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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549


FORM 10-Q

(Mark One)  

ý

QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the quarterly period ended June 30, 2003

OR

o

TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

Commission File number: 0-13063

SCIENTIFIC GAMES CORPORATION
(Exact name of registrant as specified in its charter)

Delaware
(State or other jurisdiction of incorporation or organization)
  81-0422894
(IRS Employer Identification No.)

750 Lexington Avenue, New York, New York 10022
(Address of principal executive offices)
(Zip Code)

(212) 754-2233
(Registrant's telephone number, including area code)

        Indicate by check mark whether the registrant (1) has filed all reports to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes ý    No o

        Indicate by check mark whether the registrant is an accelerated filer (as defined in Rule 12b-2 of the Exchange Act). Yes ý    No o

APPLICABLE ONLY TO CORPORATE ISSUERS:

        Indicate the number of shares outstanding of each of the issuer's classes of common stock as of August 13, 2003:

Class A Common Stock: 60,118,142
Class B Common Stock: None




SCIENTIFIC GAMES CORPORATION AND SUBSIDIARIES
INDEX TO CONSOLIDATED FINANCIAL STATEMENTS
AND OTHER INFORMATION
THREE MONTHS ENDED JUNE 30, 2003

 
   
  Page
PART I. FINANCIAL INFORMATION    
 
Item 1.

 

Consolidated Financial Statements:

 

 

 

 

    Balance Sheets as of December 31, 2002 and June 30, 2003

 

3

 

 

    Statements of Operations for the Three Months Ended June 30, 2002 and 2003

 

4

 

 

    Statements of Operations for the Six Months Ended June 30, 2002 and 2003

 

5

 

 

    Condensed Statements of Cash Flows for the Six Months Ended June 30, 2002 and 2003

 

6

 

 

    Notes to Consolidated Financial Statements

 

7
 
Item 2.

 

Management's Discussion and Analysis of Financial Condition and Results of Operations

 

21
 
Item 3.

 

Quantitative and Qualitative Disclosures About Market Risk

 

29
 
Item 4.

 

Controls and Procedures

 

32

PART II. OTHER INFORMATION

 

 
 
Item 1.

 

Legal Proceedings

 

33
 
Item 4.

 

Submission of Matters to a Vote of Security Holders

 

33
 
Item 6.

 

Exhibits and Reports on Form 8-K

 

34

2



SCIENTIFIC GAMES CORPORATION AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
(Unaudited, in thousands, except per share amounts)

 
  December 31,
2002

  June 30,
2003

 
ASSETS            
Current assets:            
  Cash and cash equivalents   $ 34,929   41,122  
  Accounts receivable, net of allowance for doubtful accounts of $3,772 and $3,488 at December 31, 2002 and June 30, 2003, respectively     53,260   60,109  
  Inventories     20,535   26,389  
  Prepaid expenses, deposits and other current assets     22,654   19,673  
   
 
 
    Total current assets     131,378   147,293  
   
 
 
Property and equipment, at cost     404,685   418,078  
  Less accumulated depreciation     203,819   224,055  
   
 
 
    Net property and equipment     200,866   194,023  
   
 
 
Goodwill     183,770   210,843  
Other intangible assets, net     57,822   59,218  
Other assets and investments     83,986   84,431  
   
 
 
    Total assets   $ 657,822   695,808  
   
 
 
LIABILITIES AND STOCKHOLDERS' EQUITY            
Current liabilities:            
  Current installments of long-term debt   $ 3,865   3,795  
  Accounts payable     23,888   26,397  
  Accrued liabilities     53,513   61,268  
  Interest payable     3,597   3,496  
   
 
 
    Total current liabilities     84,863   94,956  
   
 
 
Deferred income taxes     25,207   25,050  
Other long-term liabilities     22,318   29,017  
Long-term debt, excluding current installments     356,664   353,460  
   
 
 
    Total liabilities     489,052   502,483  
   
 
 
Commitments and contingencies        

Stockholders' equity:

 

 

 

 

 

 
  Series A convertible preferred stock, par value $1.00 per share, 1,600 shares authorized, 1,248 and 1,286 shares outstanding at December 31, 2002 and June 30, 2003, respectively     1,248   1,286  
  Series B preferred stock, par value $1.00 per share, 2 shares authorized, 1.238 and 1.194 shares outstanding at December 31, 2002 and June 30, 2003, respectively     1   1  
  Class A common stock, par value $0.01 per share, 199,300 shares authorized, 59,375 and 59,934 shares outstanding at December 31, 2002 and June 30, 2003, respectively     594   599  
  Class B non-voting common stock, par value $0.01 per share, 700 shares authorized, none outstanding        
  Additional paid-in capital     384,927   389,912  
  Accumulated losses     (214,135 ) (193,986 )
  Treasury stock, at cost     (3,539 ) (3,539 )
  Accumulated other comprehensive loss     (326 ) (948 )
   
 
 
    Total stockholders' equity     168,770   193,325  
   
 
 
    Total liabilities and stockholders' equity   $ 657,822   695,808  
   
 
 

See accompanying notes to consolidated financial statements.

3



SCIENTIFIC GAMES CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
Three Months Ended June 30, 2002 and 2003
(Unaudited, in thousands, except per share amounts)

 
  2002
  2003
Operating revenues:          
  Services   $ 96,760   110,130
  Sales     17,507   18,719
   
 
      114,267   128,849
   
 
Operating expenses (exclusive of depreciation and amortization shown below):          
  Services     55,237   59,886
  Sales     11,676   12,531
  Amortization of service contract software     1,214   1,344
   
 
      68,127   73,761
   
 
Total gross profit     46,140   55,088
Selling, general and administrative expenses     15,753   19,369
Depreciation and amortization     9,669   9,847
   
 
Operating income     20,718   25,872
   
 
Other deductions (income):          
  Interest expense     11,561   6,172
  Other (income) expense     (161 ) 72
   
 
      11,400   6,244
   
 
Income before income tax expense     9,318   19,628
Income tax expense     1,196   7,058
   
 
Net income     8,122   12,570
Convertible preferred stock paid-in-kind dividend     1,851   1,895
   
 
Net income available to common stockholders   $ 6,271   10,675
   
 
Basic and diluted net income per share (See Note 1):          
  Basic net income available to common stockholders   $ 0.15   0.18
   
 
  Diluted net income available to common stockholders   $ 0.11   0.14
   
 
Weighted average number of shares used in per share calculations:          
  Basic shares     43,048   59,868
   
 
  Diluted shares     71,983   89,228
   
 

See accompanying notes to consolidated financial statements.

4



SCIENTIFIC GAMES CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
Six Months Ended June 30, 2002 and 2003
(Unaudited, in thousands, except per share amounts)

 
  2002
  2003
 
Operating revenues:            
  Services   $ 189,263   215,397  
  Sales     31,976   36,670  
   
 
 
      221,239   252,067  
   
 
 
Operating expenses (exclusive of depreciation and amortization shown below):            
  Services     108,486   117,514  
  Sales     20,914   24,938  
  Amortization of service contract software     2,423   2,611  
   
 
 
      131,823   145,063  
   
 
 
Total gross profit     89,416   107,004  
Selling, general and administrative expenses     30,113   37,711  
Depreciation and amortization     18,866   19,628  
   
 
 
Operating income     40,437   49,665  
   
 
 
Other deductions (income):            
  Interest expense     23,012   12,404  
  Other income     (229 ) (32 )
   
 
 
      22,783   12,372  
   
 
 
Income before income tax expense     17,654   37,293  
Income tax expense     12,541   13,402  
   
 
 
Net income     5,113   23,891  
Convertible preferred stock paid-in-kind dividend     3,654   3,742  
   
 
 
Net income available to common stockholders   $ 1,459   20,149  
   
 
 
Basic and diluted net income per share (See Note 1):            
  Basic net income available to common stockholders   $ 0.03   0.34  
   
 
 
  Diluted net income available to common stockholders   $ 0.03   0.27  
   
 
 
Weighted average number of shares used in per share calculations:            
  Basic shares     42,546   59,660  
   
 
 
  Diluted shares     49,411   88,386  
   
 
 

See accompanying notes to consolidated financial statements.

5



SCIENTIFIC GAMES CORPORATION AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
Six Months Ended June 30, 2002 and 2003
(Unaudited, in thousands)

 
  2002
  2003
 
Cash flows from operating activities:            
    Net income   $ 5,113   23,891  
   
 
 
    Adjustments to reconcile net income to cash provided by operating activities:            
      Depreciation and amortization     21,289   22,239  
      Changes in operating assets and liabilities, net of effects of business acquisitions     (14,752 ) (8,596 )
      Change in deferred income taxes     9,338   10,095  
      Other     1,433   1,274  
   
 
 
        Total adjustments     17,308   25,012  
   
 
 
Net cash provided by operating activities     22,421   48,903  
   
 
 
Cash flows from investing activities:            
    Capital expenditures     (6,628 ) (5,543 )
    Wagering systems expenditures     (6,888 ) (4,756 )
    Business acquisition, net of cash acquired     (4,104 ) (20,760 )
    Increase in other assets and liabilities, net     (4,372 ) (9,481 )
   
 
 
Net cash used in investing activities     (21,992 ) (40,540 )
   
 
 
Cash flows from financing activities:            
    Net borrowings under lines of credit     (4,250 )  
    Payments on long-term debt     (4,401 ) (3,761 )
    Proceeds from the issuance of common stock     1,273   1,157  
   
 
 
Net cash used in financing activities     (7,378 ) (2,604 )
   
 
 
Effect of exchange rate changes on cash and cash equivalents     1,128   434  
   
 
 
Increase (decrease) in cash and cash equivalents     (5,821 ) 6,193  
Cash and cash equivalents, beginning of period     12,649   34,929  
   
 
 
Cash and cash equivalents, end of period   $ 6,828   41,122  
   
 
 
Supplemental disclosure of cash flow information:            
  Cash paid during the period for:            
    Interest   $ 22,000   11,796  
   
 
 
    Income taxes, net of refunds   $ (1,126 ) 2,283  
   
 
 
  Non-cash financing activity during the period:            
    Convertible preferred stock paid-in-kind dividends   $ 3,654   3,742  
   
 
 

See accompanying notes to consolidated financial statements.

6



SCIENTIFIC GAMES CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited, in thousands, except per share amounts)

(1)   Consolidated Financial Statements

Basis of Presentation

        The consolidated balance sheet as of June 30, 2003 and the consolidated statements of operations for the three and six months ended June 30, 2002 and 2003, and the consolidated condensed statements of cash flows for the six months then ended, have been prepared by the Company without audit. In the opinion of management, all adjustments necessary to present fairly the consolidated financial position of the Company at June 30, 2003 and the results of its operations for the three and six months ended June 30, 2002 and 2003 and its cash flows for the six months ended June 30, 2002 and 2003 have been made.

        Certain information and footnote disclosures normally included in consolidated financial statements prepared in accordance with accounting principles generally accepted in the United States of America have been condensed or omitted. These consolidated financial statements should be read in conjunction with the consolidated financial statements and notes thereto included in the Company's 2002 Annual Report on Form 10-K, as amended. The results of operations for the periods ended June 30, 2003 are not necessarily indicative of the operating results for the full year.

        Certain reclassifications have been made to the prior year's consolidated financial statements to conform to the current presentation.

Basic and Diluted Net Income Per Share

        The following represents a reconciliation of the numerator and denominator used in computing basic and diluted net income available to common stockholders per share for the three and six months ended June 30, 2002 and 2003:

 
  Three Months Ended
June 30,

  Six Months Ended
June 30,

 
  2002
  2003
  2002
  2003
Income (numerator)                  
Net income available to common stockholders (basic)   $ 6,271   10,675   1,459   20,149
Add back preferred stock paid-in-kind dividend     1,851   1,895   3,654   3,742
   
 
 
 
Income before preferred dividend available to common stockholders (diluted)   $ 8,122   12,570   5,113   23,891
   
 
 
 
Shares (denominator)                  
Basic weighted average common shares outstanding     43,048   59,868   42,546   59,660
Effect of dilutive securities-stock options, warrants, convertible preferred shares and deferred shares     28,935   29,360   6,865   28,726
   
 
 
 
Diluted weighted average common shares outstanding     71,983   89,228   49,411   88,386
   
 
 
 
Basic and diluted per share amounts                  
Basic net income per share available to common stockholders   $ 0.15   0.18   0.03   0.34
   
 
 
 
Diluted net income per share available to common stockholders   $ 0.11   0.14   0.03   0.27
   
 
 
 

        At June 30, 2002 and 2003, the Company had outstanding stock options, warrants, Performance Accelerated Restricted Stock Units and Series A Convertible Preferred Stock, which could potentially

7



dilute basic earnings per share in the future. Potential common shares are not included in the calculation of dilutive net loss per share for the six months ended June 30, 2002 since inclusion would be anti-dilutive. (See Notes 14 and 15 to the Consolidated Financial Statements for the year ended December 31, 2002 in the Company's 2002 Annual Report on Form 10-K, as amended.)

Stock-Based Compensation

        The Company has chosen to continue to account for stock-based compensation using the intrinsic-value method prescribed by Accounting Principles Board Opinion No. 25. Accordingly, no stock compensation expense has been recognized for a substantial majority of its stock-based compensation plans. Had the Company elected to recognize compensation cost based on the fair value of the stock options at the date of grant under SFAS 123, as amended by SFAS 148, such costs would have been recognized ratably over the vesting period of the underlying instruments and the Company's net income and net income per share would have changed to the pro forma amounts indicated in the table below:

 
  Three Months Ended
June 30,

  Six Months Ended
June 30,

 
 
  2002
  2003
  2002
  2003
 
Net income available to common stockholders as reported   $ 6,271   10,675   1,459   20,149  
Add: Stock-based compensation expense included in reported net income, net of related tax effects            
Deduct: Total stock-based employee compensation expense determined under fair value based method for all awards, net of related tax effects     (658 ) (999 ) (1,315 ) (1,882 )
   
 
 
 
 
Pro forma net income available to common stockholders   $ 5,613   9,676   144   18,267  
   
 
 
 
 
Net income available to common stockholders per basic share:                    
  As reported   $ 0.15   0.18   0.03   0.34  
   
 
 
 
 
  Pro forma   $ 0.13   0.16     0.31  
   
 
 
 
 
Net income available to common stockholders per diluted share:                    
  As reported   $ 0.11   0.14   0.03   0.27  
   
 
 
 
 
  Pro forma   $ 0.11   0.13     0.26  
   
 
 
 
 

(2)   Acquisition of MDI Entertainment, Inc.

        On January 17, 2003, the Company completed the acquisition of MDI Entertainment, Inc. ("MDI") through (i) a tender offer at $1.60 per share, in cash, (ii) the purchase of shares from MDI's President and Chief Executive Officer pursuant to a separate stock purchase agreement and (iii) a merger agreement, whereby the remaining eight percent of MDI common shares was converted into the right to receive $1.60 per share in cash. With the purchase of MDI, the Company significantly expanded its offerings of licensed branded products and prize fulfillment and related services. MDI focuses on helping lotteries attract players to new kinds of tickets and second chance games that allow players to win merchandise, such as Harley Davidson motorcycles and trips and prizes such as tickets to NBA playoff games. The Company's portfolio of licensed brands now includes Mandalay Bay, NBA, Harley Davidson, Wheel of Fortune, and many others. The Company expects that its acquisition of MDI will enable it to further expand the use of branded games and prize fulfillment services to continue to help its customers generate revenues to meet the needs of their beneficiaries. The acquisition was recorded using the purchase method of accounting and the acquired assets and liabilities have been recorded at their estimated fair values at the date of acquisition. The purchase price totaled approximately $22,958, including fees and expenses. The excess of the purchase price over

8



the fair value of the net assets acquired is currently estimated to be approximately $26,933 and has been recorded as goodwill. This estimate is subject to revisions until the valuations of MDI's assets and liabilities are completed. The operating results of MDI have been included in the Company's consolidated operating results since the date of acquisition. Had the operating results of MDI been included as if the transaction had been consummated on January 1, 2003, the Company's pro forma operating results for the three and six months ended June 30, 2003 would not have been materially different from the actual reported results.

(3)   Business Segments

        The following tables represent revenues, profits, depreciation, amortization, and capital expenditures for the three and six months ended June 30, 2002 and 2003, and assets at June 30, 2002 and 2003, by business segment. Corporate expenses, interest expense and other (income) deductions are not allocated to business segments.

 
  Three Months Ended June 30, 2002
 
  Lottery Group
  Pari-Mutuel
Group

  Venue
Management
Group

  Telecommunications
Products
Group

  Totals
Service revenues   $ 59,446   21,033   16,281       96,760
Sales revenues     5,897   1,557     10,053     17,507
   
 
 
 
 
Total revenues     65,343   22,590   16,281   10,053     114,267
   
 
 
 
 
Cost of service     32,550   11,808   10,879       55,237
Cost of sales     4,226   811     6,639     11,676
Amortization of service contract software     538   676         1,214
   
 
 
 
 
Total operating expenses     37,314   13,295   10,879   6,639     68,127
   
 
 
 
 
Gross profit     28,029   9,295   5,402   3,414     46,140
Selling, general and administrative expenses     7,041   2,499   685   1,075     11,300
Depreciation and amortization     5,805   2,872   435   470     9,582
   
 
 
 
 
Segment operating income     15,183   3,924   4,282   1,869     25,258
   
 
 
 
     
Unallocated corporate expense                       4,540
                     
Consolidated operating income                     $ 20,718
                     
Capital and wagering systems expenditures   $ 3,149   2,158   781   594     6,682
   
 
 
 
 

9



 


 

Three Months Ended June 30, 2003

 
  Lottery Group
  Pari-Mutuel
Group

  Venue
Management
Group

  Telecommunications
Products
Group

  Totals
Service revenues   $ 72,530   20,775   16,825       110,130
Sales revenues     5,511   776     12,432     18,719
   
 
 
 
 
Total revenues     78,041   21,551   16,825   12,432     128,849
   
 
 
 
 
Cost of service     36,970   11,250   11,666       59,886
Cost of sales     3,833   469     8,229     12,531
Amortization of service contract software     749   595         1,344
   
 
 
 
 
Total operating expenses     41,552   12,314   11,666   8,229     73,761
   
 
 
 
 
Gross profit     36,489   9,237   5,159   4,203     55,088
Selling, general and administrative expenses     9,071   3,140   847   1,177     14,235
Depreciation and amortization     5,733   2,793   514   631     9,671
   
 
 
 
 
Segment operating income     21,685   3,304   3,798   2,395     31,182
   
 
 
 
     
Unallocated corporate expense                       5,310
                     
Consolidated operating income                     $ 25,872
                     
Capital and wagering systems expenditures   $ 4,046   1,879   311   688     6,924
   
 
 
 
 

 


 

Six Months Ended June 30, 2002

 
  Lottery Group
  Pari-Mutuel
Group

  Venue
Management
Group

  Telecommunications
Products
Group

  Totals
Service revenues   $ 117,524   40,657   31,082       189,263
Sales revenues     7,838   3,310     20,828     31,976
   
 
 
 
 
Total revenues     125,362   43,967   31,082   20,828     221,239
   
 
 
 
 
Cost of service     64,715   22,683   21,088       108,486
Cost of sales     5,708   1,545     13,661     20,914
Amortization of service contract software     1,121   1,302         2,423
   
 
 
 
 
Total operating expenses     71,544   25,530   21,088   13,661     131,823
   
 
 
 
 
Gross profit     53,818   18,437   9,994   7,167     89,416
Selling, general and administrative expenses     13,524   4,337   1,314   2,223     21,398
Depreciation and amortization     11,211   5,681   855   945     18,692
   
 
 
 
 
Segment operating income     29,083   8,419   7,825   3,999     49,326
   
 
 
 
     
Unallocated corporate expense                       8,889
                     
Consolidated operating income                     $ 40,437
                     
Assets at June 30, 2002   $ 296,435   226,732   35,374   36,965     595,506
   
 
 
 
 
Capital and wagering systems expenditures   $ 7,794   3,499   945   1,278     13,516
   
 
 
 
 

10


 
  Six Months Ended June 30, 2003
 
  Lottery Group
  Pari-Mutuel
Group

  Venue
Management
Group

  Telecommunications
Products
Group

  Totals
Service revenues   $ 143,494   39,705   32,198       215,397
Sales revenues     11,558   2,816     22,296     36,670
   
 
 
 
 
Total revenues     155,052   42,521   32,198   22,296     252,067
   
 
 
 
 
Cost of service     73,301   21,998   22,215       117,514
Cost of sales     8,318   1,722     14,898     24,938
Amortization of service contract software     1,410   1,201         2,611
   
 
 
 
 
Total operating expenses     83,029   24,921   22,215   14,898     145,063
   
 
 
 
 
Gross profit     72,023   17,600   9,983   7,398     107,004
Selling, general and administrative expenses     18,304   5,372   1,749   2,391     27,816
Depreciation and amortization     11,406   5,562   1,017   1,278     19,263
   
 
 
 
 
Segment operating income     42,313   6,666   7,217   3,729     59,925
   
 
 
 
     
Unallocated corporate expense                       10,260
                     
Consolidated operating income                     $ 49,665
                     
Assets at June 30, 2003   $ 337,449   282,417   35,663   40,279     695,808
   
 
 
 
 
Capital and wagering systems expenditures   $ 5,768   2,935   610   986     10,299
   
 
 
 
 

        The following table provides a reconciliation of consolidated operating income to the consolidated income before income tax expense for each period:

 
  Three Months Ended
June 30,

  Six Months Ended
June 30,

 
 
  2002
  2003
  2002
  2003
 
Reportable consolidated operating income   $ 20,718   25,872   40,437   49,665  
Interest expense     11,561   6,172   23,012   12,404  
Other (income) expense     (161 ) 72   (229 ) (32 )
   
 
 
 
 
Income before income tax expense   $ 9,318   19,628   17,654   37,293  
   
 
 
 
 

(4)   Income Tax Expense

        Income tax expense was $7,058 and $13,402 for the three and six months ended June 30, 2003, respectively. Due to the recognition of the income tax asset from the net operating loss carryforward ("NOL") in the fourth quarter of 2002 the effective income tax rate for the three and six months ended June 30, 2003 is approximately 36%, which differed from the federal statutory rate of 35% primarily due to foreign and state income taxes.

        For the three and six months ended June 30, 2002, income tax expense totaled $1,196 and $12,541, respectively. This expense primarily reflects foreign and state income taxes, and a $9,790 charge in the first quarter of 2002 related to the adoption of SFAS 142, which caused us to reduce the recorded amount of our NOL from $18,520 and $8,730 to reflect the reduced amount of net taxable temporary differences that are expected to reverse during the NOL carryforward period because of the cessation of amortization of the tradename and employee workforce intangible assets. No current tax benefit was

11


recognized on domestic operating losses in either period in 2002 in excess of the amount of net taxable temporary differences that are expected to reverse during the NOL carryforward period.

(5)   Comprehensive Income

        The following presents a reconciliation of net income to comprehensive income for the three and six month periods ended June 30, 2002 and 2003:

 
  Three Months Ended
June 30,

  Six Months Ended
June 30,

 
 
  2002
  2003
  2002
  2003
 
Net income   $ 8,122   12,570   5,113   23,891  
Other comprehensive income (loss):                    
  Foreign currency translation     3,789   2,381   2,786   2,308  
  Unrealized gain on investments     (355 ) 7     876  
  Unrealized gain (loss) on interest rate swap agreements     (159 )   1,702    
  Unrealized loss on Canadian dollar hedges       (2,325 )   (3,806 )
   
 
 
 
 
  Other comprehensive income (loss)     3,275   63   4,488   (622 )
   
 
 
 
 
Comprehensive income   $ 11,397   12,633   9,601   23,269  
   
 
 
 
 

(6)   Inventories

        Inventories consist of the following:

 
  December 31,
2002

  June 30,
2003

Parts and work-in-process   $ 10,850   14,422
Finished goods     9,685   11,967
   
 
    $ 20,535   26,389
   
 

        Parts and work-in-process include costs for equipment expected to be sold. Costs incurred for equipment associated with specific wagering system service contracts not yet placed in service are classified as construction in progress in property and equipment.

(7)   Debt

        At June 30, 2003, the Company had approximately $26,918 available for borrowing under the Company's revolving credit facility, which was entered into on December 19, 2002 as part of the Company's new senior secured credit facility (the "2002 Facility"). There were no borrowings outstanding under the revolving credit feature of the 2002 Facility, but approximately $23,082 in letters of credit was issued under the 2002 Facility at June 30, 2003. At December 31, 2002, the Company's available borrowing capacity under the 2002 Facility was $28,171. As of June 30, 2003, there was $288,550 outstanding under the Term B Loan under the 2002 Facility, and $65,584 of the Company's 121/2% Senior Subordinated Notes (the "Notes") were outstanding.

12



(8)   Goodwill and Intangible Assets, Impairment of Long-Lived Assets and Long-Lived Assets to be Disposed Of

        The following disclosure presents certain information regarding the Company's acquired intangible assets as of December 31, 2002 and June 30, 2003. Amortized intangible assets are being amortized over their estimated useful lives, as indicated below, with no estimated residual values.

Intangible Assets

  Weighted
Average
Amortization
Period

  Gross
Carrying
Amount

  Accumulated
Amortization

  Net Balance
Balance at December 31, 2002                  
Amortizable intangible assets:                  
  Patents   15   $ 1,084   163   921
  Customer lists   14     14,600   4,089   10,511
  Customer service contracts   15     3,341   1,053   2,288
       
 
 
          19,025   5,305   13,720
       
 
 
Non-amortizable intangible assets:                  
  Trade name         32,200   2,118   30,082
  Connecticut off-track betting system operating right         22,339   8,319   14,020
       
 
 
          54,539   10,437   44,102
       
 
 
Total intangible assets       $ 73,564   15,742   57,822
       
 
 
Balance at June 30, 2003                  
Amortizable intangible assets:                  
  Patents   15   $ 2,570   193   2,377
  Customer lists   14     15,375   5,037   10,338
  Customer service contracts   15     3,567   1,166   2,401
       
 
 
          21,512   6,396   15,116
       
 
 
Non-amortizable intangible assets:                  
  Trade name         32,200   2,118   30,082
  Connecticut off-track betting system operating right         22,339   8,319   14,020
       
 
 
          54,539   10,437   44,102
       
 
 
Total intangible assets       $ 76,051   16,833   59,218
       
 
 

        The aggregate intangible amortization expense for the six-month period ended June 30, 2003 was approximately $1,091. The estimated intangible asset amortization expense for the year ending December 31, 2003 and for each of the subsequent four years ending December 31, 2007 are $2,246, $2,006, $1,258, $971 and $969, respectively.

        The table below reconciles the change in the carrying amount of goodwill, by reporting unit, which is the same as operating segment, for the period from December 31, 2002 to June 30, 2003. The Company recorded a $915 increase in goodwill in 2003 in connection with an earnout payment pursuant to the SERCHI (as defined below) purchase agreement. Goodwill in the amount of $775, which was directly related to the value of customer service contracts acquired as part of the June 5, 2002 acquisition of 65% of the issued and outstanding shares of Serigrafica Chilena S.A. ("SERCHI"), was reclassified to intangible assets effective January 2003 as a result of the completion of the final purchase price valuation and allocation during the first quarter of 2003. The Company recorded an increase to goodwill on January 9, 2003 of $26,933 related to the initial purchase price allocation of the

13



MDI acquisition, subject to revision pending the completion of the final valuation and allocation of the purchase price.

Goodwill

  Lottery Group
  Pari-Mutuel
Group

  Venue
Management
Group

  Telecommunications
Group

  Totals
 
Balance at December 31, 2002   $ 183,283   487       183,770  
Adjustments:                        
  Addition to goodwill in connection with the final price allocation of SERCHI     915         915  
  Reclassification of customer service contract to intangible assets in connection with the final purchase price allocation of SERCHI     (775 )       (775 )
  Record the initial value of goodwill acquired in connection with the acquisition of MDI     26,933         26,933  
   
 
 
 
 
 
Balance at June 30, 2003   $ 210,356   487       210,843  
   
 
 
 
 
 

(9)   Financial Information for Guarantor Subsidiaries and Non-Guarantor Subsidiaries

        The Company conducts substantially all of its business through its domestic and foreign subsidiaries. The Notes and the 2002 Facility are fully, unconditionally and jointly and severally guaranteed by substantially all of the Company's wholly owned domestic subsidiaries (the "Guarantor Subsidiaries").

        Presented below is condensed consolidating financial information for (i) Scientific Games Corporation (the "Parent Company"), which includes the activities of Scientific Games Management Corporation, (ii) the Guarantor Subsidiaries and (iii) the wholly owned foreign subsidiaries and the non-wholly owned domestic and foreign subsidiaries (the "Non-Guarantor Subsidiaries") as of December 31, 2002 and June 30, 2003 and for the three and six months ended June 30, 2002 and 2003. The condensed consolidating financial information has been presented to show the nature of assets held, results of operations and cash flows of the Parent Company, Guarantor Subsidiaries and Non-Guarantor Subsidiaries assuming the guarantee structure of the Notes and the 2002 Facility was in effect at the beginning of the periods presented. Separate financial statements for Guarantor Subsidiaries are not presented based on management's determination that they would not provide additional information that is material to investors.

        The condensed consolidating financial information reflects the investments of the Parent Company in the Guarantor and Non-Guarantor Subsidiaries using the equity method of accounting. In addition, corporate interest and administrative expenses have not been allocated to the subsidiaries.

14



SCIENTIFIC GAMES CORPORATION AND SUBSIDIARIES
SUPPLEMENTAL CONDENSED CONSOLIDATING BALANCE SHEET
December 31, 2002
(unaudited, in thousands)

 
  Parent
Company

  Guarantor
Subsidiaries

  Non-Guarantor
Subsidiaries

  Eliminating
Entries

  Consolidated
ASSETS                      
  Cash and cash equivalents   $ 25,323   180   9,426     34,929
  Accounts receivable, net       35,521   17,779   (40 ) 53,260
  Inventories       16,591   4,480   (536 ) 20,535
  Other current assets     10,810   6,988   4,826   30   22,654
  Property and equipment, net     3,572   151,366   46,559   (631 ) 200,866
  Investment in subsidiaries     348,585   4,240     (352,825 )
  Goodwill     183   179,672   3,915     183,770
  Intangible assets       52,892   4,930     57,822
  Other assets     47,817   38,693   6,001   (8,525 ) 83,986
   
 
 
 
 
    Total assets   $ 436,290   486,143   97,916   (362,527 ) 657,822
   
 
 
 
 
LIABILITIES AND STOCKHOLDERS' EQUITY                      
  Current installments of long-term debt   $ 3,281   9   575     3,865
  Current liabilities     13,342   49,047   17,970   639   80,998
  Long-term debt, excluding current installments     356,418   1   245     356,664
  Other non-current liabilities     7,569   28,972   10,845   139   47,525
  Intercompany balances     (113,090 ) 96,751   17,822   (1,483 )
  Stockholders' equity     168,770   311,363   50,459   (361,822 ) 168,770
   
 
 
 
 
    Total liabilities and stockholders' equity   $ 436,290   486,143   97,916   (362,527 ) 657,822
   
 
 
 
 

15


SCIENTIFIC GAMES CORPORATION AND SUBSIDIARIES
SUPPLEMENTAL CONDENSED CONSOLIDATING BALANCE SHEET
June 30, 2003
(unaudited, in thousands)

 
  Parent
Company

  Guarantor
Subsidiaries

  Non-Guarantor
Subsidiaries

  Eliminating
Entries

  Consolidated
ASSETS                      
  Cash and cash equivalents   $ 30,798   (488 ) 10,812     41,122
  Accounts receivable, net       39,144   21,004   (39 ) 60,109
  Inventories       20,776   6,221   (608 ) 26,389
  Other current assets     7,171   6,375   6,097   30   19,673
  Property and equipment, net     3,366   140,284   51,004   (631 ) 194,023
  Investment in subsidiaries     411,780   27,248     (439,028 )
  Goodwill     183   206,605   4,055     210,843
  Intangible assets       54,126   5,092     59,218
  Other assets     45,189   41,376   6,196   (8,330 ) 84,431
   
 
 
 
 
    Total assets   $ 498,487   535,446   110,481   (448,606 ) 695,808
   
 
 
 
 
LIABILITIES AND STOCKHOLDERS' EQUITY                      
  Current installments of long-term debt   $ 3,287   6   502     3,795
  Current liabilities     13,855   51,999   24,354   953   91,161
  Long-term debt, excluding current installments     353,318     142     353,460
  Other non-current liabilities     15,410   27,010   11,525   122   54,067
  Intercompany balances     (80,708 ) 64,622   17,883   (1,797 )
  Stockholders' equity     193,325   391,809   56,075   (447,884 ) 193,325
   
 
 
 
 
    Total liabilities and stockholders' equity   $ 498,487   535,446   110,481   (448,606 ) 695,808
   
 
 
 
 

16


SCIENTIFIC GAMES CORPORATION AND SUBSIDIARIES
SUPPLEMENTAL CONDENSED STATEMENT OF OPERATIONS
Three Months Ended June 30, 2002
(unaudited, in thousands)

 
  Parent
Company

  Guarantor
Subsidiaries

  Non-Guarantor
Subsidiaries

  Eliminating
Entries

  Consolidated
 
Operating revenues   $   86,166   29,972   (1,871 ) 114,267  
Operating expenses       48,305   20,397   (1,789 ) 66,913  
Amortization of service contract software       1,114   100     1,214  
   
 
 
 
 
 
  Gross profit       36,747   9,475   (82 ) 46,140  

Selling, general and administrative expenses

 

 

4,451

 

8,720

 

2,585

 

(3

)

15,753

 
Depreciation and amortization     87   7,652   1,934   (4 ) 9,669  
   
 
 
 
 
 
  Operating income (loss)     (4,538 ) 20,375   4,956   (75 ) 20,718  
Interest expense     11,296   227   348   (310 ) 11,561  
Other (income) expense     2   (892 ) 434   295   (161 )
   
 
 
 
 
 
Income (loss) before equity in income of subsidiaries, and income taxes     (15,836 ) 21,040   4,174   (60 ) 9,318  
Equity in income of subsidiaries     24,100       (24,100 )  
Income tax expense     142   61   993     1,196  
   
 
 
 
 
 
Net income   $ 8,122   20,979   3,181   (24,160 ) 8,122  
   
 
 
 
 
 

SCIENTIFIC GAMES CORPORATION AND SUBSIDIARIES
SUPPLEMENTAL CONDENSED STATEMENT OF OPERATIONS
Three Months Ended June 30, 2003
(unaudited, in thousands)

 
  Parent
Company

  Guarantor
Subsidiaries

  Non-Guarantor
Subsidiaries

  Eliminating
Entries

  Consolidated
Operating revenues   $   97,387   33,126   (1,664 ) 128,849
Operating expenses       52,000   22,018   (1,601 ) 72,417
Amortization of service contract software       1,245   99     1,344
   
 
 
 
 
  Gross profit       44,142   11,009   (63 ) 55,088

Selling, general and administrative expenses

 

 

5,284

 

10,637

 

3,451

 

(3

)

19,369
Depreciation and amortization     176   7,500   2,171     9,847
   
 
 
 
 
  Operating income (loss)     (5,460 ) 26,005   5,387   (60 ) 25,872
Interest expense     6,031   181   1,054   (1,094 ) 6,172
Other (income) expense     87   (1,757 ) 650   1,092   72
   
 
 
 
 
Income (loss) before equity in income of subsidiaries, and income taxes     (11,578 ) 27,581   3,683   (58 ) 19,628
Equity in income of subsidiaries     30,287       (30,287 )
Income tax expense     6,139   117   802     7,058
   
 
 
 
 
Net income   $ 12,570   27,464   2,881   (30,345 ) 12,570
   
 
 
 
 

17


SCIENTIFIC GAMES CORPORATION AND SUBSIDIARIES
SUPPLEMENTAL CONDENSED STATEMENT OF OPERATIONS
Six Months Ended June 30, 2002
(unaudited, in thousands)

 
  Parent
Company

  Guarantor
Subsidiaries

  Non-Guarantor
Subsidiaries

  Eliminating
Entries

  Consolidated
 
Operating revenues   $   173,040   54,556   (6,357 ) 221,239  
Operating expenses       98,621   37,033   (6,254 ) 129,400  
Amortization of service contract software       2,223   200     2,423  
   
 
 
 
 
 
  Gross profit       72,196   17,323   (103 ) 89,416  

Selling, general and administrative expenses

 

 

8,714

 

16,329

 

5,076

 

(6

)

30,113

 
Depreciation and amortization     174   14,975   3,723   (6 ) 18,866  
   
 
 
 
 
 
  Operating income (loss)     (8,888 ) 40,892   8,524   (91 ) 40,437  
Interest expense     22,591   405   657   (641 ) 23,012  
Other (income) expense     (290 ) (1,271 ) 761   571   (229 )
   
 
 
 
 
 
Income (loss) before equity in income of subsidiaries, and income taxes     (31,189 ) 41,758   7,106   (21 ) 17,654  
Equity in income of subsidiaries     46,750       (46,750 )  
Income tax expense     10,448   98   1,995     12,541  
   
 
 
 
 
 
Net income   $ 5,113   41,660   5,111   (46,771 ) 5,113  
   
 
 
 
 
 

SCIENTIFIC GAMES CORPORATION AND SUBSIDIARIES
SUPPLEMENTAL CONDENSED STATEMENT OF OPERATIONS
Six Months Ended June 30, 2003
(unaudited, in thousands)

 
  Parent
Company

  Guarantor
Subsidiaries

  Non-Guarantor
Subsidiaries

  Eliminating
Entries

  Consolidated
 
Operating revenues   $   194,654   60,226   (2,813 ) 252,067  
Operating expenses       104,889   40,322   (2,759 ) 142,452  
Amortization of service contract software       2,412   199     2,611  
   
 
 
 
 
 
  Gross profit       87,353   19,705   (54 ) 107,004  

Selling, general and administrative expenses

 

 

10,045

 

20,989

 

6,683

 

(6

)

37,711

 
Depreciation and amortization     365   14,978   4,285     19,628  
   
 
 
 
 
 
  Operating income (loss)     (10,410 ) 51,386   8,737   (48 ) 49,665  
Interest expense     12,108   332   2,148   (2,184 ) 12,404  
Other (income) expense     (102 ) (3,095 ) 998   2,167   (32 )
   
 
 
 
 
 
Income (loss) before equity in income of subsidiaries, and income taxes     (22,416 ) 54,149   5,591   (31 ) 37,293  
Equity in income of subsidiaries     58,034       (58,034 )  
Income tax expense     11,727   204   1,471     13,402  
   
 
 
 
 
 
Net income   $ 23,891   53,945   4,120   (58,065 ) 23,891  
   
 
 
 
 
 

18


SCIENTIFIC GAMES CORPORATION AND SUBSIDIARIES
SUPPLEMENTAL CONDENSED STATEMENT OF CASH FLOWS
Six Months Ended June 30, 2002
(unaudited, in thousands)

 
  Parent
Company

  Guarantor
Subsidiaries

  Non-Guarantor
Subsidiaries

  Eliminating
Entries

  Consolidated
 
Net income   $ 5,113   41,660   5,111   (46,771 ) 5,113  
  Depreciation and amortization     174   17,198   3,923   (6 ) 21,289  
  Equity in income of subsidiaries     (46,750 )     46,750    
  Changes in operating assets and liabilities     (685 ) (13,975 ) 514   (606 ) (14,752 )
  Other non-cash adjustments     11,451   (780 ) 100     10,771  
   
 
 
 
 
 
Net cash provided by (used in) operating activities     (30,697 ) 44,103   9,648   (633 ) 22,421  
   
 
 
 
 
 
Cash flows from investing activities:                        
  Capital and wagering systems expenditures     (6 ) (8,643 ) (4,950 ) 83   (13,516 )
  Business acquisition, net of cash acquired       (4,150 ) 46     (4,104 )
  Other assets and investments     (786 ) (1,069 ) 815   (3,332 ) (4,372 )
   
 
 
 
 
 
Net cash used in investing activities     (792 ) (13,862 ) (4,089 ) (3,249 ) (21,992 )
   
 
 
 
 
 
Cash flows from financing activities:                        
  Net repayments under lines of credit     (4,250 )       (4,250 )
  Payments on long-term debt     (4,136 ) (4 ) (261 )   (4,401 )
  Net proceeds from stock issue     1,273         1,273  
  Other, principally intercompany balances     31,654   (30,791 ) (4,745 ) 3,882    
   
 
 
 
 
 
Net cash provided by (used in) financing activities     24,541   (30,795 ) (5,006 ) 3,882   (7,378 )
   
 
 
 
 
 
Effect of exchange rate changes on cash       504   624     1,128  
   
 
 
 
 
 
Decrease in cash and cash equivalents     (6,948 ) (50 ) 1,177     (5,821 )
Cash and cash equivalents, beginning of period     7,612   (415 ) 5,452     12,649  
   
 
 
 
 
 
Cash and cash equivalents, end of period   $ 664   (465 ) 6,629     6,828  
   
 
 
 
 
 

19


SCIENTIFIC GAMES CORPORATION AND SUBSIDIARIES
SUPPLEMENTAL CONDENSED STATEMENT OF CASH FLOWS
Six Months Ended June 30, 2003
(unaudited, in thousands)

 
  Parent
Company

  Guarantor
Subsidiaries

  Non-Guarantor
Subsidiaries

  Eliminating
Entries

  Consolidated
 
Net income   $ 23,891   53,945   4,120   (58,065 ) 23,891  
  Depreciation and amortization     365   17,390   4,484     22,239  
  Equity in income of subsidiaries     (58,034 )     58,034    
  Changes in operating assets and liabilities     464   (9,318 ) 663   (405 ) (8,596 )
  Deferred Income taxes     10,721   (792 ) 166     10,095  
  Other non-cash adjustments     1,134   160   (20 )   1,274  
   
 
 
 
 
 
Net cash provided by (used in) operating activities     (21,459 ) 61,385   9,413   (436 ) 48,903  
   
 
 
 
 
 
Cash flows from investing activities:                        
  Capital and wagering systems expenditures     (60 ) (1,255 ) (8,984 )   (10,299 )
  Business acquisition, net of cash acquired       (20,744 ) (16 )   (20,760 )
  Other assets and investments     (1,367 ) (9,653 ) 1,530   9   (9,481 )
   
 
 
 
 
 
Net cash used in investing activities     (1,427 ) (31,652 ) (7,470 ) 9   (40,540 )
   
 
 
 
 
 
Cash flows from financing activities:                        
  Payments on long-term debt     (3,331 ) (204 ) (226 )   (3,761 )
  Proceeds from stock issue     1,157     50   (50 ) 1,157  
  Other, principally intercompany balances     30,602   (30,066 ) (1,013 ) 477    
   
 
 
 
 
 
Net cash provided by (used in) financing activities     28,428   (30,270 ) (1,189 ) 427   (2,604 )
   
 
 
 
 
 
Effect of exchange rate changes on cash     (67 ) (131 ) 632     434  
   
 
 
 
 
 
Increase (decrease) in cash and cash equivalents     5,475   (668 ) 1,386     6,193  
Cash and cash equivalents, beginning of period     25,323   180   9,426     34,929  
   
 
 
 
 
 
Cash and cash equivalents, end of period   $ 30,798   (488 ) 10,812     41,122  
   
 
 
 
 
 

20



SCIENTIFIC GAMES CORPORATION AND SUBSIDIARIES
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS FOR
THE THREE AND SIX MONTH PERIODS ENDED JUNE 30, 2003

Background

        The following discussion addresses our financial condition as of June 30, 2003 and the results of our operations for the three and six month periods ended June 30, 2003, compared to the same periods in the prior year. This discussion should be read in conjunction with Management's Discussion and Analysis of Financial Condition and Results of Operations for the fiscal year ended December 31, 2002, included in our 2002 Annual Report on Form 10-K, as amended.

        We operate in four business segments: Lottery Group, Pari-mutuel Group, Venue Management Group and Telecommunications Products Group.

        Our Lottery Group provides instant tickets and related services and lottery systems. Instant ticket and related services includes ticket design and manufacturing as well as value-added services, including game design, sales and marketing support, inventory management and warehousing and fulfillment services. In addition, this division includes promotional instant tickets and pull-tab tickets that we sell to both lottery and non-lottery customers. Our lottery systems business includes the supply of transaction processing software for the accounting and validation of both instant ticket and on-line lottery games, point-of-sale terminal hardware sales, central site computers and communication hardware sales, and ongoing support and maintenance services for these products. This product line also includes software and hardware and support services for sports betting and credit card processing systems.

        In January 2003, we significantly expanded our offerings of licensed branded lottery products and prize fulfillment and related services with the acquisition of MDI. MDI focuses on helping lotteries attract players to new kinds of tickets and second chance games that allow players to win merchandise, such as Harley Davidson motorcycles and trips and prizes such as tickets to NBA playoff games. Our portfolio of licensed brands now includes Mandalay Bay, NBA, Harley Davidson and Wheel of Fortune, plus many others. We expect that our acquisition of MDI will enable us to further expand the use of branded games and prize fulfillment services to continue to help our customers generate additional revenues.

        Our Pari-mutuel Group is comprised of our North American and international on-track, off-track and inter-track pari-mutuel services, simulcasting and communications services, and video gaming, as well as sales of pari-mutuel systems and equipment.

        Our Venue Management Group is comprised of our Connecticut off-track betting operations, and our Dutch on-track and off-track betting operations.

        Our Telecommunications Products Group is comprised of our prepaid cellular phone cards business.

        Our revenues are derived from two principal sources: service revenues and sales revenues. Service revenues are earned pursuant to multi-year contracts to provide instant tickets and related services and on-line lottery and pari-mutuel wagering systems and services, or are derived from wagering by customers at facilities we own or lease. Sales revenues are derived from sales of prepaid phone cards and from the sale of wagering and lottery systems, equipment, and software licenses.

        The first and fourth quarters of the calendar year traditionally comprise the weakest season for our pari-mutuel wagering business. As a result of inclement weather during the winter months, a number of racetracks do not operate and those that do operate often experience missed racing days. This adversely affects the amounts wagered and our corresponding service revenues. Wagering and lottery

21



equipment sales and software license revenues usually reflect a limited number of large transactions, which do not recur on an annual basis. Consequently, revenues and operating results can vary substantially from period to period as a result of the timing of revenue recognition for major equipment sales and software licensing transactions. In addition, instant ticket and prepaid phone card sales may vary depending on the season and timing of contract awards, changes in customer budgets, inventory ticket levels, lottery retail sales and general economic conditions. Operating results may also vary significantly from period to period depending on the addition or disposition of business units in each period.

Results of Operations: See Note 3—Business Segments

Three Months Ended June 30, 2003 compared to Three Months Ended June 30, 2002

Revenue Analysis

        For the three months ended June 30, 2003, revenues of $128.8 million improved $14.6 million or 13% overall as compared to the prior year quarter, reflecting a $13.4 million or 14% increase in service revenue and a $1.2 million or 7% increase in sales revenue.

        The increase in service revenue in the three months ended June 30, 2003 is primarily attributable to a $13.1 million or 22% increase in revenues in the Lottery Group as compared to the prior year quarter, of which $5.6 million is the increase in licensed branded lottery products and prize fulfillment and related services, primarily attributable to the addition of MDI beginning January 10, 2003, $3.7 million improvement in revenues related to the Company's cooperative services programs and European lottery operations, and a $3.6 million improvement in lottery ticket sales, primarily in the US and Latin America. Pari-mutuel Group service revenues were down slightly compared to the previous year primarily due to lower wagering caused by concerns over the war in Iraq, a slowing economy and a horsemen's strike in Chicago. Venue Management Group service revenues increased approximately $0.5 million or 3% compared to the prior year quarter due primarily to increased Handle (dollars wagered) in its raceview centers and more favorable exchange rates in The Netherlands.

        The $1.2 million increase in sales revenue in the three months ended June 30, 2003 is primarily attributable to the $2.4 million or 24% improvement in revenues in the Telecommunications Products Group as compared to the prior year quarter due primarily to increased sales volume and the impact of favorable exchange rates, partially offset by lower pari-mutuel and lottery systems and equipment sales.

Gross Profit Analysis

        Gross profit of $55.1 million for the three months ended June 30, 2003 increased $8.9 million or 19% as compared to the same period in 2002, reflecting an $8.6 million or 21% improvement on service revenues, and a $0.3 million or 6% improvement on sales revenues. Margin improvements related to service revenues were primarily attributable to the addition of MDI beginning January 10, 2003, increased revenues in our cooperative services programs and European lottery operations, and increased lottery ticket sales, primarily in the US and Latin America, as compared to the prior year quarter. An increase of $0.3 million or 3% in gross margin in the Pari-mutuel Group is primarily due to a new service contract customer in Poland and favorable euro exchange rates. Increased gross profit on sales were due to increased sales revenue in the Telecommunications Products Group, which contributed approximately $0.8 million or 23% in gross margin increase during the second quarter of 2003 as compared to the same period in 2002 primarily due to improved volumes and favorable exchange rates, partially offset by an unfavorable mix of systems and equipment sold.

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Expense Analysis

        Selling, general and administrative expenses of $19.4 million in the three months ended June 30, 2003 were $3.6 million or 23% higher than in the same period in 2002, primarily due to $1.5 million of selling, general and administrative expenses of the recently acquired SERCHI and MDI businesses, $1.8 million for increased sales and marketing costs, compensation, medical costs and professional service fees, and $0.3 million in costs associated with the commencement of the integration of our totalisator and lottery systems businesses.

        Depreciation and amortization expense, including amortization of service contract software, of $11.2 million in the three months ended June 30, 2003 increased $0.3 million or 3% from the same period in 2002, primarily due to the acquisition of MDI and increased amortization expense on intangibles as a result of reclassifications made pursuant to the final purchase price allocation of SERCHI.

        Interest expense of $6.2 million in the three months ended June 30, 2003 decreased $5.4 million from $11.6 million in the same period in 2002, primarily as a result of the debt reduction program begun in 2002. (See "Liquidity, Capital Resources and Working Capital.")

Income Tax Expense

        Income tax expense of $7.1 million in the three months ended June 30, 2003 increased $5.9 million from $1.2 million in the same period in 2002. Due to the recognition of the income tax asset from the net operating loss carryforward ("NOL") in the fourth quarter of 2002, the income tax provision for the three-month period ended June 30, 2003 is approximately 36% compared to a tax rate of approximately 13% in the same period in 2002. We estimate that our cash tax rate for fiscal 2003 will be approximately 18%.

Six Months Ended June 30, 2003 compared to Six Months Ended June 30, 2002

Revenue Analysis

        For the six months ended June 30, 2003, revenues of $252.1 million improved $30.8 million or 14% overall as compared to the prior year period, reflecting a $26.1 million or 14% increase in service revenue and a $4.7 million or 15% increase in sales revenue.

        The increase in service revenue in the six months ended June 30, 2003 is primarily attributable to a $26.0 million or 22% increase in revenues in the Lottery Group as compared to the prior year period, of which $9.8 million improvement is in licensed branded lottery products and prize fulfillment and related services, primarily attributable to the addition of MDI beginning January 10, 2003, $4.8 million improvement in revenues related to the Company's cooperative services programs and European lottery operations, and a $11.4 million improvement in lottery ticket sales, primarily in the US and Latin America. Pari-mutuel Group service revenues were approximately $1.0 million or 2% lower than the prior year period primarily due to lower Handle caused by severe winter weather conditions in the northeast, concerns over the war in Iraq, a slowing economy and a horsemen's strike in Chicago. Venue Management Group service revenues increased approximately $1.1 million or 4% compared to the prior year period due primarily to increased Handle in its raceview centers, increased commissions from the Mohegan Sun Casino, and more favorable exchange rates in The Netherlands.

        The $4.7 million increase in sales revenue in the six months ended June 30, 2003 is primarily attributable to higher levels of systems and equipment sales in the Lottery Group, coupled with a $1.5 million or 7% improvement in revenues in the Telecommunications Products Group as compared to the prior year period, due primarily to increased volume and the impact of favorable exchange rates in the European prepaid cellular phone card market.

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Gross Profit Analysis

        Gross profit of $107.0 million for the six months ended June 30, 2003 increased $17.6 million or 20% as compared to the same period in 2002, reflecting a $16.9 million or 22% improvement on service revenues, and a $0.7 million or 6% improvement on sales revenues. Margin improvements as compared to the prior year period related to service revenues were primarily attributable to improvement in revenues related to our cooperative services programs and European lottery operations, and improvement in lottery ticket sales, primarily in the US and Latin America, and the addition of MDI beginning January 10, 2003. A decrease of $0.2 million or 1% in gross margin was caused by lower Handle-related service revenues in the Pari-mutuel Group as explained above. Increased sales revenue contributed approximately $0.7 million or 6% in gross margin increase during the six-month period of 2003 as compared to the same period in 2002 primarily due to higher levels of lottery systems and equipment sales, coupled with a $0.2 million margin improvement in the Telecommunications Products Group as compared to the prior year period due primarily to increased volume.

Expense Analysis

        Selling, general and administrative expenses of $37.7 million in the six months ended June 30, 2003 were $7.6 million or 25% higher than in the same period in 2002, primarily due to the $2.9 million of selling, general and administrative expenses of the recently acquired SERCHI and MDI businesses, a $3.8 million increase in sales and marketing costs, compensation, medical costs and professional service fees, a $0.5 million favorable settlement of litigation in 2002, and $0.3 million in costs associated with the commencement of the integration of our totalisator and lottery systems businesses.

        Depreciation and amortization expense, including amortization of service contract software, of $22.2 million in the six months ended June 30, 2003 increased $1.0 million or 4% from the same period in 2002, primarily due to the acquisition of MDI, increased amortization expense on intangibles as a result of reclassifications made pursuant to the final purchase price allocation of SERCHI, and the amortization of deferred installation costs of new lottery contracts.

        Interest expense of $12.4 million in the six months ended June 30, 2003 decreased $10.6 million from $23.0 million in the same period in 2002, primarily as a result of the debt reduction program begun in 2002. (See "Liquidity, Capital Resources and Working Capital.")

Income Tax Expense

        Income tax expense of $13.4 million in the six months ended June 30, 2003 increased $0.9 million from $12.5 million in the same period in 2002. Due to the recognition of the income tax asset from the NOL in the fourth quarter of 2002, the income tax provision for the period ended June 30, 2003 is approximately 36% compared to a state and foreign tax rate of approximately 16% in the same period in 2002. In the first quarter of 2002, we also recorded a charge of $9.8 million relating to the adoption of SFAS 142, which caused us to reduce the recorded amount of our NOL from $18.5 million to $8.7 million to reflect the reduced amount of net taxable temporary differences that are expected to reverse during the NOL carryforward period because of the cessation of amortization of the tradename and employee workforce intangible assets. No current tax benefit was recognized on domestic operating losses as of June 30, 2002 in excess of the amount of net taxable temporary differences that are expected to reverse during the NOL carryforward period.

Critical Accounting Policies

        Our consolidated financial statements and accompanying notes are prepared in accordance with accounting principles generally accepted in the United States of America. Preparing consolidated financial statements requires us to make estimates and assumptions that affect the reported amounts of

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assets, liabilities, revenue, and expenses. These estimates and assumptions are affected by the application of our accounting policies. Our significant accounting policies are described in Note 2 to the Consolidated Financial Statements in our 2002 Annual Report on Form 10-K, as amended. Critical accounting policies are those that require application of management's most difficult, subjective, or complex judgments, often as a result of matters that are inherently uncertain and may change in subsequent periods. Critical accounting policies for us include revenue recognition on percentage of completion contracts related to lottery development projects and pari-mutuel systems software development projects, capitalization of software development costs, evaluation of the recoverability of assets, the assessment of litigation and contingencies, accounting for stock-based compensation, accounting for derivative instruments and hedging activities, and accounting for income and other taxes. Actual results could differ from estimates.

Liquidity, Capital Resources and Working Capital

        In 2002, we initiated a debt reduction program. In July 2002, we completed the public offering and sale of 14.4 million shares of our Class A Common Stock at a price of $7.25 per share (the "2002 Offering") and used the net proceeds of approximately $98.4 million (after deducting underwriting discounts, commissions and prior to deducting offering expenses) to redeem approximately $83.0 million of our 121/2% Senior Subordinated Notes ("Notes"). As a result of these transactions, our capital structure improved, and Standard & Poor's Ratings Group and Moody's Investors Service, Inc. upgraded our credit ratings to BB- and Ba3, respectively, where they remain today. In December 2002, we replaced our existing senior secured credit facility (the "2000 Facility"), with the 2002 Facility, which consists of a $50.0 million revolving credit facility due 2006 that can be increased to $70.0 million, and a $290.0 million Term B Loan due 2008. In May 2003, we repurchased an additional $1.5 million of our Notes. As a result of our debt reduction program, we expect interest expense in 2003 to total approximately $26.0 million, assuming debt levels and interest rates remain constant. Approximately 82% of our debt is in variable rate instruments. Consequently, we are exposed to fluctuations in interest rates. The effect of a 0.125% change in the interest rates associated with our unhedged variable rate debt will result in a change of approximately $0.4 million per year in our interest expense assuming no change in our outstanding borrowings.

        Our financing arrangements impose certain limitations on our and our subsidiaries' operations.

        The credit agreement governing the 2002 Facility (the "Credit Agreement") contains certain covenants that, among other things, limit our ability, and the ability of certain of our subsidiaries, to incur additional indebtedness, pay dividends or make distributions or certain other restricted payments, purchase or redeem capital stock, make investments or extend credit, engage in certain transactions with affiliates, engage in sale leaseback transactions, consummate certain asset sales, effect a consolidation or merger, or sell, transfer, lease or otherwise dispose of all or substantially all assets, and create certain liens and other encumbrances on new assets. Additionally, the Credit Agreement governing the 2002 Facility contains the following financial covenants at June 30, 2003 that are computed quarterly on a rolling four-quarter basis as applicable:

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        For purposes of the foregoing limitations, Consolidated EBITDA means the sum of (i) consolidated net income, (ii) consolidated interest expense with respect to all outstanding indebtedness, (iii) provisions for taxes based on income, (iv) total depreciation expense, (v) total amortization expense and (vi) certain adjustments, in each case for the period being measured, all of the foregoing as determined on a consolidated basis for us and our subsidiaries in accordance with GAAP. Although we were in compliance with our loan covenants at June 30, 2003 and expect to continue to remain in compliance over the next 12 months, no assurances can be provided that we will be able to do so or that we will be able to continue to meet the covenant requirements beyond 12 months.

        The 2002 Facility provides for borrowings up to $50.0 million to be used for working capital and general corporate purpose loans and for letters of credit. At June 30, 2003, we had outstanding letters of credit of $23.1 million, but no outstanding borrowings under the 2002 Facility, leaving us with a total availability of $26.9 million as compared to $28.2 million at December 31, 2002. Our ability to continue to borrow under the 2002 Facility will depend on remaining in compliance with the limitations imposed by our lenders, including maintenance of specified financial covenants. Presently, we have not sought and, therefore, do not have any other financing commitments.

        Our contractual obligations and commercial commitments principally include obligations associated with our outstanding indebtedness and future minimum operating lease obligations.

        Our Series A Convertible Preferred Stock requires dividend payments at a rate of 6% per annum. To date, we have satisfied the dividend requirement using additional shares of preferred stock. The terms of the convertible preferred stock provide us with the flexibility to satisfy the dividend in cash, subject to bank approval. We expect that we will continue to make such payments in-kind.

        Our pari-mutuel wagering and on-line lottery systems service contracts require us to, among other things, maintain the central computing system and related hardware in efficient working order, provide added software functionality upon request, provide on-site computer operators, and furnish necessary supplies. Our primary expenditures associated with these services are personnel and related costs, which are expensed as incurred and are included in Operating Expenses-Services in the consolidated statements of operations. Historically, the revenues we derive from our service contracts have exceeded the direct costs associated with fulfilling our obligations under these pari-mutuel wagering and lottery systems service contracts. We expect that we will continue to realize positive cash flow and operating

26



income as we extend or renew existing service contracts. We also expect that we will enter into new contracts that are accretive to our cash flow. In addition, through advancements in technology, we are continually deploying more efficient and cost effective methods for manufacturing and delivering our products and services to our customers. We expect that technological efficiencies will continue to positively impact our future cash flows and operating results. We are not party to any other material short term or long-term obligations or commitments pursuant to these service contracts.

        Periodically, we bid on new pari-mutuel and on-line lottery contracts. Once awarded, these contracts generally require significant up-front capital expenditures for terminal assembly, customization of software, software and equipment installation and telecommunications configuration. Historically we have funded these up front costs through cash flows generated from operations, available cash on hand and borrowings under our credit facilities. Our ability to continue to procure new contracts will depend on, among other things, our then present liquidity levels and/or our ability to obtain additional financing at commercially acceptable rates to finance the initial up front costs. Once operational, long term service contracts have been accretive to our operating cash flow. For fiscal 2003, we anticipate that capital expenditures and software expenditures will be approximately $35.0 million. However, the actual level of expenditures will ultimately depend on the extent to which we are successful in winning new contracts. The amount of capital expenditures in fiscal 2004 and beyond will largely depend on the extent to which we are successful in winning new contracts. Furthermore, our pari-mutuel wagering network consists of approximately 26,000 wagering terminals. Periodically, we elect to upgrade the technological capabilities of older terminals and replace terminals that have exhausted their useful lives. We presently have no commitments to replace our existing terminal base and our obligation to upgrade the terminals is discretionary. Servicing our installed terminal base requires that we maintain a supply of parts and accessories on hand. We are also required, contractually in some cases, to provide spare parts over an extended period of time, principally in connection with our systems and terminal sale transactions. To meet our contractual obligations and maintain sufficient levels of on-hand inventory quantities to service our installed base, we purchase inventory on an as needed basis. We presently have no inventory purchase obligations.

        At June 30, 2003, our available cash and borrowing capacity totaled $68.0 million compared to $63.1 million at December 31, 2002. Our available cash and borrowing capacities fluctuate principally based on the timing of collections from our customers, cash expenditures associated with new and existing pari-mutuel wagering and lottery systems contracts, repayment of our outstanding debt and changes in our working capital position. In the six months ended June 30, 2003, net cash provided by operating activities of $48.9 million exceeded cash used in investing activities of $40.5 million, including $20.7 million to fund the acquisition of MDI, and net cash used to repay long-term debt. The $48.9 million amount consisted of $57.5 million that was provided by operations and $8.6 million that was used for changes in working capital. The working capital changes occurred principally from increases in accounts receivable and inventory and decreases in accrued liabilities.

        We believe that our cash flow from operations, available cash and available borrowing capacity under our revolving credit facility will be sufficient to meet our liquidity needs, including anticipated capital expenditures, for the foreseeable future; however, we cannot assure you that this will be the case. While we are not aware of any particular trends, our contracts periodically renew and we cannot assure you that we will be successful in sustaining our cash flow from operations through renewal of our existing contracts or through the addition of new contracts. In addition, lottery customers in the United States generally require service providers to provide performance bonds in connection with each state contract. Our ability to obtain performance bonds on commercially reasonable terms is subject to prevailing market conditions, which may be impacted by economic and political events. Although we have not experienced any difficulty obtaining such bonds, we cannot assure you that we will continue to be able to obtain performance bonds on commercially reasonable terms or at all. While we are not aware of any reason to do so, if we need to refinance all or part of our indebtedness, including our

27



121/2% Senior Subordinated Notes, on or before maturity, or provide letters of credit or cash in lieu of performance bonds, we cannot assure you that we will be able to obtain new financing or to refinance any of our indebtedness, including our revolving credit facility and our 121/2% Senior Subordinated Notes, on commercially reasonable terms or at all.

Impact of Recently Issued Accounting Standards

        In May 2003, the Financial Accounting Standards Board (the "FASB") issued Statement No. 150, Accounting for Certain Financial Instruments with Characteristics of both Liabilities and Equity ("SFAS 150"). SFAS 150 requires that certain financial instruments which have characteristics of both liabilities and equity be classified as liabilities, or, in some circumstances, assets, if they fall within the scope of SFAS 150. We were required to adopt SFAS 150 for all financial instruments entered into or modified after May 31, 2003, and on July 1, 2003 for all other financial instruments. The adoption of SFAS 150 did not have a material impact on our consolidated operations or financial position, as we are now constituted.

        In April 2003, the FASB issued Statement No. 149, Amendment of Statement 133 on Derivative Instruments and Hedging Activities ("SFAS 149"). SFAS 149 requires that contracts with comparable characteristics be accounted for similarly, clarifies under what circumstances a contract meets the characteristics of a derivative, clarifies when a derivative contains a financing component and amends the definition of an underlying to conform it to language used in FASB Interpretation No. 45. We are required to adopt SFAS 149 for all contracts entered into or modified after June 30, 2003. We do not expect the adoption of SFAS 149 to have a material impact on our consolidated operations or financial position, as we are now constituted.

        In December 2002 the FASB issued Interpretation No. 46, Consolidation of Variable Interest Entities, which elaborates on Accounting Research Bulletin No. 51, Consolidated Financial Statements, to addresses consolidation by business enterprises of variable interest entities (previously often referred to as special purpose entities), which have one or both of the following characteristics:

        Interpretation No. 46 applies immediately to variable interest entities created after January 31, 2003, and to variable interest entities in which an enterprise obtains an interest after that date. It applies in the first fiscal year or interim period beginning after June 15, 2003, to variable interest entities in which an enterprise holds a variable interest that it acquired before February 1, 2003. We do not believe that this statement will have an impact on our financial statements.

        In November 2002, the FASB issued Interpretation No. 45, Guarantor's Accounting and Disclosure Requirements for Guarantees, Including Indirect Guarantees of Indebtedness of Others, which elaborates on the disclosures to be made by a guarantor in its interim and annual financial statements about its obligations under certain guarantees it has issued, and clarifies that a liability is to be recognized at the

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inception of a guarantee for the fair value of the obligation undertaken in issuing the guarantee. We complied with the disclosure requirements of Interpretation No. 45 in our December 31, 2002 financial statements and have adopted the initial recognition and initial measurement provisions, which are applicable on a prospective basis to guarantees issued or modified after December 31, 2002. We do not believe that Interpretation No. 45 will have an impact on our financial statements.

        In April 2002, the FASB issued Statement No. 145, Rescission of FASB Statements No. 4, 44 and 64, Amendment of FASB Statement No. 13, and Technical Corrections ("SFAS 145"). SFAS 145 updates, clarifies and simplifies existing accounting pronouncements. Among other changes, SFAS 145 rescinds Statement No. 4, which required all gains and losses from extinguishment of debt to be aggregated and, if material, classified as an extraordinary item, net of related income tax effect. As a result, the criteria in Accounting Principles Board Opinion No. 30 will now be used to classify those gains and losses because Statement No. 4 has been rescinded. We were required to adopt SFAS 145, effective January 1, 2003. Pursuant to SFAS 145, we will be required to reclassify the extraordinary losses we incurred in 2002 to other income/deductions in future reports.

        On March 12, 2003, the FASB added to its agenda two projects that will seek to improve the accounting and disclosures relating to stock-based compensation and pension costs. Among other issues, the project on stock-based compensation will address whether to require that the cost of employee stock options be treated as an expense. The FASB plans to start deliberating the key issues on this subject at future public meetings with a view to issuing an Exposure Draft later this year that could become effective in 2004. Separately, the FASB decided to add a project to its agenda that would seek to improve disclosures relating to employer pension plans. As part of this project, the FASB will address perceived deficiencies in current pension accounting by identifying ways to enhance disclosures about pension costs, plan assets, obligations and funding requirements. Until final standards are issued, we will not be able to quantify the impact, if any, that these two projects will have on our future consolidated operations or financial position.

Recent Developments

        On July 24, 2003, we announced that we expected to revise our previously filed financial statements for the fiscal year ended October 31, 2000 and subsequent periods through December 31, 2002. On August 14, 2003, we amended our Annual Report on Form 10-K for the year ended December 31, 2002 and our Quarterly Reports on Form 10-Q for each of the quarterly periods in fiscal 2002 and the quarter ended March 31, 2003. These restatements arose because it was determined that a portion of the deferred tax asset, in the form of a net operating loss carryforward, recognized in the fourth quarter of 2002, should have been recognized at the time of the Company's acquisition of Scientific Games Holdings Corp. on September 6, 2000 as a reduction to the goodwill resulting from that acquisition. These restatements are non-cash adjustments that have no effect on our previously reported revenues or EBITDA (earnings before interest, taxes, depreciation and amortization), nor do they have any effect on revenues, EBITDA or net income for fiscal 2003 and future years.

        On June 4, 2003, we announced that our Austrian subsidiary, Scientific Games International GmbH ("Scientific Games Austria"), signed a contract with SWISSLOS to deliver an on-line gaming system that will operate the Swiss version of the popular ODDSET sports betting products. Langen, the first Oddset game, is scheduled to launch in October 2003. Software for the existing terminals will be provided by the incumbent terminal vendor, Wincor Nixdorf, which will provide its products as a subcontractor to Scientific Games Austria.


QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

        Our products and services are sold to a diverse group of customers throughout the world. As such, we are subject to certain risks and uncertainties as a result of changes in general economic conditions,

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sources of supply, competition, foreign exchange rates, tax reform, litigation and regulatory developments. The diversity and breadth of our products and geographic operations mitigate the risk that adverse changes from any single event would materially affect our financial position. Additionally, as a result of the diversity of our customer base, we do not consider ourselves exposed to concentration of credit risks. These risks are further minimized by setting credit limits, ongoing monitoring of customer account balances, and assessment of the customers' financial strengths.

        Inflation has not had an abnormal or unanticipated effect on our operations. Inflationary pressures would be significant to our business if raw materials used for instant lottery ticket production, prepaid phone card production or terminal manufacturing are significantly affected. Available supply from the paper and electronics industries tends to fluctuate and prices may be affected by supply.

        For fiscal 2002, inflation was not a significant factor in our results of operations, and we were not impacted by significant pricing changes in our costs, except for personnel related expenditures. We are unable to forecast the prices or supply of substrate, component parts or other raw materials in 2003, but we currently do not anticipate any substantial changes that will materially affect our operating results.

        In certain limited cases, our lottery contracts with our customers contain provisions to adjust for inflation on an annual basis, but we cannot be assured that this adjustment would cover raw material price increases or other costs of services. While we have long-term and generally satisfactory relationships with most of our suppliers, we also believe alternative sources to meet our raw material and production needs are available.

        In the normal course of business, we are exposed to fluctuations in interest rates and equity market risks as we seek debt and equity capital to sustain our operations. At June 30, 2003 approximately 18% of our debt was in fixed rate instruments. We consider the fair value of all financial instruments to be not materially different from their carrying value at year-end. The following table provides information about our financial instruments that are sensitive to changes in interest rates. The table presents principal cash flows and related weighted-average interest rates by expected maturity dates. (See "Liquidity, Capital Resources and Working Capital.")

Principal Amount by Expected Maturity—Average Interest Rate
June 30, 2003

 
  2003
  2004
  2005
  2006
  2007
  Thereafter
  Total
  Fair value
 
  (dollars in thousands)

Long-term debt:                                  
  Fixed interest rate   $           65,584   65,584   78,701
  Interest rate               12.5 % 12.5 %  
  Variable interest rate   $ 2,050   3,564   3,324   3,312   3,249   276,172   291,671   290,647
  Average interest rate     4.99 % 4.75 % 4.62 % 4.63 % 4.62 % 4.62 % 4.59 %  

        Since 2002, we have been party to derivative contracts to hedge part of our foreign currency exposure with respect to future cash receipts under our contract with the Ontario Lottery Commission. These instruments, which have a notional value of 59.7 million Canadian dollars at June 30, 2003, have been designated as cash flow hedges. For the three month and six month periods ended June 30, 2003, we recorded debits to other comprehensive income (loss) of $3.8 million and $6.3 million, respectively, for the change in the fair value of these foreign exchange instruments, bringing the cumulative total to a debit balance of $6.0 million.

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        The following table provides notional amounts and exchange rate information about our Canadian currency hedge derivative financial instruments. We do not hold any market risk instruments for trading purposes.

Notional Amount by Expected Maturity—Canadian Currency Hedge
June 30, 2003

 
  Notional Amount
   
 
 
  Fair
value

 
 
  2003
  2004
  2005
  2006
  2007
  Thereafter
  Total
 
 
  (dollars in thousands)

 
Canadian currency hedge:                                    
U.S. $ amount   $ 35,188   2,725           37,913   (5,992 )
Exchange rate     1.57   1.59           1.57    

        We are also exposed to fluctuations in foreign currency exchange rates as the financial results of our foreign subsidiaries are translated into U.S. dollars in consolidation. Assets and liabilities outside the United States are primarily located in the United Kingdom, Germany, The Netherlands, France, Austria, Chile and Peru. Our investment in foreign subsidiaries with a functional currency other than the U.S. dollar are generally considered long-term investments. Accordingly, we do not hedge these net investments. Translation gains and losses historically have not been material. We manage our foreign currency exchange risks on a global basis by one or more of the following: (i) securing payment from our customers in U.S. dollars, when possible; (ii) utilizing borrowings denominated in foreign currency; and (iii) entering into foreign currency exchange contracts. In addition, a significant portion of the cost attributable to our foreign operations is incurred in the local currencies. We believe that a 10% adverse change in currency exchange rates would not have a significant adverse effect on our net earnings or cash flows. We may, from time to time, enter into foreign currency exchange or other contracts to hedge the risk associated with certain firm sales commitments, anticipated revenue streams and certain assets and liabilities denominated in foreign currencies.

        Our cash and cash equivalents and investments are in high-quality securities placed with a wide array of financial institutions with high credit ratings. This investment policy limits our exposure to concentration of credit risks.

Forward-Looking Statements

        Throughout this Quarterly Report on Form 10-Q we make "forward-looking statements" within the meaning of the United States Private Securities Litigation Reform Act of 1995. In some cases, forward-looking statements can be identified by the use of forward-looking terminology such as "may," "will," "estimate," "intend," "continue," "believe," "expect" or "anticipate," or the negatives thereof, variations thereon or similar terminology. The forward-looking statements contained in this Quarterly Report on Form 10-Q are generally located in the material set forth under the heading "Management's Discussion and Analysis of Financial Condition and Results of Operations" but may be found in other locations as well. These forward-looking statements generally relate to plans and objectives for future operations and are based upon management's reasonable estimates of future results or trends. Although we believe that the plans and objectives reflected in or suggested by such forward-looking statements are reasonable, such plans or objectives may not be achieved.

        Actual results may differ from projected results due, but not limited, to unforeseen developments, including developments relating to the following:

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        Actual future results may be materially different from what we expect. We will not update forward-looking statements even though our situation may change in the future.


CONTROLS AND PROCEDURES

        We maintain "disclosure controls and procedures," as such term is defined under Rules 13a-15(e) and 15d-15(e) under the Securities Exchange Act of 1934, as amended (the "Exchange Act"), that are designed to ensure that information required to be disclosed in our reports filed or submitted under the Exchange Act is recorded, processed, summarized and reported within the time periods specified in the Securities and Exchange Commission's rules and forms and that such information is accumulated and communicated to our management, including our Chief Executive Officer and Chief Financial Officer, as appropriate, to allow timely decisions regarding required disclosure.

        As of the end of the period covered by this quarterly report, we conducted an evaluation of the effectiveness of the design and operation of our disclosure controls and procedures, as required by Rule 13a-15 under the Exchange Act. This evaluation was carried out under the supervision and with the participation of our management, including our Chief Executive Officer and Chief Financial Officer. Based upon that evaluation, our Chief Executive Officer and Chief Financial Officer concluded that our disclosure controls and procedures were effective. There has been no change in our internal control over financial reporting that has occurred during our last fiscal quarter that has materially affected, or is reasonably likely to materially affect, our internal control over financial reporting.

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SCIENTIFIC GAMES CORPORATION AND SUBSIDIARIES
Three Months Ended June 30, 2003

PART II. OTHER INFORMATION

Item 1. Legal Proceedings

        No significant changes have occurred with respect to legal proceedings as disclosed in our Annual Report on Form 10-K/A for the year ended December 31, 2002.


Item 4. Submission of Matters to a Vote of Security Holders

        The Annual Meeting of our Stockholders was held on June 23, 2003 to elect nine directors, to ratify the appointment of Deloitte & Touche LLP as independent accountants for the fiscal year ending December 31, 2003 and to approve the adoption of our 2003 Incentive Compensation Plan. The holders of our Class A Common Stock and our Series A Convertible Preferred Stock at the close of business on May 16, 2003, the record date for the Annual Meeting, voted together as a single class with respect to all matters other than the election of the four directors designated by the holders of the Preferred Stock, Messrs. Antonio Belloni, Rosario Bifulco, Peter A. Cohen and Michael S. Immordino. The holders of our convertible preferred stock voted as a separate class with respect to the election of such directors. The holders of 52,954,571 shares of our Class A Common Stock and 1,197,052 shares of our Series A Convertible Preferred Stock, representing a total of 76,426,178 votes of such Common Stock and Preferred Stock on an "as-converted" basis, were present in person or represented by proxy at the Annual Meeting. All matters put before the stockholders were approved as follows:

 
   
  For
  Withheld
  Against
  Abstain
  Broker
Non-Votes

Proposal 1   Election of Directors                    
    A. Lorne Weil   69,797,898   6,628,280      
    Colin J. O'Brien   75,393,482   1,032,696      
    Eric M. Turner   76,096,260   329,918      
    Sir Brian G. Wolfson   70,391,373   6,034,805      
    Alan J. Zakon   75,567,591   858,587      
    Antonio Belloni   1,197,052        
    Rosario Bifulco   1,197,052        
    Peter A. Cohen   1,197,052        
    Michael S. Immordino   1,197,052        

Proposal 2

 

Ratification of Appointment of Deloitte & Touche LLP as independent accountants for the fiscal year ending December 31, 2003

 

76,055,320

 


 

338,984

 

31,874

 


Proposal 3

 

Approval of the Company's 2003 Incentive Compensation Plan

 

52,875,706

 


 

5,680,716

 

483,564

 

17,386,192

33



Item 6. Exhibits and Reports on Form 8-K

34


SCIENTIFIC GAMES CORPORATION AND SUBSIDIARIES
Three Months and Six Months Ended June 30, 2003

SIGNATURES

        Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.

    SCIENTIFIC GAMES CORPORATION
(Registrant)

 

 

By:

 

/s/  
DEWAYNE E. LAIRD      
    Name:   DeWayne E. Laird
    Title:   Vice President and Chief Financial Officer
(principal financial and accounting officer)

Dated: August 14, 2003

35



SCIENTIFIC GAMES CORPORATION AND SUBSIDIARIES
Three Months and Six Months Ended June 30, 2003

INDEX TO EXHIBITS

(a) Exhibit
      Number

  Description
31.1   Certification of the Chief Executive Officer of the Company pursuant to Rule 13a-14(a) under the Securities Exchange Act of 1934.

31.2

 

Certification of the Chief Financial Officer of the Company pursuant to Rule 13a-14(a) under the Securities Exchange Act of 1934.

32.1

 

Certification of the Chief Executive Officer of the Company pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.

32.2

 

Certification of the Chief Financial Officer of the Company pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.

36




QuickLinks

SCIENTIFIC GAMES CORPORATION AND SUBSIDIARIES CONSOLIDATED BALANCE SHEETS (Unaudited, in thousands, except per share amounts)
SCIENTIFIC GAMES CORPORATION AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF OPERATIONS Three Months Ended June 30, 2002 and 2003 (Unaudited, in thousands, except per share amounts)
SCIENTIFIC GAMES CORPORATION AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF OPERATIONS Six Months Ended June 30, 2002 and 2003 (Unaudited, in thousands, except per share amounts)
SCIENTIFIC GAMES CORPORATION AND SUBSIDIARIES CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS Six Months Ended June 30, 2002 and 2003 (Unaudited, in thousands)
SCIENTIFIC GAMES CORPORATION AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited, in thousands, except per share amounts)
SCIENTIFIC GAMES CORPORATION AND SUBSIDIARIES MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS FOR THE THREE AND SIX MONTH PERIODS ENDED JUNE 30, 2003
QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
CONTROLS AND PROCEDURES
SIGNATURES