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State of Arizona
Office
of the
Auditor General
PERFORMANCE AUDIT
Report to the Arizona Legislature
By Debra K. Davenport
Auditor General
ARIZONA STATE
LOTTERY
COMMISSION
June 2002
Report No. 02-02
The Auditor General is appointed by the Joint Legislative Audit Committee, a bipartisan committee
composed of five senators and five representatives. Her mission is to provide independent and impar-tial
information and specific recommendations to improve the operations of state and local government
entities. To this end, she provides financial audits and accounting services to the state and political
subdivisions and performance audits of state agencies and the programs they administer.
The Joint Legislative Audit Committee
Representative Roberta L. Voss, Chairman
Senator Ken Bennett, Vice Chairman
Senator Herb Guenther Representative Robert Blendu
Senator Dean Martin Representative Gabrielle Giffords
Senator Peter Rios Representative Barbara Leff
Senator Tom Smith Representative James Sedillo
Senator Randall Gnant (ex-officio) Representative James Weiers (ex-officio)
Audit Staff
Shan Hays—Manager
and Contact Person (602) 553-0333
Monique Cordova—Team Leader
Mark Haldane—Team Member
Pam Eck—Team Member
Jason Blake—Team Member
Copies of the Auditor General’s reports are free.
You may request them by contacting us at:
Office of the Auditor General
2910 N. 44th Street, Suite 410
Phoenix, AZ 85018
(602) 553-0333
Additionally, many of our reports can be found in electronic format at:
www.auditorgen.state.az.us
2910 NORTH 44th STREET • SUITE 410 • PHOENIX, ARIZONA 85018 • (602) 553 -0333 • FAX (602) 553 -0051
DEBRA K. DAVENPORT, CPA
AUDITOR GENERAL
STATE OF ARIZONA
OFFICE OF THE
AUDITOR GENERAL
WILLIAM THOMSON
DEPUTY AUDITOR GENERAL
June 3, 2002
Members of the Arizona Legislature
The Honorable Jane Dee Hull, Governor
Mr. Geoffrey Gonsher, Executive Director
Arizona State Lottery Commission
Transmitted herewith is a report of the Auditor General, A Performance Audit of the Arizona
State Lottery Commission. This report is in response to an August 9, 2001, resolution of the
Joint Legislative Audit Committee. The performance audit was conducted under the authority
vested in the Auditor General by A.R.S. §41-1279 and as part of the Sunset review set forth in
A.R.S. §41-2951 et seq. I am also transmitting with this report a copy of the Report Highlights
for this audit to provide a quick summary for your convenience.
As outlined in its response, the Arizona State Lottery Commission agrees with all of the
findings and plans to implement 10 of the 11 finding recommendations and implement 1
finding recommendation in a different manner.
My staff and I will be pleased to discuss or clarify items in the report.
This report will be released to the public on June 4, 2002.
Sincerely,
Debbie Davenport
Auditor General
Enclosure
OFFICE OF THE AUDITOR GENERAL
Program Fact Sheet
Arizona State Lottery Commission
Services: The statutory purpose of the Arizona State Lottery Commission is to “oversee a state lottery to pro-duce
the maximum amount of net revenue consonant with the dignity of the State.” The Lottery markets a variety
of games through a network of nearly 2,570 retailers in order to earn revenue for the State General Fund and
several state programs. The Lottery's responsibilities include ensuring game integrity, monitoring retailer
sales and compliance, investigating allegations of criminal activity related to Lottery tickets, and overseeing
outside contractors.
$245
$250
$255
$260
$265
$270
$275
$280
2000 2001
Millions
Ticket Sales Other Revenues
Revenue Distribution
($274)
Beneficiary Funds
$151
$77.77
$18.50 $26.83
Lottery Prize Fund
Beneficiary Funds
Operations and Retained Earnings
Retailer Commissions
$23.28
$23.00
$16.97
$7.65
$3.70 $3.17
State General Fund
Local Transportation Assistance Fund
State Heritage Fund
County Assistance Fund
Mass Transit Fund
Commerce and Economic Development Fund
Distribution of Lottery Revenues
Fiscal Year 2001
(in Millions)
Assets: $31,312,009 (fiscal year 2001)
The Arizona State Lottery Fund’s assets totaled
approximately $31.3 million in June 30, 2001.
Cash
($18.8 million)
Ticket Inventory
($0.9 million)
Deposit—
PowerBall
($5 million)
Other Current
Assets
($2.8 million)
Net Property
and Equipment
($3.8 million)
Program Revenue: $274 million
(fiscal year 2001)
OFFICE OF THE AUDITOR GENERAL
Marketing (3)
Director's
Division (17)
Security (18)
Sales (40)
Administration
(25)
Information
Technology (20)
Personnel: 123 full-time equivalent staff
(fiscal year 2001)
Facilities and Equipment: The Arizona Lottery
owns its Phoenix facility at 4740 East University
Drive. It also leases an office at 4010 East Grant Road
in Tucson.
The Lottery’s equipment includes typical office
equipment such as furniture and computer equip-ment.
In addition, the Lottery leases 321 Instant-Ticket
Vending Machines, which are located at supermarket
chains.
Program Goals (fiscal years 2002-2004):
1. To sustain revenue.
2. To continue to increase agency efficiency.
3. To expand public awareness regarding the
Lottery's image, beneficiaries, winners, and prod-ucts.
4. To enhance retailer relationships.
5. To promote responsible gaming.
6. To attract and retain high-quality employees.
7. To support diversity in the workplace.
Adequacy of Goals, Objectives, and Performance
Measures:
The Lottery’s 7 goals appear to be reasonably aligned
with its mission, and it has established 12 objectives
and 33 performance measures in line with its goals.
However, the Lottery could improve some of its
goals, objectives, and performance measures. For
example:
The Lottery should amend its first goal to better
reflect its statutory purpose. Instead of seeking to
sustain revenue, the Lottery should strive to
increase revenue in order to improve its ability to
support the state programs it earns revenues for.
The Lottery should add new objectives and per-formance
measures such as:
Monitoring retailer compliance with Lottery
rules and regulations. (Goal 2)
Increasing the public’s knowledge of Lottery
games, and the programs that Lottery dollars
support. (Goal 3)
Recruiting and retaining Lottery retailers.
(Goal 4)
Enforcing underage wagering laws. (Goal 5)
The Office of the Auditor General has conducted a performance
audit and Sunset review of the Arizona State Lottery
Commission, in response to an August 9, 2001, resolution of the
Joint Legislative Audit Committee. This performance audit was
conducted under the authority vested in the Auditor General by
A.R.S. §41-1279 and as part of the Sunset review set forth in
A.R.S. §41-2951 et seq.
The statutory purpose of the Arizona State Lottery Commission
is “to oversee a state lottery to produce a maximum amount of
net revenue consonant with the dignity of the State.” The
Arizona Lottery’s mission is to support Arizona programs for
the public benefit by maximizing revenue in a responsible man-ner.
In fiscal year 2001, the Lottery transferred nearly $78 mil-lion
to beneficiary funds, such as the Local Transportation
Assistance Fund, the State Heritage Fund, and the State General
Fund, and an additional $1.5 million from unclaimed prizes to
support the Court Appointed Special Advocate program.
The Lottery Should Do More
To Maximize Its Sales
(See pages 15 through 24)
Although the Arizona Lottery has made improvements to
increase sales, overall revenues show little change. In the past 5
years, the Lottery has updated its online games, modified
instant-ticket games, added higher-priced instant tickets, and
implemented annual sales and marketing strategies. In spite of
these improvements, online game sales, which tend to vary
according to jackpot levels, have decreased. These declining
online game sales have offset most of the increased instant-tick-et
sales. For example, annual instant-ticket sales averaged $83.5
million and online sales averaged $177.4 million between fiscal
years 1994 and 1997; however, during the 4-year period from
fiscal years 1998 through 2001, average annual instant-ticket
sales rose to $121.0 million, while average online sales fell to
$140.8 million.
OFFICE OF THE AUDITOR GENERAL i
SUMMARY
In addition, in an effort to increase sales, in 1997 the Legislature
increased the percentage of Lottery revenues paid out in prizes,
and decreased the percentage going to state programs. Even
though instant game sales increased by 30 percent between 1997
and 2001, the increased prize payouts resulted in a net reduction in
the total amount instant games provided to beneficiary funds,
from $33 million to $29 million. To further increase instant-ticket
sales, the Lottery should expand its use of instant-ticket vending
machines, which have proven successful in Arizona in increasing
sales, and introduce more variety in instant-ticket prices. The
Lottery should also develop and submit to the Lottery
Commission a plan to implement new types of instant tickets, such
as pull-tab tickets, which are used by other states such as Missouri
and Kentucky.
In addition, the Lottery could enhance its overall sales by more
effectively using its sales representatives and expanding its retailer
incentives. The Lottery should follow though with its plans to pri-vatize
ticket delivery, to enable sales representatives to provide
more support to retailers, and to recruit new retailers. Finally, the
Lottery should consider incentives used in other states, such as the
contests with cash prizes awarded to retailers for marketing lottery
products in Missouri and Connecticut. The Lottery has already
begun to offer game-related promotional incentives and should
continue its efforts to expand its retailer incentive program.
The Lottery Should Improve
Compliance Inspections and
Underage Wagering Education
and Enforcement
(See pages 25 through 29)
The Lottery should take steps to improve its program for moni-toring
retailer compliance with Lottery regulations and enforcing
underage wagering laws. The Lottery’s security division is
responsible for regulatory enforcement, retailer education, and
criminal investigations. A recent expansion of investigation staff
has allowed the Lottery to add new retailer compliance and edu-cation
programs. Investigative staff increased in fiscal year 2000,
after the Legislature approved two new positions to enforce
underage wagering requirements. First-year results from its com-pliance
inspections indicate that the Lottery should modify its
Summary
ii OFFICE OF THE AUDITOR GENERAL
annual inspection goal, and track inspection results. The Lottery
should also develop a comprehensive program to deter under-age
wagering that includes ensuring retailer knowledge of the
age limit for buying Lottery tickets, increasing retailers’ use of
age limit signs, and adopting training standards for retailers.
Further Changes in Control
Procedures Would Enhance
Operational Improvements Made
in Recent Years
(See pages 31 through 37)
The Lottery has made significant progress in implementing rec-ommendations
from a 1997 Auditor General report (see Report
No. 97-15) to improve agency management practices in some
areas, but it can still strengthen certain control procedures. The
Lottery has improved oversight of its retailer network by estab-lishing
a license renewal process that includes credit checks,
implementing collection procedures, and enhancing its mini-mum
sales policy. Additionally, it strengthened its internal cash
and asset controls and has improved contract and procurement
oversight by developing contract oversight procedures and hir-ing
a procurement manager. Further, the Lottery has added
computer system resources and improved computer system
security.
However, the Lottery should further improve its control proce-dures.
First, the Lottery should change its current practice for
distributing revenues from two games. The Lottery’s current
practice is inconsistent with statutory requirements and delays
payments to the Heritage Fund until late in the fiscal year.
Finally, the Lottery should develop additional accounting pro-cedures
for Lottery-specific transactions that are not covered in
the Arizona State Accounting Manual.
Summary
OFFICE OF THE AUDITOR GENERAL iii
iv OFFICE OF THE AUDITOR GENERAL
(This Page Intentionally Left Blank)
Page
Introduction and Background . . . . . . . . 1
Finding I: The Lottery Should Do
More To Maximize Its Sales . . . . . . . . 15
Despite Steps To Increase Sales,
Declining Online Game Revenues
Offset Instant Ticket Revenue Growth . . . . . . . 15
The Lottery Should Take
Additional Steps to
Increase Sales . . . . . . . . . . . . . . . . . . . . . . . . . . . . 19
Recommendations . . . . . . . . . . . . . . . . . . . . . . . . 24
Finding II: The Lottery Should Improve
Compliance Inspections and
Underage Wagering Education
and Enforcement . . . . . . . . . . . . . . . . 25
Recommendations . . . . . . . . . . . . . . . . . . . . . . . . 29
Finding III: Further Changes in
Control Procedures Would
Enhance Operational
Improvements Made
in Recent Years . . . . . . . . . . . . . . . . . . 31
Lottery Has Improved Many
Management Practices . . . . . . . . . . . . . . . . . . . . 31
The Lottery Can Further
Improve Its Control Procedures . . . . . . . . . . . . . 35
Recommendations . . . . . . . . . . . . . . . . . . . . . . . . 37
OFFICE OF THE AUDITOR GENERAL v
TABLE OF CONTENTS
Sunset Factors . . . . . . . . . . . . . . . . . . . . 39
Appendix . . . . . . . . . . . . . . . . . . . . . . . . . a-i
Agency Response
Figures
Figure 1 Arizona State Lottery Commission
Distributions To Beneficiary Funds
Year Ended June 30, 2001 . . . . . . . . . 2
Figure 2 Arizona State Lottery Commission
Distribution of Lottery Revenues
Year Ended June 30, 2001
in Millions
(Unaudited) . . . . . . . . . . . . . . . . . . . . . 4
Figure 3 Arizona State Lottery Commission
Lottery Monies Distributed To
Beneficiary Funds Since
Lottery’s Inception
Years Ended June 30, 1982 Through
2001 (Unaudited) . . . . . . . . . . . . . . . . 5
Figure 4 Arizona State Lottery Commission
Sales Compared To Total Distributions
To Beneficiary Funds
Years Ended June 30, 1994
Through 2001 (Unaudited) . . . . . . . . 17
Figure 5 Arizona State Lottery Commission
Distributions To Beneficiary Funds
Year Ended June 30, 2001
(Unaudited) . . . . . . . . . . . . . . . . . . . . . 19
Table of Contents
vi OFFICE OF THE AUDITOR GENERAL
TABLE OF CONTENTS (cont’d)
Page
Table of Contents
Tables
Table 1 Arizona State Lottery Commission
Schedule of Revenues, Expenses,
and Retained Earnings
Years Ended June 30, 1999,
2000, and 2001 (Unaudited) . . . . . . . . 10
Table 2 Arizona State Lottery Commission
Lottery Expenditures and Related
Statutory Restrictions
Year Ended June 30, 2001
(Unaudited) . . . . . . . . . . . . . . . . . . . . . 11
Photos
Photo 1 Instant-Ticket Vending Machine . . . . 20
Photo 2 Lottery Claim Store . . . . . . . . . . . . . . 33
OFFICE OF THE AUDITOR GENERAL vii
TABLE OF CONTENTS (concl’d)
Page
viii OFFICE OF THE AUDITOR GENERAL
(This Page Intentionally Left Blank)
The Office of the Auditor General has conducted a perform-ance
audit and Sunset review of the Arizona State Lottery
Commission, in response to an August 9, 2001, resolution of
the Joint Legislative Audit Committee. The audit was con-ducted
under the authority vested in the Auditor General by
Arizona Revised Statutes §41-1279 and as part of the Sunset
review set forth in A.R.S. §41-2951 et seq.
Lottery History and Mission
Arizona citizens established the Lottery in 1980 through an ini-tiative
petition in the general election, and it began operating
in 1981. In 1998, the voters approved a referendum to extend
the Lottery until July 2003. The statutory purpose of the
Arizona State Lottery Commission is:
“To oversee a state lottery to produce the maximum amount
of net revenue consonant with the dignity of the State.”
Similarly, the Lottery’s mission statement is:
“To support Arizona programs for the public benefit by max-imizing
revenue in a responsible manner.”
The Arizona Lottery was established to maximize revenue
dedicated to various beneficiary funds, which support a vari-ety
of state and local programs, through statutory formulas.
The Lottery distributed nearly $78 million from fiscal year 2001
revenues, and another $1.5 million from unclaimed prizes to
various funds, which receive funding in accordance with state
law. Appendix A (see page i) describes the nine statutorily des-ignated
beneficiary funds, and Figure 1 (see page 2) illustrates
the distribution process.
OFFICE OF THE AUDITOR GENERAL 1
INTRODUCTION AND BACKGROUND
Introduction and Background
2 OFFICE OF THE AUDITOR GENERAL
Figure 1
Arizona State Lottery Commission
Distributions To Beneficiary Funds
Year Ended June 30, 2001
PowerBall
31.6% of revenues
$24,702,800
Mass Transit
Up to $18M Total
PowerBall
$3,702,800
Other Games
0
Pick 3
29% of revenues
$2,018,700
Bingo Scratchers
21.5% of revenues
$5,534,500
The Pick
29% of revenues
$13,789,600
Fantasy 5
29% of revenues
$3,039,800
Non-Designated
Scratchers
21.5% of revenues
$23,235,900
Local Transportation
Assistance Fund
Up to $23M
$23,000,000
County Assistance
Fund
Up to $7.65M
$7,650,000
Heritage Fund
Up to $20M
$16,968,500
Arizona Clean
Air Fund
Up to $10M
(70% of excess to
Mass Transit;
30% to Healthy AZ)
0
Healthy AZ
Prop. 203
Adjusted annually
from $17M base
0
Two Designated
Scratchers Games
21.5% of revenues
$3,168,200
Commerce and
Economic
Development
$3,168,200
State General Fund
Up to $21M
$21,000,000
Unclaimed Prizes
$1,503,200
Mandated
Advertising Transfer
$2,283,400
State General
Fund
$2,283,400
Court Appointed
Special Advocates
$1,503,200
1
1 The statutory cap on State General Fund revenues from PowerBall was increased to $31 million in March 2002.
Source: Arizona Lottery's graphical representation of fiscal year 2001 beneficiary funds distribution
process.
Eight of the Lottery’s nine beneficiary funds receive their dis-tributions
directly from the State Lottery Fund. The remaining
fund—Court-Appointed Special Advocate Fund (CASA)—
receives its financial support from the Lottery’s Unclaimed
Prize Fund. The CASA Fund receives 30 percent of the
Lottery’s unclaimed prize revenues, which amounted to more
than $1.5 million in fiscal year 2001.
Figure 2 (see page 4) illustrates the distribution of fiscal year
2001 Lottery Fund revenues, which shows that more than 55
percent of the Lottery revenues were transferred to the Lottery
Prize Fund and another 28 percent to beneficiary funds. The
State General Fund and the Local Transportation Assistance
Fund received most of the revenues distributed to beneficiary
funds. Two of the funds, the Clean Air Fund and Healthy
Arizona, did not receive any revenues in fiscal year 2001.
The amount of Lottery monies distributed to state programs
has declined in recent years. As shown in Figure 3 (see page 5),
distributions peaked in fiscal year 1990, when they totaled
almost $113 million. Between fiscal years 1994 and 1997, the
Lottery distributed a total of nearly $343.4 million to state pro-grams.
In contrast, the Lottery distributed a total of $319.7 mil-lion
between fiscal years 1998 and 2001, which represents a
decline of 6.9 percent from the previous 4-year period.
Decreased sales of online game types, and statutory changes in
distribution formulas, which took effect in fiscal year 1998,
contributed to this decline. (See Finding I, pages 15 through 24,
for further discussion.) The decline in online game sales has
particularly affected the amount available for distribution.
Online ticket sales vary with the size of the jackpot, an unpre-dictable
factor the Lottery cannot control. In addition, a 2001
study found that in Arizona an increase in the numbers of slot
machines in Indian casinos has been associated with a decrease
in lottery revenues, especially online game revenues.1 Finally,
the Lottery’s advertising budget has been reduced since fiscal
year 2000, which may also have contributed to the decline in
online game sales.
Introduction and Background
OFFICE OF THE AUDITOR GENERAL 3
1 Siegal, Donald and Gary Anders, “The Impact of Indian Casinos on
State Lotteries: A Case Study of Arizona,” Public Finance Review, Vol.
29, No. 2, March 2001, 139-147.
Introduction and Background
4 OFFICE OF THE AUDITOR GENERAL
Figure 2
Arizona State Lottery Commission
Distribution of Lottery Revenues
Year Ended June 30, 2001
in Millions
(Unaudited)
Source: Auditor General staff analysis of the Arizona State Lottery Commission financial statements audited by
Deloitte & Touche LLP for the year ended June 30, 2001, and Arizona Lottery Revenues and Transfers to Other
Funds FY 2001.
Revenue Distribution
($274)
Beneficiary Funds
$151
$77.77
$18.50 $26.83
Lottery Prize Fund
Beneficiary Funds
Operations and Retained Earnings
Retailer Commissions
$23.28
$23.00
$16.97
$7.65
$3.70 $3.17
State General Fund
Local Transportation Assistance Fund
State Heritage Fund
County Assistance Fund
Mass Transit Fund
Commerce and Economic Development Fund
Introduction and Background
OFFICE OF THE AUDITOR GENERAL 5
1 Includes distributions from unclaimed prizes to support programs such as the Court Appointed Special Advocate program.
Source: Auditor General staff analysis of Arizona State Lottery financial report Arizona Lottery Revenues and Transfers to Other State Funds FY1982-FY2001.
filename: \Pad3\Lottery\Lottery Graphics\New Figure 3 EPS.eps
$36.6
$18.0
$37.0
$65.2
$112.7
$94.2
$79.3
$84.4
$78.0
$81.1
$87.3
$82.4
$93.2 $92.5
$88.2
$100.0
$50.7
$22.0
$31.8
$78.1
$0.0
$20.0
$40.0
$60.0
$80.0
$100.0
$120.0
1982 1983 1984 1985 1986 1987 1988 1989 1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001
ea
Millions of Dollars
Figure 3
Arizona State Lottery Commission
Lottery Monies Distributed To Beneficiary Funds Since Lottery's Inception 1
Years Ended June 30, 1982 Through 2001
(Unaudited)
Fiscal Year
Lottery Products
The Lottery offers state-sanctioned games of chance, which are
delivered in both an online and instant-ticket format. Since
inception, the Lottery has sold more than 292.4 million win-ning
tickets and awarded more than $2.7 billion in prize
money.
Arizona Lottery Online Games
Online Games—The Pick™, PowerBall®, Fantasy 5™, and
Pick3™ are called online games because retailers use comput-er
terminals to record the numbers players select. Players
attempt to select numbers that will match numbers drawn
biweekly or throughout the week to win cash prizes. The Pick,
Fantasy 5, and Pick3 games are offered within state boundaries
only. PowerBall, however, is a multi-state online game operat-ed
jointly by the 22 states forming the Multi-State Lottery
Association (MUSL). Twenty-one of the 22 MUSL member
states participate in the PowerBall game. In fiscal year 2001,
online sales revenues were nearly $135.8 million.
Players choose 6 out of 41 numbers ranging from 1
to 41. Minimum $1 million jackpot.
Players pick 5 out of 49 numbers (from 1 to 49) for
the first set of numbers, and 1 out of 42 numbers
(from 1 to 42) for the second set (the PowerBall).
Minimum jackpot is $10 million.
Players select 5 out of 35 numbers (from 1 to 35).
Maximum jackpot is $50,000.
Players pick any 3-digit number from 000 to 999.
Top prize is $500.
Introduction and Background
6 OFFICE OF THE AUDITOR GENERAL
®
TM
Introduction and Background
OFFICE OF THE AUDITOR GENERAL 7
Arizona Lottery Instant-Ticket Games
Called ScratchersSM, Arizona’s instant-ticket games
offer immediate results to players when they scratch
off latex-covered play areas on the tickets. A player can
win an instant-ticket game by matching three identical
symbols or figures, adding numbers for a specific total,
or playing familiar game styles like tic-tac-toe or bingo.
The Lottery offered 29 instant-ticket games in fiscal
year 2001. By law, the Lottery must offer two instant-ticket
games a year to benefit state economic develop-ment
programs. Along with its traditional $1 product,
the Lottery now offers $2, $3, and $5 instant-ticket
games. In fiscal year 2001, instant-ticket sales revenues
were $136.9 million.
Lottery Retailers
The Lottery has nearly 2,570 retailers licensed to sell its prod-ucts.
These include convenience stores, grocery chains, inde-pendent
food stores, liquor stores, and truck stops. Lottery
retailers receive 6.5 to 7 percent in sales commissions. In fiscal
year 2000, the Lottery implemented an incentive program to
award an extra 0.5 percent commission above the standard 6.5
percent to retailers with additional sales and promotions
efforts. Grocery and chain convenience stores—such as Circle
K convenience stores, and the Fry’s, Safeway, and Bashas’ gro-cery
chains—accounted for more than 62 percent of the
Lottery’s total sales in fiscal year 2001.
Organizational Oversight and Structure
A.R.S. §5-502 established the Arizona State Lottery Commission,
which oversees the Lottery. The Lottery Commission consists of
five Governor-appointed members, who are confirmed by the
Arizona Senate. The Commission meets monthly to make recom-mendations
or set policy, approve or reject Lottery Directory
reports, approve Lottery games, and transact other Lottery busi-ness.
The Governor also appoints an executive director to admin-ister
Lottery operations. The director serves as the Commission’s
The Lottery’s instant-ticket
games are called
Scratchers.SM
secretary and executive officer. As of February 2002, the
Lottery had a total of 123 full-time equivalent (FTE) employees
in the following divisions:
Director’s Division (17 FTE)—This division oversees agency
operations, game design, internal audit, administrative
rules, human resources, risk management, communica-tions
programs such as “Where the Money Goes,” and
compulsive gambling programs.
Administration (25 FTE)—The administration division is
responsible for budget and strategic planning, accounting,
payroll, procurement, and purchasing, and the Phoenix
and Tucson claims stores where the public can purchase
tickets and redeem winning tickets. The claims stores are
located in Lottery offices.
Sales (40 FTE)—The sales division is responsible for sales
planning, ticket distribution to retailers, retailer promo-tions,
incentive plans, and training; and field support for
the retail outlets.
Marketing (3 FTE)—The marketing division is responsible
for advertising and marketing research. In addition, divi-sion
personnel act as a liaison to broadcast and advertising
vendors.
Security (18 FTE)—The security division licenses retailers,
conducts investigations, maintains security in the Lottery’s
warehouse and claims stores, and monitors online game
broadcast drawings. The division is also responsible for
ensuring game integrity, monitoring retailer compliance
with administrative rules, reinforcing prevention of under-age
wagering, and investigating allegations of criminal
activity, such as lottery ticket theft and fraud.
Information Technology (20 FTE)—This division is respon-sible
for network management, telecommunications, com-puter
operations, programming development, technical
support, and computer system security.
Introduction and Background
8 OFFICE OF THE AUDITOR GENERAL
Budget, Revenues, and Expenditures
The Legislature approves the Lottery’s annual budget based
on projected ticket sales revenues. Annually, the Lottery
receives authority to spend monies from the State Lottery
Fund, which receives its revenues primarily from ticket sales.
Table 1 (see page 10) summarizes the Lottery’s actual revenues
and expenditures for fiscal years 1999, 2000, and 2001. Total
ticket sales during these three fiscal years were above $250 mil-lion.
The highest sales occurred in fiscal year 2001, when total
sales were nearly $272.7 million.
In fiscal year 2001, the Lottery’s administrative expenses were
$44.5 million, or approximately 16.3 percent of gross Lottery
revenues. By statute, the Lottery is restricted to spending no
more than 18.5 percent of annual gross revenues to operate the
Lottery. State statutes also restrict advertising of expenditures
and mandate retailer commissions, as shown in Table 2 (see
page 11).
Audit Scope and Methodology
This audit focused on the Department’s progress in addressing
concerns identified in the Auditor General’s 1997 performance
audit report and Sunset review (Report No. 97-15). This audit
also included a review of the Lottery’s compliance inspection
program, and its use of special investigators. This performance
audit report and Sunset review includes finding and recom-mendations
in three areas:
Although the Lottery has implemented most sales-related
recommendations from the 1997 audit, it should still do
more to maximize sales and increase returns to state bene-ficiaries.
For example, the Lottery should increase its use of
instant-ticket vending machines, consider adding new
games, and make better use of its sales force.
The Lottery should take steps to improve its retailer com-pliance
inspection program, and it can also do more to
enforce underage wagering laws and rules.
Introduction and Background
OFFICE OF THE AUDITOR GENERAL 9
Introduction and Background
10 OFFICE OF THE AUDITOR GENERAL
Table 1
Arizona Lottery Commission
Schedule of Revenues, Expenses, and Retained Earnings
Years Ended June 30, 1999, 2000, and 2001
(Unaudited)
1999 2000 2001
Revenues:
Lottery ticket sales:
Instant $102,924,766 $120,593,632 $124,259,935
Economic Development 6,514,717 8,889,811 12,643,498
PowerBall 93,698,288 69,723,954 74,291,623
Lotto/Pick 48,651,557 41,397,014 44,984,263
Fantasy 5 8,975,930 8,396,212 9,911,652
Pick 3 7,498,118 6,552,320 6,579,893
Total Lottery ticket sales 268,263,376 255,552,943 272,670,864
Transfers to the State Lottery Prize Fund 1 (144,011,884) (140,127,307) (150,887,186)
Net Lottery ticket revenue 124,251,492 115,425,636 121,783,678
State General Fund appropriation 2 1,500,000
Retail license fees 12,467 10,117 18,976
Other 882,776 1,257,836 1,292,312
Total revenues 125,146,735 118,193,589 123,094,966
Expenses:
Retailers’ commissions 17,437,399 16,798,267 18,496,981
Advertising and promotion 8,997,172 8,104,360 7,155,050
Online system 8,498,261 8,089,857 8,541,672
Tickets purchased 2,508,819 1,994,522 2,322,238
Personal services and employee-related 4,289,862 4,554,561 4,951,238
Contract services 327,983 698,904 531,690
Other administrative 3 2,385,218 2,222,110 2,545,132
Total expenses 44,444,714 42,462,581 44,544,001
Net income before transfers to other State of
Arizona funds 80,702,021 75,731,008 78,550,965
Transfers to other State of Arizona Funds (80,473,300) (75,442,600) (77,772,900)
Increase in retained earnings 228,721 288,408 778,065
Retained earnings, beginning of year 7,379,873 7,608,594 7,897,002
Retained earnings, end of year $ 7,608,594 $ 7,897,002 $ 8,675,067
1 The State Lottery Prize Fund, an Expendable Trust Fund of the State of Arizona, accounts for cash and assets
held by the Commission in a trustee capacity. The Commission transfers monies to the Fund to pay prizes to
winning ticket holders.
2 In 2000, the Commission was appropriated $1.5 million to provide additional advertising.
3 Includes depreciation expenses of $650,546, $313,520, and $308,212, for 1999, 2000, and 2001, respectively.
Source: Auditor General staff analysis of the Arizona Lottery Commission financial statements audited by Deloitte
& Touche LLP for the years ended June 30, 1999, 2000, and 2001.
Introduction and Background
OFFICE OF THE AUDITOR GENERAL 11
The Lottery has taken several steps to improve manage-ment
practices and internal controls since the 1997 per-formance
audit, but it should further improve some of its
control procedures.
Auditors used a variety of methods to study the issues
addressed in this report, including interviewing Lottery
Commission members, management, and staff; attending four
Lottery Commission meetings between September 2001 and
February 2002; interviewing members of the Lottery’s Retailer
Advisory Committee, and representatives from selected retail-ers,
such as Bashas’, Safeway, IGA, and 7-Eleven; interviewing
the directors of Arizona Food Marketing Alliance and the
Arizona Licensed Beverage Association; reviewing statutes,
rules, and Lottery policies and procedures; reviewing annual
reports and audited financial statements for fiscal years 1997
through 2001; reviewing strategic planning documents for fiscal
years 2001 and 2002, including budget plans, sales and market-ing
plans, and security plans; and reviewing industry compari-son
data in the North American Association of State and Provincial
Lotteries 2001 Lottery Resource Handbook, and the LaFleur’s 2001
World Lottery Almanac; and other literature. The following spe-cific
methods were also used:
Table 2
Arizona State Lottery Commission
Lottery Expenditures and Related Statutory Restrictions
Year Ended June 30, 2001
(Unaudited)
Percentage
Expenditures
(millions)
Actual
Statutory
Limit1
Administrative expenses2 $44.5 16.3% 18.5%
Advertising 7.2 2.6 4.0
Retailer commission 18.5 6.8 6.5 – 7.0
1 The statutory limit on administrative expenses and advertising is a percentage of gross
revenues; the statutory limit on retailer commissions is a percentage of total sales.
2 Includes advertising and retailer commissions.
Source: Auditor General staff analysis of the Arizona Lottery Commission financial
statements audited by Deloitte & Touche LLP for the year ended June 30, 2001, and
Arizona Revised Statutes §5-505.
Introduction and Background
12 OFFICE OF THE AUDITOR GENERAL
To assess the Lottery’s progress in improving sales and to
identify other strategies that the Lottery could pursue to
improve sales, auditors examined the Lottery’s current
sales practices such as current retailer incentive plans and
sales representatives’ job activities; contacted sales direc-tors
in seven states to identify their strategies for increasing
instant-ticket sales and online ticket sales; and compared
instant-ticket sales trend data among Lottery retailers who
have Instant-Ticket Vending Machines and those who do
not.1
To evaluate the adequacy of the Lottery’s new compliance
inspection program and underage wagering enforcement
efforts, auditors examined the Lottery’s new retailer com-pliance
inspection procedures; reviewed the Lottery’s
retailer compliance inspection form to ensure it addressed
compliance with underage wagering regulations; contact-ed
security directors in seven states to determine how they
conducted retailer compliance inspections; interviewed
investigators at the Arizona Department of Liquor Licenses
and Controls to determine how they conduct compliance
inspections and enforce underage drinking laws; and
reviewed monthly investigation reports for February 1,
2000 through December 31, 2001, and 19 criminal investi-gation
files for all stolen ticket investigations conducted in
October 2001 to identify the actual activities undertaken by
Lottery investigators.2
To assess the Lottery’s efforts to improve management
practices and internal controls, auditors conducted an
internal control review of the Lottery’s financial controls
including cash-handling activities in its Phoenix and
1 Auditors contacted officials in Connecticut, Kentucky, Maryland,
Missouri, New Jersey, New Mexico, and Washington. These states’ 2000
per capita instant-ticket sales were close to the national per capita instant-ticket
sales average, and were comparable to Arizona in terms of popula-tion
and competition with other gaming activities, such as tribal casinos
or riverboat gambling.
2 Auditors contacted security directors from the same states identified pre-viously.
Introduction and Background
OFFICE OF THE AUDITOR GENERAL 13
Tucson claims stores; examined computer system controls
and resources; and reviewed policies and procedures for
accounting and security practices unique to the Lottery.
The audit was conducted in accordance with government
auditing standards.
The Auditor General and staff express appreciation to the
Commissioners of the Arizona State Lottery Commission, and
the Executive Director of the Arizona State Lottery and his
staff, for their cooperation and assistance throughout the audit.
14 OFFICE OF THE AUDITOR GENERAL
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The Arizona Lottery should take additional steps to maximize
its ticket sales. While the Lottery has made improvements to
increase sales in recent years, total sales have not grown sub-stantially.
As a result, state funds such as the Heritage Fund
and Mass Transit continue to receive less money than the law
allows, and some programs continue to receive no Lottery
funding at all. The Lottery should take several steps to increase
sales, including installing additional instant-ticket vending
machines, adding higher-priced instant tickets and pull-tab
tickets, more effectively using its sales representatives, and
expanding its retailer incentive plan.
Despite Steps To Increase Sales,
Declining Online Game Revenues
Offset Instant Ticket Revenue Growth
In response to previous Auditor General recommendations,
the Lottery has in recent years taken several steps designed to
strengthen sales and maximize state revenue. In spite of these
improvements, total sales for fiscal years 1998-2001 were about
the same as the previous 4-year period. This lack of growth in
total sales, coupled with increases in the percentage of Lottery
revenues being paid out in prizes, has lowered revenues for
beneficiary funds that depend on Lottery funding.
The Lottery has taken steps to increase sales—Responding to
Auditor General recommendations, the Lottery has taken sever-al
steps to strengthen sales in order to maximize state revenue.
In 1997, an Auditor General report (see Report No. 97-15) found
that several Lottery practices contributed to poor sales and inef-ficiently
used resources, limiting monies available for state pro-grams.
The report recommended revamping online games,
adding additional games to the game mix, replacing instant-tick-et
games more quickly, and varying game prices and prize struc-tures.
The report also recommended implementing long-term
planning and using sales staff more productively to increase its
sales. The Lottery responded by:
OFFICE OF THE AUDITOR GENERAL 15
FINDING I THE LOTTERY SHOULD DO MORE
TO MAXIMIZE ITS SALES
The Arizona Lottery
improved sales prac-tices
in response to a
1997 Auditor General
report.
Updating The Pick and Fantasy 5;
Adding a 3-number game, Pick3;
Shortening the average time instant-ticket games stay in
the market to 16 weeks, reducing the number of tickets
printed for each game, and adding $3 and $5 tickets;
Increasing instant-ticket prize payouts;
Modifying ticket size and appearance and obtaining addi-tional
instant-ticket vending machines (ITVMs);
Addressing marketing strategy and long-term planning by
implementing annual updates of strategic plans for mar-keting,
instant tickets, online games, media, and communi-cations
and research; and
Restructuring its sales department, including creating a
promotions section, and instituting a new sales department
incentive plan.
Further, the Lottery is now conducting research as a basis for
making better business decisions and regularly evaluates its
advertising expenditures to maximize their effect on sales. The
Lottery contracts with two advertising agencies to conduct
market research, collect and analyze data, develop market and
media strategies, and implement agreed-upon recommenda-tions
based on available resources. In addition to its primary
advertising contract, the Lottery has a separate contract for
advertising services to the Hispanic market. Its primary adver-tising
agency provides the Lottery with an annual market
research tracking study report and monthly findings regard-ing
player demographics and market trends. Further, the
Lottery evaluates its advertising mix, adjusting amounts spent
on television, radio, print media, and transit, to reach the tar-geted
audience with the desired message for the best value.
Decreased online sales result in less money for beneficiary funds—
Despite these changes, Arizona’s online games, like those in
many other states, have experienced a drop in sales. As illus-trated
in Figure 4, declining sales of online tickets have offset
Finding I
16 OFFICE OF THE AUDITOR GENERAL
increases in instant ticket sales, and have essentially kept total
Lottery revenues relatively unchanged.
Instant-ticket sales respond to changes in prize payouts, ticket
design, and marketing strategies, but online ticket sales vary
with the size of the jackpot, an unpredictable factor the Lottery
cannot control. For example, annual instant-ticket sales aver-aged
about $83.5 million and online sales averaged approxi-mately
$177.4 million between fiscal years 1994 and 1997.
However, during the 4-year period from fiscal years 1998
through 2001, average annual instant-ticket sales rose to
approximately $121 million, while average online ticket sales
fell to about $140.8 million.
Finding I
OFFICE OF THE AUDITOR GENERAL 17
Figure 4
Arizona State Lottery Commission
Sales Compared To Total Distributions To Beneficiary Funds
Years Ended June 30, 1994 Through 2001
(Unaudited)
Source: Auditor General staff analysis of the Arizona State Lottery Commission financial
statement audited by Deloitte & Touche LLP for the fiscal years ended June 30, 1994
through 2001.
$0
$50
$100
$150
$200
$250
$300
$350
1994 1995 1996 1997 1998 1999 2000 2001
Year
Millions
Total Sales Instant Ticket Sales
Online Sales Distributions To Beneficiary Funds
Declining online sales
have offset gains in
instant-ticket sales.
Increased prize payouts reduce monies for beneficiary funds—
An increase in the percentage of Lottery revenues returned to
participants in the form of prize money has resulted in less
money going to beneficiary funds that receive Lottery rev-enues.
As a means of increasing overall sales, the Legislature
changed the distribution formula to increase prize payouts,
particularly for instant tickets, starting in fiscal year 1998. Prior
to September 1997, beneficiary funds received 31.5 percent of
all sales. However, beginning September 30, 1997, the distri-bution
formula changed to one in which the funds received 29
percent of all online game revenues, and 21.5 percent of
instant-ticket sales.1 Thus, even though instant game sales
increased by 30 percent between 1997 and 2001, the amount of
monies beneficiary funds received from instant games
dropped from approximately $33 million to $29 million.
Beneficiary funds affected—The decline in Lottery monies dis-tributed
to the State has affected some state lottery beneficiar-ies.
Beneficiary funds, including the State General Fund,
received $343.4 million over the 4-year period from fiscal year
1994 through fiscal year 1997. However, these funds received
a total of only $319.7 million from fiscal year 1998 through fis-cal
year 2001, or $23.7 million less. Because of falling distribu-tions,
funds such as the Heritage Funds and Mass Transit have
been funded at levels below those permitted by law (see Figure
5, page 19). For example, the Heritage Funds have not received
full funding since 1998. Additionally, the law permits Mass Transit
to receive up to $18 million annually in Lottery monies, but in fis-cal
year 2001, it received only $3.7 million. Further, other programs
have never received Lottery revenue, including Healthy Families,
Health Start, the Board of Regents’ health education system,
teenage pregnancy programs, disease control research, and the
Women, Infants and Children food program, collectively referred
to as “Healthy Arizona.” Additionally, the Clean Air Fund, which
received a one-time distribution of $500,000 from the Lottery’s
unclaimed prize fund in 1997, has not subsequently received any
of its potential $10 million annual distribution.
Finding I
18 OFFICE OF THE AUDITOR GENERAL
1 Laws 1999, 1st S. S., Ch. 3, §12 subsequently increased the PowerBall®
distribution to 31.6 percent of sales for fiscal years 2000 and 2001. Laws
2001, Ch. 238, §16 made the same distribution increase effective for fis-cal
years 2002 and 2003.
The State Heritage
Fund and other pro-grams
have received
less money than per-mitted
by law.
However, even if the Lottery increases sales, some of these
programs may never receive full funding. In order for all ben-eficiaries
to receive their maximum distribution, total Lottery
sales would need to increase between a minimum of $422.8
million to nearly $543 million in annual sales.1
The Lottery Should Take
Additional Steps To
Increase Sales
The Lottery should take several additional steps to further
increase instant ticket sales and attempt to enhance online
sales. These steps include expanding the use of instant-tick-
Finding I
OFFICE OF THE AUDITOR GENERAL 19
Figure 5
Arizona State Lottery Commission
Distributions To Beneficiary Funds
Year Ended June 30, 2001
(Unaudited)
1 The Court-Appointed Special Advocate (CASA) program receives its monies from the Lottery's Unclaimed Prize
Fund.
Source: Auditor General staff analysis of A.R.S. §5-522 and Arizona State Lottery Commission financial statement
audited by Deloitte & Touche LLP for the year ended June 30, 2001.
General
Fund
Local
Transportation
Assistance
Heritage
Fund
County
Assistance
Fund
Mass
Transit
Fund
Commerce
and
Economic
Development
Fund
Healthy
Arizona
Clean
Air
Fund
Court-
Appointed
Special
Advocate1
Actual Allowable
$0
$5
$10
$15
$20
$25
Million of Dollars
1 This range takes into account the different percentages that PowerBall, state
online games like The Pick, and instant-ticket games contribute to the State.
It excludes economic development instant-ticket sales.
et vending machines, adding new types of instant tickets that
have proven to be successful in other states, using sales rep-resentatives’
time more effectively, and expanding its retailer incen-tive
plan.
Expanding the use of instant-ticket vending machines
(ITVMs)—The Lottery has successfully introduced ITVMs to
its retailer market, but should expand their use to further
increase instant-ticket sales. The
Lottery first began installing ITVMs in
fiscal year 1994. Currently, the Lottery
has 321 ITVMs, nearly all located in
chain grocery stores, with a total
annual lease cost to the Lottery of
$847,440. Nontraditional retailers,
such as truckstops and gas stations,
have the remaining ITVMs. One hun-dred
retailers that received ITVMs in
2001 experienced an average 38 per-cent
increase in instant-ticket sales,
totaling $6.04 million in 2001, com-pared
to $4.37 million in fiscal year
2000.1 Overall, in fiscal year 2001,
chain grocery stores with ITVMs aver-aged
about $78,000 in instant-ticket
sales compared to about $35,000 in
chain grocery stores without ITVMs.
Although ITVMs can be an economi-cal
method of increasing sales, they
were located at only 8 percent of
Arizona Lottery retailers in fiscal year
2000. According to LaFleur’s 2001
World Lottery Almanac, this is less than half the average per-centage
for other state lotteries. The Lottery should identify the
number of additional retailers that would benefit from having
an ITVM, and determine the expected costs and benefits of
placing ITVMs at additional retailers. For example, currently,
the annual lease for each 12-game machine is $2,640. Taking
into account the percentage of sales dedicated to prize pay-ments,
stores that have 12-game ITVMs need to increase
Finding I
20 OFFICE OF THE AUDITOR GENERAL
1 Fiscal year 2001 sales figures include 3 months of sales (July-September
2000) before ITVMs were installed.
The Lottery leases 321
ITVMs, which are mostly
located in supermarkets.
The Lottery has suc-cessfully
introduced
ITVMs to some retail-ers.
Photo 1:
Instant-Ticket
Vending Machine
(ITVM)
instant-ticket sales by only $127 per week in order to offset the
lease fee incurred by the Lottery. ITVMs with more or fewer
bins have different lease costs and may be suitable for some
retailers. According to Lottery officials, ITVMs also offer other
benefits. First, because ITVMs are self-service ticket dis-pensers,
checkout clerks and other store personnel need not
actively sell or account for tickets. Further, ITVMs safeguard
tickets and money, which are locked in a machine rather than
on or beneath a sales counter or in a cash register. Their visi-bility
also provides advertising for instant tickets, which are
often an impulse purchase. Once its study of costs and benefits
is complete, the Lottery should request authorization from the
Legislature to use monies from the Lottery Fund to lease the
additional ITVMs.
Implementing new instant-ticket types and denominations—
The Lottery should develop and submit to the Lottery
Commission plans to implement new types of instant tickets
and at a variety of prices. For example, pull-tab instant tickets
have allowed several states, such as Missouri and Kentucky, to
increase their instant-ticket sales and enter nontraditional
retail markets such as restaurants, bars, and clubs. Pull-tab
instant tickets require that a player pull off a paper tab rather
than scratching a latex covering to determine a winning ticket.
They have generally been sold in 25- and 50-cent denomina-tions,
although some states have $1 pull-tabs. In fiscal year
2000, 10.3 percent of Kentucky’s instant-ticket sales and 9.7
percent of Missouri’s instant-ticket sales were derived from
pull-tabs. The Lottery’s statutes allow it to offer different game
play-styles, which include pull-tab instant tickets. Pull-tabs
might allow the Lottery to increase its sales in restaurants and
bars. Currently, there are only 35 restaurants and bars in
Arizona that sell Lottery tickets.
In addition to pull-tabs, some states sell instant tickets at prices
that Arizona does not use. For example, 20 of 37 lottery states
have $10 “scratcher” instant tickets, and one state, New
Hampshire, has a top instant-ticket price of $7. In contrast, the
Arizona Lottery’s highest-priced ticket is $5. Higher-priced
tickets have helped increase sales in other states. For example,
Connecticut had $141.4 million in $10-ticket sales in fiscal year
2000, or 27 percent of its total instant-ticket sales. Similarly,
Michigan had $106.2 million in $10-ticket sales, or 16.5 percent
Finding I
OFFICE OF THE AUDITOR GENERAL 21
of its total fiscal year 2000 instant ticket sales. The Lottery plans
to introduce its first $10 instant-ticket game, and offer more $3
and $5 games in fiscal year 2003.
Using sales representatives more effectively—The Lottery should
use its sales representatives in ways that enable them to effec-tively
increase sales. In 1997, the Auditor General recommend-ed
that the Lottery find better ways to handle ticket distribu-tion
and allow sales representatives to spend more time work-ing
to increase sales (see Report No. 97-15), because they were
spending most of their time delivering tickets. The Arizona
Lottery recently issued a Request for Proposals for instant-ticket
printing and a ticket delivery and management system.
The Request for Proposal for a new ticket distribution system
includes provisions not only to contract for ticket delivery but
also for the contractor to track sales and calculate data to help
sales representatives provide retailers with the best products
for their locations. The Lottery anticipates that the successful
bidder will fully implement the system by January 14, 2003.
Sales representatives in other states engage in sales support,
such as informing retailers of upcoming games and events,
and conducting retailer incentive programs and promotions.1
Additionally, they discuss product displays, troubleshoot
machines, and address retailer concerns. Unlike Arizona’s
sales representatives, they are also responsible for recruiting
new retailers. Once the new ticket delivery system is in place,
the Lottery should ensure that its sales representatives are
trained to provide sales support responsive to retailer needs
and make the sales representatives responsible for recruiting
new retailers.
Expanding retailer incentives—To encourage retailers to
increase sales, the Lottery should expand its retailer incentive
program. The Lottery pays one of the higher retailer sales com-missions
among United States lotteries, 6.5 percent, based on
its sales. Additionally, retailers can earn an extra 0.5 percent
annually if their sales exceed the prior year by more than 5 per-cent.
However, other states, such as New Jersey and Missouri,
Finding I
22 OFFICE OF THE AUDITOR GENERAL
1 Auditors surveyed sales and marketing managers from Connecticut,
Kentucky, Maryland, Missouri, New Jersey, New Mexico, and Washington.
In 1997, the Auditor
General recommended
that the Lottery make
better use of its sales
representatives.
Some states offer a
variety of retailer
incentives.
provide retailers with sales bonuses for selling winning tickets
and cashing winning tickets. Moreover, Missouri has contests
and promotions between retailers with cash and prize awards
for successful retailers. These incentives can change with lot-tery
goals and encourage retailers to more actively market lot-tery
products. The Lottery has already introduced some pro-motions
to benefit retailers. For example, it has conducted four
game-related retail promotions since April 2000. The first pro-motion
focused on boosting sales for The Pick, while the latter
three promotions attempted to boost Fantasy 5 sales. In addi-tion
to promotional incentives, the Lottery has been working
with its retailer advisory group and budget analysts to revise
its retailer incentive program, but to date has focused mainly
on the requirements for earning the extra 0.5 percent. It should
continue its efforts to expand its incentive program to increase
retailer sales efforts, including considering the innovations
implemented in other states.
Finding I
OFFICE OF THE AUDITOR GENERAL 23
Recommendations
1. The Lottery should identify the number of retailers who
would benefit from having an Instant-Ticket Vending
Machine (ITVM), document the financial benefits expected
from their utilization, and study the impact of leasing or
purchasing ITVMs with varying numbers of ticket bins. It
should then request authorization from the Legislature to
use monies from the Lottery Fund for additional ITVMs.
2. The Lottery should develop a plan to use pull-tab instant
tickets to expand its retailer network and player base. The
plan should be submitted to the Lottery Commission for its
consideration.
3. The Lottery should follow through on its fiscal year 2003
plan to offer more $3 and $5 instant-ticket games and sell
instant-ticket games at prices above its current $5 tickets.
4. The Lottery should (a) follow through with its plans to sub-contract
the delivery of instant tickets to retailers through
its instant-ticket printing vendor and (b) ensure that such a
delivery system includes the ability to track sales and cal-culate
data that helps sales representatives assist retailers.
5. Once it has the new ticket delivery system in place, the
Lottery should restructure the duties of its sales represen-tatives
to include recruiting new retailers and providing
sales support and training to current retailers.
6. To increase retailer sales efforts, the Lottery should contin-ue
its efforts to offer game-related retail incentives and
expand its retailer incentive program with input from its
retailer advisory committee and budget analysts. It should
present its plan to the Lottery Commission for considera-tion.
Finding I
24 OFFICE OF THE AUDITOR GENERAL
The Lottery should take steps to improve its compliance
inspection program and develop a comprehensive program to
enforce underage wagering laws. The Lottery’s Security
Division is responsible for regulatory enforcement, retailer
education, and criminal investigations. A recent expansion of
investigation staff has allowed the Lottery to add new retailer
compliance and education programs. The compliance inspec-tion
program is designed to ensure compliance with Lottery
requirements. First-year results, however, indicate that the
Lottery can improve the program by modifying its inspection
goal and instituting tracking measures. The Lottery should
also develop a comprehensive program to monitor and deter
underage people from wagering.
In recent years, the Lottery has taken steps to enhance its Security
Division, which is responsible for ensuring the integrity of games
and operations. The Division’s duties include regulatory enforce-ment,
retailer education, criminal investigations, ensuring game
integrity, licensing, and the physical security of the Lottery’s
offices. The Division’s staff comprises seven peace officers, includ-ing
the Security Director, a chief investigator, and five special
investigators.1
Recent expansion in investigative staff has led to addition of
new retailer education and regulatory enforcement programs—
According to the Lottery, a recent expansion of its investigative
staff has allowed the agency to enhance retailer education and
regulatory enforcement. In 1999, investigative staff increased
when the Legislature approved two new investigator positions
to enforce underage wagering requirements. According to the
OFFICE OF THE AUDITOR GENERAL 25
FINDING II THE LOTTERY SHOULD IMPROVE
COMPLIANCE INSPECTIONS
AND UNDERAGE WAGERING
EDUCATION AND ENFORCEMENT
1 By statute, the Lottery’s security director must be a peace officer certified by
the Arizona Police Officer Standards and Training Board (Arizona
P.O.S.T). Although not required by state statute, the Lottery requires its
investigative staff to have limited peace officer status.
Lottery director, having a larger investigative unit has allowed the
agency to improve the entire security program. The Division’s six
investigators are responsible for conducting retailer education,
compliance inspections, and criminal investigation activities.
Since the addition of the two new investigators, the Lottery has
added new retailer education and regulatory enforcement pro-grams,
including a retailer loss prevention program, a retailer
compliance inspection program, and a low-volume sales program
to monitor retailers who fail to meet the Lottery’s minimum sales
requirements.
Compliance inspection program designed to ensure compliance
with Lottery requirements—The Lottery adopted this program in
2000 to improve retailer oversight. Its objective is to ensure that all
licensed retailers conduct their business in compliance with estab-lished
Lottery policies and procedures, and retailer rules and
statutes. These regulations pertain to issues such as lottery termi-nal
operation, prize payment limitations, placement of instant-ticket
games and instant-ticket vending machines (ITVMs), and
enforcement of underage wagering laws. The Lottery’s special
investigators conduct the inspections at retailer locations, and use
a checklist to record compliance with retailer regulations. For
example, the investigators record things such as whether the
retailer’s online terminal is functioning properly, whether instant-ticket
games are displayed so customers can see them, whether
the retailers have placed ITVMs in locations where retail staff can
easily observe customer activity, and whether employees know
prize payment redemption requirements, which limit retailer
prize payments to $599 or less.
Arizona has a more formal inspection program than some other
states. Of the seven states contacted for this audit, only one had a
formal compliance inspection program in place.
First-year results indicate that the Lottery can modify and
improve compliance inspection program—Results from the
Lottery’s first year of conducting compliance inspections indicate
that it can take several steps to improve the program, such as:
Revising its inspection goal—The Lottery should devel-op
a systematic plan for identifying the number of retailers
to be inspected during a year. During the program’s first
year, the Lottery was unable to meet its goal of inspecting
Finding II
26 OFFICE OF THE AUDITOR GENERAL
each retailer each year. In calendar year 2001, investigators
completed compliance inspections of 1,122 retailers, or 42
percent of the total. According to security officials, the
problems they are finding mainly consist of lack of knowl-edge
regarding prize redemption limitations and stolen
ticket procedures, and incorrect handling of validated tick-ets.
Lottery officials have determined that investigators’
other duties, such as conducting criminal investigations
into theft and robbery of lottery tickets, investigating com-plaints
from retailers and the public, and conducting retail-er
loss prevention seminars, have a higher priority than
compliance inspections.
Lottery officials plan to revise the compliance inspection
goal, and have begun drafting a policy to reduce the num-ber
of compliance inspections to 500 per year, or nearly 19
percent of retailers. As part of reducing its compliance
inspection goal, the Lottery should adopt a rationale for
selecting the retailers to be inspected, and develop a new
annual inspection plan for the Commission’s approval.
Tracking inspection results—The Lottery should begin
tracking compliance inspection results in its database.
Although the Lottery maintains a compliance inspections
database that includes a field to record violations, Lottery
staff do not enter violation information in the database.
Entering information in a database would allow the Lottery
to identify common problems that need to be corrected,
such as insufficient employee training or knowledge of reg-ulations.
The Lottery could then use this information to
enhance retailer training and education.
Additional steps needed to monitor underage wagering—Finally,
the Lottery should expand its retailer compliance program to
address underage wagering more directly. In 1999, the
Legislature approved two new investigator positions to
enforce underage wagering requirements beginning in fiscal
year 2000. However, the Lottery has not directly used these
new resources to improve monitoring and enforcement of
these requirements. According to the Lottery director, the two
positions were generally approved for underage wagering, but
the Lottery has used them to strengthen the entire security pro-gram.
Because the minimum age to play lottery games will
increase from 18 to 21 in June 2003, the Lottery should begin
Finding II
OFFICE OF THE AUDITOR GENERAL 27
Tracking results could
improve the program.
taking steps now to educate retailers and the public about the
pending change.
To improve its ability to monitor and enforce underage wager-ing
requirements, the Lottery should develop a comprehensive
program to monitor underage wagering that includes the fol-lowing
components:
Revise its current compliance inspection checklist—The
Lottery should add questions to its compliance inspection
checklist to specifically address retailer staff knowledge of
minimum age requirements. Although the current checklist
includes a question about the placement of ITVMs and
whether they are visible to customer-service personnel, it does
not include any questions that directly address awareness of
underage wagering laws and rules.
Increase its use of age limit signs—The Lottery has placed
signs on customer-operated ITVMs reminding players of the
age restrictions. Similarly, the Lottery should post age limit
signs on store-operated terminals to remind players and
licensed retailers about age restrictions. The Missouri and
New Jersey lotteries place signs on both the customer-operat-ed
ITVMs and store-operated terminals.
Adopt training standards for retailers—As part of retailer
training, the Lottery should adopt some of the training stan-dards
established by Arizona Liquor Licenses and Control to
enforce underage drinking laws. For example, the Lottery
should remind retailers to regularly check the players’ identi-fication
to ensure that they are old enough to play lottery
games, train retailers to recognize invalid identification cards,
and provide them with a list of acceptable identification cards.
Finding II
28 OFFICE OF THE AUDITOR GENERAL
The Lottery can
enhance monitoring of
underage wagering
activities.
Recommendations
1. The Lottery should improve the management compliance
inspections by developing a systematic compliance inspec-tion
plan to present to the Commission for its approval.
2. The Lottery should track compliance violations in a data-base
and use it to enhance retailer training and education.
3. The Lottery should develop a comprehensive program to
monitor underage wagering for the Lottery Commission’s
consideration that includes the following components:
a. Adding a question to its compliance checklist that
directly addresses retailer knowledge of underage laws;
b. Placing signs on its online terminals to remind retailers
and players about age restrictions; and
c. Adopting policies for retailer training similar to those
that the Arizona Department of Liquor Licenses and
Controls has established to enforce underage drinking
laws. For example, the Lottery should train retailers to
check identification on a regular basis, recognize
invalid identification cards, and provide retailers with a
list of acceptable identification cards.
Finding II
OFFICE OF THE AUDITOR GENERAL 29
30 OFFICE OF THE AUDITOR GENERAL
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The Lottery has made considerable progress in implementing
previous audit recommendations to improve agency manage-ment
practices, internal controls, contract oversight, and infor-mation
technology resources. Certain control procedures, how-ever,
can be further strengthened. In particular, the Lottery
needs to amend the process it uses to distribute monies to state
programs to comply with state statute, and adopt accounting
procedures for Lottery-specific transactions.
Lottery Has Improved Many
Management Practices
Since the Auditor General’s 1997 performance audit (Report
No. 97-15), the Lottery has improved a number of internal con-trols
and acquired some needed information technology
resources as recommended. Specifically, the Lottery has
improved oversight of its retailer network, strengthened cash-handling
controls, improved contract oversight, and added
information technology security controls and resources.
Improved oversight over retailer network—The Lottery has
strengthened oversight over its retailer network since the 1997 per-formance
audit and improved management controls related to
retailer oversight. Specific improvements include:
Instituting a license renewal process and credit checks—
The 1997 audit reported that the Lottery had not renewed
retailer licenses since 1991 and did not ensure that existing
retailers were creditworthy. However, in January 2001, the
Lottery instituted a license renewal process, which requires
OFFICE OF THE AUDITOR GENERAL 31
FINDING III FURTHER CHANGES IN
CONTROL PROCEDURES WOULD
ENHANCE OPERATIONAL
IMPROVEMENTS MADE
IN RECENT YEARS
The Lottery has
improved retailer
licensing, collections,
and minimum sales
policies.
all retailer licenses to be renewed every 3 years, in accor-dance
with regulations. The new program includes con-ducting
criminal background and credit checks on owners
and retailers. In addition, the Lottery has also centralized all
licensing and renewal processes into its Security Division in
order to more efficiently carry out these activities.
Implementation of collection policies and procedures—
The 1997 audit found that retailers were allowed to contin-ue
to sell tickets even if they had not paid for previous tick-ets.
Retailers’ debt totaled more than $735,000 in 1997. The
Lottery has since improved its debt collection policies and
procedures. From June 1998 through June 2001, the Lottery
used a private collections agency to collect retailer debt until
receivables dropped to a level Lottery staff could manage.
As a result, overall retailer debt dropped from $735,000 in
1997 to about $417,700 at the end of fiscal year 2001.
Retailers that are out of business, bankrupt, or cannot be
located owe approximately $414,200, or 99 percent, of this
amount. The Lottery has transferred these cases to the
Attorney General’s Office for possible legal action. Active
retailers owed the remaining $3,500. In addition to hiring a
private collections agency, the Lottery instituted a new pol-icy
to prevent retailers from accumulating debt. In March
2000, the Lottery began suspending retailer licenses and
deactivating retailers’ computer terminals to prevent them
from selling more tickets if their bank account balances fail
to cover ticket expenses at least twice in a 3-year period.
Enforcement of minimum sales rules—In 1997, the Lottery
failed to ensure that retailers met minimum sales require-ments
of 400 online and 250 instant tickets per week. The
Lottery now requires retailers that sell below minimum lev-els
to pay the $182 per-quarter telephone terminal charges.
This fee will be increased to $260 in fiscal year 2003 to fully
cover telecommunications costs. According to the Lottery,
in fiscal year 2001, 253 retailers paid the telephone charges,
and 104 relinquished their license rather than pay the
charges. The Lottery granted 276 telephone charge waivers
for reasons such as business disruption due to construction.
Stronger internal controls involving cash and other assets—The
Lottery has improved internal controls related to its cash-handling
practices, vault balances in its claims stores, and revolving fund,
Finding III
32 OFFICE OF THE AUDITOR GENERAL
and instituted regular checks of employee payroll transactions,
as recommended in the 1997 performance audit. Improvements
include the following:
Reviews of cash reconcilia-tions—
The 1997 performance
audit found that the Lottery
did not adequately segregate
cash-handling duties at its
Phoenix and Tucson claim
stores. These stores, located
inside Lottery offices, sell
instant and online lottery tick-ets
and redeem winning tick-ets.
Now, although store
employees continue to per-form
store cash reconcilia-tions,
other Lottery employees
review these reconciliations
each day.
Reduced cash balances—The 1997 audit found that the
claim stores maintained excessive daily cash balances at the
Phoenix location. Although auditors again found high cash
balances during this audit, the Lottery has since reduced the
cash balances to a level sufficient to pay instant-ticket winners.
The Lottery now monitors its cash levels and pays winners by
cash or by check, depending on the amount of cash available.
New revolving fund controls—In 1997, the Lottery’s revolv-ing
fund contained excessive balances and lacked documenta-tion
of expenditures. The Lottery has now reduced the balance
from a maximum of $30,000 to approximately $2,500, and
upper management must approve all revolving fund expen-ditures
before they are made.
Payroll transaction checks—The 1997 audit found that the
Lottery’s payroll and internal audit departments did not peri-odically
check calculations of employee wages and associated
deductions. Now, the Lottery’s accounting supervisor regu-larly
reviews employee payroll transactions. In addition, audi-tors’
examination of the Lottery’s current payroll procedures
Finding III
OFFICE OF THE AUDITOR GENERAL 33
Lottery claim stores sell
Lottery tickets and redeem
prizes.
Photo 2:
Lottery Claim Store
and payroll documents indicates that the Lottery has estab-lished
effective payroll transaction checks.
Contract and procurement oversight is stronger—The Lottery
appears to have strengthened its contract oversight and procure-ment
practices since a 1995 Auditor General special financial audit
(see Arizona Lottery: Report on Special Review, April-October 1995),
and the 1997 performance audit, which determined that many of
the issues identified in 1995 had not been corrected. The 1995 audit
found that the Lottery did not provide adequate oversight over its
advertising vendor. For example, the audit reported that the
Lottery lacked adequate procedures to oversee its $8 million
advertising contract and did not perform vendor compliance
reviews. Actions taken since that time include:
Addition of a procurement manager—In 2000, the Lottery
hired a procurement manager experienced in Arizona state
procurement and contract management. This employee
works closely with Lottery management and the State
Procurement Office to develop requests for proposals and
review bids for new contracts.
Development of contract oversight procedures—In 2001,
the Lottery instituted a new contract oversight policy, which
established procedures for monitoring advertising, instant-ticket
printing, and online service contracts.
Additional security controls and resources for information
technology—Finally, the Lottery has addressed concerns raised
in the 1997 performance audit regarding computer system
resources, computer security controls, and information technol-ogy
policies. Actions taken include:
Increased computer system resources—The 1997 audit
found that the Lottery had inadequate computer resources to
support its games. For example, although state lotteries that
participate in the multi-state PowerBall game must have a
backup processor, the Lottery had only one high-speed
computer data line between the office and its contractor,
and only one mainframe processor with no backup equip-ment
in case of breakdown. The Lottery now has two data
lines and four processors.
Finding III
34 OFFICE OF THE AUDITOR GENERAL
Cash-handling controls
have improved.
Employee access controls—The 1997 audit reported that
employees had inappropriate access to data files that could be
deleted or manipulated, which increased the potential for
fraud and abuse. Now, the Lottery has an access control list
that limits employee access to the computer system accord-ing
to position and need. In addition, the Lottery has insti-tuted
an electronic access control to keep unauthorized per-sonnel
from entering the information technology area, and
has erected physical barriers such as doors and walls to
enclose this area.
Progress in developing information technology policies—
The 1997 audit found that the Lottery lacked written proce-dures
regarding computer systems and information technolo-gy.
For example, audit staff noted a general lack of policies
and procedures regarding computer basics, such as securi-ty,
operations, and system failures, and also noted that soft-ware
program instruction and problem-solving manuals
had not been maintained. The Lottery has since begun to
develop its internal procedures in these areas, although they
are not yet complete.
The Lottery Can Further
Improve Its Control Procedures
The Lottery should take additional steps to improve its internal
controls. First, the Lottery should revise its procedures for dis-tributing
monies to state programs to ensure that the order of
distribution is consistent with statutes. In addition, the Lottery
should develop some new accounting procedures to cover
Lottery-specific transactions.
Complying with statutory requirements for distributing monies
to certain beneficiary programs—The Lottery has not updated
its distribution procedures since state statutes were amended in
1997, and, as a result, has been incorrectly distributing revenues
from two games. The incorrect distribution involves payments
to four Funds—Local Transportation Assistance Fund (LTAF),
the County Assistance Fund, the State Heritage Fund, and the
Clean Air Fund. Currently, the Lottery incorrectly pays rev-enues
from its 3-number online game and bingo-themed
instant-ticket game to LTAF and the County Assistance Fund,
until they have received their statutorily allowed amounts, and
Finding III
OFFICE OF THE AUDITOR GENERAL 35
only then begins to distribute these game revenues to the State
Heritage Fund. Although the total amount transferred to each
fund is the same as if the Lottery followed the statute, the
Lottery’s practice delays payments to the State Heritage Fund
until late in the fiscal year. In fiscal year 2001, the Lottery did
not begin paying the State Heritage Fund until March.
Statutes specify the conditions for distributing monies to the
State Heritage Fund. A.R.S. §5-522(D) directs the Lottery to dis-tribute
up to $20 million to the State Heritage Fund from any
monies remaining in the Lottery Fund after operating expenses
have been paid and the LTAF and County Assistance Fund
have received their full allowed amounts. These monies derive
from The Pick, Fantasy 5, and instant-ticket games. However,
according to statutory amendments approved in 1997, A.R.S.
§5-522(A)(4) requires the Lottery Director to determine whether
the State Heritage Fund will receive its full allowed amount for
the year. If he determines that it will not, the 1997 amendments
require the Lottery to pay (1) 29 percent of 3-number online
game revenues and (2) 21.5 percent of revenues from a bingo-themed
instant ticket game to the State Heritage Fund. These
revenues go to the Clean Air Fund if the State Heritage Fund
has already received its fully allowed amount.
The Lottery should correct its procedures to follow the order
specified in statutes.
Improving accounting procedures—Finally, the Lottery should
adopt additional written procedures to cover Lottery-specific
accounting functions. Lottery officials state that they follow pro-cedures
prescribed in its existing accounting manual and the State
Accounting Manual. However, these current resources are not
comprehensive because they lack written procedures for account-ing
functions that are unique to the Lottery, such as automated
weekly revenue collections from retailers.
Finding III
36 OFFICE OF THE AUDITOR GENERAL
Recommendations
1. The Lottery should directly distribute revenues from the 3-
number online game and the bingo-themed instant-ticket
game to the Heritage Fund consistent with statutory
requirements.
2. The Lottery should supplement its State Accounting Manual-based
procedures with additional accounting procedures
for lottery-specific transactions, such as automated weekly
revenue collections from retailers.
Finding III
OFFICE OF THE AUDITOR GENERAL 37
38 OFFICE OF THE AUDITOR GENERAL
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In accordance with Arizona Revised Statutes (A.R.S.) §41-2951, the
Legislature should consider the following 12 factors in determining
whether the Arizona State Lottery Commission should be continued
or terminated.
1. The objective and purpose in establishing the Lottery.
The Arizona State Lottery Commission was proposed by ini-tiative
petition and approved by voters in the November
1980 general election. Voters again approved the Lottery in
the November 1998 election, after the Legislature referred the
issue to the voters. The 1998 voter-approved measure
extends the Arizona State Lottery Commission through July
1, 2003.
According to A.R.S. §5-504(B), the Lottery Commission’s
statutory purpose is:
“to oversee a state lottery to produce the maximum
amount of net revenue consonant with the dignity of the
State.”
The Lottery attempts to meet its statutory mission by admin-istering
instant-ticket and online games in order to generate
revenues for the State General Fund, and various state pro-grams.
The agency mission statement is,
“To support Arizona programs for the public benefit by
maximizing revenue in a responsible manner.”
Although the primary objective of maximizing revenue
for state programs has not changed, the Lottery’s strate-gic
plan for fiscal years 2002-2004 also emphasizes corpo-rate
citizenship, which includes the promotion of respon-sible
gaming. The Lottery’s strategic issues consist of sup-port
for public programs, corporate citizenship, and
organizational efficiency.
OFFICE OF THE AUDITOR GENERAL 39
SUNSET FACTORS
2. The effectiveness with which the Lottery has met its
objective and purpose and the efficiency with which it
has operated.
Since its inception in 1981, the Lottery has generated
approximately $4.1 billion in revenues, returned more
than $1.4 billion in net revenue to support the State
General Fund and other state programs, and awarded
more than $2.7 billion in prizes. Since the 1997 perform-ance
audit, the Lottery has demonstrated operational
improvements. Specifically, the Lottery:
¾ Maintained low administrative costs—Since the 1997
performance audit and Sunset review, the Lottery has
consistently kept its administrative costs within the
statutory allowable limit of 18.5 percent of total rev-enues,
which includes sales revenue, retailer license
fees, and investment income. Operating expenses as a
percentage of total revenues were 16.3 percent in fiscal
year 2001.
¾ Improved management practices and internal con-trols—
The Lottery has made considerable progress in
implementing 1997 performance audit recommenda-tions
to improve agency management practices, inter-nal
and management controls, contract oversight, and
information technology resources. For example, it has
improved its oversight of the Lottery retailer network,
and strengthened controls related to cash handling,
and improved computer security. (See Finding III,
pages 31 through 37.)
In addition to maintaining these improvements, the
Department should take a number of steps to further
enhance its effectiveness. First, the Lottery should con-sider
additional options to increase ticket sales revenues,
and the net sales revenue distributed to state programs.
Although the Lottery has implemented all but one of the
1997 audit recommendations to increase sales, decreased
online ticket sales have offset most of the increase in
instant-ticket sales. The decline in online sales, coupled
with an increase in the percentage of Lottery revenues
being paid out in prizes, has lowered revenues for pro-grams
that depend on the Lottery for funding, such as the
Sunset Factors
40 OFFICE OF THE AUDITOR GENERAL
State Heritage Fund. Some state programs, such as the
Clean Air Fund and Healthy Arizona programs, have
never received funding from net game revenues. In order
for all programs to receive funding, the Lottery would
need to generate from between $422.8 million and nearly
$593 million. Some options that the Lottery should imple-ment
to further increase sales include expanding use of
Instant-Ticket Vending Machines (ITVMs), implement-ing
new ticket types, such as “pull-tabs,” using sales staff
more effectively, and expanding its retailer incentive pro-gram.
(See Finding I, pages 15 through 24.)
The Lottery should also take steps to improve the new
compliance inspection program that it enhanced in 2000
to improve retailer oversight. Specifically, the Lottery
should develop a plan to select which retailers will
undergo inspections and incorporate tracking proce-dures
into the program. In addition, the Lottery should
develop a plan to improve enforcement of the Lottery’s
underage wagering rules and laws. (See Finding II, pages
25 through 29.)
Finally, in addition to improvements in agency manage-ment
practices, the Lottery can make further improve-ments.
Specifically, it can further improve accounting
procedures and improve controls over sports-themed
noncash prizes. In addition, it should follow statutory
requirements for distributing monies to state programs.
(See Finding III, pages 31 through 37.)
3. The extent to which the Lottery has operated within the
public interest.
The Lottery has taken several steps to better serve the
public interest. Determining the extent to which the
Lottery operates within the public interest depends on
individual beliefs regarding public-sponsored gambling.
Proponents argue that the Lottery has operated within
the public interest by generating substantial net revenues
that are apportioned to a variety of designated state
funds and programs. In contrast, critics maintain that the
Lottery is a form of state-sponsored and state-advertised
gambling. Such critics maintain that the social costs asso-
Sunset Factors
OFFICE OF THE AUDITOR GENERAL 41
ciated with raising such revenue are unknown, and may
in fact exceed the public benefit gained from Lottery
sales.
Since the 1997 audit, the Lottery has introduced public
awareness campaigns to improve the public perception
of the Lottery, educate the public about the programs
supported by Lottery proceeds, and increase the visibili-ty
of winners. New programs include the Lottery’s
“Where the Money Goes” campaign, and its “Winner
Awareness” program. The Lottery also tracks public
opinion and perception regarding various Lottery issues
through monthly surveys. Further, the Arizona Lottery
oversees a Compulsive Gambling Treatment and
Information program that the State Legislature approved
in 1999, as provided in the General Appropriation Act,
Laws 1999, Chapter 1, 1st Special Session. Beginning in
2000, the State required the Lottery to administer this pro-gram.
By state law, 50 percent of the appropriation must
be used to support a compulsive gambling toll-free crisis
hotline, and 50 percent must be used to contract for com-pulsive
gambling treatment programs. The Legislature
appropriated $500,000 in fiscal years 2000 and 2001. The
Lottery contracts with the Arizona Department of Health
Services to administer treatment services.
4. The extent to which rules and regulations promulgated
by the Lottery are consistent with the legislative man-date.
The Lottery has made most, but not all, of the rules
required of it. The Lottery director’s general rule-making
authority is stated in A.R.S. §5-504(B).1 As reported in a
review conducted by the Governor’s Regulatory Review
Council, at the request of the Auditor General’s Office, the
Lottery should adopt rules in four areas.
Sunset Factors
42 OFFICE OF THE AUDITOR GENERAL
1 Under A.R.S. §§41-1044 and 41-1057, rules that relate to the design, opera-tion,
or prize structure of a lottery game are reviewed and approved by the
Attorney General’s Office, rather than the Governor’s Regulatory Review
Council.
¾ First, the Lottery should develop rules pertaining to
the two special economic development games that it
offers each year as required by A.R.S. §5-504(H).
¾ Second, as required under A.R.S. §5-513(A)(3)(c), the
Lottery should adopt rules to determine the fees asso-ciated
with processing the voluntary assignment of a
Lottery prize, such as an annuity, to another party.
According to state statute, Lottery prize winners may
assign a Lottery prize to another party, under specific
circumstances.
¾ Third, the Lottery needs to adopt rules related to its
liability setoff program, as required under A.R.S. §5-
525(A). Under this program, Lottery prize payments
are used to satisfy debts that a person owes to the
State. Currently, the Lottery receives data from the
Arizona Department of Economic Security, Arizona’s
county courts, and Northern Arizona University.
¾ Finally, the Lottery should adopt personnel rules for
sales personnel who deliver products, as required
under A.R.S. §5-504(E). This statute, which became
effective July 1, 1997, states that Lottery personnel
who handle its products are not covered by the State’s
personnel system. The law applies only to sales per-sonnel
hired after the law’s effective date. Four of the
Lottery’s 23 representatives were hired after the law
became effective. Despite the law, Lottery officials
contend that all sales representatives remain “cov-ered
positions.” Since this contention conflicts with
the law, the Lottery should promulgate rules to pro-vide
sales personnel hired after the law changed with
the same protections afforded by the personnel sys-tem
or request that the Legislature change the law to
not exempt sales personnel from the State’s personnel
system.
In addition, GRRC identified a problem with Lottery
rules pertaining to license fees. Currently, Lottery rules
state that retailer license application fees are nonrefund-able.
However, A.R.S. §41-1077 provides that if any
agency does not send to the applicant a written notice
Sunset Factors
OFFICE OF THE AUDITOR GENERAL 43
granting or denying a license application within the
applicable time frame, the agency must refund all fees
charged for reviewing and acting on the application. The
Lottery should amend its license application rules to con-form
to state statute. The Lottery is currently undergoing
its 5-year rules review. As part of this process, the Lottery
intends to adopt the required rules, and amend its license
application rules, as recommended by GRRC.
5. The extent to which the Lottery has encouraged input
from the public before promulgating its rules and reg-ulations
and the extent to which it has informed the
public as to its actions and their expected impact on
the public.
The Lottery has actively encouraged input from the pub-lic
before promulgating rules and regulations. Proposed
rules are summarized in the Administrative Register, and
any proposed rule is placed on a regular Commission
meeting agenda for consideration. Commission meeting
notices are posted at both the Phoenix and Tucson
Lottery offices. The Lottery also notifies industry and
retailer representatives of proposed rules and regulations
that could affect them. In September 2000, the Lottery
formed a Retailer Advisory Committee to review, evalu-ate,
and recommend revisions to retailer rules. Typical
discussion issues include license qualifications, mini-mum
sales requirements, and license suspension/revo-cation
procedures.
Finally, the Lottery also maintains a Web site to inform
the public of its activities. Some of the information post-ed
includes information on the most recent online draw-ings
and the status of active instant-ticket games.
6. The extent to which the agency has been able to
investigate and resolve complaints that are within its
jurisdiction.
The Lottery receives and responds to a variety of infor-mal
complaints from both retailers and the public.
Sunset Factors
44 OFFICE OF THE AUDITOR GENERAL
Common grievances may include complaints about
Lottery terminals, retailers, and fraud and stolen tickets.
The Lottery assigns the complaints to appropriate per-sonnel,
such as the Security Division investigators, for
further research and disposition. Actions taken may
include filing criminal complaints with law enforcement
agencies and suspending or revoking retailer licenses.
7. The extent to which the Attorney General or any other
applicable agency of state government has the author-ity
to prosecute actions under enabling legislation.
A.R.S. §5-512.01 provides the Attorney General and
county attorneys concurrent prosecution authority for an
offense arising out of or in connection with the formation,
management, operation, or conduct of the State Lottery.
For example, the Lottery has worked with Mohave
County law enforcement officials to investigate and pros-ecute
a case involving ticket theft and embezzlement that
took place over a 3-year period.
8. The extent to which the agency has addressed defi-ciencies
in the enabling statutes which prevent it from
fulfilling its statutory mandate.
The Lottery has supported several changes to statutes
that were amended in the 2000 Legislative Session. For
example, A.R.S. §5-504(J) prohibits online or electronic
keno games or any Internet games. Subsection (K) also
requires the Lottery to print on each lottery ticket a state-ment
that help is available if a person has a gambling
problem, and a telephone number to call for assistance.
A.R.S. §5-506(10) states that the Lottery has 30 days after
receiving an allegation that a retailer has violated state
laws or rules to determine whether the retailer has vio-lated
the rule, or whether a criminal investigation is war-ranted.
Finally, A.R.S. §5-515.01 makes it unlawful to sell
a lottery ticket to a person who uses an electronic benefits
card or public assistance voucher. A.R.S. §5-515.02 also
makes it unlawful for a person under 21 years of age to
purchase a lottery ticket, beginning on June 1, 2003.
Sunset Factors
OFFICE OF THE AUDITOR GENERAL 45
9. The extent to which changes are necessary in the laws
of the agency to adequately comply with the factors
listed in the sunset law.
This audit did not identify any needed statutory changes.
10. The extent to which the termination of the agency
would significantly harm the public health, safety, or
welfare.
Terminating the Lottery would not have a detrimental
effect on the public health, safety, or welfare. However,
terminating the Lottery would eliminate a significant
amount of revenue that has been made available to the
State. The Arizona Lottery has transferred an average of
$70.6 million per year to the State since its inception.
A November 1998 ballot measure asked voters whether
they wanted to eliminate the Lottery or extend it through
July 1, 2003. Nearly 67 percent of voters approved
extending the Lottery. According to the Arizona
Attorney General, the decision to continue or terminate
the Lottery beyond this date must either be determined
by a super-majority of the Legislature (75 percent of both
houses) or be referred to Arizona voters. On April 25,
2002, the Legislature referred the issue to the voters for
consideration in the November 2002 election. The meas-ure,
if approved, would sunset the Lottery on July 1,
2012, and include the Lottery in the Legislature’s regular
sunset cycle process, thus discontinuing the need to refer
the matter back to the voters.
11. The extent to which the level of regulation exercised by
the agency is appropriate and whether less or more
stringent levels of regulation would be appropriate.
The Lottery is not a regulatory agency. However, statute
requires the Lottery to license lottery retailers, giving the
retailers the right to sell online and instant lottery tickets.
Some of the benefits associated with licensing retailers
include conducting background checks to assess the
character of potential retailers, and credit checks to assess
Sunset Factors
46 OFFICE OF THE AUDITOR GENERAL
whether they pay their bills on time. Licensure also
allows the Lottery to suspend or revoke retailers’ ability
to sell Lottery products if they fail to comply with Lottery
rules, or do not meet minimum sales requirements.
12. The extent to which the agency has used private con-tractors
in the performance of its duties and how effec-tive
use of private contractors could be accomplished.
The Arizona Lottery makes extensive use of private con-tractors
in the performance of its duties. Private contrac-tors
are used for functions such as ticket printing; adver-tising;
online game systems, services and tickets; annu-ities
to fund grand prizes; advertising; sponsorships; and
promotional materials. Private contractors also perform
auditing functions, oversight of game drawings, and
security monitoring. According to the Lottery, more than
86 percent of its fiscal year 2001 expenditures were out-sourced.
The Lottery will further privatize its functions
after it contracts out the delivery of instant tickets, as rec-ommended
in the 1997 audit. The Lottery expects a con-tractor
to complete implementation of this function by
January 2003.
Sunset Factors
OFFICE OF THE AUDITOR GENERAL 47
48 OFFICE OF THE AUDITOR GENERAL
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Arizona State Lottery Commission
Funds and Programs Designated in State Statute
To Receive Lottery Monies
¾ State General Fund—Currently limited to $31 million of
PowerBall revenues each fiscal year. Until fiscal year 2002,
the limit on PowerBall revenues was $21 million per year.
The General Fund also received a one-time transfer from
unclaimed lottery prizes in fiscal year 1999 and mandatory
transfers from the Lottery’s Fund’s advertising budget in
fiscal years 2000 and 2001. If all other beneficiary funds
receive their statutory allotments, any remaining monies
revert to the General Fund.
¾ Local Transportation Assistance Fund—Limited to a
maximum of $23 million each fiscal year from The Pick,
Fantasy 5, and instant-ticket games. Used by Arizona cities
and towns for transportation projects and a variety of other
purposes. Up to 10 percent may be used for socio-cultural
and arts programs if matched by private monies.
¾ State Heritage Fund—Limited to $20 million each fiscal
year from instant-ticket games and the online games, The
Pick, Pick3, and Fantasy 5. Approved by voters in 1990 to
support Arizona State Parks and Arizona Game and Fish
Commission projects such as trail and park maintenance,
land acquisition, and educational programs. Funding began
in fiscal year 1991.
¾ County Assistance Fund—Limited to $7.65 million each
fiscal year from The Pick and Fantasy 5 online games, and
instant-ticket games. The State’s 15 counties use Lottery
monies for a variety of programs, such as law enforcement,
education, and health.
¾ Commerce and Economic Development Fund—The
Arizona Department of Commerce Economic Development
OFFICE OF THE AUDITOR GENERAL a-i
APPENDIX
Commission receives proceeds from two instant-ticket
games designated by the Arizona Lottery for economic
development programs such as the “Main Street Program,”
which supports rural Arizona downtown revitalization
efforts. Funding began in fiscal year 1990.
¾ Mass Transit Fund—Limited to $18 million each fiscal year
from PowerBall, Pick3, and the Bingo instant ticket game.
Established in 1995 as a second local transportation assistance
fund to support public transit. Funding began in fiscal year
1998.
¾ Healthy Arizona Programs—Funded from online games of
The Pick, Fantasy 5, Pick3, and instant-ticket games only after
the Heritage Fund receives its annual $20 million. Established
in 1996 to provide Lottery monies to the Arizona Area Health
Education System; Disease Control Research Fund; Healthy
Families Pilot Program; Health Start Pilot Program; teenage
pregnancy prevention programs; and the Women, Infants and
Children Food Program.
¾ Clean Air Fund—Funded only after the Heritage Fund
receives its annual $20 million. Established in 1996 for the
Arizona Department of Commerce to use for purposes such as
grants promoting the use of alternative fuels and High
Occupancy Vehicle signs on federal and state roads. The fund
received a one-time transfer of $500,000 from unclaimed prizes
in fiscal year 1997.
¾ Court-Appointed Special Advocates Fund—Funded solely
from 30 percent of the Lottery’s Unclaimed Prize Fund. Used
to train over 900 Court-Appointed Special Advocates, who
provide a voice in the courtroom for abused, neglected, and
abandoned children. Funding began in fiscal year 1992.
Appendix
a-ii OFFICE OF THE AUDITOR GENERAL
OFFICE OF THE AUDITOR GENERAL
AGENCY RESPONSE
OFFICE OF THE AUDITOR GENERAL
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May 28, 2002
Ms. Debbie Davenport
Auditor General
Office of the Auditor General
2910 N. 44th St., #410
Phoenix, AZ 85018
Dear Ms. Davenport:
Thank you for conducting the performance audit of the Arizona Lottery. We appreciate the favorable
overview and positive evaluation of the progress made since the last performance audit in 1997 and
welcome the Auditor General’s recommendations as the basis for continuing the successful strategies
for the future of the organization.
The performance audit provides an excellent record of the status of the Lottery. Compared to the prior
audit conducted five years ago, the Lottery has gone from a D+ grade up to an A- grade. This
document will be an extremely useful resource for the following reasons:
· The audit identifies several significant improvements and initiatives that have been
introduced during the past five years.
· The audit recognizes that some of the improvements and initiatives incorporated into the
agency’s operations may still require continuing support and attention.
· The audit recommends improvements and initiatives that can be presented to the State
Legislature for support and funding for future implementation.
· The audit identifies improvements and initiatives that can be introduced as the Lottery enters
a new era of growth and prosperity.
Ms. Debbie Davenport
May 28, 2002
Page 2
During the past five years, the Lottery has achieved a level of stability that reflects our commitment to
responsible public management, sound business practices and professional marketing strategies. By
adopting internal policies and procedures, preparing and implementing product strategic plans and
conducting responsible advertising, the Lottery has maintained a consistent sales level, a respectable
return to the State and an impressive measure of public trust and confidence. We pledge to continue the
following:
· Operate the agency in an efficient and effective manner to responsibly maximize revenue to
benefit State projects and programs.
· Help retailers, players, and the general public understand the need to be aware of the
problem gambling and underage wagering issues.
· Increase the Lottery’s positive visibility among players, retailers, employees, business leaders,
the media, and the general public.
· Design, develop and manage ScratchersSM games to maintain the Lottery’s most successful
product for players’ enjoyment.
· Enhance online games to achieve the “more winners, more often” objective.
By adhering to the above practices, we will retain the Arizona Lottery’s place in the forefront of public
performance for the people of Arizona.
Sincerely,
Geoffrey E. Gonsher
Executive Director
TABLE OF CONTENTS
Introduction ................................................................................................................................... 1
The Lottery Has Made Significant Progress Since 1997 ........................................................... 1
The Lottery Conducts Itself as a Business Enterprise............................................................... 1
Responsible Strategic Issues Are Emphasized ......................................................................... 2
Sales and Performance ..................................................................................................................... 3
Results Have Exceeded Expectations ..................................................................................... 3
Scratchers Games Are an Award-Winning Success Story......................................................... 3
Changes to Online Games Have Been Made, but Competition and Other Factors
Have Impacted Sales ............................................................................................................ 4
Marketing and Advertising Are Conducted in a Professional Manner ........................................ 5
Communications Have Improved Visibility and Public Image .................................................. 6
Several Honors and Awards Have Been Received ................................................................... 7
Sales Strategies Have Resulted in Improved Retailer Relations and Performance
in the Marketplace................................................................................................................ 7
Game Proceeds Continue to Support Statutory Beneficiaries .................................................... 8
Player Research Is Incorporated into Policies and Decisions..................................................... 8
Security and Integrity ....................................................................................................................... 9
The Lottery’s Security Protects Players, Retailers, Employees and the General Public ................ 9
Information Technology Continues to Improve Efficiency and Reliability ............................... 10
The Lottery Has Taken a Leadership Role in Responsible Gambling....................................... 11
Findings and Recommendations ...................................................................................................... 13
1
INTRODUCTION
THE LOTTERY HAS MADE SIGNIFICANT PROGRESS SINCE 1997.
In 1997, the Lottery was receiving considerable negative attention because of the agency’s management,
game sales and retailer relations. Subsequently, Governor Jane Dee Hull took office and recognized
questionable practices within the agency, terminated the executive director and charged the new
management team with the responsibility to reestablish the Lottery’s credibility.
Our immediate impression was that the Lottery was an agency in transition. We needed to return to a
professional management track and to make responsible marketing, advertising and sales decisions. We
also needed to revitalize our games and halt the trend of declining sales. Expanded gaming competition,
greater player boredom, and unexciting games were contributing to an environment in which regular
Lottery players were buying fewer tickets less often and occasional Lottery players were buying tickets
only when jackpots were high.
In addition, we were confronted with the Auditor General’s performance audit that identified deficiencies
in the way the Lottery as a public entity managed its games, retailers and operations. This performance
audit was a wake-up call to the Lottery, telling us in no uncertain terms that the manner in which the
Lottery had been conducting business was no longer acceptable or appropriate to achieve the agency’s
statutory objectives.
It was obvious that we could no longer hope for success and continue to do business as we had in the past.
We could no longer rely upon stale, out-of-date marketing approaches. And we could no longer assume
that people would buy our products just because the games were in the dispenser. This environment
motivated us to do a better job with our products and our customers and challenged us to remain a
dependable source of revenue for the State of Arizona.
This year’s audit and the Lottery’s response describe the progress we have made since 1997. We have
restructured our games to appeal to a wide variety of players and, as a result, have met or exceeded our
sales goals, thereby generating financial support for our statutory beneficiaries.
Further, we have stabilized the agency’s management. We have improved and strengthened our public
image. We have taken the initiative to be an accountable, productive and responsible public agency. In
the performance audit and in this audit response, you will read about the policies, practices, and
philosophies that serve as the basis for how the Lottery conducts business today for the people of Arizona.
THE LOTTERY CONDUCTS ITSELF AS A BUSINESS ENTERPRISE.
The Arizona Lottery is a state entity in a business environment. But because the Lottery is a government
agency, it is not widely viewed as a business. This is unfortunate because the Lottery must conduct itself
as a private sector business in order to be successful.
2
The Lottery is similar to major corporations in that it designs, manufactures, distributes and sells
consumer products in the retail market. The Lottery’s sales are achieved with low administrative
overhead costs, which reflects the Lottery’s achievement of 86% privatization with a reliance upon an
extensive group of contractors to provide services.
Structured as a public entity, the Lottery is obligated to conduct business consistent with statutory
requirements. This includes fiscal, personnel, procurement, operations and several other areas of policy
and practice. One of our objectives has been to incorporate private sector concepts, practices, and
policies into both our day-to-day and long-term operations.
We have achieved this objective by including individuals who have private-sector experience in the
decision-making process. Representatives from local businesses, other lotteries and major government
organizations have participated in procurement evaluation panels. Members of the business and
professional community are serving on the Retailer Advisory and the Responsible Gambling Advisory
Committees. And individuals with private sector experience have participated on several job interview
panels. Their perspectives have enabled us to introduce new, different and effective management
principles and practices to balance our internal focus.
The Arizona Lottery is truly a corporate organization existing in a governmental structure. Private sector
businesses have stockholders, boards of directors and customers. Similarly, the Arizona Lottery has
stockholders (the people of Arizona), a regulatory body (the Arizona Legislature), a Chairman of the
Board (the Governor) and customers (players and retailers).
It is for all these reasons that the Arizona Lottery makes every effort to conduct itself as a business while
still respecting the mandates of government. We prepare annual budgets, develop strategic plans, conduct
sales and marketing campaigns, perform customer research, design new products and promotions, track
industry trends, support a retail distribution network and contribute to the community. These activities
are essential if we are to remain a successful member of the Arizona business community.
RESPONSIBLE STRATEGIC ISSUES ARE EMPHASIZED.
The Lottery’s strategic issues stress statutory requirements to generate revenue for the State of Arizona.
In addition, the issues respond to our commitment to operate in an efficient and effective manner and
outline our continual efforts to promote the Lottery as a responsible corporate organization.
Consistent with our continuing improvements, the Lottery’s Strategic Plan incorporates the following:
· Mission Statement. The mission statement emphasizes greater support for Arizona programs
in a responsible manner.
· Strategic Issues. The strategic issues include support for public programs, corporate
citizenship and organizational efficiency.
· Goals and Performance. The performance measures for the agency goals address the
strategic issues by promoting responsible gaming, pursuing corporate and community
partnerships and expanding public awareness of the Lottery’s benefits to the people of
Arizona.
3
SALES AND PERFORMANCE
RESULTS HAVE EXCEEDED EXPECTATIONS.
Over the past few years, the Lottery’s sales projections have been established at a realistic, conservative
level because of the State’s political environment, increasing competition, and unpredictable jackpot
levels. The success of our efforts, however, has resulted in the Lottery exceeding the sales forecast for
the past four years.
Sales
· The Lottery completed the best four years in its 20-year history with total revenue over
$1 billion.
· In FY 01, total sales were nearly $273 million, marking the first time in the history of the
Lottery that sales exceeded a quarter of a billion dollars for four consecutive years.
· FY 02 total sales are projected to reach $290 million, a record high in the Lottery’s 20-year
history.
· Instant ticket sales reached an all-time high of $136.9 million in FY 01, an increase of 30%
since 1997.
Winning Tickets and Prizes
· Players had 16.9 million more winning tickets for Lottery games during the past four years
compared to the prior four-year period.
· Players won $228.8 million in prizes in FY 01, $96 million more than the prior year.
Retailer Benefits
· Retailers received an additional $5.8 million in commissions during the past four years
compared to the prior four-year period.
· Retailer commissions of $18.5 million (an all-time high) were $1.7 million, or 10% more than
the prior year.
SCRATCHERS GAMES ARE AN AWARD-WINNING SUCCESS STORY.
The evolution of the Lottery’s Scratchers product over the past four years has been one of our best
success stories. Sales for these games culminated in an all-time high of $136.9 million in FY 01. This
success is a direct result of our focused attention on the management of the product design and
development. It has included player research, ticket design, printing levels, balanced product mix,
attractive prize payouts, retailer placement and games that are appropriate for the Arizona market. Our
original goal was to increase product sales, and we achieved it beyond our expectations.
4
Several new Scratchers policies have been implemented to support the increase in sales. New game
concepts have replaced overused, outdated themes. Tickets are now larger with enhanced graphics and
larger fonts for easier readability. We decreased the quantity of tickets printed per game depending on
theme and prize, thereby creating opportunities to offer new games more often. The top prize for $1
games has been lowered to $250 - $1,000 in many games to fund more meaningful mid-tier prizes and
provide more players with a winning experience. The $2, $3, $5 and extended-play games, which
continue to be popular with players, are a substantive part of our product mix. All of these improvements
have been recognized and appreciated by players, as evidenced by the record sales.
The Lottery’s Scratchers strategy incorporates the following objectives to increase players’ enjoyment of
the games:
· Continue to introduce popular games and themes at regular intervals to provide fresh
excitement for the players.
· Offer a balanced mix of $1, $2 and $5 tickets, player-supported themes and extended-play
games.
· Introduce new $3 and $5 games in response to player enthusiasm and retailer appreciation.
· Provide a competitive prize payout that guarantees the State the statutory distribution,
compares favorably to the payout in the industry and sustains the number of meaningful
mid-tier prizes.
· Design attractive and appealing game graphics that are easy to read and understand.
This strategy reinforces the product initiatives introduced in 1997 and has become a model for current and
future decisions. The Lottery now has an analytical trend basis, substantial data and sales results upon
which future Arizona Lottery management can make informed decisions. The ultimate objective of the
strategy is to continue to improve the management of the agency’s instant ticket product to increase sales
for greater revenue for the State of Arizona.
CHANGES TO ONLINE GAMES HAVE BEEN MADE, BUT COMPETITION AND OTHER
FACTORS HAVE IMPACTED SALES.
Prior to 1997, no positive changes had been made to the Lottery’s online products for several years.
Consequently, sales were decreasing at a steady pace.
In our first message to the Legislature five years ago, we proposed changes to the games that included
new matrices, higher jackpots, more winners and more popular games. Since that time, structural
improvements have been introduced to the Arizona-based online games, The PickTM, Fantasy 5TM and
Pick 3TM.
The purpose of the Lottery’s online strategy is to continue providing creative, sales and management
support to the Lottery’s online games to maximize sales for greater revenue for the State of Arizona. The
online strategy includes the following objectives:
5
· Provide a prize payout that protects the required distribution to the State, sustains the
number of meaningful mid-tier prizes, promotes increased sales and remains competitive
with industry standards.
· Balance the results of Arizona-specific player research against industry trends in the
development and modification of games.
· Optimize existing games to maintain their appeal in an ever-changing entertainment
environment.
· Ensure that online game players can clearly understand game play styles, options and prize
structures so responsible purchases are made by informed customers.
Despite these efforts, the Lottery’s online games are still suffering. Every recommendation included in
the 1997 audit has been introduced, but, as noted by the recent audit, factors outside the Lottery’s control
have negatively impacted online sales.
An audit-noted factor is the dramatic increase in competition from the Indian casinos. The audit also
noted that the major games are jackpot driven. The Pick players do not buy tickets until the jackpot
increases substantially. Powerball® sales do not increase measurably until the jackpot hits $70 million or
above. A third contributing factor was the legislative reduction in advertising funds by 30%, which
severely limited the Lottery’s ability to market these games.
In FY 03, the Lottery plans additional changes to The Pick and Fantasy 5 in another effort to rejuvenate
these games for greater player appeal and increased revenue. In addition, a new corporate sponsor for
Pick 3 will provide advertising and marketing support that the Lottery cannot afford today.
MARKETING AND ADVERTISING ARE CONDUCTED IN A PROFESSIONAL MANNER.
Four years ago, the Lottery introduced a new strategic direction for all marketing and advertising
activities. The primary focus in all public communications was to position the Lottery as a responsible
corporate citizen with professional business practices. These themes are now the nucleus of all marketing
and advertising activities.
The Lottery will continue these themes as they have been so well received and have positively impacted
both the organization’s public image and sales. The focus is to reinforce the Lottery’s reputation among
players and the general public, to raise awareness of how game proceeds are distributed and to increase
the visibility of winners. The marketing strategy incorporates these elements into the following
objectives:
· Conduct all advertising in a responsible manner.
· Design advertising to appeal primarily to regular and occasional players.
· Promote the beneficiaries of Lottery game proceeds.
· Provide jackpot information for Powerball and The Pick to maximize sales.
6
· Promote premium Scratchers games that appeal to a variety of players to continue the
strong growth pattern.
· Conduct player research to develop game concepts responsive to player interest and to
measure public perceptions and attitudes.
Our commitment to responsible advertising is not to entice players to spend their money on fantasies,
dreams and high expectations. Nor will players be barraged with obnoxious characters, seductive
temptations or confusing messages. The Lottery’s approach to all player and public communications will
continue to be clear, responsible, professional and informative.
The Lottery’s marketing strategy continues to move the Arizona Lottery into a new era of public
communications. With fewer financial resources available, the Lottery must leverage the campaigns’
investments wherever possible to achieve maximum impact. It is critical to reinforce the commitment
that the Arizona Lottery has already made to responsible advertising and marketing standards.
COMMUNICATIONS HAVE IMPROVED VISIBILITY AND PUBLIC IMAGE.
The Arizona Lottery actually has two products to position and promote. The first, and most obvious,
includes all of the online and Scratchers games that generate revenue for public programs and projects.
The second, and equally important, is the image of our business. The Lottery has strategies and activities
for supporting both of these products.
The Communications strategy has two components, one for internal communications and one for external
communications. During the past few years, we have devoted substantial resources to support the
external constituencies, including players, retailers, media and the general public. We conduct monthly
research to track public opinions and attitudes toward the Lottery. The latest survey shows 78% of the
public believes that the agency is run with honesty and with integrity. An independent retailer survey
concluded that retailers “overwhelmingly had positive comments and opinions regarding services they are
receiving from the Lottery.” These are impressive indicators of a positive public and customer image.
We are just as proud of our efforts to strengthen internal relationships with our employees. The recent
Employee Satisfaction Survey conducted by the State of Arizona revealed that a high percentage of
Lottery employees expressed satisfaction with their jobs, with internal communications and with their
work environment. The agency ratings were higher than the previous year and higher than the statewide
average. For the third consecutive year, the Lottery enjoyed a favorably rating. It is encouraging to see
that our communications efforts are succeeding among our employees as well.
We are pleased to have achieved several of the Lottery’s communications objectives for players, retailers,
employees, the general public and the media. The following are the Communications objectives:
· Reinforce general public communications by continuing the highly successful “Where The
Money Goes” campaign.
· Improve retailer communications with a quarterly newsletter, game announcements and flyers
announcing store-specific winners.
7
· Strengthen media relations by continuing to develop relationships with key media throughout
the State and increased visibility and exposure in rural communities.
· Enhance employee communications by distributing a monthly employee newsletter,
maintaining agency policies, participating in employee surveys and supporting recognition
awards activities.
· Expand player communications with an updated and enhanced Web site, prompt response to
player feedback, increased player hotline capacity, informative lobby displays, winner
awareness program, and responsible gambling program and educational brochures.
The Communications strategies have increased the Lottery’s positive visibility and image among players,
retailers, employees, business leaders, the media and the general public.
SEVERAL HONORS AND AWARDS HAVE BEEN RECEIVED.
The Lottery has been honored to receive public recognition of its successes during the past few years.
· A recipient of the Governor’s Spirit of Excellence Award for three consecutive years
(Reduction of Outstanding Retailer Receivables; Game Development Team; and Scratchers:
A Product Management Success Story).
· Selection of Cindy Esquer, Communications Manager, and Jeff Hoffman,
Telecommunications Specialist, by the Arizona Administrators Association as the top two
employees of the year in Arizona State government.
· The only lottery in the industry recognized by the American Gaming Association with the
organization’s first Communications Award for the Best Annual Report by a Public Agency.
SALES STRATEGIES HAVE RESULTED IN IMPROVED RETAILER RELATIONS AND
PERFORMANCE IN THE MARKETPLACE.
The Lottery’s sales objective is to generate the maximum amount of revenue in a responsible manner in
order to support Arizona programs. To accomplish this objective, the Sales Department has developed a
comprehensive action plan for the distribution, display and promotion of all Lottery products in the retail
market.
Because the retail community is a critical component of our success, our sales strategies and guidelines
strengthen this partnership. During the past four years, we have made the following progress within the
retailer community:
· Communications. Retailer Roundup newsletter; Executive Director’s letters regarding game
enhancements, increased commissions, Problem Gambling Helpline information, underage
wagering and public assistance voucher prohibition; Sales Director’s letters regarding game
changes, promotional opportunities and retailer incentives; winning ticket flyers; and jackpot
alert plan.
8
· Participation. Retailer Advisory Committee, Playcenter RFP Evaluation Panel, General
Market Advertising RFP Evaluation Panel, Lottery job interview panels, Arizona Food
Marketing Alliance Partnership, Promotions Team and Economic Development Road Trip.
· Improved Operations. New online system with greater retailer reliability and flexibility of
operations, policies for low-volume locations and partial pack returns.
· Security. Three-digit validation code, tracking ticket stock by retailer, enhanced password
options, retailer loss prevention seminars, and routine compliance inspections.
· Training. Online Terminal Training Manual, training terminals at corporate sites, new
equipment training, and Sales Representatives Training Program.
· Bonus Opportunities. Incentive bonuses for the relaunch of The Pick, Fantasy 5 and Pick 3,
and new Retailer Incentive Plan.
· Promotional Support. Lottery promotions van, in-store promotions, industry-specific point-of-
sale items and expanded line of point-of-sale items.
GAME PROCEEDS CONTINUE TO SUPPORT STATUTORY BENEFICIARIES.
Lottery game proceeds are distributed annually based upon statute. As a result of the strong sales in
FY 01, three of the five major statutory beneficiaries received the maximum distribution. The Local
Transportation Assistance Fund, County Assistance Fund, and the General Fund have consistently
received the maximum distribution allowed. In FY 01, the Heritage Fund also received an increase of
$774,900, nearly 5% over the prior year. In addition, the Commerce and Economic Development Fund
received $3.17 million, almost 34% more than the prior year. Distribution from unclaimed prize monies
to support the Court Appointed Spec ial Advocate (CASA) Program was $1.5 million.
Powerball® proceeds are designated for the General Fund and Mass Transit. Heritage Fund monies come
from four games (Scratchers, The Pick, Fantasy 5 and Pick 3) that are shared among several beneficiaries.
Prior to FY 98, the Lottery was required to return 31.5% of Scratchers sales and 31.5% of online sales to
the State. After FY 98, the required return to the State was reduced to 21.5% for Scratchers and 29% for
on-line games. The Powerball percentage was increased to 31.6% in FY 00. This a
Object Description
| TITLE | Performance audit, Arizona State Lottery Commission Report Number 02-02 |
| CREATOR | Office of the Auditor General |
| SUBJECT | Arizona State Lottery Commission--Auditing; Revenue--Arizona--Auditing; Gambling--Arizona--Auditing; Lotteries--Arizona--Auditing; |
| Browse Topic |
Government and politics |
| DESCRIPTION | This title contains one or more publications |
| Language | English |
| Publisher | Office of the Auditor General |
| Material Collection | State Documents |
| Acquisition Note | Report No. 02-02 |
| Source Identifier | LG 6.2:R 36 |
| Location | o50104552 |
| REPOSITORY | Arizona State Library, Archives and Public Records--Law and Research Library |
Description
| TITLE | Performance audit, Arizona State Lottery Commission |
| DESCRIPTION | 85 pages (PDF version). File size: 1067 KB |
| TYPE |
Text |
| Acquisition Note | Report No. 02-02 |
| RIGHTS MANAGEMENT | Copyright to this resource is held by the creating agency and is provided here for educational purposes only. It may not be downloaded, reproduced or distributed in any format without written permission of the creating agency. Any attempt to circumvent the access controls placed on this file is a violation of United States and international copyright laws, and is subject to criminal prosecution. |
| DATE ORIGINAL | 2002-06 |
| Time Period |
2000s (2000-2009) |
| ORIGINAL FORMAT | Born Digital |
| Source Identifier | LG 6.2:R 36 |
| Location | o50104552 |
| DIGITAL IDENTIFIER | 02-02.pdf |
| DIGITAL FORMAT | PDF (Portable Document Format) |
| REPOSITORY | Arizona State Library, Archives and Public Records--Law and Research Library. |
| File Size | 1092549 Bytes |
| Full Text | State of Arizona Office of the Auditor General PERFORMANCE AUDIT Report to the Arizona Legislature By Debra K. Davenport Auditor General ARIZONA STATE LOTTERY COMMISSION June 2002 Report No. 02-02 The Auditor General is appointed by the Joint Legislative Audit Committee, a bipartisan committee composed of five senators and five representatives. Her mission is to provide independent and impar-tial information and specific recommendations to improve the operations of state and local government entities. To this end, she provides financial audits and accounting services to the state and political subdivisions and performance audits of state agencies and the programs they administer. The Joint Legislative Audit Committee Representative Roberta L. Voss, Chairman Senator Ken Bennett, Vice Chairman Senator Herb Guenther Representative Robert Blendu Senator Dean Martin Representative Gabrielle Giffords Senator Peter Rios Representative Barbara Leff Senator Tom Smith Representative James Sedillo Senator Randall Gnant (ex-officio) Representative James Weiers (ex-officio) Audit Staff Shan Hays—Manager and Contact Person (602) 553-0333 Monique Cordova—Team Leader Mark Haldane—Team Member Pam Eck—Team Member Jason Blake—Team Member Copies of the Auditor General’s reports are free. You may request them by contacting us at: Office of the Auditor General 2910 N. 44th Street, Suite 410 Phoenix, AZ 85018 (602) 553-0333 Additionally, many of our reports can be found in electronic format at: www.auditorgen.state.az.us 2910 NORTH 44th STREET • SUITE 410 • PHOENIX, ARIZONA 85018 • (602) 553 -0333 • FAX (602) 553 -0051 DEBRA K. DAVENPORT, CPA AUDITOR GENERAL STATE OF ARIZONA OFFICE OF THE AUDITOR GENERAL WILLIAM THOMSON DEPUTY AUDITOR GENERAL June 3, 2002 Members of the Arizona Legislature The Honorable Jane Dee Hull, Governor Mr. Geoffrey Gonsher, Executive Director Arizona State Lottery Commission Transmitted herewith is a report of the Auditor General, A Performance Audit of the Arizona State Lottery Commission. This report is in response to an August 9, 2001, resolution of the Joint Legislative Audit Committee. The performance audit was conducted under the authority vested in the Auditor General by A.R.S. §41-1279 and as part of the Sunset review set forth in A.R.S. §41-2951 et seq. I am also transmitting with this report a copy of the Report Highlights for this audit to provide a quick summary for your convenience. As outlined in its response, the Arizona State Lottery Commission agrees with all of the findings and plans to implement 10 of the 11 finding recommendations and implement 1 finding recommendation in a different manner. My staff and I will be pleased to discuss or clarify items in the report. This report will be released to the public on June 4, 2002. Sincerely, Debbie Davenport Auditor General Enclosure OFFICE OF THE AUDITOR GENERAL Program Fact Sheet Arizona State Lottery Commission Services: The statutory purpose of the Arizona State Lottery Commission is to “oversee a state lottery to pro-duce the maximum amount of net revenue consonant with the dignity of the State.” The Lottery markets a variety of games through a network of nearly 2,570 retailers in order to earn revenue for the State General Fund and several state programs. The Lottery's responsibilities include ensuring game integrity, monitoring retailer sales and compliance, investigating allegations of criminal activity related to Lottery tickets, and overseeing outside contractors. $245 $250 $255 $260 $265 $270 $275 $280 2000 2001 Millions Ticket Sales Other Revenues Revenue Distribution ($274) Beneficiary Funds $151 $77.77 $18.50 $26.83 Lottery Prize Fund Beneficiary Funds Operations and Retained Earnings Retailer Commissions $23.28 $23.00 $16.97 $7.65 $3.70 $3.17 State General Fund Local Transportation Assistance Fund State Heritage Fund County Assistance Fund Mass Transit Fund Commerce and Economic Development Fund Distribution of Lottery Revenues Fiscal Year 2001 (in Millions) Assets: $31,312,009 (fiscal year 2001) The Arizona State Lottery Fund’s assets totaled approximately $31.3 million in June 30, 2001. Cash ($18.8 million) Ticket Inventory ($0.9 million) Deposit— PowerBall ($5 million) Other Current Assets ($2.8 million) Net Property and Equipment ($3.8 million) Program Revenue: $274 million (fiscal year 2001) OFFICE OF THE AUDITOR GENERAL Marketing (3) Director's Division (17) Security (18) Sales (40) Administration (25) Information Technology (20) Personnel: 123 full-time equivalent staff (fiscal year 2001) Facilities and Equipment: The Arizona Lottery owns its Phoenix facility at 4740 East University Drive. It also leases an office at 4010 East Grant Road in Tucson. The Lottery’s equipment includes typical office equipment such as furniture and computer equip-ment. In addition, the Lottery leases 321 Instant-Ticket Vending Machines, which are located at supermarket chains. Program Goals (fiscal years 2002-2004): 1. To sustain revenue. 2. To continue to increase agency efficiency. 3. To expand public awareness regarding the Lottery's image, beneficiaries, winners, and prod-ucts. 4. To enhance retailer relationships. 5. To promote responsible gaming. 6. To attract and retain high-quality employees. 7. To support diversity in the workplace. Adequacy of Goals, Objectives, and Performance Measures: The Lottery’s 7 goals appear to be reasonably aligned with its mission, and it has established 12 objectives and 33 performance measures in line with its goals. However, the Lottery could improve some of its goals, objectives, and performance measures. For example: The Lottery should amend its first goal to better reflect its statutory purpose. Instead of seeking to sustain revenue, the Lottery should strive to increase revenue in order to improve its ability to support the state programs it earns revenues for. The Lottery should add new objectives and per-formance measures such as: Monitoring retailer compliance with Lottery rules and regulations. (Goal 2) Increasing the public’s knowledge of Lottery games, and the programs that Lottery dollars support. (Goal 3) Recruiting and retaining Lottery retailers. (Goal 4) Enforcing underage wagering laws. (Goal 5) The Office of the Auditor General has conducted a performance audit and Sunset review of the Arizona State Lottery Commission, in response to an August 9, 2001, resolution of the Joint Legislative Audit Committee. This performance audit was conducted under the authority vested in the Auditor General by A.R.S. §41-1279 and as part of the Sunset review set forth in A.R.S. §41-2951 et seq. The statutory purpose of the Arizona State Lottery Commission is “to oversee a state lottery to produce a maximum amount of net revenue consonant with the dignity of the State.” The Arizona Lottery’s mission is to support Arizona programs for the public benefit by maximizing revenue in a responsible man-ner. In fiscal year 2001, the Lottery transferred nearly $78 mil-lion to beneficiary funds, such as the Local Transportation Assistance Fund, the State Heritage Fund, and the State General Fund, and an additional $1.5 million from unclaimed prizes to support the Court Appointed Special Advocate program. The Lottery Should Do More To Maximize Its Sales (See pages 15 through 24) Although the Arizona Lottery has made improvements to increase sales, overall revenues show little change. In the past 5 years, the Lottery has updated its online games, modified instant-ticket games, added higher-priced instant tickets, and implemented annual sales and marketing strategies. In spite of these improvements, online game sales, which tend to vary according to jackpot levels, have decreased. These declining online game sales have offset most of the increased instant-tick-et sales. For example, annual instant-ticket sales averaged $83.5 million and online sales averaged $177.4 million between fiscal years 1994 and 1997; however, during the 4-year period from fiscal years 1998 through 2001, average annual instant-ticket sales rose to $121.0 million, while average online sales fell to $140.8 million. OFFICE OF THE AUDITOR GENERAL i SUMMARY In addition, in an effort to increase sales, in 1997 the Legislature increased the percentage of Lottery revenues paid out in prizes, and decreased the percentage going to state programs. Even though instant game sales increased by 30 percent between 1997 and 2001, the increased prize payouts resulted in a net reduction in the total amount instant games provided to beneficiary funds, from $33 million to $29 million. To further increase instant-ticket sales, the Lottery should expand its use of instant-ticket vending machines, which have proven successful in Arizona in increasing sales, and introduce more variety in instant-ticket prices. The Lottery should also develop and submit to the Lottery Commission a plan to implement new types of instant tickets, such as pull-tab tickets, which are used by other states such as Missouri and Kentucky. In addition, the Lottery could enhance its overall sales by more effectively using its sales representatives and expanding its retailer incentives. The Lottery should follow though with its plans to pri-vatize ticket delivery, to enable sales representatives to provide more support to retailers, and to recruit new retailers. Finally, the Lottery should consider incentives used in other states, such as the contests with cash prizes awarded to retailers for marketing lottery products in Missouri and Connecticut. The Lottery has already begun to offer game-related promotional incentives and should continue its efforts to expand its retailer incentive program. The Lottery Should Improve Compliance Inspections and Underage Wagering Education and Enforcement (See pages 25 through 29) The Lottery should take steps to improve its program for moni-toring retailer compliance with Lottery regulations and enforcing underage wagering laws. The Lottery’s security division is responsible for regulatory enforcement, retailer education, and criminal investigations. A recent expansion of investigation staff has allowed the Lottery to add new retailer compliance and edu-cation programs. Investigative staff increased in fiscal year 2000, after the Legislature approved two new positions to enforce underage wagering requirements. First-year results from its com-pliance inspections indicate that the Lottery should modify its Summary ii OFFICE OF THE AUDITOR GENERAL annual inspection goal, and track inspection results. The Lottery should also develop a comprehensive program to deter under-age wagering that includes ensuring retailer knowledge of the age limit for buying Lottery tickets, increasing retailers’ use of age limit signs, and adopting training standards for retailers. Further Changes in Control Procedures Would Enhance Operational Improvements Made in Recent Years (See pages 31 through 37) The Lottery has made significant progress in implementing rec-ommendations from a 1997 Auditor General report (see Report No. 97-15) to improve agency management practices in some areas, but it can still strengthen certain control procedures. The Lottery has improved oversight of its retailer network by estab-lishing a license renewal process that includes credit checks, implementing collection procedures, and enhancing its mini-mum sales policy. Additionally, it strengthened its internal cash and asset controls and has improved contract and procurement oversight by developing contract oversight procedures and hir-ing a procurement manager. Further, the Lottery has added computer system resources and improved computer system security. However, the Lottery should further improve its control proce-dures. First, the Lottery should change its current practice for distributing revenues from two games. The Lottery’s current practice is inconsistent with statutory requirements and delays payments to the Heritage Fund until late in the fiscal year. Finally, the Lottery should develop additional accounting pro-cedures for Lottery-specific transactions that are not covered in the Arizona State Accounting Manual. Summary OFFICE OF THE AUDITOR GENERAL iii iv OFFICE OF THE AUDITOR GENERAL (This Page Intentionally Left Blank) Page Introduction and Background . . . . . . . . 1 Finding I: The Lottery Should Do More To Maximize Its Sales . . . . . . . . 15 Despite Steps To Increase Sales, Declining Online Game Revenues Offset Instant Ticket Revenue Growth . . . . . . . 15 The Lottery Should Take Additional Steps to Increase Sales . . . . . . . . . . . . . . . . . . . . . . . . . . . . 19 Recommendations . . . . . . . . . . . . . . . . . . . . . . . . 24 Finding II: The Lottery Should Improve Compliance Inspections and Underage Wagering Education and Enforcement . . . . . . . . . . . . . . . . 25 Recommendations . . . . . . . . . . . . . . . . . . . . . . . . 29 Finding III: Further Changes in Control Procedures Would Enhance Operational Improvements Made in Recent Years . . . . . . . . . . . . . . . . . . 31 Lottery Has Improved Many Management Practices . . . . . . . . . . . . . . . . . . . . 31 The Lottery Can Further Improve Its Control Procedures . . . . . . . . . . . . . 35 Recommendations . . . . . . . . . . . . . . . . . . . . . . . . 37 OFFICE OF THE AUDITOR GENERAL v TABLE OF CONTENTS Sunset Factors . . . . . . . . . . . . . . . . . . . . 39 Appendix . . . . . . . . . . . . . . . . . . . . . . . . . a-i Agency Response Figures Figure 1 Arizona State Lottery Commission Distributions To Beneficiary Funds Year Ended June 30, 2001 . . . . . . . . . 2 Figure 2 Arizona State Lottery Commission Distribution of Lottery Revenues Year Ended June 30, 2001 in Millions (Unaudited) . . . . . . . . . . . . . . . . . . . . . 4 Figure 3 Arizona State Lottery Commission Lottery Monies Distributed To Beneficiary Funds Since Lottery’s Inception Years Ended June 30, 1982 Through 2001 (Unaudited) . . . . . . . . . . . . . . . . 5 Figure 4 Arizona State Lottery Commission Sales Compared To Total Distributions To Beneficiary Funds Years Ended June 30, 1994 Through 2001 (Unaudited) . . . . . . . . 17 Figure 5 Arizona State Lottery Commission Distributions To Beneficiary Funds Year Ended June 30, 2001 (Unaudited) . . . . . . . . . . . . . . . . . . . . . 19 Table of Contents vi OFFICE OF THE AUDITOR GENERAL TABLE OF CONTENTS (cont’d) Page Table of Contents Tables Table 1 Arizona State Lottery Commission Schedule of Revenues, Expenses, and Retained Earnings Years Ended June 30, 1999, 2000, and 2001 (Unaudited) . . . . . . . . 10 Table 2 Arizona State Lottery Commission Lottery Expenditures and Related Statutory Restrictions Year Ended June 30, 2001 (Unaudited) . . . . . . . . . . . . . . . . . . . . . 11 Photos Photo 1 Instant-Ticket Vending Machine . . . . 20 Photo 2 Lottery Claim Store . . . . . . . . . . . . . . 33 OFFICE OF THE AUDITOR GENERAL vii TABLE OF CONTENTS (concl’d) Page viii OFFICE OF THE AUDITOR GENERAL (This Page Intentionally Left Blank) The Office of the Auditor General has conducted a perform-ance audit and Sunset review of the Arizona State Lottery Commission, in response to an August 9, 2001, resolution of the Joint Legislative Audit Committee. The audit was con-ducted under the authority vested in the Auditor General by Arizona Revised Statutes §41-1279 and as part of the Sunset review set forth in A.R.S. §41-2951 et seq. Lottery History and Mission Arizona citizens established the Lottery in 1980 through an ini-tiative petition in the general election, and it began operating in 1981. In 1998, the voters approved a referendum to extend the Lottery until July 2003. The statutory purpose of the Arizona State Lottery Commission is: “To oversee a state lottery to produce the maximum amount of net revenue consonant with the dignity of the State.” Similarly, the Lottery’s mission statement is: “To support Arizona programs for the public benefit by max-imizing revenue in a responsible manner.” The Arizona Lottery was established to maximize revenue dedicated to various beneficiary funds, which support a vari-ety of state and local programs, through statutory formulas. The Lottery distributed nearly $78 million from fiscal year 2001 revenues, and another $1.5 million from unclaimed prizes to various funds, which receive funding in accordance with state law. Appendix A (see page i) describes the nine statutorily des-ignated beneficiary funds, and Figure 1 (see page 2) illustrates the distribution process. OFFICE OF THE AUDITOR GENERAL 1 INTRODUCTION AND BACKGROUND Introduction and Background 2 OFFICE OF THE AUDITOR GENERAL Figure 1 Arizona State Lottery Commission Distributions To Beneficiary Funds Year Ended June 30, 2001 PowerBall 31.6% of revenues $24,702,800 Mass Transit Up to $18M Total PowerBall $3,702,800 Other Games 0 Pick 3 29% of revenues $2,018,700 Bingo Scratchers 21.5% of revenues $5,534,500 The Pick 29% of revenues $13,789,600 Fantasy 5 29% of revenues $3,039,800 Non-Designated Scratchers 21.5% of revenues $23,235,900 Local Transportation Assistance Fund Up to $23M $23,000,000 County Assistance Fund Up to $7.65M $7,650,000 Heritage Fund Up to $20M $16,968,500 Arizona Clean Air Fund Up to $10M (70% of excess to Mass Transit; 30% to Healthy AZ) 0 Healthy AZ Prop. 203 Adjusted annually from $17M base 0 Two Designated Scratchers Games 21.5% of revenues $3,168,200 Commerce and Economic Development $3,168,200 State General Fund Up to $21M $21,000,000 Unclaimed Prizes $1,503,200 Mandated Advertising Transfer $2,283,400 State General Fund $2,283,400 Court Appointed Special Advocates $1,503,200 1 1 The statutory cap on State General Fund revenues from PowerBall was increased to $31 million in March 2002. Source: Arizona Lottery's graphical representation of fiscal year 2001 beneficiary funds distribution process. Eight of the Lottery’s nine beneficiary funds receive their dis-tributions directly from the State Lottery Fund. The remaining fund—Court-Appointed Special Advocate Fund (CASA)— receives its financial support from the Lottery’s Unclaimed Prize Fund. The CASA Fund receives 30 percent of the Lottery’s unclaimed prize revenues, which amounted to more than $1.5 million in fiscal year 2001. Figure 2 (see page 4) illustrates the distribution of fiscal year 2001 Lottery Fund revenues, which shows that more than 55 percent of the Lottery revenues were transferred to the Lottery Prize Fund and another 28 percent to beneficiary funds. The State General Fund and the Local Transportation Assistance Fund received most of the revenues distributed to beneficiary funds. Two of the funds, the Clean Air Fund and Healthy Arizona, did not receive any revenues in fiscal year 2001. The amount of Lottery monies distributed to state programs has declined in recent years. As shown in Figure 3 (see page 5), distributions peaked in fiscal year 1990, when they totaled almost $113 million. Between fiscal years 1994 and 1997, the Lottery distributed a total of nearly $343.4 million to state pro-grams. In contrast, the Lottery distributed a total of $319.7 mil-lion between fiscal years 1998 and 2001, which represents a decline of 6.9 percent from the previous 4-year period. Decreased sales of online game types, and statutory changes in distribution formulas, which took effect in fiscal year 1998, contributed to this decline. (See Finding I, pages 15 through 24, for further discussion.) The decline in online game sales has particularly affected the amount available for distribution. Online ticket sales vary with the size of the jackpot, an unpre-dictable factor the Lottery cannot control. In addition, a 2001 study found that in Arizona an increase in the numbers of slot machines in Indian casinos has been associated with a decrease in lottery revenues, especially online game revenues.1 Finally, the Lottery’s advertising budget has been reduced since fiscal year 2000, which may also have contributed to the decline in online game sales. Introduction and Background OFFICE OF THE AUDITOR GENERAL 3 1 Siegal, Donald and Gary Anders, “The Impact of Indian Casinos on State Lotteries: A Case Study of Arizona,” Public Finance Review, Vol. 29, No. 2, March 2001, 139-147. Introduction and Background 4 OFFICE OF THE AUDITOR GENERAL Figure 2 Arizona State Lottery Commission Distribution of Lottery Revenues Year Ended June 30, 2001 in Millions (Unaudited) Source: Auditor General staff analysis of the Arizona State Lottery Commission financial statements audited by Deloitte & Touche LLP for the year ended June 30, 2001, and Arizona Lottery Revenues and Transfers to Other Funds FY 2001. Revenue Distribution ($274) Beneficiary Funds $151 $77.77 $18.50 $26.83 Lottery Prize Fund Beneficiary Funds Operations and Retained Earnings Retailer Commissions $23.28 $23.00 $16.97 $7.65 $3.70 $3.17 State General Fund Local Transportation Assistance Fund State Heritage Fund County Assistance Fund Mass Transit Fund Commerce and Economic Development Fund Introduction and Background OFFICE OF THE AUDITOR GENERAL 5 1 Includes distributions from unclaimed prizes to support programs such as the Court Appointed Special Advocate program. Source: Auditor General staff analysis of Arizona State Lottery financial report Arizona Lottery Revenues and Transfers to Other State Funds FY1982-FY2001. filename: \Pad3\Lottery\Lottery Graphics\New Figure 3 EPS.eps $36.6 $18.0 $37.0 $65.2 $112.7 $94.2 $79.3 $84.4 $78.0 $81.1 $87.3 $82.4 $93.2 $92.5 $88.2 $100.0 $50.7 $22.0 $31.8 $78.1 $0.0 $20.0 $40.0 $60.0 $80.0 $100.0 $120.0 1982 1983 1984 1985 1986 1987 1988 1989 1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 ea Millions of Dollars Figure 3 Arizona State Lottery Commission Lottery Monies Distributed To Beneficiary Funds Since Lottery's Inception 1 Years Ended June 30, 1982 Through 2001 (Unaudited) Fiscal Year Lottery Products The Lottery offers state-sanctioned games of chance, which are delivered in both an online and instant-ticket format. Since inception, the Lottery has sold more than 292.4 million win-ning tickets and awarded more than $2.7 billion in prize money. Arizona Lottery Online Games Online Games—The Pick™, PowerBall®, Fantasy 5™, and Pick3™ are called online games because retailers use comput-er terminals to record the numbers players select. Players attempt to select numbers that will match numbers drawn biweekly or throughout the week to win cash prizes. The Pick, Fantasy 5, and Pick3 games are offered within state boundaries only. PowerBall, however, is a multi-state online game operat-ed jointly by the 22 states forming the Multi-State Lottery Association (MUSL). Twenty-one of the 22 MUSL member states participate in the PowerBall game. In fiscal year 2001, online sales revenues were nearly $135.8 million. Players choose 6 out of 41 numbers ranging from 1 to 41. Minimum $1 million jackpot. Players pick 5 out of 49 numbers (from 1 to 49) for the first set of numbers, and 1 out of 42 numbers (from 1 to 42) for the second set (the PowerBall). Minimum jackpot is $10 million. Players select 5 out of 35 numbers (from 1 to 35). Maximum jackpot is $50,000. Players pick any 3-digit number from 000 to 999. Top prize is $500. Introduction and Background 6 OFFICE OF THE AUDITOR GENERAL ® TM Introduction and Background OFFICE OF THE AUDITOR GENERAL 7 Arizona Lottery Instant-Ticket Games Called ScratchersSM, Arizona’s instant-ticket games offer immediate results to players when they scratch off latex-covered play areas on the tickets. A player can win an instant-ticket game by matching three identical symbols or figures, adding numbers for a specific total, or playing familiar game styles like tic-tac-toe or bingo. The Lottery offered 29 instant-ticket games in fiscal year 2001. By law, the Lottery must offer two instant-ticket games a year to benefit state economic develop-ment programs. Along with its traditional $1 product, the Lottery now offers $2, $3, and $5 instant-ticket games. In fiscal year 2001, instant-ticket sales revenues were $136.9 million. Lottery Retailers The Lottery has nearly 2,570 retailers licensed to sell its prod-ucts. These include convenience stores, grocery chains, inde-pendent food stores, liquor stores, and truck stops. Lottery retailers receive 6.5 to 7 percent in sales commissions. In fiscal year 2000, the Lottery implemented an incentive program to award an extra 0.5 percent commission above the standard 6.5 percent to retailers with additional sales and promotions efforts. Grocery and chain convenience stores—such as Circle K convenience stores, and the Fry’s, Safeway, and Bashas’ gro-cery chains—accounted for more than 62 percent of the Lottery’s total sales in fiscal year 2001. Organizational Oversight and Structure A.R.S. §5-502 established the Arizona State Lottery Commission, which oversees the Lottery. The Lottery Commission consists of five Governor-appointed members, who are confirmed by the Arizona Senate. The Commission meets monthly to make recom-mendations or set policy, approve or reject Lottery Directory reports, approve Lottery games, and transact other Lottery busi-ness. The Governor also appoints an executive director to admin-ister Lottery operations. The director serves as the Commission’s The Lottery’s instant-ticket games are called Scratchers.SM secretary and executive officer. As of February 2002, the Lottery had a total of 123 full-time equivalent (FTE) employees in the following divisions: Director’s Division (17 FTE)—This division oversees agency operations, game design, internal audit, administrative rules, human resources, risk management, communica-tions programs such as “Where the Money Goes,” and compulsive gambling programs. Administration (25 FTE)—The administration division is responsible for budget and strategic planning, accounting, payroll, procurement, and purchasing, and the Phoenix and Tucson claims stores where the public can purchase tickets and redeem winning tickets. The claims stores are located in Lottery offices. Sales (40 FTE)—The sales division is responsible for sales planning, ticket distribution to retailers, retailer promo-tions, incentive plans, and training; and field support for the retail outlets. Marketing (3 FTE)—The marketing division is responsible for advertising and marketing research. In addition, divi-sion personnel act as a liaison to broadcast and advertising vendors. Security (18 FTE)—The security division licenses retailers, conducts investigations, maintains security in the Lottery’s warehouse and claims stores, and monitors online game broadcast drawings. The division is also responsible for ensuring game integrity, monitoring retailer compliance with administrative rules, reinforcing prevention of under-age wagering, and investigating allegations of criminal activity, such as lottery ticket theft and fraud. Information Technology (20 FTE)—This division is respon-sible for network management, telecommunications, com-puter operations, programming development, technical support, and computer system security. Introduction and Background 8 OFFICE OF THE AUDITOR GENERAL Budget, Revenues, and Expenditures The Legislature approves the Lottery’s annual budget based on projected ticket sales revenues. Annually, the Lottery receives authority to spend monies from the State Lottery Fund, which receives its revenues primarily from ticket sales. Table 1 (see page 10) summarizes the Lottery’s actual revenues and expenditures for fiscal years 1999, 2000, and 2001. Total ticket sales during these three fiscal years were above $250 mil-lion. The highest sales occurred in fiscal year 2001, when total sales were nearly $272.7 million. In fiscal year 2001, the Lottery’s administrative expenses were $44.5 million, or approximately 16.3 percent of gross Lottery revenues. By statute, the Lottery is restricted to spending no more than 18.5 percent of annual gross revenues to operate the Lottery. State statutes also restrict advertising of expenditures and mandate retailer commissions, as shown in Table 2 (see page 11). Audit Scope and Methodology This audit focused on the Department’s progress in addressing concerns identified in the Auditor General’s 1997 performance audit report and Sunset review (Report No. 97-15). This audit also included a review of the Lottery’s compliance inspection program, and its use of special investigators. This performance audit report and Sunset review includes finding and recom-mendations in three areas: Although the Lottery has implemented most sales-related recommendations from the 1997 audit, it should still do more to maximize sales and increase returns to state bene-ficiaries. For example, the Lottery should increase its use of instant-ticket vending machines, consider adding new games, and make better use of its sales force. The Lottery should take steps to improve its retailer com-pliance inspection program, and it can also do more to enforce underage wagering laws and rules. Introduction and Background OFFICE OF THE AUDITOR GENERAL 9 Introduction and Background 10 OFFICE OF THE AUDITOR GENERAL Table 1 Arizona Lottery Commission Schedule of Revenues, Expenses, and Retained Earnings Years Ended June 30, 1999, 2000, and 2001 (Unaudited) 1999 2000 2001 Revenues: Lottery ticket sales: Instant $102,924,766 $120,593,632 $124,259,935 Economic Development 6,514,717 8,889,811 12,643,498 PowerBall 93,698,288 69,723,954 74,291,623 Lotto/Pick 48,651,557 41,397,014 44,984,263 Fantasy 5 8,975,930 8,396,212 9,911,652 Pick 3 7,498,118 6,552,320 6,579,893 Total Lottery ticket sales 268,263,376 255,552,943 272,670,864 Transfers to the State Lottery Prize Fund 1 (144,011,884) (140,127,307) (150,887,186) Net Lottery ticket revenue 124,251,492 115,425,636 121,783,678 State General Fund appropriation 2 1,500,000 Retail license fees 12,467 10,117 18,976 Other 882,776 1,257,836 1,292,312 Total revenues 125,146,735 118,193,589 123,094,966 Expenses: Retailers’ commissions 17,437,399 16,798,267 18,496,981 Advertising and promotion 8,997,172 8,104,360 7,155,050 Online system 8,498,261 8,089,857 8,541,672 Tickets purchased 2,508,819 1,994,522 2,322,238 Personal services and employee-related 4,289,862 4,554,561 4,951,238 Contract services 327,983 698,904 531,690 Other administrative 3 2,385,218 2,222,110 2,545,132 Total expenses 44,444,714 42,462,581 44,544,001 Net income before transfers to other State of Arizona funds 80,702,021 75,731,008 78,550,965 Transfers to other State of Arizona Funds (80,473,300) (75,442,600) (77,772,900) Increase in retained earnings 228,721 288,408 778,065 Retained earnings, beginning of year 7,379,873 7,608,594 7,897,002 Retained earnings, end of year $ 7,608,594 $ 7,897,002 $ 8,675,067 1 The State Lottery Prize Fund, an Expendable Trust Fund of the State of Arizona, accounts for cash and assets held by the Commission in a trustee capacity. The Commission transfers monies to the Fund to pay prizes to winning ticket holders. 2 In 2000, the Commission was appropriated $1.5 million to provide additional advertising. 3 Includes depreciation expenses of $650,546, $313,520, and $308,212, for 1999, 2000, and 2001, respectively. Source: Auditor General staff analysis of the Arizona Lottery Commission financial statements audited by Deloitte & Touche LLP for the years ended June 30, 1999, 2000, and 2001. Introduction and Background OFFICE OF THE AUDITOR GENERAL 11 The Lottery has taken several steps to improve manage-ment practices and internal controls since the 1997 per-formance audit, but it should further improve some of its control procedures. Auditors used a variety of methods to study the issues addressed in this report, including interviewing Lottery Commission members, management, and staff; attending four Lottery Commission meetings between September 2001 and February 2002; interviewing members of the Lottery’s Retailer Advisory Committee, and representatives from selected retail-ers, such as Bashas’, Safeway, IGA, and 7-Eleven; interviewing the directors of Arizona Food Marketing Alliance and the Arizona Licensed Beverage Association; reviewing statutes, rules, and Lottery policies and procedures; reviewing annual reports and audited financial statements for fiscal years 1997 through 2001; reviewing strategic planning documents for fiscal years 2001 and 2002, including budget plans, sales and market-ing plans, and security plans; and reviewing industry compari-son data in the North American Association of State and Provincial Lotteries 2001 Lottery Resource Handbook, and the LaFleur’s 2001 World Lottery Almanac; and other literature. The following spe-cific methods were also used: Table 2 Arizona State Lottery Commission Lottery Expenditures and Related Statutory Restrictions Year Ended June 30, 2001 (Unaudited) Percentage Expenditures (millions) Actual Statutory Limit1 Administrative expenses2 $44.5 16.3% 18.5% Advertising 7.2 2.6 4.0 Retailer commission 18.5 6.8 6.5 – 7.0 1 The statutory limit on administrative expenses and advertising is a percentage of gross revenues; the statutory limit on retailer commissions is a percentage of total sales. 2 Includes advertising and retailer commissions. Source: Auditor General staff analysis of the Arizona Lottery Commission financial statements audited by Deloitte & Touche LLP for the year ended June 30, 2001, and Arizona Revised Statutes §5-505. Introduction and Background 12 OFFICE OF THE AUDITOR GENERAL To assess the Lottery’s progress in improving sales and to identify other strategies that the Lottery could pursue to improve sales, auditors examined the Lottery’s current sales practices such as current retailer incentive plans and sales representatives’ job activities; contacted sales direc-tors in seven states to identify their strategies for increasing instant-ticket sales and online ticket sales; and compared instant-ticket sales trend data among Lottery retailers who have Instant-Ticket Vending Machines and those who do not.1 To evaluate the adequacy of the Lottery’s new compliance inspection program and underage wagering enforcement efforts, auditors examined the Lottery’s new retailer com-pliance inspection procedures; reviewed the Lottery’s retailer compliance inspection form to ensure it addressed compliance with underage wagering regulations; contact-ed security directors in seven states to determine how they conducted retailer compliance inspections; interviewed investigators at the Arizona Department of Liquor Licenses and Controls to determine how they conduct compliance inspections and enforce underage drinking laws; and reviewed monthly investigation reports for February 1, 2000 through December 31, 2001, and 19 criminal investi-gation files for all stolen ticket investigations conducted in October 2001 to identify the actual activities undertaken by Lottery investigators.2 To assess the Lottery’s efforts to improve management practices and internal controls, auditors conducted an internal control review of the Lottery’s financial controls including cash-handling activities in its Phoenix and 1 Auditors contacted officials in Connecticut, Kentucky, Maryland, Missouri, New Jersey, New Mexico, and Washington. These states’ 2000 per capita instant-ticket sales were close to the national per capita instant-ticket sales average, and were comparable to Arizona in terms of popula-tion and competition with other gaming activities, such as tribal casinos or riverboat gambling. 2 Auditors contacted security directors from the same states identified pre-viously. Introduction and Background OFFICE OF THE AUDITOR GENERAL 13 Tucson claims stores; examined computer system controls and resources; and reviewed policies and procedures for accounting and security practices unique to the Lottery. The audit was conducted in accordance with government auditing standards. The Auditor General and staff express appreciation to the Commissioners of the Arizona State Lottery Commission, and the Executive Director of the Arizona State Lottery and his staff, for their cooperation and assistance throughout the audit. 14 OFFICE OF THE AUDITOR GENERAL (This Page Intentionally Left Blank) The Arizona Lottery should take additional steps to maximize its ticket sales. While the Lottery has made improvements to increase sales in recent years, total sales have not grown sub-stantially. As a result, state funds such as the Heritage Fund and Mass Transit continue to receive less money than the law allows, and some programs continue to receive no Lottery funding at all. The Lottery should take several steps to increase sales, including installing additional instant-ticket vending machines, adding higher-priced instant tickets and pull-tab tickets, more effectively using its sales representatives, and expanding its retailer incentive plan. Despite Steps To Increase Sales, Declining Online Game Revenues Offset Instant Ticket Revenue Growth In response to previous Auditor General recommendations, the Lottery has in recent years taken several steps designed to strengthen sales and maximize state revenue. In spite of these improvements, total sales for fiscal years 1998-2001 were about the same as the previous 4-year period. This lack of growth in total sales, coupled with increases in the percentage of Lottery revenues being paid out in prizes, has lowered revenues for beneficiary funds that depend on Lottery funding. The Lottery has taken steps to increase sales—Responding to Auditor General recommendations, the Lottery has taken sever-al steps to strengthen sales in order to maximize state revenue. In 1997, an Auditor General report (see Report No. 97-15) found that several Lottery practices contributed to poor sales and inef-ficiently used resources, limiting monies available for state pro-grams. The report recommended revamping online games, adding additional games to the game mix, replacing instant-tick-et games more quickly, and varying game prices and prize struc-tures. The report also recommended implementing long-term planning and using sales staff more productively to increase its sales. The Lottery responded by: OFFICE OF THE AUDITOR GENERAL 15 FINDING I THE LOTTERY SHOULD DO MORE TO MAXIMIZE ITS SALES The Arizona Lottery improved sales prac-tices in response to a 1997 Auditor General report. Updating The Pick and Fantasy 5; Adding a 3-number game, Pick3; Shortening the average time instant-ticket games stay in the market to 16 weeks, reducing the number of tickets printed for each game, and adding $3 and $5 tickets; Increasing instant-ticket prize payouts; Modifying ticket size and appearance and obtaining addi-tional instant-ticket vending machines (ITVMs); Addressing marketing strategy and long-term planning by implementing annual updates of strategic plans for mar-keting, instant tickets, online games, media, and communi-cations and research; and Restructuring its sales department, including creating a promotions section, and instituting a new sales department incentive plan. Further, the Lottery is now conducting research as a basis for making better business decisions and regularly evaluates its advertising expenditures to maximize their effect on sales. The Lottery contracts with two advertising agencies to conduct market research, collect and analyze data, develop market and media strategies, and implement agreed-upon recommenda-tions based on available resources. In addition to its primary advertising contract, the Lottery has a separate contract for advertising services to the Hispanic market. Its primary adver-tising agency provides the Lottery with an annual market research tracking study report and monthly findings regard-ing player demographics and market trends. Further, the Lottery evaluates its advertising mix, adjusting amounts spent on television, radio, print media, and transit, to reach the tar-geted audience with the desired message for the best value. Decreased online sales result in less money for beneficiary funds— Despite these changes, Arizona’s online games, like those in many other states, have experienced a drop in sales. As illus-trated in Figure 4, declining sales of online tickets have offset Finding I 16 OFFICE OF THE AUDITOR GENERAL increases in instant ticket sales, and have essentially kept total Lottery revenues relatively unchanged. Instant-ticket sales respond to changes in prize payouts, ticket design, and marketing strategies, but online ticket sales vary with the size of the jackpot, an unpredictable factor the Lottery cannot control. For example, annual instant-ticket sales aver-aged about $83.5 million and online sales averaged approxi-mately $177.4 million between fiscal years 1994 and 1997. However, during the 4-year period from fiscal years 1998 through 2001, average annual instant-ticket sales rose to approximately $121 million, while average online ticket sales fell to about $140.8 million. Finding I OFFICE OF THE AUDITOR GENERAL 17 Figure 4 Arizona State Lottery Commission Sales Compared To Total Distributions To Beneficiary Funds Years Ended June 30, 1994 Through 2001 (Unaudited) Source: Auditor General staff analysis of the Arizona State Lottery Commission financial statement audited by Deloitte & Touche LLP for the fiscal years ended June 30, 1994 through 2001. $0 $50 $100 $150 $200 $250 $300 $350 1994 1995 1996 1997 1998 1999 2000 2001 Year Millions Total Sales Instant Ticket Sales Online Sales Distributions To Beneficiary Funds Declining online sales have offset gains in instant-ticket sales. Increased prize payouts reduce monies for beneficiary funds— An increase in the percentage of Lottery revenues returned to participants in the form of prize money has resulted in less money going to beneficiary funds that receive Lottery rev-enues. As a means of increasing overall sales, the Legislature changed the distribution formula to increase prize payouts, particularly for instant tickets, starting in fiscal year 1998. Prior to September 1997, beneficiary funds received 31.5 percent of all sales. However, beginning September 30, 1997, the distri-bution formula changed to one in which the funds received 29 percent of all online game revenues, and 21.5 percent of instant-ticket sales.1 Thus, even though instant game sales increased by 30 percent between 1997 and 2001, the amount of monies beneficiary funds received from instant games dropped from approximately $33 million to $29 million. Beneficiary funds affected—The decline in Lottery monies dis-tributed to the State has affected some state lottery beneficiar-ies. Beneficiary funds, including the State General Fund, received $343.4 million over the 4-year period from fiscal year 1994 through fiscal year 1997. However, these funds received a total of only $319.7 million from fiscal year 1998 through fis-cal year 2001, or $23.7 million less. Because of falling distribu-tions, funds such as the Heritage Funds and Mass Transit have been funded at levels below those permitted by law (see Figure 5, page 19). For example, the Heritage Funds have not received full funding since 1998. Additionally, the law permits Mass Transit to receive up to $18 million annually in Lottery monies, but in fis-cal year 2001, it received only $3.7 million. Further, other programs have never received Lottery revenue, including Healthy Families, Health Start, the Board of Regents’ health education system, teenage pregnancy programs, disease control research, and the Women, Infants and Children food program, collectively referred to as “Healthy Arizona.” Additionally, the Clean Air Fund, which received a one-time distribution of $500,000 from the Lottery’s unclaimed prize fund in 1997, has not subsequently received any of its potential $10 million annual distribution. Finding I 18 OFFICE OF THE AUDITOR GENERAL 1 Laws 1999, 1st S. S., Ch. 3, §12 subsequently increased the PowerBall® distribution to 31.6 percent of sales for fiscal years 2000 and 2001. Laws 2001, Ch. 238, §16 made the same distribution increase effective for fis-cal years 2002 and 2003. The State Heritage Fund and other pro-grams have received less money than per-mitted by law. However, even if the Lottery increases sales, some of these programs may never receive full funding. In order for all ben-eficiaries to receive their maximum distribution, total Lottery sales would need to increase between a minimum of $422.8 million to nearly $543 million in annual sales.1 The Lottery Should Take Additional Steps To Increase Sales The Lottery should take several additional steps to further increase instant ticket sales and attempt to enhance online sales. These steps include expanding the use of instant-tick- Finding I OFFICE OF THE AUDITOR GENERAL 19 Figure 5 Arizona State Lottery Commission Distributions To Beneficiary Funds Year Ended June 30, 2001 (Unaudited) 1 The Court-Appointed Special Advocate (CASA) program receives its monies from the Lottery's Unclaimed Prize Fund. Source: Auditor General staff analysis of A.R.S. §5-522 and Arizona State Lottery Commission financial statement audited by Deloitte & Touche LLP for the year ended June 30, 2001. General Fund Local Transportation Assistance Heritage Fund County Assistance Fund Mass Transit Fund Commerce and Economic Development Fund Healthy Arizona Clean Air Fund Court- Appointed Special Advocate1 Actual Allowable $0 $5 $10 $15 $20 $25 Million of Dollars 1 This range takes into account the different percentages that PowerBall, state online games like The Pick, and instant-ticket games contribute to the State. It excludes economic development instant-ticket sales. et vending machines, adding new types of instant tickets that have proven to be successful in other states, using sales rep-resentatives’ time more effectively, and expanding its retailer incen-tive plan. Expanding the use of instant-ticket vending machines (ITVMs)—The Lottery has successfully introduced ITVMs to its retailer market, but should expand their use to further increase instant-ticket sales. The Lottery first began installing ITVMs in fiscal year 1994. Currently, the Lottery has 321 ITVMs, nearly all located in chain grocery stores, with a total annual lease cost to the Lottery of $847,440. Nontraditional retailers, such as truckstops and gas stations, have the remaining ITVMs. One hun-dred retailers that received ITVMs in 2001 experienced an average 38 per-cent increase in instant-ticket sales, totaling $6.04 million in 2001, com-pared to $4.37 million in fiscal year 2000.1 Overall, in fiscal year 2001, chain grocery stores with ITVMs aver-aged about $78,000 in instant-ticket sales compared to about $35,000 in chain grocery stores without ITVMs. Although ITVMs can be an economi-cal method of increasing sales, they were located at only 8 percent of Arizona Lottery retailers in fiscal year 2000. According to LaFleur’s 2001 World Lottery Almanac, this is less than half the average per-centage for other state lotteries. The Lottery should identify the number of additional retailers that would benefit from having an ITVM, and determine the expected costs and benefits of placing ITVMs at additional retailers. For example, currently, the annual lease for each 12-game machine is $2,640. Taking into account the percentage of sales dedicated to prize pay-ments, stores that have 12-game ITVMs need to increase Finding I 20 OFFICE OF THE AUDITOR GENERAL 1 Fiscal year 2001 sales figures include 3 months of sales (July-September 2000) before ITVMs were installed. The Lottery leases 321 ITVMs, which are mostly located in supermarkets. The Lottery has suc-cessfully introduced ITVMs to some retail-ers. Photo 1: Instant-Ticket Vending Machine (ITVM) instant-ticket sales by only $127 per week in order to offset the lease fee incurred by the Lottery. ITVMs with more or fewer bins have different lease costs and may be suitable for some retailers. According to Lottery officials, ITVMs also offer other benefits. First, because ITVMs are self-service ticket dis-pensers, checkout clerks and other store personnel need not actively sell or account for tickets. Further, ITVMs safeguard tickets and money, which are locked in a machine rather than on or beneath a sales counter or in a cash register. Their visi-bility also provides advertising for instant tickets, which are often an impulse purchase. Once its study of costs and benefits is complete, the Lottery should request authorization from the Legislature to use monies from the Lottery Fund to lease the additional ITVMs. Implementing new instant-ticket types and denominations— The Lottery should develop and submit to the Lottery Commission plans to implement new types of instant tickets and at a variety of prices. For example, pull-tab instant tickets have allowed several states, such as Missouri and Kentucky, to increase their instant-ticket sales and enter nontraditional retail markets such as restaurants, bars, and clubs. Pull-tab instant tickets require that a player pull off a paper tab rather than scratching a latex covering to determine a winning ticket. They have generally been sold in 25- and 50-cent denomina-tions, although some states have $1 pull-tabs. In fiscal year 2000, 10.3 percent of Kentucky’s instant-ticket sales and 9.7 percent of Missouri’s instant-ticket sales were derived from pull-tabs. The Lottery’s statutes allow it to offer different game play-styles, which include pull-tab instant tickets. Pull-tabs might allow the Lottery to increase its sales in restaurants and bars. Currently, there are only 35 restaurants and bars in Arizona that sell Lottery tickets. In addition to pull-tabs, some states sell instant tickets at prices that Arizona does not use. For example, 20 of 37 lottery states have $10 “scratcher” instant tickets, and one state, New Hampshire, has a top instant-ticket price of $7. In contrast, the Arizona Lottery’s highest-priced ticket is $5. Higher-priced tickets have helped increase sales in other states. For example, Connecticut had $141.4 million in $10-ticket sales in fiscal year 2000, or 27 percent of its total instant-ticket sales. Similarly, Michigan had $106.2 million in $10-ticket sales, or 16.5 percent Finding I OFFICE OF THE AUDITOR GENERAL 21 of its total fiscal year 2000 instant ticket sales. The Lottery plans to introduce its first $10 instant-ticket game, and offer more $3 and $5 games in fiscal year 2003. Using sales representatives more effectively—The Lottery should use its sales representatives in ways that enable them to effec-tively increase sales. In 1997, the Auditor General recommend-ed that the Lottery find better ways to handle ticket distribu-tion and allow sales representatives to spend more time work-ing to increase sales (see Report No. 97-15), because they were spending most of their time delivering tickets. The Arizona Lottery recently issued a Request for Proposals for instant-ticket printing and a ticket delivery and management system. The Request for Proposal for a new ticket distribution system includes provisions not only to contract for ticket delivery but also for the contractor to track sales and calculate data to help sales representatives provide retailers with the best products for their locations. The Lottery anticipates that the successful bidder will fully implement the system by January 14, 2003. Sales representatives in other states engage in sales support, such as informing retailers of upcoming games and events, and conducting retailer incentive programs and promotions.1 Additionally, they discuss product displays, troubleshoot machines, and address retailer concerns. Unlike Arizona’s sales representatives, they are also responsible for recruiting new retailers. Once the new ticket delivery system is in place, the Lottery should ensure that its sales representatives are trained to provide sales support responsive to retailer needs and make the sales representatives responsible for recruiting new retailers. Expanding retailer incentives—To encourage retailers to increase sales, the Lottery should expand its retailer incentive program. The Lottery pays one of the higher retailer sales com-missions among United States lotteries, 6.5 percent, based on its sales. Additionally, retailers can earn an extra 0.5 percent annually if their sales exceed the prior year by more than 5 per-cent. However, other states, such as New Jersey and Missouri, Finding I 22 OFFICE OF THE AUDITOR GENERAL 1 Auditors surveyed sales and marketing managers from Connecticut, Kentucky, Maryland, Missouri, New Jersey, New Mexico, and Washington. In 1997, the Auditor General recommended that the Lottery make better use of its sales representatives. Some states offer a variety of retailer incentives. provide retailers with sales bonuses for selling winning tickets and cashing winning tickets. Moreover, Missouri has contests and promotions between retailers with cash and prize awards for successful retailers. These incentives can change with lot-tery goals and encourage retailers to more actively market lot-tery products. The Lottery has already introduced some pro-motions to benefit retailers. For example, it has conducted four game-related retail promotions since April 2000. The first pro-motion focused on boosting sales for The Pick, while the latter three promotions attempted to boost Fantasy 5 sales. In addi-tion to promotional incentives, the Lottery has been working with its retailer advisory group and budget analysts to revise its retailer incentive program, but to date has focused mainly on the requirements for earning the extra 0.5 percent. It should continue its efforts to expand its incentive program to increase retailer sales efforts, including considering the innovations implemented in other states. Finding I OFFICE OF THE AUDITOR GENERAL 23 Recommendations 1. The Lottery should identify the number of retailers who would benefit from having an Instant-Ticket Vending Machine (ITVM), document the financial benefits expected from their utilization, and study the impact of leasing or purchasing ITVMs with varying numbers of ticket bins. It should then request authorization from the Legislature to use monies from the Lottery Fund for additional ITVMs. 2. The Lottery should develop a plan to use pull-tab instant tickets to expand its retailer network and player base. The plan should be submitted to the Lottery Commission for its consideration. 3. The Lottery should follow through on its fiscal year 2003 plan to offer more $3 and $5 instant-ticket games and sell instant-ticket games at prices above its current $5 tickets. 4. The Lottery should (a) follow through with its plans to sub-contract the delivery of instant tickets to retailers through its instant-ticket printing vendor and (b) ensure that such a delivery system includes the ability to track sales and cal-culate data that helps sales representatives assist retailers. 5. Once it has the new ticket delivery system in place, the Lottery should restructure the duties of its sales represen-tatives to include recruiting new retailers and providing sales support and training to current retailers. 6. To increase retailer sales efforts, the Lottery should contin-ue its efforts to offer game-related retail incentives and expand its retailer incentive program with input from its retailer advisory committee and budget analysts. It should present its plan to the Lottery Commission for considera-tion. Finding I 24 OFFICE OF THE AUDITOR GENERAL The Lottery should take steps to improve its compliance inspection program and develop a comprehensive program to enforce underage wagering laws. The Lottery’s Security Division is responsible for regulatory enforcement, retailer education, and criminal investigations. A recent expansion of investigation staff has allowed the Lottery to add new retailer compliance and education programs. The compliance inspec-tion program is designed to ensure compliance with Lottery requirements. First-year results, however, indicate that the Lottery can improve the program by modifying its inspection goal and instituting tracking measures. The Lottery should also develop a comprehensive program to monitor and deter underage people from wagering. In recent years, the Lottery has taken steps to enhance its Security Division, which is responsible for ensuring the integrity of games and operations. The Division’s duties include regulatory enforce-ment, retailer education, criminal investigations, ensuring game integrity, licensing, and the physical security of the Lottery’s offices. The Division’s staff comprises seven peace officers, includ-ing the Security Director, a chief investigator, and five special investigators.1 Recent expansion in investigative staff has led to addition of new retailer education and regulatory enforcement programs— According to the Lottery, a recent expansion of its investigative staff has allowed the agency to enhance retailer education and regulatory enforcement. In 1999, investigative staff increased when the Legislature approved two new investigator positions to enforce underage wagering requirements. According to the OFFICE OF THE AUDITOR GENERAL 25 FINDING II THE LOTTERY SHOULD IMPROVE COMPLIANCE INSPECTIONS AND UNDERAGE WAGERING EDUCATION AND ENFORCEMENT 1 By statute, the Lottery’s security director must be a peace officer certified by the Arizona Police Officer Standards and Training Board (Arizona P.O.S.T). Although not required by state statute, the Lottery requires its investigative staff to have limited peace officer status. Lottery director, having a larger investigative unit has allowed the agency to improve the entire security program. The Division’s six investigators are responsible for conducting retailer education, compliance inspections, and criminal investigation activities. Since the addition of the two new investigators, the Lottery has added new retailer education and regulatory enforcement pro-grams, including a retailer loss prevention program, a retailer compliance inspection program, and a low-volume sales program to monitor retailers who fail to meet the Lottery’s minimum sales requirements. Compliance inspection program designed to ensure compliance with Lottery requirements—The Lottery adopted this program in 2000 to improve retailer oversight. Its objective is to ensure that all licensed retailers conduct their business in compliance with estab-lished Lottery policies and procedures, and retailer rules and statutes. These regulations pertain to issues such as lottery termi-nal operation, prize payment limitations, placement of instant-ticket games and instant-ticket vending machines (ITVMs), and enforcement of underage wagering laws. The Lottery’s special investigators conduct the inspections at retailer locations, and use a checklist to record compliance with retailer regulations. For example, the investigators record things such as whether the retailer’s online terminal is functioning properly, whether instant-ticket games are displayed so customers can see them, whether the retailers have placed ITVMs in locations where retail staff can easily observe customer activity, and whether employees know prize payment redemption requirements, which limit retailer prize payments to $599 or less. Arizona has a more formal inspection program than some other states. Of the seven states contacted for this audit, only one had a formal compliance inspection program in place. First-year results indicate that the Lottery can modify and improve compliance inspection program—Results from the Lottery’s first year of conducting compliance inspections indicate that it can take several steps to improve the program, such as: Revising its inspection goal—The Lottery should devel-op a systematic plan for identifying the number of retailers to be inspected during a year. During the program’s first year, the Lottery was unable to meet its goal of inspecting Finding II 26 OFFICE OF THE AUDITOR GENERAL each retailer each year. In calendar year 2001, investigators completed compliance inspections of 1,122 retailers, or 42 percent of the total. According to security officials, the problems they are finding mainly consist of lack of knowl-edge regarding prize redemption limitations and stolen ticket procedures, and incorrect handling of validated tick-ets. Lottery officials have determined that investigators’ other duties, such as conducting criminal investigations into theft and robbery of lottery tickets, investigating com-plaints from retailers and the public, and conducting retail-er loss prevention seminars, have a higher priority than compliance inspections. Lottery officials plan to revise the compliance inspection goal, and have begun drafting a policy to reduce the num-ber of compliance inspections to 500 per year, or nearly 19 percent of retailers. As part of reducing its compliance inspection goal, the Lottery should adopt a rationale for selecting the retailers to be inspected, and develop a new annual inspection plan for the Commission’s approval. Tracking inspection results—The Lottery should begin tracking compliance inspection results in its database. Although the Lottery maintains a compliance inspections database that includes a field to record violations, Lottery staff do not enter violation information in the database. Entering information in a database would allow the Lottery to identify common problems that need to be corrected, such as insufficient employee training or knowledge of reg-ulations. The Lottery could then use this information to enhance retailer training and education. Additional steps needed to monitor underage wagering—Finally, the Lottery should expand its retailer compliance program to address underage wagering more directly. In 1999, the Legislature approved two new investigator positions to enforce underage wagering requirements beginning in fiscal year 2000. However, the Lottery has not directly used these new resources to improve monitoring and enforcement of these requirements. According to the Lottery director, the two positions were generally approved for underage wagering, but the Lottery has used them to strengthen the entire security pro-gram. Because the minimum age to play lottery games will increase from 18 to 21 in June 2003, the Lottery should begin Finding II OFFICE OF THE AUDITOR GENERAL 27 Tracking results could improve the program. taking steps now to educate retailers and the public about the pending change. To improve its ability to monitor and enforce underage wager-ing requirements, the Lottery should develop a comprehensive program to monitor underage wagering that includes the fol-lowing components: Revise its current compliance inspection checklist—The Lottery should add questions to its compliance inspection checklist to specifically address retailer staff knowledge of minimum age requirements. Although the current checklist includes a question about the placement of ITVMs and whether they are visible to customer-service personnel, it does not include any questions that directly address awareness of underage wagering laws and rules. Increase its use of age limit signs—The Lottery has placed signs on customer-operated ITVMs reminding players of the age restrictions. Similarly, the Lottery should post age limit signs on store-operated terminals to remind players and licensed retailers about age restrictions. The Missouri and New Jersey lotteries place signs on both the customer-operat-ed ITVMs and store-operated terminals. Adopt training standards for retailers—As part of retailer training, the Lottery should adopt some of the training stan-dards established by Arizona Liquor Licenses and Control to enforce underage drinking laws. For example, the Lottery should remind retailers to regularly check the players’ identi-fication to ensure that they are old enough to play lottery games, train retailers to recognize invalid identification cards, and provide them with a list of acceptable identification cards. Finding II 28 OFFICE OF THE AUDITOR GENERAL The Lottery can enhance monitoring of underage wagering activities. Recommendations 1. The Lottery should improve the management compliance inspections by developing a systematic compliance inspec-tion plan to present to the Commission for its approval. 2. The Lottery should track compliance violations in a data-base and use it to enhance retailer training and education. 3. The Lottery should develop a comprehensive program to monitor underage wagering for the Lottery Commission’s consideration that includes the following components: a. Adding a question to its compliance checklist that directly addresses retailer knowledge of underage laws; b. Placing signs on its online terminals to remind retailers and players about age restrictions; and c. Adopting policies for retailer training similar to those that the Arizona Department of Liquor Licenses and Controls has established to enforce underage drinking laws. For example, the Lottery should train retailers to check identification on a regular basis, recognize invalid identification cards, and provide retailers with a list of acceptable identification cards. Finding II OFFICE OF THE AUDITOR GENERAL 29 30 OFFICE OF THE AUDITOR GENERAL (This Page Intentionally Left Blank) The Lottery has made considerable progress in implementing previous audit recommendations to improve agency manage-ment practices, internal controls, contract oversight, and infor-mation technology resources. Certain control procedures, how-ever, can be further strengthened. In particular, the Lottery needs to amend the process it uses to distribute monies to state programs to comply with state statute, and adopt accounting procedures for Lottery-specific transactions. Lottery Has Improved Many Management Practices Since the Auditor General’s 1997 performance audit (Report No. 97-15), the Lottery has improved a number of internal con-trols and acquired some needed information technology resources as recommended. Specifically, the Lottery has improved oversight of its retailer network, strengthened cash-handling controls, improved contract oversight, and added information technology security controls and resources. Improved oversight over retailer network—The Lottery has strengthened oversight over its retailer network since the 1997 per-formance audit and improved management controls related to retailer oversight. Specific improvements include: Instituting a license renewal process and credit checks— The 1997 audit reported that the Lottery had not renewed retailer licenses since 1991 and did not ensure that existing retailers were creditworthy. However, in January 2001, the Lottery instituted a license renewal process, which requires OFFICE OF THE AUDITOR GENERAL 31 FINDING III FURTHER CHANGES IN CONTROL PROCEDURES WOULD ENHANCE OPERATIONAL IMPROVEMENTS MADE IN RECENT YEARS The Lottery has improved retailer licensing, collections, and minimum sales policies. all retailer licenses to be renewed every 3 years, in accor-dance with regulations. The new program includes con-ducting criminal background and credit checks on owners and retailers. In addition, the Lottery has also centralized all licensing and renewal processes into its Security Division in order to more efficiently carry out these activities. Implementation of collection policies and procedures— The 1997 audit found that retailers were allowed to contin-ue to sell tickets even if they had not paid for previous tick-ets. Retailers’ debt totaled more than $735,000 in 1997. The Lottery has since improved its debt collection policies and procedures. From June 1998 through June 2001, the Lottery used a private collections agency to collect retailer debt until receivables dropped to a level Lottery staff could manage. As a result, overall retailer debt dropped from $735,000 in 1997 to about $417,700 at the end of fiscal year 2001. Retailers that are out of business, bankrupt, or cannot be located owe approximately $414,200, or 99 percent, of this amount. The Lottery has transferred these cases to the Attorney General’s Office for possible legal action. Active retailers owed the remaining $3,500. In addition to hiring a private collections agency, the Lottery instituted a new pol-icy to prevent retailers from accumulating debt. In March 2000, the Lottery began suspending retailer licenses and deactivating retailers’ computer terminals to prevent them from selling more tickets if their bank account balances fail to cover ticket expenses at least twice in a 3-year period. Enforcement of minimum sales rules—In 1997, the Lottery failed to ensure that retailers met minimum sales require-ments of 400 online and 250 instant tickets per week. The Lottery now requires retailers that sell below minimum lev-els to pay the $182 per-quarter telephone terminal charges. This fee will be increased to $260 in fiscal year 2003 to fully cover telecommunications costs. According to the Lottery, in fiscal year 2001, 253 retailers paid the telephone charges, and 104 relinquished their license rather than pay the charges. The Lottery granted 276 telephone charge waivers for reasons such as business disruption due to construction. Stronger internal controls involving cash and other assets—The Lottery has improved internal controls related to its cash-handling practices, vault balances in its claims stores, and revolving fund, Finding III 32 OFFICE OF THE AUDITOR GENERAL and instituted regular checks of employee payroll transactions, as recommended in the 1997 performance audit. Improvements include the following: Reviews of cash reconcilia-tions— The 1997 performance audit found that the Lottery did not adequately segregate cash-handling duties at its Phoenix and Tucson claim stores. These stores, located inside Lottery offices, sell instant and online lottery tick-ets and redeem winning tick-ets. Now, although store employees continue to per-form store cash reconcilia-tions, other Lottery employees review these reconciliations each day. Reduced cash balances—The 1997 audit found that the claim stores maintained excessive daily cash balances at the Phoenix location. Although auditors again found high cash balances during this audit, the Lottery has since reduced the cash balances to a level sufficient to pay instant-ticket winners. The Lottery now monitors its cash levels and pays winners by cash or by check, depending on the amount of cash available. New revolving fund controls—In 1997, the Lottery’s revolv-ing fund contained excessive balances and lacked documenta-tion of expenditures. The Lottery has now reduced the balance from a maximum of $30,000 to approximately $2,500, and upper management must approve all revolving fund expen-ditures before they are made. Payroll transaction checks—The 1997 audit found that the Lottery’s payroll and internal audit departments did not peri-odically check calculations of employee wages and associated deductions. Now, the Lottery’s accounting supervisor regu-larly reviews employee payroll transactions. In addition, audi-tors’ examination of the Lottery’s current payroll procedures Finding III OFFICE OF THE AUDITOR GENERAL 33 Lottery claim stores sell Lottery tickets and redeem prizes. Photo 2: Lottery Claim Store and payroll documents indicates that the Lottery has estab-lished effective payroll transaction checks. Contract and procurement oversight is stronger—The Lottery appears to have strengthened its contract oversight and procure-ment practices since a 1995 Auditor General special financial audit (see Arizona Lottery: Report on Special Review, April-October 1995), and the 1997 performance audit, which determined that many of the issues identified in 1995 had not been corrected. The 1995 audit found that the Lottery did not provide adequate oversight over its advertising vendor. For example, the audit reported that the Lottery lacked adequate procedures to oversee its $8 million advertising contract and did not perform vendor compliance reviews. Actions taken since that time include: Addition of a procurement manager—In 2000, the Lottery hired a procurement manager experienced in Arizona state procurement and contract management. This employee works closely with Lottery management and the State Procurement Office to develop requests for proposals and review bids for new contracts. Development of contract oversight procedures—In 2001, the Lottery instituted a new contract oversight policy, which established procedures for monitoring advertising, instant-ticket printing, and online service contracts. Additional security controls and resources for information technology—Finally, the Lottery has addressed concerns raised in the 1997 performance audit regarding computer system resources, computer security controls, and information technol-ogy policies. Actions taken include: Increased computer system resources—The 1997 audit found that the Lottery had inadequate computer resources to support its games. For example, although state lotteries that participate in the multi-state PowerBall game must have a backup processor, the Lottery had only one high-speed computer data line between the office and its contractor, and only one mainframe processor with no backup equip-ment in case of breakdown. The Lottery now has two data lines and four processors. Finding III 34 OFFICE OF THE AUDITOR GENERAL Cash-handling controls have improved. Employee access controls—The 1997 audit reported that employees had inappropriate access to data files that could be deleted or manipulated, which increased the potential for fraud and abuse. Now, the Lottery has an access control list that limits employee access to the computer system accord-ing to position and need. In addition, the Lottery has insti-tuted an electronic access control to keep unauthorized per-sonnel from entering the information technology area, and has erected physical barriers such as doors and walls to enclose this area. Progress in developing information technology policies— The 1997 audit found that the Lottery lacked written proce-dures regarding computer systems and information technolo-gy. For example, audit staff noted a general lack of policies and procedures regarding computer basics, such as securi-ty, operations, and system failures, and also noted that soft-ware program instruction and problem-solving manuals had not been maintained. The Lottery has since begun to develop its internal procedures in these areas, although they are not yet complete. The Lottery Can Further Improve Its Control Procedures The Lottery should take additional steps to improve its internal controls. First, the Lottery should revise its procedures for dis-tributing monies to state programs to ensure that the order of distribution is consistent with statutes. In addition, the Lottery should develop some new accounting procedures to cover Lottery-specific transactions. Complying with statutory requirements for distributing monies to certain beneficiary programs—The Lottery has not updated its distribution procedures since state statutes were amended in 1997, and, as a result, has been incorrectly distributing revenues from two games. The incorrect distribution involves payments to four Funds—Local Transportation Assistance Fund (LTAF), the County Assistance Fund, the State Heritage Fund, and the Clean Air Fund. Currently, the Lottery incorrectly pays rev-enues from its 3-number online game and bingo-themed instant-ticket game to LTAF and the County Assistance Fund, until they have received their statutorily allowed amounts, and Finding III OFFICE OF THE AUDITOR GENERAL 35 only then begins to distribute these game revenues to the State Heritage Fund. Although the total amount transferred to each fund is the same as if the Lottery followed the statute, the Lottery’s practice delays payments to the State Heritage Fund until late in the fiscal year. In fiscal year 2001, the Lottery did not begin paying the State Heritage Fund until March. Statutes specify the conditions for distributing monies to the State Heritage Fund. A.R.S. §5-522(D) directs the Lottery to dis-tribute up to $20 million to the State Heritage Fund from any monies remaining in the Lottery Fund after operating expenses have been paid and the LTAF and County Assistance Fund have received their full allowed amounts. These monies derive from The Pick, Fantasy 5, and instant-ticket games. However, according to statutory amendments approved in 1997, A.R.S. §5-522(A)(4) requires the Lottery Director to determine whether the State Heritage Fund will receive its full allowed amount for the year. If he determines that it will not, the 1997 amendments require the Lottery to pay (1) 29 percent of 3-number online game revenues and (2) 21.5 percent of revenues from a bingo-themed instant ticket game to the State Heritage Fund. These revenues go to the Clean Air Fund if the State Heritage Fund has already received its fully allowed amount. The Lottery should correct its procedures to follow the order specified in statutes. Improving accounting procedures—Finally, the Lottery should adopt additional written procedures to cover Lottery-specific accounting functions. Lottery officials state that they follow pro-cedures prescribed in its existing accounting manual and the State Accounting Manual. However, these current resources are not comprehensive because they lack written procedures for account-ing functions that are unique to the Lottery, such as automated weekly revenue collections from retailers. Finding III 36 OFFICE OF THE AUDITOR GENERAL Recommendations 1. The Lottery should directly distribute revenues from the 3- number online game and the bingo-themed instant-ticket game to the Heritage Fund consistent with statutory requirements. 2. The Lottery should supplement its State Accounting Manual-based procedures with additional accounting procedures for lottery-specific transactions, such as automated weekly revenue collections from retailers. Finding III OFFICE OF THE AUDITOR GENERAL 37 38 OFFICE OF THE AUDITOR GENERAL (This Page Intentionally Left Blank) In accordance with Arizona Revised Statutes (A.R.S.) §41-2951, the Legislature should consider the following 12 factors in determining whether the Arizona State Lottery Commission should be continued or terminated. 1. The objective and purpose in establishing the Lottery. The Arizona State Lottery Commission was proposed by ini-tiative petition and approved by voters in the November 1980 general election. Voters again approved the Lottery in the November 1998 election, after the Legislature referred the issue to the voters. The 1998 voter-approved measure extends the Arizona State Lottery Commission through July 1, 2003. According to A.R.S. §5-504(B), the Lottery Commission’s statutory purpose is: “to oversee a state lottery to produce the maximum amount of net revenue consonant with the dignity of the State.” The Lottery attempts to meet its statutory mission by admin-istering instant-ticket and online games in order to generate revenues for the State General Fund, and various state pro-grams. The agency mission statement is, “To support Arizona programs for the public benefit by maximizing revenue in a responsible manner.” Although the primary objective of maximizing revenue for state programs has not changed, the Lottery’s strate-gic plan for fiscal years 2002-2004 also emphasizes corpo-rate citizenship, which includes the promotion of respon-sible gaming. The Lottery’s strategic issues consist of sup-port for public programs, corporate citizenship, and organizational efficiency. OFFICE OF THE AUDITOR GENERAL 39 SUNSET FACTORS 2. The effectiveness with which the Lottery has met its objective and purpose and the efficiency with which it has operated. Since its inception in 1981, the Lottery has generated approximately $4.1 billion in revenues, returned more than $1.4 billion in net revenue to support the State General Fund and other state programs, and awarded more than $2.7 billion in prizes. Since the 1997 perform-ance audit, the Lottery has demonstrated operational improvements. Specifically, the Lottery: ¾ Maintained low administrative costs—Since the 1997 performance audit and Sunset review, the Lottery has consistently kept its administrative costs within the statutory allowable limit of 18.5 percent of total rev-enues, which includes sales revenue, retailer license fees, and investment income. Operating expenses as a percentage of total revenues were 16.3 percent in fiscal year 2001. ¾ Improved management practices and internal con-trols— The Lottery has made considerable progress in implementing 1997 performance audit recommenda-tions to improve agency management practices, inter-nal and management controls, contract oversight, and information technology resources. For example, it has improved its oversight of the Lottery retailer network, and strengthened controls related to cash handling, and improved computer security. (See Finding III, pages 31 through 37.) In addition to maintaining these improvements, the Department should take a number of steps to further enhance its effectiveness. First, the Lottery should con-sider additional options to increase ticket sales revenues, and the net sales revenue distributed to state programs. Although the Lottery has implemented all but one of the 1997 audit recommendations to increase sales, decreased online ticket sales have offset most of the increase in instant-ticket sales. The decline in online sales, coupled with an increase in the percentage of Lottery revenues being paid out in prizes, has lowered revenues for pro-grams that depend on the Lottery for funding, such as the Sunset Factors 40 OFFICE OF THE AUDITOR GENERAL State Heritage Fund. Some state programs, such as the Clean Air Fund and Healthy Arizona programs, have never received funding from net game revenues. In order for all programs to receive funding, the Lottery would need to generate from between $422.8 million and nearly $593 million. Some options that the Lottery should imple-ment to further increase sales include expanding use of Instant-Ticket Vending Machines (ITVMs), implement-ing new ticket types, such as “pull-tabs,” using sales staff more effectively, and expanding its retailer incentive pro-gram. (See Finding I, pages 15 through 24.) The Lottery should also take steps to improve the new compliance inspection program that it enhanced in 2000 to improve retailer oversight. Specifically, the Lottery should develop a plan to select which retailers will undergo inspections and incorporate tracking proce-dures into the program. In addition, the Lottery should develop a plan to improve enforcement of the Lottery’s underage wagering rules and laws. (See Finding II, pages 25 through 29.) Finally, in addition to improvements in agency manage-ment practices, the Lottery can make further improve-ments. Specifically, it can further improve accounting procedures and improve controls over sports-themed noncash prizes. In addition, it should follow statutory requirements for distributing monies to state programs. (See Finding III, pages 31 through 37.) 3. The extent to which the Lottery has operated within the public interest. The Lottery has taken several steps to better serve the public interest. Determining the extent to which the Lottery operates within the public interest depends on individual beliefs regarding public-sponsored gambling. Proponents argue that the Lottery has operated within the public interest by generating substantial net revenues that are apportioned to a variety of designated state funds and programs. In contrast, critics maintain that the Lottery is a form of state-sponsored and state-advertised gambling. Such critics maintain that the social costs asso- Sunset Factors OFFICE OF THE AUDITOR GENERAL 41 ciated with raising such revenue are unknown, and may in fact exceed the public benefit gained from Lottery sales. Since the 1997 audit, the Lottery has introduced public awareness campaigns to improve the public perception of the Lottery, educate the public about the programs supported by Lottery proceeds, and increase the visibili-ty of winners. New programs include the Lottery’s “Where the Money Goes” campaign, and its “Winner Awareness” program. The Lottery also tracks public opinion and perception regarding various Lottery issues through monthly surveys. Further, the Arizona Lottery oversees a Compulsive Gambling Treatment and Information program that the State Legislature approved in 1999, as provided in the General Appropriation Act, Laws 1999, Chapter 1, 1st Special Session. Beginning in 2000, the State required the Lottery to administer this pro-gram. By state law, 50 percent of the appropriation must be used to support a compulsive gambling toll-free crisis hotline, and 50 percent must be used to contract for com-pulsive gambling treatment programs. The Legislature appropriated $500,000 in fiscal years 2000 and 2001. The Lottery contracts with the Arizona Department of Health Services to administer treatment services. 4. The extent to which rules and regulations promulgated by the Lottery are consistent with the legislative man-date. The Lottery has made most, but not all, of the rules required of it. The Lottery director’s general rule-making authority is stated in A.R.S. §5-504(B).1 As reported in a review conducted by the Governor’s Regulatory Review Council, at the request of the Auditor General’s Office, the Lottery should adopt rules in four areas. Sunset Factors 42 OFFICE OF THE AUDITOR GENERAL 1 Under A.R.S. §§41-1044 and 41-1057, rules that relate to the design, opera-tion, or prize structure of a lottery game are reviewed and approved by the Attorney General’s Office, rather than the Governor’s Regulatory Review Council. ¾ First, the Lottery should develop rules pertaining to the two special economic development games that it offers each year as required by A.R.S. §5-504(H). ¾ Second, as required under A.R.S. §5-513(A)(3)(c), the Lottery should adopt rules to determine the fees asso-ciated with processing the voluntary assignment of a Lottery prize, such as an annuity, to another party. According to state statute, Lottery prize winners may assign a Lottery prize to another party, under specific circumstances. ¾ Third, the Lottery needs to adopt rules related to its liability setoff program, as required under A.R.S. §5- 525(A). Under this program, Lottery prize payments are used to satisfy debts that a person owes to the State. Currently, the Lottery receives data from the Arizona Department of Economic Security, Arizona’s county courts, and Northern Arizona University. ¾ Finally, the Lottery should adopt personnel rules for sales personnel who deliver products, as required under A.R.S. §5-504(E). This statute, which became effective July 1, 1997, states that Lottery personnel who handle its products are not covered by the State’s personnel system. The law applies only to sales per-sonnel hired after the law’s effective date. Four of the Lottery’s 23 representatives were hired after the law became effective. Despite the law, Lottery officials contend that all sales representatives remain “cov-ered positions.” Since this contention conflicts with the law, the Lottery should promulgate rules to pro-vide sales personnel hired after the law changed with the same protections afforded by the personnel sys-tem or request that the Legislature change the law to not exempt sales personnel from the State’s personnel system. In addition, GRRC identified a problem with Lottery rules pertaining to license fees. Currently, Lottery rules state that retailer license application fees are nonrefund-able. However, A.R.S. §41-1077 provides that if any agency does not send to the applicant a written notice Sunset Factors OFFICE OF THE AUDITOR GENERAL 43 granting or denying a license application within the applicable time frame, the agency must refund all fees charged for reviewing and acting on the application. The Lottery should amend its license application rules to con-form to state statute. The Lottery is currently undergoing its 5-year rules review. As part of this process, the Lottery intends to adopt the required rules, and amend its license application rules, as recommended by GRRC. 5. The extent to which the Lottery has encouraged input from the public before promulgating its rules and reg-ulations and the extent to which it has informed the public as to its actions and their expected impact on the public. The Lottery has actively encouraged input from the pub-lic before promulgating rules and regulations. Proposed rules are summarized in the Administrative Register, and any proposed rule is placed on a regular Commission meeting agenda for consideration. Commission meeting notices are posted at both the Phoenix and Tucson Lottery offices. The Lottery also notifies industry and retailer representatives of proposed rules and regulations that could affect them. In September 2000, the Lottery formed a Retailer Advisory Committee to review, evalu-ate, and recommend revisions to retailer rules. Typical discussion issues include license qualifications, mini-mum sales requirements, and license suspension/revo-cation procedures. Finally, the Lottery also maintains a Web site to inform the public of its activities. Some of the information post-ed includes information on the most recent online draw-ings and the status of active instant-ticket games. 6. The extent to which the agency has been able to investigate and resolve complaints that are within its jurisdiction. The Lottery receives and responds to a variety of infor-mal complaints from both retailers and the public. Sunset Factors 44 OFFICE OF THE AUDITOR GENERAL Common grievances may include complaints about Lottery terminals, retailers, and fraud and stolen tickets. The Lottery assigns the complaints to appropriate per-sonnel, such as the Security Division investigators, for further research and disposition. Actions taken may include filing criminal complaints with law enforcement agencies and suspending or revoking retailer licenses. 7. The extent to which the Attorney General or any other applicable agency of state government has the author-ity to prosecute actions under enabling legislation. A.R.S. §5-512.01 provides the Attorney General and county attorneys concurrent prosecution authority for an offense arising out of or in connection with the formation, management, operation, or conduct of the State Lottery. For example, the Lottery has worked with Mohave County law enforcement officials to investigate and pros-ecute a case involving ticket theft and embezzlement that took place over a 3-year period. 8. The extent to which the agency has addressed defi-ciencies in the enabling statutes which prevent it from fulfilling its statutory mandate. The Lottery has supported several changes to statutes that were amended in the 2000 Legislative Session. For example, A.R.S. §5-504(J) prohibits online or electronic keno games or any Internet games. Subsection (K) also requires the Lottery to print on each lottery ticket a state-ment that help is available if a person has a gambling problem, and a telephone number to call for assistance. A.R.S. §5-506(10) states that the Lottery has 30 days after receiving an allegation that a retailer has violated state laws or rules to determine whether the retailer has vio-lated the rule, or whether a criminal investigation is war-ranted. Finally, A.R.S. §5-515.01 makes it unlawful to sell a lottery ticket to a person who uses an electronic benefits card or public assistance voucher. A.R.S. §5-515.02 also makes it unlawful for a person under 21 years of age to purchase a lottery ticket, beginning on June 1, 2003. Sunset Factors OFFICE OF THE AUDITOR GENERAL 45 9. The extent to which changes are necessary in the laws of the agency to adequately comply with the factors listed in the sunset law. This audit did not identify any needed statutory changes. 10. The extent to which the termination of the agency would significantly harm the public health, safety, or welfare. Terminating the Lottery would not have a detrimental effect on the public health, safety, or welfare. However, terminating the Lottery would eliminate a significant amount of revenue that has been made available to the State. The Arizona Lottery has transferred an average of $70.6 million per year to the State since its inception. A November 1998 ballot measure asked voters whether they wanted to eliminate the Lottery or extend it through July 1, 2003. Nearly 67 percent of voters approved extending the Lottery. According to the Arizona Attorney General, the decision to continue or terminate the Lottery beyond this date must either be determined by a super-majority of the Legislature (75 percent of both houses) or be referred to Arizona voters. On April 25, 2002, the Legislature referred the issue to the voters for consideration in the November 2002 election. The meas-ure, if approved, would sunset the Lottery on July 1, 2012, and include the Lottery in the Legislature’s regular sunset cycle process, thus discontinuing the need to refer the matter back to the voters. 11. The extent to which the level of regulation exercised by the agency is appropriate and whether less or more stringent levels of regulation would be appropriate. The Lottery is not a regulatory agency. However, statute requires the Lottery to license lottery retailers, giving the retailers the right to sell online and instant lottery tickets. Some of the benefits associated with licensing retailers include conducting background checks to assess the character of potential retailers, and credit checks to assess Sunset Factors 46 OFFICE OF THE AUDITOR GENERAL whether they pay their bills on time. Licensure also allows the Lottery to suspend or revoke retailers’ ability to sell Lottery products if they fail to comply with Lottery rules, or do not meet minimum sales requirements. 12. The extent to which the agency has used private con-tractors in the performance of its duties and how effec-tive use of private contractors could be accomplished. The Arizona Lottery makes extensive use of private con-tractors in the performance of its duties. Private contrac-tors are used for functions such as ticket printing; adver-tising; online game systems, services and tickets; annu-ities to fund grand prizes; advertising; sponsorships; and promotional materials. Private contractors also perform auditing functions, oversight of game drawings, and security monitoring. According to the Lottery, more than 86 percent of its fiscal year 2001 expenditures were out-sourced. The Lottery will further privatize its functions after it contracts out the delivery of instant tickets, as rec-ommended in the 1997 audit. The Lottery expects a con-tractor to complete implementation of this function by January 2003. Sunset Factors OFFICE OF THE AUDITOR GENERAL 47 48 OFFICE OF THE AUDITOR GENERAL (This Page Intentionally Left Blank) Arizona State Lottery Commission Funds and Programs Designated in State Statute To Receive Lottery Monies ¾ State General Fund—Currently limited to $31 million of PowerBall revenues each fiscal year. Until fiscal year 2002, the limit on PowerBall revenues was $21 million per year. The General Fund also received a one-time transfer from unclaimed lottery prizes in fiscal year 1999 and mandatory transfers from the Lottery’s Fund’s advertising budget in fiscal years 2000 and 2001. If all other beneficiary funds receive their statutory allotments, any remaining monies revert to the General Fund. ¾ Local Transportation Assistance Fund—Limited to a maximum of $23 million each fiscal year from The Pick, Fantasy 5, and instant-ticket games. Used by Arizona cities and towns for transportation projects and a variety of other purposes. Up to 10 percent may be used for socio-cultural and arts programs if matched by private monies. ¾ State Heritage Fund—Limited to $20 million each fiscal year from instant-ticket games and the online games, The Pick, Pick3, and Fantasy 5. Approved by voters in 1990 to support Arizona State Parks and Arizona Game and Fish Commission projects such as trail and park maintenance, land acquisition, and educational programs. Funding began in fiscal year 1991. ¾ County Assistance Fund—Limited to $7.65 million each fiscal year from The Pick and Fantasy 5 online games, and instant-ticket games. The State’s 15 counties use Lottery monies for a variety of programs, such as law enforcement, education, and health. ¾ Commerce and Economic Development Fund—The Arizona Department of Commerce Economic Development OFFICE OF THE AUDITOR GENERAL a-i APPENDIX Commission receives proceeds from two instant-ticket games designated by the Arizona Lottery for economic development programs such as the “Main Street Program,” which supports rural Arizona downtown revitalization efforts. Funding began in fiscal year 1990. ¾ Mass Transit Fund—Limited to $18 million each fiscal year from PowerBall, Pick3, and the Bingo instant ticket game. Established in 1995 as a second local transportation assistance fund to support public transit. Funding began in fiscal year 1998. ¾ Healthy Arizona Programs—Funded from online games of The Pick, Fantasy 5, Pick3, and instant-ticket games only after the Heritage Fund receives its annual $20 million. Established in 1996 to provide Lottery monies to the Arizona Area Health Education System; Disease Control Research Fund; Healthy Families Pilot Program; Health Start Pilot Program; teenage pregnancy prevention programs; and the Women, Infants and Children Food Program. ¾ Clean Air Fund—Funded only after the Heritage Fund receives its annual $20 million. Established in 1996 for the Arizona Department of Commerce to use for purposes such as grants promoting the use of alternative fuels and High Occupancy Vehicle signs on federal and state roads. The fund received a one-time transfer of $500,000 from unclaimed prizes in fiscal year 1997. ¾ Court-Appointed Special Advocates Fund—Funded solely from 30 percent of the Lottery’s Unclaimed Prize Fund. Used to train over 900 Court-Appointed Special Advocates, who provide a voice in the courtroom for abused, neglected, and abandoned children. Funding began in fiscal year 1992. Appendix a-ii OFFICE OF THE AUDITOR GENERAL OFFICE OF THE AUDITOR GENERAL AGENCY RESPONSE OFFICE OF THE AUDITOR GENERAL (This Page Intentionally Left Blank) May 28, 2002 Ms. Debbie Davenport Auditor General Office of the Auditor General 2910 N. 44th St., #410 Phoenix, AZ 85018 Dear Ms. Davenport: Thank you for conducting the performance audit of the Arizona Lottery. We appreciate the favorable overview and positive evaluation of the progress made since the last performance audit in 1997 and welcome the Auditor General’s recommendations as the basis for continuing the successful strategies for the future of the organization. The performance audit provides an excellent record of the status of the Lottery. Compared to the prior audit conducted five years ago, the Lottery has gone from a D+ grade up to an A- grade. This document will be an extremely useful resource for the following reasons: · The audit identifies several significant improvements and initiatives that have been introduced during the past five years. · The audit recognizes that some of the improvements and initiatives incorporated into the agency’s operations may still require continuing support and attention. · The audit recommends improvements and initiatives that can be presented to the State Legislature for support and funding for future implementation. · The audit identifies improvements and initiatives that can be introduced as the Lottery enters a new era of growth and prosperity. Ms. Debbie Davenport May 28, 2002 Page 2 During the past five years, the Lottery has achieved a level of stability that reflects our commitment to responsible public management, sound business practices and professional marketing strategies. By adopting internal policies and procedures, preparing and implementing product strategic plans and conducting responsible advertising, the Lottery has maintained a consistent sales level, a respectable return to the State and an impressive measure of public trust and confidence. We pledge to continue the following: · Operate the agency in an efficient and effective manner to responsibly maximize revenue to benefit State projects and programs. · Help retailers, players, and the general public understand the need to be aware of the problem gambling and underage wagering issues. · Increase the Lottery’s positive visibility among players, retailers, employees, business leaders, the media, and the general public. · Design, develop and manage ScratchersSM games to maintain the Lottery’s most successful product for players’ enjoyment. · Enhance online games to achieve the “more winners, more often” objective. By adhering to the above practices, we will retain the Arizona Lottery’s place in the forefront of public performance for the people of Arizona. Sincerely, Geoffrey E. Gonsher Executive Director TABLE OF CONTENTS Introduction ................................................................................................................................... 1 The Lottery Has Made Significant Progress Since 1997 ........................................................... 1 The Lottery Conducts Itself as a Business Enterprise............................................................... 1 Responsible Strategic Issues Are Emphasized ......................................................................... 2 Sales and Performance ..................................................................................................................... 3 Results Have Exceeded Expectations ..................................................................................... 3 Scratchers Games Are an Award-Winning Success Story......................................................... 3 Changes to Online Games Have Been Made, but Competition and Other Factors Have Impacted Sales ............................................................................................................ 4 Marketing and Advertising Are Conducted in a Professional Manner ........................................ 5 Communications Have Improved Visibility and Public Image .................................................. 6 Several Honors and Awards Have Been Received ................................................................... 7 Sales Strategies Have Resulted in Improved Retailer Relations and Performance in the Marketplace................................................................................................................ 7 Game Proceeds Continue to Support Statutory Beneficiaries .................................................... 8 Player Research Is Incorporated into Policies and Decisions..................................................... 8 Security and Integrity ....................................................................................................................... 9 The Lottery’s Security Protects Players, Retailers, Employees and the General Public ................ 9 Information Technology Continues to Improve Efficiency and Reliability ............................... 10 The Lottery Has Taken a Leadership Role in Responsible Gambling....................................... 11 Findings and Recommendations ...................................................................................................... 13 1 INTRODUCTION THE LOTTERY HAS MADE SIGNIFICANT PROGRESS SINCE 1997. In 1997, the Lottery was receiving considerable negative attention because of the agency’s management, game sales and retailer relations. Subsequently, Governor Jane Dee Hull took office and recognized questionable practices within the agency, terminated the executive director and charged the new management team with the responsibility to reestablish the Lottery’s credibility. Our immediate impression was that the Lottery was an agency in transition. We needed to return to a professional management track and to make responsible marketing, advertising and sales decisions. We also needed to revitalize our games and halt the trend of declining sales. Expanded gaming competition, greater player boredom, and unexciting games were contributing to an environment in which regular Lottery players were buying fewer tickets less often and occasional Lottery players were buying tickets only when jackpots were high. In addition, we were confronted with the Auditor General’s performance audit that identified deficiencies in the way the Lottery as a public entity managed its games, retailers and operations. This performance audit was a wake-up call to the Lottery, telling us in no uncertain terms that the manner in which the Lottery had been conducting business was no longer acceptable or appropriate to achieve the agency’s statutory objectives. It was obvious that we could no longer hope for success and continue to do business as we had in the past. We could no longer rely upon stale, out-of-date marketing approaches. And we could no longer assume that people would buy our products just because the games were in the dispenser. This environment motivated us to do a better job with our products and our customers and challenged us to remain a dependable source of revenue for the State of Arizona. This year’s audit and the Lottery’s response describe the progress we have made since 1997. We have restructured our games to appeal to a wide variety of players and, as a result, have met or exceeded our sales goals, thereby generating financial support for our statutory beneficiaries. Further, we have stabilized the agency’s management. We have improved and strengthened our public image. We have taken the initiative to be an accountable, productive and responsible public agency. In the performance audit and in this audit response, you will read about the policies, practices, and philosophies that serve as the basis for how the Lottery conducts business today for the people of Arizona. THE LOTTERY CONDUCTS ITSELF AS A BUSINESS ENTERPRISE. The Arizona Lottery is a state entity in a business environment. But because the Lottery is a government agency, it is not widely viewed as a business. This is unfortunate because the Lottery must conduct itself as a private sector business in order to be successful. 2 The Lottery is similar to major corporations in that it designs, manufactures, distributes and sells consumer products in the retail market. The Lottery’s sales are achieved with low administrative overhead costs, which reflects the Lottery’s achievement of 86% privatization with a reliance upon an extensive group of contractors to provide services. Structured as a public entity, the Lottery is obligated to conduct business consistent with statutory requirements. This includes fiscal, personnel, procurement, operations and several other areas of policy and practice. One of our objectives has been to incorporate private sector concepts, practices, and policies into both our day-to-day and long-term operations. We have achieved this objective by including individuals who have private-sector experience in the decision-making process. Representatives from local businesses, other lotteries and major government organizations have participated in procurement evaluation panels. Members of the business and professional community are serving on the Retailer Advisory and the Responsible Gambling Advisory Committees. And individuals with private sector experience have participated on several job interview panels. Their perspectives have enabled us to introduce new, different and effective management principles and practices to balance our internal focus. The Arizona Lottery is truly a corporate organization existing in a governmental structure. Private sector businesses have stockholders, boards of directors and customers. Similarly, the Arizona Lottery has stockholders (the people of Arizona), a regulatory body (the Arizona Legislature), a Chairman of the Board (the Governor) and customers (players and retailers). It is for all these reasons that the Arizona Lottery makes every effort to conduct itself as a business while still respecting the mandates of government. We prepare annual budgets, develop strategic plans, conduct sales and marketing campaigns, perform customer research, design new products and promotions, track industry trends, support a retail distribution network and contribute to the community. These activities are essential if we are to remain a successful member of the Arizona business community. RESPONSIBLE STRATEGIC ISSUES ARE EMPHASIZED. The Lottery’s strategic issues stress statutory requirements to generate revenue for the State of Arizona. In addition, the issues respond to our commitment to operate in an efficient and effective manner and outline our continual efforts to promote the Lottery as a responsible corporate organization. Consistent with our continuing improvements, the Lottery’s Strategic Plan incorporates the following: · Mission Statement. The mission statement emphasizes greater support for Arizona programs in a responsible manner. · Strategic Issues. The strategic issues include support for public programs, corporate citizenship and organizational efficiency. · Goals and Performance. The performance measures for the agency goals address the strategic issues by promoting responsible gaming, pursuing corporate and community partnerships and expanding public awareness of the Lottery’s benefits to the people of Arizona. 3 SALES AND PERFORMANCE RESULTS HAVE EXCEEDED EXPECTATIONS. Over the past few years, the Lottery’s sales projections have been established at a realistic, conservative level because of the State’s political environment, increasing competition, and unpredictable jackpot levels. The success of our efforts, however, has resulted in the Lottery exceeding the sales forecast for the past four years. Sales · The Lottery completed the best four years in its 20-year history with total revenue over $1 billion. · In FY 01, total sales were nearly $273 million, marking the first time in the history of the Lottery that sales exceeded a quarter of a billion dollars for four consecutive years. · FY 02 total sales are projected to reach $290 million, a record high in the Lottery’s 20-year history. · Instant ticket sales reached an all-time high of $136.9 million in FY 01, an increase of 30% since 1997. Winning Tickets and Prizes · Players had 16.9 million more winning tickets for Lottery games during the past four years compared to the prior four-year period. · Players won $228.8 million in prizes in FY 01, $96 million more than the prior year. Retailer Benefits · Retailers received an additional $5.8 million in commissions during the past four years compared to the prior four-year period. · Retailer commissions of $18.5 million (an all-time high) were $1.7 million, or 10% more than the prior year. SCRATCHERS GAMES ARE AN AWARD-WINNING SUCCESS STORY. The evolution of the Lottery’s Scratchers product over the past four years has been one of our best success stories. Sales for these games culminated in an all-time high of $136.9 million in FY 01. This success is a direct result of our focused attention on the management of the product design and development. It has included player research, ticket design, printing levels, balanced product mix, attractive prize payouts, retailer placement and games that are appropriate for the Arizona market. Our original goal was to increase product sales, and we achieved it beyond our expectations. 4 Several new Scratchers policies have been implemented to support the increase in sales. New game concepts have replaced overused, outdated themes. Tickets are now larger with enhanced graphics and larger fonts for easier readability. We decreased the quantity of tickets printed per game depending on theme and prize, thereby creating opportunities to offer new games more often. The top prize for $1 games has been lowered to $250 - $1,000 in many games to fund more meaningful mid-tier prizes and provide more players with a winning experience. The $2, $3, $5 and extended-play games, which continue to be popular with players, are a substantive part of our product mix. All of these improvements have been recognized and appreciated by players, as evidenced by the record sales. The Lottery’s Scratchers strategy incorporates the following objectives to increase players’ enjoyment of the games: · Continue to introduce popular games and themes at regular intervals to provide fresh excitement for the players. · Offer a balanced mix of $1, $2 and $5 tickets, player-supported themes and extended-play games. · Introduce new $3 and $5 games in response to player enthusiasm and retailer appreciation. · Provide a competitive prize payout that guarantees the State the statutory distribution, compares favorably to the payout in the industry and sustains the number of meaningful mid-tier prizes. · Design attractive and appealing game graphics that are easy to read and understand. This strategy reinforces the product initiatives introduced in 1997 and has become a model for current and future decisions. The Lottery now has an analytical trend basis, substantial data and sales results upon which future Arizona Lottery management can make informed decisions. The ultimate objective of the strategy is to continue to improve the management of the agency’s instant ticket product to increase sales for greater revenue for the State of Arizona. CHANGES TO ONLINE GAMES HAVE BEEN MADE, BUT COMPETITION AND OTHER FACTORS HAVE IMPACTED SALES. Prior to 1997, no positive changes had been made to the Lottery’s online products for several years. Consequently, sales were decreasing at a steady pace. In our first message to the Legislature five years ago, we proposed changes to the games that included new matrices, higher jackpots, more winners and more popular games. Since that time, structural improvements have been introduced to the Arizona-based online games, The PickTM, Fantasy 5TM and Pick 3TM. The purpose of the Lottery’s online strategy is to continue providing creative, sales and management support to the Lottery’s online games to maximize sales for greater revenue for the State of Arizona. The online strategy includes the following objectives: 5 · Provide a prize payout that protects the required distribution to the State, sustains the number of meaningful mid-tier prizes, promotes increased sales and remains competitive with industry standards. · Balance the results of Arizona-specific player research against industry trends in the development and modification of games. · Optimize existing games to maintain their appeal in an ever-changing entertainment environment. · Ensure that online game players can clearly understand game play styles, options and prize structures so responsible purchases are made by informed customers. Despite these efforts, the Lottery’s online games are still suffering. Every recommendation included in the 1997 audit has been introduced, but, as noted by the recent audit, factors outside the Lottery’s control have negatively impacted online sales. An audit-noted factor is the dramatic increase in competition from the Indian casinos. The audit also noted that the major games are jackpot driven. The Pick players do not buy tickets until the jackpot increases substantially. Powerball® sales do not increase measurably until the jackpot hits $70 million or above. A third contributing factor was the legislative reduction in advertising funds by 30%, which severely limited the Lottery’s ability to market these games. In FY 03, the Lottery plans additional changes to The Pick and Fantasy 5 in another effort to rejuvenate these games for greater player appeal and increased revenue. In addition, a new corporate sponsor for Pick 3 will provide advertising and marketing support that the Lottery cannot afford today. MARKETING AND ADVERTISING ARE CONDUCTED IN A PROFESSIONAL MANNER. Four years ago, the Lottery introduced a new strategic direction for all marketing and advertising activities. The primary focus in all public communications was to position the Lottery as a responsible corporate citizen with professional business practices. These themes are now the nucleus of all marketing and advertising activities. The Lottery will continue these themes as they have been so well received and have positively impacted both the organization’s public image and sales. The focus is to reinforce the Lottery’s reputation among players and the general public, to raise awareness of how game proceeds are distributed and to increase the visibility of winners. The marketing strategy incorporates these elements into the following objectives: · Conduct all advertising in a responsible manner. · Design advertising to appeal primarily to regular and occasional players. · Promote the beneficiaries of Lottery game proceeds. · Provide jackpot information for Powerball and The Pick to maximize sales. 6 · Promote premium Scratchers games that appeal to a variety of players to continue the strong growth pattern. · Conduct player research to develop game concepts responsive to player interest and to measure public perceptions and attitudes. Our commitment to responsible advertising is not to entice players to spend their money on fantasies, dreams and high expectations. Nor will players be barraged with obnoxious characters, seductive temptations or confusing messages. The Lottery’s approach to all player and public communications will continue to be clear, responsible, professional and informative. The Lottery’s marketing strategy continues to move the Arizona Lottery into a new era of public communications. With fewer financial resources available, the Lottery must leverage the campaigns’ investments wherever possible to achieve maximum impact. It is critical to reinforce the commitment that the Arizona Lottery has already made to responsible advertising and marketing standards. COMMUNICATIONS HAVE IMPROVED VISIBILITY AND PUBLIC IMAGE. The Arizona Lottery actually has two products to position and promote. The first, and most obvious, includes all of the online and Scratchers games that generate revenue for public programs and projects. The second, and equally important, is the image of our business. The Lottery has strategies and activities for supporting both of these products. The Communications strategy has two components, one for internal communications and one for external communications. During the past few years, we have devoted substantial resources to support the external constituencies, including players, retailers, media and the general public. We conduct monthly research to track public opinions and attitudes toward the Lottery. The latest survey shows 78% of the public believes that the agency is run with honesty and with integrity. An independent retailer survey concluded that retailers “overwhelmingly had positive comments and opinions regarding services they are receiving from the Lottery.” These are impressive indicators of a positive public and customer image. We are just as proud of our efforts to strengthen internal relationships with our employees. The recent Employee Satisfaction Survey conducted by the State of Arizona revealed that a high percentage of Lottery employees expressed satisfaction with their jobs, with internal communications and with their work environment. The agency ratings were higher than the previous year and higher than the statewide average. For the third consecutive year, the Lottery enjoyed a favorably rating. It is encouraging to see that our communications efforts are succeeding among our employees as well. We are pleased to have achieved several of the Lottery’s communications objectives for players, retailers, employees, the general public and the media. The following are the Communications objectives: · Reinforce general public communications by continuing the highly successful “Where The Money Goes” campaign. · Improve retailer communications with a quarterly newsletter, game announcements and flyers announcing store-specific winners. 7 · Strengthen media relations by continuing to develop relationships with key media throughout the State and increased visibility and exposure in rural communities. · Enhance employee communications by distributing a monthly employee newsletter, maintaining agency policies, participating in employee surveys and supporting recognition awards activities. · Expand player communications with an updated and enhanced Web site, prompt response to player feedback, increased player hotline capacity, informative lobby displays, winner awareness program, and responsible gambling program and educational brochures. The Communications strategies have increased the Lottery’s positive visibility and image among players, retailers, employees, business leaders, the media and the general public. SEVERAL HONORS AND AWARDS HAVE BEEN RECEIVED. The Lottery has been honored to receive public recognition of its successes during the past few years. · A recipient of the Governor’s Spirit of Excellence Award for three consecutive years (Reduction of Outstanding Retailer Receivables; Game Development Team; and Scratchers: A Product Management Success Story). · Selection of Cindy Esquer, Communications Manager, and Jeff Hoffman, Telecommunications Specialist, by the Arizona Administrators Association as the top two employees of the year in Arizona State government. · The only lottery in the industry recognized by the American Gaming Association with the organization’s first Communications Award for the Best Annual Report by a Public Agency. SALES STRATEGIES HAVE RESULTED IN IMPROVED RETAILER RELATIONS AND PERFORMANCE IN THE MARKETPLACE. The Lottery’s sales objective is to generate the maximum amount of revenue in a responsible manner in order to support Arizona programs. To accomplish this objective, the Sales Department has developed a comprehensive action plan for the distribution, display and promotion of all Lottery products in the retail market. Because the retail community is a critical component of our success, our sales strategies and guidelines strengthen this partnership. During the past four years, we have made the following progress within the retailer community: · Communications. Retailer Roundup newsletter; Executive Director’s letters regarding game enhancements, increased commissions, Problem Gambling Helpline information, underage wagering and public assistance voucher prohibition; Sales Director’s letters regarding game changes, promotional opportunities and retailer incentives; winning ticket flyers; and jackpot alert plan. 8 · Participation. Retailer Advisory Committee, Playcenter RFP Evaluation Panel, General Market Advertising RFP Evaluation Panel, Lottery job interview panels, Arizona Food Marketing Alliance Partnership, Promotions Team and Economic Development Road Trip. · Improved Operations. New online system with greater retailer reliability and flexibility of operations, policies for low-volume locations and partial pack returns. · Security. Three-digit validation code, tracking ticket stock by retailer, enhanced password options, retailer loss prevention seminars, and routine compliance inspections. · Training. Online Terminal Training Manual, training terminals at corporate sites, new equipment training, and Sales Representatives Training Program. · Bonus Opportunities. Incentive bonuses for the relaunch of The Pick, Fantasy 5 and Pick 3, and new Retailer Incentive Plan. · Promotional Support. Lottery promotions van, in-store promotions, industry-specific point-of- sale items and expanded line of point-of-sale items. GAME PROCEEDS CONTINUE TO SUPPORT STATUTORY BENEFICIARIES. Lottery game proceeds are distributed annually based upon statute. As a result of the strong sales in FY 01, three of the five major statutory beneficiaries received the maximum distribution. The Local Transportation Assistance Fund, County Assistance Fund, and the General Fund have consistently received the maximum distribution allowed. In FY 01, the Heritage Fund also received an increase of $774,900, nearly 5% over the prior year. In addition, the Commerce and Economic Development Fund received $3.17 million, almost 34% more than the prior year. Distribution from unclaimed prize monies to support the Court Appointed Spec ial Advocate (CASA) Program was $1.5 million. Powerball® proceeds are designated for the General Fund and Mass Transit. Heritage Fund monies come from four games (Scratchers, The Pick, Fantasy 5 and Pick 3) that are shared among several beneficiaries. Prior to FY 98, the Lottery was required to return 31.5% of Scratchers sales and 31.5% of online sales to the State. After FY 98, the required return to the State was reduced to 21.5% for Scratchers and 29% for on-line games. The Powerball percentage was increased to 31.6% in FY 00. This a |
