Table of Contents

 

 

 

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 September 30, 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 required 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 October 31, 2008:

 

Class A Common Stock:  92,877,876

Class B Common Stock:  None

 

 

 



Table of Contents

 

SCIENTIFIC GAMES CORPORATION AND SUBSIDIARIES

INDEX TO FINANCIAL INFORMATION

AND OTHER INFORMATION

THREE MONTHS ENDED SEPTEMBER 30, 2008

 

PART I.

 

FINANCIAL INFORMATION

 

 

 

 

 

 

 

Item 1.

 

Financial Statements

 

 

 

 

 

 

 

 

 

Consolidated Balance Sheets as of September 30, 2008 and December 31, 2007

 

 

 

 

 

 

 

 

 

Consolidated Statements of Income for the Three Months Ended September 30, 2008 and 2007

 

 

 

 

 

 

 

 

 

Consolidated Statements of Income for the Nine Months Ended September 30, 2008 and 2007

 

 

 

 

 

 

 

 

 

Condensed Consolidated Statements of Cash Flows for the Nine Months Ended September 30, 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 1.

 

Legal Proceedings

 

 

 

 

 

 

 

Item 1A.

 

Risk Factors

 

 

 

 

 

 

 

Item 2.

 

Unregistered Sales of Equity Securities and Use of Proceeds

 

 

 

 

 

 

 

Item 6.

 

Exhibits

 

 

 

2



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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 and in this Quarterly Report on Form 10-Q.   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



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SCIENTIFIC GAMES CORPORATION AND SUBSIDIARIES

CONSOLIDATED BALANCE SHEETS

As of September 30, 2008 and December 31, 2007

(Unaudited, in thousands, except per share amounts)

 

PART 1.  FINANCIAL INFORMATION

 

Item 1.  Financial Statements

 

 

 

September 30,

 

December 31,

 

 

 

2008

 

2007

 

ASSETS

 

 

 

 

 

Current assets:

 

 

 

 

 

Cash and cash equivalents

 

$

161,770

 

$

29,403

 

Accounts receivable, net of allowance for doubtful accounts of $8,860 and $9,184 as of September 30, 2008 and December 31, 2007, respectively

 

241,237

 

203,074

 

Inventories

 

91,686

 

92,565

 

Deferred income taxes, current portion

 

15,849

 

15,929

 

Prepaid expenses, deposits and other current assets

 

72,171

 

56,906

 

Total current assets

 

582,713

 

397,877

 

Property and equipment, at cost

 

1,084,272

 

966,291

 

Less accumulated depreciation

 

(454,302

)

(404,667

)

Net property and equipment

 

629,970

 

561,624

 

Goodwill, net

 

702,032

 

716,856

 

Intangible assets, net

 

116,198

 

133,030

 

Other assets and investments

 

326,028

 

290,652

 

Total assets

 

$

2,356,941

 

$

2,100,039

 

 

 

 

 

 

 

LIABILITIES AND STOCKHOLDERS’ EQUITY

 

 

 

 

 

Current liabilities:

 

 

 

 

 

Debt payments due within one year

 

$

53,488

 

$

4,942

 

Accounts payable

 

65,991

 

64,108

 

Accrued liabilities

 

153,379

 

148,464

 

Total current liabilities

 

272,858

 

217,514

 

Deferred income taxes

 

52,632

 

51,661

 

Other long-term liabilities

 

89,320

 

97,024

 

Long-term debt, excluding current installments

 

1,217,594

 

1,072,625

 

Total liabilities

 

1,632,404

 

1,438,824

 

 

 

 

 

 

 

Commitments and contingencies

 

 

 

 

 

 

 

 

 

 

 

Stockholders’ equity:

 

 

 

 

 

Class A common stock, par value $0.01 per share, 199,300 shares authorized, and 92,877 and 93,414 shares outstanding as of September 30, 2008 and December 31, 2007, respectively

 

929

 

934

 

Additional paid-in capital

 

551,294

 

521,902

 

Accumulated earnings

 

171,636

 

97,323

 

Treasury stock, at cost, 2,140 and 1,140 shares held as of September 30, 2008 and December 31, 2007, respectively

 

(37,459

)

(19,442

)

Accumulated other comprehensive income

 

38,137

 

60,498

 

Total stockholders’ equity

 

724,537

 

661,215

 

Total liabilities and stockholders’ equity

 

$

2,356,941

 

$

2,100,039

 

 

See accompanying notes to consolidated financial statements.

 

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SCIENTIFIC GAMES CORPORATION AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF INCOME

Three Months Ended September 30, 2008 and 2007

(Unaudited, in thousands, except per share amounts)

 

 

 

Three Months Ended September 30,

 

 

 

2008

 

2007

 

Operating revenues:

 

 

 

 

 

Services

 

$

265,430

 

$

244,526

 

Sales

 

26,505

 

22,374

 

 

 

291,935

 

266,900

 

Operating expenses:

 

 

 

 

 

Cost of services (exclusive of depreciation and amortization)

 

157,480

 

141,935

 

Cost of sales (exclusive of depreciation and amortization)

 

17,257

 

15,874

 

Selling, general and administrative expenses

 

41,937

 

43,738

 

Depreciation and amortization

 

36,487

 

61,266

 

Operating income

 

38,774

 

4,087

 

Other (income) expense:

 

 

 

 

 

Interest expense

 

17,659

 

15,975

 

Equity in earnings of joint ventures

 

(13,356

)

(8,344

)

Other income, net

 

(818

)

(123

)

 

 

3,485

 

7,508

 

Income (loss) before income taxes

 

35,289

 

(3,421

)

Income tax expense (benefit)

 

9,879

 

(543

)

Net income (loss)

 

$

25,410

 

$

(2,878

)

 

 

 

 

 

 

Basic and diluted net income per share:

 

 

 

 

 

Basic net income (loss) per share

 

$

0.27

 

$

(0.03

)

Diluted net income (loss) per share

 

$

0.27

 

$

(0.03

)

 

 

 

 

 

 

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

 

 

 

 

 

Basic shares

 

92,841

 

92,737

 

Diluted shares

 

94,626

 

92,737

 

 

 See accompanying notes to consolidated financial statements.

 

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SCIENTIFIC GAMES CORPORATION AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF INCOME

Nine Months Ended September 30, 2008 and 2007

(Unaudited, in thousands, except per share amounts)

 

 

 

 

Nine Months Ended September 30,

 

 

 

2008

 

2007

 

Operating revenues:

 

 

 

 

 

Services

 

$

764,044

 

$

690,180

 

Sales

 

90,867

 

88,563

 

 

 

854,911

 

778,743

 

Operating expenses:

 

 

 

 

 

Cost of services (exclusive of depreciation and amortization)

 

440,394

 

388,380

 

Cost of sales (exclusive of depreciation and amortization)

 

63,808

 

64,815

 

Selling, general and administrative expenses

 

140,775

 

123,378

 

Depreciation and amortization

 

106,099

 

122,600

 

Operating income

 

103,835

 

79,570

 

Other (income) expense:

 

 

 

 

 

Interest expense

 

45,962

 

43,141

 

Equity in earnings of joint ventures

 

(48,612

)

(31,623

)

Early extinguishment of long-term debt

 

2,960

 

 

Other income, net

 

(1,513

)

(166

)

 

 

(1,203

)

11,352

 

Income before income taxes

 

105,038

 

68,218

 

Income tax expense

 

30,725

 

19,230

 

Net income

 

$

74,313

 

$

48,988

 

 

 

 

 

 

 

Basic and diluted net income per share:

 

 

 

 

 

Basic net income per share

 

$

0.80

 

$

0.53

 

Diluted net income per share

 

$

0.79

 

$

0.51

 

 

 

 

 

 

 

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

 

 

 

 

 

Basic shares

 

92,933

 

92,440

 

Diluted shares

 

94,588

 

95,894

 

 

 See accompanying notes to consolidated financial statements.

 

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SCIENTIFIC GAMES CORPORATION AND SUBSIDIARIES

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

Nine Months Ended September 30, 2008 and 2007

(Unaudited, in thousands, except per share amounts)

 

 

 

Nine Months Ended September 30,

 

 

 

2008

 

2007

 

Net cash provided by operating activities

 

$

145,597

 

$

141,592

 

 

 

 

 

 

 

Cash flows from investing activities:

 

 

 

 

 

Capital expenditures

 

(10,886

)

(27,430

)

Wagering system expenditures

 

(123,479

)

(108,927

)

Other intangible assets and software expenditures

 

(33,711

)

(28,608

)

Change in other assets and liabilities, net

 

(1,826

)

(25,732

)

Business acquisitions, net of cash acquired

 

(3,174

)

(102,840

)

Net cash used in investing activities

 

(173,076

)

(293,537

)

 

 

 

 

 

 

Cash flows from financing activities:

 

 

 

 

 

Net borrowings (repayments) under revolving credit facility

 

(158,000

)

(45,000

)

Proceeds of issuance from long-term debt

 

797,243

 

200,000

 

Payments on long-term debt

 

(447,069

)

(3,639

)

Payment of financing fees

 

(15,085

)

 

Purchase of treasury stock

 

(18,017

)

 

Net proceeds from issuance of common stock

 

3,020

 

11,701

 

Net cash provided by financing activities

 

162,092

 

163,062

 

Effect of exchange rate changes on cash and cash equivalents

 

(2,246

)

2,164

 

Increase in cash and cash equivalents

 

132,367

 

13,281

 

Cash and cash equivalents, beginning of period

 

29,403

 

27,791

 

Cash and cash equivalents, end of period

 

$

161,770

 

$

41,072

 

 

See accompanying notes to consolidating financial statements.

 

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SCIENTIFIC GAMES CORPORATION AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited, in thousands, except per share amounts)

 

Notes to Consolidated Financial Statements

 

(1) Consolidated Financial Statements

 

Basis of Presentation

 

The consolidated balance sheet as of September 30, 2008, the consolidated statements of income for the three and nine months ended September 30, 2008 and 2007, and the condensed consolidated statements of cash flows for the nine months ended September 30, 2008 and 2007, have been prepared by Scientific Games Corporation and are unaudited.  When used in these notes, the terms “we,” “us,” “our” and “Company” refer to 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 September 30, 2008, the results of our operations for the three and nine months ended September 30, 2008 and 2007 and our cash flows for the nine months ended September 30, 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 September 30, 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 and nine months ended September 30, 2008 and 2007:

 

 

 

Three Months Ended

 

Nine Months Ended

 

 

 

September 30,

 

September 30,

 

 

 

2008

 

2007

 

2008

 

2007

 

Income (numerator)

 

 

 

 

 

 

 

 

 

Net income (loss)

 

$

25,410

 

$

(2,878

)

$

74,313

 

$

48,988

 

 

 

 

 

 

 

 

 

 

 

Shares (denominator)

 

 

 

 

 

 

 

 

 

Weighted-average basic common shares outstanding

 

92,841

 

92,737

 

92,933

 

92,440

 

Effect of dilutive securities-stock rights

 

1,785

 

 

1,649

 

2,147

 

Effect of dilutive shares related to convertible debentures

 

 

 

6

 

1,307

 

Weighted-average diluted common shares outstanding

 

94,626

 

92,737

 

94,588

 

95,894

 

 

 

 

 

 

 

 

 

 

 

Basic and diluted per share amounts

 

 

 

 

 

 

 

 

 

Basic net income (loss) per share

 

$

0.27

 

$

(0.03

)

$

0.80

 

$

0.53

 

Diluted net income (loss) per share

 

$

0.27

 

$

(0.03

)

$

0.79

 

$

0.51

 

 

The weighted-average diluted common shares outstanding for the three months ended September 30, 2008 and 2007 excludes the effect of approximately 3,744 and 1,511, respectively, weighted stock rights outstanding, because their effect would be anti-dilutive.

 

The aggregate number of shares that we could be obligated to issue upon conversion of the remaining $273,782 in aggregate principal amount of our 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.

 

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SCIENTIFIC GAMES CORPORATION AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited, in thousands, except per share amounts)

 

(1) Consolidated Financial Statements (continued)

 

During the third quarter of 2008, the average price of our common stock was lower than the conversion price of the Convertible Debentures. Therefore, no shares related to the Convertible Debentures were included in our weighted-average diluted common shares outstanding for the three months ended September 30, 2008. During the second quarter of 2008, the average price of the Company’s common stock exceeded the conversion price of the Convertible Debentures, therefore, we have included approximately 6 shares related to our Convertible Debentures in our weighted-average diluted common shares outstanding for the year-to-date period ended September 30, 2008.

 

During the third quarter of 2007, the average price of the Company’s common stock exceeded the conversion price of the Convertible Debentures, however, due to the net loss for the quarter ended September 30, 2007, we did not include 1,669 potentially dilutive shares related to our Convertible Debentures in our weighted-average dilutive shares outstanding because their effect would be anti-dilutive. For the nine months ended September 30, 2007, we have included 1,307 shares related to our Convertible Debentures in our diluted weighted-average common shares outstanding.  We have not included 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) Operating Segment Information

 

We operate in three segments. Our Printed Products Group provides lotteries with instant ticket and related services that 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 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. This division also includes our pari-mutuel gaming operations in Connecticut, Maine and the Netherlands.

 

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SCIENTIFIC GAMES CORPORATION AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited, in thousands, except per share amounts)

 

(2) Operating Segment Information (continued)

 

The following tables represent revenues, profits, depreciation, amortization and selling, general and administrative expenses for the three and nine month periods ended September 30, 2008 and 2007, by reportable segments. Corporate expenses, including interest expense, other income, and depreciation and amortization, are not allocated to the reportable segments.

 

 

 

Three Months Ended September 30, 2008

 

 

 

Printed 
Products
Group

 

Lottery
Systems Group

 

Diversified
Gaming Group

 

Totals

 

Service revenues

 

$

147,142

 

62,354

 

55,934

 

265,430

 

Sales revenues

 

7,431

 

15,072

 

4,002

 

26,505

 

Total revenues

 

154,573

 

77,426

 

59,936

 

291,935

 

 

 

 

 

 

 

 

 

 

 

Cost of services (exclusive of depreciation and amortization)

 

91,459

 

32,597

 

33,424

 

157,480

 

Cost of sales (exclusive of depreciation and amortization)

 

4,423

 

11,581

 

1,253

 

17,257

 

Selling, general and administrative expenses

 

14,330

 

6,860

 

5,449

 

26,639

 

Depreciation and amortization

 

9,276

 

15,409

 

11,519

 

36,204

 

Segment operating income

 

$

35,085

 

10,979

 

8,291

 

54,355

 

Unallocated corporate costs

 

 

 

 

 

 

 

$

15,581

 

Consolidated operating income

 

 

 

 

 

 

 

$

38,774

 

 

 

 

Three Months Ended September 30, 2007

 

 

 

Printed 
Products
Group

 

Lottery
Systems Group

 

Diversified
Gaming Group

 

Totals

 

Service revenues

 

$

139,132

 

54,583

 

50,811

 

244,526

 

Sales revenues

 

9,378

 

8,429

 

4,567

 

22,374

 

Total revenues

 

148,510

 

63,012

 

55,378

 

266,900

 

 

 

 

 

 

 

 

 

 

 

Cost of services (exclusive of depreciation and amortization)

 

82,399

 

28,867

 

30,669

 

141,935

 

Cost of sales (exclusive of depreciation and amortization)

 

7,805

 

3,809

 

4,260

 

15,874

 

Selling, general and administrative expenses

 

16,541

 

8,606

 

4,846

 

29,993

 

Depreciation and amortization

 

37,013

 

16,130

 

7,893

 

61,036

 

Segment operating income

 

$

4,752

 

5,600

 

7,710

 

18,062

 

Unallocated corporate costs

 

 

 

 

 

 

 

$

13,975

 

Consolidated operating income

 

 

 

 

 

 

 

$

4,087

 

 

10



Table of Contents

 

SCIENTIFIC GAMES CORPORATION AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited, in thousands, except per share amounts)

 

(2) Operating Segment Information (continued)

 

 

 

Nine Months Ended September 30, 2008

 

 

 

Printed 
Products 
Group

 

Lottery 
Systems Group

 

Diversified 
Gaming Group

 

Totals

 

Service revenues

 

$

421,153

 

178,332

 

164,559

 

764,044

 

Sales revenues

 

24,648

 

47,335

 

18,884

 

90,867

 

Total revenues

 

445,801

 

225,667

 

183,443

 

854,911

 

 

 

 

 

 

 

 

 

 

 

Cost of services (exclusive of depreciation and amortization)

 

249,650

 

92,429

 

98,315

 

440,394

 

Cost of sales (exclusive of depreciation and amortization)

 

16,309

 

38,352

 

9,147

 

63,808

 

Selling, general and administrative expenses

 

47,860

 

25,742

 

19,493

 

93,095

 

Depreciation and amortization

 

28,728

 

45,765

 

30,774

 

105,267

 

Segment operating income

 

$

103,254

 

23,379

 

25,714

 

152,347

 

Unallocated corporate costs

 

 

 

 

 

 

 

$

48,512

 

Consolidated operating income

 

 

 

 

 

 

 

$

103,835

 

 

 

 

Nine Months Ended September 30, 2007

 

 

 

Printed 
Products 
Group

 

Lottery 
Systems Group

 

Diversified 
Gaming Group

 

Totals

 

Service revenues

 

$

370,714

 

161,726

 

157,740

 

690,180

 

Sales revenues

 

28,734

 

29,944

 

29,885

 

88,563

 

Total revenues

 

399,448

 

191,670

 

187,625

 

778,743

 

 

 

 

 

 

 

 

 

 

 

Cost of services (exclusive of depreciation and amortization)

 

208,929

 

86,335

 

93,116

 

388,380

 

Cost of sales (exclusive of depreciation and amortization)

 

23,809

 

15,935

 

25,071

 

64,815

 

Selling, general and administrative expenses

 

43,746

 

23,941

 

15,408

 

83,095

 

Depreciation and amortization

 

55,536

 

45,486

 

20,894

 

121,916

 

Segment operating income

 

$

67,428

 

19,973

 

33,136

 

120,537

 

Unallocated corporate costs

 

 

 

 

 

 

 

$

40,967

 

Consolidated operating income

 

 

 

 

 

 

 

$

79,570

 

 

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SCIENTIFIC GAMES CORPORATION AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited, in thousands, except per share amounts)

 

(2) 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
September 30,

 

Nine Months Ended
September 30,

 

 

 

 

 

 

 

2008

 

2007

 

2008

 

2007

 

Reported segment operating income

 

$

54,355

 

$

18,062

 

$

152,347

 

$

120,537

 

Unallocated corporate costs

 

(15,581

)

(13,975

)

(48,512

)

(40,967

)

Consolidated operating income

 

38,774

 

4,087

 

103,835

 

79,570

 

Interest expense

 

(17,659

)

(15,975

)

(45,962

)

(43,141

)

Equity in earnings of joint ventures

 

13,356

 

8,344

 

48,612

 

31,623

 

Early extinguishment of long-term debt

 

 

 

(2,960

)

 

Other income

 

818

 

123

 

1,513

 

166

 

Income (loss) before income tax expense

 

$

35,289

 

$

(3,421

)

$

105,038

 

$

68,218

 

 

In evaluating financial performance, we focus on operating income as a segment’s measure of profit or loss. Operating income is income 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 2007 Annual Report on Form 10-K).

 

(3) Equity Investments in Joint Ventures

 

We are a member of Consorzio Lotterie Nazionali (“CLN”), a consortium consisting principally of the 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 and nine months ended September 30, 2008, we recorded income of $12,015 and $42,977, respectively, representing our share of the earnings of the consortium for the indicated periods.   For the three and nine months ended September 30, 2007, we recorded income of $7,345 and $29,315, respectively, representing our share of the earnings of the consortium for the indicated periods.

 

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Table of Contents

 

 SCIENTIFIC GAMES CORPORATION AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited, in thousands, except per share amounts)

 

(4) Comprehensive Income

 

The following presents a reconciliation of net income to comprehensive income for the three and nine month periods ended September 30, 2008 and 2007:

 

 

 

Three Months Ended
September 30,

 

Nine Months Ended
September 30,

 

 

 

 

 

 

 

2008

 

2007

 

2008

 

2007

 

Net income (loss)

 

$

25,410

 

$

(2,878

)

$

74,313

 

$

48,988

 

Other comprehensive income (loss)

 

 

 

 

 

 

 

 

 

Foreign currency translation gain (loss)

 

(40,808

)

17,994

 

(22,180

)

30,012

 

Unrealized gain (loss) on investments

 

 

831

 

(181

)

1,197

 

Other comprehensive income (loss)

 

(40,808

)

18,825

 

(22,361

)

31,209

 

Comprehensive income (loss)

 

$

(15,398

)

$

15,947

 

$

51,952

 

$

80,197

 

 

(5) Inventories

 

Inventories consist of the following:

 

 

 

September 30,

 

December 31,

 

 

 

2008

 

2007

 

Parts and work-in-process

 

$

49,580

 

$

48,167

 

Finished goods

 

42,106

 

44,398

 

 

 

$

91,686

 

$

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.

 

(6) Long-Term Debt

 

In June 2008, we entered into certain debt financing transactions structured to extend the average maturity of the Company’s debt, create additional borrowing capacity and revise certain financial covenants to be more favorable to the Company.  We and our 100%-owned subsidiary, Scientific Games International, Inc. (“SGI”), entered into a credit agreement, dated as of June 9, 2008 (the “Credit Agreement”), among SGI, as borrower, the Company, as guarantor, and the several lenders from time to time parties thereto.  The Credit Agreement replaces the Company’s credit agreement, dated as of December 23, 2004, as amended and restated as of January 24, 2007 (the “2004 Credit Agreement”).  All amounts outstanding under the 2004 Credit Agreement were paid on June 9, 2008, and the 2004 Credit Agreement was terminated.  In addition, on June 11, 2008, SGI issued $200,000 of 7.875% senior subordinated notes due 2016 (the “2008 Notes”).   The 2008 Notes were issued pursuant to an indenture dated as of June 11, 2008 (the “Indenture”) among SGI, as issuer, the Company, as a guarantor, the Company’s subsidiary guarantors party thereto and the trustee.  In connection with the Credit Agreement and the issuance of the 2008 Notes, an aggregate of $13,004 was paid to certain financial institutions in the form of fees and initial purchasers’ discounts.

 

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Table of Contents

 

SCIENTIFIC GAMES CORPORATION AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited, in thousands, except per share amounts)

 

(6) Long-Term Debt (continued)

 

Credit Agreement

 

The Credit Agreement provides for a $250,000 senior secured revolving credit facility (the “Revolver”) and a $550,000 senior secured term loan credit facility (the “Term Loan”).  Under the terms of the Credit Agreement, SGI has the ability, subject to certain terms and conditions, to request additional tranches of term loans or to request an increase in the commitments under the Revolver, or a combination thereof, in a maximum aggregate amount of $200,000 at a later date.

 

Amounts under the Revolver may be borrowed, repaid and reborrowed by SGI from time to time until maturity.  The Credit Agreement will terminate on June 9, 2013, provided that the Revolver and the Term Loan will both mature on March 1, 2010 unless one of the following conditions is met:

 

·                the right of holders of our Convertible Debentures to require the repurchase of their Convertible Debentures is eliminated;

 

·                such Convertible Debentures are refinanced, redeemed or defeased (or a trust or escrow is established, on terms reasonably satisfactory to the administrative agent under the Credit Agreement, for purposes of and in an amount sufficient to discharge all payment obligations with respect to such Convertible Debentures); or

 

·                  the sum of the aggregate unused and available Revolver commitments under the Credit Agreement plus the unrestricted cash of SGI and the guarantors under the Credit Agreement is not less than the sum of the principal amount of such Convertible Debentures then outstanding plus $50,000.

 

The Revolver and the Term Loan will both mature on September 15, 2012, unless one of the following conditions is met:

 

·                  our 6.25% Senior Subordinated Notes due 2012 (the “2004 Notes”)  are refinanced, redeemed or defeased (or a trust or escrow is established, on terms and conditions reasonably satisfactory to the administrative agent under the Credit Agreement, for purposes of and in an amount sufficient to discharge such notes); or

 

·                    the sum of the aggregate unused and available Revolver commitments under the Credit Agreement plus the unrestricted cash of SGI and the guarantors under the Credit Agreement is not less than the sum of the principal amount of the 2004 Notes then outstanding plus $50,000.

 

Voluntary prepayments and commitment reductions under the Credit Agreement are permitted at any time in whole or in part, without premium or penalty (other than breakfunding costs), upon proper notice and subject to a minimum dollar requirement.

 

Borrowings under the Credit Agreement bear interest at a rate per annum equal to, at SGI’s option, either (1) a base rate determined by reference to the higher of (a) the prime rate of JPMorgan Chase Bank, N.A. and (b) the federal funds effective rate plus 0.50%, or (2) a reserve-adjusted LIBOR rate, in each case plus an applicable margin.  The applicable margin varies based on the consolidated leverage ratio of the Company from 0.75% to 1.75% above the base rate for base rate loans, and 1.75% to 2.75% above LIBOR for LIBOR-based loans.  From the date of the Credit Agreement to the filing date of this Quarterly Report, the applicable margins for base rate loans and LIBOR-based loans were 1.50% and 2.50%, respectively.  During the term of the Credit Agreement, SGI will pay its lenders a fee equal to the product of 0.50% per annum and the unused portion of the Revolver.

 

We and our direct and indirect 100%-owned domestic subsidiaries (other than SGI) have provided a guarantee of the payment of SGI’s obligations under the Credit Agreement.  In addition, the obligations under the Credit Agreement are secured by a first priority, perfected lien on (1) substantially all the property and assets (real and personal, tangible and intangible) of the Company and its direct and indirect 100%-owned domestic subsidiaries and (2) 100% of our interest in the capital stock (or other equity interests) of all of our direct and indirect 100%-owned domestic subsidiaries and 65% of our interest in the capital stock (or other equity interests) of the first-tier foreign subsidiaries of SGI and the guarantors.

 

The Credit Agreement contains covenants customary for financings of this type, including negative covenants that, among other things, limit the ability of the Company and its 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.  In addition, the Credit Agreement requires us to maintain the following financial ratios:

 

·                  a Consolidated Leverage Ratio as at the last day of a fiscal quarter not to exceed the ratio set forth below with respect to such fiscal quarter or with respect to the period during which such fiscal quarter ends:

 

·                  4.25 to 1:00 (fiscal quarter ended June 30, 2008 through December 31, 2009)

 

·                  4.00 to 1:00 (fiscal quarter ending March 31, 2010 and thereafter)

 

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Table of Contents

 

SCIENTIFIC GAMES CORPORATION AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited, in thousands, except per share amounts)

 

(6) Long-Term Debt  (continued)

 

“Consolidated Leverage Ratio” means, as of the last day of any period, the ratio of (1) Consolidated Total Debt (defined as the aggregate principal amount of our indebtedness, determined on a consolidated basis and required to be reflected on our balance sheet in accordance with Generally Accepted Accounting Principles (“GAAP”)) on such day, to (2) Consolidated EBITDA for the period of four consecutive fiscal quarters then ended.

 

·                  a Consolidated Senior Debt Ratio as at the last day of a fiscal quarter not to exceed 2.50 to 1.00.

 

“Consolidated Senior Debt Ratio” means, as of the last day of any period, the ratio of (1) Consolidated Total Debt (other than the 2004 Notes, the 2008 Notes, the Convertible Debentures and any additional subordinated debt permitted under the Credit Agreement) to (2) Consolidated EBITDA for the period of four consecutive fiscal quarters then ended.

 

·                  a Consolidated Interest Coverage Ratio for any period of four consecutive fiscal quarters of at least 3.50 to 1.00 for any period of four consecutive fiscal quarters.

 

“Consolidated Interest Coverage Ratio” means, for any period, the ratio of (1) Consolidated EBITDA for such period to (2) total cash interest expense with respect to all outstanding indebtedness of the Company and its subsidiaries for such period.

 

For purposes of the foregoing, “Consolidated EBITDA” means, for any period, consolidated net income (or loss) of the Company and its subsidiaries for such period, determined in accordance with GAAP (excluding (a) the income (or deficit) of any entity accrued prior to the date it becomes a subsidiary of the Company or is merged into or consolidated with us or any of our subsidiaries, (b) the income (or deficit) of any entity (other than subsidiaries) in which we or our subsidiaries have an ownership interest, except to the extent such income is actually received by us or our subsidiaries through dividends or other distributions and (c) the undistributed earnings of any subsidiary (other than SGI) to the extent that the declaration or payment of dividends or similar distributions by such subsidiary is not at the time permitted by the terms of any contractual obligation (other than under the Credit Agreement or any related document) or requirement of law), plus, to the extent reflected as a charge in the statement of such consolidated net income for such period, the sum of (1) income tax expense, (2) interest expense, amortization or write-off of debt discount and debt issuance costs and commissions, discounts and other fees and charges associated with indebtedness, (3) depreciation and amortization expense, (4) amortization of intangibles (including goodwill) and organization costs, (5) certain earn-out payments, (6) extraordinary charges or losses determined in accordance with GAAP, (7) non-cash stock-based compensation expenses, (8) certain expenses, charges or losses resulting from certain investments in Peru not to exceed $3,000 (9) the non-cash portion of any nonrecurring write-offs or write-downs as required in accordance with GAAP and (10) any advisory fees and related expenses in connection with permitted acquisitions, and minus, to the extent included in the statement of such consolidated net income for such period, the sum of (i) interest income, (ii) any extraordinary income or gains determined in accordance with GAAP and (iii) any income or gains with respect to certain earn-out payments.

 

In addition, the Credit Agreement requires mandatory prepayments of the Term Loan with the net cash proceeds from (1) the incurrence of indebtedness by the Company or any of its subsidiaries (excluding certain permitted indebtedness) and (2)  the sale of assets that yields net cash proceeds to the Company or any of its subsidiaries in excess of $5,000 (excluding certain permitted sales of assets) or any settlement of or payment in respect of any property or casualty insurance claim or any condemnation proceeding relating to any asset of the Company of its subsidiaries, subject to a reinvestment exclusion.

 

We were in compliance with our covenants as of September 30, 2008.

 

As of September 30, 2008, we had approximately $178,414 available for additional borrowing or letter of credit issuance under our Revolver.  There were no borrowings and $71,586 in outstanding letters of credit under our Revolver as of September 30, 2008.  Our ability to borrow under the Credit Agreement will depend on us remaining in compliance with the limitations imposed by our lenders, including the maintenance of the foregoing financial ratios.

 

2008 Notes

 

The 2008 Notes bear interest at the rate of 7.875% per annum, which accrues from June 11, 2008 and is payable semiannually in arrears on June 15 and December 15 of each year, commencing on December 15, 2008.  The 2008 Notes mature on June 15, 2016, unless earlier redeemed or repurchased, and are subject to the terms and conditions set forth in the Indenture.

 

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Table of Contents

 

SCIENTIFIC GAMES CORPORATION AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited, in thousands, except per share amounts)

 

(6) Long-Term Debt (continued)

 

SGI may redeem some or all of the 2008 Notes at any time prior to June 15, 2012 at a price equal to 100% of the principal amount of the 2008 Notes, plus accrued and unpaid interest, if any, to the date of redemption and a “make whole” premium calculated as set forth in the Notes.  SGI may redeem some or all of the 2008 Notes for cash at any time on or after June 15, 2012 at redemption prices equal to 103.938%, 101.969% and 100% of the principal amount thereof if redeemed during the 12-month periods commencing on June 15 of 2012, 2013, and 2014 and thereafter, respectively, plus, in each case, accrued and unpaid interest, if any, to the date of redemption.  In addition, at any time on or prior to June 15, 2011, SGI may redeem up to 35% of the initially outstanding aggregate principal amount of the 2008 Notes at a redemption price equal to 107.875% of the principal amount thereof, plus accrued and unpaid interest, if any, to the date of redemption, with the net cash proceeds contributed to the capital of SGI from one or more equity offerings of the Company.  Additionally, if a holder of 2008 Notes is required to be licensed or found qualified under any applicable gaming laws or regulations and that holder does not become so licensed or found qualified or suitable, then SGI will have the right to, subject to certain notice provisions set forth in the Indenture, (1)  require that holder to dispose of all or a portion of those 2008 Notes or (2) redeem the 2008 Notes of that holder at a redemption price calculated as set forth in the Notes.

 

Upon the occurrence of a change of control (as defined in the Indenture), SGI must make an offer to purchase the 2008 Notes at a purchase price equal to 101% of the principal amount thereof, plus accrued and unpaid interest, if any, to the date of repurchase.  In addition, following an asset sale (as defined in the Indenture) and subject to the limitations contained in the Indenture, SGI must make an offer to purchase certain amounts of the 2008 Notes using the net cash proceeds from such asset sale to the extent such proceeds are not applied as set forth in the Indenture, at a purchase price equal to 100% of the principal amount of the 2008 Notes to be repurchased, plus accrued interest to the date of repurchase.  SGI is not required to make any mandatory redemption or sinking fund payments with respect to the 2008 Notes.

 

The 2008 Notes are subordinated to all of SGI’s existing and future senior debt, rank equally with all of SGI’s existing and future senior subordinated debt, and rank senior to all of SGI’s future debt that is expressly subordinated to the 2008 Notes.  The 2008 Notes are guaranteed on a senior subordinated unsecured basis by the Company and all of our 100%-owned domestic subsidiaries (other than SGI).  The guarantees of the 2008 Notes are subordinated to all of the guarantors’ existing and future senior debt, rank equally with all of their existing and future senior subordinated debt, and rank senior to all of their future debt that is expressly subordinated to the guarantees of the 2008 Notes.  The 2008 Notes are structurally subordinated to all of the liabilities of the Company’s non-guarantor subsidiaries.

 

The Indenture contains certain covenants that, among other things, limit the Company’s ability, and the ability of certain of its subsidiaries, to incur additional indebtedness, pay dividends or make distributions or certain other restricted payments, purchase or redeem capital stock, make investments or extend credit, engage in certain transactions with affiliates, engage in sale-leaseback transactions, consummate certain asset sales, effect a consolidation or merger, or sell, transfer, lease or otherwise dispose of all or substantially all assets, or create certain liens and other encumbrances on assets.

 

The 2008 Notes were issued in a private offering to qualified institutional buyers in accordance with Rule 144A under the Securities Act of 1933, as amended (the “Securities Act”), and to persons outside the United States under Regulation S under the Securities Act.  Under the terms of a registration rights agreement, we and SGI agreed, for the benefit of the holders of the 2008 Notes, to use our commercially reasonable efforts to file with the Securities and Exchange Commission (the “SEC”) and cause to become effective a registration statement relating to an offer to exchange the 2008 Notes for an issue of SEC-registered notes (the “Exchange Notes”) with terms identical to the 2008 Notes (except that the Exchange Notes will not be subject to restrictions on transfer or to any increase in annual interest rate as described below).  If applicable interpretations of the staff of the SEC do not permit SGI to effect the exchange offer, SGI will use its commercially reasonable efforts to cause to become effective a shelf registration statement relating to resales of the 2008 Notes and to keep that shelf registration statement effective until the first anniversary of the date such shelf registration statement becomes effective, or such shorter period that will terminate when all 2008 Notes covered by the shelf registration statement have been sold.  The obligation to complete the exchange offer and/or file a shelf registration statement will terminate on the second anniversary of the date of the registration rights agreement.

 

If the exchange offer is not completed (or, if applicable, the shelf registration statement is not declared effective) on or before March 11, 2009, the annual interest rate borne by the 2008 Notes will be increased by 0.25% per annum for the first 90-day period immediately following such date and by an additional 0.25% per annum with respect to each subsequent 90-day period, up to a maximum additional rate of 1.0% per annum thereafter until the exchange offer is completed, the shelf registration statement is declared effective or the obligation to complete the exchange offer and/or file the shelf registration statement terminates, at which time the interest rate will revert to the original interest rate on the date the 2008 Notes were originally issued.

 

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Table of Contents

 

SCIENTIFIC GAMES CORPORATION AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited, in thousands, except per share amounts)

 

(6) Long-Term Debt (continued)

 

Other Debt

 

Our 2004 Notes in an aggregate principal amount of $200,000 and our Convertible Debentures in an aggregate principal amount of $273,782 remain outstanding.  Please see our 2007 Annual Report on Form 10-K for descriptions of the 2004 Notes and the Convertible Debentures.

 

Short-term debt includes approximately $47,596 of unsecured borrowings, denominated in Chinese Renminbi Yuan (“RMB”), from two banks in China.  The borrowings have maturity dates of less than one year and interest rates ranging from 6.2% to 7.8%, which is 95% to 105% of the rate set by the People’s Bank of China for similar type loans.  The lending banks have received standby letters of credit issued under the Revolver to guarantee repayment of these borrowings.  Proceeds from the borrowings are being used to procure and install our terminal validation network in China.

 

(7) Goodwill and Intangible Assets

 

The following disclosure presents certain information regarding our acquired intangible assets as of September 30, 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 September 30, 2008

 

 

 

 

 

 

 

Amortizable intangible assets:

 

 

 

 

 

 

 

Patents

 

$

11,050

 

(2,681

)

8,369

 

Customer lists

 

30,903

 

(14,615

)

16,288

 

Customer service contracts

 

4,088

 

(2,563

)

1,525

 

Licenses

 

48,818

 

(32,317

)

16,501

 

Intellectual property

 

20,584

 

(12,587

)

7,997

 

Lottery contracts

 

28,091

 

(26,199

)

1,892

 

 

 

143,534

 

(90,962

)

52,572

 

Non-amortizable intangible assets:

 

 

 

 

 

 

 

Trade name

 

38,454

 

(2,118

)

36,336

 

Connecticut off-track betting system operating right

 

35,609

 

(8,319

)

27,290

 

 

 

74,063

 

(10,437

)

63,626

 

Total intangible assets

 

$

217,597

 

(101,399

)

116,198

 

 

 

 

 

 

 

 

 

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 and nine months ended September 30, 2008 was approximately $6,900 and $21,800, respectively.  The aggregate intangible amortization expense for the three and nine months ended September 30, 2007 was approximately $19,800 and $35,400, respectively.

 

17



Table of Contents

 

SCIENTIFIC GAMES CORPORATION AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited, in thousands, except per share amounts)

 

(7) 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 September 30, 2008.  In 2008, we recorded (a) a $2,208 increase in goodwill associated with the acquisition of Oberthur Gaming Technologies and related companies (“OGT”), (b) a $115 increase in goodwill associated with the acquisition of Games Media Limited, and (c) a decrease in goodwill of $17,147 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

 

501

 

456

 

(15,781

)

(14,824

)

Balance as of September 30, 2008

 

$

329,220

 

194,975

 

177,837

 

702,032

 

 

(8) Pension and Other Post-Retirement Plans

 

We have defined benefit pension plans for our union employees based in the U.S. and the U.K. (the “U.S. Plan” and the “U.K. Plan”).  In addition, with the acquisition of OGT, we have a pension plan for 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 and nine months ended September 30, 2008 and 2007.

 

 

 

Three Months Ended

 

Nine Months Ended

 

 

 

September 30,

 

September 30,

 

 

 

2008

 

2007

 

2008

 

2007

 

Components of net periodic pension benefit cost:

 

 

 

 

 

 

 

 

 

Service cost

 

$

713

 

$

798

 

$

2,138

 

$

1,964

 

Interest cost

 

1,366

 

1,225

 

4,099

 

3,079

 

Expected return on plan assets

 

(1,440

)

(1,393

)

(4,321

)

(3,487

)

Amortization of actuarial gains/losses

 

280

 

252

 

840

 

758

 

Amortization of prior service costs

 

11

 

11

 

32

 

32

 

Net periodic cost

 

$

930

 

$

893

 

$

2,788

 

$

2,346

 

 

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SCIENTIFIC GAMES CORPORATION AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited, in thousands, except per share amounts)

 

(9) Income Taxes

 

The effective tax rates of 28.0% and 29.3%, respectively, for the three and nine months ended September 30, 2008 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.  The effective tax rates for the three and nine months ended September 30, 2007 of 15.9% and 28.2%, 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.

 

(10) Stockholders’ Equity

 

The following demonstrates the change in the number of shares of Class A common stock outstanding during the three months ended September 30, 2008 and during the fiscal year ended December 31, 2007:

 

 

 

Three Months

 

Twelve Months

 

 

 

Ended

 

Ended

 

 

 

September 30,

 

December 31,

 

 

 

2008

 

2007

 

Shares outstanding as of beginning of period

 

92,757

 

91,628

 

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

 

120

 

1,786

 

Other shares issued

 

 

10

 

Shares repurchased into treasury stock

 

 

(10

)

Shares outstanding as of end of period

 

92,877

 

93,414

 

 

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SCIENTIFIC GAMES CORPORATION AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited, in thousands, except per share amounts)

 

(11) Stock-Based Compensation

 

As of September 30, 2008, we had approximately 2,377 shares available for grants of equity awards under our equity-based compensation plans, of which 1,340 shares were available for grants of restricted stock units (“RSUs”).

 

Stock Options

 

A summary of the changes in stock options outstanding under our equity-based compensation plans during 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

 

871

 

Cancelled

 

(103

)

 

 

26.56

 

 

Options outstanding as of March 31, 2008

 

7,020

 

6.4

 

$

20.41

 

$

31,770

 

Granted

 

513

 

 

 

25.63

 

 

Exercised

 

(132

)

 

 

15.96

 

2,082

 

Canceled

 

(8

)

 

 

26.78

 

 

Options outstanding as of June 30, 2008

 

7,393

 

6.5

 

$

20.85

 

$

70,143

 

Granted

 

137

 

 

 

29.82

 

 

Exercised

 

(88

)

 

 

14.75

 

1,426

 

Canceled

 

(10

)

 

 

31.11

 

 

Options outstanding as of September 30, 2008

 

7,432

 

6.3

 

$

21.07

 

$

36,795

 

 

 

 

 

 

 

 

 

 

 

Options exercisable as of September 30, 2008

 

3,576

 

4.4

 

$

15.82

 

$

32,753

 

 

The weighted-average grant date fair value of options granted during the three months ended September 30, 2008 was $12.78.  The weighted-average grant date fair value of options granted during the three months ended June 30, 2008 was $12.58.  The weighted-average grant date fair value of options granted during the three months ended March 31, 2008 was $8.96.  For the three and nine months ended September 30, 2008, we recognized equity-based compensation expense of approximately $3,800 and $11,300, respectively, related to the vesting of stock options and the related tax benefit of approximately $1,100 and $3,300, respectively.  For the three and nine months ended September 30, 2007, we recognized equity-based compensation expense of approximately $2,600 and $8,700, respectively, related to the vesting of stock options and the related tax benefit of approximately $400 and $2,500, respectively.  As of September 30, 2008, we had unearned compensation of approximately $31,700 relating to stock option awards that will be amortized over a weighted-average period of approximately two years.

 

20



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SCIENTIFIC GAMES CORPORATION AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited, in thousands, except per share amounts)

 

(11) Stock-Based Compensation (continued)

 

Restricted Stock Units

 

A summary of the changes in RSUs outstanding under our equity-based compensation plans during 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

 

Granted

 

314

 

$

28.76

 

Vested

 

(36

)

$

36.66

 

Canceled

 

(1

)

$

24.60

 

Non-vested units as of June 30, 2008

 

1,800

 

$

28.97

 

Granted

 

42

 

$

29.99

 

Vested

 

(52

)

$

30.63

 

Canceled

 

(3

)

$

30.22

 

Non-vested units as of September 30, 2008

 

1,787

 

$

29.00

 

 

For the three and nine months ended September 30, 2008, we recognized equity-based compensation expense of approximately $4,300 and $12,900, respectively, related to the vesting of RSUs and the related tax benefit of approximately $1,200 and $3,800, respectively.  For the three and nine months ended September 30, 2007, we recognized equity-based compensation expense of approximately $3,700 and $9,500, respectively, related to the vesting of RSUs and the related tax benefit of approximately $500 and $2,700, respectively.  As of September 30, 2008, we had unearned compensation of approximately $39,100 relating to RSUs that will be amortized over a weighted-average period of approximately two years.

 

(12) Recently Issued Accounting Standards

 

In May 2008, the Financial Accounting Standards Board (“FASB”) issued FASB Staff Position (“FSP”) No. Accounting Principles Board (“APB”) 14-1, Accounting for Convertible Debt Instruments That May Be Settled in Cash upon Conversion (Including Partial Settlement) (“FSP APB 14-1”).  FSP APB 14-1 clarifies that convertible debt instruments that may be settled in cash upon conversion (including partial cash settlement) are not addressed by paragraph 12 of APB Opinion No. 14, Accounting for Convertible Debt and Debt Issued with Stock Purchase Warrants. Additionally, this FSP specifies that issuers of such instruments should separately account for the liability and equity components in a manner that will reflect the entity’s nonconvertible debt borrowing rate when interest cost is recognized in subsequent periods. FSP APB 14-1 is effective for financial statements issued for fiscal years beginning after December 15, 2008, and interim periods within those fiscal years, and must be applied retrospectively to all periods presented.  We are currently evaluating the potential impact FSP APB 14-1 will have on our consolidated financial statements.

 

(13) Subsequent Events

 

Effective October 17, 2008, SGI entered into a three-year interest rate swap agreement (the “Hedge”) with JPMorgan Chase Bank N.A. (“JPMorgan”).  Under the Hedge, SGI will pay interest on a $100 million notional amount of debt at a fixed rate of 3.49% and will receive interest on a $100 million notional amount of debt at the prevailing 3-month LIBOR rate.  The objective of the Hedge is to eliminate the variability of cash flows attributable to the LIBOR component of interest expense paid on $100 million of Scientific Games’ variable-rate debt.

 

Mexico’s Federal Competition Commission has launched an investigation into possible anti-competitive practices in the country’s lottery market.  Neither the Company nor its customer is a subject of this investigation.  The investigation is focused on whether distribution agreements and other contracts provide a competitive advantage to one of the market participants.  The Company anticipates a favorable outcome of this investigation that would create improved market conditions and positively affect profitability of the Company’s lottery business in Mexico.  In the absence of a positive effect, the Company might have to write-down some or all of the $53 million USD capital invested in the lottery system there.

 

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SCIENTIFIC GAMES CORPORATION AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited, in thousands, except per share amounts)

 

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

 

We conduct substantially all of our business through our domestic and foreign subsidiaries.  SGI’s obligations under the Credit Agreement and the 2008 Notes are fully and unconditionally and jointly and severally guaranteed by Scientific Games Corporation (the “Parent Company”) and our 100%-owned domestic subsidiaries other than SGI (the “Guarantor Subsidiaries”).  Our 2004 Notes and our Convertible Debentures, which were issued by the Parent Company, are fully and unconditionally and jointly and severally guaranteed by our 100%-owned domestic subsidiaries, including SGI.

 

Presented below is condensed consolidating financial information for (i) the Parent Company, (ii) SGI, (iii) the 100%-owned Guarantor Subsidiaries other than SGI and (iv) the 100%-owned foreign subsidiaries and the non-100%-owned domestic and foreign subsidiaries (the “Non-Guarantor Subsidiaries”) as of September 30, 2008 and December 31, 2007 and for the three and nine months ended September 30, 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, SGI, the Guarantor Subsidiaries and the Non-Guarantor Subsidiaries assuming the guarantee structures of the Credit Agreement, the 2008 Notes, 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.

 

22



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SCIENTIFIC GAMES CORPORATION AND SUBSIDIARIES

 SUPPLEMENTAL CONDENSED CONSOLIDATING BALANCE SHEET

September 30, 2008

(Unaudited, in thousands)

 

 

 

Parent
Company

 

SGI

 

Guarantor
Subsidiaries

 

Non-
Guarantor
Subsidiaries

 

Eliminating
Entries

 

Consolidated

 

Assets

 

 

 

 

 

 

 

 

 

 

 

 

 

Cash and cash equivalents

 

$

95,798

 

208

 

 

71,586

 

(5,822

)

161,770

 

Accounts receivable, net

 

 

104,977

 

57,946

 

78,314

 

 

241,237

 

Inventories

 

 

33,621

 

28,685

 

29,805

 

(425

)

91,686

 

Other current assets

 

28,288

 

11,272

 

13,800

 

34,660

 

 

88,020

 

Property and equipment, net

 

5,579

 

186,690

 

129,735

 

308,566

 

(600

)

629,970

 

Investment in subsidiaries

 

832,531

 

359,696

 

28,633

 

 

(1,220,860

)

 

Goodwill

 

6,526

 

273,194

 

67,926

 

354,386

 

 

702,032

 

Intangible assets

 

 

46,058

 

49,937

 

20,203

 

 

116,198

 

Intercompany balances

 

261,550

 

 

101,948

 

 

(363,498

)

 

Other assets

 

56,250

 

140,234

 

27,354

 

108,291

 

(6,101

)

326,028

 

Total assets

 

$

1,286,522

 

1,155,950

 

505,964

 

1,005,811

 

(1,597,306

)

2,356,941

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Liabilities and stockholders’ equity

 

 

 

 

 

 

 

 

 

 

 

 

 

Current installments of long-term debt

 

$

 

5,500

 

 

47,988

 

 

53,488

 

Current liabilities

 

39,608

 

55,454

 

47,613

 

82,511

 

(5,816

)

219,370

 

Long-term debt, excluding current installments

 

473,782

 

741,750

 

 

2,062

 

 

1,217,594

 

Other non-current liabilities

 

48,595

 

28,746

 

17,134

 

47,471

 

6

 

141,952

 

Intercompany balances

 

 

149,393

 

 

214,113

 

(363,506

)

 

Stockholders’ equity

 

724,537

 

175,107

 

441,217

 

611,666

 

(1,227,990

)

724,537

 

Total liabilities and stockholders’ equity

 

$

1,286,522

 

1,155,950

 

505,964

 

1,005,811

 

(1,597,306

)

2,356,941

 

 

23



Table of Contents

 

SCIENTIFIC GAMES CORPORATION AND SUBSIDIARIES

SUPPLEMENTAL CONDENSED CONSOLIDATING BALANCE SHEET

December 31, 2007

(Unaudited, in thousands)

 

 

 

Parent
Company

 

SGI

 

Guarantor
Subsidiaries

 

Non-
Guarantor
Subsidiaries

 

Eliminating
Entries

 

Consolidated

 

Assets

 

 

 

 

 

 

 

 

 

 

 

 

 

Cash and cash equivalents

 

$

955

 

(119

)

(268

)

28,835

 

 

29,403

 

Accounts receivable, net

 

 

87,154

 

57,000

 

58,920

 

 

203,074

 

Inventories

 

 

45,717

 

20,187

 

27,086

 

(425

)

92,565

 

Other current assets

 

30,940

 

8,193

 

6,345

 

27,357

 

 

72,835

 

Property and equipment, net

 

5,014

 

174,755

 

129,601

 

252,854

 

(600

)

561,624

 

Investment in subsidiaries

 

724,263

 

308,079

 

2,264

 

214,825

 

(1,249,431

)

 

Goodwill

 

(162

)

295,875

 

49,557

 

371,586

 

 

716,856

 

Intangible assets

 

 

49,878

 

53,995

 

29,157

 

 

133,030

 

Other assets

 

96,477

 

77,458

 

21,692

 

101,126

 

(6,101

)

290,652

 

Total assets

 

$

857,487

 

1,046,990

 

340,373

 

1,111,746

 

(1,256,557

)

2,100,039

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Liabilities and stockholders’ equity

 

 

 

 

 

 

 

 

 

 

 

 

 

Current installments of long-term debt

 

$

4,500

 

 

 

442

 

 

4,942

 

Current liabilities

 

32,916

 

34,438

 

54,652

 

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

 

30,111

 

17,423

 

45,058

 

6

 

148,685

 

Intercompany balances

 

(968,513

)

815,678

 

(57,647

)

210,482

 

 

 

Stockholders’ equity

 

661,215

 

166,763

 

325,945

 

763,957

 

(1,256,665

)

661,215

 

Total liabilities and stockholders’ equity

 

$

857,487

 

1,046,990

 

340,373

 

1,111,746

 

(1,256,557

)

2,100,039

 

 

24



Table of Contents

 

SCIENTIFIC GAMES CORPORATION AND SUBSIDIARIES

SUPPLEMENTAL CONDENSED CONSOLIDATING STATEMENT OF INCOME

Three Months Ended September 30, 2008

(Unaudited, in thousands)

 

 

 

Parent Company

 

SGI

 

Guarantor Subsidiaries

 

Non-Guarantor Subsidiaries

 

Eliminating
Entries

 

Consolidated

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Operating revenues

 

$

 

129,920

 

43,030

 

120,228

 

(1,243

)

291,935

 

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

 

 

77,857

 

29,770

 

68,338

 

(1,228

)

174,737

 

Selling, general and administrative expenses

 

14,776

 

12,924

 

4,294

 

9,958

 

(15

)

41,937

 

Depreciation and amortization

 

283

 

12,486

 

7,833

 

15,885

 

 

36,487

 

Operating income

 

(15,059

)

26,653

 

1,133

 

26,047

 

 

38,774

 

Interest expense

 

4,632

 

12,082

 

10

 

935

 

 

17,659

 

Other income

 

(18,714

)

24,099

 

(28,446

)

8,887

 

 

(14,174

)

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

 

(977

)

(9,528

)

29,569

 

16,225

 

 

35,289

 

Equity in income (loss) of subsidiaries

 

26,047

 

27,516

 

 

 

(53,563

)

 

Income tax expense

 

(340

)

6,527

 

116

 

3,576

 

 

9,879

 

Net income