Arizona State Lottery, A Component Unit of the State of Arizona Financial Statements as of and for the Year Ended June 30, 2007, Supplemental Schedule for the Year Ended June 30, 2007, and Independent Auditors’ Report ARIZONA STATE LOTTERY, A COMPONENT UNIT OF THE STATE OF ARIZONA TABLE OF CONTENTS Page INTRODUCTION SECTION — Letter of Transmittal i INDEPENDENT AUDITORS’ REPORT 1–2 MANAGEMENT’S DISCUSSION AND ANALYSIS 3–6 FINANCIAL STATEMENTS AS OF AND FOR THE YEAR ENDED JUNE 30, 2007: Statement of Net Assets 7 Statement of Revenues, Expenses, and Changes in Fund Net Assets 8 Statement of Cash Flows 9 Notes to Financial Statements SUPPLEMENTAL SCHEDULE FOR THE YEAR ENDED JUNE 30, 2007 — Supplemental Schedule of Gross Profit by Game for Games Expiring During the Year Ended June 30, 2007 10–14 15 16–21 February 27, 2008 Dear Arizona Lottery Commissioners: The Arizona Lottery is pleased to submit its audited financial statements for the year ended June 30, 2007, as prepared by the Lottery Accounting Department and audited by Deloitte & Touche LLP. The Lottery is responsible for the accuracy and completeness of all data and disclosures in this report. To the best of our knowledge, the information presented is accurate and complete in all material respects and fairly depicts the financial position of the Arizona Lottery. This report includes a statement of net assets of the Arizona Lottery, the related statement of revenues, expenses, and changes in fund net assets; the statement of cash flows; footnotes related to the financial reports; and the supplemental schedules of gross profit by game. The audit of the Arizona Lottery was performed under the authority of A.R.S. § 5-505 and A.R.S. § 5-524, which require an annual audit of the Lottery. The Arizona Lottery was created in 1980 when Arizona voters approved a ballot initiative adding Title 5, Chapter 5 to the Arizona Revised Statutes. The Lottery began selling instant “scratchoff” tickets in July 1981 and during its 26 years of operation has offered a variety of instant and on-line products. The Lottery operates as an agency of the State of Arizona and is reported as an enterprise fund within the state’s Comprehensive Annual Financial Report. The fund is operated in a manner similar to a private business enterprise. In fiscal year 2007, the Arizona Lottery had revenues of $462.2 million from Lottery ticket sales, 1.4% less than last fiscal year, and an income before transfers of $140.0 million, 0.8% less than last fiscal year. More than $257 million was paid to our players in prizes and our retail partners received $31.1 million for sales commissions. In its 26 years of operation, the Lottery has produced nearly $6.4 billion in Lottery ticket sales. In fiscal year 2007, the Arizona Lottery made transfers to other State Funds of $32.8 million for the Local Transportation Assistance Fund, $7.7 million for the County Assistance Fund, $20.0 million for the Heritage Fund, $2.9 million for the Economic Development Fund, $0.3 million i i Arizona Lottery Commissioners Page 2 for the Department of Gaming, $20.7 million for the Healthy Arizona Fund, and $52.9 million was transferred to the State General Fund for allocation by the state legislature. In addition, from the Lottery Prize Fund, over $2.6 million was transferred to the Court Appointed Special Advocate (CASA). In total, $139.9 million was transferred to other State Funds for FY 2007. In its 26 years of operation, the Lottery has returned nearly $2.1 billion to its beneficiaries. Further financial results for fiscal year 2007 are detailed in Management’s Discussion and Analysis, included in this report. ii INDEPENDENT AUDITORS’ REPORT To the Commissioners of Arizona State Lottery Phoenix, Arizona We have audited the accompanying statement of net assets of Arizona State Lottery (the “Lottery”), a component unit of the State of Arizona, as of June 30, 2007, and the related statements of revenues, expenses, and changes in fund net assets and of cash flows for the year then ended. 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 and the standards applicable to financial audits contained in Government Auditing Standards issued by the Comptroller General of the United States. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the respective financial statements are free of material misstatement. An audit includes consideration of internal control over financial reporting as a basis for designing audit procedures that are appropriate in the circumstances, but not for the purpose of expressing an opinion on the effectiveness of the Lottery’s internal control over financial reporting. Accordingly, we express no such opinion. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, 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. In our opinion, such financial statements present fairly, in all material respects, the financial position of the Lottery as of June 30, 2007, and the changes in net assets and its cash flows for the year then ended in conformity with accounting principles generally accepted in the United States of America. The accompanying required supplementary information, management’s discussion and analysis, is presented on pages 3 through 6 and is not a required part of the basic financial statements, but is supplementary accounting information required by the Governmental Accounting Standards Board. This supplementary information is the responsibility of the Lottery’s management. We have applied certain limited procedures, which consisted principally of inquiries of management regarding the methods of measurement and presentation of the required supplementary information. However, we did not audit the information and we do not express an opinion on it. Our audit was conducted for the purpose of forming an opinion on the Lottery’s basic financial statements. The accompanying schedule of gross profit by game is presented for purposes of additional analysis and is not a required part of the basic financial statements. This schedule is the responsibility of the Lottery’s management. Such information has been subjected to the auditing procedures applied by us in the audit of the basic financial statements and, in our opinion, is fairly stated in all material respects in relation to the basic financial statements taken as a whole. -1- In accordance with Government Auditing Standards, we have also issued our report dated February 27, 2008, on our consideration of the Lottery’s internal control over financial reporting and our tests of its compliance and other matters. The purpose of that report is to describe the scope of our testing, and not to provide an opinion on the internal control over financial reporting or on compliance. That report is an integral part of an audit performed in accordance with Government Auditing Standards and should be read in conjunction with this report in considering the results of our audit. February 27, 2008 -2- ARIZONA STATE LOTTERY, A COMPONENT UNIT OF THE STATE OF ARIZONA PROPRIETARY FUND — ENTERPRISE FUND MANAGEMENT’S DISCUSSION AND ANALYSIS YEAR ENDED JUNE 30, 2007 This discussion and analysis of the Lottery’s financial statements is a required component of financial reporting under Government Accounting Standards and was prepared by Arizona Lottery Management. It provides an overview of financial activities for the year ended June 30, 2007, and should be read in conjunction with the Lottery’s financial statements and notes to the financial statements. This annual report consists of three types of financial statements and accompanying notes that provide explanations and details of accounting policies, account balances and activities. Account balances and activities are shown as of and for the year ended June 30, 2007, with comparative totals for June 30, 2006. The statement of net assets; the statement of revenues, expenses and changes in net assets; and the notes are presented using the accrual method of accounting. Under this method, financial transactions are recorded when earned or incurred regardless of when cash is received or disbursed. The statement of cash flows reflects cash receipts and disbursements during the same twelve-month periods. The statement of net assets provides information about the assets and liabilities of the Lottery. Assets consist of cash, substantially all held by the State Treasurer, amounts owed to the Lottery from licensed Lottery retailers and other State agencies, ticket inventory and property. Liabilities represent amounts owed by the Lottery to vendors, to employees for wages and benefits, to prize winners and to other State funds. Net assets represent the portion of the Lottery’s assets that are not encumbered by liabilities. It serves as an indicator of the net worth of the Lottery. A summary of the financial results of operations for the twelve-month periods is presented in the statement of revenues, expenses and changes in Fund net assets. Operating revenues include sales of Lottery tickets, retailer licensing fees and commissions earned on the sales of Lottery tickets at Lottery offices, and special events. Direct costs and administrative expenses comprise the operating expenses section of this statement. Direct costs are variable expenses that fluctuate with the level of sales. Marketing and overhead costs are included in the administrative expenses category. Nonoperating revenues consist of interest earned on prize fund cash investments from the State Treasurer and interest credited to the Multi-State Lottery Association (“MUSL”) unreserved account. The Transfers category includes transfers to other State Funds as required by Lottery statutes. The statement of cash flows includes cash receipts and disbursements from operating, noncapital financing and investment earnings. This statement also includes a reconciliation of operating income presented on the accrual basis of accounting to net cash provided by operating activities. The notes to the financial statements present information on accounting policies, transfers and statutory requirements, commitments, contingencies and retirement benefits. These notes are an integral part of the financial statements. -3- SALES ACTIVITIES Revenues from the sale of Lottery products for the fiscal year ended June 30, 2007 were slightly lower than Fiscal Year 2006. As shown in the financial statements, sales decreased 1.4% from the prior year, from $468.7 million in Fiscal Year 2006 to $462.2 million in the current year. The increases in ScratchersSM, The ® Pick, Pick 5™, and Pick 3™ sales nearly offset the decrease in Powerball sales. Powerball sales are directly impacted by jackpot size and this year’s jackpots were down from last year’s record jackpots of $340 million and $365 million. The largest jackpot in Fiscal Year 2007 was $254 million in January. The following table compares Lottery product sales between fiscal years. Sales are presented in millions of dollars. Product Sales Scratchers (including economic development) Powerball The Pick Pick 5 Pick 3 Total FY 2007 FY 2006 Difference Percentage $261.0 127.3 52.4 12.6 8.9 $249.8 157.9 43.1 10.0 7.9 $11.2 -30.6 9.3 2.6 1.0 4.5% -19.4% 21.7% 25.8% 12.7% $462.2 $468.7 $-6.5 -1.4% TOTAL REVENUES Nonoperating revenues for the year ended June 30, 2007 were approximately $780,100 as compared to approximately $764,600 for the year ended June 30, 2006. Nonoperating revenue is comprised of interest earned on invested cash. The increase of approximately $15,500 is primarily due to higher interest rates in Fiscal Year 2007. Total revenues were $463.1 million for the year ended June 30, 2007 as compared to $469.5 million for the year ended June 30, 2006. As mentioned above, the decrease was due to the decrease in sales revenues. MAJOR EXPENSES $303.1 million of the Lottery’s total operating expenses of $323.1 million for the year ended June 30, 2007 were incurred in direct support of the sales of Lottery games. These expenses include prize expense, retailer commissions and incentives, purchases of Scratchers tickets, telecommunication network costs, compensation to the vendor for Scratchers ticket distribution and compensation to the vendor who maintains and supports the on-line gaming system. In comparison, $308.6 million of the Lottery’s total operating expenses of $328.3 million for the year ended June 30, 2006 were game-related expenses. -4- The following table compares the game-related expenses between fiscal years. All expenses are presented in millions of dollars. Game Related Expenses Prize Expense Retailer Commissions On-line System Expenses Scratchers System and Distribution Expenses Tickets Purchased Total FY 2007 FY 2006 Difference Percentage $257.5 31.1 8.2 2.2 4.1 $259.1 31.3 12.2 1.9 4.1 $-1.6 -.2 -4.0 .3 0 -.6% -.6% -32.8% 15.8% 0% $303.1 $308.6 $-5.5 -1.8% The decrease in prize expense, retailer commissions and tickets purchased is reflective of the decrease in product sales. See the product sales schedule above. The decrease in on-line system expenses is made up of two elements. On-line vendor fees are based on a contracted percentage of on-line sales and fees were reduced with the implementation of a new contract in Fiscal Year 2007. The second element is the telecommunications costs associated with the Lottery retailer network are now included in the on-line contractor’s fees, which decreased approximately $2,171,000 this fiscal year. The Lottery’s contract with an outside vendor for Scratchers ticket distribution and accounting services resulted in increased costs of approximately $251,500 over last fiscal year because of higher Scratchers sales. Of the $19.9 million in Fiscal Year 2007 in other operating expenses, $10.7 million was used for advertising and promotion and $6.1 million was used to compensate Lottery employees. In comparison, of the $19.7 million in Fiscal Year 2006 other operating expenses, $11.0 million was used for advertising and promotion and $5.7 million was used to compensate Lottery employees. TRANSFERS TO OTHER STATE FUNDS Note 3 to the financial statements details the amounts transferred to other State Funds. The Lottery transferred $139.9 million to other State Funds. The decrease in product sales of $6.5 million in this fiscal year resulted in a decrease of $1.2 million in the amount transferred to other State Funds. This year’s transfers were $19.5 million above the minimum transfers required in Lottery Statutes. OTHER FINANCIAL INFORMATION Statement of Net Assets FY 2007 FY 2006 Current Assets Capital Assets Other Assets — Deposit $68.1 4.1 7.1 $63.0 3.7 7.3 Total Assets 79.3 74.0 Current Liabilities 68.0 62.7 $11.3 $11.3 Net Assets -5- The Lottery’s total assets at June 30, 2007 were $79.3 million. Assets consisted of cash held substantially by the State Treasurer of $59.8 million, receivables from Lottery retailers for the sale of Lottery products of $4.3 million, Scratchers ticket inventory of $3.9 million, net investment in fixed assets of $4.2 million and a deposit with MUSL of $7.1 million. Comparable figures at June 30, 2006 were $74.0 million in total assets, including $56.6 million in cash held by the State Treasurer, $3.5 million in receivables from retailers, $2.9 million in Scratchers ticket inventory, net investment in fixed assets of $3.7 million and a MUSL deposit of $7.3 million. Total liabilities at June 30, 2007 were $68.0 million, consisting of $4.5 million in accounts payable and accrued expenses, prize liabilities of $33.5 million and amounts due to other State Funds of $30.0 million. All of the Lottery’s liabilities were current liabilities. The Lottery’s total liabilities at June 30, 2006 were $62.7 million, which consisted of $2.9 million of accounts payable and accrued expenses, prize liabilities of $34.8 million and amounts due to other State Funds of $25.0 million. All liabilities were current liabilities. Total net assets at June 30, 2007 were $11.4 million, an increase of $0.1 million or .8% over total net assets at June 30, 2006. $7.2 million of the Lottery’s total net assets are unrestricted. BUDGETARY HIGHLIGHTS The Lottery’s budget is set by the legislative appropriations process on a biennial basis. The budgets for Fiscal Years 2007 and 2006 were set in the regular legislative session of 2005. The Lottery’s budget was amended in the regular legislative session of 2006. The Lottery’s appropriation for sales-related expenditures is based on approved percentages of projected revenues and is allowed to increase for these items without a supplemental appropriations request if actual revenues exceed projected revenues. The appropriation does not include an amount for prizes because Lottery statutes set this amount at “not less than fifty percent of the total annual revenues accruing from the sale of Lottery tickets or shares.” The Lottery’s appropriation was $71.4 million at the beginning of the year and decreased to $70.5 million as actual revenues did not meet budgeted projections. CONTACTING THE LOTTERY’S FINANCIAL MANAGEMENT This management’s discussion and analysis (“MD&A”) is designed to provide Arizona citizens, Arizona government officials, our players, retailers and other interested parties with an overview of the Lottery’s financial activity for Fiscal Year 2007 and to demonstrate the Lottery’s accountability for the money it received from the sale of Lottery products. If you have questions about the MD&A or need additional information, contact the Arizona Lottery’s Director of Audit and Accounting, 4740 East University, Phoenix, Arizona 85034. -6- ARIZONA STATE LOTTERY, A COMPONENT UNIT OF THE STATE OF ARIZONA PROPRIETARY FUND — ENTERPRISE FUND STATEMENT OF NET ASSETS AS OF JUNE 30, 2007 (With comparative totals for June 30, 2006) 2007 2006 ASSETS CURRENT ASSETS: Cash — substantially all held by the State Treasurer Accounts receivable — net of allowance for doubtful accounts of $145,000 and $155,000, respectively Scratch ticket inventory $ 59,850,581 $ 56,615,737 4,265,176 3,946,174 3,489,195 2,897,235 68,061,931 63,002,167 937,830 330,865 3,488,840 2,577,775 118,319 (3,298,892) 937,830 330,865 3,299,667 4,074,410 171,859 (5,142,216) 4,154,737 3,672,415 7,128,149 7,315,835 79,344,817 73,990,417 CURRENT LIABILITIES: Accounts payable and accrued expenses Prize liability Due to other state funds 4,472,896 33,484,616 30,005,031 2,862,236 34,855,944 24,980,485 TOTAL 67,962,543 62,698,665 INVESTED IN CAPITAL ASSETS 4,154,737 3,672,415 UNRESTRICTED 7,227,537 7,619,337 $ 11,382,274 $ 11,291,752 Total current assets CAPITAL ASSETS: Land Land improvements Buildings Furniture, fixtures, and equipment Construction in progress Less accumulated depreciation Total capital assets OTHER ASSETS — Deposit — Powerball TOTAL LIABILITIES NET ASSETS TOTAL See notes to financial statements. -7- ARIZONA STATE LOTTERY, A COMPONENT UNIT OF THE STATE OF ARIZONA PROPRIETARY FUND — ENTERPRISE FUND STATEMENT OF REVENUES, EXPENSES, AND CHANGES IN FUND NET ASSETS FOR THE YEAR ENDED JUNE 30, 2007 (With comparative totals for the year ended June 30, 2006) 2007 OPERATING REVENUES: Ticket sales: Scratchers Economic development Powerball The Pick Pick 5 Pick 3 2006 $ 250,680,198 10,338,253 127,278,294 52,410,989 12,566,113 8,926,133 $ 234,854,290 14,975,015 157,891,886 43,064,318 9,988,384 7,922,934 462,199,980 468,696,827 100,213 81,408 462,300,193 468,778,235 257,493,027 31,121,336 8,171,753 2,174,504 4,152,149 259,093,779 31,275,665 12,187,053 1,923,011 4,092,461 Total direct costs 303,112,769 308,571,969 Advertising and promotion Wages and related expenses Contract services Depreciation Administrative expenses 10,683,681 6,118,238 368,051 260,370 2,531,722 10,986,062 5,656,855 316,568 214,706 2,601,547 323,074,831 328,347,707 139,225,362 140,430,528 780,136 764,556 INCOME BEFORE TRANSFERS 140,005,498 141,195,084 TRANSFERS TO OTHER STATE FUNDS 139,914,976 141,123,619 90,522 71,465 11,291,752 11,220,287 $ 11,382,274 $ 11,291,752 Total ticket sales Other operating revenue Total operating revenues OPERATING EXPENSES: Direct costs: Prize expense Retailer commissions and incentives On-line system expenses Scratcher system and distribution expenses Tickets purchased Total operating expenses OPERATING INCOME NONOPERATING REVENUES CHANGE IN FUND NET ASSETS FUND NET ASSETS — Beginning of year FUND NET ASSETS — End of year See notes to financial statements. -8- ARIZONA STATE LOTTERY, A COMPONENT UNIT OF THE STATE OF ARIZONA PROPRIETARY FUND — ENTERPRISE FUND STATEMENT OF CASH FLOWS FOR THE YEAR ENDED JUNE 30, 2007 (With comparative totals for the year ended June 30, 2006) CASH FLOWS FROM OPERATING ACTIVITIES: Cash received from retailers — net of commission and incentives Cash from other sources Cash payments for prizes and related taxes Cash payments to suppliers of goods or services Cash payments to employees 2007 2006 $ 248,496,403 40,594,066 (117,034,564) (27,743,259) (6,131,058) $ 267,416,157 13,151,549 (94,667,102) (32,971,691) (5,554,550) Net cash provided by operating activities 138,181,588 147,374,363 CASH FLOWS FROM NONCAPITAL FINANCING ACTIVITIES — Cash payments to beneficiaries per Lottery Statutes (134,890,430) (140,836,668) CASH FLOWS FROM CAPITAL FINANCING ACTIVITIES — Payments for acquisition of capital assets (738,038) (412,853) 681,724 297,719 NET INCREASE IN CASH 3,234,844 6,422,561 CASH — Beginning of year 56,615,737 50,193,176 CASH FLOWS FROM INVESTING ACTIVITIES — Receipts of interest CASH — End of year $ RECONCILIATION OF OPERATING INCOME TO NET CASH PROVIDED BY OPERATING ACTIVITIES: Operating income $ 139,225,362 $ 140,430,528 260,370 7,337 214,706 3,158 Adjustments to reconcile operating income to net cash provided by operating activities: Depreciation Loss on disposal of equipment Changes in assets and liabilities: Accounts receivable and due from other State agencies Ticket inventory Deposit — Powerball Accounts payable and accrued expenses Prizes and withholdings payable Total adjustments NET CASH PROVIDED BY OPERATING ACTIVITIES 59,850,581 -9- 56,615,737 (677,569) (1,048,939) 187,686 1,598,669 (1,371,328) 3,365,262 (569,769) (586,286) (270,689) 4,787,453 (1,043,774) 6,943,835 $ 138,181,588 See notes to financial statements. $ $ 147,374,363 ARIZONA STATE LOTTERY, A COMPONENT UNIT OF THE STATE OF ARIZONA NOTES TO FINANCIAL STATEMENTS AS OF AND FOR THE YEAR ENDED JUNE 30, 2007 1. DESCRIPTION OF OPERATIONS The Arizona State Lottery (the “Lottery”) was created by enactment of Title 5, Chapter 5 to the Arizona Revised Statutes (“ARS”), which was an initiative measure approved by the voters of the State of Arizona in 1980. The Lottery commenced operations in 1981. The Lottery is a component unit of the State of Arizona (the “State”). The accompanying financial statements present information as to the transactions of the Lottery. For the period July 1, 2006 through June 30, 2007, the Lottery held 102 instant games (games 400-401, 404, 416, 417, 419-420, 430-431, 439-440, 446-447, 449-453, 455-459, 461-463, 465-475, 477-498, 500-501, 503-512, 514-523, 526-528, 530, 532-535, 537-540, 542-544, 546-547, 549, and 554), three of which were Economic Development games (games 449, 459, and 502). During 2007, the Lottery continued the “Pick 3,” “Pick 5,” “The Pick,” and “Powerball” on-line games. As required, the Lottery has a deposit with “Powerball,” a multistate on-line lottery game, of $7,128,149. 2. SIGNIFICANT ACCOUNTING POLICIES The Lottery prepares its financial statements in accordance with accounting principles generally accepted in the United States of America. State Lottery Fund — The State Lottery Fund (the “Fund”), which is an Enterprise Fund of the State of Arizona, accounts for revenues received from the sale of lottery tickets and the receipt of license fees. The Fund is operated in a manner similar to a private business enterprise where the governing body has decided that periodic determination of revenues earned, expenses incurred, and net income is appropriate for capital maintenance, management control, accountability, or other purposes. Activities accounted for in the proprietary fund follow all applicable Government Accounting Standards Board (“GASB”) pronouncements as well as applicable Financial Accounting Standards Board (“FASB”) pronouncements issued on or before November 30, 1989. The Fund accounts for prize payments, operational expenses, including consulting, promotional, and advertising expenses, and transfers of monies to other State funds. Receipts from each type of lottery game are to be allocated as follows: • Not less than 50% of the total annual revenue from lottery ticket sales is apportioned for the payment of prizes to the holders of winning tickets for the period July 1, 2006 to June 30, 2007. • During the period of July 1, 2006 to June 30, 2007, not less than 29% of receipts for “Pick 5,” “Pick 3,” and “The Pick,” not less than 31.6% of receipts for “Powerball,” and not less than 21.5% of receipts for instant games must be apportioned for transfer to a designated State fund. • Expenditures related to promotional or advertising services are restricted to not more than 4.0% of the total annual gross revenues of the Lottery. Legislative appropriation further restricted advertising expenditures during 2007 to 2.7% of the gross revenues or $11 million, whichever is less. All other receipts can be used by the Lottery for operations, subject to legislative appropriation, or transferred to other State funds. - 10 - In addition, State statute requires that 30% of all unclaimed prizes be transferred to the Court Appointed Special Advocate Account, a fund within the State’s General Fund. Ticket Sales and Revenue Recognition — Revenue is recognized and the related direct expenses of ticket sales are accrued based upon the known relationship of the amount of ticket sales to the amount of prizes for each game. This method of measuring revenue is necessary in order to properly match revenues and expenses. Property and Equipment — Property and equipment of the Fund, which consists principally of buildings, land, land improvements, and office furniture and equipment are stated at historical cost. Expenditures for normal repairs and maintenance are charged to operations as incurred, whereas expenditures for major renewals, replacements, and betterments are capitalized and depreciated. Depreciation is provided for as follows: Buildings Land improvements Furniture, fixtures, and computer equipment Method Estimated Useful Life Straight-line Straight-line Straight-line 40 years 20 years 5–7 years Investment Income — Investment income from all investments is recognized in the Fund, which includes invested cash held by the State Treasurer and invested prize reserves held by the Multi-State Lottery Association. Ticket Inventory — Ticket inventory is stated at cost, which represents the amount incurred by the Lottery for purchasing the tickets. Cash — Substantially, all the Lottery’s cash is held by the State Treasurer for pooled investment purposes. Statutes require the State Treasurer to invest these pooled funds in obligations of the U.S. government and are recorded at fair value. Compensated Absences — Vacation leave vests with the employee as it is earned. Employees may carry forward only the amount of vacation benefits equal to the maximum allowable accumulated credits for the preceding calendar year. Accordingly, at June 30, 2007, the Fund’s accounts payable balance includes an accrual of vacation pay and related benefits of approximately $347,850. Upon termination or retirement, an employee will be compensated for accumulated leave up to a maximum of 240 hours, dependent upon accumulated time and the individual’s benefits associated with their rank as defined by State personnel rule #R2-5-403. Payment will be based on the individual’s rate of pay at termination or retirement. Upon death, the same benefits shall be paid to the employee’s beneficiary. 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 these estimates. - 11 - 3. TRANSFERS AND STATUTORY REQUIREMENTS The Lottery made the following transfers during the year ended June 30, 2007, as required by ARS Section 5-505. Transfers to the State of Arizona: County Assistance Fund Court Appointed Special Advocate Account Department of Gaming Economic Development Commission Fund General Fund Healthy Arizona Fund Heritage Fund Local Transportation Assistance Fund $ 7,650,000 2,666,176 300,000 2,920,700 52,922,300 20,672,000 20,000,000 32,783,800 $ 139,914,976 Total transfers to other State of Arizona funds These transactions met the minimum percentage requirements imposed upon the Lottery by statute. 4. CAPITAL ASSETS Capital assets activity for the year ended June 30, 2007, was as follows: Beginning Balance Capital assets: Land Land improvements Buildings Furniture, fixtures, and equipment Construction in progress Total capital assets Less accumulated depreciation for: Land improvements Buildings Furniture, fixtures, and equipment Total accumulated depreciation Total capital assets — net $ 937,830 330,865 3,299,667 4,074,410 171,859 Increases $ - Decreases $ - (2,111,031) 8,814,631 750,029 (2,111,031) (313,547) (1,281,586) (3,547,083) (16,347) (95,849) (148,174) 2,103,694 (5,142,216) (260,370) 2,103,694 $ 3,672,415 $ - $ (189,173) 937,830 330,865 3,299,667 2,577,775 307,492 - 7,453,629 189,173 614,396 135,633 $ 489,659 $ (7,337) Ending Balance Transfers (329,894) (1,377,435) (1,591,563) $ - (3,298,892) $ 4,154,737 5. PRIZE LIABILITY Prize liability activity for the year ended June 30, 2007, was as follows: Beginning Balance Prize liability $ 34,855,944 Increases $ 260,406,216 - 12 - Decreases $ (261,777,544) Ending Balance $ 33,484,616 6. COMMITMENTS The Lottery enters into various contracts for goods and services during the normal course of its business. All contacts and purchasing activity are subject to the Arizona State Procurement Code and the rules of the Arizona State Procurement Office. All contracts have incorporated into them the “Standard Terms and Conditions” as required by the Arizona State Procurement Office. These terms and conditions in all the contracts allow for cancellation for lack of funding in the current fiscal year or next fiscal year. The contract may also be terminated for the Lottery’s convenience at any time with no penalty when it is in the best interest of the State. Net rental expense for the years ended June 30, 2007 and 2006, was $60,287 and $55,263, respectively. Effective September 1, 2006, the Lottery entered into a five-year contract with G-Tech Services, Inc. for computer processing services at a base contract rate of 3.5455% of on-line sales. 7. CONTINGENCIES Annuities are purchased for all prizes over $400,000 for which winners will receive the jackpot in annual installments for The Pick on-line game. These annuities are purchased from qualifying insurance companies, which have the highest ratings from among A.M. Best Company, Standard & Poor’s, Moody, Duff & Phelps, or Weiss. The Lottery remains contingently liable on all annuities. Aggregate future payments to prize winners on existing annuities totaled approximately $126,954,000 at June 30, 2007. Approximately $97,439,000 of the total aggregate future payments at June 30, 2007, relate to annuities purchased from five separate insurance companies, of which approximately $34,112,000 relates to a single insurance company. The Lottery is involved in various legal proceedings, which arose in the normal course of business. Management of the Lottery does not believe that the ultimate resolution of these matters will have a material effect on the financial position, results of operations, or cash flows of the Lottery. 8. RETIREMENT PLAN Permanent, full-time employees of the Lottery are covered by the Arizona State Retirement Plan (the “Plan”), a retirement plan administered by the Arizona State Retirement System (“ASRS”), which is a multiple employer, cost-sharing pension plan. The Comprehensive Annual Financial Report of the ASRS can be obtained by accessing www.azasrs.gov. The Plan was established by the State to provide benefits for employees of the State and employees of participating political subdivisions and school districts. The Plan became effective on July 1, 1971. By actuarial computation, employee member contributions to the Plan were fixed at 8.60%, 6.90%, and 5.20% of their compensation for the years ended June 30, 2007, 2006, and 2005, respectively, with the contributions made through payroll deduction. Employee contributions vest immediately. Total contributions to the Plan for the years ended June 30, 2007, 2006, and 2005 by the Lottery’s covered employees were $382,129, $287,330, and $214,819, respectively. Matching employer member contributions were actuarially determined and fixed at 8.60%, 6.90%, and 5.20% of the compensation of all employee members for the years ended June 30, 2007, 2006, and 2005, respectively. Total matching contributions to the Plan for the years ended June 30, 2007, 2006, and 2005 by the Lottery were $382,129, $287,330, and $214,819, respectively. In the event the Plan’s actuary determines that additional contributions are needed in order to amortize an unfunded accrued liability, every employer member will be required to contribute the revised contribution percentage that is set by the Plan. - 13 - All full-time employees of the Lottery are required to become members of the Plan. The Lottery’s total payroll for employees covered by this Plan for the years ended June 30, 2007, 2006, and 2005 was $4,495,657, $4,272,430, and $4,163,347, respectively. Contributions to the Plan by the Lottery for its covered employees become fully vested immediately after membership in the Plan. All required employer contributions were made to the Plan within 30 days after June 30, 2007. ****** - 14 - SUPPLEMENTAL SCHEDULE - 15 - ARIZONA STATE LOTTERY, A COMPONENT UNIT OF THE STATE OF ARIZONA SUPPLEMENTAL SCHEDULE OF GROSS PROFIT BY GAME FOR GAMES EXPIRING DURING THE YEAR ENDED JUNE 30, 2007 Game 400 TICKET SALES $ 21,628,112 DIRECT EXPENSES: Commissions Game 401 100.00 % $ 41,499,908 Game 404 100.00 % $ 11,292,315 100.00 % 1,405,827 6.50 2,697,494 6.50 734,001 6.50 12,976,867 900,999 60.00 4.17 20,749,954 6,027,199 50.00 14.52 4,516,926 2,612,350 40.00 23.13 Total prizes 13,877,866 64.17 26,777,153 64.52 7,129,276 63.13 Ticket purchases Advertising 396,460 1.83 729,957 1.76 141,384 278,664 1.25 2.47 15,680,153 72.50 30,204,604 72.78 8,283,325 73.35 $ 5,947,959 27.50 $ 11,295,304 27.22 $ 3,008,990 26.65 Prizes — low tier Prizes — high tier Total direct expenses GROSS PROFIT BY GAME Game 416 TICKET SALES $ 2,634,646 DIRECT EXPENSES: Commissions Game 417 100.00 % $ 2,238,619 Game 419 100.00 % $ 3,312,272 100.00 % 171,252 6.50 145,511 6.50 215,297 6.50 1,264,631 296,050 48.00 11.24 1,186,468 66,828 53.00 2.99 1,523,645 488,700 46.00 14.75 Total prizes 1,560,681 59.24 1,253,296 55.99 2,012,345 60.75 Ticket purchases Advertising 84,102 3.19 40,819 1.82 44,787 1.35 1,816,035 68.93 1,439,626 64.31 2,272,429 68.61 818,611 31.07 798,993 35.69 $ 1,039,843 31.39 Prizes — low tier Prizes — high tier Total direct expenses GROSS PROFIT BY GAME $ $ Game 420 TICKET SALES $ 2,222,759 DIRECT EXPENSES: Commissions Game 430 100.00 % $ 2,694,844 Game 440 100.00 % $ 10,029,750 100.00 % 144,480 6.50 175,165 6.50 651,934 6.50 1,155,835 103,249 52.00 4.65 1,266,577 355,251 47.00 13.18 3,425,160 2,623,050 34.15 26.15 Total prizes 1,259,084 56.65 1,621,828 60.18 6,048,210 60.30 Ticket purchases Advertising 40,792 1.84 43,860 1.63 60,019 0.60 1,444,356 64.98 1,840,853 68.31 6,760,163 67.40 778,403 35.02 853,991 31.69 $ 3,269,587 32.60 Prizes — low tier Prizes — high tier Total direct expenses GROSS PROFIT BY GAME $ $ (Continued) - 16 - ARIZONA STATE LOTTERY, A COMPONENT UNIT OF THE STATE OF ARIZONA SUPPLEMENTAL SCHEDULE OF GROSS PROFIT BY GAME FOR GAMES EXPIRING DURING THE YEAR ENDED JUNE 30, 2007 Game 443 TICKET SALES $ 9,323,460 DIRECT EXPENSES: Commissions Game 446 100.00 % $ 5,330,805 Game 447 100.00 % $ 1,676,727 100.00 % 606,025 6.50 346,503 6.50 108,988 6.50 3,729,384 2,271,320 40.00 24.36 2,665,402 695,440 50.00 13.05 855,131 84,600 51.00 5.05 Total prizes 6,000,704 64.36 3,360,842 63.05 939,731 56.05 Ticket purchases Advertising 66,951 15,381 0.72 0.16 105,668 186,046 1.98 3.49 42,336 2.52 6,689,061 71.74 3,999,059 75.02 1,091,055 65.07 $ 2,634,399 28.26 $ 1,331,746 24.98 $ 585,672 34.93 Prizes — low tier Prizes — high tier Total direct expenses GROSS PROFIT BY GAME Game 449 TICKET SALES $ 4,443,010 DIRECT EXPENSES: Commissions Game 450 100.00 % $ 1,230,239 Game 452 100.00 % $ 1,246,981 100.00 % 288,797 6.50 79,966 6.50 81,053 6.50 Prizes—low tier Prizes—high tier 1,599,487 1,020,501 36.00 22.97 627,422 67,950 51.00 5.52 660,900 40,280 53.00 3.23 Total prizes 2,619,988 58.97 695,372 56.52 701,180 56.23 Ticket purchases Advertising 94,497 2.13 26,624 2.17 26,624 2.14 3,003,282 67.60 801,962 65.19 808,857 64.87 $ 1,439,728 32.40 428,277 34.81 $ 438,124 35.13 Total direct expenses GROSS PROFIT BY GAME $ Game 455 TICKET SALES $ 1,234,781 DIRECT EXPENSES: Commissions Game 456 100.00 % $ 2,095,872 Game 457 100.00 % $ 2,930,446 100.00 % 80,261 6.50 136,232 6.50 190,479 6.50 Prizes—low tier Prizes—high tier 617,391 79,760 50.00 6.46 1,006,019 247,350 48.00 11.80 1,406,614 336,550 48.00 11.48 Total prizes 697,151 56.46 1,253,369 59.80 1,743,164 59.48 Ticket purchases Advertising 30,542 2.47 84,261 4.02 45,504 1.56 807,954 65.43 1,473,862 70.32 1,979,147 67.54 426,827 34.57 622,010 29.68 $ 951,299 32.46 Total direct expenses GROSS PROFIT BY GAME $ $ (Continued) - 17 - ARIZONA STATE LOTTERY, A COMPONENT UNIT OF THE STATE OF ARIZONA SUPPLEMENTAL SCHEDULE OF GROSS PROFIT BY GAME FOR GAMES EXPIRING DURING THE YEAR ENDED JUNE 30, 2007 Game 458 TICKET SALES $ 3,337,501 DIRECT EXPENSES: Commissions Game 459 100.00 % $ 2,487,350 Game 461 100.00 % $ 22,468,545 100.00 % 216,939 6.50 161,677 6.50 1,460,456 6.50 1,787,608 100,100 53.56 3.00 1,218,802 260,570 49.00 10.48 7,289,577 6,099,700 32.44 27.15 Total prizes 1,887,708 56.56 1,479,372 59.48 13,389,277 59.59 Ticket purchases Advertising 75,694 2.27 38,199 1.53 253,762 1.13 2,180,341 65.33 1,679,248 67.51 15,103,495 67.22 $ 1,157,160 34.67 808,102 32.49 $ 7,365,050 32.78 Prizes — low tier Prizes — high tier Total direct expenses GROSS PROFIT BY GAME $ Game 462 TICKET SALES $ 1,046,126 DIRECT EXPENSES: Commissions Game 463 100.00 % $ 1,680,750 Game 465 100.00 % $ 14,721,620 100.00 % 67,998 6.50 109,252 6.50 956,906 6.50 491,679 90,950 47.00 8.69 649,890 515,895 38.67 30.69 5,112,818 3,695,950 34.73 25.11 Total prizes 582,629 55.69 1,165,785 69.36 8,808,768 59.84 Ticket purchases Advertising 30,542 2.92 62,186 459,385 3.70 27.33 86,551 0.58 681,169 65.11 1,796,608 106.89 9,852,225 66.92 364,957 34.89 $ 4,869,395 33.08 Prizes — low tier Prizes — high tier Total direct expenses GROSS PROFIT BY GAME $ $ Game 466 (6.89) Game 467 100.00 % 60,706 6.50 119,006 6.50 74,356 6.50 476,306 45,070 51.00 4.83 823,886 252,350 45.00 13.78 571,965 70,580 50.00 6.17 Total prizes 521,376 55.83 1,076,236 58.78 642,545 56.17 Ticket purchases Advertising 30,535 3.27 35,422 1.93 27,046 2.36 612,617 65.60 1,230,664 67.21 743,947 65.03 321,317 34.40 600,194 32.78 399,983 34.97 DIRECT EXPENSES: Commissions Prizes — low tier Prizes — high tier Total direct expenses GROSS PROFIT BY GAME $ $ 1,830,858 Game 469 933,934 TICKET SALES $ (115,858) $ 100.00 % $ 1,143,930 $ 100.00 % (Continued) - 18 - ARIZONA STATE LOTTERY, A COMPONENT UNIT OF THE STATE OF ARIZONA SUPPLEMENTAL SCHEDULE OF GROSS PROFIT BY GAME FOR GAMES EXPIRING DURING THE YEAR ENDED JUNE 30, 2007 Game 470 TICKET SALES $ 1,674,516 DIRECT EXPENSES: Commissions Game 471 100.00 % $ 1,146,273 Game 472 100.00 % $ 1,150,876 100.00 % 108,845 6.50 74,508 6.50 74,807 6.50 775,859 398,015 46.33 23.77 626,631 61,520 54.67 5.37 606,130 44,900 52.67 3.90 Total prizes 1,173,874 70.10 688,151 60.04 651,030 56.57 Ticket purchases Advertising 139,399 18,217 8.33 1.09 27,026 138,449 2.36 12.07 27,088 138,449 2.35 12.03 1,440,335 86.02 928,134 80.97 891,374 77.45 234,181 13.98 218,139 19.03 259,502 22.55 Prizes — low tier Prizes — high tier Total direct expenses GROSS PROFIT BY GAME $ $ Game 473 TICKET SALES $ 1,742,512 DIRECT EXPENSES: Commissions $ Game 474 100.00 % $ 2,133,636 Game 475 100.00 % $ 1,171,041 100.00 % 113,263 6.50 138,687 6.50 76,118 6.50 940,956 132,460 54.00 7.60 1,095,266 259,160 51.33 12.14 573,810 86,600 49.00 7.40 Total prizes 1,073,416 61.60 1,354,426 63.47 660,410 56.40 Ticket purchases Advertising 47,605 138,449 2.73 7.95 59,871 202,869 2.81 9.51 30,460 2.60 1,372,733 78.78 1,755,853 82.29 766,988 65.50 369,779 21.22 377,783 17.71 404,053 34.50 Prizes — low tier Prizes — high tier Total direct expenses GROSS PROFIT BY GAME $ $ Game 477 TICKET SALES DIRECT EXPENSES: Commissions $ 10,636,250 Game 482 100.00 % $ $ Game 486 935,346 100.00 % $ 5,623,390 100.00 % 691,356 6.50 60,798 6.50 365,521 6.50 3,533,363 2,855,750 33.22 26.85 467,673 60,900 50.00 6.51 2,399,315 1,190,700 42.67 21.17 Total prizes 6,389,113 60.07 528,573 56.51 3,590,015 63.84 Ticket purchases Advertising 74,634 10,447 0.70 0.10 30,281 3.24 189,749 3.38 7,165,550 67.37 619,652 66.25 4,145,285 73.72 $ 3,470,700 32.63 315,694 33.75 $ 1,478,105 26.28 Prizes — low tier Prizes — high tier Total direct expenses GROSS PROFIT BY GAME $ (Continued) - 19 - ARIZONA STATE LOTTERY, A COMPONENT UNIT OF THE STATE OF ARIZONA SUPPLEMENTAL SCHEDULE OF GROSS PROFIT BY GAME FOR GAMES EXPIRING DURING THE YEAR ENDED JUNE 30, 2007 Game 488 TICKET SALES $ 1,556,183 DIRECT EXPENSES: Commissions Game 492 100.00 % $ Game 493 793,465 100.00 % $ 751,709 100.00 % 101,154 6.50 51,576 6.50 48,861 6.50 793,653 77,960 51.00 5.01 380,863 64,820 48.00 8.17 345,786 78,000 46.00 10.38 Total prizes 871,613 56.01 445,683 56.17 423,786 56.38 Ticket purchases Advertising 39,273 2.52 35,669 4.49 35,902 4.78 1,012,040 65.03 532,928 67.16 508,549 67.66 544,143 34.97 260,537 32.84 243,160 32.35 Prizes — low tier Prizes — high tier Total direct expenses GROSS PROFIT BY GAME $ $ Game 494 TICKET SALES $ 2,045,050 DIRECT EXPENSES: Commissions $ Game 495 100.00 % $ 2,153,924 Game 497 100.00 % $ 776,858 100.00 % 132,928 6.50 140,005 6.50 50,496 6.50 981,624 241,850 48.00 11.83 1,012,344 273,670 47.00 12.71 380,660 54,150 49.00 6.97 Total prizes 1,223,474 59.83 1,286,014 59.71 434,810 55.97 Ticket purchases Advertising 35,224 1.72 35,368 1.64 35,662 32,128 4.59 4.14 1,391,626 68.05 1,461,387 67.85 553,096 71.20 653,424 31.95 692,537 32.15 223,762 28.80 Prizes — low tier Prizes — high tier Total direct expenses GROSS PROFIT BY GAME $ $ $ Game 507 640,544 100.00 % 41,636 6.50 301,056 56,140 47.00 8.76 Total prizes 357,196 55.76 Ticket purchases Advertising 35,747 5.59 434,579 67.85 205,965 32.15 TICKET SALES $ DIRECT EXPENSES: Commissions Prizes — low tier Prizes — high tier Total direct expenses GROSS PROFIT BY GAME $ (Continued) - 20 - ARIZONA STATE LOTTERY, A COMPONENT UNIT OF THE STATE OF ARIZONA SUPPLEMENTAL SCHEDULE OF GROSS PROFIT BY GAME FOR GAMES EXPIRING DURING THE YEAR ENDED JUNE 30, 2007 Pick Drawings January 1, 2006 to December 31, 2006 TICKET SALES DIRECT EXPENSES: Commissions Total prizes Advertising Total direct expenses GROSS PROFIT BY GAME $ 42,266,503 100.00 % Pick 5 Drawings January 1, 2006 to December 31, 2006 $ 11,225,072 100.00 % Powerball Drawings January 1, 2006 to December 31, 2006 $ 141,695,349 100.00 % 2,747,312 21,999,666 1,255,617 6.50 52.05 2.97 729,617 5,487,019 93,458 6.50 48.88 0.83 9,210,190 70,847,675 1,146,475 6.50 50.00 0.81 26,002,595 61.52 6,310,094 56.21 81,204,340 57.31 $ 16,263,908 38.48 $ 4,914,978 43.79 $ 60,491,009 42.69 Pick 3 Drawings January 1, 2006 to December 31, 2006 TICKET SALES DIRECT EXPENSES: Commissions Total prizes Advertising Total direct expenses GROSS PROFIT BY GAME NOTE: $ 8,353,000 100.00 % 542,941 4,176,500 72,052 6.50 50.00 0.86 4,791,493 57.36 $ 3,561,507 42.64 After the announced completion of ticket sales for each game, customers have a 180-day period in which to redeem their winning tickets. The above gross profit information includes games in which the 180-day grace period expired during the fiscal year ended June 30, 2007. - 21 - (Concluded)