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 June 30, 2009

 

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 has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§ 232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).  Yes o   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 August 5, 2009:

Class A Common Stock:  92,742,958

Class B Common Stock:  None

 

 

 



Table of Contents

 

SCIENTIFIC GAMES CORPORATION AND SUBSIDIARIES

INDEX TO FINANCIAL INFORMATION

AND OTHER INFORMATION

 

PART I.

FINANCIAL INFORMATION

2

 

 

 

Item 1.

Financial Statements

2

 

 

 

 

Consolidated Balance Sheets as of June 30, 2009 and December 31, 2008

2

 

 

 

 

Consolidated Statements of Operations for the Three Months Ended June 30, 2009 and 2008

3

 

 

 

 

Consolidated Statements of Operations for the Six Months Ended June 30, 2009 and 2008

4

 

 

 

 

Condensed Consolidated Statements of Cash Flows for the Six Months Ended June 30, 2009 and 2008

5

 

 

 

 

Notes to Consolidated Financial Statements

6

 

 

 

Item 2.

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

28

 

 

 

Item 3.

Quantitative and Qualitative Disclosures About Market Risk

40

 

 

 

Item 4.

Controls and Procedures

40

 

 

 

PART II.

OTHER INFORMATION

41

 

 

 

Item 1A.

Risk Factors

41

 

 

 

Item 2.

Unregistered Sales of Equity Securities and Use of Proceeds

50

 

 

 

Item 4.

Submission of Matters to a Vote of Security Holders

50

 

 

 

Item 6.

Exhibits

51

 



Table of Contents

 

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; recent changes to certain contracts; 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; ability to enhance and develop successful gaming concepts; influence of certain stockholders; dependence on suppliers and manufacturers; liability for product defects; 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 Current Report on Form 8-K filed on May 18, 2009 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.

 

1



Table of Contents

 

PART 1.  FINANCIAL INFORMATION

 

Item 1.  Financial Statements

 

SCIENTIFIC GAMES CORPORATION AND SUBSIDIARIES

CONSOLIDATED BALANCE SHEETS

As of June 30, 2009 and December 31, 2008

(Unaudited, in thousands, except per share amounts)

 

 

 

June 30,

 

December 31,

 

 

 

2009

 

2008

 

ASSETS

 

 

 

 

 

Current assets:

 

 

 

 

 

Cash and cash equivalents

 

$

234,833

 

$

140,639

 

Accounts receivable, net of allowance for doubtful accounts of $5,956 and $6,465 as of June 30, 2009 and December 31, 2008, respectively

 

183,536

 

212,487

 

Inventories

 

79,939

 

75,371

 

Deferred income taxes, current portion

 

14,663

 

14,360

 

Prepaid expenses, deposits and other current assets

 

56,237

 

68,921

 

Total current assets

 

569,208

 

511,778

 

Property and equipment, at cost

 

1,056,496

 

1,016,767

 

Less accumulated depreciation

 

(481,738

)

(441,288

)

Property and equipment, net

 

574,758

 

575,479

 

Goodwill, net

 

773,891

 

657,211

 

Intangible assets, net

 

117,267

 

120,946

 

Other assets and investments

 

294,337

 

317,039

 

Total assets

 

$

2,329,461

 

$

2,182,453

 

 

 

 

 

 

 

LIABILITIES AND STOCKHOLDERS’ EQUITY

 

 

 

 

 

Current liabilities:

 

 

 

 

 

Debt payments due within one year

 

$

178,620

 

$

43,384

 

Accounts payable

 

50,443

 

64,635

 

Accrued liabilities

 

144,788

 

152,665

 

Total current liabilities

 

373,851

 

260,684

 

Deferred income taxes

 

34,352

 

33,809

 

Other long-term liabilities

 

90,998

 

96,048

 

Long-term debt, excluding current installments

 

1,190,458

 

1,196,083

 

Total liabilities

 

1,689,659

 

1,586,624

 

 

 

 

 

 

 

Commitments and contingencies

 

 

 

 

 

 

 

 

 

 

 

Stockholders’ equity:

 

 

 

 

 

Class A common stock, par value $0.01 per share, 199,300 shares authorized, and 92,642 and 92,601 shares outstanding as of June 30, 2009 and December 31, 2008, respectively

 

926

 

926

 

Additional paid-in capital

 

643,603

 

628,356

 

Accumulated earnings

 

53,215

 

58,059

 

Treasury stock, at cost, 3,130 and 2,608 shares held as of June 30, 2009 and December 31, 2008, respectively

 

(48,126

)

(42,586

)

Accumulated other comprehensive income

 

(9,816

)

(48,926

)

Total stockholders’ equity

 

639,802

 

595,829

 

Total liabilities and stockholders’ equity

 

$

2,329,461

 

$

2,182,453

 

 

See accompanying notes to consolidated financial statements.

 

2



Table of Contents

 

SCIENTIFIC GAMES CORPORATION AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF OPERATIONS

Three Months Ended June 30, 2009 and 2008

(Unaudited, in thousands, except per share amounts)

 

 

 

Three Months Ended June 30,

 

 

 

2009

 

2008

 

Operating revenues:

 

 

 

 

 

Services

 

$

218,254

 

$

264,661

 

Sales

 

6,774

 

41,308

 

 

 

225,028

 

305,969

 

Operating expenses:

 

 

 

 

 

Cost of services (exclusive of depreciation and amortization)

 

124,143

 

152,536

 

Cost of sales (exclusive of depreciation and amortization)

 

4,963

 

29,707

 

Selling, general and administrative expenses

 

39,132

 

49,050

 

Depreciation and amortization

 

30,261

 

35,108

 

Operating income

 

26,529

 

39,568

 

Other (income) expense:

 

 

 

 

 

Interest expense

 

21,395

 

17,680

 

Equity in earnings of joint ventures

 

(15,480

)

(18,397

)

(Gain) loss on early extinguishment of debt

 

(1,756

)

2,960

 

Other (income) expense, net

 

931

 

(745

)

 

 

5,090

 

1,498

 

Income before income taxes

 

21,439

 

38,070

 

Income tax expense

 

1,093

 

12,316

 

Net income

 

$

20,346

 

$

25,754

 

 

 

 

 

 

 

Basic and diluted net income per share:

 

 

 

 

 

Basic net income per share

 

$

0.22

 

$

0.28

 

Diluted net income per share

 

$

0.22

 

$

0.27

 

 

 

 

 

 

 

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

 

 

 

 

 

Basic shares

 

92,463

 

92,645

 

Diluted shares

 

93,959

 

94,420

 

 

 See accompanying notes to consolidated financial statements.

 

3



Table of Contents

 

SCIENTIFIC GAMES CORPORATION AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF OPERATIONS

Six Months Ended June 30, 2009 and 2008

(Unaudited, in thousands, except per share amounts)

 

 

 

Six Months Ended June 30,

 

 

 

2009

 

2008

 

Operating revenues:

 

 

 

 

 

Services

 

$

428,592

 

$

498,614

 

Sales

 

27,126

 

64,362

 

 

 

455,718

 

562,976

 

Operating expenses:

 

 

 

 

 

Cost of services (exclusive of depreciation and amortization)

 

249,905

 

282,914

 

Cost of sales (exclusive of depreciation and amortization)

 

20,385

 

46,551

 

Selling, general and administrative expenses

 

80,618

 

96,066

 

Employee termination costs

 

3,920

 

2,772

 

Depreciation and amortization

 

61,404

 

69,612

 

Operating income

 

39,486

 

65,061

 

Other (income) expense:

 

 

 

 

 

Interest expense

 

40,204

 

34,825

 

Equity in earnings of joint ventures

 

(30,578

)

(35,256

)

(Gain) loss on early extinguishment of long-term debt

 

(4,044

)

2,960

 

Other income, net

 

(986

)

(695

)

 

 

4,596

 

1,834

 

Income before income taxes

 

34,890

 

63,227

 

Income tax expense

 

39,734

 

20,810

 

Net income (loss)

 

$

(4,844

)

$

42,417

 

 

 

 

 

 

 

Basic and diluted net income per share:

 

 

 

 

 

Basic net income (loss) per share

 

$

(0.05

)

$

0.46

 

Diluted net income (loss) per share

 

$

(0.05

)

$

0.45

 

 

 

 

 

 

 

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

 

 

 

 

 

Basic shares

 

92,500

 

92,979

 

Diluted shares

 

92,500

 

94,473

 

 

See accompanying notes to consolidated financial statements.

 

4



Table of Contents

 

SCIENTIFIC GAMES CORPORATION AND SUBSIDIARIES

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

Six Months Ended June 30, 2009 and 2008

(Unaudited, in thousands, except per share amounts)

 

 

 

Six Months Ended June 30,

 

 

 

2009

 

2008

 

Cash flows from operating activities:

 

 

 

 

 

Net income (loss)

 

$

(4,844

)

$

42,417

 

 

 

 

 

 

 

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

 

 

 

 

 

Depreciation and amortization

 

61,404

 

69,612

 

Change in deferred income taxes

 

35,016

 

855

 

Stock-based compensation

 

18,618

 

16,128

 

Non-cash interest expense

 

8,402

 

8,735

 

Undistributed equity in earnings of joint ventures

 

(347

)

(11,471

)

Gain on early extinguishment of debt

 

(4,044

)

2,960

 

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

 

 

 

 

 

Accounts receivable

 

32,514

 

(21,475

)

Inventories

 

(2,456

)

(4,307

)

Accounts payable

 

(15,340

)

595

 

Accrued liabilities

 

(11,457

)

(6,128

)

Other current assets and liabilities

 

12,857

 

4,772

 

Other

 

190

 

3,750

 

Net cash provided by operating activities

 

130,513

 

106,443

 

 

 

 

 

 

 

Cash flows from investing activities:

 

 

 

 

 

Capital expenditures

 

(6,019

)

(8,062

)

Wagering systems expenditures

 

(31,750

)

(85,146

)

Other intangible assets and software expenditures

 

(18,351

)

(21,959

)

Change in other assets and liabilities, net

 

1,026

 

(771

)

Business acquisitions, net of cash acquired

 

(89,271

)

(7,957

)

Net cash used in investing activities

 

(144,365

)

(123,895

)

 

 

 

 

 

 

Cash flows from financing activities:

 

 

 

 

 

Net borrowings (repayments) under revolving credit facility

 

 

(158,000

)

Proceeds from issuance of long-term debt

 

259,687

 

796,179

 

Payment on long-term debt

 

(139,657

)

(444,207

)

Payment of financing fees

 

(8,594

)

(14,190

)

Purchases of treasury stock

 

(5,539

)

(18,017

)

Net proceeds from issuance of common stock

 

1,341

 

2,288

 

Net cash provided by financing activities

 

107,238

 

164,053

 

Effect of exchange rate changes on cash and cash equivalents

 

808

 

1,826

 

Increase in cash and cash equivalents

 

94,194

 

148,427

 

Cash and cash equivalents, beginning of period

 

140,639

 

29,403

 

Cash and cash equivalents, end of period

 

$

234,833

 

$

177,830

 

 

See accompanying notes to consolidated financial statements.

 

5



Table of Contents

 

SCIENTIFIC GAMES CORPORATION AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited, in thousands, except per share amounts)

 

Notes to Consolidated Financial Statements

 

(1) Consolidated Financial Statements

 

Basis of Presentation

 

The Consolidated Balance Sheet as of June 30, 2009, the Consolidated Statements of Operations for the three and six months ended June 30, 2009 and 2008, and the Condensed Consolidated Statements of Cash Flows for the six months ended June 30, 2009 and 2008, 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 June 30, 2009, the results of our operations for the three and six months ended June 30, 2009 and 2008 and our cash flows for the six months ended June 30, 2009 and 2008 have been made.  Management has evaluated subsequent events through the date of financial statement issuance on August 10, 2009.

 

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 Current Report on Form 8-K filed on May 18, 2009 (which retrospectively adjusted portions of our Annual Report on Form 10-K for the fiscal year ended December 31, 2008 to reflect a change in accounting principle to reflect our adoption, effective January 1, 2009, of FASB Staff Position APB 14-1, “Accounting for Convertible Debt Instruments That May Be Settled in Cash upon Conversion (Including Partial Cash Settlement)”).  The results of operations for the period ended June 30, 2009 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 six months ended June 30, 2009 and 2008:

 

 

 

Three Months Ended

 

Six Months Ended

 

 

 

June 30,

 

June 30,

 

 

 

2009

 

2008

 

2009

 

2008

 

Income (numerator)

 

 

 

 

 

 

 

 

 

Net income (loss)

 

$

20,346

 

$

25,754

 

$

(4,844

)

$

42,417

 

 

 

 

 

 

 

 

 

 

 

Shares (denominator)

 

 

 

 

 

 

 

 

 

Weighted-average basic common shares outstanding

 

92,463

 

92,645

 

92,500

 

92,979

 

Effect of dilutive securities-stock rights

 

1,496

 

1,756

 

 

1,484

 

Effect of dilutive shares related to convertible debentures

 

 

19

 

 

10

 

Weighted-average diluted common shares outstanding

 

93,959

 

94,420

 

92,500

 

94,473

 

 

 

 

 

 

 

 

 

 

 

Basic and diluted per share amounts

 

 

 

 

 

 

 

 

 

Basic net income (loss) per share

 

$

0.22

 

$

0.28

 

$

(0.05

)

$

0.46

 

Diluted net income (loss) per share

 

$

0.22

 

$

0.27

 

$

(0.05

)

$

0.45

 

 

The weighted-average diluted common shares outstanding for the three months ended June 30, 2009 excludes the effect of approximately 6,257 weighted-average stock rights outstanding because their effect would be anti-dilutive.  For the six months ended June 30, 2009, there were no dilutive stock rights or shares related to our 0.75% convertible senior subordinated notes due 2024 (the “Convertible Debentures”), due to the net loss reported for the period.  The weighted-average diluted common shares outstanding for the three and six months ended June 30, 2008 excludes the effect of approximately 3,505 and 4,235 weighted-average stock rights outstanding, respectively, because their effect would be anti-dilutive.

 

The aggregate number of shares that we could be obligated to issue upon conversion of the remaining $142,379 in aggregate principal amount of the Convertible Debentures, is approximately 4,893.  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.

 

6



Table of Contents

 

SCIENTIFIC GAMES CORPORATION AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited, in thousands, except per share amounts)

 

(1) Consolidated Financial Statements (continued)

 

During the second quarter of 2009, 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 June 30, 2009.  During the second quarter of 2008, the average price of our common stock exceeded the conversion price of the Convertible Debentures.  For the three and six months ended June 30, 2008 we have included approximately 19 and 10 shares, respectively, related to our Convertible Debentures in our weighted-average diluted common shares outstanding.

 

(2) Operating Segment Information

 

We operate in three segments.  Our Printed Products Group provides lotteries with instant tickets 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 access to a licensed property portfolio 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, 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.

 

7



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)

 

The following tables represent revenues, profits, depreciation, amortization and selling, general and administrative expenses for the three and six month periods ended June 30, 2009 and 2008, by reportable segments. Corporate expenses, including interest expense, other income, and depreciation and amortization, are not allocated to the reportable segments.

 

 

 

Three Months Ended June 30, 2009

 

 

 

Printed
Products
Group

 

Lottery
Systems Group

 

Diversified
Gaming Group

 

Totals

 

Service revenues

 

$

112,795

 

$

55,003

 

$

50,456

 

$

218,254

 

Sales revenues

 

2,151

 

4,075

 

548

 

6,774

 

Total revenues

 

$

114,946

 

$

59,078

 

$

51,004

 

$

225,028

 

 

 

 

 

 

 

 

 

 

 

Cost of services (exclusive of depreciation and amortization)

 

$

65,617

 

$

27,895

 

$

30,631

 

$

124,143

 

Cost of sales (exclusive of depreciation and amortization)

 

1,928

 

2,486

 

549

 

4,963

 

Selling, general and administrative expenses

 

10,850

 

7,383

 

6,493

 

24,726

 

Depreciation and amortization

 

8,200

 

10,698

 

11,193

 

30,091

 

Segment operating income

 

$

28,351

 

$

10,616

 

$

2,138

 

$

41,105

 

Unallocated corporate costs

 

 

 

 

 

 

 

14,576

 

Consolidated operating income

 

 

 

 

 

 

 

$

26,529

 

 

 

 

Three Months Ended June 30, 2008

 

 

 

Printed
Products
Group

 

Lottery
Systems Group

 

Diversified
Gaming Group

 

Totals

 

Service revenues

 

$

146,785

 

$

61,332

 

$

56,544

 

$

264,661

 

Sales revenues

 

8,546

 

24,499

 

8,263

 

41,308

 

Total revenues

 

$

155,331

 

$

85,831

 

$

64,807

 

$

305,969

 

 

 

 

 

 

 

 

 

 

 

Cost of services (exclusive of depreciation and amortization)

 

$

87,378

 

$

31,183

 

$

33,975

 

$

152,536

 

Cost of sales (exclusive of depreciation and amortization)

 

5,641

 

20,899

 

3,167

 

29,707

 

Selling, general and administrative expenses

 

15,789

 

9,604

 

7,261

 

32,654

 

Depreciation and amortization

 

9,476

 

15,382

 

9,970

 

34,828

 

Segment operating income

 

$

37,047

 

$

8,763

 

$

10,434

 

$

56,244

 

Unallocated corporate costs

 

 

 

 

 

 

 

16,676

 

Consolidated operating income

 

 

 

 

 

 

 

$

39,568

 

 

8



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)

 

 

 

Six Months Ended June 30, 2009

 

 

 

Printed
Products
Group

 

Lottery
Systems Group

 

Diversified
Gaming Group

 

Totals

 

Service revenues

 

$

222,872

 

$

107,071

 

$

98,649

 

$

428,592

 

Sales revenues

 

6,741

 

17,944

 

2,441

 

27,126

 

Total revenues

 

$

229,613

 

$

125,015

 

$

101,090

 

$

455,718

 

 

 

 

 

 

 

 

 

 

 

Cost of services (exclusive of depreciation and amortization)

 

$

132,711

 

$

56,770

 

$

60,424

 

$

249,905

 

Cost of sales (exclusive of depreciation and amortization)

 

4,529

 

14,294

 

1,562

 

20,385

 

Selling, general and administrative expenses

 

22,373

 

14,873

 

11,669

 

48,915

 

Employee termination costs

 

2,016

 

125

 

433

 

2,574

 

Depreciation and amortization

 

15,879

 

21,430

 

23,750

 

61,059

 

Segment operating income

 

$

52,105

 

$

17,523

 

$

3,252

 

$

72,880

 

Unallocated corporate costs

 

 

 

 

 

 

 

32,048

 

Corporate employee terminaion costs

 

 

 

 

 

 

 

1,346

 

Consolidated operating income

 

 

 

 

 

 

 

$

39,486

 

 

 

 

Six Months Ended June 30, 2008

 

 

 

Printed
Products
Group

 

Lottery
Systems Group

 

Diversified
Gaming Group

 

Totals

 

Service revenues

 

$

274,011

 

$

115,978

 

$

108,625

 

$

498,614

 

Sales revenues

 

17,217

 

32,263

 

14,882

 

64,362

 

Total revenues

 

$

291,228

 

$

148,241

 

$

123,507

 

$

562,976

 

 

 

 

 

 

 

 

 

 

 

Cost of services (exclusive of depreciation and amortization)

 

$

158,191

 

$

59,832

 

$

64,891

 

$

282,914

 

Cost of sales (exclusive of depreciation and amortization)

 

11,886

 

26,771

 

7,894

 

46,551

 

Selling, general and administrative expenses

 

30,758

 

18,882

 

14,044

 

63,684

 

Employee termination costs

 

2,772

 

 

 

2,772

 

Depreciation and amortization

 

19,452

 

30,356

 

19,255

 

69,063

 

Segment operating income

 

$

68,169

 

$

12,400

 

$

17,423

 

$

97,992

 

Unallocated corporate costs

 

 

 

 

 

 

 

32,931

 

Consolidated operating income

 

 

 

 

 

 

 

$

65,061

 

 

9



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)

 

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

 

 

 

Three Months Ended

 

Six Months Ended

 

 

 

June 30,

 

June 30,

 

 

 

2009

 

2008

 

2009

 

2008

 

Reported segment operating income

 

$

41,105

 

$

56,244

 

$

72,880

 

$

97,992

 

Unallocated corporate costs

 

(14,576

)

(16,676

)

(32,048

)

(32,931

)

Corporate employee termination costs

 

 

 

(1,346

)

 

Consolidated operating income

 

26,529

 

39,568

 

39,486

 

65,061

 

Interest expense

 

(21,395

)

(17,680

)

(40,204

)

(34,825

)

Equity in income of joint ventures

 

15,480

 

18,397

 

30,578

 

35,256

 

Gain (loss) on early extinguishment of debt

 

1,756

 

(2,960

)

4,044

 

(2,960

)

Other income (expense), net

 

(931

)

745

 

986

 

695

 

Income before income taxes

 

$

21,439

 

$

38,070

 

$

34,890

 

$

63,227

 

 

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 to our Consolidated Financial Statements in our Current Report on Form 8-K filed on May 18, 2009).

 

(3) Equity Investments in Joint Ventures

 

We are a member of Consorzio Lotterie Nazionali (“CLN”), a consortium consisting principally of us, Lottomatica S.p.A, and Arianna 2001, a company owned by the Federation of Italian Tobacconists. The consortium has a contract with the Italian Monopoli di Stato to be the exclusive operator of the Italian Gratta e Vinci instant lottery (the “Concession”).  The Concession commenced in mid-2004 and has an initial term of six years with a six-year extension option at the option of the Monopoli di Stato. Under our contract with CLN, we supply instant lottery tickets, game development services, marketing support, and the instant ticket management system and systems support during the term of the Concession, including any renewal term.  We also participate in the profits or losses of CLN 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 six months ended June 30, 2009, we recorded income of $12,462 and $26,577, respectively, representing our share of the earnings of CLN in each period.  For the three and six months ended June 30, 2008, we recorded income of $15,846 and $30,962, respectively, representing our share of the earnings of the consortium for the indicated periods. During the second quarter of 2009, we received a cash distribution of approximately $28.0 million from CLN.

 

10



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 six month periods ended June 30, 2009 and 2008:

 

 

 

Three Months Ended

 

Six Months Ended

 

 

 

June 30,

 

June 30,

 

 

 

2009

 

2008

 

2009

 

2008

 

Net income (loss)

 

$

20,346

 

$

25,754

 

$

(4,844

)

$

42,417

 

Other comprehensive income (loss):

 

 

 

 

 

 

 

 

 

Foreign currency translation gain

 

67,426

 

3,698

 

38,309

 

18,628

 

Gain on derivative financial instruments

 

909

 

 

801

 

 

Unrealized loss on investments

 

 

 

 

(181

)

Other comprehensive income

 

68,335

 

3,698

 

39,110

 

18,447

 

Comprehensive income

 

$

88,681

 

$

29,452

 

$

34,266

 

$

60,864

 

 

(5) Inventories

 

Inventories consist of the following:

 

 

 

June 30,

 

December 31,

 

 

 

2009

 

2008

 

Parts and work-in-process

 

$

31,714

 

$

36,449

 

Finished goods

 

48,225

 

38,922

 

 

 

$

 79,939

 

$

75,371

 

 

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

 

On May 21, 2009, Scientific Games International, Inc. (“SGI”) issued $225,000 in aggregate principal amount of its 9.25% Senior Subordinated Notes due 2019 (the “2009 Notes”) at an issue price of 96.823% of the principal amount.  The 2009 Notes were issued pursuant to an indenture dated as of May 21, 2009 (the “2009 Notes Indenture”) among SGI, as issuer, the Company, as a guarantor, the Company’s subsidiary guarantors party thereto and The Bank of Nova Scotia Trust Company of New York, as trustee.

 

The 2009 Notes bear interest at the rate of 9.25% per annum, which accrues from May 21, 2009 and is payable semiannually in arrears on June 15 and December 15 of each year, commencing on December 15, 2009. The 2009 Notes mature on June 15, 2019, unless earlier redeemed or repurchased, and are subject to the terms and conditions set forth in the 2009 Notes Indenture.

 

SGI may redeem some or all of the 2009 Notes at any time prior to June 15, 2014 at a price equal to 100% of the principal amount of the 2009 Notes plus accrued and unpaid interest, if any, to the date of redemption plus a “make whole” premium. SGI may redeem some or all of the 2009 Notes for cash at any time on or after June 15, 2014 at the prices specified in the 2009 Notes Indenture. In addition, at any time on or prior to June 15, 2012, SGI may redeem up to 35% of the initially outstanding aggregate principal amount of the 2009 Notes at a redemption price of 109.25% 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 the 2009 Notes is required to be licensed, qualified or found suitable under any applicable gaming laws or regulations and that holder does not become so licensed or qualified or is not found to be suitable, then SGI will have the right to, subject to certain notice provisions set forth in the 2009 Notes Indenture, (1) require that holder to dispose of all or a portion of those Notes or (2) redeem the 2009 Notes of that holder at a redemption price calculated as set forth in the 2009 Notes Indenture. If the Company or SGI experiences specific kinds of changes in control or the Company or any of its restricted subsidiaries sells certain of its assets, then SGI must offer to repurchase the 2009 Notes on the terms set forth in the 2009 Notes Indenture.

 

11



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)

 

The 2009 Notes are unsecured senior subordinated obligations of SGI and 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 2009 Notes.  The 2009 Notes are structurally subordinated to all of the liabilities of the Company’s non-guarantor subsidiaries.

 

The 2009 Notes are guaranteed on a senior subordinated unsecured basis by the Company and all of its 100%-owned domestic subsidiaries (other than SGI). The guarantees of the 2009 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 2009 Notes. The 2009 Notes are structurally subordinated to all of the liabilities of the Company’s non-guarantor subsidiaries.

 

The 2009 Notes 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 assets 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 2009 Notes Indenture contains events of default customary for agreements of its type (with customary grace periods, as applicable) and provides that, upon the occurrence of an event of default arising from certain events of bankruptcy or insolvency with respect to the Company or SGI, all outstanding Notes will become due and payable immediately without further action or notice. If any other type of event of default occurs and is continuing, then the trustee or the holders of at least 25% in principal amount of the then outstanding Notes may declare all the 2009 Notes to be due and payable immediately.

 

The 2009 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.  In connection with the issuance of the 2009 Notes, SGI, the Company, the Company’s subsidiary guarantors party thereto, and J.P. Morgan Securities Inc., Banc of America Securities LLC, Credit Suisse Securities (USA) LLC and Goldman, Sachs & Co., as representatives for the initial purchasers listed therein, entered into a registration rights agreement, dated May 21, 2009 (the “Registration Rights Agreement”). Under the Registration Rights Agreement, SGI and the guarantors agreed, for the benefit of the holders of the 2009 Notes, that they will file with the Securities and Exchange Commission (the “SEC”) within 90 days after the date the 2009 Notes are issued, and use their commercially reasonable efforts to cause to become effective, a registration statement relating to an offer to exchange the 2009 Notes for an issue of SEC-registered notes (the “2009 Exchange Notes”) with terms identical to the 2009 Notes (except that the 2009 Exchange Notes will not be subject to restrictions on transfer or to any increase in annual interest rate as described below).

 

Under certain circumstances, including if applicable interpretations of the staff of the SEC do not permit SGI to effect the exchange offer, SGI and the guarantors will use their commercially reasonable efforts to cause to become effective a shelf registration statement relating to resales of the 2009 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 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 registration statement is not filed within 90 days after the date the 2009 Notes are issued, or the exchange offer is not completed (or, if required, the shelf registration statement is not declared effective) on or before February 15, 2010 (subject to the right of the Company to extend such date by up to 90 additional days under customary “blackout” provisions if the Company determines in good faith that it is in possession of material, non-public information), the annual interest rate borne by the 2009 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 2009 Notes were originally issued.

 

On May 7, 2009, the Company entered into an agreement with the principal selling shareholder and key management of Global Draw Limited (“Global Draw”) related to the earn-out and contingent bonuses that were payable to them in connection with the Company’s 2006 acquisition.  Based on the performance of the business, the total amount payable was determined to be approximately £60,600, of which approximately £30,500 was paid in May 2009.  Approximately £28,100 of the total amount payable was deferred under the terms of two-year, senior unsecured promissory notes issued by certain of the Company’s foreign subsidiaries (and guaranteed by the Company and certain of its U.S. subsidiaries).  The earn-out balance of approximately £2,000 is expected to be paid by September 30, 2009.

 

12



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)

 

The promissory note issued to the principal selling shareholder, which was executed on May 7, 2009 by Scientific Games Luxembourg Finance S.a.r.l. (“SGLF”), an indirect 100%-owned subsidiary of the Company, has a principal amount of approximately £26,000 and bears simple interest at the rate of 6.90% per annum, which interest is payable quarterly in arrears on the last day of March, June, September and December of each year, commencing on June 30, 2009.  The note matures on May 7, 2011.  Although not required to do so (except in connection with an event of default as described below), SGLF may repay all or a portion of the principal amount of the note at any time prior to maturity without premium or penalty.  The note is a senior unsecured obligation of SGLF and is guaranteed on a joint and several basis by the Company and certain of its 100%-owned domestic subsidiaries (including SGI).  Such guaranty represents “senior debt” as that term is defined in the indentures governing the Company’s 6.25% Senior Subordinated Notes due 2012, the Convertible Debentures, SGI’s 7.875% Senior Subordinated Notes due 2016 and the 2009 Notes.

 

If an event of default under the note shall occur and be continuing, the holder of the note may declare the principal amount of, and accrued interest on, the note to be immediately due and payable.  An “event of default” under the note shall occur if (1) SGLF shall fail to pay the then unpaid principal amount under the note within 15 days after the maturity date or any interest payment that is due and payable within 15 days after the applicable interest payment date, or (2) an “event of default” (as defined in the Credit Agreement) shall occur and be continuing and, as a result thereof, the amounts owing under the Credit Agreement immediately become due and payable.

 

The terms of the promissory notes issued to key management of Global Draw and the related guaranties are substantially identical to the note and guaranties described above, except that one of the notes was issued by a different foreign subsidiary of the Company.

 

On March 27, 2009, we and our 100%-owned subsidiary, SGI, entered into an amendment (the “Amendment”) to the credit agreement, dated as of June 9, 2008 (the “Credit Agreement”), among SGI, as borrower, the Company, as guarantor, the several lenders from time to time parties thereto and JPMorgan Chase Bank, N.A. (“JPMorgan”), as administrative agent  The purpose of the Amendment was to provide the Company with additional operating and financing flexibility.

 

Under the Amendment, (i) up to approximately $18,800 in certain charges incurred and reserves created in the fourth quarter of 2008, (ii) up to $15,000 of certain charges that may be incurred during the 12-month period commencing on March 1, 2009, including charges in connection with cost-reduction initiatives, and (iii) certain costs and fees incurred in connection with the Amendment, will be added back to “Consolidated EBITDA” for purposes of calculating the “Consolidated Leverage Ratio” and the “Consolidated Senior Debt Ratio” (as such terms are defined under the Credit Agreement).  In addition, for purposes of determining the Consolidated Leverage Ratio and the Consolidated Senior Debt Ratio as of any date prior to the earliest date on which any of the holders of Convertible Debentures may require the Company to repurchase their Convertible Debentures (currently June 1, 2010) (the “Convertible Debentures Repurchase Date”) neither (i) the earn-out payable with respect to the Company’s acquisition of Global Draw nor (ii) the principal amount of any unsecured promissory notes that may be issued in order to defer payment of up to the equivalent of $60,000 of such earn-out (provided that, among other terms of such promissory notes, no principal payment thereon is required prior to September 30, 2010), will be included as “Indebtedness” in the calculation of “Consolidated Total Debt” (as such terms are defined in the Credit Agreement).  Accordingly, the promissory notes described above that were issued to the principal selling shareholder and key management of Global Draw will not be included as Indebtedness in the calculation of Consolidated Total Debt for purposes of determining the Consolidated Leverage Ratio and the Consolidated Senior Debt Ratio prior to the Convertible Debenture Repurchase Date.

 

In conjunction with the promissory notes issued to defer payment of a portion of the Global Draw earn-out, the revolving credit facility and the term loan facility under the Credit Agreement will mature (if earlier than the date that would otherwise apply under the terms of the Credit Agreement) on February 7, 2011 unless on such date no such promissory notes remain outstanding or the sum of the aggregate available revolving commitments under the Credit Agreement plus unrestricted cash and cash equivalents of SGI and the guarantors under the Credit Agreement is not less than $50,000 in excess of the amount required to repay in full such outstanding promissory notes.

 

Under the Amendment, for purposes of determining the Consolidated Leverage Ratio as of any date of determination prior to the earlier of the Convertible Debentures Repurchase Date and the date the Convertible Debentures are redeemed in full, unrestricted cash and cash equivalents of SGI and the guarantors up to the “Debenture Reserve Amount” at such determination date will be netted against the then outstanding principal amount of the Convertible Debentures (and Consolidated Total Debt will be thereby reduced to the extent of such netting).  The “Debenture Reserve Amount” is an amount equal to the net cash proceeds received by SGI or the guarantors after the date of the Amendment and prior to the Convertible Debentures Repurchase Date from (i) the issuance by the Company of shares of its capital stock (other than disqualified stock), or the issuance of “Permitted Additional Senior Indebtedness” or “Permitted Additional Subordinated Debt”, or Indebtedness under the “Incremental Facilities” (as such terms are defined in the Credit Agreement), and (ii) any “Asset Sales” (as defined in the Credit Agreement) (up to an aggregate of $125,000 of net cash proceeds) with respect to which a reinvestment notice is timely given (provided that the Debenture Reserve Amount will (A) not exceed the outstanding principal amount of the Convertible Debentures, (B) be reduced to zero on the Convertible Debentures Repurchase Date and (C) to the extent the Debenture Reserve Amount is increased as a result of Assets Sales, will be decreased if and

 

13



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)

 

to the extent that term loans under the Credit Agreement are prepaid in lieu of reinvesting the net cash proceeds there from pursuant to a reinvestment notice).  The 2009 Notes constitute “Permitted Additional Subordinated Debt” and, as such, the net cash proceeds from the issuance of such notes (approximately $212,000) will be included in the “Debenture Reserve Amount.”

 

The Amendment will increase each of the interest rates set forth in the pricing grid in the Credit Agreement by 0.25% such that, depending upon the Consolidated Leverage Ratio, the interest rate will vary from 2.00% to 3.00% above LIBOR for eurocurrency loans, and 1.00% to 2.00% above the higher of (i) the prime rate or (ii) the Federal Funds Effective Rate plus 0.50% for base rate loans.  Notwithstanding the foregoing, from the Effective Date (as defined in the Credit Agreement) until the date the compliance certificate for the third fiscal quarter of 2009 is delivered pursuant to the Credit Agreement, the applicable margin for eurocurrency loans will be deemed to be 3.00% and the applicable margin for base rate loans will be deemed to be 2.00%.

 

In connection with the Amendment, SGI agreed to pay an aggregate of approximately $2,800 in fees to consenting lenders and the administrative agent.

 

Our  Credit Agreement is 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.

 

On June 30, 2009, we had $199,439 of availability under our revolving credit facility.  There were no borrowings and $50,561 in outstanding letters of credit under our revolving credit facility as of June 30, 2009.

 

We were in compliance with our debt covenants as of June 30, 2009.

 

The Company may, from time to time, seek to retire or purchase its outstanding debt in open market purchases, in privately negotiated transactions, or otherwise. Any such retirement or purchase of debt may be funded by cash flows from operations, borrowings or other sources and will depend upon prevailing market conditions, liquidity requirements, contractual restrictions and other factors, and the amounts involved may be material.  During the three and six months ended June 30, 2009, we repurchased approximately $84,403 and $131,403, respectively, in aggregate principal amount of our Convertible Debentures for approximately $81,722 and $124,003, respectively, in cash under our previously announced Convertible Debenture repurchase program.  During the three and six months ended June 30, 2009, we recognized a gain on early extinguishment of debt related to the Convertible Debentures of approximately $1,401 and $3,689, respectively, from the Convertible Debenture repurchase program. Between July 1, 2009 and August 10, 2009, we repurchased approximately $26,847 in aggregate principal amount of the Convertible Debentures for approximately $26,279 in cash under our previously announced Convertible Debenture repurchase program.  During the three months ended June 30, 2009, we repurchased approximately $12,925 in aggregate principal amount of our 6.25% senior subordinated notes due 2012 (the “2004 Notes”) for approximately $12,396 cash under our previously announced 2004 Notes repurchase program.  During the three months ended June 30, 2009, we recognized a gain on early extinguishment of debt related to the 2004 Notes of approximately $355.

 

During the second quarter of 2009, in connection with repurchases made during the first half of 2009 under our Convertible Debenture repurchase program, we unwound a corresponding portion of the convertible bond hedge and warrant option transactions that we entered into in December 2004 in connection with the original issuance of the Convertible Debentures such that the number of call options held by us under the bond hedge was reduced from 275 to approximately 144 and the number of warrants held by the warrant counterparties was reduced from approximately 9,450 to approximately 4,893.  We received a net cash settlement of approximately $1,204 during the three months ended June 30, 2009 as a result of this unwinding of a portion of the convertible bond hedge and warrant option transactions.  For additional information on the bond hedge and warrants, refer to Note 8 of the Notes to Consolidated Financial Statements included in our Current Report on Form 8-K filed on May 18, 2009.

 

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, FSP APB 14-1 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 adopted FSP APB 14-1 on January 1, 2009.  The impact of adoption was an adjustment to accumulated earnings of approximately $22,600 representing the cumulative effect of a change in accounting principle as of January 1, 2007.

 

14



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)

 

The adoption of FSP APB 14-1 had the following effect on our Consolidated Statements of Operations for the three and six months ended June 30, 2008:

 

 

 

Three Months Ended

 

Six Months Ended

 

 

 

June 30, 2008

 

June 30, 2008

 

 

 

Previously

 

As

 

Effect of

 

Previously

 

As

 

Effect of

 

 

 

Reported

 

Adjusted

 

Change

 

Reported

 

Adjusted

 

Change

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Interest expense

 

$

14,419

 

$

17,680

 

$

3,261

 

$

28,303

 

$

34,825

 

$

6,522

 

Income tax expense

 

 

12,335

 

 

12,316

 

 

(19

)

 

20,846

 

 

20,810

 

 

(36

)

Net income

 

 

28,996

 

 

25,754

 

 

(3,242

)

 

48,903

 

 

42,417

 

 

(6,486

)

Basic net income per share

 

$

0.31

 

$

0.28

 

$

(0.03

)

$

0.53

 

$

0.46

 

$

(0.07

)

Diluted net income per share

 

$

0.31

 

$

0.27

 

$

(0.04

)

$

0.52

 

$

0.45

 

$

(0.07

)

 

The adoption of FSP APB 14-1 had the following effect on our Consolidated Balance Sheet as of December 31, 2008:

 

 

 

December 31, 2008

 

 

 

Previously

 

As

 

Effect of

 

 

 

Reported

 

Adjusted

 

Change

 

 

 

 

 

 

 

 

 

Other assets and investments

 

$

317,818

 

$

317,039

 

$

(779

)

Long-term debt, excluding current installments

 

 

1,216,264

 

 

1,196,083

 

 

(20,181

)

Additional paid-in capital

 

 

561,202

 

 

628,356

 

 

67,154

 

Accumulated earnings

 

 

105,811

 

 

58,059

 

 

(47,752

)

 

As of January 1, 2008, the cumulative effect of the change in accounting principle on accumulated earnings and additional paid-in capital was approximately $34,800 and $67,200, respectively.

 

The adoption of FSP APB 14-1 had the following effect on our Consolidated Statement of Cash Flows for the six months ended June 30, 2008:

 

 

 

Six Months Ended June 30, 2008

 

 

 

Previously

 

As

 

Effect of

 

 

 

Reported

 

Adjusted

 

Change

 

 

 

 

 

 

 

 

 

Cash flows from operating activities:

 

 

 

 

 

 

 

Net income

 

$

48,903

 

$

42,417

 

$

(6,486

)

Change in deferred income taxes

 

 

891

 

 

855

 

 

(36

)

Non-cash interest expense

 

 

2,213

 

 

8,735

 

 

6,522

 

 

As of June 30, 2009 and December 31, 2008, the equity component of the Convertible Debentures under FSP APB 14-1 was approximately $64,173 and $68,592, respectively.  The following represents the principal amount of the liability component, the unamortized discount, and the net carrying amount of our convertible debt instruments as of June 30, 2009 and December 31, 2008, respectively:

 

 

 

June 30,

 

December 31,

 

 

 

2009

 

2008

 

Principal

 

$

142,379

 

$

273,782

 

Unamortized discount

 

(6,825

)

(20,181

)

Net carrying amount

 

$

135,554

 

$

253,601

 

 

15



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)

 

As of June 30, 2009, the remaining discount will be amortized over a period of approximately 11 months.  The conversion price of the remaining $142,379 in aggregate principal amount of the Convertible Debentures is $29.10 and the aggregate number of shares that we could be obligated to issue upon conversion is approximately 4,893.

 

The effective interest rate on the liability component of the Convertible Debentures is approximately 6.25% for the three and six months ended June 30, 2009 and 2008.  The amount of interest cost recognized for the contractual interest coupon during the three and six months ended June 30, 2009 was approximately $403 and $896, respectively.  The amount of interest cost recognized for the contractual interest coupon during the three and six months ended June 30, 2008 was approximately $513 and $1,026, respectively.  The amount of interest cost recognized for the amortization of the discount on the liability component of the Convertible Debentures during the three months and six ended June 30, 2009 was approximately $2,784 and $6,085, respectively.  The amount of interest cost recognized for the amortization of the discount on the liability component of the Convertible Debentures during the three and six months ended June 30, 2008 was approximately $3,362 and $6,724, respectively.

 

(7) Derivative Financial Instruments

 

Effective October 17, 2008, SGI entered into a three-year interest rate swap agreement (the “Hedge”) with JPMorgan.  Under the Hedge, which is designated as a cash flow hedge in accordance with Statement of Financial Accounting Standards (“SFAS”) No. 133, Accounting for Derivative Instruments and Hedging Activities,” SGI pays interest on a $100,000 notional amount of debt at a fixed rate of 3.49% and receives interest on a $100,000 notional amount of debt at the prevailing three-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 $100,000 of our variable-rate debt.  As of June 30, 2009, the Hedge was measured at a fair value of $4,099 using Level 2 valuation techniques of the fair value hierarchy and included in other long-term liabilities on the consolidated balance sheet.

 

We believe we have matched the critical terms of the hedged variable-rate debt with the Hedge and expect the Hedge to be highly effective in offsetting changes in the expected cash flows due to fluctuation in the three-month LIBOR based rate over the term of the forecasted interest payments related to the $100,000 notional amount of variable-rate debt.  Hedge effectiveness is measured quarterly on a retrospective basis using the cumulative dollar-offset approach in which the cumulative changes in the cash flows of the actual swap are compared to the cumulative changes in the cash flows of the hypothetical swap.  The effective portion of the Hedge is recorded in other comprehensive income (loss) and the ineffective portion of the Hedge, if any, is recorded in the Consolidated Statement of Operations.  During the quarter ended June 30, 2009, we recorded a gain of approximately $909 in other comprehensive income (loss).  There was no ineffective portion of the Hedge recorded in the Consolidated Statement of Operations. Amounts recorded in other comprehensive income (loss) that were deferred on the effective hedged forecasted transactions are reclassified to earnings when the interest expense related to the hedged item affects earnings.

 

16



Table of Contents

 

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 June 30, 2009 and December 31, 2008.  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 June 30, 2009

 

 

 

 

 

 

 

Amortizable intangible assets:

 

 

 

 

 

 

 

Patents

 

$

12,140

 

$

(3,429

)

$

8,711

 

Customer lists

 

29,658

 

(16,428

)

13,230

 

Customer service contracts

 

3,940

 

(2,668

)

1,272

 

Licenses

 

63,810

 

(37,145

)

26,665

 

Intellectual property

 

18,588

 

(14,710

)

3,878

 

Lottery contracts

 

27,965

 

(27,866

)

99

 

 

 

156,101

 

(102,246

)

53,855

 

Non-amortizable intangible assets:

 

 

 

 

 

 

 

Trade name

 

37,791

 

(2,118

)

35,673

 

Connecticut off-track betting system operating right

 

36,058

 

(8,319

)

27,739

 

 

 

73,849

 

(10,437

)

63,412

 

Total intangible assets

 

$

229,950

 

$

(112,683

)

$

117,267

 

 

 

 

 

 

 

 

 

Balance as of December 31, 2008

 

 

 

 

 

 

 

Amortizable intangible assets:

 

 

 

 

 

 

 

Patents

 

$

11,563

 

$

(2,871

)

$

8,692

 

Customer lists

 

28,772

 

(14,044

)

14,728

 

Customer service contracts

 

3,892

 

(2,505

)

1,387

 

Licenses

 

60,237

 

(32,615

)

27,622

 

Intellectual property

 

17,057

 

(11,425

)

5,632

 

Lottery contracts

 

27,926

 

(27,498

)

428

 

 

 

149,447

 

(90,958

)

58,489

 

Non-amortizable intangible assets:

 

 

 

 

 

 

 

Trade name

 

37,285

 

(2,118

)

35,167

 

Connecticut off-track betting system operating right

 

35,609

 

(8,319

)

27,290

 

 

 

72,894

 

(10,437

)

62,457

 

Total intangible assets

 

$

222,341

 

$

(101,395

)

$

120,946

 

 

The aggregate intangible amortization expense for the three and six months ended June 30, 2009 was approximately $4,300 and $9,200, respectively.  The aggregate intangible amortization expense for the three and six months ended June 30, 2008 was approximately $7,000 and $14,900, respectively.

 

17



Table of Contents

 

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, 2008 to June 30, 2009.  In 2009, we recorded (a) a $86,937 increase in goodwill associated with the final purchase price adjustment in accordance with the Global Draw earn-out, as defined, and (b) an increase in goodwill of $29,743 as a result of foreign currency translation.

 

Goodwill

 

Printed
Products
Group

 

Lottery
Systems
Group

 

Diversified
Gaming
Group

 

Totals

 

Balance as of December 31, 2008

 

$

324,245

 

$

190,341

 

$

142,625

 

$

657,211

 

Adjustments

 

3,427

 

1,210

 

112,043

 

116,680

 

Balance as of June 30, 2009

 

$

327,672

 

$

191,551

 

$

254,668

 

$

773,891

 

 

(9) Pension and Other Post-Retirement Plans

 

We have defined benefit pension plans for our U.S.-based union employees, our U.K.-based union employees, and certain Canadian-based employees (the “U.S. Plan,” the “U.K. Plan” and the “Canadian Plan,” respectively).  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 the three and six months ended June 30, 2009 and 2008.

 

 

 

Three Months Ended

 

Six Months Ended

 

 

 

June 30,

 

June 30,

 

 

 

2009

 

2008

 

2009

 

2008

 

Components of net periodic pension benefit cost:

 

 

 

 

 

 

 

 

 

Service cost

 

$

371

 

$

713

 

$

742

 

$

1,426

 

Interest cost

 

1,052

 

1,366

 

2,104

 

2,732

 

Expected return on plan assets

 

(888

)

(1,440

)

(1,777

)

(2,880

)

Amortization of actuarial gains

 

119

 

280

 

238

 

560

 

Amortization of prior service costs

 

11

 

11

 

22

 

22

 

Net periodic cost

 

$

665

 

$

930

 

$

1,329

 

$

1,860

 

 

We have a 401(k) plan for U.S.-based employees who are not covered by a collective bargaining agreement.  Effective February 28, 2009, we reduced the matching contributions from 50 cents to 25 cents on the dollar for the first 6% of participant contributions for a match of up to 1.5% of eligible compensation.

 

18



Table of Contents

 

SCIENTIFIC GAMES CORPORATION AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited, in thousands, except per share amounts)

 

(10) Income Taxes

 

The effective tax rates of 5.1% and 113.9%, respectively, for the three and six months ended June 30, 2009 were determined using an estimated annual effective tax rate.  The effective tax rate for the three and six months ended June 30, 2009 includes the impact of a valuation allowance against the deferred tax asset related to foreign tax credits and the release of certain FIN 48 reserves related to tax settlements in the second quarter.  The effective tax rates of 32.4% and 32.9%, respectively, for the three and six months ended June 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 earnings from operations outside the United States.

 

At December 31, 2008, the Company had a deferred tax asset for its foreign tax credit (“FTC”) carry forward of approximately $40,400.  The Company has been and will continue to explore tax planning strategies to use all of its FTC but at March 31, 2009, the Company established a valuation allowance of approximately $33,833 against the FTC deferred tax asset to reduce the asset to the net amount management estimates is “more likely than not” to be realized.

 

Further, the Company determined it is not “more likely than not” that the foreign taxes generated in 2009 will be realized in full against its U.S. tax liability during the FTC carry forward period.  As a result, the Company’s 2009 annual effective income tax rate is greater than the federal statutory rate because of the valuation allowance established against the deferred tax asset for a portion of the FTC generated in 2009.

 

(11) Stockholders’ Equity

 

The following demonstrates the change in the number of shares of Class A common stock outstanding during the three months ended June 30, 2009 and during the fiscal year ended December 31, 2008:

 

 

 

Three Months

 

Twelve Months

 

 

 

Ended

 

Ended

 

 

 

June 30,

 

December 31,

 

 

 

2009

 

2008

 

Shares outstanding as of beginning of period

 

92,286

 

93,414

 

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

 

356

 

655

 

Shares repurchased into treasury stock

 

 

(1,468

)

Shares outstanding as of end of period

 

92,642

 

92,601

 

 

19



Table of Contents

 

SCIENTIFIC GAMES CORPORATION AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited, in thousands, except per share amounts)

 

(12) Stock-Based Compensation

 

As of June 30, 2009, we had approximately 3,033 shares available for grants of equity awards under our equity-based compensation plans.

 

Stock Options

 

A summary of the changes in stock options outstanding under our equity-based compensation plans during 2009 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, 2008

 

7,378

 

6.0

 

$

21.03

 

$

21,516

 

Granted

 

850

 

 

 

12.23

 

 

 

Exercised

 

(23

)

 

 

5.88

 

146

 

Cancelled

 

(115

)

 

 

22.89

 

 

 

Options outstanding as of March 31, 2009

 

8,090

 

6.0

 

$

20.12

 

$

10,927

 

Granted

 

30

 

 

 

12.41

 

 

 

Exercised

 

(193

)

 

 

8.31

 

1,750

 

Cancelled

 

(309

)

 

 

26.10

 

 

 

Options outstanding as of June 30, 2009

 

7,618

 

5.9

 

$

20.14

 

$

18,891

 

 

 

 

 

 

 

 

 

 

 

Options exercisable as of June 30, 2009

 

4,307

 

4.1

 

$

17.84

 

$

15,963

 

 

The weighted-average grant date fair value of options granted during the three months ended June 30, 2009 and March 31, 2009 was $6.00 and $5.74, respectively.  For the three and six months ended June 30, 2009, we recognized equity-based compensation expense of approximately $3,000 and $7,800, respectively, related to the vesting of stock options and the related tax benefit of approximately $1,000 and $2,600, respectively.  For the three and six months ended June 30, 2008, we recognized equity-based compensation expense of approximately $3,400 and $7,500, respectively, related to the vesting of stock options and the related tax benefit of approximately $1,000 and $2,200, respectively.

 

As of June 30, 2009, we had unearned compensation of approximately $23,600 relating to stock option awards that will be amortized over a weighted-average period of approximately two years.

 

20



Table of Contents

 

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 2009 is presented below:

 

 

 

Number of
Restricted
Stock

 

Weighted
Average Grant
Date Fair
Value Per
Share

 

Non-vested units as of December 31, 2008

 

1,673

 

$

28.30

 

Granted

 

973

 

$

12.06

 

Vested

 

(273

)

$

28.16

 

Cancelled

 

(13

)

$

26.24

 

Non-vested units as of March 31, 2009

 

2,360

 

$

21.88

 

Granted

 

68

 

$

14.55

 

Vested

 

(177

)

$

29.59

 

Cancelled

 

(9

)

$

18.66

 

Non-vested units as of June 30, 2009

 

2,242

 

$

21.00

 

 

For the three and six months ended June 30, 2009, we recognized equity-based compensation expense of approximately $4,300 and $10,800, respectively, related to the vesting of RSUs and the related tax benefit of approximately $1,700 and $4,200, respectively.  For the three and six months ended June 30, 2008, we recognized equity-based compensation expense of approximately $4,200 and $8,600, respectively, related to the vesting of RSUs and the related tax benefit of approximately $1,300 and $2,600, respectively.  As of June 30, 2009, we had unearned compensation of approximately $36,300 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.  SGI’s obligations under the Credit Agreement, its 7.875% senior subordinated notes due 2016 (the “2008 Notes”) and the 2009 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 June 30, 2009 and December 31, 2008 and for the three and six months ended June 30, 2009 and 2008. 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 2009 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.

 

21



Table of Contents

 

SCIENTIFIC GAMES CORPORATION AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited, in thousands, except per share amounts)

 

SCIENTIFIC GAMES CORPORATION AND SUBSIDIARIES

SUPPLEMENTAL CONDENSED CONSOLIDATING BALANCE SHEET

June 30, 2009

 

 

 

Parent
Company

 

SGI

 

Guarantor
Subsidiaries

 

Non-
Guarantor
Subsidiaries

 

Eliminating
Entries

 

Consolidated

 

Assets

 

 

 

 

 

 

 

 

 

 

 

 

 

Cash and cash equivalents

 

$

178,594

 

$

1

 

$

 

$

65,389

 

$

(9,151

)

$

234,833

 

Accounts receivable, net

 

 

74,080

 

36,887

 

72,569

 

 

183,536

 

Inventories

 

 

32,076

 

15,323

 

32,540

 

 

79,939

 

Other current assets

 

18,479

 

13,458

 

8,644

 

30,319

 

 

70,900

 

Property and equipment, net

 

2,109

 

190,782

 

122,394

 

259,473

 

 

574,758

 

Investment in subsidiaries

 

511,665

 

579,119

 

7,222

 

118,486

 

(1,216,492

)

 

Goodwill

 

 

273,656

 

74,453

 

425,782

 

 

773,891

 

Intangible assets

 

 

44,237

 

60,190

 

12,840

 

 

117,267

 

Intercompany balances

 

313,901

 

 

54,035

 

 

(367,936

)

 

Other assets

 

10,040

 

171,250

 

13,227

 

105,921

 

(6,101

)

294,337

 

Total assets

 

$

1,034,788

 

$

1,378,659

 

$

392,375

 

$

1,123,319

 

$

(1,599,680

)

$

2,329,461

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Liabilities and stockholders’ equity

 

 

 

 

 

 

 

 

 

 

 

 

 

Current installments of long-term debt

 

$

135,554

 

$

5,500

 

$

 

$

37,566

 

$

 

$

178,620

 

Current liabilities

 

26,777

 

52,411

 

41,899

 

83,295

 

(9,151

)

195,231

 

Long-term debt, excluding current installments

 

187,075

 

955,520

 

 

47,863

 

 

1,190,458

 

Other non-current liabilities

 

45,580

 

9,140

 

15,195

 

55,429

 

6

 

125,350

 

Intercompany balances

 

 

146,756

 

(9

)

221,192

 

(367,939

)

 

Stockholders’ equity