28,808 
Pari-mutuel systems                              12,879      12,784      12,545      14,176     9,338 
Gaming operations                                20,019      19,873      19,386      19,189    15,661 
                                               --------     -------     -------     -------   ------- 
                                                125,233     126,981     112,348     117,715   116,204 
                                               --------     -------     -------     -------   ------- 
     Gross profit                                75,918      69,954      64,333      63,447    72,578 

OTHER OPERATING EXPENSES:                                                                             
Selling, general and administrative              36,635      31,655      28,697      31,140    34,000 
Research and development                         10,011       9,788       7,969       8,888     8,513 
Other charges                                       ---         ---      34,135       2,763    23,994 
Depreciation and amortization                    19,701      21,995      23,822      22,587    20,694 
                                               --------     -------     -------     -------   ------- 
                                                 66,347      63,438      94,623      65,378    87,201 
                                               --------     -------     -------     -------   ------- 

Earnings (loss) from operations                   9,571       6,516     (30,290)     (1,931)  (14,623)

Other income (expense)                           (1,590)     (2,869)     (2,694)     (1,833)     (242)
                                               --------     -------     -------     -------   ------- 

Earnings (loss) before income taxes and                                                               
   extraordinary items                            7,981       3,647     (32,984)     (3,764)  (14,865)

Income tax benefit (expense)                     (3,405)      1,135       8,753         846    (1,303)
                                               --------     -------     -------     -------   ------- 

Net earnings (loss) from continuing operations    4,576       4,782     (24,231)     (2,918)  (16,168)

Reversal of loss on discontinuance of                                                                 
   pari-mutuel systems, net                         ---         ---       5,482      (5,482)      --- 
                                               --------     -------     -------     -------   ------- 

Net earnings (loss) before extraordinary items    4,576       4,782     (18,749)     (8,400)  (16,168)

Extraordinary gain, net                             ---      13,269       4,014         ---       --- 
                                               --------     -------     -------     -------   ------- 

     Net earnings (loss)                       $  4,576      18,051     (14,735)     (8,400)  (16,168)
                                               ========     =======     =======     =======   ========


- 31 -

10-K405
32nd Page of 74
TOC
1st
Previous
Next
Bottom
Just 32nd
                                                                · Download Table

                                                 Years Ended December 31,         
                                  1998    1997        1996        1995      1994  
                                  ----    ----        ----        ----      ----  
                                                                                  

EARNINGS (LOSS) PER SHARE DATA:                                                   
Basic:                                                                            
Continuing operations             $0.43    0.46       (2.28)      (0.28)    (1.56)
Net earnings (loss)               $0.43    1.75       (1.39)      (0.80)    (1.56)
                                  =====    ====       =====       =====     ===== 
Diluted:                                                                          
Continuing operations             $0.42    0.46       (2.28)      (0.28)    (1.56)
Net earnings (loss)               $0.42    1.72       (1.39)      (0.80)    (1.56)
                                  =====    ====       =====       =====     ===== 
Weighted average shares:                                                          
Basic                            10,580  10,329      10,635      10,555    10,337 
Potential Common Stock(1)           323     160         ---         ---       --- 
                                 ------  ------      ------      ------    ------ 
Diluted                          10,903  10,489      10,635      10,555    10,337 
                                 ======  ======      ======      ======    ====== 

                                                                · Download Table

                                                      As of December 31,           
                                      1998     1997      1996        1995     1994 
                                      ----     ----      ----        ----     ---- 
                                                                                   

BALANCE SHEET DATA                                                                 
Working capital                     $41,177   37,050    28,083      19,987   23,344
Total assets                        188,475  161,397   168,043     165,851  174,032
Total long-term debt                                                               
  (excluding current installments)   51,765   31,446     9,312      12,885    9,060
Stockholders' equity                 87,978   82,146    72,231      86,448   94,112


(1)  Excluded if antidilutive                                                   

- 32 -

10-K405
33rd Page of 74
TOC
1st
Previous
Next
Bottom
Just 33rd


ITEM 7.  MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS                                                 

 Results of Operations

     The following  table  presents for the years  indicated  the  percentage of
revenues  represented  by certain  operational  data, as well as the  percentage
change in such items.                                                           

                                                        · Enlarge/Download Table

                                      Percentage (%) of Total Revenues  Percentage (%) Increase
                                                Years Ended                   (Decrease)       
                                                December 31,            -----------------------
                                      --------------------------------  Year 1998     Year 1997
                                          1998      1997       1996     Over 1997     Over 1996
                                          ----      ----       ----     ---------     ---------
                                                                                               

Revenues:                                                                                      
Lottery systems                           51.5      48.1       50.3         9.3            6.8 
Gaming machines and systems               26.4      29.3       24.7        (7.6)          32.1 
Pari-mutuel systems                       10.0      10.2       11.6         ---           (2.0)
Gaming operations                         12.1      12.4       13.4        (0.4)           3.0 
                                         -----     -----      -----                            
                                         100.0     100.0      100.0         2.2          (11.5)
                                         -----     -----      -----                            

Costs and expenses:                                                                            
Lottery systems                           31.0      31.7       33.6        (0.3)           5.4 
Gaming machines and systems               15.0      16.2       11.9        (5.3)          50.7 
Pari-mutuel systems                        6.4       6.5        7.1         0.8            2.4 
Gaming operations                          9.9      10.1       11.0         0.5            2.6 
Selling, general and administrative       18.2      16.0       16.3        15.8           10.1 
Research and development                   5.0       5.0        4.5         2.0           22.5 
Depreciation and amortization              9.8      11.2       13.5       (10.5)          (7.6)
Other charges                              ---       ---       19.3         ---         (100.0)
                                         -----     -----      -----                            

                                          95.2      96.7      117.1         0.6           (7.9)
                                          ----     -----      -----                            

Earnings (loss) from operations            4.8       3.3      (17.1)       47.7         (121.5)

Other expense, net                        (0.8)     (1.5)      (1.5)      (44.8)           7.4 
                                         -----     -----      -----                            
Net earnings (loss) before income taxes                                                        
  and extraordinary items                  4.0       1.8      (18.6)      122.2         (110.9)
                                         =====     =====      =====                            

     As a holding  company  whose  principal  assets are the  securities  of its
subsidiaries,  the Company's  ability to meet debt service  obligations  and pay
operating  expenses and  dividends,  if  authorized  by the  Company's  board of
directors,  depends primarily on the receipt of sufficient  dividends from those
operating subsidiaries. In addition, gaming statutes and license requirements in
the jurisdictions in which the Company's  subsidiaries  currently operate or may
operate  in the  future  may  require  the  maintenance  of  minimum  amounts of
statutory  capital and place certain  restrictions  upon the amount of dividends
that the Company's subsidiaries may pay.                                        

     The success of the Company will be dependent, to a significant extent, upon
the continued services of a relatively small group of executive  personnel.  The
loss  or  unavailability  of one or  more  of  such  executive  officers  or the
inability to attract or retain key employees in the future could have an adverse
effect upon the Company's operations.                                           

Revenues                                                                        
--------                                                                        

     Revenue  from  the  lottery  systems  segment   consists   primarily  of  a
contractual percentage of lottery ticket sales in certain states in the U. S. as
well as  revenue  from  software  license  fees  and  sales of  on-line  lottery
equipment.  Software  license  fees and  equipment  sales  revenue is  generally
generated from customers outside of the United States.  The segment revenue will
experience  fluctuations  depending  on                                         

- 33 -

10-K405
34th Page of 74
TOC
1st
Previous
Next
Bottom
Just 34th

contract  start and end  dates,  relative  sizes of  jackpots  and the number of
terminals  on-line and selling  tickets.  The Company  expects  lottery  systems
revenue to continue to be a  significant  component  of  consolidated  revenues.
Lottery systems revenue is generated by the Company's subsidiary, AWI.          

     Revenue  from the gaming  machines and systems  segment  consists of sales,
repair,  service and lease of gaming  machines and related  parts as well as the
development  and sale of central  control  systems  inclusive  of  software  and
hardware to the video lottery and casino markets.  If and when new jurisdictions
approve legislation for new or expanded gaming venues, or when the Company first
enters a new jurisdiction (assuming the Company is successful in obtaining sales
contracts  in any such  jurisdictions),  the segment may  experience  a surge in
sales  revenue.  Subsequently,  revenues from that  jurisdiction  may or may not
experience  significant  volatility.  The volatility would depend on among other
things,  technology  availability,   timing  of  replacement,   and  legislative
expansion.  The Company  expects gaming machines and systems revenue to continue
to be a significant  component of  consolidated  revenues.  Gaming  machines and
systems revenue is primarily generated by the Company's subsidiary, VLC.        

     The Company is actively seeking to expand its operations into jurisdictions
that have legalized gaming. There can be no assurance, however, that the Company
will be able to identify or capitalize on any opportunities in suitable markets.
The Company's  ability to expand will be dependent upon a number of factors many
of which are beyond the  Company's  control,  including  negotiating  acceptable
terms,  securing  required  state,  foreign,  and local licenses,  permits,  and
approvals,  securing  adequate  financing on acceptable  terms,  voter and other
political approvals, demographic trends, and consumers' gaming preferences. As a
result,  there can be no assurance  that the Company will be able to develop new
markets for its products. In addition, the Company may incur costs in connection
with pursuing new lottery and gaming  opportunities  that it cannot  recover and
may be required to expense certain of these costs,  which may negatively  affect
the Company's reported  operating  performance for the periods during which such
costs are incurred.                                                             

     Revenue from pari-mutuel  systems is generated primarily from a contractual
percentage of handle processed through computerized pari-mutuel wagering systems
from over 120 contracts in North America.  Outside North America,  the Company's
practice had been  primarily  sales and lease of pari-mutuel  wagering  systems.
While  on-track  attendance and handle from  pari-mutuel  wagering in the United
States  has  declined  over the last  decade  there has also been a  substantial
increase in simulcast  and off-track  wagering  handle.  Due to the  significant
increase of alternate forms of gaming over the last several years,  there can be
no assurance that such  historical  patterns will remain the same in the future,
nor can the Company predict the magnitude of any resulting net economic  effects
on this segment of its business. The Company expects pari-mutuel systems revenue
to be a significant component of consolidated revenues.                         

     Gaming  operations  revenue  consists of revenue from the Company's  gaming
machine route operations and the operation of a horse racing facility in Sunland
Park, New Mexico. In 1999, the gaming  operations  segment will include revenues
generated  from the  operation  of a casino  which  opened in  February  1999 at
Sunland Park.  Route  operations  revenue  consists  primarily of gaming machine
wagers net of payouts to patrons and state gaming taxes.                        

Gross Profit                                                                    
------------                                                                    

     Gross  profit for each  segment  is herein  defined  as  revenues  for that
segment less the corresponding  costs and expenses  (excluding  depreciation and
amortization  expense  and any  special or other  charges).  Costs and  expenses
related to on-line  lottery  revenue  include  all  direct  costs and  allocated
indirect  costs  involved  in  operating  the  on-line  lottery  system  in each
jurisdiction  in which the Company has a contract as well as costs of  equipment
sales, inclusive of materials, labor and allocated manufacturing overhead. Costs
and  expenses  related to sales of gaming  machines and systems  include  direct
costs of production, including labor and allocated manufacturing overhead. Costs
and expenses related to gaming  operations  include direct and indirect costs of
operating  the  racetrack  facility  and the location  owners'  share of the net
machine revenues for route operations. Costs and expenses related to pari-mutuel
systems revenue include direct and indirect costs  associated with the operation
of the  wagering  equipment at  racetracks  as well as direct costs of equipment
sales.                                                                          

- 34 -

10-K405
35th Page of 74
TOC
1st
Previous
Next
Bottom
Just 35th

Selling, General and Administrative Expenses                                    
--------------------------------------------                                    

     Selling,  general  and  administrative  expenses  consist  of labor  costs,
professional  fees, repairs and maintenance  expense,  promotion and advertising
costs,  occupancy  and other  costs,  other  than  those  included  in costs and
expenses  applicable  to the  determination  of gross profit as defined above or
research and development as discussed below.                                    

Research and Development                                                        
------------------------                                                        

     Research and development costs represent costs incurred to gain and develop
new knowledge  applicable to the Company's  various operating  segments.  Labor,
material, consulting,  occupancy and other expenses associated with the research
and  development  efforts  are  included  in the  costs.  Development  costs are
capitalized for certain software developed for sale or lease.                   

Other Charges                                                                   
-------------                                                                   

     Other charges include  special and unusual charges  recorded by the Company
for restructurings,  asset valuation impairments,  liquidated damage assessments
and other contract losses. The Company excludes special and unusual charges from
the calculation of gross profit due to the nature of each charge as disclosed in
the  discussion  of gross  profit  margin  for  each  segment  of the  Company's
operations.  Such other charges are considered special and unusual in nature and
are not  associated  with the  revenue  stream of any  segment of the  Company's
operations.  Accordingly,  the Company believes that the inclusion of such other
charges in the  determination  of gross profit would not be  indicative of past,
current or future gross profit margins.  The Company has not incurred any "other
charges" since 1996.                                                            

Year 2000                                                                       
---------                                                                       

     The Year 2000 issue is pervasive and complex.  Virtually every  information
technology  ("IT") system,  including the Company's  internal  systems,  systems
delivered to customers,  and suppliers'  systems, as well as non-IT systems will
be affected in some way by the  rollover  of the  two-digit  year value to "00".
Non-IT systems include  manufacturing systems and physical facilities including,
but not limited to,  security  systems and  utilities.  The result  could create
errors  in  information  or  system  failures.   Recognizing  this  uncertainty,
management  has and is  continuing  to  actively  analyze,  assess  and plan for
various Year 2000  issues.  Management  has  appointed a task force that reports
periodically  to the Company's CEO and Board of Directors,  and has also engaged
outside consultants to assist and advise management in this assessment process. 

     The  Company's  Year 2000 team has  completed  an  inventory  of all of its
computer  systems and technology  that may be impacted by Year 2000 issues.  The
programming and testing of mission  critical  systems was virtually  complete by
the end of 1998 and contingency  plans are planned for completion by April 1999.
In calendar  year 1999,  the Company  plans to replace or upgrade  those systems
that  are  identified  as  non-Year-2000  compliant  at an  incremental  cost of
approximately $0.5 million.  Non-IT system issues are more difficult to identify
and  resolve.  The  Company is  actively  identifying  non-IT  Year 2000  issues
concerning  its  products  and  services,  as  well  as  its  physical  facility
locations.  As non-IT areas are identified,  management formulates the necessary
actions  to  ensure  minimal  disruption  to its  business  processes.  Although
management  believes that its efforts will be  successful  and the costs will be
immaterial to its consolidated financial position and results of operations,  it
also  recognizes  that any  failure or delay  could  cause a  disruption  in its
business and may have a significant financial impact.                           

     The  Company has  evaluated  its  strategy  and legal  obligations  for any
communication to its customers. The Year 2000 readiness of its customers varies,
and the Company is  encouraging  its customers to evaluate and prepare their own
systems.  In many cases the Company is assisting  customers by providing  new or
modified systems to resolve Year 2000 issues.                                   

     The Company is also assessing the Year 2000 readiness of its key suppliers.
The  Company's  direction  in this effort is to ensure the adequacy of resources
and  supplies to  minimize  any  potential  business  interruptions.  Management
expects to complete this part of its Year 2000  readiness plan in the first half
of  1999.  As part of the  Company's  contingency  plans,  management  will,  as
considered                                                                      

- 35 -

10-K405
36th Page of 74
TOC
1st
Previous
Next
Bottom
Just 36th

necessary,  begin to identify  and  communicate  with  alternative  suppliers to
ensure the continuation of its critical business operations.                    

     The Company believes that because of modifications already made and current
plans for additional  modifications  of existing  computer  systems,  updates by
vendors  and  conversion  to new  software,  the Year 2000  issue  will not pose
significant operations problems for the Company.  However, if such modifications
and conversions are not completed properly or in a timely manner, or third party
software and systems  relied on by the Company  fail,  the Year 2000 issue could
have a material impact on the business and operations of the Company.  The costs
of  modifications  and conversions are not anticipated to be material,  and will
principally   represent  a  re-deployment  of  existing  or  otherwise   planned
resources.  No assurance can be given that the Company will  successfully  avoid
any problems associated with the Year 2000 issue.                               

1998 compared with 1997                                                         
-----------------------                                                         

     Consolidated  revenues increased by $4.2 million,  or 2%, to $201.2 million
from $196.9 million in 1997.  The  consolidated  gross profit  increased by $6.0
million,  or 9%, to $75.9  million  from $69.9  million in 1997.  Earnings  from
operations  were $9.6  million  in 1998 as  compared  to $6.5  million  in 1997.
Earnings  from  operations  as a  percentage  of  revenues  were 4.8% in 1998 as
compared to 3.3% in 1997. Earnings before depreciation,  amortization,  interest
and taxes ("EBITDA") were $29.3 million in 1998 and $28.5 million in 1997.      

Lottery Systems                                                                 
---------------                                                                 

     Total revenues from the lottery systems segment  increased by $8.8 million,
or 9%, to $103.6 million from $94.8 million in 1997.  Approximately,  two-thirds
of the increase was generated from certain  domestic  on-line lottery  customers
that experienced significantly higher lottery ticket sales. The remainder of the
increase  reflects   additional  sales  of  lottery  terminals  and  systems  to
international and domestic customers.                                           

     The lottery system  segment's  growth and  profitability  is dependent upon
management's  strategy to  selectively  bid on domestic  lottery  contracts  and
continue  to pursue  international  opportunities.  In  addition  to  finalizing
replacement  contracts  with the  Pennsylvania  Lottery in 1998 and the  Florida
Lottery in 1999,  the  Company  was awarded  contracts  by the South  Dakota and
Indiana  lotteries in 1998.  The South Dakota Lottery has been a customer of the
Company since 1990. In 1998, the  Pennsylvania  and Florida  contracts  combined
accounted for over 25% of consolidated revenues. The new contracts with Florida,
Pennsylvania and South Dakota have start-up dates in 1999.                      

     Also in 1998, the Company was awarded  contracts to deliver lottery systems
or terminals  in Vietnam,  Norway and  Switzerland.  The delivery of the lottery
system to Vietnam is in process at December 31, 1998 and the contract to deliver
the lottery  system to  Switzerland is anticipated to be finalized in the second
quarter 1999.                                                                   

     Lottery  contracts  for thirteen  state  lotteries (of which the Company is
currently party to only one) are expected to be up for procurement over the next
three years.  Given the significant  cost of bidding for new lottery  contracts,
the Company  targets  those  states that it believes has  established  a bidding
process  based  exclusively  on technical  capability,  price and service.  This
strategy allows the Company to efficiently allocate its resources so that it may
also  pursue  international  growth  opportunities.  The  Company  is  currently
pursuing a number of  jurisdictions  worldwide  that are  expected to  implement
on-line  lottery  programs  within the next two  years.  In 1998,  revenue  from
lottery systems sales to international customers was $8.8 million as compared to
$8.7 million in 1997.                                                           

     Additionally,   the  Company's   sophisticated   on-line   lottery  system,
MasterLink(TM),  affords the Company the ability to develop add-on  products and
services.  Given the maturity of the on-line lottery  industry,  state lotteries
desire ways to  increase  lottery  ticket  sales and reduce  costs.  The Company
continues to develop new  products  and  services for its existing  customers to
enhance revenues as well as reduce operating costs.                             

- 36 -

10-K405
37th Page of 74
TOC
1st
Previous
Next
Bottom
Just 37th

     The gross  profit  margin for lottery  system  revenues  was 40% in 1998 as
compared to 34% in 1997.  The gross profit margin from service  revenues was 40%
in 1998 and 33% in 1997. The gross profit on lottery  systems and terminal sales
was 50% in 1998 and 48% in 1997.  The Company  expects gross profit  margins for
lottery systems  revenues to be 35% to 40% in 1999;  however,  numerous  factors
could cause the margins to vary significantly from expectations.                

Gaming Machines and Systems                                                     
---------------------------                                                     

     Revenue  from the gaming  machines  and systems  segment  decreased by $4.4
million,  or 8%, to $53.2  million  from  $57.6  million  in 1997.  The  Company
recorded  revenue on shipments of 5,290 units in 1998 as compared to 7,047 units
in 1997.  Revenue  from leases of gaming  machines  was $8.4  million in 1998 as
compared to $11.0 million in 1997.                                              

     The decline in units and revenues  from 1997 levels  reflects a significant
level of efforts  devoted on bidding  for gaming  machine  sales to the  Ontario
video  lottery  program  that was  cancelled in 1998.  Despite the  diversion of
resources to the Ontario bid, the Company more then doubled  sales  revenue from
the casino  market in 1998  compared to 1997.  In 1997,  the  Company  delivered
nearly  1,700  gaming  machines to Quebec as compared to none in 1998;  however,
pursuant to a contract awarded in 1998, the Company will deliver a gaming system
and related communications equipment to Quebec worth approximately $13.0 million
during 1999 and 2000.  In the fourth  quarter  1998,  the Company  delivered 600
gaming machines to Peru under a sale and participation agreement.  Also in 1998,
the Company was awarded  contracts  or received  orders for gaming  machines and
systems in Victoria and South Australia to be delivered to customers in 1999 and
2000.                                                                           

     The  growth  and  success of the gaming  machines  and  systems  segment is
dependent upon the Company's ability to expand its leading position in the video
lottery gaming market,  penetrate  established casino markets such as Nevada and
New Jersey and  participate in the growth of new markets.  The Company  believes
that new markets and the  replacement  of older  gaming  machines and systems in
Australia  and North America will provide for future  growth  opportunities  for
this segment.                                                                   

     Increasing  sales to  established  casino  markets  such as Nevada  and New
Jersey is primarily  dependent on the Company's  ability to gain  visibility and
acceptance of its gaming  machines in the markets  while  offering a competitive
price.  The Company  believes that its gaming  machines are capable of producing
above  average  play and net win  amounts  given  gaming  machine  graphics  and
playability.                                                                    

     Developing  casino  opportunities  at  pari-mutuel  racetracks is dependent
initially  upon the  enactment  of  legislation  to allow  gaming  at  racetrack
facilities. A small number of states, including New Mexico, Iowa, West Virginia,
Delaware, Rhode Island and Louisiana have enacted legislation to allow gaming at
racetracks.  The Company anticipates the trend to continue although there can be
no assurances that such programs will be implemented.                           

     The gross profit margin on gaming  machines and systems  revenue was 44% in
1998 as compared to 45% in 1997.  Revenue  from  leasing of gaming  machines has
minimal  ongoing  direct costs.  Depreciation  expense of gaming  machines under
lease and revenue share  agreements  is recorded as a component of  depreciation
and amortization  expense in the Company's  consolidated  financial  statements.
Although  there can be no  assurance  given,  the Company  expects  gross profit
margin levels in this segment to remain around the 40% level.                   

Pari-mutuel Systems                                                             
-------------------                                                             

     Revenue from pari-mutuel  systems service  contracts was  approximately $20
million in 1998 and 1997.  Included  in the $20.0  million  amounts are sales of
equipment of $2.0 million in 1998 and $2.5 million in 1997.                     

     The gross profit margin from pari-mutuel  systems revenue was approximately
36% in 1998  and  1997  and is  expected  to  remain  at that  level.  Sales  of
pari-mutuel  equipment  generated  gross profit of $0.8 million in 1998 and $1.2
million in 1997.                                                                

- 37 -

10-K405
38th Page of 74
TOC
1st
Previous
Next
Bottom
Just 38th

     Recent declines in general attendance at pari-mutuel facilities has created
pricing  pressures  for the Company and its  competitors.  The Company  does not
anticipate those pricing pressures to decrease in the near future.  Accordingly,
the Company plans to maintain  profitability by improving customer service while
maintaining  or reducing  operating  costs.  Additionally,  as  discussed in the
gaming machines and systems  segment,  a number of  jurisdictions  have recently
enacted legislation  allowing casino style gaming at pari-mutuel  racetracks and
facilities.  The Company  believes  that this  expansion of gaming at racetracks
will increase the attendance at the racetracks.  The Company  provides  wagering
systems and service to over 120 of the approximate 350 pari-mutuel facilities in
North America.                                                                  

Gaming Operations                                                               
-----------------                                                               

     The gaming  operations  segment  generated  approximately  $24.3 million of
revenue in 1998 and 1997. Revenue from gaming machine route operations was $17.4
million in 1998 and $17.7  million in 1997 and revenue from the operation of the
racetrack in Sunland Park was  approximately  $6.9 million in 1998 and 1997. The
segments revenue in 1999 will include  revenues  generated from casino gaming at
the racetrack  facility  which started in February  1999. The addition of casino
gaming at the  racetrack  is expected to  significantly  increase  revenues  and
profitability over current levels,  however, the Company cannot reliably predict
the level of success of casino gaming at the racetrack.                         

     The gross  profit  margin on route  operations  revenue was 27% in 1998 and
1997.  Gross profit from  racetrack  operations  was ($0.4)  million in 1998 and
($0.3) million in 1997.                                                         

Selling, General and Administrative Expenses                                    
--------------------------------------------                                    

     Selling,  general and  administrative  ("SG&A") expenses  increased by $5.0
million,  or 16%, to $36.6  million  from $31.6  million in 1997.  The  increase
primarily  reflects higher labor expenses in the areas of business  development,
sales and marketing and engineering.  The Company anticipates 1999 SG&A expenses
to increase with anticipated  business growth and future  development;  however,
should  revenue  growth become  unlikely,  management  would  implement  expense
reduction measures.                                                             

Research and Development                                                        
------------------------                                                        

     In 1998,  the Company  expended  $10.0 million on research and  development
activities as compared to $9.8 million in 1997. In 1997, the Company capitalized
approximately $1.0 million of software development costs in conjunction with the
development  of the  Company's  lottery  systems  MasterLink(R)  central  system
software. Research and development expenditures were approximately 4.9% and 5.5%
of  consolidated  revenues  in 1998  and  1997,  respectively.  The  Company  is
increasing  research  and  development  efforts  to  maintain  and  improve  its
competitive position.                                                           

1997 Compared with 1996                                                         
-----------------------                                                         

     Consolidated revenues increased by $20.3 million, or 11%, to $196.9 million
from $176.6 million in 1996.  The  consolidated  gross profit  increased by $5.6
million,  or 9%, to $69.9  million  from $64.3  million in 1996.  Earnings  from
operations  were $6.5 million in 1997 as compared to a loss from  operations  of
$30.3 million in 1996. The 1996 loss from  operations  included $34.1 million of
special and unusual charges recorded by the Company discussed below.  Absent the
special and unusual  charges,  1996  earnings  from  operations  would have been
approximately $3.8 million. Earnings from operations as a percentage of revenues
were 3.3% in 1997 as  compared  to 2.2% in 1996  without the special and unusual
charges.                                                                        

Lottery Systems                                                                 
---------------                                                                 

     Total revenues from the lottery systems segment  increased by $5.9 million,
or 7%, to $94.7 million from $88.8 million in 1996. The increase reflects higher
revenues from certain domestic  on-line lottery  contracts as well revenues from
the Company's  installation and sale of an on-line lottery system in Chile. 1996
lottery  system  revenues  include   approximately  $7.3  million  from  lottery
contracts with the Arizona and Washington  lottery  authorities.  Both contracts
terminated in 1996.                                                             

- 38 -

10-K405
39th Page of 74
TOC
1st
Previous
Next
Bottom
Just 39th

     In 1997, revenue from lottery systems sales to international  customers was
$8.7 million as compared to $3.1 million in 1996.                               

     The gross  profit  margin from lottery  systems  revenue was 34% in 1997 as
compared to 33% in 1996.  The gross profit  margin from lottery  system  service
revenues  was 33% in 1997 and 1996.  The gross  profit on lottery  terminal  and
system sales was 48% in 1997 and 12% in 1996.                                   

     In 1996, the Company  recorded  approximately  $31.0 million of special and
unusual  charges  associated  with the  lottery  systems  segment.  The  charges
consisted of $18.0 million for inventory reserves and write-downs,  $8.4 million
for  contractual  liabilities  and  settlement  of customer  disputes that arose
primarily during the Company's former relationship with EDS and $4.6 million for
impairment  of  intangible  and  other  assets  related  to an  on-line  lottery
contract.  These charges have been excluded in the determination of gross profit
due to  their  unusual  nature  and  are not  considered  by the  Company  to be
indicative of anticipated future operating results.                             

Gaming Machines and Systems                                                     
---------------------------                                                     

     Revenue  from the gaming  machines and systems  segment  increased by $14.0
million,  or 32%,  to $57.6  million  from $43.6  million in 1996.  Revenue  was
recognized  on  shipments  of 7,047  units in 1997 as compared to 6,235 units in
1996.  Revenue  from  leases of gaming  machines  was $11.0  million  in 1997 as
compared to $10.7 million in 1996.                                              

     The  increase in  revenues  over 1996 levels  reflects  increased  sales in
international  markets of Quebec,  Canada and South  Africa as well as  domestic
jurisdictions  of Nevada,  New Jersey and Minnesota.  These increased  levels of
sales were offset by  reductions  in sales in  international  markets of Norway,
Peru and Alberta, Canada.                                                       

     The gross profit margin on gaming  machines and systems  revenue was 45% in
1997 as compared to 52% in 1996.  The  decrease  reflects  the  relative  higher
revenues from sales in Quebec,  Canada.  Revenue from leasing of gaming machines
has minimal ongoing direct costs.  Depreciation expense of gaming machines under
lease and revenue share  agreements  is recorded as a component of  depreciation
and amortization expense.                                                       

Pari-mutuel Systems                                                             
-------------------                                                             

     Revenue from  pari-mutuel  systems  service  contracts was $17.5 million in
1997 as compared  to $18.4  million in 1996.  The  decrease is the result of the
closure of two  customer  facilities  in  Wisconsin  and Texas,  the loss of two
customers to  competitors,  and decreased  revenues  from a Philippine  customer
resulting from contractual  handle rate decreases and a currency  devaluation in
Asia. These decreases were partially offset by increased revenues generated from
the start up of live  racing at Lone  Star  Park in Texas,  additional  services
under existing contracts,  and increased levels of simulcasting in the industry.
In 1997,  United  Tote  signed  contracts  with two new  customers  and  renewed
contracts with seventeen  existing  customers.  Included in contract renewals in
1997 were extension of contracts with Churchill Downs, Turfway Park, and the Red
Mile in Kentucky. Pari-mutuel wagering systems equipment sales were $2.5 million
in 1997 as compared to $2.1 million in 1996.                                    

     The gross profit margin from pari-mutuel  systems revenue was approximately
36% in 1997 and 39% in 1996.  Sales of  pari-mutuel  equipment  generated  gross
profit of $1.2 million in 1997 compared  with $.9 million in 1996.  The decrease
is the result of the closure of two customer  facilities in Wisconsin and Texas,
the  loss  of two  customers  to  competitors,  and  decreased  revenues  from a
Philippine  customer  resulting from  contractual  handle rate decreases and the
Asian   currency   devaluation.   Increased   operating   expenses   related  to
implementation  of a comprehensive  employee  training  program,  and liquidated
damages payments to two customers also contributed to the decreased margins.    

Gaming Operations                                                               
-----------------                                                               

     Revenue  from route  operations  was $17.7  million in 1997 as  compared to
$16.5 million in 1996. The gross profit margin from route operations revenue was
27% in 1997 and 29% in 1996.                                                    

- 39 -

10-K405
40th Page of 74
TOC
1st
Previous
Next
Bottom
Just 40th

     Racetrack  operation revenues were $6.8 million in 1997 and $7.2 million in
1996.  The decrease  reflects the Company's  decision in 1997 to hold fewer live
racing days, which are not profitable. Gross profit for the racetrack operations
was $(.3) million in 1997 and 1996.                                             

Selling, General and Administrative Expenses                                    
--------------------------------------------                                    

     Selling,  general and administrative expenses increased by $3.0 million, or
10%, to $31.7  million from $28.7  million in 1996.  The Company  expended  more
capital and  resources  for  marketing  and  proposal  efforts in 1997 over 1996
levels.  The increased  expenditures  were in the Company's  on-line lottery and
gaming  machine  segments  which  account  for  over 86% of the  Company's  1997
consolidated revenues.                                                          

Research and Development                                                        
------------------------                                                        

     In 1997,  the Company  expended  $9.8  million (net of  capitalization)  on
research and  development  activities  as compared to $8.0 million in 1996.  The
Company capitalized  approximately $1.0 million in 1997 and $4.1 million in 1996
of  software  development  costs  in  conjunction  with the  development  of the
Company's MasterLink(R) central system software. In 1997 the Company implemented
new modules and other  significant  enhancements  in a number of on-line lottery
systems  provided  to  domestic  and  international   customers.   Research  and
development  expenditures  were  approximately  5.5%  and  6.8% of  consolidated
revenues in 1997 and 1996, respectively.                                        

Liquidity and Capital Resources                                                 
-------------------------------                                                 

     In 1998 the Company  generated  $19.3  million of cash from  operations  as
compared  to $35.9  million in 1997  representing  a number of  fluctuations  in
operating  assets and  liabilities.  The  fluctuations  include an  increase  in
inventory levels,  deferred income taxes and accounts  receivable and a decrease
in accounts  payable and  accrued  liabilities.  Working  capital  increased  by
approximately  $4.1 million from  December 31, 1997 to $41.2 million at December
31, 1998.                                                                       

     Approximately  $34.9  million  was  invested  in  property,  equipment  and
intangible  and  other  assets  in 1998 as  compared  to $9.0  million  in 1997.
Approximately  $22.2  million has been  expended for the initial  implementation
cost of the on-line  lottery  system in  Pennsylvania  in 1998 and an additional
$19.0 is  expected  for 1999.  The  Company  spent  $4.5  million in 1998 on the
development  of the casino at Sunland Park and $3.6 million to  manufacture  and
install new tote equipment.  The Company anticipates  expending an additional $3
to $4 million on the casino development and start-up in the first quarter 1999. 

     In October 1998, the Company  completed  negotiations  for a $100.0 million
(with an option for an additional  $25.0  million)  credit  facility with Lehman
Brothers,  Inc. The credit facility replaces the credit facility with U. S. Bank
and,  among other things,  provides for two $25.0 million term loans maturing in
five and six  years,  respectively,  and a  revolving  line of credit  for $50.0
million expiring September 30, 2003. The Company may utilize up to $15.0 million
of the $50.0  million  revolving  line of credit as  collateral  for its bonding
program.  Contractual  obligations  at December 31, 1998 required  approximately
$8.5 million in outstanding  letters of credit.  The proceeds from the two $25.0
million term loans were used to pay off  existing  debt of  approximately  $27.9
million  and  provide  capital  for  existing  commitments  to  manufacture  and
implement the on-line lottery system in  Pennsylvania,  continue the development
of the Company's  gaming  machine  casino at the racetrack in Sunland Park,  New
Mexico and other  anticipated  contracts.  At December 31, 1998, the Company had
approximately $41.5 million available under the revolving line of credit.       

     In  March  1999,  the  Company  announced  that  AWI  and the  Lottery  had
renegotiated  and signed an amended  contract  under  which AWI will  provide an
on-line lottery system and related services to the Florida  Lottery.  A decision
by the Lottery not to join the multi-state  game  Powerball(R)  necessitated the
renegotiation  of the contract  entered into in October 1998.  Under the amended
contract,  the Company will design,  install and operate a new statewide on-line
lottery  system for an initial  term of five years and three  months,  with two,
two-year renewal options.  The Company estimates that revenues from the contract
over the initial 63-month period will be approximately $200 million. AWI will be
compensated at a                                                                

- 40 -

10-K405
41st Page of 74
TOC
1st
Previous
Next
Bottom
Just 41st

base rate of  on-line  sales,  and,  if on-line  ticket  sales  exceed  targeted
amounts, an additional incentive rate. The October 1998 contract between AWI and
the Department of Lottery of the State of Florida was for a nine-year  term. The
Lottery  had  originally  awarded the  contract  to AWI in October  1996 after a
competitive  procurement  process in which the  Lottery's  evaluation  committee
judged AWI the most highly qualified vendor based on its superior technology and
lower cost.  Subsequent to the  announcement  of the contract award in 1996, the
losing  vendor  filed two  consecutive  protests,  both of which were  rejected,
resulting  in a final order from the  Lottery  awarding  the  contract to AWI in
March 1998.  A further  attempt by the losing  vendor to enjoin the contract was
rejected by the Florida  district  court,  allowing the parties to negotiate and
finalize  the terms of the  nine-year  agreement.                               

     The Company has entered into a contract  with the  Pennsylvania  Lottery to
replace  the  contract  the  Company  currently  has with the  lottery.  The new
contract expires in December 2005.                                              

     In October 1998, the Company announced that its on-line division,  AWI, had
been selected by the Hoosier Lottery to provide a new on-line lottery system and
related  services for the State of Indiana.  The decision by the Lottery was the
result of a competitive procurement in which several companies participated.  In
January  1999,  the Company  announced  that AWI had signed a contract  with the
Hoosier  Lottery of the State of Indiana to provide the on-line  lottery system,
terminals and system operation for seven years with extension  options for up to
an additional  three years.  Revenues from the initial  seven-year  contract are
estimated  to exceed  $80  million.  The  Hoosier  Lottery  Commission  formally
approved the AWI contract in December after announcing the award in October. AWI
will install its MasterLink(TM)  Advanced Gaming System along with approximately
4,000  lottery  retailer  terminals.  The scheduled  date for  completion of the
conversion to the new AWI system from the Lottery's current vender is August 29,
1999.                                                                           

     Total  anticipated  capital  requirements  for the Company is  estimated at
approximately $60.0 million for 1999. The Company believes that anticipated cash
from  operations,  borrowing  available  under the current  credit  facility and
current   working  capital  are  sufficient  to  satisfy   anticipated   capital
requirements;  however,  the Company cannot provide  assurance that  anticipated
cash flows will be adequate.                                                    

- 41 -

10-K405
42nd Page of 74
TOC
1st
Previous
Next
Bottom
Just 42nd


ITEM 7a. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK             

     The  Company  is  exposed to the risk of  foreign  currency  exchange  rate
fluctuations. The tables below illustrate the portion of the Company's sales and
receivables  denominated  in foreign  currencies.  All foreign  receivables  are
expected to be  collected  within the next twelve  months.  The Company does not
currently hedge against foreign currency exposures.                             

                                                        · Enlarge/Download Table


                                                     (Amounts in millions)                   

                                        1998                   1997                1996      
                                  -----------------     -----------------   -----------------
                                                                                             

Total revenues                    $201.2     100.0%     $196.9     100.0%   $176.7     100.0%
Revenues denominated in                                                                      
  foreign currencies                $9.2       4.6%      $20.3      10.3%    $16.6       9.4%

Transaction gain (loss) included                                                             
  in net income                    $(0.4)      ---       $(0.7)      ---      $0.1       --- 

Total accounts and notes                                                                     
  receivable                       $38.0     100.0%      $31.6     100.0%                    

Receivables denominated in:                                                                  
         Canadian dollars            0.4       1.1%        5.9      18.7%                    
         Australian dollars          0.7       1.8%        2.3       7.3%                    
         Other                       0.1       0.2%        0.2       0.6%                    

ITEM 8.  FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA                            

                                                                            Page
                                                                            ----
Index to Consolidated Financial Statements                                      

Independent Auditors' Report                                                  43

Consolidated Financial Statements:                                              
Statements of Earnings for the years                                        
       ended December 31, 1998, 1997 and 1996                                 44
  Balance Sheets as of December 31, 1998 and 1997                             45
Statements of Stockholders' Equity for the years                            
       ended December 31, 1998, 1997 and 1996                                 46
Statements of Cash flows for the years                                      
       ended December 31, 1998, 1997 and 1996                                 47

Notes to Consolidated Financial Statements                                    48

All schedules are omitted because the information  prescribed thereon is neither
applicable nor required or is furnished in the consolidated financial statements
or notes thereto.                                                               

- 42 -

10-K405
43rd Page of 74
TOC
1st
Previous
Next
Bottom
Just 43rd

(KPMG LLP logo)                                                                 

P. O. Box 7108                                                                  
Billings, MT 59103                                                              

INDEPENDENT AUDITORS' REPORT

The Board of Directors and Stockholders                                         
Powerhouse Technologies, Inc.:                                                  

         We  have  audited  the  accompanying  consolidated  balance  sheets  of
Powerhouse Technologies, Inc. and subsidiaries as of December 31, 1998 and 1997,
and the related  consolidated  statements of earnings,  stockholders' equity and
cash flows for each of the years in the  three-year  period  ended  December 31,
1998. These  consolidated  financial  statements are the  responsibility  of the
Company's  management.  Our  responsibility  is to  express  an opinion on these
consolidated financial statements 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 consolidated financial statements referred to above
present fairly, in all material  respects,  the financial position of Powerhouse
Technologies,  Inc.  and  subsidiaries  as of December 31, 1998 and 1997 and the
results  of their  operations  and their cash flows for each of the years in the
three-year period ended December 31, 1998 in conformity with generally  accepted
accounting principles.                                                          

                /S/ KPMG LLP

Billings, Montana                                                               
February 19, 1999                                                               

- 43 -

10-K405
44th Page of 74
TOC
1st
Previous
Next
Bottom
Just 44th
                                                        · Enlarge/Download Table

                 POWERHOUSE TECHNOLOGIES, INC. AND SUBSIDIARIES                                  
                       CONSOLIDATED STATEMENTS OF EARNINGS                                       
                      (in thousands except for share data)                                       
                                                                    Years Ended December 31      
                                                                    -----------------------      
                                                                 1998         1997         1996  
                                                                 ----         ----         ----  
                                                                                                 
REVENUES:                                                                                        
 Lottery systems                                                $103,581      94,771      88,843 
 Gaming machines and systems                                      53,215      57,626      43,632 
 Pari-mutuel systems                                              20,028      20,177      20,499 
 Gaming operations                                                24,327      24,361      23,707 
                                                                --------     -------     ------- 
   Total revenues                                                201,151     196,935     176,681 

COSTS OF REVENUES:                                                                               
 Lottery systems                                                  62,281      62,558      59,333 
 Gaming machines and systems                                      30,054      31,766      21,084 
 Pari-mutuel systems                                              12,879      12,784      12,545 
 Gaming operations                                                20,019      19,873      19,386 
                                                                --------     -------     ------- 
                                                                 125,233     126,981     112,348 
                                                                --------     -------     ------- 
  Gross Profit                                                    75,918      69,954      64,333 

OTHER OPERATING EXPENSES:                                                                        
 Selling, general and administrative                              36,635      31,655      28,697 
 Research and development                                         10,011       9,788       7,969 
 Depreciation and amortization                                    19,701      21,995      23,822 
 Other charges                                                       ---         ---      34,135 
                                                                --------     -------     ------- 

                                                                  66,347      63,438      94,623 
                                                                --------     -------     ------- 

Earnings (loss) from operations                                    9,571       6,516     (30,290)
                                                                --------     -------     ------- 

OTHER INCOME (EXPENSE):                                                                          
 Interest and other income                                         1,454       1,021       1,060 
 Interest expense                                                 (3,044)     (3,890)     (3,754)
                                                                --------     -------     ------- 
                                                                  (1,590)     (2,869)     (2,694)
                                                                --------     -------     ------- 

Earnings (loss) before income taxes and extraordinary items        7,981       3,647     (32,984)

Income tax (expense) benefit                                      (3,405)      1,135       8,753 
                                                                --------     -------     ------- 

Net earnings (loss) from continuing operations                     4,576       4,782     (24,231)

Reversal of loss on discontinuance of pari-mutuel systems, net       ---         ---        5,482
                                                                --------     -------      -------

Net earnings (loss) before extraordinary items                     4,576       4,782     (18,749)

Extraordinary gain, net                                              ---      13,269       4,014 
                                                                --------     -------     ------- 

Net earnings (loss)                                             $  4,576      18,051     (14,735)
                                                                ========     =======     ======= 

EARNINGS (LOSS) PER SHARE DATA:                                                                  
Basic:                                                                                           
Continuing operations                                              $0.43       0.46        (2.28)
Net earnings (loss)                                                $0.43       1.75        (1.39)
                                                                   =====       ====        ===== 

Diluted:                                                                                         
Continuing operations                                              $0.42       0.46        (2.28)
Net earnings (loss)                                                $0.42       1.72        (1.39)
                                                                   =====       ====        ===== 

Weighted average shares:                                                                         
Basic                                                             10,580      10,329      10,635 
Potential Common Stock(1)                                            323         160         --- 
                                                                  ------    --------      ------ 
Diluted                                                           10,903      10,489      10,635 
                                                                  ======      ======      ====== 

(1)  Excluded if antidilutive                                                   
See accompanying notes to consolidated financial statements.

- 44 -

10-K405
45th Page of 74
TOC
1st
Previous
Next
Bottom
Just 45th

POWERHOUSE TECHNOLOGIES, INC. AND SUBSIDIARIES
 CONSOLIDATED BALANCE SHEETS
(in thousands except for share data)

                                                        · Enlarge/Download Table

                                                                        December 31,      
                                                                        ------------      
                                                                       1998        1997   
                                                                       ----        ----   
                                                                                          

ASSETS                                                                                    
 Current assets:                                                                          
  Cash and cash equivalents                                          $ 16,371      13,772 
  Restricted cash and deposits                                          1,992       1,423 
  Accounts receivable, net                                             21,786      25,839 
  Current installments of notes receivable, net                         6,179       3,192 
  Inventories                                                          18,630      15,942 
  Prepaid expenses                                                      1,574       1,037 
  Deferred income taxes                                                 9,549      11,444 
                                                                     --------     ------- 
   Total current assets                                                76,081      72,649 
                                                                     --------     ------- 

 Property and equipment, net                                           76,355      63,160 

 Restricted cash deposits                                                 376       2,408 
 Notes receivable, excluding current installments                      10,049       2,547 
 Goodwill, net                                                          8,495       9,314 
 Intangible and other assets, net                                      17,119      11,319 
                                                                     --------     ------- 
                                                                     $188,475     161,397 
                                                                     ========     ======= 

LIABILITIES                                                                               
 Current liabilities:                                                                     
  Current installments of long-term debt                             $  4,445       4,381 
  Accounts payable                                                     12,611       9,513 
  Accrued expenses                                                     17,848      21,705 
                                                                     --------     ------- 
   Total current liabilities                                           34,904      35,599 
                                                                     --------     ------- 

 Long-term debt, excluding current installments                        51,765      31,446 
 Deferred income taxes                                                 13,828      12,206 
                                                                     --------     ------- 
   Total liabilities                                                  100,497      79,251 
                                                                     --------     ------- 

Commitments and contingencies (Note 15)                                                   

STOCKHOLDERS' EQUITY                                                                      
 Preferred stock, $.01 par value.  Authorized 10,000,000 shares; no                       
  shares issued                                                           ---         --- 
 Common stock, $.01 par value.  Authorized 25,000,000 shares              106         105 
 Paid-in capital                                                       91,304      89,451 
 Deferred restricted stock compensation                                  (815)       (217)
 Accumulated deficit                                                   (2,617)     (7,193)
                                                                     --------     ------- 
   Total stockholders' equity                                          87,978      82,146 
                                                                     --------     ------- 
                                                                     $188,475     161,397 
                                                                     ========     ======= 

See accompanying notes to consolidated financial statements.

- 45 -

10-K405
46th Page of 74
TOC
1st
Previous
Next
Bottom
Just 46th

POWERHOUSE TECHNOLOGIES, INC. AND SUBSIDIARIES
 CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
(in thousands except for share data)

                                                        · Enlarge/Download Table

---------------------------------------------------------------------------------------------------------------------
                                      Series A                             Deferred                                  
                                      Preferred    Common                  restricted                      Total     
                                        Stock       Stock       Paid-in   stock compen-   Accumulated   stockholders'
                                      par value   par value     capital     sation          deficit        equity    
---------------------------------------------------------------------------------------------------------------------
                                                                                                                     
December 31, 1995                         $19           107      97,284         (453)       (10,509)       86,448    

Net loss                                  ---           ---         ---          ---        (14,735)      (14,735)   

Amortization of deferred restricted                                                                                  
     stock compensation                   ---           ---         133           36            ---           169    

Stock issued under stock purchase                                                                                    
     plan                                 ---             1         348          ---            ---           349    
                                        -----          ----      ------       ------        -------        ------    

December 31, 1996                          19           108      97,765         (417)       (25,244)       72,231    

Net earnings                              ---           ---         ---          ---         18,051        18,051    

Stock options exercised and shares                                                                                   
     issued under stock purchase plan     ---             2         762          ---            ---           764    

Shares redeemed pursuant to                                                                                          
     EDS settlement                       (19)           (5)     (9,076)         ---            ---        (9,100)   

Amortization of deferred restricted                                                                                  
     stock compensation                   ---           ---         ---          200            ---           200    
                                        -----          ----      ------       ------        -------        ------    

December 31, 1997                         ---           105      89,451         (217)        (7,193)       82,146    

Net earnings                              ---           ---         ---          ---          4,576         4,576    

Restricted stock issued                   ---             1       1,062       (1,063)           ---           ---    

Amortization of deferred restricted                                                                                  
     stock compensation                   ---           ---         ---          465                          465    

Proceeds from sale of common stock,                                                                                  
     net                                  ---             2       2,078          ---            ---         2,080    

Stock options exercised and shares                                                                                   
     issued under stock purchase                                                                                     
     plan                                 ---             1       1,135          ---            ---         1,136    

Stock redemptions                         ---            (3)     (2,422)         ---            ---        (2,425)   
                                        -----          ----      ------       ------        -------        ------    

December 31, 1998                       $ ---           106      91,304         (815)        (2,617)       87,978    
                                        =====          ====      ======       ======        =======        ======    
---------------------------------------------------------------------------------------------------------------------

                                                        · Enlarge/Download Table

-----------------------------------------------------------------------------------------------------------
Share Amounts                   1998                      1997                         1996                
                             ----------     ----------------------------     ------------------------------
                              Common           Series A         Common          Series A           Common  
Balance                        Stock        Preferred Stock     Stock        Preferred Stock        Stock  
-----------------------------------------------------------------------------------------------------------
                                                                                                           

Beginning of year            10,477,952       1,912,728       10,829,184        1,912,728        10,682,109
Restricted stock issued         108,000             ---              ---              ---            30,000
Sale of common stock            220,204             ---              ---              ---                  
Stock options exercised and                                                                                
     shares issued              127,161             ---          194,222                            117,075
Stock redemptions              (285,000)     (1,912,728)        (545,454)             ---               ---
                             ----------      ----------       ----------        ---------        ----------
End of year                  10,648,317             ---       10,477,952        1,912,728        10,829,184
                             ==========      ==========       ==========        =========        ==========

See accompanying notes to consolidated financial statements.

- 46 -

10-K405
47th Page of 74
TOC
1st
Previous
Next
Bottom
Just 47th

POWERHOUSE TECHNOLOGIES, INC. AND SUBSIDIARIES
 CONSOLIDATED STATEMENTS OF CASH FLOWS
(in thousands)

                                                        · Enlarge/Download Table

                                                             Years Ended December 31   
                                                             -----------------------   
                                                       1998         1997         1996  
                                                       ----         ----         ----  
                                                                                       

CASH FLOWS FROM OPERATING ACTIVITIES:                                                  
     Net earnings (loss)                              $ 4,576      18,051      (14,735)
     Adjustments to reconcile net earnings (loss) to                                   
         net cash provided by operating                                                
         activities:                                                                   
         Reversal of provision for loss on sale of                                     
              pari-mutuel systems operations              ---         ---       (5,482)
         Depreciation and amortization                 19,701      21,995       23,822 
         Other charges                                    ---         ---       34,135 
         Extraordinary gain, net                          ---     (13,269)      (4,014)
         Other, net                                        60         337           79 
     Changes in operating assets and liabilities:                                      
         Sales of receivables                             ---         ---        1,467 
         Receivables, net                              (6,118)     (7,191)       1,942 
         Inventories                                   (2,110)      5,709       (3,489)
         Prepaid expenses                                 (80)        (10)         235 
         Accounts payable                               3,099       2,867        2,006 
         Accrued expenses                              (3,392)      6,649      (10,854)
         Income taxes                                   3,517         806       (6,411)
                                                      -------     -------      ------- 
Net cash provided by operating activities              19,253      35,944       18,701 
                                                      -------     -------      ------- 

CASH FLOWS FROM INVESTING ACTIVITIES:                                                  
     Expenditures on property and equipment           (28,456)     (6,977)     (25,522)
     Expenditures on intangible and other assets       (6,485)     (1,974)     (10,037)
     Proceeds from sales of equipment                     395         117          109 
     Change in restricted cash deposits                 1,463         (70)         700 
                                                      -------     -------      ------- 
Net cash used in investing activities                 (33,083)     (8,904)     (34,750)
                                                      -------     -------      ------- 

CASH FLOWS FROM FINANCING ACTIVITIES:                                                  
     Net payments on notes payable                        ---      (7,650)        (600)
     Proceeds from issuance of long-term debt          50,000         643        4,365 
     Payments of loan origination fees                 (2,041)        ---          --- 
     Repayments of long-term debt                     (32,321)    (11,220)     (13,079)
     Amounts payable to EDS                               ---         ---       27,343 
     Redemption of common stock                        (2,425)        ---          --- 
     Proceeds from sale of common stock                 2,080         ---          --- 
     Common stock sold under employee benefit plans     1,136         637          349 
                                                      -------     -------      ------- 
Net cash provided by (used in) financing activities    16,429     (17,590)      18,378 
                                                      -------     -------      ------- 

Net increase in cash and cash equivalents               2,599       9,450        2,329 

Cash and cash equivalents, beginning of year           13,772       4,322        1,993 
                                                      -------     -------      ------- 

Cash and cash equivalents, end of year                $16,371      13,772        4,322 
                                                      =======     =======      ======= 

See accompanying notes to consolidated financial statements.

- 47 -

10-K405
48th Page of 74
TOC
1st
Previous
Next
Bottom
Just 48th

(1)  SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES                                 

     Principles of consolidation.  The consolidated financial statements include
the accounts of Powerhouse Technologies,  Inc. and subsidiaries (the "Company").
Prior to January 1, 1998 the  Company was known as Video  Lottery  Technologies,
Inc. All significant intercompany balances and transactions have been eliminated
in consolidation.                                                               

     Revenue  recognition.   Revenue  from  the  sale  of  lottery,  gaming  and
pari-mutuel  system  equipment and related parts is recognized  upon delivery to
the  customer.  Revenue from sales of lottery  systems and video gaming  central
site systems (including  customized  software and equipment) is recognized using
the  percentage of completion  method of accounting  for long-term  construction
type  contracts  where costs to complete can  reasonably be estimated.  Prior to
revenue recognition on system sales, costs incurred are applied against progress
billings  and  recorded as a net accrued  liability  or other  current  asset as
appropriate.                                                                    

     Lottery and pari-mutuel  systems contract  services revenues are recognized
as the services are performed and  primarily  relate to revenues from  long-term
contracts  which require  installation  and operation of lottery and pari-mutuel
wagering  networks.  Revenues  under these  contracts are  generally  based on a
percentage of sales volume, which may fluctuate over the lives of the contracts.

Gaming operations revenue consists of route and racetrack operations. 

     Route operations  revenue consists  primarily of gaming machine wagers, net
of payouts and state gaming taxes,  generated under revenue  sharing  agreements
with  route  customers.  Route  operations  revenue  is  recorded  weekly as the
revenues are earned.                                                            

     Revenue from  racetrack  operations  primarily  represents  commissions  on
wagers  placed  on  live  and  simulcast  pari-mutuel  racing  at the  Company's
racetrack in Sunland Park, New Mexico, and is recorded on the day of each race. 

     Cash and  cash  equivalents.  Cash  deposits  and all  highly  liquid  debt
instruments  with  maturity  dates of three  months or less when  purchased  are
considered cash equivalents in the statements of cash flows.                    

     Restricted  cash and  deposits.  Cash  deposits  expected to be refunded or
released within one year are classified as restricted  short-term deposits.  The
deposits are for bonds,  required by customers,  for  proposals and  performance
under  long-term  contracts and for prize purses at the  Company's  horse racing
facility.                                                                       

     Inventories.  The  Company  manufactures  inventories  for sale and  lease.
Inventories are carried at the lower of cost or market value. Cost is determined
using the first-in, first-out method and includes materials, labor and allocated
indirect manufacturing overhead.                                                

     Property and equipment. Property and equipment is stated at cost. Equipment
acquired  under capital  leases is recorded at the lower of the present value of
minimum  lease  payments at the  beginning  of the lease term or the fair market
value of the asset at the  inception  of the  lease.  The  Company  manufactures
equipment used in the provision of services pursuant to long-term contracts.    

     Depreciation   of  property   and   equipment  is   calculated   using  the
straight-line  method over the estimated  useful lives of the assets or the life
of the related contract (including executed contract extensions) as follows:    

 Item                                                     Estimated life
 ----                                                     --------------
 Lottery and pari-mutuel systems equipment                   3 - 9 years
 Gaming equipment                                            3 - 7 years
 Buildings and improvements                                 7 - 40 years
 Machinery and equipment                                    3 - 10 years
 Furniture and fixtures                                     5 - 10 years

- 48 -

10-K405
49th Page of 74
TOC
1st
Previous
Next
Bottom
Just 49th

     Equipment  purchased under capital leases is depreciated on a straight-line
basis over the shorter of the lease term or estimated useful life of the asset. 

     Goodwill,  intangible  and other assets.  Goodwill,  which  represents  the
excess of  purchase  price  over fair  value of net  assets  acquired,  is being
amortized on a straight-line  basis through 2009.  Accumulated  amortization was
$4.6 million at December 31, 1998 and $3.8 million at December 31, 1997.        

     Intangible  and  other  assets  are  stated  at  cost  net  of  accumulated
amortization.  Intangible and other assets are amortized  over their  respective
economic useful lives of up to ten years. Accumulated amortization of intangible
and other  assets was  approximately  $8.9 million at December 31, 1998 and $6.9
million at December 31, 1997.                                                   

     Long-lived  assets and certain  identifiable  intangibles  are reviewed for
impairment  whenever  events  or  changes  in  circumstances  indicate  that the
carrying amount of an asset may not be recoverable. In performing the review for
recoverability,  the Company  estimates the future cash flows expected to result
from the use of the  asset  and its  eventual  disposition.  If the sum of these
expected future cash flows  (undiscounted  and without interest charges) is less
than the carrying amount of the asset, the asset is considered "impaired" and an
impairment loss is recognized.                                                  

     Foreign  currency  transactions and  remeasurements.  Gains and losses from
foreign  currency  transactions  and  remeasurements  are included in results of
operations.                                                                     

     Interest  rate  hedging.  The Company  uses  interest  rate swaps to manage
exposure to interest rate fluctuations on its variable rate debt.  Premiums paid
on interest rate hedges are deferred and amortized to interest  expense over the
term of the hedge contract.                                                     

     Income taxes.  Deferred tax assets and liabilities are generally determined
based on the  difference  between the financial  statement  carrying  amounts of
assets  and  liabilities  and  their  respective  tax  bases.  The  current  and
noncurrent  portions of these deferred tax assets and liabilities are classified
in the balance sheet based on the  respective  classification  of the assets and
liabilities which give rise to such deferred income taxes.                      

     Earnings per share.  In the fourth  quarter 1997,  the Company  adopted the
Financial  Accounting Standards Board ("FASB") Statement of Financial Accounting
Standards No. 128 ("SFAS 128"), "Earnings per Share ("EPS")", issued in February
1997.  Under SFAS 128 basic EPS includes no dilution and is computed by dividing
income available to common stockholders by the weighted-average number of common
shares  outstanding for the period.  Diluted EPS reflects the potential dilution
of securities  that could share in the earnings of an entity.  The Company has a
complex capital  structure as defined under SFAS 128.  Diluted  weighted average
common  shares  includes  potential  common stock of  approximately  323,000 and
160,000  shares for the years ended  December 31, 1998 and 1997. The Company had
losses from continuing operations in 1996.  Accordingly,  potential common stock
has been excluded from weighted average share computations for that year because
inclusion would have been anti-dilutive.                                        

     Fair  value of  financial  instruments.  The  carrying  value of  financial
instruments,  consisting  primarily of cash,  accounts  receivable  and accounts
payable,  approximates  fair value due to the liquid nature of the  instruments.
(See Notes 5 and 11 for fair value  estimates of notes  receivable and long-term
debt.)                                                                          

     Stock based  compensation  plans.  Stock-based  compensation  is recognized
using the intrinsic  value method.  For  disclosure  purposes (see Note 13), pro
forma  earnings  and  earnings  per share data are provided as if the fair value
method had been applied.                                                        

     Reclassifications. Certain reclassifications have been made to the 1997 and
1996 amounts to conform to the 1998  presentation.  The Company  reorganized its
reportable  segments in 1998 to reflect  changes in the management  organization
and how the related  financial  information  is used  internally  to monitor and
evaluate  segment  performance and resource  allocation.  The gaming  operations
reporting  segment was created and includes  operating  and  financial  position
information from the Company's                                                  

- 49 -

10-K405
50th Page of 74
TOC
1st
Previous
Next
Bottom
Just 50th

Montana route operations and the Company's racetrack operations in Sunland Park,
New Mexico.  Previously,  the route  operations  were  included  with the gaming
machines  and  systems  segment  and  racetrack   operations  were  included  in
pari-mutuel systems segment data.                                               

     Accounting  pronouncements  not yet  adopted.  In April 1998,  the American
Institute  of  Certified  Public  Accountants'  Accounting  Standards  Executive
Committee  issued  Statement of Position (SOP) 98-5,  "Reporting on the Costs of
Start-up  Activities," which requires that start-up costs and organization costs
be expensed as incurred under certain circumstances. This statement is effective
for fiscal years  beginning  after  December 15,  1998,  with early  application
permitted.   The  Company  will  adopt  SOP  98-5  beginning  January  1,  1999.
Accordingly,  certain start-up costs incurred prior to January 1, 1999 will then
be charged to expense as a cumulative effect of a change in accounting principle
(net of tax effects),  and subsequently  such start-up costs will be expensed as
incurred. At December 31, 1998, the Company had capitalized $0.4 million related
to the  start-up of its Sunland Park Casino.  Upon  adoption of this  statement,
approximately  $0.2  million,  net of related  tax  effects,  will be charged to
expense.                                                                        

     The FASB, in June 1998,  issued SFAS No. 133,  "Accounting  for  Derivative
Instruments and Hedging Activities," which establishes  accounting and reporting
standards for derivative  instruments,  including certain derivative instruments
embedded in other  contracts,  and for hedging  activities.  This  statement  is
effective for all fiscal  quarters of all fiscal years  beginning after June 15,
1999,  although  earlier  application  is  encouraged.  The statement may not be
applied  retroactively.  The Company  expects to adopt this statement  effective
January  1,  1999,  and does not expect  adoption  to have a material  effect on
either its financial position or results of operations.                         

     Management estimates. The preparation of financial statements in conformity
with  generally  accepted  accounting  principles  requires  management  to make
estimates  and  assumptions  that  affect  the  reported  amounts  of assets and
liabilities  and disclosure of contingent  assets and liabilities at the date of
the  financial  statements  and the  reported  amounts of revenues  and expenses
during the reporting period. Actual results could differ from those estimates.  

     Segment  Information.  In June 1997, the FASB issued Statement of Financial
Accounting  Standards Number 131 (SFAS No. 131),  "Disclosures about Segments of
an Enterprise and Related  Information." SFAS No. 131 establishes  standards for
the way public companies are to report  information about operating  segments in
annual  financial  statements and requires those  enterprises to report selected
information  about  operating  segments in interim  financial  reports issued to
stockholders.  It also  establishes  standards  for  related  disclosures  about
products and services,  geographic  areas, and major customers.  SFAS No. 131 is
effective for financial  statements  for periods  beginning  after  December 15,
1997. The Company adopted SFAS No. 131 for the year ended December 31, 1997. The
adoption did not affect the Company's  historical  presentation of segment data;
however,  in 1998, the operating segments were reorganized to reflect management
and other organizational changes within the Company. The reorganization included
combining  the  route  operations  and  racetrack  operations  into  the  gaming
operations  segment.  Prior  to the  reorganization,  the  route  and  racetrack
operations  were  included in the gaming  machines  and systems and  pari-mutuel
systems segments,  respectively. The Company's casino operation in Sunland Park,
New Mexico will be included in the gaming  operations  segment upon  start-up in
1999.                                                                           

(2)  BUSINESS SEGMENTS                                                          

     The Company  operates  principally  in four  business  segments:  the sale,
design, manufacture,  installation and operation of on-line lottery systems; the
design,  manufacture,  sale and  leasing of video  gaming  machines  and central
control  systems  and  related  services;  gaming  operations  and  the  design,
manufacture, sale and operation of computerized pari-mutuel wagering systems for
dog and horse racing tracks.                                                    

- 50 -

10-K405
51st Page of 74
TOC
1st
Previous
Next
Bottom
Just 51st
                                                        · Enlarge/Download Table

                                                              Years Ended December 31,     
                                                              ------------------------     
                                                           1998         1997        1996   
                                                           ----         ----        ----   
                                                          (000s)       (000s)       (000s) 
                                                                                           

Revenues:                                                                                  
Lottery systems                                          $103,581       94,771      88,843 
Gaming machines and systems                                53,593       58,286      44,722 
Pari-mutuel systems                                        20,258       20,194      20,499 
Gaming operations                                          24,327       24,361      23,707 
     Less intercompany revenues                              (608)        (677)     (1,090)
                                                         --------      -------     ------- 
          Total revenues                                 $201,151      196,935     176,681 
                                                         ========      =======     ======= 

Operating profit (loss):                                                                   
Lottery systems                                           $15,340        4,896     (29,449)
Gaming machines and systems                                 3,145        9,111       7,954 
Pari-mutuel systems                                           194          463      (1,975)
Gaming operations                                            (686)        (338)       (541)
General corporate expenses                                 (8,829)      (7,866)     (6,826)
     Intercompany profit                                      407          250         547 
                                                         --------      -------     ------- 
          Total operating profit (loss)                  $  9,571        6,516     (30,290)
                                                         ========      =======     ======= 

Operating profit (loss) before "other charges":                                            
Lottery systems                                          $ 15,340        4,896       1,623 
Gaming machines and systems                                 3,145        9,111       7,954 
Pari-mutuel systems                                           194          463       1,088 
Gaming operations                                            (686)        (338)       (541)
General corporate expenses                                 (8,829)      (7,866)     (6,826)
     Intercompany profit                                      407          250         547 
                                                         --------      -------     ------- 
          Total operating profit before "other charges"  $  9,571        6,516       3,845 
                                                         ========      =======     ======= 

Capital expenditures:                                                                      
Lottery systems                                           $17,253        1,043      16,271 
Gaming machines and systems                                 1,496          825       4,724 
Pari-mutuel systems                                         3,720        4,084       3,149 
Gaming operations                                           4,609          669       1,391 
Corporate                                                   1,416          548         403 
     Less intercompany step-up in basis                       (38)        (192)       (416)
                                                         --------      -------     ------- 
          Total capital expenditures                     $ 28,456        6,977      25,522 
                                                         ========      =======     ======= 

Depreciation and amortization:                                                             
Lottery systems                                          $ 10,290       12,509      14,248 
Gaming machines and systems                                 2,657        3,328       3,851 
Pari-mutuel systems                                         4,332        3,869       3,922 
Gaming operations                                           2,032        2,159       2,221 
Corporate                                                     834          563         501 
     Less depreciation on intercompany step-up basis         (444)        (433)       (921)
                                                         --------      -------     ------- 
          Total depreciation and amortization            $ 19,701       21,995      23,822 
                                                         ========      =======     ======= 

                                                                · Download Table

                                              Years Ended December 31,     
                                              ------------------------     
                                           1998         1997         1996  
                                           ----         ----         ----  
                                          (000s)       (000s)       (000s) 
                                                                           
Identifiable assets:                                                       
Lottery systems                          $ 58,030       46,380      62,350 
Gaming machines and systems                52,107       49,935      38,417 
Pari-mutuel systems                        22,357       21,527      19,982 
Gaming operations                          29,106       28,401      29,949 
Corporate                                  27,937       16,621      19,067 
     Less intercompany step-up in basis    (1,062)      (1,467)     (1,722)
                                         --------      -------     ------- 
          Total identifiable assets      $188,475      161,397     168,043 
                                         ========      =======     ======= 

- 51 -

10-K405
52nd Page of 74
TOC
1st
Previous
Next
Bottom
Just 52nd

     Operating  profit (loss) before "other charges"  excludes special and other
charges discussed in Note 14.                                                   

A summary of revenues and related direct costs of revenues follows:   

                                              Years Ended December 31,
                                              ------------------------
                                           1998         1997          1996
                                           ----         ----          ----
                                           (000s)       (000s)        (000s)
Revenues:                                                                       
        Services                           $139,559      128,136       126,543
        Tangible products                    53,186       57,752        39,438
        Lease                                 8,406       11,047        10,700
                                           --------      -------       -------
                                           $201,151      196,935       176,681
                                           ========      =======       =======

Costs of revenues:                                                              
        Services                            $90,298       89,430        86,864
        Tangible products                    34,411       37,551        25,484
        Lease                                   524          ---           ---
                                           --------      -------       -------
                                           $125,233      126,981       112,348
                                           ========      =======       =======

Gross profit:                                                                   
        Services                            $41,713       38,706        39,679
        Tangible products                    26,323       20,201        13,954
        Lease                                 7,882       11,047        10,700
                                           --------      -------       -------
                                            $75,918       69,954        64,333
                                            =======      =======       =======

     Gross  profit for each  segment  is herein  defined  as  revenues  for that
segment less the corresponding  costs and expenses  (excluding  depreciation and
amortization expense and any special or other charges).                         

(3)  REVENUE CONCENTRATION                                                      

     The Company  derives  its  revenues  from  equipment  and system  sales and
services to customers primarily in jurisdictions that have enacted  governmental
legislation and/or regulatory controls over various types of gaming and wagering
activities.  The Company recorded revenues from customers or distributors within
a specific gaming or wagering jurisdiction, subject to governmental legislation,
which  accounted  for more than 10% of the  Company's  consolidated  revenues as
follows:                                                                        

                                              Years Ended December 31,
                                              ------------------------
                                            1998         1997         1996
                                            ----         ----         ----
                                            (000s)       (000s)       (000s)

   Florida                                 $29,273       31,528       30,203
   Pennsylvania                             22,639       23,042       23,164
   Montana                                  23,449       23,434       22,458
                                           =======       ======       ======

     Revenues from the lottery and pari-mutuel  systems  segments of the company
are  primarily  derived from  contracts  with terms up to ten years with varying
options for extensions and renewals.                                            

     Montana   revenue   includes  total  revenues  from  route   operations  of
approximately $17.4 million in 1998, $17.7 million in 1997, and $16.5 million in
1996.                                                                           

     Export Sales.  The Company had total export sales from the United States of
approximately  $22.9  million,  $37.0 million and $28.6 million during the years
ended December 31, 1998, 1997 and 1996, respectively.                           

- 52 -

10-K405
53rd Page of 74
TOC
1st
Previous
Next
Bottom
Just 53rd

(4)  NOTES AND ACCOUNTS RECEIVABLE                                              

A summary of receivables follows:                                     

                                            December 31,
                                            ------------
                                            1998                        1997
                                            ----                        ----
                                            (000s)                      (000s)

   Trade                                   $22,647                    26,946
   Notes receivable                         16,403                     5,964
                                           -------                    ------
                                            39,050                    32,910
    Less allowance for doubtful accounts     (1,036)                   (1,332)
                                           -------                    ------

                                           $38,014                    31,578
                                           =======                    ======

     The Company finances sales of gaming and pari-mutuel  systems  equipment to
certain  customers  meeting  minimum credit  standards.  Installment  notes bear
interest  at rates up to 18% and  mature  from one to nine  years.  The  Company
estimates  the fair value of gross  notes  receivable  at  December  31, 1998 to
approximate carrying value of the associated notes receivable.  This estimate is
based on  current  discount  rates for  instruments  of similar  credit  quality
available in the secondary market.                                              

     At December 31, 1998,  approximately 14% of the Company's  receivables were
from various governments or their designated agencies.                          

     Amounts charged to expense for estimated bad debts were  approximately $0.3
million,  $0.1  million and $0.2  million in the years ended  December 31, 1998,
1997 and 1996, respectively.  The Company wrote off previously reserved doubtful
accounts of  approximately  $0.5 million,  $0.1 million and $2.1 million for the
years ended December 31, 1998, 1997 and 1996, respectively.                     

(5)  INVENTORIES                                                                

A summary of inventories, net of valuation reserves, follows:         

                                                December 31,
                                            1998                      1997
                                            (000s)                    (000s)
Manufacturing:                                                        
     Raw materials                         $ 6,497                     6,703
     Work-in-process                         1,166                       662
     Finished goods                          9,604                     7,427
   Customer service and other                1,363                     1,150
                                           -------                    ------
                                           $18,630                    15,942
                                           =======                    ======

     The Company had reserves for inventories of approximately  $4.0 million and
$8.2 million at December 31, 1998 and 1997,  respectively,  primarily related to
finished goods. The Company charged to expense  approximately $0.3 million,  $.1
million and $18.0 million in the years ended  December 31, 1998,  1997 and 1996,
respectively,  for reserves and  impairments of  inventories.  Of these charges,
$18.0 million in the year ended December 31, 1996 related to the  termination of
three on-line lottery projects for which inventory was specifically procured.   

     Inventory  reserves  were  reduced by $4.5  million,  $6.1 million and $9.0
million in the years ended December 31, 1998,  1997 and 1996,  respectively,  as
the applicable  inventories were sold or otherwise  disposed of. At December 31,
1998 and 1997,  respectively,  inventories  included  approximately  700 and 600
finished video gaming machines located in various casino gaming locations, under
trial arrangements with customers.                                              

- 53 -

10-K405
54th Page of 74
TOC
1st
Previous
Next
Bottom
Just 54th

(6)  PROPERTY AND EQUIPMENT                                                     

A summary of property and equipment follows:                          

                                                    December 31,
                                                    ------------
                                                  1998                  1997
                                                  ----                  ----
                                                  (000s)                (000s)

    Lottery and pari-mutuel equipment systems   $125,623               107,729
    Land, buildings and improvements              19,085                14,669
    Machinery and equipment                       12,464                 6,906
    Gaming equipment                              18,831                20,267
    Furniture and fixtures                         2,736                 2,503
                                                --------               -------
         Total                                   178,739               152,074
                                                --------               -------
     Less accumulated depreciation               (102,384)              (88,914)
                                                 --------               --------
                                                $ 76,355                63,160
                                                ========               =======

     In 1997 the Company  transferred to inventory,  gaming equipment with a net
book  value  of  approximately  $2.2  million,  due to the  expiration  of lease
agreements.  In 1996, the Company  transferred  on-line lottery equipment with a
net book value of approximately  $2.4 million to inventories in conjunction with
the  termination  of an on-line  lottery  contract.  Other  additions  to gaming
equipment and on-line lottery  equipment in the  three-years  ended December 31,
1998, are included in the Consolidated  Statements of Cash Flows as expenditures
on property and equipment.                                                      

     Gaming  equipment  at December  31,  1998 and 1997  includes  video  gaming
machines  with an  aggregate  cost of  approximately  $10.9  million  and  $13.4
million,  respectively,  and a carrying value of approximately  $5.4 million and
$7.8 million, respectively,  which are under lease or revenue sharing agreements
with  customers.  For  the  years  ended  December  31,  1998,  1997  and  1996,
depreciation  expense on this  equipment was  approximately  $1.7 million,  $2.3
million  and $2.8  million,  respectively.  Two lease  agreements  provide  rent
payments to the Company based on a percentage of net gaming receipts. One of the
two  agreements  is on a  month-to-month  basis and the other is for a five-year
period ending in December 2000 with  provisions for three  one-year  extensions.
Another  agreement is a master lease  whereby  terminal  lease terms are for one
year, with four consecutive  automatic  one-year  renewals with decreasing lease
payments, with an option by the lessee to terminate the lease at the end of each
such year.  Future lease receipts,  by the Company,  under the contractual lease
agreements, assuming renewals, based on the terminals delivered through December
31, 1998, are approximately as follows:                                         

Year ending December 31,                     (000s)                   
1999                                    $3,400              
2000                                     2,713              
2001                                       386              
                          ------
                          $6,499
                          ======

(7)  INTANGIBLE AND OTHER ASSETS                                                

 A summary of intangible and other assets, net of amortization, follows:

                                                  December 31,
                                                  ------------
                                                1998                  1997
                                                ----                  ----
                                                (000s)                (000s)

   Software development costs                   $ 7,606                8,849
   Deferred costs                                 9,513                2,470
                                                -------               ------
                                                $17,119               11,319
                                                =======               ======

     The Company  capitalized  approximately  $1.0  million and $4.1  million of
software  development  costs in the  years  ended  December  31,  1997 and 1996,
respectively. No costs were capitalized in 1998. The costs are primarily related
to the development of the MasterLink(TM) system.                                

- 54 -

10-K405
55th Page of 74
TOC
1st
Previous
Next
Bottom
Just 55th

     Deferred costs include the costs of implementing and installing lottery and
pari-mutuel  systems used to provide services under long-term  contracts.  These
costs are amortized over the lives of the related contracts.                    

     Total  amortization  expense  of  intangible  and other  assets  (including
Goodwill) was approximately $2.8 million, $3.7 million and $4.2 million in 1998,
1997  and  1996,  respectively.  Amortization  of  software  development  costs,
included in total amortization  expense,  was approximately  $1.2 million,  $1.5
million and $1.3 million in 1998, 1997 and 1996, respectively.                  

(8)  LEASE OBLIGATIONS                                                          

     The Company has noncancelable  operating leases for office space, equipment
and vehicles  which expire at various dates over the next eleven  years.  Future
minimum lease payments under  noncancelable  operating leases as of December 31,
1998, are approximately as follows:                                             

Year ending December 31,                     (000s)                   
------------------------                                              
1999                                    $4,625              
2000                                     3,770              
2001                                     3,020              
2002                                     2,368              
2003                                     2,009              
Thereafter                               8,567              

     In 1998, 1997 and 1996, rental expense was approximately $5.0 million, $4.7
million and $0.8 million, respectively.                                         

(9)  ACCRUED EXPENSES                                                           

A summary of accrued expenses follows:                                

                                                        December 31,
                                                        ------------
                                                       1998             1997
                                                       ----             ----
                                                       (000s)           (000s)

    Labor and benefits                                $ 8,191          5,911
Deferred revenue and estimated costs to complete                    
       long-term contract obligations                     880          4,835
    Other, combined                                     8,777         10,959
                                                      -------         ------
                                                      $17,848         21,705
                                                      =======         ======

     Contracts  involving a substantial  construction  component are recorded as
long-term  contracts,  and  associated  revenues  are  recognized  on either the
percentage of completion or completed  contract method.  Included within Accrued
Expenses in the Company's consolidated balance sheets are the following balances
related to such contracts in process:                                           

                                                              December 31,
                                                              ------------
                                                         1998           1997
                                                         ----           ----
                                                         (000s)         (000s)

Costs and estimated earnings in excess of billings                    
      on uncompleted contracts                          $2,124           ---
Billings in excess of costs and estimated earnings                    
       on uncompleted contracts                          (2,162)       (2,936)
                                                        ------        ------
                                                         $  (38)       (2,936)
                                                        ======        ======

- 55 -

10-K405
56th Page of 74
TOC
1st
Previous
Next
Bottom
Just 56th

(10) LONG-TERM DEBT                                                             

     A summary of  long-term  debt,  including  capitalized  lease  obligations,
follows:                                                                        

                                                                · Download Table


                                                                     December 31,  
                                                                     ------------  
                                                                    1998      1997 
                                                                    ----      ---- 
                                                                   (000s)    (000s)
                                                                                   

Variable rate term loan (8.04% at December 31, 1998), quarterly                    
   payments of $62,500 through 2004, remaining balance due                         
   December 2004                                                 $24,938        ---
Variable rate term loan (7.54% at December 31, 1998), quarterly                    
   payments increasing from $625,000 to $3,125,000 through                         
   September 2003                                                 24,375        ---
Notes payable paid in October 1998                                   ---     30,303
8.25% note payable in monthly installments including interest,                     
   through September 2001                                          4,240      4,940
4.95% to 10.4% various notes and capital lease obligations, due                    
   in monthly installments of $4,189 to $40,448 including                          
   interest maturing through February 2004                         2,657        584
                                                                 -------     ------

                                                                  56,210     35,827

Less current installments                                          4,445      4,381
                                                                 -------     ------

Long-term debt, excluding current installments                   $51,765     31,446
                                                                 =======     ======

The aggregate maturities of long-term debt are as follows:            

    Year ending December 31,                                            (000s)

         1999                                                          $ 4,445
         2000                                                            5,661
         2001                                                            5,743
         2002                                                            6,568
         2003                                                           10,033
         Thereafter                                                     23,760
                                                                       -------
                                                                       $56,210
                                                                       =======

     Cash paid for interest (including  capitalized  interest) was approximately
$4.6  million,  $2.0 million and $2.6  million for the years ended  December 31,
1998, 1997 and 1996,  respectively.  In 1998 the Company capitalized interest of
$0.5 million during construction of capital assets.                             

     Based on interest rates  currently  available to the Company for borrowings
with similar terms and maturities,  the fair value of long-term debt at December
31, 1998 approximates carrying value.                                           

     In October 1998, the Company  completed  negotiations  for a $100.0 million
credit facility.  The credit facility  replaced an existing credit facility and,
among other things,  provides for two $25.0 million term loans  maturing in five
and six years,  respectively,  and a revolving  line of credit for $50.0 million
expiring  September 30, 2003. The credit facility is secured by stock of certain
subsidiaries,   inventories,  receivables,  equipment,  intellectual  and  other
property of the Company.  At the Company's  option,  the credit  facility  bears
interest at a Base Rate  approximating  prime or LIBOR plus an applicable margin
percentage.  The margin  percentage  above the LIBOR rate may fluctuate  between
1.75%  and 2.75%  depending  on the  Company's  consolidated  leverage  ratio as
defined in the  credit  facility  agreements  (collectively  referred  to as the
"Credit  Agreement").  The Company may utilize up to $15.0  million of the $50.0
million   revolving  line  of  credit  to  collateralize  its  bonding  program.
Contractual obligations at December 31, 1998 required approximately $8.5 million
in outstanding letters of credit. The Company purchased a 30-month interest rate
swap which caps the base rate interest rate on one of the $25 million           

- 56 -

10-K405
57th Page of 74
TOC
1st
Previous
Next
Bottom
Just 57th

term loans at 8.5%. Such cap expires 2001. The credit facility carries customary
restrictive  covenants  including  but not limited to minimum  leverage and cash
flow  ratios,   limitations  on  domestic  and  foreign   capital   investments,
restrictions  on change in  control,  restrictions  on  payments  of  dividends,
maintenance of minimum  consolidated net worth,  limitations on additional debt,
liens and asset dispositions.  Upon closing, in October, the Company advanced on
the two $25.0  million term loans.  The  proceeds  were used to pay off existing
debt  of   approximately   $27.9  million  and  provide   capital  for  existing
commitments.  At December 31, 1998 the Company had $42.5 million available under
the revolving line of credit.                                                   

(11) INCOME TAXES                                                               

 Income tax expense (benefit) from operations consists of the following:

                                            Years Ended December 31,
                                            ------------------------
                                          1998         1997         1996
                                          ----         ----         ----
                                          (000s)       (000s)       (000s)
Current:                                                              
       Federal                              $  ---          343        (3,533)
      State                                    14        1,281            70
      Foreign                                (126)         (14)          ---
                                           ------        -----        ------
                                              (112)       1,610        (3,463)
                                           ------        -----        ------
Deferred:                                                             
       Federal                               2,762        5,348        (3,614)
       State                                   671          555        (1,602)
       Foreign                                  84           33           (74)
                                           ------        -----        ------
                                             3,517        5,936        (5,290)
                                           ------        -----        ------
                                             3,405        7,546        (8,753)
   Less tax expense on extraordinary items    ---        8,681           ---
                                           ------        -----        ------
                                            $3,405       (1,135)       (8,753)
                                           ======        =====        ======

     The  provision  for income tax expense  (benefit)  differs  from the amount
which would be provided by applying the Federal statutory income tax rate of 35%
to income or loss from  continuing  operations  before  extraordinary  items and
before income taxes as follows:                                                 

                                              Years Ended December 31,
                                              ------------------------
                                           1998          1997         1996
                                           ----          ----         ----
                                           (000s)        (000s)       (000s)

    Computed expected tax expense (benefit) $2,793         1,276       (8,403)
    Extraordinary gain                         ---         7,683       (1,345)
    State taxes, net of Federal impact         445         1,193         (996)
   Change in valuation reserve               (229)       (3,000)       1,582
   Non-deductible expenses                    343           281          219
   Goodwill amortization                      288           287          287
    Other, net                                (235)         (174)         (97)
                                           ------         -----       ------
                                            $3,405         7,546       (8,753)
                                           ======         =====       ======

- 57 -

10-K405
58th Page of 74
TOC
1st
Previous
Next
Bottom
Just 58th

     The tax effects of temporary  differences and carryforwards  that give rise
to deferred tax assets and liabilities consist of the following:                

                                                              December 31,
                                                              ------------
                                                           1998           1997
                                                           ----           ----
                                                            (000s)        (000s)
Deferred tax assets:                                                  
       Allowance for doubtful accounts                   $   407           507
       Inventory reserves                                  1,585         3,237
       Net operating loss carryforward and tax credits     9,174         7,867
       Other                                                 279           ---
       Accrued liabilities                                 1,730         3,688
                                                         -------        ------
       Deferred tax assets                                13,175        15,299
        Less valuation reserve                             (3,626)       (3,855)
                                                         -------        ------
       Net deferred tax assets                             9,549        11,444
                                                         -------        ------

Deferred tax liabilities:                                             
        Property and equipment, principally depreciation   (8,376)       (9,367)
        Deferred costs                                     (5,271)       (3,202)
       Lease obligations                                     ---           128
       Other                                                (181)          235
                                                         -------       -------
        Net deferred tax liabilities                      (13,828)      (12,206)
                                                         -------       -------
        Net deferred income tax asset (liability)         $(4,279          (762)
                                                         =======       =======

     The  ultimate  realization  of deferred  tax assets is  dependent  upon the
existence of, or  generation  of,  taxable  income in the periods in which those
temporary differences and carryforwards are deductible. Management considers the
scheduled  reversal of deferred tax liabilities,  taxes paid in carryback years,
projected  future  taxable  income and tax  planning  strategies  in making this
assessment.  Based upon the level of historical  taxable income and  projections
for future  taxable  income  over the periods  the net  deferred  tax assets are
deductible, at December 31, 1998, management has a valuation reserve established
for  deferred  tax assets for which it is more  likely than not that the Company
will not realize the benefits of these deductible differences and carryforwards.
This  valuation  reserve is evaluated  and  adjusted as facts and  circumstances
affecting the Company's tax situation  evolve and the  likelihood of recovery of
deferred tax assets  changes.  During the fourth  quarter of 1997 the  valuation
reserve  was  adjusted as a result of the  Company's  1997  cumulative  earnings
substantiating  that it is more likely than not that a portion of the deductible
differences will be realized.                                                   

     The Tax Reform Act of 1986 expanded the corporate  alternative  minimum tax
(AMT).  Under the Act, the Company's tax liability is the greater of its regular
tax or the AMT. The Company is subject to the AMT primarily due to  depreciation
limitations for AMT purposes.  The AMT that is actually paid will potentially be
allowed as a credit  against  regular  tax in the  future to the  extent  future
regular  tax  expense  exceeds  AMT.  At  December  31,  1998,  the  Company had
approximately $1.1 million of estimated AMT credit  carryforwards.  In addition,
at  December  31,  1998,  the  Company had  approximately  $13.5  million of net
operating loss  carryforwards  primarily for Federal regular income tax purposes
which expire in 2011.                                                           

     Net cash received from prior period refunds was approximately  $0.2 million
in 1998, $1.9 million in 1997 and $2.4 million in 1996.                         

(12) EXTRAORDINARY ITEMS                                                        

         In 1994,  Electronic Data Systems Corporation ("EDS") purchased 545,454
shares of the  Company's  Common  Stock and  1,912,728  shares of the  Company's
Series A Junior Preferred Stock ("Series A Preferred Stock").  Additionally, the
Company entered into an agreement with EDS which, among other things, called for
EDS to provide to the Company  enhanced  computing,  communications,  system and
engineering and field maintenance  services under the lottery systems contracts.
In 1996, the Company  withheld  certain  payments to EDS due to EDS  performance
issues and related on-line lottery customer  disputes.  In mid-1996 the contract
with EDS was  terminated and EDS filed a complaint  against the Company  seeking
payment of  outstanding  fees. On January 30, 1997,  the Company and EDS settled

- 57 -

10-K405
59th Page of 74
TOC
1st
Previous
Next
Bottom
Just 59th

all  claims  against  each  other.  The  settlement  resulted  in a net of taxes
extraordinary gain on debt  extinguishment of approximately $13.3 million ($1.29
and $1.26 per basic and diluted share,  respectively) for the Company. The terms
of the  settlement  included the  redemption by the Company of all of the Common
and Series A  Preferred  Stock  owned by EDS,  the  transfer  to the  Company of
certain  assets  used  in the  provision  of EDS  services  to  on-line  lottery
customers and the  extinguishment of approximately  $38.0 million of outstanding
fees in exchange for a note payable with a present value of $26.1  million.  The
note was paid in October  1998.  The  transition of the EDS services and related
employees to the Company was completed in 1997.                                 

     The Company paid or accrued  approximately  $81.6  million to EDS for costs
and  expenses in 1996.  Of those costs and expenses  approximately  $5.1 million
were capitalized primarily in conjunction with software development and deferred
start-up costs in 1996.                                                         

     In 1994, the Company completed the purchase of all of the outstanding stock
of United Wagering Systems,  Inc. ("UWS").  During 1995, the Company did not pay
principal and interest  obligations  under the terms of the promissory  notes to
the sellers because of disputes related to the  acquisition.  In March 1996, the
Company   effected  a  settlement   agreement   resulting  in  a  net  of  taxes
extraordinary  gain of $4.0 million  ($.37 per basic and diluted  share) gain on
debt extinguishment.                                                            

     In the fourth  quarter  1995,  the  Company  made a  decision  to sell UWS,
exclusive of the racetrack in Sunland Park, New Mexico. The Company entered into
a non-binding  letter of intent in the fourth  quarter 1995 for the sale of this
segment;  however,  this transaction was abandoned because final terms could not
be negotiated. The Company continued to review other potential opportunities for
the sale of this  operation  through the second  quarter 1996;  however,  due to
operational improvements and industry and market conditions, the Company decided
to no longer  actively  pursue the  disposal of the  wagering  systems  segment.
Accordingly, the results of operations of the wagering systems segment have been
reclassified  to  continuing  operations.  The  estimated  provision for loss on
disposal of  approximately  $5.5  million  ($.52 per basic and  diluted  share),
recorded in 1995, was reversed in the third quarter of 1996.                    

(13) BENEFIT PLANS                                                              

     The  Company's  1994 Stock  Incentive  Plan (the  "Plan")  provides for the
granting of options,  stock appreciation rights,  restricted stock,  performance
units and  performance  shares to  employees,  consultants  and  advisors of the
Company and the  granting of options to  non-employee  directors  of the Company
(collectively or individually,  "Awards).  The total number of shares authorized
for issuance  under the Plan to 1,500,000.  At December 31, 1998,  the remaining
number  of  shares  available  for  issuance  under  the Plan was  approximately
163,000.                                                                        

     Options  granted under the Plan are  designated as either  incentive  stock
options or as non-incentive stock options.  The term of an option may not exceed
10 years  from the date the option is granted or 15 years in the case of certain
non-incentive stock options.                                                    

     In February  1993,  the Board of  Directors  adopted a  Non-Employee  Stock
Option Plan whereby  non-employee  directors of the Company elected or appointed
after  January  1, 1993  shall  receive a  one-time  grant of options to acquire
20,000 shares of Common Stock. The exercise,  pricing, vesting, duration and all
other  terms  and  conditions  applicable  to  each  option  granted  under  the
Non-Employee Stock Option Plan shall be in accordance with the provisions of the
1992 Stock Incentive Plan.                                                      

     All options  currently  outstanding  are 100%  exercisable  no later than 4
years after grant date.                                                         

- 59 -

10-K405
60th Page of 74
TOC
1st
Previous
Next
Bottom
Just 60th

                                                                Weighted Average
                                                  Shares        Exercise Price
                                                   ------       ----------------
Year ended December 31, 1996                                          
Outstanding, beginning of year                 919,782          11.45 
  Granted                                     352,500           4.78
  Exercised                                       ---            ---
  Cancelled                                  (348,693)         11.74
                             ---------
Outstanding, end of year                       923,589           8.76 
                             =========
Exercisable, end of year                       547,749           9.67 
                             =========

Year ended December 31, 1997                                          
  Granted                                     232,000           5.58
  Exercised                                   (26,698)          7.23
  Cancelled                                  (126,208)          8.95
                             ---------
Outstanding, end of year                     1,002,683           8.04 
                             =========
Exercisable, end of year                       644,011           8.96 
                             =========

Year ended December 31, 1998                                          
  Granted                                     286,000          11.65
  Exercised                                   (29,165)          5.40
  Cancelled                                   (44,854)         10.62
                             ---------
Outstanding, end of year                     1,214,664           8.86 
                             =========
Exercisable, end of year                       828,645           8.73 
                             =========

     Information  regarding options  outstanding and exercisable at December 31,
1998, follows:                                                                  

                                                        · Enlarge/Download Table


                                  Options Outstanding                 Options Exercisable   
Range of         -----------------------------------------------   -------------------------
Exercise                    Weighted Average   Weighted Average            Weighted Average 
 Price           Shares      Exercise Price    Remain Life (Yrs)   Shares    Exercise Price 
--------         ------     ----------------   -----------------   ------   ----------------
                                                                                            

$3.00 - 5.00      268,301           $4.09            8.0          210,291         $4.17     
$5.00 - 10.00     444,168            7.69            6.7          347,159          8.05     
$10.00 - 15.00    460,195           12.10            7.5          229,195         12.60     
$15.00 - 28.00     42,000           16.23            5.5           42,000         16.23     
                ---------                                         -------                   
                1,214,664                            7.2          828,645                   
                =========                            ===          =======                   

     A stock purchase plan was  established  in 1991,  which is available to all
permanent full-time employees. The Stock Purchase Plan provides for the purchase
of the  Company's  Common Stock  through  payroll  deductions  of up to 3% of an
employee's  current  compensation.  In  addition,  the  Company  may  make  cash
contributions  to each employee's  stock purchase account in an amount up to 50%
of each  payroll  deduction  credited to the  account.  In 1997,  an  additional
500,000  shares were  authorized  by a vote of  stockholders  bringing the total
number of shares  authorized  for  issuance  under  the Stock  Purchase  Plan to
700,000. Under the Stock Purchase Plan, the Company will offer to sell shares of
its Common  Stock at the end of each one year  period (the  "Purchase  Period"),
which  begins  January  1 and ends  December  31 of each  year.  Shares  will be
purchased at the lesser of 85% of the fair market value of the Company's  Common
Stock on the first or last day of the Purchase Period.  There were 97,997 shares
at $9.99 per share  purchased in January of 1999 for the 1998  Purchase  Period;
132,524  shares at $3.35 per share  purchased  in  January  of 1998 for the 1997
Purchase  Period;  and 117,075 shares at $2.98 per share purchased in January of
1997 for the 1996 Purchase  Period.  Under the Stock  Purchase Plan, the Company
contributed  approximately  $322,000,  $149,000 and $117,000 for 1998,  1997 and
1996, respectively. Remaining authorized shares available for issuance under the
plan were approximately 172,000 at December 31, 1998.                           

     The Company  applies  Accounting  Principles  Board  Opinion 25 and related
interpretations  in  accounting  for stock  option and employee  stock  purchase
benefit plans.  Accordingly,  no  compensation  cost has been  recognized in the
Company's  consolidated  statement of operations for options  granted and shares
purchased under the plans. Had compensation cost for the options granted and the
shares of Common Stock issued under the Company's  employee  stock purchase plan
been determined  based on the                                                   

- 60 -

10-K405
61st Page of 74
TOC
1st
Previous
Next
Bottom
Just 61st

fair value at the grant  dates for awards  under the plans  consistent  with the
method of Financial  Accounting Standards Board Statement 123, the Company's net
earnings  (loss)  and per share  amounts  would  have been as  reflected  in the
pro-forma amounts indicated below:                                              

                                    1998              1997              1996
                                    (000s)            (000s)            (000s)

     Net earnings (loss)             $3,060            17,637           (15,352)
                                    ======            ======           =======

Net earnings (loss) per share:                                        

     Basic                            $0.29             1.71              (1.44)
                                     =====             ====              =====

     Diluted                          $0.28             1.68              (1.44)
                                     =====             ====              =====

     The fair value of the options granted and shares issued under the Company's
employee stock  purchase  plans in the three years ending  December 31, 1998 was
estimated using the Black-Scholes model with the following assumptions: dividend
yield of 0%; expected life of 4 years for 1998, 5 years for 1997 and 1996, and a
risk-free  interest  rate of  5.25%  for 1998  and 6% for  1997  and  1996.  The
volatility  factors used for the pro-forma  amounts are 206% for 1998,  129% for
1997 and 57% for 1996.                                                          

     Employees  aged 21 and above are eligible to  participate  in the Company's
401(K) employee savings plan the first of the month after hire (or after one day
of service).  Employer  contributions are discretionary under the plan. Employer
contributions  under the plan were approximately  $783,000 in 1998,  $607,000 in
1997and $237,000 in 1996.                                                       

(14) OTHER CHARGES                                                              

     In 1996 the Company recorded approximately $34.1 million of special charges
for  restructuring  costs and asset  impairments,  consisting  of $31.0  million
related to the on-line lottery segment and approximately $3.1 million related to
the wagering systems segment as discussed in Note 12.                           

(15) COMMITMENTS AND CONTINGENCIES                                              

     The  Company  has  employment  agreements  with  certain  of its  executive
officers that provide for lump sum severance payments and accelerated vesting of
options and  restricted  stock upon  termination  of  employment  under  certain
circumstances or a change in control, as defined.                               

     The Company is obligated to provide services and/or equipment under certain
of its  contracts.  In addition,  the various  state  on-line  lottery and video
gaming  contracts  contain  provisions under which the Company may be subject to
monetary penalties for central computer downtime,  terminal failures,  delays in
servicing  inoperable  terminals  within specified time periods and ticket stock
shortages  among other things.  The Company accrues any net losses in fulfilling
the terms of these  contracts  when the loss is probable  and can be  reasonably
estimated (see Note 14).                                                        

     The Company  typically posts bid,  litigation,  and  performance  bonds for
on-line lottery  contracts.  At December 31, 1998, the Company had collateral in
support  of  the  various  bonds  outstanding  consisting  of  $1.2  million  of
restricted  deposits and $7.5 million of irrevocable  standby letters of credit.
Should the Company fail to meet contractually  specified  obligations during the
contract term,  the lottery  authority may assess damages and exercise its right
to collect on the  applicable  bond. The Company has had disputes with customers
over implementation schedules,  deliverables and other issues. The Company works
with these customers to resolve these differences;  however,  should the Company
be unable to resolve any disputes in a mutually satisfactory manner, the Company
may  suffer  negative  consequences  in its  relationships  with these and other
customers and its pursuit of future  business.  The ultimate cost to the Company
of such  damages  (if any)  would be net of its  claims  under  risk  management
policies in effect as appropriate.                                              

- 61 -

10-K405
62nd Page of 74
TOC
1st
Previous
Next
Bottom
Just 62nd

     The recovery of a  significant  amount of the  Company's  investment in the
racetrack  operations in Sunland Park, New Mexico is largely contingent upon the
success of gaming at the  racetrack.  The Company's  investment in the racetrack
operations   is   approximately   $23.4  million  and  current  plans  call  for
approximately  $3 million to $4 million of additional  expenditures for facility
enhancements, gaming machines and related equipment.                            

     A significant percentage of the Company's consolidated revenues are derived
from  sales  to  customers  in  jurisdictions  that  have  enacted   legislation
permitting various types of gaming.  Such enacted  legislation may change due to
political and economic  conditions  within the  jurisdiction  which could have a
material  adverse  effect upon the Company's  financial  position and results of
future operations.                                                              

     International  sales  denominated  in  foreign  currencies   accounted  for
approximately  $9.2 million or 4.3% of the  Company's  consolidated  revenues in
1998, $20.3 million or 10% of consolidated revenues in 1997 and $16.6 million or
9% of  consolidated  revenues in 1996.  Management  can give no assurances  that
changes in currency and exchange rates will not materially  affect the Company's
revenues,  costs, cash flows and business practices and plans.  Additional risks
inherent in the Company's  international  business activities  generally include
unexpected changes in regulatory requirements, tariffs and other trade barriers,
delays in  receiving  payments on accounts  receivable  balances,  reimbursement
approvals   (both   governmental   and   private),   difficulties   in  managing
international operations, potentially adverse tax consequences,  restrictions on
repatriation  of earnings  and the burdens of  complying  with a wide variety of
foreign laws and  regulations.  In addition,  the Company's  foreign  operations
would be affected by general economic conditions in the international markets in
which the Company does business, such as a prolonged economic downturn in Europe
or the Asian-Pacific  region.  There can be no assurances that such factors will
not  have a  material  adverse  effect  on the  Company's  future  international
revenues and,  consequently,  on the Company's  business,  financial  condition,
results of operations or cash flows. The Company has not historically  attempted
to hedge the risks of fluctuating  exchange rates given the currencies  involved
and the terms of payment granted to its customers.                              

     In March 1996, Ladbroke Holdings del Peru S.A. ("Ladbroke") filed an action
in the United  States  District  Court,  Eastern  District of Michigan,  against
United Tote Company and the Company. The complaint alleged, in part, that United
Tote had  violated an agreement  that it had entered  with  Ladbroke to "supply,
install,  commission and operate" a number of wagering terminals and that United
Tote,  without  justification,  notified  Ladbroke that it was  terminating  the
agreement.   Ladbroke  alleged  that  United  Tote  and  the  Company's  conduct
constituted a breach of contract,  wrongful termination of contract,  fraudulent
misrepresentation and tortious interference with contract/business relationship.
The  complaint  does not  specify  a damage  figure  but seeks  recovery  of all
"actual,  incidental  and  consequential  damages."  The Company and United Tote
filed a counterclaim  against Ladbroke  alleging claims for breach of certain of
Ladbroke's   obligations   under  the  contract  and  unjust   enrichment.   The
counterclaim  alleged,  in part,  that Ladbroke  failed to identify a sufficient
number of viable retailer  locations,  and failed to promote,  design and market
the game so as to create  sufficient  demand.  The case is in discovery  and the
Company intends to continue to vigorously defend the action.  The Company cannot
reasonably predict the ultimate outcome of this litigation.                     

     The Company is involved in various other claims and legal  actions  arising
in the  ordinary  course  of  business.  In the  opinion  of  management,  after
consultation with legal counsel, the ultimate disposition of these other matters
will not have a material adverse effect on its consolidated  financial  position
or results of operations.                                                       

- 62 -

10-K405
63rd Page of 74
TOC
1st
Previous
Next
Bottom
Just 63rd


ITEM 9.  CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND        
FINANCIAL DISCLOSURE.                                         

None                                                                  

PART III

ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS                                       

The directors and executive officers of the Company are as follows:   

Name                     Age  Position                                
----                     ---  --------                                

Richard R. Burt          52   Chairman and Director                   
James J. Davey (1)(2)    57   Vice Chairman and Director              
Patricia W. Becker (1)   47   Director                                
John R. Hardesty (1)(2)  59   Director                                
Richard M. Haddrill      45   President, Chief Executive Officer, and 
    Director
Susan J. Carstensen      36   Chief Financial Officer and Treasurer   
Michael L. Eide          48   President of Gaming Operations          
Alan Rassaby             43   Senior Vice President of Legal and      
          Administration
     Christer S. T. Roman     47   Senior Vice President of Product and Business
       Development
----------                                                                      
(1)  Member of the Audit Committee.                                             
(2)  Member of the Compensation Committee.                                      

     Richard R. Burt became a director  and  chairman of the Company on December
15,  1994.  Mr. Burt is a founder  and the  chairman  of IEP  Advisors,  Inc. in
Washington  D.C., a consulting and merchant banking firm. From 1991 to 1994, Mr.
Burt was a partner in McKinsey & Co., a world-wide  management  consulting firm.
During the period from 1989 to 1991, Mr. Burt served as the Chief  Negotiator in
the Strategic Arms Reduction  Talks (START) with the former Soviet Union. He was
the U.S.  Ambassador to the Federal  Republic of Germany from 1985 to 1989.  Mr.
Burt was the Assistant Secretary of State for European and Canadian Affairs from
1983 to 1985, and served as Director of  Politico-Military  Affairs from 1981 to
1983. Mr. Burt also serves as the Chairman of the Board of Weirton Steel,  Inc.,
a  tin-plate  manufacturer,  and serves on the Board of  Directors  of the Paine
Webber Mutual Funds,  Hollinger  International,  a company owning  newspapers in
Europe,  Canada,  Australia and the United States,  Archer Daniels  Midland,  an
agri-business  company and Homestake,  a gold mining company.  In addition,  Mr.
Burt is a member of the Textron Corporation's International Advisory Council    

     James J. Davey was elected as a director of the Company effective  February
25, 1993,  and was elected as vice chairman on May 31, 1994. He first joined the
Company as chief  operating  officer in October 1992.  Mr. Davey served as chief
executive  officer from February 25, 1993 until May 31, 1994,  and from February
24, 1994 until May 31,  1994,  he also served as  president.  From  October 1992
until  February  1993,  Mr. Davey served as president of the  Company's  on-line
lottery services  subsidiary,  AWI. From 1986 to October 1992, Mr. Davey was the
director for the Oregon State  Lottery.  From 1985 to 1986, Mr. Davey was deputy
director and assistant  director of administration for the Oregon State Lottery.
From 1980  through  1984,  Mr.  Davey  served as  administrator  for the  Oregon
Department of Revenue.                                                          

     Patricia  W.  Becker  was  appointed  to the Board of  Directors  effective
January 18, 1995 to fill a newly  created  position  thereon.  Ms. Becker is the
owner of Patricia Becker & Associates, a consulting firm. She is a consultant to
the Company and serves as chair of its Compliance  Committee.  Ms. Becker served
as the chief of staff to Bob Miller,  Governor of Nevada,  from  October 1993 to
January 1995. Prior to that, she was senior vice president,  general counsel and
secretary  of  Harrah's  Casino  Hotels  from  June  1989 to July  1993 and vice
president,  general  counsel and  secretary  from 1984 to 1989.  Ms.  Becker was
deputy and chief deputy attorney  general assigned to the Nevada Gaming Division
from 1979 until she was appointed to the State Gaming Control  Board,  where she
served  until  September  1984.  Ms.  Becker is a                               

- 63 -

10-K405
64th Page of 74
TOC
1st
Previous
Next
Bottom
Just 64th

vice chair for the Gaming Law Section of the  American Bar  Association,  a past
president of the Nevada Trial Lawyers Association and secretary and a trustee of
the International  Association of Gaming Attorneys.  Ms. Becker currently serves
on the Board of Directors of Fitzgeralds  Gaming Company, a Nevada based company
which owns casinos.                                                             

     John R. Hardesty was appointed to the Board of Directors effective December
18,  1996 to fill a vacancy  thereon  created by the  resignation  of Jeffrey D.
Cushman.  Mr. Hardesty is chairman of Electro  Dynamics Crystal  Corporation,  a
manufacturer  of  electronic  components  for the  communication  industry.  Mr.
Hardesty also owns 100% of Thermo  Dynamics,  Inc., a manufacturer  of synthetic
quartz for the electronics industry and investments,  J.G. Inmobiliaria SA De.CV
and Inmobiliaria San Panchos De.RL De.CV,  Mexican  corporations which hold real
estate investments; and Zona Virtual SA De.CV, a Mexican corporation which is an
internet  provider and computer  sales and service  company in Puerto  Vallerta,
Mexico. Mr. Hardesty serves as a director and Chief Financial Officer of LeTeko,
Inc., a gold exploration company. From 1988 until its sale in 1995, Mr. Hardesty
was the  owner and  chairman  of  Dixson  Inc.,  a  manufacturer  of  electronic
instruments for the heavy-duty truck market and process control market.         

     Richard M. Haddrill was appointed as chief executive officer of the Company
on June 18, 1997 and as  president  of the Company and to its Board of Directors
on August 21, 1996. He filled the Board vacancy  created by the  resignation  of
Stephen  Vanderwoude.  In  addition,  on June 18,  1997 he was  appointed  chief
executive  officer  of the  Company's  Automated  Wagering  International,  Inc.
("AWI") subsidiary,  and has served as president of AWI since December 1996. Mr.
Haddrill  joined the Company in December  1994 as the Company's  executive  vice
president  of  operations  and  chief  financial  officer.  He  served  as chief
financial  officer until May 15, 1997. In December 1994,  Mr.  Haddrill was also
appointed  treasurer of the Company.  In August 1995, Mr. Haddrill was appointed
to the Board of Directors of the Company's United Wagering Systems, Inc. ("UWS")
subsidiary,  and  assumed  the  position  of chief  executive  officer of UWS in
February  1996.  From July 1992 until  November  1994,  Mr.  Haddrill  served as
executive   vice   president  --  corporate  and   president  of   international
subsidiaries  for  Knowledgeware,  Inc., a provider of  application  development
software and services worldwide. Prior to joining Knowledgeware, Inc. in 1991 as
an executive vice president and chief  financial  officer,  Mr. Haddrill was the
managing  partner of the Colorado and New Mexico offices of the accounting  firm
of Ernst & Young from August 1989 to October 1991 and held various  positions as
a partner or employee with Ernst & Young from January 1975 to September 1989.   

     Susan J. Carstensen was appointed  treasurer of the Company on June 4, 1998
and has served as chief financial officer since May 15, 1997. Ms. Carstensen was
vice  president,  finance of the Company from  November 7, 1996 to May 15, 1997.
From June 1995 to November  1996 she was corporate  controller  for the Company.
From February  1995 to June 1995 she was the director of internal  audit for the
Company.  Ms.  Carstensen  managed the cost and financial  accounting for Martin
Marietta  Astronautics Group in Denver,  Colorado from May 1991 through February
1995.  From August 1985 through May 1991 Ms.  Carstensen was with the accounting
firm of Ernst & Young in Denver, Colorado.                                      

     Michael L. Eide was appointed  President of the Company's  recently  formed
Gaming  Operations  Division  overseeing the development of Sunland Park and the
Montana Route  operations in June of 1998. He is also currently  serving as vice
president and director of the  Company's  wholly-owned  subsidiary,  VLC. He had
served as president of VLC since December 1, 1994.  Prior to that time he served
as  treasurer  and chief  financial  officer of the Company  from May 1991 until
December 1994 and assistant  secretary from October 1992 through  December 1994.
He has also held the positions of secretary,  treasurer and assistant  secretary
with VLC during the period  November 1990 through  December  1994.  From 1977 to
December  1988,  Mr.  Eide  was a  principal  in the  accounting  firm of  Neil,
Williamson, Eide and Staker in Bozeman, Montana.                                

     Alan  Rassaby  joined the  Company as Senior  Vice  President  of Legal and
Administration on December 3, 1998. Prior to his appointment,  Mr. Rassaby was a
partner at Phillips Fox,  Lawyers.  He has provided counsel to the Company since
1992. Mr. Rassaby was instrumental in developing  gaming laws for the Australian
state of Victoria and was active in other  government  programs prior to joining
Phillips Fox.                                                                   

- 64 -

10-K405
65th Page of 74
TOC
1st
Previous
Next
Bottom
Just 65th

     Christer S. T. Roman joined the Company as Senior Vice President of Product
and  Business  Development  on  December 3, 1998.  Prior to that time Mr.  Roman
served five years as the managing director of EssNet AB, a Sweden-based  lottery
systems  supplier.  From 1984 until 1992 Mr.  Roman  served as  president of the
London-based Datech Group Plc, an international information systems company.    

     The Board of Directors  adopted a new director  compensation plan effective
July 1,  1998.  Directors,  who are not  employees  of the  Company,  receive  a
calendar year retainer of $25,000  annually,  50% in quarterly cash payments and
50% in common stock of the Company, for serving on the Board of Directors,  plus
$1,000  for each  Board  meeting  and $1,000  for each  Audit,  Compensation  or
Executive  Committee  meeting  attended  in person  or $500 for each  telephonic
meeting they attend.  A  non-employee  director  serving as  chairperson  of the
Company's Board of Directors receives an all inclusive calendar year retainer of
$100,000, 75% in quarterly cash payments and 25% in common stock of the Company,
for  serving in such  capacity.  Each  non-employee  director  who serves as the
chairperson of any committee of the Board of Directors receives a further fee of
$2,000 for each  committee  meeting  attended  for his or her  services  in such
capacity.  Directors are also reimbursed for out-of-pocket  expenses incurred in
attending Board of Directors and committee meetings. Non-employee directors also
receive $1,000 per day for time spent on licensing related matters or fulfilling
special assignments requested by the Chief Executive Officer, up to a maximum of
five (5) days per  calendar  year.  Mr.  Burt was  granted an option to purchase
10,000  shares of Common Stock  pursuant to the Company's  1994 Stock  Incentive
Plan,  and an option to purchase  20,000 shares  pursuant to the Company's  1993
Stock  Incentive Plan for  Non-Employee  Directors,  with both options having an
exercise  price of $8.25 per  share;  and Ms.  Becker  was  granted an option to
purchase  10,000  shares of Common Stock  pursuant to the  Company's  1994 Stock
Incentive Plan and an option to purchase 20,000 shares pursuant to the Company's
1993 Stock Incentive Plan for Non-Employee  Directors,  with both options having
an exercise price of $9.28 per share.  On August 12, 1996,  concurrent  with his
becoming a  non-employee  director,  Mr.  Davey  received  an option to purchase
10,000  shares of Common Stock  pursuant to the Company's  1994 Stock  Incentive
Plan and an option to purchase  20,000  shares  pursuant to the  Company's  1993
Stock  Incentive Plan for  Non-Employee  Directors,  with both options having an
exercise  price of $3.41 per share.  On December 18, 1996,  concurrent  with his
becoming a non-employee  director,  Mr. Hardesty  received an option to purchase
10,000  shares of Common Stock  pursuant to the Company's  1994 Stock  Incentive
Plan and an option to purchase  20,000  shares  pursuant to the  Company's  1993
Stock  Incentive Plan for  Non-Employee  Directors,  with both options having an
exercise  price of $4.13 per share.  Effective June 4, 1998,  each  non-employee
director  receives  500 shares of  restricted  common  stock  after each  annual
meeting of  stockholders.  The  restricted  stock is issued under the  Company's
stock  incentive  plan  and  the  restrictions  lapse  in  one-third  increments
beginning  on the  first  anniversary  of the  grant  date.  Directors  who  are
employees of the Company  receive no  additional  compensation  for serving as a
director, except that all directors and executive officers receive up to $10,000
in reimbursement of their expenses in connection with matters related to various
regulatory  disclosure  requirements and up to $1,500 per quarter  thereafter to
keep such information current.                                                  

Section 16(a) - Beneficial Ownership Reporting Compliance                       
---------------------------------------------------------                       

     Section  16(a) of the  Securities  Exchange  Act of 1934,  as amended  (the
"Exchange Act"),  requires the Company's directors and executive  officers,  and
persons who own more than ten  percent of a  registered  class of the  Company's
equity  securities,  to file by specific  dates with the SEC initial  reports of
ownership  and reports of changes in  ownership of Common Stock and other equity
securities of the Company on Forms 3, 4 and 5.  Officers,  directors and greater
than  ten-percent  stockholders  are required by SEC  regulations to furnish the
Company  with  copies of all  Section  16(a)  forms  they file.  The  Company is
required  to report any  failure to file by the  relevant  due date any of these
reports based solely on the Company's review of copies of such reports furnished
to it and written  representations  received by the Company that the filing of a
Form 5 was not required. Based upon this review, the Company is not aware of any
person who at any time  during  1998,  was a director,  officer or a  beneficial
owner of ten  percent or more of any class of equity  securities  of the Company
registered  pursuant to the  Exchange  Act who failed to file on a timely  basis
reports required by Section 16(a) of the Exchange Act during 1998.              

- 65 -

10-K405
66th Page of 74
TOC
1st
Previous
Next
Bottom
Just 66th


ITEM 11.  EXECUTIVE COMPENSATION                                                

     The  following  table sets  forth  certain  information  for the year ended
December 31, 1998 and for years ended December 31, 1997 and 1996  concerning the
compensation of the chief executive officer as of December 31, 1998 and the most
highly compensated executive officers of the Company with compensation in excess
of  $100,000  (other  than the chief  executive  officer)  who were  serving  as
executive officers as of December 31, 1998.                                     

                                                        · Enlarge/Download Table

                           SUMMARY COMPENSATION TABLE                                               

                                                                 Long Term Compensation             
                                                                 ----------------------             
                                                     Other               Awards                     
                                Annual Compensation  Annual              ------            All Other
Name and                        -------------------  Compen-    Restricted  Stock Options   Compen- 
Principal Position        Year  Salary $    Bonus $  sation $   Stock $(1)     (Shares)     sation  
------------------        ----  --------    -------  --------   ----------  -------------  ---------
                                                                                                    

Richard M. Haddrill       1998   387,015    522,000    34,815(2)   452,000      50,000         ---  
 President and Chief      1997   260,523    430,000   154,189(2)       ---         ---         ---  
 Executive Officer        1996   202,133    150,000       ---      133,200     140,000         ---  

Susan J. Carstensen       1998   126,508     54,000       ---          ---      15,000         ---  
 Chief Financial Officer  1997   100,031     48,000       ---          ---      18,000         ---  
 and Treasurer            1996    69,276      5,000       ---          ---         ---         ---  

Michael L. Eide           1998   203,051     40,500       ---          ---         ---         ---  
 President - Gaming       1997   203,256    126,000       ---       40,313       8,000         ---  
 Operations               1996   203,256     40,000       ---          ---      20,000         ---  

----------                                                                      

(1)  With respect to Mr.  Haddrill's  restricted stock holdings,  of the initial
     grant in 1998 of 100,000 shares,  75,000 remained  restricted as of January
     1, 1999 with a market value of approximately $1,035,937. Restrictions lapse
     on 25,000 shares each in January of 2,000, 2,001 and 2002. Mr. Haddrill was
     also awarded  30,000 shares of restricted  Common Stock in 1996,  10,000 of
     which  remained  restricted  as of December 31, 1998 with a market value of
     approximately  $145,000  and such  restrictions  on the 10,000  shares will
     lapse in  September  1999.  (See  "Employment  and Other  Contracts.")  All
     dividends  declared  and paid by the  Company,  if any,  on the  restricted
     stock,  shall be held by the Company until such restrictions  thereon lapse
     at which time the dividends,  without interest thereon,  shall be paid. Mr.
     Eide received  3,000 shares of restricted  stock in February 1998, of which
     3,000 remain  restricted at January 1, 1999, with an aggregate market value
     of $41,437.  Mr. Eide's restricted  shares vest in one-third  increments on
February 13, 1999, 2000 and 2001.                                     
(2)  Relocation assistance.                                                     

Option Grants in Last Fiscal Year                                               
---------------------------------                                               

     The following table sets forth  information with respect to options granted
under the Company's 1994 Stock Incentive Plan to each of the executive  officers
and directors named in the Summary Compensation Table above during 1998.        

- 66 -

10-K405
67th Page of 74
TOC
1st
Previous
Next
Bottom
Just 67th
                                                        · Enlarge/Download Table


                           OPTION GRANTS DURING 1998                                                     
                                Individual Grants                                                        
                     -------------------------------------------------------  Potential Realizable Value 
                     Number of     Percent of                                   at Assumed Annual Rates  
                     Securities   Total Options                               of Stock Price Appreciation
                     Underlying    Granted to       Exercise                      for Option Term(2)     
                      Options      Employees         Price        Expiration  ---------------------------
Name                  Granted       in 1998      (per Share)(1)      Date        5%               10%    
-------------------  ----------   -------------  --------------   ----------  --------         ----------
                                                                                                         

Richard M. Haddrill   50,000(4)          17.5%        $11.49       02/13/08   $520,034         $1,168,291

Susan J. Carstensen    7,000(3)           5.2%        $11.49       02/13/08    $72,805           $163,561
                       8,000(3)           2.8%        $12.06       12/14/08    $59,115           $151,262

Michael L. Eide          ---              ---            ---            ---        ---                ---

----------                                                                      

(1)  All  options  were  granted at an  exercise  price equal to the fair market
     value of the Common Stock which is the average of the closing  value of the
     Common  Stock for the 20 trading  days  immediately  preceding  the date of
     grant.  Such options may not be exercised  later than 10 years,  or earlier
than one year, after the date of grant.                               
(2)  These amounts represent certain assumed rates of appreciation  only. Actual
     gains,  if any,  on stock  option  exercises  are  dependent  on the future
     performance of the Common Stock and overall market conditions.  The amounts
reflected in this table may not necessarily be achieved.              
(3)  These options vest over a period of three years.                           
(4)  These options fully vest on grant date.                                    

The following table provides certain  information with respect to the number and
value of unexercised options outstanding as of December 31, 1998.               

                                                        · Enlarge/Download Table

                        Aggregated 1998 Option Exercises                                  
                       and December 31, 1998 Option Values                                

                         Number of Unexercised Options                                    
                               (in Common Shares)        Value of Unexercised In-the-Money
                              at December 31, 1998        Options at December 31, 1998(1) 
                         -----------------------------   ---------------------------------
                            Exercisable/Unexercisable        Exercisable/Unexercisable    
                         -----------------------------   ---------------------------------
                                                                                          

Richard M. Haddrill(2)            314,800/---                     $1,605,570/---          
Susan J. Carstensen                 6,000/27,000                     $43,744/$117,829     
Michael L. Eide                    77,333/2,667                     $491,655/$26,670      


----------                                                                      

(1)  Options  are in the  money  if the  fair  market  value  of the  underlying
     securities  exceeds the  exercise or base price of the option.  Fair market
     value of the Common Stock  underlying  the options on December 31, 1998 was
     $13.81,  the average of the high and low reported sales price on the Nasdaq
    National Market System on that date, which does not exceed the base price.
(2)  Mr.  Haddrill  exercised  8,000 options with an exercise price of $4.44 per
share on December 27, 1998.                                           

DEFINED BENEFIT AND LONG-TERM COMPENSATION PLAN                                 
-----------------------------------------------                                 

     The  Company  does not have any defined  benefit,  actuarial  or  long-term
incentive plan.                                                                 

- 67 -

10-K405
68th Page of 74
TOC
1st
Previous
Next
Bottom
Just 68th

EMPLOYMENT AND CERTAIN OTHER CONTRACTS

     Employment Agreement with Richard M. Haddrill:  Pursuant to the terms of an
employment  agreement  with Mr.  Haddrill  approved by the Board of Directors on
February 26, 1998,  Mr.  Haddrill  serves the Company as its president and chief
executive  officer.   Unless  sooner  terminated  pursuant  to  its  terms,  the
employment  agreement  terminates  on January 1, 2003 and is subject to one-year
extensions  thereafter.  The employment  agreement provides for a base salary of
$380,000.  Mr.  Haddrill is eligible to receive  annual  bonuses up to twice the
base salary if certain  performance  criteria are  satisfied  for such year.  In
addition,  Mr.  Haddrill was awarded  100,000 shares of restricted  Common Stock
that vest at the rate of one-fourth  annually over the next four years beginning
on January 1, 1999 and options to purchase  50,000  shares of Common Stock at an
exercise  price of $11.48 per share,  the  average of the  closing  value of the
Common Stock for the 30 trading days  immediately  preceding  the date of grant.
The employment  agreement further provides that if Mr. Haddrill's  employment is
terminated for any reason,  then all unvested  restricted shares shall revert to
the  Company.  In  addition,  the  employment  agreement  provides  that  if Mr.
Haddrill's  employment is terminated  for "cause" (as defined in the  employment
agreement) or by him other than for "good reason" (as defined in the  employment
agreement),  then all unvested  options  shall be forfeited.  If Mr.  Haddrill's
employment  is  terminated  for any other  reason,  then  certain of the options
become  exercisable.  All such options become immediately  exercisable,  and all
restrictions on restricted stock held by Mr. Haddrill  immediately lapse, upon a
"change in control" (as defined in the employment  agreement) of the Company. In
addition,  if Mr. Haddrill's  employment is terminated for any reason other than
"cause"  or if  he  terminates  his  employment  for  "good  reason"  (including
termination in certain circumstances  following a change in control), then he is
entitled to receive  all  accrued  but unpaid  salary and bonus and to receive a
lump sum equal to two times the sum of the total base salary plus annual  bonus,
as well as  payment  of  certain  benefits  through  the  remaining  term of the
employment  agreement.  Mr. Haddrill is entitled to the reimbursement of certain
relocation  expenses  and  other  business  expenses.  Finally,  the  employment
agreement  provides  that Mr.  Haddrill  will not compete with the Company for a
period of 18 months following his termination.                                  

     Agreement  with Susan J.  Carstensen:  On  December  5, 1996,  the  Company
entered into an agreement with Ms. Carstensen. If Ms. Carstensen is removed from
her position with the Company  without cause,  she will receive her then current
salary for a period of six months following termination. In the event there is a
change of control of the Company and Ms.  Carstensen's  employment is terminated
by the Company without good cause, or by Ms.  Carstensen for certain reasons set
forth in the  agreement,  then Ms.  Carstensen is entitled to an amount equal to
one-half  of  her  annual  salary.   Ms.   Carstensen  also  agreed  to  certain
confidentiality, non-competition and similar provisions.                        

     Agreement  with Michael L. Eide: On January 17, 1995,  the Company  entered
into an agreement  with Mr. Eide to provide for the  continuance of his position
as president  of VLC. If Mr. Eide is removed from his position  with the Company
without  cause,  he will  receive  his then  current  salary for a period of six
months following  termination.  In the event there is a change of control of the
Company and Mr. Eide's  employment  is  terminated  by the Company  without good
cause, or by Mr. Eide for certain  reasons set forth in the agreement,  then Mr.
Eide is entitled to an amount  equal to twice his annual  salary.  Mr. Eide also
agreed to certain confidentiality, non-competition and similar provisions       

     Agreement with Alan Rassaby:  On July 2, 1998, the Company  entered into an
agreement  with Mr.  Rassaby.  The  agreement  provides Mr.  Rassaby with a base
salary of $180,000  and an annual  bonus  potential  of $100,000  based upon the
Company's  executive  incentive  compensation  plan.  In  addition,   under  the
agreement,  Mr.  Rassaby was awarded an option to purchase  20,000 shares of the
Company's  Common  Stock on the first day of his  employment  which vests over a
three-year  period  from the date of grant.  The  exercise  price of $11.79  per
share. Mr. Rassaby received  reimbursement for relocation expenses. In the event
of  termination  without  cause,  Mr.  Rassaby is entitled to receive a lump sum
payment  equal to twelve  months  salary  if  terminated  in the  first  year of
employment, eight months salary if terminated in the second or third year or six
months base salary if terminated without cause in year four or subsequent.      

     Agreement  with  Christer S. T. Roman:  On December 15,  1998,  the Company
entered  into an  agreement  with Mr.  Roman  for a period of three  years.  The
agreement  provides Mr. Roman with a base salary of $180,000 and an annual bonus
potential of $100,000 based upon the Company's executive                        

- 68 -

10-K405
69th Page of 74
TOC
1st
Previous
Next
Bottom
Just 69th

incentive  compensation  plan. In addition,  under the agreement,  Mr. Roman was
awarded an option to purchase 20,000 shares of the Company's Common Stock on the
first day of his employment  which vests over a three-year  period from the date
of  grant.   The  exercise  price  is  $11.79  per  share.  Mr.  Roman  received
reimbursement for relocation expenses.  In the event of termination without good
cause,  Mr. Roman would be entitled to receive his base annual  salary in effect
plus guaranteed bonuses for the remaining term of the agreement.                

     Richard R.  Burt,  who became the  chairman  of the Board of  Directors  in
December 1994, is the chairman and a founder of IEP Advisors,  Inc. (IEP), which
has been  retained by the Company to provide  consulting  services and to assist
the Company in connection with its  international  activities since October 1994
at a rate of $15,000 per month plus expenses.  The Company paid IEP an aggregate
of  approximately  $189,641 in 1998.  The  current  contract  with IEP  Advisors
terminates  in  December of 1999  unless  terminated  upon 30 days notice by the
Company or IEP.                                                                 

     In addition,  Mr. Burt and the Company entered into a consulting  agreement
in  November  1994,  under which Mr.  Burt is to provide  advice and  assistance
relating  to the  promotion  of the  Company's  business  and to  assist  in the
development of business  opportunities for the Company.  The agreement  provides
for a per day  rate of  $1,000  for each day such  services  are  performed  and
reimbursement of out-of-pocket  expenses. The agreement is separate and distinct
from Mr. Burt's duties and  responsibilities  as a director of the Company.  The
agreement  further  provides for termination of the agreement by Mr. Burt or the
Company,  without  penalty,  upon 90 days' prior written notice.  During 1998 an
aggregate of approximately $4,000 was paid pursuant to the agreement.           

     In December  1995 the Company  entered  into a  consulting  agreement  with
Patricia  W.  Becker,  a director  of the  Company,  for the period of two years
commencing  January 16, 1995. In September  1997 the Board renewed the agreement
for an  additional  period of one year. In December 1998 the agreement was again
renewed and  provides  that Ms.  Becker  shall serve as the  chairperson  of the
Compliance Committee of the Company, and otherwise provide advice and assistance
to the Company on matters of  regulatory  compliance  and such other  matters as
requested by the Company.  The agreement  provides for an annual retainer fee of
$100,000  plus a per day rate of $1,000 for each day such services are performed
and  reimbursement  of  out-of-pocket  expenses.  The  agreement is separate and
distinct  from Ms.  Becker's  duties and  responsibilities  as a director of the
Company.  The agreement further provides for termination of the agreement by Ms.
Becker or the Company,  without penalty, upon 90 days' prior written notice. The
Company paid Ms. Becker an aggregate amount of approximately $75,000 during 1998
pursuant to the agreement.                                                      

- 69 -

10-K405
70th Page of 74
TOC
1st
Previous
Next
Bottom
Just 70th


ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT         

     The following table sets forth certain information regarding the beneficial
ownership  of the  Common  Stock as of March 1, 1999 by (i) each  person  owning
beneficially  more than five  percent  of the  outstanding  shares of the Common
Stock, (ii) each director and director nominee of the Company, (iii) each person
named in the Summary  Compensation Table appearing elsewhere herein and (iv) all
executive  officers  and  directors of the Company as a group.  The  information
under this caption is based on representations made to the Company by individual
directors or nominees  and/or  filings  made with the SEC.  Each person has sole
investment  and voting  power with  respect  to the shares  indicated  except as
otherwise shown. In conjunction with the Merger Agreement  entered into on March
10, 1999, the directors and executive  officers of the Company have entered into
or agreed to enter into voting  agreements  with Anchor Gaming pursuant to which
such directors and officers,  among other things, agreed to vote an aggregate of
approximately 4.4% of the Company's outstanding shares in favor of the Merger.  

     On March 10, 1999,  the Company  announced  its pending  merger with Anchor
Gaming.  A  definitive  merger  agreement  has been signed  which  provides  for
Anchor's  acquisition  of Powerhouse  at $19.50 per share.  The  transaction  is
subject to approval by the  shareholders  of  Powerhouse  and the  expiration of
applicable  waiting periods under the  Hart-Scott-Rodino  Antitrust  Improvement
Act. The merger, which will also require approval of various gaming authorities,
is expected to close in the second half of calendar 1999.                       

                                                        · Enlarge/Download Table

         SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT                                 

                                                               Number of Shares         Percent of Class
                                                               ----------------         ----------------
                                                             Beneficially Owned(1)      March 1, 1999(1)
                                                             ---------------------      ----------------
                                                                                                        

Dimensional Fund Advisors Inc................................   720,900 (2)                     6.4%    
  1299 Ocean Ave., 11th Floor                                                                           
  Santa Monica, CA 90401-1038                                                                           
Fir Tree Partners (Fir Tree, Inc. d/b/a Fir Tree Partners)...   697,400 (3)                     6.3%    
   1211 Ave of the Americas, 29th Floor                                                                 
   New York, NY 10036                                                                                   
Capital Technology Inc.......................................   616,100 (4)                     5.5%    
  8314 Pineville-Matthews Road, Suite 295                                                               
  Charlotte, NC 28226                                                                                   
Richard M. Haddrill+, ++.....................................   590,357 (5)(6)                  5.3%    
Michael L. Eide..............................................   216,707 (7)                     1.9%    
John R. Hardesty+............................................   117,837 (8)                     1.1%    
James Davey+.................................................    35,135 (8)                        *    
Richard R. Burt+.............................................    32,285 (8)                        *    
Patricia W. Becker+..........................................    31,392 (8)                        *    
Susan J. Carstensen ++.......................................    15,653 (9)                        *    
All directors and executive officers as a group.............. 1,039,366 (5)(6)(7)(8)(9)         9.3%    


----------                                                                      

+    Director of the Company                                                    
++   Executive Officer of the Company                                           
*    Denotes less than 1%                                                       

(1)  Based on 10,622,958  shares of Common Stock  outstanding as of the close of
     business on March 1,1999.  The share  holdings in this table do not include
     rights to receive stock or options  granted under various  Company plans to
     directors  and executive  officers  that do not vest or become  exercisable
within 60 days of March 1,1999.                                       
(2)  Dimensional Fund Advisors Inc.  ("Dimensional"),  incorporated in Delaware,
     an investment advisor registered under the Investment Advisors Act of 1940,
     furnishes  investment advice to four investment  companies registered under
     Investment Company Act of 1940, and serves as investment manager to certain
     other  investment  vehicles,  including  commingled  groups trusts.  (These
investment companies                                                  

- 70 -

10-K405
71st Page of 74
TOC
1st
Previous
Next
Bottom
Just 71st

     and investment  vehicles are the  "Portfolios").  In its role as investment
     advisor  and  investment  manager,  Dimensional  possesses  both voting and
     investment  power over the securities of the Company  reported in this item
     that  are  owned  by the  Portfolios.  All the  securities  of the  Company
     reported  in  this  item  are  owned  by the  Portfolios,  and  Dimensional
disclaims beneficial ownership of such securities.                    
(3)  Fir  Tree,  Inc.  is a New  York  corporation  doing  business  as Fir Tree
     Partners ("Fir Tree Partners"), of which Mr. Jeffrey Tannenbaum is the sole
     shareholder,  executive  officer,  director and principal.  Mr.  Tannenbaum
     acquired the shares  through his position as principal of Fir Tree Partners
     for an institutional  account for which Fir Tree Partners serves as trading
     advisor  and for the account of the Fir Tree Value  Fund,  L.P.  ("Fir Tree
     Value  Fund") of which Mr.  Tannenbaum  is the  general  partner.  Fir Tree
     Partners' holdings are reported pursuant to amendment to Form 13D. Fir Tree
     Partners is the beneficial owner of 697,400 shares of Common Stock of which
     45,315 shares are  beneficially  owned by Fir Tree Partners in its capacity
     as investment  advisor to Fir Tree LDC, a Cayman Islands  limited  duration
     company ("Fir Tree LDC").  Jeffrey  Tannenbaum is the investment advisor of
     Fir Tree LDC and, as such,  retains voting and  dispositive  power over the
     shares.  546,465 shares are beneficially owned by Fir Tree Partners for the
     account  of the Fir Tree  Value  Fund and  105,620  shares are held for the
account of the Fir Tree Institutional Value Fund.                     
(4)  Capital  Technology  Inc.  is an  investment  advisor  organized  in  North
     Carolina.  Capital  Technology Inc. has sole power to dispose or direct the
     disposal  of all  shares  beneficially  owned and has sole power to vote or
direct to vote 279,500 shares.                                        
(5)  Includes 75,000 shares of restricted  stock of the Company vesting in equal
     installments on each of January 1, 2000, 2001 and 2002 and 10,000 shares of
restricted stock of the Company vesting on September 9, 1999.         
(6)  Includes  options to purchase  364,800  shares of Common  Stock,  currently
     exercisable or which will be exercisable  within 60 days,  granted pursuant
to the Company's 1994 Stock Incentive Plan.                           
(7)  Includes  options  to  purchase  78,333  shares of Common  Stock  currently
     exercisable  granted  pursuant  to  the  Company's  1994  Stock  Incentive.
     Includes  12,318  shares  held  by Mr.  Eide's  son as to  which  Mr.  Eide
disclaims beneficial ownership.                                       
(8)  Includes  options  to  purchase  10,000  shares of Common  Stock  currently
     exercisable granted pursuant to the Company's 1994 Stock Incentive Plan and
     options to purchase  20,000  shares of Common Stock  currently  exercisable
     pursuant  to the  Company's  1993  Stock  Incentive  Plan for  Non-Employee
Directors.                                                            
(9)  Includes  options to purchase  11,665  shares of Common Stock granted under
     the Company's 1994 Incentive Stock Plan currently exercisable or which will
be exercisable within 60 days.                                        

ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS                         

     During 1998 the Company and its  subsidiaries  have had no  transactions in
which any director of the Company,  or any member of the immediate family of any
such director,  had a material direct or indirect interest  reportable under the
applicable rules of the SEC except as follows:                                  

     In December 1997, the Company entered into an agreement with William Spier,
who served as a director  from July 1991 to February  1998,  with respect to the
exercise of his demand  registration  rights  under a  stockholder's  agreement,
which  provided that a  registration  include,  in the  offering,  all shares of
Company's  Common  Stock  held by Mr.  Spier and the  Spier  Group.  It  further
provided  that Mr.  Spier must resign as a director of the  Company.  The shares
were marketed and sold principally to a variety of institutional  investors. The
sale of all the Spier Group stock was completed on February 10, 1998.           

     For certain additional  information  regarding  transactions  involving the
Company and its officers and directors,  see "Item 10. Executive  Compensation -
Compensation Committee Interlocks and Insider Participation."                   

- 71 -

10-K405
72nd Page of 74
TOC
1st
Previous
Next
Bottom
Just 72nd

 PART IV

ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K       

     (a)  1.  Financial  Statements  (See page 42 for the Index to  consolidated
financial statements)                               

Independent Auditors' Report                        
Consolidated Financial Statements:                  
Statements of Earnings for the years                
ended  December 31, 1998,  1997 and 1996    
Balance  Sheets as of December 31, 1998 and 1997    
Statements of Stockholders'  Equity for the years   
ended December 31, 1998, 1997 and 1996      
Statements of Cash Flows for the years              
ended December 31, 1998, 1997 and 1996      
Notes to Consolidated Financial Statements          

(a)  2. Financial Statement Schedules                                 

          All schedules are omitted because the information  prescribed  thereon
is neither applicable nor required or is furnished in the consolidated financial
statements or notes thereto.                                                    

(a)  3. Listing of Exhibits                                           

        3.1     Certificate  of  Incorporation   of  Company   (incorporated  by
                reference to Exhibit 3.1 to the Company's Registration Statement
                on Form S-18  (Registration No. 33-41000) (the 1991 Registration
Statement)                                      

        3.2     Bylaws of the Company  (incorporated by reference to Exhibit 3.2
to the 1991 Registration Statement)             

        4.1     Specimen  form  of  the  Company's   Common  Stock   Certificate
                (incorporated   by   reference   to  Exhibit  4.1  to  the  1991
Registration Statement)                         

        10.1    Video  Lottery   Technologies,   Inc.  1991  Stock  Option  Plan
                (incorporated   by   reference  to  Exhibit  10.1  to  the  1991
Registration Statement)                         

        10.2    Video Lottery  Technologies,  Inc. 1991 Employee  Stock Purchase
                Plan  (amended  June 18,  1997)  (incorporated  by  reference to
Exhibit 10.2 to the 1997 Form 10-K.)            

        10.3    1992 Video  Lottery  Technologies,  Inc.  Stock  Incentive  Plan
                (incorporated  by  reference  to  Exhibit  10.3 to the 1997 Form
10-K.)                                          

        10.4    1993 Video Lottery Technologies, Inc. 1993 Stock Option Plan for
                Non-Employee  Directors  (incorporated  by  reference to Exhibit
10.4 to the 1997 Form 10-K.)                    

        10.5    1994 Powerhouse Technologies, Inc. Stock Incentive Plan (amended
                June 18, 1997 and February 13, 1998)  (incorporated by reference
to Exhibit 10.5 to the 1997 Form 10-K.)         

        10.6    Form of  Indemnification  Agreement  between the Company and its
                directors  and  officers  (incorporated  by reference to Exhibit
10.3 to the 1991 Registration Statement)        

        10.7    Credit   Agreement  and  related   documents  among   Powerhouse
                Technologies,  Inc.,  Lehman  Brothers Inc.,  Lehman  Commercial
                Paper Inc.,  and Canadian  Imperial Bank of Commerce dated as of
                October 9, 1998  (incorporated  by  reference to Exhibit 10.1 to
the September 30, 1998 Form 10-Q.)              

        10.8    Settlement Agreement between Video Lottery  Technologies,  Inc.,
                and the Shelhamers  (incorporated  by reference to Exhibit 10.16
to the 1995 Form 10-K.)                         

        *10.9   International Equity Partners Related Party Consulting Agreement
dated December 15, 1998                         

- 72 -

10-K405
73rd Page of 74
TOC
1st
Previous
Next
Bottom
Just 73rd

        10.10   Richard R. Burt Related Party Consulting Agreement (incorporated
    by reference to Exhibit 10.22 to the 1996 Form 10-K)

        *10.11  Patricia W. Becker  Related  Party  Consulting  Agreement  dated
December 15, 1998                               

        10.12   Richard M. Haddrill  Employment  Agreement dated January 1, 1998
                (incorporated  by  reference  to Exhibit  10.23 to the 1997 Form
10-K.)                                          

*10.13  Alan Rassaby Employment Agreement                       

*10.14  Christer S. T. Roman Employment Agreement               

        10.15   Susan  J.  Carstensen  Employment  Agreement   (incorporated  by
 reference to Exhibit 10.28 to the 1996 Form 10-K)

        10.16   Michael L. Eide Employment Agreement  (incorporated by reference
to Exhibit 10.26 to the 1996 Form 10-K)         

*22.1   List of Subsidiaries                                    

*24.1   Independent Auditors' Consent                           

*EX-27  Financial Data Schedule (For SEC Use Only)              

     (b) Reports on Form 8-K filed during the last quarter of the period covered
by this report:                                                                 

Form 8-K dated  March 12, 1999  reporting  the  Agreement  to Merger with Anchor
Gaming.                                                                         

     (c) Exhibits  required by Item 601 of  Regulation  S-K: The exhibits  filed
herewith and  incorporated  by reference  herein are set forth in Item  14(a)(3)
above. Included in those exhibits are the following executive compensation plans
and arrangements:                                                               

10.1  Video Lottery Technologies, Inc. 1991 Stock Option    
       10.2  Video Lottery Technologies, Inc. 1991 Employee Stock Purchase
Plan                                      
10.3  1992 Video Lottery Technologies, Inc. Stock Incentive 
          10.4  1993 Video Lottery Technologies, Inc. 1993 Stock Option Plan for
Non-Employee Directors                    
 10.5  1994 Powerhouse Technologies, Inc. Stock Incentive Plan
       10.6  Form of Indemnification Agreement between the Company and its
directors and officers                    
          10.9  International Equity Partners Related Party Consulting Agreement
dated December 15, 1998                   
10.10  Richard R. Burt Related Party Consulting Agreement     
    10.11  Patricia W. Becker Related Party Consulting Agreement dated
December 15, 1998                         
       10.12  Richard M. Haddrill Employment Agreement dated January 1, 1998
10.13  Alan Rassaby Employment Agreement                      
10.14  Christer S. T. Roman Employment Agreement              
10.15  Susan J. Carstensen Employment Agreement               
10.16  Michael L. Eide Employment Agreement                   

     (d) See page 42 for the  Index to  consolidated  financial  statements  and
financial statement schedules.                                                  

*Filed herewith                                                                 

- 73 -

10-K405
Last Page of 74
TOC
1st
Previous
Next
Bottom
Just 74th

SIGNATURES

     Pursuant to the  requirements  of Section 13 or 15(d) of the Securities Act
of 1934,  the  Registrant has duly caused this report to be signed on its behalf
by the undersigned thereunto duly authorized.                                   

                   POWERHOUSE TECHNOLOGIES, INC.

Date:  March 30, 1999              /s/ RICHARD M. HADDRILL                      
                                   ---------------------------------------------
                                   Richard M. Haddrill
                                   President and Chief Executive Officer
                                   (Principal Executive Officer)

     Pursuant to the  requirements of the Securities  Exchange Act of 1934, this
report has been signed by the following  persons on behalf of the registrant and
in the capacities and on the dates indicated:                                   

Signature                  Title                                  Date          
---------                  -----                                  ----          

/s/ SUSAN J. CARSTENSEN    Chief Financial Officer and            March 30, 1999
------------------------      Treasurer (Principal Financial                    
Susan J. Carstensen       and Accounting Officer)                       

/s/ RICHARD R. BURT        Chairman and Director                  March 30, 1999
------------------------                                                        
Richard R. Burt                                                         

/s/ JAMES J. DAVEY         Vice Chairman and Director             March 30, 1999
------------------------                                                        
James J. Davey                                                          

/s/ RICHARD M. HADDRILL    President, Chief Executive Officer     March 30, 1999
------------------------      and Director (Principal Executive                 
Richard M. Haddrill       Officer)                                      

/s/ PATRICIA W. BECKER     Director                               March 30, 1999
------------------------                                                        
Patricia W. Becker                                                      

/s/ JOHN R. HARDESTY       Director                               March 30, 1999
------------------------                                                        
John R. Hardesty                                                        

- 74 -

Dates Referenced Herein   and   Documents Incorporated By Reference

				Referenced-On Page
This 10-K405 Filing		Date		First		Last			Other Filings
		1/1/93		59
		2/25/93		63
		2/24/94		63
		5/31/94		63
		12/1/94		64
		12/15/94		63
		1/16/95		69
		1/17/95		68
		1/18/95		63
		12/31/95		46
		8/12/96		65
		8/21/96		64
		11/7/96		64
		12/5/96		68
		12/18/96		64		65			SC 13D/A
		12/31/96		42		72			10-K405, DEF 14A, 10-K/A
		1/2/97		29					SC 13D/A
		1/30/97		58					8-K
		3/31/97		30					10-Q/A, 10-Q
		5/15/97		64
		6/18/97		64		72
		6/30/97		7		30			10-Q/A, 10-Q
		9/30/97		30					10-Q, 10-Q/A, PRER14A
		12/15/97		50
		12/31/97		30		72			10-K, 8-K
		1/1/98		48		73
		2/10/98		71					424B4, S-3/A
		2/13/98		72					SC 13D/A, 4
		2/26/98		68
		3/31/98		30					10-Q
		6/4/98		64		65			DEF 14A
		6/30/98		30					10-Q
		7/1/98		65					8-K
		7/2/98		68					8-K
		9/30/98		30		72			10-Q
		10/9/98		72
		12/3/98		64		65
		12/15/98		50		73
		12/27/98		67
For The Period Ended		12/31/98		1		72
		1/1/99		50		68
		2/13/99		66
		2/19/99		43
		2/22/99		4		12
		3/1/99		1		70
		3/10/99		3		70
		3/12/99		73					8-K
		3/30/99		74
Filed On / Filed As Of		3/31/99							10-Q
		6/15/99		50
		6/30/99		11
		8/29/99		5		41
		9/9/99		71
		1/1/0		71
		2/13/0		66
		1/1/1		71
		2/13/1		66
		1/1/2		71
		1/1/3		68
		9/30/3		40		56
Top									List All Filings