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 March 31, 2008

 

 

 

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, a non-accelerated filer, or a smaller reporting company. See definitions of “large accelerated filer,” “accelerated filer,” and “smaller reporting company” in Rule 12b-2 of the Exchange Act. (Check one):

 

Large accelerated filer x

 

Accelerated filer o

 

 

 

Non-accelerated filer o

 

Smaller reporting company o

(Do not check if a smaller reporting company)

 

 

 

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

 

The registrant has the following number of shares outstanding of each of the registrant’s classes of common stock as of May 7, 2008:

 

Class A Common Stock:  92,614,278

Class B Common Stock:  None

 

 



 

SCIENTIFIC GAMES CORPORATION AND SUBSIDIARIES

 INDEX TO FINANCIAL INFORMATION

 AND OTHER INFORMATION

THREE MONTHS ENDED MARCH 31, 2008

 

PART I.

FINANCIAL INFORMATION

 

 

 

 

Item 1.

Financial Statements

 

 

 

 

 

Consolidated Balance Sheets as of March 31, 2008 and December 31, 2007

 

 

 

 

 

Consolidated Statements of Income for the Three Months Ended March 31, 2008 and 2007

 

 

 

 

 

Condensed Consolidated Statements of Cash Flows for the Three Months Ended March 31, 2008 and 2007

 

 

 

 

 

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 2.

Unregistered Sales of Equity Securities and Use of Proceeds

 

 

 

 

Item 6.

Exhibits

 

 

2



 

Forward-Looking Statements

 

Throughout this Quarterly Report on Form 10-Q we make “forward-looking statements” within the meaning of the U.S. Private Securities Litigation Reform Act of 1995. Forward-looking statements describe future expectations, plans, results or strategies and can often be identified by the use of terminology such as “may,” “will,” “estimate,” “intend,” “continue,” “believe,” “expect,” “anticipate,” “could,” “potential,” “opportunity,” or similar terminology. The forward-looking statements contained in this Quarterly Report on Form 10-Q are generally located in the material set forth under the heading “Management’s Discussion and Analysis of Financial Condition and Results of Operations” but may be found in other locations as well. These statements are based upon management’s current expectations, assumptions and estimates and are not guarantees of future results or performance. Actual results may differ materially from those projected in these statements due to a variety of risks and uncertainties and other factors, including, among other things: competition; material adverse changes in economic and industry conditions in our markets; technological change; retention and renewal of existing contracts and entry into new contracts; availability and adequacy of cash flow to satisfy obligations and indebtedness or future needs; protection of intellectual property; security and integrity of software and systems; laws and government regulation, including those relating to gaming licenses, permits and operations; inability to identify, complete and integrate future acquisitions; seasonality; dependence on suppliers and manufacturers; factors associated with foreign operations; dependence on key personnel; failure to perform on contracts; resolution of pending or future litigation; labor matters; and stock price volatility. Additional information regarding risks and uncertainties and other factors that could cause actual results to differ materially from those contemplated in forward-looking statements is set forth from time to time in our filings with the SEC, including under the heading “Risk Factors” in our most recent Annual Report on Form 10-K. Forward-looking statements speak only as of the date they are made, and except for our ongoing obligations under the U.S. federal securities laws, we undertake no obligation to publicly update any forward-looking statements whether as a result of new information, future events or otherwise.

 

3



 

SCIENTIFIC GAMES CORPORATION AND SUBSIDIARIES

CONSOLIDATED BALANCE SHEETS

As of March 31, 2008 and December 31, 2007

(Unaudited, in thousands, except per share amounts)

 

PART 1. FINANCIAL INFORMATION

 

Item 1. Financial Statements

 

 

 

March 31,

 

December 31,

 

 

 

2008

 

2007

 

ASSETS

 

 

 

 

 

Current assets:

 

 

 

 

 

Cash and cash equivalents

 

$

31,924

 

$

29,403

 

Accounts receivable, net of allowance for doubtful accounts of $9,443 and $9,184 as of March 31, 2008 and December 31, 2007, respectively

 

198,936

 

203,074

 

Inventories

 

93,926

 

92,565

 

Deferred income taxes, current portion

 

16,172

 

15,929

 

Prepaid expenses, deposits and other current assets

 

62,831

 

56,906

 

Total current assets

 

403,789

 

397,877

 

Property and equipment, at cost

 

1,035,211

 

966,291

 

Less: accumulated depreciation

 

(439,117

)

(404,667

)

Net property and equipment

 

596,094

 

561,624

 

Goodwill, net

 

724,892

 

716,856

 

Intangible assets, net

 

129,103

 

133,030

 

Other assets and investments

 

312,654

 

290,652

 

Total assets

 

$

2,166,532

 

$

2,100,039

 

 

 

 

 

 

 

 

LIABILITIES AND STOCKHOLDERS’ EQUITY

 

 

 

 

 

Current liabilities:

 

 

 

 

 

Current installments of long-term debt

 

$

13,777

 

$

4,942

 

Accounts payable

 

56,657

 

64,108

 

Accrued liabilities

 

146,494

 

148,464

 

Total current liabilities

 

216,928

 

217,514

 

Deferred income taxes

 

53,272

 

51,661

 

Other long-term liabilities

 

95,680

 

97,024

 

Long-term debt, excluding current installments

 

1,111,920

 

1,072,625

 

Total liabilities

 

1,477,800

 

1,438,824

 

 

 

 

 

 

 

Commitments and contingencies

 

 

 

 

 

 

 

 

 

 

 

Stockholders’ equity:

 

 

 

 

 

Class A common stock, par value $0.01 per share, 199,300 shares authorized, and 92,581 and 93,414 shares outstanding as of March 31, 2008 and December 31, 2007, respectively

 

926

 

934

 

Additional paid-in capital

 

532,788

 

521,902

 

Accumulated earnings

 

117,230

 

97,323

 

Treasury stock, at cost, 2,140 and 1,140 shares held as of March 31, 2008 and December 31, 2007, respectively

 

(37,459

)

(19,442

)

Accumulated other comprehensive income

 

75,247

 

60,498

 

Total stockholders’ equity

 

688,732

 

661,215

 

Total liabilities and stockholders’ equity

 

$

2,166,532

 

$

2,100,039

 

 

See accompanying notes to consolidated financial statements.

 

4



 

SCIENTIFIC GAMES CORPORATION AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF INCOME

Three Months Ended March 31, 2008 and 2007

 (Unaudited, in thousands, except per share amounts)

 

 

 

Three Months Ended March 31,

 

 

 

2008

 

2007

 

Operating revenues:

 

 

 

 

 

Services

 

$

233,953

 

$

210,993

 

Sales

 

23,054

 

31,273

 

 

 

257,007

 

242,266

 

Operating expenses:

 

 

 

 

 

Cost of services (exclusive of depreciation and amortization)

 

130,378

 

116,747

 

Cost of sales (exclusive of depreciation and amortization)

 

16,844

 

22,485

 

Selling, general and administrative expenses

 

49,788

 

39,145

 

Depreciation and amortization

 

34,504

 

29,078

 

Operating income

 

25,493

 

34,811

 

Other (income) expense:

 

 

 

 

 

Interest expense

 

13,884

 

12,892

 

Equity in income of joint ventures

 

(16,859

)

(11,878

)

Other (income) expense, net

 

50

 

(390

)

 

 

(2,925

)

624

 

Income before income taxes

 

28,418

 

34,187

 

Income tax expense

 

8,511

 

9,428

 

Net income

 

$

19,907

 

$

24,759

 

 

 

 

 

 

 

Basic and diluted net income per share:

 

 

 

 

 

Basic net income per share

 

$

0.21

 

$

0.27

 

Diluted net income per share

 

$

0.21

 

$

0.26

 

 

 

 

 

 

 

Weighted-average number of shares used in per share calculations:

 

 

 

 

 

Basic shares

 

93,314

 

91,993

 

Diluted shares

 

94,718

 

95,288

 

 

 See accompanying notes to consolidated financial statements.

 

5



 

SCIENTIFIC GAMES CORPORATION AND SUBSIDIARIES

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

Three months Ended March 31, 2008 and 2007

(Unaudited, in thousands, except per share amounts)

 

 

 

Three Months Ended March 31,

 

 

 

2008

 

2007

 

Net cash provided by operating activities

 

$

38,430

 

$

30,420

 

 

 

 

 

 

 

Cash flows from investing activities:

 

 

 

 

 

Capital expenditures

 

(3,680

)

(2,465

)

Wagering system expenditures

 

(49,315

)

(23,543

)

Other intangible assets and software expenditures

 

(11,031

)

(8,354

)

Change in other assets and liabilities, net

 

14

 

(6,447

)

Business acquisitions, net of cash acquired

 

(2,742

)

(336

)

Net cash used in investing activities

 

(66,754

)

(41,145

)

 

 

 

 

 

 

Cash flows from financing activities:

 

 

 

 

 

Net borrowings under revolving credit facility

 

40,500

 

(191,000

)

Net proceeds of long-term debt

 

7,417

 

198,665

 

Purchase of treasury stock

 

(18,017

)

 

Net proceeds from issuance of common stock

 

(27

)

8,360

 

Net cash provided by financing activities

 

29,873

 

16,025

 

Effect of exchange rate changes on cash and cash equivalents

 

972

 

140

 

Increase in cash and cash equivalents

 

2,521

 

5,440

 

Cash and cash equivalents, beginning of period

 

29,403

 

27,791

 

Cash and cash equivalents, end of period

 

$

31,924

 

$

33,231

 

 

See accompanying notes to consolidating 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 March 31, 2008, the consolidated statements of income for the three months ended March 31, 2008 and 2007, and the condensed consolidated statements of cash flows for the three months ended March 31, 2008 and 2007, have been prepared by Scientific Games Corporation and are unaudited.  When used in these notes, the terms “the Company,” “we,” “us,” “our” and “our Company” mean Scientific Games Corporation and all entities included in our consolidated financial statements unless otherwise specified or the context otherwise indicates. In the opinion of management, all adjustments necessary to present fairly our consolidated financial position as of March 31, 2008 and the results of our operations and our cash flows for the three months ended March 31, 2008 and 2007 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 our 2007 Annual Report on Form 10-K.  The results of operations for the period ended March 31, 2008 are not necessarily indicative of the operating results for a 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 months ended March 31, 2008 and 2007:

 

 

 

Three Months Ended

 

 

 

March 31,

 

 

 

2008

 

2007

 

Income (numerator)

 

 

 

 

 

Net income

 

$

19,907

 

$

24,759

 

 

 

 

 

 

 

Shares (denominator)

 

 

 

 

 

Weighted-average basic common shares outstanding

 

93,314

 

91,993

 

Effect of dilutive securities-stock rights

 

1,404

 

2,611

 

Effect of dilutive shares related to convertible debentures

 

 

684

 

Weighted-average diluted common shares outstanding

 

94,718

 

95,288

 

 

 

 

 

 

 

Basic and diluted per share amounts

 

 

 

 

 

Basic net income per share

 

$

0.21

 

$

0.27

 

Diluted net income per share

 

$

0.21

 

$

0.26

 

 

The weighted-average diluted common shares outstanding for the three months ended March 31, 2008 and 2007 excludes the effect of approximately 3,439 and 1,142, respectively, out-of-the-money stock options, because their effect would be anti-dilutive.

 

The aggregate number of shares that we could be obligated to issue upon conversion of the remaining $273,800 in aggregate principal amount of 0.75% convertible senior subordinated notes due 2024 (the “Convertible Debentures”), which were sold in December 2004, is approximately 9,408. The Convertible Debentures provide for net share settlement upon conversion. In December 2004, we purchased a bond hedge to mitigate the potential dilution from conversion of the Convertible Debentures during the term of the bond hedge.

 

7



 

SCIENTIFIC GAMES CORPORATION AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited, in thousands, except per share amounts)

 

(1) Consolidated Financial Statements (continued)

 

During the first quarter of 2008, the conversion price of the Convertible Debentures exceeded the average price of our common stock. Therefore, the weighted-average diluted common shares outstanding for the three months ended March 31, 2008 excludes the effect of shares that could be issued upon conversion of the Convertible Debentures because their effect would be anti-dilutive. During the first quarter of 2007, the average price of our common stock exceeded the conversion price of the Convertible Debentures. For the three months ended March 31, 2007 we have included approximately 684 shares related to our Convertible Debentures in our weighted-average diluted common shares outstanding.  For the three months ended March 31, 2007, we did not include the offset from the bond hedge in the weighted-average diluted common shares outstanding as it would be anti-dilutive. To the extent the Convertible Debentures are converted during the term of the bond hedge, the diluted share amount will decrease because the bond hedge will mitigate the dilution from conversion of the Convertible Debentures.

 

(2) Acquisitions

 

During the third quarter of 2007, we announced plans to close our instant ticket printing plant in San Antonio, Texas in conjunction with ongoing integration efforts related to our May 1, 2007 acquisition of Oberthur Gaming Technologies and related companies (“OGT”). We recorded approximately $8,221 in liabilities, primarily related to involuntary employee terminations, asset disposals and termination of contractual obligations. The table below summarizes the balance of the accrued integration costs as of March 31, 2008:

 

 

 

Severance

 

Asset

 

 

 

 

 

 

 

Pay and

 

Disposal

 

Contractual

 

Total

 

 

 

Benefits

 

Costs

 

Obligations

 

Liability

 

Accrued costs as of December 31, 2007

 

$

517

 

865

 

3,889

 

5,271

 

Adjustments to liability

 

 

1,483

 

 

 

1,483

 

Payments

 

(1,461

)

(7

)

(911

)

(2,379

)

Accrued costs as of March 31, 2008

 

$

539

 

858

 

2,978

 

4,375

 

 

8



 

SCIENTIFIC GAMES CORPORATION AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited, in thousands, except per share amounts)

 

(2) Acquisitions (continued)

 

In conjunction with the purchase of substantially all of the online lottery assets of EssNet AB (“EssNet”) in March of 2006, we recorded approximately $26,717 in liabilities, primarily related to involuntary employee terminations, termination of leases and termination of service contracts that will result from the integration. The table below summarizes the payments made and adjustments to the balance of the accrued integration costs from December 31, 2007 to March 31, 2008:

 

 

 

Severance

 

 

 

 

 

 

 

 

 

Pay and

 

Lease

 

Contractual

 

Total

 

 

 

Benefits

 

Terminations

 

Obligations

 

Liability

 

Accrued costs as of December 31, 2007

 

$

345

 

329

 

2,913

 

3,587

 

Payments

 

(115

)

(313

)

(227

)

(655

)

Foreign exchange rate adjustments

 

15

 

14

 

123

 

152

 

Accrued costs as of March 31, 2008

 

$

245

 

30

 

2,809

 

3,084

 

 

(3) Operating Segment Information

 

We operate in three segments. Our Printed Products Group provides lotteries with 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 licensed brand products and manufactures prepaid phone cards for cellular phone service providers. Our Lottery Systems Group offers online, instant and video lottery products and online and instant ticket validation systems. This division also provides 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.  Our Diversified Gaming Group provides services and systems to private and public operators in the wide area gaming markets and the pari-mutuel wagering industry. The product offerings of the Diversified Gaming Group include server-based gaming machines (including our Nevada™ dual screen terminals, which can offer Great Britain regulated Category B2 or B3 content on the same machines), video lottery terminals (“VLTs”), monitor games, wagering systems for the pari-mutuel racing industry, sports betting systems and services, and Great Britain regulated Category C Amusement With Prize (“AWP”) and Skill With Prize (“SWP”) terminals.

 

9



 

SCIENTIFIC GAMES CORPORATION AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited, in thousands, except per share amounts)

 

(3) Operating Segment Information (continued)

 

The following tables represent revenues, profits, depreciation, amortization and selling, general and administrative expenses for the three month periods ended March 31, 2008 and 2007, by current reportable segments. Corporate expenses, including interest expense, other income, and depreciation and amortization, are not allocated to the reportable segments.

 

 

 

Three Months Ended March 31, 2008

 

 

Printed
Products
Group

 

Lottery
Systems Group

 

Diversified
Gaming Group

 

Totals

 

Service revenues

 

$

127,226

 

54,646

 

52,081

 

233,953

 

Sales revenues

 

8,671

 

7,764

 

6,619

 

23,054

 

Total revenues

 

135,897

 

62,410

 

58,700

 

257,007

 

 

 

 

 

 

 

 

 

 

 

Cost of services (exclusive of depreciation and amortization)

 

70,813

 

28,649

 

30,916

 

130,378

 

Cost of sales (exclusive of depreciation and amortization)

 

6,245

 

5,872

 

4,727

 

16,844

 

Selling, general and administrative expenses

 

17,741

 

9,278

 

6,783

 

33,802

 

Depreciation and amortization

 

9,976

 

14,974

 

9,285

 

34,235

 

Segment operating income

 

$

31,122

 

3,637

 

6,989

 

41,748

 

Unallocated corporate costs

 

 

 

 

 

 

 

$

16,255

 

Consolidated operating income

 

 

 

 

 

 

 

$

25,493

 

 

 

 

Three Months Ended March 31, 2007

 

 

 

Printed 
Products 
Group

 

Lottery 
Systems Group

 

Diversified
Gaming Group

 

Totals

 

Service revenues

 

$

104,631

 

54,331

 

52,031

 

210,993

 

Sales revenues

 

9,262

 

11,049

 

10,962

 

31,273

 

Total revenues

 

113,893

 

65,380

 

62,993

 

242,266

 

 

 

 

 

 

 

 

 

 

 

Cost of services (exclusive of depreciation and amortization)

 

55,662

 

29,391

 

31,694

 

116,747

 

Cost of sales (exclusive of depreciation and amortization)

 

7,624

 

6,238

 

8,623

 

22,485

 

Selling, general and administrative expenses

 

11,481

 

7,997

 

5,348

 

24,826

 

Depreciation and amortization

 

8,400

 

14,131

 

6,322

 

28,853

 

Segment operating income

 

$

30,726

 

7,623

 

11,006

 

49,355

 

Unallocated corporate costs

 

 

 

 

 

 

 

$

14,544

 

Consolidated operating income

 

 

 

 

 

 

 

$

34,811

 

 

10



 

SCIENTIFIC GAMES CORPORATION AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited, in thousands, except per share amounts)

 

(3) Operating Segment Information (continued)

 

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

 

 

 

Three Months Ended

 

 

 

March 31,

 

 

 

2008

 

2007

 

Reported segment operating income

 

$

41,748

 

$

49,355

 

Unallocated corporate costs

 

(16,255

)

(14,544

)

Consolidated operating income

 

25,493

 

34,811

 

Interest expense

 

(13,884

)

(12,892

)

Equity in income of joint ventures

 

16,859

 

11,878

 

Other income (expense), net

 

(50

)

390

 

Income before income taxes

 

$

28,418

 

$

34,187

 

 

In evaluating financial performance, we focus on operating income as a segment’s measure of profit or loss. Operating income is before interest income, interest expense, equity in earnings of 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 Notes to Consolidated Financial Statements in our Annual Report on Form 10-K for the year ended December 31, 2007).

 

(4) Equity Investments in Joint Ventures

 

We are a member of Consorzio Lotterie Nazionali, a consortium consisting principally of our Company, Lottomatica S.p.A, and Arianna 2001, a company owned by the Federation of Italian Tobacconists. The consortium has a signed contract with the Italian Monopoli di Stato to be the exclusive operator of the Italian Gratta e Vinci instant lottery. The contract commenced in 2004 and has an initial term of six years with a six year-extension option. Under our contract with the consortium, we supply instant lottery tickets, game development services, marketing support, and the instant ticket management system and systems support. We also participate in the profits or losses of the consortium as a 20% equity owner, and assist Lottomatica S.p.A in the lottery operations. We account for this investment using the equity method of accounting. For the three months ended March 31, 2008 and 2007, we recorded income of $15,116 and $11,563, respectively, representing our share of the earnings of the consortium for the indicated periods.

 

11



 

SCIENTIFIC GAMES CORPORATION AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited, in thousands, except per share amounts)

 

(5) Comprehensive Income

 

The following presents a reconciliation of net income to comprehensive income for the three month periods ended March 31, 2008 and 2007:

 

 

 

Three Months Ended

 

 

 

March 31,

 

 

 

2008

 

2007

 

Net income

 

$

19,907

 

$

24,759

 

Other comprehensive income

 

 

 

 

 

Foreign currency translation gain

 

14,930

 

1,720

 

Unrealized gain (loss) on investments

 

(181

)

114

 

Other comprehensive income

 

14,749

 

1,834

 

Comprehensive income

 

$

34,656

 

$

26,593

 

 

(6) Inventories

 

Inventories consist of the following:

 

 

 

March 31,

 

December 31,

 

 

 

2008

 

2007

 

Parts and work-in-process

 

$

50,906

 

$

48,167

 

Finished goods

 

43,020

 

44,398

 

 

 

$

93,926

 

$

92,565

 

 

Point of sale terminals we manufacture may be sold to customers or included as part of long-term wagering system contracts. 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 and are not depreciated.

 

(7) Long-Term Debt

 

On March 31, 2008, we had $60,898 available for additional borrowing or letter of credit issuance under our revolving credit facility due in December 2009 (the “Revolver”). There were $198,500 of borrowings and $40,602 in outstanding letters of credit under our Revolver as of March 31, 2008.

 

Our credit agreement dated as of December 23, 2004, as amended and restated as of January 24, 2007 (the “Credit Facility”), is secured by a first priority, perfected lien on: (i) substantially all the property and assets (real and personal, tangible and intangible) of our Company and our 100%-owned domestic subsidiaries; (ii) 100% of the capital stock of all of our direct and indirect 100%-owned domestic subsidiaries and 65% of our interest in the capital stock of our 100%-owned first-tier foreign subsidiaries; and (iii) all inter-company indebtedness owing among our Company and our 100%-owned domestic subsidiaries. The Credit Facility is supported by guarantees provided by all of our direct and indirect 100%-owned domestic subsidiaries.

 

We were in compliance with our debt covenants as of March 31, 2008.

 

12



 

SCIENTIFIC GAMES CORPORATION AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited, in thousands, except per share amounts)

 

(8) Goodwill and Intangible Assets

 

The following disclosure presents certain information regarding our acquired intangible assets as of March 31, 2008 and December 31, 2007.  Amortizable intangible assets are amortized over their estimated useful lives, as indicated below, with no estimated residual values.

 

Intangible Assets

 

Gross Carrying
Amount

 

Accumulated
Amortization

 

Net Balance

 

Balance as of March 31, 2008

 

 

 

 

 

 

 

Amortizable intangible assets:

 

 

 

 

 

 

 

Patents

 

$

10,349

 

(2,311

)

8,038

 

Customer lists

 

31,958

 

(12,817

)

19,141

 

Customer service contracts

 

4,250

 

(2,528

)

1,722

 

Licenses

 

49,047

 

(28,081

)

20,966

 

Intellectual property

 

22,222

 

(10,910

)

11,312

 

Lottery contracts

 

25,923

 

(21,216

)

4,707

 

 

 

143,749

 

(77,863

)

65,886

 

Non-amortizable intangible assets:

 

 

 

 

 

 

 

Trade name

 

38,995

 

(2,118

)

36,877

 

Connecticut off-track betting system operating right

 

34,659

 

(8,319

)

26,340

 

 

 

73,654

 

(10,437

)

63,217

 

Total intangible assets

 

$

217,403

 

(88,300

)

129,103

 

 

 

 

 

 

 

 

 

Balance as of December 31, 2007

 

 

 

 

 

 

 

Amortizable intangible assets:

 

 

 

 

 

 

 

Patents

 

$

10,309

 

(2,135

)

8,174

 

Customer lists

 

37,454

 

(17,164

)

20,290

 

Customer service contracts

 

4,078

 

(2,358

)

1,720

 

Licenses

 

45,603

 

(24,614

)

20,989

 

Intellectual property

 

22,176

 

(9,542

)

12,634

 

Lottery contracts

 

26,776

 

(20,756

)

6,020

 

 

 

146,396

 

(76,569

)

69,827

 

Non-amortizable intangible assets:

 

 

 

 

 

 

 

Trade name

 

38,981

 

(2,118

)

36,863

 

Connecticut off-track betting system operating right

 

34,659

 

(8,319

)

26,340

 

 

 

73,640

 

(10,437

)

63,203

 

Total intangible assets

 

$

220,036

 

(87,006

)

133,030

 

 

The aggregate intangible amortization expense for the three month periods ended March 31, 2008 and 2007 was approximately $7,850 and $7,300, respectively.

 

13



 

SCIENTIFIC GAMES CORPORATION AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited, in thousands, except per share amounts)

 

(8) Goodwill and Intangible Assets (continued)

 

The table below reconciles the change in the carrying amount of goodwill, by reporting segment, for the period from December 31, 2007 to March 31, 2008.  In 2008, we recorded (a) a $1,478 increase in goodwill associated with the acquisition of OGT, (b) a $115 increase in goodwill associated with the acquisition of Games Media Limited (“Games Media”), and (c) an increase in goodwill of $6,443 as a result of foreign currency translation.

 

Goodwill

 

Printed
Products
Group

 

Lottery
Systems
Group

 

Diversified 
Gaming
Group

 

Totals

 

Balance as of December 31, 2007

 

$

328,719

 

194,519

 

193,618

 

716,856

 

Adjustments

 

3,375

 

4,059

 

602

 

8,036

 

Balance as of March 31, 2008

 

$

332,094

 

198,578

 

194,220

 

724,892

 

 

(9) Pension and Other Post-Retirement Plans

 

We have defined benefit pension plans for our U.S.-based union employees and U.K.-based union employees (the “U.S. Plan” and the “U.K. Plan”) and, with the acquisition of OGT, certain Canadian-based employees (the “Canadian Plan”). Retirement benefits under the U.S. Plan are based upon the number of years of credited service up to a maximum of 30 years for the majority of the employees. Retirement benefits under the U.K. Plan are based on an employee’s average compensation over the two years preceding retirement. Retirement benefits under the Canadian Plan are generally based on the number of years of credited service. Our policy is to fund the minimum contribution permissible by the respective tax authorities.

 

The following table sets forth the combined amount of net periodic benefit cost recognized for three month periods ended March 31, 2008 and 2007.

 

 

 

Three Months Ended

 

 

 

March 31,

 

 

 

2008

 

2007

 

Components of net periodic pension benefit cost:

 

 

 

 

 

Service cost

 

$

713

 

$

476

 

Interest cost

 

1,366

 

776

 

Expected return on plan assets

 

(1,440

)

(869

)

Amortization of actuarial gains/losses

 

280

 

241

 

Amortization of prior service costs

 

11

 

11

 

Net periodic cost

 

$

930

 

$

635

 

 

14



 

SCIENTIFIC GAMES CORPORATION AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited, in thousands, except per share amounts)

 

(10) Income Taxes

 

We and our subsidiaries file income tax returns in the U.S. federal jurisdiction, and various states and foreign jurisdictions.  With few exceptions, we are no longer subject to U.S. federal, state and local, or non-U.S. income tax examinations by tax authorities for years before 2001. We do not believe that the amount of uncertain tax positions will change by a significant amount within the next 12 months.

 

The effective tax rates for the three months ended March 31, 2008 and 2007 of 30.0% and 27.6%, 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 increase in our earnings from operations outside the United States and the tax benefit of the 2004 debt restructuring.

 

(11) Stockholders’ Equity

 

The following demonstrates the change in the number of shares of Class A common stock outstanding during the three months ended March 31, 2008 and during the fiscal year ended December 31, 2007:

 

 

 

Three Months

 

Twelve Months

 

 

 

Ended

 

Ended

 

 

 

March 31,

 

December 31,

 

 

 

2008

 

2007

 

Shares outstanding as of beginning of period

 

93,414

 

91,628

 

Shares issued as part of equity-based compensation plans and the ESPP, net of restricted stock units surrendered for taxes

 

167

 

1,786

 

 

Other shares issued

 

 

10

 

Shares repurchased into treasury stock

 

(1,000

)

(10

)

Shares outstanding as of end of period

 

92,581

 

93,414

 

 

15



 

SCIENTIFIC GAMES CORPORATION AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited, in thousands, except per share amounts)

 

(12) Stock-Based Compensation

 

As of March 31, 2008, we had approximately 328 stock options or restricted stock units (“RSUs”) authorized to be granted under our equity-based compensation plans.

 

Stock Options

 

A summary of the changes in stock options outstanding under our equity-based compensation plans during the three months ended March 31, 2008 is presented below:

 

 

 

Number of 
Options

 

Weighted 
Average 
Remaining 
Contract 
Term
(Years)

 

Weighted 
Average 
Exercise 
Price Per 
Share

 

Aggregate 
Intrinsic 
Value

 

Options outstanding as of December 31, 2007

 

6,132

 

6.1

 

$

20.13

 

$

81,575

 

Granted

 

1,065

 

 

 

21.84

 

 

Exercised

 

(74

)

 

 

9.32

 

870,694

 

Cancelled

 

(103

)

 

 

26.56

 

 

Options outstanding as of March 31, 2008

 

7,020

 

6.4

 

$

20.41

 

$

31,770

 

 

 

 

 

 

 

 

 

 

 

Options exercisable as of March 31, 2008

 

3,526

 

4.7

 

$

14.92

 

$

30,013

 

 

The weighted-average grant date fair value of options granted during the three months ended March 31, 2008 was $8.96. For the three months ended March 31, 2008 and 2007, we recognized equity-based compensation expense of approximately $4,100 and $2,600, respectively, related to the vesting of stock options and the related tax benefit of approximately $1,200 and $1,100, respectively.  As of March 31, 2008, we had unearned compensation of approximately $31,200 relating to stock option awards that will be amortized over a weighted-average period of approximately two years.

 

16



 

SCIENTIFIC GAMES CORPORATION AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited, in thousands, except per share amounts)

 

(12) Stock-Based Compensation (continued)

 

Restricted Stock Units

 

A summary of the changes in RSUs outstanding under our equity-based compensation plans during the three months ended March 31, 2008 is presented below:

 

 

 

Number of 
Restricted 
Stock

 

Weighted 
Average Grant 
Date Fair 
Value Per 
Share

 

Non-vested units as of December 31, 2007

 

1,222

 

$

32.02

 

Granted

 

450

 

$

22.01

 

Vested

 

(127

)

$

32.20

 

Cancelled

 

(22

)

$

28.28

 

Non-vested units as of March 31, 2008

 

1,523

 

$

29.18

 

 

For the three months ended March 31, 2008 and 2007, we recognized equity-based compensation expense of approximately $4,400 and $3,200, respectively, related to the vesting of RSUs and the related tax benefit of approximately $1,300 and $900, respectively.  As of March 31, 2008, we had unearned compensation of approximately $37,300 relating to RSUs that will be amortized over a weighted-average period of approximately two years.

 

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

 

We conduct substantially all of our business through our domestic and foreign subsidiaries.  Our 6.25% senior subordinated notes due 2012 (“2004 Notes”), our Convertible Debentures and our Credit Facility are fully, unconditionally and jointly and severally guaranteed by substantially all of our 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 (the “Non-Guarantor Subsidiaries”) as of March 31, 2008 and December 31, 2007 and for the three months ended March 31, 2008 and 2007. 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, the Guarantor Subsidiaries and the Non-Guarantor Subsidiaries assuming the guarantee structures of the Credit Facility, the Convertible Debentures and the 2004 Notes were in effect at the beginning of the periods presented.

 

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.

 

17



 

SCIENTIFIC GAMES CORPORATION AND SUBSIDIARIES

 

SUPPLEMENTAL CONDENSED CONSOLIDATING BALANCE SHEET

 

March 31, 2008

 

(Unaudited, in thousands)

 

 

 

Parent
Company

 

Guarantor
Subsidiaries

 

Non-
Guarantor
Subsidiaries

 

Eliminating
Entries

 

Consolidated

 

Assets

 

 

 

 

 

 

 

 

 

 

 

Cash and cash equivalents

 

$

1,625

 

(4,419

)

34,718

 

 

31,924

 

Accounts receivable, net

 

 

136,653

 

62,283

 

 

198,936

 

Inventories

 

 

67,047

 

27,304

 

(425

)

93,926

 

Other current assets

 

30,463

 

17,182

 

31,358

 

 

79,003

 

Property and equipment, net

 

5,620

 

315,772

 

275,302

 

(600

)

596,094

 

Investment in subsidiaries

 

794,619

 

154,646

 

194,793

 

(1,144,058

)

 

Goodwill

 

183

 

346,832

 

377,877

 

 

724,892

 

Intangible assets

 

 

102,216

 

26,887

 

 

129,103

 

Other assets

 

93,162

 

119,259

 

106,334

 

(6,101

)

312,654

 

Total assets

 

$

925,672

 

1,255,188

 

1,136,856

 

(1,151,184

)

2,166,532

 

 

 

 

 

 

 

 

 

 

 

 

 

Liabilities and stockholders’ equity

 

 

 

 

 

 

 

 

 

 

 

Current installments of long-term debt

 

$

4,500

 

 

9,277

 

 

13,777

 

Current liabilities

 

33,359

 

74,817

 

94,975

 

 

203,151

 

Long-term debt, excluding current installments

 

1,110,657

 

 

1,263

 

 

1,111,920

 

Other non-current liabilities

 

52,090

 

50,106

 

46,750

 

6

 

148,952

 

Intercompany balances

 

(963,666

)

756,085

 

207,581

 

 

 

Stockholders’ equity

 

688,732

 

374,180

 

777,010

 

(1,151,190

)

688,732

 

Total liabilities and stockholders’ equity

 

$

925,672

 

1,255,188

 

1,136,856

 

(1,151,184

)

2,166,532

 

 

18



 

SCIENTIFIC GAMES CORPORATION AND SUBSIDIARIES

 

SUPPLEMENTAL CONDENSED CONSOLIDATING BALANCE SHEET

 

December 31, 2007

 

(Unaudited, in thousands)

 

 

 

Parent
Company

 

Guarantor
Subsidiaries

 

Non-
Guarantor
Subsidiaries

 

Eliminating
Entries

 

Consolidated

 

Assets

 

 

 

 

 

 

 

 

 

 

 

Cash and cash equivalents

 

$

955

 

(387

)

28,835

 

 

29,403

 

Accounts receivable, net

 

 

144,154

 

58,920

 

 

203,074

 

Inventories

 

 

65,904

 

27,086

 

(425

)

92,565

 

Other current assets

 

30,940

 

14,538

 

27,357

 

 

72,835

 

Property and equipment, net

 

5,014

 

304,356

 

252,854

 

(600

)

561,624

 

Investment in subsidiaries

 

724,263

 

153,226

 

214,825

 

(1,092,314

)

 

Goodwill

 

(162

)

345,432

 

371,586

 

 

716,856

 

Intangible assets

 

 

103,873

 

29,157

 

 

133,030

 

Other assets

 

96,477

 

99,150

 

101,126

 

(6,101

)

290,652

 

Total assets

 

$

857,487

 

1,230,246

 

1,111,746

 

(1,099,440

)

2,100,039

 

 

 

 

 

 

 

 

 

 

 

 

 

Liabilities and stockholders’ equity

 

 

 

 

 

 

 

 

 

 

 

Current installments of long-term debt

 

$

4,500

 

 

442

 

 

4,942

 

Current liabilities

 

32,916

 

89,090

 

90,464

 

102

 

212,572

 

Long-term debt, excluding current installments

 

1,071,282

 

 

1,343

 

 

1,072,625

 

Other non-current liabilities

 

56,087

 

47,534

 

45,058

 

6

 

148,685

 

Intercompany balances

 

(968,513

)

758,031

 

210,482

 

 

 

Stockholders’ equity

 

661,215

 

335,591

 

763,957

 

(1,099,548

)

661,215

 

Total liabilities and stockholders’ equity

 

$

857,487

 

1,230,246

 

1,111,746

 

(1,099,440

)

2,100,039

 

 

19



 

SCIENTIFIC GAMES CORPORATION AND SUBSIDIARIES

 

SUPPLEMENTAL CONDENSED CONSOLIDATING STATEMENT OF INCOME

 

Three Months Ended March 31, 2008

 

(Unaudited, in thousands)

 

 

 

Parent
Company

 

Guarantor
Subsidiaries

 

Non-
Guarantor
Subsidiaries

 

Eliminating
Entries

 

Consolidated

 

 

 

 

 

 

 

 

 

 

 

 

 

Operating revenues

 

$

 

155,527

 

102,861

 

(1,381

)

257,007

 

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

 

 

85,388

 

63,200

 

(1,366

)

147,222

 

Selling, general and administrative expenses

 

15,858

 

20,405

 

13,545

 

(20

)

49,788

 

Depreciation and amortization

 

269

 

21,139

 

13,096

 

 

34,504

 

Operating income (loss)

 

(16,127

)

28,595

 

13,020

 

5

 

25,493

 

Interest expense

 

13,619

 

74

 

191

 

 

13,884

 

Other (income) expense

 

(943

)

(15,837

)

(34

)

5

 

(16,809

)

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

 

(28,803

)

44,358

 

12,863

 

 

28,418

 

Equity in income (loss) of subsidiaries

 

56,213

 

 

 

(56,213

)

 

Income tax expense

 

7,503

 

225

 

783

 

 

8,511

 

Net income

 

$

19,907

 

44,133

 

12,080

 

(56,213

)

19,907

 

 

 

SCIENTIFIC GAMES CORPORATION AND SUBSIDIARIES

 

SUPPLEMENTAL CONDENSED CONSOLIDATING STATEMENT OF INCOME

 

Three Months Ended March 31, 2007

 

(Unaudited, in thousands)

 

 

 

Parent
Company

 

Guarantor
Subsidiaries

 

Non-
Guarantor
Subsidiaries

 

Eliminating
Entries

 

Consolidated

 

 

 

 

 

 

 

 

 

 

 

 

 

Operating revenues

 

$

 

159,929

 

84,657

 

(2,320

)

242,266

 

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

 

 

86,493

 

54,960

 

(2,221

)

139,232

 

Selling, general and administrative expenses

 

872

 

30,725

 

7,647

 

(99

)

39,145

 

Depreciation and amortization

 

 

19,400

 

9,678

 

 

29,078

 

Operating income

 

(872

)

23,311

 

12,372

 

 

34,811

 

Interest expense

 

12,551

 

274

 

67

 

 

12,892

 

Other income

 

(209

)

(11,712

)

(347

)

 

(12,268

)

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

 

(13,214

)

34,749

 

12,652

 

 

34,187

 

Equity in income (loss) of subsidiaries

 

46,654

 

 

 

(46,654

)

 

Income tax expense

 

8,681

 

33

 

714

 

 

9,428

 

Net income

 

$

24,759

 

34,716

 

11,938

 

(46,654

)

24,759

 

 

20



 

SCIENTIFIC GAMES CORPORATION AND SUBSIDIARIES

 

SUPPLEMENTAL CONDENSED CONSOLIDATING STATEMENT OF CASH FLOWS

 

Three months Ended March 31, 2008

 

(Unaudited, in thousands)

 

 

 

Parent
Company

 

Guarantor
Subsidiaries

 

Non-
Guarantor
Subsidiaries

 

Eliminating
Entries

 

Consolidated

 

Net cash provided by operating activities

 

$

 (25,520

)

44,078

 

19,944

 

(72

)

38,430

 

 

 

 

 

 

 

 

 

 

 

 

 

Cash flows from investing activities:

 

 

 

 

 

 

 

 

 

 

 

Capital and wagering systems expenditures

 

(288

)

(24,346

)

(28,361

)

 

(52,995

)

Business acquisitions, net of cash acquired

 

 

(2,548

)

(194

)

 

(2,742

)

Other assets and investments

 

8,985

 

(7,996

)

15,549

 

(27,555

)

(11,017

)

 

 

 

 

 

 

 

 

 

 

 

Net cash provided by (used in) investing activities

 

8,697

 

(34,890

)

(13,006

)

(27,555

)

(66,754

)

 

 

 

 

 

 

 

 

 

 

 

 

Cash flows from financing activities:

 

 

 

 

 

 

 

 

 

 

 

Net proceeds/payments on long-term debt

 

39,375

 

 

8,542

 

 

47,917

 

Net proceeds from stock issue

 

(8,359

)

1,099

 

(20,057

)

27,290

 

(27

)

Purchase of treasury stock

 

(18,017

)

 

 

 

 

(18,017

)

Other, principally intercompany balances

 

4,494

 

(14,322

)

9,348

 

480

 

 

Net cash provided by (used in) financing activities

 

17,493

 

(13,223

)

(2,167

)

27,770

 

29,873

 

 

 

 

 

 

 

 

 

 

 

 

 

Effect of exchange rate changes on cash

 

 

3

 

1,112

 

(143

)

972

 

 

 

 

 

 

 

 

 

 

 

 

 

Increase (decrease) in cash and cash equivalents

 

670

 

(4,032

)

5,883

 

 

2,521

 

Cash and cash equivalents, beginning of period

 

955

 

(387

)

28,835

 

 

29,403

 

Cash and cash equivalents, end of period

 

$

1,625

 

(4,419

)

34,718

 

 

31,924

 

 

21



 

SCIENTIFIC GAMES CORPORATION AND SUBSIDIARIES

 

SUPPLEMENTAL CONDENSED CONSOLIDATING STATEMENT OF CASH FLOWS

 

Three months Ended March 31, 2007

 

(Unaudited, in thousands)

 

 

 

Parent
Company

 

Guarantor
Subsidiaries

 

Non-
Guarantor
Subsidiaries

 

Eliminating
Entries

 

Consolidated

 

Net cash provided by operating activities

 

$

5,667

 

14,457

 

10,296

 

 

30,420

 

 

 

 

 

 

 

 

 

 

 

 

 

Cash flows from investing activities:

 

 

 

 

 

 

 

 

 

 

 

Capital and wagering systems expenditures

 

 

(8,860

)

(17,148

)

 

(26,008

)

Business acquisitions, net of cash acquired

 

 

 

(336

)

 

(336

)

Other assets and investments

 

(20,263

)

(8,355

)

(22,624

)

36,441

 

(14,801

)

 

 

 

 

 

 

 

 

 

 

 

Net cash provided by (used in) investing activities

 

(20,263

)

(17,215

)

(40,108

)

36,441

 

(41,145

)

 

 

 

 

 

 

 

 

 

 

 

 

Cash flows from financing activities:

 

 

 

 

 

 

 

 

 

 

 

Net proceeds/payments on long-term debt

 

7,875

 

 

(210

)

 

7,665

 

Net proceeds from stock issue

 

8,360

 

5

 

36,436

 

(36,441

)

8,360

 

Other, principally intercompany balances

 

(1,639

)

11,119

 

(9,308

)

(172

)

 

Net cash provided by (used in) financing activities

 

14,596

 

11,124

 

26,918

 

(36,613

)

16,025

 

 

 

 

 

 

 

 

 

 

 

 

 

Effect of exchange rate changes on cash

 

 

 

(32

)

172

 

140

 

 

 

 

 

 

 

 

 

 

 

 

 

Increase (decrease) in cash and cash equivalents

 

 

8,366

 

(2,926

)

 

5,440

 

Cash and cash equivalents, beginning of period

 

 

4,072

 

23,719

 

 

27,791

 

Cash and cash equivalents, end of period

 

$

 

12,438

 

20,793

 

 

33,231

 

 

(14) Subsequent Event

 

In the fourth quarter of 2007 we sold our interest in International Lotto Corp., SRL (“ILC”), which sale agreement was officially registered with a public notary in January 2008.  In April 2008, the buyers of ILC informed us that they were voiding the sale agreement for certain specified reasons.  We objected to their position and are now in arbitration in Peru with the buyers and are assessing our other legal rights and obligations.

 

22



 

Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations

 

The following discussion addresses the results of operations of Scientific Games Corporation (together with its consolidated subsidiaries, “we,” “us,” “our” or the “Company”), for the three months ended March 31, 2008, compared to the corresponding period in the prior year. This discussion should be read in conjunction with “Management’s Discussion and Analysis of Financial Condition and Results of Operations” for the fiscal year ended December 31, 2007, included in our 2007 Annual Report on Form 10-K.

 

Our results may vary significantly from period to period depending on the addition or disposition of business units in each period. The acquisition of OGT in May 2007 affects the comparability of operations for the three month periods ended March 31, 2008 and 2007.

 

The first and fourth quarters of the calendar year traditionally comprise the weakest season for our Diversified Gaming segment. As a result of inclement weather during the winter months, a number of racetracks do not operate and those that do operate often experience missed racing days. This adversely affects the amounts wagered and our corresponding service revenues. Additionally, the fourth quarter is the weakest quarter for Global Draw Limited (“Global Draw”) due to reduced wagering during the holiday season. Wagering and lottery equipment sales and software license revenues usually reflect a limited number of large transactions, which do not recur on an annual basis. Consequently, revenues and operating results of our Lottery Systems Group can vary substantially from period to period as a result of the timing of revenue recognition for major equipment sales and software licensing transactions. In addition, Printed Products sales may vary depending on the season and timing of contract awards, changes in customer budgets, inventory ticket levels, lottery retail sales and general economic conditions.

 

Background

 

We operate primarily in three business segments: Printed Products Group, Lottery Systems Group and Diversified Gaming Group. Our revenues consist of two major components: services revenues and sales revenues.

 

Printed Products Group

 

We provide instant tickets and related services. Instant ticket and related services include 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, including Major League Baseball®, NASCAR®, National Basketball Association, Harley-Davidson®, Wheel-of-Fortune®, Hasbro®, Corvette®, World Poker Tour® and Deal or No Deal™. This division also includes promotional instant tickets and pull-tab tickets that we sell to both lottery and non-lottery customers.

 

We are a worldwide manufacturer of prepaid phone cards, which entitle cellular phone users to a defined value of airtime. Prepaid phone cards offer consumers a cost-effective way to purchase cellular airtime, without requiring phone companies to extend credit or consumers to commit to contracts.

 

Prepaid phone cards utilize the secure process that we employ in the production of instant lottery tickets. This helps to ensure integrity and reliability of the product, thus providing consumers in more than 50 countries with access to prepaid cellular phone service.

 

In the fourth quarter of 2007 we sold our interest in International Lotto Corp., SRL (“ILC”), which sale agreement was officially registered with a public notary in January 2008.  In April 2008, the buyers of ILC informed us that they were voiding the sale agreement for certain specified reasons.  We objected to their position and are now in arbitration in Peru with the buyers and are assessing our other legal rights and obligations.

 

Lottery Systems Group

 

Our lottery systems business includes the supply of transaction processing software for the accounting and validation of instant ticket, online and video lottery games, point-of-sale terminal hardware sales, central site computers and communication hardware sales, and ongoing support and maintenance services for these products. This business also includes software and hardware and support services for sports betting and operation of credit card processing systems.

 

Diversified Gaming Group

 

Our Diversified Gaming Group provides services and systems to private and public operators in the wide area gaming markets and in the pari-mutuel wagering industry. Our product offering includes server-based gaming machines (including our Nevada™ dual screen terminals, which can offer Great Britain regulated Category B2 or B3 content on the same machines), video lottery terminals (“VLTs”), monitor games, wagering systems for the pari-mutuel racing industry, sports betting systems and services and Great Britain regulated Category C Amusement With Prize (“AWP”) and Skill With Prize (“SWP”) terminals. Business units within the Diversified Gaming Group include: Global Draw, a leading supplier of gaming terminals, systems and monitor games to licensed bookmakers, primarily in the U.K., Austria and Mexico; Scientific Games Racing LLC, a leading worldwide supplier of computerized systems for pari-mutuel wagering; Games Media Limited (“Games Media”), our AWP and SWP terminal supplier in the U.K. public house (or pub) market; and our pari-mutuel gaming operations in Connecticut, Maine and the Netherlands.

 

23



 

Results of Operations

 

Three Months Ended March 31, 2008 Compared to Three Months Ended March 31, 2007

 

The following analysis compares the results of operations for the quarter ended March 31, 2008 to the results of operations for the quarter ended March 31, 2007.

 

Overview

 

Revenue Analysis

 

For the quarter ended March 31, 2008, total revenue was $257.0 million compared to $242.3 million for the quarter ended March 31, 2007, an increase of $14.7 million or 6%. Our service revenue for the quarter ended March 31, 2008 was $234.0 million compared to $211.0 million for the quarter ended March 31, 2007, an increase of $23.0 million, or 11%. The increase was primarily attributable to service revenues from OGT which was acquired in May 2007 ($19.5 million) and increased sales of instant lottery tickets in Italy, the U.S. and China, partially offset by the impact of the re-priced Pennsylvania cooperative services contract, which began impacting revenue during the fourth quarter 2007 ($4.7 million), decreased licensed property revenue and reduced revenue as a result of the sale of our interest in ILC, our lottery operations in Peru, in December 2007. Our sales revenue for the quarter ended March 31, 2008 was $23.1 million compared to $31.3 million in the prior year quarter, a decrease of $8.2 million or 26%. The decrease primarily reflects decreased sales from Games Media reflecting the expected decline in sales of analog AWP terminals as a result of the roll-out of digital AWP terminals, which are being deployed under revenue participation agreements, the absence of a one-time sale of ticket checker machines in Canada during the first quarter of 2007 and a decline in phone card sales. The decrease was partially offset by increased software and hardware sales to international Lottery Systems customers.

 

Expense Analysis

 

Cost of services of $130.4 million for the quarter ended March 31, 2008 were $13.7 million or 12% higher than for the quarter ended March 31, 2007. The increase was primarily related costs from OGT, which was acquired in May 2007 and increased costs associated with increased sales of instant lottery tickets, partially offset by a decline in licensed property costs and reduced costs from ILC as a result of the sale of this business in 2007.  Cost of sales of $16.8 million for the quarter ended March 31, 2008 was $5.7 million or 25% lower than the quarter ended March 31, 2007 primarily reflecting lower sales from Games Media reflecting the expected decline in sales of analog AWP terminals as a result of the roll-out of digital AWP terminals, which are being deployed under revenue participation agreements, the absence of a one-time sale of ticket checker machines in Canada during the first quarter of 2007 and a decreased level of phone card sales. The decrease was partially offset by costs associated with increased software and hardware sales to international Lottery Systems customers.

 

Selling, general and administrative expense of $49.8 million for the quarter ended March 31, 2008 was $10.7 million or 27% higher than for the quarter ended March 31, 2007. The increase was primarily related to costs from OGT, which was acquired in May 2007, expense associated with the restructuring of phone card manufacturing in the U.K. ($2.8 million), increased costs from the Global Draw earn-out ($1.8 million) and increased legal, compliance and business development costs.

 

Depreciation and amortization expense of $34.5 million for the quarter ended March 31, 2008 increased $5.4 million or 19% from the same period in 2007, primarily due to depreciation from the acquisition of OGT in May 2007, increased depreciation from Global Draw, and increased depreciation from our domestic pari-mutuel business.

 

Interest expense of $13.9 million for the quarter ended March 31, 2008 increased $1.0 million or 8% from the same period in 2006, primarily attributable to increased borrowings, partially offset by a decline in interest rates.

 

Equity in earnings of joint ventures primarily reflects our share of the earnings of the Italian joint venture in connection with the operation of the Italian Gratta e Vinci instant lottery, our share of the equity of Roberts Communications Network (“RCN”), which provides communications services to racing and non-racing customers using both satellite and terrestrial services, and our interest in Guard Libang, which provides instant validation services to 21 provinces and certain cooperative service functions to 44 cities in China for the China Welfare Lottery. For the quarter ended March 31, 2008, our share of the Italian consortium’s net income totaled $15.1 million compared to $11.6 million in the quarter ended March 31, 2007. The increase in income for the quarter ended March 31, 2008 reflects continued growth of instant ticket sales in Italy. For the quarter ended March 31, 2008, our share of the earnings of RCN was $1.0 million and our share of the earnings of Guard Libang was $0.9 million.

 

Income tax expense was $8.5 million for the quarter ended March 31, 2008 versus $9.4 million for the quarter ended March 31, 2007.  The effective income tax rate for the quarter ended March 31, 2008 and 2007 was approximately 30.0% and 28.0% respectively.  The increase in the effective income tax rate was primarily due to higher U.S. income taxes in the first quarter of 2008.

 

24



 

Segment Overview

 

Printed Products

 

For the quarter ended March 31, 2008, total revenue for Printed Products was $135.9 million compared to $113.9 million in the quarter ended March 31, 2007, an increase of $22.0 million or 19%. For the quarter ended March 31, 2008, service revenue for Printed Products was $127.2 million compared to $104.6 million in the corresponding period in the prior year, an increase of $22.6 million or 22%. The increase was primarily attributable to service revenue from OGT, which was acquired in May 2007 ($19.5 million) and increased sales of instant lottery tickets in Italy, the U.S. and China, partially offset by the impact of the re-priced Pennsylvania cooperative services contract, which began impacting revenue during the fourth quarter 2007 ($4.7 million), decreased licensed property revenue and reduced revenue from ILC as a result of our disposal of the business in January 2008.

 

Printed Products sales revenue for the quarter ended March 31, 2008 was $8.7 million compared to $9.3 million for the quarter ended March 31, 2007, a decrease of $0.6 million or 6%. The decrease was primarily the result of a continuing decline in phone card prices and volumes reflecting a market shift to lower priced products.

 

Cost of services of $70.8 million for the quarter ended March 31, 2008 was $15.1 million or 27% higher than from the same period in 2007. The increase was primarily due to costs from OGT which was acquired in May 2007 plus higher costs attributable to increased instant ticket sales, partially offset by a decline in licensed property costs and reduced costs from ILC as a result of our disposal of the business in January 2008.

 

Cost of sales of $6.2 million for the quarter ended March 31, 2008 was $1.4 million or 18% lower than for the quarter ended March 31, 2007 primarily due to the decreased level of phone card sales.

 

Selling, general and administrative expense of $17.7 million for the quarter ended March 31, 2008 was $6.2 million or 54% higher than in the quarter ended March 31, 2007. The increase was primarily attributable to costs from OGT, which was acquired in May 2007, increased expense associated with the restructuring of phone card manufacturing in the U.K. ($2.8 million) and increased legal, compliance and business development costs.

 

Depreciation and amortization expense of $10.0 million for the quarter ended March 31, 2008 increased $1.6 million or 19% compared to the quarter ended March 31, 2007, primarily due to depreciation from the acquisition of OGT in May 2007 and increased amortization on licensed property contracts and increased costs associated with our new printing press, partially offset by reduced depreciation from ILC as a result of our disposal of the business in January 2008.

 

Lottery Systems

 

For the quarter ended March 31, 2008, total revenue for Lottery Systems was $62.4 million compared to $65.4 million in the quarter ended March 31, 2007, a decrease of $3.0 million or 5%. Lottery Systems service revenue for the quarter ended March 31, 2008 was $54.6 million compared to $54.3 million for the quarter ended March 31, 2007, an increase of $0.3 million or 1%. The increase was primarily due to increased revenue from the Maryland and Mexico online contracts, increased revenue on the New Mexico video contract and increased revenue from international customers due to favorable exchange rate changes. The increases were mostly offset by reduced revenue from the Korea contract which expired in December 2007 and reduced revenue from the South Carolina online contract.

 

Lottery Systems sales revenue for the quarter ended March 31, 2008 was $7.8 million compared to $11.0 million for the quarter ended March 31, 2007, a decrease of $3.2 million or 29%. The decrease was primarily due to the absence of a one-time sale of ticket checker machines in Canada during the first quarter of 2007, partially offset by increased international software and hardware sales.

 

Cost of services of $28.6 million for the quarter ended March 31, 2008 was $0.8 million or 3% lower than in the quarter ended March 31, 2007. The decrease was primarily due to lower costs on international maintenance contracts.

 

Cost of sales of $5.9 million for the quarter ended March 31, 2008 was $0.3 million or 5% lower than in the quarter ended March 31, 2007, primarily due to the absence of a one-time sale of ticket checker machines in Canada during the first quarter of 2007, partially offset by costs associated with increased international software and hardware sales.

 

Selling, general and administrative expense of $9.3 million for the quarter ended March 31, 2008 was $1.3 million or 16% higher than in the quarter ended March 31, 2007. The increase was primarily attributable to increased legal, compliance and business development costs.

 

Depreciation and amortization expense of $15.0 million for the quarter ended March 31, 2008 increased $0.9 million or 6% as compared to the quarter ended March 31, 2007, primarily due to increased amortization of deferred installation costs for our Lottery Systems contract in Mexico, partially offset by reduced amortization on the South Carolina and Korea contracts.

 

Diversified Gaming

 

For the quarter ended March 31, 2008, total revenue for Diversified Gaming was $58.7 million compared to $63.0 million in the quarter ended March 31, 2007, a decrease of $4.3 million or 7%. Diversified Gaming service revenue for the first quarter of 2008 was $52.1 million compared to $52.0 million for the quarter ended March 31, 2007, an increase of $0.1 million. The increase in service revenue primarily reflects increased revenue from Global Draw, partially offset by decreased revenue from our venue management business and lower revenue as a result of the sale of our racing and data communications businesses in February 2007.

 

25



 

The Diversified Gaming sales revenue for the quarter ended March 31, 2008 was $6.6 million compared to $11.0 million in the same quarter in the prior year, a decrease of $4.4 million or 40%.  The decrease was primarily due to decreased sales from Games Media reflecting the expected decline in sales of analog AWP terminals, as a result of the roll-out of digital AWP terminals, which are being deployed under revenue participation agreements.

 

Cost of services of $30.9 million for the quarter ended March 31, 2008 was $0.8 million or 3% lower than for the quarter ended March 31, 2007. The decrease was primarily due to reduced costs as a result of the sale of our racing and data communications businesses in February 2007, partially offset by costs associated with increased revenues from Global Draw.

 

Cost of sales of $4.7 million for the quarter ended March 31, 2008 was $3.9 million or 45% lower than in the quarter ended March 31, 2007, primarily due to reduced sales from Games Media.

 

Selling, general and administrative expense of $6.8 million for the quarter ended March 31, 2008 was $1.5 million or 28% higher than in the quarter ended March 31, 2007. The increase was primarily due to increased costs from the Global Draw earn-out ($1.8 million), partially offset by lower legal and marketing costs and reduced costs as a result of the sale of our racing and data communications businesses in February 2007.

 

Depreciation and amortization expense of $9.3 million for the quarter ended March 31, 2008 increased $3.0 million or 48% from the quarter ended March 31, 2007, primarily due to increased depreciation from Global Draw and Games Media plus increased depreciation from our domestic pari-mutuel business.

 

Critical Accounting Policies

 

There have been no material changes to our critical accounting policies from those discussed under the caption “Critical Accounting Policies” in “Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations” in our Annual Report on Form 10-K for the fiscal year ended December 31, 2007.

 

Liquidity, Capital Resources and Working Capital

 

On March 31, 2008, we had $60.9 million available for additional borrowing or letter of credit issuance under our revolving credit facility due December 2009 (the “Revolver”). There were $198.5 million of borrowings and $40.6 million in outstanding letters of credit under our Revolver as of March 31, 2008.

 

Our credit agreement dated as of December 23, 2004, as amended and restated as of January 24, 2007 (the “Credit Facility”) is secured by a first priority, perfected lien on: (i) substantially all the property and assets (real and personal, tangible and intangible) of our Company and our 100%-owned domestic subsidiaries; (ii) 100% of the capital stock of all of our direct and indirect 100%-owned domestic subsidiaries and 65% of the capital stock of our 100%-owned first-tier foreign subsidiaries; and (iii) all inter-company indebtedness owing among our Company and our 100%-owned domestic subsidiaries. The Credit Facility is supported by guarantees provided by all of our direct and indirect 100%-owned domestic subsidiaries.

 

26



 

Our pari-mutuel wagering and online lottery systems service contracts require us to, among other things, maintain the central computing system and related hardware in efficient working order, provide added software functionality upon request, provide on-site computer operators, and furnish necessary supplies. Our primary expenditures associated with these services are personnel and related costs, which are expensed as incurred and are included in Cost of Services in the consolidated statements of income. Historically, the revenues we derive from our pari-mutuel wagering and lottery systems service contracts have generally exceeded the direct costs associated with fulfilling our obligations thereunder. We expect that we will continue to realize positive cash flow and operating income as we extend or renew existing service contracts. We also expect that we will enter into new contracts that are accretive to our cash flow. In addition, through advancements in technology, we are continually deploying more efficient and cost effective methods for manufacturing and delivering our products and services to our customers. We expect that technological efficiencies will continue to positively impact our future cash flows and operating results. We are not party to any other material short-term or long-term obligations or commitments pursuant to these service contracts.

 

Periodically, we bid on new pari-mutuel and online lottery contracts. Once awarded, these contracts generally require significant up-front capital expenditures for terminal assembly, customization of software, software and equipment installation and telecommunications configuration. Historically, we have funded these up-front costs through cash flows generated from operations, available cash on hand and borrowings under our credit facilities. Our ability to continue to procure new contracts will depend on, among other things, our then present liquidity levels and/or our ability to borrow at commercially acceptable rates to finance the initial up-front costs. Once operational, long-term service contracts have been accretive to our operating cash flow. The actual level of capital expenditures will ultimately largely depend on the extent to which we are successful in winning new contracts. Furthermore, our pari-mutuel wagering network consists of approximately 26,000 wagering terminals. Periodically, we elect to upgrade the technological capabilities of older terminals and replace terminals that have exhausted their useful lives. During the remainder of 2008, we expect to place approximately 84,000 ticket checking machines into operations for our new contract with the China Sports Lottery for a total cost of approximately $47 million. Servicing our installed terminal base requires that we maintain a supply of parts and accessories on hand. We are also required, contractually in some cases, to provide spare parts over an extended period of time, principally in connection with our systems and terminal sale transactions. To meet our contractual obligations and maintain sufficient levels of on-hand inventory to service our installed base, we purchase inventory on an as-needed basis. We presently have no inventory purchase obligations, other than in the ordinary course of business.

 

As of March 31, 2008, our available cash and borrowing capacity totaled $92.8 million compared to $150.6 million as of December 31, 2007. The amount of our available cash fluctuates principally based on the timing of collections from our customers, cash expenditures associated with new and existing online lottery systems service and pari-mutuel and fixed odds wagering contracts, borrowings or repayments under our credit facilities and changes in our working capital position.

 

The $2.5 million increase in our available cash from the December 31, 2007 level principally reflects the net cash provided by operating activities for the three months ended March 31, 2008 of $38.4 million along with $47.9 million of additional net borrowings, offset by wagering and other capital expenditures and other investing activities totaling $64.0 million, acquisition related payments of $2.7 million and the effects of exchange rates. The $38.4 million of net cash provided by operating activities is derived from approximately $48.1 million of net cash provided by operations offset by approximately $9.7 million from changes in working capital. The working capital changes occurred principally from increases in inventory and other current assets, and decreases in accounts payable and prepaid expenses offset by decreases in accounts receivable. Capital expenditures were $3.7 million in the three months ended March 31, 2008 compared to $2.5 million in the corresponding period in 2007. Wagering system expenditures totaled $49.3 million in the three months ended March 31, 2008, compared to $23.5 million in the corresponding period in 2007, and consisted primarily of our lottery contracts in Connecticut and fixed odds betting terminals related to Global Draw contracts with its customers. Other intangible assets and software expenditures during the three months ended March 31, 2008 consisted primarily of licensed properties, lottery contracts in Connecticut and gaming contracts related to Global Draw. Cash flow from financing activities principally reflects the borrowings under the Credit Facility.

 

We believe that our cash flow from operations, available cash and available borrowing capacity under the Credit Facility will be sufficient to meet our liquidity needs, including anticipated capital expenditures, for the foreseeable future; however, there can be no assurance that this will be the case. While we are not aware of any particular trends, our contracts periodically renew and there can be no assurance that we will be successful in sustaining our cash flow from operations through renewal of our existing contracts or through the addition of new contracts. In addition, lottery customers in the United States generally require service providers to provide performance bonds in connection with each state contract. Our ability to obtain performance bonds on commercially reasonable terms is subject to prevailing market conditions, which may be impacted by economic and political events. Although we have not experienced any difficulty in obtaining such bonds, there can be no assurance that we will continue to be able to obtain performance bonds on commercially reasonable terms or at all. While we are not aware of any reason to do so, if we need to refinance all or part of our indebtedness, on or before maturity, or provide letters of credit or cash in lieu of performance bonds, there can be no assurance that we will be able to obtain new financing or to refinance any of our indebtedness, on commercially reasonable terms or at all.

 

Item 3.  Quantitative and Qualitative Disclosures about Market Risk

 

We have no material changes to the disclosure on this matter made in our  2007 Annual Report on Form 10-K.

 

27



 

Item 4.  Controls and Procedures

 

Evaluation of Disclosure Controls and Procedures

 

We have evaluated the effectiveness of the design and operation of our disclosure controls and procedures (as defined in Rules 13a-15(e) and 15d-15(e) under the Securities Exchange Act of 1934, as amended (the “Exchange Act”)) as of the end of the period covered by this Form 10-Q.  The evaluation was conducted under the supervision and with the participation of our management, including our Chief Executive Officer and our Chief Financial Officer. Based upon that evaluation, the Chief Executive Officer and Chief Financial Officer concluded that our disclosure controls and procedures were effective in alerting management in a timely fashion to all material information required to be included in our periodic filings with the Securities and Exchange Commission.

 

There were no changes in our internal control over financial reporting during the quarter ended March 31, 2008 that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.

 

28



 

PART II.  OTHER INFORMATION

 

Item 2.  Unregistered Sales of Equity Securities and Use of Proceeds

 

ISSUER PURCHASES OF EQUITY SECURITIES

 

Period

 

Total Number of
Shares
Purchased (2)

 

Average
Price Paid
per Share

 

Total Number of Shares
Purchased as Part of
Publicly Announced Plans
or Programs

 

Approximate Dollar Value
of Shares that May Yet Be
Purchased Under the Plans
or Programs (3)

 

1/1/2008 - 1/31/2008

 

968

 

$32.56

 

 

$190.2 million

 

2/1/2008 - 2/29/2008

 

32,215

 

$21.61

 

 

$190.2 million

 

3/1/2008 - 3/31/2008 (1)

 

1,000,258

 

$18.03

 

1,000,000

 

$172.1 million

 

Total

 

1,033,441

 

$18.15

 

1,000,000

 

$172.1 million

 

 


(1)          The date of the last repurchase as part of the publicly announced repurchase program was March 19, 2008.

 

(2)          In addition to the open market purchases made under the stock repurchase program, the activity in this column reflects 33,441 shares acquired from employees to satisfy the withholding taxes associated with the vesting of restricted stock units during the three months ended March 31, 2008.

 

(3)          The stock repurchase program was originally publicly announced on November 2, 2006 and extended on December 13, 2007. Under the repurchase program, we are authorized to repurchase, from time to time in the open market through December 31, 2008, shares of our outstanding common stock in an aggregate amount up to $200 million.  Purchases are funded by cash flows from operations, borrowings, or a combination thereof. The timing and amount of purchases is determined by our management based on its evaluation of market conditions, share price and other factors, including limitations under the terms of certain of our debt agreements.  The stock repurchase program may be suspended or discontinued at any time.

 

29



 

Item 6.  Exhibits

 

Exhibit
Number