Arizona State Lottery, A Component Unit of the State of Arizona Financial Statements as of and for the Year Ended June 30, 2008, Supplemental Schedule for the Year Ended June 30, 2008, 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–ii INDEPENDENT AUDITORS’ REPORT 1–2 MANAGEMENT’S DISCUSSION AND ANALYSIS 3–6 FINANCIAL STATEMENTS AS OF AND FOR THE YEAR ENDED JUNE 30, 2008: 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, 2008 — Schedule of Gross Profit by Game for Games Expiring During the Year 10–14 15 16–21 DCS0525212 Proofread/Unprotected v16 Preliminary Draft — For Discussion Purposes Only 2344228_27.DOC To be returned to Deloitte & Touche LLP and not to be reproduced in any form without their permission 3/6/2009 8:19 AM January 23, 2009 Dear Arizona Lottery Commissioners: The Arizona Lottery is pleased to submit its audited financial statements as of and for the year ended June 30, 2008, 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 schedule 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 27 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 2008, the Arizona Lottery had revenues of $472.9 million from Lottery ticket sales, 2.3% more than last fiscal year, and an income before transfers of $144.6 million, 3.3% more than last fiscal year. More than $262 million was paid to our players in prizes and our retail partners received $31.3 million for sales commissions. In its 27 years of operation, the Lottery has produced nearly $6.9 billion in Lottery ticket sales. In fiscal year 2008, the Arizona Lottery made transfers to other State Funds of $34.5 million for the Local Transportation Assistance Fund, $7.7 million for the County Assistance Fund, $20.0 million for the Heritage Fund, $3.6 million for the Economic Development Fund, $0.3 million i i DCS0525212 Proofread/Unprotected v16 Preliminary Draft — For Discussion Purposes Only 2344228_27.DOC To be returned to Deloitte & Touche LLP and not to be reproduced in any form without their permission 3/6/2009 8:19 AM Arizona Lottery Commissioners Page 2 for the Department of Gaming, $21.3 million for the Healthy Arizona Fund, $1.0 million to the Department of Economic Security for homeless shelters and $53.5 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, $144.5 million was transferred to other State Funds for fiscal year 2008. In its 27 years of operation, the Lottery has returned over $2.2 billion to its beneficiaries. Further financial results for fiscal year 2008 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, 2008 (with comparative totals 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 (with comparative totals for the year ended June 30, 2007). 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. The prior year comparative totals information has been derived from the Lottery’s 2007 financial statements and, in our report dated February 27, 2008, we expressed an unqualified opinion on those financial statements. 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 of America. 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, 2008, and the changes in its 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. In accordance with Government Auditing Standards, we have also issued our report dated January 23, 2009, 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. January 23, 2009 -2- ARIZONA STATE LOTTERY, A COMPONENT UNIT OF THE STATE OF ARIZONA PROPRIETARY FUND — ENTERPRISE FUND MANAGEMENT’S DISCUSSION AND ANALYSIS AS OF AND FOR THE YEAR ENDED JUNE 30, 2008 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 as of and for the year ended June 30, 2008, 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, 2008, with comparative totals for June 30, 2007. The statement of net assets; the statement of revenues, expenses, and changes in Fund 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 12-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. Fund 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 12-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 Lottery’s Multistate Lottery Association (MUSL) unreserved account for interest earned on prize reserves at MUSL. 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, 2008 were higher than Fiscal Year 2007. As shown in the financial statements, sales increased 2.3% from the prior year, from $462.2 ® million in Fiscal Year 2007 to $472.9 million in the current year. The increases in Powerball , The Pick, Pick 5™, and Pick 3™ sales, and the introduction of the Arizona Raffle™ and Fast Play™ games more than offset the decrease in ScratchersSM sales. 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 Arizona Raffle Pick 3 Fast Play Total FY 2008 FY 2007 $252.5 130.4 52.6 14.2 11.9 9.5 1.8 $261.0 127.3 52.4 12.6 $472.9 $462.2 8.9 Difference Percentage -$8.5 3.1 0.2 1.6 11.9 0.6 1.8 -3.3% 2.4% 0.4% 12.7% 100.0% 6.7% 100.0% $10.7 2.3% Total Revenues Nonoperating revenues for the year ended June 30, 2008, were approximately $1,135,100 as compared to approximately $780,100 for the year ended June 30, 2007. Nonoperating revenue is comprised of interest earned on invested cash and periodic recognition of commissions earned by the Lottery. Total revenues were $474.2 million for the year ended June 30, 2008, as compared to $463.1 million for the year ended June 30, 2007. As mentioned above, most of the increase was due to an increase in sales revenues. Major Expenses $309.6 million of the Lottery’s total operating expenses of $329.6 million for the year ended June 30, 2008 were incurred in direct support of the sales of Lottery games. These expenses include prize expense, retailer commissions and incentives, purchases of Scratchers tickets, compensation to the vendor for Scratchers ticket distribution, and compensation to the vendor who maintains and supports the on-line gaming system. In comparison, $303.1 million of the Lottery’s total operating expenses of $323.1 million for the year ended June 30, 2007, 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 2008 FY 2007 Difference Percentage $262.5 31.3 8.9 2.1 4.8 $257.5 31.1 8.2 2.2 4.1 $5.0 0.2 0.7 -0.1 0.7 1.9% 0.6% 8.5% -4.5% 17.1% $309.6 $303.1 $6.5 2.1% The increase in prize expense, retailer commissions, and on-line system expenses is reflective of the increase in product sales. See the product sales schedule above. The increase in tickets purchased is related to the higher number of Scratchers games ended during the period and the inclusion of higher price point tickets that are costlier to print into the sales mix. The Lottery’s contract with an outside vendor for Scratchers ticket distribution and accounting services resulted in decreased costs of approximately $66,600 over last fiscal year because of lower Scratchers sales. Of the $20.0 million in Fiscal Year 2008 in other operating expenses, $10.8 million was used for advertising and promotion and $6.1 million was used to compensate Lottery employees. In comparison, of the $19.9 million in Fiscal Year 2007 other operating expenses, $10.7 million was used for advertising and promotion and $6.1 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 $144.5 million to other State Funds. The increase in product sales of $10.7 million in this fiscal year resulted in an increase of $4.6 million in the amount transferred to other State Funds. This year’s transfers were $17.6 million above the minimum transfers required in Lottery Statutes. Other Financial Information Statement of Net Assets FY 2008 FY 2007 Current Assets Capital Assets Other Assets — Deposit $64.5 4.0 7.8 $68.1 4.1 7.1 Total Assets 76.3 79.3 Current Liabilities 64.8 68.0 $11.5 $11.3 Net Assets The Lottery’s total assets at June 30, 2008, were $76.3 million. Assets consisted of cash held substantially by the State Treasurer of $55.8 million, receivables from Lottery retailers for the sale of Lottery products of $5.2 million, Scratchers ticket inventory of $3.5 million, net investment in fixed assets of $4.0 million, and a deposit with MUSL of $7.8 million. -5- Comparable figures at June 30, 2007, were $79.3 million in total assets, including $59.8 million in cash held by the State Treasurer, $4.3 million in receivables from retailers, $3.9 million in Scratchers ticket inventory, net investment in fixed assets of $4.2 million, and a MUSL deposit of $7.1 million. Total liabilities at June 30, 2008, were $64.8 million, consisting of $3.6 million in accounts payable and accrued expenses, prize liabilities of $34.3 million, and amounts due to other State Funds of $26.9 million. All of the Lottery’s liabilities were current liabilities. The Lottery’s total liabilities at June 30, 2007, were $68.0 million, which consisted of $4.5 million of accounts payable and accrued expenses, prize liabilities of $33.5 million, and amounts due to other State Funds of $30.0 million. All liabilities were current liabilities. Total net assets at June 30, 2008, were $11.5 million, an increase of $0.1 million or .9% over total net assets at June 30, 2007. $7.4 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 2008 and 2007 were set in the regular legislative session of 2007. The Lottery’s budget was amended in the regular legislative session of 2008. 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 50% of the total annual revenues accruing from the sale of Lottery tickets or shares.” The Lottery’s appropriation was $70.2 million at the beginning of the year and decreased to $69.6 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 2008 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, 2008 (With comparative totals for June 30, 2007) 2008 2007 ASSETS CURRENT ASSETS: Cash — substantially all held by the State Treasurer Accounts receivable — net of allowance for doubtful accounts of $145,000 and $145,000 in 2008 and 2007, respectively Scratch ticket inventory $ 55,850,443 $ 59,850,581 5,172,990 3,514,250 4,265,176 3,946,174 64,537,683 68,061,931 937,830 330,865 3,602,783 2,376,841 45,489 (3,292,008) 937,830 330,865 3,488,840 2,577,775 118,319 (3,298,892) 4,001,800 4,154,737 7,747,729 7,128,149 $ 76,287,212 $ 79,344,817 $ 3,644,267 34,273,436 26,879,603 $ 4,472,896 33,484,616 30,005,031 64,797,306 67,962,543 INVESTED IN CAPITAL ASSETS 4,001,800 4,154,737 UNRESTRICTED 7,488,106 7,227,537 $ 11,489,906 $ 11,382,274 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 CURRENT LIABILITIES: Accounts payable and accrued expenses Prize liability Due to other state funds TOTAL 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, 2008 (With comparative totals for the year ended June 30, 2007) 2008 OPERATING REVENUES: Ticket sales: Scratchers Economic development Powerball The Pick Pick 5 Arizona Raffle Pick 3 Fast Play 2007 $ 239,227,853 13,220,586 130,424,083 52,552,416 14,191,389 11,943,120 9,530,550 1,847,281 $ 250,680,198 10,338,253 127,278,294 52,410,989 12,566,113 472,937,278 462,199,980 114,916 100,213 473,052,194 462,300,193 262,486,159 31,312,957 8,890,551 2,107,944 4,756,628 257,493,027 31,121,336 8,171,753 2,174,504 4,152,149 Total direct costs 309,554,239 303,112,769 Advertising and promotion Wages and related expenses Contract services Depreciation Administrative expenses 10,816,867 6,095,428 348,976 316,099 2,447,080 10,683,681 6,118,238 368,051 260,370 2,531,722 329,578,689 323,074,831 143,473,505 139,225,362 1,135,098 780,136 INCOME BEFORE TRANSFERS 144,608,603 140,005,498 TRANSFERS TO OTHER STATE FUNDS 144,500,971 139,914,976 107,632 90,522 11,382,274 11,291,752 $ 11,489,906 $ 11,382,274 Total ticket sales Other operating revenues Total operating revenues OPERATING EXPENSES: Direct costs: Prize expense Retailer commissions and incentives On-line system expense Scratcher system and distribution expenses Tickets purchased Total operating expenses OPERATING INCOME NONOPERATING REVENUES — Interest earnings CHANGE IN FUND NET ASSETS FUND NET ASSETS — Beginning of year FUND NET ASSETS — End of year See notes to financial statements. -8- 8,926,133 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, 2008 (With comparative totals for the year ended June 30, 2007) CASH FLOWS FROM OPERATING ACTIVITIES: Cash received from retailers — net of commissions and incentives Cash received from other sources Cash payments for prizes and related taxes Cash payments to supplies of goods or services Cash payments to employees Net cash provided by operating activities CASH FLOWS USED BY NONCAPITAL FINANCING ACTIVITIES — Cash payments to beneficiaries per Lottery Statutes CASH FLOWS USED BY CAPITAL FINANCING ACTIVITIES — Payments for acquisition of capital assets CASH FLOWS FROM INVESTING ACTIVITIES — Receipts of interest 2008 2007 $ 262,696,646 10,412,785 (93,863,066) (29,955,778) (6,087,607) $ 248,496,403 40,594,066 (117,034,564) (27,743,259) (6,131,058) 143,202,980 138,181,588 (147,626,398) (134,890,430) (163,161) (738,038) 586,441 681,724 NET (DECREASE) INCREASE IN CASH (4,000,138) 3,234,844 CASH — Beginning of year 59,850,581 56,615,737 CASH — End of year $ 55,850,443 $ 59,850,581 RECONCILIATION OF OPERATING INCOME TO NET CASH PROVIDED BY OPERATING ACTIVITIES: Operating income $ 143,473,505 $ 139,225,362 316,099 43,589 260,370 7,337 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 (402,748) 431,924 (619,580) (828,629) 788,820 (677,569) (1,048,939) 187,686 1,598,669 (1,371,328) (270,525) (1,043,774) $ 143,202,980 See notes to financial statements. -9- $ 138,181,588 ARIZONA STATE LOTTERY, A COMPONENT UNIT OF THE STATE OF ARIZONA NOTES TO FINANCIAL STATEMENTS AS OF AND FOR THE YEAR ENDED JUNE 30, 2008 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. The financial statements include prior-year comparative information, but the notes to the financial statements omit prior-year information required for a presentation in conformity with generally accepted accounting principles. Accordingly, such prior-year information should be read in conjunction with the Lottery’s financial statements for the year ended June 30, 2007, from which the information was derived. For the period July 1, 2007 through June 30, 2008, the Lottery held 105 instant games (games 439, 453, 468, 478, 480-481, 483-485, 487, 489-491, 496, 498, 499-506, 508-535, 537-544, 546-547, 549-565, 567-590, 598, 600, and 603), four of which were Economic Development games (games 499, 502, 553 and 572). During 2008, the Lottery introduced its “Arizona Raffle” game, which was held twice during the fiscal year. During 2008, the Lottery continued the “Pick 3,” “Pick 5,” “The Pick,” and “Powerball” on-line games, and introduced the “Fast Play” on-line game. As required, the Lottery has a deposit with “Powerball,” a multistate on-line lottery game, of $7,747,729 at June 30, 2008. 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 pronouncements as well as applicable Financial Accounting Standards Board 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, 2007 to June 30, 2008. • During the period of July 1, 2007 to June 30, 2008, not less than 29% of receipts for “Pick 5,” “Pick 3,” “The Pick” and “Powerball,” and not less than 21.5% of receipts for instant games must be apportioned for transfer to a designated State fund. - 10 - • 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 2008 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. 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 Multistate 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, 2008, the Fund’s accounts payable and accrued expenses balance includes an accrual of vacation pay and related benefits of $320,940. 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 - 11 - 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. 3. TRANSFERS AND STATUTORY REQUIREMENTS The Lottery made the following transfers during the year ended June 30, 2008, 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 Department of economic security — homeless shelters $ Total transfers to other State of Arizona funds 7,650,000 2,612,271 300,000 3,605,500 53,500,800 21,320,700 20,000,000 34,511,700 1,000,000 $ 144,500,971 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, 2008, was as follows: Beginning Balance Capital assets: Land Land improvements Buildings Furniture, fixtures, and equipments Construction in progress Total capital assets Less accumulated depreciation for: Land improvements Buildings Furniture, fixtures, and equipments Total accumulated depreciation Total capital assets — net $ 937,830 330,865 3,488,840 2,577,775 118,319 Increases $ - Decreases $ - 7,453,629 163,162 (329,894) (1,377,435) (1,591,563) (485) (102,272) (213,342) 322,983 (3,298,892) (316,099) 322,983 $ 4,154,737 - 12 - $ (152,937) $ (8,514) (314,469) 113,535 49,627 - - (122,457) 937,830 330,865 3,602,783 2,376,841 45,489 - 7,293,808 122,457 (322,983) $ Ending Balance Transfers $ (330,379) (1,479,707) (1,481,922) $ - (3,292,008) $ 4,001,800 5. PRIZE LIABILITY Prize liability activity for the year ended June 30, 2008, was as follows: Balance July 1, 2007 Prize liability $ 33,484,616 Increases $ 265,123,205 Decreases $ (264,334,385) Balance June 30, 2008 $ 34,273,436 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 year ended June 30, 2008, was $60,287. 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 may incur future liabilities on these annuities. Aggregate future payments to prize winners on existing annuities totaled approximately $98,655,156 at June 30, 2008. Approximately $76,926,787 of the total aggregate future payments at June 30, 2008, relate to annuities purchased from five separate insurance companies, of which approximately $22,409,756 relates to a single insurance company. Tort claims against the Lottery, its agents, officers, and employees who are acting in the scope and course of their employment with the Lottery are covered pursuant to the State Risk Management statute, A.R.S. § 41-621. There is no limit to that coverage. Therefore, as to any claims based on tort, there is no contingent liability to the budget of the Arizona Lottery. 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 - 13 - districts. The Plan became effective on July 1, 1971. By actuarial computation, employee member contributions to the Plan were fixed at 9.10%, 8.60%, and 6.90% of their compensation for the years ended June 30, 2008, 2007, and 2006, respectively, with the contributions made through payroll deduction. Employee contributions vest immediately. Total contributions to the Plan for the years ended June 30, 2008, 2007, and 2006, by the Lottery’s covered employees were $397,693, $382,129, and $287,330, respectively. Matching employer member contributions were actuarially determined and fixed at 9.10%, 8.60%, and 6.90% of the compensation of all employee members for the years ended June 30, 2008, 2007, and 2006, respectively. Total matching contributions to the Plan for the years ended June 30, 2008, 2007, and 2006 by the Lottery were $397,693, $382,129, and $287,330, 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. 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, 2008, 2007, and 2006 was $4,422,107, $4,495,661, and $4,272,430, 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, 2008. ****** - 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, 2008 Game 431* TICKET SALES $ 10,639,035 DIRECT EXPENSES: Commissions Game 431 100.00 % $ 8,999,889 Game 439 100.00 % $ 20,922,260 100.00 % 691,538 6.50 584,996 6.50 1,359,947 6.50 5,745,079 892,950 54.00 8.39 4,859,940 886,050 54.00 9.85 11,507,243 1,001,630 55.00 4.79 Total prizes 6,638,029 62.39 5,745,990 63.85 12,508,873 59.79 Ticket purchases Advertising 177,991 1.67 171,170 1,497 1.90 0.02 272,263 1.30 7,507,558 70.56 6,503,653 72.26 14,141,083 67.59 $ 3,131,477 29.43 $ 2,496,236 27.74 $ 6,781,177 32.41 Prizes — low tier Prizes — high tier Total direct expenses GROSS PROFIT BY GAME Game 451 TICKET SALES $ 1,227,017 DIRECT EXPENSES: Commissions Game 468 100.00 % $ 16,128,010 Game 478 100.00 % $ 3,838,540 100.00 % 79,757 6.50 1,048,322 6.50 249,505 6.50 576,698 109,401 47.00 8.92 6,938,270 2,739,233 43.02 16.98 1,996,041 301,850 52.00 7.86 Total prizes 686,099 55.92 9,677,503 60.00 2,297,891 59.86 Ticket purchases Advertising 28,740 2.34 156,786 0.97 156,702 4.08 794,596 64.76 10,882,611 67.48 2,704,098 70.45 432,421 35.24 $ 5,245,399 32.52 $ 1,134,442 29.55 Prizes — low tier Prizes — high tier Total direct expenses GROSS PROFIT BY GAME $ Game 479 TICKET SALES DIRECT EXPENSES: Commissions $ 10,134,505 Game 481 100.00 % $ 63,559,134 Game 483 100.00 % $ 13,208,340 100.00 % 658,746 6.50 4,131,344 6.50 858,544 6.50 4,560,528 1,984,725 45.00 19.58 30,476,605 7,532,050 47.95 11.85 6,163,892 2,146,050 46.67 16.25 Total prizes 6,545,253 64.58 38,008,655 59.80 8,309,942 62.91 Ticket purchases Advertising 131,249 1.30 1,145,693 1.80 200,224 1.52 7,335,248 72.38 43,285,692 68.10 9,368,710 70.93 $ 2,799,257 27.62 $ 20,273,442 31.90 $ 3,839,630 29.07 Prizes — low tier Prizes — high tier Total direct expenses GROSS PROFIT BY GAME * Portion of game designated for economic development (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, 2008 Game 484 TICKET SALES $ 21,722,190 DIRECT EXPENSES: Commissions Game 485 100.00 % $ 1,177,977 Game 487 100.00 % $ 10,912,260 100.00 % 1,411,942 6.50 76,570 6.50 709,297 6.50 6,197,341 6,696,301 28.53 30.83 541,869 121,650 46.00 10.33 4,364,904 2,830,750 40.00 25.94 Total prizes 12,893,642 59.36 663,519 56.33 7,195,654 65.94 Ticket purchases Advertising 142,030 0.65 36,872 3.13 72,483 0.66 14,447,614 66.51 776,961 65.96 7,977,434 73.11 $ 7,274,576 33.49 401,016 34.04 $ 2,934,826 26.89 Prizes — low tier Prizes — high tier Total direct expenses GROSS PROFIT BY GAME $ Game 489 TICKET SALES $ 2,332,606 DIRECT EXPENSES: Commissions Game 491 100.00 % $ 2,205,330 Game 496 100.00 % $ 1,208,789 100.00 % 151,620 6.50 143,348 6.50 78,572 6.50 Prizes—low tier Prizes—high tier 1,212,955 185,520 52.00 7.95 1,146,772 96,875 52.00 4.39 628,570 45,600 52.00 3.77 Total prizes 1,398,475 59.95 1,243,647 56.39 674,170 55.77 Ticket purchases Advertising 41,596 1.78 47,099 2.14 34,731 2.87 1,591,691 68.23 1,434,094 65.03 787,473 65.14 740,915 31.76 771,236 34.97 421,316 34.85 Total direct expenses GROSS PROFIT BY GAME $ $ Game 498 TICKET SALES $ 2,580,972 DIRECT EXPENSES: Commissions Game 499 100.00 % $ 3,204,759 $ Game 500 100.00 % $ 14,231,860 100.00 % 167,763 6.50 208,310 6.50 925,071 6.50 Prizes—low tier Prizes—high tier 1,109,817 445,240 43.00 17.25 1,532,945 454,450 47.83 14.18 3,986,344 5,140,270 28.01 36.12 Total prizes 1,555,057 60.25 1,987,395 62.01 9,126,614 64.13 Ticket purchases Advertising 67,018 2.60 93,187 2.91 306,701 627,558 2.16 4.41 1,789,838 69.35 2,288,892 71.42 10,985,944 77.20 791,134 30.65 915,867 28.58 $ 3,245,916 22.81 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, 2008 Game 501 TICKET SALES $ 1,352,370 DIRECT EXPENSES: Commissions Game 502 100.00 % $ 8,413,490 Game 503 100.00 % $ 1,052,182 100.00 % 87,906 6.50 546,877 6.50 68,393 6.50 676,185 72,072 50.00 5.33 2,847,125 2,216,750 33.84 26.35 494,526 97,750 47.00 9.29 Total prizes 748,257 55.33 5,063,875 60.19 592,276 56.29 Ticket purchases Advertising 39,089 2.89 71,036 0.84 40,134 3.81 875,252 64.72 5,681,788 67.53 700,803 66.60 477,118 35.28 $ 2,731,702 32.47 351,379 33.40 Prizes — low tier Prizes — high tier Total direct expenses GROSS PROFIT BY GAME $ Game 504 TICKET SALES $ 1,090,882 DIRECT EXPENSES: Commissions $ Game 505 100.00 % $ 1,607,940 Game 506 100.00 % $ 1,456,998 100.00 % 70,909 6.50 104,516 6.50 94,705 6.50 545,441 69,750 50.00 6.39 771,811 175,400 48.00 10.91 692,074 186,200 47.50 12.78 Total prizes 615,191 56.39 947,211 58.91 878,274 60.28 Ticket purchases Advertising 39,084 3.58 65,744 4.09 44,253 3.03 725,184 66.47 1,117,471 69.50 1,017,232 69.81 365,698 33.52 490,469 30.50 439,766 30.18 Prizes — low tier Prizes — high tier Total direct expenses GROSS PROFIT BY GAME $ Game 508 TICKET SALES $ 2,175,472 DIRECT EXPENSES: Commissions $ Game 509 100.00 % $ 5,527,895 $ Game 511 100.00 % $ 4,506,980 100.00 % 141,406 6.50 359,315 6.50 292,956 6.50 1,044,227 245,800 48.00 11.30 2,499,162 821,650 45.21 14.86 2,034,000 642,950 45.13 14.27 Total prizes 1,290,027 59.30 3,320,812 60.07 2,676,950 59.40 Ticket purchases Advertising 44,020 2.02 64,781 1.17 187,414 17,720 4.16 0.39 1,475,453 67.82 3,744,908 67.74 3,175,040 70.45 700,019 32.18 $ 1,782,987 32.25 $ 1,331,940 29.55 Prizes — low tier Prizes — high tier Total direct expenses GROSS PROFIT BY GAME $ (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, 2008 Game 512 TICKET SALES $ 2,988,219 DIRECT EXPENSES: Commissions Game 513 100.00 % $ 1,102,458 Game 514 100.00 % $ 2,014,955 100.00 % 194,236 6.50 71,660 6.50 130,874 6.50 1,523,992 331,740 51.00 11.10 523,668 130,350 47.50 11.82 818,273 398,100 40.61 19.76 Total prizes 1,855,732 62.10 654,018 59.32 1,216,373 60.37 Ticket purchases 45,223 1.52 43,107 3.91 69,580 3.45 89,387 4.44 1,506,214 74.76 508,741 25.25 Prizes — low tier Prizes — high tier Advertising Total direct expenses GROSS PROFIT BY GAME $ 2,095,191 70.12 893,028 29.88 $ Game 516 TICKET SALES $ 1,534,595 DIRECT EXPENSES: Commissions 768,785 69.73 333,673 30.27 $ Game 517 100.00 % $ 1,350,983 Game 518 100.00 % $ 1,178,724 100.00 % 99,751 6.50 87,815 6.50 76,618 6.50 690,568 477,152 45.00 31.09 736,287 74,440 54.50 5.51 618,832 47,200 52.50 4.00 Total prizes 1,167,720 76.09 810,727 60.01 666,032 56.50 Ticket purchases 124,052 8.08 41,657 3.08 44,172 3.75 21,471 1.40 90,308 6.68 90,308 7.66 1,412,994 92.07 1,030,507 76.27 877,130 74.41 121,601 7.92 320,476 23.72 301,594 25.59 Prizes — low tier Prizes — high tier Advertising Total direct expenses GROSS PROFIT BY GAME $ $ Game 520 TICKET SALES $ 1,599,876 DIRECT EXPENSES: Commissions $ Game 521 100.00 % $ 1,840,252 Game 523 100.00 % $ 939,232 100.00 % 103,993 6.50 119,616 6.50 61,051 6.50 799,938 93,050 50.00 5.82 901,723 192,701 49.00 10.47 483,706 43,490 51.50 4.63 Total prizes 892,988 55.82 1,094,424 59.47 527,196 56.13 Ticket purchases 39,214 2.45 40,026 2.18 40,236 4.29 1,036,195 64.77 1,254,066 68.15 628,483 66.92 563,681 35.23 586,186 31.85 310,749 33.09 Prizes — low tier Prizes — high tier Advertising 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, 2008 Game 527 TICKET SALES $ 2,874,680 DIRECT EXPENSES: Commissions Game 528 100.00 % $ 2,408,034 Game 529 100.00 % $ 655,795 100.00 % 186,854 6.50 156,522 6.50 42,628 6.50 1,351,100 360,079 47.00 12.53 1,167,896 256,151 48.50 10.64 327,898 37,349 50.00 5.70 Total prizes 1,711,179 59.53 1,424,047 59.14 365,247 55.70 Ticket purchases 63,833 2.22 50,285 2.08 39,214 5.98 1,961,866 68 1,630,854 68 447,089 68 912,814 31.75 777,180 32.27 208,706 31.82 Prizes — low tier Prizes — high tier Advertising Total direct expenses GROSS PROFIT BY GAME $ $ Game 532 TICKET SALES $ 1,123,965 DIRECT EXPENSES: Commissions $ Game 533 100.00 % $ 1,543,984 Game 534 100.00 % $ 2,653,530 100.00 % 73,059 6.50 100,359 6.50 172,481 6.50 483,305 161,950 43.00 14.41 694,793 239,800 45.00 15.53 1,127,752 590,550 42.50 22.26 Total prizes 645,255 57.41 934,593 60.53 1,718,302 64.76 Ticket purchases 55,681 4.95 58,903 3.82 72,483 2.73 773,995 68.86 1,093,855 70.85 1,963,266 73.99 349,970 31.14 450,129 29.15 690,264 26.01 Prizes — low tier Prizes — high tier Advertising Total direct expenses GROSS PROFIT BY GAME $ $ Game 535 TICKET SALES $ $ Game 537 829,186 100.00 % 53,898 975,724 100.00 % 6.50 63,423 6.50 135,006 6.50 414,593 48,700 50.00 5.87 487,862 60,780 50.00 6.23 996,971 275,788 48.00 13.28 Total prizes 463,293 55.87 548,642 56.23 1,272,759 61.28 Ticket purchases 46,440 5.61 43,215 4.43 54,072 2.61 82,189 3.96 1,544,026 74.35 532,996 25.66 DIRECT EXPENSES: Commissions Prizes — low tier Prizes — high tier $ Game 539 $ 2,077,022 Advertising Total direct expenses GROSS PROFIT BY GAME $ 563,631 67.98 265,555 32.03 $ 655,280 67.16 320,444 32.84 $ 100.00 % (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, 2008 Game 543 TICKET SALES $ Game 546 987,790 100.00 % 64,207 6.50 111,264 6.50 107,369 6.50 498,835 62,320 50.50 6.31 753,173 261,160 44.00 15.26 735,068 235,301 44.50 14.24 Total prizes 561,155 56.81 1,014,333 59.26 970,369 58.74 Ticket purchases 43,296 4.38 46,281 2.70 46,281 2.80 668,658 67.69 1,171,878 68.46 1,124,019 68.04 319,132 32.31 539,878 31.54 527,819 31.95 DIRECT EXPENSES: Commissions Prizes — low tier Prizes — high tier $ 1,711,756 Game 547 100.00 % $ 1,651,838 100.00 % Advertising Total direct expenses GROSS PROFIT BY GAME $ Pick Drawings January 1, 2007 to December 31, 2007 TICKET SALES DIRECT EXPENSES: Commissions Total prizes O/L System Expenses Advertising Total direct expenses GROSS PROFIT BY GAME $ 53,370,586 100.00 % DIRECT EXPENSES: Commissions Total prizes O/L System Expenses Advertising Total direct expenses GROSS PROFIT BY GAME $ Pick 5 Drawings January 1, 2007 to December 31, 2007 $ 13,513,003 100.00 % Powerball Drawings January 1, 2007 to December 31, 2007 $130,567,659 100.00 % 3,469,075 27,865,258 2,129,154 1,442,548 6.50 52.21 3.99 2.70 878,335 6,866,219 538,685 410,543 6.50 50.81 3.99 3.04 8,486,889 65,283,830 5,175,347 820,927 6.50 50.00 3.96 0.63 34,906,035 65.40 8,693,782 64.34 79,766,993 61.09 $ 18,464,551 34.60 $ 4,819,221 35.66 $ 50,800,666 38.91 Pick 3 Drawings January 1, 2007 to December 31, 2007 TICKET SALES $ $ 9,394,503 100.00 % Arizona Raffle Drawings January 1, 2007 to December 31, 2007 $ 7,000,000 100.00 % Fast Play Drawings January 1, 2007 to December 31, 2007 $ 268,881 100.00 % 610,636 4,697,252 374,167 389,523 6.50 50.00 3.98 4.15 455,000 3,500,000 282,254 824,892 6.50 50.00 4.03 11.78 17,408 153,485 10,842 147,036 6.47 57.08 4.03 54.68 6,071,578 64.63 5,062,146 72.32 328,771 122.27 $ 3,322,925 35.37 $ 1,937,854 27.68 (59,890) (22.27) NOTE: 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, 2008. - 21 - $ (Concluded)