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 September 30, 2004

 

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

 

81-0422894

(State or other jurisdiction of
incorporation or organization)

 

(I.R.S. 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 November 4, 2004:

 

Class A Common Stock: 88,084,307

Class B Common Stock: None

 

 

 



 

 

SCIENTIFIC GAMES CORPORATION AND SUBSIDIARIES

INDEX TO CONSOLIDATED FINANCIAL STATEMENTS

 AND OTHER INFORMATION

 

THREE MONTHS ENDED SEPTEMBER 30, 2004

 

 

 

 

 

PART I.

FINANCIAL INFORMATION

 

 

 

 

 

 

Item 1.

Consolidated Financial Statements:

 

 

 

 

 

 

 

Balance Sheets as of December 31, 2003 and September 30, 2004

 

 

 

 

 

 

 

Statements of Income for the Three Months Ended September 30, 2003 and 2004

 

 

 

 

 

 

 

Statements of Income for the Nine Months Ended September 30, 2003 and 2004

 

 

 

 

 

 

 

Condensed Statements of Cash Flows for the Nine Months Ended September 30, 2003 and 2004

 

 

 

 

 

 

 

Notes to Consolidated Financial Statements

 

 

 

 

 

 

Item 2.

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

 

 

 

 

 

 

Item 3.

Quantitative and Qualitative Disclosures About Market Risk

 

 

 

 

 

 

Item 4.

Controls and Procedures

 

 

 

 

 

 

PART II.

OTHER INFORMATION

 

 

 

 

 

 

Item 1.

Legal Proceedings

 

 

Item 2.

Unregistered Sales of Equity Securities, Use of Proceeds and Issuer Purchases of Equity Securities

 

 

Item 4.

Submission of Matters to a Vote of Security Holders

 

 

Item 6.

Exhibits

 

 

 

 

 

2



 

 

SCIENTIFIC GAMES CORPORATION AND SUBSIDIARIES

CONSOLIDATED BALANCE SHEETS

(Unaudited, in thousands, except per share amounts)

 

 

 

 

 

December 31,
2003

 

September 30,
2004

 

ASSETS

 

 

 

 

 

Current assets:

 

 

 

 

 

Cash and cash equivalents

 

$

79,373

 

96,629

 

Accounts receivable, net of allowance for doubtful accounts of $4,589 and $3,767 at December 31, 2003 and September 30, 2004, respectively

 

99,639

 

100,534

 

Inventories

 

26,896

 

32,391

 

Prepaid expenses, deposits and other current assets

 

31,457

 

31,135

 

Total current assets

 

237,365

 

260,689

 

Property and equipment, at cost

 

473,610

 

509,128

 

Less accumulated depreciation

 

244,880

 

264,896

 

Net property and equipment

 

228,730

 

244,232

 

Goodwill, net

 

308,355

 

303,786

 

Operating right, net

 

14,020

 

14,020

 

Other intangible assets, net

 

77,428

 

72,773

 

Other assets and investments

 

97,091

 

103,591

 

Total assets

 

$

962,989

 

999,091

 

LIABILITIES AND STOCKHOLDERS’ EQUITY

 

 

 

 

 

Current liabilities:

 

 

 

 

 

Current installments of long-term debt

 

$

6,327

 

7,010

 

Accounts payable

 

34,603

 

29,125

 

Accrued liabilities

 

117,493

 

93,325

 

Total current liabilities

 

158,423

 

129,460

 

Deferred income taxes

 

4,595

 

3,993

 

Other long-term liabilities

 

36,983

 

38,698

 

Long-term debt, excluding current installments

 

525,836

 

523,621

 

Total liabilities

 

725,837

 

695,772

 

Commitments and contingencies

 

 

 

Stockholders’ equity:

 

 

 

 

 

Series A convertible preferred stock, par value $1.00 per share, 1,600 shares authorized, 1,325 shares outstanding at December 31, 2003 and none outstanding at September 30, 2004

 

1,325

 

 

Series B preferred stock, par value $1.00 per share, 2 shares authorized, 1.238 shares outstanding at December 31, 2003 and none outstanding at September 30, 2004

 

1

 

 

Class A common stock, par value $0.01 per share, 199,300 shares authorized, 61,504 and 87,709 shares outstanding at December 31, 2003 and September 30, 2004, respectively

 

615

 

877

 

Class B non-voting common stock, par value $0.01 per share, 700 shares authorized, none outstanding

 

 

 

Additional paid-in capital

 

405,957

 

415,901

 

Accumulated losses

 

(169,649

)

(112,980

)

Treasury stock, at cost

 

(6,743

)

(9,262

)

Accumulated other comprehensive income

 

5,646

 

8,783

 

Total stockholders’ equity

 

237,152

 

303,319

 

Total liabilities and stockholders’ equity

 

$

962,989

 

999,091

 

 

See accompanying notes to consolidated financial statements.

 

 

3



 

 

SCIENTIFIC GAMES CORPORATION AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF INCOME

Three Months Ended September 30, 2003 and 2004

 (Unaudited, in thousands, except per share amounts)

 

 

 

2003

 

2004

 

Operating revenues:

 

 

 

 

 

Services

 

$

110,350

 

152,636

 

Sales

 

21,713

 

26,673

 

 

 

132,063

 

179,309

 

Operating expenses (exclusive of depreciation and amortization shown below):

 

 

 

 

 

Services

 

60,174

 

84,039

 

Sales

 

15,229

 

18,450

 

Amortization of service contract software

 

1,325

 

553

 

 

 

76,728

 

103,042

 

Total gross profit

 

55,335

 

76,267

 

Selling, general and administrative expenses

 

18,741

 

23,273

 

Depreciation and amortization

 

9,866

 

14,528

 

Operating income

 

26,728

 

38,466

 

Other deductions (income):

 

 

 

 

 

Interest expense

 

6,171

 

7,692

 

Other income

 

(199

)

(313

)

 

 

5,972

 

7,379

 

Income before income tax expense

 

20,756

 

31,087

 

Income tax expense

 

7,519

 

9,626

 

Net income

 

13,237

 

21,461

 

Convertible preferred stock dividend

 

1,942

 

757

 

Net income available to common stockholders

 

$

11,295

 

20,704

 

Basic and diluted net income per share (See Note 1):

 

 

 

 

 

Basic net income available to common stockholders

 

$

0.19

 

0.26

 

Diluted net income available to common stockholders

 

$

0.15

 

0.24

 

Weighted average number of shares used in per share calculations:

 

 

 

 

 

Basic shares

 

60,123

 

78,661

 

Diluted shares

 

89,196

 

90,777

 

 

See accompanying notes to consolidated financial statements.

 

 

4



 

 

SCIENTIFIC GAMES CORPORATION AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF INCOME

Nine Months Ended September 30, 2003 and 2004

 (Unaudited, in thousands, except per share amounts)

 

 

 

2003

 

2004

 

Operating revenues:

 

 

 

 

 

Services

 

$

325,747

 

441,839

 

Sales

 

58,383

 

101,047

 

 

 

384,130

 

542,886

 

Operating expenses (exclusive of depreciation and amortization shown below):

 

 

 

 

 

Services

 

177,688

 

237,568

 

Sales

 

40,167

 

69,861

 

Amortization of service contract software

 

3,936

 

3,584

 

 

 

221,791

 

311,013

 

Total gross profit

 

162,339

 

231,873

 

Selling, general and administrative expenses

 

56,452

 

77,620

 

Depreciation and amortization

 

29,494

 

42,094

 

Operating income

 

76,393

 

112,159

 

Other deductions (income):

 

 

 

 

 

Interest expense

 

18,575

 

22,889

 

Other income

 

(231

)

(89

)

 

 

18,344

 

22,800

 

Income before income tax expense

 

58,049

 

89,359

 

Income tax expense

 

20,921

 

27,969

 

Net income

 

37,128

 

61,390

 

Convertible preferred stock dividend

 

5,684

 

4,721

 

Net income available to common stockholders

 

$

31,444

 

56,669

 

Basic and diluted net income per share (See Note 1):

 

 

 

 

 

Basic net income available to common stockholders

 

$

0.53

 

0.83

 

Diluted net income available to common stockholders

 

$

0.43

 

0.68

 

Weighted average number of shares used in per share calculations:

 

 

 

 

 

Basic shares

 

59,758

 

67,958

 

Diluted shares

 

87,157

 

90,511

 

 

See accompanying notes to consolidated financial statements.

 

 

5



 

 

SCIENTIFIC GAMES CORPORATION AND SUBSIDIARIES

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

Nine Months Ended September 30, 2003 and 2004

(Unaudited, in thousands)

 

 

 

2003

 

2004

 

Cash flows from operating activities:

 

 

 

 

 

Net income

 

$

37,128

 

61,390

 

Adjustments to reconcile net income to cash provided by operating activities:

 

 

 

 

 

Depreciation and amortization

 

33,430

 

45,678

 

Change in deferred income taxes

 

16,193

 

5,443

 

Non-cash interest expense

 

1,115

 

1,576

 

Changes in operating assets and liabilities, net of effects of business acquisitions

 

(21,829

)

(31,568

)

Other

 

724

 

128

 

Total adjustments

 

29,633

 

21,257

 

Net cash provided by operating activities

 

66,761

 

82,647

 

Cash flows from investing activities:

 

 

 

 

 

Capital expenditures

 

(8,726

)

(17,056

)

Wagering systems expenditures

 

(13,855

)

(34,963

)

Business acquisition, net of cash acquired

 

(20,760

)

(1,709

)

Increase in other assets and liabilities, net

 

(18,086

)

(12,929

)

Net cash used in investing activities

 

(61,427

)

(66,657

)

Cash flows from financing activities:

 

 

 

 

 

Net payments on long-term debt

 

(4,747

)

(1,529

)

Proceeds from the issuance of common stock

 

1,761

 

6,226

 

Preferred stock cash dividends

 

 

(4,721

)

Net cash used in financing activities

 

(2,986

)

(24

)

Effect of exchange rate changes on cash and cash equivalents

 

348

 

1,290

 

Increase in cash and cash equivalents

 

2,696

 

17,256

 

Cash and cash equivalents, beginning of period

 

34,929

 

79,373

 

Cash and cash equivalents, end of period

 

$

37,625

 

96,629

 

Supplemental disclosure of cash flow information:

 

 

 

 

 

Cash paid during the period for:

 

 

 

 

 

Interest

 

$

19,581

 

24,400

 

Income taxes, net of refunds

 

$

4,077

 

20,193

 

Non-cash financing activity during the period:

 

 

 

 

 

Convertible preferred stock paid-in-kind dividends

 

$

5,684

 

 

Financing activities in connection with the early extinguishment of debt:

 

 

 

 

 

Write-off of deferred financing fees

 

$

56

 

 

Cash payment of call premiums and related fees

 

$

237

 

 

 

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)

 

Notes to Consolidated Financial Statements

 

(1)            Consolidated Financial Statements

 

Basis of Presentation

 

         The consolidated balance sheet as of September 30, 2004, the consolidated statements of income for the three and nine months ended September 30, 2003 and 2004, and the consolidated condensed statements of cash flows for the nine 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 September 30, 2004 and the results of its operations for the three and nine months ended September 30, 2003 and 2004 and its cash flows for the nine months ended September 30, 2003 and 2004 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 2003 Annual Report on Form 10-K.  The results of operations for the periods ended September 30, 2004 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 per share available to common stockholders for the three and nine months ended September 30, 2003 and 2004:

 

 

 

Three Months Ended
September 30,

 

Nine Months Ended
September 30,

 

 

 

2003

 

2004

 

2003

 

2004

 

Income (numerator)

 

 

 

 

 

 

 

 

 

Net income available to common stockholders (basic)

 

$

11,295

 

20,704

 

31,444

 

56,669

 

Add back preferred stock dividend

 

1,942

 

757

 

5,684

 

4,721

 

Income before preferred dividend available to common stockholders (diluted)

 

$

13,237

 

21,461

 

37,128

 

61,390

 

Shares (denominator)

 

 

 

 

 

 

 

 

 

Basic weighted average common shares outstanding

 

60,123

 

78,661

 

59,758

 

67,958

 

Effect of dilutive securities-stock options, warrants, convertible preferred shares and deferred shares

 

29,073

 

12,116

 

27,399

 

22,553

 

Diluted weighted average common shares outstanding

 

89,196

 

90,777

 

87,157

 

90,511

 

Basic and diluted per share amounts

 

 

 

 

 

 

 

 

 

Basic net income per share available to common stockholders

 

$

0.19

 

0.26

 

0.53

 

0.83

 

Diluted net income per share available to common stockholders

 

$

0.15

 

0.24

 

0.43

 

0.68

 

 

 

7



 

         During the periods presented, the Company had outstanding shares of Series A Convertible Preferred Stock, Series B Preferred Stock and warrants to purchase shares of Class A Common Stock which were converted or exercised during the quarter ended September 30, 2004. The holders of such securities received an aggregate 24,035 shares of Class A Common Stock upon conversion or exercise of the securities. Such shares have been previously reflected in our reported diluted net income per share and similar information. At September 30, 2004 the Company has outstanding stock options and deferred shares known as Performance Accelerated Restricted Stock which could potentially dilute basic earnings per share in the future. (See Notes 12 and 13 to the Consolidated Financial Statements for the year ended December 31, 2003 in the Company’s 2003 Annual Report on Form 10-K.)

 

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
September 30,

 

Nine Months Ended
September 30,

 

 

 

2003

 

2004

 

2003

 

2004

 

Net income available to common stockholders as reported

 

$

11,295

 

20,704

 

31,444

 

56,669

 

Add back preferred stock dividend

 

1,942

 

757

 

5,684

 

4,721

 

Add: Stock-based compensation expense included in reported net income, net of related tax effects

 

 

46

 

 

140

 

Deduct: Total stock-based employee compensation expense determined under fair value based method for all awards, net of related tax effects

 

(906

)

(1,287

)

(2,832

)

(3,981

)

Pro forma net income available to common stockholders

 

$

12,331

 

20,220

 

34,296

 

57,549

 

Net income available to common stockholders per basic share:

 

 

 

 

 

 

 

 

 

As reported

 

$

0.19

 

0.26

 

0.53

 

0.83

 

Pro forma

 

$

0.17

 

0.25

 

0.48

 

0.79

 

Net income available to common stockholders per diluted share:

 

 

 

 

 

 

 

 

 

As reported

 

$

0.15

 

0.24

 

0.43

 

0.68

 

Pro forma

 

$

0.14

 

0.23

 

0.40

 

0.65

 

 

 

8



 

 

(2)            Acquisitions

 

On November 6, 2003, the Company acquired IGT OnLine Entertainment Systems, Inc. from International Game Technology for $143,000 in cash plus expenses and a $10,244 working capital adjustment payment.  Upon consummation of the acquisition, the Company changed the name of IGT OnLine Entertainment Systems, Inc. to Scientific Games Online Entertainment Systems, Inc (“OES”).  The results of OES have been included in the Company’s results of operations from the date of acquisition.  OES had annual revenues of approximately $148,818 during its most recent fiscal year ended September 27, 2003 which were reported in the Company’s Form 8-K filed on February 2, 2004.

 

The acquisition of OES strengthens the Company’s presence in the lottery industry, expands the Company’s geographic presence, broadens its lottery product offerings and accelerates its entrance into the video lottery systems business.  As a result of the acquisition, the Company has contracts to operate online lottery systems in 16 states and supports systems that OES delivered to customers in Korea, Norway, Switzerland and Shanghai. The acquisition also included OES’s Advanced Gaming System (AGS) video system contracts in six jurisdictions throughout the world, certain intellectual property and an exclusive license to specific IGT slot brands for both instant and online games.  The acquired assets and liabilities were recorded at their preliminarily estimated fair value at the date of acquisition. The excess of the purchase price over the fair values of the net assets acquired was preliminarily estimated at $96,473, subject to finalization. Goodwill from the OES acquisition will be deductible for tax purposes.

 

The following table presents unaudited pro forma results of operations for the three and nine months ended September 30, 2003 as if the acquisition of OES had occurred at the beginning of the periods presented, rather than on the acquisition date of November 6, 2003.  These pro forma results have been prepared for comparative purposes and do not purport to be indicative of what would have occurred had the acquisition been consummated on January 1, 2003, or the results that may occur in the future.

 

 

 

Three Months Ended
September 30, 2003

 

Nine Months Ended
September 30, 2003

 

 

 

(unaudited)

 

(unaudited)

 

Operating revenues

 

$

169,382

 

495,760

 

Operating income

 

37,108

 

98,437

 

Income before income tax expense

 

29,748

 

74,813

 

Net income

 

19,103

 

47,773

 

Convertible preferred stock dividend

 

1,942

 

5,684

 

Net income available to common stockholders

 

$

17,161

 

42,089

 

Basic net income per share available to common stockholders

 

$

0.29

 

0.70

 

Diluted net income per share available to common stockholders

 

$

0.21

 

0.55

 

 

 

 

9



 

 

(3)            Business Segments

 

         The following tables represent revenues, profits, depreciation, amortization, and capital expenditures for the three and nine months ended September 30, 2003 and 2004, by business segment.  Corporate expenses, interest expense and other (income) deductions are not allocated to business segments.

 

 

 

Three Months Ended September 30, 2003

 

 

 

Lottery
Group

 

Pari-Mutuel
Group

 

Venue
Management
Group

 

Telecom-
munications
Products
Group

 

Totals

 

Service revenues

 

$

72,578

 

21,340

 

16,432

 

 

110,350

 

Sales revenues

 

8,506

 

1,465

 

 

11,742

 

21,713

 

Total revenues

 

81,084

 

22,805

 

16,432

 

11,742

 

132,063

 

Cost of service

 

36,647

 

11,728

 

11,799

 

 

60,174

 

Cost of sales

 

6,413

 

766

 

 

8,050

 

15,229

 

Amortization of service contract software

 

743

 

582

 

 

 

1,325

 

Total operating expense

 

43,803

 

13,076

 

11,799

 

8,050

 

76,728

 

Gross profit

 

37,281

 

9,729

 

4,633

 

3,692

 

55,335

 

Selling, general and administrative expenses

 

8,164

 

3,363

 

877

 

1,310

 

13,714

 

Depreciation and amortization

 

5,770

 

2,776

 

501

 

645

 

9,692

 

Segment operating income

 

$

23,347

 

3,590

 

3,255

 

1,737

 

31,929

 

Unallocated corporate expense

 

 

 

 

 

 

 

 

 

5,201

 

Consolidated operating income

 

 

 

 

 

 

 

 

 

$

26,728

 

Capital and wagering systems expenditures

 

$

10,504

 

1,599

 

86

 

93

 

12,282

 

 

 

 

10



 

 

 

 

 

Three Months Ended September 30, 2004

 

 

 

Lottery
Group

 

Pari-Mutuel
Group

 

Venue
Management
Group

 

Telecom-
munications
Products
Group

 

Totals

 

Service revenues

 

$

116,477

 

20,596

 

15,563

 

 

152,636

 

Sales revenues

 

9,042

 

381

 

 

17,250

 

26,673

 

Total revenues

 

125,519

 

20,977

 

15,563

 

17,250

 

179,309

 

Cost of service

 

61,285

 

11,459

 

11,295

 

 

84,039

 

Cost of sales

 

5,264

 

253

 

 

12,933

 

18,450

 

Amortization of service contract software

 

866

 

(313

)

 

 

553

 

Total operating expenses

 

67,415

 

11,399

 

11,295

 

12,933

 

103,042

 

Gross profit

 

58,104

 

9,578

 

4,268

 

4,317

 

76,267

 

Selling, general and administrative expenses

 

12,716

 

1,993

 

774

 

1,489

 

16,972

 

Depreciation and amortization

 

9,598

 

3,284

 

524

 

909

 

14,315

 

Segment operating income

 

$

35,790

 

4,301

 

2,970

 

1,919

 

44,980

 

Unallocated corporate expense

 

 

 

 

 

 

 

 

 

6,514

 

Consolidated operating income

 

 

 

 

 

 

 

 

 

$

38,466

 

Capital and wagering systems expenditures

 

$

17,442

 

2,324

 

300

 

238

 

20,304

 

 

 

 

 

Nine Months Ended September 30, 2003

 

 

 

Lottery Group

 

Pari-Mutuel Group

 

Venue Management Group

 

Telecom- munications Products Group

 

Totals

 

Service revenues

 

$

216,072

 

61,045

 

48,630

 

 

325,747

 

Sales revenues

 

20,064

 

4,281

 

 

34,038

 

58,383

 

Total revenues

 

236,136

 

65,326

 

48,630

 

34,038

 

384,130

 

Cost of service

 

109,948

 

33,726

 

34,014

 

 

177,688

 

Cost of sales

 

14,731

 

2,488

 

 

22,948

 

40,167

 

Amortization of service contract software

 

2,153

 

1,783

 

 

 

3,936

 

Total operating expense

 

126,832

 

37,997

 

34,014

 

22,948

 

221,791

 

Gross profit

 

109,304

 

27,329

 

14,616

 

11,090

 

162,339

 

Selling, general and administrative expenses

 

26,470

 

8,733

 

2,626

 

3,701

 

41,530

 

Depreciation and amortization

 

17,176

 

8,338

 

1,518

 

1,923

 

28,955

 

Segment operating income

 

$

65,658

 

10,258

 

10,472

 

5,466

 

91,854

 

Unallocated corporate expense

 

 

 

 

 

 

 

 

 

15,461

 

Consolidated operating income

 

 

 

 

 

 

 

 

 

$

76,393

 

Capital and wagering systems expenditures

 

$

16,272

 

4,534

 

696

 

1,079

 

22,581

 

 

11



 

 

 

 

 

Nine Months Ended September 30, 2004

 

 

 

Lottery Group

 

Pari- Mutuel Group

 

Venue Management Group

 

Telecom- munications Products Group

 

Totals

 

Service revenues

 

$

333,511

 

60,946

 

47,382

 

 

441,839

 

Sales revenues

 

54,404

 

2,848

 

 

43,795

 

101,047

 

Total revenues

 

387,915

 

63,794

 

47,382

 

43,795

 

542,886

 

Cost of service

 

171,040

 

32,324

 

34,204

 

 

237,568

 

Cost of sales

 

35,309

 

1,686

 

 

32,866

 

69,861

 

Amortization of service contract software

 

2,512

 

1,072

 

 

 

3,584

 

Total operating expenses

 

208,861

 

35,082

 

34,204

 

32,866

 

311,013

 

Gross profit

 

179,054

 

28,712

 

13,178

 

10,929

 

231,873

 

Selling, general and administrative expenses

 

45,443

 

5,801

 

2,972

 

4,406

 

58,622

 

Depreciation and amortization

 

28,998

 

8,593

 

1,521

 

2,347

 

41,459

 

Segment operating income

 

$

104,613

 

14,318

 

8,685

 

4,176

 

131,792

 

Unallocated corporate expense

 

 

 

 

 

 

 

 

 

19,633

 

Consolidated operating income

 

 

 

 

 

 

 

 

 

$

112,159

 

Capital and wagering systems expenditures

 

$

41,882

 

8,631

 

962

 

544

 

52,019

 

 

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

 

 

 

Three Months Ended
September 30,

 

Nine Months Ended
September 30,

 

 

 

2003

 

2004

 

2003

 

2004

 

Reportable consolidated operating income

 

$

26,728

 

38,466

 

76,393

 

112,159

 

Interest expense

 

6,171

 

7,692

 

18,575

 

22,889

 

Other income

 

(199

)

(313

)

(231

)

(89

)

Income before income tax expense

 

$

20,756

 

31,087

 

58,049

 

89,359

 

 

(4)            Income Tax Expense

 

         The effective income tax rates for the three and nine months ended September 30, 2004 of 31.0% and 31.3% respectively, differed from the federal statutory rate of 35% due primarily to benefits from the realization of foreign tax credits and the implementation of the extra-territorial income exclusion regime.  The effective income tax rate for the three and nine months ended September 30, 2003 was approximately 36%, which differed from the federal statutory rate of 35% due primarily to foreign and state income taxes.

 

 

12



 

 

(5)            Comprehensive Income

 

         The following presents a reconciliation of net income to comprehensive income for the three and nine month periods ended September 30, 2003 and 2004:

 

 

 

Three Months Ended
September 30,

 

Nine Months Ended
September 30,

 

 

 

2003

 

2004

 

2003

 

2004

 

Net income

 

$

13,237

 

21,461

 

37,128

 

61,390

 

Other comprehensive income (loss):

 

 

 

 

 

 

 

 

 

Foreign currency translation

 

(127

)

129

 

2,181

 

896

 

Unrealized gain on investments

 

4

 

407

 

880

 

1,134

 

Unrealized gain (loss) on Canadian dollar hedges

 

(101

)

 

(3,907

)

1,107

 

Other comprehensive income (loss)

 

(224

)

536

 

(846

)

3,137

 

Comprehensive income

 

$

13,013

 

21,997

 

36,282

 

64,527

 

 

(6)            Inventories

 

         Inventories consist of the following:

 

 

 

December 31,
2003

 

September 30,
2004

 

Parts and work-in-process

 

$

17,990

 

20,631

 

Finished goods

 

8,906

 

11,760

 

 

 

$

26,896

 

32,391

 

 

         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)            Accrued Liabilities

 

         Accrued liabilities consist of the following:

 

 

 

December 31,
2003

 

September 30,
2004

 

Compensation and benefits

 

$

30,364

 

27,012

 

Accrued acquisition costs

 

11,037

 

8,578

 

Accrued contract costs

 

19,985

 

10,596

 

Deferred revenue

 

7,720

 

5,550

 

Other

 

48,387

 

41,589

 

 

 

$

117,493

 

93,325

 

 

(8)    Debt

 

At September 30, 2004, the Company had approximately $27,351 available for borrowing under the Company’s revolving credit facility, which was entered into on November 6, 2003 as part of the Company’s senior secured credit facility (as amended and restated, the “2003 Facility”).  There were no borrowings outstanding under the revolving credit facility, but approximately $47,649 in letters of credit were issued and outstanding at September 30, 2004.  At December 31, 2003, the Company’s available borrowing capacity under the revolving credit facility was $27,146.  At September 30, 2004, there was $459,354 in outstanding Term Loans under the 2003 Facility.

 

13



 

 

The Company obtained two amendments to the 2003 Facility in the second quarter of 2004.  The first amendment gave the Company the ability to incur up to $300,000 of new convertible indebtedness, provided such indebtedness was subordinated to the 2003 Facility and provided that the proceeds of such convertible subordinated indebtedness were used to reduce outstanding Term C Loans.  The primary purpose of the second amendment (the “Second Amendment”) was to support the Company’s reorganization of its international operations.  The Second Amendment permits the transfer of ownership or disposition of certain assets and subsidiaries of the Company to other subsidiaries of the Company which would otherwise have been limited by the credit agreement governing the 2003 Facility.  The Second Amendment made certain other changes to the 2003 Facility, including a reduction to the interest rate charged on Term C Loans by converting the $460,511 outstanding principal balance of Term C Loans into new term loans (the “Term D Loans”) effective July 2, 2004.  The Term D Loans contain the same terms and conditions as the Term C Loans except for a 0.25% reduction in the Applicable Margins  and the addition of a pricing grid that provides for a further 0.25% rate reduction should the Consolidated Senior Debt Ratio  be less than 1.75 (as each term is defined in the Amended Credit Agreement).

 

At September 30, 2004, $65,584 of the Company’s 12 ½% senior subordinated notes (the “Notes”) was outstanding.

 

(9)    Goodwill and Intangible Assets

 

The following disclosure presents certain information regarding the Company’s acquired intangible assets as of December 31, 2003 and September 30, 2004.  Amortizable 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, 2003

 

 

 

 

 

 

 

 

 

Amortizable intangible assets:

 

 

 

 

 

 

 

 

 

Patents

 

15

 

$

3,139

 

291

 

2,848

 

Customer lists

 

14

 

15,375

 

5,984

 

9,391

 

Customer service contracts

 

15

 

3,781

 

1,280

 

2,501

 

Licenses

 

1-15

 

3,928

 

1,136

 

2,792

 

Lottery contracts

 

1-7.5

 

31,000

 

1,186

 

29,814

 

 

 

 

 

57,223

 

9,877

 

47,346

 

Non-amortizable intangible assets:

 

 

 

 

 

 

 

 

 

Tradename

 

 

 

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

 

 

 

$

111,762

 

20,314

 

91,448

 

Balance at September 30, 2004

 

 

 

 

 

 

 

 

 

Amortizable intangible assets:

 

 

 

 

 

 

 

 

 

Patents

 

15

 

$

3,807

 

444

 

3,363

 

Customer lists

 

14

 

15,375

 

7,347

 

8,028

 

Customer service contracts

 

15

 

3,768

 

1,464

 

2,304

 

Licenses

 

1-15

 

6,214

 

2,633

 

3,581

 

Lottery contracts

 

1-7.5

 

31,802

 

6,387

 

25,415

 

 

 

 

 

60,966

 

18,275

 

42,691

 

Non-amortizable intangible assets:

 

 

 

 

 

 

 

 

 

Tradename

 

 

 

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

 

 

 

$

115,505

 

28,712

 

86,793

 

 

         The aggregate intangible amortization expense for the nine month periods ended September 30, 2003 and 2004 was approximately $2,429 and $8,398, respectively.

 

 

14



 

 

The table below reconciles the change in the carrying amount of goodwill, by reporting unit, which is the same as business segment, for the period from January 1, 2004 to September 30, 2004.  In 2004, the Company recorded (a) a $1,190 increase in goodwill in connection with an earnout payment pursuant to the Serigrafica Chilena S.A. (“SERCHI”) purchase agreement and (b) a $5,759 decrease in the OES goodwill which is primarily attributable to a contract termination payment received by the Company from a third party.

 

Goodwill

 

Lottery Group

 

Pari-mutuel Group

 

Venue Management Group

 

Telecom-munications Products Group

 

Totals

 

Balance at December 31, 2003

 

$

307,868

 

487

 

 

 

308,355

 

Adjustments:

 

 

 

 

 

 

 

 

 

 

 

SERCHI earnout payment

 

1,190

 

 

 

 

1,190

 

Adjustments to OES goodwill

 

(5,759

)

 

 

 

(5,759

)

Balance at September 30, 2004

 

$

303,299

 

487

 

 

 

303,786

 

 

(10)  Pension Plans

 

The Company has two funded defined benefit pension plans. It has a defined benefit plan for its U.S. based union employees. Retirement benefits under this plan are based upon the number of years of credited service up to a maximum of 30 years for the majority of the employees.  It also has a defined benefit plan for U.K. based employees.  Retirement benefits under the U.K. plan are based on an employee’s average compensation over the two years preceding retirement.  The Company’s policy is to fund the minimum contribution permissible by the respective regulatory authorities.

 

In connection with its U.S. based collective bargaining agreements, the Company participates with other companies in a defined benefit pension plan covering union employees. The Company expects to make payments to the multi-employer plan of approximately $250 during the year ending December 31, 2004.

 

The Company has a 401(k) plan covering all U.S. based employees who are not covered by a collective bargaining agreement. Company contributions to the plan are at the discretion of the Company’s Board of Directors.  The Company has a 401(k) plan for all union employees which does not provide for Company contributions.

 

The Company also has an unfunded, nonqualified Supplemental Executive Retirement Plan (the “SERP”), which is intended to provide supplemental retirement benefits for certain senior executives of the Company. The SERP provides for retirement benefits according to a formula based on each participant’s compensation and years of service with the Company.

 

 

15



 

 

 

The following table sets forth the combined amount of net periodic benefit cost recognized for the three and nine month periods ended September 30, 2003 and 2004:

 

 

 

Three Months Ended
September 30,

 

Nine Months Ended
September 30,

 

 

 

2003

 

2004

 

2003

 

2004

 

Components of net periodic pension benefit cost:

 

 

 

 

 

 

 

 

 

Service cost

 

$

569

 

676

 

1,707

 

2,377

 

Interest cost

 

512

 

641

 

1,536

 

1,923

 

Expected return on plan assets

 

(370

)

(448

)

(1,111

)

(1,344

)

Actuarial loss

 

185

 

295

 

554

 

885

 

Net amortization and deferral

 

13

 

13

 

41

 

40

 

Amortization of prior service costs

 

133

 

192

 

399

 

576

 

Net periodic cost

 

$

1,042

 

1,369

 

3,126

 

4,457

 

 

(11)  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 2003 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, 2003 and September 30, 2004 and for the three and nine months ended September 30, 2003 and 2004.  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 2003 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.  Corporate interest and administrative expenses have not been allocated to the subsidiaries.

 

 

16



 

 

SCIENTIFIC GAMES CORPORATION AND SUBSIDIARIES

SUPPLEMENTAL CONDENSED CONSOLIDATING BALANCE SHEET

December 31, 2003

(unaudited, in thousands)

 

 

 

Parent
Company

 

Guarantor
Subsidiaries

 

Non-
Guarantor
Subsidiaries

 

Eliminating
Entries

 

Consolidated

 

ASSETS

 

 

 

 

 

 

 

 

 

 

 

Cash and cash equivalents

 

$

67,618

 

(4,473

)

16,228

 

 

79,373

 

Accounts receivable, net

 

 

77,670

 

22,008

 

(39

)

99,639

 

Inventories

 

 

19,716

 

7,788

 

(608

)

26,896

 

Other current assets

 

4,686

 

17,005

 

9,736

 

30

 

31,457

 

Property and equipment, net

 

3,135

 

171,692

 

54,534

 

(631

)

228,730

 

Investment in subsidiaries

 

469,385

 

184,313

 

 

(653,698

)

 

Goodwill

 

183

 

304,117

 

4,055

 

 

308,355

 

Intangible assets

 

 

86,982

 

4,466

 

 

91,448

 

Other assets

 

47,159

 

49,293

 

8,940

 

(8,301

)

97,091

 

Total assets

 

$

592,166

 

906,315

 

127,755

 

(663,247

)

962,989

 

LIABILITIES AND STOCKHOLDERS’ EQUITY

 

 

 

 

 

 

 

 

 

 

 

Current installments of long-term debt

 

$

5,015

 

654

 

658

 

 

6,327

 

Current liabilities

 

15,615

 

110,158

 

25,370

 

953

 

152,096

 

Long-term debt, excluding current installments

 

525,664

 

 

172

 

 

525,836

 

Other non-current liabilities

 

(3,844

)

31,633

 

13,689

 

100

 

41,578

 

Intercompany balances

 

(203,592

)

189,865

 

15,524

 

(1,797

)

 

Stockholders’ equity

 

253,308

 

574,005

 

72,342

 

(662,503

)

237,152

 

Total liabilities and stockholders’ equity

 

$

592,166

 

906,315

 

127,755

 

(663,247

)

962,989

 

 

SCIENTIFIC GAMES CORPORATION AND SUBSIDIARIES

SUPPLEMENTAL CONDENSED CONSOLIDATING BALANCE SHEET

September 30, 2004

(unaudited, in thousands)

 

 

 

Parent

Company

 

Guarantor

Subsidiaries

 

Non-

Guarantor

Subsidiaries

 

Eliminating

Entries

 

Consolidated

 

ASSETS

 

 

 

 

 

 

 

 

 

 

 

Cash and cash equivalents

 

$

68,702

 

4,003

 

23,924

 

 

96,629

 

Accounts receivable, net

 

 

73,476

 

27,097

 

(39

)

100,534

 

Inventories

 

 

23,193

 

9,806

 

(608

)

32,391

 

Other current assets

 

4,427

 

16,960

 

9,718

 

30

 

31,135

 

Property and equipment, net

 

2,852

 

188,128

 

53,883

 

(631

)

244,232

 

Investment in subsidiaries

 

590,847

 

186,022

 

 

(776,869

)

 

Goodwill

 

183

 

298,358

 

5,245

 

 

303,786

 

Intangible assets

 

 

83,553

 

3,240

 

 

86,793

 

Other assets

 

41,051

 

58,012

 

12,771

 

(8,243

)

103,591

 

Total assets

 

$

708,062

 

931,705

 

145,684

 

(786,360

)

999,091

 

LIABILITIES AND STOCKHOLDERS’ EQUITY

 

 

 

 

 

 

 

 

 

 

 

Current installments of long-term debt

 

$

4,903

 

12

 

2,095

 

 

7,010

 

Current liabilities

 

8,606

 

84,176

 

28,437

 

1,231

 

122,450

 

Long-term debt, excluding current installments

 

522,000

 

 

1,621

 

 

523,621

 

Other non-current liabilities

 

(2,787

)

30,772

 

14,670

 

36

 

42,691

 

Intercompany balances

 

(144,135

)

127,497

 

18,838

 

(2,200

)

 

Stockholders’ equity

 

319,475

 

689,248

 

80,023

 

(785,427

)

303,319

 

Total liabilities and stockholders’ equity

 

$

708,062

 

931,705

 

145,684

 

(786,360

)

999,091

 

 

17



 

 

SCIENTIFIC GAMES CORPORATION AND SUBSIDIARIES

SUPPLEMENTAL CONDENSED STATEMENT OF INCOME

Three Months Ended September 30, 2003

(unaudited, in thousands)

 

 

 

Parent
Company

 

Guarantor
Subsidiaries

 

Non-
Guarantor
Subsidiaries

 

Eliminating
Entries

 

Consolidated

 

Operating revenues

 

$

 

99,074

 

34,369

 

(1,380

)

132,063

 

Operating expenses

 

 

53,465

 

23,329

 

(1,391

)

75,403

 

Amortization of service contract software

 

 

1,226

 

99

 

 

1,325

 

Gross profit

 

 

44,383

 

10,941

 

11

 

55,335

 

Selling, general and administrative expenses

 

5,177

 

10,291

 

3,276

 

(3

)

18,741

 

Depreciation and amortization

 

174

 

7,517

 

2,175

 

 

9,866

 

Operating income (loss)

 

(5,351

)

26,575

 

5,490

 

14

 

26,728

 

Interest expense

 

5,866

 

233

 

962

 

(890

)

6,171

 

Other (income) expense

 

(197

)

(1,439

)

555

 

882

 

(199

)

Income (loss) before equity in income of subsidiaries, and income taxes

 

(11,020

)

27,781

 

3,973

 

22

 

20,756

 

Equity in income of subsidiaries

 

30,708

 

 

 

(30,708

)

 

Income tax expense

 

6,451

 

114

 

954

 

 

7,519

 

Net income

 

$

13,237

 

27,667

 

3,019

 

(30,686

)

13,237

 

 

SCIENTIFIC GAMES CORPORATION AND SUBSIDIARIES

SUPPLEMENTAL CONDENSED STATEMENT OF INCOME

Three Months Ended September 30, 2004

(unaudited, in thousands)

 

 

 

Parent
Company

 

Guarantor
Subsidiaries

 

Non-
Guarantor
Subsidiaries

 

Eliminating
Entries

 

Consolidated

 

Operating revenues

 

$

 

137,410

 

45,312

 

(3,413

)

179,309

 

Operating expenses

 

 

74,813

 

31,106

 

(3,430

)

102,489

 

Amortization of service contract software

 

 

478

 

75

 

 

553

 

Gross profit

 

 

62,119

 

14,131

 

17

 

76,267

 

Selling, general and administrative expenses

 

6,301

 

13,040

 

3,935

 

(3

)

23,273

 

Depreciation and amortization

 

213

 

10,900

 

3,415

 

 

14,528

 

Operating income (loss)

 

(6,514

)

38,179

 

6,781

 

20

 

38,466

 

Interest expense

 

7,318

 

318

 

1,332

 

(1,276

)

7,692

 

Other (income) expense

 

(229

)

(1,526

)

357

 

1,085

 

(313

)

Income (loss) before equity in income of subsidiaries, and income taxes

 

(13,603

)

39,387

 

5,092

 

211

 

31,087

 

Equity in income of subsidiaries

 

41,689

 

 

 

(41,689

)

 

Income tax expense

 

6,625

 

1,251

 

1,750

 

 

9,626

 

Net income

 

$

21,461

 

38,136

 

3,342

 

(41,478

)

21,461

 

 

18



 

 

SCIENTIFIC GAMES CORPORATION AND SUBSIDIARIES

SUPPLEMENTAL CONDENSED STATEMENT OF INCOME

Nine Months Ended September 30, 2003

(unaudited, in thousands)

 

 

 

Parent
Company

 

Guarantor Subsidiaries

 

Non- Guarantor Subsidiaries

 

Eliminating Entries

 

Consolidated

 

Operating revenues

 

$

 

295,039

 

94,595

 

(5,504

)

384,130

 

Operating expenses

 

 

159,665

 

63,651

 

(5,461

)

217,855

 

Amortization of service contract software

 

 

3,638

 

298

 

 

3,936

 

Gross profit

 

 

131,736

 

30,646

 

(43

)

162,339

 

Selling, general and administrative expenses

 

15,222

 

31,280

 

9,959

 

(9

)

56,452

 

Depreciation and amortization

 

539

 

22,495

 

6,460

 

 

29,494

 

Operating income (loss)

 

(15,761

)

77,961

 

14,227

 

(34

)

76,393

 

Interest expense

 

17,974

 

565

 

3,110

 

(3,074

)

18,575

 

Other (income) expense

 

(299

)

(4,534

)

1,553

 

3,049

 

(231

)

Income (loss) before equity in income of subsidiaries, and income taxes

 

(33,436

)

81,930

 

9,564

 

(9

)

58,049

 

Equity in income of subsidiaries

 

88,742

 

 

 

(88,742

)

 

Income tax expense

 

18,178

 

318

 

2,425

 

 

20,921

 

Net income

 

$

37,128

 

81,612

 

7,139

 

(88,751

)

37,128

 

 

SCIENTIFIC GAMES CORPORATION AND SUBSIDIARIES

SUPPLEMENTAL CONDENSED STATEMENT OF INCOME

Nine Months Ended September 30, 2004

(unaudited, in thousands)