Report 13-11 July 2013 Wisconsin Lottery Department of Revenue Legislative Audit Bureau n Report 13-11 July 2013 Wisconsin Lottery Department of Revenue Joint Legislative Audit Committee Members Senate Members: Assembly Members: Robert Cowles, Co-chairperson Samantha Kerkman, Co-chairperson Mary Lazich Howard Marklein Alberta Darling John Nygren Kathleen Vinehout Jon Richards John Lehman Melissa Sargent Report 13-11 July 2013 LEGISLATIVE AUDIT BUREAU State Auditor The Bureau is a nonpartisan legislative service agency responsible Joe Chrisman for conducting financial and program evaluation audits of state agencies. The Bureau’s purpose is to provide assurance to the Special Assistant Legislature that financial transactions and management decisions Joshua Smith are made effectively, efficiently, and in compliance with state law and that state agencies carry out the policies of the Legislature and Deputy State Auditor for Program Evaluation the Governor. Audit Bureau reports typically contain reviews of Paul Stuiber financial transactions, analyses of agency performance or public policy issues, conclusions regarding the causes of problems found, Financial Audit and recommendations for improvement. Director Sherry Haakenson Reports are submitted to the Joint Legislative Audit Committee and made available to other committees of the Legislature and to Program Evaluation the public. The Audit Committee may arrange public hearings on Supervisor Jay Schad the issues identified in a report and may introduce legislation in response to the audit recommendations. However, the findings, Financial Audit conclusions, and recommendations in the report are those of the Supervisor Legislative Audit Bureau. Shellee Bauknecht Legislative Analyst The Bureau accepts confidential tips about fraud, waste, and Dan Kleinmaier mismanagement in any Wisconsin state agency or program Legislative Auditors through its hotline at 1-877-FRAUD-17. Michelle Hoehne Lanae Nickelotti For more information, visit www.legis.wisconsin.gov/lab. Publications Coordinator Susan Skowronski Contact the Bureau at 22 East Mifflin Street, Suite 500, Madison, Wisconsin 53703; [email protected]; or (608) 266-2818. CONTENTS Letter of Transmittal 1 Report Highlights 3 Introduction 9 Wisconsin Lottery Ticket Sales 9 Wisconsin Lottery Operating Expenses 13 Staffing Levels 15 Property Tax Credits 15 Statutory Requirements 16 Lottery Game Management 19 Game Availability and Sales 19 Lotto Games 19 Instant Games 21 Evaluation of Instant Games 22 Retailer Compensation 27 Retailers Selling Lottery Tickets 27 Payments to Retailers 29 Retailer Commissions 29 Retailer Performance Program 31 Effect of Short-term Incentives on Sales 34 Audit Opinion 37 Independent Auditor’s Report on the Financial Statements of the Wisconsin Lottery Management’s Discussion and Analysis 41 Financial Statements 51 Statement of Net Assets as of June 30, 2012, and June 30, 2011 52 Statement of Revenues, Expenses, and Changes in Net Assets for the Years Ended June 30, 2012, and June 30, 2011 53 Statement of Cash Flows for the Years Ended June 30, 2012, and June 30, 2011 54 Notes to the Financial Statements 57 Supplementary Information 79 Schedule 1—Reconciliation of Lottery General Operations Expenses to the Budgetary Basis of Accounting for the Years Ended June 30, 2012, and June 30, 2011 80 Schedule 2—Statutorily Defined Lottery Administrative Expenses for the Years Ended June 30, 2012, June 30, 2011, and June 30, 2010 81 Schedule 3—Summary of Prize Expenses for the Years Ended June 30, 2008, through June 30, 2012 82 Report on Internal Control and Compliance 83 Independent Auditor’s Report on Internal Control over Financial Reporting and on Compliance and Other Matters Based on an Audit of Financial Statements Performed in Accordance with Government Auditing Standards Response From the Department of Revenue July 23, 2013 Senator Robert Cowles and Representative Samantha Kerkman, Co-chairpersons Joint Legislative Audit Committee State Capitol Madison, Wisconsin 53702 Dear Senator Cowles and Representative Kerkman: As authorized by s. 13.94(1)(em), Wis. Stats., we have completed an annual financial audit and a biennial program evaluation of the Wisconsin Lottery, which is administered by the Department of Revenue (DOR). We have provided an unqualified opinion on the Wisconsin Lottery’s fiscal year (FY) 2011-12 and FY 2010-11 financial statements. Sales of instant and lotto tickets increased 10.7 percent over the past five years, from $494.7 million in FY 2007-08 to $547.6 million in FY 2011-12. The Wisconsin Constitution requires that net proceeds from the Wisconsin Lottery be used exclusively for property tax relief for Wisconsin residents. From FY 2007-08 through FY 2011-12, lottery proceeds funded $700.8 million in property tax relief. Because instant game ticket sales account for the majority of the Wisconsin Lottery’s revenues, we reviewed the process to develop instant games, including those associated with trademarked and copyrighted properties. While all lottery games generate revenue to be used for property tax relief, we question whether the additional expenses associated with trademarked or copyrighted properties maximized the net revenue available for this purpose. Therefore, we recommend the Wisconsin Lottery consider discontinuing the introduction of instant games for which it must pay license fees. In addition, we found the Wisconsin Lottery overestimated the success of certain short-term retailer incentives, and we recommend it consider all relevant factors when assessing the effects of these incentives on sales. We appreciate the courtesy and cooperation extended to us by Wisconsin Lottery staff in DOR. DOR’s response follows our report. Respectfully submitted, Joe Chrisman State Auditor JC/PS/SH/ss Report Highlights We provide an unqualified A 1987 amendment to the Wisconsin Constitution allowed the opinion on the Wisconsin Legislature to create a state lottery and required that its net proceeds Lottery’s FY 2010-11 be distributed for property tax relief. The Wisconsin Lottery began and FY 2011-12 operations the following year and has been managed by the financial statements. Department of Revenue (DOR) since 1995. Lottery tickets are the Wisconsin Lottery’s primary revenue source and are sold at more Wisconsin Lottery sales increased 10.7 percent than 3,600 retailer locations in Wisconsin. The Wisconsin Lottery from FY 2007-08 offers “instant games,” which include both scratch-off and through FY 2011-12. pull-tab tickets, and “lotto games,” which were formerly known as online games. From FY 2007-08 through FY 2011-12, Wisconsin As authorized by s. 13.94(1)(em), Wis. Stats., we have completed a Lottery proceeds provided financial audit and program evaluation of the Wisconsin Lottery. $700.8 million in In conducting the financial audit, we considered internal controls, property tax relief. substantiated account balances, and verified compliance with certain We question whether laws and regulations. We have provided an unqualified opinion on the Wisconsin Lottery the Wisconsin Lottery’s financial statements for the years ended has maximized revenue June 30, 2012, and June 30, 2011. generated from the sale of certain instant games. In conducting the program evaluation, we: . examined trends in sales, operating revenues, and operating expenses; . evaluated the development and management of instant games, which generate the largest share of lottery revenue; and 3 4REPORT HIGHLIGHTS . evaluated the compensation paid to lottery retailers through commissions and the Retailer Performance Program. Revenues and Expenses As shown in Table 1, Wisconsin Lottery sales increased from $494.7 million in fiscal year (FY) 2007-08 to $547.6 million in FY 2011-12, or by 10.7 percent. Increases in ticket sales in the last several years resulted primarily from increases in the sales of instant games priced at $20 per ticket; the addition of the Mega Millions lotto game, which had a record jackpot in March 2012; and an increase in the price of a Powerball ticket from $1 to $2 in January 2012. Table 1 Wisconsin Lottery Sales (in millions) Fiscal Year Amount 2007-08 $494.7 2008-09 473.4 2009-10 480.9 2010-11 502.7 2011-12 547.6 Lottery ticket sales vary by county. In FY 2011-12, lottery sales ranged from less than $200,000 in Menominee County to more than $100 million in Milwaukee County. We also found that FY 2011-12 per capita sales ranged from $59 per adult in Menominee County to $200 per adult in Marinette County. In FY 2011-12, the Wisconsin Lottery’s operating expenses totaled $391.2 million and included $320.1 million in prizes paid to winning ticket holders. Operating expenses increased by 8.6 percent from FY 2010-11 to FY 2011-12 because expenses generally increase as ticket sales increase. Other expenses included retailer compensation, game development and production costs, product information costs, and staff salaries and fringe benefits. The number of full-time equivalent (FTE) positions authorized for the Wisconsin Lottery REPORT HIGHLIGHTS 5 decreased from 97.85 in July 2008 to 82.70 in July 2012. However, an additional 4.0 FTE positions were authorized by 2013 Wisconsin Act 20, the 2013-15 Biennial Budget Act. Property Tax Relief The Wisconsin Constitution requires that net proceeds from the Wisconsin Lottery be used exclusively for property tax relief for Wisconsin residents. From FY 2007-08 through FY 2011-12, Wisconsin Lottery proceeds provided $700.8 million in property tax relief. Statutes require that each year at least 50 percent of Wisconsin Lottery sales be returned to players as prize payments. In FY 2011-12, the prize payout percentage was 58.5 percent, which increased from 58.2 percent in the prior year. Statutes limit certain Wisconsin Lottery administrative expenses to no more than 10 percent of gross lottery revenues. FY 2011-12 administrative expenses were 6.1 percent of gross lottery revenues. Lottery Game Management Effective game development and management help to maximize sales revenue and increase the net proceeds available to fund property tax relief.