UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D. C.  20549

Form 10-Q

{Mark One}

x

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

 

 

 

For the quarterly period ended June 30, 2006

 

 

 

OR

 

 

 

o

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

 

 

 

For the transition period from          to

 

 

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

 

(I.R.S. Employer Identification No.)

incorporation or organization)

 

 

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 x      No o

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer or a non-accelerated filer. See definition of “accelerated filer and large accelerated filer” in Rule 12b-2 of the Exchange Act. (Check one):

Large accelerated filer  x                    Accelerated filer  o                    Non-accelerated filer  o

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).    Yes o ¨    No x

APPLICABLE ONLY TO CORPORATE ISSUERS:

Indicate the number of shares outstanding of each of the issuer’s classes of common stock as of August 7, 2006:

Class A Common Stock:  91,306,716

Class B Common Stock:  None

 




SCIENTIFIC GAMES CORPORATION AND SUBSIDIARIES
INDEX TO CONSOLIDATED FINANCIAL STATEMENTS
AND OTHER INFORMATION

THREE MONTHS ENDED JUNE 30, 2006

PART I.

FINANCIAL INFORMATION

 

 

 

 

Item 1.

Consolidated Financial Statements:

 

 

 

 

 

Balance Sheets as of December 31, 2005 and June 30, 2006

 

 

 

 

 

Statements of Income for the Three Months Ended June 30, 2005 and 2006

 

 

 

 

 

Statements of Income for the Six Months Ended June 30, 2005 and 2006

 

 

 

 

 

Condensed Statements of Cash Flows for the Six Months Ended June 30, 2005 and 2006

 

 

 

 

 

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

 

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,
2005

 

June 30,
2006

 

ASSETS

 

 

 

 

 

Current assets:

 

 

 

 

 

Cash and cash equivalents

 

$

38,942

 

34,155

 

Accounts receivable, net of allowance for doubtful accounts of $6,149 and $6,288 at December 31, 2005 and June 30, 2006, respectively

 

129,250

 

158,739

 

Inventories

 

40,148

 

50,993

 

Deferred income taxes

 

14,242

 

31,948

 

Prepaid expenses, deposits and other current assets

 

31,971

 

39,907

 

Total current assets

 

254,553

 

315,742

 

Property and equipment, at cost

 

666,469

 

755,490

 

Less accumulated depreciation

 

300,250

 

327,797

 

Net property and equipment

 

366,219

 

427,693

 

Goodwill, net

 

339,169

 

570,663

 

Operating rights, net

 

14,020

 

26,000

 

Other intangible assets, net

 

73,269

 

116,028

 

Other assets and investments

 

125,283

 

140,442

 

Total assets

 

$

1,172,513

 

1,596,568

 

 

 

 

 

 

 

LIABILITIES AND STOCKHOLDERS’ EQUITY

 

 

 

 

 

Current liabilities:

 

 

 

 

 

Current installments of long-term debt

 

$

6,055

 

2,818

 

Accounts payable

 

54,223

 

54,107

 

Accrued liabilities

 

80,305

 

123,459

 

Interest payable

 

779

 

1,597

 

Total current liabilities

 

141,362

 

181,981

 

Deferred income taxes

 

9,759

 

10,507

 

Other long-term liabilities

 

59,879

 

71,060

 

Long-term debt, excluding current installments

 

574,680

 

855,229

 

Total liabilities

 

785,680

 

1,118,777

 

Commitments and contingencies

 

 

 

 

 

 

 

 

 

 

 

Stockholders’ equity:

 

 

 

 

 

Class A common stock, par value $0.01 per share, 199,300 shares authorized, 89,869 and 91,305 shares outstanding at December 31, 2005 and June 30, 2006, respectively

 

899

 

913

 

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

 

 

 

Additional paid-in capital

 

425,750

 

451,142

 

Accumulated earnings (losses)

 

(33,309

)

14,038

 

Treasury stock, at cost

 

(9,556

)

(9,556

)

Accumulated other comprehensive income

 

3,049

 

21,254

 

Total stockholders’ equity

 

386,833

 

477,791

 

Total liabilities and stockholders’ equity

 

$

1,172,513

 

1,596,568

 

See accompanying notes to consolidated financial statements.

3




SCIENTIFIC GAMES CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF INCOME
Three Months Ended June 30, 2005 and 2006
(Unaudited, in thousands, except per share amounts)

 

 

2005

 

2006

 

Operating revenues:

 

 

 

 

 

Services

 

$

160,867

 

214,232

 

Sales

 

36,557

 

25,405

 

 

 

197,424

 

239,637

 

Operating expenses

 

 

 

 

 

Cost of services (exclusive of depreciation and amortization)

 

87,432

 

118,595

 

Cost of sales (exclusive of depreciation and amortization)

 

25,503

 

19,248

 

Selling, general and administrative expenses

 

25,725

 

35,346

 

Depreciation and amortization

 

17,119

 

23,525

 

Operating income

 

41,645

 

42,923

 

Other deductions:

 

 

 

 

 

Interest expense

 

6,812

 

11,115

 

Equity in net (income) loss in joint ventures

 

955

 

(3,157

)

Other income, net

 

(578

)

(226

)

 

 

7,189

 

7,732

 

Income before income tax expense

 

34,456

 

35,191

 

Income tax expense

 

9,692

 

10,214

 

Net income

 

$

24,764

 

24,977

 

 

 

 

 

 

 

Basic and diluted net income per share:

 

 

 

 

 

Basic net income available to common stockholders

 

$

0.28

 

0.27

 

Diluted net income available to common stockholders

 

$

0.27

 

0.26

 

 

 

 

 

 

 

Weighted average number of shares used in per share calculations:

 

 

 

 

 

Basic shares

 

89,207

 

91,202

 

Diluted shares

 

92,142

 

95,989

 

See accompanying notes to consolidated financial statements.

4




SCIENTIFIC GAMES CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF INCOME
Six Months Ended June 30, 2005 and 2006
(Unaudited, in thousands, except per share amounts)

 

 

2005

 

2006

 

Operating revenues:

 

 

 

 

 

Services

 

$

316,621

 

391,192

 

Sales

 

65,359

 

56,574

 

 

 

381,980

 

447,766

 

Operating expenses

 

 

 

 

 

Cost of services (exclusive of depreciation and amortization)

 

172,681

 

213,543

 

Cost of sales (exclusive of depreciation and amortization)

 

45,777

 

43,792

 

Selling, general and administrative expenses

 

53,453

 

67,738

 

Depreciation and amortization

 

31,594

 

42,817

 

Operating income

 

78,475

 

79,876

 

Other deductions:

 

 

 

 

 

Interest expense

 

13,222

 

18,317

 

Equity in net (income) loss in joint ventures

 

1,498

 

(4,733

)

Other income, net

 

(722

)

(869

)

 

 

13,998

 

12,715

 

Income before income tax expense

 

64,477

 

67,161

 

Income tax expense

 

18,698

 

19,814

 

Net income

 

$

45,779

 

47,347

 

 

 

 

 

 

 

Basic and diluted net income per share:

 

 

 

 

 

Basic net income available to common stockholders

 

$

0.51

 

0.52

 

Diluted net income available to common stockholders

 

$

0.50

 

0.50

 

 

 

 

 

 

 

Weighted average number of shares used in per share calculations:

 

 

 

 

 

Basic shares

 

88,913

 

90,687

 

Diluted shares

 

92,047

 

94,992

 

See accompanying notes to consolidated financial statements.

5




SCIENTIFIC GAMES CORPORATION AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
Six Months Ended June 30, 2005 and 2006
(Unaudited, in thousands)

 

 

2005

 

2006

 

Cash flows from operating activities:

 

 

 

 

 

Net income

 

$

45,779

 

47,347

 

 

 

 

 

 

 

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

 

 

 

 

 

Depreciation and amortization

 

31,594

 

42,817

 

Change in deferred income taxes

 

9,604

 

(3,212

)

Share-based compensation

 

 

9,444

 

Tax benefit from exercise of employee stock options

 

5,636

 

 

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

 

(46,547

)

(3,626

)

Change in short-term investments

 

43,875

 

 

Other

 

4,980

 

(2,571

)

Net cash provided by operating activities

 

94,921

 

90,199

 

 

 

 

 

 

 

Cash flows from investing activities:

 

 

 

 

 

Capital expenditures

 

(11,878

)

(8,516

)

Wagering systems expenditures

 

(31,555

)

(71,954

)

Other intangible assets and software expenditures

 

(8,786

)

(24,502

)

Change in other assets and liabilities, net

 

(10,231

)

(9,696

)

Business acquisitions, net of cash acquired

 

(24,774

)

(267,010

)

Net cash used in investing activities

 

(87,224

)

(381,678

)

 

 

 

 

 

 

Cash flows from financing activities:

 

 

 

 

 

Proceeds from issuance of long-term debt

 

600,482

 

1,791,269

 

Payments on long-term debt

 

(622,585

)

(1,514,089

)

Excess tax benefit from equity-based compensation plan

 

 

4,082

 

Net proceeds from issuance of common stock

 

4,903

 

11,540

 

Net cash provided by (used in) financing activities

 

(17,200

)

292,802

 

Effect of exchange rate changes on cash and cash equivalents

 

(3,971

)

(6,110

)

Decrease in cash and cash equivalents

 

(13,474

)

(4,787

)

Cash and cash equivalents, beginning of period

 

66,120

 

38,942

 

Cash and cash equivalents, end of period

 

$

52,646

 

34,155

 

 

 

 

 

 

 

Supplemental disclosure of cash flow information:

 

 

 

 

 

Cash paid during the period for:

 

 

 

 

 

Interest

 

$

10,786

 

15,358

 

Income taxes, net of refunds

 

$

384

 

16,480

 

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 June 30, 2006, the consolidated statements of income for the three and six months ended June 30, 2005 and 2006, and the consolidated condensed statements of cash flows for the six months ended June 30, 2005 and 2006, have been prepared by Scientific Games Corporation (together with its consolidated subsidiaries, 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, 2006 and the results of its operations for the three and six months ended June 30, 2005 and 2006 and its cash flows for the six months ended June 30, 2005 and 2006 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 2005 Annual Report on Form 10-K.  The results of operations for the period ended June 30, 2006 are not necessarily indicative of the operating results for the full year.

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 six months ended June 30, 2005 and 2006:

 

 

Three months ended 
June 30,

 

Six months ended 
June 30,

 

 

 

2005

 

2006

 

2005

 

2006

 

Income (numerator)

 

 

 

 

 

 

 

 

 

Net income (basic)

 

$

24,764

 

24,977

 

$

45,779

 

47,347

 

Shares (denominator)

 

 

 

 

 

 

 

 

 

Basic weighted average common shares outstanding

 

89,207

 

91,202

 

88,913

 

90,687

 

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

 

2,935

 

2,793

 

3,134

 

2,889

 

Effect of dilutive shares related to convertible debentures

 

 

1,994

 

 

1,416

 

Diluted weighted average common shares outstanding

 

$

92,142

 

95,989

 

92,047

 

94,992

 

 

 

 

 

 

 

 

 

 

 

Basic and diluted per share amounts

 

 

 

 

 

 

 

 

 

Basic net income per share available to common stockholders

 

$

0.28

 

0.27

 

$

0.51

 

0.52

 

Diluted net income per share available to common stockholders

 

$

0.27

 

0.26

 

$

0.50

 

0.50

 

The aggregate number of shares that the Company could be obligated to issue upon conversion of its $275,000, 0.75% convertible subordinated notes due 2024 (the “Convertible Debentures”), which the Company sold in December 2004, is approximately 9,450. The Convertible Debentures provide for net share settlement upon exercise and the Company has purchased a bond hedge to mitigate the potential economic dilution from conversion. During the second quarter of 2006, the average price of the Company’s common stock exceeded the specified conversion price. For the three and six months ended June 30, 2006, the Company has included 1,994 and 1,416 shares, respectively, related to its Convertible Debentures in its diluted weighted average common shares outstanding.  Such shares were excluded from the three and six months ended June 30, 2005 calculation, as they were anti-dilutive.  The Company has not included the offset from the bond hedge as it would be anti-dilutive; however, when the Convertible Debenture matures, the diluted share amount will decrease because the bond hedge will offset the economic dilution from conversion.

7




(2)    Acquisitions

On April 20, 2006, the Company acquired The Global Draw Limited and certain related companies (“Global Draw”). In such transaction, Scientific Games International Holdings acquired the entire share capital of Neomi Associates Inc, of which The Global Draw Limited is a 100% owned subsidiary, and Scientific Games Beteiligungsgesellschaft mbH acquired the entire share capital of Research and Development GmbH.  Global Draw is a leading United Kingdom supplier of fixed odds betting terminals and systems, and interactive sports betting systems. The Company expects that the acquisition of Global Draw will strengthen its role in the worldwide sports betting and video lottery business. The purchase price was approximately $183 million (subject to adjustment), plus an earn-out to the selling shareholders, as well as contingent bonuses to certain members of the management team, based on the future financial performance of the business.  The aggregate amount of such payments would total one-third of an amount equal to Global Draw’s EBITDA (EBITDA, for such purposes, is defined as the consolidated earnings before interest, tax, depreciation and amortization) for the year ended December 31, 2008 multiplied by a specific price multiple depending on the level of EBITDA earned. In accordance with current accounting standards, such payments made to selling shareholders will be capitalized as additional purchase price and any such payments made to management will be expensed. The acquisition was recorded using the purchase method of accounting.  Approximately $2 million of the preliminary estimate of goodwill of approximately $152 million from the acquisition of Global Draw is deductible for tax purposes.  All other assets and liabilities acquired in the transaction were included in the preliminary purchase price allocation.  The Company financed the acquisition through a combination of borrowings under its existing revolving credit facility and a new $100,000 term loan. The operating results of Global Draw have been included in the Diversified Gaming segment since the beginning of the second quarter of 2006.  The following table represents the unaudited pro forma results of operations for the three and six months ended June 30, 2005 and 2006 as if the transaction had occurred at the beginning of the periods presented.

 

Three Months Ended 
June 30,

 

Six Months Ended 
June 30,

 

 

 

2005

 

2006

 

2005

 

2006

 

Operating revenues

 

$

219,327

 

239,637

 

$

427,431

 

471,314

 

Operating income

 

$

50,818

 

42,923

 

$

99,119

 

91,347

 

Net income

 

$

29,581

 

24,977

 

$

57,038

 

53,789

 

Basic net income per share

 

$

0.33

 

0.27

 

$

0.64

 

0.59

 

Diluded net income per share

 

$

0.32

 

0.26

 

$

0.62

 

0.57

 

These pro forma results have been prepared for comparative purpose and do not purport to be indicative of what would have occurred had the acquisition been consummated on January 1, 2005, or the results that may occur in the future.

On April 5, 2006, the Company acquired certain assets of The Shoreline Star Greyhound Park and Simulcast Facility (“Shoreline”) located in Bridgeport, Connecticut. The Company expects that the acquisition of Shoreline will allow it to maximize the potential of its Connecticut operations. Additionally, the deal eliminates existing restrictions on the Company’s ability to simulcast live racing in certain portions of the state.  The purchase price was approximately $12 million (subject to adjustment) plus an earn-out, based on the future financial performance of the business.  The Company paid cash for the acquisition which will be recorded using the purchase method of accounting.  The acquisition of Shoreline was not material to the Company’s operations.

On March 22, 2006, the Company acquired substantially all of the online lottery assets of Swedish firm EssNet AB (“EssNet”) which specializes in online lottery systems and terminals to run online lotteries, sports betting, instant tickets and mobile games on a national level. EssNet’s lottery customers include seven states in Germany, the national lotteries of Hungary and Norway, Golden Casket and Tattersall’s Lottery in Australia, and other national lotteries.  The Company expects that its acquisition of EssNet will enable it to further expand into the European lottery market.  The purchase price was approximately $60 million in cash.  The acquisition was recorded using the purchase method of accounting.  The operating results of EssNet are included in the Lottery

8




Systems segment and have been included in the Company’s statements of operations since the date of acquisition.  Approximately $55 million of the preliminary estimate of goodwill of approximately $75 million from the acquisition of EssNet is deductible for tax purposes.  Additionally, other assets and liabilities acquired in the transaction, such as certain intangible assets, property and equipment, current assets and liabilities were included in the preliminary purchase price allocation.  The acquisition of EssNet was not material to the Company’s operations.

In conjunction with the purchase of EssNet, the Company has a plan to integrate certain operating locations as part of the integration of EssNet.  The Company has recorded approximately $27 million in liabilities, primarily related to involuntary employee terminations, termination of leases and termination of service contracts that will result from the integration.

(3)    Operating Segment Information

SFAS No. 131, “Disclosures about Segments of an Enterprise and Related Information” (“SFAS No. 131”), defines operating segments to be those components of a business for which separate financial information is available that is regularly evaluated by management in making operating decisions and in assessing performance. SFAS No. 131 further requires that segment information be presented consistently with the basis and manner in which management internally disaggregates financial information for the purposes of assisting in making internal operating decisions.

As previously reported in its Quarterly Report on Form 10-Q for the quarter ended March 31, 2006, the Company determined that its previously reported segments consisting of Lottery, Pari-mutuel, Venue Management and Telecommunications Products no longer reflected the way the Company managed the business. Beginning in the first quarter of 2006, the Company reported its business in three segments – Printed Products, Lottery Systems and Diversified Gaming. The Printed Products segment includes the instant lottery ticket business and the pre-paid phone card business (formerly the Telecommunications Product Group). The Lottery Systems segment includes the Company’s online lottery business. The Diversified Gaming segment includes the Company’s pari-mutuel wagering systems business (formerly the Pari-mutuel Group) and the Company’s off-track wagering business (formerly the Venue Management Group). All prior period amounts have been restated to conform to the current segment reporting format.

The Printed Products Group provides instant ticket and related services that 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. Additionally this division provides lotteries with over 80 licensed brand products and includes prepaid phone cards for cellular phone service providers. The Lottery Systems Group offers online, instant and video lottery products and online and instant ticket validation systems. Its business includes the supply of transaction processing software for the accounting and validation of both instant and online lottery games, point-of-sale terminal hardware sales, central site computers and communication hardware sales, and ongoing support and maintenance for these products.  The Diversified Gaming Group provides computerized wagering systems and services such as race simulcasting and communications services and telephone and internet account wagering to the pari-mutuel wagering industry. It owns and operates licensed pari-mutuel wagering facilities in Connecticut, Maine and the Netherlands.  Additionally, with the acquisition of Global Draw, this division is a supplier of fixed odd betting terminals and systems, and interactive sports betting terminals and systems throughout Europe.

The following tables represent revenues, profits, depreciation, amortization, and capital expenditures for the three months and six ended June 30, 2005 and 2006, by current reportable segments.  Corporate expenses, interest expense and other (income) deductions are not allocated to the reportable segments. All prior period amounts have been restated to reflect the current reportable segments.

9




 

 

 

Three Months Ended June 30, 2005

 

 

 

Printed 
Products 
Group

 

Lottery 
Systems
Group

 

Diversified 
Gaming 
Group

 

Totals

 

Service revenues

 

$

83,426

 

42,904

 

34,537

 

160,867

 

Sales revenues

 

18,035

 

15,003

 

3,519

 

36,557

 

Total revenues

 

101,461

 

57,907

 

38,056

 

197,424

 

 

 

 

 

 

 

 

 

 

 

Cost of services (exclusive of depreciation and amortization)

 

42,472

 

20,709

 

24,251

 

87,432

 

Cost of sales (exclusive of depreciation and amortization)

 

13,380

 

9,835

 

2,288

 

25,503

 

Selling, general and administrative expenses

 

9,103

 

6,165

 

3,118

 

18,386

 

Depreciation and amortization

 

4,469

 

8,422

 

3,938

 

16,829

 

Segment operating income

 

$

32,037

 

12,776

 

4,461

 

49,274

 

Unallocated corporate expense

 

 

 

 

 

 

 

7,629

 

Consolidated operating income

 

 

 

 

 

 

 

$

41,645

 

 

 

 

 

 

 

 

 

 

 

Capital and wagering systems expenditures

 

$

2,654

 

13,518

 

3,973

 

20,145

 

 

 

 

Three Months Ended June 30, 2006

 

 

 

Printed 
Products 
Group

 

Lottery 
Systems 
Group

 

Diversified 
Gaming 
Group

 

Totals

 

Service revenues

 

$

100,615

 

56,659

 

56,958

 

214,232

 

Sales revenues

 

11,818

 

12,409

 

1,178

 

25,405

 

Total revenues

 

112,433

 

69,068

 

58,136

 

239,637

 

 

 

 

 

 

 

 

 

 

 

Cost of services (exclusive of depreciation and amortization)

 

52,695

 

33,694

 

32,206

 

118,595

 

Cost of sales (exclusive of depreciation and amortization)

 

9,206

 

8,861

 

1,181

 

19,248

 

Selling, general and administrative expenses

 

10,849

 

8,079

 

4,534

 

23,462

 

Depreciation and amortization

 

6,141

 

11,041

 

6,099

 

23,281

 

Segment operating income

 

$

33,542

 

7,393

 

14,116

 

55,051

 

Unallocated corporate expense

 

 

 

 

 

 

 

12,128

 

Consolidated operating income

 

 

 

 

 

 

 

$

42,923

 

 

 

 

 

 

 

 

 

 

 

Capital and wagering systems expenditures

 

$

5,201

 

28,890

 

10,892

 

44,983

 

 

10




 

 

 

Six Months Ended June 30, 2005

 

 

Printed 
Products 
Group

 

Lottery 
Systems 
Group

 

Diversified 
Gaming 
Group

 

Totals

 

Service revenues

 

$

166,943

 

82,778

 

66,900

 

316,621

 

Sales revenues

 

36,664

 

24,819

 

3,876

 

65,359

 

Total revenues

 

203,607

 

107,597

 

70,776

 

381,980

 

 

 

 

 

 

 

 

 

 

 

Cost of services (exclusive of depreciation and amortization)

 

85,631

 

41,439

 

45,611

 

172,681

 

Cost of sales (exclusive of depreciation and amortization)

 

26,888

 

16,186

 

2,703

 

45,777

 

Selling, general and administrative expenses

 

19,508

 

12,878

 

7,033

 

39,419

 

Depreciation and amortization

 

8,818

 

14,935

 

7,276

 

31,029

 

Segment operating income

 

$

62,762

 

22,159

 

8,153

 

93,074

 

Unallocated corporate expense

 

 

 

 

 

 

 

14,599

 

Consolidated operating income

 

 

 

 

 

 

 

$

78,475

 

 

 

 

 

 

 

 

 

 

 

Assets at June 30, 2005

 

$

432,162

 

347,987

 

112,940

 

893,089

 

Unallocated assets at June 30, 2005

 

 

 

 

 

 

 

207,682

 

Consolidated assets at June 30, 2005

 

 

 

 

 

 

 

$

1,100,771

 

 

 

 

 

 

 

 

 

 

 

Capital and wagering systems expenditures

 

$

4,000

 

33,103

 

6,330

 

43,433

 

 

11




 

 

 

Six Months Ended June 30, 2006

 

 

 

Printed 
Products 
Group

 

Lottery 
Systems 
Group

 

Diversified 
Gaming 
Group

 

Totals

 

Service revenues

 

$

194,194

 

109,376

 

87,622

 

391,192

 

Sales revenues

 

25,939

 

27,108

 

3,527

 

56,574

 

Total revenues

 

220,133

 

136,484

 

91,149

 

447,766

 

 

 

 

 

 

 

 

 

 

 

Cost of services (exclusive of depreciation and amortization)

 

98,986

 

61,367

 

53,190

 

213,543

 

Cost of sales (exclusive of depreciation and amortization)

 

19,979

 

20,453

 

3,360

 

43,792

 

Selling, general and administrative expenses

 

22,205

 

15,528

 

6,975

 

44,708

 

Depreciation and amortization

 

11,326

 

21,534

 

9,495

 

42,355

 

Segment operating income

 

$

67,637

 

17,602

 

18,129

 

103,368

 

Unallocated corporate expense

 

 

 

 

 

 

 

23,492

 

Consolidated operating income

 

 

 

 

 

 

 

$

79,876

 

 

 

 

 

 

 

 

 

 

 

Assets at June 30, 2006

 

$

503,435

 

549,563

 

361,878

 

1,414,876

 

Unallocated assets at June 30, 2006

 

 

 

 

 

 

 

181,692

 

Consolidated assets at June 30, 2006

 

 

 

 

 

 

 

$

1,596,568

 

 

 

 

 

 

 

 

 

 

 

Capital and wagering systems expenditures

 

$

10,859

 

51,788

 

17,823

 

80,470

 

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,

 

 

 

2005

 

2006

 

2005

 

2006

 

Reported consolidated operating income

 

$

41,645

 

42,923

 

$

78,475

 

79,876

 

Interest expense

 

6,812

 

11,115

 

13,222

 

18,317

 

Equity in net (income) loss of joint ventures

 

955

 

(3,157

)

1,498

 

(4,733

)

Other income, net

 

(578

)

(226

)

(722

)

(869

)

Income before income tax expense

 

$

34,456

 

35,191

 

$

64,477

 

67,161

 

 

12




 

In evaluating financial performance, the Company focuses on operating profit as a segment’s measure of profit or loss. Operating profit is before investment income, interest expense, equity in net (income) loss in joint ventures, corporate expenses and income taxes. The accounting policies of the reportable segments are the same as those described in the summary of significant accounting policies (see Note 1 of our Annual Report on Form 10-K).

(4)            Income Tax Expense

The effective tax rates for the three and six months ended June 30, 2006 of 29.0% and 29.5%, respectively, were determined using an estimated annual effective tax rate, which was less than the federal statutory rate of 35% due to lower tax rates applicable to the Company’s operations outside the United States and the tax benefit of the 2004 debt restructuring.  The effective income tax rates for the three and six months ended June 30, 2005 of approximately 28.1% and 29.0%, respectively, differed from the federal statutory rate due to benefits from expanded business outside the United States, the 2004 debt restructuring and increased research and development activities.

(5)            Comprehensive Income

The following presents a reconciliation of net income to comprehensive income for the three and six month periods ended June 30, 2005 and 2006:

 

 

Three Months Ended

 

Six Months Ended

 

 

 

June 30,

 

June 30,

 

 

 

2005

 

2006

 

2005

 

2006

 

Net income

 

$

24,764

 

24,977

 

$

45,779

 

47,347

 

Other comprehensive income (loss):

 

 

 

 

 

 

 

 

 

Foreign currency translation

 

(5,262

)

17,976

 

(8,652

)

18,716

 

Unrealized loss (gain) on investments

 

1,656

 

264

 

1,645

 

(511

)

Other comprehensive income (loss)

 

(3,606

)

18,240

 

(7,007

)

18,205

 

Comprehensive income

 

$

21,158

 

43,217

 

$

38,772

 

65,552

 

 

13




(6)            Inventories

Inventories consist of the following:

 

December 31,

 

June 30,

 

 

 

2005

 

2006

 

Parts and work-in-process

 

$

20,694

 

27,346

 

Finished goods

 

19,454

 

23,647

 

 

 

$

40,148

 

50,993

 

 

Point of sale terminals manufactured by the Company may be sold to customers or included as part of a long-term wagering system contract. Parts and work-in-process includes costs for equipment expected to be sold. Costs incurred for equipment associated with specific wagering system 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,

 

June 30,

 

 

 

2005

 

2006

 

Compensation and benefits

 

$

21,992

 

21,349

 

Customer advances

 

6,667

 

1,847

 

Deferred revenue

 

8,873

 

13,004

 

Taxes, other than income

 

4,489

 

7,002

 

Accrued licenses

 

5,396

 

1,464

 

Liabilites assumed in business combinations

 

 

25,589

 

Accrued contract costs

 

9,461

 

11,439

 

Other

 

23,427

 

41,765

 

 

 

$

80,305

 

123,459

 

14




(8)   Long-Term Debt

On July 7, 2006, the Company amended (the “Amendment”) its existing Credit Agreement dated as of December 31, 2004, as amended and restated as of March 31, 2006 (the “March 2006 Amended and Restated Credit Agreement”), to provide for a new $150 million senior secured term loan (the “Term Loan D”) and to make certain other changes to the March 2006 Amended and Restated Credit Agreement (the March 2006 Amended and Restated Credit Agreement and the Amendment are collectively referred to as the “July 2006 Amended and Restated Credit Agreement”). The proceeds from the Term Loan D were used to repay, in full, the remaining $98.5 million of existing Term Loan B and to pay down approximately $51 million of borrowings under the Company’s existing revolving credit facility  The interest rate with respect to the Term Loan D will vary, depending upon the Company’s consolidated leverage ratio, from 75 basis points to 150 basis points above LIBOR for eurocurrency loans and from zero basis points to 50 basis points above the higher of (i) the prime rate or (ii) the Federal Funds Effective Rate plus 0.50%, for base rate loans.  The Company paid approximately $0.5 million in banking, legal and other fees in connection with the Amendment.  The July 2006 Amended and Restated Credit Agreement will terminate on December 23, 2009.

Effective July 7, 2006, the Company had approximately $113,754 available for borrowing under the Company’s revolving credit facility under the July 2006 Amended and Restated Credit Agreement.   There were $182,500 of borrowings and $56,246 in letters of credit outstanding under the revolving credit facility at June 30, 2006.

The July 2006 Amended and Restated Credit Agreement contains certain covenants that, among other things, limit the Company’s ability, and the ability of certain of the Company’s 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, sell, transfer, lease or otherwise dispose of all or substantially all assets, or create certain liens and other encumbrances on assets. Additionally, the Amended and Restated Credit Agreement contains the following financial covenants that are computed quarterly on a rolling four-quarter basis as applicable:

·       A maximum Consolidated Leverage Ratio of 3.75 until December 2009.  Consolidated Leverage Ratio means the ratio of (x) the aggregate stated balance sheet amount of the Company’s indebtedness determined on a consolidated basis in accordance with Generally Accepted Accounting Principles (“GAAP”) as of the last day of the fiscal quarter for which such determination is being made to (y) Consolidated Earnings Before Interest, Taxes, Depreciation and Amortization (“EBITDA”) for the four consecutive fiscal quarters ended on the last day of the fiscal quarter for which such determination is being made.

·       A maximum Consolidated Senior Debt Ratio of 2.50 until December 2009.  Consolidated Senior Debt Ratio means the ratio of (x) the aggregate stated balance sheet amount of the Company’s indebtedness, the amount of the Company’s 6.25% senior subordinated notes due 2012 (the “2004 Notes”) and the Convertible Debentures determined on a consolidated basis in accordance with GAAP as of the last day of the fiscal quarter for which such determination is being made to (y) Consolidated EBITDA for the four consecutive fiscal quarters ended on the last day of the fiscal quarter for which such determination is being made.

·       A minimum Consolidated Interest Coverage Ratio of 3.50 until December 2009. Consolidated Interest Coverage Ratio means, as of any date of determination, the ratio computed for the Company’s four most recent fiscal quarters of (x) Consolidated EBITDA to (y) the total interest expense less non-cash amortization costs included in interest expense.

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 the Company and its subsidiaries in accordance with GAAP.

The Company was in compliance with its covenants as of March 31, 2006 and June 30, 2006.

15




(9)            Goodwill and Intangible Assets

The following disclosure presents certain information regarding the Company’s acquired intangible assets as of December 31, 2005 and June 30, 2006.  Amortizable intangible assets are amortized over their estimated useful lives, as indicated below, with no estimated residual values. For the three months ended June 30, 2006, intangible assets were impacted by foreign currency translation adjustments of approximately $300.

Intangible Assets

 

Weighted
Average
Amortization
Period

 

Gross Carrying 
Amount

 

Accumulated
Amortization

 

Net Balance

 

Balance at December 31, 2005

 

 

 

 

 

 

 

 

 

Amortizable intangible assets:

 

 

 

 

 

 

 

 

 

Patents

 

15

 

$

5,201

 

811

 

4,390

 

Customer lists

 

14

 

18,813

 

8,804

 

10,009

 

Customer service contracts

 

15

 

3,793

 

1,392

 

2,401

 

Licenses

 

4

 

14,458

 

6,906

 

7,552

 

Lottery contracts

 

5

 

31,902

 

13,441

 

18,461

 

 

 

 

 

74,167

 

31,354

 

42,813

 

Non-amortizable intangible assets:

 

 

 

 

 

 

 

 

 

Tradename

 

 

 

32,574

 

2,118

 

30,456

 

Connecticut off-track betting system operating right

 

 

 

22,339

 

8,319

 

14,020

 

 

 

 

 

54,913

 

10,437

 

44,476

 

Total intangible assets

 

 

 

$

129,080

 

41,791

 

87,289

 

 

 

 

 

 

 

 

 

 

 

Balance at June 30, 2006

 

 

 

 

 

 

 

 

 

Amortizable intangible assets:

 

 

 

 

 

 

 

 

 

Patents

 

14

 

$

7,116

 

903

 

6,213

 

Customer lists

 

10

 

28,060

 

10,055

 

18,005

 

Customer service contracts

 

15

 

3,577

 

1,711

 

1,866

 

Licenses

 

4

 

26,039

 

9,346

 

16,693

 

Intellectual property

 

4

 

20,581

 

1,443

 

19,138

 

Lottery contracts

 

5

 

34,782

 

16,360

 

18,422

 

 

 

 

 

120,155

 

39,818

 

80,337

 

Non-amortizable intangible assets:

 

 

 

 

 

 

 

 

 

Tradename

 

 

 

37,809

 

2,118

 

35,691

 

Connecticut off-track betting system operating right

 

 

 

34,319

 

8,319

 

26,000

 

 

 

 

 

72,128

 

10,437

 

61,691

 

Total intangible assets

 

 

 

$

192,283

 

50,255

 

142,028

 

 

16




The aggregate intangible amortization expense for the three month periods ended June 30, 2005 and 2006 was approximately $2,600 and $5,400, respectively.  The aggregate intangible amortization expense for the six month periods ended June 30, 2005 and 2006 was approximately $5,300 and $8,200, respectively.

The table below reconciles the change in the carrying amount of goodwill, by reporting segment, for the period from January 1, 2006 to June 30, 2006.  In 2006, the Company recorded (a) a $489 increase in goodwill associated with the final purchase price valuation and allocation adjustments of Promo-Travel International, Inc., (b) a $ 618 decrease in goodwill associated with the acquisition of IGT OnLine Entertainment Systems, Inc., (c) a $314 decrease in goodwill associated with the acquisition of the remaining 35% minority interest in Scientific Games Latin America S.A., (d) a $74,811 increase in goodwill in connection with the acquisition of the online assets of EssNet, (e) a $43 increase in goodwill for the acquisition of an off-track betting operation, (f) a $149,986 increase in goodwill for the acquisition of Global Draw and (g) a $7,097 increase in goodwill, as a result of foreign currency translation.

Goodwill

 

Printed
Products
Group

 

Lottery
Systems
Group

 

Diversified
Gaming 
Group

 

Totals

 

Balance at December 31, 2005

 

$

243,439

 

95,115

 

615

 

339,169

 

Adjustments:

 

918

 

78,371

 

152,205

 

231,494

 

Balance at June 30, 2006

 

$

244,357

 

173,486

 

152,820

 

570,663

 

(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 certain 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 tax authorities.

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 following table sets forth the combined amount of net periodic benefit cost recognized for the three and six month periods ended June 30, 2005 and 2006:

 

Three Months Ended

 

Six Months Ended

 

 

 

June 30,

 

June 30,

 

 

 

2005

 

2006

 

2005

 

2006

 

Components of net periodic pension benefit cost:

 

 

 

 

 

 

 

 

 

Service cost

 

$

813

 

548

 

$

1,627

 

1,095

 

Interest cost

 

787

 

551

 

1,575

 

1,102

 

Expected return on plan assets

 

(626

)

(561

)

(1,251

)

(1,123

)

Actuarial loss

 

420

 

276

 

839

 

551

 

Net amortization and deferral

 

16

 

20

 

32

 

40

 

Amortization of prior service costs

 

192

 

 

384

 

 

Net periodic cost

 

$

1,602

 

834

 

$

3,206

 

1,665

 

17




The Company previously disclosed in its financial statements for the year ended December 31, 2005, that it expected to contribute approximately $2,500 to its defined benefit pension plans in 2006. As of June 30, 2006, approximately $1,000 and $20 of contributions to the U.K. Plan and U.S. Plan, respectively, have been made. The Company presently anticipates contributing an additional $1,480 of contributions to its defined benefit pension plans, in 2006, for a total of $2,500.

(11)     Stockholders’ Equity

At June 30, 2006, the Company had a total of 2,000 shares of preferred stock, $1.00 par value, authorized for issuance, including 229 authorized shares of Series A Convertible Preferred Stock and 1 authorized share of Series B Preferred Stock. No shares of preferred stock are currently outstanding.

(12)  Stock-Based Compensation

On January 1, 2006, the Company adopted, using the modified prospective application, Statement of Financial Accounting Standards No. 123(revised 2004), “Share-Based Payment” (“SFAS 123(R)”). SFAS 123(R) requires all share-based payments to employees, including grants of employee stock options and shares purchased under an employee stock purchase plan (if certain parameters are not met), to be recognized in the financial statements based on their fair values and did not change the accounting guidance for share-based payment transactions with parties other than employees provided in SFAS 123, “Accounting for Stock Based Compensation” (“SFAS 123”), as originally issued and Emerging Issues Task Force (“EITF”) 96-18, “Accounting for Equity Instruments That Are Issued to Other Than Employees for Acquiring, or in Conjunction with Selling, Goods or Services.” SFAS 123(R) did not address the accounting for employee share ownership plans, which are subject to Statement of Position (“SOP”) 93-6, “Employers’ Accounting for Employee Stock Ownership Plans.”  Under the modified prospective method the Company’s prior interim periods and prior fiscal year financial statements will not reflect any restated amounts for the adoption of SFAS 123(R).

Upon its adoption of SFAS 123(R), the Company began recording compensation cost related to the continued vesting of all stock options that remained unvested as of January 1, 2006, as well as for all stock options granted, modified or cancelled after the Company’s adoption date. The compensation cost to be recorded is based on the fair value at the grant date. The adoption of SFAS 123(R) did not have an effect on the Company’s recognition of compensation expense relating to the vesting of restricted stock grants.

Prior to the adoption of SFAS 123(R), cash flows resulting from the tax benefit related to equity-based compensation was presented in the Company’s operating cash flows, along with other tax cash flows, in accordance with the provisions of EITF 00-15, “Classification in the Statement of Cash Flows of the Income Tax Benefit Received by a Company upon Exercise of a Nonqualified Employee Stock Option,” (“EITF 00-15”). SFAS 123(R) superseded EITF 00-15, amended SFAS 95, “Statement of Cash Flows,” and requires tax benefits relating to excess equity-based compensation deductions to be prospectively presented in the Company’s statement of cash flows as financing cash inflows.

The effect of adopting SFAS 123(R) on the Company’s income from operations, income before income taxes, net income, net cash provided by operating activities, net cash provided by financing activities, and basic and diluted earnings per share for the three and six month periods ended June 30, 2006, is as follows (in thousands, except per share data):

18




 

 

Three Months
Ended
June 30, 2006

 

Six Months
Ended
June 30, 2006

 

Income from operations, as reported

 

$

42,923

 

79,876

 

Effect of adopting SFAS 123(R) on income from operations

 

3,470

 

7,161

 

Income from operations

 

$

46,393

 

87,037

 

 

 

 

 

 

 

Income before income taxes, as reported

 

$

35,191

 

67,161

 

Effect of adopting SFAS 123(R) on income before income taxes

 

3,470

 

7,161

 

Income before income taxes

 

$

38,661

 

74,322

 

 

 

 

 

 

 

Net income, as reported

 

$

24,977

 

47,347

 

Effect of adopting SFAS 123(R) on net income

 

2,318

 

4,784

 

Net income

 

$

27,295

 

52,131

 

 

 

 

 

 

 

Net cash provided by operating activities, as reported

 

$

56,035

 

90,199

 

Effect of adopting SFAS 123(R) on net cash provided by operating activities

 

2,318

 

4,784

 

Net cash provided by operating activities

 

$

58,353

 

94,983

 

 

 

 

 

 

 

Net cash provided by financing activities, as reported

 

$

215,950

 

292,802

 

Effect of adopting SFAS 123(R) on net cash provided by financing activities

 

(2,318

)

(4,784

)

Net cash provided by financing activities

 

$

213,632

 

288,018

 

 

 

 

 

 

 

Net income per share, as reported:

 

 

 

 

 

Basic

 

$

0.27

 

0.52

 

Diluted

 

$

0.26

 

0.50

 

 

 

 

 

 

 

Effect of adopting SFAS 123(R) on net income per share, basic and diluted

 

$

0.02

 

0.05

 

 

 

 

 

 

 

Net income per share:

 

 

 

 

 

Basic

 

$

0.29

 

0.57

 

Diluted

 

$

0.28

 

0.55

 

Prior to its adoption of SFAS 123(R), the Company accounted for equity-based compensation under the provisions and related interpretations of Accounting Principles Board (“APB”) No. 25, “Accounting for Stock Issued to Employees” (“APB 25”). Accordingly, the Company was not required to record compensation expense when stock options were granted to its employees as long as the exercise price was not less than the fair market value of the stock at the grant date. Also, the Company was not required to record compensation expense when the Company issued common stock under its Employee Stock Purchase Plan as long as the purchase price was not less than 85% of the fair market value of the Company’s common stock on the grant date. In October 1995, FASB issued SFAS 123, which allowed the Company to continue to follow the guidelines of APB 25, but required pro-forma disclosures of net income and earnings per share as if the Company had adopted the provisions of SFAS 123. In December 2002, the FASB issued SFAS 148, “Accounting for Stock-Based Compensation — Transition and Disclosure — an Amendment of FASB 123,” which provided alternative methods of transition for an entity that voluntarily changes to the fair value based method of accounting for equity-based employee compensation. The Company continued to account for equity-based compensation under the provisions of APB 25 using the intrinsic value method.

19




Had compensation cost for the Company’s equity-based compensation plans been determined based on the fair value at the grant dates for awards under those plans in accordance with the provisions of SFAS 123, the Company’s net income and net income per share for the three and six month periods ended June 30, 2005, would have been as follows (in thousands, except per share data):

 

Three Months
Ended
June 30, 2005

 

Six Months
Ended
June 30, 2005

 

Net income, as reported

 

$

24,764

 

45,779

 

Equity-based compensation included in net income, as reported

 

51

 

103

 

Equity-based compensation under SFAS 123

 

(2,152

)

(4,024

)

Pro forma net income

 

$

22,663

 

41,858

 

 

 

 

 

 

 

Reported net income per share:

 

 

 

 

 

Basic

 

$

0.28

 

0.51

 

Diluted

 

$

0.27

 

0.50

 

 

 

 

 

 

 

Pro forma net income per share:

 

 

 

 

 

Basic

 

$

0.26

 

0.48

 

Diluted

 

$

0.25

 

0.46

 

The Company grants stock options to employees and directors under the Company’s equity incentive plans at not less than the fair market value of the stock at the date of grant. Options granted over the last several years have been exercisable in four or five equal installments beginning on the first anniversary of the date of grant with a maximum term of ten years.

The Company grants restricted stock units to employees and directors under the Company’s equity incentive plans. Restricted stock units have only been granted over the last year and have been exercisable in five equal installments beginning on the first anniversary of the date of grant with a maximum term of five years.

Stock Options

A summary of the changes in stock options outstanding under the Company’s equity-based compensation plans in 2006 is presented below:

20




 

 

 

Number of
Options

 

Weighed
Average
Remaining
Contract
Term
(Years)

 

Weighed
Average 
Exercise
Price

 

Aggregate
Intrinsic
Value

 

 

 

(In thousand except share price and year)

 

 

 

 

 

 

 

 

 

 

 

Options outstanding at December 31, 2005

 

9,701

 

 

 

$

15.52

 

$

 

Granted

 

405

 

 

 

31.76

 

 

Exercised

 

(1,241

)

 

 

7.27

 

31,523

 

Canceled

 

(772

)

 

 

26.79

 

 

Options outstanding at March 31, 2006

 

8,093

 

7.1

 

$

16.54

 

$

149,610

 

Granted

 

155

 

 

 

37.04

 

 

Exercised

 

(148

)

 

 

13.42

 

3,657

 

Canceled

 

(30

)

 

 

21.16

 

 

Options outstanding at June 30, 2006

 

8,070

 

6.8

 

$

16.98

 

$

144,007

 

 

 

 

 

 

 

 

 

 

 

Options excercisable at

 

 

 

 

 

 

 

 

 

March 31, 2006

 

3,001

 

4.8

 

$

7.49

 

$

82,659

 

June 30, 2006

 

3,080

 

4.5

 

$

7.39

 

$

84,492

 

 

 

Three Months Ended

 

 

 

March 31, 2006

 

June 30, 2006

 

Weighted average per-share fair value of options granted during the period

 

$

13.16

 

15.70

 

The fair value of each option grant is estimated on the date of grant using the Black-Scholes option pricing model.  The weighted average assumptions used in the model are outlined in the following table:

21




 

 

Six Months Ended

 

 

 

June 30, 2006

 

 

 

 

 

Assumptions:

 

 

 

Expected volatility

 

33.25

%

Risk-free interest rate

 

4.4% - 5.2

%

Dividend yield

 

%

Expected life (in years)

 

6

 

The computation of the expected volatility is based on historical daily stock price over a term less than the expected term. A timeframe was used that provided a better representation of the current and future expected volatility. Expected life is based on annual historical employee exercise behavior of option grants with similar vesting periods and option expiration data. The risk-fee interest rate is based on the yield of zero-coupon U.S. Treasury securities. There are no dividends to be paid.

For the three and six month periods ended, June 30, 2006, the Company recognized equity-based compensation expense of approximately $3,500 and $7,200, respectively, related to the vesting of stock options and the related tax benefit of approximately $800 and $2,200, respectively.  At June 30, 2006, the Company had unearned compensation of approximately $42,000 relating to stock option awards that will be amortized over a period of approximately four years. At June 30, 2006, the Company had 2,400 options and restricted stock units available to be granted under its equity-based compensation plans.

Restricted Stock Unit

A summary of the changes in restricted stock unit outstanding under the Company’s equity compensation plans during the six months ended June 30, 2006 is presented below:

 

Number of
Restricted
Stock

 

Weighed
Average
Grant Date
Fair Value

 

 

 

(In thousands except share price)

 

 

 

 

 

 

 

Non-vested shares at December 31, 2005

 

363

 

$

27.57

 

Granted

 

541

 

30.84

 

Vested

 

 

 

Canceled

 

(2

)

28.11

 

Non-vested shares at March 31, 2006

 

902

 

$

29.53

 

Granted

 

124

 

38.08

 

Vested

 

 

 

Canceled

 

(2

)

27.68

 

Non-vested shares at June 30, 2006

 

1,024

 

$

30.67

 

22




In the three and six months ended June 30, 2006, we recognized equity-based compensation expense of approximately $1,500 and $2,200, respectively, related to the vesting of restricted stock unit and the related tax benefit of approximately $600 and $900, respectively.  At June 30, 2006, the Company had unearned compensation of approximately $26,500 relating to restricted stock units that will be amortized over a period of approximately four years.

Employee Stock Purchase Plan

In 2002, the Company adopted, and its stockholders approved, an Employee Stock Purchase Plan (“ESPP”) under which a total of up to 1,000 shares of Class A Common Stock may be purchased by eligible employees under offerings made by the Company each January 1 and July 1. Employees participate through payroll deductions up to a maximum of 15% of eligible compensation. The term of each offering period is six months and shares are purchased on the last day of the offering period at a discount on the stock’s market value. Under an amendment to the ESPP adopted in 2005, the purchase price for offering periods beginning in 2006 will represent a 15% discount on the closing price of the stock on the last day of the offering period (rather than a 15% discount on the lower of (x) the closing price of the stock on the first day of the offering period and (y) the closing price of the stock on the last day of the offering period).  The Company issued 18 shares under the ESPP during the quarter ended June 30, 2006.

(13)     Litigation

On April 28, 2006, the Company agreed to settle the previously reported patent litigation with Oberthur Gaming Technologies Corporation (“OGT”). As part of the settlement, the parties dismissed litigation in Georgia federal court and Munich, Germany.  In addition, on April 28, 2006 the Company obtained a non-exclusive, pre-paid license to the patents of OGT for a one-time payment of $1,750.

As previously reported, in November 2005, the Company was advised that the North Carolina Secretary of State referred to the North Carolina Attorney General for investigation alleged misdemeanor violations of the North Carolina Lobbying Act by the Company’s subsidiary Scientific Games International, Inc. and one of its now former employees for alleged failure to timely register as a lobbyist. On May 22, 2006, the Company learned that the former employee and two former consultants were charged with misdemeanors for failing to register as lobbyists by the District Attorney for North Carolina who had been assigned the investigation and that the investigation has now been concluded. The Company is cooperating with the prosecution.

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

The Company conducts substantially all of its business through its domestic and foreign subsidiaries.  The 2004 Notes, the Convertible Debentures and the July 2006 Amended and Restated Credit Agreement are fully, unconditionally and jointly and severally guaranteed by substantially all of the Company’s 100% owned domestic subsidiaries (the “Guarantor Subsidiaries”).

Presented below is condensed consolidating financial information for (i) Scientific Games Corporation (the “Parent Company”), (ii) the 100% owned Guarantor Subsidiaries and (iii) the 100% owned foreign subsidiaries and the non-100% owned domestic and foreign subsidiaries (collectively, the “Non-Guarantor Subsidiaries”) as of December 31, 2005 and June 30, 2006 and for the three and six months ended June 30, 2005 and 2006.  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 July 2006 Amended and Restated Credit Agreement, the Convertible Debentures and the 2004 Notes were 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.

23




Scientific Games Management Corporation has been reclassified from the Parent Company to the Guarantor Subsidiaries for the three and six months ended June 30, 2005.

24




SCIENTIFIC GAMES CORPORATION AND SUBSIDIARIES
SUPPLEMENTAL CONDENSED CONSOLIDATING BALANCE SHEET

December 31, 2005
(Unaudited, in thousands)

 

Parent
Company

 

Guarantor
Subsidiaries

 

Non-
Guarantor
Subsidiaries

 

Eliminating
Entries

 

Consolidated

 

ASSETS

 

 

 

 

 

 

 

 

 

 

 

Cash and cash equivalents

 

$

 

15,575

 

23,367

 

 

38,942

 

Accounts receivable, net

 

 

98,704

 

30,585

 

(39

)

129,250

 

Inventories

 

 

29,653

 

10,920

 

(425

)

40,148

 

Other current assets

 

4,938

 

22,102

 

19,173

 

 

46,213

 

Property and equipment, net

 

 

261,027

 

105,759

 

(567

)

366,219

 

Investment in subsidiaries

 

417,182

 

187,577

 

(26,482

)

(578,277

)

 

Goodwill

 

183

 

300,015

 

38,971

 

 

339,169

 

Intangible assets

 

 

74,638

 

12,651

 

 

87,289

 

Other assets

 

11,446

 

91,140

 

28,798

 

(6,101

)

125,283

 

Total assets

 

$

433,749

 

1,080,431

 

243,742

 

(585,409

)

1,172,513

 

 

 

 

 

 

 

 

 

 

 

 

 

LIABILITIES AND STOCKHOLDERS’ EQUITY

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Current installments of long-term debt

 

$

1,000

 

 

5,055

 

 

6,055

 

Current liabilities

 

(7,465

)

96,259

 

46,398

 

115

 

135,307

 

Long-term debt, excluding current installments

 

573,000

 

 

1,680

 

 

574,680

 

Other non-current liabilities

 

(13,673

)

61,143

 

22,162

 

6

 

69,638

 

Intercompany balances

 

(698,987

)

658,194

 

40,793

 

 

 

Stockholders’ equity

 

579,874

 

264,835

 

127,654

 

(585,530

)

386,833

 

Total liabilities and stockholders’ equity

 

$

433,749

 

1,080,431

 

243,742

 

(585,409

)

1,172,513

 

25




SCIENTIFIC GAMES CORPORATION AND SUBSIDIARIES
SUPPLEMENTAL CONDENSED CONSOLIDATING BALANCE SHEET
June 30, 2006
(Unaudited, in thousands)

 

Parent 
Company

 

Guarantor
Subsidiaries

 

Non-
Guarantor
Subsidiaries

 

Eliminating
Entries

 

Consolidated

 

ASSETS

 

 

 

 

 

 

 

 

 

 

 

Cash and cash equivalents

 

$

 

(4,050

)

38,205

 

 

34,155

 

Accounts receivable, net

 

 

109,325

 

49,414

 

 

158,739

 

Inventories

 

 

40,734

 

10,684

 

(425

)

50,993

 

Other current assets

 

8,231

 

22,368

 

41,256

 

 

71,855

 

Property and equipment, net

 

 

298,035

 

130,195

 

(537

)

427,693

 

Investment in subsidiaries

 

682,257

 

191,714

 

113,090

 

(987,061

)

 

Goodwill

 

183

 

299,886

 

270,594

 

 

570,663

 

Intangible assets

 

 

98,281

 

43,747

 

 

142,028

 

Other assets

 

11,665

 

99,909

 

34,929

 

(6,061

)

140,442

 

Total assets

 

$

702,336

 

1,156,202

 

732,114

 

(994,084

)

1,596,568

 

 

 

 

 

 

 

 

 

 

 

 

 

LIABILITIES AND STOCKHOLDERS’ EQUITY

 

 

 

 

 

 

 

 

 

 

 

Current installments of long-term debt

 

$

2,000

 

 

818

 

 

2,818

 

Current liabilities

 

(1,242

)

77,306

 

103,020

 

79

 

179,163

 

Long-term debt, excluding current installments

 

853,750

 

 

1,479

 

 

855,229

 

Other non-current liabilities

 

(13,674

)

73,360

 

21,875

 

6

 

81,567

 

Intercompany balances

 

(720,048

)

684,059

 

35,989

 

 

 

Stockholders’ equity

 

581,550

 

321,477

 

568,933

 

(994,169

)

477,791

 

Total liabilities and stockholders’ equity

 

$

702,336

 

1,156,202

 

732,114

 

(994,084

)

1,596,568

 

26




SCIENTIFIC GAMES CORPORATION AND SUBSIDIARIES
SUPPLEMENTAL CONDENSED STATEMENT OF INCOME
Three Months Ended June 30, 2005
(Unaudited, in thousands)

 

Parent
Company

 

Guarantor 
Subsidiaries

 

Non-
Guarantor
Subsidiaries

 

Eliminating
Entries

 

Consolidated

 

Operating revenues

 

$

 

152,056

 

49,657

 

(4,289

)

197,424

 

Cost of services and cost of sales (exclusive of depreciation and amortization)

 

 

81,653

 

35,471

 

(4,189

)

112,935

 

Selling, general and administrative expenses

 

570

 

20,709

 

4,466

 

(20

)

25,725

 

Depreciation and amortization

 

28

 

13,613

 

3,478

 

 

17,119

 

Operating income (loss)

 

(598

)

36,081

 

6,242

 

(80

)

41,645

 

Interest expense

 

6,356

 

155

 

301

 

 

6,812

 

Other (income) expense, net

 

 

245

 

99

 

33

 

377

 

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

 

(6,954

)

35,681

 

5,842

 

(113

)

34,456

 

Equity in income of subsidiaries

 

38,629

 

 

 

(38,629

)

 

Income tax expense

 

6,911

 

1,642

 

1,139

 

 

9,692

 

Net income

 

$

24,764

 

34,039

 

4,703

 

(38,742

)

24,764

 

SCIENTIFIC GAMES CORPORATION AND SUBSIDIARIES
SUPPLEMENTAL CONDENSED STATEMENT OF INCOME
Three Months Ended June 30, 2006
(Unaudited, in thousands)

 

Parent
Company

 

Guarantor
Subsidiaries

 

Non-
Guarantor
Subsidiaries

 

Eliminating
Entries

 

Consolidated

 

Operating revenues

 

$

 

155,180

 

89,884

 

(5,427

)

239,637

 

Cost of services and cost of sales (exclusive of depreciation and amortization)

 

 

84,372

 

58,898