California State Lottery Commission. Nicholas Buchen Deputy Director, Finance Division. Item 10(i) Fiscal Year Budget

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1 Date: June 25, 2015 To: California State Lottery Commission From: Prepared By: Paula D. LaBrie Acting Director Nicholas Buchen Deputy Director, Finance Division Subject: Item 10(i) Fiscal Year Budget ISSUE Should the California State Lottery Commission (Commission) approve the proposed budget that presents a sales goal of $6.0 billion and is estimated to provide $1.44 billion to public education for Fiscal Year (FY) ? RECOMMENDATION Staff recommends the Commission approve the Lottery budget for FY as reflected in the attached documents. Both the level of sales and the contribution to education projected in the FY Budget are the highest in California State Lottery (Lottery) history. BACKGROUND Attachment I to this memo presents the Lottery s proposed FY Budget. As included in the draft budget presented at the May 2015 Commission meeting, the proposed FY Budget reflects the Lottery s goal of $6.0 billion in sales and is estimated to result in $1.44 billion in profits to California public education. This proposed budget includes resources necessary to implement the FY Business Plan (the final year of the three-year strategic plan), which was also presented at the May 2015 Commission meeting. These business initiatives, in conjunction with proposed operational growth resources, balance tactics in delivering sales growth as well as providing investments for continued growth in contributions to public education in future years.

2 California State Lottery Commission June 25, 2015 Page 2 DISCUSSION Development of the Lottery s FY Budget began by generating a preliminary contribution to education target and then focusing on investment in tactics that are estimated to yield the highest profit. Using preliminary sales projections, a base budget was developed to determine the availability of resources to fund such tactics and to address operational improvements to drive increased sales and contributions to public education. The Business Plan initiatives were developed by reviewing our business operations as well as industry trends. Broad objectives and strategies were developed and prioritized. Tactics to implement these strategies were developed by staff and evaluated by senior management based on the availability of Lottery resources and the expected benefits those tactics would deliver. The result of this process is the FY Business Plan that was approved at the May 2015 Commission meeting and the proposed FY Budget that is presented now for approval. A summary of the proposed Business Plan initiatives with their associated costs as well as the proposed resources to address operational growth and other improvements are included in this issue memo as Attachment II. Funding for the cost of the initiatives and other revisions reflected on Attachment II is included in the proposed FY Budget. In order to achieve the growth in sales and profits to become one of the largest lotteries in the nation, a foundation for the Lottery s strategic direction was formed based on six objectives to finish the final year of the three-year strategic plan and drive bottom-line profits. All goals and major initiatives tie back to one or more of these six objectives: Increasing the Lottery s profits by improving draw game sales. Reducing perceived barriers to buying Lottery tickets through efforts aimed at both players and non-players. Commemorating the Lottery s 30 th Anniversary by thanking players, retailers, employees, stakeholders, and Californians in general. Increasing efficiency and customization of marketing efforts directed at existing players and reallocating funding to attract new players. Strengthening the relationship with Lottery retailers and providing support

3 California State Lottery Commission June 25, 2015 Page 3 through more customized approaches in selling, training, communications, and incentives. Making improvements in the Lottery s infrastructure to increase efficiencies and effectiveness and further grow profits. This comprehensive assessment of profit and sales goals and the funding needed to deliver those goals culminates in the budget being proposed for the upcoming fiscal year. A summary of the elements of the proposed FY Budget is presented below: Sales Total sales for all Lottery products are projected to be $6.0 billion for FY This represents a $570 million, or 10.5 percent increase over estimated year-end sales levels for FY The chart below compares estimated FY year-end sales with proposed sales goals for the FY Budget. Following the chart is background information for the sales goals for each product type. Comparison of Revenues Proposed FY Budget and FY Estimated Year-End Sales (Dollars In Thousands) Proposed Budget FY Estimated Year-End FY Sales: Difference Scratchers $4,295,000 $3,810,000 $485,000 Multi-State Jackpot Games 830, ,000 35,000 SuperLotto Plus 300, ,000 12,000 Daily Games 355, ,000 23,000 Hot Spot 220, ,000 15,000 Total Sales $6,000,000 $5,430,000 $570,000 Scratchers The largest increase in projected sales is in the Scratchers product line with sales expected to grow $485 million for a total of $4.295 billion. This sales goal represents a 12.7 percent increase over estimated year-end sales for FY The increase in sales is supported by Business Plan initiatives focused on the marketing plan campaign to enhance summer promotion/advertisement and mitigate sales declines experienced in summer months. The increase in sales is also attributed to launching 47 games during the FY , including

4 California State Lottery Commission June 25, 2015 Page 4 additional $1 games, another $20 Scratchers game (starting in July 2015), and a $30 game to commemorate the Lottery s 30 th Anniversary (starting in late August 2015). With the $30 game and additional $20 games (a total of three $20 games in FY ), the aggregate prize payout for Scratchers is projected to rise to 68.9 percent in FY This compares with an estimated year-end payout of 68.2 percent in FY Multi-State Jackpot Games The $830 million sales goal proposed for the Multi-State Jackpot games represents an increase of $35 million (4.4 percent) over estimated year-end sales for FY A change in the Powerball matrix in October is expected to result in more frequent large jackpot rolls while improving the odds for players to win lower level prizes. This sales figure assumes that jackpots will exceed $500 million twice within the fiscal year. SuperLotto Plus Sales for SuperLotto Plus are projected to be $300 million, an increase of $12 million (or 4.2 percent) over estimated for year-end sales in FY The goal set for SuperLotto Plus next fiscal year is supported by FY Business Plan initiatives to provide promotional support (including e-coupons, in-store signage, and on-line marketing) and year-round advertising campaigns. Daily Games The proposed sales goal for Daily Games (Fantasy 5, Daily 3, Daily 4 and Daily Derby) is $355 million, which is a $23 million (6.9 percent) increase from the projected year-end sales level for FY The projected increase in sales is due primarily to the Business Plan initiative to enhance Fantasy 5 game sales by reallocating the prize pool to focus on Top Prize growth, as well as a full year of jackpot signs advertising the top prize in Fantasy 5 and Daily Derby. Hot Spot A sales goal of $220 million is proposed for Hot Spot, an increase of $15 million (7.3 percent) over estimated year-end sales for FY The projected increase in sales is due primarily to Business Plan initiatives making enhancements to this game, including a mobile application and changing prize payout amounts. Expenses Prize Expenses The proposed sales goals in the FY Budget are supported by higher prize payouts. This is primarily a result of the higher sales projection as well as

5 California State Lottery Commission June 25, 2015 Page 5 an additional $20 Scratchers game and the introduction of a $30 Scratchers game. Prize Expenses are budgeted at $3.83 billion, which is $402 million (11.7 percent) above the expected prize level for FY Administrative Expenses The Administrative Expense budget is comprised of retailer compensation, gaming costs, and operating costs. Per the Lottery Act, Administrative Expenses are capped at 13 percent of total annual revenues. Total budgeted Administrative Expenses for FY are $780 million, an increase of $103 million (15.2 percent) over expected FY expenses. This increase is due to the expected increase in sales for FY , investment in Business Plan initiatives that are designed to increase the Lottery s contribution to education, and the inclusion of a reserve for insurable risk and an administrative spending reserve (it is anticipated that we will end FY without incurring costs in either reserve). It is important to note the majority of this increase results from the cost of selling Lottery products, i.e., retailer compensation costs and game operating costs. Retailer compensation costs are estimated to total $422.5 million for FY This amount represents an increase of $44.3 million (11.7 percent) over expected FY retailer compensation costs and is directly attributable to the higher sales goals in the upcoming year. Gaming costs are budgeted at $122.4 million for FY This budget category includes the cost of operating the gaming system, gaming equipment installation and maintenance, and production and distribution of Scratchers tickets. The increase of $11.6 million (10.5 percent) over FY is primarily due to higher projected sales for FY Excluding the reserves, retailer compensation and gaming costs account for almost 71% of the Administrative Expense budget for FY The remaining elements of the Administrative Expense budget are grouped as operating costs, which are comprised of personnel costs, advertising/marketing costs, and other overhead expenses. Operating costs also include the funding and resources required to execute the FY Business Plan initiatives as well as funding for operational improvements. As shown on Attachment II, the proposed budget includes establishment of 12.0 new positions and $19 million allocated to meet the Business Plan and program expansion needs. Also included within Administrative Expenses for FY is a $5 million reserve for insurable risk to cover fiscal exposures for the areas of our organization that we are continuing to self insure. In addition, a $4.8 million administrative spending reserve is included as a safeguard against future

6 California State Lottery Commission June 25, 2015 Page 6 uncertainties and to provide the Commission and the Lottery the flexibility to take advantage of sales growing opportunities that may emerge over the course of the upcoming year. The administrative spending reserve is an element of the 13 percent of total revenues specified for Administrative Expenses, and the entire unspent amount within both the administrative spending reserve and the reserve for insurable risk will be transferred directly to public education. Summary The proposed FY Budget contains sales goals of $6.0 billion, a 10.5 percent increase over expected sales for FY This level of sales, combined with the other elements in the budget, is estimated to generate $1.44 billion in contributions to California public schools, an increase of $85 million over the contribution level projected for FY Both the projected sales level and the estimated contribution to education for FY are the highest in the Lottery s 30-year history. In addition, FY will mark the 16 th consecutive year the Lottery will surpass a billion dollars in contributions to public education. While the $6.0 billion sales goal and the $1.44 billion estimated contribution to education for FY represent unprecedented levels, they are based on execution of a vast array of Business Plan initiatives designed to result in sustainable growth of future revenues. The proposed budget includes a balanced approach between actions that will increase sales and profit above the record setting levels of FY as well as prudent investments that will enable us to continue laying the foundation to sustain growth in sales and contributions to public education in years to come. Attachments

7 Attachment I FISCAL YEAR PROPOSED BUDGET (Dollars in Thousands) FY FY Proposed % of Year-End % of Budget Sales Estimate Sales Difference SALES: Scratchers $4,295, % $3,810, % $485,000 Multi-State Jackpot Games 830, % 795, % 35,000 SuperLotto Plus 300, % 288, % 12,000 Daily Games 355, % 332, % 23,000 Hotspot 220, % 205, % 15,000 TOTAL, ESTIMATED SALES $6,000,000 $5,430,000 $570,000 Prize Payout % Prize Payout % PRIZE EXPENSE: Scratchers $2,959, % $2,598, % $360,454 Multi-State Jackpot Games 415, % 397, % 17,500 SuperLotto Plus 159, % 157, % 1,168 Daily Games 174, % 159, % 15,002 Hot Spot 138, % 129, % 9,450 2nd Chance 24,059 23, Prize Expense Savings (40,000) (38,000) (2,000) TOTAL, PRIZE EXPENSE $3,830, % $3,428, % $402,049 NET SALES AFTER PRIZE EXPENSE $2,169,152 $2,001,200 $167,952 ADMINISTRATIVE EXPENSES: Retailer Compensation: Commission $354, % $320, % $33,630 Cashing Bonus 38, % 31, % 6,988 Special Handling 24, % 21, % 2,733 Incentives 6, % 5, % 929 Gaming Costs: Gaming Contract (IGT/GTECH) 108, % 105, % 2,528 Administrative Retailer Fees (22,000) (21,000) (1,000) Gaming Monitor Fees (600) (520) (80) Scratchers Ticket Costs 31, % 21, % 10,126 Scratchers Delivery and Support Costs 5, % 5, % 26 TOTAL, RETAILER & GAMING COSTS $544, % $489, % $55,878 Operating Costs: Personal Services $82, % $73, % $9,165 Marketing Plan 87, % 78, % 9,738 Contractual Services 18, % 12, % 6,873 Depreciation 14, % 9, % 5,062 Operating Expense 22, % 15, % 6,549 Reserve for Insurable Risk 5, % 0 0.0% 5,000 Administrative Spending Reserve 4, % 0 0.0% 4,827 Subtotal, Operating Costs $235, % $187, % $47,214 TOTAL, ADMINISTRATIVE EXPENSES $780, % $676, % $103,092 % of Sales % of Sales CONTRIBUTION TO EDUCATION $1,389, % $1,324, % $64,859 Unclaimed Prizes 35, % 25, % 10,000

8 Attachment I Interest Income 1,250 1,250 0 TOTAL AVAILABLE FOR EDUCATION $1,425,402 $1,350,543 $74,858 TOTAL CONTRIBUTION TO EDUCATION WITH RESERVES $1,435,229 $1,350,543 $84,685

9 FISCAL YEAR Attachment II SUMMARY OF FUNDING NEEDS BY OBJECTIVE (Dollars in Thousands) Objective Positions Cost Products $2,020 Increase the Lottery s profits by improving draw game sales Players Reduce perceived barriers to buying Lottery tickets through efforts aimed at both players and non-players $4,694 Commemorate the Lottery s 30th Anniversary by thanking players, retailers, employees, stakeholders, and Californians in general Increase efficiency and customization of marketing efforts directed at existing players and re-allocate funding to attracting new players $5,687 $2,664 Retailers Strengthen the relationship with Lottery retailers and provide support through more customized approaches in selling, training, communications, and incentives Infrastructure Make improvements in the Lottery s infrastructure to increase efficiencies, effectiveness, and further grow profits $ $3,138 Total, FY Initiatives and Other Revisions 12.0 $18,993

10 DRAFT FISCAL YEAR BUDGET Proposed Fiscal Year Budget Presentation to California State Lottery Commission June 25, 2015 Item 10(i)

11 Proposed Fiscal Year Budget

12 Sales FY FY Proposed % of Year-End % of Budget Sales Estimate Sales Difference SALES: Scratchers $4,295, % $3,810, % $485,000 Powerball 415, % 383, % 32,000 Mega Millions 415, % 412, % 3,000 SuperLotto Plus 300, % 288, % 12,000 Hotspot 220, % 205, % 15,000 Fantasy 5 165, % 144, % 20,750 Daily 3 140, % 140, % 0 Daily 4 29, % 28, % 250 Daily Derby 21, % 19, % 2,000 TOTAL, ESTIMATED SALES $6,000,000 $5,430,000 $570,000

13 Prize Expense FY Proposed Budget Prize Payout % FY Year-End Estimate Prize Payout % Difference PRIZE EXPENSE: Scratchers $2,959, % $2,598, % $360,454 Powerball 207, % 191, % 16,000 Mega Millions 207, % 206, % 1,500 SuperLotto Plus 159, % 157, % 1,168 Hot Spot 138, % 129, % 9,450 Fantasy 5 80, % 66, % 13,882 Other Draw Games 94, % 93, % 1,121 2nd Chance - Scratchers 17,975 17, nd Chance - Draw Games 6,084 6,084 0 Prize Expense Savings (40,000) (38,000) (2,000) TOTAL, PRIZE EXPENSE $3,830, % $3,428, % $402,049 NET SALES AFTER PRIZE EXPENSE $2,169,152 $2,001,200 $167,952

14 Administrative Expenses FY Proposed Budget % of Sales FY Year-End Estimate % of Sales ADMINISTRATIVE EXPENSES: Difference Retailer Compensation: Commission $354, % $320, % $33,630 Cashing Bonus 38, % 31, % 6,988 Special Handling 24, % 21, % 2,733 Incentives 6, % 5, % 929 Subtotal, Retailer Compensation Costs 422, ,253 44,280 Gaming Costs: Gaming Contract (IGT/GTECH) 108, % 105, % 2,528 Administrative Retailer Fees (22,000) (21,000) (1,000) Gaming Monitor Fees (600) (520) (80) Scratchers Ticket Costs 31, % 21, % 10,126 Scratchers Delivery and Support Costs 5, % 5, % 26 Subtotal, Gaming Costs 122, ,837 11,599 TOTAL, RETAILER & GAMING COSTS $544, % $489, % $55,878 Operating Costs: Personal Services $82, % $73, % $9,165 Marketing Plan 87, % 78, % 9,738 Contractual Services 18, % 12, % 6,873 Depreciation 14, % 9, % 5,062 Operating Expense 22, % 15, % 6,549 Reserve for Insurable Risk 5, % 0 0.0% 5,000 Administrative Spending Reserve 4, % 0 0.0% 4,827 Subtotal, Operating Costs $235, % $187, % $47,214 TOTAL, ADMINISTRATIVE EXPENSES $780, % $676, % $103,092

15 Fiscal Year Summary Of Funding Needs By Objective (Dollars in Thousands)

16 Distribution of Administrative Expenses FY Operating Costs 18% Marketing Plan 11% Retailer Compensation 55% Game Operations 16%

17 Contribution To Education FY Proposed Budget FY Year-End Estimate Difference CONTRIBUTION TO EDUCATION $1,389,152 $1,324,292 $64,859 Unclaimed Prizes 35,000 25,000 10,000 Interest Income 1,250 1,250 0 TOTAL AVAILABLE FOR EDUCATION $1,425,402 $1,350,543 $74,858 TOTAL CONTRIBUTION TO EDUCATION WITH RESERVES $1,435,229 $1,350,543 $84,685