Table of Contents

 

 

 

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D. C.  20549

 

FORM 10-Q

 

{Mark One}

 

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

 

For the quarterly period ended September 30, 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 November 5, 2010:

 

Class A Common Stock: 91,607,449

Class B Common Stock:  None

 

 

 



Table of Contents

 

SCIENTIFIC GAMES CORPORATION AND SUBSIDIARIES

INDEX TO FINANCIAL INFORMATION

AND OTHER INFORMATION

THREE AND NINE MONTHS ENDED SEPTEMBER 30, 2010

 

PART I.

FINANCIAL INFORMATION

4

 

 

 

Item 1.

Financial Statements

4

 

 

 

 

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

4

 

 

 

 

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

5

 

 

 

 

Consolidated Statements of Operations for the Nine Months Ended September 30, 2010 and 2009

6

 

 

 

 

Consolidated Statements of Cash Flows for the Nine Months Ended September 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

28

 

 

 

Item 3.

Quantitative and Qualitative Disclosures About Market Risk

40

 

 

 

Item 4.

Controls and Procedures

41

 

 

 

PART II.

OTHER INFORMATION

41

 

 

 

Item 1A.

Risk Factors

41

 

 

 

Item 2.

Unregistered Sales of Equity Securities and Use of Proceeds

47

 

 

 

Item 6.

Exhibits

48

 

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” and “Risk Factors” 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; inability to fully realize, and risks associated with, our deferred tax assets; availability and adequacy of cash flows 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; failure of our joint venture to enter into the Illinois Lottery private management agreement (including as a result of a protest) or failure to meet the related net income targets or otherwise realize the anticipated benefits under such agreement; 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 September 30, 2010 and December 31, 2009

(Unaudited, in thousands, except per share amounts)

 

 

 

September 30,

 

December 31,

 

 

 

2010

 

2009

 

ASSETS

 

 

 

 

 

Current assets:

 

 

 

 

 

Cash and cash equivalents

 

$

249,570

 

$

260,131

 

Accounts receivable, net of allowance for doubtful accounts of $2,406 and $2,140 as of September 30, 2010 and December 31, 2009, respectively

 

167,265

 

177,967

 

Inventories

 

74,857

 

73,940

 

Deferred income taxes, current portion

 

15,838

 

22,557

 

Prepaid expenses, deposits and other current assets

 

45,549

 

47,031

 

Assets held for sale

 

88,638

 

91,102

 

Total current assets

 

641,717

 

672,728

 

Property and equipment, at cost

 

796,339

 

751,713

 

Less: accumulated depreciation

 

(329,634

)

(283,274

)

Property and equipment, net

 

466,705

 

468,439

 

Goodwill, net

 

766,356

 

772,732

 

Intangible assets, net

 

72,343

 

79,822

 

Other assets and investments

 

440,271

 

298,071

 

Total assets

 

$

2,387,392

 

$

2,291,792

 

 

 

 

 

 

 

LIABILITIES AND STOCKHOLDERS’ EQUITY

 

 

 

 

 

Current liabilities:

 

 

 

 

 

Debt payments due within one year

 

$

8,401

 

$

24,808

 

Accounts payable

 

45,206

 

57,309

 

Accrued liabilities

 

130,157

 

122,989

 

Liabilities held for sale

 

18,945

 

20,097

 

Total current liabilities

 

202,709

 

225,203

 

Deferred income taxes

 

36,603

 

37,418

 

Other long-term liabilities

 

60,840

 

67,158

 

Long-term debt, excluding current installments

 

1,468,875

 

1,342,255

 

Total liabilities

 

1,769,027

 

1,672,034

 

 

 

 

 

 

 

Commitments and contingencies

 

 

 

 

 

 

 

 

 

 

 

Stockholders’ equity:

 

 

 

 

 

Class A common stock, par value $0.01 per share, 199,300 shares authorized, and 91,572 and 93,883 shares outstanding as of September 30, 2010 and December 31, 2009, respectively

 

976

 

939

 

Additional paid-in capital

 

673,346

 

651,348

 

Accumulated earnings

 

27,428

 

18,180

 

Treasury stock, at cost, 5,748 and 3,130 shares held as of September 30, 2010 and December 31, 2009, respectively

 

(74,460

)

(48,125

)

Accumulated other comprehensive loss

 

(8,925

)

(2,584

)

Total stockholders’ equity

 

618,365

 

619,758

 

Total liabilities and stockholders’ equity

 

$

2,387,392

 

$

2,291,792

 

 

See accompanying notes to consolidated financial statements

 

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SCIENTIFIC GAMES CORPORATION AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF OPERATIONS

Three Months Ended September 30, 2010 and 2009

(Unaudited, in thousands, except per share amounts)

 

 

 

Three Months Ended September 30,

 

 

 

2010

 

2009

 

Revenues:

 

 

 

 

 

Instant tickets

 

$

115,968

 

$

117,744

 

Services

 

92,813

 

104,279

 

Sales

 

12,280

 

17,123

 

Total revenues

 

221,061

 

239,146

 

 

 

 

 

 

 

Operating expenses:

 

 

 

 

 

Cost of instant tickets (1)

 

67,138

 

69,897

 

Cost of services (1)

 

57,723

 

57,876

 

Cost of sales (1)

 

7,977

 

10,513

 

Selling, general and administrative expenses

 

36,435

 

38,861

 

Write-down of assets held for sale

 

2,155

 

 

Employee termination costs

 

602

 

 

Depreciation and amortization

 

27,284

 

32,049

 

Operating income

 

21,747

 

29,950

 

Other expense (income):

 

 

 

 

 

Interest expense

 

24,617

 

22,736

 

Equity in earnings of joint ventures

 

(13,031

)

(14,180

)

Loss (gain) on early extinguishment of debt

 

2,236

 

(550

)

Other income, net

 

(3,011

)

(27

)

 

 

10,811

 

7,979

 

Income before income taxes

 

10,936

 

21,971

 

Income tax expense

 

2,232

 

6,865

 

Net income

 

$

8,704

 

$

15,106

 

 

 

 

 

 

 

Basic and diluted net income per share:

 

 

 

 

 

Basic net income per share

 

$

0.09

 

$

0.16

 

Diluted net income per share

 

$

0.09

 

$

0.16

 

 

 

 

 

 

 

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

 

 

 

 

 

Basic shares

 

91,844

 

92,727

 

Diluted shares

 

92,240

 

94,028

 

 


(1)          Exclusive of depreciation and amortization.

 

See accompanying notes to consolidated financial statements

 

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Table of Contents

 

SCIENTIFIC GAMES CORPORATION AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF OPERATIONS

Nine Months Ended September 30, 2010 and 2009

(Unaudited, in thousands, except per share amounts)

 

 

 

Nine Months Ended September 30,

 

 

 

2010

 

2009

 

Revenues:

 

 

 

 

 

Instant tickets

 

$

343,506

 

$

340,616

 

Services

 

287,527

 

309,999

 

Sales

 

39,400

 

44,249

 

Total revenues

 

670,433

 

694,864

 

 

 

 

 

 

 

Operating expenses:

 

 

 

 

 

Cost of instant tickets (1)

 

199,282

 

202,608

 

Cost of services (1)

 

167,336

 

175,070

 

Cost of sales (1)

 

27,843

 

30,898

 

Selling, general and administrative expenses

 

115,543

 

119,479

 

Write-down of assets held for sale

 

8,029

 

 

Employee termination costs

 

602

 

3,920

 

Depreciation and amortization

 

82,017

 

93,453

 

Operating income

 

69,781

 

69,436

 

Other expense (income):

 

 

 

 

 

Interest expense

 

74,176

 

62,940

 

Equity in earnings of joint ventures

 

(42,474

)

(44,758

)

Loss (gain) on early extinguishment of debt

 

2,236

 

(4,594

)

Other expense (income), net

 

9,555

 

(1,013

)

 

 

43,493

 

12,575

 

Income before income taxes

 

26,288

 

56,861

 

Income tax expense

 

17,040

 

46,599

 

Net income

 

$

9,248

 

$

10,262

 

 

 

 

 

 

 

Basic and diluted net income per share:

 

 

 

 

 

Basic net income per share

 

$

0.10

 

$

0.11

 

Diluted net income per share

 

$

0.10

 

$

0.11

 

 

 

 

 

 

 

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

 

 

 

 

 

Basic shares

 

93,122

 

92,577

 

Diluted shares

 

93,648

 

93,859

 

 


(1)          Exclusive of depreciation and amortization.

 

 See accompanying notes to consolidated financial statements

 

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SCIENTIFIC GAMES CORPORATION AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF CASH FLOWS

Nine Months Ended September 30, 2010 and 2009

(Unaudited, in thousands, except per share amounts)

 

 

 

Nine Months Ended September 30,

 

 

 

2010

 

2009

 

Cash flows from operating activities:

 

 

 

 

 

Net income

 

$

9,248

 

$

10,262

 

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

 

 

 

 

 

Depreciation and amortization

 

82,017

 

93,453

 

Change in deferred income taxes

 

11,541

 

34,350

 

Stock-based compensation

 

17,383

 

25,903

 

Non-cash interest expense

 

5,276

 

11,234

 

Undistributed equity in earnings of joint ventures

 

(8,062

)

(13,778

)

Write-down of assets held for sale

 

8,029

 

 

Loss (gain) on early extinguishment of debt

 

2,236

 

(4,594

)

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

 

 

 

 

 

Accounts receivable

 

7,012

 

4,144

 

Inventories

 

(2,375

)

2,070

 

Accounts payable

 

(8,970

)

(8,701

)

Accrued liabilities

 

(3,463

)

(23,743

)

Other current assets and liabilities

 

22,886

 

45,432

 

Other

 

483

 

(38

)

Net cash provided by operating activities

 

143,241

 

175,994

 

 

 

 

 

 

 

Cash flows from investing activities:

 

 

 

 

 

Capital expenditures

 

(6,873

)

(9,135

)

Wagering systems expenditures

 

(45,257

)

(44,870

)

Other intangible assets and software expenditures

 

(26,335

)

(26,040

)

Change in other assets and liabilities, net

 

(571

)

3,611

 

Investment in joint venture

 

(127,314

)

 

Business acquisitions, net of cash acquired

 

(12,493

)

(89,453

)

Net cash used in investing activities

 

(218,843

)

(165,887

)

 

 

 

 

 

 

Cash flows from financing activities:

 

 

 

 

 

Proceeds from issuance of long-term debt

 

355,541

 

259,658

 

Payment on long-term debt

 

(242,758

)

(183,632

)

Payment of financing fees

 

(12,969

)

(11,535

)

Purchases of treasury stock

 

(26,334

)

(5,539

)

Net proceeds from issuance of common stock

 

(2,067

)

2,191

 

Net cash provided by financing activities

 

71,413

 

61,143

 

Effect of exchange rate changes on cash and cash equivalents

 

(8,965

)

1,189

 

(Decrease) increase in cash and cash equivalents

 

(13,154

)

72,439

 

Cash and cash equivalents, beginning of period

 

260,131

 

140,639

 

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

 

2,593

 

 

Cash and cash equivalents, end of period

 

$

249,570

 

$

213,078

 

 

See accompanying notes to consolidated financial statements

 

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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 September 30, 2010, the Consolidated Statements of Operations for the three and nine months ended September 30, 2010 and 2009, and the Consolidated Statements of Cash Flows for the nine months ended September 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 the “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 September 30, 2010, the results of our operations for the three and nine months ended September 30, 2010 and 2009 and our cash flows for the nine months ended September 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 September 30, 2010 are not necessarily indicative of the operating results for a full year.

 

In order to provide users of our financial statements better visibility into our revenue streams, beginning with our results for the year ended December 31, 2009, we segregated revenues related to our instant ticket fulfillment/services businesses from other service revenues.

 

Basic and Diluted Net Income Per Share

 

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

 

 

 

Three Months Ended

 

Nine Months Ended

 

 

 

September 30,

 

September 30,

 

 

 

2010

 

2009

 

2010

 

2009

 

Income (numerator)

 

 

 

 

 

 

 

 

 

Net income

 

$

8,704

 

$

15,106

 

$

9,248

 

$

10,262

 

 

 

 

 

 

 

 

 

 

 

Shares (denominator)

 

 

 

 

 

 

 

 

 

Weighted-average basic common shares outstanding

 

91,844

 

92,727

 

93,122

 

92,577

 

Effect of dilutive securities-stock rights

 

396

 

1,301

 

526

 

1,282

 

Weighted-average diluted common shares outstanding

 

92,240

 

94,028

 

93,648

 

93,859

 

 

 

 

 

 

 

 

 

 

 

Basic and diluted per share amounts

 

 

 

 

 

 

 

 

 

Basic net income per share

 

$

0.09

 

$

0.16

 

$

0.10

 

$

0.11

 

Diluted net income per share

 

$

0.09

 

$

0.16

 

$

0.10

 

$

0.11

 

 

The weighted-average diluted common shares outstanding for the three and nine months ended September 30, 2010 excludes the effect of approximately 6,917 and 6,496 weighted-average stock rights outstanding, respectively, because their effect would be anti-dilutive.  The weighted-average diluted common shares outstanding for the three and nine months ended September 30, 2009 excludes the effect of approximately 5,774 and 6,470 weighted-average stock rights outstanding, respectively, because their effect would be anti-dilutive.

 

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Table of Contents

 

(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, segment employee termination costs and operating income for the three and nine month periods ended September 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 September 30, 2010

 

 

 

Printed
Products
Group

 

Lottery
Systems Group

 

Diversified
Gaming Group

 

Totals

 

Revenues:

 

 

 

 

 

 

 

 

 

Instant tickets

 

$

115,968

 

$

 

$

 

$

115,968

 

Services

 

 

46,630

 

46,183

 

92,813

 

Sales

 

1,024

 

6,141

 

5,115

 

12,280

 

Total revenues

 

$

116,992

 

$

52,771

 

$

51,298

 

$

221,061

 

 

 

 

 

 

 

 

 

 

 

Cost of instant tickets (1)

 

$

67,138

 

$

 

$

 

$

67,138

 

Cost of sevices (1)

 

 

26,450

 

31,273

 

57,723

 

Cost of sales (1)

 

954

 

4,063

 

2,960

 

7,977

 

Selling, general and administrative expenses

 

12,479

 

7,889

 

6,117

 

26,485

 

Write-down of assets held for sale

 

 

 

2,155

 

2,155

 

Employee termination costs

 

 

 

602

 

602

 

Depreciation and amortization

 

8,184

 

10,969

 

8,005

 

27,158

 

Segment operating income

 

$

28,237

 

$

3,400

 

$

186

 

$

31,823

 

Unallocated corporate expenses

 

 

 

 

 

 

 

10,076

 

Consolidated operating income

 

 

 

 

 

 

 

$

21,747

 

 


(1)          Exclusive of depreciation and amortization.

 

 

 

Three Months Ended September 30, 2009

 

 

 

Printed
Products
Group

 

Lottery
Systems Group

 

Diversified
Gaming Group

 

Totals

 

Revenues:

 

 

 

 

 

 

 

 

 

Instant tickets

 

$

117,744

 

$

 

$

 

$

117,744

 

Services

 

 

52,343

 

51,936

 

104,279

 

Sales

 

3,035

 

13,144

 

944

 

17,123

 

Total revenues

 

$

120,779

 

$

65,487

 

$

52,880

 

$

239,146

 

 

 

 

 

 

 

 

 

 

 

Cost of instant tickets (1)

 

$

69,897

 

$

 

$

 

$

69,897

 

Cost of services (1)

 

 

26,741

 

31,135

 

57,876

 

Cost of sales (1)

 

2,199

 

7,733

 

581

 

10,513

 

Selling, general and administrative expenses

 

11,768

 

8,169

 

5,614

 

25,551

 

Depreciation and amortization

 

8,216

 

11,452

 

12,209

 

31,877

 

Segment operating income

 

$

28,699

 

$

11,392

 

$

3,341

 

$

43,432

 

Unallocated corporate expenses

 

 

 

 

 

 

 

13,482

 

Consolidated operating income

 

 

 

 

 

 

 

$

29,950

 

 


(1)          Exclusive of depreciation and amortization.

 

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Nine Months Ended September 30, 2010

 

 

 

Printed
Products
Group

 

Lottery
Systems Group

 

Diversified
Gaming Group

 

Totals

 

Revenues:

 

 

 

 

 

 

 

 

 

Instant tickets

 

$

343,506

 

$

 

$

 

$

343,506

 

Services

 

 

148,334

 

139,193

 

287,527

 

Sales

 

6,625

 

24,518

 

8,257

 

39,400

 

Total revenues

 

$

350,131

 

$

172,852

 

$

147,450

 

$

670,433

 

 

 

 

 

 

 

 

 

 

 

Cost of instant tickets (1)

 

$

199,282

 

$

 

$

 

$

199,282

 

Cost of sevices (1)

 

 

78,760

 

88,576

 

167,336

 

Cost of sales (1)

 

4,931

 

17,708

 

5,204

 

27,843

 

Selling, general and administrative expenses

 

38,714

 

23,973

 

17,671

 

80,358

 

Write-down of assets held for sale

 

 

 

8,029

 

8,029

 

Employee termination costs

 

 

 

602

 

602

 

Depreciation and amortization

 

25,150

 

32,622

 

23,872

 

81,644

 

Segment operating income

 

$

82,054

 

$

19,789

 

$

3,496

 

$

105,339

 

Unallocated corporate expenses

 

 

 

 

 

 

 

35,558

 

Consolidated operating income

 

 

 

 

 

 

 

$

69,781

 

 


(1)          Exclusive of depreciation and amortization.

 

 

 

Nine Months Ended September 30, 2009

 

 

 

Printed
Products
Group

 

Lottery
Systems Group

 

Diversified
Gaming Group

 

Totals

 

Revenues:

 

 

 

 

 

 

 

 

 

Instant tickets

 

$

340,616

 

$

 

$

 

$

340,616

 

Services

 

 

159,414

 

150,585

 

309,999

 

Sales

 

9,776

 

31,088

 

3,385

 

44,249

 

Total revenues

 

$

350,392

 

$

190,502

 

$

153,970

 

$

694,864

 

 

 

 

 

 

 

 

 

 

 

Cost of instant tickets (1)

 

$

202,608

 

$

 

$

 

$

202,608

 

Cost of services (1)

 

 

83,511

 

91,559

 

175,070

 

Cost of sales (1)

 

6,728

 

22,027

 

2,143

 

30,898

 

Selling, general and administrative expenses

 

34,141

 

23,042

 

17,283

 

74,466

 

Employee termination costs

 

2,016

 

125

 

433

 

2,574

 

Depreciation and amortization

 

24,095

 

32,882

 

35,959

 

92,936

 

Segment operating income

 

$

80,804

 

$

28,915

 

$

6,593

 

$

116,312

 

Unallocated corporate expenses

 

 

 

 

 

 

 

45,530

 

Corporate employee termination costs

 

 

 

 

 

 

 

1,346

 

Consolidated operating income

 

 

 

 

 

 

 

$

69,436

 

 


(1)          Exclusive of depreciation and amortization.

 

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

 

 

 

Three Months Ended

 

Nine Months Ended

 

 

 

September 30,

 

September 30,

 

 

 

2010

 

2009

 

2010

 

2009

 

Reported segment operating income

 

$

31,823

 

$

43,432

 

$

105,339

 

$

116,312

 

Unallocated corporate expenses

 

(10,076

)

(13,482

)

(35,558

)

(45,530

)

Corporate employee termination costs

 

 

 

 

(1,346

)

Consolidated operating income

 

21,747

 

29,950

 

69,781

 

69,436

 

Interest expense

 

(24,617

)

(22,736

)

(74,176

)

(62,940

)

Equity in earnings of joint ventures

 

13,031

 

14,180

 

42,474

 

44,758

 

(Loss) gain on early extinguishment of debt

 

(2,236

)

550

 

(2,236

)

4,594

 

Other income (expense), net

 

3,011

 

27

 

(9,555

)

1,013

 

Income before income taxes

 

$

10,936

 

$

21,971

 

$

26,288

 

$

56,861

 

 

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

 

Consorzio Lotterie Nazionali / Lotterie Nazionali S.r.l.

 

During the last six years, 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, held the concession from the Italian Monopoli di Stato to be the exclusive operator of the Italian Gratta e Vinci instant ticket lottery.  Under our contract with CLN, we supplied instant lottery tickets, game development services, marketing support, the instant ticket management system and systems support.  We also participated in the profits or losses of CLN as a 20% equity owner, and assisted Lottomatica Group S.p.A. in the lottery operations.  We accounted for this investment using the equity method of accounting.  For the three and nine months ended September 30, 2010, we recorded income of $10,832 and $35,168, respectively, representing our share of the pre-tax earnings of CLN.  For the three and nine months ended September 30, 2009, we recorded income of $11,235 and $37,812, respectively, representing our share of the pre-tax earnings of CLN.  CLN’s concession expired on September 30, 2010.

 

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 concession. The members of CLN were awarded the sole concession on May 13, 2010 by the Monopoli di Stato. Our bidding group formed and capitalized a new vehicle, Lotterie Nazionali S.r.l. (“LNS”), to hold the concession.  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 to LNS during the second quarter of 2010 and  €56,000 was paid to LNS in October 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 originally scheduled to expire on May 31, 2010 and the new concession was scheduled to 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 began on October 1, 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 record 20% of LNS’s net income or losses on our Consolidated Statement of Operations as equity in earnings of joint ventures (whereas we recorded 20% of CLN’s pre-tax earnings under our accounting for our interest in CLN).  The upfront fees associated with the new concession will be amortized by LNS (anticipated to be approximately €89,000 per year of the new concession), which will reduce our equity in earnings of joint ventures.  Our share of the amortization is expected to be approximately €18,000 per year of the new concession on a pre-tax basis.  Subject to applicable limitations, we are entitled to receive annual cash dividends as well as periodic return of capital payments over the life of the concession.

 

Northstar Lottery Group, LLC

 

On July 29, 2010, we entered into an agreement with GTECH Corporation, a subsidiary of Lottomatica Group S.p.A. to form a joint venture called Northstar Lottery Group, LLC (“Northstar”), to bid in a competitive procurement to be the private manager of the Illinois Lottery for a ten-year term. We are a 20% equity owner in Northstar.  On September 15, 2010, Northstar was selected as the private manager.  As the private manager, Northstar will be responsible for the day-to-day operations of the Illinois Lottery and its core functions, including, among other services, lottery game development, supply of goods and services, and marketing and advertising, subject to oversight by the lottery. We will be responsible for the design, development, manufacturing, warehousing and distribution of instant lottery tickets and will be compensated based on a percentage of retail sales. We will also be entitled to our pro rata share of Northstar’s earnings. Under the contemplated terms of the private management agreement, Northstar will receive annual incentive compensation payments to the extent it is successful in increasing the Illinois Lottery’s net income above certain target levels, subject to a cap of 5% of the applicable year’s net income. Northstar will be responsible for payments to the State of Illinois to the extent such targets are not achieved, subject to a similar cap. Northstar is expected to be reimbursed for most of its operating expenses under the arrangement. Operations under the new arrangement are scheduled to commence on July 1, 2011 following a transition period. There was no financial impact from this equity interest in the third quarter of 2010. Two protests against the award to Northstar have been filed by other bidders, which protests remain pending as of the date of this Quarterly Report on Form 10-Q.

 

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(4) Comprehensive Income

 

The following presents a reconciliation of net income to comprehensive income for the three and nine month periods ended September 30, 2010 and 2009:

 

 

 

Three Months Ended

 

Nine Months Ended

 

 

 

September 30,

 

September 30,

 

 

 

2010

 

2009

 

2010

 

2009

 

Net income

 

$

8,704

 

$

15,106

 

$

9,248

 

$

10,262

 

Other comprehensive (loss) income:

 

 

 

 

 

 

 

 

 

Foreign currency translation (loss) gain

 

56,592

 

5,343

 

(6,656

)

43,651

 

Gain on derivative financial instruments

 

27

 

1,349

 

315

 

2,150

 

Other comprehensive (loss) income

 

56,619

 

6,692

 

(6,341

)

45,801

 

Comprehensive income

 

$

65,323

 

$

21,798

 

$

2,907

 

$

56,063

 

 

(5) Inventories

 

Inventories consist of the following:

 

 

 

 

September 30,

 

December 31,

 

 

 

2010

 

2009

 

Parts and work-in-process

 

$

26,870

 

$

26,643

 

Finished goods

 

47,987

 

47,297

 

 

 

$

74,857

 

$

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 until placed into service.

 

(6) Long-Term Debt

 

Issuance of 8.125% Senior Subordinated Notes

 

On September 22, 2010, the Company issued $250,000 in aggregate principal amount of its 8.125% Senior Subordinated Notes due 2018 (the “2018 Notes”) at a price of 100% of the principal amount thereof 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.  The 2018 Notes were issued pursuant to an indenture dated as of September 22, 2010 (the “2018 Indenture”) among the Company, the subsidiary guarantors party thereto and The Bank of Nova Scotia Trust Company of New York, as trustee.

 

The 2018 Notes bear interest at the rate of 8.125% per annum, which accrues from September 22, 2010 and is payable semiannually in arrears on March 15 and September 15 of each year, commencing on March 15, 2011. The 2018 Notes mature on September 15, 2018, unless earlier redeemed or repurchased by the Company, and are subject to the terms and conditions set forth in the 2018 Indenture.

 

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The Company may redeem some or all of the 2018 Notes at any time prior to September 15, 2014 at a price equal to 100% of the principal amount of the 2018 Notes plus accrued and unpaid interest, if any, to the date of redemption plus a “make whole” premium. The Company may redeem some or all of the 2018 Notes for cash at any time on or after September 15, 2014 at the prices specified in the 2018 Indenture. In addition, at any time on or prior to September 15, 2013, the Company may redeem up to 35% of the initially outstanding aggregate principal amount of the 2018 Notes at a redemption price of 108.125% of the principal amount thereof, plus accrued and unpaid interest, if any, to the date of redemption, with the net cash proceeds from one or more equity offerings of the Company. Additionally, if a holder of 2018 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 the Company will have the right, subject to certain notice provisions set forth in the 2018 Indenture, (1) to require that holder to dispose of all or a portion of those 2018 Notes or (2) to redeem the 2018 Notes of that holder at a redemption price calculated as set forth in the 2018 Indenture. If the Company experiences a change in control, as defined in the 2018 Indenture, or the Company or any of its restricted subsidiaries sells certain of its assets, then the Company must offer to repurchase the 2018 Notes on the terms set forth in the 2018 Indenture.

 

The 2018 Notes are subordinated to all of the Company’s existing and future senior debt, including the Company’s guarantee of the indebtedness of its subsidiary, Scientific Games International, Inc. (“SGI”), under its credit facilities, will rank equally with all of the Company’s existing and future senior subordinated debt, including the Company’s 6.25% senior subordinated notes due 2012 (the “2012 Notes”), the Company’s guarantee of SGI’s 7.875% senior subordinated notes due 2016 (the “2016 Notes”), and the Company’s guarantee of SGI’s 9.25% senior subordinated notes due 2019 (the “2019 Notes”), and will rank senior to all of the Company’s future debt that is expressly subordinated to the 2018 Notes. The 2018 Notes will be guaranteed on a senior subordinated unsecured basis by all of the Company’s wholly owned domestic subsidiaries. The guarantees of the 2018 Notes will be subordinated to all of the guarantors’ existing and future senior debt, including, in the case of SGI, indebtedness under its credit facilities and, in the case of each of the other guarantors, their guarantees of SGI’s indebtedness under its credit facilities, will rank equally with all of their existing and future senior subordinated debt, including, in the case of SGI, the 2016 Notes and the 2019 Notes and its guarantee of the 2012 Notes, and, in the case of the other guarantors, their guarantees of the 2012 Notes, the 2016 Notes and the 2019 Notes, and will rank senior to all of their future debt that is expressly subordinated to the guarantees of the 2018 Notes. The 2018 Notes will be structurally subordinated to all of the liabilities of the Company’s non-guarantor subsidiaries.

 

The 2018 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 2018 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, all outstanding 2018 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 2018 Notes may declare all the 2018 Notes to be due and payable immediately.

 

In connection with the issuance of the 2018 Notes, the Company, the guarantors party thereto, and J.P. Morgan Securities LLC, as representative for the initial purchasers listed therein, entered into a registration rights agreement, dated as of September 22, 2010 (the “Registration Rights Agreement”). Under the Registration Rights Agreement, the Company and the guarantors agreed, for the benefit of the holders of the 2018 Notes, that they will file with the Securities and Exchange Commission (the “SEC”) within 180 days after the date the 2018 Notes are issued, and use their commercially reasonable efforts to cause to become effective, a registration statement relating to an offer to exchange the 2018 Notes for an issue of SEC-registered notes (the “Exchange Notes”) with terms identical to the 2018 Notes (except that the Exchange Notes will not be subject to restrictions on transfer or to any increase in annual interest rate as described below).

 

Under certain circumstances, including if applicable interpretations of the staff of the SEC do not permit the Company to effect the exchange offer, the Company and the guarantors will use their commercially reasonable efforts to cause to become effective a shelf registration statement relating to resales of the 2018 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 2018 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 September 22, 2012.

 

If the exchange offer registration statement is not filed within 180 days after the date the 2018 Notes were issued, or the exchange offer is not completed (or, if required, the shelf registration statement is not declared effective) on or before June 20, 2011 (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 2018 Notes

 

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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 1.00% 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 2018 Notes were originally issued.

 

Tender Offer and Consent Solicitation

 

On October 6, 2010, the Company completed a tender offer pursuant to which it purchased $107,617 in aggregate principal amount of the 2012 Notes, including $107,562 aggregate principal purchased as of September 30, 2010. In connection with the tender offer, the Company completed a consent solicitation under which tendering holders consented to proposed amendments to the indenture relating to the 2012 Notes to eliminate substantially all restrictive covenants and certain default provisions in the indenture governing the 2012 Notes. As of September 30, 2010, $79,513 in aggregate principal amount of the 2012 Notes were outstanding. As of the date of this Quarterly Report on Form 10-Q, $79,458 in aggregate principal amount of the 2012 Notes were outstanding.

 

Credit Agreement

 

On June 17, 2010, the Company entered into a first incremental amendment to the credit agreement, dated as of June 9, 2008 (as amended, the “Credit Agreement”) among 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).

 

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

 

·                                          no amounts remain outstanding under the two-year, senior unsecured promissory notes issued by certain of the Company’s foreign subsidiaries to defer a portion of the earn-out payable in connection with our 2006 acquisition of Global Draw Limited (“Global Draw”) (which notes are guaranteed by the Company and certain of its U.S. subsidiaries, including SGI) (the “Global Draw Promissory Notes”); or

 

·                                          the sum of the available revolving credit facility commitments plus the unrestricted cash of SGI and the guarantors under the Credit Agreement is not less than the sum of the principal amount of the 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, leaving approximately £628 in aggregate principal amount of the Global Draw Promissory Notes outstanding.

 

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The revolving credit facility and the term loan credit facility will both mature on September 15, 2012, unless either:

 

·                                          the 2012 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 the 2012 Notes then outstanding plus $50,000.

 

As of the date of this Quarterly Report on Form 10-Q, there is $79,458 in aggregate principal amount of the 2012 Notes outstanding.

 

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 any remaining amount due under the Global Draw Promissory Notes in 2011 or the 2012 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.

 

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 the Company’s 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);

 

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“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 the 2012 Notes, the 2016 Notes, the 2018 Notes and the 2019 Notes 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 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 Global Draw, or any “Permitted Acquisitions” (defined generally as 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;

 

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·                                          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 transactions 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 the Racing Business, 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 (“Games Media”) by Playtech;

 

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

 

·                                          interest income;

 

·                                          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 September 30, 2010.

 

As of September 30, 2010, the balance of outstanding loans under the term loan facilities under the Credit Agreement was $573,860.

 

As of September 30, 2010, we had approximately $150,832 available for additional borrowing or letter of credit issuances under our revolving credit facility. There were no borrowings and $56,548 in outstanding letters of credit under our revolving credit facility as of September 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.

 

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Convertible Debentures

 

On June 1, 2010, the remaining $9,943 in aggregate principal amount of our 0.75% convertible senior subordinated debentures due 2024 (the “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.

 

(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 September 30, 2010, the Hedge was measured at a fair value of $3,252 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 nine months ended September 30, 2010, we recorded a gain of approximately $27 and $315, respectively, in other comprehensive income (loss).  During the three and nine months ended September 30, 2009, we recorded a gain of approximately $1,349 and $2,150, 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 2010, we entered into several short-term forward contracts (the “Forwards”) with various counterparties, some of which remain outstanding as of September 30, 2010.  Under the Forwards, we locked in the price to purchase or sell 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 September 30, 2010, the unsettled Forwards were measured in “other assets and investments” having a fair value of approximately $3,146 using Level 2 valuation techniques of the fair value hierarchy and matured on October 1, 2010 and the remaining Forwards are scheduled to mature on November 18, 2010.

 

During the three and nine months ended September 30, 2010, we recorded a gain of approximately $3,164 and a net loss of approximately $12,559, respectively, on forward contracts in our Consolidated Statements of Operations.  The (gain) loss on forward contracts is included in “other expense (income), net.”

 

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(8) Goodwill and Intangible Assets

 

The following disclosure presents certain information regarding our intangible assets as of September 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 September 30, 2010

 

 

 

 

 

 

 

Amortizable intangible assets:

 

 

 

 

 

 

 

Patents

 

$

11,515

 

$

(4,106

)

$

7,409

 

Customer lists

 

30,224

 

(18,601

)

11,623

 

Licenses

 

66,224

 

(49,120

)

17,104

 

Intellectual property

 

17,943

 

(17,694

)

249

 

Lottery contracts

 

4,745

 

(4,313

)

432

 

 

 

130,651

 

(93,834

)

36,817

 

Non-amortizable intangible assets:

 

 

 

 

 

 

 

Trade name

 

37,644

 

(2,118

)

35,526

 

Total intangible assets

 

$

168,295

 

$

(95,952

)

$

72,343

 

 

 

 

 

 

 

 

 

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 nine months ended September 30, 2010 was approximately $3,400 and $10,900, respectively.  The aggregate intangible amortization expense for the three and nine months ended September 30, 2009 was approximately $4,400 and $13,600, respectively.

 

The table below reconciles the change in the carrying amount of goodwill, by reporting segment, for the period from December 31, 2009 to September 30, 2010.  In 2010, we recorded an increase of approximately $4,700 in goodwill associated with the acquisition of substantially all of the assets of GameLogic Inc. (“GameLogic”) and a decrease in goodwill of approximately $11,000 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

 

4,901

 

(4,267

)

(7,010

)

(6,376

)

Balance as of September 30, 2010

 

$

334,560

 

$

188,566

 

$

243,230

 

$

766,356

 

 

(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 pension authorities.

 

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The following table sets forth the combined amount of net periodic benefit cost recognized for the three and nine months ended September 30, 2010 and 2009.

 

 

 

Three Months Ended

 

Nine Months Ended

 

 

 

September 30,

 

September 30,

 

 

 

2010

 

2009

 

2010

 

2009

 

Components of net periodic pension benefit cost:

 

 

 

 

 

 

 

 

 

Service cost

 

$

478

 

$

371

 

$

1,421

 

$

1,114

 

Interest cost

 

1,226

 

1,052

 

3,699

 

3,156

 

Expected return on plan assets

 

(1,243

)

(888

)

(3,695

)

(2,665

)

Amortization of actuarial gains

 

124

 

119

 

403

 

357

 

Amortization of prior service costs

 

6

 

11

 

28

 

32

 

Net periodic cost

 

$

591

 

$

665

 

$

1,856

 

$

1,994

 

 

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 20.4% and 64.8%, respectively, for the three and nine months ended September 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 nine months ended September 30, 2010 includes the impact of a valuation allowance against certain U.S. state deferred tax assets and the release of certain reserves due to the expiration of statutes of limitation for tax-related claims.

 

The effective tax rates of 31.2% and 82.0%, respectively, for the three and nine months ended September 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 nine months ended September 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 second quarter of 2010, the Company determined that the net realizable value of its state deferred tax assets was $6,328 and therefore recorded a valuation allowance of $11,797.  Our decision to reserve a portion of the Company’s state deferred tax assets was primarily due to a revised forecast of future state taxable income.

 

(11) Stockholders’ Equity

 

The change in the number of shares of our Class A common stock outstanding during the nine months ended September 30, 2010 and during the fiscal year ended December 31, 2009 is as follows:

 

 

 

Nine Months

 

 

 

 

 

Ended

 

Year Ended

 

 

 

September 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

 

308

 

1,804

 

Shares repurchased into treasury stock

 

(2,619

)

(522

)

Shares outstanding as of end of period

 

91,572

 

93,883

 

 

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(12) Stock-Based Compensation

 

As of September 30, 2010, we had approximately 3,239 shares of our Class A common stock 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 nine months ended September 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

 

Granted

 

55

 

 

 

10.25

 

 

 

Exercised

 

(143

)

 

 

3.14

 

1,109

 

Cancelled

 

(20

)

 

 

25.38

 

 

 

Options outstanding as of September 30, 2010

 

6,104

 

5.9

 

$

22.20

 

$

1,124

 

 

 

 

 

 

 

 

 

 

 

Options exercisable as of September 30, 2010

 

4,216

 

4.9

 

$

23.23

 

$

1,124

 

 

The weighted-average grant date fair value of options granted during the three months ended September 30, 2010, June 30, 2010 and March 31, 2010 was $5.13, $7.07 and $7.95, respectively.  For the three and nine months ended September 30, 2010, we recognized stock-based compensation expense of approximately $1,800 and $5,800, respectively, related to the vesting of stock options and the related tax benefit of approximately $700 and $2,300, respectively.  For the three and nine months ended September 30, 2009, we recognized stock-based compensation expense of approximately $2,900 and $10,700, respectively, related to the vesting of stock options and the related tax benefit of approximately $850 and $3,140, respectively.  As of September 30, 2010, we had unearned compensation of approximately $12,200 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 (“RSUs”)

 

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

 

 

 

Number of
Restricted
Stock Units

 

Weighted
Average Grant
Date Fair
Value Per
 Share

 

Non-vested RSUs as of December 31, 2009

 

1,586

 

$

19.54

 

Granted

 

897

 

15.49

 

Vested

 

(303

)

20.38

 

Cancelled

 

(26

)

17.49

 

Non-vested RSUs as of March 31, 2010

 

2,154

 

$

17.78

 

Granted

 

24

 

13.40

 

Vested

 

(39

)

26.95

 

Cancelled

 

 

 

Non-vested RSUs as of June 30, 2010

 

2,139

 

$

17.57

 

Granted

 

48

 

10.25

 

Vested

 

(55

)

31.03

 

Cancelled

 

(48

)

15.69

 

Non-vested RSUs as of September 30, 2010

 

2,084

 

$

17.09

 

 

For the three and nine months ended September 30, 2010, we recognized equity-based compensation expense of approximately $3,000 and $11,500, respectively, related to the vesting of RSUs and the related tax benefit of approximately $1,200 and $4,500, respectively.  For the three and nine months ended September 30, 2009, we recognized equity-based compensation expense of approximately $4,300 and $15,100, respectively, related to the vesting of RSUs and the related tax benefit of approximately $1,330 and $4,700, respectively.  As of September 30, 2010, we had unearned compensation of approximately $25,800 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 2016 Notes and the 2019 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”).  The 2012 Notes and 2018 Notes are, and our Convertible Debentures were, fully and unconditionally and jointly and severally guaranteed by our 100%-owned domestic subsidiaries, including SGI.  The 2012 Notes, the 2018 Notes and the Convertible Debentures were issued by the Parent Company.

 

Presented below is condensed consolidating financial information for (1) the Parent Company, (2) SGI, (3) the 100%-owned Guarantor Subsidiaries and (4) the 100%-owned foreign subsidiaries and the non-100%-owned domestic and foreign subsidiaries (collectively, the “Non-Guarantor Subsidiaries”) as of September 30, 2010 and December 31, 2009 and for the three and nine months ended September 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 2016 Notes, the 2019 Notes, the 2012 Notes, the Convertible Debentures and the 2018 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 Subsidiaries and the 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 September 30, 2010

 

 

 

Parent Company

 

SGI

 

Guarantor
Subsidiaries

 

Non-Guarantor
Subsidiaries

 

Eliminating
Entries

 

Consolidated

 

Assets

 

 

 

 

 

 

 

 

 

 

 

 

 

Cash and cash equivalents

 

$

132,208

 

$

148

 

$

 

$

123,137

 

$

(5,923

)

$

249,570

 

Accounts receivable, net

 

 

71,132

 

41,049

 

55,084

 

 

167,265

 

Inventories

 

 

32,686

 

15,772

 

26,399

 

 

74,857

 

Other current assets

 

19,333

 

11,924

 

11,840

 

18,290

 

 

61,387

 

Assets held for sale

 

 

 

62,464

 

33,386

 

(7,212

)

88,638

 

Property and equipment, net

 

1,775

 

173,246

 

43,925

 

247,759

 

 

466,705

 

Investment in subsidiaries

 

663,745

 

743,529

 

 

273,920

 

(1,681,194

)

 

Goodwill, net

 

 

273,656

 

78,843

 

413,857

 

 

766,356

 

Intangible assets, net

 

 

42,061

 

22,013

 

8,269

 

 

72,343

 

Intercompany balances

 

130,869

 

 

143,741

 

 

(274,610

)

 

Other assets and investments

 

43,275

 

144,469

 

4,907

 

253,720

 

(6,100

)

440,271

 

Total assets

 

$

991,205

 

$

,1,492,851

 

$

424,554

 

$

1,453,821

 

$

(1,975,039

)

$

2,387,392

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Liabilities and stockholders’ equity

 

 

 

 

 

 

 

 

 

 

 

 

 

Debt payments due within one year

 

$

 

$

6,280

 

$

 

$

2,121

 

$

 

$

8,401

 

Current liabilities

 

26,786

 

58,189

 

30,073

 

66,249

 

(5,934

)

175,363

 

Liabilities held for sale

 

 

 

11,526

 

7,419

 

 

18,945

 

Long-term debt, excluding current

 

329,513

 

1,112,004

 

 

27,358

 

 

1,468,875

 

Other non-current liabilities

 

16,541

 

13,459

 

8,471

 

58,972

 

 

97,443

 

Intercompany balances

 

 

26,685

 

 

247,917

 

(274,602

)

 

Stockholders’ equity

 

618,365

 

276,234

 

374,484

 

1,043,785

 

(1,694,503

)

618,365

 

Total liabilities and stockholders’ equity

 

$

991,205

 

$

1,492,851

 

$

424,554

 

$

1,453,821

 

$

(1,975,039

)

$

2,387,392

 

 

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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