It was the best of times; it was the worst of times. The immortal words of Charles Dickens are a fair depiction of the current state of affairs at GTech Holdings (NYSE:GTK). The world's largest lottery systems operator posted impressive first-quarter numbers today, but allegations of bribery continue to cloud the short-term picture.
First the bad news. As Rich Smith pointed out back in May, several top executives of GTech's Brazilian division are facing possible criminal charges related to bribery. Brazil's public ministry has a few questions about the methodology used in awarding a contract extension to GTech, concerns that have not gone unnoticed at the SEC. This is not the first time that bribery charges have been leveled at GTech's management, as former CEO Guy Snowden resigned in 1998 under similar circumstances.
GTech has vehemently denied any wrongdoing, insisting that the 25-month contract extension was awarded fairly. Unfortunately, it could take years to resolve the case, and the backlash of negative publicity has already cost GTech at least one contract: a seven-year $66.7-million deal in Puerto Rico that was recently awarded to rival Scientific Games (NASDAQ:SGMS). Losing Brazil's business would be an even bigger setback, as the lottery- and soccer-loving country is GTech's single-largest customer, representing 10% of last year's total revenues.
Aside from the legal entanglements, it's been business as usual. Backing out a $6.4-million gain from the sale of the company's 50% stake in Gaming Entertainment, first-quarter earnings jumped 15% to $47.2 million, or $0.71 per share. Additionally, a number of international contract extensions were secured, while Washington and Illinois state lotteries contracted for new instant ticket-dispensing machines. The company is anticipating full-year revenue growth exceeding 20%, and lifted earnings guidance by a nickel to a $3.05-$3.15 range.
New markets for lotteries are indeed drying up, but GTech's recurring service business continues to throw off healthy cash flows, which last year topped a record $176 million. The firm controls 70% of the global market, and servicing those contracts accounted for 90% of total revenues last quarter, with profit margins reaching 42%.
The risk associated with Brazil will likely weigh heavily on GTech stock until the matter has been resolved. The possibility of losing the contract has largely been discounted, however, and should the allegations of bribery prove to be unfounded, investors willing to shoulder the risk should be rewarded. Cautious investors may want to adopt a wait-and-see approach, but for others there are plenty of things to like about the company, which is trading at only 16 times the low end of this year's earnings.
Fool contributor Nathan Slaughter is still waiting for his lucky lotto numbers of 5,11,14,17,20, & 34 to pay off. He owns none of the companies mentioned.
