An Agency of the State of California COMPREHENSIVE ANNUAL FINANCIAL REPORT

Transcription

1 An Agency of the State of California COMPREHENSIVE ANNUAL FINANCIAL REPORT FOR THE FISCAL YEAR ENDED JUNE 30, 2003

2 California Lottery Comprehensive Annual Financial Report For the fiscal year ended June 30, 2003 TABLE OF CONTENTS INTRODUCTORY SECTION Letter of Transmittal...1 Organizational Chart with Principal Officials...9 FINANCIAL SECTION Independent Auditors Report...11 Management s Discussion and Analysis...12 Financial Statements Statement of Net Assets...17 Statement of Revenues, Expenses, and Changes in Net Assets...18 Statement of Cash Flows...19 Notes to Financial Statements...21 STATISTICAL SECTION California Statistics Demographics for Population and Players...33 Sales by Product and Other Revenues - Last Ten Fiscal Years...36 Expenses by Type and Contributions - Last Ten Fiscal Years...36 U.S. Lottery Statistics U.S. Lottery Data for Fiscal Year Lottery Sales, Profit, Population, and Annual Sales Per Capita U.S. Lottery Data for Fiscal Year Lottery Sales, Prizes, Commissions, Profit, Population, and Annual Sales Per Capita

3 INTRODUCTORY SECTION 2003 COMPREHENSIVE ANNUAL FINANCIAL REPORT

4 California Lottery 600 North 10th Street Sacramento, California December 31, 2003 To the citizens of California: The California Lottery (the Lottery) is pleased to provide this Comprehensive Annual Financial Report (CAFR) for the fiscal year ended June 30, The Finance Department of the California Lottery prepared this CAFR, which includes its annual financial statements presented in accordance with generally accepted accounting principles and audited in accordance with generally accepted auditing standards, to present an overview of the California Lottery. The California Lottery, an agency of the State of California, was created in 1984, and is operated as a business enterprise within the framework of state laws and regulations. The mission of the California Lottery is to implement the public s mandate to provide supplemental funds for public education by maximizing the sale of creative and entertaining lottery products. In carrying out this mission, the Lottery is guided by the principles of efficiency, integrity and customer service. The CAFR covers financial activity of the California Lottery in a single enterprise fund. The report follows formal standards of the Government Finance Officers Association of the United States and Canada (GFOA). Government organizations that publish this type of report can be compared to each other, because similar kinds of information are included in the three sections. This letter of transmittal is designed to complement the management s discussion and analysis that accompanies the financial statements and should be read in conjunction with it. Introductory Section This section includes this transmittal letter describing the Lottery and its business activities, and the California Lottery organization chart with the names of the principal officials. This section is not audited because it contains subjective information. Audited Financial Section This section contains the Independent Auditors Report, management s discussion and analysis, and the audited financial statements and the related notes

5 Statistical Section This section covers other relevant financial, economic, and demographic statistical information, including lottery industry data. This information has not been audited. Management is responsible for the accuracy and completeness of the presentation, including all disclosures in the report. To the best of our knowledge, the enclosed information is accurate in all material respects and is reported in a manner designed to present fairly the financial position, results of operations, and the cash flows of the Lottery. All disclosures necessary to gain an understanding of the Lottery s financial activities have been included. History of the Lottery The California Lottery was created by a 1984 ballot initiative that was approved by 58% of the voters. The Lottery was established as an independent state agency to market and sell lottery products to the California public. By law, the Lottery is required to return 50% of revenues to prizes, at least 34% to public education and no more than 16% for administrative costs. The act specifies that the Lottery is operated and administered by a five member Commission appointed by the Governor. A Director, who is appointed by the Governor, heads the Lottery. The Legislature has the authority to amend the Lottery Act by a two-thirds majority if, by doing so, it furthers the purposes of the measure. Lottery ticket sales began on October 3, 1985 with the sale of the first instant game ticket called California Jackpot. Over 21 million tickets were sold on the very first day. Over 1.7 billion tickets were sold in the first 9 months. On-line sales began on October 14, 1986 with Lotto 6/49. Eighteen years later, the Lottery has had sales over $40 billion and offers a full range of lottery products. Economic Outlook California ranks number four among the largest economies in the world with an output of goods and services exceeding $1.3 trillion. 1 The current downturn in the economy and the decline of Internet and high-tech companies has put unemployment in the state at 6.7% for A study from the University of California, Los Angeles (UCLA) Anderson Forecast indicates personal income grew 3.2% in 2003 and is predicted to rise 3.9% in Economists at UCLA predict 1% job growth and an overall slow recovery for the State s diversified economy for The Congressional Budget Office indicates national unemployment is projected at 6.2% for 2003 and UCLA Anderson Forecast indicates national gross domestic product (GDP) growth rates are near 2.5% for 2003 and 2004, and in the 3.0% - 3.5% range for According to Bloomberg News, the U.S. economy may expand in 2004 at the fastest rate in the past six years, fueled by a surge in business investment and sustained increases in consumer purchases 6. Economists have grown more optimistic after the government reported the economy expanded at the fastest pace in 19 years from July to September, The changes in the economy could affect personal disposable incomes and spending patterns, which in turn could impact future lottery sales. Lottery Products The California Lottery offers different games in two styles of play, Scratchers and on-line draw style games. Description of the games follows: 1 California's Economy: Economic Data. September 24, Kasler, Dale State recovery is on slow track. Sacramento Bee December 11, Kasler, Dale State recovery is on slow track. Sacramento Bee December 11, Congressional Budget Office 5 UCLA Anderson Forecast. _9_03_1.asp September 23, U.S. economy may expand at a 6-year high in Bloomberg News November 11, U.S. economy may expand at a 6-year high in Bloomberg News November 11,

6 Scratchers Scratchers are instant games that are played by scratching the latex covering off a play area to reveal combinations and learning instantly whether the ticket is a winner. There are different ways to win a Scratchers game, such as matching two or three like symbols, your score beats their score, or your symbol matches a key symbol. The Lottery started Scratchers game sales in October 1985 with a $1 game. Multiple Scratchers games were initially offered in October Sales for the Lottery s first Scratchers game that retailed for over $1 began in October Retailers pay prizes of up to $599 and prizes for over $599 are paid directly by the Lottery. Players have 180 days from the announced end-of-game to claim prizes. Draw Games The California Lottery started draw game sales in October 1986 with Lotto 6/49. Daily draw games were introduced in March The Lottery currently offers five draw games. All draw game prizes are pari-mutuel and players have 180 days from the date of the drawing to claim cash prizes. Retailers pay prizes up to $599 and prizes for over $599 are paid directly by the Lottery. A brief description of each draw game is provided below. SuperLOTTO Plus Players select five lotto numbers from a field of 1 to 47 and one mega number from a field of 1 to 27. There are nine prize categories in this game. To win the jackpot, players must match all five lotto numbers plus the mega number. Jackpot prizes start at $7 million and have reached over $190 million. The lowest individual prize is $1 for matching just the mega number. Winning numbers are drawn every Wednesday and Saturday at 7:57 p.m. In SuperLOTTO Plus, large jackpots fuel game sales and about 42% of the sales come from draws where the jackpot is $30 million or more. Hot Spot This game was designed primarily for social retail trade styles like restaurants and bars, but is available at all retailer locations. Players select from a field of 1 to 80 numbers and have a choice of playing five different spots. They can play two, three, four, five, or eight spots. If players choose to play a three spot, then they would pick a set of three numbers. There are a total of 14 prize categories in this game. Prizes will vary for this game due to its pari-mutuel nature. Draws are conducted daily every five minutes with the first draw at 6:05 a.m. and last draw at 1:00 a.m. Twenty winning numbers are selected for each draw. Draw results are broadcast by the gaming system to 6,500 television monitors located in retail locations statewide. Daily 3 This daily game was designed to provide very good odds of winning smaller prizes. Players select a set of three numbers from 0 to 9. Players can try to match the three numbers drawn in the exact order or in various combinations. There are seven prize categories in this game. The top prize averages between $400 and $600. Daily 3 is a shared prize pool game; therefore, prize amounts are based on the amount wagered per draw and the number of winners sharing that amount. Fantasy 5 This daily game was designed to be a lotto-type game with life changing prizes and better odds of winning than SuperLOTTO Plus. Players select a set of five numbers from 1 to 39. Winning tickets are those that match any two, three, four, or all five of the five numbers drawn. There are four prize categories in this game. Jackpot prizes start at $50,000 and have reached over $700,000 for matching all five numbers. Daily Derby This daily game was designed with a horse racing theme, but is not associated with the results of any actual horse race. Players select three horses from a field of twelve and a race time which is a set of three unique numbers (e.g., 0, 1, 9) with each number selected from a field of 0 to 9. There are five prize categories in this game. Jackpot prizes start at $50,000 and have reached over $800,000 for matching the race time and all three horses in exact order. The lowest prize is $2 for matching the 1 st place horse

7 Highlights of Fiscal Year 2003 Another Billion Dollars Contribution to Education The California Lottery had yet another great year in the fiscal year. The Lottery introduced 33 new Scratchers games this past year, and the share of sales from $2 and $3 Scratchers games continues to be around 65 percent. Sales for SuperLOTTO Plus exceeded $1.1 billion which was partially attributable to the $122 million jackpot in August 2002, the highest for the fiscal year and the 3 rd largest jackpot in California history. Total sales approached $2.8 million, which led to more than $1 billion raised for the State s public schools. This marks the third consecutive year of a contribution of over $1 billion to education. Integrated Cost Saving Technology After two years of an extensive procurement and evaluation process, and for the first time in its history, the California Lottery awarded a single contract to GTECH Corporation to provide a fully integrated gaming and telecommunication system. The new contract will not only provide new technology for on-line and off-line gaming business requirements, it will also deliver additional functionalities and ease of use, reliability, and more flexible solutions for the Lottery s current and future business needs. The procurement was a groundbreaking accomplishment. It resulted in a GTECH bid based on a reduced percentage of sales charge, that is anticipated to save over $40 million per year over the six-year contract term. Game Enhancements Several games enhancements were implemented during the fiscal year On November 4, 2002, the Lottery introduced a mid-day draw for Daily 3. Since the twice-per-day draw was initiated, sales on that product have increased by about 25% a week. Additionally, on September 25, 2002, a bill was signed that amended the California Lottery Act and specifically lifted the restriction from offering bingo themed games. The first bingo game began in May 2003 and was very successful selling over $3 million in tickets per week. The past year sales also included a Scratchers game tie-in with the NBA, where the logos of the seven teams in the Pacific Division were featured on the tickets. Retailer Website To simplify the accounting process for retailers and to utilize Internet technology to extend data interchange capabilities, a customized retailer website was developed for California retailers early in the fiscal year. This website provides, through a secure login, information, reports, and data that previously were sent via the mail. The website has produced enormous efficiencies for retailers. Data can be accessed anytime and be downloaded directly into retailers accounting systems. California was the first lottery to develop this type of website and other states have expressed interest in this technology. Amber Alert In July 2002, the Governor instituted the Child Abduction Alert System (Amber Alert), and in March 2003, the Lottery began a partnership with the California Highway Patrol. Various Lottery equipment, including all of the 19,000 terminals, is used to display messages statewide including a description of the missing child in question

8 Financial Information The California Lottery operates like a business within the state government structure. The Lottery functions as an enterprise activity, in which lottery tickets are sold to fund all costs of running the Lottery business and to generate supplemental funding to California s K-12 schools, colleges, and universities. Since its inception in 1985 and through June 30, 2003, the Lottery has generated over $40 billion in sales. The retailers who sell the lottery tickets have received $2.5 billion in commissions and bonuses. Approximately Contributions to Education $14.9 Operating Expenses $2.1 Direct Costs $1.1 Retailer Compensation $2.5 Prizes $20.3 $20.3 billion has been won by lucky winners including 1,730 millionaires. Additionally, the Lottery has exceeded its mandate, requiring that 34 percent of all lottery sales revenues, interest income, and unclaimed prizes be given to public education. Since October 1985, the Lottery has contributed an additional $455 million to education through operational savings. Accounting System and Policies The California Lottery operates the California State Lottery fund, an enterprise fund that, like a private business, utilizes the full accrual basis of accounting in accordance with accounting principles generally accepted in the United States of America. Budgetary Controls Budgetary control for the California Lottery is addressed through its enabling legislation, which provides specific limitations on operating and administrative expenses. A comprehensive annual budget is prepared in conjunction with the Lottery s Annual Business Plan. The budget is prepared on both a cash basis and a full accrual basis of accounting. It is also prepared in distinct quarterly segments to facilitate comparison to the quarterly financial statements. The budget is based on sales forecasts, industry trends, program proposals, and approved action plans. While the Lottery does not have a legislatively approved budget, the operating budget is submitted to the Lottery Commission with the Business Plan for approval. Actual costs are monitored throughout the year for compliance with the approved budget and appropriate adjustments are approved if necessary. Internal Controls An internal control structure has been designed to ensure that assets are protected from loss, theft, or misuse, and to ensure that the accounting system allows compilation of accurate and timely financial information. The internal controls are designed to provide reasonable assurance that these objectives are met. To enhance controls, management has separated responsibilities and provides approval and oversight for the following functions: personnel and payroll; purchasing and accounts payable; general ledger and accounts receivable; cash receipts and cash disbursements; retailer network management and retailer accounts receivable; and system data processing and system programming. Reviews of operations are conducted by the following audits. Draw audit: An independent certified public accountant (CPA) must witness the draws (except for computer automated drawings) of Lottery games, and inspect any equipment used in such draws, before and after each draw. Security audit: An independent firm experienced in security procedures conducts a comprehensive study and evaluation of all aspects of security in the operation of the Lottery on a bi-annual basis

9 State Administrative Manual (SAM) audit: The State Controller s Office performs a study and evaluation of accounting and administrative controls every two years. To ensure the integrity of the Lottery the following measures have been implemented: Specialized security and law enforcement staff. Secured facilities and gaming equipment. Background checks on retailers, contractors and Lottery employees. Lottery tickets with special inks, dyes and security codes. Detailed and strict security procedures for game drawings. Lottery random number generators are in stand-alone systems and are certified by an independent audit firm prior to installation. Lottery drawing balls are weighed and measured once a month to ensure standard compliance, set by the Weights and Measures Division of the California Department of Agriculture. Employees The Lottery has 650 authorized employee positions at its headquarters located in Sacramento, and at nine district offices located in Sacramento, San Francisco, Hayward, Fresno, Van Nuys, Santa Fe Springs, Santa Ana, Riverside and San Diego. Debt Administration The Lottery s long-term liabilities include payments owed to lotto jackpot winners, Big Spin winners and weekly grand winners. The payments due winners are funded by amounts invested in zero coupon U. S. Treasury bonds. Cash Management Cash due from approximately 19,000 retailers is collected on a weekly basis through an electronic funds transfer system and deposited into an account within the California State Treasury. Idle cash is invested in the Surplus Money Investment Fund, in which interest earnings are received semiannually. The fund is administered by the Pooled Money Investment Board which is composed of the State Treasurer, the State Controller, and the Director of Finance. Risk Management The Lottery has elected, with a few exceptions, to be self-insured against loss or liability. Losses are accrued when the related liabilities occur. Except for workers compensation costs initially paid by State Compensation Insurance Fund for self-insured state agencies, the Lottery has purchased commercial insurance policies for protection from loss on certain assets. Additionally, major or critical contracts for the purchases of goods and services include requirements of vendors to maintain insurance coverage and/or financial security instruments, such as performance bonds or letters of credit. Future projects Transition to the Future The fiscal year will represent a Transition to the Future for the California Lottery as the organization takes a first step into a new tomorrow. The new gaming and telecommunications system provided by GTECH will accommodate all draw and Scratchers games, a telecommunications network, equipment and its associated systems and services. The system implementation and conversion in fiscal year is the biggest operational endeavor in the California Lottery history. Some 80,000 pieces of new equipment will be installed in over 18,000 retail locations. This conversion deployment is believed to be the largest in North American history. The Lottery anticipates that the new system will be a vast improvement over what it has today. Some of the improvements include PC-based gaming terminals with the latest touch screen technology; faster transaction processing; an open architecture based system to allow flexibility in purchasing gaming - 6 -

10 equipment and software from other vendors; real time access to data; advanced reporting capabilities; parameter-driven games and promotions; display devices that notify players of a winning ticket and amount won; and a telecommunication network that uses satellite and wireless technology. The new technological developments will provide the Lottery more effective and efficient business solutions, which will ultimately benefit the public schools who are the recipients of the profits from the Lottery. Performance Target With anticipated cost savings resulting from the new gaming and telecommunications system contract, additional prize money should be available for the Scratchers products, and additional advertising is planned for introducing new Scratchers games. More $3 Scratchers games will be introduced to increase sales in the upcoming year. To increase the visibility of lottery games, the Lottery will investigate and test new methods to enhance product availability and visibility at retail locations. The Lottery will make an effort to recruit new retailers and gain new accounts particularly in new trade channels. Most of all, a contribution of over $1 billion, for the fourth consecutive year, is expected for education. Improve Public Awareness of Lottery Contributions To improve public awareness of Lottery contributions to education and how the Lottery operates with the utmost responsibility, the Lottery plans to develop a uniform corporate message that can be used in all communications. In addition, the Lottery will continue to be active in sponsoring key events and speaking at various functions. A Smooth Workforce Transition As retirements accelerate in the upcoming years, a plan will be developed that will address anticipated retirements and the ramification of our maturing workforce. The Lottery will continue to invest in training and development programs that recognize employees and facilitate better internal communications. Proposal of Legislative changes To explore new ways to maximize profits for education, the Lottery is sponsoring a bill for the legislative session that would permit higher prize payouts. According to projections, providing the Lottery with the flexibility to increase prize payouts will increase sales, and thus generate more funds for public education. GFOA Certificate of Achievement The GFOA offers a Certificate of Achievement for Excellence in Financial Reporting to government units that publish an easily readable and efficiently organized CAFR. In addition, the report must satisfy both generally accepted accounting principles and applicable legal requirements. The Lottery believes that this CAFR meets the requirements of this prestigious award and we are submitting it to the GFOA to determine eligibility for a certificate. Independent Audit California statutes require an annual financial audit by an independent CPA. The independent auditors opinion on the Lottery s financial statements is included in the financial section of this report

11 Acknowledgements This report demonstrates the professionalism and dedicated team effort of Lottery employees. We appreciate their contribution to the success of this report. The Lottery is committed to providing thorough and relevant financial information to the public. Publishing this CAFR reflects our commitment to meet the highest standards of accountability and to maintain public trust through the highest ethics and integrity. Due credit should also be given to the Lottery Commissioners for their responsiveness and guidance in operating the California Lottery. Respectfully submitted, Patricia Eberhart, Director Finance and Administrative Division Anthony S. Molica Director - 8 -

12 ORGANIZATION CHART WITH PRINCIPAL OFFICIALS LOTTERY COMMISSION Harold N. Barker Stacy L. Faierman-Marks (3 Vacancies) DEPUTY DIRECTOR Ann Turtle DIRECTOR Anthony S. Molica CHIEF DEPUTY DIRECTOR Dennis Sequeira OFFICE OF ENTERPRISE INFORMATION TECHNOLOGY Richard Yamadera LEGAL OFFICE Joseph Symkowick INTERNAL AUDITS OFFICE Cathleen Dinubilo PUBLIC RELATIONS AND COMMUNICATIONS OFFICE Rosa Escutia BUSINESS AND COMMUNITY RELATIONS OFFICE (Vacant) LEGISLATIVE LIAISON OFFICE Randy Cheek FINANCE AND ADMINISTRATION DIVISION DIRECTOR'S OFFICE Patricia Eberhart CUSTOMER SERVICE DIVISION DIRECTOR'S OFFICE Rudy DiMassa SECURITY AND LAW ENFORCEMENT DIVISION DIRECTOR'S OFFICE (Vacant) TECHNOLOGY SERVICES AND SUPPORT DIVISION DIRECTOR'S OFFICE Dianne Koelzer MARKETING DIVISION DIRECTOR'S OFFICE James Hasegawa SALES DIVISION DIRECTOR'S OFFICE Tricia Metzger BUDGET DEPARTMENT VALIDATION SERVICES SECTION FIELD OPERATIONS APPLICATIONS DEVELOPMENT DEPARTMENT GAME OPERATIONS DEPARTMENT KEY ACCOUNTS DEPARTMENT NORTHERN FIELD OPERATIONS FINANCE DEPARTMENT HUMAN RESOURCES DEPARTMENT BUSINESS AND FACILITIES SERVICES DEPARTMENT CUSTOMER SERVICE CALL CENTER MAIL AND REPRODUCTION SERVICES SECTION HEADQUARTERS OPERATIONS IT OPERATIONS DEPARTMENT CUSTOMER SUPPORT DEPARTMENT GAMING AND QUALITY MANAGEMENT DEPARTMENT COMMUNICATIONS SUPPORT DEPARTMENT CONSUMER MARKETING AND ADVERTISING DEPARTMENT RETAILER NETWORK MANAGEMENT DEPARTMENT SOUTHERN FIELD OPERATIONS - 9 -

13 FINANCIAL SECTION 2003 COMPREHENSIVE ANNUAL FINANCIAL REPORT

14 INDEPENDENT AUDITORS REPORT The California State Lottery Commission Sacramento, California: We have audited the accompanying financial statements of the California State Lottery Fund (the Lottery) as of and for the year ended June 30, 2003, as listed in the table of contents. These financial statements are the responsibility of the Lottery's management. Our responsibility is to express an opinion on these financial statements based on our audit. We conducted our audit in accordance with auditing standards generally accepted in the United States of America. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audit provides a reasonable basis for our opinion. As discussed in note 1, the financial statements present only the California State Lottery Fund and do not purport to, and do not, present fairly the financial position of the State of California, as of June 30, 2003, and the changes in its financial position and its cash flows, where applicable, for the year then ended in conformity with accounting principles generally accepted in the United States of America. In our opinion, the financial statements referred to above present fairly, in all material respects, the financial position of the California State Lottery Fund as of June 30, 2003, and the changes in its financial position and its cash flows for the year then ended in conformity with accounting principles generally accepted in the United States of America. The management's discussion and analysis on pages 12 through 16 is not a required part of the basic financial statements but is supplementary information required by accounting principles generally accepted in the United States of America. We have applied certain limited procedures, which consisted principally of inquiries of management regarding the methods of measurement and presentation of the supplementary information. However, we did not audit the information and express no opinion on it. Our audit was conducted for the purpose of forming an opinion on the financial statements that collectively comprise the California State Lottery Fund s basic financial statements. The introductory section and statistical tables are presented for purposes of additional analysis and are not a required part of the basic financial statements. The introductory section and statistical tables have not been subjected to the auditing procedures applied in the audit of the basic financial statements and, accordingly, we express no opinion on them. October 15,

15 MANAGEMENT'S DISCUSSION AND ANALYSIS The following discussion and analysis of the California Lottery's financial performance provides an overview of financial activities for the fiscal year ended June 30, Please read it in conjunction with the California Lottery Financial Statements that follow this section. FINANCIAL HIGHLIGHTS The assets of the Lottery exceeded its liabilities at the close of the most recent fiscal year by $462.0 million, which is attributable to unrealized gains on investments the Lottery holds to fund future payments due on annuitized lottery prizes. Net assets increased approximately $144.9 million or 45.7% which was caused by the increase in the market value of investments. Operating revenues decreased by approximately 4% from the previous year because the SuperLOTTO Plus jackpot did not reach a record-breaking amount as in the year ended June 30, Total expenses decreased by 3.8% as there is a direct correlation between expenses and operating revenues. Non-operating revenues increased approximately $84.6 million or 121.0%, due to increases in investment earnings for the fiscal year ended June 30, OVERVIEW OF THE FINANCIAL STATEMENTS These required statements offer short- and long-term financial information about the California Lottery. The Statement of Net Assets provides information about the nature and amounts of investments in resources (assets) and obligations (liabilities) at the close of the fiscal year. All of the current year's revenues and expenses are accounted for in the Statement of Revenues, Expenses, and Changes in Net Assets. This statement measures the success of the Lottery's operations over the past year. The final required financial statement is the Statement of Cash Flows. The primary purpose of this statement is to provide information about the Lottery's cash receipts and cash payments during the reporting period. The statement reports cash receipts, cash payments, and net changes in cash resulting from operations, investing, and financing activities, and provides answers to such questions as where did cash come from, and what was cash used for. The financial statements are prepared on the accrual basis in accordance with accounting principles generally accepted in the United States of America. The California Lottery is structured as a single enterprise fund with revenues recognized when earned, not when received

16 FINANCIAL ANALYSIS NET ASSETS A summary of the California Lottery's net assets is presented below: Dollar Percent June 30, 2002 June 30, 2003 Change Change Current and other assets $3,172,194,880 $3,188,786,279 $ 16,591, % Capital assets 35,352,134 43,863,510 8,511, % Total assets 3,207,547,014 3,232,649,789 25,102, % Current liabilities 782,076, ,129,400 (3,946,930) (0.5%) Long-term prize liability 2,108,355,194 1,992,519,300 (115,835,894) (5.5%) Total liabilities 2,890,431,524 2,770,648,700 (119,782,824) (4.1%) Invested in capital assets 35,352,134 43,863,510 8,511, % Restricted for unrealized gains on Investments 317,115, ,001, ,885, % Unrestricted (deficit) (35,352,134) (43,863,510) (8,511,376) 24.1% Total net assets $ 317,115,490 $ 462,001,089 $ 144,885, % Net assets increased by $144.9 million or 45.7% in fiscal year 2003 because of decreases in market yields used to determine the fair value of investments. Also, capital assets increased during the current year primarily due to the purchase of vending machines. A summary of the California Lottery's change in net assets is presented below: Dollar Percent June 30, 2002 June 30, 2003 Change Change Operating revenues - Lottery sales $2,896,372,533 $2,781,569,856 $ (114,802,677) (4.0%) Prizes 1,502,966,618 1,451,804,079 (51,162,539) (3.4%) Sales after prizes 1,393,405,915 1,329,765,777 (63,640,138) (4.6%) Game costs 278,193, ,046,825 (10,146,681) (3.6%) Income before operating expenses 1,115,212,409 1,061,718,952 (53,493,457) (4.8%) Operating expenses 104,704,239 94,295,448 (10,408,791 ) (9.9% ) Operating income 1,010,508, ,423,504 (43,084,666) (4.3%) Non-operating revenues 69,896, ,460,099 84,563, % Income before transfer to Education Fund 1,080,404,781 1,121,883,603 41,478, % Transfer to Education Fund (1,027,185,343) (976,998,004) 50,187,339 (4.9%) Change in net assets 53,219, ,885,599 91,666, % Total net assets - beginning of year 263,896, ,115,490 53,219, % Total net assets - end of year $ 317,115,490 $ 462,001,089 $ 144,885, %

17 REVENUES The following chart shows the major sources and the percentages of operating revenues for the fiscal year ended June 30, 2003: Operating Revenues Hot Spot 6.5% Daily Games 10.0% SuperLOTTO Plus 39.9% Off-line 43.6% A summary of total revenues for the fiscal year ended June 30, 2003, and the amount and percentage of change in relation to prior year amounts is as follows: Dollar Percent June 30, 2002 June 30, 2003 Change Change Operating revenues: SuperLotto/SuperLOTTO Plus $1,275,714,605 $1,110,682,365 $(165,032,240) (12.9%) Off-line 1,184,119,073 1,211,719,532 27,600, % Hot Spot 184,432, ,160,160 (4,272,401) (2.3%) Daily games 252,106, ,007,799 26,901, % Total operating revenues 2,896,372,533 2,781,569,856 (114,802,677) (4.0%) Non-operating revenues: Unrealized gains on investments 53,219, ,885,599 91,666, % Interest on funds held by State Treasurer 16,221,680 9,365,650 (6,856,030) (42.3%) Other income 455, ,850 (246,643) (54.1%) Total non-operating revenues 69,896, ,460,099 84,563, % Total revenues $2,966,269,144 $2,936,029,955 $ (30,239,189 ) (1.0% ) The $114.8 million or 4.0% decrease in operating revenues was caused by lower SuperLOTTO Plus sales due to frequent, smaller jackpots. This was partially offset however, by greater sales from Daily 3 s additional mid-day draw. Unrealized gains on investments increased by $91.7 million or 172.2% and are associated with the change in fair value of investments. These gains are not realized however, as investments are held to maturity. The decrease in interest on funds held by the State Treasurer was caused by a decline in interest rates. Other income decreased because gains from the sale of vehicles were recognized in the fiscal year ended June 30,

18 EXPENSES The following chart shows prizes, game costs and operating expenses as a percentage of operating revenues for the fiscal year ended June 30, Prizes, Game Costs and Operating Expenses as a Percent of Operating Revenues Transfer to Education 34.8% Prizes 52.2% Operating Expenses 3.4% On-line/Off-line Game Costs 2.8% Retailer Costs 6.8% A summary of expenses for the fiscal year ended June 30, 2003, and the amount and percentage change in relation to prior year amounts is as follows: Dollar Percent June 30, 2002 June 30, 2003 Change Change Prizes: On-line prizes $ 830,258,513 $ 773,552,591 $ (56,705,922) (6.8%) Off-line prizes 672,708, ,251,488 5,543, % Total prizes 1,502,966,618 1,451,804,079 (51,162,539) (3.4%) Game costs: Retailer costs 198,064, ,814,979 (8,249,512) (4.2%) On-line/off-line game costs 80,129,015 78,231,846 (1,897,169) (2.4%) Total game costs 278,193, ,046,825 (10,146,681) (3.6%) Operating expenses: Salaries, wages, and benefits 36,902,774 36,652,764 (250,010) (0.7%) Advertising 30,421,150 26,385,118 (4,036,032) (13.3%) Promotion, public relations, and point of sale 11,234,301 7,234,777 (3,999,524) (35.6%) Other professional services 8,110,006 6,771,068 (1,338,938) (16.5%) Depreciation and amortization 7,972,377 8,069,014 96, % Other general and administrative expenses 10,063,631 9,182,707 (880,924) (8.8%) Total operating expenses 104,704,239 94,295,448 (10,408,791) (9.9%) Total expenses $1,885,864,363 $1,814,146,352 $ (71,718,011 ) (3.8% )

19 Advertising expense was lower by approximately $4.0 million or 13.3% in the fiscal year ended June 30, 2003, because discretionary expenses were curbed during the last half of this fiscal year. Promotion, public relations, and point of sale expense decreased by approximately $4.0 million or 35.6% because a special Scratcher promotional draw was held in the previous fiscal year. In addition, upgrades to retailer point of sale materials were realized in the fiscal year ended June 30, CAPITAL ASSETS A summary of capital assets as of June 30, 2003, and the amount and percentage of change in relation to prior year amounts is as follows: Dollar Percent June 30, 2002 June 30, 2003 Change Change Non-depreciable capital assets: Land $ 4,922,805 $ 4,922,805 $ - - Depreciable capital assets: Gaming terminals 31,263,946 31,275,712 11, % Common carrier public network 27,319,294 27,253,468 (65,826) (0.2%) Vending machines 22,292,109 34,466,109 12,174, % Buildings 22,754,724 23,727, , % Data processing equipment 13,746,928 15,332,795 1,585, % Office furniture and equipment 7,716,435 7,888, , % Leasehold improvements 522, ,912 60, % Other 5,726,534 5,978, , % Subtotal 131,342, ,505,562 15,162, % Less accumulated depreciation (100,913,553) (107,564,857) (6,651,304) 6.6% Total depreciable capital assets 30,429,329 38,940,705 8,511, % Capital assets, net $ 35,352,134 $ 43,863,510 $ 8,511, % During the 2003 fiscal year, depreciable capital assets increased by $15.2 million or 11.5% primarily because 1500 vending machines were purchased throughout the year ended June 30, Additional detailed information on capital assets may be found in the accompanying notes to the financial statements. CONTACTING THE LOTTERY'S FINANCIAL MANAGER This financial report is designed to provide a general overview of the California Lottery's finances and to demonstrate the accountability for the money the Lottery earns. If you have questions about this report or need additional financial information, contact the California Lottery, Finance Department, 600 N. 10 th Street, Sacramento, CA

20 CALIFORNIA STATE LOTTERY FUND STATEMENT OF NET ASSETS JUNE 30, 2003 ASSETS Current assets: Cash and cash equivalents (Note 2) $ 248,510,064 Investments, current portion (Note 2) 352,926,019 Accounts receivable, net of allowances (Note 3) 134,260,251 Due from state funds (Note 4) 4,034,964 Ticket inventories 4,901,258 Other 492,112 Total current assets 745,124,668 Long-term assets: Investments, less current portion (Note 2) 2,443,391,448 Capital assets, net (Note 5) 43,863,510 Deferred charges, net 270,163 TOTAL ASSETS $3,232,649,789 LIABILITIES Current liabilities: Accounts payable $ 30,638,027 Current prize liability (Note 6) 530,074,177 Due to state funds (Note 7) 209,931,666 Accrued liabilities 5,425,744 Deferred revenue 2,046,386 Retailer deposits 13,400 Total current liabilities 778,129,400 Long-term liabilities: Prize liability, less current portion (Note 6) 1,992,519,300 Total liabilities 2,770,648,700 Commitments and contingencies (Notes 8 and 12) NET ASSETS Invested in capital assets 43,863,510 Restricted for unrealized gains on investments (Note 2) 462,001,089 Unrestricted (deficit) (43,863,510) Total net assets 462,001,089 TOTAL LIABILITIES AND NET ASSETS $3,232,649,789 See accompanying notes to the financial statements

21 CALIFORNIA STATE LOTTERY FUND STATEMENT OF REVENUES, EXPENSES AND CHANGES IN NET ASSETS JUNE 30, 2003 Operating revenues: Lottery sales $2,781,569,856 Prizes 1,451,804,079 Sales after prizes 1,329,765,777 Less game costs: Retailer costs 189,814,979 On-line game costs 45,914,606 Off-line game costs 32,317,240 Total game costs 268,046,825 Income before operating expenses 1,061,718,952 Operating expenses: Salaries, wages, and benefits 36,652,764 Advertising 26,385,118 Promotion, public relations, and point of sale 7,234,777 Other professional services 6,771,068 Depreciation and amortization 8,069,014 Other general and administrative expenses 9,182,707 Total operating expenses 94,295,448 Operating income 967,423,504 Non-operating revenues: Investment earnings (Note 9) 154,251,249 Other income 208,850 Total non-operating revenues 154,460,099 Income, before transfer to Education Fund 1,121,883,603 Transfer to Education Fund (Note 7) (976,998,004) Change in net assets 144,885,599 Total net assets - beginning of year 317,115,490 Total net assets end of year $ 462,001,089 See accompanying notes to the financial statements

22 CALIFORNIA STATE LOTTERY FUND STATEMENT OF CASH FLOWS JUNE 30, 2003 Cash flows from operating activities: Receipts from customers $2,762,895,747 Payments for prizes (1,696,837,198) Payments to retailers (189,826,803) Payments to suppliers for goods and services (122,556,443) Payments to employees (35,998,346) Internal activity-payments to state (5,044,367) Other receipts 142,312 Net cash flows provided by operating activities 712,774,902 Cash flows from non-capital financing activities: Distributions to Education Fund (1,026,473,503) Net cash flows used in non-capital financing activities (1,026,473,503) Cash flows from capital and related financing activities: Proceeds from disposal of capital assets 59,156 Payments for capital assets (15,757,101) Net cash flows used in capital and related financing activities (15,697,945) Cash flows from investing activities: Purchase of securities (66,214,618) Proceeds from matured securities 350,566,000 Surplus Money Investment Fund interest 12,826,690 Net cash flows provided by investing activities 297,178,072 Decrease in cash and cash equivalents (32,218,474) Cash and cash equivalents at June 30, ,728,538 Cash and cash equivalents at June 30, 2003 $ 248,510,064 See accompanying notes to the financial statements

23 CALIFORNIA STATE LOTTERY FUND STATEMENT OF CASH FLOWS JUNE 30, 2003 Cash flows from operating activities: Operating income $967,423,504 Adjustments to reconcile operating income to net cash provided by operating activities: Depreciation and amortization 8,069,014 Provision for doubtful accounts (45,453) Provision for returned tickets (205,526) Provision for free ticket redemptions (828,265) Net gain on retirement or disposal of capital assets (56,133) Other income 208,850 Changes in assets and liabilities: Increase in accounts receivable (17,743,491) Increase in due from state funds (203,307) Increase in ticket inventories (1,073,694) Decrease in other assets 247,210 Increase in deferred charges (165,083) Increase in accounts payable 2,827,822 Decrease in prize liability (245,033,119) Decrease in due to state funds (571,879) Decrease in accrued liabilities (251,407) Increase in deferred revenues 204,759 Decrease in retailer deposits (28,900) (254,648,602) Net cash flows provided by operating activities $712,774,902 Supplemental disclosure of non-cash activities: Interest accreted on annuitized prizes $172,545,398 Unclaimed prizes directly transferred to the Education Fund $ 42,818,968 Unrealized gain on investments $144,885,599 See accompanying notes to the financial statements

24 CALIFORNIA STATE LOTTERY FUND NOTES TO FINANCIAL STATEMENTS JUNE 30, SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES Organization The California State Lottery Fund (the Lottery) was created with the passage of the California State Lottery Act of 1984 (the Act). The Lottery is a part of the primary government of the State of California and is reported as a proprietary fund and business-type activity within the State of California's financial statements. The purpose of the Act is to support the preservation of the rights, liberties, and welfare of the people by providing additional monies to benefit education without the imposition of additional or increased taxes. The operations of the Lottery are separate and distinct from other operations of the State of California. The Act mandates that, as nearly as practical, 50 percent of the total annual revenues from Lottery sales be returned to the public in the form of prizes and that at least 34 percent be allocated to benefit public education. No more than 16 percent of the total annual revenues from sales of tickets or shares shall be allocated for payment of operating expenses of the Lottery (Note 11). Basis of Presentation The Lottery is accounted for as an enterprise fund. The financial statements are prepared on the accrual basis of accounting and the economic resources measurement focus in accordance with accounting principles generally accepted in the United States of America. Operating revenue and expenses are those that result from providing services and producing and delivering goods and/or services. Revenue Recognition - Off-Line Games Sales of lottery tickets are made to the public through contracted retailers. Revenue is recognized upon the sale of tickets to the retailers. An allowance is recognized for the retailers' right to return unsold tickets after each game end. An allowance is also recognized for free tickets which have not been redeemed. Operating revenue is reduced upon redemption of free tickets. Retailers receive a commission of six percent which is recognized when tickets are sold to the retailers. Revenue Recognition - On-Line Games Lottery sales are made to the public through gaming terminals at contracted retailers. Revenue is recognized upon the sale to the public. The public has the right to cancel a sale on the same day before pool closure. The applicable retailers' commission of four and one-half to six percent is recognized when sales are made to the public. Recognition of the revenue from sales for future draws is deferred until those draws become current. The retailers' commission related to the deferred revenue is reflected as a prepaid expense until the related deferred revenue is recognized. Prizes - Off-Line Games Prize expense for off-line games is recognized based on the predetermined prize structure for each game in the period ticket revenue is recognized. Prizes that are not claimed are recognized as unclaimed prizes 180 days after the end of each game. Unclaimed prizes not directly payable by the commission are recognized as a reduction of prize expense and included in the Lottery's operating income that is distributed to the Education Fund. Unclaimed prizes directly payable by the commission are transferred directly to the Education Fund. Prize expense relative to the Lottery's weekly off-line grand prize drawing is recorded

25 CALIFORNIA STATE LOTTERY FUND NOTES TO FINANCIAL STATEMENTS JUNE 30, SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (continued) Prizes - Off-Line Games (continued) based on the estimated prize structure for each game as revenue is recognized. Periodically, prize expense is adjusted to reflect amounts actually won. Prizes of $1 million or more are generally paid in twenty equal annual installments. The Weekly Grand, the Extravaganza 2000, the Twice as Grand, and the Weekly $2,000 Payday top prizes are paid in weekly installments for twenty years. Prize expense for these prizes is based on the present value of the annuity using an interest rate equal to the interest yield on the zero coupon U.S. Treasury bonds which the Lottery acquires to fund the annuity payments. Interest earned is imputed on the annuity using the same interest rate. Prizes - On-Line Games SuperLOTTO Plus - Prize expense for the twice-weekly, on-line game is recognized on the basis of the predetermined prize structure when the revenue is recognized. Nine distinct prize categories are established which are dependent upon the amount of money wagered and the quantity of numbers to be matched. In the event that no winning share for a specific prize category is selected, all monies allocated for that prize are carried forward to the following drawing and added to the Five of Five plus MEGA number category (grand prize). All SuperLOTTO Plus prizes won but not claimed within the specified period are transferred directly to the Education Fund. Grand prizes won prior to April 1, 1998 of $1 million or more are paid in twenty equal annual installments. Effective April 1, 1998 grand prizes of $1 million or more are paid in either twenty-six graduated annual payments or in a single payment equal to the cash value of the twenty-six-payment annuity, in accordance with the rules and regulations of the Lottery. Payments for all other prize categories are made in a single payment. Fantasy 5 - Prize expense for the seven-draws-per-week, on-line game is recognized on the basis of the predetermined prize structure when the revenue is recognized. Distinct prize categories are established dependent upon the amount of money wagered and the quantity of numbers to be matched. In the event that no winning share for a specific prize category is selected, all monies allocated for that prize category are carried forward to the following drawing and added to the 5 of 5 prize category. All Fantasy 5 prizes won but not claimed within the specified period are transferred directly to the Education Fund. Daily 3 - Prize expense for the two-draws-per-day, on-line game is recognized on the basis of the predetermined prize structure when the revenue is recognized. Distinct prize categories are established which are dependent upon the amount of money wagered, the quantity of numbers to be matched, and the order of numbers chosen. All Daily 3 prizes won but not claimed within the specified period are transferred directly to the Education Fund

26 CALIFORNIA STATE LOTTERY FUND NOTES TO FINANCIAL STATEMENTS JUNE 30, SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (continued) Prizes - On-Line Games (continued) Daily Derby - Prize expense for the seven-draws-per-week, on-line game is recognized on the basis of the predetermined prize structure when the revenue is recognized. Distinct prize categories are established which are dependent upon the amount of money wagered, the quantity of numbers to be matched, and the order of numbers chosen. In the event that no winning share for a specific prize category is selected, all monies allocated for that prize category are carried forward to the following drawing and added to the Grand Prize category. All Daily Derby prizes won but not claimed within the specified period are transferred directly to the Education Fund. Hot Spot - Prize expense for the multiple-draws-per-day, on-line game is recognized on the basis of the predetermined prize structure when the revenue is recognized. Distinct prize categories are established which are dependent upon the amount of money wagered and the quantity of numbers to be matched. In the event that no winning share for a specific Hot Spot prize category is selected, all monies allocated for that prize category are carried forward to the following drawing and added to the 8 spot prize category, the 5 of 5 prize category, the 4 of 4 prize category, or the 3 of 3 prize category. All Hot Spot prizes won but not claimed within the specified period are transferred directly to the Education Fund. Cash Equivalents Cash equivalents represent cash deposited in the Surplus Money Investment Fund. Investments The Lottery applies Statement No. 31 of the Governmental Accounting Standards Board (GASB 31), Accounting and Financial Reporting for Certain Investments and for External Investment Pools. This statement establishes accounting and financial reporting standards for all investments held by governmental external investment pools and establishes fair value standards for other governmental entities. In accordance with GASB 31, the Lottery has stated investments, which consist of zero coupon U.S. Treasury bonds, at fair value. The difference between the carrying value and the fair value of the investment is reported as a component of total net assets on the Statement of Net Assets. Allowances for Doubtful Accounts, Ticket Returns, and Free Ticket Redemptions The allowance for doubtful accounts is based on an analysis of collectibility of accounts receivable which considers the age of the accounts and current economic conditions. An allowance for ticket returns for offline games is estimated using sales revenue and historical return data for the games in progress at the end of the reporting period. An allowance for free ticket redemptions for off-line games is estimated using sales revenue and free ticket redemption data for games in progress at the end of the reporting period

27 CALIFORNIA STATE LOTTERY FUND NOTES TO FINANCIAL STATEMENTS JUNE 30, SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (continued) Ticket Inventories Inventories are carried at cost and consist of tickets for games in progress not yet sold to retailers and tickets for future games. The cost of tickets is charged to operations when the tickets are sold to retailers. The cost of unissued and returned tickets is written off at the end of each game. Capital Assets The Lottery has adopted a policy of capitalizing assets with an acquisition cost or established value of $1,000 or greater. Capital assets are carried at cost. Depreciation on property and equipment is computed using the straight-line method over estimated lives ranging from three to seven years. Depreciation on buildings, improvements, and land improvements is computed using the straight-line method over estimated lives of five to forty years. When assets are retired or otherwise disposed of, the costs and related accumulated depreciation are removed from the accounts and any resulting gain or loss is reflected in operations in the period of disposal. Amortization of leasehold improvements is computed using the straight-line method over the remaining lease terms. Deferred Charges The Lottery incurs costs in connection with certain contracts which extend beyond a one-year period. These costs are deferred and amortized over the life of the contracts. Advertising Advertising costs are expensed when the related liability is incurred. Advertising expense totaled $26,385,118 for the year ended June 30, Investment Earnings Investment earnings are comprised of both unrealized gains or losses associated with the change in fair value of investments and interest income. Unrealized gains and losses are generally not realized as the investments are held to maturity, however the investments must be stated at fair value thus creating investment earnings in the interim. Generally, all cash is held on deposit with the California State Treasurer and is invested by that office in the Surplus Money Investment Fund. Interest on funds held by the State Treasurer is distributed semi-annually. Compensated Absences Payable Vested vacation balances are accrued as a liability and adjusted quarterly. Use of Estimates The preparation of financial statements in conformity with accounting principles generally accepted in the United States of America 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

28 CALIFORNIA STATE LOTTERY FUND NOTES TO FINANCIAL STATEMENTS JUNE 30, SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (continued) Government Accounting Standards Board Statement No. 20 (GASB 20) As required under GASB 20, Accounting and Financial Reporting for Proprietary Funds and Other Governmental Entities That Use Proprietary Fund Accounting, the Lottery will continue to apply all applicable GASB pronouncements as well as Financial Accounting Standards Board (FASB) Statements and Interpretations, Accounting Principles Board (APB) Opinions, and Accounting Research Bulletins (ARBS) of the Committee on Accounting Procedure issued on or before November 30, 1989, unless those pronouncements conflict or contradict GASB pronouncements. The Lottery has elected under GASB 20 to not apply all FASB Statements and Interpretations issued after November 30, 1989, due to the governmental nature of the Lottery operations. Government Accounting Standards Board Statement No. 40 (GASB 40) GASB 40, Deposit and Investment Risk Disclosures, an amendment of GASB 3, establishes and modifies disclosure requirements related to deposit and investment risks. The Lottery applies the standards set forth in GASB 40 and certain footnote disclosures have been added accordingly to conform to the Statement. 2. DEPOSITS AND INVESTMENTS Investments consist of zero coupon U.S. Treasury bonds with yields ranging from percent to percent as follows: Face Amount Cost Fair Value Current portion: For off-line games $ 26,475,000 $ 9,831,798 $ 26,334,790 For on-line games 328,252, ,253, ,591,229 Total current portion 354,727, ,085, ,926,019 Long-term portion: For off-line games 144,597,000 55,471, ,008,361 For on-line games 2,884,753,000 1,051,472,073 2,322,383,087 Total long-term portion 3,029,350,000 1,106,944,025 2,443,391,448 Total investments $3,384,077,000 $1,267,029,290 $2,796,317,467 As discussed in Note 1, the Lottery applies the provisions of GASB 31. In accordance with GASB 31, the Lottery carries its investments at fair value. The fair value of investments is based on published market prices and quotations from a major investment firm. The following represents the changes in fair value of investments for the year ended June 30, 2003, in accordance with the requirements of GASB 31. Changes in fair value of investments: Unrealized investment gains at July 1, 2002 $ 317,115,490 Unrealized investment gains, current period 144,885,599 Total unrealized investment gains $ 462,001,

29 CALIFORNIA STATE LOTTERY FUND NOTES TO FINANCIAL STATEMENTS JUNE 30, DEPOSITS AND INVESTMENTS (continued) Unrealized investment gains represent the excess of fair value over the original purchase cost plus interest accreted on investments at June 30, The prize investments are uninsured and unregistered investments held in book-entry form at the Federal Reserve Bank of New York. The U.S. Treasury bonds are backed by the full faith and credit of the United States government. All of the Lottery s investments are included in category A, the lowest risk as defined by the Governmental Accounting Standards Board. The deposit and investment policies of the Lottery are determined by the Lottery Commission and state statute. Prize investments consist of zero coupon U.S. Treasury bonds, which are carried at fair value and are adjusted for the accretion of interest based on the purchased yield and maturity date. Deposits are held in insured depositories, or by the State Treasury, or in the Surplus Money Investment Fund. As of June 30, 2003, deposits in financial institutions were covered by federal depository insurance or were collateralized by the financial institution through a pool of securities held to collateralize all public deposits the institution holds and are included in category A, the lowest risk as defined by the Governmental Accounting Standards Board. The following deposits, included in cash and cash equivalents, are in pools managed by other State of California government units and are not evidenced by securities. Interest income earned on outstanding cash balances is allocated among pool participants based on average daily cash balances. As of June 30, 2003, the carrying value of deposits in the Surplus Money Investment Fund approximated fair value. State Treasury $ 9,929,059 Surplus Money Investment Fund 238,552, ACCOUNTS RECEIVABLE $248,481,059 Accounts receivable consist of the following: Amounts due, primarily from retailers $165,380,002 Less: Allowance for free ticket redemption (22,147,586) Allowance for doubtful accounts (4,299,725) Allowance for ticket returns (4,672,440) Accounts receivable, net $134,260, DUE FROM STATE FUNDS Due from state funds consists primarily of interest income due on cash deposited with the State Treasurer in the Surplus Money Investment Fund

30 CALIFORNIA STATE LOTTERY FUND NOTES TO FINANCIAL STATEMENTS JUNE 30, CAPITAL ASSETS Capital assets consist of the following: Beginning Balance Increase Decrease Ending Balance Non-depreciable capital assets: Land $ 4,922, $ 4,922,805 Depreciable capital assets: Gaming terminals 31,263,946-31,275,712 Common carrier public network 27,319,294 - (65,826) 27,253,468 Vending machines 22,292,109 12,174,000-34,466,109 Buildings 22,754, ,735-23,727,459 Data processing equipment 13,746,928 1,888,747 (302,880) 15,332,795 Office furniture and equipment 7,716, ,546 (48,301) 7,888,680 Leasehold improvements 522,912 60, ,912 Other 5,726, ,307 (177,414) 5,978, ,265,687 15,757,101 (594,421) 151,428,367 Less accumulated depreciation and amortization (100,913,553) (107,564,857) Capital assets, net $ 35,352,134 $ 43,863,510 Depreciation and amortization charged to income on capital assets was $7,242,703 for the year ended June 30, PRIZE LIABILITY Prize liability consists of the following: Off-Line On-Line Total Current: Annuitized prizes $ 30,079,748 $ 365,672,575 $ 395,752,323 Other prizes 111,232,231 23,089, ,321,854 Total current prize liability 141,311, ,762, ,074,177 Long-term annuitized prizes 144,597,000 2,884,753,000 3,029,350,000 Less imputed interest (43,675,793) (993,154,907) (1,036,830,700) Net present value of long-term prizes 100,921,207 1,891,598,093 1,992,519,300 Total prize liability $242,233,186 $2,280,360,291 $2,522,593,477 The amount of prizes due within one year is $530,074,

31 CALIFORNIA STATE LOTTERY FUND NOTES TO FINANCIAL STATEMENTS JUNE 30, PRIZE LIABILITY (continued) Long-term prize liability as of June 30, 2003 for each of the next five years and for subsequent years is as follows: Principal Interest Total For the year ending June 30, 2005 $ 149,070,015 $168,601,241 $ 317,671, ,852, ,542, ,395, ,811, ,767, ,579, ,455, ,421, ,877, ,522,744 83,302, ,825, ,039, ,683, ,722, ,886,948 31,283, ,170, ,613,154 8,434,236 57,047, ,691,995 1,538,267 17,230,262 Total long-term prize liability $1,106,943,926 $885,575,374 $1,992,519,300 Activity in the prize liability accounts consists of: Balance, July 1, 2002 $2,637,900,166 Prize expense 1,451,804,079 Prize payments (1,696,837,198) Interest imputed on annuities 172,545,398 Unclaimed prizes (42,818,968) Balance, June 30, 2003 $2,522,593, DUE TO STATE FUNDS Due to state funds consists of the following: Due to Education Fund $ 209,838,332 Due to other state funds 93,334 Total due to state funds $ 20 9,931,666 Activity in the Due to Education Fund account consists of: Balance, July 1, 2002 $ 216,494,863 Income, due to Education Fund, earned by the California State Lottery Fund $ 976,998,004 Unclaimed prizes directly transferred to the Education Fund 42,818,968 1,019,816,972 Distributions to the Education Fund (1,026,473,503) Balance, June 30, 2003 $ 209,838,

32 CALIFORNIA STATE LOTTERY FUND NOTES TO FINANCIAL STATEMENTS JUNE 30, LEASES The Lottery leases office, warehouse, and parking lot facilities under operating leases. These leases expire in various years through October 31, Every operating lease has a provision for early termination. These leases could be terminated between September 2003 and October The future minimum lease payments under operating leases as of June 30, 2003, are as follows: Operating Leases For the year ending June 30, 2004 $1,049, ,005, , , ,308 Thereafter 621,804 Total minimum payments $3,919,676 Rental expense for all operating leases totaled $1,201,760 for the year ended June 30, INVESTMENT EARNINGS Investment earnings consist of: Interest on funds held by State Treasurer $ 9,365,650 Unrealized gains on investments 144,885,599 Interest accreted on investments 172,545, ,796,647 Less interest expense imputed on annuity liability (172,545,398) Investment earnings, net $ 154,251,

33 CALIFORNIA STATE LOTTERY FUND NOTES TO FINANCIAL STATEMENTS JUNE 30, RETIREMENT PLAN The Lottery contributes to the Public Employees Retirement Fund administered by the Public Employees' Retirement System of the State of California (PERS), an agent multiple-employer public employee defined benefit pension plan. PERS provides retirement benefits to plan members and beneficiaries. In addition, post-retirement health care benefits are provided by the primary government. PERS acts as a common investment and administrative agent for participating public entities within the State of California and uses the accrual basis of accounting. Benefit provisions and all other requirements are established by state statute. Since all state agencies are considered collectively to be a single employer, the actuarial present value of vested and nonvested accumulated plan benefits attributable to the Lottery's employees cannot be determined. Similarly, the net assets available for benefits of Lottery employees cannot be determined. PERS issues a separate comprehensive annual financial report that includes financial statements and required supplementary information. The PERS annual financial report may be obtained from their executive office: 400 P Street, Sacramento, CA Generally, full-time employees are eligible to participate as members of PERS and are eligible to retire at age 50 with at least five years of service or age 55 with at least ten years of service depending on the plan selected by the employee. Annual retirement benefits are determined based on age at retirement, the length of membership service, and the amount of earnings based on the highest or last 12 consecutive months' average. Active plan members are required to contribute a percentage of their salary depending on their plan selection and employment classification. Employees required contributions vary from 0.0% to 7.5%. The Lottery is required to contribute at an actuarially determined rate. The Lottery's contributions are based on a percentage of annual covered payroll depending on the plan selected and member status. For the year ended June 30, 2003, the Lottery's payroll for employees covered by PERS was approximately $26.9 million and the total payroll for the period was approximately $27.2 million. The contribution requirements of plan members and the Lottery are established and may be amended by PERS. Required employer contribution rates (expressed as a percentage of compensation) for the 2002/2003 fiscal year are as follows: State Miscellaneous Member First Tier 7.413% State Miscellaneous Member Second Tier 2.813% Peace Officer % The Lottery s pension cost for the year ended June 30, 2003, for PERS was equal to the Lottery s required contributions which was determined as part of the most recent actuarial valuation of PERS dated June 30, Three year trend information for the Lottery: Fiscal Year Ending Annual Pension Cost (APC) Percentage Of APC Contributed Net Pension Obligation 6/30/01 $ 48, % $0 6/30/02 $1,099, % $0 6/30/03 $3,049, % $0-30 -

34 CALIFORNIA STATE LOTTERY FUND NOTES TO FINANCIAL STATEMENTS JUNE 30, STATUTORY COMPLIANCE Lottery prize payments and other operating expenses are shown below as a percentage of operating revenue for the year ended June 30, The Act mandates that, as nearly as practical, 50 percent of the total annual revenues from Lottery sales be returned to the public in the form of prizes and that at least 34 percent be allocated to benefit public education. No more than 16 percent of the total annual revenues from Lottery sales shall be allocated for payment of expenses of the Lottery. In addition, unclaimed prizes not directly payable by the commission, which amounted to $18,435,218 for the year ending June 30, 2003, are recognized as a reduction of prize expense and included in the Lottery's net income that is distributed to the Education Fund. Unclaimed prizes directly payable by the commission are transferred directly to the Education Fund. Finally, all of the interest earned on funds held in the State Lottery Fund shall be allocated for the benefit of public education. This interest is not to be considered part of the 34 percent of the total annual revenues from sales that is otherwise required to be allocated for public education. Lottery sales $2,781,569, % Prizes 1,451,804, % Expenses of the Lottery Retailer costs 189,814, % Game costs 78,231, % Operating expenses 94,295, % Less bartered operating expenses (66,538) 0.00% Total expenses of the Lottery $ 362,275, % Revenues to Education Allocation of sales $967,490, % Unclaimed prizes directly transferred to the Education Fund 42,818,968 Interest income 9,365,650 Other income 208,850 Less bartered income (66,538) Total declared for transfer to Education Fund $1,019,816,

35 CALIFORNIA STATE LOTTERY FUND NOTES TO FINANCIAL STATEMENTS JUNE 30, COMMITMENTS AND CONTINGENCIES The Lottery has entered into an agreement with GTECH Corporation to install and operate an on-line gaming system including 13,000 vendor-supplied terminals. The term of the contract is from October 14, 1993 through October 13, 2003, with an estimated cost of $373 million. Approximately $360 million has been expended under the contract as of June 30, A new contract has been awarded to GTECH and will include both gaming and telecommunication systems and services. The term of the contract is from October 14, 2003 through October 13, 2009, with an estimated cost of $300 million. The Lottery has entered into an agreement with High Integrity Systems, Inc. (HISI) related to providing an Automated Ticket Gaming System. The Lottery will pay to HISI a fee based on a percentage of sales occurring at HISI terminal locations during the contract term ending October 13, The expenses incurred under the contract for the year ended June 30, 2003, approximated $31 million. The Lottery has been named as a defendant in a number of lawsuits and claims totaling several million dollars. While the ultimate monetary outcome of these claims cannot be estimated at this time, it is the opinion of management, after consulting with legal counsel, that the disposition of any litigation in which the Lottery is involved will not have a material adverse effect on the financial condition or on the operations of the Lottery. 13. RISK MANAGEMENT Since its inception, the Lottery has been primarily self-insured for risks such as flood, business interruption, theft, employee errors and omissions, and other potential liabilities. Losses are recognized when conditions for accrual are met. Liabilities for workers' compensation costs are accrued based on estimates derived from the State Compensation Insurance Fund. This estimate is based on actuarial reviews of the employee workers compensation program and includes indemnity payments, compensation benefits, and leave benefits

36 STATISTICAL SECTION 2003 COMPREHENSIVE ANNUAL FINANCIAL REPORT