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, 2010

 

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 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 August 6, 2010:

 

 

Class A Common Stock: 91,419,609

 

Class B Common Stock:  None

 

 

 



Table of Contents

 

SCIENTIFIC GAMES CORPORATION AND SUBSIDIARIES

INDEX TO FINANCIAL INFORMATION

AND OTHER INFORMATION

THREE AND SIX MONTHS ENDED JUNE 30, 2010

 

PART I.

FINANCIAL INFORMATION

 

4

 

 

 

 

Item 1.

Financial Statements

 

4

 

 

 

 

 

Consolidated Balance Sheets as of June 30, 2010 and December 31, 2009

 

4

 

 

 

 

 

Consolidated Statements of Operations for the Three Months Ended June 30, 2010 and 2009

 

5

 

 

 

 

 

Consolidated Statements of Operations for the Six Months Ended June 30, 2010 and 2009

 

6

 

 

 

 

 

Consolidated Statements of Cash Flows for the Six Months Ended June 30, 2010 and 2009

 

7

 

 

 

 

 

Notes to Consolidated Financial Statements

 

8

 

 

 

 

Item 2.

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

 

29

 

 

 

 

Item 3.

Quantitative and Qualitative Disclosures About Market Risk

 

39

 

 

 

 

Item 4.

Controls and Procedures

 

40

 

 

 

 

PART II.

OTHER INFORMATION

 

40

 

 

 

 

Item 1A.

Risk Factors

 

40

 

 

 

 

Item 2.

Unregistered Sales of Equity Securities and Use of Proceeds

 

44

 

 

 

 

Item 6.

Exhibits

 

44

 

2



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 the Company’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; technological change; retention and renewal of existing contracts and entry into new or revised 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; inability to benefit from, and risks associated with, our joint ventures and strategic investments and relationships; inability to complete the proposed sale of our racing and venue management businesses; seasonality; inability to identify and capitalize on trends and changes in the lottery and gaming industries; inability to enhance and develop successful gaming concepts; dependence on suppliers and manufacturers; liability for product defects; fluctuations in foreign currency exchange rates and other factors associated with foreign operations; influence of certain stockholders; 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 Securities and Exchange Commission (“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



Table of Contents

 

PART 1.  FINANCIAL INFORMATION

 

Item 1.  Financial Statements

 

SCIENTIFIC GAMES CORPORATION AND SUBSIDIARIES

CONSOLIDATED BALANCE SHEETS

As of June 30, 2010 and December 31, 2009

(Unaudited, in thousands, except per share amounts)

 

 

 

June 30,

 

December 31,

 

 

 

2010

 

2009

 

ASSETS

 

 

 

 

 

Current assets:

 

 

 

 

 

Cash and cash equivalents

 

$

151,453

 

$

260,131

 

Accounts receivable, net of allowance for doubtful accounts of $2,252 and $2,140 as of June 30, 2010 and December 31, 2009, respectively

 

157,131

 

177,967

 

Inventories

 

66,852

 

73,940

 

Deferred income taxes, current portion

 

15,792

 

22,557

 

Prepaid expenses, deposits and other current assets

 

43,488

 

47,031

 

Assets held for sale

 

89,273

 

91,102

 

Total current assets

 

523,989

 

672,728

 

Property and equipment, at cost

 

770,300

 

751,713

 

Less: accumulated depreciation

 

(310,016

)

(283,274

)

Property and equipment, net

 

460,284

 

468,439

 

Goodwill, net

 

736,704

 

772,732

 

Intangible assets, net

 

73,844

 

79,822

 

Other assets and investments

 

405,876

 

298,071

 

Total assets

 

$

2,200,697

 

$

2,291,792

 

 

 

 

 

 

 

LIABILITIES AND STOCKHOLDERS’ EQUITY

 

 

 

 

 

Current liabilities:

 

 

 

 

 

Debt payments due within one year

 

$

8,873

 

$

24,808

 

Accounts payable

 

37,908

 

57,309

 

Accrued liabilities

 

113,052

 

122,989

 

Liabilities held for sale

 

20,532

 

20,097

 

Total current liabilities

 

180,365

 

225,203

 

Deferred income taxes

 

34,826

 

37,418

 

Other long-term liabilities

 

61,228

 

67,158

 

Long-term debt, excluding current installments

 

1,368,921

 

1,342,255

 

Total liabilities

 

1,645,340

 

1,672,034

 

 

 

 

 

 

 

Commitments and contingencies

 

 

 

 

 

 

 

 

 

 

 

Stockholders’ equity:

 

 

 

 

 

Class A common stock, par value $0.01 per share, 199,300 shares authorized, 97,295 and 97,013 issued and 92,398 and 93,883 shares outstanding as of June 30, 2010 and December 31, 2009, respectively

 

973

 

939

 

Additional paid-in capital

 

667,557

 

651,348

 

Accumulated earnings

 

18,724

 

18,180

 

Treasury stock, at cost, 4,897 and 3,130 shares held as of June 30, 2010 and December 31, 2009, respectively

 

(66,352

)

(48,125

)

Accumulated other comprehensive loss

 

(65,545

)

(2,584

)

Total stockholders’ equity

 

555,357

 

619,758

 

Total liabilities and stockholders’ equity

 

$

2,200,697

 

$

2,291,792

 

 

See accompanying notes to consolidated financial statements

 

4



Table of Contents

 

SCIENTIFIC GAMES CORPORATION AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF OPERATIONS

Three Months Ended June 30, 2010 and 2009

(Unaudited, in thousands, except per share amounts)

 

 

 

Three Months Ended June 30,

 

 

 

2010

 

2009

 

Revenues:

 

 

 

 

 

Instant tickets

 

$

118,439

 

$

112,795

 

Services

 

101,010

 

105,459

 

Sales

 

13,584

 

6,774

 

Total revenues

 

233,033

 

225,028

 

 

 

 

 

 

 

Operating expenses:

 

 

 

 

 

Cost of instant tickets (exclusive of depreciation and amortization)

 

68,227

 

65,617

 

Cost of services (exclusive of depreciation and amortization)

 

55,171

 

58,526

 

Cost of sales (exclusive of depreciation and amortization)

 

9,600

 

4,963

 

Selling, general and administrative expenses

 

40,552

 

39,132

 

Write-down of assets held for sale

 

5,874

 

 

Depreciation and amortization

 

27,078

 

30,261

 

Operating income

 

26,531

 

26,529

 

Other expense (income):

 

 

 

 

 

Interest expense

 

24,845

 

21,395

 

Equity in earnings of joint ventures

 

(13,631

)

(15,480

)

Gain on early extinguishment of debt

 

 

(1,756

)

Other expense, net

 

6,584

 

931

 

 

 

17,798

 

5,090

 

Income before income taxes

 

8,733

 

21,439

 

Income tax expense

 

13,076

 

1,093

 

Net (loss) income

 

$

(4,343

)

$

20,346

 

 

 

 

 

 

 

Basic and diluted net (loss) income per share:

 

 

 

 

 

Basic net (loss) income per share

 

$

(0.05

)

$

0.22

 

Diluted net (loss) income per share

 

$

(0.05

)

$

0.22

 

 

 

 

 

 

 

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

 

 

 

 

 

Basic shares

 

93,552

 

92,463

 

Diluted shares

 

93,552

 

93,959

 

 

See accompanying notes to consolidated financial statements

 

5



Table of Contents

 

SCIENTIFIC GAMES CORPORATION AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF OPERATIONS

Six Months Ended June 30, 2010 and 2009

(Unaudited, in thousands, except per share amounts)

 

 

 

Six Months Ended June 30,

 

 

 

2010

 

2009

 

Revenues:

 

 

 

 

 

Instant tickets

 

$

227,538

 

$

222,872

 

Services

 

194,714

 

205,720

 

Sales

 

27,120

 

27,126

 

Total revenues

 

449,372

 

455,718

 

 

 

 

 

 

 

Operating expenses:

 

 

 

 

 

Cost of instant tickets (exclusive of depreciation and amortization)

 

132,144

 

132,711

 

Cost of services (exclusive of depreciation and amortization)

 

109,613

 

117,194

 

Cost of sales (exclusive of depreciation and amortization)

 

19,866

 

20,385

 

Selling, general and administrative expenses

 

79,108

 

80,618

 

Write-down of assets held for sale

 

5,874

 

 

Employee termination costs

 

 

3,920

 

Depreciation and amortization

 

54,733

 

61,404

 

Operating income

 

48,034

 

39,486

 

Other expense (income):

 

 

 

 

 

Interest expense

 

49,559

 

40,204

 

Equity in earnings of joint ventures

 

(29,443

)

(30,578

)

Gain on early extinguishment of debt

 

 

(4,044

)

Other expense (income), net

 

12,566

 

(986

)

 

 

32,682

 

4,596

 

Income before income taxes

 

15,352

 

34,890

 

Income tax expense

 

14,808

 

39,734

 

Net income (loss)

 

$

544

 

$

(4,844

)

 

 

 

 

 

 

Basic and diluted net income (loss) per share:

 

 

 

 

 

Basic net income (loss) per share

 

$

0.01

 

$

(0.05

)

Diluted net income (loss) per share

 

$

0.01

 

$

(0.05

)

 

 

 

 

 

 

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

 

 

 

 

 

Basic shares

 

93,771

 

92,500

 

Diluted shares

 

94,364

 

92,500

 

 

 See accompanying notes to consolidated financial statements.

 

6



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SCIENTIFIC GAMES CORPORATION AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF CASH FLOWS

Six Months Ended June 30, 2010 and 2009

(Unaudited, in thousands, except per share amounts)

 

 

 

Six Months Ended June 30,

 

 

 

2010

 

2009

 

Cash flows from operating activities:

 

 

 

 

 

Net income (loss)

 

$

544

 

$

(4,844

)

Adjustments to reconcile net income (loss) to cash provided by operating activities:

 

 

 

 

 

Depreciation and amortization

 

54,733

 

61,404

 

Change in deferred income taxes

 

11,611

 

35,016

 

Stock-based compensation

 

12,533

 

18,618

 

Non-cash interest expense

 

3,396

 

8,402

 

Undistributed equity in earnings of joint ventures

 

4,133

 

(347

)

Write-down of assets held for sale

 

5,874

 

 

Gain on early extinguishment of debt

 

 

(4,044

)

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

 

 

 

 

 

Accounts receivable

 

16,131

 

32,514

 

Inventories

 

2,220

 

(2,456

)

Accounts payable

 

(13,818

)

(15,340

)

Accrued liabilities

 

(8,711

)

(11,457

)

Other current assets and liabilities

 

14,491

 

12,857

 

Other

 

(1

)

190

 

Net cash provided by operating activities

 

103,136

 

130,513

 

 

 

 

 

 

 

Cash flows from investing activities:

 

 

 

 

 

Capital expenditures

 

(3,329

)

(6,019

)

Wagering systems expenditures

 

(31,502

)

(31,750

)

Other intangible assets and software expenditures

 

(18,009

)

(18,351

)

Change in other assets and liabilities, net

 

(767

)

1,026

 

Investment in joint venture

 

(126,810

)

 

Business acquisitions, net of cash acquired

 

(5,906

)

(89,271

)

Net cash used in investing activities

 

(186,323

)

(144,365

)

 

 

 

 

 

 

Cash flows from financing activities:

 

 

 

 

 

Proceeds from issuance of long-term debt

 

105,541

 

259,687

 

Payment on long-term debt

 

(91,507

)

(139,657

)

Payment of financing fees

 

(6,778

)

(8,594

)

Purchases of treasury stock

 

(18,227

)

(5,539

)

Net proceeds from issuance of common stock

 

(394

)

1,341

 

Net cash (used in) provided by financing activities

 

(11,365

)

107,238

 

Effect of exchange rate changes on cash and cash equivalents

 

(14,753

)

808

 

(Decrease) increase in cash and cash equivalents

 

(109,305

)

94,194

 

Cash and cash equivalents, beginning of period

 

260,131

 

140,639

 

Change in cash and cash equivalents of held for sale operations at June 30, 2010

 

627

 

 

Cash and cash equivalents, end of period

 

$

151,453

 

$

234,833

 

 

See accompanying notes to consolidated financial statements.

 

7


 

 


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, 2010, the Consolidated Statements of Operations for the three and six months ended June 30, 2010 and 2009, and the Consolidated Statements of Cash Flows for the six months ended June 30, 2010 and 2009, 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 our opinion, all adjustments necessary to present fairly our consolidated financial position as of June 30, 2010, the results of our operations for the three and six months ended June 30, 2010 and 2009 and our cash flows for the six months ended June 30, 2010 and 2009 have been made.  Such adjustments are of a normal, recurring nature.

 

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 2009 Annual Report on Form 10-K.  The results of operations for the period ended June 30, 2010 are not necessarily indicative of the operating results for a full year.

 

Basic and Diluted Net (Loss) Income Per Share

 

The following represents a reconciliation of the numerator and denominator used in computing basic and diluted net (loss) income per share available to common stockholders for the three and six months ended June 30, 2010 and 2009:

 

 

 

Three Months Ended

 

Six Months Ended

 

 

 

June 30,

 

June 30,

 

 

 

2010

 

2009

 

2010

 

2009

 

Income (numerator)

 

 

 

 

 

 

 

 

 

Net (loss) income

 

$

(4,343

)

$

20,346

 

$

544

 

$

(4,844

)

 

 

 

 

 

 

 

 

 

 

Shares (denominator)

 

 

 

 

 

 

 

 

 

Weighted-average basic common shares outstanding

 

93,552

 

92,463

 

93,771

 

92,500

 

Effect of dilutive securities-stock rights

 

 

1,496

 

593

 

 

Weighted-average diluted common shares outstanding

 

93,552

 

93,959

 

94,364

 

92,500

 

 

 

 

 

 

 

 

 

 

 

Basic and diluted per share amounts

 

 

 

 

 

 

 

 

 

Basic net (loss) income per share

 

$

(0.05

)

$

0.22

 

$

0.01

 

$

(0.05

)

Diluted net (loss) income per share

 

$

(0.05

)

$

0.22

 

$

0.01

 

$

(0.05

)

 

For the three months ended June 30, 2010, there were no dilutive stock rights outstanding due to the net loss reported for the period.  The weighted-average diluted common shares outstanding for the six months ended June 30, 2010 excludes the effect of approximately 6,408 weighted-average stock rights outstanding, because their effect would be anti-dilutive.  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 outstanding due to the net loss reported for the period.

 

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

 

We operate in three segments:  Printed Products Group; Lottery Systems Group; and Diversified Gaming Group.

 

The following tables represent revenues, cost of revenues, depreciation, amortization, selling, general and administrative expenses, write-down of assets held for sale and operating income for the three and six month periods ended June 30, 2010 and 2009, by reportable segments. Corporate expenses, including interest expense, other (income) expense, (gain) loss on early extinguishment of debt, corporate depreciation and amortization and corporate employee termination costs, are not allocated to the reportable segments.

 

 

 

Three Months Ended June 30, 2010

 

 

 

Printed
Products
Group

 

Lottery
Systems Group

 

Diversified
Gaming Group

 

Totals

 

Revenues:

 

 

 

 

 

 

 

 

 

 

 

 

Instant tickets

 

$

118,439

 

$

 

$

 

$

118,439

 

Services

 

 

53,517

 

47,493

 

101,010

 

Sales

 

2,731

 

8,666

 

2,187

 

13,584

 

Total revenues

 

$

121,170

 

$

62,183

 

$

49,680

 

$

233,033

 

 

 

 

 

 

 

 

 

 

 

Cost of instant tickets (1)

 

$

68,227

 

$

 

$

 

$

68,227

 

Cost of services (1)

 

 

25,637

 

29,534

 

55,171

 

Cost of sales (1)

 

1,969

 

6,186

 

1,445

 

9,600

 

Selling, general and administrative expenses

 

13,887

 

8,806

 

5,181

 

27,874

 

Write-down of assets held for sale

 

 

 

5,874

 

5,874

 

Depreciation and amortization

 

8,429

 

10,839

 

7,686

 

26,954

 

Segment operating income

 

$

28,658

 

$

10,715

 

$

(40

)

$

39,333

 

Unallocated corporate costs

 

 

 

 

 

 

 

12,802

 

Consolidated operating income

 

 

 

 

 

 

 

$

26,531

 


(1)    Exclusive of depreciation and amortization

 

 

 

Three Months Ended June 30, 2009

 

 

 

Printed
Products
Group

 

Lottery
Systems Group

 

Diversified
Gaming Group

 

Totals

 

Revenues:

 

 

 

 

 

 

 

 

 

 

 

 

 

Instant tickets

 

$

112,795

 

$

 

$

 

$

112,795

 

Services

 

 

55,003

 

50,456

 

105,459

 

Sales

 

2,151

 

4,075

 

548

 

6,774

 

Total revenues

 

$

114,946

 

$

59,078

 

$

51,004

 

$

225,028

 

 

 

 

 

 

 

 

 

 

 

Cost of instant tickets (1)

 

$

65,617

 

$

 

$

 

$

65,617

 

Cost of services (1)

 

 

27,895

 

30,631

 

58,526

 

Cost of sales (1)

 

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

 


(1)    Exclusive of depreciation and amortization

 

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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)

 

 

 

Six Months Ended June 30, 2010

 

 

 

Printed
Products
Group

 

Lottery
Systems Group

 

Diversified
Gaming Group

 

Totals

 

Revenues:

 

 

 

 

 

 

 

 

 

 

 

 

 

Instant tickets

 

$

227,538

 

$

 

$

 

$

227,538

 

Services

 

 

101,704

 

93,010

 

194,714

 

Sales

 

5,601

 

18,377

 

3,142

 

27,120

 

Total revenues

 

$

233,139

 

$

120,081

 

$

96,152

 

$

449,372

 

 

 

 

 

 

 

 

 

 

 

Cost of instant tickets (1)

 

$

132,144

 

$

 

$

 

$

132,144

 

Cost of services (1)

 

 

52,310

 

57,303

 

109,613

 

Cost of sales (1)

 

3,977

 

13,645

 

2,244

 

19,866

 

Selling, general and administrative expenses

 

26,235

 

16,084

 

11,554

 

53,873

 

Write-down of assets held for sale

 

 

 

5,874

 

5,874

 

Depreciation and amortization

 

16,966

 

21,653

 

15,867

 

54,486

 

Segment operating income

 

$

53,817

 

$

16,389

 

$

3,310

 

$

73,516

 

Unallocated corporate costs

 

 

 

 

 

 

 

25,482

 

Consolidated operating income

 

 

 

 

 

 

 

$

48,034

 


(1)    Exclusive of depreciation and amortization

 

 

 

Six Months Ended June 30, 2009

 

 

 

Printed
Products
Group

 

Lottery
Systems Group

 

Diversified
Gaming Group

 

Totals

 

Revenues:

 

 

 

 

 

 

 

 

 

 

 

 

 

Instant tickets

 

$

222,872

 

$

 

$

 

$

222,872

 

Services

 

 

107,071

 

98,649

 

205,720

 

Sales

 

6,741

 

17,944

 

2,441

 

27,126

 

Total revenues

 

$

229,613

 

$

125,015

 

$

101,090

 

$

455,718

 

 

 

 

 

 

 

 

 

 

 

Cost of instant tickets (1)

 

$

132,711

 

$

 

$

 

$

132,711

 

Cost of services (1)

 

 

56,770

 

60,424

 

117,194

 

Cost of sales (1)

 

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 termination costs

 

 

 

 

 

 

 

1,346

 

Consolidated operating income

 

 

 

 

 

 

 

$

39,486

 


(1)    Exclusive of depreciation and amortization

 

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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 consolidated income before income taxes for each period:

 

 

 

Three Months Ended

 

Six Months Ended

 

 

 

June 30,

 

June 30,

 

 

 

2010

 

2009

 

2010

 

2009

 

Reported segment operating income

 

$

39,333

 

$

41,105

 

$

73,516

 

$

72,880

 

Unallocated corporate costs

 

(12,802

)

(14,576

)

(25,482

)

(32,048

)

Corporate employee termination costs

 

 

 

 

(1,346

)

Consolidated operating income

 

26,531

 

26,529

 

48,034

 

39,486

 

Interest expense

 

(24,845

)

(21,395

)

(49,559

)

(40,204

)

Equity in income of joint ventures

 

13,631

 

15,480

 

29,443

 

30,578

 

Gain on early extinguishment of debt

 

 

1,756

 

 

4,044

 

Other income (expense), net

 

(6,584

)

(931

)

(12,566

)

986

 

Income before income taxes

 

$

8,733

 

$

21,439

 

$

15,352

 

$

34,890

 

 

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 2009 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 us, Lottomatica Group S.p.A. and Arianna 2001, a company owned by the Federation of Italian Tobacconists. The consortium holds a concession from the Italian Monopoli di Stato to be the exclusive operator of the Italian Gratta e Vinci instant lottery.  Under our contract with CLN, we supply instant lottery tickets, game development services, marketing support, the instant ticket management system and systems support.  We also participate in the profits or losses of CLN as a 20% equity owner, and assist Lottomatica Group 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, 2010, we recorded income of $10,936 and $24,336, respectively, representing our share of the pre-tax earnings of CLN.  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 pre-tax earnings of CLN.  We received cash distributions of approximately $27,800 and $28,000 from CLN during the second quarter of 2010 and 2009, respectively.

 

In October 2009, the members of CLN tendered for a new concession to operate the Gratta e Vinci instant ticket lottery upon the termination of CLN’s existing concession. Although a maximum of four concessions could have been granted under the terms of the tender, our bidding group was the only group that submitted a bid.  In November 2009, following a challenge to the tender process by another lottery operator that complained that the terms of the tender process were onerous to non-incumbent bidding groups, an Italian administrative court voided the tender process in a ruling that was appealed by the Italian regulatory authorities and CLN.  In March 2010, the appellate court announced that it upheld the validity of the tender process that had been suspended by the lower administrative court, but struck down a term of the tender that allowed the Monopoli di Stato to have CLN manage existing instant lottery games during a transition period through January 31, 2012. The court remanded the case to the Italian regulatory authorities for further action regarding completion of the tender process. The Italian regulatory authorities revised the tender to conform to the appellate court’s ruling and re-opened the tender process.

 

The current members of CLN submitted a bid under the re-opened tender process and the Monopoli di Stato awarded our bidding group the sole concession on May 13, 2010.  Our bidding group formed and capitalized a new vehicle, Lotterie Nazionali S.r.l. (“LNS”), to hold the concession consistent with the tender requirements.  LNS is responsible for upfront fees associated with the new concession totaling €800,000.  We are responsible for our pro rata share of this amount, or €160,000, of which €104,000 was paid during the second quarter of 2010. The remaining €56,000 is payable by us during the fourth quarter of 2010.  The new concession has an initial term of nine years (subject to a performance evaluation during the fifth year) and could be extended by the Monopoli di Stato for an additional nine years. CLN’s concession was scheduled to expire on May 31, 2010 and the new concession was scheduled to

 

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begin on June 1, 2010.  However, due to the delay in completing the tender process, the Monopoli di Stato extended the expiration of CLN’s concession to September 30, 2010 in order to provide sufficient time to transition to the new concession.  The new concession is scheduled to begin on October 1, 2010.

 

Beginning in the fourth quarter of 2010, we will be the primary supplier of instant tickets to LNS under our agreement with LNS, and will participate in the profits or losses of LNS as a 20% equity owner.  We will accrue 20% of LNS’s net income on our Consolidated Statement of Operations as equity in earnings of joint ventures (compared to 20% of pre-tax earnings under our accounting for our interest in CLN).  The upfront fees associated with the new concession will be amortized by LNS and will impact our equity in earnings of joint ventures.  We anticipate that the 12-month impact of the amortization on LNS will be approximately €89,000 and the impact on our share will be a pre-tax charge of approximately €18,000 per year of the new concession.  Subject to applicable limitations, we are entitled to receive from LNS, annual cash dividends as well as periodic return of capital payments over the life of the concession.

 

(4) Comprehensive (Loss) Income

 

The following presents a reconciliation of net (loss) income to comprehensive (loss) income for the three and six month periods ended June 30, 2010 and 2009:

 

 

 

Three Months Ended

 

Six Months Ended

 

 

 

June 30,

 

June 30,

 

 

 

2010

 

2009

 

2010

 

2009

 

Net (loss) income

 

$

(4,343

)

$

20,346

 

$

544

 

$

(4,844

)

Other comprehensive (loss) income:

 

 

 

 

 

 

 

 

 

Foreign currency translation (loss) gain

 

(34,384

)

67,426

 

(63,248

)

38,309

 

Gain on derivative financial instruments

 

321

 

909

 

287

 

801

 

Other comprehensive (loss) income

 

(34,063

)

68,335

 

(62,961

)

39,110

 

Comprehensive (loss) income

 

$

(38,406

)

$

88,681

 

$

(62,417

)

$

34,266

 

 

(5) Inventories

 

Inventories consist of the following:

 

 

 

June 30,

 

December 31,

 

 

 

2010

 

2009

 

Parts and work-in-process

 

$

20,661

 

$

26,643

 

Finished goods

 

46,191

 

47,297

 

 

 

$

66,852

 

$

73,940

 

 

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

 

Credit Agreement

 

On June 17, 2010, we entered into a first incremental amendment to the credit agreement, dated as of June 9, 2008 (as amended, the “Credit Agreement”) among Scientific Games International, Inc. (“SGI”), as borrower, the Company, as guarantor, certain subsidiaries of the Company party thereto, as subsidiary guarantors, the lenders party thereto and JPMorgan Chase Bank, N.A. (“JPMorgan”), as administrative agent.  Pursuant to the amendment, several lenders provided an aggregate principal amount of $78,000 of senior secured term loans to SGI under a new incremental term loan facility pursuant to the Credit Agreement.  The incremental term loan facility is, in all material respects, subject to the same terms and conditions as SGI’s existing term loan facility under the Credit Agreement (described below).  A portion of the net proceeds from the incremental term loans were used for the repayment of outstanding indebtedness and the remaining proceeds will be used for general corporate and other working capital purposes, which may include the payment of a portion of the upfront fees associated with the award of the new Italian instant ticket lottery concession.

 

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In February 2010, we entered into certain amendments to the Credit Agreement in order to revise certain financial covenants and provide us with additional operating and financing flexibility so that we can execute on pending and future strategic initiatives, including participation in the Italian instant ticket concession tender process, the proposed sale of our racing and venue management businesses and our strategic transactions with Playtech Limited or its affiliates (“Playtech”).  For additional information regarding the amendments we entered into in February 2010, please refer to our Current Report on Form 8-K filed on February 19, 2010.

 

Giving effect to the foregoing amendments, the Credit Agreement provides for a $250,000 senior secured revolving credit facility and a $628,000 senior secured term loan credit facility, of which $615,430 remained outstanding as of June 30, 2010.

 

The Credit Agreement will terminate on June 9, 2013, provided that the revolving credit facility and the term loan credit facility will both mature on February 7, 2011 unless either:

 

·                                          no amounts remain outstanding under the 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, including SGI) (the “Global Draw Promissory Notes”) on such date; or

 

·                                          the sum of the available revolving credit facility commitments plus the unrestricted cash of SGI and the guarantors under the Credit Agreement on such date is not less than the sum of the principal amount of the Global Draw Promissory Notes then outstanding plus $50,000.

 

On June 25, 2010, we repaid approximately £27,506 of the approximately £28,100 in aggregate principal amount of the Global Draw Promissory Notes.

 

The revolving credit facility and the term loan credit facility 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 on or prior to such date; or

 

·                                          the sum of the available revolving credit facility commitments plus the unrestricted cash of SGI and the guarantors under the Credit Agreement on such date is not less than the sum of the principal amount of our 2004 Notes then outstanding plus $50,000.

 

In 2009, we repurchased approximately $12,925 of the $200,000 in aggregate principal amount of the 2004 Notes.

 

We expect that we will be able to satisfy the conditions described above and thereby prevent the acceleration of such indebtedness. However, there can be no assurance that we will be able to satisfy those conditions or to repay any accelerated indebtedness under the Credit Agreement, or to repay the remaining amount due under the Global Draw Promissory Notes in 2011 or our 2004 Notes in 2012.

 

Amounts under the revolving credit facility may be borrowed, repaid and re-borrowed by SGI from time to time until maturity. 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 break-funding 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 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 (as defined below) of the Company from 1.00% to 2.50% above the base rate for base rate loans, and from 2.00% to 3.50% above LIBOR for LIBOR-based loans. Until the delivery of the financial statements required under the Credit Agreement for the fiscal quarter ending March 31, 2010, the applicable margins for base rate loans and LIBOR-based loans were deemed to be 2.50% and 3.50%, respectively, regardless of the Consolidated Leverage Ratio.

 

During the term of the Credit Agreement, SGI will pay its lenders a fee, payable quarterly in arrears on the third business day after the last day of each of March, June, September and December and the last day of the revolving commitment period, equal to the product of (1) the available revolving credit facility commitments and (2) either 0.50% per annum if the Consolidated Leverage Ratio as of the most recent determination date is less than 4.25 to 1.00 or 0.75% per annum if the Consolidated Leverage Ratio as of the most recent determination date is greater than or equal to 4.25 to 1.00.

 

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The Company and its direct and indirect 100%-owned domestic subsidiaries (other than SGI) have guaranteed 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 the capital stock (or other equity interests) of all of our direct and indirect 100%-owned domestic subsidiaries and 65% of the capital stock (or other equity interests) of the direct foreign subsidiaries of SGI and the guarantors.

 

The Credit Agreement contains customary covenants, 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 each 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:

 

·                  5.75 to 1.00 (fiscal quarter ended December 31, 2009 through March 31, 2012);

 

·                  5.50 to 1.00 (fiscal quarter ending June 30, 2012); and

 

·                  5.25 to 1.00 (fiscal quarter ending September 30, 2012 and thereafter);

 

“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 (as defined below) for the period of four consecutive fiscal quarters then ended.

 

·                  a “Consolidated Senior Debt Ratio” as at the last day of each 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:

 

·                  2.75 to 1.00 (fiscal quarter ended December 31, 2009 through June 30, 2012); and

 

·                  2.50 to 1.00 (fiscal quarter ending September 30, 2012 and thereafter);

 

“Consolidated Senior Debt Ratio” means, as of the last day of any period, the ratio of (1) Consolidated Total Debt (other than our 2004 Notes, SGI’s 7.875% senior subordinated notes due 2016 (the “2008 Notes”), SGI’s 9.25% senior subordinated notes due 2019 (the “2009 Notes”), our 0.75% convertible senior subordinated debentures due 2024 (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 not less than the ratio set forth below with respect to such period or with respect to the period during which such four consecutive fiscal quarters ends:

 

·                  2.50 to 1.00 (four consecutive fiscal quarters ending December 31, 2009 and through June 30, 2010); and

 

·                  2.25 to 1.00 (four consecutive fiscal quarters ending September 30, 2010 and thereafter).

 

“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 debt of the Company and its subsidiaries for such period.

 

“Consolidated EBITDA” means, for any period, “Consolidated Net Income” (i.e., our consolidated net income (or loss) excluding, among other items, the income (or deficit) of our joint venture entities except to the extent that such income is actually received by us in the form of distributions or payments in respect of loans made by us to such joint venture entities in lieu of equity

 

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investments) for such period plus, to the extent reflected as a charge in the statement of such Consolidated Net Income for such period, the sum of:

 

·                                          income tax expense;

 

·                                          interest expense, amortization or write-off of debt discount and debt issuance costs and commissions, discounts and other fees and charges associated with debt;

 

·                                          depreciation and amortization expense;

 

·                                          amortization of intangibles (including goodwill) and organization costs;

 

·                                          earn-out payments with respect to certain acquisitions that we have made, such as our acquisition of The Global Draw Limited and certain related companies (“Global Draw”), or any “Permitted Acquisitions” (generally, acquisitions of companies that are primarily engaged in the same or related line of business and that become subsidiaries of ours, or acquisitions of all or substantially all of the assets of another company or division or business unit of another company), including any loss or expense with respect to such earn-out payments;

 

·                                          extraordinary charges or losses determined in accordance with GAAP;

 

·                                          non-cash stock-based compensation expenses;

 

·                                          up to $3,000 of expenses, charges or losses resulting from certain Peru investments;

 

·                                          the non-cash portion of any non-recurring write-offs or write-downs as required in accordance with GAAP;

 

·                                          advisory fees and related expenses paid to advisory firms in connection with Permitted Acquisitions;

 

·                                          “Permitted Add-Backs” (i.e., (1) up to $15,000 (less the amount of certain permitted pro forma adjustments to Consolidated EBITDA in connection with material acquisitions) of charges incurred during any 12-month period in connection with (a) reductions in workforce, (b) contract losses, discontinued operations, shutdown expenses and cost reduction initiatives, (c) transaction expenses incurred in connection with potential acquisitions and divestitures, whether or not consummated, and (d) restructuring charges and transaction expenses incurred in connection with certain transaction with Playtech and (2) reasonable and customary costs incurred in connection with amendments to the Credit Agreement);

 

provided that the foregoing amounts do not include (1) write-offs or write-downs of accounts receivable or inventory and (2) except with respect to Permitted Add-Backs, any write-off or write-down to the extent it is in respect of cash payments to be made in a future period;

 

·                                          to the extent treated as an expense in the period paid or incurred, certain payments, costs and obligations (up to a specified amount) made or incurred by us, whether directly or indirectly, in connection with any award of a concession to operate the instant ticket lottery in Italy, including up-front fees required under the applicable tender process;

 

·                                          restructuring charges, transaction expenses and shutdown expenses incurred in connection with the disposition of all or part of our racing and venue management businesses, together with any charges incurred in connection with discontinued operations and cost-reduction initiatives associated with such disposition, in an aggregate amount (for all periods combined) not to exceed $7,325; and

 

·                                          up to £5,250 during any four-quarter period of expenses or charges incurred in connection with the payment of license royalties or other fees to Playtech and for software services provided to Global Draw or Games Media Limited by Playtech;

 

minus, to the extent included in the statement of such Consolidated Net Income for such period, the sum of:

 

·                                          interest income;

 

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·                                          extraordinary income or gains determined in accordance with GAAP; and

 

·                                          income or gains with respect to earn-out payments with respect to acquisitions referred to above.

 

Consolidated EBITDA is subject to certain adjustments in connection with material acquisitions and dispositions as provided in the Credit Agreement.

 

The Credit Agreement generally requires mandatory prepayments of the term loan credit facility with the net cash proceeds from (1) the incurrence of indebtedness by us (excluding certain permitted debt) and (2) the sale of assets that yields to us net cash proceeds in excess of $5,000 (excluding certain permitted asset sales) or any settlement of or payment in respect of any property or casualty insurance claim or any condemnation proceeding relating to any of our assets.

 

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 revolving credit facility, or a combination thereof, in a maximum aggregate amount of $122,000 at a later date.

 

We were in compliance with our covenants under the Credit Agreement as of June 30, 2010.

 

As of June 30, 2010, we had approximately $164,310 available for additional borrowing or letter of credit issuance under our revolving credit facility. There were no borrowings and $64,652 in outstanding letters of credit under our revolving credit facility as of June 30, 2010.  Our ability to borrow under the Credit Agreement will depend on us remaining in compliance with the covenants contained in the Credit Agreement, including the maintenance of the foregoing financial ratios.

 

Convertible Debentures

 

On June 1, 2010, the remaining $9,943 in aggregate principal amount of our Convertible Debentures was repurchased or redeemed at par.  In accordance with the terms of the indenture governing the Convertible Debentures, holders thereof required the Company to repurchase for cash $9,935 in aggregate principal amount of the Convertible Debentures at a purchase price equal to 100% of the aggregate principal amount thereof, together with accrued but unpaid interest thereon. The Company redeemed $8 in aggregate principal amount of the Convertible Debentures at a redemption price equal to 100% of the aggregate principal amount thereof, together with accrued but unpaid interest thereon.  In connection with the repurchase and redemption, we unwound the corresponding remaining portion of the bond hedge and warrant option.

 

As of June 30, 2010 and December 31, 2009, the equity component of our Convertible Debentures was approximately $58,643.  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 December 31, 2009:

 

 

 

December 31,

 

 

 

2009

 

Principal

 

$

9,943

 

Unamortized discount

 

(212

)

Net carrying amount

 

$

9,731

 

 

The effective interest rate on the liability component of our Convertible Debentures was approximately 6.25% for the three and six months ended June 30, 2010 and for the three and six months ended June 30, 2009.  The amount of interest cost recognized for the contractual interest coupon during the three and six months ended June 30, 2010 was approximately $12 and $31, respectively.  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 amortization of the discount on the liability component of our Convertible Debentures during the three and six months ended June 30, 2010 was approximately $86 and $212, respectively.  The amount of interest cost recognized for the amortization of the discount on the liability component of our Convertible Debentures during the three and six months ended June 30, 2009 was approximately $2,784 and $6,085, respectively.

 

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(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, 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, 2010 the Hedge was measured at a fair value of $3,564 using Level 2 valuation techniques of the fair value hierarchy and included in other long-term liabilities on the Consolidated Balance Sheet.

 

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 three and six months ended June 30, 2010, we recorded a gain of approximately $321 and $287, respectively in other comprehensive income (loss).  During the three and six months ended June 30, 2009, we recorded a gain of approximately $909 and $801, respectively 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.

 

During the first and second quarter of 2010, we entered into several short-term forward contracts (the “Forwards”) with various counterparties, some of which remain outstanding as of June 30, 2010. Under the Forwards, we locked in the price to purchase a predetermined amount of Euros at a later date. The objective of the Forwards, which are not designated as hedges, was to mitigate the risk associated with cash payments required to be made by the Company in non-functional currencies.

 

As of June 30, 2010, the unsettled Forwards were measured in accrued liabilities having a fair value of approximately $18 using Level 2 valuation techniques of the fair value hierarchy and are scheduled to mature on October 1, 2010 and November 18, 2010.

 

During the three and six months ended June 30, 2010, we recorded a net loss of approximately $9,018 and $15,723, respectively, on forward contracts in our Consolidated Statement of Operations.  The loss on forward contracts is included in “other (income) expense, net.”

 

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(8) Goodwill and Intangible Assets

 

The following disclosure presents certain information regarding our acquired intangible assets as of June 30, 2010 and December 31, 2009.  Amortizable intangible assets are amortized over their estimated useful lives with no estimated residual values.

 

Intangible Assets

 

Gross Carrying
Amount

 

Accumulated
Amortization

 

Net Balance

 

Balance as of June 30, 2010

 

 

 

 

 

 

 

Amortizable intangible assets:

 

 

 

 

 

 

 

Patents

 

$

11,323

 

$

(3,905

)

$

7,418

 

Customer lists

 

29,359

 

(17,457

)

11,902

 

Licenses

 

65,047

 

(46,637

)

18,410

 

Intellectual property

 

17,194

 

(16,815

)

379

 

Lottery contracts

 

4,411

 

(3,954

)

457

 

 

 

127,334

 

(88,768

)

38,566

 

Non-amortizable intangible assets:

 

 

 

 

 

 

 

Trade name

 

37,396

 

(2,118

)

35,278

 

Total intangible assets

 

$

164,730

 

$

(90,886

)

$

73,844

 

 

 

 

 

 

 

 

 

Balance as of December 31, 2009

 

 

 

 

 

 

 

Amortizable intangible assets:

 

 

 

 

 

 

 

Patents

 

$

11,657

 

$

(4,073

)

$

7,584

 

Customer lists

 

29,706

 

(17,431

)

12,275

 

Licenses

 

63,974

 

(41,825

)

22,149

 

Intellectual property

 

18,581

 

(16,946

)

1,635

 

Lottery contracts

 

4,907

 

(4,399

)

508

 

 

 

128,825

 

(84,674

)

44,151

 

Non-amortizable intangible assets:

 

 

 

 

 

 

 

Trade name

 

37,789

 

(2,118

)

35,671

 

Total intangible assets

 

$

166,614

 

$

(86,792

)

$

79,822

 

 

The aggregate intangible amortization expense for the three and six months ended June 30, 2010 was approximately $3,300 and $7,500, respectively.  The aggregate intangible amortization expense for the three and six months ended June 30, 2009 was approximately $4,300 and $9,200, respectively.

 

The table below reconciles the change in the carrying amount of goodwill, by reporting segment, for the period from December 31, 2009 to June 30, 2010.  In the first half of 2010, we recorded a decrease in goodwill of $36,028 as a result of foreign currency translation.

 

Goodwill

 

Printed
Products
Group

 

Lottery
Systems
Group

 

Diversified
Gaming
Group

 

Totals

 

Balance as of December 31, 2009

 

$

329,659

 

$

192,833

 

$

250,240

 

$

772,732

 

Adjustments

 

(3,544

)

(13,493

)

(18,991

)

(36,028

)

Balance as of June 30, 2010

 

$

326,115

 

$

179,340

 

$

231,249

 

$

736,704

 

 

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(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, 2010 and 2009.

 

 

 

Three Months Ended

 

Six Months Ended

 

 

 

June 30,

 

June 30,

 

 

 

2010

 

2009

 

2010

 

2009

 

Components of net periodic pension benefit cost:

 

 

 

 

 

 

 

 

 

Service cost

 

$

471

 

$

371

 

$

943

 

$

742

 

Interest cost

 

1,237

 

1,052

 

2,473

 

2,104

 

Expected return on plan assets

 

(1,226

)

(888

)

(2,451

)

(1,777

)

Amortization of actuarial gains

 

140

 

119

 

280

 

238

 

Amortization of prior service costs

 

11

 

11

 

22

 

22

 

Net periodic cost

 

$

633

 

$

665

 

$

1,267

 

$

1,329

 

 

We have a 401(k) plan for U.S.-based employees who are not covered by a collective bargaining agreement.  Effective January 1, 2010,  we increased the matching contributions from 25 cents on the dollar for the first 6% of participant contributions for a match of up to 1.5% of eligible compensation to 37.5 cents on the dollar for the first 6% of participant contributions for a match of up to 2.25% of eligible compensation.

 

(10) Income Taxes

 

The effective tax rates of 149.7% and 96.5%, respectively, for the three and six months ended June 30, 2010 were determined using an estimated annual effective tax rate and after considering any discrete items for such periods.  The effective tax rate for the three and six months ended June 30, 2010 includes the impact of a valuation allowance against certain U.S. state deferred tax assets.

 

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 and considering any discrete items in such periods. 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 reserves related to tax settlements in the second quarter of 2009.

 

Deferred tax assets and liabilities are determined based on the difference between the book and tax bases of assets and liabilities, using enacted tax rates in effect for the year in which the differences are expected to reverse. Deferred tax assets are recognized if it is more likely than not that the assets will be realized in future years. We establish a valuation allowance for deferred tax assets for which realization is unlikely.  When we establish or reduce the valuation allowance against our deferred tax assets, our income tax expense increases or decreases, respectively, in the period such determination is made.

 

During the three months ended June 30, 2010, the Company determined that the net realizable value of its state deferred tax assets is $6,328 and therefore recorded a valuation allowance of $11,797 at June 30, 2010.  Our decision to reserve a portion of our state deferred tax assets is primarily due to a revised forecast of future state taxable income.

 

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(11) Stockholders’ Equity

 

The following demonstrates the change in the number of shares of Class A common stock outstanding during the six months ended June 30, 2010 and during the fiscal year ended December 31, 2009:

 

 

 

Six Months

 

Twelve Months

 

 

 

Ended

 

Ended

 

 

 

June 30,

 

December 31,

 

 

 

2010

 

2009

 

Shares outstanding as of beginning of period

 

93,883

 

92,601

 

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

 

283

 

1,804

 

Shares repurchased into treasury stock

 

(1,768

)

(522

)

Shares outstanding as of end of period

 

92,398

 

93,883

 

 

Subsequent to June 30, 2010, the Company repurchased 851 shares under its previously announced repurchase program for approximately $8,108.

 

(12) Stock-Based Compensation

 

As of June 30, 2010, we had approximately 3,102 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 the six months ended June 30, 2010 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, 2009

 

6,160

 

5.7

 

$

21.56

 

$

8,642

 

Granted

 

497

 

 

 

15.60

 

 

 

Exercised

 

(5

)

 

 

12.21

 

14

 

Cancelled

 

(25

)

 

 

27.08

 

 

 

Options outstanding as of March 31, 2010

 

6,627

 

5.8

 

$

21.10

 

$

7,937

 

Granted

 

27

 

 

 

14.01

 

 

 

Exercised

 

(2

)

 

 

6.16

 

9

 

Cancelled

 

(440

)

 

 

9.70

 

 

 

Options outstanding as of June 30, 2010

 

6,212

 

6.0

 

$

21.88

 

$

1,822

 

 

 

 

 

 

 

 

 

 

 

Options exercisable as of June 30, 2010

 

4,192

 

5.0

 

$

22.34

 

$

1,822

 

 

The weighted-average grant date fair value of options granted during the three months ended June 30, 2010 and March 31, 2010 was $7.07 and $7.95, respectively.  For the three and six months ended June 30, 2010, we recognized stock-based compensation expense of approximately $2,100 and $4,000, respectively, related to the vesting of stock options and the related tax benefit of approximately $700 and $1,300, respectively.  For the three and six months ended June 30, 2009, we recognized stock-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.   As of June 30, 2010, we had unearned compensation of approximately $14,000 relating to stock option awards that will be amortized over a weighted-average period of approximately two years.

 

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Restricted Stock Units

 

A summary of the changes in RSUs outstanding under our equity-based compensation plans during the six months ended June 30, 2010 is presented below:

 

 

 

Number of
Restricted
Stock

 

Weighted
Average Grant
Date Fair
Value Per
Share

 

Non-vested units as of December 31, 2009

 

1,586

 

$

19.54

 

Granted

 

897

 

15.49

 

Vested

 

(303

)

20.38

 

Cancelled

 

(26

)

17.49

 

Non-vested units as of March 31, 2010

 

2,154

 

$

17.78

 

Granted

 

24

 

13.40

 

Vested

 

(39

)

26.95

 

Cancelled

 

 

 

Non-vested units as of June 30, 2010

 

2,139

 

$

17.57

 

 

For the three and six months ended June 30, 2010, we recognized equity-based compensation expense of approximately $3,300 and $8,500 respectively, related to the vesting of RSUs and the related tax benefit of approximately $1,300 and $3,300 respectively.  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.  As of June 30, 2010, we had unearned compensation of approximately $29,000 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, 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 are, and our Convertible Debentures were, fully and unconditionally and jointly and severally guaranteed by our 100%-owned domestic subsidiaries, including SGI.  The 2004 Notes and the Convertible Debentures were issued by the Parent Company.

 

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, 2010 and December 31, 2009 and for the three and six months ended June 30, 2010 and 2009. 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, our Convertible Debentures and our 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.

 

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SCIENTIFIC GAMES CORPORATION AND SUBSIDIARIES

SUPPLEMENTAL CONDENSED CONSOLIDATING BALANCE SHEET

As of June 30, 2010

 

 

 

Parent Company

 

SGI

 

Guarantor
Subsidiaries

 

Non-Guarantor
Subsidiaries

 

Eliminating
Entries

 

Consolidated

 

Assets

 

 

 

 

 

 

 

 

 

 

 

 

 

Cash and cash equivalents

 

$

98,097

 

$

624

 

$

 

$

59,666

 

$

(6,934

)

$

151,453

 

Accounts receivable, net

 

 

66,191

 

35,110

 

55,830

 

 

157,131

 

Inventories

 

 

30,871

 

14,888

 

21,093

 

 

66,852

 

Other current assets

 

15,817

 

12,841

 

12,209

 

18,413

 

 

59,280

 

Assets held for sale

 

 

 

67,183

 

29,302

 

(7,212

)

89,273

 

Property and equipment, net

 

1,819

 

175,220

 

42,687

 

240,558

 

 

460,284

 

Investment in subsidiaries

 

593,357

 

724,463

 

 

275,518

 

(1,593,338

)

 

Goodwill

 

 

273,656

 

74,183

 

388,865

 

 

736,704

 

Intangible assets

 

 

42,337

 

23,490

 

8,017

 

 

73,844

 

Intercompany balances

 

40,175

 

35,992

 

137,220

 

 

(213,387

)

 

Other assets

 

34,779

 

131,073

 

5,292

 

240,833

 

(6,101

)

405,876

 

Total assets

 

$

784,044

 

$

1,493,268

 

$

412,262

 

$

1,338,095

 

$

(1,826,972

)

$

2,200,697

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Liabilities and stockholders’ equity

 

 

 

 

 

 

 

 

 

 

 

 

 

Current installments of long-term debt

 

$

 

$

6,280

 

$

 

$

2,593

 

$

 

$

8,873

 

Current liabilities

 

22,915

 

48,041

 

31,981

 

55,050

 

(7,027

)

150,960

 

Liabilities held for sale

 

 

 

11,604

 

8,928

 

 

20,532

 

Long-term debt, excluding current installments

 

187,075

 

1,153,435

 

 

28,411

 

 

1,368,921

 

Other non-current liabilities

 

18,697

 

13,867

 

7,889

 

55,601

 

 

96,054

 

Intercompany balances

 

 

 

 

213,294

 

(213,294

)

 

Stockholders’ equity

 

555,357

 

271,645

 

360,788

 

974,218

 

(1,606,651

)

555,357

 

Total liabilities and stockholders’ equity

 

$

784,044

 

$

1,493,268

 

$

412,262

 

$

1,338,095

 

$

(1,826,972

)

$

2,200,697

 

 

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Table of Contents

 

SCIENTIFIC GAMES CORPORATION AND SUBSIDIARIES

SUPPLEMENTAL CONDENSED CONSOLIDATING BALANCE SHEET

As of December 31, 2009

 

 

 

Parent Company

 

SGI

 

Guarantor Subsidiaries

 

Non-Guarantor Subsidiaries

 

Eliminating Entries

 

Consolidated

 

Assets

 

 

 

 

 

 

 

 

 

 

 

 

 

Cash and cash equivalents

 

$

147,220

 

$

137

 

$

 

$

113,053

 

$

(279

)

$

260,131

 

Accounts receivable, net

 

 

79,294

 

37,189

 

61,484

 

 

177,967

 

Inventories

 

 

30,511

 

15,017

 

28,412

 

 

73,940

 

Other current assets

 

26,303

 

12,612

 

12,114

 

18,559

 

 

69,588

 

Assets held for sale

 

 

 

70,962

 

27,352

 

(7,212

)

91,102

 

Property and equipment, net

 

1,954

 

170,350

 

44,762

 

251,373

 

 

468,439

 

Investment in subsidiaries

 

468,405

 

562,537

 

 

218,540

 

(1,249,482

)

 

Goodwill

 

 

273,656

 

74,183

 

424,893

 

 

772,732

 

Intangible assets

 

 

43,040

 

27,572

 

9,210

 

 

79,822

 

Intercompany balances

 

178,848

 

 

86,720

 

 

(265,568

)

 

Other assets

 

45,858

 

132,059

 

9,180

 

117,075

 

(6,101

)

298,071

 

Total assets

 

$

868,588

 

$

1,304,196

 

$

377,699

 

$

1,269,951

 

$

(1,528,642

)

$

2,291,792

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Liabilities and stockholders’ equity

 

 

 

 

 

 

 

 

 

 

 

 

 

Current installments of long-term debt

 

$

9,731

 

$

5,500

 

$

 

$

9,577

 

$

 

$

24,808

 

Current liabilities

 

30,271

 

44,327

 

35,614